Activity Sheet - Module 7

1. What is audit evidence?

Audit evidence is all the information, whether obtained from audit procedures or

other sources, that is used by the auditor in arriving at the conclusions on which the

auditor's opinion is based. Audit evidence consists of both information that supports and

corroborates management's assertions regarding the financial statements or internal

control over financial reporting and information that contradicts such assertions.

2. What are the factors that affect sufficiency and appropriateness of audit evidence?

Sufficiency of audit evidence is measured by the quantity of evidence obtained.

Appropriateness is measured by the quality of audit evidence. Factors influencing

Sufficiency and appropriateness of audit evidence are:

 Risk of material misstatement Auditor's past experience with the business

 Reliability of the audit evidence

 Internal control and accounting system of the client

 Materiality of the item.

3. An auditor typically works within economic limits. Explain this statement.

 Auditor's opinion is influenced by time and cost. He must decide if the obtained

audit evidence is within the time and cost to express an audit opinion. Thus, he works

typically works within economic limits.

4. What are the generalizations on reliability of audit evidence?

The generalization on reliability of audit evidence is

 When it is obtained directly by the auditor

 When it is obtained from a period or entity independent of the client

 When it is in document, electronic or any other reliable medium

 Where controls are effectively working in case the evident is internally

generated.

5. Explain the relationship between assertions, audit objectives, and audit evidence.

The auditor has to obtain sufficient audit evidence to support all assertion made

by the management. Thus, when assertion increases, audit objectives increases and so

will be the collection of audit evidences.

6. Enumerate, and explain, each audit procedure classified according to purpose and

according to nature.

Audit procedures are the processes, technique, and methods that auditors perform

to obtain audit evidence which enables them to make a conclusion on the set audit

objective and express their opinion. Sometimes we call audit procedures as audit
 programs Auditors normally prepare audit procedures at the planning stages once they

identified audit objectives, audit scope, audit approach, and audit risks.

Analytical Review.  Analytical review is not the procedure that uses to obtain

audit evidence, but it is the procedure used to assess the unusual transactions or events as

the principle or basic to perform other procedures.

Inquiry.  Auditors inquire accountant and related management to gather

information and obtain an explanation on the matter that found by auditors.

Observation. Observation is one of the audit procedures that auditors use to

obtain an understanding and gather audit evidence mainly to the real process or the ways

how clients have done some specific business process.

Inspection. Inspection refers to verification or vouching documents. This is one

of the most important and it can be 60% of audit work involve with the inspection of

documents.

Recalculation. Recalculation is the type of audit procedure that normally done by

re-performing the works performed by the client in the purpose of assessing if there any

difference between the audit’s work and the client’s work.

7. Define external confirmation. Give examples of situations involving external

confirmation.

External confirmation is the process of obtaining and evaluating audit evidence

through a representation of information or an existing condition directly from a third

 party in response to a request for information about a particular item affecting assertions

in the financial statements or related disclosures. For example, in the case of goods held

on consignment, evidence will be obtained about existence and rights and obligations

assertions, but not about the value. Confirmation about the completeness assertion can be

obtained by contacting certain parties.

8. What are the different forms of confirmation request? What are the situations where each

type may be used?

The auditor may use positive or negative external confirmation requests or a

combination of both. Positive confirmations request asks the respondent to reply to the

auditor in all cases by indicating the respondents’ agreement with the given information.

Positive confirmation is an auditing inquiry that requires the customer to respond,

confirming the accuracy of an item. Positive confirmation requires proof of accuracy by

affirming that the original information was correct or by providing the correct

information if incorrect. It can be used in confirming the amounts and descriptions of

various types of liabilities, the bank account information including balances, the

inventory and amount types, the investments or securities, copies of sales invoices to

ensure sales were made, and information or copies of shipping invoices to ensure

products were shipped. Negative confirmation request is a document issued by an

auditor to the customers of a client company. The letter asks the customers to

respond to the auditor only if they find a discrepancy between their records and the
 information about the client company's financial records that are supplied by the

auditor.

9. Explain the typical approach followed in performing analytical procedures.

Performing analytical procedures generally follows this four-step process:

1. Form an expectation. Here, the auditor develops an expectation of an account

balance or financial relationship. Developing an independent expectation helps the

auditor apply professional skepticism when evaluating reported amounts. Expectations

are formed by identifying relationships based on the auditor’s understanding of the

company and its industry.

2. Identify differences between expected and reported amounts. The auditor

must compare his or her expectation with the amount recorded in the company’s

accounting system. Then any difference is compared to the auditor’s threshold for

analytical testing. If the difference is less than the threshold, the auditor generally accepts

the recorded amount without further investigation and the analytical procedure is

complete. If the difference is greater than the threshold, the next step is to investigate the

source of the discrepancy.

3. Investigate the reason. The auditor brainstorms all possible causes and then

determines the most probable cause(s) for the discrepancy. Sometimes, the analytical test

or the data itself is problematic, and the auditor needs to apply additional analytical

procedures with more precise data.

 4. Evaluate differences. The auditor evaluates the likelihood of material

misstatement and then determines the nature and extent of any additional auditing

procedures. Plausible explanations require corroborating audit evidence.

10. Define substantive tests. What are the different types of substantive tests?

Substantive testing is an audit procedure that examines the financial statements

and supporting documentation to see if they contain errors. These tests are needed as

evidence to support the assertion that the financial records of an entity are complete,

valid, and accurate. There are many substantive tests that an auditor can use. The two

types of substantive procedures are analytical procedures and tests of details.

11. Differentiate fraud from error.

  The difference between fraud and error lies in the intention. Simply put, fraud is

an act that is intentionally carried out to benefit certain individuals or groups and causes

detrimental effect to others, while errors are acts of unintentional mistake or negligence.

12. What are the auditor's responsibilities regarding fraud? Regarding error?

With regard to the detection of errors and frauds, the auditor should plan and

perform the audit to identify the risks of material misstatement resulting from errors or

fraud. Fraud may occur in unavoidable or unpunished situations because responsibility

for preventing it is not a task normally attributed. The auditor should carry out an audit

engagement in line with auditing standards that contain basic principles and essential

procedures, along with related recommendations, in the form of explanatory materials

 and other materials. While conducting an audit may be a way of preventing fraud and

error, the auditor is not and cannot be held responsible for their prevention. An auditor

cannot obtain absolute certification that significant misstatements in the financial

statements will be detected but is only able to obtain reasonable assurance about that fact.

Although the audit is properly planned and deployed due to the inherent limitations of an

audit engagement, there is an inevitable risk that some material misstatements of the

financial statements will not be detected.

13. What are accounting estimates? How are accounting estimates audited?

Accounting estimates in historical financial statements measure the effects of past

business transactions or events, or the present status of an asset or liability. Some

estimates may be easily determinable, but many are inherently subjective or complex.

Auditing standards generally provide three approaches for substantively testing fair value

measurements and other accounting estimates:

 Testing management’s process. Auditors evaluate the reasonableness and

consistency of management’s assumptions, as well as test whether the underlying

data is complete, accurate, and relevant.

 Developing an independent estimate. Using management’s assumptions (or

alternative assumptions), auditors come up with an estimate to compare to what is

reported on the internally prepared financial statements.

 Reviewing subsequent events or transactions. The reasonableness of estimates

can be gauged by looking at events or transactions that happen after the balance

sheet date but before the date of the auditor’s report. Independence guidelines

generally prohibit auditors from providing certain services for their public audit
 clients. To obtain independent accounting estimates, companies often turn to

outside specialists.

14. What is audit documentation? What are the purposes of audit documentation?

Audit documentation is the written record of the basis for the auditor's

conclusions that provides the support for the auditor's representations, whether those

representations are contained in the auditor's report or otherwise. Audit documentation

also facilitates the planning, performance, and supervision of the engagement, and is the

basis for the review of the quality of the work because it provides the reviewer with

written documentation of the evidence supporting the auditor's significant

conclusions. Among other things, audit documentation includes records of the planning

and performance of the work, the procedures performed, evidence obtained, and

conclusions reached by the auditor. Audit documentation also may be referred to as work

papers or working papers.

The purpose of audit documentation is the following:

 It provides evidence of auditors’ basis for a conclusion about the

achievement of the overall objective.

 It provides evidence showing that audit work was properly planned and

performed in accordance with ISAs and other legal and regulatory

requirements.

 It assists audit team members to plan and perform their audit work in the

engagement. And it assists audit team members who are responsible for
 supervision to properly direct, supervise and review audit work, both hot

and cold review.

 It enables audit team members to be accountable for their audit tasks, it

allows the record of matters of continuing significance to be retained, and

it enables the conduct of quality control reviews and inspections.

15. Give examples of factors that affect the form and content of audit documentation.

The factors that affect the form and content of audit documentation are the following:

 The nature of the audit procedures to be performed.

 The identified risks of material misstatement.

 The extent of judgement required in performing the work and evaluating the

results.

 The significance of the audit evidence obtained.

 The nature and extent of exceptions identified.

 The need to document a conclusion or the basis for a conclusion not readily

determinable from the documentation of the work performed or audit evidence

obtained.

 The audit methodology and tools used.