Chapter 5: Evidence and Documentation

Management Assertions:
• Assertions of Transactions: exchange or interaction (i.e. a sale or payment)
• Occurrence.
• Completeness.
• Authorization.
• Accuracy.
• Cutoff.
• Classification.
• Presentation.
• Assertions of Account Balances: Assets, Liabilities, and Equity
• Existence.
• Rights and obligations.
• Completeness.
• Accuracy, valuation, and allocation.
• Classification.
• Presentation.
1. First the auditor considers the assertions the company is making about an account
2. Second the auditor decides what evidence is necessary to substantiate the truthfulness of
these assertions
Audit Evidence: Evidence that assists the auditor in evaluating management’s financial
statement assertions consists of the underlying accounting data and any additional information
available to the auditor, whether originating from the client or externally
 Information used as audit evidence.
o Accounting Records
 Records of initial entries and supporting records
 General and subsidiary ledgers, journal entries, and other adjustments to
financials not reflected in journal entries.
 Work sheets and spreadsheets supporting cost allocations, computations,
reconciliations, and disclosures
 Contracts
o Other information
 Minutes of meetings
 Confirmations from third parties
 Industry analysts’ reports
 Comparable data about competitors
 Control Manuals
 Information obtained by the auditor from inquiry, observation and
inspection
 Sufficiency and appropriateness of audit evidence.
o Sufficiency is the measure of the quantity of audit evidence.
 Greater risk of misstatement requires a higher quantity of audit evidence.
 Higher quality audit evidence results in a lower quantity of audit evidence
(inverse relationship between the sufficiency and appropriateness).
o Appropriateness is a measure of the quality of audit evidence.
 Relevance
  Reliability
 Independent source outside the entity
 Effectiveness of internal control
 Auditor’s direct personal knowledge
 Documentary evidence
 Original documents
 Evaluation of Audit Evidence:
o Proper evaluation of evidence requires an understanding of the:
 Types of evidence available.
 Relative reliability of available evidence
o An auditor should be thorough in searching for evidence and unbiased in its
evaluation.
Audit Procedures:
 Specific acts performed by the auditor to gather evidence about whether specific
assertions are being met:
o Risk assessment procedures
o Test of controls
o Substantive procedures
 A set of audit procedures prepared to test assertions for a component of the financial
statements is referred to as an audit program.
 Audit Procedures for Obtaining Audit Evidence:
o Inspection: Evidence obtained from external documents is more reliable than
evidence obtained from internal documents.
 Inquiry: In conducting inquiry, the auditor should:
 Consider the knowledge, objectivity, experience, responsibility,
and qualifications of the individual to be questioned.
 Ask clear, concise, and relevant questions.
 Use open or closed questions appropriately.
 Listen actively and effectively.
 Consider the reactions and responses and ask follow-up questions.
 Evaluate the response.
 Confirmation:
 Audit evidence obtained by the auditor as a direct written response
to the auditor from a third party.
 The reliability of evidence obtained through external confirmations
may be affected by factors such as:
 The form of the confirmation.
 Prior experience with the entity.
 The nature of the information being confirmed.
 The intended respondent.
 Recalculation
 Checking the mathematical accuracy of documents or records.
 Reperformance
 The auditor’s independent execution of procedures or controls that
were originally performed by company personnel.
  Analytical procedures
 Evaluations of financial information made by a study of plausible
relationships among both financial and nonfinancial data.
Audit Documentation:
 The auditor’s record of the audit procedures performed, relevant audit evidence obtained,
and conclusions the auditor reached.
 Audit documentation (working papers) has three purposes:
o To provide support for the audit report.
o To aid in the planning, performance, and supervision of the audit.
o To provide a focal point for reviewing work of subordinates; to provide a basis for
quality reviews.
 Audit documentation should:
o Demonstrate how the audit complied with auditing and related professional
practice standards.
o Support the basis for the auditor’s conclusions concerning each material financial
statement assertion.
o Demonstrate whether the underlying accounting records agreed or reconciled with
the financial statements.
o Include a written audit program detailing auditing procedures necessary to
accomplish audit objectives.
o Enable a knowledgeable and experienced reviewer to:
 Understand the nature, timing, extent, and results of audit procedures,
evidence obtained, and conclusions reached.
 Determine who performed and reviewed the work, as well as the dates of
the work and reviews.
 Content of Audit Documentation
o Permanent files
 Corporate charter
 Important contracts
 Chart of accounts
 Internal control documentation
 Organization chart
 Terms of stock and bond issues
 Prior years’ analytical procedures
 Prior years’ analytical procedure results
o Current files
 Adjusting journal entries
 Audit plan and programs
 Reclassification journal entries
 Working trial balance
 Current financial statements and auditor’s report
 Minutes of meetings
 Working papers supporting accounts
 Format of Audit Documentation:
o Heading
  Entity name, Title of the working paper, Entity’s year-end date
o Indexing and cross-referencing
 Notations that provide a trail from financial statements to audit documents
that a reviewer can easily follow.
o Tick marks
 Notations made next to work paper items indicating auditor actions.
 Ownership of Audit Documentation, Archiving, and Retention:
o All audit documentation is the property of the auditor, including documents
prepared by the entity at the auditor’s request.
o The Sarbanes-Oxley Act of 2002 requires audit documentation to be retained for a
number of years from the completion date of the engagement.
o Audit documentation should be organized so that audit team members and others
can find evidence supporting financial statement accounts.
Analytical Procedures:
 Purpose of Analytical Procedures
o Risk Assessment Procedures
 Used to assist the auditor to better understand the business and to plan the
nature, timing, and extent of audit procedures.
o Substantive Analytical Procedures
 Used to obtain evidential matter about particular assertions related to
account balances or classes of transactions.
o Final Analytical Procedures
 Used as an overall review of the financial information in the final review
stage of the audit
 Types of Analytical Procedures:
o Trend Analysis
o Ratio Analysis
o Reasonableness Analysis
 Auditor’s Decision Process for Substantive Analytical Procedures
o Develop an Expectation: Auditing standards require the auditor to have an
expectation whenever analytical procedures are used. An expectation can be
developed using a variety of information sources such as:
 Financial and operating data.
 Budgets and forecasts.
 Industry publications.
 Competitor information.
 Management’s analyses.
 Analysts’ reports.
o Precision - the quality of an expectation. Precision is a measure of:
 the potential effectiveness of an analytical procedure
 the degree of reliance that can be placed on the procedure
 how closely the expectation approximates the “correct” but unknown
amount.
 The degree of desired precision differs with the purpose of the analytical
procedure.
  A function of the materiality and required detection risk for the assertion
being tested.
 If the assertion being tested requires a low level of detection risk, the
expectation needs to be very precise.
 The more precise the expectation, the more extensive and expensive the
audit procedures (cost-benefit trade-off.)
 Four factors affect the precision of analytical procedures.
 Disaggregation
 The Plausibility and Predictability of the Relationship Being Studied
 Data Reliability
 Type of Analytical Procedure Used to Form an Expectation
o Define a Tolerable Difference The size of the tolerable difference depends on:
 the significance of the account;
 the desired degree of reliance on the substantive analytical procedures;
 the level of disaggregation in the amount being tested; and
 the precision of the expectation.
 Tolerable difference will usually be equal to the account’s tolerable
misstatement
o Compare the expectation to the recorded amount and investigate any differences
greater than the tolerable difference.
o Investigate Differences Greater Than the Tolerable Difference: Differences
identified by substantive analytical procedures indicate an increased likelihood of
misstatements
 Explanations for significant differences observed (substantive analytical
procedures) must be followed up and resolved through:
 Quantification: Involves determining whether the explanation or
error can explain the observed difference.
 Corroboration: Auditors must corroborate explanations by
obtaining sufficient appropriate audit evidence linking the
explanation to the difference and substantiating that the
information supporting the explanation is reliable
 Evaluation: Auditor should evaluate the results of the substantive
analytical procedures to conclude whether the desired level of
assurance has been achieved.
o Investigate Differences for Risk Assessment and Final Analytical Procedures:
 Risk Assessment Procedures Differences (used in planning)
 Corroborating evidence is not required.
 Final Analytical Procedures Differences
 Corroborating evidence is required.
 If the auditor cannot find sufficient evidence within the working
papers, the auditor would:
o formulate possible explanations,
o conduct additional testing, and
o seek an explanation from the entity’s personnel.