Chapter 5

Audit Evidence and Documentation

 Relationship of Audit Evidence
to the Audit Report

Financial Audit
statements report

Management assertions Auditor reaches

about elements of a conclusion based
financial statements on the evidence

Provide evidence on the

Audit
fairness of the
procedures
financial statements
 Management Assertions

Occurrence Completeness

Assertions about
classes of transactions Classification
and events for the
period under audit

Cut-off Accuracy
 Management Assertions

Existence Completeness

Assertions about
end-of-the-period
account balances

Rights and Valuation

obligations and allocation
 Management Assertions

Occurrence and
rights and obligations

Assertions
Accuracy and
about presentation
valuation
and disclosure

Completeness Classification and

understandability
 Class Exercise

Which of the following statements about the existence and completeness

objectives is not true?

1.The existence and completeness objectives emphasize opposite audit

concerns.

2.Existence deals with overstatements and completeness deals with

understatements.

3.Existence deals with understatements and completeness deals with

overstatements.

4.The completeness objective deals with unrecorded transactions.

 Class Exercise

An auditor most likely would analyze inventory turnover

rates to obtain evidence concerning management’s
assertions about

1. Existence or occurrence.
2. Rights and obligations.
3. Valuation or allocation.
4. Presentation and disclosure.
 Audit Evidence

All the information, from

whatever source, used
by the auditor in arriving at
the conclusions on which the
audit opinion is based.
The Concepts of Audit Evidence

Nature of audit evidence

Sufficiency and appropriateness

of audit evidence

Evaluation of audit evidence

 Nature of Audit Evidence

Invoices
Records of
initial entries and
supporting records
Spreadsheets
supporting cost
General allocations
and subsidiary
Worksheets
ledgers

Other
computations,
Adjustments reconciliations, and
to financial Contracts disclosures
statements
 Sufficiency of Audit Evidence

Sufficiency is a measure of
the quantity of audit evidence.

Greater risk of Higher quality

misstatement requires audit evidence results
a higher quantity in a lower quantity
of audit evidence. of audit evidence.
 Appropriateness of Audit Evidence

Relevance
Appropriateness is a measure
of the quality of audit evidence.
Reliability

• Knowledgeable independent source of the

evidence
• Effectiveness of internal control
• Auditor’s direct personal knowledge
• Documentary evidence
• Original documents
 Evaluation of Audit Evidence

Proper evaluation of evidence

requires an understanding of the

1. Relative reliability of available evidence.

2. Types of evidence available.

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 to determine
if specific assertions are
being met.

Risk assessment Test of Substantive

procedures controls procedures
 Audit Procedures
A set of audit procedures prepared to test
assertions for a component of the financial
statements is referred to as an audit plan.
Audit Plan for Accounts Receivable
Management Assertions Examples of Audit Procedures
Existence Confirm accounts receivables.
Rights and obligations Inquire if accounts receivables have been sold or pledged.
Completeness Agree controlling account with total of subsidiary accounts.
Select shipping documents immediatley prior to year end and
ensure sales invoices were recorded.
Valuation or allocation Trace accounts from aged trial balance to subsidiary accounts.
Test the adequacy of the allowance for doubtful accounts.
Presentation and disclosure Look for amounts due from related parties.
Evaluate accounts receivables for note disclosure. 15
 Audit Procedures for
Obtaining Audit Evidence

Inspection Inspection
of records and of tangible Observation
documents assets

Confirmation Recalculation
Inquiry

Analytical Scanning
Reperformance
procedures
16
 Audit Procedures for
Obtaining Audit Evidence

Inspection Evidence obtained from

of records and external documents is more
documents reliable than evidence obtained
from internal documents.

Vouching
(Occurrence) Journal
or
Source Ledger
Documents
Tracing
(Completeness)
 Audit Procedures for
Obtaining Audit Evidence

Inspection Physical examination of

of tangible a tangible asset.
assets

The process of watching a process or

procedure being performed by
Observation
others.
 Audit Procedures for obtaining
Audit Evidence

In conducting inquiry, the auditor should:

• Consider the knowledge, objectivity,
experience, responsibility, and
qualifications of the person to be
questioned.
• Ask clear, concise, and relevant
questions.
Inquiry
• Use open or closed questions
appropriately.
• Listen actively and effectively.
• Consider the reactions and responses,
then ask follow-up questions.
• Evaluate the response.
 Audit Procedures for obtaining
Audit Evidence

The process of obtaining a representation

Confirmation of information of an existing condition
directly from a third party.

The reliability of evidence obtained through confirmations is

directly 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.
 Audit Procedures for obtaining
Audit Evidence

Confirmation

Information Frequently
Confirmed by Auditors Source of Confirmation
Cash balance Bank
Accounts receivable Individual customers
Inventory on consignment Consignee
Accounts payable Individual vendors
Bonds payable Bondholders/trustee
Common stock outstanding Registrar/transfer agent
Insurance coverage Insurance company
Collateral for loans Creditors
 Audit Procedures for obtaining
Audit Evidence

Determining the mathematical

Recalculation accuracy of documents or records.

The auditor’s independent execution

of procedures or controls that
Reperformance were originally performed as part
of the internal control system.
 Audit Procedures for obtaining
Audit Evidence

Evaluations of financial information

made by a study of plausible
Analytical
relationships among both financial
procedures and nonfinancial data.

Review of accounting data to

Scanning identify significant or unusual items.
 Class exercise

The most reliable type of audit evidence that an auditor can

obtain is:

1. Physical examination by the auditor.

2. Calculations by the auditor from company records.
3. Confirmations received directly from third parties.
4. External documents.
 Class exercise

The least reliable type of evidence is:

1. Vendor invoice.
2. Bank statement obtained from the client.
3. Computations made by the auditor.
4. Prenumbered sales invoices.
Reliability of Types of Evidence
Audit Testing Hierarchy
 Example of Filling the Assurance Buckets for Each Assertion
(Accounts Payable)

Figure 5–5 Accounts Payable Example of Filling the Assurance Buckets for Each Assertion
 Audit Documentation

Audit documentation (working papers) has three functions:

1 To provide support for the audit report;
2 To aid in the planning, performance and supervision of
the audit;
3 To provide basis for quality reviews; to provide evidence
supporting the auditor’s significant conclusions;
 Content of Audit Documentation

Audit documentation provides the principal support for the

representations in the auditor’s report and should:

Demonstrate how the audit complied with auditing

and related professional practice standards.

Support the basis for the auditor’s conclusions

concerning each material financial statement
assertion.

Demonstrate that the underlying accounting

records agreed or reconciled with the financial
statements.
 Content of Audit Documentation

Audit documentation should:

1. Include an audit plan detailing auditing procedures necessary to

accomplish audit objectives;

2. Enable an experienced auditor to understand:

• The nature, timing and extent of audit procedures performed;

• The results of the audit procedure performed;

• Significant matters arising during the audit, the conclusions

reached thereon, and significant professional judgments made in
reaching those conclusions.
 Content of Audit Documentation

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

Corporate charter Important contracts

Chart of accounts Internal control documentation
Organization chart Terms of stock and bond issues
Prior years’ analytical procedures
 Content of Audit Documentation

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

Audit report Adjusting journal entries

Audit strategy and plan Reclassification journal entries
Working trial balance Current financial statements
Minutes of meetings Working papers supporting accounts
 Format of Audit Documentation

Entity name
Heading Title of the working paper
Entity’s year-end date

Notations that provide a trail

Indexing and
from financial statements to
cross-referencing
audit documents.

Notations made next to

Tick marks working paper items indicating
auditor/reviewer actions.
35
 Audit Documentation
Organization

Audit documentation should be organized so

that audit team members and others can find
evidence supporting financial statement accounts.

All audit documentation is the property of the

auditor, including documents prepared
by the entity at the auditor’s request.

ISQC1 requires audit documentation to be retained

ordinarily for minimum five years from
the date of the auditor’s report.
 Audit Procedures for
Obtaining Audit Evidence

Inspection Inspection
of tangible Observation
of records and
documents assets

Recalculation
Inquiry Confirmation

Analytical Scanning
Reperformance
procedures
37
Audit Testing Hierarchy
 Purposes of Analytical Procedures
Used to assist the auditor to
Planning Risk better understand the
stage Assessment business and to plan the
Procedures nature, timing and extent of
audit procedures.

Used to obtain evidential

Substantive matter about particular
Field work
stage Analytical assertions related to account
Procedures balances or classes of
transactions.

Review Final Used as an overall review of the

stage Analytical financial information in the final
Procedures review stage of the audit.
Analytical Procedures (See Table 5-10)

Ratio Analysis

Trend Analysis

Reasonableness Analysis

40

40
 Reasonableness Analysis

e.g., Conduct a substantive analytical procedure on the EWC’s assertion

that its 2013 interest expense is $983,000.

What would you do?

41
 Reasonableness
Analysis

e.g., Conduct a substantive analytical procedure on the EWC’s assertion

that its 2013 interest expense is $983,000.

Analytical test:

1. Average monthly ending balance of short term credit

2. Average interest rate

42
 Reasonableness Analysis

e.g., Conduct a substantive analytical procedure on the EWC’s assertion

that its 2013 interest expense is $983,000.

Analytical test:

1. Obtain the ending monthly balance for the short-term line of credit
from the monthly bank loan statement and calculate the average
monthly ending balance.

2. Determine the average interest rate for the year for the short-term line
of credit based on the bank’s published rate in the monthly bank loan
statement.

43
 Reasonableness Analysis

Month Balance (in $ 1000)

1 21500
2 18600
3 18100
4 17900
5 16100
6 15500
7 14200
8 20200
9 34500
10 28100
11 15200
12 11000
Total 230900

Average 19241.66667

44
 Reasonableness Analysis

e.g., Conduct a substantive analytical procedure on the EWC’s assertion

that its 2013 interest expense is $983,000.

Assume that the calculated average interest rate is 5.25%.

Expectation for interest expense: 19242000 * 0.0525 = 1,010,000

Compare expectation and reported value:

1,010,000 > 983, 000

Difference = 1,010,000 – 983,000 = 27,000

45
 Reasonableness Analysis

e.g., Conduct a substantive analytical procedure on the EWC’s assertion

that its 2013 interest expense is $983,000.

• Assume that the calculated average interest rate is 5.25%.

Compare tolerable difference to the difference between expectation and

reported value.

Suppose the auditor sets the amount of tolerable difference at

5% * 983,000 = 49,150

Difference 27,000 < 49, 150

Conclusion: the auditor would accept that the interest expense is fairly
stated.
46
 Substantive Analytical Procedures Decision Process

Figure 5–7
Overview of
the Auditor’s
Decision
Process for
Substantive
Analytical
Procedures
 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.
• Analyst’s reports.
 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.
• The precision of the expectation.
But the amount should generally not exceed performance materiality!
 Compare and Investigate

Compare the expectation to the recorded amount and investigate any differences
greater than the tolerable difference.
The Investigation of Differences for Risk Assessment
and Final Analytical Procedures

Risk
Final Analytical
Assessment
Procedures
Procedures
Differences
Differences

Corroborating Corroborating
evidence is not evidence is
required required
 Common Financial Ratios
 Short-term liquidity ratios
 Activity ratios
 Ability to meet long-term obligations
 Profitability ratios
 Summary of Analytical Procedures

• They involve the computation of ratios and other comparisons

of recorded amounts to form auditor’s expectation.

• They are used in planning to understand the client’s business

and industry.

• They are used throughout the audit to identify possible

misstatements, reduce detailed tests, and to assess going-
concern issues.
Thanks!