Auditing (Arens) 14e Chapter 5 PowerPoint Slides

Auditing: The Art and Science of Assurance
Engagements
Fourteenth Canadian Edition
Chapter 5
Audit Evidence
Copyright © 2019 Pearson Canada Inc. 5-1

Learning Objectives (1 of 2)
1. Understand the purpose and types of audit evidence
used throughout the audit process.
2. Explain the three audit evidence decisions to determine
what evidence to gather and how much to accumulate.
3. Use professional judgment to determine the degree of
persuasiveness of audit evidence.
4. Describe the types of audit procedures for gathering audit
evidence.
5. Design analytical procedures for the various phases of
the audit process.

Learning Objectives (2 of 2)
6. Understand the purposes of audit documentation.
7. Prepare organized audit documentation.
8. Explain how technology affects audit evidence and audit
documentation.
9. Understand and apply professional skepticism to
evidence and documentation decisions.

Nature of Audit Evidence (1 of 2)
• Most of the auditor’s work in forming an audit opinion
consists of obtaining and evaluating audit evidence.
• CAS 500 explains that audit evidence is information used
by the auditor in arriving at conclusions upon which the
audit opinion is based.
• Evidence includes information generated by the auditor,
third parties, and the client.

Nature of Audit Evidence (2 of 2)
• Evidence is both information that supports and
corroborates management’s assertions, and any
information that contradicts those assertions. In some
cases, it can be the absence of information (for example,
management refuses to provide a requested document).
• As illustrated in Figure 5-1, evidence is gathered in all
phases of the audit process and is used to help the auditor
make a variety of judgments and conclusions—to accept
(or continue with) the client, to plan the audit, to decide
where there could be a risk of material misstatement in the
financial statements, to develop an appropriate risk
response, and to conclude as to the type of audit report.
Audit Evidence Decisions
• NATURE: Which audit procedures to use?
• EXTENT: Which items to select for testing?
• TIMING: When to perform the procedures?

Audit Procedures (1 of 2)
• What is an audit procedure?
– It is the detailed instructions for the collection of audit evidence—
that is, the actual task that you do to obtain evidence with respect
to an audit objective: for example, when you count inventory, you
note the quantity, location, tag number, unit of measure and
condition.

Audit Procedures (2 of 2)
• Audit procedures fall into three categories:
– Risk assessment procedures—performed by the auditor to
obtain information for identifying and assessing risks of material
misstatement in the financial statements due to fraud or error.
– Tests of controls—designed to evaluate the operating
effectiveness of controls at the assertion level.
– Substantive procedures—designed to detect material
misstatements in accounts which include tests of details and
analytical procedures.

Audit Procedures: Risk Assessment
Procedures
• For each major class of transactions and material general
ledger account, the auditor looks at the potential for the
risk of material misstatement.
• Knowledge of the client’s industry, business, and operating
procedures will help the auditor complete this assessment.

The Why, What, How, and When of Audit
Procedures: Which Items to Select
• Once an audit procedure is determined, the auditor may:
(1) select all items in the population,
(2) select specific items in the population,
(3) use audit sampling, or
(4) use some combination of first three.
• The choice depends upon the purpose of the test and the
particular circumstances, such as the extent of automated
controls and the risk of material misstatement, as well as
the practicality and/or efficiency of the procedure.
Copyright © 2019 Pearson Canada Inc. 5 - 10

The Why, What, How, and When of Audit
Procedures: Timing
• An audit of financial statements usually covers a period
such as a year, and an audit is often not completed until
several weeks or months after the end of the fiscal period.
• The timing of audit procedures can vary from early in the
accounting period to long after it has ended.

Audit Program
• The set of detailed instructions for the entire collection of
evidence for an audit area is called an audit program.
• There may be several audit programs for a cycle,
depending upon the number of staff assigned to an
engagement.
• Normally, there is an audit program for each component of
the audit (e.g., accounts receivable and sales). An excerpt
of an audit program that includes audit procedures (the
how), sample size, items to select (the what), timing (the
when) and the relevant assertion (the why) is given in
Table 5-3.

Appropriateness: Sample Size
• The sample size will vary depending upon:
– The sampling method chosen;
– The type of test (e.g., test of controls vs. test of details); and
– The amount of assurance to be obtained from the test.
• The sampling method and size is related to assessed

risks.

Persuasiveness of Evidence
• Sufficient appropriate evidence is persuasive rather than
conclusive.
• Persuasive evidence is:
– Appropriate—relevant and reliable
– Sufficient—enough evidence
– Timely—covering the appropriate time period

Appropriateness
• Appropriateness or sufficient appropriate evidence means
that there is enough evidence of a high enough quality to
form a conclusion with respect to the audit opinion.
• The auditor must be persuaded that his or her opinion is
correct with a high level of assurance.
• The sample size will vary depending upon:
– The sampling method chosen;
– The type of test (e.g., test of controls vs. test of details); and
– The amount of assurance to be obtained from the test.
• The sampling method and size is related to assessed risks.

Relevance
• Relevance of evidence deals with the logical connection
with the design of the audit procedure and the assertion or
control that is being tested.
• Relevance can be considered only in terms of specific
audit objectives.

Reliability of Evidence (1 of 3)
• There are six factors to consider when assessing the
reliability of evidence:
– Evidence obtained directly by auditor—evidence obtained
directly by the auditor through physical examination, observation,
reperformance and/or inspection.
– Independence of source (ie., the information provider)—
evidence obtained from a source outside the entity is more reliable
than that obtained from within.

– Qualifications of source (ie., the information provider)—
individuals providing information should be competent and
qualified to do so.
– Consistency from multiple sources—evidence with all sources
consistent is more reliable than inconsistent evidence.

– The effectiveness of client’s internal controls—when a client’s
internal controls are effective, evidence obtained internally is more
reliable than when controls are weak.
– Degree of objectivity—evidence that requires the use of a high
level of judgment is less objective.

Sufficiency
• The quantity of evidence obtained determines its
sufficiency.
• Quantity is measured primarily by the sample size the
auditor selects.
• The most important factors determining the appropriate
sample size are:
– The auditor’s expectation of errors
– The effectiveness of the client’s internal controls.

Timeliness
• The timeliness of audit evidence can refer to either when
it was accumulated or the period covered by the audit.
– For balance sheet accounts, evidence is more persuasive when it
is obtained as close to the balance sheet date as possible.
– For income statement accounts, evidence is more persuasive if it
covers the entire period under audit rather than only a part of the
period.

Combined Effect (1 of 2)
• The auditor needs to consider all of the evidence factors
together, i.e., the combined effects of sufficiency,
appropriateness and timeliness in the context of the risk of
material misstatement for that audit objective.
• Part of the evidence gathering decision is related to the
tradeoff of the cost of gathering evidence versus its
persuasiveness.

Combined Effect (2 of 2)
Table 5-1 Relationships Among Evidence Decisions and
Persuasiveness
Audit Evidence Decisions Quality Affecting Persuasiveness of Evidence
Nature of audit procedures Appropriateness

Relevance
Reliability
• Obtained directly by the auditor
• Independence of source
• Qualifications of source
• Consistency of evidence
• Effectiveness of internal controls
• Objectivity of evidence
Extent of Testing Sufficiency
• Adequate sample size
• Selection of proper population items
Timing Timeliness
• When procedures are performed
• Portion of period being audited

Specific Types of Audit Procedures (1 of 5)
• Paragraphs A10 to A25 of CAS 500 set out seven “ways”
to collect evidence:
(1) Inspection—literally the auditor’s inspection or count of a
tangible asset or document. Inspection is regarded as one of the
most reliable and useful types of audit evidence.
(2) Observation—observation is the use of one’s senses to assess
certain activities. It is never sufficient by itself, and the auditor
must follow up initial impressions with other kinds of
corroborative evidence.

Inspection: Internal Versus External
Documentation
• An internal document is one that has been prepare and
used within the client’s organization and is retained without
ever going to an outside party such as a customer or a
vendor.
• An external document is one that has been in the hands
of someone outside the client’s organization who is a party
to the transaction being documented.
• External documents are regarded as more reliable than
those that are internal.

Inspection: Vouching and Tracing
• Vouching is the use of documentation to support recorded
transactions or amounts.
• Tracing is the use of documentation to determine if
transactions or amounts are included in the accounting
records.

(3) External confirmation—The receipt of a written or oral
response from an independent third party verifying the accuracy
of information. Auditors typically obtain written responses rather
than oral ones. Confirmations are highly regarded and often
used; however, they are costly to obtain.

(4) Recalculation—involves rechecking the computations and
mathematical work completed by the client during the period
under audit.
(5) Reperformance—the redoing of non-mathematical procedures
such as internal controls. This could include rechecking of
transfers of information. Re-performance relies heavily upon the
use of computer-assisted audit tests.

(6) Analytical procedures—the use of comparisons and
relationships between financial and non-financial information to
determine whether account balances appear reasonable. CAS
520 states that analytical procedures should be used on all
audits to conduct risk assessments, and at, or near the end of,
the audit when assessing the financial statements as a whole.

(7) Inquiry—obtaining of written or oral information from the client in
response to questions from the auditor. It is usually necessary to
obtain further corroborating evidence through other procedures.

Appropriateness of Types of Procedures
• The effectiveness of internal controls has a significant
effect on the reliability of most types of evidence.
• Both inspection and reperformance are likely to be highly
reliable if internal controls are effective.
• Some types of evidence are rarely sufficient to provide
competent evidence to satisfy an objective.
• Consider the cost of the procedure.

Reliability of Types of Audit Procedures (1 of 2)
Table 5-4 Reliability of Types of Audit Procedures
Criteria to Determine Reliability
Effectiveness of
Type of Audit Independence of Client’s Internal Auditor’s Direct Qualifications of Objectivity of
Procedure Provider Control Knowledge Provider Evidence
Inspection— High (auditor Varies High Normally high High
Physical does procedure) (auditor does
Examination procedure)
Inspection— Varies—external Varies Low Varies High
Documents and documents
Records more
independent
than internal
documents
Observation High (auditor Varies High Normally high Medium
does) (auditor does)
Inquiries of the Low (client Not applicable Low Varies Varies—low to
client provides) high

Reliability of Types of Audit Procedures (2 of 2)
Table 5-4 Continued
Criteria to Determine Reliability
Effectiveness of
Type of Audit Independence of Client’s Internal Auditor’s Direct Qualifications of Objectivity of
Procedure Provider Control Knowledge Provider Evidence
External High Not applicable Low Varies—usually High
confirmation high
Recalculation High (auditor Varies High High (auditor High
does) does)
Reperformance High (auditor Varies High High (auditor High
does) does)
Analytical High/low (auditor Varies Low Normally high Varies—depends
procedures does/client (auditor on the reliability
responds) does/client of the data
responds)

Terms, Audit Procedures, and Types of
Evidence (1 of 3)
Table 5-5 Terms, Audit Procedures, and Types of Evidence
Term and Definition Illustrative Audit Procedure Type of Audit Procedure
Examine—A reasonably detailed study of Examine a sample of vendors’ invoices or Inspection
a document or record to determine data to determine whether the goods or
specific facts about it. services received are reasonable and of
the type normally used by the client’s
business.
Scan—A less detailed examination of a Scan the sales report, looking for large Analytical procedures
document or record to determine if and unusual transactions.
there is something unusual warranting For large sales history files, use audit
further investigation.
software to run an exception report for
large amounts.
Read—An examination of written Read the minutes of a board of directors’ Inspection
information to determine facts pertinent meeting, and summarize all information
to the audit and the recording of those that is pertinent to the financial
facts in a working paper. statements in a working paper.
Compute—A calculation done by the Compute the inventory turnover ratios, and Analytical procedures
auditor independent of the client. compare to previous years as a test of
inventory.

Evidence (2 of 3)
Table 5-5 Continued
Recompute—A calculation done to Recompute the unit sales price times the Recalculation
determine whether a client’s calculation number of units for a sample of duplicate
is correct. sales invoices, and compare the totals to
the client’s calculations.
Foot—An addition of a column of numbers Foot the sales history files using audit Recalculation
to determine if the total is the same as software, and compare all totals to the
the client’s. general ledger.
Trace—An instruction normally associated Trace a sample of sales transactions from Recalculation Reperformance
with documentation or reperformance. the sales reports to sales invoices, and
The instruction should state what the compare customer name, date, and the
auditor is tracing and where it is being total dollar value of the sale.
traced from and to. Frequently, an audit Trace postings from the sales reports to
procedure that includes the term “trace” the general ledger accounts.
will also include a second instruction,
such as “compare” or “recompute.”

Evidence (3 of 3)
Table 5-5 Continued
Compare—A comparison of information in Select a sample of sales invoices and Reperformance
two different locations. The instruction compare the unit selling price as stated
should state which information is being on the invoice to the master files of unit
compared in as much detail as is selling prices authorized by
practical. management.
Count—A determination of assets on hand Count petty cash on hand at the balance Inspection
at a given time. This term should only be sheet date.
associated with the type of evidence
defined as physical examination.
Observe—The act of observation should Observe whether the two inventory count Observation
be associated with the type of evidence teams independently count and record
defined as observation. inventory quantities.
Inquire—The act of inquiry should be Inquire of management whether there is Inquiries of client
associated with the type of evidence any obsolete inventory on hand at the
defined as inquiry. balance sheet date.
Source: Based on Glover, Steven M., and Douglas F. Prawitt. “Enhancing Auditor Professional Skepticism: The
Professional Skepticism Continuum.” Current Issues in Auditing 8.2 (2014): p1-p10.

Design Analytical Procedures
• Per CAS 520.4, analytical procedures are evaluations of
financial information through analysis of plausible
relationships among financial and nonfinancial data.
• They may be performed throughout the engagement:
1. In audit planning
2. During the risk response
3. During the completion

Four Types of Analytical Procedures
• The auditor typically compares the client’s balances and
ratios with expected balances and ratios using one or more
of the following types of analytical procedures. In each
case, auditors compare client data with:
1. Industry data.
2. Similar prior-period data.
3. Client-determined expected results.
4. Auditor-determined expected results.
• Statistical techniques that aid in interpreting results can be

applied to analytical procedures.

Using Analytical Procedures as Substantive
Tests
• CAS 520 describes the process of developing substantive
analytical procedures:
– Develop an independent expectation
– Define a significant difference
– Compute the difference
– Investigate significant differences
• The degree of precision of the analytical procedures is

dependent on a number of different factors.

Documentation
• Audit documentation is the written or electronic record of
risk assessments, procedures or tests performed,
information obtained, and conclusions reached.
• Audit documentation is prepared and kept:
– As a basis for planning the audit
– As a record of the evidence accumulated and the results of the
tests
– To provide support for determining the proper type of auditor’s
report
– Basis for review by supervisory personnel

File Archive: Working Paper Contents and
Organization

Preparation of Working Papers
• Working papers should possess certain characteristics:
– Each working paper should be properly identified with such
information as the client’s name, the period covered, a description
of the contents, the name of the preparer, the date of preparation,
and an index code.
– Working papers should be indexed and cross-referenced to aid in
organizing and filing.
– Completed working papers must clearly indicate the audit work
performed
– Each working paper should include enough information to fulfill the
objectives for which it was designed.

Ownership of Working Papers and
Confidentiality of Working Papers
• The working papers prepared during the engagement,
including those prepared by the client for the auditor, are
the property of the auditor.
• The rules of conduct of the professional accounting bodies
require their members not to disclose any confidential
information obtained in the course of a professional
engagement except with the consent of the client or when
required by the courts or by the professional accounting
associations.

Effect of Technology on Audit Evidence and
Audit Documentation
• Audit software is software used to automate preparation
of audit working papers or the analysis of client data files.
• Auditors often use engagement management software to
organize and analyze audit documentation.
• Auditors also use local area networks and groupshare
software programs to access audit documentation
simultaneously from remote locations.

Professional Skepticism, Evidence, and
Documentation
• The auditor adjusts both the level of evidence and
documentation according to the amount of skepticism
necessary based upon the risk of material misstatement
and whether the evidence collected is consistent with the
original risk assessment.

Applying Professional
Skepticism

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Auditing: The Art and Science of Assurance

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• The sampling method and size is related to assessed

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• The sampling method and size is related to assessed risks.

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Nature of audit procedures Appropriateness

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• Statistical techniques that aid in interpreting results can be

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• The degree of precision of the analytical procedures is

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