Auditing and Assurance Services

A Systematic Approach
Eleventh Edition

CHAPTER 5
Evidence and
Documentation

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 Learning Objective 05-1

Relationship of Audit Evidence to

the Audit Report
Financial Audit
statements report

Management assertions Auditor reaches

about components of a conclusion based
financial statements on the evidence

Provide evidence on the

Audit
fairness of the
procedures
financial statements

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 Learning Objective 05-2

Management Assertions (1 of 2)

Occurrence
Completeness
Presentation

Assertions about classes of

transactions and events,
and related disclosures, for
Classification the period under audit Authorization

Cutoff Accuracy

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 Learning Objective 05-2

Management Assertions (2 of 2)
Rights and
Existence
Obligations

Assertions about
Presentation account balances, and Completeness
related disclosures, at
the period end

Accuracy,
Classification valuation, and
allocation

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 Learning Objective 05-2

TABLE 5-2 Summary of Management Assertions

by Category (1 of 2)

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 Learning Objective 05-2

TABLE 5-2 Summary of Management Assertions

by Category (2 of 2)

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 Learning Objective 05-3

Audit Evidence

The information used by the auditor in

arriving at the conclusions on which the
audit opinion is based.

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 Learning Objective 05-3

The Concepts of Audit Evidence

Nature of audit evidence

Sufficiency and appropriateness

of audit evidence

Evaluation of audit evidence

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 Learning Objective 05-3

Nature of Audit Evidence

Refers to the form or type of information
Accounting Records Other Information
• Records of initial entries and • Minutes of meetings
supporting records • Confirmations from third
• General and subsidiary ledgers, parties
journal entries, and other • Industry analysts’ reports
adjustments to financials not • Comparable data about
reflected in journal entries. competitors
• Work sheets and spreadsheets • Control Manuals
supporting cost allocations, • Information obtained by the
computations, reconciliations, auditor from inquiry,
and disclosures observation and inspection
• Contracts

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 Learning Objective 05-3

Sufficiency of Audit Evidence

Sufficiency is the 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.

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 Learning Objective 05-3

Appropriateness of Audit Evidence

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

Independent source outside the entity

Effectiveness of internal control

Auditor’s direct personal knowledge

Documentary evidence

Original documents

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 Learning Objective 05-3

Knowledge Assessment

Which of the following sources of evidence are more reliable?

1. Inquiry of an accounts receivable clerk regarding the

accounts receivable balance – or – accounts receivable
confirmations sent to a sample of customers

2. Physical examination of lumber inventory performed by

the external auditor – or – physical examination of
inventory performed by internal auditors

(Stop and Think p. 135)

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 Learning Objective 05-3

Knowledge Assessment

Which of the following sources of evidence are more reliable?

1. Inquiry of an accounts receivable clerk regarding the

accounts receivable balance – or – Accounts receivable
confirmations sent to a sample of customers

2. Physical examination of lumber inventory

performed by the external auditor – or – Physical
examination of inventory performed by internal auditors

(Stop and Think p. 135)

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 Learning Objective 05-3

Evaluation of Audit Evidence

Proper evaluation of evidence

requires an understanding of the:

Types of evidence available.

Relative reliability of available evidence.

An auditor should be thorough in searching

for evidence and unbiased in its evaluation.

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 Learning Objective 05-4

Audit Procedures (1 of 2)
Specific acts
performed by the auditor
to gather evidence about
whether specific assertions
are being met.

Risk assessment Test of Substantive

procedures controls procedures

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 Learning Objective 05-4

Audit Procedures (2 of 2)
A set of audit procedures prepared to test assertions for
a component of the financial statements is referred to as
an audit program.

Audit Program for

Accounts Receivable
Management Assertions
Existence
Rights and obligations
Completeness
Valuation or allocation
Example Audit Procedures
Confirm accounts receivable.
Inquire of management whether receivables
have been sold.
Agree total of accounts receivable subsidiary
ledger to accounts receivable control account.
Test the adequacy of the allowance for doubtful
accounts.

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (1 of 7)
Inspection of records and documents
• Evidence obtained from external documents is more
reliable than evidence obtained from internal
documents
Vouching
(Occurrence)
Source Journal or
Documents Ledger
Tracing
(Completeness)

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (2 of 7)
Inspection of tangible assets
• Physical examination of a tangible assets

Observation
• The process of watching a process or procedure being
performed by others

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (3 of 7)
Inquiry
In conducting inquiry, the auditor should:
• Consider the knowledge, objectivity, experience,
responsibility, and qualifications of the individual to be
questioned
• Ask clear, concise, relevant questions
• Use open or closed questions appropriately
• Listen actively and effectively
• Consider the reactions and responses and ask follow-up
questions
• Evaluate responses

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (4 of 7)
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.

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (5 of 7)
Confirmation

Information Frequently
Source of Confirmation
Confirmed by Auditors
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 Creditor

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (6 of 7)
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

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (7 of 7)
Analytical Procedures
• Evaluations of financial information made by a study
of plausible relationships among both financial and
nonfinancial data

Scanning
• Judgmentally review accounting data to identify
significant or unusual items to test

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 Learning Objective 05-5

TABLE 5-6 General Guidelines for Reliability

Hierarchy by Evidence Type

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 Learning Objective 05-6

FIGURE 5-3 Audit Testing Hierarchy: An Evidence Decision Process

for Testing Classes of Transactions or Significant Balances

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 Learning Objective 05-6

FIGURE 5-4 Filling the Assurance Bucket

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 Learning Objective 05-6

FIGURE 5-5 Accounts Payable Example of Filling

the Assurance Buckets for Each Assertion

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 Learning Objective 05-6

Knowledge Assessment

Consider the “assurance bucket” analogy. Why are some of

the buckets larger than others for particular assertions or
accounts?

(Review Question 5-12)

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 Learning Objective 05-7

Audit Documentation
The auditor’s record of the audit procedures
performed, relevant evidence obtained, and
conclusions reached.

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 a focal point for reviewing work of
subordinates; to provide a basis for quality
reviews

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 Learning Objective 05-7

Content of Audit Documentation (1 of 4)

Audit documentation should:

Demonstrate how the audit complied with

1 auditing and related professional practice
standards

Support the basis for the auditor’s conclusions

2 concerning each material financial statement
assertion

Demonstrate that the underlying accounting

3 records agreed or reconciled with the financial
statements

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 Learning Objective 05-7

Content of Audit Documentation (2 of 4)

Audit documentation should:

Include a written audit program detailing

4 auditing procedures necessary to accomplish
audit objectives

Enable a knowledgeable and experienced

5
reviewer to:

Understand the nature, timing,

Determine who performed and
extent, and results of audit
reviewed the work, as well as
procedures, evidence
the dates of the work and
obtained, and conclusions
reviews.
reached

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 Learning Objective 05-7

Content of Audit Documentation (3 of 4)

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

• Corporate charter • Organization chart

• Important contracts • Terms of stock and bond
• Chart of accounts issues
• Internal control • Prior years’ analytical
documentation procedures (and results)

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 Learning Objective 05-7

Content of Audit Documentation (3 of 4)

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

• Adjusting journal entries • Current financial

• Audit plan and programs statements and auditor’s
• Reclassification journal report
entries • Minutes of meetings
• Working trial balance • Working papers supporting
accounts

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 Learning Objective 05-8

Format of Audit Documentation

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

Indexing and Notations that provide a trail

from financial statements to audit
cross-referencing documents

Notations made next to work

Tick Marks paper items indicating
auditor/reviewer actions

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 Learning Objective 05-8

EXHIBIT 5-2 Example of Account Analysis

Working Paper

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 Learning Objective 05-8

Ownership of Audit Documentation,

Archiving, and Retention
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.

The Sarbanes-Oxley Act of 2002 requires

audit documentation to be retained for a number of
years from the completion date of the engagement.

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 Learning Objective 05-9 (and 05-4)

Purposes of Analytical Procedures

Risk Used to assist the auditor to better
understand the business and to plan the
Assessment nature, timing, and extent of audit
Procedures procedures.

Substantive Used to obtain evidential matter about

Analytical particular assertions related to account
balances or classes of transactions.
Procedures

Final Used as an overall review of the financial

Analytical information in the final review stage of the
audit.
Procedures

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 Learning Objective 05-9

Types of Analytical Procedures

Trend Analysis

Ratio Analysis

Reasonableness
Analysis

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 Learning Objective 05-9

Figure 5-7 Substantive Analytical Procedures Decision Process

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 Learning Objective 05-9

Develop an Expectation (1 of 3)
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

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 Learning Objective 05-9

Develop an Expectation (2 of 3)
Precision – the quality of an expectation
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. Detection Precision Extensiveness
Risk Required of Procedures
• A function of the materiality and required
detection risk for assertion being tested. LOW HIGH HIGH
• 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).
HIGH LOW LOW

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 Learning Objective 05-9

Develop an Expectation (3 of 3)
Four factors affect the precision of analytical
procedures:
• Disaggregation
• The plausibility and predictability of the
relationship being studied
• Data reliability
• Type of analytical procedures used to
form an expectation

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 Learning Objective 05-9

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

Tolerable difference will usually be equal to the account’s

tolerable misstatement

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 Learning Objective 05-9

Compare the Expectation to the

Recorded Amount

Compare the expectation to the recorded

amount and investigate any differences
greater than the tolerable difference.

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 Learning Objective 05-9

Investigate Differences Greater Than

the Tolerable Difference (1 of 2)
Differences identified by substantive
analytical procedures indicate an increase
likelihood of misstatements

Explanations for significant differences observed

(substantive analytical procedures) must be followed
up and resolved through:
• Quantification
• Corroboration
• Evaluation

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 Learning Objective 05-9

Investigate Differences Greater Than

the Tolerable Difference (2 of 2)
Involves determining whether the explanation
Quantification or error can explain the observed difference

Auditors must corroborate explanations by

obtaining sufficient appropriate audit evidence
Corroboration linking the explanation to the difference and
substantiating that the information supporting
the explanation is reliable

Auditor should evaluate the results of the

substantive analytical procedures to conclude
Evaluation whether the desired level of assurance has
been achieved

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 Learning Objective 05-9

Investigate Differences for Risk Assessment

and Final Analytical Procedures

Risk Assessment Final Analytical

Procedure Differences Procedures Differences
(used in planning)

Corroborating evidence Corroborating evidence

is not required is required

If the auditor cannot find sufficient evidence within the

working papers, the auditor would formulate possible
explanations, conduct additional testing, and seek an
explanation from the entity’s personnel.

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 Learning Objective 05-9

Knowledge Assessment

The primary objective of final analytical procedures is to:

A. Obtain evidence from details tested to corroborate particular

assertions
B. Identify areas that represent specific risks relevant to the audit
C. Assist the auditor in assessing the validity of the conclusions
reached on the audit
D. Satisfy doubts when questions arise about an entity’s ability to
continue in existence

(MC Question 5-28)

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 Learning Objective 05-9

Knowledge Assessment

The primary objective of final analytical procedures is to:

A. Obtain evidence from details tested to corroborate particular

assertions
B. Identify areas that represent specific risks relevant to the audit
C. Assist the auditor in assessing the validity of the
conclusions reached on the audit
D. Satisfy doubts when questions arise about an entity’s ability to
continue in existence

(MC Question 5-28)

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 Learning Objective 05-10

Short-Term Liquidity Ratios

Short-term liquidity ratios indicate the entity’s

ability to meet its current obligations.

Operating
Current
Quick Ratio Cash Flow
Ratio
Ratio

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 Learning Objective 05-10

Activity Ratios
Activity ratios indicate how effectively the entity’s
assets are managed. Activity ratios may also be
effective in helping the auditor determine if these
accounts contain material misstatements.
Days
Receivables Outstanding
Turnover in Accounts
Receivable

Days of
Inventory
Inventory on
Turnover Hand

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 Learning Objective 05-10

Profitability Ratios
Profitability ratios indicate the entity’s success or
failure for a given period. Each ratio should be
interpreted by comparison to industry data.

Gross Profit
Profit Margin
Percentage

Return on Return on
Assets Equity

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 Learning Objective 05-10

Coverage Ratios
Coverage ratios provide information on the
long-term solvency of the entity. These ratios
give the auditor important information on the
ability of the entity to continue as a going
concern.

Times
Debt to
Interest
Equity
Earned

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