Ch 7
Audit Evidence
What is Evidence ???
O Evidence : is any information used by the
auditor to determine whether the
information being audited is in accordance
with the established criteria.
Audit Evidence Decisions
1. Which audit procedures to use
2. What sample size to select for a given
procedure.
3. Which items to select from the population.
4. When perform the procedures.
Audit Procedures
O Is the detailed instructions that explain the
audit evidence to be obtained during the
audit.
O In specific terms.
O EX : obtain cash disbursement journal and
compare the payee name,amout,and date
on the cancelled checks.
Sample Size
O Sample size can vary from one to all the
items in the population.
O The decision of how many items to test must
be made by the auditor for each audit.
O EX: 50 checks of 6600 recorded in the cash
disbursement journal.
O The sample size for any procedure is likely to
vary from audit to audit.
Items to select
O Selecting the 50 checks :
1. Select a week and examine the first 50
checks.
2. Select 50 checks with the largest amounts.
3. Select the checks randomly.
4. Select those checks that the auditor thinks
are most likely to be in error.
Timing
O The SEC requires that all public companies
file audited financial statements within 60
to 90 days of the company’s fiscal year-end.
Audit Program
O The list of audit procedures for an audit area
or an entire audit.
O It always includes a list of the audit
procedures, and is usually includes sample
sizes, items to select and the timing of the
test.
Persuasiveness of Evidence
O Two determinants:
1.
2.
Appropriateness
Sufficiency
Appropriateness
O Is a measure of the quality of evidence,
meaning its relevance and reliability in
meeting audit objectives.
1. Relevance of Evidence
2. Reliability of Evidence
Relevance of Evidence
O Evidence must pertain to or be relevant to
the audit objective that the auditor is
testing.
O EX : Auditor is concerned that the client is
failing to bill customers(completeness
transaction objective).
O What is the appropriate procedure ???
O If the auditor selects a sample of duplicate
sales invoices and traces each to related
shipping documents, is this evidence
relevant ???
O A relevant procedure is to trace a sample of
shipping documents to related duplicate
sales invoices, to determine whether each
shipment was billed.
Reliability of Evidence
O Refers to the degree to which evidence can be
believed or worthy of trust.
O Six Characteristics of Reliable Evidence:
1. Independence of provider
2. Effectiveness of client’s internal controls
3. Auditor’s direct knowledge
4. Qualification of individuals providing the information
5. Degree of objectivity
6. Timeliness
1. Independence of provider.
Evidence obtained from a source outside the
entity is more reliable than that obtained from
within.
EX: communication from banks, attorneys, or
customers is more reliable than answers by
the client.
2. Effectiveness of client’s internal controls
When internal controls are effective, evidence
obtained is more reliable.
3. Auditor’s direct knowledge
Evidence obtained directly by the auditor
through physical examination, observation,
recalculation and inspection is more reliable
than information obtained indirectly.
4. Qualification of individuals providing the information.
The individual providing the evidence is qualified.
EX: communication with banks and attorneys.
EX: auditor lacks qualification to examine an inventory
of diamonds.
5.Degree of objectivity.
Objective evidence is more reliable than evidence that
requires judgment.
EX of objectives evidence : conformation of A/R and
bank balances or the physical count of cash.
EX of subjective evidence a letter from the client’s
attorney discussing the likely outcome of and
outstanding lawsuit.
6. Timeliness.
Evidence is more reliable for balance sheet
accounts when it is obtained as close to the
balance sheet date as possible.
Sufficiency
O Is measured primarily by the sample size the
auditor selects.
O The quantity of evidence obtained determines its
sufficiency.
O Factors to determine the appropriate sample size :
1. Auditor’s expectation of misstatement.
2. The effectiveness of the client’s internal control
O In addition to sample size, individual items tested
affect the sufficiency of evidence.
O EX : sample containing items with large dollar
amounts.
O Items with high likelihood of misstatement.
O Items that are representative of the population.
Combined Effect
O The persuasiveness of evidence can be
evaluated only by considering the
combination of appropriateness and
sufficiency
O A large sample of evidence provided by an
independent party is not persuasive unless
it is relevant to the audit objective.
Relationships Among Audit
Evidence and Persuasiveness
Audit Evidence Decisions
Audit procedures and timing
Qualities Affecting Persuasiveness
of Evidence
Appropriateness
Relevance
Reliability
Independence of provider
Effectiveness of internal controls
Auditor's direct knowledge
Qualifications of provider
Objectivity of evidence
Timeliness
When procedures are performed
Portion of period being audited
Sample size and items to select Sufficiency
Adequate sample size
Selection of proper population items
Persuasiveness and Cost
O The auditors goal is to obtain a sufficient
amount of appropriate evidence at the
lowest possible total cost.
Types of Audit Evidence
1. Physical examination
2. Confirmation
3. Documentation
4. Analytical procedures
5. Inquiries of the client
6. Recalculation
7. Reperformance
8. Observation
Physical Examination
O Is the inspection or count by the auditor of a tangible
asset.
O Most often associated with inventory and cash but can
applicable to securities, notes receivable and
intangible fixed assets.
O Is a direct means for verifying that an asset actually
exists (existence objective).
O It is considered one of the most reliable and useful
types of evidence.
O Used for ascertaining both the quantity and the
description of the asset.
O Is not sufficient to verify that existing assets are
owned by the client(rights and obligations).
O Not sufficient to verify (realizable value) or (accuracy).
Confirmation
O The receipt of a written or oral response from an
independent third party verifying the accuracy of
information that was requested by the auditor.
O They are from an independent source and so are
highly regarded.
O Are costly to obtain and may cause inconvenience
to those asked to supply them.
O Auditors typically obtain written responses rather
than oral ones.
O Auditor must decide whether to use confirmation or
O
O
O
O
O
not.
Not used for fixed assets (physical examination and
documentation) .
Are not used to verify individual transactions
between organizations such as sales.
The auditor determines that there are 2
extraordinary large sales transactions recorded
before balance sheet date, here confirmation may
be used.
Used for A/R.
They must be controlled by the auditor from the time
they are prepared to the time they are received.
Confirmation
Information
Source
Assets
Cash in bank
Marketable securities
Accounts receivable
Notes receivable
Owned inventory out on consignment
Inventory held in public warehouses
Cash surrender value of life insurance
Bank
Investment Custodian
customer
Maker
consignee
Public warehouse
Insurance company
Confirmation
Information
Source
Liabilities
Accounts payable
Notes payable
Advances from customers
Mortgages payable
Bonds payable
Creditor
Lender
Customer
Mortgagor
Bondholder
Confirmation
Information
Source
Owners’ Equity
Shares outstanding
Registrar and
transfer agent
Other Information
Insurance coverage
Contingent liabilities
Bond indenture agreements
Collateral held by creditors
Insurance company
Bank, lender, and
client’s legal counsel
Bond holder
Creditor
Documentation
It is the auditor’s inspection of the client’s
documents and records.
Provide information of conducting business.
May be in paper or electronic form.
Large volume of documents is usually available.
Is widely used because its available at low cost.
O
O
O
O
O
O Could be internal or External.
O An Internal document has been prepared and used
within the client’s organization without ever leaving
it. EX : employee time reports/duplicate sales
invoices.
O An External document has been handled by
someone outside the client’s organization.
EX: insurance policies/title of land.
O External are more reliable why ???
O Internal documents created under good control.
O Original better than photocopies.
Analytical Procedures
O Use comparison and relationships to assess
whether account balance or other data appear
reasonable.
O Compare gross margin % of this year with the
preceding year.
O Required during the planning and completion
phases on all audit.
Purposes of Analytical Procedures
1- Understand the client’s industry and business.
O Auditor must obtain knowledge about client’s industry
and business as a part of planning an audit.
O Current year’s unaudited information is compared with
the prior year’s audited information or industry data.
O Changes are highlighted.
O These changes can represent important trends or
specific events which will influence audit planning.
O EX : decline of gross margin percentage may indicate
increasing competition.
Purposes of Analytical Procedures
2-Assess the entity’s ability to continue as a going
concern.
O Determine whether the client company has financial
problems.
O Higher than normal ratio of long term debt to net worth
is combined with lower than normal ratio of profits to
total assets “indicates high risk of financial Failure”
O This will affect the audit plan and a report modification.
Purposes of Analytical Procedures
3- Indicate the presence of possible misstatements in
the financial statements.
O Unusual Fluctuations : significant differences between
the current year’s unaudited financial data and other
data used in comparison.
O If the unusual fluctuation is large the auditor must
determine the reason and be satisfied that the cause
is valid economic event and not a misstatement.
O Allowance for uncollectible accounts compared to last
year.
O This needs “Attention Directing”.
Purposes of Analytical Procedures
4-Reduce detailed audit tests.
When there is no unusual fluctuations this
means that the possibility of material
misstatement is minimized.
Inquiries of the Client
O It is the obtaining of written or oral information from the
client in response to questions from the auditor.
O It is not from an independent source and may be
biased.
O The auditor has to obtain additional evidence.
Recalculation
O
It involves rechecking a sample of calculation made
by the client.
Reperformance
It is the auditor’s independent tests of client
accounting procedures or controls that were
originally done.
O Information in the sales journal has been included for
the proper customer at the correct amount in the
subsidiary A/R and is accurately summarized in the
general ledger.
O
Observation
O It is the use of the senses to assess client activities.
O The auditor may tour the plant to obtain a general
impression of the client’s facilities.
Appropriateness of Types of
Evidence
 Type of evidence
 Independence of provider
 Effectiveness of client’s internal controls
 Auditor’s direct knowledge
 Qualifications of provider
 Objectivity of evidence
Type of
Evidence
Independence
of the provider
Effectiveness
of Client’s
internal
Control
Auditors
Direct
Knowledge
Qualification of Objectivity Of
the Provider
evidence
Physical
Examination
High
Varies
High
Normally high
(auditor Does)
High
Confirmatio
n
High
Not
Applicable
Low
Varies-Usually
high
High
Low
varies
High
documentati Varies (external varies
on
more
independent
than internal
Independenc Effectiveness
e of the
of Client’s
provider
internal
Control
Auditors
Direct
Knowledge
Qualification
of the
Provider
Analytical
procedures
High/low
(auditor
does/client
responses)
varies
Low
Normally high Varies-usually
(auditor
low
does/client
responses)
Inquires of
client
Low (client
provides)
Not
applicable
Low
Varies
Varies-low to
high
Varies
High
High(auditor
Does)
High
Type of
Evidence
Recalculation High(auditor
does)
Objectivity Of
evidence
Type of
Evidence
Independen Effectiveness
ce of the
of Client’s
provider
internal
Control
Auditors
Direct
Knowledge
Qualification
of the
Provider
Objectivity Of
evidence
High
Reperformance High
(auditor
does)
Varies
High
High (auditor
does)
Observation
Varies
High
Normally high Medium
(auditor does)
High
(auditor
does)
Cost of Types of Evidence
O Physical examination and confirmation the most
expensive types of evidence.
 Physical examination requires the presence of the
auditor when the client is counting the asset.
 Conformation must follow careful procedures in the
confirmation preparation, mailing, and receipt.
Cost of Types of Evidence
O Documentation and analytical procedures are
moderately costly.
 If clients personnel locate documents for the auditor
and organize them for convenient use, documentation
will have low cost.
 Analytical procedures are less expensive than
confirmation and physical examination.
 Therefore, most auditors prefer to replace tests of
details with analytical procedures.
Cost of Types of Evidence
O The lest expensive types are observation, inquires of
the client and reperformance.
Types of Evidence and Four Evidence Decisions for a
Balance-Related Audit Objective for Inventory*
Evidence Decisions
Type of Evidence
Audit Procedure
Sample Size
Items to Select
Timing
Observation
All count teams
Observes client’s personnel
counting inventory to
determine whether they are
properly following instructions
Not applicable
Balance
sheet date
Physical examination
Count a sample of
inventory and compare
quantity and description
to client’s counts
120 items
40 items with
large dollar
value, plus 80
randomly
selected
Balance
sheet date
Documentation
Compare quantity on
client’s perpetual records
to quantity on client’s
counts
70 items
30 items with large
dollar value, plus
40 randomly
selected
Balance
sheet date
Term
Definition
Examine
A reasonably detailed study of a
document or record to determine specific
facts about it.
Documentation
Scan
Less detailed examination of a document
or record to determine whether there is
something unusual warranting further
investigation.
Analytical procedures
Read
An examination of a written information to
determine facts pertinent to the audit.
Documentation
A calculation done by the auditor
independent of the client.
Analytical procedures
compute
Type of
evidence
Term
Definition
Recompute
A calculation done to determine
whether a client’s calculation is correct.
Type of evidence
Recalculation
Foot
Addition of a column of numbers to
Recalculation
determine whether the total is the same
as the client’s.
Trace
An instruction normally associated with
documentation or reperformance.
The instruction should state what the
auditor is tracing and where it is being
traced from and to.
Documentation/Reperforman
ce
Compare
Comparison of information in two
different locations. The instruction
should state which information is being
compared in as much detail as
practical.
Documentation
Term
Definition
Type of evidence
Count
A determination of assets on hand at a
given time. This term should be
associated only with the type of
evidence defined as physical
examination.
Physical examination
Observe
The act of observation should be
associated with the type of evidence
defined as observation.
Observation
Inquire
The act of inquiry should be associated
with the type of evidence defined as
inquiry.
Inquiries of client
Vouch
The use of documents to verify
recorded transactions or amounts.
Documentation
Audit Documentation
O Audit documentation is the principal record of auditing
procedures applied, evidence obtained, and
conclusions reached by the auditor in the
engagement.
Purposes of audit documentation
1) A Basis for Planning the Audit.
2) A Record of the evidence accumulated and the
Results of the Tests.
3) Data for Determining the Proper type of the Audit.
4) A Basis for Review by supervisors and partners.
Ownership of audit files
O Is the property of the auditor.
Confidentiality
O A member shall not disclose any confidential obtained in the
course of professional engagement except with the consent of
the client.
Retention of Audit Documentation
O Auditing standards require that the records of private
companies be retained for a minimum of five years.
O The Sarbanes-Oxley Act requires auditors of public
companies to prepare and maintain audit working
papers for a period of no less than seven years.
Contents of Audit files
O Permanent Files : These files are intended to contain
data of a historical or continuing nature pertinent to
the current audit. (EX : contracts).
O Current Files : all audit Documentation applicable to
the year under audit. (EX : Audit Program).