Electronic
Presentations
in Microsoft®
PowerPoint®
Prepared by
Brad MacDonald
SIAST
© 2003 McGraw-Hill
Ryerson Limited
Chapte
r
4
Audit Objectives, Procedures,
and Working Papers
Copyright © 2003 McGraw-Hill Ryerson Limited
2
Chapter 4 Overview
Activities
Preengagement
arrangements
Understand
the client’s
business
Obtain the
financial
statements
Basic Concepts
Management
assertions &
audit
objectives
Chapter 4
Sufficient
appropriate
evidence
General
audit
procedures
Copyright © 2003 McGraw-Hill Ryerson Limited
Audit
working
papers
3
Learning Objective 1
Describe the activities auditors undertake
before beginning an audit.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
4
Pre-engagement Arrangements
Auditors undertake two types of activities before
beginning an audit:
– Risk management:
• Auditors try to reduce the risk (probability of
something going wrong) by carefully managing the
engagement.
– Quality management:
• Auditors manage audit in accordance with quality
control standards.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
5
Pre-engagement Arrangements
Client selection and retention:
– An important element of an accounting firm’s quality
control policies and procedures is a system for
deciding
• (a) to accept a new client, and
• (b) whether to resign from audit engagements.
– Accounting firms are not obligated to accept
undesirable clients, nor retain existing audit clients.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
6
Client Acceptance and
Retention Policies
Client acceptance and retention procedures
should include:
– Obtain and review financial information about
prospective client.
– Enquire of bankers, legal counsel, other.
– Communication with predecessor auditor.
– Consider unusual risks.
– Evaluate independence.
– Consider needs for special skills.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
7
Communication Between Predecessor
and Successor Auditors
When companies change auditors, the former
auditor is the predecessor auditor, and the new
auditor is the successor auditor.
– Rules of professional conduct require the successor
auditor to contact the predecessor auditor.
• Ask if there are issues that should be considered
in accepting the client.
• Obtain information from the predecessor auditor
for planning the audit.
– Predecessor auditor is required by the rules of
conduct to respond to the communication.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
8
Communication Between Predecessor
and Successor Auditors
Successor auditor should ask the client to consent
to discussions with the predecessor auditor.
– Consent is not required, the communication must
take place.
– Consent allows the predecessor auditor to relay more
information.
• Predecessor auditor still has a duty to maintain
confidentiality.
• Audit files belong to the auditor, not the client.
– Auditor should be wary of any client who refuses
consent.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
9
Engagement Letters
When a new audit client is accepted an
engagement letter should be obtained.
– The engagement letter forms the contract for
the audit.
• Engagement letters are highly
recommended to reduce the risk of
misunderstandings.
– A new engagement letter should be obtained
every year of a continuing audit.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
10
Pre-engagement Arrangements
Staff assignment:
– When the new client is obtained, accounting firms
assign a full-service team to the new client.
•
•
•
•
•
•
Engagement partner
Audit manager
One or more senior audit staff members
Staff assistants
Specialists
A tax partner, a consulting services partner and a
second audit partner
– For a small firm or client, audit team may be just one
or two people.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
11
Pre-engagement Arrangements
Time budget:
– The partner or manager propose a plan for the timing
of the work (interim and year-end).
– Time reports are recorded by budget categories for
• evaluation of the efficiency of audit team members
• billing the client
• planning of the next audit
– Time budget allows the audit firm to spread its
workload between interim and year-end periods.
• Interim – before the statement date
• Year-end – at or after the statement date
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
12
Example Time Budget
Audit Time Budget (hours)
Year-End
Interim
15
Knowledge of the business
10
Internal audit familiarization
10
30
Assessment of control risk
25
Audit program planning
15
5
Related parties investigation
18
10
Client conferences
15
10
Cash
5
15
Accounts receivable
20
35
Inventory
35
5
Accounts payable
20
Representation letters
25
Financial statement review
12
Report preparation
175
160
Total
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
13
Learning Objective 2
Identify the procedures and sources of
information that auditors can use to obtain
knowledge of a client’s business and
industry.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
14
Understanding the Client’s
Business
Auditing standards require a sufficient
understanding of the business to plan and perform
audit work.
– Objectives:
• Effective audit: identify and address all significant
risks of material misstatement
• Efficient audit: provides sufficient appropriate audit
evidence in an economical manner
• Enhance accuracy of auditor’s evaluation
• Provide better ancillary services to client
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
15
Strategic Systems Approaches
to Auditing
A recent trend in audit practice, referred to as
“strategic systems approach” (SSA), is to base
more of the audit on knowledge of the business.
– Used by two of the Big four firms, but has not yet
filtered down to smaller firms.
– SSA is a top-down approach.
• Starts with corporate strategy to determine effects
on financial statements (Ch. 13).
– Traditional audits use a bottom-up approach.
• Gather evidence on individual transactions and
aggregate to financial statement level.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
16
Understanding the
Client’s Business
Methods and sources of information:
– For continuing audits, information is available in the
permanent files.
– Enquiry and interview with client management and
personnel to
• obtain information for computer based audit work
• determine needs of users of the statements
– Observation and tour of company’s physical facilities
– Study and review of published materials, guides and
reference materials on the industry and the client.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
17
Understanding the
Client’s Business
Other aspects of understanding the
business:
– First-time audits require more work.
– Audit efficiency can be realized by working in
tandem with the internal auditors.
– Analysis of client financial statements and
ratios contribute a significant understanding
of the business.
– Understanding enables the auditor to
determine the need for specialists.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
18
Learning Objective 3
Name the principal accounts in each cycle
in accounting and business processes.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
19
Management’s Financial
Statements
There are two important points to remember
about client financial statements:
• Management is responsible for preparing
them, and they contain management’s
assertions about economic actions and
events.
• The financial statement numbers are
produced by the company's accounting
system and summarized by the trial
balance.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
20
Management’s Financial
Statements
To simplify the audit plan, auditors typically
group the accounts into several cycles.
– This text contains four cycles:
(1) revenues and collection
(2) acquisition and expenditure
(3) production and conversion
(4) finance and investment
– The purpose of using cycles is to group
together related accounts by transactions that
normally affect them all.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
21
Trial
Balance
Accounts are
organized by
cycle
Should list
comparative
period
Chapter 4
Revenue and collection cycle
Acquistion and expenditure cycle
Production and conversion cycle
Financing and investment cycle
X
X
X
X
X
X
X
Cash
Accounts receivable
Allowance for doubtful accounts
Sales
Sales returns
Bad debt expense
X X
Inventory
X
Capital assets
X
Accum. Amortization
X
Accounts payable
X
Accrued expenses
X
General expenses
X
Cost of goods sold
X
Amortization expense
X Bank loans
X Long term notes
X Accrued interest
X Share capital
X Retained earnings
X Dividends declared
X Interest expense
X Income tax expense
Copyright © 2003 McGraw-Hill Ryerson Limited
Debit
484
400
Credit
30
8,500
400
50
1,940
4,000
1,800
600
10
1,955
5,265
300
750
400
40
2,000
900
40
196
22
Learning Objective 4
Describe and define the five principal
management assertions in financial
statements, and explain their role
for establishing audit objectives.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
23
Management Assertions
and Audit Objectives
Existence or occurrence:
– Establish with evidence that assets, liabilities
and equities actually exist and that revenue
and expense transactions actually occurred
as of a proper date.
– Cut-off: No transactions from the next period
are recorded at the statement date.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
24
Management Assertions
and Audit Objectives
Completeness:
– Establish with evidence that all transactions
and accounts that should be presented in the
financial reports are included.
– Cut-off: All transactions from the period are
recorded in the period.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
25
Management Assertions
and Audit Objectives
Rights and obligations:
– Establish with evidence that amounts
reported as assets of the company represent
property rights and the amounts reported as
liabilities represent obligations.
Valuation or allocation:
– Determine whether proper values have been
assigned to assets, liabilities, equities,
revenues, and expenses.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
26
Management Assertions
and Audit Objectives
Presentation and disclosure:
– Determine whether the accounting principles
are properly selected and applied and
whether disclosures are adequate.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
27
Management Assertions
and Audit Objectives
A compliance assertion:
– Management asserts compliance with laws
and regulations.
– Not normally listed as a separate
management assertion.
Importance of assertions
– Financial statement assertions are the focal
points for audit procedures.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
28
Assertions
7 assertions listed in
CICA Handbook
Existence
Occurrence -> transactions
Completeness
Ownership
Valuation
Measurement
Statement presentation
Chapter 4
5 textbook categories of
assertions
Existence or occurrence
Completeness
Rights & obligations
Valuation or allocation
Presentation & disclosure
Copyright © 2003 McGraw-Hill Ryerson Limited
29
Learning Objective 5
Explain audit evidence in terms of its
appropriateness and relative strength of
persuasiveness.
Chapter 4
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30
Appropriateness of Evidence
To be considered appropriate, evidence
must be relevant and reliable.
– Relevant: audit evidence must relate to one
of the management assertions.
– Reliability: of audit evidence depends on
nature and source.
• Reliability combined with relevance
determine the persuasiveness of evidence.
• The following hierarchy of evidence can be
used to judge reliability.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
31
Reliability of Evidence
1. Auditors direct, personal knowledge:
– Gained though observation and recalculation
– This is the most reliable evidence.
2. External evidence:
– Documentary evidence that is obtained
directly from independent sources.
– Very reliable evidence
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
32
Reliability of Evidence
3. External-internal evidence:
– Documentary evidence that originates outside the
client’s system, but that has been received and
processed by the client:
– This is reliable evidence (although circumstances of
internal control are important).
4. Internal evidence:
– Evidence that is produced within the client’s system.
– Low reliability, but used extensively under
satisfactory internal control conditions.
– Plentiful and easy to obtain, less costly than other
evidence.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
33
Reliability of Evidence
5. Spoken and written representations:
– Evidence that comes from the client’s
officers, directors, management, and
employees in response to enquiry.
– Generally considered the weakest form of
evidence.
• Representations should be corroborated
with other types of evidence.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
34
Sufficiency of Evidence
Sufficiency of evidence is a question of how
much appropriate evidence is enough.
– No official standard, the auditor must use
professional judgement.
• Test of sufficiency is whether you can
persuade someone else that you have
collected enough evidence to support your
conclusion.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
35
Learning Objective 6
List and describe six general types of audit
techniques for gathering evidence.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
36
General Audit Procedures
The third examination standard identifies six
techniques for gathering evidence:
– computation
– observation
– confirmation
– enquiry
– inspection
– analysis
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
37
General Audit Procedures
Computation:
– Performing independent calculations or
recalculating the client’s calculations.
• Computation produces highly reliable
mathematical evidence.
• Computation addresses existence and
valuation for calculated amounts.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
38
General Audit Procedures
Observation:
– Looking at the application of policy or
procedures by others.
• Reliable evidence as to performance at the
time of observation.
• Produces a general awareness of events.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
39
General Audit Procedures
Confirmation:
– Consists of (written) enquiry to verify
accounting records.
• Confirmation with independent parties is
used widely for a variety of transactions
and balances.
• Confirmation can produce evidence
regarding existence, ownership, valuation
and cut-off.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
40
General Audit Procedures
Confirmation procedures:
– Confirmations should be printed on the
client’s letterhead, signed by a client officer.
– Auditor needs to ensure that the address on
the confirmation is legitimate.
– The recipient should be able to provide the
information.
– The auditor must mail the confirmations.
– Responses must be returned directly to the
auditor.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
41
General Audit Procedures
Forms of confirmations:
– Positive confirmations: request a reply in all
cases.
• Follow-up is required for all exceptions
reported, and for all unreturned
confirmations.
– Negative confirmations: request a reply only
where information is incorrect.
• Only exceptions need to be followed up.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
42
General Audit Procedures
Enquiry:
– Involves the collection of oral evidence from
the client and independent third parties.
• Evidence from enquiry requires
corroboration.
• Evidence from enquiry is important in
understanding the client’s business.
• SSA audits put increasing stress on
enquiry.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
43
General Audit Procedures
Inspection:
– Looking at records, documents, or assets
having physical substance.
• Reliable evidence for existence, supports
valuation.
• Documents can be prepared by
independent outside parties as either
formal authoritative or ordinary documents.
• Documents can also be prepared by the
entity under audit.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
44
Particular Inspection Techniques
Vouching:
– Information is selected from an account or
other summary of information and the auditor
goes back through the control system to find
the source documentation.
• Vouching supports existence.
Source
documents
Chapter 4
Vouch
Copyright © 2003 McGraw-Hill Ryerson Limited
Account /
other
summary
45
Particular Inspection Techniques
Tracing:
– Auditor selects source documents and
proceeds forward through the control system
to the final recording of the transaction.
• Tracing supports completeness
Source
documents
Chapter 4
Vouch
Trace
Copyright © 2003 McGraw-Hill Ryerson Limited
Account /
other
summary
46
Particular Inspection Techniques
Scanning:
– An eyes-open approach of looking for
anything unusual.
• Does not produce direct evidence, but can
raise questions.
• Computers can be used to scan electronic
data files.
• Scanning can be used to reduce sampling
risk by scanning the items not selected.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
47
General Audit Procedures
Analysis:
– Evaluation of financial items in determining other
audit programs and performing analytic procedures
that compare recorded amounts to expectations.
• Analysis is the “other” category in the list of audit
techniques.
• Analytical procedures are both important and
effective.
• Analysis is used in planning, execution, and
completion of the audit.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
48
Analytic Procedures
Some typical analytic procedures:
– Compare current year to prior year.
– Compare current year to budget.
– Evaluate current year balances against other
current year balances.
– Compare financial ratios to industry
standards.
– Study relationship of balances and nonfinancial information.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
49
Learning Objective 7
Discuss the effectiveness of various audit
procedures.
Chapter 4
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50
Effectiveness of
Audit Procedures
Audits are designed to provide reasonable
assurance of detecting misstatements that
are material to the financial statements.
– Soft procedures (enquiry and analysis)
account for 45% to 50% of discovered errors.
• Note: these procedures are applied first.
– Detail procedures are also effective.
• Misstatements uncovered by soft
procedures will be quantified by detail
procedures.
Chapter 4
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51
Learning Objective 8
Review an audit working paper for proper
form and content.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
52
Audit Working Papers
Working papers are the auditors’ record of
compliance with GAAS.
– Working papers should contain support for
the decisions made in the course of the audit.
– The auditor is the owner of the working
papers.
• Confidentiality requires client consent
before the file is opened to third parties.
– There are three categories of working papers,
generally stored in two files.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
53
Audit Working Papers
Permanent file:
– Permanent file papers: information of
continuing interest.
Current file:
– Audit administrative papers: documentation
of early planning.
– Audit evidence papers: evidence obtained
and decisions made.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
54
Working Paper Arrangement
and Indexing
Working papers (W/P) are grouped in order
according to financial statement captions.
– Each page in the file must have:
• Index: A page number that allows a W/P to
be removed and replaced properly.
• Cross-referencing: Connects information
between pages in the W/P file.
• Heading: Includes the entity under audit,
period being audited, and a descriptive
title.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
55
Working Paper Arrangement
and Indexing
W/P are grouped in order according to
financial statement captions.
– Each page in the file must have:
• Initials: from the auditor and the reviewer.
• Dates: of the preparation and review.
• Tick marks: to indicate the work
performed.
• Tick marks should be appropriately described.
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
56
Audit W/P Software
Specialized W/P software is becoming very
popular. Advantages include:
– increase in productivity by automating tasks
– integration with client database (extraction of
trial balance or transactions)
– facilitation of analysis, links to other
databases, and websites
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
57
Framework for Strategic
Analysis (Appendix 4A)
PEST analysis:
– Political factors
• Stability, tax policy, spending, international
– Economic factors
• Inflation, employment, interest rates, GNP
– Social and cultural factors
• Demographics, education, lifestyle, income
– Technological factors
• New developments, speed of technology transfer,
rate of obsolescence
Chapter 4
Copyright © 2003 McGraw-Hill Ryerson Limited
58
Porter’s Five Forces Model
(Appendix 4A)
New Entrants
Bargaining
power of
suppliers
Threat of
new entrants
Industry competitors
Suppliers
Firm
Intensity of rivalry
Threat of
substitutes
Chapter 4
Buyers
Bargaining power
of buyers
Substitutes
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59