Uploaded by YK Lee

Seminar 4 Materiality doc CAAT Evidence

ACC3603 Assurance & Attestation
Seminar 4:
Audit Documentation,
Audit Evidence
Ms Chu Mui Kim
Seminar 4: Learning Outcomes
4.1 Explain and apply materiality.
4.2 Understand the purpose of documentation
4.3 Identify and explain the types of Computer-Assisted
Audit Techniques (CAATs)
4.4 Understand the nature of audit evidence & explain
the sufficiency and appropriateness of evidence.
4.5 Evaluate the reliability of evidence.
4.6 Explain the different types of audit procedures
4.1 Materiality
• Misstatements, including omissions, are considered to be material
if they, individually or in the aggregate, could reasonably be
expected to influence the economic decisions of users taken on
the basis of the financial statements;
• Judgments about materiality are made in light of surrounding
circumstances, and are affected by the size or nature of a
misstatement, or a combination of both; and
The concept of materiality is applied by the auditor in
performing the audit
evaluating the effect of identified misstatements on the audit and
of uncorrected misstatements, if any, on the financial statements
• forming the opinion in the auditor’s report.
Materiality in planning
In planning the audit, the auditor makes judgments about
the size of misstatements that will be considered material.
These judgments provide a basis for:
• Determining the nature, timing and extent of risk
assessment procedures;
• Identifying and assessing the risks of material
misstatement; and
• Determining the nature, timing and extent of further
audit procedures.
Determining Materiality during planning
Two types of materiality:
• Materiality for financial statements as a whole
• Performance materiality
Determine materiality for FS as a whole
Determining materiality involves the exercise of
professional judgment.
A percentage is often applied to a chosen benchmark as a
starting point in determining materiality for the financial
statements as a whole
Determining Materiality during planning
Materiality for financial statements as a whole
Examples of benchmarks that may be appropriate,
depending on the circumstances of the entity, include
categories of reported income such as profit before tax,
total revenue, gross profit and total expenses, total equity
or net asset value.
Profit before tax from continuing operations is often used
for profit-oriented entities. When profit before tax from
continuing operations is volatile, other benchmarks may be
more appropriate, such as gross profit or total revenues.
Determining Materiality during planning
Materiality by nature
Certain items in the accounts
require “precision” regardless
of their financial value.
• Omission of a disclosure
required by Companies Act or
financial reporting standards;
Therefore, any error (however
small) in respect of these items
would be considered material
and must be adjusted.
• Items which are misstated in
the accounts such as those
linked to fraud and illegal acts;
• Items which involve the
directors or which are legally
required such as share capital.
Qualitative Materiality Factors
Determining Materiality during planning
SSA 320 says that as well as setting materiality for the financial
statements as a whole, it may be necessary to do so for a particular
balance or class of transactions as well.
Performance materiality
“the amount or amounts set by the auditor at less than materiality for
the financial statements as a whole to reduce to an appropriately low
level the probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial statements as a
Performance materiality must be less than materiality for the financial
statements as a whole. Some audit firms have set as a guide that
performance materiality should be no more than 70-75% of materiality
for the financial statements as a whole. It must be a smaller number
because auditors must consider the effect of aggregated errors.
Determining Materiality during planning
Determining performance materiality
The determination of performance materiality is not a
simple mechanical calculation and involves the exercise of
professional judgment.
It is affected by the auditor’s understanding of the entity,
updated during the performance of the risk assessment
procedures; and the nature and extent of misstatements
identified in previous audits and thereby the auditor’s
expectations in relation to misstatements in the current
Determining Materiality during planning
Another example of performance materiality relates to the
testing of director remuneration. Something may be
considered material not just because of its value but also
because of its nature.
Director remuneration is a very sensitive area because any
money that the directors choose to pay themselves
reduces distributable profits.
Therefore performance materiality may be set as $1 so that
every transaction, no matter how low in value, would be
tested by the auditors.
Activity 4.1
Your firm is the auditor of four companies.
(a) For the audit of each of the company described below:
(i) Suggest and explain a suitable benchmark; and
(ii) Calculate the materiality for the financial statements as a whole.
(16 marks)
(b) During the year, you discovered that Beta had taken up a significant bank loan
and one of the terms in the loan covenant requires Beta’s debt to equity ratio to be
below 1:1 at all times.
(i) Describe how your materiality for the financial statements as a whole would be
(3 marks)
(ii) Explain what your assessment of financial statements assertions at risk of Beta
for the year ended 31 March 20x6 would be.
(6 marks)
Activity 4.1
Alpha is an established family-owned business with no external borrowings and its
business is in property investment. Over the years, its investment portfolio has
grown to include a sizeable amount of assets. Due to government’s measures to
stabilize the property market, its earnings have been flat in the past three years.
For the 12 months ended 31 December 20x5, its financial information is as follows:
Profit before tax
Profit after tax
Net assets
Total assets
Activity 4.1
Beta is a small listed company with significant amount of bank borrowings. It
operates a fleet of private yachts for corporate charter and business has been brisk
for the company as demand for private sea-charter had been increasing steadily
over the past few years.
For the 9 months ended 31 December 20x5, its financial information is as follows:
Profit before tax
Profit after tax
Net assets
Total assets
Activity 4.1
Gamma specialises in providing food catering services and is owned by a husband
and wife team with no external borrowings. For the 12 months ended 31
December 20x5, the owners, Mr. and Mrs Lim, had withdrawn an amount of $1.2
million from the business earnings in the form of salary, instead of dividends.
For the 12 months ended 31 December 20x5, its financial information is as follows:
Profit before tax
Profit after tax
Net assets
Total assets
Activity 4.1
Omega is a large family-owned business providing marine services to the oil and
gas companies. Due to the significant decline in oil prices, Omega faced a series of
cancelled and postponed contracts so earnings have been on the decline over the
past three years. It is in desperate need for capital injection from venture
For the 12 months ended 31 December 20x5, its financial information is as follows:
Profit before tax
Profit after tax
Net assets
Total assets
4.2 Audit Documentation
Audit documentation that meets the requirements of SSA
230 and the specific documentation requirements of other
relevant SSAs provides:
• Evidence of the auditor’s basis for a conclusion about
the achievement of the overall objectives of the auditor;
• Evidence that the audit was planned and performed in
accordance with SSAs and applicable legal and
regulatory requirements.
Purposes of Audit Documentation
Audit documentation serves a number of additional purposes,
including the following:
• Assisting the engagement team to plan and perform the audit.
• Assisting members of the engagement team responsible for
supervision to direct and supervise the audit work, and to
discharge their review responsibilities.
• Enabling the engagement team to be accountable for its work.
• Retaining a record of matters of continuing significance to future
• Enabling the conduct of quality control reviews and inspections.
• Enabling the conduct of external inspections in accordance with
applicable legal, regulatory or other requirements.
Types of Audit Documentation
Audit working papers are collected in the current audit file and the
permanent audit files.
Current audit file
For each annual audit assignment, the working papers are collected in the
current audit file. The file shows all of the work that was done throughout
the audit process and includes:
• a planning section;
• sections for each area of financial statements showing the work that was
done; for example, audit procedures performed on inventory, bank
balances etc;
• a completion section showing the final task carried out at the end of the
audit, including a schedule of points for manager’s and partner’s
attention and a schedule of points for next year’s audit.
Types of Audit Documentation
Permanent audit file
Information that is of continuing use to the audit year-on-year is kept
on the permanent file and includes the following items:
• the engagement letter;
• organisational charts that show the company’s organizational
structure and key employees;
• system flow charts;
• company’s Articles of Association and Memorandum; and
• long term agreements such as loan agreements, lease agreements
Types of Audit Documentation
Good documentation includes:
• Enough details to allow reader to understand audit
process & reperform tests
• Initials of audit staff who performed work & of review
by team leader, manager & partner
• Use of appropriate tick marks & legends
• Index to identify location of work done on specific
accounts & procedures
• Proper cross-referencing of related data & transactions
4.3 CAATs
Many of the concepts applicable to manual systems hold for
computerised systems.
The auditor will want to:
• Gain assurance that the processes and computer programs are
working correctly
• Trace transactions through the processing system to determine
that transactions have been correctly processed
• Select transactions for more detailed testing and analysis
Types of commonly used CAATs:
• Integrated test facility
• Tagging and tracing (tracing transactions through the system)
• Generalized audit software
Integrated Test Facility
Test the application controls in the client’s computer programs by
creating a set of simulated data (includes both valid and invalid
data) for processing.
Test data are developed to determine whether:
• Control procedures built into the applications are functioning
• The computer application is processing transactions correctly
• All transactions and master files are fully and correctly updated
• Only test application controls and do not test if the company has
adequate controls to prevent submission of unauthorised or
incorrect data.
Tagging and testing: Tracing transactions through the
• A transaction is selected at the input stage and is electronically
• The transaction is then electronically tracked through processing
• This allows the auditor to determine whether the transaction has
been properly recorded and that the correct files have been
– Works concurrently with client's processing of regular
– Flexible: auditor is able to select transactions to "mark"
– Can be used to track transactions through distributed processing
Generalised audit software
Designed to read existing computer files and perform function such
• Footing a file
• Selecting a sample ‐ either statistically or judgmentally
• Extracting, sorting, and summarizing data
• Obtaining file statistics
• Evaluating statistical sample results
• Perform analytical procedures
• Finding how many transactions or population items meet
specified criteria
• Checking for gaps in processing sequences
• Checking for duplicates
• Performing arithmetic calculations
• Analyzing data files for unusual patterns
Generalised audit software
The most widely used of all computerized audit
Allows auditors to perform a variety of procedures
– Analyzing files
– Selecting transactions based on logical identifiers
– Scanning accounts for unusual entries
– Selecting statistical samples
– Performing basic and advanced numerical analysis
– Creating reports
Audit approaches for E-commerce
Audit of entity using E‐Commerce follows basic audit
approach; auditor must understand business processes,
important applications, control environment, and risks
Risk analysis
• Risks in common with traditional information systems:
o Unauthorized access
o Unauthorized changes to programs or data files
o Misstatements caused by processing or logic errors
o Lack of physical security
Audit approaches for E-commerce
Risk analysis
• Risks unique to E‐Commerce systems
o Security of system and protection against
penetration by outsiders
o Integrity of processing may be threatened by many
different sources
o Integrity of data communications
o Trading partner agreements
o Systems interdependencies
o Paperless systems coupled with "soft" controls
Audit approaches for E-commerce
Process and Control Audit
• Audits of E‐Commerce will focus on tests of controls
and processes
• Auditor develops understanding of controls and
approach to determine that controls are working
Tagging and Tracing
• Tagging is more complicated than process identified
earlier in chapter
• Auditor must work with IT to develop logic
Activity 4.2
Select the audit procedures from the following list and enter it in the appropriate
place on the grid.
Audit procedures:
1. Test data method
2. Custom audit software
3. Auditing around the computer
4. Generalized audit software
Description of audit technique
a. program written by the auditor to compute the
depreciation charge for a particular client
Audit procedure
b. audit the inputs and outputs of the system without
verification of the processing of data
c. process fictitious and real data through the client’s IT system
d. select receivables with balances that exceed a certain
criteria and prepare confirmation letters.
4.4 Audit evidence: Nature
SSA 500 Audit evidence
Information used by the auditor in arriving at the conclusions on
which the auditor’s opinion is based.
Audit evidence includes both information contained in the
accounting records underlying the
financial statements and other
The auditor gathers evidence to
evaluate the management assertions
underlying the financial statements.
4.4 Audit evidence: sufficiency and appropriateness
The auditor should obtain sufficient appropriate audit evidence to be
able to draw reasonable conclusions on which to base the audit
Sufficiency of audit evidence refers to the measure of the quantity
of audit evidence to be obtained by the auditor to meet audit
It is affected by
• the auditor’s assessment of the risks of misstatement (the higher
the assessed risks, the more audit evidence is likely to be
required) and
• the quality of such audit evidence (the higher the quality, the less
may be required).
Audit evidence: sufficiency and appropriateness
Appropriateness of audit evidence is the measure of the quality of
audit evidence; that is, its relevance and its reliability in providing
support for the conclusions on which the auditor’s opinion is based.
• The reliability of evidence means that the evidence must be
• The relevance of evidence means that the evidence must be
related to assertion tested..
Auditors often rely on persuasive rather than convincing evidence,
– Audit must be completed within reasonable time/cost, hence only
test on sample basis.
– Evidence obtained may not be perfectly reliable.
4.5 Factors affecting reliability of evidence
• Audit evidence from independent external sources is more reliable than
that obtained from the entity’s records.
• Audit evidence obtained from the entity’s records is more reliable when
the related accounting and internal control system operates effectively.
• Evidence obtained by auditors is more reliable than that obtained by or
from entity.
• Evidence in the form of documents and written representations is more
reliable than oral representations.
• Original documents are more reliable than photocopies, telexes or
• Evidence created in the normal course of business is better than
evidence specially created to satisfy the auditor.
• Evidence about the future is particularly difficult to obtain and is less
reliable than evidence about past events
Paper vs Electronic documentation
Major challenge for auditors to determine which
electronic data is reliable.
Computer systems can be designed to provide safeguards
similar to paper‐based systems.
If auditor is going to rely on electronic data, he/she must
develop an understanding of the
– Client's computer system
– Controls used to safeguard electronic data from
manipulation or destruction
4.6 Audit procedures to obtain audit evidence
• Inspection of records refers to examination of records or
documents that provide evidence of varying degree of reliability
depending on the source of audit evidence and the internal
controls over their processing.
• Inspection of tangible assets refers to examination of tangible
assets that provide evidence on the existence and condition of
the assets.
• Reperformance requires the auditor to carry out the process or
procedures being performed by others.
• Recalculation is performed when the auditor checks the
arithmetical accuracy of source documents and accounting
records, and investigate unusual items or fluctuations.
Audit procedures to obtain audit evidence
• Inquiry refers to seeking information from knowledgeable persons
inside or outside the entity, such as enquiring about sale of old
inventories from sales managers; enquiring about store operations
from store supervisor.
• Observation requires the auditor to look at the process or
procedures being performed by others., such as attending wages
payout, attending stock takes.
• Confirmation requires the auditor to obtain a written response to
an audit inquiry from persons outside or within the entity to
support information contained in accounting records.
• Analytical procedure (refer to Seminar 3)
• Scanning
Activity 4.3
For each of the following specific audit procedures, indicate the type of audit
procedure it represents: (1) inspection of records or documents; (2)
inspection of tangible assets; (3) reperformance; (4) recalculation; (5)
scanning; (6) inquiry; (7) observation; (8) confirmation; and (9) analytical
a. Sending a written request to the client’s customers requesting that they
report the amount owed to the client.
b. Examining large sales invoices for a period of two days before and after
year-end to determine if sales are recorded in the proper period.
c. Agreeing the total of the accounts receivable subsidiary ledger to the
accounts receivable general ledger account.
d. Discussing the adequacy of the allowance for doubtful accounts with the
credit manager.
Activity 4.3
e. Comparing the current-year gross profit percentage with the gross profit
percentage for the last four years.
Examining a new plastic extrusion machine to ensure that this major
acquisition was received.
g. Watching the client’s warehouse personnel count the raw materials
h. Performing test counts of the warehouse personnel’s count of the raw
Obtaining a letter from the client’s attorney indicating that there were no
lawsuits in progress against the client.
Tracing the prices used by the client’s billing programme for pricing sales
invoices to the client’s approved price list.
k. Review the general ledger for unusual adjusting entries.
Reliability of Audit procedures (general guidelines)
Activity 4.4
Q1. Which of the following would be the most persuasive type of evidence?
a. Check register
b. Bank statement
c. Observation of assets
d. Inquiry with the in-house attorney
Q2. Which of the following would be the least persuasive type of evidence?
a. Confirmation returned by bank directly to the auditor
b. Letters of communication from the Securities Exchange Commission
c. Physical examination of inventory
d. General ledger in a newly developed information system
Activity 4.4
Q3. An audit junior assigned to the audit of accounts receivable balances of
Recall Pte Ltd has obtained the following audit evidence:
i. Aged receivable report performed by the accounts receivable staff.
ii. Accounts receivable confirmation.
iii. Verbal confirmation from the Chief Finance Officer that all
transactions relating to accounts receivable balances have been
iv. Comparison of accounts payable turnover days with prior year done
by audit senior.
Rank the order of reliability of the audit evidence starting with the most
reliable first.
a. ii, iv, i, iii.
b. iv, ii, i, iii.
c. ii, i, iv, iii.
d. i, iii, ii, iv.