AUDITING
CHAPTER 6
Evidence
By
David N. Ricchiute
TOPICS
Acquisition & evaluation of evidence
Financial statement assertions, audit
objectives, & audit procedures
Tests of controls, substantive tests,
analytical procedures & nonfinancial
measures
Audit documentation
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GBW 8th ed., Ch. 6
AUDIT EVIDENCE
Sufficient competent evidential matter is
to be obtained through inspection,
observation, inquiries, and
confirmations to afford a reasonable
basis for an opinion regarding financial
statements under audit.
SAS 31 & SAS 80, Amendment to SAS 31.
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GBW 8th ed., Ch. 6
MEANING OF SUFFICIENT,
COMPETENT EVIDENCE
Sufficient: quantity of evident necessary
to test management’s assertions
Competent: relevant, valid, reliable
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Kinds of evidence necessary to test
management’s assertions
Link audit risk & audit evidence
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Relevance
Amount of evidence
GBW 8th ed., Ch. 6
EVIDENTIAL MATTER
Underlying accounting data
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Records of original entry (journals, ledgers,
etc.)
Data files
Spreadsheets
Corroborating information
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Documents (checks, invoices, contracts)
Written representations from 3rd parties
(vendors, attorneys)
Inquiries of management
GBW 8th ed., Ch. 6
FINANCIAL STATEMENT
ASSERTIONS
Existence or Occurrence
Completeness
Rights & Obligations
Valuation or Allocation
Presentation & Disclosure
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GBW 8th ed., Ch. 6
ACCOUNTS & JOURNAL
ENTRIES
Purchase & sale of inventory
Inventory
Accounts payable
Cost of Goods Sold
Inventory
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GBW 8th ed., Ch. 6
EXISTENCE OR
OCCURRENCE ASSERTION
All assets, liabilities, equities exist
All transactions occurred
Example
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Test whether inventory physically existed
at balance sheet date
GBW 8th ed., Ch. 6
COMPLETENESS
ASSERTION
All transactions that occurred during
period are reported for the time period
All accounts complete as to data
Examples
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Test whether all purchases goods, services
are recorded
Test whether all obligations included as
liabilities
GBW 8th ed., Ch. 6
RIGHTS & OBLIGATIONS
ASSERTION
Entity entitled to assets (rights)
Entity liable for obligations
Example
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Test whether all inventory is
owned, not on consignment
GBW 8th ed., Ch. 6
VALUATION OR
ALLOCATION ASSERTION
Assets, liabilities, equities, revenues,
expenses recorded at proper
amounts
Example

Test whether inventory valued at lower
cost/market
Revenues, costs, expenses allocated
to proper accounting periods
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GBW 8th ed., Ch. 6
PRESENTATION &
DISCLOSURE ASSERTION
Financial statement
components properly
classified, described &
disclosed
Example
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Test to assure financial
statements, notes reveal
substance of recorded
transactions
GBW 8th ed., Ch. 6
AUDIT PROCEDURES
Observation
Documentation
Confirmation
Mechanical tests
Analytical procedures (Comparisons)
Inquiries
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GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
OBSERVATION
Direct evidence
about existence
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Example: physically
observing client’s
assets
GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
DOCUMENTATION
Internal evidence in
documentary form to
support existence,
valuation
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Example: vouch documents
supporting selected cash
disbursements or liabilities
GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
CONFIRMATION
External evidence
from third parties
supporting
existence, valuation
of account balances
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Example: request
confirmation of
accounts receivable
GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
MECHANICAL TESTS
Direct evidence to support
valuation
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Example: recomputing (footing)
cash receipts journal
Direct evidence to support
presentation
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Example: trace transactions
through accounting system for
proper recording, classification
GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
COMPARISONS
Analytical procedures
(Comparisons)
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Direct evidence about
completeness, presentation,
disclosure
Example: examine trends for
advertising expense to
determine whether more
procedures necessary
Example: compare disclosures
with prior periods
GBW 8th ed., Ch. 6
RELATING OBJECTIVES TO
INQUIRIES
Direct evidence
although less
persuasive, may help
generate leads
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Corroborated through
other procedures
GBW 8th ed., Ch. 6
TESTS OF CONTROLS &
SUBSTANTIVE TESTS
Tests of controls
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Audit procedures to assess the ability of
controls to prevent or detect material
misstatements
Provide evidence about control risk
Substantive tests
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Audit procedures that detect material
misstatements
Provide evidence about detection risk
GBW 8th ed., Ch. 6
TESTS OF CONTROLS
Procedures address questions such as
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How are controls applied?
Are controls applied consistently?
By whom are controls applied?
GBW 8th ed., Ch. 6
TESTS OF CONTROLS &
CONTROL RISK
Tests of controls are procedures to
assess control risk
Assessed level control risk helps
determine acceptable level detection
risk
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GBW 8th ed., Ch. 6
CATEGORIES OF CONTROL
ACTIVITIES
Controls that create documentation, i.e.,
leave an audit trail
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Manager’s initials for credit approval
Prevention control
Controls that do not create documentation
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Bank reconciliation provides no evidence of
independence of preparer for cash function
Detection control
GBW 8th ed., Ch. 6
COMBINED SUBSTANTIVE
& CONTROL TESTS
Dual-purpose tests
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Provide evidence about control
risk & monetary error
Example: recomputing
extensions on sales invoices
GBW 8th ed., Ch. 6
SUBSTANTIVE TESTS
Tests of details
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Transactions
Balances
Analytical tests
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GBW 8th ed., Ch. 6
ANALYTICAL
PROCEDURES
Evaluations of financial information
made by a study of plausible
relationships among both financial and
nonfinancial data
SAS No. 56
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GBW 8th ed., Ch. 6
TESTS OF DETAILS v.
ANALYTICAL TESTS
Comparisons
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Tests of details tests all 5 assertions but
analytical procedures do not support
existence or rights & obligations
 Analytical procedures are high level tests
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Tests of details lead to conclusions about
aggregated data but analytical procedures
test aggregated data
GBW 8th ed., Ch. 6
USING ANALYTICAL
PROCEDURES
When
Purpose
Planning (required)
Directs attention to
likely misstatements
Substantive tests
Supports or refutes
account balances
Reviews
reasonableness
account balances
Overall review (required)
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GBW 8th ed., Ch. 6
TYPES ANALYTICAL
PROCEDURES
Trend analysis
Ratio analysis
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Activity ratios
Profitability ratios
Liquidity ratios
Solvency ratios
Modeling
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Statistical tests, i.e., regression
GBW 8th ed., Ch. 6
JUDGMENT ERRORS &
ANALYTICAL PROCEDURES
Over reliance on unaudited numbers
Disregard for unchanging account
balances
Overreliance on management’s
explanations
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GBW 8th ed., Ch. 6
CUSTOMER PERSPECTIVE
& SKEPTICISM
Issue
Professional skepticism
Time
Declining on-time delivery
rates
Quality
Increasing customer
complaints
Increasing customer
complaints
Performance
Cost
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Failure to be low-cost
provider
GBW 8th ed., Ch. 6
INTERNAL BUSINESS &
SKEPTICISM
Issue
Professional skepticism
Development
Failure to be first to market
Quality
Increasing defect rates
Productivity
Unfavorable price, quantity
variances
Employees fail certification exams
Core
competencies
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GBW 8th ed., Ch. 6
INTERNAL LEARNING &
SKEPTICISM
Issue
Professional Skepticism
Improved
performance
Poor performance against
industry best practices
Innovation
Lagging product development
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GBW 8th ed., Ch. 6
COGNITIVE BIASES IN
EVALUATING EVIDENCE
Heuristics: simplifying rules of thumb
that may bias decision making
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Representativeness
Availability
Anchoring-and-adjustment
GBW 8th ed., Ch. 6
COGNITIVE BIASES:
Representativeness
Given an item, b, and a class of items, A,
making a judgment based on how much
b resembles other items from class A
rather than making a judgment based
on the probability that b came from
class A.
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GBW 8th ed., Ch. 6
COGNITIVE BIASES:
Availability
The decision maker evaluates the
likelihood of a particular outcome based
on infrequent but highly publicized
outcomes rather than outcomes
predicted by the profession’s collected
experience.
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GBW 8th ed., Ch. 6
COGNITIVE BIASES:
Anchoring-and-Adjustment
The decision maker assesses likelihood of
an outcome with an initial, sometimes
biased probability estimate (anchor)
then adjusts the probability
insufficiently when discovering new
information.
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GBW 8th ed., Ch. 6
AUDIT DOCUMENTATION
ASB Standards
Auditor’s judgment about nature, extent
of documentation depends on
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Risk of misstatement
Judgment about audit work
Nature of procedures
Significance of evidence
Nature, extent of assertions tested
GBW 8th ed., Ch. 6
AUDIT DOCUMENTATION
PCAOB
Reviewability standard
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Derived from governmental standards
Documents sufficient for experienced
auditor to understand work performed,
when, why
Rebuttable presumption
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Absent documentation of audit work,
presumption that work not performed
GBW 8th ed., Ch. 6
AUDIT DOCUMENTATION
FILES
Correspondence (administrative) file
Permanent file
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Information of continuing interest &
relevance
Tax file
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Past, present, future income & property tax
obligations
GBW 8th ed., Ch. 6
ROLE OF AUDIT
DOCUMENTATION
Work was adequately planned,
supervised, and reviewed (1st standard
fieldwork)
Internal control considered as basis for
substantive tests (2nd standard
fieldwork)
Sufficient competent evidential matter
was obtained (3rd standard fieldwork)
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GBW 8th ed., Ch. 6
AUTOMATED
DOCUMENTATION
Spreadsheet software
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Analytical procedures, data
import/export, graphing, sorting
Database management
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Relational structuring: combining 2 or
more files for single query
Text retrieval
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Access & retrieve electronically stored
text
GBW 8th ed., Ch. 6