Rittenberg/Schwieger/Johnstone
Auditing: A Business Risk Approach
Sixth Edition
Chapter 5
Audit Evidence:
A Framework
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo,
and South-Western are trademarks used herein under license.
1
Overview
Auditing is a process of objectively gathering, evaluating,
and documenting the evidence needed to provide assurance
on the financial statements
In planning an audit, three questions need to be
answered:
 What audit procedures should be performed?
 How much evidence is needed?
 When should the audit procedures be performed?
The audit programs detail the auditor's plan to gather, evaluate,
and document evidence
2
Overview (continued)
The evidence gathering process is the core
of the audit; evidence is needed to
Reduce audit risk
Support the opinion
In deciding which evidence to gather, the
auditor considers
Risk associated with an account balance or
other measures of performance
Types of evidence available
Reliability of alternative sources of evidence
3
Third Standard of Fieldwork
Sufficient, competent evidential
matter is to be obtained through
audit procedures performed to
afford a reasonable basis for an
opinion regarding the financial
statements under audit
4
What is the assertion model?
The auditor gathers evidence to evaluate
the management assertions embodied in
the financial statements and individual
accounts
Existence or occurrence
Completeness
Rights and obligations
Valuation or allocation
Presentation and disclosure
5
Gathering Sufficient, Competent
Evidence
Because each audit is unique, there is no set amount
or type of evidence that must be gathered
When considering the best approach to gather
evidence, the auditor needs to consider factors
affecting the reliability of the financial data:
 Management integrity
 Client economic risk
 Quality of client's information system
 Client's control structure
 Current market conditions and competitor actions
6
The Steps in the Overall
Audit Process
1. Understand the client and
industry
2. Assess environment risk
3. Directly test transactions and/or
account balances
4. Assess adequacy of evidence
7
Sufficient, Competent Evidence
There are two dimensions to audit evidence: sufficient (quantity) and
competent (quality/reliability)
The relationship between these dimensions is inverse: if evidence is of
lesser quality, greater amounts must be collected (and vice versa)
When gathering evidence, auditors consider which procedures provide
the most reliable evidence in the most efficient manner
Reliability depends on the circumstances under which evidence is
gathered:
 Evidence obtained from independent outside sources is more reliable than
evidence obtained from the client
 Evidence obtained from auditor's direct knowledge is more reliable than evidence
obtained indirectly
 Evidence obtained from client with strong internal controls is more reliable than
evidence obtained from client with weak internal controls
8
Internal Documentation
Reliability varies with
Quality of client's internal controls
Management's motivation to misstate (fraud
potential)
Formality of the documentation including
acknowledgement by independent parties
Preparation of the document independently of
the accounting system and management
9
External Documentation
Generally considered highly
reliable
External documents provided
by a client should be viewed
more critically than documents
received directly from the
external party
10
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
11
The Nature of Audit Testing
When directly testing an account balance or
transactions, the auditor examines two
basic types of evidence
The underlying accounting data and records
Corroborating information that validates the
underlying accounting data
12
The Nature of Audit Testing
(continued)
Auditors have traditionally used direct tests
of year-end account balances, as opposed
to examining the transactions that make
up the account balance
Generally,
There are usually fewer items in the ending
balance than the number of underlying
transactions during the year
More reliable evidence usually exists for an
ending balance than for the underlying
transaction
13
The Nature of Audit Testing
(continued)
However, for many long term accounts
(assets, liabilities, owners' equity), the
auditor may focus on the transactions that
occurred during the audit period
For these accounts,
There are usually fewer transactions during
the year than items in the ending balance
Reliance forms of evidence are often
available
14
Audit Procedures
The procedures an auditor will use vary
according to the risks associated with the
client and the methods used to record
transactions.
Three major phases of the audit:
Preliminary planning and risk analysis
Understand and test system
Test account balances or other business
measurements
15
Audit Procedures: Preliminary
Planning and Risk Analysis
Review prior-year audit work
Review publicly available data
about the organization
Perform analytical procedures
Inquire of management and
employees
16
Audit Procedures: Understand
and Test the System
For all systems:
Inquire of management and employees
Review system documentation
Observe system in operation
Document system flow and control points
Select transactions and trace through processing
Additional work for computerized systems:
Test important computer controls
Use computer software to trace transactions through
system
Use software to select transactions for further
verification
17
Audit Procedures: Test Account
Balances or Other Business
Measurements
Direct tests of account balances:
Review authoritative records and documents
Examine client-retained documentation
Examine outside documentation
Examine electronic records
Testimonial evidence:
Inquire of client personnel
Inquire of and analyze responses from
outside parties
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Audit Procedures: Test Account
Balances or Other Business
Measurements (continued)
Auditor-generated evidence:
Direct observation
Perform re-computations
Reprocess transactions from source documents to
accounting records
Vouch transactions from accounting records back to
source documents
Physically examine assets
Perform analytical procedures
Each of these procedures has strengths and
weaknesses; the auditor's task is to determine
which procedures provide a sufficient level of
evidence with the least amount of audit cost
19
Directional Testing
(Audit Efficiency)
Directional testing: auditor tests for over- or
understatement, not both Increases audit
efficiency
Misstatements are more likely to occur in one direction
(assets and revenues overstated, liabilities and
expenses understated)
With directional testing, auditor uses procedures that
focus on the most likely misstatements
Vouching and reprocessing are examples of directional
tests
Can also provide evidence about complementary
accounts
Some management assertions are directional by nature
(existence addresses overstatement; completeness,
20
understatement)
Evidence-gathering Procedures
 Auditors use a variety of procedures to gather evidence
 For certain accounts or management assertions, certain procedures
may be more efficient or effective than other procedures
 When writing audit programs, the auditor tries to use those procedures
 The primary types of audit procedures include:
 Observation of client personnel and procedures
 Physical examination of assets
 Inquiry
 Confirmations
 Examination of documents
 Re-computation of data
 Reprocessing transactions
 Vouching transactions
 Analytical procedures
21
Evidence-gathering Procedures
(continued)
Observation of client personnel and
procedures
Most often used to gain an understanding of
client processing system
Also used to observe counting of physical
inventory
Limitations:
Intrusive and time-consuming
Employees know they're being watched and act
differently; this makes it difficult to generalize the
evidence obtained
22
Evidence-gathering Procedures
(continued)
Physical examination of assets
Useful in verifying existence of tangible
assets
May be useful in identifying potential
obsolescence or wear and tear
Does not provide evidence on completeness,
ownership, or proper valuation (except as in
item above)
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Evidence-gathering Procedures
(continued)
Inquiry
 Used extensively, especially early in the audit to gain an
understanding
 Efficient way to gather evidence
 Not considered persuasive, should be corroborated by other
sources of evidence
Confirmations
 Auditor sends letter to outside party asking them to verify client
information
 Considered strong evidence because they come from external
parties
 Limitations:
Respondents may not adequately check information being
confirmed
Respondents may not respond in a timely fashion
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Respondents may not challenge figures in their favor
Evidence-gathering Procedures
(continued)
Examination of documents
Much of the audit process involves examining
documents
Useful for evaluating all of the assertions
Auditor should establish document
authenticity in order to rely on it
Recalculation
Includes footing, cross-footing, tests of
extensions, re-computation
Often used to test accuracy of estimated
accounts and allowances
25
Evidence-gathering Procedures
(continued)
Test of transactions involve reconciling source
documents with recorded accounting information
Reprocessing
Select sample of source documents and reprocess
them to make sure they have all been properly
recorded
Includes reviewing journalizing and posting of the
transaction
Helps establish completeness (all valid items have
been recorded)
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Evidence-gathering Procedures
(continued)
Vouching
Reverse of reprocessing
Select sample of already recorded transactions and
trace back to the underlying source documents
Helps establish that recorded transactions are valid
(existence)
Analytics
Compare recorded account balances (or ratios of
balances) to expectations developed by the auditor
Sources used to develop these expectations include
client's prior period information, industry data,
expected results
27
Timing of Audit Procedures
In addition to what procedures to perform, the
auditor must also decide when to perform
them
As of the balance sheet date
After the balance sheet date
Before the balance sheet date (interim testing)
Advantages of interim testing:
Audit may be completed, and statements
distributed, sooner
Typically means less overtime for audit staff
28
Timing of Audit Procedures
(continued)
Disadvantages of interim testing:
Risk of material misstatement between
interim date and year-end
Interim testing is feasible:
When client has strong internal controls
When there is low probability of significant
change in account balances between interim
work and year-end
For accounts in which the auditor focuses on
tests of transactions rather than the year-end
balance (example: non-current assets)
29
The Extent of Audit Procedures
In addition to deciding what procedures to perform
and when to perform them, the auditor must also
decide how much evidence is needed
The extent of testing is affected by:
Auditor's assessment of the risk of account balance
misstatement
Amount of misstatement considered material
Persuasiveness of alternative forms of evidence
The amount of evidence may also be influenced by
the auditor's individual risk preferences
30
What are audit programs? (1)
Audit programs specify the audit objectives
and procedures used to gather, document,
and evaluate evidence
Audit programs guide the conduct of the
audit and provide an effective means for:
Organizing and distributing audit work
Monitoring the audit process
Recording audit work performed
Reviewing the audit procedures performed
and evidence gathered
31
What is documenting audit
evidence?
The audit work papers include all forms of
documentation including:
Evidence of planning, including audit programs
The client's trial balance and any auditor adjustments
Copies of selected internal and external documents
including confirmation and representation letters and
abstracts of company documents
Schedules prepared or obtained by the auditor
Auditor memos
Results of analytical procedures and tests of client
records
Auditor analysis of account balance
32
What are audit programs? (2)
The work papers are the primary evidence in
support of audit conclusions and should cover all
relevant audit work, support the audit report, and
leave no significant points unresolved
The work papers aid in the conduct and
supervision of the work, facilitate performance of
an effective review, demonstrate adherence to
professional and Firm auditing standards and
procedures, and assist in planning the following
year's audit
33
Characteristics of Good Audit
Documentation
Well-developed audit documentation contains:
A heading that includes client name, explanatory title,
and balance sheet date
Initials of the auditor who prepared the documentation
and date completed
Initials of the reviewer and date review completed
Description of the tests performed and the findings
Assessment of whether tests indicate material
misstatement in an account
Tick marks and legend indicating work performed by
the auditor
Index to identify the location of papers
Cross-reference to related documentation, when
applicable
34
Importance of Quality Review
Audits of corporations subject to SEC
regulation must be subjected to a
concurring partner review before the audit
report is issued
The concurring partner should not be
involved in the audit, but should have
knowledge of the client's business and
industry
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