Audit Evidence Chapter 7

Learning Objective 1

• Contrast audit evidence with evidence used by other professions.

EVIDENCE: any information used by the auditor to determine whether the information being audited is stated in accordance with the established criteria.

Nature of Evidence

• The use of evidence is not unique to auditors
• Evidence is also used by scientists, lawyers, and historians

All use evidence to help them draw conclusions.

Learning Objective 2

• Identify the four audit evidence decisions that are needed to
•  Create an audit program.

Audit Evidence Decisions

About what evidence to gather and how much of it to accumulate.

1. Which audit procedures to use

Detailed instruction that explains the audit evidence to be obtained during the audit.

2. What sample size to select for a given procedure

Vary the sample size from one to all the items in the population being tested.

3. Which items to select from the population

Methods can be used to select the specific items to be examined.

4. When to perform the procedures (timing)

Vary from early in the accounting period to long after it has ended. In part, the timing decision is affected by when the client needs the audit to be completed.

Audit Program

It includes a list of the audit procedures the auditor considers necessary.
-Sample sizes
-Items to select
-Timing of the tests

Most auditors use computers to facilitate the preparation of audit programs.

Learning Objective 3

• Specify the characteristics that determine the persuasiveness of evidence.

Persuasiveness of Evidence
* Appropriateness

Is a measure of the quality of evidence, meaning its relevance and reliability in meeting audit objectives

Selecting audit procedures that Are relevant to the audit objective that the auditor is testing

When the auditor traced from the duplicate sales invoices to related shipping documents, the evidence was relevant for the occurrence transaction objective tracing from shipping documents to sales invoices, the auditor can determine whether shipments have been billed to customers. Relevant for completeness.
*Sufficiency

The quantity of evidence obtained determines its sufficiency.

Six Characteristics of Reliable Evidence

Refers to the degree to which evidence can be believable or worthy of trust

1. Independence of provider

Evidence obtained from a source outside the entity is more reliable than that obtained from within.

2. Effectiveness of client’s internal controls

When a client’s internal controls are effective, evidence obtained is more reliable than when they are weak.

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 evidence must be qualified.
5. Degree of objectivity
Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. The qualifications of the person providing the evidence in subjective evidence.
6. Timeliness
Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the balance sheet date as possible for income statement accounts, evidence is more reliable if there is a sample from the entire period under audit, such as a random sample of sales transactions for the entire year

Persuasiveness and Cost

• In making decisions about evidence for a given audit, both persuasiveness and cost must be considered.
• The auditor’s goal is to obtain a sufficient amount of appropriate evidence at the lowest total cost.

Learning Objective 4

—Identify and apply the eight types of evidence used in auditing.

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

The most reliable and useful types of audit evidence

-  It is the inspection or count by the auditor of a tangible asset.

-This type of evidence is most often associated with inventory and cash.

Verifying that an asset actually exists (existence objective) verifying existing assets are recorded (completeness objective).

Confirmation

The receipt of a direct written response from a third party verifying the accuracy of information that was requested by the auditor

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 Liabilities	Bank Customer Maker Consignee Public warehouse Insurance company Investment custodian
Accounts payable Notes payable Advances from customers Mortgages payable Bonds payableOwners’ Equity	Creditor Lender Customer Mortgagor Bondholder
Shares outstanding Other Information	Registrar and transfer agent
Insurance coverage Contingent liabilities Bond indenture agreements Collateral held by creditors	Insurance company Bank, lender, and client’s legal counsel Bond holder Creditor

Documentation

Internal document has been prepared and used within the client’s organization and is retained without ever going to an outside party. Internal documents include duplicate sales invoices,

employees’ time reports, and inventory receiving reports

External document has been handled by someone outside the client’ s organization who is a party to the transaction being documented, but which are either currently held by the client or readily accessible

Vendors’ invoices, cancelled notes payable, and insurance policies

•External one is more reliable than Internal documents

•Internal documents created and processed under effective internal control is more reliable than conditions of weak internal control

•Original documents are considered more reliable than photocopies or facsimiles.

When auditors use documentation to support recorded transactions or amounts, the process is often called vouching.

Analytical Procedures

Use comparisons and relationships to assess whether account balances or other data appear reasonable compared to the auditor’s expectations.

- Understand the client’s industry and business (highlighted any changes)

- Assess the entity’s ability to continue as a going concern (assess the likelihood of failure)

- Indicate the presence of possible misstatements in the financial statements

- Significant unexpected differences. Unusual fluctuations

- Reduce detailed audit tests

Analytical procedure reveals no unusual fluctuations; this implies the possibility of a material misstatement is minimized. Perform fewer detailed tests

Inquiries of the Client

It is the obtaining of written or oral information from the client in response to questions from the auditor.

Recalculation

It involves rechecking a sample of calculations made by the client.

Reperformance

It is the auditor’s independent tests of client accounting procedures or controls that were originally done.

Observation

It is the use of the senses to assess client activities.

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

Terms and Types of Evidence

Terms	Type of Evidence
Examine Scan Read Compute Recomputed Foot Trace Compare Count Observe Inquire Vouch	Documentation Analytical procedures Documentation Analytical procedures Recalculation Recalculation Documentation/Reperformance Documentation Physical examination Observation Inquiries of client Documentation

Learning Objective 5

• Understand the purposes of audit documentation.

Working papers

Audit Documentation

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

A Basis for Planning the Audit
a Record of the Evidence Accumulated and the Results of the Tests
Data for Determining the Proper Type of Audit Report
A Basis for Review by Supervisors and Partners T

-Ownership of audit files

Is the property of the auditor.

-Confidentiality of audit files

Care must be taken to safeguard the audit files at all times.

Learning Objective 6

—Prepare organized audit documentation.

Permanent Files

These files are intended to contain data of a historical or continuing nature pertinent to the current audit.

Current Files

-  Audit program

- General information

- Working trial balance

Listing of the general ledger accounts and their year-end balances.

- Adjusting and reclassification entries

summarize all entries that have not been recorded in a separate audit schedule as a means of assessing their cumulative effect.

- Supporting schedules

include all audit documentation applicable to the year under audit.

Schedules prepared by the client or the auditors in support of specific amounts on the financial statements

Types of Supporting Schedules

- Analysis

- Trial balance or list

- Reconciliation of amounts

- Tests of reasonableness

- Summary of procedures

- Examination of supporting documents

- Informational

-  Outside documentation

Preparation of Audit Documentation

- Each audit file should be properly identified

- Documentation should be indexed and cross-referenced

- Completed documentation must clearly Indicate the audit work performed

- It should include sufficient information

- It should plainly state the conclusions reached

Learning Objective 7

— Describe how technology affects audit evidence and audit documentation.

Effect of Technology

- Audit evidence is increasingly in electronic form

- Auditors must evaluate how electronic information affects their ability to gather evidence

- Auditors use computers to read and examine evidence

- Software programs are typically Windows-based