CH5 Audit Evidence Solutions - Auditing PDF

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Chapter 5 Solutions 5.12 The 'occurrence' assertion means that management are asserting that the income or expense shown in the income statement occurred, or the transaction increasing or decreasing an asset or liability or equity balance took place. The 'existence' assertion means that management are asserting that the asset or liability or equity item shown on the balance sheet exists. The assertions are similar because they both relate to management's claim that an item shown in the accounting records is a true reflection of an item or transaction in the real world.

5.14 Evidence is higher quality when it is more relevant and/or more reliable. Evidence is obtained by performing audit procedures. Auditors choose procedures which will give them reasonable assurance about management assertions at the transaction, account balance, or disclosure level. If auditors choose procedures to gather evidence about the occurrence assertion, the evidence is relevant to the occurrence assertion but will not be relevant to the completeness assertion. For example, the evidence shows whether recorded sales occurred, but not whether all sales that occurred are in the records. Therefore, the evidence is likely to be of high quality for the occurrence assertion, but low quality for the completeness assertion.

5.16 An auditor can ask a third party to confirm in writing the balance of an account recorded in the client's records. The auditor could use a confirmation as evidence of a client's account payable or account receivable. A confirmation request is generated by the auditor using the list of accounts in the client's records. That is, the auditor selects the items from the client' s records, and then sends the written request for confirmation to that third party. The assertion most at risk for debtors is existence; that is, does the account shown in the client's records as an amount owing to it by a third party really exist? The assertion most at risk for creditors is completeness; that is, are the accounts shown in the client's records as amounts owing to a third party a complete record of amounts owing by the client to others? Sending confirmation requests to any, or even all, of the creditors shown on the list presented by the client to the auditor will not address the completeness assertion (the auditor needs to discover if there are any payables NOT on the list). However, sending confirmation requests to debtors from the client's list is useful to the auditor because they want to discover if any of the debtors on the list do not exist. Therefore, confirmations are more likely to be used for receivables than payables because they will provide evidence about the assertion most at risk for receivables, but will not do so for payables.

5.18 The auditor can use an expert to provide sufficient, appropriate evidence when the auditor does not have the requisite skills and knowledge to assess the validity of an account or a transaction. The expert could be from within or external to, the audit firm. The auditor must decide if an expert is required and the scope of the work to be done by the expert. The auditor must assess the capacity of the expert to do the job and the expert's level of objectivity. The auditor

must assess the expert's completed work and draw a conclusion. Ultimate responsibility rests with the auditor. The auditor does not usually have the same level of expertise as the expert, but is able to assess the capacity and the objectivity of the expert based on their qualifications, experience, and association with the client. The auditor is able to make a judgement about the validity and usefulness of the expert's report based on their reading of the report and the consistency of the expert's conclusions with other evidence gathered during the audit. The expert should write the report in such a way that an auditor can understand the technical content of the report. This means that the expert should details each stage of the process used in arriving at the overall opinion or conclusion in the report. The auditor should be able to understand the process and how the expert reached the conclusion. The expert should explain the data sources or estimation models used or calculations conducted. The auditor would be able to check the data and re-perform the calculations. The auditor will assess the consistency of any assumptions made with those in prior years and with other known information. The auditor also assesses the consistency of the expert's report and conclusions with other information they have gathered about the client, and with other corroborating information gathered by the audit team.

5.19. What is the difference between recalculation and re-performance? Explain using examples.

Recalculation involves checking additions and computations. Re-performance means following a process used by a client. For example, reconciling the bank account in the client’s ledger with the bank account balance as per the bank records through preparing a bank reconciliation statement is a client process.

The auditor could re-perform the bank reconciliation by confirming the opening balance, tracing unpresented cheques and deposits in transit, and identifying fees, charges and other items that are on the bank statement, and ensuring that the bank ledger balance can be reconciled to the bank statement balance. Recalculation in this context would involve only checking the accuracy of the sub-totals and totals, such as the total of unpresented cheques. This means that re-performance is a more involved procedure than recalculation and produces more reliable and comprehensive evidence

5.20. Explain the difference between ‘occurrence’ and ‘existence’ assertions. How do both differ from ‘completeness’?

The ’occurrence’ assertion relates to transactions. For example, when management present a profit and loss statement they are asserting that the revenue shown in the statement occurred; the sales took place.

The ‘existence’ assertion relates to balance sheet items. For example, when management present a balance sheet they are asserting that the inventory shown on the balance sheet exists; the inventory is physically in the warehouse or otherwise under the client’s control. The occurrence and existence assertions are different because one relates to transactions occurring during the period and the other to balances of accounts at the end of the period.

The assertions are similar because they both relate to management’s claim that an item shown in the accounting records is a true reflection of an item or transaction in the real world. They are also both opposite to ‘completeness’. When management present the financial statements they are also asserting that

the accounting records are complete; there are no items or transactions in the real world that have been omitted from the accounting records.

5.21. Explain why a search for physical items in the client’s premises would be part of the test of the completeness assertion for fixed assets? The auditor will search the client's premises for physical items because the auditor is interested in whether all the physical items at the premises are properly reflected in the client's accounts. For example, the auditor will walk through the office and note how many pieces of furniture and equipment are physically present, then go to the accounting records to check if that number of items are recorded as assets in the appropriate accounts. This type of test is part of the test of completeness because the auditor is interested in whether the accounting records are complete. 5.22 How does inspecting a client’s tangible assets assist the audit of the existence assertion for fixed assets

5.24 Repairs and maintenance costs should be expensed, not capitalised. Only improvements to an asset should be capitalised. If a repair expense is mistakenly capitalised the profit for the period will be overstated and assets will be overstated. Therefore, management's assertion that expenses are complete will be incorrect and their assertion that assets exist will be incorrect. The reference in the board papers to the sale of machines during the year also suggests that the existence assertion for assets will be at risk because some assets shown in the balance sheet do not exist if the sale transactions were not processed correctly.

5.25 Inventory assertion most at risk for this client: valuation will be at risk because the special branding and promotional packaging will make it difficult for the client to sell these items after the promotional period ends, and the client will also find it difficult to return the items to the supplier. Evidence:

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Auditor should inspect the terms of the contract with suppliers to determine if there is any provision for return of items not sold.

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Inspection of inventory records to determine if any items are held for long periods, suggesting they could be obsolete.

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Physical inspection of inventory to search for out of date items (e.g. at back of shelves, dusty, branded with discontinued promotional material).

Other inventory assertions also at risk: Rights and obligations for inventory could also be at risk because some items may be held on consignment. That is, the ownership of the items remains with the supplier until the audit client sells them. If the items are not sold, the items have to be returned to the supplier. Because the items are not purchased, they should not be included in the client' s inventory.

Evidence:

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Auditor should inspect the terms of the contract with suppliers to determine if ownership passes to the client.

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Inspection of inventory records to determine if any items held on consignment are included in the inventory balance by mistake.

Existence of inventory is also at risk. Do all items shown in the inventory account exist? There is a risk that items shown as purchased from suppliers have not been received, and items sold have not been removed from inventory records. Evidence:

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Vouch items held in inventory to the suppliers invoices. Observe client stocktake, perform test counts, to obtain evidence that items shown in inventomy records are held by client.

Prepayments assertion most at risk for this client: Existence. Large deposits are paid when items of inventory are ordered. The payments are made 6 months in advance from overseas suppliers. There is a risk that orders are not completed and the prepayments shown in the accounts should be reversed, or that when orders are completed, the prepayment amount is not reversed when the balance of the account is paid to the supplier. In both cases, the prepayment account is at risk of overstatement and the assertion most at risk is existence. Evidence: e Auditor should inspect the terms of the contract with suppliers to determine the amount agreed as a prepayment and payment terms when contract is completed.

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All outstanding amounts in prepayments should be matched to unfilled contracts.

Completeness of prepayments is also at risk. There is a risk that amounts paid in advance to suppliers are not correctly recorded as prepayments (the amount is debited in error to expenses at the time of payment). Evidence:

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The auditor should inspect all outstanding contracts for supply of inventory to determine if amounts have been paid in advance and determine if they are recorded correctly in the accounts....