Lecture Notes - Week 5 PDF

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Lecture Notes - Week 5...

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ACCG3040 Lecture Notes – Week 5 Audit evidence (ASA 500) Audit evidence is a fundamental concept in auditing by which the auditor achieves the objective of reasonable assurance that none of management’s assertions is materially misstated, and consists of: Underlying accounting data Books of original entry General and subsidiary ledgers Worksheets, schedules, calculations, etc. Related accounting manuals

All available corroborating information Documents (eg. cheques, authorisations for direct bank transfers, invoices, contracts, etc.) Confirmations and other written representations Information from inquiry, observations, inspection, and physical examination All other information obtained or developed by the auditor

The auditor is required to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion. Audit evidence is obtained from performance of:   

Risk assessment procedures Tests of controls (internal controls) Substantive testing (financial information – ie. $)

Sufficient and appropriate audit evidence (ASA 500.5)

Types of audit evidence Audit evidence can take several forms, including:   

Visual observations Documentary Oral

 

Physical Electronic

 

Written representations Analytical procedures results

Documentary evidence includes:   

Accounting records and supporting/source documentation Minutes of meetings Confirmations

Sources of audit evidence (ASA 500.A1 & A7-A9) Evidence can be:    

Created by external parties and transmitted directly to auditor Created by external parties and held by client Created and held by client Electronic documents

The nature and source of the evidence affect the level of assurance the auditor derives from the information.

Reliability of audit evidence Most reliable

Least reliable

Externally generated documents sent directly to the auditor Externally generated documents held by the client/entity Internally generated documents that are circulated externally Internally generated documents that are not circulated externally

       

Examples Cut-off bank statements Confirmations Supplier’s invoice Bank statement Receipted bank deposit slip Receipted shipping document Duplicate sales invoice Purchase requisition

Audit procedures (ASA 500.A14-A25) Audit procedures are methods and techniques used to obtain audit evidence:       

Enquiry Inspection (includes tracing and vouching) Observation External confirmation Re-calculation Re-performance Analytical procedures

These may be used as risk assessment procedures, tests of controls, or substantive procedures, depending on the context in which they are applied by the auditor (ASA 500.A11). Many of these procedures can be performed or facilitated through the use of generalised audit software (GAS).

Audit procedures: Enquiry

Enquiry consists of seeking information of knowledgeable persons, both financial and non-financial, within the entity or outside the entity. Evaluating responses to enquiries is an integral part of the enquiry process. 

For example: enquire of sales personnel concerning possible excess or obsolete inventory items to identify slow-moving, excess, defective, or obsolete items included in inventory

Audit procedures: Inventory and Observation Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset. 

For example: select a sample of inventory lines and compare with supplier’s invoices to ensure inventories are properly stated at cost

Observation consists of looking at a process or procedure being performed by other (limited to specific point in time). 

For example: observe inventory test counts by entity’s personnel

Audit procedures: External confirmation External confirmation represents audit evidence obtained as a direct written response to the auditor from a third party, in paper form, or by electronic or other medium. It is often performed in addressing/verifying account balances. Confirmations often obtained include: Information Cash at bank Accounts receivable Owned inventory on consignment / external warehouses Accounts payable Other loans / payables

Source Bank/s Customer/s Consignee / Warehouse Creditor Lender / financer

Audit procedures: Re-calculation and Re-performance Re-calculation consists of checking the mathematical accuracy of documents or records (manually or electronically). 

For example: multiplying inventory on hand by inventory cost price to check inventory valuation

Re-performance involves auditor’s independent execution of procedures or controls. 

For example: re-performing a sales transaction to ensure that the inventory control system correctly updates inventory levels

Audit procedures for obtaining audit evidence (ASA 500.A10)

(Substantive test of details, Substantive analytical procedures)

Tests of controls vs. Substantive procedures (ASA 330.4) Tests of controls are procedures designed to obtain audit evidence about the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. (Ie. evaluate a company’s internal controls) Substantive procedures are procedures designed to obtain audit evidence to detect material misstatements at the assertion level (provide direct evidence as to the fairness of management’s financial statement assertions), and consist of:  

Substantive analytical procedures Tests of details (transactions, balances, disclosures)

Substantive procedures Substantive analytical procedures involve the use of comparisons to assess fairness. 

For example: a comparison of an account balance with previous year’s balance or budgeted amount

Tests of details of transactions involve obtaining evidence of individual debits and credits posted to an account. 

For example: vouching debits in accounts receivable to entries in sales journal and supporting sales invoices

Tests of details of balances involves examining support for the closing balance directly. 

For example: confirming accounts receivable directly with customers

Substantive test of details of transactions

Auditing accounting estimates – including fair value (ASA 540) Some financial report items cannot be measured precisely, but can only be estimated, for example: 

Financial instruments, PPE when revaluation model used, inventory obsolescence, and various provision accounts (eg. doubtful debts, warranty, outcome of litigation)

Degree of estimation uncertainty affects risk of material misstatement. Auditor needs to obtain sufficient appropriate audit evidence to determine whether accounting estimates, including fair value estimates, are reasonable (and related disclosures are adequate).

The audit process

Auditor’s responses to assessed risks (ASA 330) Auditor determines overall response to address risk of material misstatement (RMM) at financial report level (ASA 330.5 & A1-A3). For example:  

Assigning more experienced staff/experts, providing greater supervision Incorporating unpredictability into selection of audit procedures

Auditor designs and performs further audit procedures whose nature, timing, and extent are responsive to risk of material misstatement at assertion level (ASA 330.6 & A4-A8), considering issues, for example:   

Significance of risk and likelihood of misstatement/s Presence and effectiveness of controls used by entity Clear linkage between significant risk, nature, extent, and timing of audit procedures

Audit procedures 

 

Nature purpose (TOC/ST) and type (inspection, recalculation, etc.) o Tests of controls (TOCs) – mandatory when reliance to be placed on effectiveness of identified mitigating controls (ASA 330.8) o Substantive tests (STs) – mandatory for all material accounts/disclosures regardless of assessed level of risk, or extent of TOC (ASA 330.18) o Substantive tests of detail – mandatory for significant risk accounts/assertions when substantive approach adopted (ASA 330.21) Extent of procedures (ie. sampling) o Function of materiality, assessed risk, planned level of assurance Timing o Auditor may perform TOCs or STs at interim date or period end o Higher risk of material misstatement  More effective to perform STs nearer to, or at, period end  More likely to perform audit procedures unannounced or at unpredictable times o Performing procedures before period end may facilitate identification and resolution of significant matters at early stage o Certain procedures can be performed only at, or after period end (eg. agreeing financial report to accounting records, examining adjustments made while preparing financial report)

Audit strategy/approach (ASA 330 A3-A4) The audit strategy/approach at the assertion level is determined by the assessment of IR and existence of relevant effective controls (CR).  

Combined approach: use both tests of controls and substantive procedures (relevant effective ICs identified) Substantive approach: emphasis on substantive procedures (generally where ICs absent/poor)

Auditor’s selection of audit approach

How expectations formed about ICs at the planning stage affect TOC

Selecting audit procedures The selection of audit procedures is influenced by the following factors:       

Auditor’s understanding of entity and environment Auditor’s assessment of business risk and inherent risk Nature of the inherent control structure and auditor’s assessment of control risk Materiality of components of financial report Experience gained from previous audits Results of other audit procedures Source/s and reliability of information available...