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5.17

Why does an auditor have to consider the persuasiveness of corroborating evidence? Explain.

Corroborating evidence is evidence that supports the client’s records in terms of accuracy. Corroborating evidence can be internally generated by the client, such as copies of documents, externally generated evidence held by the client, such as bank statements and supplier invoices, or externally generated evidence sent directly to the auditor, such as lawyers’ representation letters or debtors’ confirmations. The auditor must consider the persuasiveness of corroborating evidence to help them judge how much weight to place on each piece of evidence. The auditor needs to gather sufficient appropriate evidence about the assertions and the financial reports as a whole. If the evidence is very persuasive the auditor would need to gather less of it. If the evidence is not very persuasive the auditor might judge that there is not sufficient appropriate evidence to support their audit opinion, and try to gather more persuasive evidence. The most persuasive evidence, generally, is the externally generated evidence sent directly to the auditor, and the least persuasive evidence is, generally, the internally generated evidence. 5.23

Account balances at risk Whisk & Whim is a new client of Maidenhair Partners. Whisk & Whim is a lowcost cruise ship operator, travelling between Australia and five countries in South-East Asia. The planning for the first audit is underway. The auditors have become aware that police in two countries are investigating several Whisk & Whim employees for stealing food and other supplies from the ships’ kitchens and selling it at local markets. The police have charged ten cabin stewards of Whisk & Whim with theft and fraud. Required (a)What account balances are at risk? Explain. (b)What key assertions for the above accounts are likely to be affected?

Various supplies and asset accounts (food, alcohol, table linen, kitchen and restaurant equipment) are at risk of overstatement because items are missing because of theft – the existence assertion is at risk. The auditor should perform test counts and observe client stocktakes to determine if the accounts are overstated. Sales revenue could also be overstated (occurrence and accuracy assertions) if the employees have been covering their thefts by recording fictitious sales or overstating genuine sales. The auditor should investigate if there is documentation (either signed sales dockets or cash register records) to support the sales.

5.25

Assertions and evidence

The auditor is planning for the audit of a car accessories retail business. Inventory is material, and items range in value from $1 to over $500. The nature of the store means that many items are specially ordered with special branding and promotional packaging. Orders are placed six months in advance from overseas suppliers. Large deposits are required to be paid to suppliers when orders are placed. The auditor believes that the account balances for inventory and prepayments are at risk of material misstatement. Required (a) Identify the key assertions at risk in relation to inventory and prepayments. (b) For each assertion in (a), identify a type of evidence that would be persuasive. Inventory assertion most at risk for this client: accuracy, valuation and allocation 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:  Auditor should inspect the terms of the contract with suppliers to determine if there is any provision for return of items not sold.  Inspection of inventory records to determine if any items are held for long periods, suggesting they could be obsolete.  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:  Auditor should inspect the terms of the contract with suppliers to determine if ownership passes to the client.  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:  Vouch items held in inventory to the suppliers invoices.  Observe client stocktake, perform test counts, to obtain evidence that items shown in inventory 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 (the prepayment does not exist). Evidence:  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.  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:  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.

5.32

Revenue assertions 1 The audit program for the Revenue account for a client has been drafted. The following item appears:

Required (a) Does the procedure address the stated assertion? Explain. (b) If your answer to (a) is no, provide the correct assertion or explain what work would be required to address the assertion. (c) Explain what type of evidence is obtained by performing the stated procedure. How persuasive is it? (a) The completeness assertion relates to the claim by management that revenue shown in the profit and loss is a complete record of all revenue earned by the client. If the auditor tests the revenue that has been recorded in the accounts they are testing the occurrence assertion – that recorded revenue did occur, not the completeness assertion. (b) A more appropriate test of the completeness of revenue would be to select a sample of the delivery dockets or customer orders and trace the details to the revenue account. This test would detect any orders or deliveries of goods that were not subsequently invoiced to the customer and recorded as a debit to debtors and credit to sales. (c) The evidence obtained from the procedure described in the question is documentary evidence. The sales invoice is internally generated. The customer order is generated by a third party. The delivery docket that has been authorised by the customer is verified by a third party. The third party documents are more persuasive than internally generated documents.

5.33

Revenue assertions 2 The audit program for the Revenue account for a client has been drafted. The following item appears:

Required (a) Does the procedure address the stated assertion? Explain. (b) If your answer to (a) is no, provide the correct assertion or explain what work would be required to address the assertion. (c) Explain what type of evidence is obtained by performing the stated procedure. How persuasive is it? (a) The cut-off assertion relates to claims by management that sales revenue has been recorded in the correct accounting period. The risk is that sales revenue will be overstated by bringing items delivered in the first few days of the new financial year into the previous financial year. This can be done by backdating invoices to the last few days of the financial year for goods delivered in the first few days of the new year. The planned procedure to examine sales invoices in the last few days of the year to determine if the items were delivered prior to the end of the financial year will address the cut-off assertion. (b) The auditor should also examine invoices for the new year to determine if sales are recorded late. This test would address the completeness assertion for sales and provide additional evidence about cut-off for both periods. (c) The evidence is documentary evidence. The invoices and delivery dockets are internally generated by the client. The evidence that the client has accepted delivery (e.g. by signing the docket) is documentary evidence provided by a third party. The third party evidence is more persuasive than the internally generated evidence.

5.34

Revenue assertions 3 The audit program for the Revenue account for a client has been drafted. The following item appears:

Required (a) Does the procedure address the stated assertion? Explain. (b) If your answer to (a) is no, provide the correct assertion or explain what work would be required to address the assertion. (c) Explain what type of evidence is obtained by performing the stated procedure. How persuasive is it? (a) The test gathers evidence on whether the correct price is used to calculate the total sales price for the recorded sale. This addresses accuracy. (b) The auditor should also test the calculations and item numbers because items x price = sales, and the auditor is gathering evidence only about one part of the total sales amount. If the sales invoices are generated by computer, the test would include a test of the computer program and data. (c) All the evidence for the stated test comes from internal documents. This is only reasonably persuasive (more persuasive than verbal evidence from the client, but not verified by third parties). The auditor could increase the persuasiveness of the evidence by examining the authorisation controls for the sales price list (i.e. approval by management, control over sales price list files). Checking the calculations as suggested in (b) would provide computational evidence to increase persuasiveness.

5.36

Gathering evidence Ethan Edwards is a junior auditor who has just started with the team conducting the audit of a new client in the construction industry. Freya Jones is trying to teach Ethan about the benefits of getting to know the client. Freya is also trying to help Ethan develop experience in picking up subtle signals about the client’s problems and what the client might be trying to hide from the auditor. Ethan is getting a little frustrated with the time he is required to spend in training. He can’t understand why Freya is spending so much time talking to the client’s staff and touring the various construction sites and offices. When Freya is not doing this, she is working on a spreadsheet of the client’s previous financial report and unaudited interim data. Ethan wants to know when they are going to do some ‘real’ work and start gathering audit evidence. Freya tells Ethan that they have already started.

Required (a) Discuss Freya’s comment that they have already started the audit. What evidence have they gathered so far? (b) Explain what work is being done with the spreadsheets of financial data. Give some specific examples for this client. How is this type of work relevant to all stages of the audit? (c) When Freya is touring the client’s premises, she is taking notes of equipment and furniture items she sees, especially anything that looks either newly purchased or older and unused. Why might she be doing this? Explain. (a) Freya has been gathering the following types of evidence: 

Oral: Freya has been holding conversations with staff. During these conversations she will be discovering how they perform their duties, whether there are staff shortages in certain areas at various times, how management are communicating their attitudes towards control systems and profit targets, whether controls are overridden at various times.



Physical evidence: Freya has inspected physical assets of the company during her tours. She can see if assets exist, whether they are being protected, their condition, how they are used. For example, she can see if construction equipment appears to be new or well maintained. She can also observe staff performing their duties, both on the construction sites and in the offices.



Computational evidence: Freya is calculating ratios and reviewing the trial balance. She is looking for indicators of problems, such as unusual fluctuations, and whether the data appear to reflect the state of the business as described by management.

(b) The spreadsheets are reviewed to identify unusual patterns which could indicate problem areas for further investigation, and to calculate trends and ratios, including common size statements, to quantify the fluctuations. Freya will use the results of the analytical procedures to justify increased or decreased focus on specific areas, and the nature, timing and extent of further procedures. For this type of business Freya will be using the data to determine if profitability is comparable to previous periods and with other similar clients. She will analyse the specific movement of physical materials used in construction and whether this is consistent with the financial data. For example, if the quantities of physical materials delivered to a site are lower because of slower construction progress, is the cost of materials also lower? Is the progress of the build consistent with the use of labour and machinery? Is revenue recognised on building in progress consistent with the progress and cost of the construction? (c) Observing the assets during the tour provides a starting point for investigating the assertions of completeness (whether the items she observes are in the accounting records) and accuracy, valuation and allocation (whether the items appear to be in poor condition, and thus have impaired values). The older items or unused items are more likely to be obsolete and thus either impaired in value or scrapped from the accounting records. The newer items are more likely to be of higher value, but could also be not recorded in the accounting records. 5.38

Confirmation evidence

Discuss the strength and weaknesses of debtor confirmations as audit evidence for CMG. Debtor confirmations would provide evidence about the existence assertion for accounts receivable at CMG. If the debtor replies with an affirmative answer, they provide external evidence that they owe CMG for services rendered. Debtor confirmations also provide evidence about the rights and obligations assertion, because they give evidence about whether the amounts were owed to CMG companies. They do not provide reliable evidence about the accuracy, valuation and allocation assertion because the debtor does not provide any more assurance that they intend to pay the account, although they may note that there is an error in the account balance. The balance of receivables for Everfree is material, and although payment terms are 14 days, many of the smaller accounts are more than 60 days overdue. This suggests that procedures at Everfree for approval of credit and collection of debtors are not very effective. Debtors confirmations could be sent to the large balances (60% is owed by 5 medical practitioners) to obtain evidence about their existence. However, further procedures would be required to gather reliable evidence about their valuation. It is not stated how long these accounts have been outstanding. If they are within 14 days, it is less likely that there are significant doubts about their eventual recovery. However, a subsequent receipts review would provide additional evidence which would be necessary because of the material nature of the accounts. The smaller accounts, 40% of the balance, appear to be more likely to be in doubt because most are well over the allowed 14 days. Debtor’s confirmations would provide evidence about their existence, but other procedures would be required for the accuracy, valuation and allocation assertion. As the allowance for doubtful debts is taken directly against the trade receivables account, the auditor would need to review the transactions and assess their reasonableness in light of the apparently poor credit control. Subsequent receipts review and analysis of the characteristics of the debtors would also provide evidence about their valuation....