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Audit Evidence
Audit Evidence gives the guideline to Auditor to design & perform audit procedures in such a
way that it enables auditors to:
Substanstive Procedure:
- Analytical Procedure
- Tests of detail of transactions, account balances & disclosures.
ISA 330 also requires that, whatever level of substantive procedures are carried out
the auditor must carry out the following procedures:
1. Transactions:
o Occurrence — the transactions actually took place
o Completeness — all transactions that should have been recorded have
been recorded
o Accuracy — the transactions were recorded at the appropriate
amounts
o Authorization — all transactions were properly authorized
o Cutoff — the transactions have been recorded in the correct
accounting period
o Classification — the transactions have been recorded in the proper
accounts
2. Accounts balances:
o Existence — assets, liabilities and equity balances exist
o Rights and Obligations — the entity holds or controls the rights to its
assets and owes obligations to its liabilities
o Completeness — all assets, liabilities and equity balances that should
have been recorded have been recorded
o Valuation and Allocation — assets, liabilities and equity balances are
included in the financial statements at appropriate amounts and any
resulting valuation or allocation adjustments are appropriately
recorded.
Directorial Testing:
Analytical Procedure:
1. prior periods
2. budgets
3. forecasts
4. similar industries and so on.
Example Question:
You are part of the audit team auditing the financial statements of Sweep Co, a
small office supplies business, for the year ended 31 March 20X9. The company
employed the following staff at the start of the financial year: 7 office and
warehouse managers, 20 warehouse staff and 25 office staff.
You have been asked to audit the wages and salaries expense for the year. All staff
were given a 4% pay rise in the year, backdated to the start of the year. One of the
office managers left the company part-way through the year. There were two new
members of warehouse staff and three new members of office staff. The expense
for the year is shown in the draft income statement as $1,249,450.
Required
Using analytical procedures, perform a proof in total on the wages and salaries
expense for the year.
Answer
An expectation of the charge for the year can be developed using the information
provided and compared to the charge in the draft income statement to assess its
reasonableness.
Managers
$287,300
Total average salary for year (i.e. 40, exclude starters): $1,006,200
$1,062,100
Difference: 8%
The difference between the expected total and the expense in the draft income
statement is 8%. The auditor needs to consider whether this is acceptable in light
of materiality for the financial statements as a whole and performance materiality
and the risk of material misstatement and whether further explanations from
management may be necessary.
Accounting Estimate
Inventory Obscolescence.
Warranty Obligation.
Depriciation method or useful life.
Provision regarding the CV of an investment where there is uncertainty
regarding its recoverability.
Audit Sampling:
Definition
Audit sampling means the application of audit procedures to less
than 100% of the items within a class of transactions or account
balance such that all sampling units have an equal chance of
selection, in order to assist in forming a conclusion concerning
the population from which the sample is drawn [ISA 530].
Lecture example 3
Preparation
You are auditing trade receivables and have obtained the following
results based on your sample:
– Total value of the population $1,000,000
– Number of items in the population 400
– Number of items tested 20
– Sample value $200,000
– Error in sample $9,000
Required
(a) Assuming the errors are not anomalous ones, calculate the
expected error in the population. (b) Assuming that tolerable error was
set at $40,000, explain what action should be taken.
Solution
• Ratio method extrapolation
Error rate in sample x total value in population
Computer-Assisted Audit Techniques (CAATs) which provide a means of accessing
large amounts of data in a format that can provide transparency not attainable through
other auditing procedures. The use of CAAT’s increases audit effectiveness, improves
efficiency and decreases the audit risk.
With the use of a specialized software tool, our team can provide organizations with a
unique and powerful combination of data access, analysis and integrated reporting. Using
the specialized software tool our experts can access and compare enterprise data, flat files
or relational databases, spreadsheets, report files, on PCs or servers, allowing the source
data to remain intact for complete data quality and integrity.
NON-CURRENT ASSETES
Completeness
– All additions and disposals that occurred in the year have been.
– Balances represent assets in use at the year-end.
Rights and obligations
Goodwill:
Inventory
Completeness
Cut Off
Cut-Off
2. Review the aged trial balance to determine if there are natural groups within the
total population of accounts.
3. Select those groups that will be confirmed 100% by the use of positive confirmation letters.
a. Identify the accounts selected on the aged trial balance.
b. Review those accounts selected for confirmation with the owner/manager. If the client objects to
a confirmation with a particular customer, determine if this restriction will affect your ability to
accomplish the audit objectives for receivables.
c. Have the client prepare the positive confirmation letters reflecting, if possible, on the face of the
letter or in an attached statement, the individual invoice number, invoice date, and invoice amounts that
make up the customer’s balance.
d. Include the audit firm’s return address on all envelopes to ensure that all confirmation requests
that are undeliverable by the post office are returned directly to the audit firm.
4. For the remaining balance that is not confirmed 100% in Step 3, determine if a sample of the
accounts making up the balance should be selected for confirmation.
a. If sampling is appropriate, document the sampling selection process.
b. Repeat program Steps 3a through 3h on accounts being sampled.
Cash balances include cash on hand and at bank. Cash on hand includes undeposited
receipts and petty cash. Cash at bank includes cash held in current and savings accounts
which is available on demand. Unlike any other account balance, cash may be either an
asset or a liability. The latter arises where the bank with which the entity holds an
account allows the entity to write cheques in excess of the balance in the account up to an
agreed limit known as an overdraft. Using the assertions described in SAS 400 (ISA 500)
the audit objectives to be achieved in verifying cash balances are identified in
Table 1.
• control all cash held by the entity until all funds have been counted;
• insist that the custodian of the cash be present throughout the count;
• list each item making up the balance;
• obtain a signed receipt from the custodian on return of the funds;
• ascertain that all undeposited cheques are payable to the order of the entity, either
directly or through endorsement;
• trace each item listed to the subsequent bank deposit.
The control of all funds is designed to prevent transfers by entity personnel of counted
funds to uncounted funds. Having the custodian present and requiring his or her signature
on return of the funds minimises the possibility, in the event of a shortage, of the
custodian claiming that all cash was intact when released to the auditors for counting.
Tracing items to the subsequent deposit tests the possibility of a teeming and lading
fraud.
It is customary for the auditors to confirm cash on deposit and loan balances at balance
sheet date directly with the bank. The procedure in the UK is laid down in APB Practice
Note 16, Bank Reports for Audit Purposes, based on an agreement with the British
Bankers Association. Similar arrangements with the banking industry may exist in other
countries. A confirmation request should be sent to all banks with which the entity had
dealings at any time during the year. In addition to confirmation of the balance
outstanding, the opportunity is also taken to request the bank to furnish other information
such as securities held in safekeeping.
The confirming of cash on deposit provides evidence primarily as to the existence of cash
at bank (because there is written acknowledgement that the balance exists), and as to
rights and obligations (because the balances are in the name of the entity). The response
from the bank also provides some evidence for the valuation assertion for cash at bank in
that the confirmed balance is used in arriving at the correct cash balance at the balance
sheet date. Furthermore, it contributes to the completeness assertion; however, it cannot
be relied on entirely because the bank confirmation usually contains a disclaimer in
favour of the bank. The bank cannot be held liable if the information supplied is
incomplete or inaccurate.
• existence, because there is written acknowledgement that the loan balance exists;
• rights and obligations, because the loan is a debt of the entity;
• valuation, because the response indicates the amount of the loan balance.
This test also contributes to the completeness assertion in the same manner as confirming
deposit balances.
When the entity prepares bank reconciliations on a regular basis that are expected to be
reliable, the auditors will test reconciliations prepared as at balance sheet date. The test
will normally include:
• comparing the closing bank balance with the balance confirmed by the bank;
• verifying the validity of deposits in transit and outstanding cheques by,
— tracing entries in the bank statement for the last month of the fiscal year to the
cash book or bank reconciliation at the beginning of the month, marking them off
in the process,
— identifying deposits and cheques recorded in the cash book for the last month
of the fiscal year, or in the reconciliation at the beginning of that month not
marked as appearing on the bank statement, and tracing them to the closing
reconciliation,
— clearing the bank reconciliation to ensure that all applicable outstanding
deposits and outstanding cheques are marked as having been traced from the cash
book and that none are fictitious.
• establishing the mathematical accuracy of the reconciliation;
• vouching other reconciling items such as bank charges to supporting
documentation;
• investigating old items such as cheques outstanding for a long period of time and
unusual items;
• tracing outstanding cheques and deposits in transit to the subsequent period's bank
statement.
When the entity does not prepare a bank reconciliation or when control risk over entity
prepared reconciliations is high (such as where it is prepared by the cashier), the auditors
may prepare the bank reconciliation. When the auditors suspect possible material
misstatements, the auditors may obtain the year-end bank statement directly from the
bank for use in preparing the bank reconciliation and not rely on the copy of the bank
statement held by the entity. This procedure will prevent the entity from making
alterations to the data to cover any misstatements.
Testing or preparing a bank reconciliation establishes the correct cash at bank balance at
the balance sheet date. Thus, it is a primary source of evidence for the valuation assertion.
This test also provides evidence for the existence, completeness, and rights and
obligations assertions.
The subsequent period's bank statement would normally be issued at the end of the month
following the entity's financial year-end. The entity should be requested to instruct the
bank to send a copy of the subsequent period's bank statement directly to the auditors. In
tracing outstanding cheques the auditors may find that a prior period cheque not on the
list of outstanding cheques has cleared the bank and that some of the cheques listed as
outstanding have not cleared the bank. The latter may be due to delays in mailing the
cheques by the entity or in depositing the cheques by the payees. The auditors should
investigate any unusual circumstances.
When the total of uncleared cheques is material, it may indicate an irregularity known as
window dressing. This is a deliberate attempt to enhance an entity's apparent short-term
solvency. (Assume, at balance sheet date, that the entity's balances show current assets of
£800,000 and current liabilities of £400,000. If £100,000 of cheques to short-term
creditors have been prematurely entered, the correct totals are current assets of £900,000
and current liabilities of £500,000, which results in a 1.8:1 current ratio instead of the
reported 2:1.) Window dressing is normally perpetrated by writing cheques on the last
day of the financial year but not mailing them until several weeks later, when cleared
funds are available at the bank to meet those cheques. If none of a sequence of cheques is
presented for payment on the bank statement for more than two weeks after the balance
sheet date, the auditors should make inquiries of the treasurer. Recipients do not usually
delay banking cheques once received and it is normal for most cheques to clear the bank
statement within a week of issue.