audit

Audit Evidence (TIP PIE ACDO) I.

GENERAL Audit evidence is all the information the auditor uses to arrive at the conclusions on which the audit opinion is based. It includes information in written or electronic form as well as observable assets or activities, and it must be obtained to support auditor conclusions. Audit evidence is gathered throughout the audit when performing: (1) Risk assessment procedures (2) Tests of controls (3) Substantive procedures (4) Other audit procedures

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TYPES OF AUDIT EVIDENCE Audit Evidence consists of underlying accounting records and corroborating evidence. The auditor should have access to all pertinent accounting data and corroborating audit evidence (otherwise scope limitation).

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A. Underlying Accounting Records (ex: checks, records of electronic fund transfers, invoices, contracts, ledgers, journal entries, and worksheets) – initial entries and any supporting records. The auditor tests the accounting records through analytical procedures and substantive procedures (retracing, recalculation, and reconciliation). Accounting records alone do not provide sufficient support for the audit opinion. **however, internal consistency among records provide some evidence that the F/S are presented fairly.** B. Corroborating Evidence Includes minutes of meetings, confirmations, industry analysts’ reports, data about competitors, and information obtained through **observation, inquiry, and inspection.*** It provides additional support and gives validity to the recorded accounting data. C. Evidence in Electronic Form – electronic not always available so you should consider NET of auditing procedures. THIRD STANDARD OF FIELDWORK (TIP PIE ACDO): “the auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. “ Objective is to detect material misstatement in F/S A. Reasonable Basis for an Opinion - evidence must persuade the auditor that the ending balances in the F/S are fairly presented. (reasonable assurance, not a guarantor). Auditor relies on persuasive evidence rather than conclusive. It is subjective and unique to each audit. Cost-benefit B. Sufficiency of Audit Evidence ( Quantity, related to audit risk and materiality) Auditor’s decision regarding the sufficiency of evidence is influenced by: 1. The Risk of material misstatement: greater risk implies more evidence 2. The Quality of audit evidence: less audit evidence may be required when that evidence is of higher quality. Evidence can be conclusive on small amounts, but it is not sufficient when its too small to support large account. C. Appropriateness of Audit Evidence (reliable and relevant/ valid and relevant)

Appropriate audit evidence must be both reliable and relevant. The appropriateness of evidence depends on its being pertinent, objective, timely, and corroborated by other evidence. 1. Reliability of Evidence = validity Reliability of audit evidence is dependent on the circumstances under which it is gathered, also influenced by its source and nature. a. Auditor’s Direct Personal knowledge – Best b. External Evidence – evidence sent directly to auditor or to client c. Importance of Effective Controls (improves reliability of internal evidence) Some internal evidences are : Purchase orders, sales orders, general ledgers, and management reports. d. Documentary Evidence – documentary form is more reliable than oral evidence, original is more reliable than photocopies, faxes or documents that have been converted to electronic form. Oral = least reliable e. Consistency of evidence – evidence from different sources is consistent, greater degree of assurance is provided f. Information produced by client- must get evidence about accuracy and completeness. ***AEIOU**** 2. Relevance of Evidence - Evidence must relate to the financial statement assertion(s)COVERU under consideration. For example, accounts receivable confirmations are relevant to the existence of receivables. ***PCAOB*** page 6 Relevance of audit evidence depends on: the design of the audit procedure, in particular whether it is designed to test the assertion directly and whether it is designed to test for understatement or overstatement. And the timing of the audit procedure. D. Evaluation of Audit Evidence IV.

SUBSTANTIVE PROCEDURES ***substantiate validity of management’s assertions*** (1) Test of details applied to transactions, balances, and disclosures (2) Substantive analytical procedures A. Test of Details – support account balances; performed on ending balances, the details of transactions, or a combination of the two. B. Analytical procedures Analytical procedures are evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data, and they generally involve comparisons of recorded amounts to independent expectations developed by the auditor. Ratios, percentages, comparisons of actual to budget, and other comparisons may be used to establish expected relationships, and the auditor then looks for unusual relationships, discrepancies, or variances. 1. Use of analytical procedures – Must for planning (understanding) and review, may use for substantive testing.

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ANALYTICAL PROCEDURES A. Procedures

1. Comparisons of Financial Data – analytical procedures generally include a review of the current and prior year’s financial statements and the current year’s budget. Also internal consistency – ex: net income would agree with the increase in retained earnings. 2. Auditor Expectations – The auditor also develops independent expectations for comparison to recorded amounts. These expectations may be developed based on: a. Financial information for comparable prior periods; b. Budgets and forecasts; c. Relationships among current data d. Industry norms e. Nonfinancial information B. Substantive Analytical Procedures – NOT REQUIRED Sometimes analytical procedures are more effective than substantive tests. 1. Efficiency and Effectiveness of Analytical Procedures The efficiency and effectiveness of analytical procedures in detecting potential misstatements depends, among other things, on the following four factors: a. Nature of the assertion being tested – not apparent from an examination or when details are unavailable b. Plausibility and Predictability of the Data Relationship**I/Sis more predictable than B/S, since B/S has a drop dead date, while I/S is over a period** In order to provide an appropriate level of assurance, analytical procedures should be based on predictable relationships. c. Availability and Reliability of Data Used to Develop the Expectation d. Precision of the Expectation – more precise expectations are more effective in detecting misstatements. 2. Documentation Requirements: when analytical procedure is used as the principal substantive test of a significant financial statement assertion, auditor is required to document the: a. Auditor’s Expectation b. Factors considered in the development of the expectation c. Results of the comparison of expectation to recorded amounts. d. Additional audit procedures performed e. Results of additional procedures C. Ratio Analysis – ratios developed from recorded amounts to expected ratios developed by the auditor *** D. Investigation of significant differences - investigate any significant differences or unusual items that arise. – 1st reconsider the expectation that was developed, make inquiries of management, expand audit procedures. If non adequate explanations can be obtained try alternative procedures E. Limitations of Analytical Procedures – differences do not necessarily indicate errors or fraud, but simply indicate the need for further investigation. VI.

TESTS OF DETAIL A. Directional Testing – forward or backword Tracing forward from source documents to journal entries to provide evidence of completeness.

Vouching backward from journal entries to source documents provides evidence of existence OVERSTATE Revenue/assets – Vouch for existence (backward/down) UNDERSTATE liabilities/expenses– TRACE FOR COMPLETENESS (forward/up) B. Standard Auditing Procedures – FIVE CARROT CARS page 10 Sampling is an aspect of the performance of most audit procedures. The Specifics for the sampling plan (objective, population, sample size, method of selection) are included in the audit plan for each procedure and are documented along with the results and evaluation of the results. The following standard procedures are used in every audit as risk assessment procedures, tests of controls, or substantive tests. FIVE CARROT CARS Footing, crossfooting, and recalculation Inquiry Requesting info from knowledgeable parties both internally and externally (inquiry alone is not enough) ask appropriate questions, consider qualification and objectivity, and evaluation responses and take appropriate action Vouching Existence to make sure revenue and assets are not overstated Examination/inspection Existence – examination may also provide evidence of the terms of contracts, loans and commitments. Confirmation Confirmation is a specific type of inquiry that involves obtaining representations from independent third parties about account balances and transactions or events. Analytical Procedures Evaluations of financial information made by a study of meaningful relationships among data, to help highlight unusual fluctuations that could be the result of errors or fraudulent omissions or overstatements. (scanning can also be analytical procedure) Reperformance Auditor independently performs procedures or controls that were originally performed as part of an entity’s internal control Reconciliation Substantiates the existence and valuation of accounts Observation

Observation occurs when an auditor looks at a process or procedure performed by others. Tracing – looks at coverage from source documents and traces forward/up to provide assurance that he event is being given proper recognition in the books and records (gather evidence regarding understatement errors **completeness assertion**) Cut-off Review (backdating) The auditor should perform cut-off review of year-end transactions, especially inventory, cash, purchases, sales, and accruals. Auditing Related Accounts Simultaneously Certain accounts can be audited simultaneously, such as: a. Long-term liabilities and interest expense b. Capital additions to plant and equipment and repairs and maintenance expense c. Investments and dividend and interest income. Representation Letter At the conclusion of fieldwork, the independent auditor must obtain a management representation letter from the client. Subsequent Events Review The auditor is required to perform certain procedures for the period after the balance sheet date up to the date of the auditor’s report. Evidence becoming available after the balance sheet date should be used in making judgments about the valuation of assets and liabilities on the balance sheet date. C. Review of Relevant Assertions = COVER U for balances, transactions and disclosures 1. Account Balances (CVER) – Asset, liability and equity account balances a. Completeness – All assets, liabilities and equity interests that should have been recorded have been recorded. b. Valuation, Allocation, and Accuracy – Assets, liabilities, and equity interests are recorded fairly and at the appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded. c. Existence and Occurrence Assets, liabilities, and equity interest exist. d. Rights and Obligations 2. Transactions and Events (COVEU) a. Completeness – all transactions and events that should have been recorded have been recorded. b. Cut-Off Transactions and events have been recorded in the correct accounting period c. Valuation, Allocation, and Accuracy Amounts and other data relating to the recorded transactions and events have been recorded appropriately d. Existence and Occurrence

Transactions and events that have been recorded have occurred and pertain to the entity. e. Understandability and Classification Transactions and events have been recorded in the proper accounts 3. Presentation and Disclosure (CVRU) a. Completeness All disclosures that should have been included in the financial statements have been included b. Valuation, Allocation, and Accuracy Financial information and other information are disclosed fairly and at appropriate amounts c. Rights and Obligations, and Occurrence Disclosed events and transactions have occurred and pertain to the entity d. Understandability and Classification Financial information is appropriately presented and described and disclosures are clearly expressed D. Selecting Items for Testing to Obtain Audit Evidence Designing substantive procedures and tests of controls includes determining the means of selecting items for testing. The following methods can be used: 1. Selecting all items – population consists of small number of high dollar value items. 2. Selecting specific items – specific characteristics, such as testing key items that are important for accomplishing objective of the procedure or exhibit some other characteristic, or testing all items over a certain amount. (projection not possible) 3. Audit Sampling – application of an audit procedure to less than 100 percent of the items in the account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class. E. Matching Auditing procedures (five carrot cars) to Specific Assertions (COVER U) PAGE 16***

AUDIT PROCEDURES BY TRANSACTION CYCLE (TIP PIE ACDO) I.

TRANSACTION CYCLES Audits are generally performed by transaction cycle. The most common transaction cycles are listed in the chart below. Auditing by transaction cycle enables the auditor to gather evidence for related accounts, transactions, and disclosures simultaneously. This makes the audit process more efficient. Revenue – sales revenue, receivables, and cash receipts Expenditure – purchases, payables, and cash disbursements Inventory – Includes perpetual inventory, physical counts, and manufacturing costs Investments – includes investments in debt and equity and the income received from investments PPE- includes acquisitions and disposals and related depreciation expense Payroll and Personnel- includes payroll (salaried and hourly) and personnel functions

Financing – includes debt and equity financing, repayments to borrowers, interest expense, and dividends II.

REVENUE CYCLE – overstatement vouch for existence A. Fraud Risk Common revenue frauds are: 1. Early revenue recognition 2. Holding the books open past and close the accounting period (cutoff) 3. Fictitious sales 4. Failure to record sales returns 5. Side agreements 6. Channel stuffing 7. Overstatement of receivalbes **risk reduced by ARC** B. Internal Control-SALES (PAID TIPS) 1. Prenumbered sales order – sent to credit department for approval 2. Credit approval = valuation assertion Authority – credit department determines whether or not the customer may receive goods on open account. If order is approved, a copy of the approved sales order is send to shipping, billing, and accounting departments. 3. Shipment - a serially numbered bill of lading is prepared and a copy is sent to the customer (custody) 4. Billing – serially numbered sales invoice (record keeping) 5. Accounting (record keeping) C. Internal Control – Accounts Receivable 1. Sales 2. Collection of cash receipts 3. Uncollectible receivables Auditor can observe preparation of aging schedule to support assessing control risk below MAXimum 4. Sales Returns – serially numbered receiving report maybe used as sales return slip. Once return is approved, related receivable is eliminated. Credit memos should not be prepared by individuals who collect or receive cash payments on accounts receivable. 5. Sales discounts – ensure receivables are not overstated D. Internal Control – Cash Receipts 1. Collection of cash receipts (page 19 flowchart) E. Internal Control – Flowchart (page 19-20) F. Substantive Procedures Related to Revenue Cycle 1. Auditing Accounts Receivable (Balances) CVER a. Completeness b. Valuation, Allocation, and Accuracy c. Existence and Occurrence d. Rights and Obligations 2. Auditing Sales Transactions (COVEU) a. Completeness b. Cutoff c. Valuation, allocation, and accuracy

d. Existence and occurrence e. Understandability and classification 3. Auditing Presentation and Disclosure (CVRU) a. Completeness b. Valuation, allocation, and accuracy c. Rights and Obligation and Occurrence d. Understandability and Classification G. Accounts Receivable Confirmations – required usually Required unless receivables are immaterial, confirmation would be ineffective, or inherent and control risks are very low and evidence provided by other procedures is sufficient to reduce audit risk to an acceptably low level. If confirms are not sent, the auditor must document how the omission of this procedure was overcome. 1. Positive confirms best – large accts, expect errors/disputes, weak internal control. If no response send 2nd request then consider alternative. 2. Negative confirmations Not as good – for low risk, small balances, expect customer attention. Answer s requested only if the amount stated is incorrect. No explicit verification 3. Confirmation exceptions: investigate for timing differences and misstatements 4. Confirmation non-responses – followed up with 2nd and third requests. III.

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Expenditure Cycle = TRACE A. Internal Control-Purchases (should be segregated) 1. Purchase requisition 2. Purchase orders 3. Receipt of goods or services (blind copy) B. Internal Control – Accounts Payable 1. Record payable = A/P approval of bill 2. Approving invoice for payments and recording payment C. Internal Control – Cash Disbursements = treasury paying bills D. Internal Control – flowchart E. Substantive Procedures Expenditure Cycle Confirmations not required for A/P CASH – vouch A. Fraud Risk – Lapping and Kiting B. Internal Control – ARC and voucher system C. Substantive Procedures for CASH 1. Audit Ending Cash Balance- bank confirms and bank reconciliation (CVE) 2. Audit Cash receipt and cash disbursements 3. Presentation and Disclosure (CVRU) INVENTORY CYCLE A. Internal Control – reconcile inventory with cogs (adequate safeguards and segregation of duty) . The following should be segregated 1. Purchasing 2. Receiving 3. Warehouse 4. Shipping B. Substantive Procedures Related to Inventory

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VII. VIII. IX.

1. Auditing Ending inventory balances 2. Auditing inventory transactions 3. Auditing presentation and disclosure INVESTMENT CYCLE – vouch overstatement A. Internal Control – ARC B. Substantive Procedures PPE – overstatement Vouch PAYROLL AND PERSONNEL CYCLE FINANCING CYCLE

AUDIT PROCEDURES BY TRANSACTION CYCLE (TIP PIE ACDO) I.

RELATED PARTY TRANSACTIONS A. Auditor’s Responsibility - proper disclosure? B. Accounting for Related Party Transactions C. Audit Objectives D. Determining the Existence of Related Parties E. Identifying and Examining Related Party Transactions

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ACCOUNTING ESTIMATES AUDITING FAIR VALUES EVALUATING CONTINGENCIES

EVALUATE AUDIT FINDINGS Page 54 I. ANALYTICAL PROCEDURES USED AS AN OVERVIEW – REQUIRED II. EVALUATE WHETHER THE FINANCIAL STATEMENTS ARE FREE OF MATERIAL MISSTATEMNT III. REVIEWING THE WORK OF OTHERS