Audit Evidence and Documentation AN AUDIT: SUMMARY
Plan the engagement: Identify risks and areas
where internal controls may be relied upon
CHAPTER "NET": Nature, extent and timing of audit
procedures is planned.
Where internal controls may be relied upon,
test those controls to justify reliance
Apply substantive procedures for everything
Bob Anderson, UCSB Intro CHAPTER
& Chapter 5-1 Bob Anderson, UCSB Intro & Chapter 5-2
MANAGEMENT'S ASSERTIONS PCAOB ONE-UP'S THE AICPA
I WILL teach using AICPA management assertions, but know
"Coverd" (i.e covered but misspelled): that it can be broken into more confusing detail, which the
Most difficult to test
Completeness PCAOB did which is not "CEO APROVeD"
High Risk due to subjectivity, therefore Completeness
CutOff generally focus in audit
Valuation, allocation & accuracy Occurrence
Existence & occurrence Allocation
Rights & Obligations
Presentation and Disclosure Obligations
Intro & Chapter 5-3 Intro & Chapter 5-4
THIRD STANDARD OF FIELDWORK Competence of Evidential
So management makes the COVERD assertions.
It is then the auditors responsibility to validate To be appropriate evidence must be:
those assertions, as required by the third Relevant- does it apply to the objective we are
Reliable/ Valid- Is the evidence any good?
"Sufficient Appropriate Audit Evidence" is to be Independent sources have greater reliability
obtained to afford a reasonable basis for an than those within the client organization.
opinion regarding the financial statements Strong internal control increases reliability of
under audit" evidence created within the client organization.
Directly obtained evidence is more reliable than
evidence obtained second hand.
REQUIRES JUDGMENT RELIABLE (or VALID)-
see next slide
Bob Anderson, UCSB Intro & Chapter 5-5 Bob Anderson, UCSB Intro & Chapter 5-6
SUBSTANTIVE PROCEDURES SUBSTANTIVE Audit Procedures
Recall that we generally utilize a "balance sheet" approach- we are testing sales by
testing accounts receivable.
Accounting information system
Can be: Documentary evidence
By testing the ending balance, then you are inherently testing ALL of the transactions. Reconciliations
If you wanted to audit the ending cash balance, do you think we would need to
look at every single entry that impacted cash during the year?
BALANCE SHEET APPROACH- MORE: Computations--Reperformance
Does NOT imply ignoring the income statement! At a MINIMUM you must perform
analytics of the income statement. Data interrelationships--Analytical procedures
In many instances, can perform easy substantive procedures on the income
statement lines, or in connection with testing a balance sheet account.
Client representations WEAKEST
Letters of representations
Bob Anderson, UCSB Intro & Chapter 5-7 Bob Anderson, UCSB Intro & Chapter 5-8
Vouching vs. Tracing INTERNAL CONTROLS
MUST obtain an understanding of the internal controls (that's the 2nd standard
When we examine audit evidence we often look of fieldowkr... the "I" in PIE from Chapter 2)
for one thing to match another. We could be
Many "classes of transactions" are very "routine" to a client. Accordingly the
vouching or tracing... we "vouch" FROM the client may establish strong internal controls over those transactions to
financials and we "trace" TO them: ensure that misstatements are Prevented or Detected in a timely fashion.
If the internal controls over a class of transactions is strong the auditor
MAY rely upon those controls. However, in order to rely, the auditor must
Tests of Design (TOD's): Would the controls prevent/ detect errors?
When testing existence (of something recorded Tests of Operational Effectiveness (TOE's): Are the controls functioning as
in the financial statements) we ... designed?
VOUCH IF NOT PERFORMING TOD'S AND TOE'S TO RELY UPON INTERNAL
CONTROLS, THEN THE AUDITOR MUST PERFORM "SUBSTANTIVE TESTS".
When testing completeness (to see if something WHY WOULD AN AUDITOR GENERALLY SEEK TO RELY UPON CONTROLS
FOR ROUTINE TRANSACTIONS?
is recorded in the financial statements) we ...
TRACE EFFICIENCY IN THE AUDIT!!
Intro & Chapter 5-9 Bob Anderson, UCSB Intro & Chapter 5-10
Audit Risk Audit Risk Formula
An audit can NOT provide absolute assurance. The risk that there is a material
error in the financial statements undetected by the audit is the DETECTION
RISK. All of the risks combined are the "audit risk"
There are several risk factors which can be categorized into three groups:
1. Inherent Risk--Risk of a material misstatement occurring in an SPECIFIC
assertion assuming no related internal controls. Impacted by
AR = IR * CR * DR
factors such as: RMM
Complexity of transactions and/ or accounting issues;
Number of transactions; CLIENT
Degree of judgment involved AR = Audit risk
Volatility of valuations IR = Inherent risk
2. Control Risk--Risk that a material misstatement in an assertion CR = Control risk
will not be prevented or detected on a timely basis by the OPERATIONS-
company's internal control. combined= Risk of DR = Detection risk
Controls are designed and implemented by management to mitigate Material
the inherent risks Misstatement
Controls can be designed to PREVENT and/ or DETECT an error (RMM)
Control risk is the residual risk that an error was neither
PREVENTIVE nor DETECTED
3. Detection Risk--Risk that the auditors' procedures will lead them
to conclude that a material misstatement does not exist in an SPECIFIC TO
assertion when in fact such misstatement does exist. THE AUDITORS
Bob Anderson, UCSB Intro & Chapter 5-11 Bob Anderson, UCSB Intro & Chapter 5-12
An Illustration of Audit Risk Basic Approaches to Auditing Accounting
BEFORE application of Estimates
Sand internal controls,
Review and test management's process
Internal controls for developing the estimate.
prevent/ detect & rectify
Risk of misstatements, Independently develop an estimate to
compare to management's estimate.
Material mitigating inherent risk
Review subsequent events or
transactions bearing on the estimate.
not prevented by client
controls VALUABLE TOOL IN AUDITORS' ARSENAL:
Audit Risk = Auditors Fail to Detect
Bob Anderson, UCSB Intro & Chapter 5-13 Bob Anderson, UCSB Intro & Chapter 5-14
USE OF SPECIALISTS
Auditing Fair Values The auditor is responsible for the adequacy of the
procedures applied. Maybe they need a specialist to
supplement where they lack specific expertise. If
If the item is traded on an organized they do, they are responsible for the work of the
market, fair value may be obtained from specialist, and at a minimum must (DON'T FORGET
market prices Satisfy themselves with the professional qualifications
If the item does not trade on an organized of the specialist
market determine fair value by: Obtain an understanding of the methods and
Analyzing to a similar market is possible assumptions used by the specialist
Test any data furnished to the specialist (client could
Using a valuation model give them bad data- a specialist just works with what
Use of specialists they get, they do not "audit" it)
Using subsequent information
Bob Anderson, UCSB Intro & Chapter 5-15 Bob Anderson, UCSB Intro & Chapter 5-16
Sufficiency of Audit Documentation Functions of Working Papers
Audit documentation should be sufficient to Provide a means of assigning and
enable members of the audit team AND coordinating audit work
future reviewers of the workpapers to: Aid in supervising and reviewing the audit
To understand who performed and reviewed work
the work Provide support for the auditors' opinion
To understand what work was performed Document the auditors' compliance with
To show that the accounting agree or reconcile generally accepted auditing standards,
to the financial statements especially the standards of field work
Aid in planning and conducting future audits
SHOULD ALLOW FOR REPERFORMANCE!!
Bob Anderson, UCSB Intro & Chapter 5-17 Bob Anderson, UCSB Intro & Chapter 5-18
Types of Working Files TYPES OF WORKPAPERS
Current files- AKA Workpapers Specific to the
period being audited (see next slide)
Permanent files- Documents which have an AUDIT PERM-FILE
impact to current/ Prior/ Future periods, GENERAL BINDER=
examples: Working trial balance Per prior slide,
Debt agreement Planning
Lead schedules legal and other
Adjusting journal documents of
Articles of incorporation entries and reclass.
General recurring nature
Important resolutions of the BOD RETENTION REQUIRED: compliance items entries
Stock subscription agreements 7 YEARS B Y PCAOB Completion Analysis of a ledger
Deferred compensation plans Formal evidence of Reconciliations
5 YEARS BY AICPA
Employment contracts (if material) required Computational
considerations and working papers
Bob Anderson, UCSB Intro & Chapter 5-19 Bob Anderson, UCSB Intro & Chapter 5-20
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