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AUDIT PROCEDURES Substantive Testing and Evidence

AUDIT PROCEDURES Substantive Testing and Evidence

Evidence is anything that can make a person believe that a fact, proposition, or assertion is true or false.

Audit evidence is all of the information used by the auditor in arriving at the conclusions on which the audit opinion is based. (ISA 500) It includes the accounting records and other information underlying the financial statements.

Evidence

(ISA 500) – It includes the accounting records and other information underlying the financial statements. Evidence

Audit evidence is different from the legal evidence.

In a civil lawsuit, evidence must be strong enough to incline a person to believe one side or the other. In a criminal case evidence must establish proof of a crime beyond a reasonable doubt. Audit evidence provides only reasonable assurance

must establish proof of a crime beyond a reasonable doubt . Audit evidence provides only reasonable

Accounting records generally include the records of initial entries and supporting records.

Initial entries include: records of initial entries such as checks and electronic fund transfers; contracts, invoices; shipping notices, purchase orders, sales orders, the general and subsidiary ledgers, journal entries and other adjustments to the financial statements.

Supporting records examples are computer files, databases, work sheets, spreadsheets, computer and manual logs, computations, reconciliations, and disclosures.

databases, work sheets, spreadsheets, computer and manual logs, computations, reconciliations, and disclosures. evidence
evidence
evidence
The auditor obtains audit evidence to draw reasonable conclusions on which to base the audit
The auditor obtains audit evidence to draw reasonable conclusions
on which to base the audit opinion by performing audit procedures
to:

Obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels (“risk assessment procedures”); Test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level (“tests of controls”); and Detect material misstatements at the assertion level (“substantive procedures”) – ISA 500

Substantive Procedures

Defined Substantive procedures are tests performed to obtain audit evidence to detect material misstatements at the assertion level. Two types – (1) tests of details of classes of transactions, account balances, and disclosures and (2) analytical procedures

– (1) tests of details of classes of transactions, account balances, and disclosures and (2) analytical

Legal Proof and Evidence

Legal standards of proof

– beyond a reasonable doubt

– preponderance of evidence

– clear and convincing evidence

– probable cause

Legal evidence

convincing evidence – probable cause • Legal evidence – proof results direct or circumstantial – Source

– proof results direct or circumstantial

– Source

real tangible and can be presented to a court for inspection

testimonial evidence given by witnesses under oath.

original documentary evidence

ASSERTIONS about classes of transactions and events for the period under audit

Occurrence

Transactions and events that have been recorded have occurred and pertain to the entity.

Completeness

All transactions and events that should have been recorded have been recorded.

Accuracy

Amounts and other data relating to recorded transactions and events have been recorded accurately.

Cutoff

Transactions and events have been recorded in the correct accounting period

Classification

Transactions and events have been recorded in the proper accounts

ASSERTIONS about account balances at the period end

Existence

Assets, liabilities, and equity interests exist

Rights and obligations

The entity holds or controls the rights to assets and liabilities are the obligations of the entity

Completeness

All assets, liabilities and equity interests that should have been recorded have been recorded

Valuation and Allocation

Assets, liabilities and equity interests are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded

ASSERTIONS about presentation and disclosure

Occurrence and rights and obligations

Disclosed matters have occurred and pertain to the entity.

Completeness

All disclosures that should have been included in the financial statements have been included

Classification and understandability (not in text)

financial information is appropriately presented and described, and disclosures are clearly expressed

Accuracy and valuation

Financial and other information are disclosed fairly and at appropriate amounts

Illustration 10.2

Sufficient Appropriate Audit Evidence

Sufficiency is the measure of the quantity of audit evidence

is the measure of the quantity of audit evidence • Appropriateness is the measure of quality

Appropriateness is the measure of quality of audit evidence, its reliability, & its relevance in providing support for, or detecting, misstatements in transactions, balances, disclosures and related assertions

in providing support for, or detecting, misstatements in transactions, balances, disclosures and related assertions

Relevance of evidence is the appropriateness (pertinence) of the evidence to the audit objective being tested.

• Reliability is the quality of information when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.

by users to represent faithfully that which it either purports to represent or could reasonably be
by users to represent faithfully that which it either purports to represent or could reasonably be

Reliability of audit evidence

Audit evidence obtained directly by the auditor (e.g., observation, re-performance) is more reliable than audit evidence obtained indirectly or by inference. Audit evidence is more reliable when it exists in documentary form, whether paper, electronic, or other medium. Audit evidence is more reliable when it is obtained from independent sources outside the entity Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles. The effectiveness of the client’s internal control structure has a significant impact on reliability of evidence.

Information Provided by the Auditee

When information produced by the entity is used by the auditor to perform audit procedures, the auditor should obtain audit evidence about the accuracy and completeness of the information.

perform audit procedures, the auditor should obtain audit evidence about the accuracy and completeness of the
are examining Nature of Substantive procedures Tests of details of transactions audit procedures related to
are

are

examining

Nature of Substantive procedures

Tests of details of transactions audit procedures related to

the processing of

particular classes of

transactions through the accounting systems. Tests of balances are substantive tests that provide either reasonable assurance of the validity of a general ledger balance or identifies a misstatement in the account.

Analytical procedures

Tests of Balances

Tests of Balances are used to examine the actual details making up high turnover accounts such as cash, Accounts Receivable, Accounts Payable, etc Why is tests of balances so important? Because the auditor’s ultimate objective is to express an opinion on financial statements that are made up of account balances.

Tests of Balances

In tests of balances the auditor is concerned with overstatement or understatement of the line item in the financial statement. Test makes use of the inherent properties of double-entry accounting systems. From the auditor’s perspective, this means that a test of one side of the transaction simultaneously tests the other side of the transactions.

Audit Procedures for Gathering Evidence

Evidence-gathering techniques are techniques employed by an auditor to obtain evidence.

Evidence-gathering techniques are:

Inquiry

Observation

Inspection (physical evidence and examination of documents) Recalculation –– ReperformanceReperformance

Confirmation

Analytical procedures.

Inquiry

Inquiry consists of seeking information of knowledgeable persons inside (client) or outside the entity. Largest amount of audit evidence in an audit is obtained from client inquiry

audit evidence in an audit is obtained from client inquiry cannot be regarded as conclusive because

cannot be regarded as conclusive because it is not from an independent source and might be biased the auditor must gather evidence to corroborate inquiry evidence by doing other alternative procedures.

Observation Observation consists of looking at a process or procedure being performed by others. For
Observation Observation consists of looking at a process or procedure being performed by others. For

Observation

Observation consists of looking at a process or procedure being performed by others. For example, the observation by the auditor of the counting of inventories by the entity’s personnel or by the performance of internal control procedures that leave no audit trail. Observation should be supported by other types of evidence.

count of physical inventory

ISA 501 “When inventory is material to the financial statements, the auditor should obtain sufficient appropriate audit evidence regarding its existence and condition by attendance at physical inventory counting.”

If unable to attend the physical inventory count, the auditor should take or observe some physical counts on an alternative date and, when necessary, perform tests of controls of intervening transactions.

Alternative procedures for attending physical inventory include Auditor review of:

Management’s instructions regarding the application of control procedures (e.g. collection of used stock sheets, accounting for unissued stock sheets and count and re-count procedures); Accurate identification of the stage of completion of work in progress, of slow-moving, obsolete, or damaged items and items on consignment Whether appropriate arrangements are made regarding the movement of inventory between areas and the shipping and receipt of inventory before and after the cutoff date.

Inspection Inspection is the auditor's examination of the client's documents records or tangible assets to

Inspection

Inspection is the auditor's examination of the client's documents records or tangible assets to substantiate the important information related to the financial statements.

Internal documents and external documents.

Internal documents processed under good internal controls are more reliable than those processed under weak controls. External documents may be processed by both internal and external parties representing agreement. External documents like title to property, insurance policies and contracts are very reliable evidence.

Vouching and Tracing

Vouching is the use of documentation to support

recorded transactions or amounts.

documentation to support recorded transactions or amounts. It is an audit process whereby the auditor selects

It is an

audit process whereby the auditor selects sample items from an account and goes backward through the accounting system to find the source documentation that supports the item selected. Tracing is an audit procedure whereby the auditor selects sample items from basic source documents and proceeds forward through the accounting system to find the final recording of the transactions (e.g., in the ledger).

Recalculation & Reperformance

Recalculation consists of checking the arithmetical accuracy of source documents and accounting records or of performing independent calculations. Reperformance is the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control, either manually or through the use of CAATs.

that were originally performed as part of the entity’s internal control, either manually or through the

Recalculation

Examples:

Extending sales invoices

Adding journals and subsidiary records Checking calculations of depreciation Checking mechanical accuracy

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records and ledgers.

CONFIRMATION

CONFIRMATION Defined: It is the auditor’s receipt of a written or oral response from a independent

Defined: It is the auditor’s receipt of a written or oral response from a independent third party verifying the accuracy or the information requested. Four Key Characteristics:

1. Information is requested by auditor.

2. Request and response is in writing, sent to the auditor.

3. Response comes from an independent third party.

4. Positive confirmation involves a receipt of information.

Confirmation

Confirmation An auditor may use a confirmation in response to a significant risk The auditor must

An auditor may use a confirmation in response to a significant risk The auditor must ordinarily confirm accounts receivable. . Written confirmations received from third parties are highly persuasive, but very costly and an inconvenience for those who are asked to supply them.

Positive confirmation: Asks the recipient (debtor, creditor or other third party) to confirm agreement or to express disagreement with the recorded balance.

Reliable evidence

Negative confirmation: A reply is requested only in the event of disagreement with the recorded balance.

only in the event of disagreement with the recorded balance. Use for large number small balances,
only in the event of disagreement with the recorded balance. Use for large number small balances,
only in the event of disagreement with the recorded balance. Use for large number small balances,

Use for large number small balances, low control risk, response is expected

Search for unrecorded liabilities

Defined:

A substantive test usually performed on accounts payable is a search for unrecorded liabilities. This test provides evidence as a completeness and some evidence as to valuation. By reviewing cash disbursements subsequent to the balance sheet date, the auditor has a good idea of the potential population of unrecorded accounts payable.

Reliability of Procedures

A list of the mostmost reliablereliable to the leastleast reliablereliable evidence gathering techniques are in general:

1 Recalculation 2. Inspection.

3 Reperformance.

4 Observation.

5 Confirmation.

6 Analytical procedures.

7 Inquiry.

Cost of Procedures

The auditor considers the relationship between the cost of obtaining audit evidence and the usefulness of the information obtained. The evidence-gathering procedures in order of cost from most costly to least costly are in general:

1 Confirmation.

2 Inspection.

3 Recalculation 4. Reperformance

5 Observation.

6 Analytical procedures.

7 Inquiry.