AUDITING S1_2019.

SOLUTIONS TO QUESTIONS FROM LECTURE AND TUTORIAL

OUTLINE FOR WEEK 2

ANSWER QUESTION 1 (a)

The audit trail is the complete set of accounting documents and records that are prepared by
an entity in order to process its transactions from inception through to the financial report for
the period. It permits the tracing of transactions from the point at which they are first
recorded through any intermediate records and then to the financial reports; and the
vouching of reported items back through any intermediate records to the point at which they
were first recorded..

LEARNING OBJECTIVE: Lecture 2 Learning Objective 8: Understand concept of direction

of testing

REFERENCES: Lecture slides: Lecture 2, slide 61

ANSWER QUESTION 1 (b)

Inventory is an account balance, and so, according to ASA 315.A128 (b), management
would be making assertions regarding the following: Existence, Rights and Obligations,
Completeness, Accuracy Valuation and Allocation, Classification and Presentation.
Specifically management would be asserting that:
• The inventory recognised in the Statement of Financial Position exists.
• The entity owns the inventory.
• All the inventory that the entity owns is recognised.
• $20m is an appropriate amount at which to recognize the inventory
• The inventory has been properly classified
• The required disclosures about inventory have been made.

LEARNING OBJECTIVE: Lecture 2 Learning Objective 1: Understand that, essentially,

financial statements are a set of assertions.

REFERENCES: Lecture slides: Lecture 2, slides 25-35

Textbook: pp.282-284

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ANSWER QUESTION 2 (Only one example of each was required, however, two examples
of each form of evidence are provided here).

Evidence Form Example 1 Example 2

Underlying accounting data Sales Journal Ledger Account for Inventory

Corroborating information Shipping note Receiving Note

Documentary evidence Tax Invoice Sales contract

Third party representations Bank Confirmation Debtors Confirmation

Physical evidence Plant and Equipment Item of Inventory

Computations Footing a column total Calculating the present value

of a future cash flow
Data interrelationships Inventory turnover ratio Current ratio

Client representations Representation from Management representation

accounting staff letter
regarding how the
collectability of a debt
was determined

LEARNING OBJECTIVE: Lecture 2 Learning Objective 4: Understand nature of audit

evidence

REFERENCES: Lecture slides: Lecture 2, slides 38-50

Textbook: pp. 342-345
Reading 6 Whittington, Ray & Pany, Kurt, Principles of Auditing & Other
Assurance Services, 18th ed., McGraw-Hill Irwin, New York, pp. 141-149

ANSWER QUESTION 3
Auditors use assertions as a focal point of the audit to assess risks by considering the different
types of potential misstatements that may occur and then to design audit procedures that are
aimed at uncovering that type of misstatement.

Assertions can be either explicit or implicit. Assertions concern transactions and events, and
Related disclosures; and account balances, and related disclosures. For example, in

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recognising inventory asset on its balance sheet, the client is making the assertion, that the
inventory exists at balance date, that the complete holdings of inventory are recognised,
that inventory is properly valued, and that the client controls the inventor (I.e. has the right to
recognise) payables). Existence, completeness, valuation and allocation, and rights and
obligations are the financial report assertions that relate to balance sheet items such as
inventory.

Auditors use management assertions as the basis for their testing. This is done through the
specification of audit objectives. I.e. for each material assertion made in the financial
statements, the auditor asks the question: is the assertion justified? As such audit objectives
“mirror” financial report assertions.

The specification of audit objectives in this way provides the auditor with a framework for
audit testing. That is, if a balance sheet item is misstated it will be for one or more of the
following reasons: (1) the item that was recognised does not exist; (2) the item recognised
was not complete; (3) for an asset, the client did not have a right to control it, and for a
liability, the client did not have a present obligation to pay; and (4) the item was appropriately
valued and /or any allocation such as depreciation was appropriate.

If an income statement item is misstated it will be for one or more of the following reasons:
(1) the transaction did not occur; (2) recognised transactions are not complete; (3)
transactions were not processed accurately; (4) transactions were incorrectly classified; or
(5) some transactions around balance date were not recorded in the correct period (cut-off).

LEARNING OBJECTIVES Lecture 2 Learning Objectives (1): Understand that, essentially,

financial reports are a set of assertions. (2): Understand how the auditor uses assertions
when planning and executing an audit.

REFERENCES Lecture Slides Lecture 3, slides 4-36

Textbook: pp. 280-284
Additional Guidance: Assertions

ANSWER QUESTION 4

Transaction or Balance Assertion

i Ending Balance Presentation
ii Transactions Cut-off
iii Ending Balance Rights and obligations
iv Ending Balance Accuracy, Valuation and Allocation

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 v Ending Balance Existence
vi Transactions Completeness
vii Ending Balance Accuracy, Valuation and Allocation
viii Ending Balance Presentation
ix Transactions Occurrence
x Transactions Classification

LEARNING OBJECTIVE: Lecture 2 Learning Objectives (1): Understand that, essentially,

financial reports are a set of assertions.

REFERENCES: Lecture Slides Lecture 2, slides 4-36

Textbook: pp.280-284
Additional Guidance: Assertions; Determining the Assertion_ Questions;
Determining the Assertion_ Answers.

ANSWER QUESTION 5 (a)

The term, “direction of testing” refers to the direction along the audit trail that the auditor
tests. For transactions, a test can be in the direction in which transactions are routinely
processed, in which case it is from the source document to the record (completeness).
Conversely, the direction can be from the accounting record to the source document
(occurrence). For physical items a test can be from the item to the record (completeness) or
from the record to the item (existence).

ANSWER QUESTION 5 (b)

In a test for understatement, we are testing for completeness. Thus we want to test whether
or not what actually occurred was recorded. As such, we test from the source document for
a transaction to the accounting record of the transaction (tracing).

Conversely, in a test for overstatement, we are testing for occurrence. Thus we want to test
whether what was recorded actually occurred. As such we test from the accounting record
for the transaction to the source document for the transaction (vouching).

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ANSWER QUESTION 5 (c)

1 2 3 4
Assertion Starting point Verification Tracing or Vouching

Completeness Physical asset Asset Register Tracing

Occurrence Sales journal Shipping note Vouching

Existence Inventory record Item of inventory Vouching

Completeness Receiving note Purchases Journal Tracing

Occurrence Purchases Journal Receiving note Vouching

Completeness Shipping note Sales Journal Tracing

Occurrence Payroll journal Timesheet Vouching

LEARNING OBJECTIVE: Lecture 2 Learning Objective 8: Understand concept of direction

of testing

REFERENCES Lecture slides: Lecture 2, slides 61-74

ANSWER QUESTION 6 (a)

ASA 500 deals with the issue of sources of audit evidence at paragraphs A7 to A9.
Paragraph A7 highlights the importance of establishing the internal consistency of
accounting records through the application of a variety of procedures.

However, ASA 500, at paragraph A8, notes that is usual for auditors to gather evidence from
other sources (other than the accounting records). In particular, it notes the importance of
gathering evidence to corroborate the accounting records from sources external to
(independent from) the client.
Paragraph A9 provides examples external sources of audit evidence. They include external
confirmations and analysts’ reports.

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ANSWER QUESTION 6 (b)
The criteria for evaluating the reliability of audit evidence are provided at paragraph A31 of
ASA 500. They are:

Independence: Audit evidence obtained from independent sources is considered to be

more reliable than that obtained from within the entity.

Internal Control: Internally generated audit evidence that is obtained from a client with an
effective internal control system is considered to be more reliable than internally generated
evidence obtained where the internal controls are not effective.

Direct knowledge: Where an auditor obtains evidence directly is considered to be more

reliable than evidence obtained indirectly (by inference).

Objectivity: Audit evidence in documentary form (either hard copy or an electronic file) is
Considered to be more reliable than oral audit evidence

Origin: Original documents that are used as audit evidence are considered to be more
reliable than copies of the documents.

LEARNING OBJECTIVE: Lecture 2 Learning Objective 6: Understand criteria for

determining the reliability of audit evidence.

REFERENCES Lecture slides: Lecture 2, slides 54-59

Textbook: pp.336-337
Handbook: ASA 500, paragraph A31.