CH 10 Auditing

Slide 10
.1
• Evidence is anything that can Evidence

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.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] © Pearson Education Limited 2007
Slide 10
.2
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
Slide 10
.3
Sufficient Appropriate Audit Evidence
• Sufficiency is the measure of the quantity of

audit evidence
• 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
Slide 10
.4
• 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.
Slide 10
.5
Slide 10
.6
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.
Slide 10
.7
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.
Slide 10
.8
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
Slide 10
.9
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) substantive
analytical procedures
Slide 10
.10

Slide 10
.11
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
Illustration 10.2
Slide 10
.12
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 Assets, liabilities and equity interests are
Allocation included in the financial statements at
appropriate amounts and any resulting
valuation adjustments are appropriately
recorded
Illustration 10.2
Slide 10
.13
ASSERTIONS about presentation and disclosure
Occurrence and Disclosed matters have occurred

rights and and pertain to the entity.
obligations
Completeness All disclosures that should have
been included in the financial
statements have been included
Classification financial information is
and appropriately presented and
understandability described, and disclosures are
(not in text) clearly expressed
Accuracy and Financial and other information are
valuation disclosed fairly and at appropriate
Illustration 10.2 amounts
Slide 10
.14
Nature of Substantive
procedures
 Tests of details of transactions

are audit procedures related to
examining 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
Slide 10
.15
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.
Slide 10
.16
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.
Slide 10
.17
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
– Reperformance
– Confirmation
– Analytical procedures.
–
Slide 10
.18
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
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.
Slide 10
.19
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.
Slide 10
.20
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.
Slide 10
.21
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.
Slide 10
.22
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.
Slide 10
.23
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.
Slide 10
.24
Vouching and Tracing

 Vouching is the use of documentation to
support recorded transactions or amounts.
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).
Slide 10
.25
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.
Slide 10
.26
Recalculation
Examples:
 Extending sales invoices
 Adding journals and subsidiary records
 Checking calculations of depreciation
 Checking mechanical accuracy of
records and ledgers.
Slide 10
.27
CONFIRMATION
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.
Slide 10
.28
Confirmation
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.
Slide 10
.29
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.
 Use for large number small
balances, low control risk, response
is expected
Slide 10
.30
Reliability of Procedures
A list of the most reliable to the least reliable

evidence gathering techniques are in general:
1 Recalculation
2. Inspection.
3 Reperformance.
4 Observation.
5 Confirmation.
6 Analytical procedures.
7 Inquiry.
Slide 10
.31
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.
Slide 10
.32
Substantive tests on selected accounts
Slide 10
.33
Non Current Assets
• Inspect assets for condition and usage to identify sign
s of impairment: verifies valuation.
• Select a sample of additions and agree cost to suppli
er invoice: verifies valuation.
• Inspect the list of additions and confirm that they relat
e to capital
expenditure items rather than repairs and maintenanc
e: verifies existence.
• Inspect supplier invoices (for equipment), title deeds (
for property), and
registration documents (for motor vehicles) to ensure
they are in the name of the client: verifies: rights and
obligations.
Slide 10
.34
Non Current Assets
• The key assertions for non current assets are exi
stence, valuation,
completeness and rights and obligations.
• Procedures
• Obtain the non current asset register, cast and
agree the total to the financial statements: verifies
completeness
• Select a sample of assets from the non
current asset register and
physically inspect them: verifies existence.
• Cast the noncurrent asset register totals and sub
totals to ensure
arithmetical accuracy: verifies valuation.
Slide 10
.35
Non Current Assets
• If assets have been constructed by the client, obtain an a
nalysis of the
costs incurred, cast for arithmetical accuracy and agree a
sample of
costs to supporting documentation (e.g. payroll, material i
nvoices): verifies valuation.
• Disposals
• Obtain a breakdown of disposals, cast the list and agree
all assets removed from the non
current asset register: verifies existence.
• Select a sample of disposals and agree sale proceeds to
supporting
documentation such as sundry sales invoices: verifies acc
uracy of profit on disposal.
Slide 10
.36
Non Current Assets
• Depreciation
• Recalculate the depreciation charge for a sample of a
ssets to verify arithmetical accuracy.
• Inspect the financial statement disclosure of the depr
eciation charges
and policies in the draft financial statements and com
pare to the prior year to ensure consistency.
• Compare depreciation rates to companies with the sa
me type of assets to assess reasonableness.
• Perform a proof in total calculation for the depreciatio
n charged for
each category of assets, discuss with management if
significant fluctuations arise. (Analytical procedure)
Slide 10
.37
Intangible Assets (development cost)
• The key assertion for development costs is existence.
Development costs
should only be capitalised as an intangible asset if the r
ecognition criteria of IAS 38 have been met.
• Obtain a breakdown of costs capitalised, cast for mathe
matical
accuracy and agree to the amount included in the finan
cial statements: verifies valuation.
• Inspect board minutes for any discussions relating to th
e intended sale or use of the asset: verifies existence.
• Discuss the details of the project with management, to
evaluate
compliance with IAS 38 criteria: verifies existence.
Slide 10
.38
Intangible Asset (development cost)
• Inspect project plans and other documentation
to evaluate compliance with IAS 38 criteria:
verifies existence
• Inspect budgets to confirm financial feasibility:
verifies existence.
Slide 10
.39
Receivables
• The focus of testing for receivables is valuation and exi
stence. Note the
effect of directional testing, e.g. directly testing receivab
les for
overstatement also indirectly tests revenue for overstat
ement (Dr: Receivables, Cr: Revenue).
• Obtain an aged receivables listing, cast it to verify arith
metical accuracy
and agree the total to the financial statements.
• Agree the sales ledger control account with the sales le
dger list of balances: verifies completeness and
existence.
• Select a sample of year end receivable balance and
agree back to valid supporting documentation of GDN
and sales order: verifies existence
Slide 10
.40
Receivables
• Inspect after date cash receipts and follow thr
ough to pre year end receivable balance
verifies valuation, rights and obligations,
existence.
• Select a sample of goods despatched notes (
GDN) before and just
after the year end and follow through to the sal
es invoice to ensure they are recorded in the c
orrect accounting period: verifies completenes
s and existence (cutoff of revenue).
Slide 10
.41
Planning attendance at inventory count

Planning Attendance at Inventory Count In planning attendance at the
physical inventory count or the alternative procedures, the auditor would
consider:
■ the nature of the accounting and internal control systems used regarding
inventory;
■ inherent, control and detection risks, and materiality related to inventory;
■ whether adequate procedures are expected to be established and proper
instructions issued for physical inventory counting;
■ the timing of the count;
■ the locations at which inventory is held; (When inventory is located at
several locations, the auditor should determine at which locations
attendance is appropriate, taking into account the materiality of the inventory
and the assessment of inherent and control risk at different locations.)
■ whether an expert’s assistance is needed. The auditor would review
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);
Slide 10
.42
Planning attendance at inventory count
 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.
Slide 10
.43
Inventory
• The key assertions relating to inventory are:

Existence, Completeness, Rights and obligations,
Valuation and Cut-off
• Procedures
• Select a sample of items from the inventory count
sheets and physically
inspect the items in the warehouse: verifies exist
ence.
• Select a sample of physical items from the wareh
ouse and trace to the
inventory count sheets to ensure that they are rec
orded accurately: verifies completeness.
Slide 10
.44
Inventory
• Enquire of management whether goods held on behalf of t
hird parties
are segregated and recorded separately: verifies rights
and obligations.
• Inspect the inventory being counted for evidence of dama
ge or
obsolescence that may affect the net realisable value
(NRV) and make sure inventory is valued at the lower of
cost or NRV: verifies valuation.
• Attend the inventory count (if one is to be performed) at th
e third party
warehouses: verifies completeness and existence.
Slide 10
.45
Inventory
Slide 10
.46
Inventory
Slide 10
.47
Inventory
Slide 10
.48
Perpetual Inventory System

If perpetual inventory counting is used, auditors will verify that management:
(a) Ensures that all inventory lines are counted at least once a year
(b) Maintains adequate inventory records that are kept up-to-date. Auditors
may compare sales and purchase transactions with inventory movements,
and carry out other tests on the inventory records, for example, checking
casts and classification of inventory.
(c) Has satisfactory procedures for inventory counts and test-counting.
Auditors should confirm the inventory count arrangements and instructions
are as rigorous as those for a year-end inventory count by reviewing
instructions and observing counts. Auditors will be particularly concerned
with cut-off, that there are no inventory movements whilst the count is taking
place, and inventory records are updated up until the time of the inventory
count.
(d) Investigates and corrects all material differences. Reasons for
differences should be recorded and any necessary corrective action taken.
All corrections to inventory movements should be authorised by a manager
who has not been involved in the detailed work. These procedures are
necessary to guard against the possibility that inventory records may be
adjusted to conceal shortages. Auditors should check that the procedures
are being operated.
Slide 10
.49
Perpetual Inventory System
Advantages
•The auditor is less time constrained and can pic
k and choose particular
locations and inventory lines at any time to ensu
re the system is working properly.
•Slow moving and damaged inventory should be
identified and adjusted
for in the clients' records on a continuous basis t
herefore the inventory
valuation should be more reliable
Slide 10
.50
Perpetual Inventory system
Disadvantages
•The auditor will need to gain sufficient evidence
that the system
operates correctly at all times, not just at the tim
e of the count.
•Additional procedures will need to be devised t
o ensure that the year
end inventory figure is reliable, even though it m
ay not have been counted at that date.

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Slide 10

• Evidence is anything that can Evidence

Audit evidence is different from the legal

Sufficient Appropriate Audit Evidence

• Sufficiency is the measure of the quantity of

• Appropriateness is the measure of quality

Reliability of audit evidence

Information Provided by the Auditee

The auditor obtains audit evidence to draw

ASSERTIONS about classes of transactions and events for the

Accuracy Amounts and other data relating to recorded

Classification Transactions and events have been recorded

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

ASSERTIONS about presentation and disclosure

Occurrence and Disclosed matters have occurred

 Tests of details of transactions

 Tests of Balances are used to examine

In tests of balances the auditor is concerned

Audit Procedures for Gathering Evidence

• Evidence-gathering techniques are techniques

Observation consists of looking at a

• ISA 501 “When inventory is material to the

Alternative procedures for attending physical

Inspection is the auditor's examination of the

Internal documents and external documents.

 Internal documents processed under good internal

Vouching and Tracing

Recalculation & Reperformance

Defined: It is the auditor’s receipt of a written or oral

An auditor may use a confirmation in response to a

Positive confirmation: Asks the

A list of the most reliable to the least reliable

• The auditor considers the relationship between the cost of

Substantive tests on selected accounts

Non Current Assets

Non Current Assets

Non Current Assets

Non Current Assets

Intangible Assets (development cost)

Intangible Asset (development cost)

Planning attendance at inventory count

Planning attendance at inventory count

 accurate identification of the stage of

• The key assertions relating to inventory are:

Perpetual Inventory System

Perpetual Inventory System

Perpetual Inventory system

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