ACCT3600 Lec 4 Audit Evidence, Substantive Tests, Limitation of Scope, Materiality

Question 1

How much evidence does the auditor have to obtain?

Answer 1

1. Sufficient
   - quantity of audit evidence necessary to provide the auditor with a reasonable basis for an opinion on the financial report. (SAMPLING).
2. Appropriateness
   - quality of audit evidence
   - RELEVANCE to assertion
   - RELIABILITY nature and source of evidence.

Auditor’s judgement is a critical function of our understanding of these terms.

Question 2

Auditor selects most EFFICIENT and EFFECTIVE combination based on business risk analysis. What are the diff types of AUDIT PROCEDURES?

Answer 2

1. Tests of controls
   - transactions selected to test whether related controls are working. Does not directly measure MONETARY ERROR in accounting records.
2. Substantive tests of details
   - transactions selected to DETECT MATERIAL MISSTATEMENTS in the FINANCIAL REPORT ASSERTIONS.
3. Substantive analytical procedures
   - tests that determine the amount of misstatement in an account balance
4. Substantive tests of transactions
   - auditor INSPECTS UNDERLYING DOCS associated with the FLOW OF A TRANSACTION through the system
   - focus on the individual transactions that make up the balance.
5. Substantive tests of balances
   - auditor tests amounts resulting from a SUMMATION OF A NUMBER OF TRANSACTIONS
   - substantiate the ENDING BALANCE of an account (which is comprised of multiple transactions).

Question 3

What are the 5 NATURE AND SOURCE factors that determine the reliability of evidence?

Answer 3

1. External source > Internal source.
2. Evidence generated internally is more reliable when the INTERNAL CONTROL structures are effective.
3. Evidence obtained DIRECTLY by the auditor is more reliable than evidence obtained INDIRECTLY from the client. (e.g. AR - instead of internal invoices, directly confirm with debtors).
4. Written > Oral
5. Original Docs > Photocopies

Question 4

What is the hierarchy of reliable evidence?

Answer 4

1. External direct to the auditor
2. Externally generated but now in the control of the client
3. Internally generated, but circulated to different departments
4. Internally generated but not circulated

Question 5

What is the SALE CYCLE?

Answer 5

1. Sales Order
2. Packing Slip
3. Delivery Docket
4. Customer Delivery Confirmation
5. Invoice
6. Cash Receipt.

Question 6

If, after accepting the engagement, the auditor becomes aware that management has imposed a LIMITATION OF SCOPE…..

What should the auditor do?

Answer 6

1. the auditor shall request that management remove the limitation.
2. communicate the matter to those charged with governance
3. whether it is possible to perform alternative procedures to obtain sufficient appropriate audit evidence.
4. If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall qualify the opinion;

Question 7

What does the auditor need to determine materiality level for?

Answer 7

1. Financial report as a whole

2. Particular classes of transactions, account balances, and disclosures

Question 8

How do you estimate materiality?

Answer 8

• Select a base and a suitable percentage to apply to that base.
• requires professional judgment

Question 9

What are the 3 factors influencing choice of BASE?

Answer 9

Relevance, stability and predictability.

Question 10

Analyze Net Profit as a base?

Answer 10

Net profit may be the most relevant base for a company with PUBLICLY TRADED SECURITIES. However, because net profit can FLUCTUATE SIGNIFICANTLY from year to year it may lack stability, and is not relevant to entities such as NOT FOR PROFIT ORGANISATIONS.

Question 11

What are the common materiality rules?

Answer 11

Net Profit = 5-10% = Relevance

Total Revenue = 0.5-1% = Stability

Total Assets = 0.5-1% = Predictability, Stability

Equity = 1-2% = Stability

Question 12

What is the relationship between audit risk and materiality?

Answer 12

The higher the audit risk, the lower the materiality % should be set.