Audit Evidence 2 (Sem 2)

Question 1

What is audit sampling?
What is sampling required for?

Answer 1

Audit sampling means testing ‘less than 100% of items within a class of transactions or account balance’ and drawing inferences about the whole population from such tests.

Sampling is required for efficiency purposes; testing everything would take too long!

Question 2

Statistical Sampling
Any approach to sampling which includes: (2)
Anything that doesn’t is what?

Answer 2

Any approach to sampling which includes:

• Random selection of a sample
• Use of probability theory to evaluate results, e.g. so can say we are ‘95% confident result is correct, within the bounds of materiality’.

Anything which doesn’t adopt this approach is known as non-statistical sampling and is usually a matter of judgement.

Question 3

What is sampling risk?
What tests do we have to combat it? (2,2)
For this reason…?

Answer 3

Sampling risk is the risk that the opinion formed on the basis of the sample chosen is different from that which would have been formed if the whole population had been checked.

Tests of control:

• Risk of over reliance
• Risk of under reliance

Substantive tests:

• Risk of incorrect acceptance
• Risk of incorrect rejection

For this reason, even judgemental samples attempt to be as haphazard and unbiased as possible.

Question 4

Sample Size

What is it based on?
Higher sample gives…?
3 things to consider?

Answer 4

• Based on the level of risk that the firm will accept of not detecting an error.
• Higher sample gives lower risk and vice versa.
• Cost/benefit trade-off; should be efficient.
• Sampling tables exist
• Don’t always choose the same sample size!

Question 5

What should the effect of errors do?
If the result is more than the… the auditor can:(4)

Answer 5

The effect of errors found should be extrapolated across the entire population. If the result is more than the tolerable error, the auditor can:

• Increase the sample size; although this is often not possible due to cost/benefit issues.
• Apply different substantive procedures to provide corroboration
• Request that the client adjusts the balance.
• If the client refuses to adjust the balance, can issue a qualified or adverse opinion.

Question 6

When is sampling inappropriate?

Answer 6

The population is small, and it’s easier to test it all

• e.g. fixed asset additions/ disposals,
• or goodwill calculations.

Where no sampling risk can be accepted;

• e.g. in assurance assignment to discover fraud
• Rare in a financial statements audit.

Question 7

Accounting estimates arise from… made by…rather than…eg: (4)

Answer 7

Accounting estimates arise from judgements made by management, rather than transactions with third parties. E.g.:

Depreciation of assets

• Management decides over how many years the asset will be used and how much it will be worth at the end of its useful life. This estimate affects the amount of depreciation expense recognized each year.

Doubtful debt provisions

• Management assesses the likelihood of customers defaulting on their payments based on historical data and current economic conditions.

Warranty claim provisions

• Management estimates the future costs that will be incurred to honor these warranties. This involves analyzing past warranty claims and predicting future claims based on current sales data.

Provisions for losses from lawsuit

• When a company is facing legal action, it needs to estimate the potential financial impact of the lawsuit. This involves assessing the likelihood of losing the case and the potential settlement or penalty amounts. These estimates are made based on legal advice and past experiences.

Question 8

Accounting Estimates can be… (4) but they all involve and therefore?

Answer 8

Estimates can be simple or complex, routine or occasional, but they all involve judgement therefore the risk of misstatement is greater.

Three audit approaches:

1. Review and Test the process

• Understand how management arrived at the estimate, test assumptions, verify calculations, and review documentation.

2. Use an Independent Estimate for comparison

• Create an independent estimate and compare it with management’s to identify significant differences.

3. Review Subsequent Events

• Examine events after the balance sheet date to gather evidence supporting the estimate.

These can be used singly or in combination.

Question 9

Review & Test Process (7)

Answer 9

1. Evaluate the Data: using the normal criteria i.e. is it relevant, reliable, complete?
2. Evaluate Assumptions: are they based on external or internal information?
3. Test the Calculations
4. Compare with prior periods
5. Consider Approval Process: at appropriate level and documented?
6. Compare with independent estimate
7. Review subsequent event

Question 10

Gathering Evidence - Receivables

• ________________ ______________ is an effective method of obtaining audit evidence.
• _________________, ___________ evidence is provided by the _________ on the ___________ ________.
• _______________ ___________ may not _________ with __________ ___________ – but ________ to __________ and ____ ____________ items.
  What if the customer doesn’t reply?

Answer 10

• Receivables circularisation is an effective method of obtaining audit evidence.
• Independent, external evidence is provided by the customer on the balance owing.
• Customer balance may not agree with client balance – but possible to identify and test reconciling items.
• If customer doesn’t reply, follow-up procedures required.

Question 11

Follow Up Procedures Include (4)

Answer 11

• Follow-up of circularisation letter by fax, e-mail or telephone
• Proving the balance owed by checking cash received from customer after the year end
• Agreeing balances owed back to original invoices
• Checking that invoices are supported by delivery notes and orders.

Question 12

Summary Of Receivables Tests

Answer 12

Question 13

Payables - Gathering Evidence (4)

Answer 13

• Suppliers usually send monthly statements to their clients, stating the balance outstanding.
• These are good evidence of existence and valuation.
• These should be reconciled (by the client) to the client’s records.
• Differences are usually due to timing but may represent errors.

Question 14

Summary Of Payables Tests

Answer 14

Question 15

Inventory - Gathering Evidence

What procedure should management establish?

The auditor should attend the ________ if inventory is ___________ ; gives evidence of: (3)

Answer 15

Management should establish procedures to ensure stock is physically counted at least once a year

The auditor should attend the count if inventory is material; gives evidence of:

• Reliability of accounting records
• Internal controls, e.g. over counting procedures
• Existence/completeness/cut-off/valuation.

Question 16

Inventory Count - Planning

1. 4 questions asked?
2. 4?
3. 2, Further considerations include (4)
4. 2?

Answer 16

The auditor should consider:

1. Whether the count procedures are adequate

• Are instructions in writing/issued in good time/understood by relevant staff?
• What controls are there over the collection of stock sheets, for example?
• How accurate is the identification of stage of completeness or slow moving/obsolete items?
• How is the movement of inventory handled around the cut-off date?

2. The timing of the count

• Ideally the count should be at the period end
• The auditor can then gather information to test for cut-off at a later date
• If at an earlier date, the auditor can only rely on the count if controls over inventory are good
• In this case, additional work will be carried out at the period end to confirm cut-off.

3. Locations where inventory is held

If several locations, must consider which is most appropriate to attend.
If stock is held at a third-party location, confirmation of the amount held should be obtained. Further considerations include:

• Integrity and independence of third party
• Whether to observe third party inventory count
• Whether third party auditors’ report available
• Inspecting supporting documentation

4. The use of an expert.

• May be necessary to establish quantities or confirm the nature and condition of inventory; e.g. chemicals, minerals. Refer back to ‘using the work of an expert’.
• The client may use external counters, e.g. for a petrol station or public house; refer to ‘using service organisations’, as above.

Question 17

Inventory Count

During the count (5)
After the count (5)

Answer 17

During the count

• Auditor tests completeness and accuracy by test counting from records to stock and vice versa
• Auditor concentrates on items of high value
• Obtains evidence regarding obsolete stock
• Ensures third-party stock is adequately counted and separated
• Requests a re-count if procedures are inadequate.

After the count

• The final inventory listing is checked to the count records.
• The cut-off evidence obtained is followed up.
• All issues identified at the count are followed up.
• Any roll-forward procedures are checked.
• If not sufficient, reliable evidence then other procedures must be performed.

Question 18

Summary of Inventory Tests

Answer 18

Question 19

Bank & Cash - Gathering Evidence

What is the major test for the bank balance?
What is it corroborated by and what does it provide evidence of?
What is usually immaterial and how is it covered

Answer 19

The major test for the bank balance is the Bank Reconciliation.

This is corroborated by the bank confirmation letter, which also provides evidence of completeness.

Cash-in-hand balances (petty cash) are usually immaterial and are covered by analytical review and/or counting if necessary.

Question 20

Bank Reconciliation Work

Tasks (6)

Answer 20

• Test the mathematical accuracy.
• Agree to the general ledger total.
• Agree to the bank confirmation letter.
• Ensure unpresented cheques/uncredited lodgements are within correct dates.
• Verify a sample of these after the year end
• Ensure all direct debits/charges are analysed correctly.

Question 21

Additional Anti-fraud Test

Type of fraud and what it is?
When does it usually occur?
Steps to stop it (3)

Answer 21

• Teeming and lading occurs when a receipt from one customer is stolen, then the receipt from the next customer is used to hide the loss.
• This usually can only occur when segregation of duties is poor, so that the same person handles cash receipts and updates the receivables ledger.

Steps to stop teeming & lading

• Confirm accounts receivable at an interim date, by surprise
• Surprise cash count
• Compare daily cash receipts journal entries with daily deposit slips, to ensure consistency (cash received from customer is posted against their account).

Question 22

Summary of cash & bank tests

Answer 22

Question 23

Audit Of Tangible Non-current Assets

What do the key audit procedures involve?

What assertions do these give evidence towards (5)

Answer 23

• The key audit procedures involve the examination of documents regarding non-current assets.
• These give evidence towards the assertions of existence, accuracy, valuation, rights and obligations and classification.

Question 24

Summary of tangible non-current asset tests

Answer 24

Question 25

Audit Of Long-term Liabilities

Examples of long term liabilities (4)

Key procedures (3)

Answer 25

Debt, derivatives, bonds and mortgages can be complex areas which require specialised help to audit.

However, the key procedures are:

• Inspection of supporting documentation
• Confirmation from third party (debt holder)
• Substantive analytical procedures to review interest payments.

Question 26

Summary of Long-term Liability Tests

Answer 26