Audit Evidence Flashcards
Audit Evidence
All the information gathered by the auditor through observation, inquiry, analysis, or examination, to form basis of auditor’s opinion.
Can be in documentary or electronic form
Auditor gathers and analyzes evidence at almost every step in the audit process (not in last step: report)
Step 1: Engagement letter
Step 2: perform risk assessment procedures (observation, inquiry, inspection, analytical procedures); identitfy high degree of inherent risk; comparing ratios, etc.
Step 3: Evaluate RMM in given assertions (adjust NET of audit procedures)
Step 4: Design and perform audit procedures to address RMM
Test of controls: observation, inquiry, reinspection, re-perform transactions
Substantive tests: analytical procedures and tests of details
Purpose is to test managemetn’s assertions about: account balances transactions, totals, disclosures
Evidence must be from both client records and outside corroboration
Substantive tests are required for all material assertions
Step 5: Evaluate evidence
Evaluating Audit Evidence
GAAS requires that audit evidence be both:
SUFFICIENT - enough for a basis of opinion; consider RMM and quality of evidence
APPROPRIATE - both relevant (related to audit purpose and assertion being tested) and reliable (persuasive, but not conclusive beyond all doubt; consider materiality and inherent risk)
Levels of Reliability
Generated Circulated Example
- Direct Auditor Knowledge
- Externally Externally Bank Cutoff Statement; A/R Confirm
- Externally Internally Bank Statement
- Internally Externally Cancelled Check
- Internally Externally Client PO, receiving report
Most Reliable/Persuasive (top) to Least Reliable/Persuasive (bottom)
Confirmation Types
Positive Confirmation - respond whether or not they agree with the balance
Used: small number of large accounts; weak internal controls; a lot of disputed accounts
-Must follow up if no customer reply
Negative Confirmation - only respond if they disagree with balance; can’t infer information from a non-response
Used: large number of small accounts; strong internal controls: few disputed accounts
Reliability of Evidence
Reliability refers to:
Source of the evidence
Nature of the evidence
Generally, evidence is more reliable if it’s:
- from outside sources
- obtained directly by auditor
- an original document
Use Internal Auditor
Can use if objective and competant
Can ask to help with test of controls and substantive tests
Legal Letter
Letter of audit inquiry to client’s attorney (Level 2, similar to A/R confirmation; mailed by auditor)
Returned directly to auditor
Management is primary source for information about litigation and claims
ILLLC (I Love Legal Letter Confirmations)
Identify client
List of any litigation
Legal opinion on all outcomes
Limitations on attorney’s response (attorney/client priviledge, ex.)
Contingencies are communcation to client
Legal Letter: Attorney Refusal
Scope limitation
Precludes unmodified opinion (except for; qualified; disclaim)
Legal Letter: Client Refusal
Client imposed scope limitation
generally considered very material (disclaim; withdraw from engagement)
Litigation, Claims, and Assessments (audit procedures used to locate unrecorded)
RRRRR
Review the internal controls to record litigation claims and assessments
Request a list of litigation claims and assessments
Read attorney correspondence and bills
Read minutes and interim F/S and disclosures
Request management representation letter
Management Rep Letter
From management to the auditor requested at the end of the audit.
Last piece of audit evidence
-Engagement letter is first
Required under GAAS for unmodified opinion
If client refuses to give auditor MRL, it is a client imposed scope limitation (disclaim; withdraw engagement)
Management Rep Letter: Purpose
Purpose:
Confirm all representations made by management to auditor
Reduce chance of misunderstanding
Management Rep Letter: Sample
F/S are presented fairly in accordance with US GAAP or other framework
Mgmt responsible for design and implementation of internal controls (prevention and detection of fraud)
States any noncompliance with laws or regulations
All requested data has been provided
All transactions have been recorded
All required disclosures have been made in F/S (related party transactions, subsequent events, litigations, claims & assessments
Documents continuing appropriateness of managements’ representations
Signed by top management
Dated the date of the audit report (never after)
Management Rep Letter: Does not reduce
Does not reduce:
The scope of the audit
The risk of material misstatements
Auditor’s responsibility to detect errors and/or fraud in the F/S
Management Assertions
Evidence is gathered and analyzed to test management assertions
Design audit procedures to address the RMM in particular assertions
F/S are really just a set of assertions: account balances, transactions, presentation and disclosures
Account Balance Assertions
COVE
Completeness - nothing has been omitted
Ownership rights or obligations - assets and liabilities belong to company
Valuation, Allocation, Accuracy - account balance is valued accurately; estimates are reasonable
Existence or occurrence - account balance represents event that has actually occurred
Transaction Assertions
COVE
Completeness - nothing has been omitted
Cutoff - recorded in the proper period
Occurence
Valuation, Allocation, Accuracy - account balance is valued accurately; estimates are reasonable
Existence
Understandability
Classification
Presentations and Disclosures
Completeness
Ownership rights or obligations
Valuation, allocation, accuracy
Existence or occurrence
Understandability
Classification
Anayltical Procedures: Types
Tests of Controls - Observation, inquiry, inspection and re-perform transactions
Substantive tests - analytical procedures, and tests of details
Anayltical Procedures: Definition
The process of analyzing plausible relationships between financial and nonfinancial data to identify variances and unexpected changes
Anayltical Procedures: Required phases
Required in the planning phase to:
- assist auditor in understanding entity and its environment
- identiy items with high degree of inherent risk
Required in the review phase to:
- test validity of auditor’s conclusions
- evaluate overall F/S presentation
Optional in substantive testing - only circumstantial evidence; requires additional corroboration
ment–>
Ratio Analysis
Ratios are an important analytical procedure
Ratios: Measures of Liquidity (2)
Measures the ability of management to meet their short term obligations. Generally, the higher the better.
Current Ratio - Total Current Assers / Total Current Liabilities
Acid Test/Quick Ratio - (Cash + Mkt. Sec. + A/R)/Current Liabilities Most liquid assets in numerator
Ratios: Measures of Activity
A/R Turnover - measures the quality of the receivable; the higher, the better - Net Credit Sales / Average A/R
Days in A/R - 365 / A/R turnover (lower the better)
Inventory Turnover - COGS / Avg. Inventory
Days in Inventory - 365 / Inventory Inventory
A/P Turnover - COGS / Avg. A/P (measures how quickly payables are paid off; higher the better
Days in A/P - 365 / A/P Turnover
Ratios: Measures of Profitability
Gross Margin Percentage - Gross Margin (sales rev-op exp) / Net Sales
Net Operating Margin - Net Operating Income / Net Sales
Return on Assets (ROA) - Net Income / Avg. Total Assets
or Net Profit Margin (NI/Net Sales) x Asset Turnover (Net Sales / Avg. Total Assets)
Ratios: Measures of Solvency
Debt to Equity Ratio - Total Liabilities / Total Common Stockholder Equity (lower is better)
Times Interest Earned - Income before Taxes and Interest (EBIT)/ Interest Expense (higher is better)
Ratios: Investor Ratios
Book Value per Share - Total Stockholder Equity (assets minus liabilities) / # of Common Shares Outstanding (not authorized)
Earnings per Share - (NI - Preferred Dividends*) / Weighted Avg. # Common Shares Outstanding based on % of year
*if dividends are cumulative, include current period dividends in calcuated even if not declared yet
Tests of Details
Analytical Procedures > Substantive Procedures
Vouching: Existence / Overstatement - Start in Attic
Tracing: Completeness / Understatement - Start in Basement
F/S
Trial Balance
General Ledger
Subsidiary Ledger
Books of Original Entry
Source Documents
Authorization
Workpapers
Purpose is to:
- support the audit report
- adhered to GAAS
- aid in conduct of audit
- comprised of:
- permanent file (items of continuing audit interest - articles of incorporation, chart of accounts, I/C questionnaire, flowcharts)
- current file (items of current audit interest - working trial balance, lead schedules, a/r confirms)
Workpapers: Ownership
CPA owns the workpapers
Workpapers contain confidential client information
CPA needs client’s permission to disclose them to a third party
Workpapers: Retention
CPA must reain the workpapers for at least 7 years when auditing a public company (SOX)
AT least 5 years for any other audit or review (i.e. non-issuer)
Workpapers: Sufficiency
Documentation must be sufficient for a veteran auditor to understand
Nature, extent and timing of all audit procedures
Results of audit procedures
Conclusions reached by the evidence
Reconciliation of accounting records to F/S
Workpapers: Completion
Nonpublic/nonissuer company - completed within 60 days of audit report release date
Public/issuer company - completed within 45 days of audit report release date
Workpapers: Changes
Under PCAOB (public company accounting oversight board), any changes made to workpapers after the completion date:
- changes must be fully documented
- original documentation must be retained
Substantive Test: Memory Tool
CORVAIR
Confirmation
Observation and Inquiry
Retrace
Vouch
Analytical Procedures
Inspect and Examine
Reconcile
Subsequent Events: Memory Tool
Event that occurs after the balance sheet date, but before statements are issued. To search for subsequent events, use MIRACL
Management rep letter that addresses
Inquire
Read minutes and interim FS
Asset and liability valuation changes
Cutoff
Legal letters
Kiting (cash term)
Kiting - write a check from one account and deposit it in another account - overstates cash
audit procedures - bank transfer schedule - check dates of transfer between banks; look for deposit IN dated earlier than deposit OUT
internal control - proper separation of duties
Lapping (cash term)
use payment from one customer to pay another to hide stolen payments
Audt procedures - sent out A/R confirmations; use a lock box system; proper segregation of duties
