Chapter 11 Evidence and sampling Flashcards
1.1 substantive procedures
ISA 500 sets out the following types of substantive procedures
- inspection of assets or documents
- observation
- inquiry
- confirmation
- recalculation
- reperformance
- analytical procedures
Evidence is generally persuasive rather than conclusive so it may be necessary to perform more than one procedure to address a given risk.
1.2 Computer assisted audit techniques
Modern accounting systems generally are computerised so the auditor can use technology to carry out audit procedures. There are two traditional categories of CAATs, test data and audit software.
Test data is when auditor data is put into the client’s system. The data can be real, or dummy and the system can be a live or copy. It is used to test the controls in the system. An example is the auditor enters data in a timesheet with hours outside the normal range to check that the system rejects it.
Audit software is client data put into the auditor’s system. It is used as basic data analysis and substantive testing. An example is reperformance of addition or ageing of transactions and preparation of reports.
Audit data analytics
Auditors use data analytics to respond to the challenge of managing big data. It involves examining data to identify trends or correlations. Data analytics can be embedded in the audit plan to assist with:
- Transaction analysis: matching purchase orders and invoices
- Judgemental areas: using sensitivity analysis to test assumptions on the net value of inventory
- Analytical procedures: analysing revenue trends by product or region
The results of data analytics may be presented in formats such as pie charts which allow the auditor to visualise the date more easily
1.3 Analytical procedures
The process of performing analytical procedures was understand the business, develop an expectation, compare actual to expectation, unexpected variations equal a risk.
ISA 520 states the auditor can use analytical procedures as a form of substantive procedure. This does depend on factors such as:
- The strength/comparability of relationships
- The reliability of the data being used in the analysis
- The level of disaggregation of the data available
- The depth of the auditor’s knowledge of the client
At planning it is enough to identify risks areas and use this to determine the audit approach. At evidence stage, the auditor must determine if unexpected variations are acceptable and if not seek further evidence like making enquiries of management and corroborate management explanations with other evidence.
1.4 Directional testing
The auditor’s aim to identify whether the financial statements are free from material misstatement. A misstated balance can be under or overstated. Testing for overstatement requires a different approach than for an understatement. For overstatement the direction of testing is figure in accounts, intermediate documentation, supporting evidence. For understatement the direction of testing is reciprocal population, supporting evidence, intermediate documentation, figure in accounts.
1.5 Audit of accounting estimates
ISA 540 sets put the approach for estimates, for example depreciation, allowance for receivables and provisions. Estimates are high risks due to their subjective nature and the risk of management bias. The most common audit procedures for an accounting estimate are:
- Review and test the process used by management to develop the estimate
- Use an independent expert to make an estimate for comparison
- Review subsequent events for confirmation of the accuracy of the estimate
- Test the operating effectiveness of the controls over how management made the estimate
2.1 Sampling
ISA 540 states that the objective of the auditor when using sampling is to provide a reasonable basis for the auditor to draw conclusions about the sample population. Some testing procedures do not involve sampling, for example:
- Testing all items in a population (appropriate where the population is a small number of high-value items, or for unusual items)
- Testing all items with a certain characteristic such as high-value items
The sampling process can be summarised as follows: identify population, identify sampling unit, select sample, identify errors, and draw conclusions.
2.2 Identify the populations and sampling unit
The population is the entire set of data from which a sample is selected. The sampling units are the individual items constituting a population. ISA 530 requires that the auditor selects items in such a way that each sampling unit in the population has a chance of selection.
2.3 Selecting a sample
Sampling methods can be statistically or non-statistical. Statistical sampling uses random selection of the sample items and the use of probability theory to evaluate results.
Statistical sampling methods:
Method Description
Random selection All items in population have equal chance of selection by using a random generator
Systematic selection Items are selected using a random start, then a constant interval
Money unit sampling Every £1 in the population has an equal chance of being elected
Non-statistical sampling methods
Method Description
Haphazard selection Auditor selects a sample they think will be representative, without the use of theory
Sequence or block selection Select a block of items. Tends to be used for tests of control
After deciding on the method, the auditor then considers the size of the sample. Audit firms have their own methodology but will apply the requirements of ISA 530 which gives examples of factors which influence sample sizes:
- Increase in the auditor’s assessment of the risk of material misstatement (increase sample)
- Increase in the desired level of assurance (increase sample)
- Increase in the tolerable misstatement (decrease sample)
- Increase in the expected error (decrease sample)
- Stratification (process of dividing units of population into subgroups before sampling) of the population (decrease sample)
- Increase in the number of sampling units in the population (negligible effect)
2.4 Identifying errors and drawing conclusions
Once the auditor has tested the sample of items from the population, they must draw conclusions taking the following into account:
- The nature of errors identified (whether errors are true misstatements, for example mis posting between receivables accounts does not reflect an error in the receivables balance)
- The cause of errors identified (where common features are discovered, for example all errors arise in the same location, further testing will be required)
- The impact on other parts of the audit (identification of errors may influence the auditor’s assessment of the accounting and internal control systems)
- The probable misstatement in the population (results should be extrapolated, if the projected misstatement exceeds the tolerable misstatement, then additional testing is required).
3.1 Evaluation of misstatements
ISA 540 states the auditor must evaluate the effect of any uncorrected misstatements on the financial statements. The auditor must communicate all misstatements on a timely basis to management and request they correct them. Written representation must be obtained from management stating that they believe the misstatements to be immaterial.
If management refuses to correct the misstatements, the auditor should:
- Obtain an understanding of the reasons for refusal
- Determine whether the misstatements are material
- Communicate the uncorrected misstatements to those charged with governance and request they are corrected; the audit report will be modified if they are not corrected.
Matters which are not material in size but are material in nature are misstatements which.
- Affect compliance with law
- Affect compliance with debt covenants
- Affect ratios used to evaluate financial position, results, or cash flows
- Increase management compensation
