Chapter 4 - Process of assurance: evidence and reporting

Question 1

Define audit evidence.

Answer 1

Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based.

Question 2

What are the two types of tests auditors will typically carry out?

Answer 2

• Tests of controls
• Substantive procedures

Question 3

Define tests of controls.

Answer 3

Audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting material misstatements at the assertion level.

Question 4

Define substantive procedures.

Answer 4

Audit procedures designed to detect material misstatements at the assertion level. Substantive procedures comprise:

1. Tests of detail (of classes of transactions, account balances and disclosures)
2. Substantive analytical procedures

Question 5

Why do auditors carry out tests of controls?

Answer 5

When the auditors carry out tests of controls, they are seeking to rely on the good operation of the control system that the company has in place to draw a conclusion that the financial statements give a true and fair view.

Question 6

Why do auditors carry out substantive procedures?

Answer 6

When the auditors carry out substantive procedures, they are testing whether specific items within balances or transactions in the financial statements are stated correctly.

Question 7

Do ISAs require auditors to carry out substantive procedures?

Answer 7

Yes

The auditor will always assess the adequacy of the entity’s internal controls first.

If the controls are strong: the auditor can reduce the level of substantive testing and place greater reliance on the internal controls

If the controls are weak there is a greater chance of fraud and error therefore more detailed substantive testing will be required.

Substantive tests are performed on all audits, it is just the level of substantive testing that changes - it is never appropriate to just do tests of control and no substantive testing.

Question 8

Define sufficiency of audit evidence.

Answer 8

Sufficiency is the measure of the quantity of audit evidence.

Question 9

Define appropriateness of audit evidence.

Answer 9

Appropriateness is the measure of the quality or relevance and reliability of the audit evidence.

Question 10

What are the seven ways evidence can be obtained by an auditor? Outline the helpful mnemonic

Answer 10

AEIOU RC

Analytical Procedures – evaluation of financial information by studying possible relationships among financial and non-financial data

Enquiry – ask a relevant person for information

Inspection – of a document such as an invoice

Observation – of a process such as an inventory count

RecalcUlation – check the mathematical accuracy of a document

Reperformance – verification managements approach by the auditor

Confirmation – relates to evidence from a third party source

Question 11

What are the five aspects to consider when evaluating the reliability of audit reference?

Answer 11

External - Audit evidence from external sources is more reliable than that obtained from the entity’s records.

Auditor - Evidence obtained directly by auditors is more reliable than that obtained indirectly or by inference.

Entity - Evidence obtained from the entity’s records is more reliable when related control systems operate effectively.

Written - Evidence in the form of documents (paper or electronic) or written representations are more reliable than oral representations.

Originals - Original documents are more reliable than photocopies, or facsimiles.

Question 12

What are financial statement assertions?

Answer 12

Representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur.

Question 13

What are the six assertions regarding assertions about classes of transactions and events, and related disclosures, for the period under audit?

Answer 13

• Occurrence - Transactions and events recorded have actually occurred.
• Completeness - All transactions, events and disclosures included.
• Accuracy
• Cut-off - Transactions and events recorded in correct accounting period.
• Classification - Transactions and events recorded in proper accounts
• Presentation - Clearly described, relevant and understandable.

Question 14

What are six assertions about account balances, and related disclosures, at the period end?

Answer 14

• 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, equity interests and equity disclosures included.
• Accuracy, valuation and allocation - assets, liabilities, and equity interests have been included in the financial statements at appropriate amounts.
• Classification - assets, liabilities, and equity interests have been recorded in the proper accounts.
• Presentation - Clearly described, relevant and understandable.

Question 15

What are basic elements that must be found in an ‘unmodified’ auditor’s report?

Answer 15

Question 16

What are four items included only by exception in an auditors’ report?

Answer 16

• If adequate accounting records have not been kept
• If all information and explanations required for the audit have not been received
• If financial statements are not in agreement with the underlying accounting records
• If details of directors’ emoluments have not been properly disclosed in the financial statements

Question 17

What is the ‘expectations gap’?

Answer 17

The ‘expectations gap’ is defined as the difference between the apparent public perceptions of the responsibilities of auditors on the one hand and the legal and professional reality on the other.

Question 18

What are three specific issues relating to the ‘expectations gap’?

Answer 18

Misunderstanding of the nature of audited financial statements:

• the statement of financial position provides a fair valuation of the reporting entity
• the amounts in the financial statements are stated precisely
• the audited financial statements will guarantee that the entity concerned will continue to exist

Misunderstanding as to the type and extent of work undertaken by auditors:

• all items in financial statements are tested
• auditors will uncover all errors
• auditors should detect all fraud

Misunderstanding about the level of assurance provided by auditors:

• the auditors provide absolute assurance that the figures in the financial statements are correct

Question 19

The international standard on assurance engagements requires that an assurance report must have which components?

Answer 19

A title that clearly indicates the report is an independent assurance report

Addressee

An identification and description of the subject matter information and, when appropriate, the subject matter

Identification of the criteria

Significant inherent limitations

A statement restricting the use of the assurance report to those intended users or that purpose

A statement to identify the responsible party and to describe the responsibilities of the responsible party and the practitioner

A statement that the engagement was performed in accordance with International Standards on Assurance Engagements (ISAEs)

A summary of the work performed

The practitioner’s conclusion

The assurance report date

The name of the firm or practitioner, and a specific location