Lecture 8 - Audit evidence (2)

Question 1

Audit sampling means…

Answer 1

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

Question 2

Statistical sampling is….

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

Sampling risk is the risk that….

Answer 3

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.

Question 4

Sample size is based on….

Answer 4

• The level of risk that the firm will accept of not detecting an error.
• Higher sample gives lower risk and vice versa

Question 5

Sampling - When errors are found the auditor…..

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

Question 6

Sampling is inappropriate when….

Answer 6

• The population is small, so it is easier to test it all

- When no sampling risk can be accepted

Question 7

Accounting estimates arise from judgements made by:

Answer 7

Management, rather than transactions with third parties. E.g.:

• Depreciation of assets
• Doubtful debt provisions
• Warranty claim provisions
• Provisions for losses from lawsuit

Question 8

Estimates can be simple or complex, routine

or occasional, but they all involve….

Answer 8

Judgement, therefore the risk of misstatement is greater

Question 9

ISA 540 specifies three audit approaches:

Answer 9

1. Review and Test the process
2. Use an Independent Estimate for comparison
3. Review Subsequent Events

These can be used singly or in combination

Question 10

Gathering evidence - Receivables

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 for receivables include:

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

Gathering evidence - Payables

Answer 12

-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 13

Gathering evidence - Inventory

Answer 13

-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 14

The auditor should consider (ISA 501) for inventory evidence:

Answer 14

a) Whether the count procedures are adequate
b) The timing of the count
c) Locations where inventory is held
d) The use of an expert

Question 15

(a) Adequacy of count procedures - inventory

Answer 15

-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?

Question 16

(b) Timing of count - Inventory

Answer 16

-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

Question 17

(c) Inventory locations - inventory

Answer 17

• 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

Question 18

(d) Use of an expert - inventory

Answer 18

-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 19

During the inventory count….

Answer 19

-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

Question 20

After the inventory count…

Answer 20

-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