Unit 5 - Audit Evidence

Question 1

What are the five assertions about classes of transactions and events for the period under audit?

Answer 1

1. Occurrence
2. Completeness
3. Accuracy
4. Cutoff
5. Classification

Question 2

Define Assertion (1) Occurrence (about classes of transactions and events for the period under audit)

Answer 2

Transactions and events that have been recorded have occurred and pertain to the entity

ex. a client may record revenues prematurely in error, or management might record fictitious sales to overstate revenues and profit.

Question 3

Define Assertion (2) Completeness (about classes of transactions and events for the period under audit)

Answer 3

All transactions and events that should have been recorded have been recorded

ex. a client may have incurred an expense but not recorded it because the vendor’s invoice had not been received, or because management intended to understate expenses and overstate profit

Question 4

Define Assertion (3) Accuracy (about classes of transactions and events for the period under audit)

Answer 4

Amounts and other data relating to recorded transactions and events have been recorded appropriately

ex. a client might inadvertently use the wrong price on an invoice or may have complex foreign exchange calculations where errors can easily occur

Question 5

Define Assertion (4) Cutoff (about classes of transactions and events for the period under audit)

Answer 5

Transactions and events have been recorded in the correct accounting period

ex. a client may record a sale before year-end that actually occurred after year-end, or a client may record an expense after year-end that was actually incurred before year-end. Unintential cutoff mistakes may happen when internal controls are poor. Alternatively, a client may be motivated to record an expense or revenue in the wrong period to manipulate net income for the period

Question 6

Define Assertion (5) Classification (about classes of transactions and events for the period under audit)

Answer 6

Transactions and events have been recorded in the proper accounts

ex. a client may have recorded a routine maintenance expense in a fixed asset account with it should be recorded in an expense account. Auditors should be alert to misstatements that result in capitalizing an amount that should be expensed.

Question 7

What are the four assertions about account balances at the period-end?

Answer 7

6) Existence

7) Rights and obligations

8) Completeness

9) Valuation and allocation

Question 8

Define Assertion (6) Existence (about account balances at the period-end)

Answer 8

Assets, liabilities, and equity interests exist

ex. a client may miscount inventory, resulting in an overcount and overstatement, or a client may attempt to overstate inventory or accounts receivable to improve financial ratios for the period

Question 9

Define Assertion (7) Rights and obligations (about account balances at the period-end)

Answer 9

The entity holds or controls the rights to assets, and liabilities are the obligations of the entity

ex. An example of inventory that physically exists but does not satisfy the rights and obligations assertion is inventory held on consignment in the client’s warehouse (and therefore not owned by the entity), which is incorrectly recorded as an asset.

Question 10

Define Assertion (8) Completeness (about account balances at the period-end)

Answer 10

All assets, liabilities, and equity interest that should have been recorded have been recorded.

ex. a client may fail to record various accrued liabilities due to an error or an attempt to improve reported financial ratios for the period

Question 11

Define Assertion (9) Valuation and allocation (about account balances at the period-end)

Answer 11

Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

ex. an auditor verifies that inventory has been appropriately recorded at the lower of cost or net realizable value (risk of overstatement)

ex. an auditor tests for the adequacy of the allowance for doubtful accounts (risk of understatement or overstatement depending on the client’s motivation)

ex. an auditor verifies that equipment used in operations has been appropriately marked down if it is impaired (risk of overstatement)

Question 12

What are the four assertions about presentation and disclosure?

Answer 12

10) Occurrence and rights and obligations

11) Completeness

12) Classification and understandability

13) Accuracy and valuation

Question 13

Define Assertion (10) Occurrence and rights and obligations (about presentation and disclosure)

Answer 13

Disclosed events, transactions, and other matters have occurred and pertain to the entity.

Question 14

Define Assertion (11) Completeness (about presentation and disclosure)

Answer 14

All disclosures that should have been included in the financials statements have been included

Question 15

Define Assertion (12) Classification and understandability (about presentation and disclosure)

Answer 15

Financial information is appropriately presented and described, and disclosures are clearly expressed

Question 16

Define Assertion (13) Accuracy and valuation (about presentation and disclosure)

Answer 16

Financial and other information are disclosed fairly and in appropriate amounts.

Question 17

Define Relevant Assertions

Answer 17

Assertions that have a reasonable possibility of containing a material misstatement that would cause the financial statements to be materially misstated and, therefore, have a meaningful impact on whether the account is fairly stated.

Question 18

What is the Audit Program?

Answer 18

A listing of details of the audit procedures to be used when testing controls, conducting detailed substantive audit procedures, and completing the audit.

Question 19

When auditing accounts receivable, what will an auditor search for when testing for rights and obligations?

Answer 19

When testing the rights and obligations assertion for accounts receivable, the auditor should ensure the company has the right to receive the payments on receivables. The auditor could examine sales invoices and other documentation that shows the company sold and delivered goods or services to customers at a certain price, and therefore, the company has the right to be paid.

Question 20

What does the accuracy assertion mean? Use an example in the context of purchases of inventory.

Answer 20

The accuracy assertion states that amounts and other data relating to recorded transactions and events have been recorded appropriately.

Ex. when a company purchases inventory from a vendor, the vendor’s invoice will have the cost of the items purchased. When entering the cost of the items purchased, an employee typed $12 instead of $21 for an item which causes an accuracy problem.

Question 21

What is the auditor trying to ensure when considering the cutoff assertion? Use an example in the context of payroll transactions.

Answer 21

The cutoff assertion ensures that transactions and events have been recorded in the correct accounting period.

Ex. To test the cutoff assertion for payroll, an auditor should examine employee time cards from before and after year-end and compare with the payroll report to determine if the time worked (wages expense) was recorded in the proper period.

Question 22

When auditors use the phrase “sufficient appropriate evidence,” what do they mean by “appropriate?”

Answer 22

Appropriate refers to the quality of audit evidence gathered.

Typically, the higher the quality of the evidence, the less quantity that may be required.

AU-C 500.A5 and AS 1105.06 state the quality of audit evidence is determined by its relevance and reliability in providing support for the conclusions on which the auditor’s opinion is based.

Question 23

When auditors use the phrase “sufficient appropriate evidence,” what do they mean by “sufficient?”

Answer 23

Sufficient refers to the quantity of audit evidence gathered.

Essentially, auditors determine at what point they have gathered enough evidence to support their opinion on the financial statements.

AU-C 500.A4 and AS 1105.05 state the quantity of evidence needed is affected by the risk of material misstatement in a relevant assertion for an account balance or class of transactions. In other words, as risk increases, the amount of evidence the auditor should gather also increases.

Question 24

Describe the relationship between the risk of material misstatement and sufficient appropriate audit evidence.

Answer 24

The risk of material misstatement affects the quantity and quality of evidence gathered by an auditor during the risk response phase. To elaborate, if detection risk is set to low, then the auditor will perform more substantive procedures that result in a higher quality and possibly increased quantity of evidence.

Ex. assume there is a high risk that the client’s internal controls are not operating effectively. In fact, the auditor believes that high-ranking company executives are able to circumvent controls related to revenue. This will cause the auditor to set risk of material misstatement as high and detection risk as low, performing more substantive procedures since test of controls related to revenue cannot be relied upon.

Question 25

Define the audit procedure called “vouching.”

Answer 25

A type of inspection in which auditors select transactions from a journal or ledger and work backward to examine the underlying source documents. Vouching provides evidence for the occurrence or existence assertion (evidence that recorded transactions actually occurred).

Question 26

Define the audit procedure called “tracing.”

Answer 26

A type of inspection in which auditors select source documents and work forward to follow the transaction through to recording in the journal and ledger; tracing provides evidence for the completeness assertion.

Question 27

Define external confirmations.

Answer 27

An audit procedure in which the auditor corresponds directly with a third party, either in paper or electronic form, and the third party responds directly to the auditor on the matters included in the confirmation.

Evidence obtained from external confirmations is considered reliable because it is obtained from an independent source outside of the client.

Definition does not include management giving the auditor access codes for confirming party’s data. If the confirming party provides the access codes, that is within the definition.

Question 28

What is the difference between positive and negative confirmations?

Answer 28

Positive confirmations are correspondence sent directly by an auditor to a third party, who is asked to respond to the auditor on the matter included in the letter in all circumstances (that is, whether they agree or disagree with the information included in the auditor’s letter).

A negative confirmation is also a correspondence sent directly by an auditor to a third party but the third party is asked to respond to the auditor only if the party disagrees with the information provided.

Question 29

Define scanning.

Answer 29

Scanning is a type of analytical procedure in which auditors use their professional judgement to review accounting data to identify unusual or significant items to examine further.

ex. large dollar amount for a transaction such as a very large cash receipt that might be evidence of a loan, or a nonstandard journal entry

Question 30

Define Audit Data Analytics (ADA)

Answer 30

The science and art of discovering and analyzing patterns, identifying anomalies, and extracting other useful information in data underlying or related to the subject matter of an audit through analysis, modeling, and visualization for planning and performing the audit.

Question 31

What are the benefits to ADA software(3)?

Answer 31

Using ADA software makes the audit
1) more comprehensive
2) more efficient
3) allows auditors to concentrate on designing the test criteria and interpreting results than on performing the detailed audit procedures.

Question 32

What are the three categories of management assertions?

Answer 32

Classes of transactions

Account balances

Presentation and disclosure

Question 33

At the front of every audit file is the client’s _______ supporting the financial statements.

Answer 33

Trial balance

Question 34

During the risk assessment phase, what do auditors use as a guide when determining the different types of potetional material missatements that could occur or what can go wrong in the financial statements?

Answer 34

Management Assertions (explicit or implied)

Question 35

What management assertion addresses the presentation and clarity of financial statement disclosures?

Answer 35

Classification and understandability