Chapter 5 Audit Notes
Chapter 5 Audit Notes ACCT 4150
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This 9 page Class Notes was uploaded by Victoria Andreski on Friday March 4, 2016. The Class Notes belongs to ACCT 4150 at Clemson University taught by Nancy Harp in Spring 2016. Since its upload, it has received 30 views. For similar materials see Auditing in Accounting at Clemson University.
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Date Created: 03/04/16
CHAPTER 5—Evidence & Documentation Management Assertions • Assertions about classes of transactions & events for the period under audit o Occurrence o Completeness o Classification o Cutoff (Is it completed in the correct period?) o Authorization o Accuracy • Assertions about end-of-the-period account balances o Existence o Completeness o Rights & obligations o Valuation & allocation • Assertions about presentation & disclosure o Classification (current or long-term?) & understandability (easy to understand instead of just using company jargon) o Accuracy & valuation o Completeness o Occurrence & rights & obligations ID Management Assertions 1. Existence or Occurrence a. Assets & liabilities exist & recorded transactions occurred b. Existence—end-of-period balanceà test by sending company a letter for them to validate i. Does the amount reported on the balance sheet actually exist? c. Occurrence—transaction sideà take samples i. Did they actually occur? d. Can either look at each transaction or just the ending balance e. Example: i. Supplies on the balance sheet physically exist 11/15 A/R 1500 Sales Revenue 1500 ii. Is the sale real? à Pull purchase orders, invoices, shipping documents, etc. iii. Test VALIDITY 1. Is it valid? 2. Is it real? 2. Completeness a. ALL transactions & accounts that should have been recorded in the F/S were recorded b. Did something not get recorded? c. Example: i. All payroll expenses that should have been recorded were recorded ii. Accounts payableà subsequent payments iii. How do we find debt that isn’t recorded b/c they want to hide it? 1. Write letters/communicate w/ banks the company uses & see how much debt they actually owe iv. Test COMPLETENESS 3. Rights & Obligations a. Assets are actually rights of the client & recorded liabilities are actually owed by the entity b. Something can exist but we may not have the right to it i. Sometimes inventory is owned on consignment c. Example: i. The client has legal title or similar rights to inventory ii. Test OWNERSHIP 4. Valuation or Allocation a. Assets, liabilities, revenues, & expenses are appropriately valued & allocated to the proper accounting period i. Related to depreciation expense b. Inventory has to be lower of cost or market—Is it valued correctly? c. Example: i. Net A/R is valued at an amount that reasonably reflects collectability ii. Taking into account the allowance for doubtful accounts iii. Test VALUATION 5. Classification & Understandability a. Financial information is appropriately presented & described, & disclosures are clearly expressed b. Example: i. Notes Payable due in less than 1 year are classified as Current Liabilities 1. Test CLASSIFICATION 2. Check to make sure that contingent liabilities are disclosed in the footnotes a. Test DISCLOSURE 6. Accuracy a. Amounts & other data relating to recorded transactions & events have been recorded appropriately b. Properly record @ correct dollar amount—is the total correct? c. Look for inaccuracies on how things are recorded d. Example: i. Foot sales journal to see if the total sales # is added correctly & matches the G/L entry ii. Test MECHANICAL ACCURACY 7. Cutoff a. Transactions & events have been recorded in the correct accounting period i. Things are being put in the right period 1. Very important for revenue b. Example: i. Check to make sure that sales are recorded in the proper period ii. Test CUTOFF iii. Examine shipments made on 12/31 & on 1/1 to see if they were recorded in the right year 1. Look @ the invoice & see if the date it was recorded on in the system matches the date goods were actually shipped Audit Evidence • All the information, from whatever source, used by the auditor in arriving at the conclusions on which the audit opinion is based o Schedules, bank statements, inventory counts, checks, letters, ratio analysis, etc. • Concepts of Audit Evidence o 1) Nature of the Audit Evidence § Form or type of evidence • Records of initial entries & supporting records • Spreadsheets supporting cost allocations • Invoices • General & subsidiary ledgers • Contracts • Adjustments to financial statements • Worksheets • Other computations, reconciliations, & disclosures o 2) Sufficiency & Appropriateness of Audit Evidence § Sufficiency—measure of the QUANTITY of audit evidence • Is it enough? • Relative to the amount of risk • Greater risk of misstatements requires a higher quantity of audit evidence (IR x CR) • Higher quality audit evidence results in a lower quantity of audit evidence (don’t need as much) o Ex: information from a 3 party • Inverse relationship of sufficiency & appropriateness § Appropriateness—measure of the QUALITY of audit evidence • Relevance—not all evidence makes sense for the assertion being test • Reliability—how much the evidence gathered can be depended on o Independent source of the evidence § Confirmation letter form 3 party (independent of client) is very reliable o Effectiveness of internal control § Outputs from client isn’t very reliable if internal controls are weak o Auditor’s direct personal knowledge § Based on what auditor personally examines & tests • High quality • Less reliable if auditor simply calls company & gets information over the phone—you should physically see/test it yourself o Documentary evidence o Original documents—best kind o 3) Evaluation of Audit Evidence § Proper evaluation of evidence requires an understanding of the: • Types of evidence available • Relative reliability of available evidence § An auditor should be thorough in searching for evidence & unbiased in its evaluation • Ex: In a sample of 50, something is weird w/ 5 of themà evaluate ALL 50, not just most or some of them • Bias is an issue when you are friends w/ or have gotten close to your clients—be skeptical Audit Procedures • A set of audit procedures prepared to test assertions for a component of the financial statements—audit program • Audit procedures for obtaining audit evidence o Inspection of records & documents § Evidence obtained from external documents is more reliable than evidence obtained from internal documents Vouching (Occurrence) Source Journal or Documents Ledger Tracing (Completeness) § Direction of testing is very important • Tracing—start from document & see if it is in the books • Vouching—start w/ books & see if what is recorded & see if there’s a valid source document showing that it actually happened o Inspection of tangible assets § Physical examination of a tangible asset • Personal knowledge—you actually go & look at it o Observation § Process of watching a process or procedure being performed by others • Watching someone else do it • You aren’t the one physically examining it o Inquiry § Consider the knowledge, objectivity, experience, responsibility, & qualifications of the individual to be questioned • Am I asking the right person? § Ask clear, concise, & relevant questions appropriately § Use open or closed questions appropriately • Open—gives them a chance to give a lot of info • Closed—yes/no answer § Listen actively & effectively § Consider the reactions & responses, then ask follow-up questions § Evaluate the response o External Confirmation § Process of obtaining a representation of information or of an existing condition directly from a 3 party § The reliability of evidence obtained through confirmations is directly affected by factors such as: • The form of the confirmation • Prior experience w/ entity • Nature of information being confirmed • Intended respondentà who is supposed to be responding? o Recalculation § Determining the mathematical accuracy of documents or records § Example: foot the journal o Reperformance § The auditor’s independent execution of procedures or controls that were originally performed as part of the internal control system o Analytical Procedures § Evaluations of financial information made by a study of plausible relationships among both financial & nonfinancial data • Get a sense to see if it’s reasonable o Scanning § Review of accounting data to identify significant or unusual items • Skim to see if there is something wrong § Example: look for weird journal entries—JE done at 4am § CAATS—helps determine red flags w/ computer system Reliability of Types of Evidence Higher Inspection of tangible assets, reperformance, recalculation (You actually doing something) Inspection of records & documents, confirmation, analytical procedures, scanning Lower Observation, inquiry (Watching someone do something or asking them about it) Audit Documentation • The auditor’s principal record of the audit procedures performed, evidence obtained, & conclusions reached • Working papers • 3 functions: o 1. To provide support for the audit report o 2. To aid in the planning, performance, & supervision of the audit o 3. To provide basis for quality reviews & evidence supporting the auditor’s significant conclusions • Should be organized so that audit team members & others can find evidence supporting financial statement accounts • Property of the auditor, including documents prepared by the client at the auditor’s request • SOX of 2002 requires audit documentation to be retained for 7 years from the completion date of the engagement Content of Audit Documentation • Demonstrate how the audit complied w/ auditing & related professional practice standards o Work must be properly planned • Support the basis for the auditor’s conclusions concerning each material financial statement assertion • Demonstrate that the underlying accounting records agreed or reconciled w/ the financial statements o Make sure the #s you audited actually shows up on the financial statements • Include a written audit program detailing audit procedures necessary to accomplish audit objectives • Enable a knowledgeable & experienced reviewer to: o Understand the nature, timing, extent, & results of audit procedures, evidence obtained, & conclusions reached o Determine who performed & reviewed the work & the dates of the work & reviews • Audit Program—set of procedures that an auditor believes are necessary to perform to express an opinion o Basis for coordinating/supervising audit o Means to control time spent on audit o Guide for entry-level employees o Evidence of proper planning o Record of work done § Sign off on work papers & initial the audit program • Most public accounting firms maintain audit documentation in 2 types of files: o Permanent files—something needed year to yearà use it ongoing § Corporate charter § Chart of accounts § Organization chart § Accounting manual § Important contracts § Internal control documentation § Terms of stock & bond issues § Prior years’ analytical procedures o Current files—more specific for THIS year’s audit § Audit plan/audit report § Audit programs § Working trial balance § Minutes of meetings § Adjusting journal entries § Reclassification journal entries § Current financial statements § Working papers supporting accounts Format of Audit Documentation • Heading o Client name o Title of the working paper o Client’s year-end date • Indexing & cross-referencing o Notations that provide a trail from financial statements to audit documents • Tick marks o Notations made next to work paper items indicating auditor/reviewer actions o Talks about things you didà descriptions Analytics • Evaluations of financial information made by a study of plausible relationships among financial & nonfinancial data • Involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor o Comparisons w/: § Industry averages § Similar businesses § Client budget, projections, forecasts § Prior periods (reasonable?) § Nonfinancial data (logical?) • Purpose o Helps auditor understand client in general o Helps evaluation of client as a going-concern o Helps identify areas for audit work o Can reduce detail testing o **Can reduce costs • Preliminary—used to assist the auditor to better understand the business & to plan the nature, timing, & extent of audit procedures • Substantive—used to obtain evidential matter about particular assertions related to account balances or classes of transactions • Final—used as an overall review of the financial information in the final review stage of the audit • Types o Trend Analysis—least precise; trends over time o Ratio Analysis—compare to industry benchmark o Reasonableness Analysis—most precise § Predict a # based on a model used—come up w/ your best guess & compare to # they report Develop an Expectation • Auditing standards require the auditor to have an expectation whenever analytical procedures are used • An expectation can be developed by using a variety of information sources: o Financial & operating data o Budgets & forecasts o Industry publications o Competitor information o Management’s analyses o Analyst’s reports Tolerable Difference • Size of difference depends on: o Significance of account o Desired degree of reliance on the substantive analytical procedures o Level of disaggregation (broken up into smaller pieces) in the amount being tested o Precision of the expectation • Amount is always less than planning materiality o Materiality of entire audit • The more confident you are in the expectation/estimate, the smaller the tolerable difference Compare & Investigate • Compare the expectation to the recorded amount & investigate any differences greater than the tolerable difference • Preliminary analytical procedures differencesà corroborating evidence is NOT required • Final analytical procedures differences—very end of audit when you look at all the ratiosà corroborating evidence is required Ratios • Short-Term Liquidity Ratios o Current ratio o Quick ratio o Operating Cash Flow ratio • Activity Ratios o Receivables Turnoverà Days outstanding in accounts receivable o Inventory Turnoverà Days of inventory on hand • Profitability Ratios o Gross Profit Percentage o Profit Margin o Return on Assets o Return on Equity • Coverage Ratios o Debt to Equity o Times Interest Earned
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