Audit Evidence

Chapter 7

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-1

Learning Objective 1
Contrast audit evidence with evidence used by other professions.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-2

Nature of Evidence
The use of evidence is not unique to auditors Evidence is also used by scientists, lawyers, and historians

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-3

Learning Objective 2
Identify the four audit evidence decisions that are needed to create an audit program.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-4

Audit Evidence Decisions

1. Which audit procedures to use 2. What sample size to select for a given procedure

3. Which items to select from the population

4. When to perform the procedures (timing)

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-5

Audit Program
It includes a list of the audit procedures the auditor considers necessary.

Sample sizes Items to select Timing of the tests

Most auditors use computers to facilitate the preparation of audit programs.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 7-6

Learning Objective 3
Specify the characteristics that determine the persuasiveness of evidence.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-7

Persuasiveness of Evidence
Two determinants: Appropriateness

Sufficiency

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-8

Six Characteristics of Reliable Evidence

1. Independence of provider 2. Effectiveness of clients internal controls 3. Auditors direct knowledge

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7-9

Six Characteristics of Reliable Evidence

4. Qualification of individuals providing the information 5. Degree of objectivity 6. Timeliness

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 10

Relationships Among Audit Evidence and Persuasiveness

Audit Evidence Decisions Audit procedures and timing Qualities Affecting Persuasiveness of Evidence

Appropriateness Relevance Reliability Independence of provider Effectiveness of internal controls Auditor's direct knowledge Qualifications of provider Objectivity of evidence Timeliness When procedures are performed Portion of period being audited
Sufficiency Adequate sample size Selection of proper population items
7 - 11

Sample size and items to select

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Persuasiveness and Cost

In making decisions about evidence for a given audit, both persuasiveness and cost must be considered. The auditors goal is to obtain a sufficient amount of appropriate evidence at the lowest total cost.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 12

Learning Objective 4
Identify and apply the eight types of evidence used in auditing.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 13

Types of Audit Evidence

1. Physical examination
2. Confirmation 3. Documentation 4. Analytical procedures 5. Inquiries of the client 6. Recalculation 7. Reperformance 8. Observation
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 7 - 14

Relationships
Auditing standards Qualifications and conduct Physical examination Confirmation Documentation Analytical procedures Inquiries of the client Recalculation Reperformance Observation FOUR AUDIT EVIDENCE DECISIONS

Broad guidelines concerning auditor qualifications and conduct, evidence accumulation, and reporting

Evidence accumulation
Reporting Types of evidence

Audit procedures

Broad categories of evidence available for the auditors accumulation Specific instructions for the accumulation of types of evidence Timing of tests

Sample size and items to select

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 15

Physical Examination
It is the inspection or count by the auditor of a tangible asset. This type of evidence is most often associated with inventory and cash.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 16

Confirmation
Information Assets
Cash in bank Accounts receivable Notes receivable Owned inventory out on consignment Inventory held in public warehouses Cash surrender value of life insurance Bank Customer Maker Consignee Public warehouse Insurance company

Source

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 17

Confirmation
Information Liabilities
Accounts payable Notes payable Advances from customers Mortgages payable Bonds payable Creditor Lender Customer Mortgagor Bondholder

Source

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 18

Confirmation
Information Owners Equity
Shares outstanding Registrar and transfer agent

Source

Other Information
Insurance coverage Contingent liabilities Bond indenture agreements Collateral held by creditors
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Insurance company Bank, lender, and clients legal counsel Bond holder Creditor
7 - 19

Documentation
It is the auditors inspection of the clients documents and records.

Internal documents

External documents

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 20

Analytical Procedures
Understand the clients industry and business Assess the entitys ability to continue as a going concern

Indicate the presence of possible misstatements in the financial statements

Reduce detailed audit tests

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 21

Inquiries of the Client

It is the obtaining of written or oral information from the client in response to questions from the auditor.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 22

Recalculation
It involves rechecking a sample of calculations made by the client.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 23

Reperformance
It is the auditors independent tests of client accounting procedures or controls that were originally done.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 24

Observation
It is the use of the senses to assess client activities. The auditor may tour the plant to obtain a general impression of the clients facilities.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 25

Appropriateness of Types of Evidence

Type of evidence Independence of provider Effectiveness of clients internal controls Auditors direct knowledge Qualifications of provider

Objectivity of evidence

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 26

Terms and Types of Evidence

Terms
Examine Scan Read Compute Recompute Foot Trace Compare Count Observe Inquire Vouch

Type of Evidence
Documentation Analytical procedures Documentation Analytical procedures Recalculation Recalculation Documentation/Reperformance Documentation Physical examination Observation Inquiries of client Documentation
7 - 27

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Learning Objective 5
Understand the purposes of audit documentation.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 28

Audit Documentation
Audit documentation is the principal record of auditing procedures applied, evidence obtained, and conclusions reached by the auditor in the engagement.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 29

Audit Documentation
Purposes of audit documentation Ownership of audit files

Confidentiality of audit files

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 30

Sarbanes-Oxley Act
The Sarbanes-Oxley Act requires auditors of public companies to prepare and maintain audit working papers for a period of no less than seven years.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 31

Learning Objective 6
Prepare organized audit documentation.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 32

Audit File Contents and Organization

Financial Statements and Audit Report Financial Statements and Audit Report Working Trial Balance Financial Statements and Audit Report Adjusting Journal Entries Financial Statements and AuditContingent Report Liabilities Financial Statements and Audit Report Operations Financial Statements and Audit Liabilities Report and Equity Financial Statements and Audit Report Assets Financial Statements and Audit Report Analytical Procedures Financial Statements and Audit Report Tests of Controls and Substantive TOT Financial Statements and Audit Report Internal Control Financial Statements and Audit General Report Information Financial Statements and Audit Report Audit Programs Financial Statements and Audit Report Permanent Files Financial Statements and Audit Report

Robinson Associates Trial Balance 12/31/07 Cash Accounts Receivable Prepaid Insurance Interest Receivable $165,237 275,050 37,795 20,493

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 33

Permanent Files
These files are intended to contain data of a historical or continuing nature pertinent to the current audit.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 34

Current Files
Audit program General information Working trial balance Adjusting and reclassification entries Supporting schedules

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 35

Relationship of Audit Documentation to Financial Statements

FINANCIAL STATEMENTS Cash 122 Acc. WORKING TRIAL BALANCE Prelim. AJEs Cash 212 (90) LEAD SCHEDULECASH Petty Cash A-2 Cash in Bank: General A-3 Payroll A-4 Per G/L 5 Final 122 AJEs Expense 90 Cash

90 A-1

AJEs

Final 5

186 21 212

(90)
(90)

96 21 122
7 - 36

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Relationship of Audit Documentation to Financial Statements

LEAD SCHEDULECASH

Petty Cash A-2 Cash in Bank: General A-3 Payroll A-4

Per G/L 5 186 21 212

AJEs (90) (90)

A-1 Final 5 96 21 122

A-2 Cash Count Sheet A-3/1 Confirmation

A-3 Bank Reconciliation A-3/2 O/S Check List

A-4 Bank Reconciliation A-4/1 Confirmation

A-4/2 O/S Check List

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 37

Types of Supporting Schedules

Analysis Trial balance or list Reconciliation of amounts Tests of reasonableness

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 38

Types of Supporting Schedules

Summary of procedures Examination of supporting documents Informational Outside documentation

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 39

Preparation of Audit Documentation

Each audit file should be properly identified Documentation should be indexed and cross-referenced Completed documentation must clearly indicate the audit work performed It should include sufficient information

It should plainly state the conclusions reached

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 7 - 40

Learning Objective 7
Describe how e-commerce affects audit evidence and audit documentation.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 41

Effect of E-commerce
Audit evidence is increasingly in electronic form Auditors must evaluate how electronic information affects their ability to gather evidence Auditors use computers to read and examine evidence Software programs are typically Windows-based

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 42

End of Chapter 7

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

7 - 43