Audit Evidence and Documentation

1. Chapter 5 Audit Evidence and Documentation

2. Existence or Occurrence--Assets, liabilities, and owners’ equity accounts reflected in the financial statements exist; the recorded transactions have occurred. Completeness--All transactions, assets, liabilities, and elements of owners’ equity that should be presented in the financial statements are included. Rights and Obligations--The client has rights to assets and obligations to pay liabilities that are included in the financial statements. Valuation or Allocation--Assets, liabilities, owners’ equity, revenues, and expenses are presented at amounts that are determined in accordance with generally accepted accounting principles. Presentation and Disclosure--Accounts are described and classified in the financial statements in accordance with generally accepted accounting principles, and all material disclosures are provided. Management Assertions

3. Risk of Material Risk That the Audit Risk = Misstatement * Auditors Fail to the Misstatement = Inherent Control Detection Risk * Risk * Risk Inherent Risk--Risk of a material misstatement occurring in an assertion assuming no related internal controls. Control Risk--Risk that a material misstatement in an assertion will not be prevented or detected on a timely basis by the company’s internal control. Detection Risk--Risk that the auditors’ procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist. Audit Risk

4. Audit Risk Formula AR = IR * CR * DR AR = Audit risk IR = Inherent risk CR = Control risk DR = Detection risk

5. Audit Risk

6. To be competent evidence must be: Valid Relevant Principles Independent sources have greater reliability than those within the client organization. Strong internal control increases reliability of evidence created within the client organization. Directly obtained evidence is more reliable than evidence obtained second hand. Competence of Evidential Matter

7. Reliability of Certain Types of Audit Evidence • RELIABILITY TYPE EXAMPLE • High Physical Inventory Observation • Documentary • External Cutoff Bank Statement • External/Internal Purchase Invoice • Internal Sales Invoice • Low Client Representations Management Representation • Letter

8. Accounting information system Documentary evidence Third-party representations Physical evidence Computations Data interrelationships Client representations Types of Evidence

9. Accounting information system Documentary evidence Tracing Vouching Inspection Reconciliations Third-party representations--Confirmation Physical examination Computations—Reperformance Data interrelationships—Analytical procedures Client representations Inquiries Letters of representations Audit Procedures

10. Identifying Potential Misstatements

11. Review and test management’s process for developing the estimate. Independently develop an estimate to compare to management’s estimate. Review subsequent events or transactions bearing on the estimate. Basic Approaches to Auditing Accounting Estimates

12. If the item is traded on an organized market, fair value may be obtained from market prices If the item does not trade on an organized market determine fair value by: Analyzing to a similar market is possible Using a valuation model Auditing Fair Values

13. Primary functions: Support the auditors’ compliance with auditing standards Support the auditors’ opinion Secondary functions: Assist continuing and new audit team members in planning and performing the audit Serves as a record of matters of continuing audit interest Assists in supervision and review of the audit Demonstrates the accountability of team members Assists internal reviewers, external peer reviewers, PCAOB inspectors, and successor auditors in performing their roles Functions of Audit Documentation

14. Audit documentation should be sufficient to: Enable an experienced auditor to understand the work performed and the significant conclusions reached Identify who performed and reviewed the work Show that the accounting agree or reconcile to the financial statements Audit documentation should include all significant audit findings and the actions taken to address them Sufficiency of Audit Documentation

15. Audit administrative working papers Working trial balance Lead schedules Adjusting journal entries and reclassification entries Supporting schedules Analysis of a ledger account Reconciliations Computational working papers Corroborating documents Types of Working Papers

16. Current files Permanent files Types of Working Files