Slide 10

.1

Audit Evidence (ISA 500-580)

Principles of Auditing: An Introduction to
International Standards on Auditing - Ch.10

Waqar Ali

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.2

Audit Procedures for Gathering

Evidence
Inquiry
Observation
Inspection (physical evidence and
examination of documents)
Recalculation
Re-performance
Confirmation
Analytical procedures

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.3

Inquiry
Information from knowledgeable persons
inside (client) or outside the entity
Formal / Informal Query

Largest amount of audit evidence in an

audit is obtained from client inquiry

Cannot be regarded as conclusive. Why?

Reasoning, Scope, Basis of Analytics

[Give students e.g. of Sales Testing]
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.4

Observation
Looking at a process or procedure
being performed by management.

Most relevance: Controls Testing

For example,
Inventory Count Observation
Performance of internal control procedures
that leave no audit trail

Should be supported by other types of

evidence
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.5

Count of Physical Inventory

ISA 501: When inventory is material to the
financial statements, the auditor should obtain
sufficient appropriate audit evidence regarding
its existence and condition by:

Attendance at physical inventory counting:

Performing audit procedures over the entitys

final inventory records to determine whether
they accurately reflect actual inventory count
results.
Illustrate to students two-way testing
re:Inventory.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.6

Inspection

Examining records or documents,

whether internal or external,
in paper form, electronic form,
or other media,
or a physical examination of an asset.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.7

Increasing Document Reliability

Internal documents
processed under good internal controls
(authorization/SoDs) are more reliable than
those processed under weak controls. E.g.?
External documents
may be processed by both internal and
external parties
representing agreement. E.g?
External documents
like title to property, insurance policies and
contracts are very reliable evidence.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.8

Vouching and Tracing

Vouching
use of documentation to support accounting record
auditor selects sample items from an account and
finds the source documentation that supports the
item selected. E.g.? Assertions?
Tracing
auditor selects sample items from basic source
documents and
proceeds forward through the accounting system to
find the final recording of the transactions (e.g., in the
ledger). E.g.? Assertions?

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.9

Recalculation & Re-performance

Recalculation consists of checking the
mathematical accuracy of
documents or records. Assertions?

Re-performance
auditors independent execution
of procedures E.g?
or controls
that were originally performed as
part of the entitys internal control,
either manually or through the use
of CAATs. E.g?

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.10

Recalculation - Examples

Sales Invoices / Accrued (or Deferred)

Income
Adding Journals and
Checking Calculations of Depreciation
Checking mechanical accuracy of
records and ledgers (Subsidiary
Records)

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.11

Reliability of Procedures
Decreasing level of reliability (why?)
1 Re-calculation
2 Inspection
3 Re-performance
4 Observation / Confirmation
6 Analytical procedures
7 Inquiry
Illustrate to students using Revenue
Testing (Recognised, Accrued,
Deferred)
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.12
Cost of Procedures
The auditor considers the relationship
between the cost of obtaining audit evidence
and
the usefulness of the information obtained.
Procedures is decreasing cost(Why so?)
1 Confirmation
2 Inspection
3 Recalculation
4 Re-performance
5 Observation
6 Analytical procedures
7 Inquiry
Illustrate to students using examples of
various testing (link to risk).
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.13

External Confirmation
Audit evidence obtained
as a direct written response to the auditor
from a third party (the confirming party),
in paper form, or by electronic or other medium.
Most commonly: Receivables / Cash @ Bank
1. Information is requested by auditor (letter).
2. Response sent to the auditor (bank confirmation).
3. Response comes from an independent third party
(Debtor / Receivable / Bank).

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.14

Confirmations: Critical
Considerations
High efficacy: Significant Risk Audit Items
Consider Revenue Agreements
Written 3rd party confirms - Highly Persuasive
Very costly / inconvenience for the 3rd party
Consider Reliability / Cost optimum
Caveat: Confirmations rendering no response!
Positive / Negative confirmations

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.15

Positive confirmation:
A request that the confirming party respond
directly to the auditor indicating whether the
confirming party agrees or disagrees with
the information in the request, or providing
the requested information.
Reliable evidence
Negative confirmation:
A request that the confirming party respond
directly to the auditor only if the confirming
party disagrees with the information
provided in the request.
Use for large number small
balances, low control risk, response
is expected
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.16

Testing Accounting Estimates (1)

Risks of material misstatement for

accounting estimates?
Understanding how management
identifies accounting estimates and
how these estimates are made.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.17

Testing Accounting Estimates (2)

Examples (and their implications)
Inventory valuations (NRV / write-down)
Harvest Gas Stations
Depreciation method and useful life
Leasehold Assets
Provisions and contingent liabilities
Dilapidations
Irrecoverable debts / allowances
Aging
Fair value accounting
PPE, Investments, etc.
Revenue Recognition
Accrued / Deferred / Cubiks / WIP: Construction
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.18

Testing Accounting Estimates (3)

Select one cycle from previous slide.

Method / model used

Relevant controls / policies
Whether management has used an expert
Underlying assumptions
Change from the prior period in the methods for
making the accounting estimates (why imp.?)
How management has assessed the effect of
estimation uncertainty. Consider sensitivity
disclosures (esp financial institutions).

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.19

What are Written Representations?

Efficacy / Reliability concern
Quality concern
Cost concern

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.20

Written Representations by
Management
Is the written communication from the
clients management to the auditor
formalizing statements that the client has
made about matters that are pertinent to
the audit and matters that are
material to the financial
statements.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.21

Written Representations by Management

Confirms certain matters or to support other

audit evidence.
The objectives of the auditor are:
1. To obtain written representations from management
that they believe that they have fulfilled their
responsibility for the preparation of the financial
statements and for the completeness of the
information provided to the auditor.
2. To support other audit evidence relevant to the
financial statements. Such as?

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.22

Management Representations Letter

(example) contents
Managements responsibility for the fair
presentation of the financial statements.
Availability of all financial
records and related data.
Information regarding
related party transactions.
Plans or intentions that may affect the
carrying value or classification of assets.
Disclosure of compensating balances and
other arrangements involving restrictions on
cash balances.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.23

Written Representations & Documentation

on Audit of Estimates
Client Representation: significant assumptions
used in making their accounting estimates are
reasonable.
The auditor must include in the audit documentation:
the basis for the conclusions about the
reasonableness of accounting estimates and
their disclosure that give rise to significant risks;
and
indicators of possible management bias, if any.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.24

Evaluation of Misstatements Identified

During the Audit
The objective of the auditor is to evaluate the
effect of identified misstatements on the audit;
and the effect of uncorrected misstatements on
the financial statements.
Illustrate this to students using a variety of
adjustments that add up to make the total of
uncorrected misstatements.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.25

Generally if misstatements are found, the

auditor asks management to correct them.
If management corrects the misstatements that were
detected, the auditor must still perform additional audit
procedures to determine whether misstatements
remain. Linking the list to lead sheets.
If management refuses to correct some or all of the
misstatements communicated by the auditor, the
auditor should take into account managements
reasons for not making the corrections. Effect?

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.26

Students to review on their own

The auditor must request a written representation from
management and those charged with governance
whether they believe the effects of uncorrected
misstatements are immaterial, individually and in
aggregate, to the financial statements as a whole.
In their working paper documentation the auditor must
include:
The amount below which misstatements would be
regarded as clearly trivial;
All misstatements accumulated during the audit and
whether they have been corrected; and
The auditors conclusion as to whether uncorrected
misstatements are material, individually or in
aggregate and the basis for that conclusion.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.27

Related Parties
Parties are considered to be related if
one party has the ability to control the
other party or exercise significant
influence over the other party in
making financial and operational
decisions.
Consider: Directors (family),
Associates, Subsidiaries, Parent
companies, Joint Ventures,
Shareholders, etc.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.28

ISA Defines Related Party

A person or other entity that
has control or significant influence,
directly or indirectly through one or more
intermediaries,
over the reporting entity.
Another entity over which the reporting entity
has control
Another entity that is under common control
with the reporting entity through having: Common
controlling ownership; Owners who are close
family members; or Common key management.
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.29

Two aspects of related party transactions

of which an auditor must be aware are:

1.Adequate disclosure of
related party
transactions. IFRS?
2.The possibility that the
existence of related
parties increases the
risk of management
fraud. How?

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.30

Related Party Risk Assessment Procedures

Critical Considerations Illustrate to students:
Testing Difficulty: Completeness Assertion
Approach: PY comparison (Planning Stage)
Approach: Consideration @ every cycles
testing (Fieldwork Stage)
Inquire of management and others within
the entity:
about the existence of transactions
that are non-routine and
significant.
Written Representation (Conclusion / Review
Stage)
[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007
Slide 10
.31

Related Party Risk Assessment Procedures

Where a party appears to actively exert
dominant influence over the entity,
perform procedures intended to identify the parties to
which the dominant party is related

Review appropriate records or documents for

transactions that are both significant and non-
routine including
Bank, legal confirmations or any evidence
obtained by the auditor; and
Minutes of meetings of shareholders and
those charged with governance, and other
relevant statutory records.

[Hayes, Dassen, Schilder and Wallage, Principles of Auditing An Introduction to ISAs, edition 2.1] Pearson Education Limited 2007