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Chapter 5 Audit Evidence

Assertions
Assertions: are statements regarding the recognition, measurement, presentation and
disclosure of items included in the financial report.
-

Those charged with governance of an entity are responsible for ensuring that the
financial report gives a true and fair view of the entity and its operations
Management make assertions about each account and related note disclosures.
Example: Inventory Management should ensure that the item disclosed
exists, owned by the entity and is valued appropriately. A complete list
should represent the inventory owned by the entity
Auditors Uses assertions for transactions, account balances and presentations
and disclosure when assessing the risk of material misstatement and when
designing their audit procedures.
ASA 315 (ISA 315) requires auditors to use assertions when assessing the
risk of material misstatement and designing audit procedures
This means that auditors need to gather sufficient appropriate evidence
about each assertion for each transaction and account balance, or
disclosure

ASA 315 Provides auditors with a summary of


Assertions to use

Assertions
related
OCCURRENCE
to transactions
and events COMPLETENESS
related to items
onACCURACY
the Income
Statment
CUT-OFF
CLASSIFICATION

EXISTENCE

Assertions Related
to
Balances
RIGHTS
AND
(Balance
sheet)
OBLIGATIONS
COMPLETENESS
VALUATION AND
ALLOCATION

OCCURRENCE,
RIGHTS AND
PRESENTATION
OBLIGATIONS

AND DISCLOSURE
RELATED
AUDIT
COMPLETENESS
ASSERTIONS
CLASSIFICATION
AND
UNDERSTANDABIL
ITY
ACCURACY AND
VALUATION

AUDIT
ASSERTION

TESTING TRANSACTIONS

MOST SIGNIFICANT

OCCURRENCE

Transaction and events that


have been recorded have
occurred and pertain to the
entity

Most important when there is


a risk of overstatement
(e.g. revenue)

COMPLETENES
S

Transactions and events that


should have been recorded have
been recorded

Most important where there is


risk of understatement
(e.g. expenses)

ACCURACY

Amounts and other data relating


to recorded transactions and
events have been recorded
appropriately

Most important where there is


higher risk of inaccuracy
(e.g. complex foreign
exchange transactions)

CUT-OFF

Transactions and events have


been recorded in the correct
accounting period

Most important for


transactions near year-end

CLASSIFICATIO
N

Transactions and events have


been recorded in the proper
accounts

Most important for material


accounts

Assertions related to transactions and events - related to items


on the Income Statement
When testing for occurrence, an auditor searches for evidence to verify that a
recorded transaction or event, such as revenue or an expense item, took place and
relates to the entity. This assertion is particularly important when the auditor believes
that there is a risk of overstatement and that some transactions or events are recorded
but did not actually occur. For example, false sales recorded to overstate revenue and
profit.
When testing for completeness, an auditor searches for transactions or events and
makes sure these have been recorded. This assertion is particularly important when the
auditor believes there is a risk of understatement and that some transactions or events
that should have been recorded have not been recorded; for example, expenses
incurred but not recorded to understate expenses and overstate profit.
When testing for accuracy, an auditor searches for evidence that transactions and
events have been recorded at appropriate amounts. This assertion is particularly
important when the auditor believes there is a risk that the reported amounts are not
accurate. For example, when a client has complex discounting systems or foreign
exchange calculations where errors can easily occur.
When testing for cut-of, an auditor searches for evidence that transactions have
been recorded in the correct accounting period. This assertion is particularly important
for transactions close to year-end. For example, a client may record a sale before yearend that occurred after year-end. Or, a client may record an expense after year-end that
was incurred before year-end.
When testing for classification, an auditor ensures that transactions and events have
been recorded in the proper accounts.

BALANCE RELATED AUDIT ASSERTIONS


AUDIT ASSERTION

TESTING ACCOUNT
BALANCES

MOST SIGNIFICANT

EXISTENCE

Assets, liabilities and equity


interest exist

Most important where


there is risk of
overstatement (e.g.
assets)

RIGHTS AND
OBLIGATIONS

The entity holds or controls the


rights of the assets, and
liabilities are the obligation of
the entity

Most important where


there is risk that items are
held but not owned (e.g.
inventory on consignment)

COMPLETENESS

All assets, liabilities and equity


interests that should have been
recorded have been recorded

Most important where


there is risk of
understatement (e.g.
unrecorded loans)

VALUATION AND
ALLOCATION

Assets, liabilities and equity


interest are included in the
financial report at appropriate
amounts and any resulting
valuation and allocation
readjustments are appropriately
recorded

Most important where


there is risk of over or
under statement (e.g.
inventory at lower of cost
and NRV, adequacy of
doubtful debts or other
provisions

When testing for existence, an auditor searches for evidence to verify that asset,
liability and equity items included in the balances that appear in the financial report
actually exist. This assertion is particularly important when the auditor believes there is
a risk of overstatement.
When testing for rights and obligations, an auditor searches for evidence to verify
that recorded assets are owned by the entity and that recorded liabilities represent
commitments of the entity. This assertion is particularly important when the auditor
believes there is a risk that recorded assets or liabilities are not owned by the entity.
This assertion is different to existence, as the assets and liabilities may exist but not be
owned by the entity. An example of inventory that physically exists but does not satisfy
the rights and obligations assertion is inventory held on consignment (and therefore not
owned by the entity) which is recorded as an asset of the entity.
When testing for completeness, an auditor searches for assets, liabilities and equity
items and ensures they have been recorded. This assertion is particularly important
when the auditor believes there is a risk of understatement and the client has omitted
some items from the balance sheet. For example, an auditor will search for unrecorded
loans.
When testing for valuation and allocation, an auditor searches for evidence that
assets, liabilities and equity items have been recorded at appropriate amounts and
allocated to the correct general ledger accounts. This assertion is particularly important
when the auditor believes there is a risk of over or undervaluation. For example:

an auditor checks that inventory has been appropriately recorded at the lower of
cost and net realisable value (risk of overstatement)
an auditor tests for the adequacy of the allowance for doubtful debts provision
(risk of understatement)

an auditor checks that transactions are allocated to the correct account when
auditing research and development expenditure (risk of understatement of the
expense account).

PRESENTATION AND DISCLOSURE RELATED AUDIT ASSERTIONS


Presentation and disclosure assertions relate to the disclosures themselves, not the
underlying asset, liability, equity, revenue or expense items

Classification and understandability relates to the classification of the


disclosure, not whether the correct account was used for the transaction or event

AUDIT ASSERTION

TESTING PRESENTATION AND


DISCLOSURE

OCCURRENCE, RIGHTS AND


OBLIGATIONS

Disclosed events, transactions and other


matters have occurred and pertain to the
entity

COMPLETENESS

All disclosures that should have been


included in the financial report have been
included

CLASSIFICATION AND
UNDERSTANDABILITY

Financial information is appropriately


presented and described, and disclosures
are clearly expressed

ACCURACY AND VALUATION

Financial and other information are


disclosed fairly and at appropriate
amounts

Audit Evidence

Evidence is the information that an auditor uses when arriving at their opinion on
the truth and fairness of the clients financial report (ASA 500; ISA 500)
o It is the auditors responsibility to gather sufficient appropriate
evidence in order to arrive at an auditing opinion.
Those charged with governance at the client to ensure that the preparation of
financial reports is prepared in accordance with Australian Accounting Standards
and the corporations act. They also have a responsibility to ensure that records
are maintained and material misstatements are prevented (or detected and
corrected)

Sufficient Appropriate Audit evidence


Sufficiency relates to quantity of evidence & Appropriateness relates to quality of
evidence
- The appropriateness of audit evidence is impacted by its source and by the audit
assertion at risk.
Externally generated evidence is considered as more reliable than info
produced by the client
- Evidence is considered more appropriate if it provides conformation about the
assertion most at risk of material misstatement
By identifying the key risk areas for the client, an auditor is able to focus of gathering
more (sufficient) high-quality (appropriate) evidence where the risk of material
misstatement is believed to be most significant

Audit risk affects the quantity and quality of evidence gathered by an auditor during the
risk response phase of the audit.

When there is a significant risk that an account will be misstated and the clients
system of internal controls is not considered to be effective at reducing that risk,
detection risk is set as low and more high-quality evidence is gathered when
conducting substantive tests of that account.

When there is a low risk that an account will be misstated and the clients system of
internal controls is considered to be adequate for that account, detection risk is set as
high and less high-quality evidence (Low) is gathered when conducting substantive
tests of that account.
The risk patterns illustrated in the provided figures are extremes. The risk of material
misstatement associated with most accounts falls somewhere in between. As such, the
amount of evidence gathered when conducting substantive procedures is a matter for
professional judgement and will vary from account to account and client to client.
Nevertheless, there is a direct relationship between the risk of material misstatement
(inherent and control risk) and the extent of quality evidence gathered when testing
transactions and balances.

Types of Evidence
External Confirmations (ASA 505)
External confirmation is a letter sent by an auditor directly to a third party who is asked
to respond on matters outlined in the letter. Auditor requests third party to requesting
them to confirm matter in confirmation letter. Including:

Bank Confirmation: confirm cash balances (overdrafts), securities, loans, interest


rates.
This information is used to confirm that Cash at bank balance in the Balance
sheet.
It also confirms the name of the account (rights and Obligation assertion),
recorded at the appropriate amount (valuation and allocation), and that all
loans are included as part of Liabilities (Completeness Ass)
Information regarding Interest is used to when auditing the interest
income/expense account for accuracy assertion.

Lawyers Confirmation: confirm documents being held such as Property title deeds
and patents.
Information that can be confirmed in the clients name on the document
(rights and Obligation assertion) and may request the details of such
documents
A confirmation letter asks about the matter of fact details.
A representation letter may be sent to ask about the matters of legal opinion
such as the likely outcome of a court case

Creditors (payable) Confirmation: confirm amount owed, terms, by client.


Rare to send these letters
Lenders will provide details regarding amounts outstanding (completeness,
valuation and allocation), interest rates charges on those amounts (Accuracy)
They also confirm if the client has debt owing to the third party (rights and
obligations)

Debtors (receivable) Confirmation: confirm amount owed to client Verify the


receivable balances
Auditors will select who they send a letter to (those with overdue balances,
large amounts, or multiply locations of dispersal)
The primary assertion used to confirm receivable is existence - providing
audit evidence that the debtor exists.
They also provide evidence on ownership (rights and obligations) as debtors
confirm they owe money to the client.
Debtors are asked to confirm the amount they owe they do not confirm their
intention to pay back the debt.
Others Confirmation: confirm description and quantity of assets held

Types of confirmations
Negative form: reply if information incorrect
- A third party is asked to respond only if they disagree with the information in the
letter
Hard to interpret non-response: may be used be an auditor has conducted
detailed testing for existence
Positive form: reply in all circumstances

When a third party is asked to respond to matters included in the auditor in all
circumstances (that is, weather they agree or disagree with the information in
the letter)
Cannot know how well other party checked their records. However it
provide superior information compared to that of a negative form.

DOCUMENTARY EVIDENCE
Documentary evidence includes invoices, suppliers statements, bank statements,
minutes of meetings, correspondence and legal agreements. It may be internally
generated or externally generated. Internally generated documents are produced by
the client. Externally generated documents are generated by third parties. The
persuasiveness of audit evidence varies depending on its source. There are a number of
ways that documentary evidence can be used during an audit. An auditor can match
details recorded in a clients accounting records to supporting (external) documents to
verify the amount recorded.
Evidence can include:
- Purchase price detailed on invoices or statements Accuracy Assertion
- Recorded Investments- existence of the investment existence Assertion
- What is owed by the client- rights and obligation Assertion
- Traceability to financial reports classification and understandability Assertion
- Inventory held by third party included in the financial report - completeness
Assertion
- Details of agreements eg: lease agreements - classification and understandability
Assertion
- Ensuring minutes of meeting are read and adequately disclosed - classification
and understandability
Auditor can
Verify information in clients records by reading documents to confirm existence,
rights and obligations (vouching), or Trace from documents to clients records to
confirm classification, accuracy, completeness (tracing)

Representation
ASA 502 (ISA 501) requires an auditor to gather sufficient appropriate audit evidence
regarding any legal matters involving their client. Evidence is gathered from board
meeting minutes, discussions with client personnel and representation letters from their
clients lawyers. When an auditor has reason to believe that legal issues exist which
may impact the financial report, such as the client being sued by a third party, or when
a legal firm is engaged by the client for the first time, a representation letter is
requested from the legal firm(s) that their client deals with.

Legal representation letter is sent by client to its lawyers to complete and return
direct to auditor.
Can include the lawyers opinions on the legal matters, details of
disagreements with the lawyer has had with the client (ASA 502; ISA 501)

Management representation letter contains acknowledgement of


managements responsibilities for the preparation of financial reports and details of
any verbal representation made by the management during the course of the audit.
ASA 580; ISA 580
Confirming undertaking about legal compliance, confirmation of discussions
Verbal confirmation is weaker than written confirmation therefore the
Auditor still needs to gather other evidence such as the management
representation letter.

An auditor will come to this conclusion after enquiries of client personnel, reading board
meeting minutes, reading other documentation such as contracts and leases, reviewing
legal expenses and reading correspondence between their client and third parties

VERBAL EVIDENCE

Auditor documents discussions with client management and staff


Is normally documented in the working papers so that all discussions are
documented
Used to gain understanding of internal controls; corroborate other evidence
(various issues)

COMPUTATIONAL EVIDENCE

Auditor checks mathematical accuracy; re-adding, can include complex recalculations, verifying formulae

PHYSICAL EVIDENCE

Gathered by inspecting assets, to assess condition, to reconcile to clients records