AT-8706 CPA REVIEW SCHOOL OF THE PHILIPPINES: Manila AUDITING THEORY CPA Review AUDIT EVIDENCE AUDIT EVIDENCE ~ SPECIFIC CONSIDERATIONS FOR SELECTED ITEMS EXTERNAL CONFIRMATIONS AUDIT DOCUMENTATION PSA 500 AUDIT EVIDENCE 1. The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. 2. “Audit evidence” is information used by the auditor in arriving at the conclusions on which the opinion is based, and indudes the information contained in the accounting records underlying the financial statements and other information. 3. Accounting records generally include: + the records of initial accounting entries and supporting records, such as checks and records of electronic fund transfers; + invoices; * contracts; r + the general and subsidiary ledgers, journal entries and other adjustments to the financial statements that are not reflected in journal entries; and records such as work sheets and spreadsheets supporting cost allocations, computations, reconciliations and disclosures. 4. Other information that the auditor may use as audit evidence includes: minutes of meetings; ‘confirmations from third parties; analysts’ reports; comparable data about competitors (benchmarking); controls manuals; information obtained by auditors from such audit procedures as inquiry, observation, and inspection; and ‘+ other information developed by, or available to, the auditor that permits the auditor to reach conclusions through valid reasoning. 5. When designing and performing audit procedures, the auditor shall consider the relevance. and reliability of the information to be used as audit evidence. 6. When information to be used as audit evidence has been management's expert, the auditor shall, to the extent neq significance of that expert's work for the auditor's purposes, a) evaluate the competence, capabilities and objectivity of th b) obtain an understanding of the work of that expert; and ©) evaluate the appropriateness of that expert’s work as. assertion. 7. When using ir information is sufficiently reliable for circumstances: a) Obtaining audit evidence about b) Evaluating whether the i Purposes. 8 When designing tests o selecting items for testing“The means available to the auditor for selecting items for testing are: a) Selecting all items (100% examination), 100% examination ray be appropriate when: 1. The population constitutes a small number of large value items; 2. There is a significant risk and other means do not. evidence; or 3, ‘The repetitive nature of a calculation or other process performed automatically by an information system makes a 100% examination cost effective. b) Selecting specific 1, High value ooo 2. All items over a certain amount. 3. Items to obtain certain information. "Specific items selected may include: c) Audit sampling. ‘Audit sampling is designed to enable conclusion to be drawn about an entire population on the basis of testing @ sample drawn from It. 9. If audit evidence obtained from one source is inconsistent with that obtained from another, or the auditor has doubts over the reliability of information to be used as audit evidence, the auditor shall determine what modifications or additions to audit procedures are necessary tO resolve the matter, and shall consider the effect of the matter, if any, on other aspects of the audit. rade u une 10+ The following generalizations can be made about the reliability of audit evidence: TuMe BS ——_a) ut evidence Is more rable when itis obtained from Independent sources outside the onined fo oa independent sources outside | Mrdependon coos aide NEY é Sot scaly b) Audit evidence that is generated internally is more reliable when the related controls. ageism imposed by the enty are effective cc. obtonited Aiecty ¢) Audit evidence obtained direct; A ina dearer fon ‘of a control) iS n roe i eerie ore by the auditor (for example, observation of the mofe Feéllable than audit evidence obtained indirectly or by ry about the application of a control). d) Audit evidence is more reliable when it exists in a documentary form, whether paper, electronic, or other medium (for exemple, a contémporaneously written record of a meeting is more reliable than a suasequent oral representation of the matters discussed). €) Audit evidence provided by oviginal documents is more reliable than audit evidence provided by photocopies or facsimiles, or documents that have been filmed, digitized or ‘otherwise transformed into electronic form, the reliability of which may depend on the controls over their preparation and maintenance. Financial statement assertions Financial statement assertions are assertions by management, explicit or otherwise, that are ‘embodied in the financial statements and can be categorized @ coc 1. Completeness—all transections and events that recorded. 2. Occurrence—transactions and events that pertain to the entity. 3, Cutoff—transactions and events have 4, Accuracy—amounts and other been recorded appropriately. ‘Classification—ver(b) oe about account balances at the period end: “17” 1. “Completeness—all assets, liabilities and equity interests that should have been recorded have been recorded. 2. Valuation and allocation—ascets, liabilities, and equity interests are induded in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. 3. Existence—assets, liabilities, and equity interests exist. 4. Rights and obligations—the entity holds or controls the rights to assets, and liabilities are the obligations of the entity. (©) Assertions about presentation and disclosure: (corn) 1. Completeness—ail disclosures that should have been included in the financial statements have been included. 2. Occurrence and rights and obligations—discosed events, transactions, and other matters have occurred and pertain to the entity. 3, Classification and understandability—financial information is appropriately presented and described, and disclosures are clearly expressed. 4. Accuracy and valuation--financal and other information are disclosed fairly and at appropriate amounts. “The auditor may use the assertions as described above or may express them differently provided all aspects described above have been covered. Audit procedures for obtaining audit evidence 1. RISK ASSESSMENT PROCEDURES Obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels. 2. ‘TESTS OF CONTROLS When necessary or when the auditor has determined to do so, test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion ievel. 3. SUBSTANTIVE PROCEDURES Detect material misstatements at the assertion level. These include substantive analytical review procedures and tests of details. Examples of audit procedures 1, INSPECTION — consists of examining records and documents, paper form, electronic form, or other media. Inspection of tar examination of the assets. 2. OBSERVATION - consists of looking at a process or 3. INQUIRY — consists of seeking information of knowl financial, within the entity or outside the entity. 4, EXTERNAL CONFIRMATION ~ represents written response to the auditor from a electronic or other medium. 5, RECALCULATION — consists of It may be performed manually orOT et hin a hk ee ee 6. REPERFORMANCE = Is the auditor's independent execution of procedures or controls that ‘were originally performed as part of the entity's internal control, either manually or through the use of CAATS. 7. ANALYTICAL PROCEDURES — consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. It also encompasses the investigation of i fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. PSA 501 AUDIT EVIDENCE — SPECIFIC CONSIDERATIONS FOR SELECTED ITEMS Inventory 1. When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by: a) Attendance at physical inventory counting, unless impracticable, to: 4) Perform test counts; and b) Performing audit procedures over the entity's final inventory records to determine whether they accurately reflect actual inventory count results. If unable to attend the physical inventory count on the date planned due to unforeseen ‘circumstances, the auditor shall make or observe some physical counts on an alternative _ date, and perform audit procedures on intervening transactions. 3. If attendance at physical inventory counting is impracticable, the auditor shall perform alternative audit procedures to obtain suffident appropriate audit evidence regarding the existence and condition of inventory. If itis not possible to do so, the auditor shall modify _ the opinion in the auditor’s report in accordance with PSA 705 (Revised and Redrafted), “Modifications to the Opinion in the Independent Auditor’s Report.” 4, When inventory under the custody and control of a third party is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following: ‘a. Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity. ae b. Perform inspection or other audit procedures appropriate in the circumstances. Litigation and claims 1. The auditor shall design and perform audit procedures in order to identify litigation and claims involving the entity which may give rise to a risk of material misstatement, including: a) Inquiry of management and, where applicable, others within the entity, including in- house legal counsel; b) Reviewing minutes of meetings of those between the entity and its external legal ©) Reviewing legal 2. If the auditor assesses a risk of material mi have been identified, or when audit litigation or daims may exist, the auditor ‘other PSAs, seek direct communication letter of general inquiry.counsel is aware of, together with an assessment of the outcome of the litigation and claims, and an estimate of the financial implications, including costs involved. 1. If it is considered unlikely that the entity's external legal counsel will respond appropriately toa letter of general inquiry, the auditor may seek direct communication through a letter of wr aay, which includes: + Alist of ligation and claims. , + Where available, management's assessment of the outcome of each of the identified litigation and claims and its estimate of the financial implications, including costs involved. + Arequest thatthe entity external legal counsel confirm the reasonableness of management's assessments and provide the auditor with further information if the list is considered by the entity's external legal counsel to be incomplete or incorrect. . The auditor considers the status of legal matters up to the date of the audit report. . If management: refuses to give the auditor permission to communicate with the entity's lawyers, this would be a tation and should ordinarily lead to a qualified opinion or Fhe fervent ‘Segment information ‘The auditor shall obtain sufficient appropriate audit evidence regarding the presentation and disclosure of segment information in accordance with the applicable financial reporting framework by: a) b) Obtaining an understanding of the methods used by management in determining segment information, a i (Evaluating whether such methods are likely to result in disclosure in accordance with the applicable financial reporting framework; and il) Where appropriate, testing the application of such methods; and Performing analytical procedures or other audit procedures appropriate in the circumstances. PSA 505 EXTERNAL CONFIRMATIONS a External confirmation — Audit evidence obtained as a direct written response to the aus from a third party (the confirming party), in paper form, or by electronic or other medium. Positive confirmation request — 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. Negative confirmation request — A request that the "to the auditor only if the confirming party disagrees request. + When using external external confirmation requests, including: 2) Determining the information to be confirmed or ) Selecting the appropriate confirming party;/PAR = MANILA a) Inquires as to management's reasons for the refusal, and seek audit evidence as to their validity and reasonableness; ) Evaluate the implications of management's refusal.on the auditor's assessment of the relevant risks of material misstaternent, including the risk of fraud, and on the nature, timing and extent of other audit procedures; and ©) Perform alternative procedures designed to obtain relevant and reliable audit evidence, PSA 230 AUDIT DOCUMENTATION. 1. ‘Audit documentation that meets the requirements of PSA 230 and the specific documentation requirements of other relevant PSAs provides: . Evidence of the auditor's basis for a conclusion about the achievement of the overall objective of the auditor; and ‘+ Evidence that the audit was planned and performed in accordance with PSAs and applicable legal and regulatory requirements. 2. Audit documentation - The record. of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached. 3. Audit file — One or more folders or other storage media, in physical or electronic form, containing the records that comprise the audit documentation for a specific engagement. 4. Experienced auditor — An individual (whether internal or external to the firm) who has practical audit experience, and a reasonable understanding of: ‘Audit processes; PSAs and applicable legal and regulatory requirements; ‘The business environment in which the entity operates; and Auditing and financial reporting issues relevant to the entity’s industry. 5. The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand: a) The nature, timing, and extent of the audit procedures performed to comply with PSAs and applicable legal and regulatory requirernents; b) The results of the audit procedures and the audit evidence obtained; and ‘c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions. 6. In documenting the nature, timing and extent of audit procedures performed, the auditor shall record: a) The identifying characteristics of the specific items or matters tested; b) Who performed the audit work and the date such work was completed; and ©) Who reviewed the audit work performed and the date and extent of such review. . The auditor shall document discussions of significant, matters with management, those "“; charged with governance, and others, including the ‘nature i discussed and when and with whom the discussions 3. If the auditor identified information that is inconsiste regarding a significant matter, the auditor shall d inconsistency. If, in exceptional circumstances, the auditor "requirement in a PSA, the auditor shail d performed achieve the aim of that requirer If, in exceptional circumstances, the at draws new conclusions after the de a) The circumstances b) The new or additional reached, and their eff©) When and by whom the resulting changes to audit documentation were made and reviewed. Assembly of the final audit file it. ‘The auditor shall complete the assembly of the final audit file on a timely basis after the date of the auditor's report. AS PSQC 1 indicates(60 dayS)after the date of the auditor's report is ordinarily an appropriate time limit within which to complete the assembly of the final audit file. MULTIPLE CHOICE QUESTIONS . Which of the following is net an assertion relating to classes of transactions? “Av A. Accuracy. C. Occurrence. B. Cutoff. D. Consistency. . Which of the following Is not a basic procedure used in an audit? A. Risk assessment procedures. 8. Substantive test procedures. C. Tests of controls. D. Tests of direct evidence: . Which of the following should be considered by the auditor in deciding which means (or combination of means) to use in selecting items for testing? I. The risk of material misstatement related to the assertion being tested. CC. |Both I and IT D. Neither I nor I . Tt will be appropriate to audit all the items that make up a class of transactions or account balance (100% examination), except_ — A. When the class of transactions Re ane nea eID sme value items., Les fnan I< eS 1 ae 8, When the class of transactions or account balance consists of a smail number of large value items. 197 C. When there is a significant risk of misstatement and other selection methods do not provide sufficient appropriate audit evidence. D. When the repetitive nature of a calculation or other process performed automatically by ‘the client’s computer information system (CIS) makes a 100% examination cost effective. [iy/. a The appropriateness of evidence available to an auditor is least likely to be affected by the ‘A. Relevance of such evidence to the financial statement assertion being investigated. B, Relationship of the preparer of such evidence to the CC. Timeliness of such audit evidence. D. Sampling method employed by the auditor to Which of the following is a false statement about audi There should be a one-to-one relationship . Audit objectives should be developed in light financial statement components. . Selection of tests of financial understanding of internal control.10. i. dechniaus for deterining if fraud has occurred. ‘of a process but is limited to the moment " intime at which the observation takes place. wane ol jlonin Satetiephs eae See matter is true? .. Appropriate evidence supporting management's assertions should be convincing rather than merely persuasive. Effective internal control contributes litte to the reliability of the evidence created within the entity. . The cost of obtaining evidence is not an important consideration to an auditor in deciding what evidence should be obtained. D. A ciient’s records cannot be considered sufficient evidence to support the: accounting financial statements, slot Which of the following is an example of “other information” that could be used by an auditor as evidential matter supporting the financial statements? ‘A. Worksheets supporting cost allocations. Auta ~ Altonnieng eords B. Confirmation of accounts receivable. C. Special journals. D. Accounting manuals. Which of the following types of audit evidence provides the least assurance of reliability? A. Receivable confirmations received from the client's customers. 8. Prenumbered receiving reports completed by the client’s employees. C. Prior months' bank statements obtained from the dient. D. Municipal property tax bills prepared in the client’s name. In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified? A. Asubstantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers. joitiv B. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances. ‘ce C. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers. joe D. A small number of accounts may be in dispute and the accounts receivable balance arises trom sales to many customers with small balances. . Which of the following statements is correct concerning the use of negative confirmation requests? C. Unretumed negative confirmation requests necessary. . Negative confirmation requests are effective are suspected. . Which of the following is a management end? A. Transactions and events that have entity. B. Transactions and events have C. The entity holds or entity. D. Amounts and other ly.CPRAR - MANILA 14. aes 16. 18. 19, 20. 21. -AT-8708 Which of the following might be detected by an auditor's review of the client's sales cut-off? ‘A. Excessive goods returned for credit. aes runs | B. Unrecorded sales discounts. (mrtslpis/ coved | C. Lapping of year-end accounts receivable. . Inflated sales for the year. Which of the following most lkely would give the most assurance concerning the valuation and allocation assertion of accounts receivable? A. Vouching amounts in the subsidiary ledger to details on shipping documents. B. Comparing receivable turnover ratios with industry statistics for reasonableness. . Inquiring about receivables pledged under loan agreements. . Assessing the allowance for uncoliectible accounts for reasonableness. aul 4(9 sie Confirmation is “the process of obtaining and evaluating a direct communication from third party in response to a request for information about a particular item affecting financial | statement assertions.” ‘Two assertions for which confirmation of accounts receivable | balances provides primary evidence are ‘A. Completeness and valuation C. Valuation and rights and obligations B. Existence and completeness _D. Rights and obligations and existence When an auditor does not receive replies to positive requests for year-end accounts receivabie confirmations, the auditor most likely would ‘A. Inspect the allowance account to verify whether the accounts were subsequently written off, B. Increase the assessed level of detection risk for the valuation and completeness assertions. C. Send the customer a second confirmation. D. Increase the assessed level of inherent risk for the revenue cycle. “The retum of positive accounts receivable confirmation without an exception attests to the A. Collectibility of the accounts receivable. B. Accuracy of the aging of accounts receivable. C. Accuracy of the receivables balance. D. Accuracy of the allowance for bad debts. Which of the following procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies. to_second requests. Review the cash receipts journal for the month prior to year-end. . Intensify the study of internal control concerning the C. Increase the assessed level of detection risk for the D. Inspect the shipping records documenting the ‘Which of the following audit procedures is the most af cash is weak or when a client requests an investigation A. Proof of cash. C. Cash cont B. Bank reconciliation, D. Evaluate, Which of the following procedures would statement of cash flows? .. Compare the amounts included in prior year’s statement of cash fi 3. Reconcile the cutoff bank balances. . Vouch all bank transfersng ee 22. 23. 24, 25. 26. 27. 28. “The primary source of information to be reported about litigation, dlaims, and assessments isthe A. Client’s lawyer B, Client’s management. Which of the following is an audit procedure that an auditor most likely would perform concerning litigation, claims, and assessments? = ; ‘A. Request the client’s lawyer to evaluate whether the client’s pending litigation, claims, and assessments indicate a going concern problem. oe eee B. Examine the legal documents in the client’s lawyer’s possession concerning litigation, dlaims, and assessments to which the lawyer has devoted substantive attention. . Discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments. D. Confirm directly with the client’s awyer that all litigation, claims, and assessments have been recorded or disclosed in the financial statements. Which of the following procedures would an auditor ordinarily perform first in evaluating management's accounting estimates for reasonabieness? A. Obtain an understanding of how management developed its estimates. B. Develop independent expectations of management's estimates. C. Consider the appropriateness of the key factors in developing the estimates. D. Test the calculations used by management in developing the estimates. The following are ordinarily excluded from audit documentation: AGeaet CR 7D Superseded drafts of working papers and financial ‘statements Yes No No Yes Notes that reflect incomplete or preliminary-thinking Yes, Yes No No Previous copies of documents corrected for typographical or other errors Yes Yes Yes Yes Duplicates of documents Yes No Yes No Audit documentation may be recorded on paper or on electronic or other media. The following are examples of audit documentation, except A. Audit programs B. Letters of confirmation and representation C. Correspondence (including e-mail) concerning significant matters. D. The entity’s accounting records The completion of the assembly of the final audit file af does not ordinarily involve ‘A. The performance of new audit procedures or the di B. Sorting, collating and cross-referencing working pat C. Deleting or discarding superseded documentation. D. Signing off on completion checklists relating to the The primary reason auditors cross-index ‘their