HUMBER COLLEGE

THE BUSINESS SCHOOL

ACCT 4004 ADVANCED AUDITING
CLASS ACTIVITY ON AUDIT EVEDENCE AND TESTS

Question 1: For each of the following audit procedures, state and describe the type of audit evidence,
state the audit assertion that it applies to, and describe the reliability of the evidence (with reasons).

A) Watch staff scan products and enter cash received.

B) Reconcile daily cash drawer receipts (cash, debit card sales, credit card sales) with daily sales for one
week.
C) Calculate daily gross profit and gross profit by product line.
D) Account for a sequence of sales documents.
Answer: A) Watch staff scan products and enter cash received.

Type of audit evidence (with Applicable audit Reliability of evidence (high,

reason) assertion medium, or low, with reason)
Medium. Although it is being
performed by the auditor, this is
Observation, as the auditor is a point-in-time test and is
using a sense (vision) to assess limited to the actual duration of
the activity of recording sales Occurrence the observation.

B) Reconcile daily cash drawer receipts (cash, debit card sales, credit card sales) with daily sales for one
week.

Type of audit evidence (with Applicable audit Reliability of evidence (high,

reason) assertion medium, or low, with reason)
Reperformance or
recalculation, as the auditor is
redoing a summary that
would likely be completed by
the information systems of the High, as it is being performed
client Accuracy by the auditor

C) Calculate daily gross profit and gross profit by product line.

Type of audit evidence (with Applicable audit Reliability of evidence (high,

reason)
Analytical procedures, since it
looks at comparisons and
relationships between two or
more figures
assertion medium, or low, with reason)
Low, since it is not considered
sufficient evidence on its own.
It must be combined with tests
of control or tests of detail.
Useful on its own for planning
Accuracy or risk assessment.

D) Account for a sequence of sales documents.

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Type of audit evidence (with Applicable audit Reliability of evidence (high,
reason) assertion medium, or low, with reason)
Inspection, as the auditor is
examining client
documentation for the
continuity, or
reperformance, as the auditor High, as it is being performed
is re-doing and checking the by the auditor and is
issuance of an ascending substantiated by client
sequence for sales documents. Completeness documentation.

Question 2: Below are 12 audit procedures. Classify each procedure according to the following types of
audit evidence: 1) inspection, 2) external confirmation, 3) recalculation, 4) observation, 5) inquiry of the
client, 6) reperformance, and 7) analytical procedure.

Type of
Evidence Audit Procedures
1. Watch client employees count inventory to determine whether
. Observation company procedures are being followed.
2. Count inventory items and record the amount in the audit working
Inspection papers.
3. Stand by the payroll time clock to determine whether any
Observation employee "punches in" more than one time.
Analytical 4. Calculate the ratio of cost of goods sold to sales as a test of overall
procedure reasonableness of gross margin relative to the preceding year.
Inquiry of the 5. Obtain information about the client's internal controls by asking
client questions of client personnel.
6. Trace totals from the cash disbursements journal to the general
Reperformance ledger.
7. Examine a piece of equipment to make sure a recent purchase of
Inspection equipment was actually received and is in operation.
Analytical 8. Review the total of repairs and maintenance for each month to
procedure determine whether any month's total was unusually large.
9. The auditor computes the debt covenant based on the financial
information to ensure that the client's calculation was performed
Recalculation correctly.
10. Re-foot entries in the sales journal to determine whether they
Recalculation were correctly totalled by the client.
11. Make a surprise count of petty cash to verify that the amount of
Inspection the petty cash fund is intact.
External 12. Obtain a written statement from the client's bank stating the
Confirmation client's year-end balance on deposit.

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Question 3: Following are examples of evidence that could be collected during an audit of financial
statements.
1. Duplicate copies of sales invoices
2. Inspection of new $100 000 cutting machine
3. Bank confirmation
4. Remittance advices
5. Vendors' invoices
6. Standard letter from lawyer to auditor
7. Auditor inventory count sheets
8. Shipping documents
9. Payroll cheques
10. Long-term debt agreements review notes
11. Auditor interest expense calculation worksheet
12. Observation by auditor of computer error message (invalid supplier number)
13. Gross margin calculation
14. Interview notes from interview with credit manager

Required:
Classify each type of evidence as to its reliability (1 - high, 2 - moderate, 3 - low). Justify your
classification.

Type of Audit Evidence High/Low/ Justification

medium
Duplicate copies of sales invoices Moderate Moderate - Internal Documentation if internal
control (I/C) is good; otherwise, low if I/C is
poor
Inspection of new $100 000 cutting High High - physical inspection - auditor's direct
machine knowledge
Bank confirmation High High - external confirmation - independence of
provider
Remittance advices High High - external documentation - document has
been circulated to a party outside the entity
Vendors' invoices High High - external documentation - evidence
comes from an external party
Standard letter from lawyer to High High - external confirmation - independence of
auditor provider
Auditor inventory count sheets High High - physical inspection - auditor's direct
knowledge
Shipping documents Moderate Moderate - internal documentation if internal
control is good; otherwise, low if I/C is poor
Payroll cheques High High - external documentation - evidence
comes from an external party

Long-term debt agreements review High High - external documentation - evidence

notes comes from an external party
Auditor interest expense calculation Moderate Moderate - analytical review - reasonableness
worksheet test (also valid: High - reperformance)

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 Observation by auditor of computer
error message (invalid supplier
number)
Gross margin calculation
Moderate Moderate - observation - client is aware that
the auditor will be observing (depends on
quality of internal controls)
Moderate Moderate - analytical review - reasonableness
test (also valid: High - reperformance)

Interview notes from interview with Low Low - enquiry of client - evidence is not from an
credit manager independent source

Question 4: A) There are four important purposes of analytical procedures. Identify each of these four
purposes and for each purpose give a specific example of an analytical procedure that an auditor might
perform.
B) Identify each of the five major types of analytical procedures and give an example of each.
C) One purpose of performing analytical procedures in the planning phase of an audit is to assess the
client's financial condition. Explain how the assessment of a client's financial condition can affect the
auditor's decisions concerning evidence accumulation in later phases of the audit.

Answer:
A) Four important purposes of analytical procedures are:
• to help the auditor understand the client's industry and businessthe auditor might analyze recent
trends in the client's gross margin percentages to assess the effects of competition in the industry
• to aid in the assessment of the client's ability to continue as a going concernthe auditor might
analyze several of the client's key ratios including the ratio of long-term debt to net worth, the ratio of
profits to total assets, and the current ratio
• to indicate the presence of possible misstatements in the financial statementsthe auditor might
compare the current year's unaudited account balances with the previous year's audited balances
• to reduce the extent of detailed teststhe auditor might perform a simple analytical procedure such
as multiplying the client's monthly rent times 12 as a test of the client's rent expense account; if the
product agrees with the balance in rent expense, no additional testing of the account may be necessary

B) The five major types of analytical procedures are:

• Compare client and industry data. Compare the client's gross margin percentage with the industry's
average gross margin percentage to compare the client's performance with that of the average company
in the industry.
• Compare client data with similar prior-period data. Compare the client's gross margin percentage
for the current year with that of the previous two years to compare the client's performance in the
current year with that of previous years.
• Compare client data with client-determined expected results. Compare client's current-year raw
material expense with budgeted expense.
• Compare client data with auditor-determined expected results. Calculate an expected value for the
allowance for bad debts account by multiplying the three-year moving average of the client's allowance
as a percentage of gross accounts receivable by the current year's ending balance in gross accounts
receivable, then compare this expected value with the client's actual value.
• Compare client data with expected results using nonfinancial data. Calculate an expected value for
the client's payroll by multiplying total hours worked by the wage rate, then compare the resulting
product with the client's recorded payroll expense.

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C) The weaker the client's financial condition, the more assurance the auditor will require that the
financial statements are free of material misstatements. As the auditor requires greater assurance, he or
she can
1) perform detailed testing closer to the balance sheet date,
2) increase the extent of detailed testing, or
3) perform more reliable procedures.

If the auditor believes the entity is not a going concern, he or she will require proper financial statement
disclosure and presentation in order to issue an unqualified audit opinion.