ACCA F-8 Audit Evidence Audit Procedure & Sampling
Audit Evidence gives the guideline to Auditor to design & perform audit procedures in such a way that it enables auditors to:
Obtain sufficient, appropriate audit evidence. To be able to draw reasonable conclusions. To enhance confidence of the user.
Substanstive Procedure: Substanstive Procedure are tests to obtain audit evidence to detect material misstatements in the financial statements. They are generally of two types: Analytical Procedure Tests of detail of transactions, account balances & disclosures.
ISA 330 also requires that, whatever level of substantive procedures are carried out the auditor must carry out the following procedures: Agree or reconcile the financial statements to the underlying accounting records. Examine material journal entries. Examine other adjustments made during the course of prepearing the financial statements.
financial statement assertions is the set of information that the preparer of financial statements (management) is providing to another party. Financial statements represent a very complex and interrelated set of assertions. At the most aggregate level, the financial statements include broad assertions such as "total liabilities as at 31 December are $50 million", "total revenue for the year is $9 million" and "net income for the year is $3 million". Auditors decompose these broad assertions into a detailed set of statements referred to as management assertions, separated into three categories: 1. Transactions: o Occurrence — the transactions actually took place o Completeness — all transactions that should have been recorded have been recorded o Accuracy — the transactions were recorded at the appropriate amounts o Authorization — all transactions were properly authorized o Cutoff — the transactions have been recorded in the correct accounting period o Classification — the transactions have been recorded in the proper accounts 2. Accounts balances: o Existence — assets, liabilities and equity balances exist o Rights and Obligations — the entity holds or controls the rights to its assets and owes obligations to its liabilities o Completeness — all assets, liabilities and equity balances that should have been recorded have been recorded o Valuation and Allocation — assets, liabilities and equity balances are included in the financial statements at appropriate amounts and any
forecasts 4. and information in disclosures are clearly expressed.
Analytical Procedure: Analytical Procedures is one of financial audit skill which help an auditor understand the client's business and changes in the business. budgets 3. Tests designed to discover ommisions: These tests must start from outside the accounting record & then matched back to those records. to identify potential risk areas and to plan other audit procedures.
Directorial Testing: Substantive test are designed to discover errors or omissions
Tests designed to discover errors: Tests should detect any overstatement & also any understatement through causes other than omission. it would begin with a sales invoice selected from the sales ledger. prior periods 2.
3.resulting valuation or allocation adjustments are appropriately recorded. Prices would then be checked to the official price list. Analytical Procedures include comparison of financial information (data in financial statement) with 1. such as:
. similar industries and so on. Presentation and disclosure: o Occurrence — the transactions have occurred o Rights and Obligations — the transactions pertained to the entity o Completeness — all disclosures that should have been included in the financial statements have been included o Classification and Understandability — financial statements are appropriately presented and described. For example: if a test is designed to ensure that sales are priced correctly. It also includes consideration of predictable relationships. o Accuracy and Valuation — financial and other information is disclosed fairly and at appropriate amounts. For example: to discover whether all purchases are processed properly it must have GRN (Good Received Note) & post it on Inventory A/C or purchase ledger.
One of the office managers left the company part-way through the year.400 ($22. There were two new members of warehouse staff and three new members of office staff.1. backdated to the start of the year. The expense for the year is shown in the draft income statement as $1. The company employed the following staff at the start of the financial year: 7 office and warehouse managers. 20 warehouse staff and 25 office staff. Required Using analytical procedures.500
.450. All staff were given a 4% pay rise in the year.300 Office and warehouse staff Based on salary range. for the year ended 31 March 20X9.249. Managers Based on salary range. gross profit to sales.500
Total average salary for year (i. payroll costs to employees. a small office supplies business.e.100) $42. perform a proof in total on the wages and salaries expense for the year.
Answer An expectation of the charge for the year can be developed using the information provided and compared to the charge in the draft income statement to assess its reasonableness.
You are part of the audit team auditing the financial statements of Sweep Co. average annual salary:
Assume leaver left half-way through year: Total for managers: $287.200 $309. 2. average annual salary: Applying the 4% rise: $44. The pay ranges for each category of staff is shown below: Office and warehouse managers: $35-$50k per year Warehouse and office staff: $18-$25k per year
You have been asked to audit the wages and salaries expense for the year.
349.2 Statistical vs non-statistical sampling Statistical sampling is any approach to sampling that has the following characteristics: (a) sample. exclude starters): Assume starters started half-way through year: Total for office and warehouse staff: $1.006. in order to assist in forming a conclusion concerning the population from which the sample is drawn [ISA 530]. Depriciation method or useful life. Example of accounting estimates: Inventory Obscolescence.360 $1.450
The difference between the expected total and the expense in the draft income statement is 8%.
An accounting estimate is an approximation of a monetary amount in the absence of a precise means of measurement. and random selection of a
Total average salary for year (i. Provision regarding the CV of an investment where there is uncertainty regarding its recoverability.e.Applying the 4% rise:
$22. The auditor needs to consider whether this is acceptable in light of materiality for the financial statements as a whole and performance materiality and the risk of material misstatement and whether further explanations from management may be necessary.062.100 Expected total expense for wages and salaries: Expense per draft income statement: Difference: 8%
$1. Warranty Obligation. 3. 40.
Definition Audit sampling means the application of audit procedures to less than 100% of the items within a class of transactions or account balance such that all sampling units have an equal chance of selection.249.
[ISA 530]. but which avoids any conscious bias or predictability (e. 50. (b) Systematic selection. and having determined a starting point within the first 50 (preferably randomly). it may be excluded when projecting sample errors to the population
. (c) Haphazard selection. particularly when testing for overstatement. where items are selected for testing by weighting the items in proportion to their value. This may be an acceptable alternative to random selection provided the auditor is satisfied that the sample is not unrepresentative of the entire population. When using systematic selection. including measurement of sampling risk. when applied correctly ensures that every $1 in a population will have an equal likelihood of being selected for testing. the auditor needs to ensure that the population is not structured in such a manner that the sampling interval corresponds with a particular pattern in the population. e. It can often be efficient in substantive testing. the auditor should project monetary errors found in the sample to the population and compare this to the tolerable error. material balances will be automatically selected.9 Tests of detail For tests of detail. Where an error has been established as an anomalous error. in which the auditor selects the sample without following a structured technique. or always choosing or avoiding the first or last entries on a page). 3. This is a technique which. A sampling approach that does not have characteristics (a) and (b) is considered non.(b) use of probability theory to evaluate sample results.statistical sampling. four methods commonly used are (a) Random selection. in which the number of sampling units in the population is divided by the sample size. to give a sampling interval.g. Under MUS. While there are a number of selection methods. and
(d) Value weighted selection.g. avoiding difficult to locate items. using a computerised random number generator or random number tables. each 50th sampling unit thereafter is selected. It is also known as ‘monetary unit sampling’ (MUS).
Selection of the sample The auditor should select items for the sample with the expectation that all sampling units in the population have a chance of selection.
. this represents an error rate of 10% (2/20 x 100). if the auditor has performed tests of controls on a sample of 20 items and has found 2 deviations.10 Tests of controls For tests of controls. For example. The auditor must then decide if this error rate is acceptable. no explicit projection of errors is necessary since the sample error rate is also the projected rate of error for the population as a whole. 3.(but still need to be considered overall in addition to the projection of the non-anomalous errors). Where a class of transactions or account balance has been divided into strata. the error is projected for each stratum separately.
explain what action should be taken. and/or (c) consider the effect on the auditor's report.000 Number of items in the population 400 Number of items tested 20 Sample value $200.
Lecture example 3
You are auditing trade receivables and have obtained the following results based on your sample: – – – – – Total value of the population $1.000
Required (a) Assuming the errors are not anomalous ones.000 Error in sample $9.000. the auditor may: (a) request management to investigate identified errors and the potential for further errors and make any necessary adjustments. (b) Assuming that tolerable error was set at $40. calculate the expected error in the population.11: AUDIT PROCEDURES AND SAMPLING 3.11 If the evaluation of sample results indicates that the assessment of the relevant characteristic needs to be revised. timing and extent of further audit procedures. and/or (b) modify the nature.
• Ratio method extrapolation Error rate in sample x total value in population
Computer-Assisted Audit Techniques (CAATs) which provide a means of accessing large amounts of data in a format that can provide transparency not attainable through other auditing procedures. improves efficiency and decreases the audit risk.
Audit objectives for tangible non-current assets
Financial statement assertion Existence and occurrence – Additions represent assets acquired in the year and disposal represent assets sold or scrapped in the year. analysis and integrated reporting.
All additions and disposals that occurred in the year have been. – Recorded assets represent those in use at the year-end recorded. allowing the source data to remain intact for complete data quality and integrity. on PCs or servers. With the use of a specialized software tool.
. The use of CAAT’s increases audit effectiveness. flat files or relational databases. Balances represent assets in use at the year-end. spreadsheets. our team can provide organizations with a unique and powerful combination of data access. report files. Using the specialized software tool our experts can access and compare enterprise data.
Rights and obligations
The entity has rights to the assets purchased and those recorded at the year-end. accuracy and valuation)
Intangible Non-Current Asset
Key Assertions for Intangible Assets: Goodwill: Check the consideration to sale agreement. completeness.
– Additions and disposals are correctly recorded. additions and disposals. classification & valuation
Non-current assets are correctly stated at cost less accumulated depreciation. Consider whether the asset valuation is reasonable.
Assertions relating to presentation & disclosure
Disclosures relating to cost. useful lives and assets held under finance leases are adequate and in accordance with accounting standards (occurrence and rights and obligations.
Research & Development Cost: Check whether it meets the criteria of IAS 38 (Research & Development Cost)
. Check the method used for goodwill calculation & recalculate if possible. depreciation presentation and disclosure policies. Review the impairment & discuss with management. classification and understandability.
Inventory is valued correctly (Lower of Cost & NRV).-
Confirm the feasibility & viability by inspection of budgets. If required inspect the valuation from expert professionals.
Accuracy. Inventory on the financial statement physically exists.
Assertions related to Inventory Existance & Occurance Recorded Sale & Purchases reconcile with the consumption of inventory & stock on hand. Classification & Valuation Costs accurately recorded in accordance with IAS.
Completeness All purchases & Sales are recorded.
Other Intangible Assets: Assess the purchased documents agreement.
. Review amortization calculation & ensure they are correct by re-calculation.
Cut Off All purchases & Sales of inventory are recorded in the current period. All inventory in the year end are recorded in the financial statement. Recalculate amortization calculation. Inspect invoices to verify expenditure incurred on R&D expenditure.
Invoices for good dispatched after the count should not appear in the I/S for the period. A schedule of GRNs should be prepeared & items on the list should be accrued for in the accounts.
Audit Precedure for Inventory
Power Point Slide
Physical Inventory Count Where inventory is material auditors shall obtain sufficient appropriate audit evidence regarding its existence & conditions by attending the physical inventory count to do the following: Evaluate management’s instructions & procedure for physical inventory count. Procedures intended to ensure that movements into. Disclosures relating to classification & valuation are adequate & in accordance with accounting standard.Presentation & Disclosure Inventory is properly classified in the accounts. Purchase invoice should be recorded only if goods where received prior to the count.
Audit Program for Receivables
Cut-Off Auditors should consider whether management has adequate cutoff procedures. within & out of inventories are properly identified & reflected in the accounting records. Perform test counts. Sales cut-off is generally more straight forward to achieve correctly. Inspect the inventory.
4. Include the audit firm’s return address on all envelopes to ensure that all confirmation requests that are undeliverable by the post office are returned directly to the audit firm. For the remaining balance that is not confirmed 100% in Step 3. a. Review those accounts selected for confirmation with the owner/manager. Identify the accounts selected on the aged trial balance. on the face of the letter or in an attached statement.BASIC PROCEDURES 1. invoice date. Briefly inquire of management as to steps taken to ensure the trial balance is complete. Reconcile the balance to the general ledger account balance. a. test the clerical accuracy. the individual invoice number.
Audit for Cash & Balance at Bank
The article is divided into three main sections:
.) c. and invoice amounts that make up the customer’s balance. If sampling is appropriate. document the sampling selection process. b. d. Review the aged trial balance to determine if there are natural groups within the total population of accounts. 2. that all receivables due the company are included on the trial balance. Obtain or prepare an aged trial balance of accounts receivable. c. if possible.e. determine if this restriction will affect your ability to accomplish the audit objectives for receivables. b. determine if a sample of the accounts making up the balance should be selected for confirmation.
3. If the trial balance is prepared by the client. Select those groups that will be confirmed 100% by the use of positive confirmation letters. If the client objects to a confirmation with a particular customer.. Do not test the accuracy of the aging of individual accounts until you start Step 7. Have the client prepare the positive confirmation letters reflecting. a. Repeat program Steps 3a through 3h on accounts being sampled. (See also Step 10. i.
Presentation and Cash balances are properly identified and classified in the balance sheet. Confirm bank balances. Designing and executing an audit programme for cash. Obtain and use subsequent period's bank statement. 3.
Tests of details of balances Substantive tests for cash balances in this category include: 1. Verify bank reconciliations. The latter arises where the bank with which the entity holds an account allows the entity to write cheques in excess of the balance in the account up to an agreed limit known as an overdraft. Cash at bank includes cash held in current and savings accounts which is available on demand. disclosure Lines of credit. 2.1. cash may be either an asset or a liability. 4. Cash audit objectives Cash balances include cash on hand and at bank. The entity has legal title to all cash balances shown at the balance sheet Rights and obligations date. 3. Discussing considerations relevant to developing the audit plan for cash. Recorded cash balances include the effects of all cash transactions that Completeness have occurred. Recorded cash balances are realisable at the amounts stated on the Valuation balance sheet. Using the assertions described in SAS 400 (ISA 500) the audit objectives to be achieved in verifying cash balances are identified in
Table 1. Identifying the audit objectives applicable to cash balances. Unlike any other account balance. Cash on hand includes undeposited receipts and petty cash.
Table 1: Specific audit objectives for cash balances Assertion Account balance audit objective Existence Recorded cash balances exist at the balance sheet date. 2.
Count cash on hand
. loan guarantees and other restrictions on cash balances are appropriately disclosed. Count cash on hand.
Having the custodian present and requiring his or her signature on return of the funds minimises the possibility. and as to rights and obligations (because the balances are in the name of the entity). because the response indicates the amount of the loan balance. Similar arrangements with the banking industry may exist in other countries. of the custodian claiming that all cash was intact when released to the auditors for counting. Confirm bank balances It is customary for the auditors to confirm cash on deposit and loan balances at balance sheet date directly with the bank. valuation.
The control of all funds is designed to prevent transfers by entity personnel of counted funds to uncounted funds. Bank Reports for Audit Purposes. it cannot be relied on entirely because the bank confirmation usually contains a disclaimer in favour of the bank. either directly or through endorsement. The bank cannot be held liable if the information supplied is incomplete or inaccurate. because the loan is a debt of the entity.
. insist that the custodian of the cash be present throughout the count. rights and obligations. A confirmation request should be sent to all banks with which the entity had dealings at any time during the year. however. The confirming of overdraft and loan balances provides evidence as to:
• • •
existence. list each item making up the balance. The procedure in the UK is laid down in APB Practice Note 16. Furthermore.This test is often omitted as the amount of cash on hand is rarely material. If it is performed the following procedures are appropriate:
• • • • • •
control all cash held by the entity until all funds have been counted. it contributes to the completeness assertion. in the event of a shortage. obtain a signed receipt from the custodian on return of the funds. trace each item listed to the subsequent bank deposit. In addition to confirmation of the balance outstanding. based on an agreement with the British Bankers Association. the opportunity is also taken to request the bank to furnish other information such as securities held in safekeeping. because there is written acknowledgement that the loan balance exists. Tracing items to the subsequent deposit tests the possibility of a teeming and lading fraud. ascertain that all undeposited cheques are payable to the order of the entity. The confirming of cash on deposit provides evidence primarily as to the existence of cash at bank (because there is written acknowledgement that the balance exists). The response from the bank also provides some evidence for the valuation assertion for cash at bank in that the confirmed balance is used in arriving at the correct cash balance at the balance sheet date.
the auditors may prepare the bank reconciliation.
When the entity does not prepare a bank reconciliation or when control risk over entity prepared reconciliations is high (such as where it is prepared by the cashier). or in the reconciliation at the beginning of that month not marked as appearing on the bank statement. This procedure will prevent the entity from making alterations to the data to cover any misstatements. it is a primary source of evidence for the valuation assertion. This test also provides evidence for the existence. tracing outstanding cheques and deposits in transit to the subsequent period's bank statement. and rights and obligations assertions. — identifying deposits and cheques recorded in the cash book for the last month of the fiscal year. establishing the mathematical accuracy of the reconciliation.This test also contributes to the completeness assertion in the same manner as confirming deposit balances. When the auditors suspect possible material misstatements. verifying the validity of deposits in transit and outstanding cheques by. vouching other reconciling items such as bank charges to supporting documentation. The test will normally include:
• • • •
comparing the closing bank balance with the balance confirmed by the bank. investigating old items such as cheques outstanding for a long period of time and unusual items. the auditors will test reconciliations prepared as at balance sheet date. the auditors may obtain the year-end bank statement directly from the bank for use in preparing the bank reconciliation and not rely on the copy of the bank statement held by the entity. — clearing the bank reconciliation to ensure that all applicable outstanding deposits and outstanding cheques are marked as having been traced from the cash book and that none are fictitious. Testing or preparing a bank reconciliation establishes the correct cash at bank balance at the balance sheet date. and tracing them to the closing reconciliation. Verify bank reconciliations When the entity prepares bank reconciliations on a regular basis that are expected to be reliable. The entity should be requested to instruct the
. completeness. Obtain and use subsequent period's bank statement The subsequent period's bank statement would normally be issued at the end of the month following the entity's financial year-end. Thus. — tracing entries in the bank statement for the last month of the fiscal year to the cash book or bank reconciliation at the beginning of the month. marking them off in the process.
it may indicate an irregularity known as window dressing. The auditors should investigate any unusual circumstances. which results in a 1.) Window dressing is normally perpetrated by writing cheques on the last day of the financial year but not mailing them until several weeks later.8:1 current ratio instead of the reported 2:1. In tracing outstanding cheques the auditors may find that a prior period cheque not on the list of outstanding cheques has cleared the bank and that some of the cheques listed as outstanding have not cleared the bank. If none of a sequence of cheques is presented for payment on the bank statement for more than two weeks after the balance sheet date.000. (Assume.
.000 of cheques to short-term creditors have been prematurely entered. If £100. that the entity's balances show current assets of £800. the correct totals are current assets of £900.000.bank to send a copy of the subsequent period's bank statement directly to the auditors. Recipients do not usually delay banking cheques once received and it is normal for most cheques to clear the bank statement within a week of issue. The latter may be due to delays in mailing the cheques by the entity or in depositing the cheques by the payees. at balance sheet date. the auditors should make inquiries of the treasurer. when cleared funds are available at the bank to meet those cheques.000 and current liabilities of £400.000 and current liabilities of £500. This is a deliberate attempt to enhance an entity's apparent short-term solvency. When the total of uncleared cheques is material.