Auditing final revision

B.I.S
Chapter 7

Audit evidence”Audit Techniques”

Audit Evidence:

Is defined as any information used by the auditor to determine whether the

information being audited is stated in accordance with the established
criteria.

Audit Evidence Decisions: There are four decisions about what evidence
to gather and how much of it to accumulate:
1. Which audit procedures to use?
2. What sample size to select for a given procedure?
3. Which items to select from the population?
4. When to perform the procedures (Timing)?

1. Audit Procedure:
An audit procedure is the detailed instructions that explain the audit
evidence to be obtained during the audit.
For example, the following is an audit procedure for verification of cash
disbursements: Obtain the cash disbursement journal and compare the payee
name, amount and date on the cancelled check with the cash disbursement
journal.

2- Sample Size:
Once the audit procedure is selected, the sample size can be varied from one
to all items in the population being tested.
For example in an audit procedure to verify cash disbursements, suppose
5000 checks are recorded in the cash disbursements journal.The auditor
might select a sample size of 80 checks for comparison with the cash
disbursements journal.
Note: The sample size for any given procedure is likely to vary from audit to
audit. This depends on the internal control system and the errors found in the
initial sample.
 3- Items to Select:
After determining the sample size for an audit procedure, auditor must
decide which items in the population to test.
For example If the auditors decide to select 80 cancelled checks from a
population of 5000 to compare them with the cash disbursements journal.
Several methods should be used:
–Select a week and examine the first 80 checks.
–Select the 80 checks with the largest amounts.
–Select the checks randomly.
–Select those checks the auditor thinks are most likely to be in error. Or a
combination of these methods can be used .

4- Timing:
An audit of financial statements usually covers a period such as a year. The
timing can vary from early in the accounting period to long after it has
ended. Here, the auditor has to decide on the period covered by the audit.
For example, Auditors often prefer to do counts of inventory as close to the
balance sheet date as possible.

 Specify the characteristics that determine the persuasiveness of evidence:

Audit standards require the auditor to accumulate sufficient appropriate
evidence to support the opinion issued. Because of the nature of audit
evidence and the cost considerations of doing an audit, it is unlikely that the
auditor will be completely convinced that the opinion is correct. However,
the auditor must be persuaded that the opinion is correct with a high level of
assurance. The two determinants of the persuasiveness of evidence are
appropriateness and sufficiency.

 Appropriateness of evidence
is a measure of the quality of evidence, meaning its relevance and reliability
in meeting audit objectives for classes of transactions, account balances, and
related disclosures.
Relevance & Reliability of evidence
Refers to the degree to which evidence can be believable or worthy of trust,
depends on the following six characteristics of evidence:
1. Independence of provider. Evidence obtained from a source outside the
entity is more reliable than that obtained from within. For example,
Communications from banks, attorneys, or customers is generally
considered more reliable than answers obtained from inquiries of the client.
Similarly, documents that originate from outside the client’s organization,
such as an insurance policy, are considered more reliable than are those that
originate within the company and have never left the client’s organization,
such as a purchase requisition.
2. Effectiveness of client’s internal controls. When a client’s internal
controls are effective, evidence obtained is more reliable than when they are
weak. For example, if internal controls over sales and billing are effective,
the auditor can obtain more reliable evidence from sales invoices and
shipping documents than if the controls were inadequate.
3. Auditor’s direct knowledge. Evidence obtained directly by the auditor
through physical examination, observation, recalculation, and inspection is
more reliable than information obtained indirectly. For example, if the
auditor calculates the gross margin as a percentage of sales and compares it
with previous periods, the evidence is more reliable than if the auditor relies
on the calculations of the controller.
4. Qualifications of individuals providing the information. Although the
source of information is independent, the evidence will not be reliable unless
the individual providing it is qualified to do so. Therefore evidence obtained
directly by the auditor may not be reliable if the auditor lacks the
qualifications to evaluate the evidence. For example, examining an
inventory of diamonds by an auditor not trained to distinguish between
diamonds and glass is not reliable evidence.
5. Degree of objectivity. Objective evidence is more reliable than evidence
that requires considerable judgment to determine whether it is correct.
Examples of objective evidence include confirmation of accounts receivable
and bank balances, the physical count of securities and cash, and adding
(footing) a list of accounts payable to determine whether it agrees with the
balance in the general ledger. Examples of subjective evidence include a
letter written by a client’s attorney discussing the likely outcome of
outstanding lawsuits against the client, observation of obsolescence of
inventory during physical examination, and inquiries of the credit manager
about the collectability of noncurrent accounts receivable.
6. Timeliness. The timeliness of audit evidence can refer either to when it is
Accumulated or to the period covered by the audit. Evidence is usually more
Reliable for balance sheet accounts when it is obtained as close to the
balance sheet date as possible. For example, the auditor’s count of
marketable securities on the balance sheet date is more reliable than a count
2 months earlier. For income statement accounts, evidence is more reliable if
there is a sample from the entire period under audit, such as a random
sample of sales transactions for the entire year, rather than from only a part
of the period, such as a sample limited to only the first 6 months.

 Sufficiency of evidence The quantity of evidence obtained determines its

sufficiency. Sufficiency of evidence is measured primarily by the sample
size the auditor selects. For example a given audit procedure, the evidence
obtained from a sample of 100 is ordinarily more sufficient than from a
sample of 50.

Identify Types of Audit Evidence ”Techniques”: In deciding which audit

procedures to use, the auditor can choose from the following seven types of
evidence:

1.Physical examination:
Physical examination is the inspection or count by the auditor of a tangible
asset. This type of evidence is often associated with inventory and cash, but
it is also applicable to the verification of securities, notes receivables and
tangible fixed assets.
Note: Physical examination is regarded as one of the most reliable and
useful type of audit evidence because it depend on the auditor direct
knowledge
2.Confirmation
Confirmation describes the receipts of a written or oral response from an
independent third party verifying the accuracy of information that was
requested by the auditor. The request is made to the client, and the client
asks the independent third party to respond directly to the auditor.
Note: Because confirmation comes from sources independent of the client,

the are a highly reliable type of evidence .

Sources of confirmation:

 Positive Confirmation: here the customer is requested to confirm the

balance to the auditor whether correct or incorrect i.e.: In both cases, the
auditor will receive a reply

 Negative Confirmation: In this case, the recipient is requested to respond

only when the information is incorrect

3.Documentation
Documentation is the auditor’s examination of the client’s documents and
records to substantiate the information that is or should be included in the
financial statements. Each transaction in the client’s organization is normally
supported by at least one document. There is a large volume of this type of
evidence available and at a low cost, so it is the most widely used type of
evidence. Documents can be classified as internal & external.

A. Internal documents: is one that has been prepared, used and retained
within the client’s organization without going to any third party. Example of
this type, Duplicate sales invoices, Inventory receiving reports
B.External documents: is one that has been prepared by a third party
outside the client’s organization and kept inside or outside the firm, and
those documents that have been prepared by the firm but are kept outside the
firm. Example of this type, Vendor invoices, Insurance policies.
Note: Internal documents can be reliable if the client maintains a strong
internal control system.
4.Analytical procedures:
Analytical procedures use the comparison and relationships to assess
whether account balances or other data appear reasonable. An example is
comparing the gross margin percent in the current year with the preceding
year’s.
The analytical procedures are used for different purposes on an audit. The
purposes are;
1- Understand the Client’s Industry and Business;
2- Assess the entity’s ability to continue as a Going Concern;
3- Indicate the presence of possible misstatements in the financial
statements;
4- Reduce detailed audit tests.
5.Inquiries of the client :
Inquires is the obtaining of Written or Oral information from the client in
response to questions from the auditor. Although considerable evidence is
obtained from the client through the inquires, it is usually can not be
regarded as conclusive because it is not from an independent source and may
be biased in the client’s favor.
6.Reperformance”Recalculation”:
Reperformance involves rechecking a sample of the computation and
transfers of information made by the client during the period under audit.
•Rechecking of computations consists of testing the client’s arithmetic
accuracy .ex: checking the calculation of depreciation expenses and prepaid
expenses.
Note:It is a reliable type of evidence due to the auditor qualification
&knowledge.

7.Observation
Observation is the use of the sense to assess certain activities. For example.:
The auditor may tour the plant to obtain a general impression of the client’s
facilities, observe whether equipment is rusty or obsolete.

Answer cases study of the book:

7-27)
Document External Internal
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7-28)
Audit procedure Type of evidence
1- Inquiry of client
2- Documentation
3- Recalculation or Reperformance
4- Physical examination
5- Confirmation
6- Recalculation or Reperformance
7- Confirmation
8- Documentation
9- Analytical procedures
10- Inquiry of client
11- Recalculation or Reperformance
12- Observation
13- Physical examination
14- Analytical procedures
15- Documentation
16- Inquiry of client
17- Analytical procedures
18- Confirmation

7-31)
Account name From whom Information confirmed
Confirmed
1-cash in bank Bank Amount of cash
2-trade account Customer Customer name, dollar value
receivable
3-notes receivable Maker Dollar value
4-inventories Public warehouse Inventory balance
5-land No No
6-bulding No No
7-furniture No No
8-trade accounts Creditor Dollar value
payable
9-mortgage payable Mortgagor Dollar value
10-capital stock Register and Number of shares ,par value
transfer agent
11-retained earnings No No
12-sales No No
13-cost of sales No No
14-general expenses No No
15-legal and attorneys Dollar amount
professional fees
16-intrest expense bank Rate of interst

Chapter 3
 Audit report
 Definition of Audit Report: is the communication of the auditor’s
findings to users. It is The final stage in the auditing process
 Discuss the Parts of the Standard Unqualified Audit Report:
1. Report Title: Independent Auditor Report.
2. Report Address: To the stockholders of the corporation.
3. Introductory Paragraph:
a) The CPA has done an audit.
b) Name of the company being audited. (Auditee)
c) Listing of the financial statements that have been audited.
d) Preparing the financial statements is the management’s responsibility.
e) The job of the auditor is to express an opinion on the statements based on
on the audit
4. Scope Paragraph:
a) Audit is conducted in accordance with GAAS.
b) Purpose of the audit: the audit is designed to obtain reasonable assurance
that the financial statements are free of material misstatements.
c) The type of the audit evidence that have been accumulated.
d) The auditor’s responsibility for evaluating the appropriateness of the
accounting principles, estimates, and financial statements disclosures.
5. Opinion Paragraph:
a) A statement of "In Our Opinion………………"
b) A statement about whether the financial statements were fairly presented,
and in accordance with GAAP.
6. Name and Signature of the CPA firm
7. Date of the Audit report: Date of ending the audit.

 Discuss the conditions of issuing Standard un Qualified audit report?

The standard unqualified audit report is issued when the following
conditions have been met:
1. All statements—balance sheet, income statement, statement of
retained earnings ,and statement of cash flows—are included in the
financial statements.
2. The three general standards have been followed in all respects on
the engagement.
3. Sufficient appropriate evidence has been accumulated, and the
auditor has conducted the engagement in a manner that enables him or
her to conclude that the three standards of field work have been met.
 4. The financial statements are presented in accordance with U.S.
generally accepted accounting principles. This also means that
adequate disclosures have been included in the footnotes and other
parts of the financial statements.
5. There are no circumstances requiring the addition of an explanatory
paragraph or modification of the wording of the report.

 Specify types of audit reports” Auditor opinion” that he/she issue

relating auditing of financial statements:

 Discuss what is meant by materiality and how that concept affect

the opinion that auditor issue regarding the client financial
statements?”(discuss the conditions that require unqualified audit
report with explanatory paragraph or modified wording)+(discuss the
condition that required a departure from standard unqualified audit
report)?”

Answer cases study of Book

3-28)
situation Dev.or.Mod. Level of Materiality Type of Audit report
1- Yes Material Qualified report
2- Yes Material Disclaimer
3- No Immaterial Standard unqualified
4- Yes Immaterial Unqualified with
explanatory paragraph
5- Yes Material Unqualified with
modified wording
6- Yes Material Qualified report

3-29)
situation Dev.or.Mod. Level of Materiality Type of Audit report
1- Yes Material Unqualified with
explanatory paragraph
2- Yes Material Unqualified with
explanatory paragraph
3- Yes High material Adverse
5- Yes Material Qualified or disclamer
6- Yes Material Unqualified with
modified wording

Chapter 2
Quality control

 Describe what’s meant by quality control and describe its

elements with a brief example of each?

Answer case study of the book

2-19)
Procedures Elements
a. Human resources
b. Engagement performance
c. Acceptance and continuation of client engagement
d. Engagement performance
f. Engagement performance
g. Ethical requirement
h. Human resources
i. Human resources
j. Leadership reasposbilities.

Chapter 1
 The demand for audit and other assurance
Services

 Describe what is meant by audit and specify reasons for audit?

Auditing: is the accumulation and evaluation of evidence about
information to determine and report on the degree of correspondence
between the information and established criteria. Auditing should
Be done by a competent, independent person.
Reason of auditing (Causes of risk of information+ How to reduce
it):
 Remoteness of Information In a global economy, it is nearly
impossible for a decision maker to have much firsthand
knowledge about the organization with which they do business.
Information provided by others must be relied upon. When
information is obtained from others, the likelihood of it being
intentionally or unintentionally misstated increases.
 Biases and Motives of the Provider If information is provided
by someone whose goals are inconsistent with those of the
decision maker, the information may be biased in favor of the
provider, the result is a misstatement of information.
 Voluminous Data As organizations become larger, so does the
volume of their exchange transactions. This increases the
likelihood that improperly recorded information is included in
the records—perhaps buried in a large amount of other
information.
 Complex Exchange Transactions In the past few decades,
exchange transactions between organizations have become
increasingly complex and therefore more difficult to record
properly. For example include properly combining and
disclosing the results of operations of subsidiaries in different
industries and properly disclosing derivative financial
instruments.
Reduction of risk of information:
 User Verifies Information The user may go to the business
premises to examine records and obtain information about the
reliability of the statements. Normally, this is impractical
because of cost.
 User Shares Information Risk with Management There is
considerable legal precedent indicating that management is
 responsible for providing reliable information to users. If
users rely on inaccurate financial statements and as a result
incur a financial loss, they may have a basis for a lawsuit
against management.
 Audited Financial Statements Are Provided The most
common way for users to obtain reliable information is to
have an independent audit. Typically, management of
company engages the auditor to provide assurances to users
that the financial statements are reliable.

 Distinguish between Accounting and Auditing?

Accounting is the recording, classifying, and summarizing of
economic events in a logical manner for the purpose of providing
financial information for decision making. To provide relevant
information, accountants must have a thorough understanding of
the principles and rules that provide the basis for preparing the
accounting information.
Auditing accounting data, auditors focus on determining whether
recorded information properly reflects the economic events that
occurred during the accounting period.(Quality of information).

 Describe assurance services and distinguish audit services from

other assurance and non assurance services provided by CPAs?
 An assurance service is an independent professional service
that improves the quality of information for decision makers.
Such services are valued because the assurance provider is
independent and perceived as being unbiased with respect to the
information examined. Individuals who are responsible for
making business decisions seek assurance services to help
improve the reliability and relevance of the information used as
the basis for their decisions.
 An attestation service is a type of assurance service in which
the CPA firm issues a report about the reliability of an assertion
that is made by another party. Attestation services fall into five
categories:

1. Audit of historical financial statements: Management

asserts that the statements are fairly stated in accordance
 with applicable U.S. or international accounting standards.
An audit of these statements is a form of attestation service
in which the auditor issues a written report expressing an
opinion about whether the financial statements are fairly
stated in accordance with the applicable accounting
standards. These audits are the most common assurance
service provided by CPA firms.
2. Audit of internal control over financial reporting: requires
auditors to attest to the effectiveness of internal control over
financial reporting.
3. Review of historical financial statements :management
asserts that the statements are fairly stated in accordance
with accounting standards, the same as for audits. The CPA
provides a lower level of assurance for reviews of financial
statements compared to a high level for audits, therefore less
evidence is needed.
4. Attestation services on information technology: For
attestations on information technology, management makes
various assertions about the reliability and security of
electronic information
 Other Assurance services Most of the other assurance services
that CPAs provide do not meet the definition of attestation
services, but the CPA must still be independent and must provide
assurance about information used by decision makers. These
assurance services differ from attestation services in that the CPA
is not required to issue a written report.(Example: electronic seal
of auditor on certain web site ,or ISO 9000 certificates)
 Non Assurance services CPA firms perform numerous other
services that generally fall outside the scope of assurance services.
Three specific examples are:1) Accounting and bookkeeping
services,2) Tax services.

 Identify the primary types of auditors?

  Differentiate the three main types of audits & give examples for
each?

Answer Cases study of book

1-16)
Statement Audit Attestation Assurance
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1-21)
Statement Auditor Audit
2- GAO Operational Audit
3- Internal auditor Operational Audit
4- Internal auditor Financial statement
audit
6- External auditor F.S audit
7- GAO F.S audit
9- External auditor F.S audit
10- External auditor Compliance audit
11- External or internal Operational Audit
auditor