Auditing and Assurance Services

A Systematic Approach
Eleventh Edition

CHAPTER 5

Evidence and
Documentation

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 Learning Objective 05-1

Relationship of Audit Evidence to

the Audit Report
Financial Audit
statements report

Management Auditor reaches

assertions about a conclusion
components of financial based
statements on the evidence

Audit Provide evidence on the

procedures
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 fairness of
the
financial
statements

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 Learning Objective 05-2

Management Assertions (1 of 2)

Occurrence
Completeness
Presentation

Assertions about classes of

transactions and events,
and related disclosures, for
Classification
the period under audit Authorization

Cutoff Accuracy

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 Learning Objective 05-2

Management Assertions (2 of 2)
Rights and
Existence
Obligations

Assertions about
Presentation account balances, and Completeness
related disclosures, at the
period end

Accuracy,
Classification valuation,
and allocation

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 Learning Objective 05-2

TABLE 5-2 Summary of Management Assertions by

Category (1 of 2)

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 Learning Objective 05-2

TABLE 5-2 Summary of Management Assertions by

Category (2 of 2)

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 Learning Objective 05-3

Audit Evidence

The information used by the auditor in

arriving at the conclusions on which the
audit opinion is based.

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 Learning Objective 05-3

The Concepts of Audit Evidence

Nature of audit evidence

Sufficiency and appropriateness of

audit evidence

Evaluation of audit evidence

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 Learning Objective 05-3

Nature of Audit Evidence

Refers to the form or type of information
Accounting Records Other Information
• Records of initial entries • Minutes of meetings
and supporting records • Confirmations from
• General and subsidiary third parties
ledgers, journal entries, and • Industry analysts’ reports
other adjustments to financials • Comparable data about
not reflected in journal entries. competitors
• Work sheets and • Control Manuals
spreadsheets supporting cost • Information obtained by
allocations, computations, the auditor from inquiry,
reconciliations, and observation and inspection
disclosures
• Contracts

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 Learning Objective 05-3

Sufficiency of Audit Evidence

Sufficiency is the measure of

the quantity of audit evidence.

Greater risk of Higher quality

misstatement requires audit evidence results
a higher quantity in a lower quantity
of audit evidence. of audit evidence.

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 Learning Objective 05-3

Appropriateness of Audit Evidence

Relevance
Appropriateness is a measure
of the quality of audit evidence.
Reliability

Independent source outside the entity

Effectiveness of internal control

Auditor’s direct personal knowledge

Documentary evidence

Original documents

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 Learning Objective 05-3

Knowledge Assessment

Which of the following sources of evidence are more reliable?

1. Inquiry of an accounts receivable clerk regarding the

accounts receivable balance – or – accounts
receivable confirmations sent to a sample of
customers

2. Physical examination of lumber inventory performed

by the external auditor – or – physical examination of
inventory performed by internal auditors

(Stop and Think p. 135)

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 Learning Objective 05-3

Knowledge Assessment

Which of the following sources of evidence are more reliable?

1. Inquiry of an accounts receivable clerk regarding the

accounts receivable balance – or – Accounts
receivable confirmations sent to a sample of
customers

2. Physical examination of lumber inventory

performed by the external auditor – or – Physical
examination of inventory performed by internal
auditors

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(Stop and Think p. 135)

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 Learning Objective 05-3

Evaluation of Audit Evidence

Proper evaluation of evidence

requires an understanding of the:

Types of evidence available.

Relative reliability of available evidence.

An auditor should be thorough in searching for

evidence and unbiased in its evaluation.

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 Learning Objective 05-4

Audit Procedures (1 of 2)
Specific acts
performed by the auditor to
gather evidence about
whether specific assertions
are being met.

Risk assessment Test of controls Substantive

procedures procedures

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 Learning Objective 05-4

Audit Procedures (2 of 2)
A set of audit procedures prepared to test assertions for
a component of the financial statements is referred to as
an audit program.

Audit Program for

Accounts
Receivable
Management Assertions Example Audit Procedures
Existence Confirm accounts receivable.
Rights and obligations Inquire of management whether receivables
have been sold.
Completeness Agree total of accounts receivable subsidiary
ledger to accounts receivable control account.
Valuation or allocation Test the adequacy of the allowance for doubtful
accounts.

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (1 of 7)
Inspection of records and documents
• Evidence obtained from external documents is more
reliable than evidence obtained from internal
documents
Vouching
(Occurrence)
Source Journal or
Documents Ledger
Tracing
(Completeness)

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (2 of 7)
Inspection of tangible assets
• Physical examination of a tangible assets

Observation
• The process of watching a process or procedure being
performed by others

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (3 of 7)
Inquiry
In conducting inquiry, the auditor should:
• Consider the knowledge, objectivity, experience,
responsibility, and qualifications of the individual to
be questioned
• Ask clear, concise, relevant questions
• Use open or closed questions appropriately
• Listen actively and effectively
• Consider the reactions and responses and ask follow-up
questions
• Evaluate responses

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (4 of 7)
Confirmation
• Audit evidence obtained by the auditor as a direct
written response to the auditor from a third party

The reliability of evidence obtained through

external confirmations may be affected by factors
such as:
 The form of the confirmation.
 Prior experience with the entity.
 The nature of the information being confirmed.
 The intended respondent.

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (5 of 7)
Confirmation

Information Frequently
Source of Confirmation
Confirmed by Auditors
Cash balance Bank
Accounts receivable Individual customers
Inventory on consignment Consignee
Accounts payable Individual vendors
Bonds payable Bondholders/trustee
Common stock outstanding Registrar/transfer agent
Insurance coverage Insurance company
Collateral for loans Creditor

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (6 of 7)
Recalculation
• Checking the mathematical accuracy of documents
or records

Reperformance
• The auditor’s independent execution of procedures
or controls that were originally performed by
company personnel

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 Learning Objective 05-4

Audit Procedures for Obtaining

Audit Evidence (7 of 7)
Analytical Procedures
• Evaluations of financial information made by a
study of plausible relationships among both
financial and nonfinancial data

Scanning
• Judgmentally review accounting data to identify
significant or unusual items to test

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 Learning Objective 05-5

TABLE 5-6 General Guidelines for Reliability Hierarchy by

Evidence Type

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 Learning Objective 05-6

FIGURE 5-3 Audit Testing Hierarchy: An Evidence Decision Process

for Testing Classes of Transactions or Significant Balances

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 Learning Objective 05-6

FIGURE 5-4 Filling the Assurance Bucket

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 Learning Objective 05-6

FIGURE 5-5 Accounts Payable Example of Filling the

Assurance Buckets for Each Assertion

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 Learning Objective 05-6

Knowledge Assessment

Consider the “assurance bucket” analogy. Why are some of

the buckets larger than others for particular assertions or
accounts?

(Review Question 5-12)

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 Learning Objective 05-7

Audit Documentation
The auditor’s record of the audit procedures performed,
relevant evidence obtained, and conclusions reached.

Audit documentation (working papers) has three

functions:
1. To provide support for the audit report
2. To aid in the planning, performance,
and supervision of the audit
3. To provide a focal point for reviewing work
of subordinates; to provide a basis for
quality reviews

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 Learning Objective 05-7

Content of Audit Documentation (1 of 4)

Audit documentation should:

Demonstrate how the audit complied with

1 auditing and related professional practice
standards

Support the basis for the auditor’s conclusions

2 concerning each material financial statement
assertion

Demonstrate that the underlying accounting

3 records agreed or reconciled with the financial
statements

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 Learning Objective 05-7

Content of Audit Documentation (2 of 4)

Audit documentation should:

Include a written audit program detailing

4 auditing procedures necessary to accomplish
audit objectives

Enable a knowledgeable and experienced

5 reviewer to:

Understand the nature,

Determine who performed and
timing, extent, and results of
reviewed the work, as well as
audit procedures, evidence
the dates of the work and
obtained, and conclusions
reviews.
reached

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 Learning Objective 05-7

Content of Audit Documentation (3 of 4)

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

• Corporate charter • Organization chart

• Important contracts • Terms of stock and
• Chart of accounts bond issues
• Internal • Prior years’ analytical
control procedures (and
documentation results)
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 Learning Objective 05-7

Content of Audit Documentation (3 of 4)

Most public accounting firms maintain

audit documentation in two types of files:

Permanent files Current files

• Adjusting journal entries • Current financial

• Audit plan and programs statements and
• Reclassification auditor’s report
journal entries • Minutes of meetings
• Working trial balance • Working papers
supporting accounts

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 Learning Objective 05-8

Format of Audit Documentation

Entity name
Heading Title of the working paper
Entity’s year-end date

Indexing and Notations that provide a trail

from financial statements to audit
cross-referencing documents

Notations made next to work

Tick Marks paper items indicating
auditor/reviewer actions

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 Learning Objective 05-8

EXHIBIT 5-2 Example of Account Analysis Working

Paper

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 Learning Objective 05-8

Ownership of Audit Documentation,

Archiving, and Retention
Audit documentation should be organized so that
audit team members and others can find
evidence supporting financial statement accounts.

All audit documentation is the property of the

auditor, including documents prepared
by the entity at the auditor’s request.

The Sarbanes-Oxley Act of 2002 requires audit

documentation to be retained for a number of years from
the completion date of the engagement.

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 Learning Objective 05-9 (and 05-4)

Purposes of Analytical Procedures

Risk Used to assist the auditor to better
understand the business and to plan the
Assessment nature, timing, and extent of audit
Procedures procedures.

Substantive Used to obtain evidential matter about

Analytical particular assertions related to account
balances or classes of transactions.
Procedures

Final Used as an overall review of the financial

Analytical information in the final review stage of the
audit.
Procedures

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 Learning Objective 05-9

Types of Analytical Procedures

Trend Analysis

Ratio Analysis

Reasonableness
Analysis

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 Learning Objective 05-9

Figure 5-7 Substantive Analytical Procedures Decision Process

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 Learning Objective 05-9

Develop an Expectation (1 of 3)
Auditing standards require the auditor to have an
expectation whenever analytical procedures are used. An
expectation can be developed using a variety of information
sources such as:
• Financial and operating data
• Budgets and forecasts
• Industry publications
• Competitor information
• Management’s analyses
• Analysts’ reports

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 Learning Objective 05-9

Develop an Expectation (2 of 3)
Precision – the quality of an expectation
Measure of:
• The potential effectiveness of an analytical procedure
• The degree of reliance that can be placed on the procedure
• How closely the expectation approximates the “correct” but unknown
amount

• The degree of desired precision differs a re trade

with the purpose of the analytical u s -off).
procedure. d (c
• A function of the materiality and it o
required detection risk for assertion p st
being tested. r -
• If the assertion being tested requires a o b
low level of detection risk, the expectation c e
needs to be very precise. e n
• The more precise the expectation, the d ef
more extensive and expensive the u it

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Detection Risk
Exten
LOW siven
ess
of
Proce
dures

HIGH

HIGH
Precisio
n
Require
d
LOW
HIGH

LOW

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 Learning Objective 05-9

Develop an Expectation (3 of 3)
Four factors affect the precision of analytical
procedures:
• Disaggregation
• The plausibility and predictability of
the relationship being studied
• Data reliability
• Type of analytical procedures used
to form an expectation

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 Learning Objective 05-9

Define a Tolerable Difference

The size of the tolerable difference depends on:
• the significance of the account
• the desired degree of reliance on the substantive analytical
procedures
• the level of disaggregation in the amount being tested

• the precision of the expectation

Tolerable difference will usually be equal to the account’s

tolerable misstatement

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 Learning Objective 05-9

Compare the Expectation to the

Recorded Amount

Compare the expectation to the recorded

amount and investigate any differences
greater than the tolerable difference.

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 Learning Objective 05-9

Investigate Differences Greater Than

the Tolerable Difference (1 of 2)
Differences identified by substantive
analytical procedures indicate an
increase likelihood of misstatements

Explanations for significant differences observed

(substantive analytical procedures) must be followed
up and resolved through:
• Quantification
• Corroboration
• Evaluation

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 Learning Objective 05-9

Investigate Differences Greater Than

the Tolerable Difference (2 of 2)
Involves determining whether the explanation
Quantification or error can explain the observed difference

Auditors must corroborate explanations by

obtaining sufficient appropriate audit evidence
Corroboration linking the explanation to the difference and
substantiating that the information supporting
the explanation is reliable

Auditor should evaluate the results of the

substantive analytical procedures to conclude
Evaluation whether the desired level of assurance has
been achieved

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 Learning Objective 05-9

Investigate Differences for Risk Assessment

and Final Analytical Procedures

Risk Assessment Final Analytical

Procedure Differences Procedures Differences
(used in planning)

Corroborating evidence Corroborating evidence

is not required is required

If the auditor cannot find sufficient evidence within the

working papers, the auditor would formulate possible
explanations, conduct additional testing, and seek an
explanation from the entity’s personnel.

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 Learning Objective 05-9

Knowledge Assessment

The primary objective of final analytical procedures is to:

A. Obtain evidence from details tested to corroborate particular

assertions
B. Identify areas that represent specific risks relevant to the audit
C. Assist the auditor in assessing the validity of the
conclusions reached on the audit
D. Satisfy doubts when questions arise about an entity’s ability
to continue in existence

(MC Question 5-28)

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 Learning Objective 05-9

Knowledge Assessment

The primary objective of final analytical procedures is to:

A. Obtain evidence from details tested to corroborate

particular assertions
B. Identify areas that represent specific risks relevant to the audit
C. Assist the auditor in assessing the validity of the
conclusions reached on the audit
D. Satisfy doubts when questions arise about an entity’s ability to
continue in existence

(MC Question 5-28)

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 Learning Objective 05-10

Short-Term Liquidity Ratios

Short-term liquidity ratios indicate the entity’s

ability to meet its current obligations.

Operating
Current
Quick Ratio Cash Flow
Ratio
Ratio

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 Learning Objective 05-10

Activity Ratios
Activity ratios indicate how effectively the entity’s
assets are managed. Activity ratios may also be
effective in helping the auditor determine if these
accounts contain material misstatements.
Days
Receivables Outstanding
Turnover in Accounts
Receivable

Inventory Days of
Turnover Inventory on
Hand
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 Learning Objective 05-10

Profitability Ratios
Profitability ratios indicate the entity’s success or
failure for a given period. Each ratio should be
interpreted by comparison to industry data.

Gross Profit
Profit Margin
Percentage

Return on Return on
Assets Equity

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 Learning Objective 05-10

Coverage Ratios
Coverage ratios provide information on the
long-term solvency of the entity. These
ratios give the auditor important information
on the ability of the entity to continue as a
going concern.

Times
Debt to
Interest
Equity
Earned

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