Ch. 7 - SM ACC
Ch. 7 - SM ACC
Audit Evidence
Concept Checks
P. 192
FACTOR EXAMPLE OF
DETERMINING RELIABILITY RELIABLE EVIDENCE
Independence of provider Confirmation of a bank balance
Effectiveness of clients internal controls Use of duplicate sales invoices for a large
well-run company
2. The eight types of evidence and examples of each are included in the table
below.
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Concept Check, P.192 (continued)
P. 206
To provide a basis for planning the audit. The auditor may use
reference information from the previous year in order to plan this years
audit, such as the evaluation of internal control, the time budget, etc.
To provide a record of the evidence accumulated and the results of
the tests. This is the primary means of documenting that an
adequate audit was performed.
To provide data for deciding the proper type of audit report. Data are
used in determining the scope of the audit and the fairness with which
the financial statements are stated.
To provide a basis for review by supervisors and partners. These
individuals use the audit documentation to evaluate whether sufficient
appropriate evidence was accumulated to justify the audit report.
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Concept Check, P. 206 (continued)
Audit documentation is used for several purposes, both during the audit
and after the audit is completed. One of the uses is the review by more
experienced personnel. A second is for planning the subsequent year audit. A
third is to demonstrate that the auditor has accumulated sufficient appropriate
evidence if there is a need to defend the audit at a later date. For these uses, it is
important that the audit documentation provide sufficient information so that the
person reviewing an audit schedule knows the name of the client, contents of the
audit schedule, period covered, who prepared the audit schedule, when it was
prepared, and how it ties into the rest of the audit files with an index code.
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Review Questions
7-2 The four major audit evidence decisions that must be made on every audit
are:
7-3 An audit procedure is the detailed instruction for the collection of a type
of audit evidence that is to be obtained. Because audit procedures are the
instructions to be followed in accumulating evidence, they must be worded
carefully to make sure the instructions are clear.
7-4 An audit program for accounts receivable is a list of audit procedures that
will be used to audit accounts receivable for a given client. The audit procedures,
sample size, items to select, and timing should be included in the audit program.
7-5 There are two primary reasons why the auditor can only be persuaded
with a reasonable level of assurance, rather than be convinced that the financial
statements are correct:
7-8 Internal documentation is prepared and used within the clients organization
without ever going to an outside party, such as a customer or vendor.
Examples:
check request form
receiving report
payroll time record
adjusting journal entry
Examples:
vendors invoice
cancelled check
cancelled note
validated deposit slip
7-9 The most important reasons for performing analytical procedures are the
following:
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7-10 Analytical procedures are required during two phases of the audit: (1) during
the planning phase to assist the auditor in understanding the clients business
and industry and to assist in determining the nature, extent, and timing of work
to be performed, and (2) during the completion phase, as a final review for
material misstatements or financial problems. Analytical procedures are also often
done during the testing phase of the audit as part of the auditors further audit
procedures, but they are not required in this phase.
7-12 Roger Morris performs ratio and trend analysis at the end of every audit.
By that time, the audit procedures are completed. If the analysis was done at an
interim date, the scope of the audit could be adjusted to compensate for the
findings, especially when the results suggest a greater likelihood of material
misstatements. Analytical procedures must be performed in the planning phase
of the audit and near the completion of the audit.
The use of ratio and trend analysis appears to give Roger Morris an
insight into his clients business and affords him an opportunity to provide
excellent business advice to his client. It also helps provide a richer context for
Roger to really understand his clients business, which should help Roger in
assessing the risk of material misstatements.
7-14 Audit files are owned by the auditor. They can be used by the client if the
auditor wants to release them after a careful consideration of whether there might
be confidential information in them. The audit files can be subpoenaed by a court
and thereby become the property of the court. They can be released to another
CPA firm without the clients permission if they are being reviewed as a part of a
voluntary peer review program under AICPA, state CPA society, or state Board of
Accountancy authorization. The audit files can be sold or released to other users
if the auditor obtains permission from the client.
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7-15 The SarbanesOxley Act of 2002 requires auditors of public companies to
prepare and maintain audit schedules and other information related to any audit
report in sufficient detail to support the auditors conclusions, for a period of not
less than 7 years.
7-16 The permanent file contains data of an historical and continuing nature
pertinent to the current audit. Examples of items included in the file are:
1. Articles of incorporation
2. Bylaws, bond indentures, and contracts
3. Analysis of accounts that have continuing importance to the auditor
4. Information related to the understanding of internal control:
a. flowcharts
b. internal control questionnaires
5. Results of previous years analytical procedures, such as various
ratios and percentages compiled by the auditors
By separating this information from the current years audit files, it becomes
easily accessible for the following years auditors to obtain permanent file data.
7-18 Unanswered questions and exceptions may indicate the potential for
significant errors or fraud in the financial statements. These should be
investigated and resolved to make sure that financial statements are fairly
presented.
The audit files can also be subpoenaed by courts as legal evidence.
Unanswered questions and exceptions may indicate lack of due care by the
auditor.
7-19 Tick marks are symbols adjacent to information in audit schedules for the
purpose of indicating the work performed by the auditor. An explanation of the
tick mark must be included at the bottom of the audit schedule to indicate what
was done and by whom.
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7-20 The purposes of audit engagement management software are to convert
traditional paper-based documentation into electronic files and to organize the
audit documentation, and help manage the engagement. The benefits of
engagement management software are as follows:
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7-9
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7-27
7-10
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7-27 (continued)
7-11
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7-27 (continued)
7-12
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7-28
a. b.
TRANSACTION-
TYPE OF RELATED
AUDIT PROCEDURE AUDIT EVIDENCE AUDIT OBJECTIVE
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a. b.
BALANCE-
TYPE OF RELATED
AUDIT PROCEDURE AUDIT EVIDENCE AUDIT OBJECTIVE
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7-30 a. The six factors determining the reliability of evidence are:
1. Independence of provider
2. Effectiveness of clients internal controls
3. Auditors direct knowledge
4. Qualifications of individuals providing the information
5. Degree of objectivity
6. Timeliness
b.
and
c.
b. c.
TYPE OF EVIDENCE FACTOR
SITUATION THAT IS MORE RELIABLE AFFECTING RELIABILITY
1 Confirmation with business Qualifications of provider
organizations
2 Physically examine three-inch Qualifications of provider
steel plates (in this case the auditor)
3 Examine documents when Effectiveness of internal controls
several competent people are
checking each others work
4 Examine inventory of parts for the Degree of objectivity
number of units on hand
5 Discuss potential lawsuits with Independence of provider
CPA firms legal counsel
6 Confirm a bank balance Degree of objectivity
7 Confirm a bank balance Independence of provider
8 Physically count the clients Auditors direct knowledge
inventory
9 Physically count the inventory Independence of provider and
auditors direct knowledge
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a. b.
PROCEDURE APPROPRIATE TERM TYPE OF EVIDENCE
1 Recompute (e) Recalculation
2 Observe (j) Observation
3 Compute (d) Analytical procedure
4 Foot (f), Trace (g) Recalculation and reperformance
5 Scan (b) Analytical procedure
6 Inquire (k) Inquiry of client
7 Count (i) Physical examination
8 Confirm (l) Confirmation
9 Examine (a), Compare (h) Inspection
10 Read (c) Inspection
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7-32 a. The purposes of analytical procedures are:
1. Understanding the clients business and industry.
2. Assessment of the entitys ability to continue as a going concern.
3. Indication of the presence of possible misstatements in the
financial statements.
4. Reduction of detailed audit tests.
b. Analytical procedures are required in the planning and completion
phases of the audit because of their importance in planning the
audit, and as a final review for potential misstatements. Auditors use
analytical procedures extensively because of their relatively low
cost and effectiveness in identifying potential misstatements.
c. The extent to which the auditor will use the results of analytical
procedures to reduce detailed tests depends on the effectiveness
of the analytical procedure and whether it supports the correctness
of the recorded account balance. The effectiveness of the analytical
procedure is a function of the precision of the expectation developed
by the auditor and whether it is based on objective data.
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7-33 (continued)
2. Debt to equity ratio To see the companys capital investment and ability of
the company to exist on its present investment.
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7-34 (continued)
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7-35 Here are expected values for each account except sales and the calculated difference between the expected value
and actual recorded balance:
DIFFERENCE
IN EXPECTED
ACCOUNT EXPECTED VALUE AND RECORDED REASONING TO SUPPORT EXPECTED VALUE
hourly Increase due to 3% pay rate increase: two primary factors. First, payroll expense would be
payroll ($10,038,877 x 3% = $301,166 increase ($11,167,246-$11,476,319) / expected to increase 3% over the prior year to
due to pay rate increase) $11,167,246 account for the 3% wage increase for all employees
(except commissioned salespeople). Second,
8% increase due to increased production payroll expense should increase 8% to account for
($10,038,877 + $301,166 = 10,340,043 x the 8% increase in the number of units produced
108% = $11,167,246) and sold.
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7-37 In general, the audit schedule is not set up in a logical manner to show
what the auditor wants to accomplish. The primary objective of the audit schedule
is to verify the ending balance in notes receivable and interest receivable. A
secondary objective is to account for all interest income, cash received and cash
disbursed for new notes, collateral as security, and other information about the
notes for disclosure purposes.
Specific deficiencies of the audit schedule presented in the question are
included below.
a. b.
DEFICIENCY IMPROVEMENT
1. Tick mark explanation tested Should have separate tick marks meaning:
does not indicate specifically what Agreed to confirmation
was done. Footed
Traced to cash receipts journal
Recomputed, etc.
2. Explanation of some tick marks is Explain all tick marks on the same page of
not given. the audit schedule.
3. Classification of long-term portion Recompute portions of notes that are
indicates no verification. long-term.
4. Paid-to-date row is confusing. Column should say date paid to and this
should be confirmed.
5. Due dates are missing for Include due dates on the audit schedule
J.J. Co., P. Smith, and Tent Co. for these notes.
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7-37 (continued)
7-21
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7-37 (continued)
Apex Co. c * 6/15/15 / 5% / 5000 None 4000 0 1000 3000 104 175 0 279
06/15/17 None pd. Tp r Tp <
Ajax, Inc. c * 11/21/15 / 5% / 3591 None 3591 0 3591 0 0 102 102 0
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7-38 The following are deficiencies in the sufficiency and appropriateness of the
evidence in the audit of accounts payable for Grande Stores:
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7-39 ACL Problem
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7-39 (continued)
e. There are 14 exceptions in the calculation of net pay. (Use the following
Filter: Gross Pay Deductions < > Net Pay.)
f. There are no gaps in the pay period sequence. A gap would indicate
the potential that some of the payroll was omitted from the accounting
records.
g. Type of evidence:
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