Chapter 5

Audit Evidence
and
Documentation

Financial Statement
Assertions

52

Assertions about account balances

(Accounts)
Assertions about classes of
transactions and events
(Transactions)
Assertions about presentation and
disclosure (Disclosures)

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Financial Statement
Assertions
Accounts

Transactions

Disclosures

Existence

Occurrence

Occurrence

Rights and
obligations

53

Rights and
obligations

Completeness

Completeness

Completeness

Valuation and
allocation

Accuracy

Accuracy and
valuation

Cutof
Classification

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Classification and
understandability

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Combined Assertions
Used in this Text

54

Existence or Occurrence--Assets, liabilities, and equity

interests exist and recorded transactions have occurred
Rights and Obligations--The company holds rights to the
assets, and liability are the obligations of the company
Completeness--All assets, liabilities, equity interests, and
transactions that should have been recorded have been
recorded
CutofTransactions and events have been recorded in
the correct accounting period
Valuation, Allocation and AccuracyAll transactions,
assets, liabilities and equity interests are included in the
financial statements at proper amounts
Presentation and Disclosure--Accounts are described
and classified in accordance with generally accepted
accounting principles, and financial statement disclosures
are complete, appropriate, and clearly expressed

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55

Audit Risk
Audit Risk =
Misstatement
=

Risk of Material
Misstatement

Inherent
Risk

Risk That the

Auditors Fail to
the

Control
Risk

Detection
Risk

Inherent Risk--Risk of a material misstatement occurring in

an assertion assuming no related internal controls.

Control Risk--Risk that a material misstatement in an

assertion will not be prevented or detected on a timely basis
by the companys internal control.

Detection Risk--Risk that the auditors procedures will lead

them to conclude that a material misstatement does not exist
in an assertion when in fact such misstatement does exist.

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Audit Risk Formula

56

AR = IR * CR * DR
AR
IR
CR
DR

=
=
=
=

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Audit risk
Inherent risk
Control risk
Detection risk

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Audit Risk

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The Third Field Work

Standard

Third standard of field work:

58

The auditor must obtain sufficient

appropriate audit evidence by performing
audit procedures to perform a reasonable
basis for an opinion regarding the financial
statements under audit

Sufficient audit evidence

The quantity of audit evidence that must be

obtained

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Appropriateness of Audit
Evidence

To be appropriate audit evidence must be:

59

Relevant
Reliable

PrinciplesAudit evidence is ordinarily more

reliable when it is

Obtained from knowledgeable independent

sources outside the company rather than
nonindependent sources
Generated internally through a system of efective
controls rather than inefective controls.
Obtained directly by the auditor rather than
indirectly or by inference
Documentary in form rather than oral
Provided by original documents rather than copies

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Reliability of Certain Types of

Audit Evidence
RELIABILITY
High

Low

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TYPE
Physical

EXAMPLE
Inventory Observation

Documentary
External
External/Internal
Internal

Cutoff Bank Statement

Purchase Invoice
Sales Invoice

Client Representations

510

Management Representation
Letter

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Types of Audit Evidence

511

Accounting information system

Documentary evidence
Third-party representations
Physical evidence
Computations
Data interrelationships
Client representations

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Overall Types of Audit

Procedures

512

Risk assessment proceduresTo obtain

an understanding of the client and its
environment, including its internal control,
to assess the risks of material misstatement
Tests of controlsWhen appropriate, to
test the operating efectiveness of controls
in preventing material misstatements
Substantive proceduresTo detect
material misstatements at relevant
assertion level. Substantive procedures
include (a) analytical procedures, (b) tests of
details of account balances, transactions
and disclosures

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Audit Procedures

Accounting information system

Documentary evidence

513

Tracing
Vouching
Inspection
Reconciliations

Third-party representations--Confirmation
Physical examination
ComputationsReperformance
Data interrelationshipsAnalytical
procedures
Client representations

Inquiries
Letters of representations

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Analytical Procedures--I

Steps involved

514

Develop expectation of account (or ratio) balance

Determine amount of diference that can be accepted
without investigation
Compare the companys account (ratio with the
expectation
Investigate and evaluate significant diferences

Developing an expectation

Prior period information

Anticipated results
Relationships among elements of financial information
within a period
Industry information
Relationships between financial information and
relevant nonfinancial data.

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Analytical Procedures--II

Categories of ratios

515

Liquidity (e.g., current ratio)

Leverage (e.g., debt to equity)
Profitability (e.g., gross profit percentage)
Activity (e.g., inventory turnover)

Basic approaches

Horizontal analysisanalyze ratios of a company over

time
Cross sectional analysisanalyze ratios of similar
firms at a point in time
Vertical analysisanalyze relationships within a period

Common size statements prepared

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Identifying Potential
Misstatements

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Basic Approaches to Auditing

Accounting Estimates

517

Review and test managements

process for developing the
estimate.
Independently develop an estimate
to compare to managements
estimate.
Review subsequent events or
transactions bearing on the
estimate.

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Auditing Fair Values

518

If the item is traded on an organized

market, fair value may be obtained
from market prices
If the item does not trade on an
organized market determine fair
value by:

Analyzing to a similar market is possible

Using a valuation model

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Functions of Audit
Documentation

Primary functions:

519

Support the auditors compliance with auditing

standards
Support the auditors opinion

Secondary functions:

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Assist continuing and new audit team members in

planning and performing the audit
Serves as a record of matters of continuing audit
interest
Assists in supervision and review of the audit
Demonstrates the accountability of team members
Assists internal reviewers, external peer reviewers,
PCAOB inspectors, and successor auditors in
performing their roles

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Sufficiency of Audit
Documentation

Audit documentation should be sufficient

to:

520

Enable an experienced auditor to understand

the work performed and the significant
conclusions reached
Identify who performed and reviewed the work
Show that the accounting agree or reconcile to
the financial statements

Audit documentation should include all

significant audit findings and the actions
taken to address them

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521

Types of Working Papers

Audit administrative working papers

Working trial balance
Lead schedules
Adjusting journal entries and
reclassification entries
Supporting schedules
Analysis of a ledger account
Reconciliations
Computational working papers
Corroborating documents

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Types of Working Files

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Current files
Permanent files

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523

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Preparation of a Working Paper

Figure 5.8

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