Auditing Solution Chapter 6

Review Questions

The four major audit evidence decisions that must be made on every audit

6-2

are: 1. 2. 3. 4. 6.3

Whic Which h aud audit it proc proced edur ures es to use. use. What What sam sample ple size size to to selec selectt for a give given n proce procedu dure. re. Which Which items items to sele select ct from from the popul populati ation on.. When When to perf perfor orm m the the proc proced edur ure. e.

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 

An audit program for accounts receivable is a list of audit procedures that will will be used used to audi auditt acco accoun unts ts rece receiv ivab able le for for a give given n clie client nt.. The The audi auditt procedures, sample size, items to select, and timing should be included in the audit program. 6-4

6.5

Auditors should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. There are two major  phras phrases es of the the stand standar ard. d. Suffi Suffici cienc ency y deal deals s with with the quan quantit tity y of evide evidenc nce. e. Appropriateness is the measure of the quality of the evidence, its relevance, reliability and timeliness. What is sufficient and appropriate depends on the circumstances, and is affected by assessments of inherent and control risk, materiality, materiality, results from previous audits, results from other procedures, procedures, and the source and reliability of information available.

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:

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1.

The The cost cost of acc accum umula ulatin ting g evide evidence nce.. It would would be extre extreme mely ly costl costly y for  the auditor to gather enough evidence to be completely convinced. 2. Evide Evidence nce is norma normally lly not not suffici sufficien ently tly relia reliable ble to enab enable le the audito auditorr to be completely convinced. For example, confirmations from customers may come back with erroneous information, which is the fault of the customer rather than the client. The two determinants of the persuasiveness of evidence are competency 6-7 and sufficie sufficiency. ncy. Compete Competency ncy refers refers to the degree degree to which evidence evidence can be consid considere ered d belie believa vable ble or worthy worthy of trust. trust. Comp Compete etency ncy relates relates to the the audit audit proce procedur dures es select selected, ed, inclu includin ding g the timing timing of when when those those proce procedu dures res are are perform performed. ed. Sufficien Sufficiency cy refers refers to the quantity quantity of evidence evidence and it is related related to sample size and items to select.

6.8

Following are seven characteristics that determine competence and an example of each.

FACTOR DETERMINING COMPETENCE

EXAMPLE OF COMPETENT EVIDENCE

Relevance

Trace inventory items located in the warehouse to their inclusion in the inventory subsidiary ledger 

Independence of provider 

Confirmation of a bank balance

Effectiveness of client's internal controls

Use of duplicate sales invoices for a large wellrun company

Auditor's direct knowledge Physical examination of inventory by the auditor  Qualifications of provider  Letter from a solicitor dealing with the client's affairs Degree of objectivity Count of cash on hand by auditor  Timing Observe inventory as of the last day of the fiscal year 

6-9 TYPES OF AUDIT EVIDENCE EXAMPLES

1.

Physical examination

   Count petty cash on hand    Examine fixed asset additions

2.

Confirmation

  

3.

Documentation

  

Confirm accounts receivable balances of a sample of client customers    Confirm client's cash balance with bank

  

Examine presented cheques returned with bank statement Examine vendors’ invoices supporting a sample of cash payment transactions throughout the year 

4.

Observation

   Observe the taking of inventory    Observe the preparation of the monthly bank reconciliation

5.

Inquiries of the client

  

6.

Reperformance

Inquire of management whether there is obsolete inventory    Inquire of management regarding the collectibility of large accounts receivable balances    

7.

Analytical procedures

     

Recalculate invoice total by multiplying item price times quantity sold Foot the sales journal for a one-month period and compare all totals to the general ledger  Evaluate reasonableness of receivables by calculating and comparing ratios Compare expenses as a percentage of net sales with prior year's percentages

Roger Morris performs his 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. Standard requires that analytical procedures 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 client's business and affords him an opportunity to provide excellent business advice to his client. 6-18

6-23 1.

2.

(5) inquiry of client (4) observation

3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

(1) (2) (6) (2) (3) (7) (5) (6) (4) (1) (7) (3) (5) (7) (3) (6) (1) (2)

physical examination confirmation reperformance confirmation documentation analytical procedures inquiry of client reperformance observation physical examination analytical procedures documentation inquiry of client analytical procedures documentation reperformance physical examination confirmation