Audit Evidence and Documentation Chapter 5. McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-2 Management Assertions Existence.

Audit Evidence and

Documentation

Chapter 5

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Management Assertions

Existence or Occurrence--Assets, liabilities, and owners’ equity accounts reflected in the financial statements exist; the recorded transactions have occurred.

Completeness--All transactions, assets, liabilities, and elements of owners’ equity that should be presented in the financial statements are included.

Rights and Obligations--The client has rights to assets and obligations to pay liabilities that are included in the financial statements.

Valuation or Allocation--Assets, liabilities, owners’ equity, revenues, and expenses are presented at amounts that are determined in accordance with generally accepted accounting principles.

Presentation and Disclosure--Accounts are described and classified in the financial statements in accordance with generally accepted accounting principles, and all material disclosures are provided.

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Audit Risk

Risk of Material Risk That the Audit Risk = Misstatement * Auditors Fail to the Misstatement

= Inherent Control Detection Risk * Risk * 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 company’s 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

AR = IR * CR * DR

AR = Audit riskIR = Inherent riskCR = Control riskDR = Detection risk

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Audit Risk

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Competence of Evidential Matter

To be competent evidence must be: Valid Relevant

Principles Independent sources have greater reliability

than those within the client organization. Strong internal control increases reliability

of evidence created within the client organization.

Directly obtained evidence is more reliable than evidence obtained second hand.

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Reliability of Certain Types of Audit Evidence

RELIABILITY TYPE EXAMPLEHigh Physical Inventory Observation

DocumentaryExternal Cutoff Bank StatementExternal/Internal Purchase InvoiceInternal Sales Invoice

Low Client Representations Management Representation Letter

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Types of Evidence

Accounting information system Documentary evidence Third-party representations Physical evidence Computations Data interrelationships Client representations

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Audit Procedures Accounting information system Documentary evidence

Tracing Vouching Inspection Reconciliations

Third-party representations--Confirmation Physical examination Computations—Reperformance Data interrelationships—Analytical

procedures Client representations

Inquiries Letters of representations

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Identifying Potential Misstatements

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Basic Approaches to Auditing Accounting Estimates

Review and test management’s process for developing the estimate.

Independently develop an estimate to compare to management’s estimate.

Review subsequent events or transactions bearing on the estimate.

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Auditing Fair Values

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: Support the auditors’ compliance with auditing

standards Support the auditors’ opinion

Secondary functions: 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: 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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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

Current files Permanent files

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