SOMETIMES THE MOST IMPORTANT EVIDENCE IS NOT FOUND IN THE 7 AUDIT EVIDENCE SOMETIMES THE MOST IMPORTANT EVIDENCE IS NOT FOUND IN THE ACCOUNTING RECORDS

Four Evidence Decisions Which audit procedures to use What sample size to select for a given procedure Which items to select from the population When to perform the procedures

Audit Program Audit program - Includes all audit procedures the audit considers necessary in the circumstances. Think: URACECV

Legal Case, and Audit of Financial Statements TABLE 7-1 Characteristics of Evidence for a Scientific Experiment, Legal Case, and Audit of Financial Statements

Persuasiveness of Evidence Relevance Competence Appropriateness Independence of provider Effectiveness of internal controls Auditor’s direct knowledge Qualifications of individual Objective nature of evidence Sufficiency Timeliness

TYPES OF AUDIT EVIDENCE 1. Physical examination 2. Confirmation 3. Documentation 4. Observation 5. Inquiries of the client 6. Recalculation 7. Analytical procedures

TABLE 7 - 3 Information Often Confirmed Information Source Assets Cash in bank Bank Accounts receivable Customer Notes receivable Maker Owned inventory out on consignment Consignee Inventory held in public warehouses Public warehouse Cash surrender value of life insurance Insurance company Liabilities Accounts payable Creditor Notes payable Lender Advances from customers Customer Mortgages payable Mortgagor Bonds payable Bondholder Owners’ Equity Shares outstanding Registrar and transfer agent Other Information Insurance coverage Insurance company Contingent liabilities Bank, lender, and client’s counsel Bond indenture agreements Bondholder Collateral held by creditors Creditor

Criteria to Determine Competence TABLE 7 - 4 Competence to Types of Evidence Criteria to Determine Competence

Timing and Purposes of Analytical Procedures FIGURE 7 - 2 Timing and Purposes of Analytical Procedures Phase (Required) Planning Phase (Required) Completion Phase Purpose Testing Phase Understand client’s industry and business Primary purpose Assess going concern Secondary purpose Secondary purpose Indicate possible misstatements (attention directing) Secondary purpose Primary purpose Primary purpose Reduce detailed tests Secondary purpose Primary purpose

ANALYTICAL PROCEDURES FIVE TYPES OF ANALYTICAL PROCEDURES 1. Compare client and industry data. 2. Compare client data with similar prior-period data. 3. Compare client data with client-determined expected results. 4. Compare client data with auditor-determined expected results. 5. Compare client data with expected results, using nonfinancial data.

Compare Client and Industry Data 1999 1998 1999 1998 Inventory turnover 3.4 3.5 3.9 3.4 Gross margin percent 26.3% 26.4% 27.3% 26.2%

Internal Comparisons and Relationships TABLE 7 - 7 Internal Comparisons and Relationships Ratio or Comparison Possible Misstatement Raw material turnover for a Misstatement of inventory or manufacturing company cost of goods sold or obsolescence of raw material inventory Sales commissions divided by Misstatement of sales commissions net sales Sales returns and allowances Misclassified sales returns and divided by gross sales allowances or unrecorded returns or allowances subsequent to yearend Cash surrender value of life insurance Failure to record the change in cash (current year) divided by cash surrender surrender value or an error in recording value of life insurance (preceding year) the change Each of the individual manufacturing Significant misstatement of individual expenses as a percentage of total expenses within a total manufacturing expense

USING STATISTICAL TECHNIQUES AND COMPUTER SOFTWARE The use of statistical techniques is desirable to make analytical procedures more relevant. Many auditors use computer software to make statistical and nonstatistical calculations easier.

Common Financial Ratios Short-Term Debt-Paying Ability Short-Term Liquidity Ability to Meet Long-Term Debt Obligations and Preferred Dividends Operating and Performance Ratios

Essential Terms Analytical Procedures Audit Procedure Audit Program Budgets Competence of Evidence Confirmation Documentation External Document Inquiry Internal document Observation Persuasiveness of evidence Physical examination Reliability of evidence Reperformance Sufficiency of evidence Unusual fluctuations Vouching