1. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-1 Chapter Four Audit Evidence and Audit Documentation Chapter Four Audit Evidence and Audit Documentation

2. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-2 Audit Evidence Information used by the auditor in arriving at the conclusions on which the audit opinion is based.

3. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-3 Relationship of Audit Evidence to the Audit Report Management assertions about components of financial statements Financial statements Audit procedures Audit report Evidence on the fairness of the financial statements

4. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-4 Management Assertions Assertions about classes of transactions and events for the period under audit Occurrence Completeness Authorization Accuracy Cutoff Classification

5. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-5 Management Assertions Assertions about end-of-the-period account balances Rights and Obligations Valuation and allocation Completeness Existence

6. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-6 Management Assertions Assertions about presentation and disclosure Occurrence and rights and obligations Classification and understandability Accuracy and valuation Completeness

7. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-7 Audit Procedures Specific acts performed by the auditor to gather evidence to determine if specific assertions are being met. Risk assessment procedures Test of controls Substantive procedures

8. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-8 Audit Procedures A set of audit procedures prepared to test assertions for a component of the financial statements is referred to as an audit program.

9. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-9 The Concepts of Audit Evidence Nature of audit evidence Competence of audit evidence Sufficiency of audit evidence Evaluation of audit evidence

10. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-10 Nature of Audit Evidence Records of initial entries and supporting records Invoices Contracts General and subsidiary ledgers Adjustments to financial statements Worksheets Spreadsheets supporting cost allocations Other computations, reconciliations, and disclosures

11. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-11 Competence of Audit Evidence Relevance Reliability Independent source of the evidence Effectiveness of internal control Auditor’s direct personal knowledge Documentary evidence Original documents

12. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-12 Sufficiency of Audit Evidence Sufficiency is a measure of the quantity of audit evidence. Greater risk of misstatement requires a higher quantity of audit evidence. Higher quality audit evidence results in a lower quantity of audit evidence.

13. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-13 Evaluation of Audit Evidence Proper evaluation of evidence requires an understanding of the Types of evidence available. Relative reliability of available evidence. An auditor should be be thorough in searching for evidence and unbiased in its evaluation.

14. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-14 Audit Procedures for Obtaining Audit Evidence Inspection of records and documents Inspection of records and documents Evidence obtained from external documents is more reliable than evidence obtained from internal documents. Ledger Source Documents Vouching (Occurrence) Tracing (Completeness)

15. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-15 Audit Procedures for Obtaining Audit Evidence Inspection of records and documents Inspection of records and documents In conducting inquiry, the auditor should: Consider the knowledge, objectivity, experience, responsibility, and qualifications of the person to be questioned. Ask clear, concise, and relevant questions. Use open or closed questions appropriately. Listen actively and effectively. Consider the reactions and responses, then ask follow-up questions. Evaluate the response. In conducting inquiry, the auditor should: Consider the knowledge, objectivity, experience, responsibility, and qualifications of the person to be questioned. Ask clear, concise, and relevant questions. Use open or closed questions appropriately. Listen actively and effectively. Consider the reactions and responses, then ask follow-up questions. Evaluate the response. Inquiry

16. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-16 Audit Procedures for Obtaining Audit Evidence Inspection of records and documents Inspection of records and documents Inquiry Confirmation

17. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-17 Audit Procedures for Obtaining Audit Evidence Inspection of records and documents Inspection of records and documents Recalculation Observation Inquiry Scanning Inspection of tangible assets Confirmation Reperformance Analytical procedures

18. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-18 Reliability of Types of Evidence

19. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-19 Audit Documentation The auditor’s principal record of the audit procedures performed, evidence obtained,and conclusions reached. Audit documentation (working papers) have two functions:  To provide support for the audit report.  To aid in the conduct and supervision of the audit. Audit documentation (working papers) have two functions:  To provide support for the audit report.  To aid in the conduct and supervision of the audit.

20. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-20 Content of Audit Documentation Audit documentation should: Demonstrate how the audit complied with auditing and related professional practice standards. Demonstrate how the audit complied with auditing and related professional practice standards. Support the basis for audit conclusions concerning every material financial statement assertion. Show that the underlying accounting records agreed with the financial statements.

21. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-21 Content of Audit Documentation Audit documentation should: Include a written audit program detailing auditing procedures necessary to accomplish audit objectives. Enable a knowledgeable and experienced reviewer to: Understand the nature, timing, extent, and results of audit procedures, evidence obtained and conclusions reached. Determine who performed and reviewed the work, as well as the dates of the work and reviews.

22. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-22 Content of Audit Documentation Most public accounting firms maintain audit documentation in two types of files Permanent files Current files Corporate charterImportant contracts Chart of accountsInternal control documentation Organization chartTerms of stock and bond issues Accounting manualPrior years’ analytical procedures Corporate charterImportant contracts Chart of accountsInternal control documentation Organization chartTerms of stock and bond issues Accounting manualPrior years’ analytical procedures

23. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-23 Content of Audit Documentation Most public accounting firms maintain audit documentation in two types of files Permanent files Current files Audit plan, audit reportAdjusting journal entries Audit programsReclassification journal entries Working trial balanceCurrent financial statements Minutes of meetings Working papers supporting accounts Audit plan, audit reportAdjusting journal entries Audit programsReclassification journal entries Working trial balanceCurrent financial statements Minutes of meetings Working papers supporting accounts

24. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-24 Format of Audit Documentation Heading Indexing and cross-referencing Tick marks Client name Title of the working paper Client’s year-end date Client name Title of the working paper Client’s year-end date Notations that provide a trail from financial statements to audit documents. Notations made next to work paper items indicating auditor/reviewer actions.

25. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-25 Audit Documentation Audit documentation should be organized so that audit team members and others can find evidence supporting financial statement accounts. All audit documentation is the property of the auditor, including documents prepared by the client at the auditor’s request. The Sarbannes-Oxley Act of 2002 requires audit documentation to be retained for seven years from the completion date of the engagement.

26. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4-26 End of Chapter 4