1. Auditing & Investigations II
Introduction to Audit Evidence

2. Key issues
Audit Strategy

3. Audit Strategy Risk based auditing Balance Sheet Based
Directional Testing
Analytical Procedures

4. Risk based Approach
This approach is linked to the audit risk based models.
The auditor assesses the level of inherent and control within the audit.
The strategy enables the auditor to select techniques which target the items in the financial statements which are most likely to be misstated.
The approach has the advantage of focusing the auditor on the root causes of risk (e.g. business risks) and allow the auditor to gain greater understanding of the business.

5. Balance Sheet based This approach work on accounting assumptions.
Profit of the year is difference between two balance sheet.
Therefore, the auditor should focus on validating balance sheet figures at the end of the year.
This approach tend to be used on small businesses.
The approach require a lot of substantive testing

6. Directional Testing
Is an approach that recognises that the direction of that test sets the conclusion that can be drawn from the results of the test.
E.g. test one document after the other. Double entry system.
For example, checking from purchase ledger o invoice will provide evidence that the ledger entries are accurately recorded.
Directional testing tend to be used within transaction cycles.
Advantage of Directional testing is that audit work will focus on the risks associated with the individual balance.

7. Analytical Procedures
The approach is most widely used throughout the audit by focusing on relations between comparable items.
The approach can be used at: (a) planning stage; (b) substantive procedures and (c) Review stage.
The focus is to identify:
Consistencies and predicted patterns
Significant fluctuations and unexpected relationships.
The main focus of the audit will be to investigate fluctuations and unexpected results by looking at:
Legitimate business reasons
Errors
Deliberate falsifications

8. Views of Audit Evidence

9. Need for audit evidence
Basis for reaching an opinion;
Confirmation that audit procedures have been carried out.
Compliance with ISA500
Basis for considering whether relevant facts have been considered in the audit process.
Facts for supporting conclusions on assertions that be made on the financial statements.

10. Methods of obtaining audit evidence
According to ISA500, evidence can be obtained through:
Inspection – involves physical inspection of assets.
Observation - involves observation of procedures such as attendance at the inventory count.
Enquiry and Confirmation involves information obtained orally or in writing from persons inside or outside the enterprise.
Computation involves checking the arithmetical accuracy of accounting records.
Analytical Procedures involves ratio analysis on financial statements.

11. Sources of Audit Evidence
Management representation – oral testimonies or representation by management which tend to be form of letters or reports.
Work of experts – reports of expert who will have performed tasks in a areas that required highly qualified people.
Internal audits – reports of internal audits
Company records – these could financial statement or accounting records.
Accounting Processes – steps taken in processing transactions.

12. Question/Exercise
Can you identify the method (s) that could be used to obtain evidence in each of the sources in the slide below? (10 Minutes)

13. Questions Sources Methods Management Representation Work of an expert
Internal Audits
Company records
Internal Controls Systems
Accounting process

14. Financial Statement Assertion
Financial statement assertions (proclamation) are the representations made by the directors in relation to an account item or a class of transactions that are embodied in the financial statements.
Assertion that can be made by directors:
Existence: an asset or a liability exists.
Rights and obligations: an asset or a liability pertains to the entity.
Occurrence: a transaction took place pertaining to the entity.
Completeness: there are no unrecorded assets, liabilities, transactions or events.
Valuation: an asset or liability is recorded at an appropriate carrying value.

15. Financial Statements Assertion
Measurement: a transaction is recorded at the proper amount and the revenue or expense is allocated to the proper period.
Presentation and disclosure: disclosure and classification are in accordance with the applicable reporting framework (eg IASs, IFRSs)

16. Auditors Assertions
Occurrence: Transactions and events that have been recorded have occurred and pertain to the entity.
Completeness: All transactions and events that should have been recorded have been recorded.
Accuracy: Amounts and other data relating to recorded transactions and events have been recorded appropriately.
Cut-off: Transactions and events have been recorded in the correct accounting period.
Classification: Transactions and events have been recorded in the proper accounts.

17. Audit of Small Entities
The auditor is likely to find less sophisticated internal control systems in smaller entities, to carry out more substantive testing and less compliance testing than in an audit of a larger entity.
However audit evidence should still be able to be gathered to support all the financial statement assertions.
IAASB has issued an International Auditing Practice Statement IAPS 1005 The special considerations in the audit of small entities to provide guidance to auditors in carrying out the audit of small businesses in accordance with ISAs.

18. Auditing Accounting Estimates
Financial statements contain a number of items that are subject to the judgement of the directors and cannot be measured precisely.
E.g. Inventories, receivables and depreciation.
“Accounting estimate” means an approximation of the amount of an item in the absence of a precise means of measurement”
Directors and management are responsible for making accounting estimates included in financial statements

19. ISA540 – Audit of Accounting Estimate
ISA 540 sets out the rules of good practice which requires that:
“The auditor should obtain sufficient appropriate audit evidence regarding accounting estimates.”

20. Audit Procedures ISA540 requires that
“The auditor should adopt one or a combination of the following approaches in the audit of an accounting estimate:
review and test the process used by management to develop the estimate;
use an independent estimate for comparison with that prepared by management; or
review subsequent events which confirm the estimate made.”

21. Review and testing the process used by management
evaluation of the data and consideration of the assumptions on which the estimate is based;
testing of the calculations involved in the estimate;
comparison, when possible, of estimates made for prior periods with actual results of those periods; and
consideration of management’s review and approval procedures.

22. Evaluation of the results of audit procedures
the reasonableness of the estimate.
consistency with other evidence.
any significant differences between management’s estimates and audit evidence.
the impact of any differences individually and cumulatively.

23. ISA 402 – Service organisations
Many businesses employ or outsource specialist organisations to carry out special tasks.
E.g. Payroll processing, Accounting services, Share registration services for shares listed on a Stock Exchange.
ISA provide guidance to auditors on how to deal with outsourced services from a risk perspective.

24. ISA 402 – audit issues
“The auditor should determine the significance of service organisation activities to the client and the relevance to the audit.”

25. Procedures and Collecting audit evidence
Inspection of records.
Assessing controls.
Obtaining representations on transactions and balances and any assets or documents held as custodian.
Performing analytical review on records or returns made by the organisation.

26. Continued
Visiting the organisation to discuss critical issues with management.
Obtaining confirmations from the auditors of the service organisation.
Requesting the internal or external auditors to perform necessary audit procedures.
Inspection of progress reports on the adherence to the SLA as part of a normal dialogue between contractor and contractee.

27. Using the work of an expert (ISA 620)
Auditors frequently rely on evidence generated by third parties with special training or skills.
Experts may be engaged by the client or by the auditor.
An “expert” in this context means a person with special skills in a particular field other than accounting and auditing.
Examples of expert work: Valuations of assets, mineral deposit explorations, legal opinions

28. ISA 620 requirements
“The auditor should obtain sufficient appropriate audit evidence that the scope of the expert’s work is adequate for the purposes of the audit.”
The auditor should assess the appropriateness of the expert’s work as audit evidence regarding the financial statement assertion being considered.”

29. Issues the auditor must consider
Professional qualification or certification.
Experience and reputation.
Financial dependence on the client.

30. Assessing the work of an expert
The following must be considered:
the source data used;
the assumptions and methods used;
when the expert carried out the work;
the reasons for any changes in assumptions and methods compared with those used in the prior period; and
the results of the expert’s work in the light of the auditors’ overall knowledge of the business and the results of other audit procedures.

31. Referring to the work of others in the audit report
the auditor is 100% responsible for the audit report, ISA 620 requires that the auditor should not refer to the work of an expert, when issuing an unmodified audit report.
when issuing a modified report, it may be appropriate to refer to the work of an expert in explaining the nature of the modification.

32. End
Thank you