SESSION 4 AUDIT EVIDENCE

Transcription

1 SESSION 4 AUDIT EVIDENCE Learning objectives: List and describe audit procedures which used to gather audit evidence. Discuss the different sources of audit evidence. Understanding the auditor s competent in gathering audit evidence. Explain the assertions contained in the financial statement. Define audit sampling and explain the need for sampling. Identify and discuss the differences between statistical and non statistical sampling. ISA 500 AUDIT EVIDENCE Definition: Auditors should obtain sufficient appropriate audit evidence to able them to draw reasonable conclusion on which to base their audit opinion. Introduction: The purpose is to establish standards and provide guidance on the quantity and quality (or reliability) of evidence to be obtained by auditors and the procedures of obtaining such evidence. In obtaining audit evidence from tests of control, auditors should consider the sufficiency and appropriateness of the audit evidence to support the assessed level of control risk. In obtaining audit evidence from substantive tests/procedures, auditors should consider the extent of the evidence together with any evidence from tests of control to support the relevant financial statement assertions. Type of audit evidence: Audit evidence that is collected can be divided into the following categories: Observation: 1. Physical examination

2 2. Witnessing the internal control and bookkeeping procedures Independent third parties: 1. Bank letter 2. Account receivables circularisation External documents: 1. Title deed 2. Share and loan certificate Internal documents: 1. Minutes 2. Copies of sales invoices 3. Despatch notes Other documents: 1. Analytical tests 2. Tax computations 3. Accounts schedule e.g. accruals and prepayments. The techniques for collecting evidence: Physical examination Confirmation Examination of original documents Re-computations Retracing book keeping procedures Enquiry Audit evidence Page 2 of 11

3 Audit evidence Reliability Relevance Sufficiency Reliability: Documents are more reliable than oral evidence External documents are more reliable than internally generate documents. Evidence originated by the auditor is more reliable than evidence generated externally Original documents more reliable than photocopies or fax copies. Sufficiency: A great problem for auditors is to assess the sufficiency of the audit evidence. The judgement is based on the following factors: Business and industry Nature and materiality of the items Auditor experience of the client and staff Financial position of the client Persuasiveness of the evidence Nature of accounting systems and internal control systems. Relevancy: The evidence gathered should be relevant for the work carried out by the auditor Financial statements assertions The directors are responsible for the production of the company s financial statements and also for making assertion about the items in the financial statements. The following are types of assertions the director makes: Existence: an asset and liability must exist at balance sheet (the key objective is that assets are not overstated and liabilities are not understated) Audit evidence Page 3 of 11

4 Right and obligation: Entities must legal or other rights or obligations relating to the assets and liabilities).the auditor must ensure that it is the business which owns the assets and liabilities at balance sheet date. Occurrence: A financial or non financial transaction occurred during the accounting period (Over and understatement transactions). Completeness: There are no unrecorded assets or liabilities at balance sheet. The auditor must ensure there is no under/overstatement of transaction in the Balance Sheet. Valuation: The assets and liabilities are recorded at an appropriate value. For all non current assets this would be initial cost plus increases or minus decreased in value. Measurement: All transaction or events is recorded at proper amount in the correct accounting periods for example sales and purchases. Presentation and disclosures: Must be in accordance with relevant national legislation and accounting standard. ISA 230 DOCUMENTATION (Working paper file) Introduction: This ISA states that auditors should document in their working papers matters that are important in supporting the Auditors Report. Working papers should provide evidence on how the audit procedures were performed and how it is concluded. Auditors should record in their working papers their reasoning on all significant matters that require the exercise of judgement and their conclusions thereon. The auditor should maintain confidentiality and custody of the working papers. The Purpose:- To control current year work. Record the work. Evidence of work carried out. Verification. Briefing for next audit. Audit evidence Page 4 of 11

5 Documentation Permanent audit file Current audit file Type of working paper file:- The Permanent File: Statutory documents. Company rules and regulations. Letter of Engagement. Legal documents (e.g. debenture deeds, leases, loan agreements etc). The Current Audit file: Copy of last year s Audited Financial Statements. Audit Programme & Checklist. Accounts schedule (Working Papers). Minutes. Copy of Management letter Copy of Letter of Representation. Documentation Techniques Documentation techniques Narrative notes Flowcharts Questionnaires Checklists Audit evidence Page 5 of 11

6 ISA 540 AUDIT OF ACCOUNTING ESTIMATES: There are many other areas of accounting where estimates need to be made including inventories at net realisable value, depreciation and others. Accounting estimates have to be made in all areas of where precise means of measurement cannot be applied. The responsibility for these estimates lies with the directors or other governing bodies and may involve special knowledge and judgement for example depreciation charges. The auditors should obtain sufficient appropriate audit evidence on all material accounting estimates. The evidence should give assurance that the estimates are reasonable in the circumstances and appropriately disclosed. Audit Procedures: Review procedures and methods adopted by management to make accounting estimates. (Internal audit, formula). Test these processes in connection with each estimate Evaluate the data and consider the assumptions on which the estimates have been made. For example in looking at depreciation, what assumptions on obsolescence have been made? Check any calculation or application of formulae. Make independent estimates on each estimate and compare it with that of the directors. Investigate any difference. Compare estimates made in previous years with actual outcomes where known and do the same for the independent estimates of the auditors. Review subsequent events At the final review stage of the audit the auditor should make a review of the estimates and assess them in the light of: 1. Knowledge of the business 2. Consistency with other evidence obtained during the audit. If the auditor considers that a material estimate is unreasonable, he should ask the directors to adjust the financial statement if necessary. If the directors refuse to make adjustment, then the auditor should consider the implications of qualifying the audit report. Audit evidence Page 6 of 11

7 ISA 530 AUDIT SAMPLING AND OTHER MEANING TESTING Definition: Audit sampling means drawing conclusion about an entire set of data by testing representative sample of items. The sampling does not provide absolute proof of 100% accuracy but it can provide seasonable assurance that some elements of the financial statement are free from material misstatement. Definition: Population Population means the entire set of data from which a sample is selected and about which the auditor wishes to draw conclusions. For example all of the items in a class of transaction or account balance constitute a population. A population may be divided into strata or sub-population with each stratum being examined separately. Definition of Sampling Risk: Sampling risk arises from the possibility that the auditor s conclusion, based on a sample may be different from the conclusion reached if the entire population were subjected to the same audit procedures. There are two types of sampling risk: 1. The risk the auditor will conclude in the case of a test of controls that controls are effective than they actually are or in the case of a test of details, that a material error does not exit when in fact it does. This type of risk affects audit effectiveness and is more likely to lead to an inappropriate audit opinion. 2. The risk the auditor will conclude in the case of a test of controls, that controls are less effectively than they actually are or in the case of a test of details, that a material error exist when in fact it does not. This type of risk affects audit efficiency as it would usually lead to additional work to establish that conclusion was incorrect. Definition Non Sampling Risk: Non sampling risk arises from factors that cause the auditor to reach an erroneous conclusion for any reason not related to the size of the sample. For example ordinarily the auditor finds it necessary to rely on audit evidence that is persuasive rather than conclusive, the auditor might use inappropriate audit procedures or the auditor might misinterpret audit evidence and fail to recognise an error. Definition of sampling unit: Sampling unit means the individual items constituting a population for example checks listed on deposit slips, credit entries on bank statements, sales invoices or receivables balances (Trade receivables balances) or a monetary unit. Audit evidence Page 7 of 11

8 Definition of Stratification: Stratification is the process of dividing a population into sub-populations each which is a group of sampling units which have similar characteristics (Often monetary values) Definition of Tolerable Error: Tolerable error means the maximum error in population that the auditors are willing to accept and form unqualified audit opinion. The justification for sampling: Complex examination of all of the items comprising in the financial statements are not required because of the following Certification of their complete accuracy is not required It would be ineffective (particularly if few errors are found) Time constraints Cost would be prohibitive It would be an uneconomic deployment of audit resources There would be an adverse effect on staff morale. Judgement v Statistical sampling Judgement sampling: Subjectivity is involved in making sampling decision. Uses non-random selection methods Not mathematically based Does not rely on probability theory No quantitative results are obtained Sample sizes may be too high Statistical sampling: means any approach to sampling that has the following characteristics: Random selection of samples. Use of probability theory to evaluate sample results, including measurement of sampling risk. Audit evidence Page 8 of 11

9 Avoid bias Enables precise mathematical statement to be made about probabilities Avoids over large sample sizes Can be used by junior staff unable to apply judgement due to inexperience. It is defensible in court. METHOD OF SAMPLING Attribute sampling: Provides results based on two possible values Therefore used in non-monetary tests Deals with the rate of occurrence of an events (control) in the population Variables sampling: Uses to estimate the value of the population by extrapolating the value of a sample drawn from the populations. Used to test the value for example in debtors, payroll expense, fixed asset additions etc. Used to value for example in stock, by counting and pricing only a proportion of the items in a population. Monetary unit sampling (MUS): Used to select items by weighting the items in a population in proportion to their value, and drawing inferences based on attributes sampling. MUS produce conclusions based on monetary amounts by defining each 1 of a population as a separate sampling unit. Thus a sales ledger amounting to 2.6m is described as a population of 2.6m sampling units 1. Used in substantive testing Sample sizes are computed by reference to two inter-related factors: Confidence level Precision limit Audit evidence Page 9 of 11

10 Confidence is the degree of probability that the sample will represent the true condition of the population. It is converse of risk accepting a 5% risk is equivalent to being 95% confident. Precision is expressed as an error rate in the population the higher the number of errors accepted the lower the sample size required in MUS the precision limit is set at a monetary amount rather than a percentages of error level. Other methods of sample selection: Random selection: - This method ensures all items in a population have an equal chance of selection. Haphazard selection: - This may be used as an alternative to random selection but care must be taken not to bias selection towards items easily located nor to build in predictability. Sequence or block sampling:- This involves selection of adjacent items for example sales invoices in one week, customers whose names start with a particular letter & blocks of returned cheques to check for authorised signatories etc. The factors influencing sample size: Assessment of inherent and control risk Reliance on other tests related to the same audit objectives. Measure of tolerable error, the maximum error/deviation rate the auditor is willing to accept and still conclude the objective is achieved. Expected size and frequency of error/deviation from previous experience. Population value, the smaller the monetary significance of financial information, the smaller the sample sizes. Stratification the greater the efficiency of stratification the more the attention can be devoted to those items most vulnerable to material error. Hence the smaller the sample size overall. Evaluation of sample results: Analyse any error detected in the sample. 1. The auditor should predefine what constitutes an error. 2. If documentation in relation to a sample items is missing, the performance of alternative procedures may obtain appropriate evidence. Audit evidence Page 10 of 11

11 3. Qualitative aspects of error should be considered including the cause and nature of the error. Draw inferences for the population as a whole. 1. Any errors resulting from the sample should be projected to the relevant population. 2. If this is less than the tolerable error, the auditor will have to obtain sufficient assurance. 3. If the tolerable error is exceeded, the auditor may decide to perform additional/alternative procedures or purpose an adjustment to the financial statements. Audit evidence Page 11 of 11