CHAPTER 12 AUDIT PROCEDURES I Review Questions “Procedures” relate to acts to be performed “Standards” deal with measures of the quality of performance of those acts and the objectives to be attained by the use of procedures The standards are less subject to change The standards provide the criteria for rejecting, accepting, or modifying a procedure in a given circumstance An example of the relative stability of standards and procedures is found in the change from non-EDP to EDP systems New procedures were required to audit EDP systems, but auditing standards remained unchanged and were the criteria for determining the adequacy of the new procedures A “substantive audit procedure” is any action (resembling a specific variation of one of the seven general audit procedures) undertaken for the purpose of producing evidence about a peso amount of a disclosure that appears in the financial statements under audit The nature of a procedure is its description – usually associated with one of the seven general audit procedures For example, the nature of a procedure may be confirmation, document, vouching, etc The timing of a procedure is the period during which it is performed – usually distinguished as interim (before the balance sheet date), year-end (on or close to the balance sheet date), and subsequent (after the balance sheet date) The extent of a procedure is the number of details audited with it, or another measure of intensity or frequency Oftentimes, extent is measured by the sample size Inspection techniques include physical examination of assets, examination of documents and records, performance of mechanical accuracy tests, and analytical procedures Vouching and tracing are two types of commonly performed documentation Vouching involves the examination of documents that served as a basis for recording the transaction Vouching usually starts with a recorded transaction and works back to the documents and addresses existence Tracing involves determining whether source documents have been recorded properly in the accounting records By tracing, an auditor can obtain evidence that the recording of the transaction is complete 12-2 Solutions Manual - Assurance Principles, Professional Ethics… An inquiry involves requesting information from client personnel and receiving their response The request and response may be either written or oral A confirmation is a response a third party makes directly to the auditor on the request of a client The response includes information about certain transactions, relationships, and/or balances that have an impact on a specific financial statement assertion Confirmations are usually considered more reliable because they are from outside parties, while inquiries are made of client personnel When equivalent procedures are available to satisfy the need for evidence, an auditor may consider cost in selecting among the alternatives Vouching is relevant to testing the existence of sales; tracing is not Tracing is relevant to testing the completeness of sales, but vouching is not II Multiple Choice Questions c d c a c c a d d III Comprehensive Cases Case The objectives for the audit of Wesson’s securities investments at December 31 are to obtain evidence about the assertions implicit in the financial presentation, specifically: Existence Obtain evidence that the securities are bona fide and held by Wesson or by a responsible custodian Occurrence Obtain evidence that the loan transaction and securities purchase transactions actually took place during the year under audit Completeness Obtain evidence that all the securities purchase transactions were recorded Rights Obtain evidence that the securities are owned by Wesson Obligation Obtain evidence that P500,000 is the amount actually owed on the loan Valuation Obtain evidence of the cost and market value of the securities held at December 31 Decide whether any writedowns to market are required by GAAP Measurement Presentation and Disclosure Obtain evidence of the committed nature of the assets, which should mean they should be in a non-current classification like the loan Obtain evidence that restrictions on the use of the assets is disclosed fully and agrees with the loan documents Audit Procedures 12-3 Case Types of procedures used by auditors in general, with examples: Recalculation by the auditor * recomputing the client’s calculation of depreciation expense Observation by the auditor * observation, test-counting of client’s physical inventory-taking Confirmation by letter * obtaining accounts receivable confirmations * obtaining client’s lawyer’s letter Inquiry and written representations * ask client personnel about accounting events * complete an internal control questionnaire * obtain written client representation letter Vouching * find brokers’ invoices and cancelled checks showing agreement with record amounts for securities investments Tracing * select a sample of shipping documents and trace them to sales invoices, sales journal recording and posting to general ledger Scanning * scan expense accounts for credit entries * scan payroll check lists for unusually large checks Analytical procedures – any example that fits one of these: * compare financial information with prior periods * compare financial information with budgets and forecasts * study predictable financial information patterns (e.g., ratio analysis) * compare financial information to industry statistics * study financial information in relation to nonfinancial information Case a b An audit confirmation is a written statement to the CPA from someone outside the enterprise on a fact that a person is qualified to affirm The two main characteristics a confirmation should possess are: The party supplying the information requested must be knowledgeable and independent, i.e., he must have knowledge of information of interest to the auditor and he must be outside the scope of influence of the organization being audited, and The auditor must obtain the information directly from the informed party 12-4 Solutions Manual - Assurance Principles, Professional Ethics… Case Scanning for debit balances in accounts payable Recalculation of amounts on supporting documents Vouching of account entries to supporting documents Vouching of policies from expense and prepayment entries Recalculation of expiration of insurance premium Analysis of interrelationships – compare insurance coverage to assets owned and leased Scanning inventory records for “old” last-issue dates Verbal inquiry – question inventory control personnel about slow-moving inventory Vouching – examine journal entries for evidence of actual book write-down of the specific inventory items Tracing – trace remittance amounts to appropriate customer’s account Recalculation – recalculate amount of discounts and allowances Vouching – examine authoritative documents supporting unusual discounts and/or allowances Observation and examination by the auditor – of the inventory and the inventory-taking procedures Confirmation by letter – of inventory held in outside warehouses Recalculation – of the accuracy cost-flow calculations Case a A material decline in sales may indicate unrecorded sales; a decrease in cost of goods sold may be due to unrecorded purchases; and an increase in cost of good sold may be the result of omissions from the ending inventory An increase or decrease in gross profit will result from any one or a combination of the above omissions b A decline in the miscellaneous revenue account balance, or the absence of a previously existing source of miscellaneous revenue, could be attributable to a failure to record miscellaneous revenue c Unrecorded accounts payable at year-end would cause an increase in calculated accounts payable turnover d An apparent increase in accounts receivable turnover may, in fact, be the result of failure to record credit sales transactions e A higher than average operating return may be indicative of unrecorded purchases or operating expenses; a lower than average return could result from unrecorded sales Audit Procedures 12-5 Case a This is an inappropriate application of cost/benefit to auditing The second standard of audit field work states that the auditor is to gather sufficient competent evidential matter to support the audit opinion If two or more sets of audit procedures are available for satisfactorily achieving a set of specific audit objectives, the cost/benefit concept suggests selection of the least costly set of procedures In the present instance, the cost savings from not observing the branch inventories is achieved only at the sacrifice of obtaining sufficient evidence to support the audit objective concerning existence of the inventories b This is an appropriate application of the cost/benefit concept Confirmation with the trustee, who is an independent third party, achieves the audit objectives concerning existence and ownership just as satisfactorily as examination of the securities – and it is a less costly procedure Case 7 f l h e p m d 10 11 12 13 14 n k c a g b j Case 8 observation inspection (analytical procedures) inspection (examination of documents) inspection (examination of documents) inquiry inspection (mechanical accuracy tests) inspection (examination of documents) confirmation ... Types of procedures used by auditors in general, with examples: Recalculation by the auditor * recomputing the client’s calculation of depreciation expense Observation by the auditor * observation,... presentation, specifically: Existence Obtain evidence that the securities are bona fide and held by Wesson or by a responsible custodian Occurrence Obtain evidence that the loan transaction and securities...12-2 Solutions Manual - Assurance Principles, Professional Ethics… An inquiry involves requesting information