CHAPTER 13 AUDIT EVIDENCE I Review Questions Refer to page 494, 2nd and 4th paragraphs of the textbook Refer to page 494, 3rd paragraph of the textbook Refer to page 496, 3rd paragraph of the textbook Refer to page 497, 1st paragraph of the textbook Refer to page 497, 2nd paragraph of the textbook Refer to page 498, 4th paragraph of the textbook External documentary evidence is evidential matter obtained from the other party to an arm’s-length transaction or from outside independent agencies External evidence reaches the auditor directly and does not pass through the hands of the client External-internal documentary evidence is documentary material that originates outside the bounds of the client’s data processing system but which has been received and processed by the client Internal documentary evidence consists of documentary material that is produced, circulates, and is finally stored within the client’s information system Such evidence is not touched by outside parties at all or is several steps removed from third-party attention Auditors can help the effectiveness of confirmation requests by: a b c Having the confirmation letters printed on the client’s letterhead and signed by a client officer Being careful to be assured of reliable addresses for recipients; that is, being assured that the confirmations are not misdirected (for example, to a client’s accomplices in fraud) Asking confirmation of information that recipient can supply, like the amount of a balance or the amounts of specified invoices or notes (not the balances of homeowners’ mortgages or financial amounts, like certificates of deposit with accrued interest, for which people usually not keep their own accounting records) 13-2 Solutions Manual - Assurance Principles, Professional Ethics… d e Controlling the mailing and return of confirmations so the client cannot tamper with them Receiving the reply directly, so the client cannot intercept and alter them Factual evidence is direct evidence, in that conclusions may be drawn from the evidence without further corroboration An example of factual audit evidence is physical observation of inventory for existence Inferential evidence is indirect, in that direct conclusions cannot be drawn from the evidence The auditor typically examines other evidence to further corroborate the inferences drawn An oral statement by a product manager that one or more products are fully saleable and not obsolete is an example of inferential evidence The auditor may perform inventory turnover tests and/or determine the date of last sale of the product to further corroborate the product manager’s statement 10 Sufficiency of audit evidence is a matter of audit judgment Materiality and the quality of internal control are important ingredients in determining sufficiency If internal control produces over sales processing and cash receipts, for example, are effective, the auditor may elect to confirm fewer customers’ accounts receivables than under conditions of weak internal control 11 Physical evidence tests the existence assertion Examples of physical evidence are inventory observation, examination of securities, inspection of plant asset additions, and count of cash on hand 12 The quality of existing internal control is the major factor supporting the strength of documentary evidence A voucher produced under conditions of strong internal control over the processing of vendors’ invoices, for example, possesses greater validity and is therefore stronger evidence than vouchers produced under weak control conditions 13 Auditing standards define an accounting estimate as “an approximation of a financial statement element, item or amount.” Estimates are used because (1) an amount is uncertain pending specific future events or (2) relevant data cannot be accumulated on a timely, cost-effective basis Examples of accounting estimates include allowance for uncollectible accounts, obsolete inventory, useful lives and residual values of fixed assets, natural resources and intangibles, accruals for taxes on real and personal property, accruals based on actual assumptions in pension plans, contract revenue using percentage of completion method, litigation losses, fair values in nonmonetary exchanges, and current values in personal financial statements 14 In evaluating the reasonableness of accounting estimates, an auditor should consider the internal controls related to the estimates in order to reduce the likelihood of material misstatements in the estimates, whether the accounting Audit Evidence 13-3 estimates are reasonable given the situation, and whether the accounting estimates are presented in accordance with appropriate accounting principles 15 Evidence is persuasive if the auditor considers the evidence to be sufficient and competent enough to afford a reasonable basis for an opinion II Multiple Choice Questions d d c c a d d b d 10 d 11 a 12 b 13 b III Comprehensive Cases Case a Evidential matter obtained from independent sources outside an enterprise provides greater assurance of reliability (competency) than that which is secured solely within the enterprise b Accounting data and financial statements developed under satisfactory conditions of internal control are more reliable (competent) than those which are developed under unsatisfactory conditions of internal control c Direct personal knowledge obtained by the independent auditor through physical examination, observation, computation, and inspection is more persuasive than information obtained indirectly Case Types of evidence Evidential items/sources d Letter from creditor a Monthly statements b Voucher register c Audit computation of discounts in reliability rank External External-internal Internal Mathematical (based on unaudited data) c a d b Audit computation of expense amounts Letter from bond trustee Cancelled checks Minutes of directors’ meetings Mathematical (based on unaudited data) External External-internal Internal ...13-2 Solutions Manual - Assurance Principles, Professional Ethics… d e Controlling the mailing and return... typically examines other evidence to further corroborate the inferences drawn An oral statement by a product manager that one or more products are fully saleable and not obsolete is an example... validity and is therefore stronger evidence than vouchers produced under weak control conditions 13 Auditing standards define an accounting estimate as “an approximation of a financial statement element,