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1Chapter 7

Audit Evidence

Review Questions

7-1 In both a legal case and in an audit of financial statements, evidence isused by an unbiased person to draw conclusions. In addition, the consequencesof an incorrect decision in both situations can be equally undesirable. Forexample, if a guilty person is set free, society may be in danger if the personrepeats his or her illegal act. Similarly, if investors rely on materially misstatedfinancial statements, they could lose significant amounts of money. Finally, theguilt of a defendant in a legal case must be proven beyond a reasonable doubt.This is similar to the concept of sufficient appropriate evidence in an auditsituation. s with a !udge or !ury, an auditor cannot be completely convinced that

his or her opinion is correct, but rather must obtain a high level of assurance.The nature of evidence in a legal case and in an audit of financialstatements differs because a legal case relies heavily on testimony by witnessesand other parties involved. "hile inquiry is a form of evidence used by auditors,other more reliable types of evidence such as confirmation with third parties,physical examination, and documentation are also used extensively. legal casealso differs from an audit because of the nature of the conclusions made. In alegal case, a !udge or !ury decides the guilt or innocence of the defendant. In anaudit, the auditor issues one of several audit opinions after evaluating the evidence.

7-2 The four ma!or audit evidence decisions that must be made on every audit

are#

1. "hich audit procedures to use.$. "hat sample si%e to select for a given procedure.&. "hich items to select from the population.'. "hen to perform the procedure.

7-3 n audit procedure is the detailed instruction for the collection of a type ofaudit evidence that is to be obtained. (ecause audit procedures are the instructionsto be followed in accumulating evidence, they must be worded carefully to ma)esure the instructions are clear.

7-4 n audit program for accounts receivable is a list of audit procedures thatwill be used to audit accounts receivable for a given client. The audit procedures,sample si%e, items to select, and timing should be included in the audit program.

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7-5 The auditor must obtain sufficient appropriate evidence by performing auditprocedures to afford a reasonable basis for an opinion regarding the financialstatements under audit. There are three ma!or phrases of the standard.

PHRASE EA!"!# $% PHRASE

btain sufficient appropriate evidence The auditor must obtain evidence that isreliable and there must be a reasonablequantity of that evidence.

(y performing audit procedures The auditor performs audit procedures tomeet audit ob!ectives using the eighttypes of evidence.

To afford a reasonable basis for anopinion regarding the financial statements

The auditor cannot expect to becompletely certain that the financialstatements are fairly presented but theremust be persuasive evidence. Thecollection of evidence gathered by the

auditor provides the basis for the auditor-sopinion.

7-& There are two primary reasons why the auditor can only be persuadedwith a reasonable level of assurance, rather than be convinced that the financialstatements are correct#

1. The cost of accumulating evidence. It would be extremely costly for theauditor to gather enough evidence to be completely convinced.

$. vidence is normally not sufficiently reliable to enable the auditor to becompletely convinced. For example, confirmations from customers

may come bac) with erroneous information, which is the fault of thecustomer rather than the client.

7-7 The two determinants of the persuasiveness of evidence are appropriatenessand sufficiency. ppropriateness refers to the relevance and reliability ofevidence, or the degree to which evidence can be considered believable orworthy of trust. ppropriateness relates to the audit procedures selected,including the timing of when those procedures are performed. Sufficiency refersto the quantity of evidence and it is related to sample si%e and items to select.

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7'( Following are six characteristics that determine reliability and an exampleof each.

%AC)$R*E)ER"!"!# RE+"A,"+")

E.AP+E $%RE+"A,+E E/"*E!CE

Independence of provider /onfirmation of a ban) balance

ffectiveness of client-s internal controls 0se of duplicate sales invoices for a largewell+run company

uditor-s direct )nowledge hysical examination of inventory by theauditor

2ualifications of provider 3etter from an attorney dealing with theclient-s affairs

4egree of ob!ectivity /ount of cash on hand by auditor

Timeliness bserve inventory on the last day of thefiscal year

7-0

)PES $% A*") E/"*E!CE E.AP+ES

1. hysical examination /ount petty cash on hand xamine fixed asset additions

$. /onfirmation /onfirm accounts receivable balances of asample of client customers

/onfirm client5s cash balance with ban)

&. 4ocumentation xamine cancelled chec)s returned with cutoffban) statement

xamine vendors5 invoices supporting asample of cash disbursement transactionsthroughout the year

'. nalytical procedures valuate reasonableness of receivables bycalculating and comparing ratios

/ompare expenses as a percentage of netsales with prior year5s percentages

6. Inquiries of the client Inquire of management whether there isobsolete inventory

Inquire of management regarding thecollectibility of large accounts receivablebalances

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7-0 continued

)PES $% A*") E/"*E!CE E.AP+ES

7. 8ecalculation 8ecompute invoice total by multiplying itemprice times quantity sold

Foot the sales !ournal for a one+month periodand compare all totals to the general ledger

*. 8eperformance gree sales invoice price to approved price list 9atch quantity on purchase invoice to

receiving report

:. bservation bserve client employees in the process ofcounting inventory

bserve whether employees are restrictedfrom access to the chec) signing machine

7-1 The four characteristics of the definition of a confirmation are#

1. 8eceipt$. "ritten or oral response&. From independent third party'. 8equested by the auditor

confirmation is prepared specifically for the auditor and comes from anexternal source. xternal documentation is in the hands of the client at the timeof the audit and was prepared for the client-s use in the day+to+day operation ofthe business.

7-11 Internal documentationis prepared and used within the client-s organi%ationwithout ever going to an outside party, such as a customer or vendor.

xamples# chec) request form receiving report payroll time card ad!usting !ournal entry

External documentationeither originated with an outside party or was aninternal document that went to an outside party and is now either in the hands ofthe client or is readily accessible.

xamples# vendor-s invoice cancelled chec) cancelled note validated deposit slip

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7-12 nalytical procedures are useful for indicating account balances that maybe distorted by unusual or significant transactions and that should be intensivelyinvestigated. They are also useful in reviewing accounts or transactions forreasonableness to corroborate tentative conclusions reached on the basis ofother evidence.

7-13 The most important reasons for performing analytical procedures are thefollowing#

1. 0nderstanding the client-s industry and business$. ssessment of the entity-s ability to continue as a going concern&. Indication of the presence of possible misstatements in the financial

statements'. 8eduction of detailed audit tests

7-14 The decrease of the current ratio indicates a liquidity problem for ;arper/ompany since the ratio has dropped to a level close to the requirements of the

bond indenture. Special care should be exercised by the auditor to determinethat the $.

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7-1& The purposes of audit documentation are as follows#

1. To provide a basis for planning the audit. The auditor may usereference information from the previous year in order to plan thisyear-s audit, such as the evaluation of internal control, the timebudget, etc.

$. To provide a record of the evidence accumulated and the results of thetests. This is the primary means of documenting that an adequateaudit was performed.

&. To provide data for deciding the proper type of audit report. 4ata areused in determining the scope of the audit and the fairness withwhich the financial statements are stated.

'. To provide a basis for review by supervisors and partners. Theseindividuals use the audit documentation to evaluate whether sufficientappropriate evidence was accumulated to !ustify the audit report.

udit documentation are used for several purposes, both during the audit

and after the audit is completed. ne of the uses is the review by moreexperienced personnel. second is for planning the subsequent year audit. third is to demonstrate that the auditor has accumulated sufficient appropriateevidence if there is a need to defend the audit at a later date. For these uses, it isimportant that the audit documentation provide sufficient information so that theperson reviewing an audit schedule )nows the name of the client, contents of theaudit schedule, period covered, who prepared the audit schedule, when it wasprepared, and how it ties into the rest of the audit files with an index code.

7'17 The two criteria used by auditors of public companies when determiningwhether memos, correspondence, and other documents must be maintained

in the audit files are as follows#

1. The materials are created, sent, or received in connection with theaudit or review.

$. The materials contain conclusions, opinions, analyses, or financialdata related to the audit or review.

7-1( The Sarbanes+xley ct of $

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7-10 continued

Description of the contents list of the contents enables the reviewer todetermine whether all important parts of the audit schedule have beenincluded. The contents description is also used as a means of identifyingaudit files in the same manner that a table of contents is used.

Initials of the preparerIndicates who prepared the audit schedule in casethere are questions by the reviewer or someone who wants informationfrom the files at a later date. It also clearly identifies who is responsible forpreparing the audit documentation if the audit must be defended.

Date of preparation;elps the reviewer to determine the sequence of thepreparation of the audit schedules. It is also useful for the subsequent yearin planning the sequence of preparing audit schedules.

Indexing ;elps in organi%ing and filing audit schedules. Indexing alsofacilitates in searching between related portions of the audit documentation.

7-2 The permanent file contains data of an historical and continuing naturepertinent to the current audit. xamples of items included in the file are#

1. rticles of incorporation$. (ylaws, bond indentures, and contracts&. nalysis of accounts that have continuing importance to the auditor'. Information related to the understanding of internal control#

a. flowchartsb. internal control questionnaires

6. 8esults of previous years- analytical procedures, such as various ratiosand percentages compiled by the auditors

(y separating this information from the current year-s audit files, it becomeseasily accessible for the following year-s auditors to obtain permanent file data.

7-21 The purpose of an analysis is to show the activity in a general ledgeraccount during the entire period under audit, tying together the beginning andending balances. The trial balanceincludes the detailed ma)e+up of an endingbalance. It differs from an analysis in that it includes only those items comprisingthe end of the period balance. test of reasonableness schedule containsinformation that enables the auditor to evaluate whether a certain accountbalance appears to be misstated. ne example of a test of reasonableness

schedule is a schedule that compares current year expenses to prior years-amounts. This type of schedule is intended to show which accounts needinvestigation due to significant variances.

7-22 0nanswered questions and exceptions may indicate the potential forsignificant errors or fraud in the financial statements. These should be investigatedand resolved to ma)e sure that financial statements are fairly presented.

The audit files can also be subpoenaed by courts as legal evidence.0nanswered questions and exceptions may indicate lac) of due care by the auditor.

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7-23 Tic) mar)s are symbols ad!acent to information in audit schedules for thepurpose of indicating the wor) performed by the auditor. n explanation of thetic) mar) must be included at the bottom of the audit schedule to indicate whatwas done and who did it.

7-24 udit files are owned by the auditor. They can be used by the client if the

auditor wants to release them after a careful consideration of whether there mightbe confidential information in them. The audit files can be subpoenaed by a courtand thereby become the property of the court. They can be released to another/ firm without the client-s permission if they are being reviewed as a part of avoluntary peer review program under I/, state / society, or state (oardof ccountancy authori%ation. The audit files can be sold or released to otherusers ifthe auditor obtains permission from the client.

7-25 "hen evidence can be examined only in machine+readable form, auditorsuse computers to read and examine evidence. There are commercial auditsoftware programs designed specifically for use by auditors, such as /3

Software and Interactive 4ata xtraction and nalysis =I4>. Spreadsheetsoftware pac)ages can also be used by auditors to perform audit tests on datathat is available only in machine+readable form.

7-2& The purposes of audit documentation software are to convert traditionalpaper+based documentation into electronic files and to organi%e the auditdocumentation. The benefits of audit documentation software, such as utomated/lient ngagement =/>, are as follows#

The auditor can more efficiently prepare a trial balance, leadschedules, supporting audit documentation, financial statements,and ratio analysis using the computer rather than by hand.

The effects of ad!usting !ournal entries are automatically carriedthrough to the trial balance and financial statements, ma)ing last+minute ad!ustments easier to ma)e.

Tic) mar)s and review notes can be entered directly intocomputeri%ed files.

4ata can be imported and exported to other applications. For example,a client5s general ledger can be downloaded into / and taxinformation can be downloaded into a commercial tax preparationpac)age after the audit is completed.

utipe Choice Questions %ro6 CPA Ea6inations

7-27 a. =$> b. =1> c. ='> d. ='>

7-2( a. =&> b. =&> c. ='> d. ='>

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*iscussion Questions And Pro8e6s

7-20 a. 1. xternal *. Internal 1&. Internal$. Internal :. Internal 1'. xternal&. xternal @. xternal 16. Internal'. xternal 1 inquiry of client$. =:> observation&. =1> physical examination'. =$> confirmation6. =7> recalculation7. =$> confirmation

*. =&> documentation:. ='> analytical procedures@. =6> inquiry of client1 reperformance11.=:> observation1$.=1> physical examination1&.='> analytical procedures1'.=&> documentation16.=6> inquiry of client17.='> analytical procedures1*.=&> documentation

1:.=7> recalculation1@.=1> physical examination$ confirmation

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7-31 xamples of audit evidence the auditor can use to support each of thefunctions are#

a. xamine invoice from vendor4irect confirmation with vendor

b. hysical examination

4irect confirmation with custodianc. 4irect confirmation with customer

xamine cash receipts !ournal and ban) deposits for subsequentcash receipts

d. xamine title for ownership of assetxamine invoice from vendor

e. 4irect confirmation with vendorxamine client-s copy of vendor-s statement

f. hysical examinationxamine sales invoice of subsequent sale of goods showing

mar)ed down sale price

g. /ount petty cash4irect confirmation with custodian

7-32 a. /onfirmations are normally more reliable evidence than inquiries ofthe client because of the independence of the outside partyconfirming the information.

b. /onfirmation of ban) balances is considered highly reliable whereasconfirmation of a department store charge account is often notconsidered reliable. (an)s are accustomed to confirmations fromauditors and normally maintain excellent accounting records, whereasmost customers of department stores have neither characteristic.

c. If an auditor is not qualified to distinguish between valuableinventory =e.g., diamonds> and worthless inventory =e.g., glass>, thephysical examination of inventory would not be considered to bereliable evidence.

d. 8ecalculation tests are highly reliable because the auditor is able togain 1

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7-32 continued

f. 1. /onfirmation of accounts receivable + /orporation accustomedto confirmations compared to a member of the general public.

$. xamination of the corporate minutes + xperienced partnercompared to a new assistant.

&. hysical observation of inventory + uditor )nowledgeable inthe client-s inventory compared to one who is not.'. ttorney-s letter + Ceneral counsel compared to an attorney

involved only with patents.g. nalytical procedures are evidence of the li)elihood of misstatements

in the financial statements, but they are rarely sufficient bythemselves to conclude that the statements are misstated. thersupportive evidence is needed to determine whether apparentmisstatements are actually material.

7-33

ACC$!)!AE

%R$ 9H$C$!%"RE*

"!%$RA)"$!)$ ,E C$!%"RE*

/S; ID (DE ll ban)s in which Starhad deposits during theyear including thosewhich may have had anaccount that was closedout during the year.

Dame and address of the ban). The amount on deposit for eachaccount as of the balance sheet date plusthe name of each account, the accountnumber, whether or not the account issub!ect to withdrawal by chec), and theinterest rate if the account is interestbearing. The amount for which Star was

directly liable to the ban) for loans as ofthe balance sheet date plus the date ofthe loan, the due date, the interest rate,the date to which interest is paid, anddescription of the liability and collateral. If internal controls over cash arewea), the auditor may wish to requestthat the ban) include a list of authori%edsignatures with the confirmation.

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7-33 continued

ACC$!)!AE

%R$ 9H$C$!%"RE*

"!%$RA)"$!)$ ,E C$!%"RE*

T84

//0DTS8/I(3

representative sample

of debtors at a selectedconfirmation date whichmay be either at thebalance sheet or aninterim date. /onfirmationsshould also be requestedfor the following types ofaccounts# ccounts with large

balances? ast+due accounts? ccounts with %ero or

credit balances? ccounts written off

during the currentperiod?

ccounts whosecollection isconsideredquestionable?

ther accounts of anunusual nature.

The confirmation can be either a positive

or negative form of request. The positiveform requests the debtor to directly notifythe auditor whether the information iscorrect and if not correct, which items areconsidered incorrect. The negative formrequests a reply only if the information isincorrect. In both cases the informationshould include# Dame and address of the debtor ccount number =if applicable> The confirmation Gas ofG date The aged account balance or

individual invoices included in suchbalance =with invoice date>.

DTS8/I(3

selected sample ofnotes receivableoutstanding at the balancesheet date. If a notereceivable was written offduring the year, thebalance written off shouldbe confirmed.

Dame and address of the debtor. 4ate of the note. 4ue date. 0npaid balance at balance sheet

date. ayment arrangements. Interest rate. 4ate of last interest payment. /ollateral, if any, to secure the note.

IDDT8IS ublic warehouses orother outside custodians=if any>.

Dame and address of publicwarehouse or other outside custodian.

The inventory date. 4etailed lists of inventory stored.

0nder auditing standards, directconfirmation is acceptable providedsupplemental inquiries are made that theinventory is the property of the company,unless the amount is a significant percentof current or total assets.

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7-33 continued

ACC$!)!AE

%R$ 9H$C$!%"RE*

"!%$RA)"$!)$ ,E C$!%"RE*

T84

//0DTSH(3

Suppliers from whom

substantial purchaseshave been made duringthe year, regardless ofthe balances of theiraccounts at the balancesheet date.

Dame and address of the supplier.

The amount due and the amount ofany purchase commitments as of thebalance sheet date. "hen internalcontrols are considered effective, theconfirmation can be at an interimdate? however, a thorough reviewmust then be made of changes in thema!or accounts during the interveningperiod between the confirmation dateand year+end. It should also be notedthat with interim confirmation, theauditor loses a desirable audit

procedure for disclosing unrecordedand contingent liabilities at thebalance sheet date.

s an alternative to confirmation letters, itis a common practice to as) the vendor tosend, directly to the independent auditor,a statement of the vendor5s account withthe client as of the balance sheet daterather than send an accounts payableconfirmation.

98TCCSH(3

9ortgagee for eachmortgage that has abalance at the balancesheet date.

Dame and address of mortgagee. riginal amount. 4ate of note. 9aturity date. (alance due at balance sheet date. ayment arrangements. Interest rate. Interest payment dates. 4ate of last interest payment. Dature of defaults and if any events of

default are )nown to mortgagee. 3ocation of mortgaged property.

/IT3ST/E

If Star uses an outsidetransfer agent andregistrar, confirmationsshould be sent to both.

Dame and address of transfer agentand registrar.

Dumber of shares of common stoc)authori%ed, issued, outstanding, andheld as treasury shares for thecompany as of the balance sheetdate.

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7-33 continued

ACC$!)!AE

%R$ 9H$C$!%"RE*

"!%$RA)"$!)$ ,E C$!%"RE*

3C3 FS ll of Star-s ma!or

attorneys. 3etters shouldalso be sent to attorneysthat the independentauditor )nows the clienthas used extensively inprior years.

The auditor should request a letter from

each attorney as to litigation beinghandled as of and subsequent to thebalance sheet date. For each case, theattorney should give a description, reporton its status as of the balance sheet dateand as of the date of the letter, and givehis or her opinion as to the ultimateliability. The attorney should also stateStar-s indebtedness to him or her as ofthe balance sheet date.

S3S D4

DS//0DTS

ccasionally,

confirmation may berequested from anoutside party forindividual transactionscontributing to totalexpenses or sales. Thismay be true where ama!or item is based on aformal contract and theauditor wantsindependent confirmationof agreement on thesignificant term of thecontract and that theseterms have beensatisfactorily completed.

Dame and address of outside party.

ther specific information woulddepend on the nature of the item andthe reason the auditor feels it isnecessary to confirm the item.

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7-34

A*") PR$CE*RE

a'

)PE $%A*") E/"*E!CE

8',A+A!CE-RE+A)E*

A*") $,:EC)"/E

1. Test extend unit prices timesquantity on the inventory list,test foot the list and comparethe total to the general ledger.

8ecalculation 4etail tie+in

$. Trace selected quantities fromthe inventory list to the physicalinventory to ma)e sure that itexists and the quantities are thesame.

hysical examination xistence andccuracy

&. 2uestion operating personnel

about the possibility of obsoleteor slow+moving inventory.

Inquiry of the client 8eali%able value

'. Select a sample of quantities ofinventory in the factorywarehouse and trace each itemto the inventory count sheets todetermine if it has been includedand if the quantity anddescription are correct.

hysical examination /ompleteness andccuracy

6. /ompare the quantities on handand unit prices on this year-s

inventory count sheets withthose in the preceding year as atest for large differences.

nalytical procedures ccuracy

7. xamine sales invoices andcontracts with customers todetermine whether any goodsare out on consignment withcustomers. xamine vendors-invoices and contracts withvendors to determine if anygoods on the inventory listing

are owned by vendors.

4ocumentation 8ights

*. Send letters directly to thirdparties who hold the client-sinventory and request theyrespond directly to us.

/onfirmation xistence,/ompleteness,and ccuracy

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7-35 a. The six factors determining the reliability of evidence are#1. Independence of provider$. ffectiveness of client-s internal controls&. uditor-s direct )nowledge'. 2ualifications of individuals providing the information6. 4egree of ob!ectivity

7. Timelinessb. and c.

S")A)"$!)PE $% E/"*E!CE

)HA)"S $RE RE+"A,+E%AC)$R

A%%EC)"!#RE+"A,"+")

1

$

&

'

6

7

*

:

@

/onfirmation with businessorgani%ations

hysically examine three+inchsteel plates

xamine documents when

several competent people arechec)ing each other-s wor)

xamine inventory of parts forthe number of units on hand

4iscuss potential lawsuits with/ firm-s legal counsel

/onfirm a ban) balance

/onfirm a ban) balance

hysically count the client-sinventory

hysically count the inventory

2ualifications of provider

2ualifications of provider =in thiscase the auditor>

ffectiveness of internal

controls

4egree of ob!ectivity

Independence of provider

4egree of ob!ectivity

Independence of provider

uditor-s direct )nowledge

Independence of provider andauditor-s direct )nowledge

7-3&

PR$CE*REa'

APPR$PR"A)E )ER8'

)PE $% E/"*E!CE

1$&

'67*:@1/ompute =d>Foot =f>, Trace =g>

Scan =b>Inquire =)>/onfirm =l>/ount =i>xamine =a>, /ompare =h>8ecompute =e>8ead =c>

bservationnalytical procedure8ecalculation and reperformance

nalytical procedureInquiry of client/onfirmationhysical examination4ocumentation8ecalculation4ocumentation

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7-37 a. The purposes of analytical procedures are#

1. 0nderstanding the client-s industry and business.$. ssessment of the entity5s ability to continue as a going concern.&. Indication of the presence of possible misstatements in the

financial statements.

'. 8eduction of detailed audit tests.

b. nalytical procedures are required in the planning and completionphases of the audit because of their importance in planning theaudit, and as a final review for potential misstatements. uditorsuse analytical procedures extensively because of their relatively lowcost and effectiveness in identifying potential misstatements.

c. The extent to which the auditor will use the results of analyticalprocedures to reduce detailed tests depends on the effectivenessof the analytical procedure and whether it supports the correctnessof the recorded account balance. The effectiveness of the analytical

procedure is a function of the precision of the expectation developedby the auditor and whether it is based on ob!ective data.

7-3( In general, the audit schedule is not set up in a logical manner to showwhat the auditor wants to accomplish. The primary ob!ective of the audit scheduleis to verify the ending balance in notes receivable and interest receivable. secondary ob!ective is to account for all interest income, cash received and cashdisbursed for new notes, collateral as security, and other information about thenotes for disclosure purposes.

Specific deficiencies of the audit schedule presented in the question areincluded below.

a. and b.

a'*E%"C"E!C

8'"PR$/EE!)

1. Tic) mar) explanation GtestedG doesnot indicate specifically what was done.

$. xplanation of some tic) mar)s is notgiven.

&. /lassification of long+term portionindicates no verification.

'. aid+to+date row is confusing.

6. 4ue dates are missing for J.J. /o.,. Smith, and Tent /o.

Should have separate tic) mar)smeaning#

greed to confirmation Footed Traced to cash receipts !ournal 8ecomputed, etc.

xplain all tic) mar)s on the samepage of the audit schedule.

8ecompute portions of notes thatare long+term.

/olumn should say Gdate paid toGand this should be confirmed.

Include due dates on the auditschedule for these notes.

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7-3( continued

c. Spreadsheet Soution

The purpose of using an xcel spreadsheet in this problem is togive the student some experience in preparing a simple audit

schedule using an xcel spreadsheet. It should be explained tostudents that this type of audit schedule may or may not beprepared in actual practice, and that often templates are used toprepare more time+consuming audit schedules. lso, whether ornot tic) mar)s are computeri%ed is a matter to be decided. Theadvantage is that the completed audit wor) can then be stored andreviewed electronically. n the other hand, it may be more efficientto indicate audit wor) manually as it is performed, and a contrast inthe color of the tic) mar)s through use of a colored pencil may bedesirable.

The following solution was prepared with xcel =Filename

*&:.xls>. The formulas used are self+evident, so no listing isprovided, although it is available on the /ompanion "ebsite. Twoitems deserve comment#

1. n advantage of using a spreadsheet program for thesetypes of analyses is that footing and crossfooting are doneautomatically.

$. "hen auditor tic) mar)s are done by computer, a problemarises as to how to place them on the wor)sheet. ne coulduse narrow columns inserted between the scheduled clientdata, or, as done here, the tic) mar)s are placed in blan) rows

beneath the related data.

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7-3( continued

D488T /9DH Schedule D+1 4ateK/ L11< + DTS 8/I(3 repared by J4

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Cases

7-30 The following are deficiencies in the sufficiency and appropriateness of theevidence in the audit of accounts payable for Crande Stores#

cCure Advertisin@ CreditsN n insufficient number of confirmations

=four> were sent. The use of alternative procedures is probably acceptable.;owever, one credit was confirmed by telephone, rather than by writtenconfirmation. lthough the differences found were immaterial, the auditorsshould have determined the reason for the differences, and any errorsshould have been pro!ected to the population.

Twenty additional credits were selected for testing. "hether this isa sufficient number is a matter of !udgment, and depends on severalfactors. "ith a fairly small sample, it is critical that the items selected fortesting adequately represent the population. The testing relied on internaldocumentation, which is insufficient to support the credits. The placing ofthe ad is insufficient evidence without supporting evidence from the vendor

supporting the reduction in accounts payable.

Sprin@8roo; Credits N These credits were confirmed by telephone, andwere not supported by a written confirmation. The staff auditor wassuspicious of the client5s unwillingness to allow written confirmation of theamounts, as well as the client5s changing explanation of the nature of thecredits, but did not perform additional testing to resolve any doubts aboutthe validity of the credits.

Rido>i CreditsN The auditor obtained an oral confirmation that thesecredits were not valid. The client indicated that the auditor-s information

was incorrect, but would not allow the auditor to obtain writtenconfirmation for these credits. In addition, the credit memos had beenaltered, which should have further indicated to the auditor that the creditswere not valid.

Accounts Paa8e Accrua N The auditors sent 6< accounts payableconfirmations. "hether this is a sufficient number of confirmations is amatter of auditor !udgment. ;owever, the adequacy of the confirmationsas evidence is significantly undermined by the )nowledge that the clienttold suppliers how to respond. s a result, the auditor should have verifiedthe confirmed balances using alternative procedures. There is no

discussion of the performance of alternative procedures for nonresponses, orthe resolution of the six responses that were not reconciled to Crande5srecords.

The auditors agreed to an ad!ustment of M$7

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7-4 The audit schedule contains the following deficiencies#

1. There is no indication of follow+up on the identified error in the accruedinterest payable computation.

$. There is no indication whether the confirmation exception wasresolved.

&. The loan with an unwaived violation of a provision of the debtagreement is misclassified as long+term.

'. The liability activities of 3ender-s /apital /orp. and the audit scheduletotals do not crossfoot.

6. There is no indication of cross+referencing of the stoc)holder loan tothe related party transactions audit schedule.

7. There is no investigation of the payment on the stoc)holder loan thatwas reborrowed soon after year+end.

*. There is no consideration of the need to impute interest on the

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7-41 B AC+ Pro8e6 continued

8eport for requirement d#

e. There are no exceptions in the calculation of net pay for September.=se the follo'ing ilter %ross Pay * Taxes + , Net Pay.>

f. There are no duplicate chec) numbers. =se the Duplicatescommand on the chec" -cheue/ number column >. There are fourmissing chec)s =L1$&:@ + L1$&@$>. The audit concern is that theremay be unrecorded payroll transactions. =se the %aps commandon the chec" -cheue/ number column.>

"nternet Pro8e6 Soution se o> Audit So>tware >or %raud *etection and*ata Quait Assurance

7-1 The use of audit software has increased dramatically in recent years.Software is now used to fulfill administrative functions in the audit environment,document audit wor), and conduct data analysis. "hile some accounting firmsuse internally+developed software, other firms purchase software from vendorssuch as /3 and udit nalytics. "hen technology is properly used auditors are

*+$$

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"nternet Pro8e6 7-1 continued

able to focus their efforts on understanding their client and the related accountingand auditing issues. isit /35s website Rhttp#KKwww.acl.comK to learn moreabout the various software tools available for use in the audit environment.

1. 8ead about /35s solution for data quality and fraud detection.;ow might an auditor use /35s data analytics software for thesetwo purposes

Answer#(ecause companies generate very large amounts of data and usedifferent information systems to generate that data, auditors mustbe able to overcome these potential constraints. /3 has the abilityto handle huge volumes of data that are generated by variousoperating systems, database structures, and enterprise applications=e.g. 8, /89, S/9, and (I systems>. fter data are captured,

/3 can be used to independently test, reconcile, and validatetransactional data. If performed manually, these types ofprocedures can ta)e extraordinary amounts of time. /3 can alsobe used for fraud detection purposes. /3 can identify trends,generate exception reports, and highlight potential areas of concern.

uditors can then use the information from the various analysesand conduct further audit procedures to determine whether a fraudhas occurred.

$. ;ow might /3 be used by a company to comply with therequirements related to internal control over financial reporting

;int# Ta)e a loo) at /35s /ontinuous /ontrols 9onitoring =//9>software.

Answer/35s //9 software provides an independent mechanism toautomatically monitor internal controls effectiveness within )eybusiness processes. lso, //9 uses analytics and embeddedaudit Gbest practicesG in business operations so that managementreceives timely notification of unusual patterns and control breaches.

ccording to /3, the benefits of //9 include# Independent testing of controls through transaction analysis

at the source level Timely notification to management of controls brea)downs

enabling control wea)nesses to be fixed before they arereported externally

Fraud reduction and improved ris) management throughidentification of control gaps and wea)nesses that can leadto error, abuse and fraud

*+$&

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"nternet Pro8e6 7-1 continued

Improvements to operational efficiency and effectiveness

xtensibility to multiple end+to+end business processeswith independent assurance of controls effectiveness andtransaction integrity across the enterprise

=!ote# Internet problems address current issues using Internet sources. (ecauseInternet sites are sub!ect to change, Internet problems and solutions may change. /urrentinformation on Internet problems is available at www.pearsonhighered.comKarens.>