Use with The Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015

Chapter 6

The search for evidence explained

Use with The Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015

Learning objectives

• Explain why the audit evidence search is a central concept of auditing.

• Identify the stages of the audit process and show that evidence has to be collected in different ways at each stage.

• Explain the relationship between audit evidence and audit risk.

• Show there are different grades of audit evidence and that evidence may be upgraded or downgraded.

• Explain the relationship between audit evidence and the application of audit judgement.

• Show to what extent the evidence-gathering process might be affected by a decision by the auditor to rely on the directors and the control environment they have introduced.

• Form conclusions on the basis of evidence available in selected scenarios.

• Explain the difference between an audit, a limited assurance engagement, a compilation engagement and an engagement involving agreed upon procedures, and suggest how the evidence-gathering process may differ between them.

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Audit is a search for evidence to enable an opinion to be formed

• Evidence search is to enable conclusions to be formed on: – Accuracy and dependability of accounting records – Truth and fairness of financial statements – Compliance with legislation, accounting, reporting standards

• Audit evidence collected from audited entity and independent sources.

• Auditors collect audit evidence using inquiry, inspection, observation, confirmation, recalculation, re-performance, analytical procedures

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Audit is a search for evidence to enable an opinion to be formed

• Sufficient appropriate audit evidence – ‘Sufficient’: enough evidence is obtained to meet audit objectives.

Persuasiveness of audit evidence and quantity linked. – ‘Appropriate’ has two elements: Relevance: evidence must be pertinent to matter in hand. Reliability: many grades of reliability.

• Sufficiency and appropriateness related – the higher the quality the less may be required.

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Audit is a search for evidence to enable an opinion to be formed

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Figure 6.1

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Table 6.2 (a) Assertions about classes of transactions and events for period under audit

i. Occurrence – transactions and events that have been recorded have occurred and pertain to the entity – Genuine

ii. Completeness – all transactions and events that should have been recorded have been recorded – Complete

iii. Accuracy – amounts and other data relating to recorded transactions and events have been recorded appropriately – Accurate

iv. Cut-off – transactions and events have been recorded in the correct accounting period – Accurate

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Table 6.2 (b) Assertions about account balances at the period end

i. Existence – assets, liabilities, and equity interests

Exist – Genuine

i. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the obligations of the entity – Genuine

ii. Completeness – all assets, liabilities and equity interests that should have been recorded have been recorded – Complete

iii. Valuation and allocation – assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded – Accurate

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Table 6.2 (c) Assertions about presentation and disclosure

i. Occurrence and rights and obligations – Disclosed events, transactions, and other matters have occurred and pertain to the entity – Genuine

ii. Completeness – all disclosures that should have been included in the financial statements have been included – Complete

iii. Classification and understandability – financial information is appropriately presented and described, and disclosures are clearly expressed – Accurate

iv. Accuracy and valuation – financial and other information are disclosed fairly and at appropriate amounts – Accurate

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Role of management assertions in the audit process

• The importance of management assertions is that (reframed) they form audit objectives

• Assertion: All trade receivables shown in the financial statements are collectable

• Audit objective: To prove within reason that all trade receivables shown in the financial statements are collectable

• Suggested audit step to prove collectability: Test amounts received from credit customers after the year-end

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Reliability of audit evidence (grades of audit evidence)

• Reliability of audit evidence increases when from independent sources outside the entity (particularly from professional persons).

• Reliability of audit evidence generated internally increases when related controls on preparation and maintenance are effective.

• Audit evidence obtained directly by the auditor more reliable than evidence obtained indirectly or by inference.

• Audit evidence in documentary form more reliable than oral evidence.

• Audit evidence provided by original documents is more reliable than copies, reliability of which depends on controls over preparation and maintenance.

• Evidence created in normal course of business is better than evidence specially created to satisfy the auditor.

• Best-informed source of evidence normally management of the company but lack of independence reduces its value.

• Evidence about future particularly difficult to obtain and less reliable than evidence about past events.

• Evidence may be upgraded by skilful use of corroborative evidence.

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Forming conclusions on the basis of evidence: the exercise of judgement

Figure 6.2

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The business risk approach to gathering audit evidence

• If auditors form good impression of management, evidence from them may be relied on by

auditor to greater extent.

• As auditors get to know individual members of management well, engagement partners may feel they can judge integrity.

• Close involvement of audit team with management may reveal lack of integrity – reason for withdrawing from engagement.

• Trust in integrity and competence of management could lead to reducing level of substantive tests of detail.

• A basic idea of agency theory is principals cannot trust managers to use resources properly. But, auditors cannot start with presumption that managements lack integrity.

• A major issue is that business risk approach brings auditor close to management and independence may be threatened

• Protagonists of business risk approach suggest audit failures are not because auditors fail to perform tests of detail, but because they missed clear indicators of impending catastrophe.

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The stages of the audit process and evidential requirements at

each stage (1) (Table 1.1)

• See Gilsland Electronics Limited – auditors’ year

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The stages of the audit process and the evidential requirements at

each stage (2)

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The stages of the audit process and the evidential requirements at each stage (3)

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The stages of the audit process and the evidential requirements at each stage (4)

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The stages of the audit process and the evidential requirements at each stage (5)

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The stages of the audit process and the evidential requirements at each stage (6)

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The stages of the audit process and the evidential requirements at each stage (7)

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The stages of the audit process and the evidential requirements at each stage (8)

Figure 6.3 below shows the audit process, its audit stages, and evidence-gathering process in more detail.

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The stages of the audit process and evidential requirements at each stage (9) Figure 6.3

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The stages of the audit process and evidential requirements at each stage (10) (Figure 6.3 continued)

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The stages of the audit process and evidential requirements at each stage (11) (Figure 6.3 continued)

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The stages of the audit process and evidential requirements at each stage (12) (Figure 6.3 continued)

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Compilation engagements

• Professional accountants prepare financial statements on basis of data and information provided by management – not an audit. Normally carry out following procedures: – Find out what accounting principles and practices are common in entity’s industry. – Get general understanding of business, the risks facing it, nature of the

transactions, accounting principles used, and the presentation and content of the financial statements.

– Generally review the financial statements using limited analytical procedures and discuss critically with management.

– Obtain letter from management saying they have been given all the books and records and other information pertinent to the preparation of the financial statements.

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Limited assurance engagement

• Not full audit; accountant aims to obtain limited assurance financial statements

comply with legislation and accounting standards. Evidence-gathering procedures include: – Determine accounting principles and practices in industry. – Get good understanding of business, how organized, operating characteristics, risks facing it

and related controls, nature of transactions, assets and liabilities – goes further than compilation engagement work but very few detailed tests.

– Analytical procedures to identify relationships between figures appearing unusual and discuss with management. May advise management on appropriate adjustments to financial statements.

– Letter of representation from management confirming significant oral representations by management during review.

– At completion of review read financial statements to ascertain appear to conform to requirements of Companies Act and accounting standards.

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Use with The Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015

Agreed upon procedures engagement

• Similar to limited assurance engagement except certain detailed procedures would be performed – as agreed with management.

• Report would indicate detailed procedures carried out but would disclaim a full audit opinion.

• Agreed procedures would require the accountant to seek evidence the items subject to the agreed procedures have been stated appropriately.

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Figure 6.1 Audit evidence supporting reasonable

conclusions

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Figure 6.2 Evidence corroboration and upgrading in a sales system

Use with The Audit Process: Principles, Practice and Cases, 6th edn ISBN 978-1-4080-8170-9 © Iain Gray, Stuart Manson and Louise Crawford, 2015

Figure 6.3 The audit process: audit stages, evidence-gathering

process and main audit objectives