Audit Evidence and Assurance
What You Really Need to Know
Chapter 8: Audit Evidence and Assurance
Auditors obtain six basic types of evidence and use six general techniques to gather it.The six techniques are (1) recalculation/reperformance, (2) observation, (3) confirmation,(4) enquiry, (5) inspection, and (6) analysis. One or more of these techniques may be usedno matter what account balance, class of transactions, control procedure, or other informationis under audit.
Recalculation is redoing calculations already performed by auditee personnel. This producescompelling mathematical evidence as the auditee calculation is either right or wrong. Calculations made using computer programs can be recalculated using auditing software. Recalculationprovides highly reliable evidence of mathematical accuracy, but theproduct is only as good as the components; the auditor must audit every significant part of the original computation if recalculation is to provide strong, persuasive evidence.
A related type of evidence is called reperformance. Usually applied in control testing,the auditor independently executes a procedure of the organization’s internal control. Thiscan provide compelling evidence about the effectiveness of a control procedure.
Observation consists of looking at how policy or procedures is applied by others. It provideshighly reliable evidence as to performance or conditions at a given point in time, but it does not necessarily reflect performance at other times or over long periods.
Confirmation consists of awritten enquiryto verify accounting records. Directcorrespondence with independent external parties is a confirmation procedure widely usedin auditing. Most transactions involve external parties so confirmation has a lot of applications.
Enquiry generally involves collecting oral evidence from independent parties, auditee officials, and employees. Evidence gathered by formal and informal enquiryof auditee personnel generally cannot stand alone and must be corroborated by the findingsof other procedures. Further enquiries could be made and consistent responses provide an increased degree of assurance. Sometimes, however, the auditor will hear conflicting evidence. The auditor will have to use considerable judgment in reconciling the conflicting evidence or in deciding what additional evidence to gather.
Inspection consists of looking at records and documents or at assets with physical substance.
The procedures are of varying degrees of thoroughness: examining, perusing, reading,reviewing, scanning, scrutinizing, and vouching. Physically inspecting tangible assetsprovides reliable evidence of existence and may give some evidence of condition, andhence valuation, but it does not provide reliable evidence of ownership. Physical inspectionof formal documents with intrinsic value, such as securities certificates, also provides reliableevidence about existence. Scanning makes use of auditors’ alertness to unusual items and events in auditee documentation. The procedure usually does not produce directevidence itself, but it can raise questions for which other evidence must be obtained.
Auditors obtain evidence about financial statement accounts by methods of study and comparison called analysis. Auditing standards provide guidance on using analysis at therisk assessment and overall conclusion stages of the audit, and also for when auditors useanalysis as an evidence-gathering procedure during the audit. When analysis is used to provide substantive evidence, auditors need to be careful to useindependent, reliable information for comparison purposes.
The audit process beginsby obtaining an understanding of the auditee and its risks. There are a wide variety of information sources auditors use to understandthe auditee’s business, industry, and environment. Information gathered in prior audits, and documented in the working papers, can alsoprovide relevant and reliable information on the organizationand its internal control.
For first-time audits there is often no prior working paper information, so this canrequire more work than in a repeat engagement. If this is a company’s first audit but not its first year of operation, additional work includes establishing a starting place with reliableopening account balances for the audit. Audit efficiency can also be increased by working with internal auditors.
Enquiries of management help the auditor assess what is significantto users. At the same time that enquiries and interviews take place, the audit team can take a tourof the company’s physical facilities to look for activities and things that should be reflected in the accounting records. Research databasesare valuable foracquiring and maintaining industry expertise. Specific information about public companiescan be found in registration statements and annual report filings with the provincial securitiescommissions.
Auditing standards require auditors to obtain sufficient appropriate evidence to be the basis for an opinion on financial statements. 12 The accounting records (journals, ledgers,accounting policy manuals, computer files, and the like) are evidence of the bookkeeping but not appropriate supporting evidence for the financialstatements.
Appropriateness of evidence relates to the qualitative aspects of evidence. To be consideredappropriate, evidence must be relevant and reliable. Relevant audit evidence assists theauditor in achieving the audit objectives. This means that it must relate to at least one of the financial statement assertions, otherwise it is not relevant to the auditor.
The reliability of audit evidence depends on its nature and source. An auditor’s direct, personal knowledge, obtained through physical observation andhis or her own mathematical recalculations or reperformance, is generally considered the most reliable evidence. Documentary evidence obtained directly from independent external sources (externalevidence) is considered very reliable. Documentary evidence originating outside the auditee’s data processing system butreceived and processed by the auditee (external-internal evidence) is generally consideredreliable. Internal evidence consisting of documents that are produced, circulated, and finallystored within the auditee’s information system is generally considered low in reliability. Analysis using specific data that the auditor has verified is considered fairly reliable. Spoken and written representations given by the auditee’s officers, directors, owners,and employees are generally considered the least reliable evidence. Such representationsshould be corroborated with other types of evidence
Auditors must be careful about the appropriateness of evidence and choose the audit procedureproviding that which is the most reliable that can be obtained in a cost-effective manner, relative to a particular audit objective.
Before, during, and after the field work period, the auditor monitors events that may affect an auditee’s businessrisk, the client relationship, or the engagement. All the planning activities are recorded and summarized in a planning document, sometimesreferred to as the planning memorandum. This document contains the results of analytical review, the decision on materiality levels,and the risk assessment. It gives specific attention to the effect of these on the nature,extent, and timing of audit resources needed to perform the work. It is evidence that GAAS has been followed by planning the audit work.
Auditors use two types of audit programs to actually guide their field work. The internal control program lists the specific procedures for gainingunderstanding of the auditee’s business transaction processing systems and controls. The balance audit program lists the substantive procedures for gatheringdirect evidence on the assertions (i.e., existence, completeness, valuation, ownership, presentation)about dollar amounts in the account balances and related disclosures. Often, standardized programs are used but they are modified for each specific client. These modified audit programs also provide evidence that the audit has been properly planned.
An audit is not complete without proper working paper documentation. The planningdocument is a key component of the audit documentationalong with the audit programs. Documentation providesa record of the auditor’s work for the purpose of file reviews, practice and regulatoryinspections, or in some cases to defend against a law suit. Working papers are theauditors’ record of compliance with generally accepted auditing standards.
The auditor is the legal owner of theworking papers, but professional ethics requires that there is auditee consent before transferring them to a third party since some of the information in the working papers is in confidence from the auditee. Audit files must be retainedfor several years as required by professional accounting association rules and practiceinspection procedures.
Working papers can be classified into three categories: (1) permanent file papers, (2)audit administrative papers, and (3) audit evidence papers. The last two categories are often called the current file because they relate to the audit of one year.
The permanent file contains information of continuing interest over many years’ audits of the same auditee. This file can be used year after year, whereas each year’s current audit evidence papers are filed away after they have served their purpose. Documents ofpermanent interest and applicability include (1) copies or excerpts of the corporate charterand bylaws or partnership agreements; (2) copies or excerpts of continuing contracts, suchas leases, bond indentures, royalty agreements, management bonus contracts, etc.; (3) ahistory of the company, its products and its markets; (4) excerpts of minutes of shareholders’and directors’ meetings on matters of lasting interest; and (5) continuing schedulesof accounts whose balances are carried forward for several years, such as share capital,retained earnings, partnership capital and the like.
Administrative papers contain the documentation of the early planning phases of theaudit. They usually include the engagement letter, staff assignment notes, conclusionsrelated to understanding the auditee’s business, results of preliminary analytical procedures,initial assessments of audit risks, and initial assessments of audit materiality.
The current-year audit evidence working papers are typically organized in sections:major accounting processes or cycles and balance sheet accounts. Each section containsa lead sheet that shows the dollar amounts reported in the financial statements, summaryof the audit objectives in relation the account’s assertions, procedures performed, evidenceobtained, and conclusions reached for that section overall. Thesepapers communicate the quality of the audit, so they must be clear, concise, complete,neat, well indexed, and informative. Each separate working paper (or multiple pages thatgo together) must be complete in the sense that it can be removed from the working paper file and considered on its own, with proper cross-reference available to show how the paper fits in with the others.
Auditing standards recommend that the working papers show (1) evidence thatthe work was adequately planned and supervised, (2) a description of audit evidenceobtained, (3) evidence of the evaluation and disposition of misstatements, and (4) copiesof letters or notes concerning audit matters reported to the auditee.
Each paper is given an index number, like a book page number, so it canbe found, removed, and replaced without loss. An index number might consist of asection letter (e.g., C) and a page number within that section (e.g., C-2). Each sectioncould be given to a different audit team without affecting other sections. Cross-indexing means noting the index ofother paper(s) where work has been performed so that the connections can be followed. Each paper is titled with the name of the company, the period under auditdate, and a descriptive title of the contents of the working paper. If the paper wascreated by auditee personnel (rather than the auditor) this is noted in the title. The auditor who performs the work and the supervisor whoreviews it must sign the papers so that personnel can be identified. The dates of performance and review are recorded on the workingpapers so that reviewers can tell when the work was performed. Tick marks are the auditor’s shorthand for indicatingthe work performed. They must always be accompanied by a full explanation of theauditing work.
Electronic workingpapers boost productivity by automating many tasks, such as carrying adjustments over torelated working paper documents and the financial statements. An example of a working papersoftware program used in public practice is Case Ware.
Smieliauskas/Bewley, 5e © The McGraw-Hill Companies, Inc., 2010
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