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AUDIT EVIDENCE & AUDITING

PROCEDURE
Chapter 5

Aud 390 - Betsy Jomitin


Overview
On a typical audit, most of auditors work
involves obtaining and evaluating evidence
using procedures such as inspection of records
and confirmations to verify the true and fair
view of the financial statements.

To perform this task effectively and efficiently,


an auditor must thoroughly understand the
important aspects of audit evidence.

Aud 390 - Betsy Jomitin


Learning Objecives
1) To know the types of audit evidence
2) Quality and adequacy of audit evidence
3) Auditing procedure used to collect
evidence
4) Types of audit procedure and audit test
5) Compliance and substantive test
6) Test of transaction and account
balances
Aud 390 - Betsy Jomitin
What constitutes True &
Fair?
Auditors, in carrying out their examination
of an entitys financial statement(FS) will
gather and evaluate audit evidence based
on managements assertion or sometimes
referred to as audit objectives.

For a FS to be true and fair, auditors must


be satisfied that the FS was prepared
according to the management assertions.

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What is management assertions?

Management assertions are expressed or


implied representations by management
relating to its Financial Statements.
(Another word for Assertions is declarations)

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What are these assertions/
declarations made by management?
Existence or occurrence
Completeness
Obligations and rights (Ownership)
Classification
Valuation or measurement
Accuracy
Cut-of
Presentation and disclosures
of events and transactions in the entity have
been properly reflected in the FS.
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Assertions are evaluated into 3
categories:
1. Transactions (eg Sales transactions)
2. Account Balances ( eg Account
Receivables)
3. Presentation and disclosure ( Notes to the
FS)

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Existence or occurrence
Transactions and events that have been
recorded have occurred.
(Eg. Sales have occurred)
Completeness
All transactions and events that should
have been recorded have been recorded.
(All sales transactions for the year have
been recorded)

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Rights and Obligations (ownership)
The entity holds or controls the rights to
assets and liabilities are obligations of the
entity.
( PPE belongs to company and long term loan
is liability under the name of the company)
Classification
Transactions and events have been recorded
in the proper accounts. ( Eg Capital
Expenditure of PPE recorded under PPE
accounts instead of repair and maintenance)

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Valuation or measurement
Assets, liabilities and equity interests are
included in the financial statements at
appropriate amounts, and any resulting
valuation or allocation adjustments are
appropriately recorded.
(eg trade receivables have been properly
valued taking into consideration allowance
for doubtful debt)

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Accuracy
Amounts and other data relating to
recorded transactions and events have
been recorded appropriately.
(eg Sales amount have been recorded
accurately according to invoice amount)

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Cut-of
Transactions and events have been
recorded according to proper accounting
year end. (eg, all sales invoice dated
between 1/1/2010 31/12/2010 should be
recorded in the Statement of
Comprehensive Income for the year ended
31/12/2010)

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Presentation and Disclosures
The Financial Statements have been
prepared in accordance with the
presentation and disclosure requirements
of applicable accounting standards in
Malaysia.
For Public Listed Companies (Bhd
companies), applicable accounting
standards is Malaysian Financial Reporting
Standards (MFRS).
For Private Entities (Sdn Bhd companies),
applicable accounting standards is
Malaysian Private Entities
Aud 390 - Betsy Jomitin
Reporting
Standards (MPERS) or MFRS.
So, what is the
elationships between the managemen
assertions and
the work of an auditor?

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LETS TAKE A LOOK AT THE
EXAMPLE BELOW.
ABC Sdn Bhd has in its Statement of
Financial Position @31/12/2010, under
current asset, cash at bank amounting to
RM 20,000.

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WHAT WOULD BE THE MANAGEMENTS
ASSERTIONS RELATING TO ITS CASH AT
BANK OF RM 20,000 RECORDED IN ITS
CURRENT ASSETS AS AT 31/12/2010?

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BASICALLY, MANAGEMENT WOULD
ASSERT THAT.
CASH AT BANK REALLY EXIST.
AMOUNT REPORTED IS
CORRECT/ACCURATE.
THEY HAVE COMPLIED WITH THE
REQUIREMENT OF ACCOUNTING
STANDARDS RELATING TO RECORDING
OF CASH AT BANK.
THEY HAVE COMPLETELY RECORDED ALL
TRANSACTIONS RELATED TO CASH AT
BANK(COMPLETENESS).
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Therefore.
As an auditor, it is his responsibility to
obtain reasonable assurance by
verifying/checking/examining/provide proof
(BY COLLECTING REQUIRED EVIDENCES)
that the assertions made by the
management is accordingly as stated.

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What is audit evidence?

Aud 390 - Betsy Jomitin


INTRODUCTION
Audit evidence is all the information used
by auditor in arriving conclusions on which
the audit opinion is based, and includes the
information contained in the accounting
records underlying the financial statements
and other information.

A solid understanding of the characteristics


of evidence is obviously an important
conceptual tool for auditors as well as for
professionals in a variety of other settings.
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The following concepts of audit evidence are
important to understanding the conduct of
the audit:
The nature of audit evidence
The appropriateness of audit evidence
The sufficiency of audit evidence
The evaluation of audit evidence

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The nature of audit evidence

The nature of audit evidence includes:

Accounting records

Other available information

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Invoices
Contracts
General ledger
Subsidiary ledger
Accounting Journal entries
records Works sheets supporting cost
allocations, computations,
reconciliations and disclosures

Minutes of meeting
Confirmations from third parties
Analysts Reports
Other information Benchmarking data about
competitors
Internal control manual
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The appropriateness of audit evidence

ISA 500 requires the auditor to obtain


sufficient audit evidence to be able to draw
reasonable conclusions on which to base
his audit opinion on the financial
statements.
Appropriateness is a measure of the quality
of audit evidence.

Evidence, regardless of its form, is


considered appropriate when it provides
information that is both relevant and
Audreliable.
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The appropriateness of audit evidence
Relevance
The appropriateness of evidence depends on its
relevance to the management assertion being
tested.

If the auditor relies on evidence that is unrelated to


the assertion, the auditor may reach an incorrect
conclusion about the assertion.

For example, if the auditor wants to make sure the


existence of a bank account, the auditor should
check the bank statement from the respective bank
rather than just checking the bank account
transactions in the general ledger.

Aud 390 - Betsy Jomitin


The appropriateness of audit
evidence
Reliability

The reliability of audit evidence refers to


whether a particular type of audit evidence
can be relied upon to signal the true state
of an assertion.

However, the auditor should consider the


following factors when assessing the
reliability or validity of evidence :

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1) Independence of source of the
evidence
) Evidence obtained directly by the auditor
from an independent source outside the
entity is usually viewed as more reliable
than evidence solely from within the
entity.
) A confirmation of the entitys bank
balance received directly by the auditor
would be viewed as more reliable than
examination of the cash receipts journal
and cash balance recorded in the general
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ledger.
2) Efectiveness of internal control
A major objective of an entitys internal control is
to generate reliable information to assist
management decision-making.
As part of the audit, the efectiveness of the
entitys internal control is assessed.
When the auditor assesses the entitys internal
control as efective, evidence generated by that
accounting system is viewed as reliable.
Conversely, if internal control is assessed as
inefective, the evidence from the accounting
system would not be considered reliable.

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3) Auditors direct personal knowledge
Evidence obtained directly by the auditor
generally considered to be more reliable
than evidence obtained indirectly by other
means.
For example, an auditors physical
examination of an entitys inventory is
considered to be relatively reliable because
the auditor has direct personal knowledge
regarding the inventory.

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4) Documentary evidence
Audit evidence is more reliable when it exists in
documentary form, whether paper, electronic, or
other medium.
Then a written record of a board of directors meeting
is more reliable than a subsequent oral presentation
of the matters discussed.
5) Original documents
Audit evidence provided by original documents is
more reliable than audit evidence provided by
photocopies or facsimiles. An auditors examination of
an original, signed copy of a lease agreement is more
reliable than a photocopy.

Aud 390 - Betsy Jomitin


Types of audit evidence
In deciding which audit procedures to use,
there are seven broad categories of evidence
from which the auditor can choose:
Physical examination
Confirmation
Documentation
Observation
Inquiries of the client
Reperformance
Analytical procedures

Aud 390 - Betsy Jomitin


Physical examination

Is the inspection or count by the auditor of


a tangible asset.
It is regarded as one of the most reliable
and useful types of audit evidence.
Generally, it is an objective means of
ascertaining both the quantity and the
description of the asset.
In some cases, it is also a useful method for
evaluating an assetss condition or quality.
For example in a case of inventory and
property, plant and equipment.
Aud 390 - Betsy Jomitin
Confirmation

Describes the receipt of a written or oral


response from an independent third party
verifying the accuracy of information that
was requested by the auditor.
Example would be bank balance
confirmation,
trade receivables confirmation and trade
payables confirmation.
Because confirmations comes from sources
independent of the client, they are highly
regarded and are often used type of
evidence.
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Documentation/Vouching

Is the auditors examination of the clients


documents and records to substantiate the
information that is or should be included in the
financial statements.
The documents examined by the auditor are the
records used by the clients to provide information
for conducting its business in an organised manner.
Since the transactions of client are normally
supported by at least one document, there is a
large volume of document available. For eg, client
retains customer order, shipping document and
duplicate sales invoices for each sales transactions.

Aud 390 - Betsy Jomitin


Documentation/Vouching

When auditors use documentation to support recorded


transactions or amounts, it is often referred to as
vouching.
Documents can be conveniently be classified as internal
and external.
An internal document is one that has been prepared and
used within the clients organisation and is retained
without ever going to an outside party such as a
customer or a supplier.
Examples would be sales invoices, employees time card
and inventory receiving report.
External document originate from outside the clients
organisation for example suppliers invoice and insurance
policies.

Aud 390 - Betsy Jomitin


Observation
Is the use of the senses to access certain
activities.
Throughout the audit there are many
opportunities to exercise sight, hearing,
touch and smell to evaluate a wide range of
things.
For example, the auditor may tour the plant
to obtain a general impression of the
facilities and watch individuals perform
accounting tasks to determine whether the
person assigned a responsibility is
performing it.
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Inquiries of the client
Is the obtaining of written or oral
information from the client in response to
questions from the auditor.

Usually cannot be regarded as conclusive


because it is not from independent source.

Normally, it is necessary for auditor to


obtain further corroborating evidence
through other procedures.

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Re performance

Involves rechecking a sample of the


computations and transfers made by the
client during the period under audit.
Rechecking of computations consists of
testing the clients arithmetical accuracy.
Includes checking the calculation of
depreciation expense etc.

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Substantive Analytical
Procedures(SAP)
Use comparisons and relationships to
determine whether account balances or
other data appear reasonable.
An example would be comparing gross
margin per in the current year with the
preceding years.

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Audit Procedures
Audit procedures are specific acts
performed by the auditor to gather
evidence to draw conclusions on which to
base the audit opinion.

There are basically two main category of


audit procedures:
1. Tests of controls
2. Substantive procedures

Aud 390 - Betsy Jomitin


Tests of controls(TOC)
Tests of controls consist of procedures
directed toward testing the operating
efectiveness of controls.
Tests of controls include obtaining audit
evidence about how controls were applied,
and by whom or by what means they were
applied.
The auditor may use the following types of
audit procedures for testing of controls:
Inquiries of appropriate management,
supervisory and staf personnel.
AudInspection
390 - Betsy Jomitin of documents, reports, and
Tests of controls
Observation of the application of specific controls
Walkthroughs, which involve tracing a transaction from its
origination to its inclusion in the financial statements
through a combination of audit procedures including
inquiry, observation and inspection.
Test of controls are necessary in 2 circumstances ie:
When the auditors risk assessment includes an
expectation of the operating efectiveness of controls, the
auditor is required to test those controls to support the
risk assessment.
In addition, when the auditor plans to rely on internal
control, the auditor is required to perform tests of
controls to obtain audit evidence about their operating
efectiveness.

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Substantive procedures (SP)
There are 2 categories of substantive
procedures:
1. Test of details of classes of transactions,
account balances and disclosures.
2. Substantive Analytical Procedures (SAP)

Diference between TOC and SP is TOC


looks for deficiency or non-compliance in
the application of controls, while SPs are
concerned with monetary errors.

Aud 390 - Betsy Jomitin


Established criteria:are standards or framework that
the auditor used to evaluate information, eg
established criteria are the Financial reporting
standards, Companies Act 1965, Auditing Standards

Analytical Procedures: use of comparisons and


relationships to assess whether account balances or
other data appear reasonable
Identify potential misstatements
Consider factors that afect the risk of material
misstatement
Design the nature, timing and extent of further audit
procedures

Aud 390 - Betsy Jomitin

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