Acc 323 Chapter 7: Audit Evidence

Quick Ratio

(Cash + Marketable Securities + Net Accounts Receivable) / Current Liabilities

Cash Ratio

(cash + marketable securities )/ current liabilities

Return on Common Equity

(net income - preferred dividends) / average stockholders equity

Gross Profit Percentage

(net sales - COGS) / net sales

Characteristics of Audit Documentation

-Identified with Clients name, period covered, description of contents, initials of preparer, date and index code -Should be indexed and cross-referenced to aid in organizing and filing -must clearly indicate audit work performed (done by: E-signature or initialing, a written memo, or notations directly to the schedule) -should include sufficient information to fulfill the objectives it was designed for

Major Supporting Schedules

Analysis, trial balance or list, reconciliation of amounts, substantive analytical procedures, summary of procedures, examination of supporting documents, informational, outside documentation

Auditor's direct knowledge

Evidence obtained directly by the auditor through physical examination, observation, recalculation, and inspection is more reliable than information obtained indirectly (ex: auditor calculates clients gross margin % and compares it to prior periods)

Independence of Provider

Evidence obtained from a source outside the entity is more reliable than that obtained from within (ex: communications with banks, attorneys or customers)

Internal vs External Documents reliability

External documents are generally more accepted as reliable evidence, but internal documents as long as created and processed under effective internal control

Provide Evidence Supporting an Account Balance

If reliable relationships exist, substantive analytical procedures can be used to support account balances.

Reliability of evidence

the extent to which evidence is believable or worthy of trust; evidence is reliable when it is obtained (1) from an independent provider, (2) from a client with effective internal controls, (3) from the auditor's direct knowledge, (4) from qualified providers such as law firms and banks, (5) from objective sources, and (6) in a timely manner

Short-term debt paying ability ratios

cash ratio, quick ratio, current ratio -Used to measure liquidity to pay off short term debts when they become due

Compare client data with client-determined expected results

companies prepare budgets for various aspects and financial results in order to set expected results/goals for the year; auditors should investigate significant differences

Artificial Inteligence

computers perform routine, repetitive processes and begin to learn or develop "intelligence" that allows them to recognize patterns and take actions automatically

Inquires of the Client

the obtaining of written or oral information from the client in response to questions from the auditor; usually not regarded as conclusive due to lack of independence

Sufficiency of Evidence

the quantity of evidence; proper sample size

Audit Data Analytics (ADAs)

the science and art of discovering and analyzing patterns, identifying anomalies, and extracting other useful information in data underlying or related to the subject matter of an audit through analysis, modeling, and visualization for purpose of planning or performing the audit

vouching

the use of documentation to support recorded transactions or amounts

Use of Evidence for an Audit

to determine whether financial statements are fairly presented

Debt to Equity

total liabilities/total equity

How ADAs are used

used throughout entire process from planning to completion -Accessing data to make sure use is applicable -Preparing the data(Scrubbing errors) -Evaluating relevance and reliability of data -Can Examine 100% of the items in a large population, but due to this a large number of exceptions may arise and require auditor confrontation

Substantive Analytical Procedures

used to obtain evidential matter about particular assertions related to account balances or classes of transactions; could eliminate the need to perform detailed test depending on the significance of the account, predictability of the relationship and reliability of the underlying data

Tracing

using reports to satisfy the completeness of the acquisition journal(following an assets movement from reception into use)

Deep Learning

computes are trained to recognize large numbers of data that would be impossible for humans to process, but is modeled after the structure and thinking process of a human brain; involves reading vast amounts of data multiple times to allow the computer to better understand true exceptions

Observation

consists of looking at a process or procedure being performed by others; can arise from general plant tours or watching individuals perform tasks

Trial Balance or List Schedule

consists of the details that make up a year-end balance of a general ledger account (Only year end balances)

Informational Schedules

contains information for tax returns and SEC form 10-K and data such as budgets and client's working hours

Current Ratio

current assets/current liabilities

Confirmation

describes the receipt of a direct written response from a third party verifying the accuracy of information that was requested by the auditor; are highly regarded due to them coming from a third party, but can be costly and cause some inconvenience

Analysis schedule

designed to show activity in a general ledger account during the entire period under the audit, tying together beginning and ending balances

Qualifications of Individuals Providing the information

evidence will not be reliable unless individual providing information is aware of what is going on (ex:auditor examining an inventory of diamonds who is not trained to distinguish between diamonds and cubic zirconia)

Certainty of conclusions from evidence

high level of assurance

Substantive Analytical Procedures Schedule

include evidence documenting the auditor's expectations of the balance in an account

Return on Assets

income before taxes/average total assets

Moderately costly evidence

inspection(Depends on whether data is provided or needs to be found independently), analytical procedures(Much cheaper than examination and confirmation, but require professional judgement), reperformance(depends on nature of procedure being reproduced)

Recalculation

involves rechecking a sample of calculations made by the client; consists of testing the client's arithmetical accuracy and includes such procedures as extending sales invoices and inventory, adding journals and subsidiary records and checking calculation of depreciation expense

Machine Learning

involves the use of statistical techniques that allow the computer to learn from the data to progressively improve performance of a specific task; could learn from auditors evaluations of flagged exceptions

Audit Program

list of audit procedures for an audit area or entire audit; also usually includes sample sizes, items to select, and timing of tests; normally one is created for each component of an audit(one for AR, one for Sales, one for Inventory etc)

Profitability Ratios

measure a company's ability to generate cash for payment of obligations, expansion and dividends Earnings Per Share, Gross Profit Percent, Profit Margin, Return on Assets, Return on Common Equity

Earnings per Share

net income - preferred dividends / weighted average common shares outstanding

Outside documentation Schedule

not technically a schedule but is filed and indexed; consists of confirmation replies and copies of client engagements

Adjusting Entries

often prepared by the auditor but must be approved by the client; only those significantly affecting the fair presentation of financial statements must be recorded

Times Interest Earned

operating income/interest expense

Profit margin

operating income/sales

Most Expensive types of Evidence

physical examination and confirmation (Physical examination requires auditor's presences, confirmation because the auditor must follow careful procedures)

Audit documentation (working papers)

record of the audit procedures performed, relevant audit evidence, and conclusions the auditor reached; all necessary information to adequately conduct the audit and provide support for audit report

appropriateness of evidence is comprised of

reliability and relevance of evidence

Examination of Supporting Documents

show detailed tests performed, such as documents examined during tests of controls and substantive tests of transactions

Unusual Fluctuations

significant unexpected differences indicated by analytical procedures between the current year's unaudited financial data and other data used in comparisons; when significant difference exist and are not expected or vice versa

Reconciliation of Accounts Schedule

supports a specific amount and is normally expected to tie the amount recorded in the client's record to another source of information

Tick Marks

symbols used on an audit schedule that provide additional information or details of audit procedures performed

Inspection

the auditor's examination of the client's documents and records to substantiate the information that is or should be included in the financial statements; widely used as evidence because it is readily available and low cost

Reperformance

the auditors independent tests of client accounting procedures ot controls that were originally done as part of the entity's accounting and internal control system

Persuasiveness of evidence

the degree to which the auditor is convinced that the evidence supports the audit opinion

Audit Procedures

the detailed instruction that explains the audit evidence to be obtained during the audit, any auditor should be able to follow these instructions

Audit Documentation provides

1. Basis for planning the audit 2. Record of the evidence accumulated and the results of the tests 3. Data for determining the proper type of audit report 4. Basis for review by supervisors and partners

Special Concerns of Client Budgets

1. Evaluate whether the budget were realistic plans 2. current financial information was changed by client personnel to conform to the budget

Factors determining appropriate sample size in audits

1. Expectation of Misstatement 2. Effectiveness of Internal Controls

Characteristics of reliable Evidence

1. Independence of Provider 2. Effectiveness of client's internal controls 3. Auditor's direct Knowledge 4. Qualifications of Individuals providing the information 5. Degree of Objectivity 6. Timeliness

Auditors compare client data with

1. Industry data 2. Similar prior-period data 3. Client-determined expected results 4. Auditor-determined expected results

Types of Audit Evidence

1. Physical examination 2. Confirmation 3. Inspection 4. Analytical procedures 5. Inquiries of the client 6. Recalculation 7. Reperformance 8. Observation

Analytical Procedures Performance Required

1. Planning Phase (part of risk assessment procedures, help with determining nature, extent and timing of audit procedures) 2. Completion Phase (act as a final check/test for material misstatements or financial problems)

Types of AI used in Audits

1. Robotics 2. Machine Learning 3. Deep Learning

Purposes of Analytical Procedures

1. Understand the Client's industry and Business 2. Assess the Entity's ability to continue as a going concern 3. Indicate the presence of Possible Misstatements in the Financial Statements 4. Provide Evidence supporting an Account Balance

4 Audit Decisions about evidence gathering

1. Which Audit procedures to use 2. What Samples size to select for a procedure 3. Which items to select from the population 4. When to perform procedures

Ability to meet long-term debt obligations

1. debt to equity 2. times interest earned

Days to Collect Receivables

365 days / accounts receivable turnover

Days to Sell Inventory

365/inventory turnover

Compare Client Data with Similar Prior-Period Data

Able to identify trends in a company and see if anything looks off, either due to changes in economic conditions/standing or material misstatement (Ex: Current Year's Balance with that of a preceding Year, Compare details of total balance with that of preceding Year, comput ratios and percent relationships)

Ownership of Audit Files

All audit files are the property of the auditor

Analytical Procedures

Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data. (Ex: comparing gross margin from this year with last years and investigate fluctuations)

Requirements for retention of Audit Documentation

Auditing standards require records of private companies be retained for a minimum of five years. Sarbanes-Oxley Act requires auditors of public companies to maintain audit files for a minimum of seven years.

Party Evaluating Evidence

Auditor

Nature of Conclusions

Auditor issues a audit report/opinion

Sample Size for Procedure

Auditor must decide appropriate size for every procedure, can vary due to extent of automated controls and level of assurance required

Items to select from the population

Auditor must decide in what manner they want to select, could be the first of the population, largest, completely random, most likely to be an error or any combination

Inventory Turnover

COGS/Average Inventory

Assess the Entity's Ability to Continue as a Going Concern

Certain Analytical procedures can help auditors assess the likelihood of a company failing (Ex: higher than normal total debt to net worth ratio)

Use of Advanced Technologies in Audits

Many advances have been through the use of Artificial Inteligence

Evaluation of Persuasiveness of Evidence

Must take into account the combined effect of appropriateness and Sufficiency, just having one or the other is not enough

Accounts Receivable Turnover

Net Sales / Average Accounts Receivable

timing of procedure performance

Normally audits are not completed until weeks or months after the end of a period, so procedures could be very early in the the period to long after (can be affected by when client needs audit completed) -SEC requires filing 60-90 days after period depending on size of company

Degree of Objectivity

Objective evidence is more reliable than evidence that requires considerable judgement to determine whether it is correct (Ex: confirmation of AR with customers and bank balances)

Least Expensive Evidence

Observation(Done during other audit procedures), inquiries(Done extensively on every audit), and recalculation(involves simple calculations, tracing can be done and computer software can now do it)

Understanding the Client's Industry and Business

Performing analytical procedures can highlight changes between a company's performance year over year and these changes can represent important trends/events

Compare Client and Industry Data

Pros: Aid in helping understand the client's business and as an indication of financial failure, can also be helpful in identify material misstatement Cons: Cover many companies so may not be the most useful for comparison (Clients line of business is different, uses different accounting methods etc)

Evidence Alternatives

Rarely is the only one type of evidence available, but the auditor must take into account the persuasiveness and cost of obtaining a different piece of evidence

Indicate the Presence of Possible Misstatements in the Financial Statements

Significant unexpected difference between the current year's unaudited financial data and other data in comparison can reflect possible misstatement

Typical Consequences of incorrect conclusions

Statement users make incorrect decisions and auditor may be sued

Summary of Procedures Schedule

Summarizes the results of a specific audit procedure, includes the extent of testing, misstatements found and auditor's conclusion based on testing

Analytical Procedures Performance not Required

Testing Phase(Often done in conjunction with other audit procedures; must be recorded if substantive)

Confidentiality of Audit Files

The AICPA Code of Professional Conduct states that a member in public practice shall not disclose any confidential client information without the specific consent of the client.

Reliability of Evidence

The diagnosticity of evidence—that is, whether the type of evidence can be relied on to signal the true state of the assertion.

Physical Examination

The inspection or count of a tangible asset by the auditor; one of the most reliable and useful types of evidence as it verifies the actual existence of an asset

Relevance of Evidence

The relevance of audit evidence refers to its relationship to the assertion or to the objective of the control being tested; can only be considered in terms of specific audit objectives

Type of Evidence Gathered for Audit

Varies depending on what the auditor, third parties and client can generate/deem required

Effectiveness of Client's internal controls

When a client's internal controls are effective, evidence obtained is more reliable than when they are not effective (ex: internal controls over sales and billings are effective, auditor can obtain more evidence from invoices)

External document

a document that has been used by an outside party to the transaction being documented and that the client now has or can easily obtain (Ex: vendor's invoices, cancelled notes payable and insurance policies)

Internal Document

a document that is prepared and used within the client's organization (ex: sales invoices, employee time reports, inventory receiving reports)

Working trial Balance

a listing of the general ledger accounts and their year-end balances

Appropriateness of Evidence

a measure of the quality of evidence, meaning its relevance and reliability in meeting audit objectives for classes of transactions, account balances, and related disclosures

lead schedule

a summary of the accounts in or components of an account group

Liquidity Activity Ratios

accounts receivable turnover, days to collect receivables, inventory turnover, days to sell inventory -Measure the time it takes less liquid, current assets to be turned into cash

Current Files

all audit files applicable to the year under audit; Includes things like: -Audit Program -Working Trial Balance -Adjusting Entries -Supporting Schedules

Audit Evidence

any information used by the auditor to determine whether the information being audited is state in accordance with established criteria (Can vary greatly in the extent to which it persuades the auditor

Determinants of Persuasiveness of Evidence

appropriateness and sufficiency

Compare client data with auditor-determined expected results

auditor calculates expected balance for comparison with actual balance by relating it to some other balance sheet or income statement account or by making a projection

Permanent Files

auditors' files that contain data of a historical or continuing nature pertinent to the current audit such as copies of articles of incorporation, bylaws, bond indentures, and contracts, analyses from previous years of accounts that have continuing importance to auditor, information related to understanding internal controls, and results of analytical procedures from previous years

Robotics

can perform rule based processes at rapid-speed; can be used to automate processes that are based on prescribed protocols with high levels of precision and efficiency

Timeliness

can refer either to when it is accumulated or the period covered by the audit, evidence acquired closer to the date of the balance sheet is more accurate (Ex: confirmation of AR on balance sheet date is more accurate than two weeks before confimation)