Auditing Session 4 Evidence Gathering And Documentation 2023/2024 - University of Ghana PDF

ACCT 004 AUDITING SESSION 4 EVIDENCE GATHERING AND DOCUMENTATION Hadija N. Nyante, (PhD) - [email protected] 2023/2024 Academic 2022/2023 AcademicYear...

ACCT 004 AUDITING SESSION 4 EVIDENCE GATHERING AND DOCUMENTATION Hadija N. Nyante, (PhD) - [email protected] 2023/2024 Academic 2022/2023 AcademicYear Year 1  Session Overview The focus of a financial statements audit is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework (e.g. International Financial Reporting Standards). Such opinions must be based on sufficient and appropriate audit evidence documented for further reviews. This session seeks to introduce students to evidence gathering, sufficient and appropriate evidence, and documentation. 2022/2023 Academic Year HNNyante 7/16/2024 Slide 2  Learning Objectives At the end of the session, the student will be able – Explain the meaning of sufficient and appropriate evidence in auditing – Discuss risk assessment and test of control involved in evidence gathering – Describe sampling in auditing – Identify and explain other means of gathering evidence 2022/2023 Academic Year – Discuss documentation in auditing HNNyante 7/16/2024 Slide 3  Session Outline This session covers the following topics – Concept of Audit Evidence – Management Assertions – Reliability of Evidence – Audit Procedures for Evidence Gathering – Substantive test – Risk Assessment Procedures – Test of Controls – Audit sampling – Audit Documentation – Audit Risk Model 2022/2023 Academic Year HNNyante 7/16/2024 Slide 4  Reading List Read Chapter 7 and 10 of Bedi, I. (2009). Auditing& AssuranceServicesinGhana. Accra: Voyage Publishing Ltd., Accra Session Slides Other Auditing and Assurance text books available to students 2022/2023 Academic Year HNNyante 7/16/2024 Slide 5  Concept of Audit Evidence It is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based. It includes all the information contained in the accounting records underlying the financial statements. It includes all audit evidence obtained from audit procedures performed during the course of the audit. 2022/2023 Academic Year May include evidence from previous audit HNNyante 7/16/2024 Slide 6  Sufficient and Appropriate Audit Evidence Sufficiencyis a measure of the quantity of audit evidence. The quantity of audit evidence is affected by the risk of misstatement. The greater the risk, the more audit evidence that may be required. Appropriatenessis the measure of the quality of audit evidence; ie its relevance and reliability in providing support for, or detecting misstatements. The higher the quality of evidence available, 2022/2023 the less Academic Year the evidence that may be required. HNNyante 7/16/2024 Slide 7  Management Assertions Financial statements provide seven (7) main assertions; – “C” represents Completeness – “O” represents Occurrence – “V” represents Valuation – “E” represents Existence – “R” represents Rights and Obligations – “M” represents Measurement – “P” represents Presentation and Disclosure 2022/2023 Academic Year HNNyante 7/16/2024 Slide 8  Audit Procedures for Evidence Gathering Auditors use five types of tests to determine whether financial statements are fairly stated (give audit opinion): Risk assessment procedures Test of controls Substantive test of transactions Substantive analytical procedures 2022/2023 Academic Year Test of details HNNyante 7/16/2024 Slide 9  Audit Procedures for Evidence Gathering (Cont’d) The procedure adopted must allow the auditor to – Understand the business and its environment including risk (risk assessment) – Detect material misstatements Misstatement is when an item reported by management is presented wrongly and does confirm management assertions. A material misstatement is a misstatement in the financial statements that could reasonably be expected to influence the decisions of users of the financial 2022/2023statements. Academic Year HNNyante 7/16/2024 Slide 10 Evidence Gathering and Documentation Generalisation of evidence (Reliability of Audit Evidence) – Audit evidence is more reliable when it is obtained from independent sources outside the entity. – Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective. – Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the application of a control). – Audit evidence is more reliable when it exists in documentary form, whether paper, electronic, or other medium (for example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of the matters discussed). – Audit evidence provided by original documents is more reliable 2022/2023 Academic Year than audit evidence provided by photocopies or facsimiles. HNNyante 7/16/2024 Slide 11 Reliability of Certain Types of Audit Evidence TYPE EXAMPLE Most Physical Inventory Observation R Documentary E L – External Bank Confirmation I A – External/Internal Purchase Invoice B I – Internal Sales Invoice L I T Y 2022/2023 Academic Year Client Representations Letter of Representations Least  Substantive Test It is the test of details of transactions/balances and analytical procedures performed by the auditor to detect material misstatements in the account balance, transaction class and disclosure components of financial statements Types of substantive testing procedures are: – Inspection of Records or Documents – Inspection of Tangible Assets – Observation – Inquiry – Confirmation – Recalculation – Re-performance – Analytical Procedures: analysis of significant ratiosAcademic 2022/2023 and trends of relationships Year that are inconsistent with other relevant information or deviates from predictable amounts HNNyante 7/16/2024 Slide 13  Methodology for Designing Tests of Details of Balances 2022/2023 Academic Year HNNyante 7/16/2024 Slide 14  Risk Assessment Procedures The auditor performs the following risk assessment procedures to obtain an understanding of the entity and its environment, including internal controls; Inquiries of management and others within the entity. Analytical procedures. Observation and inspection. 2022/2023 Academic Year Discussions among the engagement team. HNNyante 7/16/2024 Slide 15  Test of Controls It is a test directed towards the design or operation of an internal control policy or procedure to assess its effectiveness in preventing or detecting material misstatement in the financial statement assertion. Also referred to as compliance test. For test of control to be effective, the auditor must obtain an understanding of the business (KYC) through walkthroughs. Procedures for test of controls; – Employs internal control questionnaires, – Examining reports on the controls usually by the internal auditor – Inspection of documents supporting transactions – Walk-through tests- in this case the auditor will initiate a transaction to see how well the system of control 2022/2023 works. Academic Year – Observations – Inquiries HNNyante 7/16/2024 Slide 16  Methodology for Designing Tests of Controls 2022/2023 Academic Year HNNyante 7/16/2024 Slide 17 Other forms of Evidence Gathering Management Representation – If management refuses to provide a representation that the auditor considers necessary, this constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer of opinion Attendance at Physical Inventory Counting Inquiry Regarding Litigation and Claims Valuation and Disclosure of Long-term Investments Segment Information Related Parties 2022/2023 Academic Year External confirmations HNNyante 7/16/2024 Slide 18  External Confirmation Audit evidence is more reliable when it is obtained from independent sources outside the entity. Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference. Audit evidence is more reliable when it exists in documentary form. Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles. Forms of External Confirmation – Positive confirmation – the respondent is to reply to the request in 2022/2023 Academic Year all cases – Negative confirmation – only replies if you disagree HNNyante 7/16/2024 Slide 19  Uses of External Confirmations – Bank balances and other information from bankers. – Accounts receivable balances. – Stocks held by third parties at bonded warehouses for processing or on consignment. – Property title deeds held by lawyers or financiers for safe custody or as security. – Investments purchased from stockbrokers but not delivered at the balance sheet date. – Loans from lenders. – Accounts payable balances. 2022/2023 Academic Year HNNyante 7/16/2024 Slide 20  Audit Sampling Is the application of audit procedures t less than 100% of items within a population (class of transaction or accounts balances) such that all sampling units have a chance of selection. The objective of audit sampling is to obtain and evaluate audit evidence about some characteristics of the items selected in order to form or assist informing a conclusion about the population. In sampling the audit must first consider the specific objectives to be achieved and the combination of audit procedures to be used2022/2023 to achieve the objective Academic Year of the audit. HNNyante 7/16/2024 Slide 21  Selecting Which Types of Tests to Perform Auditors typically use all five types of tests when performing an audit of the financial statements, but certain types may be emphasized, depending on the circumstances Several factors influence the auditor’s ch o ice o f t h e types o f tests to select: – The availability of the types of evidence – The relative costs of each type of test – The effectiveness of internal 2022/2023controls, and Academic Year inherent risks HNNyante 7/16/2024 Slide 22  Audit Sampling Auditors should determine sample size sufficient to reduce sampling risk to an acceptable low level Auditors should select sample items in such a way that each sampling unit in the population has a chance of selection. Two sampling approaches – Non-statistical sampling – auditor uses professional judgement to select items for the sample – Statistical sampling – sample items are selected at random so each sampling unit has a known chance 2022/2023 of being Academic Year selected HNNyante 7/16/2024 Slide 23  Audit Sampling Methods of selecting sample – Random selection –Systematic selection –Haphazard selection –Stratification selection –Value weighted selection 2022/2023 Academic Year –Monetary unit sampling (key items) HNNyante 7/16/2024 Slide 24  Audit Documentation 2022/2023 Academic Year HNNyante 7/16/2024 Slide 25  Audit Documentation The auditor must prepare, on a timely basis, audit documentation that provides: – A sufficient and appropriate record of the basis for the auditor’s report. – Evidence that the audit was performed in accordance with the applicable legal, regulatory and professional requirements. 2022/2023 Academic Year HNNyante 7/16/2024 Slide 26  Purpose of Audit Documentation Assisting the audit team to plan and perform the audit. Assisting members of the audit team responsible for supervision to direct and supervise the audit work, and to discharge their review responsibilities in accordance with ISA 220, “Quality Control for Audits of Historical Financial Information”. Enabling the audit team to be accountable for its work. Retaining a record of matters of continuing significance to future audits. Enabling an experienced auditor to conduct quality control reviews and inspections in accordance with ISQC 1, “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”. 2022/2023 Academic Year Enabling an experienced auditor to conduct external inspections in accordance with applicable legal, regulatory or other requirements. HNNyante 7/16/2024 Slide 27  Nature of Audit Documentation Audit documentation may be recorded on paper or on electronic or other media. It includes, for example, – audit programs – Analyses – issues memoranda – summaries of significant matters – letters of confirmation and representation – checklists, and correspondence (including e-mail) concerning significant matters. – Abstracts or copies of the entity’s records, for example, significant and specific contracts and agreements, may be included as part of audit documentation if considered appropriate The file must be properly outlined and referenced 2022/2023 Academic Year Documentation is a continuous process HNNyante 7/16/2024 Slide 28  The Audit Risk Model 2022/2023 Academic Year HNNyante 7/16/2024 Slide 29  Audit Risk Audit risk is the risk than an auditor may issue an unqualified opinion on materially misstated financial statements The auditor assesses engagement risk first, then sets audit risk Audit risk is inversely related to engagement risk – If the auditor accepts a client with high engagement risk The auditor must conduct a more rigorous audit The auditor does this by setting audit risk at a low level – If the auditor accepts a client with low engagement risk 2022/2023 Academic 30 Year The auditor will set audit risk at a higher level HNNyante 7/16/2024  Audit Risk and Materiality Audit risk and engagement risk relate to factors that might encourage someone to challenge the auditor's work For example, transactions that might not be material to a "healthy" company might be material to financial statement users for a company on the brink of bankruptcy The following factors help integrate the concepts of risk and materiality: – All audits involve sampling and cannot provide 100 percent assurance – Auditors must compete in an active marketplace for clients – Auditors need to understand society's expectations of financial reporting and the audit process – Auditors must identify the risky areas of a business to determine which accounts are more susceptible to material misstatement – Auditors need to develop methodologies 2022/2023 to allocateAcademic overall31 Year assessments of materiality to individual account balances HNNyante 7/16/2024  The Audit Risk Model The auditor sets desired audit risk based on assessed engagement risk AR = IR x CR x DR AR = Audit Risk IR = Inherent Risk CR = Control Risk DR = Detection Risk The audit risk model allows the auditor to consider the following: – Complex or unusual transactions are more likely to recorded in error than are simple or recurring transactions – Management may be motivated to misstate earnings or assets – Better internal controls mean a lesser likelihood of misstatement – The amount and persuasiveness of audit2022/2023 Academic evidence gathered 32 Year should vary directly with the likelihood of material misstatements HNNyante 7/16/2024  The Audit Risk Model Detection risk - risk audit procedures will fail to detect material misstatements – Relates to the effectiveness of audit procedures and their application – Detection risk is controlled by the auditor and is an integral part of audit planning – The level of detection risk set directly determines the rigor of the substantive 2022/2023 Academic Year audit work performed 33 HNNyante 7/16/2024  The Audit Risk Model Inherent Risk - Susceptibility of transactions to be recorded in error – Inherent risk is higher for some items: Complex transactions are more likely to be misstated than simple transactions Estimated balances more likely to be misstated than fact based balances – The auditor assesses inherent risk Control Risk - Risk client controls will fail to prevent or detect a misstatement – The quality of controls often varies between classes of transactions – The auditor assesses control risk 2022/2023 Academic 34 Year Environment Risk - inherent and control risks combined Reflects the likelihood of material misstatements occurring HNNyante 7/16/2024  Audit Risk Model AR = IR x CR x DR Audit risk is set inversely to the assessed level of engagement risk After audit risk is set, the auditor assesses inherent and control (environment) risks The auditor sets detection risk INVERSELY to environment risk – Example, if the auditor is examining transactions with high inherent risk, or weak controls, the auditor will set a low detection risk Low detection risk means a low probability of NOT detecting material misstatements – To achieve low detection risk, the auditor will have to perform more rigorous substantive testing – For example, larger sample sizes, more reliable forms of evidence, assign more experienced auditors, closer supervision, greater year-end (rather than interim) testing The audit risk model shows that the amount, nature, and timing of audit procedures depends on the level of audit risk2022/2023 Academic an auditor assumes,35 Year and the level of client-related risks HNNyante 7/16/2024  Audit Risk Model: Limitations Inherent risk is difficult to formally assess – Audit risk is subjectively determined – The model treats each risk component as separate and independent when clearly, this is not the case – Audit technology is not so precise that each component can be accurately assessed Because of these limitations, many auditors use the audit risk model as a functional, rather than 2022/2023 Academic 36 Year mathematical, model HNNyante 7/16/2024 Recommended Text 37