AT07 Gathering Audit Evidence PDF

AT07: GATHERING AUDIT EVIDENCE The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. “Audit evidence” is information used by the auditor in arriving at the conclusions on which the opinion...

AT07: GATHERING AUDIT EVIDENCE The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. “Audit evidence” is information used by the auditor in arriving at the conclusions on which the opinion is based, and includes the information contained in the accounting records underlying the financial statements and other information. Accounting records generally include: the records of initial accounting entries and supporting records, such as checks and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal entries and other adjustments to the financial statements that are not reflected in journal entries; and records such as work sheets and spreadsheets supporting cost allocations, computations, reconciliations and disclosures. Other information that the auditor may use as audit evidence includes: minutes of meetings; confirmations from third parties; analysts’ reports; comparable data about competitors (benchmarking); controls manuals; information obtained by auditors from such audit procedures as inquiry, observation, and inspection; and other information developed by, or available to, the auditor that permits the auditor to reach conclusions through valid reasoning. When designing and performing audit procedures, the auditor shall consider the relevance and reliability of the information to be used as audit evidence. When information to be used as audit evidence has been prepared using the work of a management’s expert, the auditor shall, to the extent necessary, having regard to the significance of that expert’s work for the auditor’s purposes,: a) evaluate the competence, capabilities and objectivity of that expert; b) obtain an understanding of the work of that expert; and c) evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion. When using information produced by the entity, the auditor shall evaluate whether the information is sufficiently reliable for the auditor’s purposes, including as necessary in the circumstances: a) Obtaining audit evidence about the accuracy and completeness of the information; and b) Evaluating whether the information is sufficiently precise and detailed for the auditor’s purposes. When designing tests of controls and tests of details, the auditor shall determine means of selecting items for testing that are effective in meeting the purpose of the audit procedure. The means available to the auditor for selecting items for testing are: a) Selecting all items (100% examination). 100% examination may be appropriate when: 1. The population constitutes a small number of large value items; 2. There is a significant risk and other means do not provide sufficient appropriate audit evidence; or 3. The repetitive nature of a calculation or other process performed automatically by an information system makes a 100% examination cost effective. b) Selecting specific items. Specific items selected may include: 1. High value or key items. 2. All items over a certain amount. 3. Items to obtain certain information. c) Audit sampling. Audit sampling is designed to enable conclusion to be drawn about an entire population on the basis of testing a sample drawn from it. If audit evidence obtained from one source is inconsistent with that obtained from another, or the auditor has doubts over the reliability of information to be used as audit evidence, the auditor shall determine what modifications or additions to audit procedures are necessary to resolve the matter, and shall consider the effect of the matter, if any, on other aspects of the audit. The following generalizations can be made about the reliability of audit evidence: a) Audit evidence is more reliable when it is obtained from independent sources outside the entity. b) Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective. c) 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). d) Audit evidence is more reliable when it exists in a 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). e) Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles, or documents that have been filmed, digitized or otherwise transformed into electronic form, the reliability of which may depend on the controls over their preparation and maintenance. Financial statement assertions Financial statement assertions are assertions by management, explicit or otherwise, that are embodied in the financial statements and can be categorized as follows: (a) Assertions about classes of transactions and events for the period under audit: 1. Completeness—all transactions and events that should have been recorded have been recorded. 2. Occurrence—transactions and events that have been recorded have occurred and pertain to the entity. 3. Cutoff—transactions and events have been recorded in the correct accounting period. 4. Accuracy—amounts and other data relating to recorded transactions and events have been recorded appropriately. 5. Classification—transactions and events have been recorded in the proper accounts. (b) Assertions about account balances at the period end: 1. Completeness—all assets, liabilities and equity interests that should have been recorded have been recorded. 2. 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. 3. Existence—assets, liabilities, and equity interests exist. 4. Rights and obligations—the entity holds or controls the rights to assets, and liabilities are the obligations of the entity. (c) Assertions about presentation and disclosure: 1. Completeness—all disclosures that should have been included in the financial statements have been included. 2. Occurrence and rights and obligations—disclosed events, transactions, and other matters have occurred and pertain to the entity. 3. Classification and understandability—financial information is appropriately presented and described, and disclosures are clearly expressed. 4. Accuracy and valuation—financial and other information are disclosed fairly and at appropriate amounts. The auditor may use the assertions as described above or may express them differently provided all aspects described above have been covered. Audit procedures for obtaining audit evidence 1. RISK ASSESSMENT PROCEDURES Obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and assertion levels.  2. TESTS OF CONTROLS When necessary or when the auditor has determined to do so, test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. 3. SUBSTANTIVE PROCEDURES Detect material misstatements at the assertion level. These include substantive analytical review procedures and tests of details. Examples of audit procedures 1. INSPECTION – consists of examining records and documents, whether internal or external, in paper form, electronic form, or other media. Inspection of tangible assets consists of physical examination of the assets. 2. OBSERVATION – consists of looking at a process or procedure being performed by others. 3. INQUIRY – consists of seeking information of knowledgeable persons, both financial and non- financial, within the entity or outside the entity. 4. EXTERNAL CONFIRMATION – represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium. 5. RECALCULATION – consists of checking the mathematical accuracy of documents or records. It may be performed manually or electronically. 6. REPERFORMANCE – is the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control, either manually or through the use of CAATs. 7. ANALYTICAL PROCEDURES – consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. It also encompasses the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. AUDIT EVIDENCE – SPECIFIC CONSIDERATIONS FOR SELECTED ITEMS Inventory When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by: a) Attendance at physical inventory counting, unless impracticable, to: 1) Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting; 2) Observe the performance of management’s count procedures; 3) Inspect the inventory; and 4) Perform test counts; and b) Performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results. If unable to attend the physical inventory count on the date planned due to unforeseen circumstances, the auditor shall make or observe some physical counts on an alternative date, and perform audit procedures on intervening transactions. If attendance at physical inventory counting is impracticable, the auditor shall perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory. If it is not possible to do so, the auditor shall modify the opinion in the auditor’s report in accordance with PSA 705 (Revised and Redrafted), “Modifications to the Opinion in the Independent Auditor’s Report.” When inventory under the custody and control of a third party is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following: a. Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity. b. Perform inspection or other audit procedures appropriate in the circumstances. Litigation and claims The auditor shall design and perform audit procedures in order to identify litigation and claims involving the entity which may give rise to a risk of material misstatement, including: a) Inquiry of management and, where applicable, others within the entity, including in- house legal counsel; b) Reviewing minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel; and c) Reviewing legal expense accounts. If the auditor assesses a risk of material misstatement regarding litigation or claims that have been identified, or when audit procedures performed indicate that other material litigation or claims may exist, the auditor shall, in addition to the procedures required by other PSAs, seek direct communication with the entity’s external legal counsel through a letter of general inquiry. A letter of general inquiry, prepared by management and sent by the auditor, requests the entity’s external legal counsel to inform the auditor of any litigation and claims that the counsel is aware of, together with an assessment of the outcome of the litigation and claims, and an estimate of the financial implications, including costs involved. If it is considered unlikely that the entity’s external legal counsel will respond appropriately to a letter of general inquiry, the auditor may seek direct communication through a letter of specific inquiry, which includes: A list of litigation and claims. Where available, management’s assessment of the outcome of each of the identified litigation and claims and its estimate of the financial implications, including costs involved. A request that the entity’s external legal counsel confirm the reasonableness of management’s assessments and provide the auditor with further information if the list is considered by the entity’s external legal counsel to be incomplete or incorrect. The auditor considers the status of legal matters up to the date of the audit report. If management refuses to give the auditor permission to communicate with the entity’s lawyers, this would be a scope limitation and should ordinarily lead to a qualified opinion or a disclaimer of opinion. Segment information The auditor shall obtain sufficient appropriate audit evidence regarding the presentation and disclosure of segment information in accordance with the applicable financial reporting framework by: a) Obtaining an understanding of the methods used by management in determining segment information, and: (i) Evaluating whether such methods are likely to result in disclosure in accordance with the applicable financial reporting framework; and (ii) Where appropriate, testing the application of such methods; and b) Performing analytical procedures or other audit procedures appropriate in the circumstances. EXTERNAL CONFIRMATIONS 1. External confirmation – Audit evidence obtained as a direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium. 2. Positive confirmation request – A request that the confirming party respond directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request, or providing the requested information. 3. Negative confirmation request – A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request. When using external confirmation procedures, the auditor shall maintain control over external confirmation requests, including: a) Determining the information to be confirmed or requested; b) Selecting the appropriate confirming party; c) Designing the confirmation requests, including determining that requests are properly addressed and contain return information for responses to be sent directly to the auditor, and d) Sending the requests, including follow-up requests when applicable, to the confirming party. If management refuses to allow the auditor to send a confirmation request, the auditor shall:  e) Inquires as to management’s reasons for the refusal, and seek audit evidence as to their validity and reasonableness; f) Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit procedures; and g) Perform alternative procedures designed to obtain relevant and reliable audit evidence. AUDITING ACCOUNTING ESTIMATES Accounting estimate means an approximation of the amount of an item in the absence of a precise means of measurement. This term is used for an amount measured at fair value where there is estimation uncertainty, as well as for other amounts that require estimation. Management is responsible for making accounting estimates and disclosures included in financial statements. Risk of material misstatement is greater when accounting estimates are involved. Thus, PSA 540 requires the auditor to obtain sufficient appropriate audit evidence regarding accounting estimates. The auditor should determine whether accounting estimates included in the financial statements are: a) Reasonable in the circumstances To be considered reasonable in the circumstances, an estimate shall possess the below characteristics. Assumptions deviating from at least one of the above characteristics will require the auditor to pay particular attention to such assumptions. ✓ Objective and not susceptible to bias ✓ Consistent with historical patterns (accounting policies adopted by the entity are consistently applied) ✓ Consistent with industry guidelines b) Properly accounted for and appropriately disclosed as required To plan the nature timing and extent of the audit procedures, the auditor uses his understanding of the procedures and methods, including the accounting and internal control systems, used by management in making the accounting estimates. The auditor should adopt one or a combination of the following approaches in the audit of an accounting estimate: c) review and test the process used by management to develop the estimate d) use an independent estimate for comparison with that prepared by management e) review subsequent events which confirm the estimate made AUDIT DOCUMENTATION Audit documentation that meets the requirements of PSA 230 and the specific documentation requirements of other relevant PSAs provides: Evidence of the auditor’s basis for a conclusion about the achievement of the overall objective of the auditor; and Evidence that the audit was planned and performed in accordance with PSAs and applicable legal and regulatory requirements. Audit documentation – The record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached. Audit file – One or more folders or other storage media, in physical or electronic form, containing the records that comprise the audit documentation for a specific engagement. Experienced auditor – An individual (whether internal or external to the firm) who has practical audit experience, and a reasonable understanding of: Audit processes; PSAs and applicable legal and regulatory requirements; The business environment in which the entity operates; and Auditing and financial reporting issues relevant to the entity’s industry. The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand: a) The nature, timing, and extent of the audit procedures performed to comply with PSAs and applicable legal and regulatory requirements; b) The results of the audit procedures and the audit evidence obtained; and  c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions. In documenting the nature, timing and extent of audit procedures performed, the auditor shall record: a) The identifying characteristics of the specific items or matters tested; b) Who performed the audit work and the date such work was completed; and c) Who reviewed the audit work performed and the date and extent of such review. The auditor shall document discussions of significant matters with management, those charged with governance, and others, including the nature of the significant matters discussed and when and with whom the discussions took place. If the auditor identified information that is inconsistent with the auditor’s final conclusion regarding a significant matter, the auditor shall document how the auditor addressed the inconsistency. If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement in a PSA, the auditor shall document how the alternative audit procedures performed achieve the aim of that requirement, and the reasons for the departure. If, in exceptional circumstances, the auditor performs new or additional audit procedures or draws new conclusions after the date of the auditor’s report, the auditor shall document: a) The circumstances encountered; b) The new or additional procedures performed, audit evidence obtained, and conclusions reached, and their effect on the auditor’s report; and c) When and by whom the resulting changes to audit documentation were made and reviewed. Assembly of the final audit file The auditor shall complete the assembly of the final audit file on a timely basis after the date of the auditor’s report. As PSQC 1 indicates, 60 days after the date of the auditor’s report is ordinarily an appropriate time limit within which to complete the assembly of the final audit file.