0:00:08.033,0:00:11.033
In this lesson we are going to learn all about
audit evidence.
0:00:11.033,0:00:16.066
Audit evidence is that stuff we gather as auditors
to support our opinion on the fairness of
presentation...
0:00:16.066,0:00:19.000
of the financial information prepared by
management.
0:00:19.000,0:00:22.033
Audit evidence must be documented.
0:00:22.033,0:00:26.033
Audit evidence must support risks at the
assertion level.
0:00:26.033,0:00:32.033
You remember what we talked about in our last
lesson about existence, completeness,
accuracy etc.
0:00:32.033,0:00:41.033
In fact, that’s where we start our story, that is by
determining which risks could result in risk of
material misstatement at the assertion level.
0:00:41.033,0:00:47.000
We are able to do this because auditors know
the business and the industry,
0:00:47.000,0:00:49.033
we can do more than just tic and bop.
0:00:49.033,0:00:56.033
We can identify balances with high risk
assertions, for whatever reason, and then focus
audit work on that area.
0:00:56.033,0:00:59.066
Perhaps it’s the valuation of an intangible asset.
0:00:59.066,0:01:03.033
Or the measurement of sales that involve
multiple deliverables.
0:01:03.033,0:01:08.066
Having identified those key risk assertions, we
design a procedure to gather evidence...
0:01:08.066,0:01:11.000
that addresses the risk associated with that
assertion.
0:01:11.000,0:01:15.033
In the case of the valuation of an intangible
asset,
0:01:15.033,0:01:22.066
we will need to inspect the future cash flow
analysis and compare the assumptions to our
own expectations.
0:01:22.066,0:01:29.000
In the case of multiple deliverables, we will need
to gather evidence to support the fair value of
each component,
0:01:29.000,0:01:34.066
and determine whether the company offers each
component separately, or only as a part of a
bundle.
0:01:34.066,0:01:41.000
These are complex examples, but intended to
illustrate how the procedures are tailored to
address specific risks.
0:01:41.000,0:01:47.033
An audit procedure is basically an instruction for
an auditor to perform to gather evidence.
0:01:47.033,0:01:53.033
However, designing a procedure in and of itself is
not enough, we also need to consider:
0:01:53.033,0:01:59.066
The sample size, because we are unlikely to
look at all the evidence available.
0:01:59.066,0:02:06.066
We also need to look at the sample selection
method, to ensure our approach is statistically
valid.
For example, in certain cases...
0:02:06.066,0:02:13.000
a random sample may be preferable to a
judgmentally selected sample, and vice-versa.
0:02:13.000,0:02:17.000
And we need to consider the timing of when to
perform the procedures.
0:02:17.000,0:02:22.000
For income statement accounts, we are
concerned about the activity that happens
throughout the year,
0:02:22.000,0:02:25.033
so we should sample and test throughout the
year.
0:02:25.033,0:02:29.066
For balance sheet accounts, we are more
concerned with the balance as at the year end
date,
0:02:29.066,0:02:35.033
and would try to perform as many audit
procedures as close to that date as possible.
0:02:35.033,0:02:42.066
An audit program is a list of audit procedures to
be performed for a particular area.
0:02:42.066,0:02:48.033
Audit programs are often computerized, and can
be easily tailored based on the risk
assessments.
0:02:48.033,0:02:54.000
And by tailored I mean we would plan on doing
more extensive procedures on areas with higher
risk.
0:02:54.000,0:03:00.033
Now we have a foundation upon which we can
discuss the persuasiveness of evidence.
0:03:00.033,0:03:05.066
GAAS requires the auditor to obtain Sufficient
Appropriate Audit Evidence...
0:03:05.066,0:03:08.033
to support their opinion on the financial
statements.
0:03:08.033,0:03:12.066
Let’s take a moment to better understand what
this really means.
0:03:12.066,0:03:16.066
Sufficiency speaks to the quantity of audit
evidence gathered,
0:03:16.066,0:03:22.066
and in general terms, the more evidence
gathered, the more persuasive it should be,
which only makes sense.
0:03:22.066,0:03:29.066
However, sample sizes are also impacted by the
effectiveness of the client’s system of internal
controls.
0:03:29.066,0:03:33.000
If we test the system of controls and convince
ourselves that the internal controls are effective,
0:03:33.000,0:03:38.066
our sample sizes can be reduced because we
are in essence,
0:03:38.066,0:03:44.066
relying in part on the client’s controls for part of
our warm fuzzy feeling.
0:03:44.066,0:03:47.000
Note we have two types of evidence here.
0:03:47.000,0:03:55.066
Test of control results is evidence that the
control system works and indirectly supports
the achievement of the management assertion.
0:03:55.066,0:04:00.066
Substantive test results is evidence directly
supporting the management assertion.
0:04:00.066,0:04:09.000
Appropriateness speaks to the quality of audit
evidence, that is, is the evidence gathered
relevant and reliable.
0:04:09.000,0:04:16.000
The higher the quality of evidence gathered, the
less of it you need before you are persuaded...
0:04:16.000,0:04:18.000
that the item of interest has been fairly
presented.
0:04:18.000,0:04:26.000
Relevance is achieved by gathering evidence
that specifically and directly addresses the
assertion of interest.
0:04:26.000,0:04:35.033
Reliability is enhanced as we gather evidence
that has been independently generated
separately from the client.
0:04:35.033,0:04:40.000
So for instance, the strongest type of evidence
comes from the auditors direct knowledge,
0:04:40.000,0:04:44.066
perhaps we saw it with our own eyes in the case
of an inventory count.
0:04:44.066,0:04:50.033
The next strongest source of evidence would
come from a provider independent of the client,
0:04:50.033,0:04:54.066
say a confirmation of the cash balance by the
bank itself.
0:04:54.066,0:05:00.033
When clients provide us with evidence, we need
to consider the strength of their internal control
system.
0:05:00.033,0:05:04.000
The stronger it is, the more persuasive the
evidence.
0:05:04.000,0:05:08.066
We should also consider the qualifications of the
individual providing evidence.
0:05:08.066,0:05:16.066
Those with expertise are far more persuasive
than those who provide evidence without
qualifications.
0:05:16.066,0:05:24.000
Consider evidence from specialists or lawyers
as being more persuasive than perhaps evidence
received from a customer.
0:05:24.000,0:05:32.000
Objectivity is important as we would prefer
evidence that is definitive over evidence that
requires judgement to interpret.
0:05:32.000,0:05:38.066
For instance, consider the subjectivity inherent
in a legal position for a lawsuit.
0:05:38.066,0:05:45.066
And lastly, sometimes multiple pieces of
evidence are required to corroborate an
assertion.
0:05:45.066,0:05:51.033
If all the evidence is pointing in the same
direction, that too is more persuasive.
0:05:51.033,0:05:58.000
Gathering evidence comes with a cost, so there
is continually a trade-off between the cost to
obtain evidence,
0:05:58.000,0:06:01.066
and obtaining the most persuasive evidence
possible.
0:06:01.066,0:06:10.033
There is tremendous pressure on auditors and
clients alike to be as efficient as possible in
conducting and containing the cost of the audit.
0:06:10.033,0:06:15.000
Now let’s talk about the ways in which auditors
gather evidence.
0:06:15.000,0:06:20.000
So far in this course I have been using nebulous
terms like “verify” to describe my audit
procedures.
0:06:20.000,0:06:27.033
This is actually a horrible descriptor as it really
doesn’t say what or how exactly the auditor is to
do it.
0:06:27.033,0:06:34.033
Similar sorts of bad language would include
“check”, “review”, “obtain”, “audit”…
0:06:34.033,0:06:38.000
Let’s look at better ways to describe and
perform our evidence gathering activity.
0:06:38.000,0:06:46.033
GAAS talks about inspection, observation,
inquiry, confirmation, recalculation,
reperformance and analytical procedures.
0:06:46.033,0:06:53.000
I’ll provide a brief description and the quality of
evidence provided by each of these sorts of
procedures.
0:06:53.000,0:06:58.066
Inspection is the physical examination of the
item of interest.
0:06:58.066,0:07:03.000
You could inspect the condition of a piece of
equipment by looking at it yourself.
0:07:03.000,0:07:07.033
You could also inspect a document that
supports an amount paid by the company.
0:07:07.033,0:07:16.000
Inspection is a wonderful way of getting at the
eexistence assertion, but note that it may do
nothing to cover off rights and obligations.
0:07:16.000,0:07:18.066
So you get the idea.
0:07:18.066,0:07:21.033
A couple of more points when it comes to
inspection and evidence.
0:07:21.033,0:07:26.033
First, keep in mind that internal documents are
less reliable than external documents.
0:07:26.033,0:07:34.066
Also, there is the concept of direction of testing
which is important for you to understand.
0:07:34.066,0:07:42.000
The so called “audit trail” is the trail of evidence
that exists in either paper or electronic form to
process a transaction.
0:07:42.000,0:07:52.033
For example, a sales transaction is initiated by
sales order, which might be mailed, faxed, or
electronically submitted through the internet.
0:07:52.033,0:07:57.066
Typically this triggers a shipping document,
which is used by the warehouse to pick an
order.
0:07:57.066,0:08:02.000
It gets dropped onto a truck which creates a bill
of lading indicating that the order has been
shipped.
0:08:02.000,0:08:09.033
This typically triggers an invoice to bill the
customer and set up a receivable and record a
sale in the general ledger.
0:08:09.033,0:08:12.000
This is an example of an audit trail.
0:08:12.000,0:08:16.033
Now if our audit objective is to verify the
existence assertion,
0:08:16.033,0:08:22.000
we would need to start at the general ledger and
work our way back to the source documents-
0:08:22.000,0:08:28.066
i.e. the sales invoice, then the bill of lading, and
then the shipping document and finally the sales
order.
0:08:28.066,0:08:31.000
This is called vouching a transaction.
0:08:31.000,0:08:36.066
However, if our audit objective is to verify the
completeness assertion,
0:08:36.066,0:08:44.000
we would start from the source documents and
work our way to the general ledger to ensure
that all shipments
0:08:44.000,0:08:45.000
have in fact been booked as revenue.
0:08:45.000,0:08:47.033
This is called tracing.
0:08:47.033,0:08:50.033
But between you and me, I can never keep the
terminology straight.
0:08:50.033,0:08:57.066
But it’s critically important that you understand
this notion of direction of testing because it’s
important for your inspection procedures.
0:08:57.066,0:09:00.066
Let’s look at another method of gathering
evidence.
0:09:00.066,0:09:05.000
Observation can be used to gather evidence by
seeing it for ourselves.
0:09:05.000,0:09:11.066
We may want to observe the client performing
certain control procedures as a test of control.
0:09:11.066,0:09:19.000
Observation, like inspection, has limitations
because what we observe may not happen all
the time.
0:09:19.000,0:09:23.066
Inquiry is another type of evidence gathering
procedure,
0:09:23.066,0:09:27.033
and it happens when we obtain written or oral
representations from the client.
0:09:27.033,0:09:34.000
This is extremely easy and cost effective
evidence to obtain, but rarely is sufficient in and
of itself.
0:09:34.000,0:09:41.066
Confirmation, on the other hand, happens
when we obtain written or oral representations
from independent third parties.
0:09:41.066,0:09:47.066
These parties verify the accuracy of the
information in management’s records.
0:09:47.066,0:09:55.033
This is much stronger evidence, but also
requires strict controls by the auditor to ensure
that the client...
0:09:55.033,0:09:57.066
does not interfere with the confirmation process.
0:09:57.066,0:10:01.066
It is also more costly to obtain confirmation
evidence.
0:10:01.066,0:10:06.000
Positive confirmations are the most common
form of confirmation.
0:10:06.000,0:10:11.000
We will confirm such things as the balance in
the bank account, loans outstanding, amounts
owed from...
0:10:11.000,0:10:14.066
customers and amounts due to suppliers.
0:10:14.066,0:10:20.033
Positive confirmation must be followed up and a
response obtained.
0:10:20.033,0:10:25.000
As a new auditor, you may find yourself
spending considerable time calling various
parties...
0:10:25.000,0:10:28.000
trying to solicit a response to your confirmation
request.
0:10:28.000,0:10:31.033
You may have to promise your first born child to
get a reply.
;-)
0:10:31.033,0:10:38.066
Negative confirmations are easier to
administer, but provide less persuasive evidence.
0:10:38.066,0:10:43.033
A negative confirmation is sent and the
respondent is only asked to reply if the amount
is wrong.
0:10:43.033,0:10:46.033
No follow up is required.
0:10:46.033,0:10:54.033
Another procedure is recalculation which
involves rechecking the computations performed
by the client to ensure arithmetical accuracy,
0:10:54.033,0:11:02.033
which is obviously important, but does not
address the assertions of existence,
completeness, right and obligations etc.
0:11:02.033,0:11:09.033
Computer-Assisted Audit Techniques, or
CAATs for short, can be used to help recalculate
huge quantities of data.
0:11:09.033,0:11:13.066
Audit software that you may come across
includes ACL and IDEA.
0:11:13.066,0:11:23.000
Basically, it works by importing to your laptop
such data as the inventory file, receivable file,
the general ledger etc.
0:11:23.000,0:11:27.000
Once the data is imported, you can do all sorts
of recalculation tests,
0:11:27.000,0:11:33.000
such as testing the inventory extensions or
aging the receivables to compare against the
client’s records.
0:11:33.000,0:11:39.000
Our next audit evidence gathering techique is
reperformance.
Reperformance is often used to
test controls.
0:11:39.000,0:11:47.000
Here the auditor reperforms the internal control
procedure to determine if the client has done it
correctly and effectively.
0:11:47.000,0:11:51.000
Once again, an auditor may use a computer to
help out.
0:11:51.000,0:11:59.000
A CAAT can be used to test those electronic
internal controls that are baked into the client’s
IT systems.
0:11:59.000,0:12:05.000
This can be a very efficient way to audit a client
who has a strong IT system as once you
prove...
0:12:05.000,0:12:12.000
that the IT system is working effectively, you
need not prove it over and over again unless
there is a change to the code.
0:12:12.000,0:12:17.000
One example is to use dummy data and have
the system process it to see what happens.
0:12:17.000,0:12:21.066
If it is processed correctly, you’ve got a system
you can rely on,
0:12:21.066,0:12:29.066
and that saves you the need for doing a whole
bunch of manual recalculation procedures.
0:12:29.066,0:12:35.033
Analytical procedures are those that compare
the current result against an expectation to...
0:12:35.033,0:12:39.066
determine whether the results appear
reasonable.
0:12:39.066,0:12:43.033
If you think that sounds a little bit wishy-washy,
you would be right,
0:12:43.033,0:12:53.066
but that’s only because analytical procedures
encompass a very broad spectrum of analysis
that can be performed and rarely stand alone.
0:12:53.066,0:12:59.066
The key is to determine what a reasonable
expectation is and there are many ways to go
about this.
0:12:59.066,0:13:06.033
Some are simple, for instance comparing a
result against the prior year or a client prepared
budget, if realistic.
0:13:06.033,0:13:11.066
However, it can get much more complex as you
get into ratio analysis, industry analysis,
0:13:11.066,0:13:20.033
regression analysis, and other statistical
techniques that can be used to determine a
plausible basis for an expectation.
0:13:20.033,0:13:32.033
Some sophiticated analytical procedures can
provide you with very high confidence levels over
your findings, which is not wishy-washy at all.
0:13:32.033,0:13:38.000
You should be well versed in financial statement
and ratio analysis to effectively use analytical
review as an audit technique.
0:13:38.000,0:13:44.066
For a refresher on ratio analyis, you can take
the Financial Literacy course...
0:13:44.066,0:13:46.066
at the FinanceLearningAcademy.com to
learn more.
0:13:46.066,0:13:56.033
Having defined the expectation, you now are
able to drill into actual results that are different
or unexplained or unusual.
0:13:56.033,0:14:01.000
Analytical procedures are so important that they
are used throughout all phases of the audit.
0:14:01.000,0:14:07.000
During the planning phase, analytical
procedures help identify areas of focus.
0:14:07.000,0:14:13.066
Analytical procedures can also be used to
assess the entity’s ability to continue as a going
concern,
0:14:13.066,0:14:19.033
which means that the entity has sufficient
liquidity to meet its obligations as they come
due.
0:14:19.033,0:14:24.033
This is an extremely important assessment
because if the entity fails this evaluation,
0:14:24.033,0:14:32.066
then it casts an entirely different light on the
financial statements and requires incremental
reporting considerations for the client.
0:14:32.066,0:14:37.000
During the execution phase, analytical
procedures are an important piece of audit
evidence.
0:14:37.000,0:14:43.033
In fact, often an analytical procedure can be a
very effective form of evidence that would
alleviate,
0:14:43.033,0:14:46.033
or reduce the need for detailed auditing testing.
0:14:46.033,0:14:54.033
For example, interest expense can often be
estimated by taking the loan balance
outstanding and the interest rate.
0:14:54.033,0:15:02.000
If this estimate of interest expense is very close
to what has been reported by the client, then
further procedures may not be necessary.
0:15:02.000,0:15:12.000
During the completion and reporting phase,
analytical procedures enable the partner to
make an overall assessment...
0:15:12.000,0:15:17.000
of the financial statements and allow for one final
assessment of whether the audit file
sufficiently...
0:15:17.000,0:15:20.033
addresses the areas of possible misstatement.
0:15:20.033,0:15:23.033
There are two areas that we spend more time
on.
0:15:23.033,0:15:28.000
The first one we have already identified and that
this the areas of material risk.
0:15:28.000,0:15:34.033
Those high risk material areas require us to
gather substantive evidence to support
management’s assertions.
0:15:34.033,0:15:40.000
The second area of particular interest to auditors
is the financial statement closing process.
0:15:40.000,0:15:48.000
This is where the senior accounting people often
make journal entries directly to the general
ledger for any number of reasons,
0:15:48.000,0:15:53.066
many are driven by GAAP or perhaps system
limitations.
0:15:53.066,0:15:58.066
And thus the auditors will spend time agreeing
journal entries to supporting documentation
0:15:58.066,0:16:04.033
and ensuring the financial statements are
reconciled the general ledger and subsidiary
ledgers.
0:16:04.033,0:16:08.066
So there you have a fairly robust discussion of
audit evidence.
0:16:08.066,0:16:11.033
Auditing is as much an art, as it is a science,
sometimes,
0:16:11.033,0:16:17.033
and as you gain more experience, you begin
developing spidey senses of whether you have
enough evidence...
0:16:17.033,0:16:21.066
or not to feel confident in the numbers
management is representing.
0:16:21.066,0:16:29.066
This concept of audit evidence will recur through
the balance of the course, so bear in mind that
not all evidence is created equal.
0:16:29.066,0:16:33.000
Until next time, Don’t stop until you get to the
top, and when you get to the top, don’t stop.