ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Chapter 7: Introduction to audit evidence
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1.5 The financial statement assertions
Modern auditing theory takes the view that the financial statements prepared by the
directors comprise a number of ‘assertions’ or representations. These assertions are
set out in ISA 315 and fall into three categories:
Assertions about classes of transactions and events for the period under audit
(i.e. income statement assertions)
Assertions about account balances at the period end (i.e. statement of financial
position assertions)
Assertions about presentation and disclosure (i.e. presentation assertions)
Assertions about classes of transactions and events are as follows:
Occurrence: Transactions and events that have been recorded have occurred and
relate to the entity.
Completeness: There are no unrecorded transactions or events.
Accuracy: Amounts and other data relating to recorded transactions and events
have been recorded appropriately.
Cut-off: Transactions and events have been recorded in the correct accounting
period.
Classification: Transactions and events have been recorded in the proper
accounts.
Assertions about account balances are as follows:
Existence: Assets, liabilities and equity interests exist.
Rights and obligations: The entity holds or controls the rights to assets, and
liabilities are those of the entity.
Completeness: There are no unrecorded assets, liabilities or equity interests.
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.
Assertions about presentation and disclosure are as follows:
Occurrence and rights and obligations: Disclosed events, transactions and other
matters have occurred and relate to the entity.
Completeness: All disclosures that should have been included in the financial
statements have been included.
Classification and understandability: Financial information is appropriately
presented and described and disclosures are clear.
Accuracy and valuation: Financial and other information are disclosed fairly
and at appropriate amounts.
For each financial statement item being audited, the auditor should therefore
generate evidence designed to reach a conclusion on the reliability of the
appropriate assertions.
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Summary of assertions
About transactions/events About account balances
About account balances
About presentation and
disclosure in the financial
statements
Occurrence Existence
Occurrence and rights and
obligations
Completeness Rights and obligations Completeness
Accuracy Completeness
Classification and
understandability
Cut-off Valuation and allocation Accuracy and valuation
Classification
Example
Required
Using your accounting knowledge from Paper F3, apply the appropriate assertions
to the audit of sales of goods.
Answer
Transaction assertions:
Occurrence: All sales invoices reflected in the accounting records relate to goods
despatched by the entity during the current year.
Completeness: All goods despatched have been invoiced and all such sales invoices
have been entered into the accounting records.
Accuracy: All invoices have been correctly priced and discounts properly applied,
and they have been accurately entered in the accounting records.
Cut-off: Goods despatched just before the year end have been invoiced and included
in sales. Goods despatched just after the year end have not been included in sales.
Classification: All sales invoices have been posted to the sales account in the
nominal ledger.
Presentation and disclosure assertions
Occurrence: The figure for “Revenue” in the financial statements agrees to the sales
account in the nominal ledger.
Completeness: All entries in the sales account in the nominal ledger have been
included within “Revenue”.
Classification: “Revenue” is properly disclosed in the financial statements in the
income statement (under IAS 1’s two statement format) or statement of
comprehensive income (single statement format) for the current year.
Accuracy: The sales account in the nominal ledger has been properly added to arrive
at the “Revenue” figure in the financial statements.
Chapter 7: Introduction to audit evidence
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Tutorial note: The other assertions relate to assets, liabilities and equity and so are not
relevant.
1.6 Types of audit procedures
In order to gather audit evidence on the above financial statement assertions, the
auditor will have to chose what types of procedures to carry out. ISA 500 identifies
the following types of procedures:
Risk assessment procedures
Further audit procedures, which comprise:
o Tests of controls
o Substantive procedures
In general, the auditor will carry out tests of controls to assess the system under
audit. If those tests show that the system is working effectively then he will carry
out a reduced amount of substantive procedures. If the results are poor then he will
carry out more substantive procedures. Substantive procedures include both tests of
detail and analytical procedures.
Tests of controls and substantive procedures are considered in detail in later
chapters.
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Audit documentation: ISA 230
Audit documentation
Reasons for preparing sufficient and appropriate audit documentation
The form, content and extent of audit documentation
The use of computer-based audit working papers
Ownership, custody and confidentiality
2 Audit documentation: ISA 230
2.1 Audit documentation (audit file)
Audit documentation is the record of:
audit procedures performed
audit evidence obtained, and
conclusions reached.
Terms such as audit working papers are also used.
The audit file is one or more folders (or other storage media) in physical or
electronic form, containing the records that comprise the audit documentation for
the whole engagement.
The objective of the auditor in respect of ISA 230 is to prepare documentation that
provides:
a sufficient and appropriate record of the basis for the auditor’s report, and
evidence that the audit was planned and performed in accordance with ISAs
and applicable legal and regulatory requirements.
ISA 230 requires the auditor to prepare documentation on a timely basis, sufficient
to enable an experienced auditor, with no previous connection with the audit to
understand:
the nature, timing and extent of the audit procedures performed
the results of the audit procedures and the audit evidence obtained, and
significant matters arising during the audit and the conclusions reached thereon.
The auditor is also required to document:
discussions of all significant matters
how any inconsistencies with the final conclusion on significant matters were
resolved
and justify any departure from a basic principle or relevant procedure specified
by an ISA.
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2.2 Reasons for preparing sufficient and appropriate audit documentation
Preparing sufficient and appropriate audit documentation on a timely basis helps
to:
enhance the quality of the audit, and
facilitate the effective review and evaluation of the audit evidence obtained
and conclusions reached, before the audit report is finalised.
Documentation prepared at the time the work is performed is likely to be more
accurate than documentation prepared later.
Other purposes of audit documentation include the following.
Assisting the audit team to plan and perform the audit.
Assisting supervisors in directing and supervising audit work.
Ensuring members of the audit team are accountable for their work.
Keeping a record of matters of continuing significance to future audits.
Enabling an experienced auditor, with no previous connection with that audit, to
conduct quality control reviews or other inspections ie by understanding the
work that has been performed and the conclusions that have been reached.
2.3 The form, content and extent of audit documentation
Audit documentation may be recorded on paper, or on electronic or other media.
The audit documentation for a specific engagement is assembled in an audit file.
The precise contents of the audit file varies, depending on the nature and size of the
client and the complexity of the audit processes required to reach a conclusion but
will include:
audit programs
analyses
summaries of significant matters
letters of confirmation and representation
checklists, and
correspondence.
Traditionally, it has been normal practice in the case of on-going audits to maintain
two types of audit files:
a permanent file, and
a current file.
Permanent file
The permanent file records information that is likely to be of significance to every
annual audit of that client. Examples of such information might include:
the legal constitution of the company
other important legal documents such as loan agreements
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a summary of the history, development and ownership of the business
a summary of accounting systems and procedures
copies of previous years’ financial statements, together with key ratios and
trends.
As such information is of continuing significance, it is important that the auditor
reviews the contents of the permanent file regularly and updates it as appropriate.
Current file
The current file contains information of relevance to the current year’s audit. This is
the evidence on which the conclusion of the current audit will be primarily based.
Examples of the contents of a current audit file include the following:
The final financial statements and audit report.
A summary of audit adjustments, including those not included in the final
reported figures.
Audit planning material (the audit plan, materiality threshold calculations, risk
assessments).
Audit control material (these are items used to control the progress of the audit,
such as time budgets, review points, and points for consideration by the audit
partner)
Audit letters (audit letters are explained in a later chapter)
For each audit area (for example, inventory, receivables)
− an audit programme (detailing the work to be done on that area)
− details of items selected for testing, the tests performed, problems
encountered (together with their resolution) and the conclusion reached on
that area
− ‘lead schedules’ giving the figures for the audit area, as they appear in the
final financial statements, cross-referenced to relevant audit tests.
All audit working papers should clearly show the following (where relevant):
The name of the client
The accounting date
A file reference
The name of the person preparing the working paper
The date the paper was prepared
The name of any person reviewing the work and the extent of such review
The date of the review
A key to ‘audit ticks’ or other symbols used in the papers
A listing of any errors or omissions identified
A conclusion on the area.
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The auditor is required to assemble the final audit file(s) on a timely basis after the
date of the auditor’s report. This usually excludes drafts of working papers or
financial statements, or notes that reflect incomplete or preliminary thinking. After
the assembly of the final audit file has been completed, the auditor must not delete
or discard audit documentation before the end of its retention period (see below).
If it does become necessary to modify existing or add new documentation after
this stage, the auditor is required to document:
when and by whom the modifications were made
the reasons for making them.
If exceptional circumstances arise after the date of the audit report, such that the
auditor:
has to perform new or additional procedures, or
reaches new conclusions
the auditor is required to document:
the circumstances
the new or additional procedures performed, audit evidence obtained,
conclusions reached and their effect on the auditor’s report, and
when and by whom the resulting changes to audit documentation were made
and who reviewed them.
2.4 The use of computer-based audit working papers
One of the features of modern auditing is the use of computer packages (often used
in conjunction with laptop computers) to make the preparation of audit
documentation more efficient for the auditor. These packages can be used to help
prepare:
analysis schedules, especially where the firm uses standardised documentation
lead schedules, and
draft financial statements
These can usually be automatically cross-referenced and updated as the audit
proceeds.
Using these packages has several advantages:
The documentation is neat, easy to read and in a standard format.
The risk of errors in processing adjustments (updates, amendments, corrections)
is reduced.
The review process can be carried out ‘remotely’, without it being necessary for
the review to take place at the client’s premises.
Significant time saving may result from the automatic processing of adjustments.
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2.5 Ownership, custody and confidentiality
Ownership of the audit documentation rests with the auditor. The working papers
do not form part of the accounting records of the client, and do not belong to the
client.
The auditor needs to decide how long to keep the audit files. The ACCA
recommends a minimum period of seven years.
Auditing standards require the auditor to ensure that working papers are kept safe
and their contents are kept confidential. Information should only be made available
to third parties in accordance with ethical guidelines (described in an earlier
chapter).
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Audit sampling: ISA 530
The nature of sampling
Sampling risk and statistical sampling
Sample design
Performing audit procedures on the sample
Projecting misstatements and evaluating the results of audit sampling
3 Audit sampling: ISA 530
3.1 The nature of sampling
As discussed in the previous chapter, auditors do not normally check 100% of
transactions and balances that go into the production of financial statements.
However, sampling is not always appropriate for auditing. For example, if a
population consists of a small number of large items, it may well be appropriate to
apply audit tests to the entire population. Also, sampling is only appropriate where
the population is homogeneous (i.e. where all the items in the population share
common characteristics). If this condition is not satisfied, it may be necessary for the
auditor to test the entire population.
For example, suppose that a company owns just three very large machines, and each
machine serves a different purpose. It would be appropriate to carry out audit tests
on all three machines instead of testing just one or two machines as a ‘sample’ of the
entire population of three machines.
Again, as discussed in the previous chapter, sampling in auditing involves applying
audit testing procedures to less than the entire population of items subject to audit.
So, if a company has issued 1,000 sales invoices in a period and the auditor tests 999
of them, this is a sampling exercise – although the size of the sample would be very
large, given the size of the total population!
The auditor is not interested in the results of the sample itself. The sample is used as
a basis for reaching a conclusion on the entire population. For example, if an auditor
tests 500 sales invoices out of a population of 1,000 invoices, the purpose of the audit
test is to make a conclusion about all 1,000 invoices, not just the 500 that are tested.
It is therefore important that the sample chosen should be representative of the
population, and should reflect the characteristics of the population as a whole. The
larger the sample, the more likely it will be to be representative and to reflect the
characteristics of the entire population. However, large samples are more time-
consuming for the auditor to select and test. For reasons of time and cost, the
auditor will want to test as small a sample as possible, consistent with the aim of
achieving the required level of detection risk and limiting audit risk to a particular
level.
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3.2 Sampling risk and statistical sampling
Per ISA 530 Audit sampling the objective of the auditor, when using audit sampling,
is to provide a reasonable basis for the auditor to draw conclusions about the
population from which the sample is drawn. This will mean designing and
selecting the sample and evaluating the results of testing in such a way that
sampling risk is kept to the desired level.
The auditor can never be certain that a sample is fully representative of the
population. Even if the auditor tests 999 out of 1,000 invoices and finds no audit
problems, it could be that the remaining single invoice contains a material error or
omission. This is the problem of sampling risk.
Sampling risk was discussed within the context of the audit risk model in the
previous chapter. Per ISA 530 sampling risk is the risk that the auditor’s
conclusion based on a sample may be different from the conclusion had he tested
the entire population. As discussed above, this will happen if the sample is not
representative of the population as a whole.
Sampling risk can lead to two types of incorrect conclusions:
For tests of controls – that controls are more effective than they actually are and
for tests of details – that a material misstatement does not exist when in fact it
does.
For tests of controls – that controls are less effective than they actually are and
for tests of details – that a material misstatement exists when in fact it does not.
The auditor is more concerned with the first type of incorrect conclusion as this type
is more likely to lead to an inappropriate audit opinion.
The usual technique for obtaining a representative sample is random selection. In
this context, ‘random’ means that each item in the sample has an equal chance of
selection, so that there is no bias in the sample selection process.
ISA 530 distinguishes between statistical sampling and non-statistical sampling:
Statistical sampling is any sampling approach that involves random selection
and applies probability theory to the evaluation of the sample results and the
measurement of sampling risk.
Non-statistical sampling (also known as judgemental sampling) is any
sampling technique not based on probability theory. Instead, it is based on a
judgemental opinion by the auditor about the results of the sample.
3.3 Sample design, size and selection of items for testing
If an audit sampling exercise is to be effective – if sampling risk is to be reduced and
therefore detection risk reduced – the sample must be designed in an appropriate
way.
When designing a sample, the auditor is required by ISA 530 to:
consider the purpose of the audit procedure and the population from which the
sample will be drawn