|
|
|
 |
|
1.4. Auditing & Attestation - Lecture |
|
|
|
|
|
|
|
|
|
|
|
Auditing & Attestation 4
Auditing & Attestation 4
1. Transaction cycles .........................................................................................................
3
2. Audit documentation ....................................................................................................
20
3. Audit evidence ............................................................................................................
24
4. Evidential procedures for selected accounts .....................................................................
35
5. Audit evidence: miscellaneous items ..............................................................................
48
6. Appendix—financial ratios .............................................................................................
54
7. Class questions ...........................................................................................................
65
A4-
2
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-3
S
ALES
TRANSACTION CYCLES
I. SUMMARY OF TRANSACTION CYCLES
Cycle Description
Revenue Includes sales revenues, receivables, and cash receipts
Expenditure Includes purchases, payables, and cash disbursements
Payroll and Personnel Includes payroll (salaried and hourly) and personnel
functions
Inventory and Production Includes perpetual inventory, physical counts, and
manufacturing costs
Property, Plant, and Equipment Includes acquisitions and disposals and related depreciation
expense
Investments Includes investments, related interest and dividend
payments, proceeds from issuance and from payments of
principal, and payments for treasury stock
Other Liabilities Includes accrued liabilities, warranty costs, deferred
income taxes, and lease obligations
PASS KEY
Transaction cycles are frequently tested on the exam.
II. REVENUE CYCLE
A. SALES
Under strong internal control, segregation of the functions in a sales transaction should exist
as follows:
1. Preparation of the Sales Order
The sales function begins with the receipt of a customer purchase order by the sales
department. If it is determined that the order can be filled, a serially numbered sales
order is prepared and sent to the credit department for approval.
2. Credit Approval
The credit department determines whether or not the customer may receive goods on
open account. If the order is approved, a copy of the approved sales order is sent to
the shipping department, the billing department, and the accounting department.
Auditing & Attestation 4 Becker CPA Review
A4-
4 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
3. Shipment
In the shipping department, a serially numbered bill of lading is prepared and a copy is
sent to the customer. The goods are shipped, and at this point a receivable arises.
4. Billing
The billing department prepares a serially numbered sales invoice. Shipping
documents, sales orders, and invoices are compared to assure that all shipments were
based on valid customer orders and were properly billed. Prices and discounts are
applied to the invoice, and necessary extensions and footings are computed. The
invoice is then sent to the customer and to the accounts receivable department.
5. Accounting
The sale is entered into the sales journal, and a receivable is recorded.
B. ACCOUNTS RECEIVABLE
1. Sales
A receivable is recorded in the accounts receivable control account in the general
ledger and in the accounts receivable subsidiary ledger. Periodically, an independent
person should reconcile these two records.
2. Collection of Cash Receipts
When payment is received from the customer, the receivable is eliminated.
3. Uncollectible Receivables
An aging schedule is prepared and sent to the credit department for use in carrying out
its collection program. At some point, uncollectible receivables should be written off.
Controls for writing off receivables include proper authorization (by the treasurer) and
recordkeeping. Without proper control, amounts subsequently collected easily could
be misappropriated by employees.
a. The auditor observes the preparation of the aging schedule as part of the study
of internal control.
4. Sales Returns
Returned goods must be examined to ensure that they correspond with the reason for
return before credit is given. A serially numbered receiving report may be used as a
sales return slip. Once the return is approved, the related receivable is eliminated.
a. Credit memos should not be prepared by individuals who collect or receive cash
payments on accounts receivable; to do so would be an inadequate segregation
of duties.
5. Sales Discounts
Sales discount procedures and records should be reviewed to ensure that discounts
are properly given and recorded. This ensures that receivables are not overstated.
R
ECEIVABLES
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-5
C
ASH
R
ECEIPTS
C. CASH RECEIPTS
1. Collection of Cash Receipts
Incoming mail must be opened by a person who does not have access to the accounts
receivable ledger. The receipts should be listed in detail with one copy and the actual
receipts sent to the cashier to prepare the bank deposit, another copy sent to the
accounts receivable department for entry in the accounts receivable subsidiary records,
and a third copy sent to the accounting department for entry in the general ledger
accounts receivable control account. The accounts receivable department should
match the details from the bank deposit ticket with the details from the remittance
advices. This will reveal any discrepancies. Cash collections should be restrictively
endorsed upon receipt and deposited daily. Devices such as cash registers or lock
boxes should be used as safeguards.
D. FLOWCHART OVERVIEW
1. Sales Flowchart
Revenue Cycle — Sales
Depts: Sales
(Authorization)
Credit
(Authorization)
Treasurer
(Authorization)
Shipping
(Custody)
Billing (A/R)
(Recordkeeping)
Accounting
(Recordkeeping)
Inventory
summary
Sales
journal
Customer
order
Prepare
sales order
Approve credit,
follow up on old
accounts, and
initiate
write-offs
Sales order
Write-offs Approved sales
order
Approved
write-offs
Review and
approve
write-offs
Write-offs
To Billing and
To Treasurer Accounting
To Shipping,
Billing, and
Accounting
Approved
sales order
1. Pull
inventory
2. Prepare bill
of lading
Goods
To
Accounting To Customer
B/L
To Billing
Approved sales
order
B/L
Approved write-off
1. Match docs
2. Prepare invoice
3. Update A/R
master file
4. Print sales
journal
Invoice
reconciliation
by
independent
party
Periodic
Sales
summary
To
Accounting
Updated A/R
master file
Updated
G/L
PostG/L
Approved
write-off
To Customer
Approved
sales order
Sales
Summary
Inventory
Summary
Auditing & Attestation 4 Becker CPA Review
A4-
6 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
2. Collections Flowchart
Revenue Cycle — Collections
Cash Receipts and Accounts Receivable
Customer
check
DEPTS:
Mailroom
(Custody)
Cashier
(Custody)
Accounts Receivable
(Recordkeeping)
Accounting
(Recordkeeping)
CR
journal
1. Match remittance
advice/check
deposit summary
2. Update A/R
master file
3. Print CR journal
D
A/R
master
file
update
CR
summary –
deposit
summary
Remittance
advice
Check
deposit
summary
Check
deposit
summary
Checks
Updated
G/L
To
A/R
Remittance
advice
From mailroom
To
Accounting
To Accounting,
Cashier, and
Accounts Receivable
1. Separate check
and advice;
restrictively
endorse check
2. Prepare listing
of checks
Prepare
deposit
Match documents:
??????
Listing of checks
??????
CR summary
??????
summary
Post G/L
Deposit
1
Listing of
checks
3
2
1
Listing of
checks
Checks
Listing
of checks
3
Checks
To
Bank
To
Cashier
1
Listing of
checks
2
To
Accounting
Check deposit
summary
CR Summary
Remittance
advice
From cashier
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-7
E. TESTS OF CONTROLS RELATED TO THE REVENUE CYCLE
1. Testing Controls Related to Sales
Testing Controls: Sales
Department Control Procedure Sample Test of Control Procedure
Order & Credit
2. Perform credit check (authorization).
3. Approve credit for returns.
4. Follow up on old or past-due
accounts.
5. Initiate write-offs, which should be
approved by the treasurer.
1. Prepare prenumbered sales order.
??????
customers (valuation).
Inquire about credit procedure for new
??????
orders (and returns), select a sample and
examine documents for evidence of credit
check (valuation).
From a population of approved sales
Warehouse &
Shipping
1. Receive approved sales order from
credit dept (must have approved
sales order before release of goods
from warehouse).
2. Pull inventory from warehouse and
release to shipping.
3. Perform independent check of goods
received from warehouse and
approved sales orders in shipping
department.
4. Prepare prenumbered bill of lading.
??????
orders (existence).
Observe warehouse personnel filling sales
??????
Observe physical controls over inventory.
??????
(existence).
Observe evidence of independent checks
??????
documents and:
Inspect a sample of prenumbered shipping
–
Agree to sales order (existence).
–
(completeness).
Account for prenumbering
Billing/
Accounts
Receivable
1. Match shipping documents and sales
orders before preparing invoice.
2. Periodically account for all
prenumbered shipping documents.
3. Perform independent check of sales
order pricing.
4. Prepare prenumbered sales invoice.
5. Batch and total invoices.
6. Update A/R master file. Agree input to
invoice batch totals.
7. Print sales journal.
8. Print sales summary. Agree to invoice
batch totals (independent check).
9. Mail monthly customer statements.
??????
(select approved sales orders from the sales
journal) to shipping documents and
approved sales orders (existence).
Vouch a sample of sales invoices
??????
(selection from prenumbered shipping
documents) to sales invoice, sales journal,
and A/R master file (completeness).
Trace a sample of shipping documents
??????
for a sample period (completeness).
Observe procedure. Reperform procedures
??????
sales invoices, check pricing with master
price list (valuation).
Reperform pricing check: From a sample of
??????
(valuation).
Observe procedure and reperform
??????
completeness, valuation).
Observe mailing (existence,
Auditing & Attestation 4 Becker CPA Review
A4-
8 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
Testing Controls: Sales
(continued)
Department Control Procedure Sample Test of Control Procedure
Accounting
2. Perform independent check of invoice
batch totals and sales summary.
3. Review sales account classifications.
4. Post to G/L.
5. Follow-up customer exceptions
(independent check).
1. Receive sales summary.
•
existence, completeness).
Observe and reperform (valuation,
•
presentation).
Observe and reperform (report
•
disposition (existence, completeness, rights,
valuation).
Inspect customer exception file and
NOTE:
A formal audit program can be prepared organized by assertion and sample population.
SEGREGATION OF DUTIES:
•
Authorization: Sales Order & Credit, Treasurer
•
Recordkeeping: Billing/Accounts Receivable/Accounting
•
Custody: Warehouse & Shipping
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-9
2. Testing Controls Related to Collections
Testing Controls: Collections
Department Control Procedure Sample Test of Control Procedure
Mailroom
advices.
2. Stamp restrictive endorsement on
checks.
3. Prepare prelisting of checks
received.
4. Forward checks to Cashier.
Forward remittance advices to A/R.
Forward prelisting to Accounting,
Cashier, and Accounts Receivable.
1. Separate checks and remittance
•
endorsement (completeness).
Inspect checks prior to deposit for
•
completeness, valuation).
Observe preparation of prelisting (existence,
Cashier
2. Prepare daily cash summary (copy to
A/R and Accounting).
3. Deliver checks to bank.
4. File validated deposit slip.
1. Receive checks and prepare deposit.
•
(existence, completeness, valuation).
Observe preparation of cash summary
•
summary (existence, completeness,
valuation).
Inspect deposit slip and compare to cash
Accounts
Receivable
1. Match remittance advices and check
deposit summary.
2. Update A/R master file.
3. Print CR journal/Updated A/R master
file.
4. Print CR summary (copy to
Accounting).
•
Observe procedure (completeness).
Accounting
summary (Cashier), the prelisting of
checks (Mailroom), and the CR
summary (A/R).
2. Post G/L.
3. Prepare bank reconciliation.
1. Independent check: Compare the cash
•
(existence, completeness, valuation).
Inspect evidence of independent check
•
dates (existence, completeness, valuation).
Reperform independent check for selected
•
completeness, valuation).
Inspect bank reconciliation (existence,
SEGREGATION OF DUTIES:
•
Recordkeeping: Accounts Receivable/Accounting
•
Custody: Mailroom & Cashier (Treasurer)
Auditing & Attestation 4 Becker CPA Review
A4-
10 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
F. AUDIT PROCEDURES RELATED TO THE REVENUE CYCLE
1. Sales
The auditor should verify that recorded sales are based on approved sales orders and
shipping documents. The auditor must also determine that all sales are recorded at the
appropriate amount and in the proper period.
a. Books and Records
The auditor should match the sales invoices with supporting shipping documents.
The auditor should compare the sales journal with the subsidiary ledgers, test the
mathematical accuracy of the trial balance, and compare the total in subsidiary
ledgers with the general ledger.
b. Cutoff
Sales invoices before and after year-end should be examined. In addition, the
auditor should analyze sales returns after year-end.
2. Accounts Receivable
The auditor should review the accounts receivable schedule for accuracy and
collectibility.
a. Confirmation
Confirmation of receivables (covered later) is considered to be a generally
accepted auditing procedure.
b. Adequacy of Uncollectible Accounts
Calculations should be made to determine the adequacy of the allowance for
uncollectible accounts. An aging schedule of accounts receivable should be
constructed. Tests of the adequacy of the allowance relate to the financial
statement assertion of valuation and allocation.
3. Cash Receipts
Audit procedures related to cash are covered in item IV below.
III. EXPENDITURE CYCLE
A. PURCHASES
Under strong internal control, segregation of the functions in a purchase transaction should
exist as follows:
1. Purchase Requisition
The purchase requisition starts the purchasing cycle. The department in need of the
asset or services sends a properly approved, serially numbered requisition to the
purchasing department. The requisitioning department should not have the authority to
actually place the purchase order. This would indicate a weakness in internal control.
2. Purchase Orders
The purchasing department should place the order only after giving proper
consideration to the time to order and the quantity to order. The purchasing
department should also obtain competitive bids from various suppliers to make sure
that the best price is obtained. The purchase order is issued only after proper
approval.
P
URCHASES
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-11
A/P
For internal control purposes, it is best that prenumbered purchase orders be used.
There should be multiple copies that will be sent to: (i) the requisitioning department;
(ii) the vendor; (iii) the receiving department; and (iv) the accounting department.
If the purchase order is canceled, all copies should be recalled and filed so that every
purchase order number is accounted for.
3. Receipt of Goods or Services
The copy of the purchase order sent to the receiving department serves as an
authorization to accept the goods when they arrive. It is preferable that the copy not
indicate the quantity ordered. Thus, the receiving department is forced to count the
goods upon arrival. A receiving report is prepared by this department and forwarded to
the accounting department. The goods are forwarded to the requisitioning department.
B. ACCOUNTS PAYABLE
The accounting department has three functions: (i) to record the payable; (ii) to approve the
invoice for payment; and (iii) to record the payment after it is paid by the Treasurer.
1. Recording the Payable
The copy of the purchase order sent to the accounting department notifies them that
there will be a future cash disbursement. The receiving report is compared with the
purchase order and the vendor's invoice as to quantity. This comparison is made to
prevent payment of charges for goods in excess of those ordered and received. The
accounting department records the goods as received in inventory, and records a
payable.
2. Approving Invoice for Payment and Recording Payment
When the invoice arrives, the accounting department approves it by matching the
invoice, purchase order, receiving report, and (sometimes) the requisition. When
payment is made, the payable is reversed. The accounting department should ensure
that the invoice amount is correct, and that it accurately reflects any purchase
discounts, before approving it for payment.
C. CASH DISBURSEMENTS
It is best for internal control purposes to pay invoices by check. For effective internal control,
the functions of approving the payment and signing the checks should be segregated.
Approved voucher packets (matched invoice, purchase order, receiving report, and
requisition) prepared by the accounting department (Accounts Payable) are received by the
Treasurer, who prepares, signs, and mails the checks and cancels all supporting documents
after payment. Paid vouchers are returned to the accounting department for posting of the
payment and filing of the documents.
Auditing & Attestation 4 Becker CPA Review
A4-
12 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
D. FLOWCHART OVERVIEW
Expenditure Cycle—Purchases, Payables, and Disbursements
ACCOUNTS TREASURER
PAYABLE
RECEIVING PURCHASING
From
Stores
1
Approved
requisition
Approve &
prepare
purchase
order
Requisition 1
Purchase order 5
Purchase order 4
Purchase order 3
Purchase order 2
To
stores
By
number
To
Receiving
To
vendor
To
Accounts
Payable
4
Purchase
order
Receive goods;
match with
purchase
order
Prepare
receiving
report
Purchase order 4
Rec. report 4
Rec. report 3
Rec. report 2
1
Receiving
report
To
Accounts
Payable
To
stores
For receipts
and returns
By
number
Receiving
report
Requisition 1
Invoice
Match
documents
Prepare and
approve voucher;
verify
accuracy
Voucher 2
Requisition 1
Purchase order 5
Rec. report 1
By
name
From
Purch.
From
Purch.
From
Receiving
From
vendor
File pending
arrival of all
documents
Invoice
1
Approved
voucher
File unpaid
vouchers
by
date
To
General
Accounting
On
due date
To
Treasurer
Purchase
order
From
Accounts
Payable
Requisition 1
Purchase order 5
Rec. report 1
1
Approved
voucher
Invoice
Voucher
package
Review documents;
prepare check
& remittance
advice
Sign check;
cancel
voucher
package
Check copy
Remittance 2
1
Remittance
advice
Signed check
Cancelled
voucher package
By
number
Cancelled
voucher
package file
To
General
Accounting
To
vendor
1
Purchase
order
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-13
E. TESTS OF CONTROLS RELATED TO THE EXPENDITURE CYCLE
1. Testing Controls Related to Purchases
Testing Controls: Purchases
Department Control Procedure Sample Test of Control Procedure
Requisitioner
2. Obtain approvals needed (authorization).
3. Send original copy to Purchasing.
4. Inspect goods when received from Receiving
dept. Sign receiving report upon receipt of
goods (independent check).
1. Prepare prenumbered requisition.
??????
Inspect requisitions for proper approval.
??????
prenumbering.
Observe procedures to account for
Purchasing
2. Contact approved vendors.
3. Issued prenumbered purchase order (PO):
1. Receive approved requisition.
??????
Original to vendor
??????
Blind copy to Receiving
??????
Copy to A/P
??????
File copy
??????
requisition.
Inspect purchase orders for approved
??????
prenumbering.
Observe procedures to account for
Receiving
2. Inspect goods. All shipments received must
have a PO.
3. Prepare receiving report (RR).
4. Match details of order received with blind
copy of PO and indicate quantity received.
5. Send goods to Requisitioning department.
Obtain signature on receiving report that
requisitioner received goods.
6. Distribute receiving report:
1. Receive goods from vendor.
??????
Original to A/P
??????
Copy to Purchasing
??????
File copy
??????
Inspect receiving report and matching PO.
??????
Observe performance by receiving clerk.
??????
(existence).
Inspect receiving report for signed receipt
??????
(selection made from prenumbered
documents) to PO, requisition, invoice, and
entry in the purchase journal and A/P
master file (completeness).
Trace a sample of receiving reports
Accounts
Payable
1. Receive vendor’s invoice.
2. Match documents: vendor’s invoice, RR, PO,
requisition.
3. Check mathematical accuracy, approvals,
G/L account coding (independent check).
4. Prepare prenumbered voucher.
5. Account for the numerical sequence of
vouchers.
6. Data Entry:
??????
Prepare purchase journal
??????
Update A/P master file
??????
7. Reconcile daily purchase summary totals and
daily entries to purchases journal.
Daily purchase summary
??????
and evidence of independent checks
(existence).
Inspect vouchers for supporting documents
??????
(completeness).
Observe procedure; reperform
??????
from the purchases journal) to all required
supporting documents (existence).
Vouch a sample of vouchers (selection made
??????
reperform (valuation).
Observe evidence of independent check;
Accounting
2. Post to G/L.
3. Reconcile G/L and A/P file.
4. Reconcile vendor’s monthly statements and A/P
master file (independent check).
1. Receive purchase summary.
??????
reperform.
Observe evidence of independent check;
??????
reperform (valuation, existence,
completeness).
Observe evidence of independent check;
SEGREGATION OF DUTIES:
??????
Authorization: Purchasing/Requisitioning Dept.
??????
Recordkeeping: Accounts Payable/Accounting
??????
Custody: Receiving
Auditing & Attestation 4 Becker CPA Review
A4-
14 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
2. Testing Controls Related to Payables
Testing Controls: Payables
Department Control Procedure Sample Test of Control Procedure
Accounts
Payable
1. Pull voucher at due date and send to
Treasurer for payment.
2. Receive cancelled voucher and
supporting documents from Treasurer.
3. Receive check summary from Treasurer
for data entry.
4. Data Entry:
√
Update A/P master file.
√
Print cash disbursements journal.
•
properly cancelled voucher packages
(existence).
Compare debits to accounts payable to
•
cash disbursement journal entries
(completeness).
Trace from cancelled voucher packages to
•
back to cancelled voucher packages
(existence).
Vouch cash disbursement journal entries
Treasurer
2. Review document for completeness
and approvals.
3. Prepare prenumbered checks.
4. Prepare check summary.
5. Sign checks (authorized signatory) and
cancel voucher and supporting
documents.
6. Mail check to vendor.
7. Forward cancelled voucher/supporting
documents to Accounts Payable.
8. Send copy of check summary:
1. Receive voucher for payment.
√
Accounts Payable
√
Accounting
•
check.
Observe performance of independent
•
(completeness).
Observe accounting for sequence
•
checks for testing and inspect signatures.
Inquire about procedure; observe. Select
•
signer.
Observe cancellation of vouchers by check
•
performance.
Inquire about procedure. Observe
Accounting
2. Post to G/L.
3. Perform independent check of totals
per check summary and amounts
journalized and posted by A/P.
4. Perform periodic independent
bank reconciliation.
1. Receive check summary.
•
Observe procedure and reperform.
•
Inspect bank reconciliation.
SEGREGATION OF DUTIES:
•
Authorization: Purchasing/Requisitioning Department
•
Recordkeeping: Accounts Payable/Accounting
•
Custody: Receiving and Treasurer
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-15
C
ASH
F. AUDIT PROCEDURES RELATED TO THE EXPENDITURE CYCLE
The presentation/disclosure, valuation, and completeness of accounts payable should be
verified.
1. Confirmations
Confirmation of payables (covered later) is not required but may be used in certain
circumstances. Regular suppliers, especially those showing small or zero balances,
should be selected for confirmation.
2. Search for Unrecorded Liabilities
The auditor should select cash disbursements made subsequent to year-end and
examine the supporting documentation (e.g., receiving reports, vendor invoices, etc.).
The auditor looks for items that should have been recorded at the balance sheet date,
but were not.
Note that cash disbursements made subsequent to year-end may be identified by
reviewing the cash disbursements journal, subsequent bank statements, or the voucher
register.
The auditor should also examine open vouchers, receiving reports, vendors' invoices,
and statements received for a period after year-end as part of the search for
unrecorded liabilities.
3. Cash Payments
Audit procedures related to cash are covered in item IV below.
IV. CASH
A. AUDIT PROCEDURES RELATED TO CASH
Cash is an integral part of both the revenue and expenditure cycles. The cash account
should be reviewed to verify the accuracy of the account and to detect theft and any evidence
of kiting or lapping. The auditor should look at all bank reconciliations and confirmations.
The auditor should obtain bank cutoff statements and, if there is more than one cash account,
the auditor should prepare bank transfer schedules for transfers between accounts.
1. Internal Control
Internal control over the handling of cash is one of the most critical areas of the audit.
Proper segregation of duties relating to cash demands that close consideration be
given to check-writing authority. Separation of cash handling, recordkeeping, and
reconciliation of bank statements should exist as well as separation of petty cash
activities. Good internal control for cash would include the use of a voucher system for
cash disbursements.
2. Cutoff
The auditor should obtain cutoff bank statements ten to fifteen days after year-end.
The auditor should verify the cutoff of cash receipts and cash disbursements and
examine all wire and interaccount cash transfers close to year-end.
3. Books and Records
Auditors should foot and crossfoot all books and records. They should mathematically
test calculations in the cash journals, vouch postings to ledger accounts, reconcile
bank statements, and verify cash transactions in one or more expense accounts.
Auditors should also compare the cash receipts journal with deposit slips for chosen
test periods.
Auditing & Attestation 4 Becker CPA Review
A4-
16 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
4. Evidence: Internal and External (Simultaneous Verification)
The auditor should examine all internal evidence. This would include counting the cash
on hand and reconciling it with the journals.
Procedures used to obtain external evidence would include confirming amounts on
deposit with banks, confirming all securities on deposit, and obtaining bank cutoff
statements.
5. Related Accounts
Almost all asset, liability, and expense accounts are related to the cash disbursement
function. Specific attention should be devoted to petty cash, payroll, purchases, and
miscellaneous expenses. These accounts should be reconciled to the appropriate
supporting journals.
6. Identification and Prevention of Fraudulent Schemes with Respect to Cash
a. Lapping
(1) Definition
The theft of cash is often concealed by failing to account for cash receipts.
The most common of these methods is known as lapping. Lapping
involves withholding current receipts of cash or checks and not recording
them. The unrecorded receipt is covered by applying a subsequent receipt
to the previously unrecorded account.
(2) How to Prevent and Detect Lapping
Some of the safeguards against lapping include independent comparison
of recorded cash receipts with funds actually deposited, separation of
incoming receipts from subsidiary accounts receivable remittance advices,
comparison of the details of bank deposits and the details of remittance
credits, provision of timely statements, and confirmation of customer
balances. One of the best methods to guard against lapping is use of a
"lock box" system. In this system, customers send their payments directly
to the bank, which prevents company employees from having access to
payments received.
One of the best methods to detect lapping is to compare the dollar
amounts and dates on the bank deposit slips with customer remittance
credits recorded in the accounts receivable ledger. Any lapping not using
exact replacement dates and amounts would be detected.
b. Kiting
(1) Definition
Kiting occurs when a check drawn on one bank is deposited in another
bank and no record is made of the disbursement in the balance of the first
bank. Kiting may be used to cover a cash shortage or to pad a company's
cash position.
(2) How to Detect Kiting
To detect kiting effectively, the cash deposits in transit at the end of a
period and the paid checks returned with the bank statements of the next
period must be examined. This is accomplished by preparing a bank
transfer schedule. A bank transfer schedule compares the dates checks
are drawn (on the disbursing bank account) to the dates checks are
deposited (in the receiving bank account). Kiting is indicated when the
date stamped by the receiving bank on the rear of the returned (paid)
check precedes the date on which the disbursement was recorded.
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-17
7. Transfer Schedules, Bank Confirmations, and Bank Statements
a. The auditor's main emphasis in testing cash is on the verification of the ending
balances (existence) and on the detection of theft or kiting. Since cash is such
an active account, most evidence will be gathered with respect to ending
balances rather than individual transactions. Special attention should also be
paid to cash handling and internal controls. The auditor's sources of evidence
will include bank transfer schedules (kiting test), bank confirmations, bank
reconciliations, and cutoff bank statements.
b. The standard bank confirmation should be sent to all banks with whom the client
has done business during the year, regardless of whether there is a year-end
balance to confirm. This is done because the bank confirmation, in addition to
verifying year-end balances, also provides evidence about actual loans and
contingent liabilities, discounted notes, pledged collateral, and guarantee or
security agreements.
Auditing & Attestation 4 Becker CPA Review
A4-
18 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
B. SAMPLE CONFIRMATION FORM
STANDARD FORM TO CONFIRM ACCOUNT
BALANCE INFORMATION WITH FINANCIAL INSTITUTIONS
CUSTOMER NAME
[ ]
Financial
Institution's
Name and
Address
]
[
We have provided to our accountants the following information as of
the close of business on , 20 , regarding our
deposit and loan balances. Please confirm the accuracy of the
information, noting any exceptions to the information provided. If the
balances have been left blank, please complete this form by furnishing
the balance in the appropriate space below.* Although we do not
request nor expect you to conduct a comprehensive, detailed search
of your records, if during the process of completing this confirmation
additional information about other deposit and loan accounts we may
have with you comes to your attention, please include such information
below. Please use the enclosed envelope to return the form directly to
our accountants.
1. At the close of business on the date listed above, our records indicated the following deposit balance(s):
ACCOUNT NAME ACCOUNT NO. INTEREST RATE BALANCE*
2. We were directly liable to the financial institution for loans at the close of business on the date listed above as follows:
ACCOUNT NO. /
DESCRIPTION BALANCE* DATE DUE INTEREST RATE
DATE THROUGH WHICH
INTEREST IS PAID DESCRIPTION OF COLLATERAL
(Customer's Authorized Signature) (Date)
The information presented above by the customer is in agreement with our records. Although we have not conducted a comprehensive,
detailed search of our records, no other deposit or loan accounts have come to our attention except as noted below.
(Financial Institution Authorized Signature) (Date)
(Title)
EXCEPTIONS AND/OR COMMENTS
Please return this form directly to our accountants:
[ ]
[ ]
* Ordinarily, balances are intentionally left blank if they are not available at the time the form is prepared.
Approved 1990 by American Bankers Association, American Institute of Certified Public Accountants, and Bank Administration
Institute. Additional forms available from: AICPA – Order Department, P.O. Box 1003, NY, NY 10108-1003
D 451 5951
ORIGINAL
To be mailed to accountant
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-19
V. RISKS TO CONSIDER
The auditor should be alert to the following risks related to the revenue and expenditure cycles.
A. INCENTIVE/PRESSURES
a. Pressure to overstate revenues to achieve EPS targets.
b. Pressure to overstate sales and/or receivables in order to improve the balance sheet
and liquidity ratios.
c. Pressure to understate liabilities in order to improve the balance sheet and liquidity
ratios.
B. POTENTIAL MISSTATEMENTS
a. Recording fictitious sales (existence assertion).
b. Holding open the sales journal to include next year's sales (improper cutoff).
c. Shipping goods that were not ordered at or near year-end (goods are generally
returned in the following period).
d. Failure to record payments.
C. OTHER POTENTIAL PROBLEMS
1. Errors
The possibility of errors may be increased due to the high volume of transactions that
flow through the sales, receivables, purchases, payables, and cash accounts.
2. Theft of Cash Collections
Sales adjustments (such as overstating discounts, recording fictitious returns, lapping
the accounts receivable, or improperly writing off customer balances) may be used to
conceal thefts of cash collections.
3. Omission
Existing sales and purchases may not be recorded (completeness assertion).
Auditing & Attestation 4 Becker CPA Review
A4-
20 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
AUDIT DOCUMENTATION
I. GENERAL
Audit documentation (also referred to as "working papers") is the principal record of audit
procedures performed, evidence obtained, and conclusions reached.
A. PURPOSE
The purpose of audit documentation is to provide:
1. Support for the auditor's report, including evidence that the audit was conducted in
accordance with generally accepted auditing standards.
2. Assistance in planning, conducting, and supervising the audit.
3. Accountability, emphasizing that the audit team is responsible for its work.
4. Information that may be useful for future audits, quality control reviews, or peer
reviews.
B. REQUIREMENTS
Audit documentation should:
1. Provide a record of accumulated evidence and the results of audit tests and
procedures;
2. Be prepared in enough detail so that an experienced auditor who has no previous
connection with the audit can understand the audit procedures performed, the evidence
obtained, the conclusions reached, and how the accounting records reconcile with the
financial statements;
3. Demonstrate compliance with the standards of fieldwork by showing that the work
performed was adequately planned and supervised, that a sufficient understanding of
the entity and its environment was obtained, and that sufficient appropriate audit
evidence was obtained to provide a reasonable basis for the opinion;
4. Include identifying characteristics of the specific items tested;
5. Enable reviewers to understand the work performed and the evidence obtained;
6. Include documentation of departures from mandatory GAAS requirements, including
justification for the departure and how appropriate alternative procedures were used to
achieve audit objectives;
7. Identify both the staff who performed the work and the staff who reviewed the work, as
well as the dates associated with each;
8. Contain proper indexing and cross-referencing; and
9. Indicate proper identification of client, purpose, and period covered.
C. RETENTION
1. Audit Documentation
Audit documentation is the property of the independent auditor, and while it may
sometimes be useful to the client, it is not considered to be part of the client's
accounting records.
2. Report Release Date
The "report release date" is defined as the date on which the auditor grants the client
permission to use the report. Often, this is the date on which the report is delivered to
the client.
A
UDIT
D
OCUMENTATION
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-21
a. Auditing standards require that audit documentation be retained for at least
years
b. The PCAOB requires auditors of public companies to keep audit documentation
for
fivefrom the report release date.seven years from the report release date.
3. Documentation Completion Date
The auditor is granted a certain window of time following the report release date, in
which to assemble the final audit documentation file. The end of this window is
referred to as the "documentation completion date." After this date, existing
documentation must not be deleted, and additions to the workpapers must be
documented as such.
a. Auditing standards require the final audit documentation file to be assembled
within
b. The PCAOB defines the documentation completion date as
the report release date, and requires preparation of an "engagement completion
document" identifying all significant findings and issues. Also, under PCAOB
standards, if work is performed by another auditor, the office issuing the report
must obtain, review, and retain certain audit documentation from the other
auditor.
60 days following the report release date.45 days following
4. Safekeeping of Audit Documentation
Reasonable precautions should be established for the safekeeping of audit
documentation, as it is the proof that a professional audit was performed. The SOX Act
of 2002 imposes tough penalties for failure to retain workpapers or for the destruction
of records.
a. The auditor should establish appropriate controls for audit documentation to
protect its integrity, prevent unauthorized changes, etc.
D. NATURE AND EXTENT OF AUDIT DOCUMENTATION
Audit documentation may be in paper form, electronic form, or other media. Oral
explanations alone are insufficient, but may be used for clarification of information included in
the audit documentation.
The specific quantity, type, and content of audit documentation are based on the auditor's
judgment. In determining the nature and extent of documentation for a specific area, the
auditor should consider:
1. The risk of material misstatement;
2. The extent to which judgment was required in performing the work and evaluating the
results;
3. The nature of the specific auditing procedure;
4. The significance of the evidence obtained;
5. The nature and extent of any problems identified; and
6. The need to document conclusions that may not be obvious.
Auditing & Attestation 4 Becker CPA Review
A4-
22 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
E. SPECIFIC CONTENTS
The form and content of audit documentation can vary, but it should be designed to meet the
circumstances of the particular engagement. Generally, audit documentation will consist of a
permanent
or continuous audit file and a current file.
1. Permanent (Continuous) File
The permanent file includes audit documentation that has a continuing interest from
year to year (such as contracts, pension plans, leases, stock options, bylaws, articles
of incorporation, minutes of meetings, bond indentures, and internal information).
2. Current File
The current file contains all audit documentation applicable to the year under audit, and
generally includes the following audit documentation:
a. The audit plan (audit program).
b. Financial statements and the auditor's report.
c. Working trial balance, adjusting journal entries, and reclassification entries.
d. Letters of confirmation and representation (e.g., letters from attorneys, a
management representation letter, and confirmation responses).
e. Analyses, worksheets, issues memoranda, and schedules or commentaries
prepared or obtained by the auditor. Note that related accounts, such as notes
receivable and interest income, are often analyzed together.
f. Abstracts or copies of entity documents, such as contracts or agreements
examined to evaluate the accounting for significant transactions.
g. Summaries of significant audit findings or issues (see below), actions taken, and
conclusions reached.
h. Records of tests of controls and substantive tests that include identification of
specific items selected for testing (i.e., the source from which the items were
selected and specific selection criteria).
3. Significant Audit Findings
Audit documentation should include significant audit findings, actions taken, and
conclusions reached. Significant audit findings include matters that:
a. Are related to the selection and application of accounting principles (and the
consistency with which they are applied), especially those involving complex or
unusual transactions, or estimates and uncertainties.
b. Are related to possible material misstatements in the financial statements.
c. Suggest a need to revise the auditor's previous risk assessment.
d. Cause significant difficulty in applying necessary audit procedures, or indicate
the need for significant revision of planned audit procedures.
e. May result in modification to the auditor's standard report.
f. Result in audit adjustments or corrections identified by the auditor that are
material, either individually or when aggregated.
Note that the auditor should document discussions with management regarding
significant findings, including when and with whom the discussions occurred. Also, if
the auditor has identified information that is inconsistent with his or her final conclusion
regarding a significant finding, the auditor should document how such contradictory
evidence was addressed.
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-23
4. Other Documentation Requirements
Specific audit documentation may also be required by other auditing standards, such
as those related to the consideration of internal control, the consideration of fraud risk
factors, etc.
5. Tickmarks
Auditors often use tickmarks, or symbols indicating the work that has been performed.
Audit documentation should include explanations of any tickmarks used.
ABC Company
Bank Reconciliation
December 31, 20XX
Cash balance per bank $ 275,000
√
Add: deposits in transit
27 - Dec $ 8,490
Δ
29 - Dec 3,000
Δ
30 - Dec 2,500
Δ 13,990 И
Less: outstanding checks
#34582 $ 2,456
Φ
#34584 1,300
Φ
#34585 1,414
Φ 5,170 И
Cash balance per books $ 283,820
И ▲
Tickmark Legend
√
Agreed to 12/31 bank statement
Δ
Agreed to deposit ticket
И
Footed
Φ
Agreed to voucher register
▲
Agreed to cash balance in general ledger
F. CONFIDENTIALITY
Audit documentation is the property of the auditor, and the information compiled therein is
confidential. Rule 301 of the 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." The auditor should adopt reasonable procedures to maintain confidentiality and
prevent unauthorized access to audit documentation. There are several situations in which
audit documentation can be provided to someone else without the client's permission:
1. If audit documentation is used as part of a voluntary quality review program under the
auspices of the AICPA or state society of CPAs.
2. If audit documentation is subpoenaed by a court.
3. If audit documentation is needed as part of an official investigation being conducted by
the AICPA, a state CPA society, or under State Board of Accountancy authorization.
4. If audit documentation is needed to respond to an official inquiry made by the AICPA, a
state CPA society, or a State Board of Accountancy (i.e., for the CPA's defense).
Auditing & Attestation 4 Becker CPA Review
A4-
24 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
AUDIT EVIDENCE
I. GENERAL
Audit evidence
opinion is based. It includes information in written or electronic form as well as observable assets
or activities, and it must be obtained to support auditor conclusions with respect to risk assessment,
tests of controls, and substantive testing. Some of the specific evidence applicable to individual
transaction cycles was covered previously. The use of sampling to collect audit evidence will be
discussed in Auditing & Attestation 5.
is all the information the auditor uses to arrive at the conclusions on which the audit
II. TYPES OF AUDIT EVIDENCE
Audit evidence consists of underlying accounting records and corroborating evidence. The auditor
should have access to all pertinent accounting data and corroborating audit evidence.
A. UNDERLYING ACCOUNTING RECORDS
This type of audit evidence consists of records of initial entries and any supporting records.
For example, accounting records include checks, records of electronic fund transfers,
invoices, contracts, ledgers, journal entries, and worksheets. The auditor tests the
accounting records through analytical procedures and substantive tests, such as retracing
procedural steps, recalculation, and reconciliation. Note that accounting records alone do not
provide sufficient support for the audit opinion. However, internal consistency among the
accounting records provides some evidence that the financial statements are presented fairly.
B. CORROBORATING EVIDENCE
Corroborating evidence includes minutes of meetings, confirmations, industry analysts'
reports, data about competitors, and information obtained through observation, inquiry and
inspection. Corroborating evidence provides additional support and gives validity to the
recorded accounting data.
C. EVIDENCE IN ELECTRONIC FORM
In certain entities, some of the accounting records or corroborating evidence may be
available only in electronic form. Source documents may be replaced by electronic
messages, or business may be transacted electronically. While electronic evidence may be
initially available, it may not be retrievable indefinitely. The auditor should therefore consider
the time during which information exists or is available in determining the nature, extent, and
timing of auditing procedures.
A
UDIT EVIDENCE
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-25
III. THIRD STANDARD OF FIELDWORK
The third standard of fieldwork states:
"The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to
afford a reasonable basis for an opinion regarding the financial statements under audit."
A. REASONABLE BASIS FOR AN OPINION
The audit evidence must persuade the auditor that the ending balances in the financial
statements are fairly presented. The audit provides
fairness of the financial statements. The auditor is not a guarantor, and, in most cases, costbenefit
considerations prohibit an examination of 100% of the accounting data. Therefore, it
generally will not be practical or possible to obtain assurance beyond all doubt, and the
auditor usually must rely on evidence that is
is a subjective concept and relates uniquely to each audit.
Note that while the cost-benefit relationship may be a valid reason for performing only certain
procedures, cost alone or difficulty in obtaining evidence is
procedure for which there is no appropriate alternative. Thus, the auditor must exercise
professional judgment in determining the procedures to be performed and the sufficiency and
appropriateness of the evidence gathered.
reasonable assurance regarding thepersuasive, rather than conclusive. Persuasionnot a valid basis for omitting a
B. SUFFICIENCY OF AUDIT EVIDENCE
Sufficiency refers to the quantity of audit evidence. The auditor must use professional
judgment in determining the amount and kinds of evidence sufficient to support an opinion.
As mentioned previously, judgments about materiality and audit risk underlie this
determination. The amount of evidence gathered directly affects the level of detection risk,
which is the risk that the auditor's evidence-gathering procedures will not be sufficient to
support the financial statement assertions. The auditor's decision regarding the sufficiency of
evidence is influenced by:
1. The risk of material misstatement: greater risk implies more evidence will be required.
2. The quality of audit evidence: less audit evidence may be required when that evidence
is of higher quality.
Note that even if it is conclusive, evidence regarding a small portion of a balance or a single
transaction would generally be insufficient to support the entire balance. For instance,
overwhelming evidence of the existence of a $500 account receivable would not be sufficient
to substantiate a total accounts receivable balance of $1,000,000.
C. APPROPRIATENESS OF AUDIT EVIDENCE
Appropriate audit evidence must be both reliable and relevant. The
appropriateness of evidence depends on its being pertinent, objective, timely, and
corroborated by other evidence.
1. Reliability of Evidence
Reliability of audit evidence is dependent on the circumstances under which it is
gathered. Reliability of evidence is also influenced by its source and nature.
a. Auditor's Direct Personal Knowledge
Any evidence obtained directly by the auditor (i.e., through observation, physical
examination, inspection, or recalculation) provides more persuasive evidence
than evidence obtained indirectly.
C
OMPETENT
E
VIDENCE
V
ALIDITY
Auditing & Attestation 4 Becker CPA Review
A4-
26 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
b. External Evidence
External evidence obtained from independent sources outside the enterprise
provides greater assurance of reliability than internally generated evidence.
There are two types of external evidence:
(1) Evidence sent directly to an independent auditor; and
(2) Evidence received and held by the client.
Evidence sent directly to the auditor (e.g., a bank confirmation) is more valid than
evidence received and held by the client.
c. Importance of Effective Controls
Internal evidence generated within the enterprise is not as reliable as external
evidence, but strong, effective internal controls improve reliability. Internal
evidence includes purchase orders, sales orders, general ledgers, and
management reports.
d. Documentary Evidence
Audit evidence in documentary form is more reliable than oral evidence, and
original documentation is more reliable than photocopies or faxes. Oral evidence
consists of statements made by clients concerning the procedures involved in a
given transaction, often resulting in the explanation of an account balance. Oral
evidence is the least reliable form of evidence.
e. Consistency of Evidence
When audit evidence obtained from different sources is consistent, a greater
degree of assurance is provided.
f. Information Produced by the Client
If the auditor intends to use information produced by the client, evidence must be
obtained about the accuracy and completeness of such information.
2. Relevance of Evidence
Evidence must relate to the financial statement assertion under consideration. For
example, accounts receivable confirmations are relevant to the existence of
receivables, not to their valuation (i.e., a customer can confirm that a receivable exists,
but this does not necessarily imply that the customer has the intent or the ability to
pay).
D. EVALUATION OF AUDIT EVIDENCE
The evaluation of audit evidence must take into consideration the achievement of audit
objectives. The auditor must be unbiased in this evaluation, considering all evidence
regardless of whether it conflicts with the financial statements.
If the auditors have doubts about a material assertion, they are required to gather sufficient
evidence to eliminate the doubt or they must express a qualified opinion or disclaimer of
opinion.
R
ELEVANCE
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-27
S
UBSTANTIVE
P
ROCEDURES
IV. SUBSTANTIVE PROCEDURES
Substantive procedures consist of: (i) tests of details (as applied to transactions,
balances, and disclosures), and (ii) substantive analytical procedures. These tests
are designed to substantiate the validity of management's assertions regarding the financial
statements.
A. TESTS OF DETAILS
Tests of details consist of audit procedures used to gather evidence to support the account
balances as reflected in the financial statements. Tests of details are performed on ending
balances, the details of transactions, or a combination of the two. If an account has a high
turnover rate with many transactions occurring during the year, the auditor generally will
concentrate more on the ending balance total. When this approach is used, the auditor must
be satisfied that internal control is strong. An alternative approach is to test the details of
transactions. This approach is employed when the account being substantiated has relatively
few transactions occurring during the year (e.g., an account for land or treasury stock). One
approach need not be used exclusively, and a combination of the two might be appropriate.
For example, during an audit of the sales revenue account, the auditor might use procedures
to substantiate the ending balance while also performing extensive procedures on samples of
transactions and related accounts (e.g., cash receipts and accounts receivable).
1. Examples of Substantive Procedures
The auditor may test the details supporting financial statement amounts and
disclosures through inspection, observation, inquiry, confirmation, recalculation,
reperformance, etc. Tests of details are discussed in greater detail later in this chapter.
B. ANALYTICAL PROCEDURES
Analytical procedures are evaluations of financial information made by a study of plausible
relationships among both financial and nonfinancial data, and they generally involve
comparisons of recorded amounts to independent expectations developed by the auditor.
Ratios, percentages, comparisons of actual to budget, and other comparisons may be used
to establish expected relationships, and the auditor then looks for unusual relationships,
discrepancies, or variances.
1. Use of Analytical Procedures
As discussed in Auditing & Attestation 3, the auditor must use analytical procedures for
planning and overall review in all audits, and also may decide to use analytical
procedures as substantive tests.
Auditing & Attestation 4 Becker CPA Review
A4-
28 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
The following chart summarizes the use of analytical procedures:
Phase Requirement Purpose
Planning Required
of other auditing procedures.
Used for risk measurement to alert the auditor to problem
areas requiring attention. This serves a vital planning
function.
To assist the auditor in planning the nature, extent, and timing
Substantive
procedures
Not required
management assertions related to account balances or
transactions.
The evidence is circumstantial and generally, additional
corroborating evidence (such as documentation) must be
obtained.
As a substantive test to obtain audit evidence about specific
Final review Required
reasonableness of account balances.
Note: In recent years there has been an increased emphasis on the use of analytical procedures.
To assist the auditor in the final review of the overall
V. ANALYTICAL PROCEDURES
A. PROCEDURES
1. Comparisons of Financial Data
Analytical procedures generally include a review of the current and prior year's financial
statements and the current year's budget. Comparisons are made between the current
year's actual and budgeted financial statements, and between the current year's actual
and prior year's actual financial statements. Comparisons are also made within the
current year's financial statements for internal consistency. For example, net income
on the income statement should agree with the increase in retained earnings on the
statement of retained earnings.
2. Auditor Expectations
The auditor also develops independent expectations for comparison to recorded
amounts. These expectations may be developed based on:
a. Financial information for comparable prior periods;
b. Anticipated results from budgets and forecasts;
c. Relationships among data within the current period;
d. Industry norms; and
e. Relationships of financial data with nonfinancial information.
A
NALYTICAL
P
ROCEDURES
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-29
B. ANALYTICAL PROCEDURES USED AS SUBSTANTIVE TESTS
In certain situations, analytical procedures are a more effective means of gathering evidence
than tests of details, and in those cases, analytical procedures may be used as substantive
tests.
1. Efficiency and Effectiveness of Analytical Procedures
The efficiency and effectiveness of analytical procedures in detecting potential
misstatements depends, among other things, on the following four factors.
a. Nature of the Assertion Being Tested
Analytical procedures are most effective and efficient for assertions in which
potential misstatements are not apparent from an examination of the detailed
evidence or when such detail is unavailable.
b. Plausibility and Predictability of the Data Relationship
In order to use analytical procedures as a substantive test, the auditor must have
a clear understanding of the relationships among data. It is possible that data
may appear to be related when in fact they are not, and failure to properly
understand such situations may lead to erroneous conclusions.
In order to provide an appropriate level of assurance, analytical procedures
should be based on predictable relationships. More predictable relationships are
provided by data generated in a stable, rather than dynamic, environment;
involving income statement, rather than just balance sheet accounts; and
involving transactions that are less subject to management discretion.
c. Availability and Reliability of Data Used to Develop the Expectation
Data used by the auditor to develop expectations should be both readily
available and reliable. Reliability of data is enhanced if it is obtained from
external rather than internal sources, obtained from independent internal sources
(i.e., unrelated to those who are responsible for the amount being audited),
generated under effective internal controls, audited previously, and obtained from
a variety of sources.
d. Precision of the Expectation
More precise expectations are more effective in detecting misstatements. An
expectation is more precise when it is developed at a sufficiently detailed level,
and when there is effective identification and consideration of factors that
significantly influence the relationship.
2. Documentation Requirements
When an analytical procedure is used as the principal substantive test of a significant
financial statement assertion, the auditor is required to document the:
a. Auditor's expectation.
b. Factors considered in the development of the expectation.
c. Results of the comparison of the expectation to recorded amounts.
d. Additional audit procedures performed in response to significant unexplained
differences.
e. Results of such additional procedures.
Auditing & Attestation 4 Becker CPA Review
A4-
30 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
C. RATIO ANALYSIS
In performing analytical procedures, recorded amounts are compared to expectations
developed by the auditor. The auditor may also choose to compare ratios developed from
recorded amounts to expected ratios developed by the auditor. A complete review of
pertinent ratios is included in the Appendix to this chapter.
D. INVESTIGATION OF SIGNIFICANT DIFFERENCES
Analytical review procedures may indicate a possible material misstatement, and therefore
the auditor should investigate any significant differences or unusual items that arise. The
auditor should reconsider the manner in which the expectation was developed, make
inquiries of management, and if necessary, expand audit procedures. If no adequate
explanations can be obtained, the auditor should obtain sufficient appropriate evidence about
the related assertion by performing alternative substantive procedures.
E. ANALYTICAL PROCEDURES USED AS AN OVERALL REVIEW
Analytical procedures are also applied during the overall review stage of an audit. Generally,
a manager or partner who has a comprehensive knowledge of the client's business and
industry performs this review.
The purpose of applying analytical procedures during the overall review stage of an audit is to
evaluate the overall financial statement presentation and to assess the conclusions reached.
The auditor should determine whether adequate evidence has been gathered in response to
unusual or unexpected balances identified during the audit. The auditor may also discover
additional unusual or unexpected balances during this overall review, and should consider
whether additional audit procedures are warranted.
F. LIMITATIONS OF ANALYTICAL PROCEDURES
Analytical review comparisons are based on expected plausible relationships among data.
Differences do not necessarily indicate errors or fraud, but simply indicate the need for further
investigation. Changes in an account, changes in accounting principle, and inherent
differences between industry norms and the client all contribute to fluctuations in expected
amounts.
VI. TESTS OF DETAILS
A. DIRECTIONAL TESTING
Directional testing refers to testing either forward or backward. Tracing forward from source
documents to journal entries provides evidence of completeness. Vouching backward from
journal entries to source documents provides evidence of existence. For instance, if
evidence were being gathered relative to the completeness assertion for sales, the auditor
would want to verify that all sales were being recorded on the income statement. The auditor
would focus attention on sales invoices and supporting documents such as customer
purchase orders and client shipping documents, and then trace forward through the
accounting system up to the income statement. On the other hand, if the possibility of
overstated sales (the existence assertion) were being addressed, the auditor would focus
attention on the income statement (all recorded sales) and then vouch backward through the
ledger and journals and ultimately to the supporting source documents such as customer
purchase orders and related shipping documents.
O
VERALL
R
EVIEW
T
ESTS OF
D
ETAILS
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-31
Financial Statements
Trial Balance
General Ledger
Subsidiary Ledger
Books of Original Entry
Source Documents
Execution of Event
Transaction Approved
V O U C H
Testing for Existence
Testing for
Support
T R A C E
Testing for Completeness
Testing for
Coverage
race
ouch
PASS KEY
Many exam questions require the candidate to determine which assertion is being tested by a specific audit procedure.
Remember that if a test starts with items in the accounting records, the proper assertion is most likely to be existence – the
auditor searches for evidence indicating that the item truly exists and has not been created by management. On the other
hand, if a test starts with source documents, it is most likely related to the completeness assertion, since the goal is probably
to make sure all transactions (as identified by the source documents) have been included in the accounting records.
B. STANDARD AUDITING PROCEDURES
In performing an audit, the auditor gathers evidence using a variety of procedures to
accomplish specific objectives. Sampling, which will be covered in Auditing & Attestation 5, is
an aspect of the performance of most audit procedures. The specifics for the sampling plan
(objective, population, sample size, method of selection) are included in the audit plan for
each procedure and are documented along with the results and evaluation of the results.
The following standard procedures are used in every audit as risk assessment procedures,
tests of controls, or substantive tests:
1. Footing, Crossfooting, and Recalculation
An auditor may verify the mathematical accuracy of statements and schedules by
adding down (footing), adding across (crossfooting), or recomputing amounts included
therein. For example, the auditor may substantiate the valuation of financial accounts
and the allocation of items such as depreciation, amortization, and accruals by
recomputing those items.
2. Inquiry
Inquiry consists of requesting information from knowledgeable parties both internally
(e.g., managers and supervisors) and externally (e.g., attorneys and bankers).
Examples include inquiries about pending litigation or pledged or obsolete inventories.
Auditing & Attestation 4 Becker CPA Review
A4-
32 © 2009 DeVry/Becker Educational Development Corp. All rights reserved.
Inquiry is used extensively throughout most audits, but since inquiry alone is generally
considered insufficient, it is most often used in conjunction with other audit procedures.
In using inquiry, the auditor should:
a. Consider the specific characteristics (knowledge, objectivity, qualifications, etc.)
of the person to whom the inquiry is directed.
b. Ask appropriate questions.
c. Evaluate the response and take appropriate action (e.g., following up with
additional inquiry, modifying planned audit procedures, etc.)
3. Vouching
Vouching is directional testing in which the auditor examines support for what has been
recorded in the records and statements, going from the financial statements
supporting documents. The objective of vouching is to gather evidence regarding
possible overstatement errors (the existence or occurrence assertions).
back to
4. Examination / Inspection
The auditor may inspect or examine records, documents, or tangible assets. Records
or documents may be internal or external, and may be in paper or electronic form.
Inspection or examination generally provides evidence about the existence assertion,
rather than about ownership, rights, obligations, or valuation. Examination may also
provide evidence of the exact terms of contracts, loans, and commitments. The
procedure of inspecting documents is often referred to as examination of evidence, and
includes the activities of scanning, scrutinizing, and reading. For example, the auditor
may
evidence of unusual amounts or unusual sources of input, which, if found, would be
investigated further. Or, the auditors may
meetings for authorization of treasury stock transactions.
scan or scrutinize entries in general ledger accounts for a period, looking forread the minutes of the board of directors
5. Confirmation
Confirmation is a specific type of inquiry that involves obtaining representations from
independent third parties about account balances and transactions or events.
Confirmations are controlled by the auditor in that the auditor selects the parties to be
contacted, prepares and mails the confirmation requests, and receives the responses
directly from the third parties. Examples include bank confirmations of the amount on
deposit or of a loan outstanding, or a confirmation from a customer regarding the
existence of a receivable balance at a certain date.
6. Analytical Procedures
Analytical procedures consist of evaluations of financial information made by a study of
meaningful relationships among data, to help highlight unusual fluctuations that could
be the result of errors or fraudulent omissions or overstatements.
be considered an analytical procedure, as the auditor uses professional judgment to
search for large, significant, or unusual items in the accounting records.
Scanning may also
7. Reperformance
Reperformance occurs when an auditor independently performs procedures or controls
that were originally performed as part of an entity's internal control.
8. Reconciliation
Reconciliation substantiates the existence and valuation of accounts. It involves
comparing financial amounts from two independent sources for agreement, such as
reconciling the physical inventory count with the perpetual inventory records. Other
examples include reconciling the cash balance per the books with the balance per
bank, and reconciling lead schedules to general ledger amounts.
E
XISTENCE
O
CCURRENCE
Becker CPA Review Auditing & Attestation 4
© 2009 DeVry/Becker Educational Development Corp. All rights reserved.
A4-33
C
OMPLETENESS
9. Observation
Observation occurs when an auditor looks at a process or procedure performed by
others. For example, at the beginning of an audit, the auditor may tour the client's
facilities to gain an understanding of the client's business, or the auditor may observe
the client's employees taking a physical inventory to obtain firsthand knowledge
regarding ending inventory.
Note that while observation provides the auditor with direct personal knowledge, the
evidence provided applies only to the point in time during which the observation
occurred. The auditor should also be aware that a process or procedure may be
performed differently when the client is aware that that the auditor is observing.
10. Tracing
As with vouching, tracing is directional testing. However, tracing is
looking for coverage in the opposite direction from vouching. Tracing starts with the
source documents and traces
given proper recognition in the books and records. The objective of tracing is to gather
evidence regarding possible understatement errors (the completeness assertion).
forward to provide assurance that the event is being
11. Subsequent Events Review
The auditor is required to perform certain procedures for the period after the balance
sheet date up to the date of the auditor's report. Evidence not available at the close of
the period often becomes available before the auditors complete their fieldwork and
write their report. For example, the bankruptcy of the auditor's client's customer shortly
after the balance sheet date indicates that the financial strength of the customer had
probably deteriorated before year-end. The settlement of a pending lawsuit constitutes
evidence that a real (rather than a contingent) liability may have existed at year-end.
Decreases in long-term debt occurring after year-end may indicate that such debt
should be reported as a current liability on the balance sheet. Evidence becoming
available after the balance sheet date should be used in making judgments about the
valuation of assets and liabilities on the balance sheet date.
12. Other Procedures
Other common procedures include:
a. Performing a cutoff review of year-end transactions, especially inventory, cash,
purchases, sales, and accruals;
b. Auditing related accounts simultaneously, such as auditing long-term liabilities
with interest expense, capital additions to plant and equipment with repairs and
maintenance expense, and investments with dividend and interest income;
c. Requesting a comprehensive management representation letter; and
d. Reading pertinent information, such as the minutes of the board of directors'
meetings, shareholder meetings, and management committee meetings.
PASS KEY
Candidates should try to use proper auditing terminology. If a question asks for audit procedures, words such as foot,
crossfoot, inquire, vouch, examine, inspect, review, confirm, analyze, recalculate, reconcile, observe, and trace should be
used.
Auditing & Attestation 4 Becker CPA Review
A4-
| | | | |
