CPA Review A-4: Substantive Testing, Audit Documentation, and Audit Evidence

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Transaction Cycle

Revenue, expenditure, payroll and personnel, inventory and production, property, plant, and equipment, investments, and other liabilities.

Asset/Revenue

The focus is often on whether the account actually exists (making sure the accounts are not overstated)

Liabilities/Expense

The focus is often on whether the items were actually recorded (making sure teh accouts are not understated)

Revenue Cycle: Valuation Assertion

Obtaining credit approval, preparing an aging schedule, and the allowance for doubtful accounts

Revenue Cycle: Existence

Confirmation

Revenue Cycle

Sales, accounts receivable, and cash receipts

Expenditure Cycle

Purchases, accounts payable, and cash disbursements

Expenditure Cycle: Completeness Assertion

The specific assertion typically addressed in the expenditure cycle is completeness, as expenses and payables may be understated

Cash: Existence

The primary assertion is existence for cash. Cash confirmation, bank statements, bank reconciliations, and transfer schedule all relate to this assertion

Audit Documentation

also called working paper. Serves as the primary record of the work performed, and provides support for the opinion rendered on the financial statements

Audit Evidence

FIVE CARROTS

Substantive Testing

Consist of tests of details and analytical procedures

Test of Details

Consists of audit procedures applied to ending balances, the details of transactions, or a combination of the two

Analytical Procedures

Involve studying relationships among data, and usually involve comparison of recorded amounts to auditor expectations

Completeness Assertion

The auditor starts from the orignal source documents and traces forward to the accounting records. This helps the auditor identify understatement errors.

Existence Assertion

The audtior starts from the accounting records and vouches backwards to the original source documents. This helps the audtor identify overstatement errors.

Inventory: Valuation Assertions

Relates to the original cost of inventory, the existence of obsolete or damaged goods, and the proper application of lower of cost or market principles.

Payroll and Personnel Cycle

Includes payroll (salaried and hourly) and personnel functions

Inventory and Production Cycle

Includes perpetual inventory, physical counts, and manufacturing costs

Property, Plant, and Equipment

Includes acquisitions and displosals 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

Account Payable

1. Record the payable 2. Approve the invoice for payment 3. Record the payment after it is paid by the Treasurer

Expenditure Cycle: Audit Procedures

The presentation/disclosure, valuation, and completeness of accounts payable should be verified.

Expenditure Cycle: Confirmations

Confirmation of payables is not required but may be used in certain circumstances. Regular suppliers, especially those showing small or zero balance, should be selected for confirmation.

Search for Unrecorded Liabilities

The auditor should select cash disbursements made subsequent to year-end and examine the supporting documentation (receiving reports, vendor invoices, etc.) Review cash disbursements journals, subsequent bank statements, voucher register, examine open vouchers, receiving reports, vendors' invoices, and statements received for a period after year-end.

Lapping

WIthholding current receipts of cash or checks and not recording them. The unrecorded receipts is covered by applying a subsequent receipt to the previously unrecorded account.

Lapping: Prevention

Independent comparison of recorded cash receipts with funds actually deposit, separation of income receipts from subsidiary account receivalbe remittance advices, comparison of the details of bank deposits and details of remittance credits, provision of timely statements, and confimration of customer balance. One of the best methods to guard against lapping is to use a "lock box" system.

Lapping: Detection

Compare the dollar amount and dates on the bank deposit slips with customer remittance credits recorded in teh accounts receivable ledger. Any lapping not using exact replacement dates and amounts would be detected.

Kiting

Occurs when a check drawn on one bank is deposited in anotehr bank and no record is made of the disbursement int he balance of the first bank. Used to cover a cash shortage or to pad a company's cash position.

Kiting: Detection

The cash deposits in transit at the end of the period and teh 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 back of the returned check precedes the date on which the disbursement was recorded.

Report Release Date

The date on which the auditor grants the client permission to use the report. This is the date on which the report is delivered to the client.

Audit Documentation

Auditing standards require that audit documentation be retained for at least five years from report release date. The PCAOB requires auditors of public companies to keep audit documentation for seven years from the report release date.

Documentation Completion Date

Auditing standards required the final audit documentation file to be assembled within 60 days following the report release date, 45 days following report release date for audit of a public company.

Permanent (Continuous) File

Includes audit documentation that has a continuing interst from year to year (contracts, pension plans, leases, stock options, bylaws, articles of incorporation, minutes of meetings, bond indentures, and internal information)

Current File

Contains all audit documentation applicable to the year under audit.

Tickmarks

Auditors often use tickmarks, or symbols indicating the work that has been performed.

Audit evidence

All the information the auditor uses to arrive at the conclusions on which the audit opinion is based.

Underlying Accounting Records

Consists of records of inital entries and any supporting records.

Corroborating Evidence

Provides additional support and gives validity to the recorded accounting data. Includes minutes of meetings, confimrations, industry analysts' report, data about competitors, and information obtained through observation, inquiry, and inspection.

Reasonable Basis for an Opinion

The auditor must rely on evidences that is persuasive, rather than conclusive.

Sufficiency

Refers to the quantity of audit evidences. Influenced by: 1. The risk of material misstatements: 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.

Appropriateness of Audit Evidence

Must be both reliable and relevant. The appropriateness of evidence depends on its being pertinent, objective, timely, and corroborated by other evidence.

Test 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 both.

Analytical Procedures

Evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data, and they general 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.

Analytical Procedures

Include a review of the current and prior year's financial statements and the current year's budget.

Directional Testing

Refers to testing either forward or backward.

Tracing

Tracing foward from source documents to journal entries provide evidence of completeness.

Vouching

Vouching backward from journal entries to source documents provides evidence of existence.

Standard Audting Procedures

FIVECARROTS

Footing, Crossfooting, and Recalculation

An audtior may verify the mathematical accuracy of statements and schedules by adding down (footing), adding across (crossfooting), or recomputing amounts included therein.

Inquiry

Consists of requesting information from knowledgeable parties both internally and externally.

Vouching

Directional testing in which the auditor examines support for what has been recorded in teh records and statements, going from financial statements back to supporting docuemtns.

Examination/Inspection

The auditor may inspect or examine records, documents, or tangible assets. Provides evidence about the existence assertion.

Confirmation

Specific type of inquiry that involves obtaining repsentations from independent third parties about account balances and transactions or events.

Analytical Procedures

Evaluations of financial informations 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.

Reperformance

Occurs when an auditor independently performs procedures or controls that were originally performed as part of an entity's internal control.

Reconciliation

Substantiates the existence and valuation of accounts. Involves comparing financial amounts from two independent sources for agreements, such as reconciling the physical inventory count with the perpetual inventory records.

Observations

Occurs when an auditor looks at a process or procedure performed by others.

Tracing

Directional testing that starts from source documents and trace forward to provide assurance that the event is being given proper recognition in the books and records.

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.

Completeness Assertion

Tracing, Analytical Review, and Observation

Proper Period Cutoff

Cutoff procedures

Accuracy

Inspection, footing, and crossfooting

Postive Confirmation

Where the auditor requests a response from the recipient. The auditor sends (to the client's customer) a confirmation stating the amount owed. Provide evidences regarding existence and rights and obligation, not valuation or completeness. Should be used when there are large individual accounts, expected errors, or items in dispute, and when internal control is weak.

Negative Confirmations

The auditor may send to a sample of customers another type of confirmation in which answers is requeste only if the amount stated is incorrect. Should be used whe the combined assessed level of inherent and control risk is low, a large number of small account balances are being confirmed, and there is no reason to expect that recipients of the requests will ignore them.

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