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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

Audit documentation should:

1. Provide a record of accumulated evidence and the results of audit tests and
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:

Audit documentation should:

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.

Retention and Completion
1. 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.

Retention and Completion
2. Document Retention

a. SAS Rules (nonissuers)
Auditing standards require that audit documentation be retained for at least five
years from the report release date.
b. PCAOB Rules (issuers)
The PCAOB requires auditors of public companies to keep audit documentation
for seven years from the report release date.

Retention and Completion
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 audit documentation must be documented as
a. SAS Rules (nonissuers)
Auditing standards require the final audit documentation file to be assembled
within 60 days following the report release date.
b. PCAOB Rules (issuers)
The PCAOB defines the documentation completion date as 45 days following 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

Retention and Completion
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 audit documentation or for the
destruction of records.
a. The auditor shouid estabiish 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
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.

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 wili consist of a
permanent or continuous audit file and a current file.

Specific Contents
1. Permanent (Continuous) File

The permanent file includes audit documentation that has a continuing interest from
year to year (such as contracts, pension plans, ieases, stock options, bylaws, articles of
incorporation, minutes of meetings, bond indentures, and internal information).

Specific Contents
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).

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.

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 whic1. 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.h
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).

Audit evidence is gathered throughout
the audit when performing:

(i) Risk assessment procedures
(ii) Tests of controls
(iii) Substantive procedures
(iv) Other audit procedures

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. "

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.

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.

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.

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.

Memorize the following hierarchy of audit evidence (from most reliable to least reliable):

1. Auditor's direct personal knowledge
2. External evidence
3. Internal evidence
4. Oral evidence

2. Relevance of Evidence

Evidence must relate to the financial statement assertion(s) under
consideration. For example, accounts receivable confirmations are relevant to the
existence of receivables, not to their valuation, because 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

Substantive procedures consist of:

(i) Tests of details applied to transactions, balances, and disclosures, and
(ii) Substantive analytical procedures.

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 testing on the ending balance.

Tests of Details

For example, during an audit of the sales revenue account, the auditor uses 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).

Examples of Substantive Procedures

The auditor may test the details supporting transactions, balances, and disclosures
through inspection, observation, inquiry, confirmation, recalculation, reperformance,

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

analytical procedures:
Phase: Planning
Requirement: Required

To assist the auditor in understanding the entity and its
Used for risk measurement to alert the auditor to problem
areas requiring attention. This serves a vital planning

analytical procedures:
Phase:Substantive procedures Requirement: Not required

As a substantive test to obtain audit evidence about specific management assertions related to account balances or
The evidence is circumstantial and generally additional
corroborating evidence (such as documentation) must be

analytical procedures:
Phase: Final review
Requirement: Required

To assist the auditor in the final review of the overall
reasonableness of account balances.

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.

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.

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
b. Plausibility and Predictability of the Data Relationship
c. Availability and Reliability of Data Used to Develop the Expectation
d. Precision of the Expectation

Efficiency and Effectiveness of Analytical Procedures
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.

Efficiency and Effectiveness of Analytical Procedures
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.

Efficiency and Effectiveness of Analytical Procedures
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

Efficiency and Effectiveness of Analytical Procedures
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.

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
e. Results of such additional procedures.

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.

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

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

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.

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


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.

tooting, Cross footing, and Recalculation

An auditor may verify the mathematical accuracy of statements and schedules by
adding down (footing), adding across (crossfooling), or recomputing amounts. 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.

Inquiry is used extensively throughout most audits. However, inquiry alone is generally
considered insufficient and therefore should be 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 back to
supporting documents. The objective of vouching is to gather evidence regarding
possible overstatement errors (the existence or occurrence assertions).

4. examination I 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 terms of contracts, loans, and commitments.

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. Scanning may also
be considered an analytical procedure, as the auditor uses professional judgment to
search for large, significant, or unusual items in the accounting records.

7. Re performance

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.

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.

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 forward to provide assurance that the event is being given
proper recognition in the books and records. The objective of tracing is to gather
evidence regarding possible understatement errors (the completeness assertion).

11. Cut-off review

The auditor should perform a cut-off review of year-end transactions, especially
inventory, cash, purchases, sales, and accruals.

12. Auditing related accounts simultaneously
Certain accounts can be audited simultaneously, such as:

a. Long-term liabilities and interest expense
b. Capital additions to plant and equipment and repairs and maintenance expense
c. Investments and dividend and interest income

13. Representation letter

At the conclusion of fieldwork, the independent auditor must obtain a management
representation letter from the client.

14. 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.

Review of Relevant Assertions
As described in Auditing and Attestation 3, the main assertions relevant to the audit of
account balances, transactions, and presentation and disclosure are:
1. Account Balances (eVER)
When audit procedures relate to asset, liability, and equity account balances, the most relevant assertions are

a. completeness
b. Valuation allocation and accuracy
c. Existaence and occurrence
d. rights and obligations.

a. completeness

All assets, liabilities, and equity interests that should have been recorded have
been recorded.

b. valuation, allocation and accuracy

Assets, liabilities, and equity interests are recorded fairly and at appropriate
amounts, and any resulting valuation or allocation adjustments are appropriately

c. existence and occurrence

Assets, liabilities, and equity interests exist.

d. Rights and obligations

The entity holds or controls the rights to assets and liabilities are the obligations
of the entity.

Transactions and Events (COVEU)
When testing transactions, the most relevant assertions are:

a. Completeness
b. Cut-off
C. valuation allocation and accuracy
d. existence and occurrence
e. understandability and classification

Presentation and Disclosure (CVRU)
When testing financial statement disclosures, the most relevant assertions are:

a. completeness
b. valuation allocation and accuracy
c. Rights and obligations and occurrence
d. understandability and classification


1. Tracing of transactions forward, starting from source documents through their
accounting recognition and ultimately to the financial statements. Note that
this directional test is the opposite of vouching (the directional test for the
existence/occurrence assertion).
2. Analytical review procedures. The auditor should consider how certain items
might be omitted from the account balance, such as unrecorded liabilities or
omissions of pledged assets.
3. Observation of processes and procedures.


1. Cut-off procedures to analyze transactions before and after year end for
proper accounting period recognition.

Valuation, Allocation and accuracy

1. Inspection of documentation supporting transactions.
2. Footing and cross-footing of schedules.
3. Independent recalculation. Examples would be aging of accounts receivable
to substantiate the value of the allowance account, or the recalculation of
depreciation charges. A prime area for recalculation are estimates made by
the client.
4. Reconciliation of supporting schedules to general ledger line items.

Existence and Occurrence

1. Confirmation of accounts with third parties.
2. Observation, inspection, and examination of assets, processes, and
procedures. (These provide very persuasive forms of eVidence.)
3. Vouching of transactions from financial statements back to supporting

Rights and obligations

1. Inspection of documentation supporting transactions, inspection of contracts,

Understandability and classification

1. Inspection of documentation supporting transactions.
2. Review of all related disclosures for compliance with GAAP.
3. Inquiry of management regarding disclosures for the account and for related

cycle: revenue

Includes sales revenues, receivables, and cash receipts

cycle: Expenditure

Includes purchases, payables, and cash disbursements

cycle: Inventory

Includes perpetual inventory, physical counts, and manufacturing costs


Includes investments in debt and equity and the income received from investments

cycle: Property, Plant, and equipment

Includes acquisitions and disposals and related depreciation expense

cycles: Payroll and personnel

Includes payroll (salaried and hourly) and personnel functions

cycles: financing

Includes debt and equity financing, repayments to borrowers, interest expense, and

Pass key

Know these mf'ing transaction cycles

A. Fraud Risk
As stated in the discussion of fraud risk i, there should be a
presumption in every audit that there is the risk of material misstatement due to revenue
recognition fraud. Common revenue frauds include:

1. Early revenue recognition.
2. Holding the books open past the close of the accounting period.
3. Fictitious sales.
4. Failure to record sales returns.
5. Side agreements used to alter sales terms and conditions to induce customers to
accept goods and services they otherwise do not need.
6. Channel stuffing achieved by convincing distributors to purchase more inventory than
they can sell in the near term.
Another common fraud related to the revenue cycle is the overstatement of receivables,
achieved by overstating balances, reporting fictitious balances, or understating the allowance
for uncollectible accounts.

B. Internal Control - 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.

Internal Control - Sales
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.

Internal Control - Sales
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.

Internal Control - Sales
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.

Internal Control - Sales
5. Accounting

The sale is entered into the sales journal, and a receivable is recorded.

Internal Control - 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.

Internal Control - Accounts Receivable
2. Collection of Cash receipts

When payment is received from the customer, the receivable is eliminated.

Internal Control - Accounts Receivable
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.

Internal Control - Accounts Receivables
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.
Credit memos should not be prepared by individuals who coilect or receive cash
payments on accounts receivable; to do so wouid be an inadequate segregation of

Internal Control - Accounts Receivables
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

Internal Control - 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.

Substantive Procedures Related to the Revenue Cycle
1. Auditing Accounts Receivable
a. Completeness

The auditor should obtain an aged trial balance of accounts receivable and trace
the total to the general ledger control account.

Auditing Accounts Receivable
Valuation, Allocation, and Accuracy

The auditor should examine the results of confirmations and test the adequacy of
the allowance for uncollectible accounts (see the discussion of Accounting
Estimates presented later in this lecture).

Auditing Accounts Receivable
Existence and Occurrence

The auditor should confirm a sample of accounts receivable (see the discussion
of accounts receivable confirmations below).


Existence is generally a more relevant assertion than completeness when auditing the revenue
cycle because the risk that accounts receivable and sales will be overstated (existence) is high
while the risk that accounts receivable and sales will be understated (completeness) is low.

Rights and Obligations

The auditor should review bank confirmations and debt agreements for liens on
receivables. The auditor should also inquire of management and review debt
agreements and board minutes for evidence that accounts receivable have been
factored or sold.

Auditing Sales Transactions

The following tests of details may also be performed as tests of controls or dual-purpose
tests. The cut-off procedure is performed most often as a substantive

Auditing Sales Transactions
a. Completeness

The auditor should trace a sample of shipping documents to the corresponding
sales invoices and to the sales journal and accounts receivable subsidiary

Auditing Sales Transactions
b. Cut-off

The auditor should compare a sample of sales invoices from shortly before and
after year-end with the shipment dates and with the dates the sales were
recorded in the sales journal. The auditor should also analyze the record of
sales returns after year-end.

Auditing Sales Transactions
c.Valuation, Allocation, and Accuracy

The auditor should compare prices and terms on a sample of sales invoices with
authorized price lists and terms of trade to determine whether sales are recorded
at the appropriate amount.

Auditing Sales Transactions
d. existence and occurrence

The auditor should vouch a sample of sales transactions from the sales journal to
the sales invoice back to the customer order and shipping documents.

Auditing Sales Transactions
e. Understandability and Classification

The auditor should examine a sample of sales invoices for proper classification
into the appropriate revenue accounts.

Auditing Presentation and Disclosure
a. Completeness
The auditor should ensure that all required disclosures related to accounts
receivable and sales have been included in the notes to the financial statements.
Revenue cycle disclosures include:

1. Revenue recognition method(s).
2. Revenue by reportable segment.
3. Related party revenues and receivables.
4. Receivables by type (trade, officer/employee, affiliates) and term (shortterm
and long-term).
5. Pledged or discounted receivables.

Auditing Presentation and Disclosure
b. Valuation, Allocation, and Accuracy

The auditor should read the footnotes and other information related to accounts
receivable and sales to determine whether the information is accurate and
presented at the appropriate amounts.

Auditing Presentation and Disclosure
c. Rights and Obligations and Occurrence

The auditor should determine whether any receivables have been pledged,
assigned or discounted and, if so, determine if disclosure is required. The
auditor should compare disclosures to other audit evidence to ensure that all
disclosed information related to accounts receivable and sales has occurred.

Auditing Presentation and Disclosure
d. Understandability and Classification

The auditor should read all accounts receivable and sales related disclosures to
ensure that they are understandable.

Accounts Receivable Confirmations
The auditor should review the accounts receivable schedule for accuracy and collectability. Confirmation is considered a required generally accepted auditing procedure unless:

(I)receivables are immaterial,
(ii) confirmation would be ineffective, or
(iii) inherent and control risks are very low and evidence provided by other procedures is sufficient to reduce audit risk to an acceptably low level. If confirmations are not sent, the auditor must document how omission of this procedure was overcome.

1. Positive Confirmations

Positive confirmations are those where the auditor requests a response from the
recipient. Generally, the auditor sends (to the client's customer) a confirmation stating
the amount owed. The customers are requested to return a statement to the auditor
indicating whether they agree with the amount, or providing information about any
exceptions. Positive confirmations should be used when there are large individual
accounts, expected errors, or items in dispute, and when internal control is weak.

Note that positive confirmations may also be "blank," which means that the recipient is
requested to fill in the balance. Blank forms provide a greater degree of assurance

(since the recipient cannot simply sign off without actually checking the balance) but
may also result in lower response rates because a greater effort is required for

How should correspondences received electronically be confirmed.

verified by calling the sender, The sender should also be requested to mail the original
confirmation directly to the auditor.

2. Negative Confirmations

The auditor may send to a sample of customers another type of confirmation in which
an answer is requested only if the amount stated is incorrect.

Negative confirmations
should be used when:

a. The combined assessed level of inherent and control risk is low;
b. A large number of small account balances are being confirmed; and
c. There is no reason to expect that recipients of the requests will ignore them.
Negative confirmations are somewhat less effective than positive confirmations
because lack of a response does not provide explicit verification of the existence of the

3. Confirmation Exceptions

Confirmation exceptions occur when there is a disparity between the amount of the
receivable recorded in the client's accounting records and the amount of the receivable
confirmed by the client's customer. For confirmation exceptions, the auditor should
determine whether the exception is due to a timing difference or a misstatement.

a. Timing Differences

Timing differences occur when there is a delay in the recording of the transaction
by the client or their customer. For example, an entity may correctly record a
receivable on December 31 when the goods are shipped to the customer, but the
customer may not record the payable until the goods are received on January 5.
This is not a misstatement.

b. Misstatements
A confirmation exception would be indicative of misstatement if the exception is
due to any of the following errors or frauds:

(1) Fictitious sale
(2) Misappropriation of cash
(3) Goods sent to the wrong customer
(4) Invoice sent to the wrong customer
(5) Payment applied to the wrong customer account
(6) Incorrect price or quantity charged to the customer

4. Confirmation Non-responses

Non-responses should be followed up with second (and sometimes third) requests.
The client may be asked to intervene. The auditor may also perform alternative
procedures, such as inspecting shipping documents or reviewing subsequent cash
receipts, when confirmation responses are not received. Alternative procedures may
not be necessary if a 100% overstatement of the accounts receivable from the nonresponding
customers would be immaterial, as long as there is no unusual pattern to
the non-responses.

Internal Control - Purchases\
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.

Internal Control - Purchases
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. For internal control purposes, it is best that prenumbered purchase orders be

Purchase Orders
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.

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.

Internal Control - 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

Accounts Payable
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 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.

Accounts 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.

Internal Control - Cash

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 Payabie) 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.

Substantive Procedures Related to the Expenditure Cycle
1. Auditing Accounts Payable
a. Completeness
The auditor should perform the following procedures:

(1) Agree the accounts payable listing to the general ledger.
(2) Obtain a sample of vendor statements and agree to the vendor accounts.
(3) Perform a Search for Unrecorded Liabilities
The auditor should select cash disbursements made subsequent to yearend
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.


For accounts payable, completeness and accuracy are generally more relevant than
existence and rights and obligations because the risk of understatement is higher than
the risk of overstatement.

Auditing Accounts Payable:
Valuation, Allocation, and Accuracy
The auditor should perform the following procedures:

(1) Obtain the accounts payable listing, foot the listing, and agree the listing to
the general ledger.
(2) Obtain a sample of vendor statements and agree the amounts to the
vendor accounts.
(3) Review the results of accounts payable confirmations

Auditing Accounts Payable:
c. Existence and Occurrence

The auditor should vouch selected amounts from the accounts payable listing to
the voucher packages. The auditor may also confirm accounts payable.

Auditing Accounts Payable:
(1) Accounts Payable Confirmations

Accounts payable confirmations are not required because good external
evidence to support accounts payable is generally available. However,
confirmations of accounts payable may be sent when internal control is
weak, when there are disputed amounts, or when monthly vendor
statements are not available. Typically, vendors with small or zero
balances would be selected for confirmation.

The major limitation of accounts payable confirmations is that they may
only be sent to recorded liabilities.

If a material error were present in
accounts payable, it would most likely involve unrecorded liabilities; as
such, no record would exist. On the other hand, unrecorded liabilities
generally surface eventually, as when unpaid vendors stop delivering

Auditing Accounts Payable:
d. Rights and Obligations

The auditor should review a sample of voucher packages for the presence of the
purchase requisition, purchase order, receiving report and vendor invoice to
verify that the accounts payable are owed by the entity.

Auditing Purchase Transactions:
a. Completeness
b. Cut-off

a. Completeness
The auditor should trace a sample of vouchers to the purchase journal.
b. Cut-off
The auditor should compare dates on a sample of vouchers with the dates the
transactions were recorded in the purchase journal. The auditor should also
examine purchases before and after year-end to determine if they were recorded
in the proper period.

Auditing Purchase Transactions:
c. Valuation, Allocation, and Accuracy
d. Existence and Occurrence
e. Understandability and Classification

c. Valuation, Allocation, and Accuracy
The auditor should recompute the mathematical accuracy of a sample of vendor
d. Existence and Occurrence
The auditor should test a sample o
f vouchers for authorization
and the presence of the receiving report.
e. Understandability and Classification
The auditor should verify the account classification of a sample of purchases.

3. Auditing Presentation and Disclosure
a. Completeness

The auditor should ensure that all required disclosures related to accounts
payable and purchases have been included in the notes to the financial

3. Auditing Presentation and Disclosure
a. Completeness
Required disclosures include:

1.Payables by type (trade, officer/employee, affiliates) and term (short-term
and long-term).
2.Purchase contracts and purchase commitments.
3. Related party purchases and payables.
4. Expenses by segment.

3. Auditing Presentation and Disclosure
b. Valuation, Allocation, and Accuracy

The auditor should read the footnotes and other information related to accounts
payable and purchases to determine whether the information is accurate and
presented at the appropriate amounts.

A. Fraud Risk
Cash is an area with high fraud risk, especially when internal control is weak. Lapping and
kiting are two common cash fraud schemes.
1. Lapping

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

a. How to Prevent and Detect Lapping

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.

2. Kiting

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.

a. 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

B. Internal Control

Control procedures and tests of controls related to cash receipts and cash disbursements
were covered above in the discussions of the revenue cycle and the expenditure cycle.
Segregation of duties is a key control over cash. Proper segregation of duties 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

Substantive Procedures Related to Cash
1. Auditing the Ending Cash Balance
a. Completeness, Valuation and Allocation, Existence

The primary audit procedures performed to test the existence, completeness and
valuation of the ending cash balance are the bank confirmation and the audit of
the year-end bank reconciliation.

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