Week 9

1
Week 9 Audit Evidence Sampling

• Week 9 Other audit and review evidence I
  (syllabus ref 17)
• Describe the sources and merits of evidence
  available.
• Describe the financial statement assertions
  commonly reported on and the principles and
  objectives of balance and transaction testing.
• Distinguish between interim and final audit.
• Describe and illustrate how analytical procedures
  are used as substantive procedures.
• Explain problems with auditing accounting
  estimates.
• Describe sources of evidence available in smaller
  entities.
• Evaluate quality of evidence collected.

2
Week 9 Audit Evidence Sampling

• Week 9 Other audit and review evidence VIII
  (syl.ref 23)
• Explain the need for sampling.
• Distinguish between statistical and
  non-statistical sampling.
• Describe and illustrate the application of the
  basic principles of statistical sampling and
  other selective testing procedures.
• Describe and illustrate the use of CAATs in
  obtaining evidence.
• Note you will not be asked to perform detailed
  sampling calculations.

3
Week 9 Summary

• Audit evidence and sampling
• Audit evidence ISA 500
• Audit sampling ISA 530
• Computer assisted audit techniques.

4
Overview of the audit process

• Evidence is collected through the audit process.
• All audits need careful planning, controlling and
  recording.
• The audit process is a series of logical
  well-defined steps.
• Audit objective object of investigation.
• Audit procedure tests and techniques used.
• Overall audit objective Do the financial
  statements give a true and fair view of the
  entitys state of affairs, its profit or loss for
  the period and its cashflow.

5
Overview of the Audit Process

• How is the audit objective achieved
• Gather information
• Observe the clients operations
• Make enquiries
• Inspect the entitys manuals/legal documents

6
Hierarchy of Audit Objectives for sales system
7
Audit Evidence

• Concept of audit evidence
• is all the information used by the auditor in
  arriving at the conclusions on which the audit
  opinion is based, and includes the information
  contained in the accounting records underlying
  the financial statements.ISA 500 Audit Evidence.
  
• Accumulate audit evidence to meet specific audit
  objectives and from this you can form conclusions
  about general audit objectives.
• Eventually you will have sufficient, appropriate
  audit evidence to support the overall audit
  objective.

8
Audit Evidence

• Sufficient appropriate audit evidence
• Sufficient is the measure of the quantity of
  audit evidence. e.g. the sample chosen should be
  large enough to be representative.
• Appropriateness is the measure of the quality
  of audit evidence. To be of good quality it
  should be relevant and reliable.

9
Audit Evidence

• It is the auditors judgement of what is
  sufficient appropriate audit evidence and will be
  influenced by the following
• Risk assessment.
• The nature of the accounting and internal
  controls.
• The materiality of the item being examined.
• Experience gained during previous audits.
• The auditors knowledge of the business and the
  industry.
• The results of the audit procedures.
• The source and reliability of the information.

10
Obtaining Audit Evidence

• Inspection of assets, records and documents.
• Reliability depends on source and nature of
  records and on effectiveness of internal controls
  over processing.
• Observation.
• Note ISA 501 Audit Evidence - additional
  considerations for specific items.
• Inquiries.
• Confirmation.
• Computations (recalculation/reperformance).
• Use of CAATs.
• Analytical Procedures.
• Note ISA 520.

11
Obtaining Audit Evidence

• What evidence is collected depends on
• Relevance
• Reliability
• Availability
• Timeliness
• Cost
• Sources of evidence
• Direct personal knowledge
• External sources
• Internal sources

12
Reliability of audit Evidence

• More reliable if
• Obtained from independent sources.
• Generated internally AND related controls are
  tested as being effective.
• Obtained directly by auditor.
• It exists in documentary form.
• It is an original document.

13
Reliability of audit Evidence
14
Audit Assertions

• Directors general assertion is that
• The financial statements prepared by them give a
  true and fair view.
• Auditors then break this general assertion down
  by firstly breaking the financial statements down
  into its various components.
• Then they test that component against relevant
  directors assertions (see next slide).

15
Assertions

• Account balances
• Existence
• Rights or obligations
• Completeness
• Valuation and allocation
• Classes of transactions
• Occurrence
• Completeness
• Accuracy
• Cutoff
• Classification

• Disclosure
• Occurrence and Rights or obligations
• Completeness
• Accuracy and Valuation
• Classification and understandability
• ACCA COVER

16
Audit Testing

• Need to establish if each financial statement
  amount and disclosure is fairly stated
• Review accounting system walk through tests.
• Testing effectiveness of internal control system
  to see if they can be relied upon. You test for
  design and operation compliance tests/Tests of
  Controls (TOCs).
• Testing financial statement amounts and
  disclosures main audit objective therefore need
  to substantiate substantive tests.

17
Audit Testing

• Substantive tests are always required!
• Tests of detail (tests of transaction and
  balances)
• Analytical procedures e.g
• Monthly comparison of payroll.
• Gross margins.
• Aged trade receivables comparison.
• ISA 500 states that TOCs are necessary in 2
  circumstances
• Where the risk assessment indicates an
  expectation of the operating effectiveness of
  controls.
• Where substantive procedures alone do not provide
  sufficient appropriate audit evidence.

18
Smaller entities

• IAPS 1005 the special considerations in the
  audit of small entities
• Difficulty with completeness.
• Possibly poor internal control.
• More tests of details (substantive tests).
• More analytical procedures.
• Therefore use of CAATs but
• if small volumes of data then manual methods may
  be more cost effective.
• Other issues with CAATs and small audits e.g.
  technical assistance, small computers, knowledge
  confined to small computer team therefore
  increased risk.

19
Accounting estimates

• Depreciation, deferred tax, doubtful debts,
  provisions for obsolete inventories, contingent
  liabilities etc.
• More risky with higher control risk.
• ISA 540 Audit of accounting estimates
• Review and test management process.
• Use the auditors/independent experts estimate to
  compare.
• Review subsequent events.

20
Audit Sampling

• Testing part of an account
• balance in order to form
• a conclusion about the whole
• account balance.

Audit sampling means the application of audit
procedures to less than 100 of the items within
a class of transactions or account balance such
that all sampling units have an equal chance of
selection, in order to assist in forming a
conclusion concerning the population from which
the sample is drawn (ISA 530).
21
Benefits of Audit Sampling

• It imposes a more formal discipline with regard
  to planning the audit of a population.
• The required sample size is determined
  objectively.
• The evaluation of the test results is made more
  precisely and the sampling risk is quantified.
• Cost effective.

22
Drawbacks of Audit Sampling

• It is more time consuming to carry out sampling.
• The sampling unit i.e.. Each individual item in
  the population must be capable of being
  identified uniquely.
• It can lead to a mechanistic audit approach and
  the experience or gut feel of the auditor can be
  minimised.
• Audit firms can be reluctant to implement due its
  complexity.

23
Specific Items(Judgmental) Sampling

• A judgmental sample is selected from a population
  based on such factors as knowledge of the
  clients business, preliminary assessments of
  inherent and control risks, and the
  characteristics of the population being tested.
• Specific items selected may include
• High value or key items
• All items over a certain amount
• Items to obtain information
• Items to test procedures
• This does not constitute audit sampling because
  it cannot be projected to the entire population.

24
Sampling and Non-sampling Risk

• Sampling risk
• Properly drawn sample may not be representative
  of the population.
• Tests of controls
• Risk of over-reliance
• Risk of under-reliance
• Substantive tests of details
• Risk of incorrect acceptance
• Risk of incorrect rejection
• Impacts on audit efficiency effectiveness

25
Sampling and Non-sampling Risk

• There are two types of sampling risk
• The risk the auditor will conclude, in the test
  of control, that control risk is lower than it
  actually is, or in the case of a substantive
  test, that a material error does not exist when
  in fact it does.
• The risk the auditor will conclude, in a test of
  control, that control risk is higher than it
  actually is, or in the case of a substantive
  test, that a material error exists when in fact
  it does not.

26
Non-sampling Risk

• Non-sampling risk
• Other audit failures.
• Cannot be quantitatively assessed.
• Controlled by planning, supervision and adherence
  to quality control standards.

27
Non-sampling Risk

• Includes all aspects of audit risk that are not
  due to sampling
• Examples are
• The failure to select appropriate audit
  procedures.
• The failure to recognize misstatements in
  documents examined.
• Misinterpreting the results of audit tests.

28
Statistical sampling

• Statistical sampling means any approach to
  sampling that has the following characteristics
• (a) Random selection of a sample and
• (b) Use of probability theory to evaluate sample
  results, including measurement of sampling risk.
• A sampling approach that does not have
  characteristics (a) and (b) is considered
  non-statistical sampling.

29
Population and other terms

• Population means the entire set of data from
  which a sample is selected and about which the
  auditor wishes to draw conclusions.
• For example, all of the items in an account
  balance or a class of transactions constitute a
  population.
• Error means either control deviations, when
  performing tests of control, or misstatements,
  when performing substantive procedures.
• Sampling risk arises from the possibility that
  the auditors conclusion, based on a sample may
  be different from the conclusion reached if the
  entire population were subjected to the same
  audit procedure.

30
Sampling size and sampling risk
Greater confidence ? larger sample
Higher risk ? larger sample
Lower acceptable error ? larger sample
Greater error ? larger sample
Little effect unless small
More stratification ? smaller sample
31
Design of the Sample

• Consider the specific objectives to be achieved
  and the combination of audit procedures used.
• Definite what constitutes an error and what
  population to use for sampling.
• The population must be appropriate and complete.
• When performing tests of control, the auditor
  generally makes a preliminary assessment of the
  rate of error the auditor expects to find in the
  population to be tested. Expected error!

32
Sample Size

• Sample size is affected by the level of sampling
  risk that the auditor is willing to accept. The
  lower the risk the auditor is willing to accept,
  the greater the sample size will need to be.
• The tolerable error rate is the maximum rate of
  deviation that an auditor will accept without
  modifying the planned assessed level of control
  risk.
• When the planned assessed level of control risk
  is low, and the degree of assurance desired from
  the sample is high, the tolerable error rate
  should be low. (Especially when other tests of
  controls are not done).

33
Use of Samples for Audit Tests

• Selecting the sample
• Random selection.
• Systematic selection.
• Haphazard selection.
• Sequence/block selection.
• Monetary unit sampling (MUS).
• e.g. page 112 BPP.

34
Selecting the Sample

• The auditor should select items for the sample
  with the expectation that all sampling units in
  the population have a chance of selection.
• Statistical sampling requires that sample items
  are selected at random so that each sampling unit
  has a known chance of being selected. The
  sampling units might be physical items (such as
  invoices) or monetary units.
• With non-statistical sampling, an auditor uses
  professional judgment to select the items for a
  sample.

35
Evaluation of Sample Results

• The auditor should consider the sample results,
  the nature and cause of any errors identified,
  and their possible effect on the particular test
  objective and on other areas of the audit.
• For substantive procedures, the auditor should
  project monetary errors found in the sample to
  the population, and should consider the effect of
  the projected error.
• The auditor projects the total error for the
  population to obtain a broad view of the scale of
  errors, and to compare this to the tolerable
  error.
• Tolerable error is will be an amount less than or
  equal to the auditors preliminary estimate of
  materiality.

36
Evaluation of Sample Results

• Is it a true error?
• Are there alternative procedures if evidence
  cant be found?
• Nature and cause of the error?
• Are they anomalous errors?
• Not representative of the population.
• One-off isolated error.

37
Audit Problems With Computer Systems

• Lack of visible audit trail.
• Lack of primary records.
• Data needed for audit purposes may be
  overwritten.
• The need of specialist expertise and assistance.
• Centralisation.

38
Computer Assisted Audit Techniques (CAATS)

• These techniques use the power of the computer to
  perform audit work.
• In other words auditing through the computer
  rather than round the computer.

39
Two Main Groups of CAATs

• Test packs (or audit test data)
• Used to review the controls in the system.
• Audit packages (or audit software)
• Used to review the actual data in the system.

40
Test Packages

• Test data is used to assess whether the computer
  is processing data correctly.
• For example, the auditor tests the
• Sales transaction program to check sales are
  being correctly processed and check actual output
  with expected output.
• Any variances will require further substantive
  testing.

41
Test Data Techniques

• Embedded audit facilities.
• (An expert system)
• This allows for continuous audit review of data
  and processing with modules built into the
  organisations accounting system.

42
Test Data Techniques

• Integrated test facility
• Creation of a false entity within the system,
  transactions are then processed to that
  fictitious entity together with normal
  transactions.
• The normal processing cycle results are then
  compared with what will be produced by the
  system.
• False entries have to be reversed by the auditor
  thus ensuring normal and fictitious data are not
  mixed up!

43
Test Data Techniques

• Code comparison programmes
• Comparing two versions of programs and
  identifying the differences.
• Logical path analysis
• Conversion of a logical program path to a flow
  charts which and be printed out and reviewed.

44
Audit Packages (or Audit Software)

• Again using the embedded audit facility
• Systems control and review file (SCARF)
• Audit program posts transactions above a certain
  amount from a specific ledger account to a file
  for later review by the auditor.

45
Systems Control and Review File (SCARF)

• For example
• Identification of sales orders over say 10k.
• Together with the name of the salesperson issuing
  the order.
• The name of the customer.
• Date of order and date of the invoice.
• The balance outstanding after the transaction and
  the credit limit.
• The auditor can assess if the system was
  operating properly and if the customer credit
  limits had been overridden or not.