Ch 5 Test 2

• When preparing the financial report, management will make assertions about each account and related disclosures in notes.
• Auditors use these assertions to assess the risk of material misstatement and design audit procedures.
• The assertions used when testing balance sheet items are existence, rights and obligations, completeness, valuation and allocation.

• The different types of audit evidence include external confirmations, documentary evidence, representations, verbal evidence, computational evidence, physical evidence and electronic evidence. 
• External confirmations are sent directly by an auditor to a third party.
• Documentary evidence may be generated internally or externally by third parties.
• Represenation letters are requested from a client's lawyers or management.
• Verbal evidence is the discussions between the auditor and client personnel or third parties. 
• Computational evidence is gathered when an auditor checks the mathematical accuracy of figures included in the financial report. 
• Physical evidence involves the inspection of tangible assets.
• Electronic evidence includes data held on a client's computer, files sent via email to the auditor, and items scanned and faxed.

• The persuasiveness of evidence used to confirm the details included in a client’s accounts varies.
• Internally generated evidence held by the client is the least persuasive as the client can alter or hide
• this evidence.
• Externally generated evidence held by the client is more persuasive as it is created by an independent third party.
• Externally generated evidence sent directly to the auditor is the most
• persuasive as the client does not handle this evidence.

• When an auditor decides to use the work of an expert, the report produced by the expert forms part
• of the evidence used by an auditor when forming their audit opinion.
• An expert is someone with
• the skill, knowledge and experience required to help an auditor.
• The auditor determines the scope
• of the work to be carried out, and assesses the capability of the expert, the objectivity of the expert
• and the expert’s report.

• An auditor may need to use the work of another auditor when their client operates in a number of locations, has divisions or subsidiaries spread around the country or the globe or has significant assets in other places.
• When this occurs the principal auditor may need to rely on evidence provided by another auditor for certain components of their client’s financial report.

• An auditor will inspect records, documentation and tangible assets.
• They will observe client staff
• undertaking various procedures.
• An auditor will make enquiries of client personnel and third parties.
• Confirmations are sent to third parties, including banks, lawyers, lenders and debtors.
• An auditor will recalculate numbers appearing in client files and records to check mathematical accuracy.
• They will re-perform some processes used by the client to check the effectiveness of
• internal controls and the validity of amounts estimated by client personnel.
• Analytical procedures are used throughout the audit to appraise the relationships between financial and non-financial information.

• auditor searches for evidence to verify that a recorded transaction or event, such as revenue or an expense item, took place and relates to the entity.
• This assertion is particularly important when the auditor believes that there is a risk of overstatement and that some transactions or events are recorded but did not actually occur.
• For example, false sales recorded to overstate revenue and profit.

• an auditor searches for transactions or events and makes sure these have been recorded.
• This assertion is particularly important when the auditor believes there is a risk
• of understatement and that some transactions or events that should have been recorded have not been
• recorded; for example, expenses incurred but not recorded to understate expenses and overstate profit.

• an auditor searches for evidence that transactions and events have been recorded at appropriate amounts.
• This assertion is particularly important when the auditor believes there is a risk that the reported amounts are not accurate. For example, when a client has complex discounting systems or foreign exchange calculations where errors can easily occur.

• an auditor searches for evidence that transactions have been recorded in the correct accounting period.
• This assertion is particularly important for transactions close to year-end

an auditor ensures that transactions and events have been recorded in the proper accounts.

• Existence
• Rights and obligations
• Completeness
• Valuation and allocation

• When testing for existence ,
• an auditor searches for evidence to verify that asset, liability and equity items included in the balances
• that appear in the financial report actually exist.
• This assertion is particularly important when the auditor believes there is a risk of overstatement.

• When testing for rights and obligations , an auditor searches for evidence to verify that recorded assets are owned by the entity and that recorded liabilities represent commitments of the entity.
• This
• assertion is particularly important when the auditor believes there is a risk that recorded assets or liabilities
• are not owned by the entity. This assertion is different to existence, as the assets and liabilities may exist but may not be owned by the entity.

An example of inventory that physically exists but does not satisfy the rights and obligations assertion is inventory held on consignment (and therefore not owned by the entity) which is recorded as an asset of the entity.

• an auditor searches for assets, liabilities and equity items and ensures they have been recorded.
• This assertion is particularly important when the auditor believes there is a risk
• of understatement and the client has omitted some items from the balance sheet.
• For example, an auditor will search for unrecorded loans.

• an auditor searches for evidence that assets, liabilities and equity items have been recorded at appropriate amounts and allocated to the correct general ledger accounts.
• This assertion is particularly important when the auditor believes there is a risk of over or undervaluation.

• For example:
• •  an auditor checks that inventory has been appropriately recorded at the lower of cost and net realisable value (risk of overstatement)
• •  an auditor tests for the adequacy of the allowance for doubtful debts provision (risk of understatement)
• •  an auditor checks that transactions are allocated to the correct account when auditing research and development expenditure (risk of understatement of the expense account).

• Occurrence, rights and obligations: Disclosed events, transactions and other matters have occurred and pertain
• to the entity.
• Completeness: All disclosures that should have been included in the financial report have
• been included.
• Classification and understandability: Financial information is appropriately presented and described, and disclosures are clearly expressed.
• Accuracy and valuation: Financial and other information are disclosed fairly and at appropriate amounts.

• An auditor ensures that all items included in the financial report are presented and disclosed appropriately.
• They check that disclosed
• items represent events and transactions that occurred for the entity, are recorded at appropriate
• amounts and are described accurately. An auditor searches to ensure that all items that should have been
• disclosed are included in the financial report.

• information that an auditor uses when arriving at their opinion on the truth and
• fairness of their client’s financial report.
• responsibility of
• those charged with governance at a client to ensure that the financial report is prepared in accordance
• with Australian Accounting Standards and the Corporations Act 2001 .
• responsibility of the auditor to gather sufficient appropriate evidence
• to arrive at their opinion.

• core concept in auditing.
• Sufficiency relates to the quantity and appropriateness relates to the quality of audit evidence gathered.
• quality of evidence gathered will affect the quantity required.
• Audit risk affects the quantity and quality of evidence gathered by an auditor during the risk response phase of the audit.
• Detection risk.

The appropriateness of audit evidence is affected by its source (externally generated evidence is considered more reliable than evidence produced by the client) and by the audit assertions at risk.

By identifying the key risk areas for the client, an auditor is able to focus on gathering more (sufficient) high-quality (appropriate) evidence where the risk of material misstatement is believed to be most significant.

• Bank confirmations
• Legal
• Payable
• Receivable
• POsitive confimations: ask the recipient to reply in all circumstances
• Negative: reply only if they disagree with the info provided.