7-1
Chapter 7
Audit Evidence
Concept Checks
P. 192
1. Following are six characteristics that determine reliability of evidence and an
example of each.
FACTOR
DETERMINING RELIABILITY
EXAMPLE OF
RELIABLE EVIDENCE
Independence of provider
Confirmation of a bank balance
Effectiveness of client’s internal controls
Use of duplicate sales invoices for a large
well-run company
Auditor’s direct knowledge
Physical examination of inventory by the
auditor
Qualifications of provider
Letter from an attorney dealing with the
client’s affairs
Degree of objectivity
Count of securities on hand by auditor
Timeliness
Observe inventory on the last day of the
fiscal year
2. The eight types of evidence and examples of each are included in the table
below.
TYPES OF AUDIT EVIDENCE
EXAMPLES
1. Physical examination
Count inventory in warehouse
Examine fixed asset additions
2. Confirmation
Confirm accounts receivable balances of a
sample of client customers
Confirm client’s cash balance with bank
3. Inspection
Examine copies of monthly bank statements
Examine vendors’ invoices supporting a
sample of cash disbursement transactions
throughout the year
Concept Check, P.192 (continued)
TYPES OF AUDIT EVIDENCE
EXAMPLES
4. Analytical procedures
Evaluate reasonableness of receivables by
calculating and comparing ratios
Compare expenses as a percentage of net
sales with prior year’s percentages
5. Inquiries of the client
Inquire of management whether there is
obsolete inventory
Inquire of management regarding the
collectibility of large accounts receivable
balances
6. Recalculation
Recompute invoice total by multiplying item
price times quantity sold
Foot the sales journal for a one-month period
and compare all totals to the general ledger
7. Reperformance
Agree sales invoice price to approved price list
Match quantity on purchase invoice to
receiving report
8. Observation
Observe client employees in the process of
counting inventory
Observe whether employees are restricted
from access to the check signing machine
P. 199
1. Analytical procedures are required during two phases of the audit: (1) during
are also often done during the testing phase of the audit as part of the auditor’s
2. The four categories of financial ratios and examples of ratios in each
category are as follows:
ratio.
interest earned.
4. Profitability – Earnings per share, gross profit percent, profit margin,
7-3
P. 206
1. The purposes of audit documentation are as follows:
To provide a basis for planning the audit. The auditor may use
To provide a record of the evidence accumulated and the results of
To provide data for deciding the proper type of audit report. Data are
To provide a basis for review by supervisors and partners. These
Audit documentation is used for several purposes, both during the audit
and after the audit is completed. One of the uses is the review by more
experienced personnel. A second is for planning the subsequent year audit. A
third is to demonstrate that the auditor has accumulated sufficient appropriate
2. Audit schedules should include the following:
Name of the client. Enables the auditor to identify the appropriate file
Period covered. Enables the auditor to identify the appropriate year to
Description of the contents. A list of the contents enables the reviewer
to determine whether all important parts of the audit schedule have
Initials of the preparer. Indicates who prepared the audit schedule in
case there are questions by the reviewer or someone who wants
7-4
Concept Check, P.206 (continued)
schedules.
Indexing. Helps in organizing and filing audit schedules. Indexing
Review Questions
guilt of a defendant in a legal case must be proven beyond a reasonable doubt.
This is similar to the concept of sufficient appropriate evidence in an audit
situation. As with a judge or jury, an auditor cannot be completely convinced that
his or her opinion is correct, but rather must obtain a high level of assurance.
7-2 The four major audit evidence decisions that must be made on every audit
are:
1. Which audit procedures to use.
4. When to perform the procedure.
7-3 An audit procedure is the detailed instruction for the collection of a type
of audit evidence that is to be obtained. Because audit procedures are the
7-5
7-4 An audit program for accounts receivable is a list of audit procedures that
statements are correct:
1. The cost of accumulating evidence. It would be extremely costly for
2. Evidence is normally not sufficiently reliable to enable the auditor to
7-6 The two determinants of the persuasiveness of evidence are appropriateness
and sufficiency. Appropriateness refers to the relevance and reliability of evidence,
or the degree to which evidence can be considered believable or worthy of trust.
7-7 The characteristics of a confirmation are:
1. Receipt directly by auditor
2. Written or electronic response
to-day operation of the business.
7-8 Internal documentation is prepared and used within the client’s organization
without ever going to an outside party, such as a customer or vendor.
Examples:
check request form
receiving report
7-6
7-8 (continued)
Examples:
vendor’s invoice
cancelled check
following:
1. Understanding the client’s business and industry
2. Assessment of the entity’s ability to continue as a going concern
procedures, but they are not required in this phase.
7-11 Attention-directing analytical procedures occur when significant, unexpected
differences are found between current year’s unaudited financial data and other
substantive tests.
Substantive analytical procedures are designed to reduce or eliminate
detailed substantive tests. The effectiveness of an analytical procedure in
7-7
7-12 (continued)
assessing the risk of material misstatements.
7-13 Liquidity activity ratios, such as accounts receivable turnover, days to
collect receivables, inventory turnover, and days to sell inventory, provide
information about how long it takes a company to convert less-liquid current
7-14 Audit files are owned by the auditor. They can be used by the client if the
auditor wants to release them after a careful consideration of whether there might
be confidential information in them. The audit files can be subpoenaed by a court
and thereby become the property of the court. They can be released to another
7-15 The Sarbanes–Oxley Act of 2002 requires auditors of public companies to
1. Articles of incorporation
2. Bylaws, bond indentures, and contracts
3. Analysis of accounts that have continuing importance to the auditor
By separating this information from the current year’s audit files, it becomes
7-17 The purpose of an analysis is to show the activity in a general ledger
account during the entire period under audit, tying together the beginning and
ending balances. The trial balance includes the detailed makeup of an ending
7-18 Unanswered questions and exceptions may indicate the potential for
presented.
The audit files can also be subpoenaed by courts as legal evidence.
was done and by whom.
7-20 The purposes of audit engagement management software are to convert
traditional paper-based documentation into electronic files and to organize the
audit documentation, and help manage the engagement. The benefits of
engagement management software are as follows:
The effects of adjusting journal entries are automatically carried
through to the trial balance and financial statements, making last–
minute adjustments easier to make.
package after the audit is completed.
Multiple Choice Questions From CPA Examinations
7-21 a. (2) b. (4) c. (4)
7-22 a. (1) b. (4) c. (2)
7-23 a. (3) b. (3) c. (4)
7-9
7-24 a. (4) b. (2) c. (1)
Discussion Questions And Problems
7-25 a. 1. Internal 7. External 13. Internal
2. Internal 8. External 14. Internal
they are still internal documents.
** Bills of lading are ordinarily signed by the freight company.
the conditions stated on the document.
7-26
1. (4) analytical procedures
2. (5) inquiries of client
3. (3) inspection
4. (2) confirmation
5. (6) recalculation
6. (1) physical examination
7-27
ACCOUNT
NAME
INFORMATION
TO BE CONFIRMED
CASH IN BANK
Name and address of the bank.
The amount on deposit for each
account as of the balance sheet date
plus the name of each account, the
account number, whether or not the
account is subject to withdrawal by
check, and the interest rate if the
account is interest bearing.
The amount for which Star was
directly liable to the bank for loans
as of the balance sheet date plus the
date of the loan, the due date, the
interest rate, the date to which interest
is paid, and description of the liability
and collateral.
If internal controls over cash are
deficient, the auditor may wish to
request that the bank include a list
of authorized signatures with the
confirmation.
TRADE
ACCOUNTS
RECEIVABLE
The confirmation can be either a positive
or negative form of request. The positive
form requests the debtor to directly
notify the auditor whether the
information is correct and, if not correct,
which items are considered incorrect.
The negative form requests a reply only
if the information is incorrect. In both
cases the information should include:
Name and address of the debtor.
Account number (if applicable).
The confirmation “as of” date.