Chapter 5 - Audit objectives and evidence
Last modified on Thursday, 11-Feb-1999 12:41:06 CST
The key concepts of this chapter:
- Audit assertions -
what the auditor gathers evidence to support.
- Audit evidence -
it must be sufficient and competent.
- Audit procedures -
how the auditor gathers the evidence.
The Concept of Audit Assertions
- When management prepares the financial statements,
they make five assertions about each line in
the financial statements.
- For each line in the financial statements, the
auditor's objective is to be sure that there are no
material misstatements in these assertions.
The 5 assertions are
- Existence or occurrence
- Rights and obligations
- Valuation or Allocation
- Presentation and disclosure
Note that each line in the financial statements contains all assertions.
However, the risk of misstatement for each assertion will vary according
to the type of account. The auditor is more concerned about the higher
risk assertions. For example, in general:
- Existence is a concern when auditing assets.
- Completeness is a concern when auditing liabilities.
- Occurrence is a concern when auditing sales.
- Completeness is a concern when auditing expenses.
Each assertion will be re-written as specific objectives.
For example, see p. 149.
To be sure that their are no material misstatements, the auditor gathers
evidence. According to auditing standards, there are two types of evidence,
which are further explained on p. 150, Figure 5-2.
- Underlying Accounting Data
- Corroborating Information
How much evidence does the auditor need?
Auditing standards are very
clear on this. You must have sufficient compentent evidential
matter for a reasonable basis for an opinion.
- What is sufficient? Sufficient means enough.
It is defined in terms of the population's
As an assertion becomes more ________,
the auditor needs more evidence.
- risky, ie, more prone to misstatement
- What is competent? Several characteristics are used to
- Relevant - Competent evidence must
relate to the auditor's objective.
- Counting cash is very relevant for testing
the existence of cash.
- Counting cash is not relevant for determining
if cash's presentation is OK.
- Source - Consider the source of the evidence.
Compentent evidence comes from:
- independent sources outside the client.
- a system with good internal control.
- through the auditor's direct personal
- For example, see Figure 5-4, page 158.
- Timeliness - evidence relates to the balance sheet date.
- Timely evidence: The auditor observes the
inventory on the balance sheet date.
- Not so timely: The client counts the inventory
before the balance sheet date. This
requires additional procedures because
the auditor must test the changes in
the inventory balance between the count
date and the balance sheet date.
- Objectivity - competent evidence is objective rather
than subjective. For example:
- Objective: Observation of physical assets
- Subjective: Opinion of credit manager about
collectibility of accounts receivable.
This relates to valuation.
- What is reasonable basis? - Auditors do not have to
be 100% certain there are no material misstatements.
You might say that you have a reasonable basis for an
opinion if another prudent practioner would agree that
there is less than a 5% chance
that there is an undetected material misstatement.
Audits are conducted in various phases. In each phase, certain
procedures are often used.
Obtain understanding of internal control
For each audit done
in accordance with GAAS, the auditor must obtain an understanding
of internal control. The appropriate procedures are:
- Make inquiries.
- Inspect manuals and other documentation.
- Observe the client.
Tests of controls
The auditor may decide to test controls. If
the tests show that the client's controls are effective at
preventing and detecting errors, the auditor has obtained some
evidence that there is a reasonable basis for issuing a report
that there are no misstatements in the financial statements.
How to test controls:
- Inquiries, inspections, and observations.
- Reperformance of client's activities.
Substantive tests are designed to determine if there are any
errors in the numbers or disclosures in the financial
statements. These are always done becuase tests of controls
are not a sufficient basis for giving an opinion on the
- Substantive tests include the ten procedures discussed on
pages 162 - 165.