AU-C Section 500 describes the sufficiency and
appropriateness of audit evidence in the following paragraphs
.A4
Sufficiency is the measure of the quantity of audit evidence. The quantity of audit
evidence needed is affected by the auditor's assessment of the risks of misstatement
(the higher the assessed risks, the more audit evidence is likely to be
required) and also by the quality of such audit evidence (the higher the quality,
the less may be required). However, obtaining more audit evidence may not
compensate for its poor quality.
.A5
Appropriateness is the measure of the quality of audit evidence (that is, its
relevance and reliability in providing support for the conclusions on which the
auditor's opinion is based). The reliability of evidence is influenced by its source
and nature and is dependent on the individual circumstances under which it is
obtained.
General types of audit procedures are also discussed in this
statement:
.A10
As required by and explained further in section 315 and section 330, audit
evidence to draw reasonable conclusions on which to base the auditor's opinion
is obtained by performing the following:
a. Risk assessment procedures
b. Further audit procedures, which comprise
i. tests of controls, when required by the AU-C sections or when the
auditor has chosen to do so, and
ii. substantive procedures, which include tests of details and
substantive analytical procedures.
To build the
foundation for designing the most cost-beneficial audit strategies, a thorough
knowledge of the basic types of tests recognized in AU-C 500 is necessary.
Tests
of Controls—Compliance
Transactions Tests (author’s words)
Compliance tests are
designed as tests of internal control procedures or activities to determine:
1. The frequency with which the control
procedures are performed.
2. The quality of the performance of the control
procedures.
3. The person performing the procedures.
4. The design effectiveness of the procedures.
Compliance tests of
controls are performed to measure the likelihood of errors occurring and going
undetected and to reduce the amount of substantive testing. Compliance
procedures consist mainly of observations, inspections and inquiries.
Documented evidence of the internal control procedures performed by a client personnel
is necessary to evaluate compliance for larger entities with effectively
designed internal controls. Examining a foreperson’s approval of hours worked
on employees’ time cards, for example, is a compliance test of control. Materiality
is measured by the frequency of errors.
Owners or managers
for small entities may perform key controls that are not documented. In these
circumstances, the auditor can assess compliance by making inquiries of an
owner or manager, evaluating their responses, and documenting their compliance
in a memo or on a working paper.
Tests of Controls—Substantive Transactions Tests (author’s words)
A substantive
transactions test is a test of the accounting system and is normally designed
to test for monetary errors. Determining that all entries recorded in the cash
disbursements journal are valid by examining supporting documents, or that the
extension of sales prices and units on sales invoices are correct, are examples
of substantive transactions testing procedures. Tests of controls are often
used as “dual-purpose” tests, i.e., both compliance and substantive tests of
transactions are performed. While both may supply sufficient evidence for
evaluation of applicable financial statement assertions, auditors can be more
efficient by performing one or the other. Only a “handful” (10%-20%) of the
transactions need be tested substantively if compliance tests are chosen.
If a client has
limited internal controls, but has a solid accounting system, an auditor may
perform only substantive transactions tests or make an assessment of control
risk using other procedures such as a systems walk-through procedure, or tests
of an owner/manager’s key controls by making inquiries and/or observations of
procedures and inspection of documents.
System’s Walk-Through Procedure
The system’s
walk-through procedure is often the most cost-efficient, annual risk assessment
procedure auditors can use, and is discussed in the auditing standards. It is
performed by tracing documents and data through the accounting system from the
inception of transaction cycles to their termination. Its primary purpose is to
provide a good understanding of the accounting system and any control
procedures or activities for risk assessment purposes. Ordinarily 5-10
transactions will be selected for this purpose; selecting more transactions
will increase the substantive evidence from this procedure.
The walk-through
procedure, coupled with good prior year experience with a client and evidence
from reading general ledger account activity, may permit an assessment of
control risk at slightly less than high to moderate. An auditor may be able to
use lesser reliable procedures (nature) for small details of an account
balance, lesser audit coverage of an account balance (extent), and/or perform
some procedures before year-end (timing) at these lower risk levels. This
procedure, considered along with other risk assessment procedures, can provide
substantive evidence that enables the auditor to plan an audit strategy that reduces
tests of balances procedures.
Reading (Scanning) the General Ledger
One of the most pervasive analytical procedures is reading, or
scanning, the general ledger account activity. Whether done manually, or with
the assistance of data extraction software, this analytical procedure is
discussed for the auditing standards.
Many auditors perform this procedure but fail to consider its
affect on their audit strategy. After any errors are corrected by proposed
journal entries, the auditor has obtained significant, substantive evidence
that relevant assertions for many account balances are reasonable. The evidence
obtained from this risk assessment procedure should enable the auditor to
reduce the assessed level of risk of material misstatement and, therefore, the
extent of evidence desired from detailed tests of balances.
This procedure is usually performed by looking for unusual
amounts or postings, transactions or general journal entries greater than the
lower limit for individually significant items, checks or disbursements to be
used in support tests, and other unusual matters. Documentation of the procedure should include the parameters
of the test, the exceptions the test revealed and the resolution of the
exceptions in a spreadsheet, memo or other working paper. Other modules of this
small audit series discuss a General Ledger Analysis Worksheet (an Excel
spreadsheet) as the most efficient documentation for listing and following up
on unusual matters.
AU-C 620, Using
the Work of an Auditor’s Specialist, differs from the previous AU section only in
that management’s specialists’ issues are discussed in the Clarified Auditing
Standard on quality control. The auditor
has responsibility to evaluate the reputation of any specialist used in and
audit and the auditor must have at least a general knowledge of the processes
used by the specialist.
Analytical procedures and tests of balances will be discussed
in Part 2 of this article.
More Information
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- Performing Auditing Tests of Balances Procedures
- Staff Training Series for Entry-Level Accountants, New In-Charge Accountants and Engagement Leaders
- Key Accounting Issues for Non-Profit Organizations
- A Practical Potpourri of Time Savings on Audits
- The Financial Reporting Framework for Small- and Medium-Sized Entities
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