4.2 Audit Procedures for Obtaining Evidence

Audit procedures are essential tools for gathering evidence in an audit. From inquiries to analytical procedures, auditors use various techniques to verify financial information and assess internal controls. Understanding these methods helps auditors plan effective strategies for obtaining reliable evidence.

Applying audit procedures to specific assertions ensures comprehensive coverage of financial statement elements. By tailoring techniques to test existence, completeness, valuation, and other assertions, auditors can systematically evaluate the accuracy and fairness of financial reporting.

Audit Procedures for Evidence Gathering

Inquiry and Inspection

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• Inquiry involves seeking information from knowledgeable persons, both financial and non-financial, within or outside the entity
  • Inquiry alone does not provide sufficient appropriate audit evidence
• Inspection involves examining records, documents, or tangible assets
  • Inspection of records and documents provides audit evidence of varying degrees of reliability, depending on their nature, source, and the effectiveness of internal controls over their production (financial statements, contracts, invoices)

Observation and Confirmation

• Observation consists of looking at a process or procedure being performed by others
  • Observation provides audit evidence about the performance of a process or procedure but is limited to the point in time at which the observation takes place (inventory count, control activities)
• Confirmation is the process of obtaining a representation of information or of an existing condition directly from a third party
  • Confirmations are frequently used in relation to account balances and their components but need not be restricted to these items (accounts receivable, bank balances, legal contingencies)

Recalculation, Reperformance, and Analytical Procedures

• Recalculation consists of checking the mathematical accuracy of documents or records
  • It can be performed through the use of information technology (depreciation expense, interest calculations)
• Reperformance involves the auditor's independent execution of procedures or controls that were originally performed as part of the entity's internal control
  • Reperformance can provide audit evidence about the appropriateness and effectiveness of internal controls (authorization of transactions, reconciliations)
• Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and non-financial data
  • Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount (ratio analysis, trend analysis, reasonableness tests)

Applying Audit Procedures to Assertions

Existence, Occurrence, Rights, and Obligations

• Existence or occurrence assertions require inspection, observation, or confirmation procedures to obtain evidence that assets or liabilities exist at a given date and that recorded transactions have occurred during the period under audit (physical inventory observation, cutoff tests)
• Rights and obligations assertions necessitate inspection or confirmation procedures to obtain evidence that the entity holds or controls the rights to assets and that liabilities are the obligations of the entity at a given date (title documents, loan agreements, confirmations with lenders)

Completeness, Valuation, Allocation, Presentation, and Disclosure

• Completeness assertions are tested through inspection, observation, confirmation, recalculation, reperformance, or analytical procedures to obtain evidence that all assets, liabilities, and transactions that should have been recorded have been recorded (search for unrecorded liabilities, review of reconciliations)
• Valuation or allocation assertions require recalculation, reperformance, or analytical procedures to obtain evidence that assets, liabilities, and transactions are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded (testing the calculation of estimates, evaluating the reasonableness of assumptions)
• Presentation and disclosure assertions are tested through inspection or recalculation procedures to obtain evidence that components of the financial statements are appropriately classified, described, and disclosed (reviewing financial statement disclosures for completeness and accuracy, testing the classification of transactions)

Audit Sampling for Evidence

Sampling Concepts and Techniques

• Audit sampling is the application of audit procedures to less than 100% of items within a population of audit relevance such that all sampling units have a chance of selection to provide the auditor with a reasonable basis on which to draw conclusions about the entire population
• The auditor should select sample items in such a way that the sample can be expected to be representative of the population
  • Random selection, systematic selection, and haphazard selection are means by which this can be achieved (random number generation, every nth item, arbitrary selection without bias)

Designing and Evaluating Samples

• When designing an audit sample, the auditor should consider the purpose of the audit procedure and the characteristics of the population from which the sample will be drawn
  • The auditor should determine a sample size sufficient to reduce sampling risk to an acceptably low level (considering expected misstatement, desired level of assurance)
• For tests of details, the auditor should project misstatements found in the sample to the population
  • For tests of controls, the auditor should evaluate the results of the sample to determine if the control is operating effectively (considering the rate of deviation from prescribed controls)

Risks of Audit Procedures

Risks Associated with Inquiry, Inspection, Observation, and Confirmation

• Inquiry procedures carry the risk that responses may not be reliable or complete, as individuals may have incentives to provide misleading or false information
• Inspection procedures have the risk that the documents or records inspected may not be authentic or accurate, particularly if internal controls over their production are weak
• Observation procedures are limited by the fact that the act of being observed may affect how the process or procedure is performed, and observations only pertain to the point in time at which they occur
• Confirmation procedures carry the risk that the party confirming the information may not be knowledgeable or independent, or that responses may not be received from all parties selected for confirmation

Risks Associated with Recalculation, Reperformance, Analytical Procedures, and Sampling

• Recalculation and reperformance procedures are less likely to be impacted by risks, but they are still dependent on the accuracy and completeness of the underlying data and the auditor's ability to properly execute the procedures
• Analytical procedures are impacted by the risk that relationships and trends identified may be influenced by factors other than those assumed by the auditor, or that unusual transactions or events may go undetected
• Sampling risk arises from the possibility that the auditor's conclusion based on a sample may be different from the conclusion that would be reached if the entire population were subjected to the same audit procedure
  • Sampling risk can lead to two types of erroneous conclusions: that controls are more effective than they actually are or that a material misstatement does not exist when in fact it does (risk of incorrect acceptance, risk of incorrect rejection)