case study on audit evidence

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How the new audit evidence standard can improve audit quality

The new principles-based standard on audit evidence , issued last week by the AICPA Auditing Standards Board, addresses issues such as emerging technology, professional skepticism, and expanding sources of information. Jay Brodish, CPA, a partner at PwC, and Bob Dohrer, CPA, CGMA, the chief auditor of the AICPA, discuss the standard in detail, explaining how it can be applied to today’s evolving business climate.

What you’ll learn from this episode:

• A breakdown of the standard’s effective dates.
• Examples of how the standard will help modernize auditing.
• Why Dohrer says there’s a tendency “to focus on fundamental concepts” any time a new standard is issued.
• Examples and guidance that practitioners can apply to auditing amid the coronavirus pandemic.

Play the episode below or read the edited transcript:

To comment on this podcast or to suggest an idea for another podcast, contact Neil Amato, a JofA senior editor, at [email protected] .

Transcript:

Neil Amato: The proposal for a new audit evidence standard was published about a year ago. I guess for Jay to lead off, can you provide an overview of the standard and where things stand with its finalization and implementation?

Jay Brodish: Sure, Neil. Thanks. The standard itself will be effective for calendar year 2022 audits, and I think it’s a culmination of a multiyear effort to modernize the evidence standard. When you think about it, the standard itself only has 10 paragraphs of requirements, but it’s really around the application materials, the guidance, and the examples that are provided around audit evidence and kind of bringing audit evidence more current, modernizing the examples that are in the standard.

That’s where it is. Bob, do you want to add anything?

Bob Dohrer: No. I think that’s right, Jay. Certainly it’s been an interesting journey I think for the

Auditing Standards Board going through this process. Very happy that the exposure period is done and finalization has taken place. Looking forward to implementation.

Brodish: I was just going to say one other thing, Neil, just on the standard itself. I think practitioners will find it helpful. There’s a lot of examples and guidance that were provided that I think, particularly given some of the challenges we’re encountering right now from a COVID perspective, working remote, alternative forms of evidence, things of that nature that I think are particularly helpful that I think practitioners will find as they look into standards.

Amato: So why is now the time to have a new standard on audit evidence? I guess, Bob, do you want to start on that one?

Dohrer: Sure, Neil. I’d be happy to. As I referenced earlier, it’s been an interesting journey. If we look back in history a little bit, one would realize that the last or most recent prior to this new standard, the most recent changes we had to our audit evidence standard occurred over a decade ago. Certainly that standard was developed in a time where principally audit evidence was obtained from internal sources to the entity. It consisted primarily almost entirely of paper, hard-copy documents. And if you think back not only the last 10 years but think about even the last year or two, as a matter of fact, how rapidly and significantly business has evolved, the way business is conducted, transactions are undertaken. One simply has to think about the onslaught of social media, the internet, big data, all of those things.

So we really believe that it was time that in order to bring audit quality forward, it was important that we modernized our audit evidence standard to recognize those facets. I think it’s interesting Jay picked up on initially during this process, of course, kind of at the last part of the finalization process, the pandemic broke loose. And I know Jay and his task force spend significant time looking at the finished document, kind of stress-testing it against the environment that we found ourselves in, the electronic information, the remote audit procedures, things like that.

So what started out originally as a modernization effort in general actually culminated in reaffirmation that where we were at today was a good place for the standard to be at also. So it’s been an interesting process, and I think the time is absolutely now to have this standard coming into effect, as Jay mentioned, in 2022.

Brodish: And I think to Bob’s point, it was interesting when we stepped back because we were close to finalizing the standard when the pandemic struck. We really took a holistic look at the standard to say, “Do we need to modify anything? Do we need to provide any additional examples or things of that nature to address what was going on?” Interestingly, I think we found that for the most part the proposed standard at that point was fit for purpose. We made a few clarifying examples and things of that nature but found that a lot of the examples we had provided in things of that nature were structured in a way that could be utilized for purposes of auditors thinking about from a working remote situation.

Amato: So specifically, how would the standard effect audit practices?

Brodish: Neil, I’ll take a crack at that. I think with any new standard, auditors need to step back and look at the requirements, how they impact their methodology, how they impact the guidance they provide, those within their firm as an example. I do think one of the interesting aspects of this that I talked about earlier was the requirements section of the standard is a couple pages long. So thinking about it from a methodology perspective, probably firms are going to need to take a look at how it might impact their existing guidance.

But I think where the changes will be with respect to the standard is the examples and guidance in how practitioners may think about applying that. So when I think about some aspects of the standard, it updates the types of evidence. It modernizes the types of things we would expect going from — I’d say the previous standard was very focused on paper documents and evidence that you would obtain directly from your clients, whereas now we’ve sort of looked at different forms of evidence that you might receive and also evaluating different third-party evidence, external information sources, things of that nature. So sort of expanding beyond those to think about and provide guidance on when you might need to be comfortable with completeness and accuracy of data or whether you may need to assess reliability of external information.

So I think the impact will be kind of helping auditors think through different types of evidence and whether, as they start planning their audits going forward, whether different types of evidence may be appropriate or sufficiently persuasive for the purpose with which you need.

Amato: Jay mentions some ways that could it probably improve audit quality. Bob, would you like to expand on that, on how you see the standard improving audit quality?

Dohrer: Yeah. Well, thank you, Neil. And I think Jay covered many aspects. I think more generally just stepping back, any time there’s a new standard it causes people to refocus or to focus on fundamental concepts underlying our standards that have been in existence and served us so well for decades.

When you think about basic things like the relevance and reliability of audit evidence, I think what we’ve been able to do with this standard is to modernize a framework or a set of considerations. And although those will certainly be helpful years down the road, I think the biggest benefit to audit quality in the near term will simply be getting auditors to focus on some of those fundamental things – the accuracy, the completeness as Jay mentioned, susceptibility to bias, authenticity, all those types of things. So I see that as being very important.

I think the other piece that we’re focused clearly today on our new audit evidence standard but also to understand the other efforts underway with the AICPA on a broader base as well as the Auditing Standards Board itself, the agenda. There is no doubt that in today’s world, financial reporting, accounting standards, so on and so forth, is becoming more and more complex. The onslaught of nonfinancial information and even some of the highly uncertain economic times that we find ourselves in really have put an onus on the auditor to think beyond what we traditionally have as being a numbers type, kind of a right-brain thinking concept.

So to think about things like bias and authenticity and whether the information corroborates or contradicts other information is really critical at this point in time. I think you take all of that together and it certainly serves to enhance audit quality now and into the future.

Brodish: I think as Bob said, one of the opportunities here for auditors is to really think about what is the evidence they need. And I think it challenges auditors a bit to think there may be different forms of evidence that may serve the purpose for what you need, but you may need to think about it differently. Whether, as Bob said, whether you think about bias or whether you think about alternative forms of evidence. They really may be appropriate but you may need to do some completeness and accuracy procedures or make sure you understand the client roles over data, as an example.

So I do think it gives an opportunity to think a little bit differently about the evidence we’re receiving, and then also to make sure that those judgments are documented appropriately.

Amato: With any new standard, there are going to be questions and obstacles as it’s starting to be applied. What would you say are the potential implementation challenges?

Brodish: Neil, I think the challenges here are — it’s interesting. This is a documentation standard versus a performance standard. So the standard itself is not necessarily going to tell you what to do. But I think it’s going to challenge auditors to, again, think a little holistically about the types of evidence you’re obtaining and then in instances where maybe you’re not going the status quo or you’re going to try doing things a little differently, documenting those judgments from that perspective.

I could also see — and this may be more of an AICPA question around just when you think about the standard itself, there’s a lot of examples and guidance. There’s an exhibit that was provided, nonauthoritative exhibit. But there may be some requests from maybe some more implementation guidance, maybe a couple of examples try not to be overly prescriptive in the standard. But I think there’s always opportunities to provide — here’s an example where we might provide how the standard could be applied. I think that was one of our thought processes of adding and exhibit that demonstrated a particular procedure around revenue where a procedure could be structured to perform both risk assessment and substantive evidence.

Again, it was a thought process. We thought it was particularly well vetted that helps to demonstrate some of the thinking in the standard.

Dohrer: Jay, I think you hit on some important points there. This standard is probably about as principles-based a type of standard that we’ve issued in quite some time. And I think in that regard, auditors may feel a little bit uneasy or uncertain when implementing the standard because there is certainly not a step-by-step procedure manual or a formula to implement these concepts. It really is a holistic thinking exercise that needs to go on.

It’s interesting that one of the things that we hear at the AICPA quite commonly is that people want principles-based standards. They want to be able to use professional judgment while applying good, healthy professional skepticism. And this standard gives them that opportunity.

It will be interesting to see the reaction when auditors start implementing the standard because, as I said, it’s one that it’s not connect the dots, it’s not item 1A, item 1B. It is thinking about different facets or aspects of audit evidence and what makes that evidence or information reliable and taking that into account all at the same time, and not discounting information simply because one facet isn’t quite as important in that context as another.

So it will be very interesting. Jay mentioned the AICPA with implementation material. I think you hit it on the head, Jay. I’m glad you mentioned the nonauthoritative exhibit that’s included in the standard. I think the question about whether an audit procedure can serve to provide both risk assessment evidence as well as substantive audit evidence concurrently is one that we have been asked many, many times in the last couple of years. And I’m really excited and very happy that the Auditing Standards Board has answered that question. And not only answered the question but provided an example or an illustration of how it might be done. So I think that’s great.

But it’s only, I think, the first step in a broader implementation plan because I think because of the principles involved in the use of judgment, I think it will be helpful for the AICPA to develop some other scenarios and case studies where a thought process can kind of be explained of where we get to when applying the standard because it may not be self-evident on its face.

Brodish: To Bob’s point, I think the nonauthoritative guidance is important right now. It is an area that is being looked at. The AICPA is not alone at looking at modernization or updating the evidence standard. Other standard setters are also looking at that so I think it’s important as the profession thinks about that, that it’s both a function of laying out our views but also making sure there’s consistency collaboration with the other standard setters.

Dohrer: Neil, I think maybe to illustrate the principles-based nature of the standard that requires judgment to use, the current standard that we have as I mentioned developed 10 years or more ago contained many — Jay, we called them truisms, I think, in the early days of the task force — where general statements that were made such as information or audit evidence obtained from a source external to the entity was higher quality than information obtained internally from the entity or more reliable, for example, and things like that.

So there were these general rules of thumb that you could use. And I think one thing we’ve done with this standard is, while still recognizing the concepts of reliability is important and certainly the credibility of the source especially from what you obtain information is important, it’s not necessarily so that information you get from one source is of a better or worse quality simply because the source is different. There are all the other aspects that go into it: how precise it is, how complete it is, how accurate it is, and those sorts of things.

So I think that’s going to be something that will take some time, and we do have a couple years now to work with our members in trying to explain that some of those broad generalizations just are different in today’s context and we provided something that will help them to think through how they will arrive at the same decisions about sufficiency and appropriateness of audit evidence.

Amato: That leads in pretty well to the next question. You mentioned time; you mentioned a few years. Tell us again timeline for next steps on the standard.

Dohrer: Thanks, Neil. I have to say this is one of the areas, it’s both exciting of course and at the same time there’s a little bit of kind of mandatory standard-setting protocol that needs to go into place with this. We know when the auditing standards board issues a new standard, there are some things that need to occur in practice, not the least of which — first of all, it takes us some time to get it through editorial and make sure it’s exactly the way we need to be. We expect that standard to be published shortly in mid-July or so at the latest.

But more importantly, the third-party methodology providers as well as the larger firms that maintain their own audit methodologies and tools and guidance need to obtain the standard, understand the standard. They need to go through a development process to incorporate the new standard into their methodologies and tools. There needs to be training of all the firm personnel. Certainly, for example, we’ve got a session at ENGAGE this year where we’ll start training on this.

Then the actual engagements upon which a new standard is implemented need to be out on the horizon a little bit to prepare everybody to be ready.

So usually when we issue a new standard it’s generally, roughly speaking, about 18 months to 24 months before we actually make it effective and, as Jay referred to, that’s for calendar year end audits of 2022 financial statements.

However, it’s always interesting. We issue these standards because we do believe they will improve audit quality and they’re in the public interest. So as is the case with all of our standards except those where we specifically prohibit it, the standard can be implemented early if a firm, auditor or CPA is ready to do so. And so that’s a possibility.

Which just means that the AICPA, immediately after the standard is published, begins a process of implementing and providing the training, developing materials. We mentioned some of the nonauthoritative perhaps illustrations and examples that we’ll do. All of that will occur over the next 12 months or so and ultimately lead to, in about a year, having all of that material in place so that it can be then implemented in 2022.

Jay, do you want to maybe expand a little bit on what your firm or a firm in general goes through with a new standard?

Brodish: Sure. I mean, all the firms would go through a process. This is not the only standard being updated, so you go through a process of evaluating the standard, comparing the standard to your existing guidance and methodology, sometimes updating words and updating policies and things of that nature. That process takes a period of time to do, as Bob said.

My thought would be that over calendar 2020 and some into 2021, firms are going to be working on this policy so that they’re updated, training has been put in place and the thought would be, given it’s a calendar 2022 implementation or effective date, you’d want to be in a position so you had all of that ready to go at the beginning of calendar 2022 because it is applicable. Again, you gather evidence sometimes throughout the whole year. You may start interim testing earlier in the year, so I think that’s another reason we wanted sufficient time to make sure auditors and their firms were prepared.

Amato: Well, this has been great. Anything to say in closing, any summation thoughts?

Brodish: I think with respect to evidence, it really gives the profession an opportunity to step back and acknowledge sort of where we are from a technological perspective, what’s going on currently with respect to working remote practices. But I think from a standard perspective it really is structured in a way to look at how business is being conducted, the type of evidence we’re obtaining in today’s business environment, and then really having auditors think about what really makes sense, what they really need to obtain. But then also making sure that those judgments, especially if you’re changing how you’ve done it historically, but making sure they’re documented appropriately.

Dohrer: Well, Neil, just a couple maybe not even directly related to audit evidence but just more broadly related to our AICPA strategy, work plan, and as it relates to the auditing standards board. This is certainly one of the more significant standards that we’ve issued in the recent past. But it’s not the only standard that’s kind of moving in lockstep with our overall effort, with our strategy of the audit of the future and modernizing our audit standard.

So while this is a key linchpin that we felt had to be in place for us to move forward, we currently have projects involving risk assessment, which is so fundamental to audit, that will enhance the auditors in risk assessment process and do so in a more principles-based way.

We’re looking at our attestation standards to make those more flexible and deal with evolving subject matters going forward and doing some fundamental work also with quality control structures within firms, especially as those will also address the firm’s use of technology, resources, automation, things of that nature.

So Jay has been absolutely a leader with this task force and getting this new standard across the finish line, and it’s kind of the leader of the pack as we unfold more of our strategy for modernizing the audit of the future going forward.

Amato: Jay, Bob, thank you very much.

Brodish: Thanks, Neil.

Dohrer: Thank you, Neil. And thanks, Jay, for all your work. It’s a pleasure.

Brodish: Thank you.

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Audit Evidence and Documentation

• First Online: 22 July 2018

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Audit evidence refers to Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information. Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is obtained by performing specific procedures.

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Analytical Procedures and Audit‐Planning Decisions, by Steven M. Glover, James Jiambalvo, and Jane Kennedy; AUDITING: A Journal of Practice & Theory , March 2000, Vol. 19, No. 1, pp. 123–143.

An Analysis of the Relative Power Characteristics of Analytical Procedures, by Yining Chen and Robert A. Leitch; AUDITING: A Journal of Practice & Theory , March 1999, Vol. 18, No. 1, pp. 117–123.

Factors Affecting Internal Auditors’ Consideration of Fraudulent Financial Reporting during Analytical Procedures, by Bryan K. Church, Jeffrey J. McMillan, and Arnold Schneider; AUDITING: A Journal of Practice & Theory , September 2000, Vol. 19, No. 2, pp. 27–45.

Which of the following assertions is inaccurate concerning audit evidence?

Audit evidence consists of all the information, whether obtained from audit procedures or other sources

Audit evidence consists of information used by the auditor in arriving at the conclusions on which his opinion is based

The relevance of audit evidence does not refer to its relationship to the assertion or to the objective of the control being tested

Audit evidence consists of both information that supports and corroborates management’s assertions regarding the financial statements or internal control over financial reporting and information that contradicts such assertions.

Audit procedures can be classified into the following categories, except:

Risk assessment procedures

Tests of controls

Substantive procedures

Substantive analytical procedures

Confirmation

Which of the below assertions is inaccurate concerning analytical procedures?

Analytical procedures involve evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data

Analytical procedures include investigation of fluctuations and relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount

Analytical procedures may be used as substantive procedures either on their own or in conjunction with tests of details

Analytical procedures cannot be used as substantive procedures either on their own or in conjunction with tests of details

The main assertions in the financial statements relating to inventory, for which audit procedures should be designed and performed are:

Completeness

When the auditor attends an inventory count as a part of the inspection procedure, the auditor is required to:

Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting

Observe the performance of management’s count procedures

Inspect the inventory

Perform test counts

Inquire about the choice of the inventory method selected by the management

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About this chapter

Lessambo, F.I. (2018). Audit Evidence and Documentation. In: Auditing, Assurance Services, and Forensics. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-90521-1_9

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Published : 22 July 2018

Publisher Name : Palgrave Macmillan, Cham

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Online ISBN : 978-3-319-90521-1

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Famous Audit Case Studies: Lessons Learned from Noteworthy Audit Failures and Successes

Audit case studies provide valuable insights into the world of auditing, offering lessons that can shape the profession and help auditors navigate complex challenges. In this blog, we delve into some famous audit case studies that have impacted the auditing profession. These case studies demonstrate the importance of thoroughness, professional scepticism, and adherence to auditing standards.

1. The Lehman Brothers Collapse

The collapse of Lehman Brothers in 2008 is a prominent example of an audit failure that had far-reaching consequences. The case highlighted the need for auditors to exercise professional scepticism and thoroughly evaluate companies’ financial statements and disclosures. The failure to identify the risks and irregularities ultimately led to the global financial crisis.

2. The Satyam Scandal

The Satyam scandal in 2009 shook the Indian corporate world. Auditors failed to detect a massive accounting fraud that involved inflating revenues, creating fictitious assets, and manipulating financial statements. This case emphasised the importance of auditors’ independence, scepticism, and the need for robust internal controls within organisations.

3. The WorldCom Fraud

The WorldCom scandal in 2002 revealed one of the largest accounting frauds in history. Auditors failed to identify the manipulation of  financial statements  through improper accounting practices. This case highlighted the significance of auditors’ responsibility to assess and verify financial information and exercise professional judgment diligently.

4. The Olympus Corporation Scandal

The Olympus Corporation scandal in 2011 involved a massive cover-up of losses through fraudulent accounting practices. This case underscored the importance of auditors conducting thorough assessments of an organization’s financial controls, risk management processes, and corporate governance structures.

5. The Waste Management, Inc. Case

In the 1990s, Waste Management, Inc. was involved in a significant accounting scandal. The case brought attention to the manipulation of financial statements and the role auditors play in ensuring accurate financial reporting. It highlighted the need for auditors to challenge management when faced with questionable practices.

Famous audit case studies serve as cautionary tales, illustrating the impact of audit failures and the importance of maintaining the highest professional standards in auditing. These cases remind auditors of the significance of independence, skepticism, and diligence in their work. By learning from these case studies, auditors can enhance their skills, sharpen their professional judgement, and contribute to the integrity and reliability of financial reporting. Continuous education, adherence to auditing standards, and a commitment to ethical conduct are essential for auditors to navigate complex audit environments and safeguard stakeholders’ interests.

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Relevant to Professional Scheme Papers 2.6 and 3.1 and new ACCA Qualification Papers F8 and P7 Questions in auditing exams on audit procedures are very common. This article considers the difference between audit procedures and audit evidence and techniques for deciding on relevant audit evidence in a variety of circumstances.

Audit procedures versus audit evidence

Audit procedures are actions that auditors carry out during the audit. Paper 2.6 questions typically ask candidates to describe audit procedures, also known as ‘audit tests’ or ‘audit work’.

Audit evidence is obtained by the auditor as a result of the audit procedure. For example, ‘performing a circularisation of receivables/debtors’ is an audit procedure, whereas ‘replies from customers’ is audit evidence. It is very important to be aware of the difference. If a question asks for audit evidence and candidates state audit procedures, then the question hasn’t been answered, and gains no marks.

Which of the following are procedures and which are evidence?

• Inspecting non-current/fixed assets for signs of obsolescence
• An item of inventory/stock that is present at the inventory/stock count
• A bank statement
• Counting petty cash
• A working paper showing a re-calculation of depreciation
• A sales invoice
• Attending a wages pay out.

Items 1, 4 and 7 are procedures (because procedures are actions, notice the use of verbs such as ‘inspecting’, ‘counting’, and ‘attending’). The other items are evidence, as they are the result of audit procedures.

However, note that the phrasing is ‘state the audit evidence that you should expect to find in undertaking your review of the audit working papers and financial statements’. Item 5 meets this criterion because it is a working paper, but items 3 and 6 are not necessarily included in audit working papers, so one would need to phrase the answer in such a way as to make this clear. For example, one could say ‘a copy sales invoice’ and ‘a copy bank statement with the balance cross-referenced to the bank reconciliation’.

Item 2 is definitely not evidence normally seen in working papers, since it is an item of physical inventory/stock. This could be rephrased as ‘a schedule showing items test-counted at the inventory/stock count’ to make it into a correct answer.

Identifying appropriate audit evidence

Substantive testing questions can be quite tricky, as they can cover a range of accounting standards, and therefore are more varied than questions on topics such as inventory/stock, receivables/debtors, payables/creditors, or non-current/fixed assets. 

Candidates need to be able to think on their feet and develop a ‘sensible answer’ approach to a wide variety of questions, even if they have never considered the subject previously. One way to do this is to use the financial statement assertions as a starting point.

The financial statement assertions are those assertions that are implicit or implied when the directors make an explicit statement that the financial statements give a true and fair view. In other words, they are attributes of the financial statements that must be true if the financial statements are to give a true and fair view.

Assertions include completeness (all assets, liabilities, transactions, and events are included) and valuation (assets and liabilities are included at an appropriate carrying value). Auditors design their audit programmes to ensure – as far as possible – that each of these assertions are true, in order to gain evidence that proves that the financial statements give a true and fair view.

Using the assertions as a starting point to answer a question can be useful if the question is general – for example ‘describe how you would audit leases’. Candidates could consider what assertions are relevant to leases and then describe audit tests and/or evidence (depending on the question) to prove each of these assertions.

You are the manager in charge of the audit of Yummy Mummy Co., a listed company with a European-wide chain of fashion stores for babies and expectant mothers. The audit for the year ended 30 September 2006 is nearing completion. The draft financial statements show a profit before tax of $50.6m (2005: $95.3m).

The audit senior has produced a schedule of ‘Points for the attention of the audit manager’ as follows:

(a) Due to the falling birth rate, the performance of the stores in Italy has been worse than expected. An impairment review was performed on 15 October 2006, treating the Italian stores as a single cash-generating unit, which indicated that the recoverable amount of the assets (based on value in use) was $23m lower than the carrying value. (6 marks)

(b) The company self-manufactures many of its clothing lines, and has a factory in Manchester, UK. Research has shown that the company could achieve substantial cost savings by outsourcing to south east Asia, and the factory in Manchester is to be closed. A provision of $3.2m to cover redundancy costs has been included in the 2006 draft financial statements. (7 marks)

(c) The company is planning to open 20 new stores in south east Asia in the next year. To assist in financing the expansion, the company sold a number of its properties on 28 September 2006 for $200m and leased them back under operating leases. (7 marks)

For each of the above points: (i)  Comment on the matters that you should consider; and (ii)  State the audit evidence that you should expect to find, in undertaking your review of the audit working papers and financial statements of Yummy Mummy Co. (20 marks)

The mark allocation is shown against each of the three points.

Formulating an answer

Note the format of the question. There are three mini-case studies, and for each the candidate has to (i) comment on the matters that should be considered and (ii) state audit evidence. As this article is about audit evidence, we will only consider Part (ii) of the question. However, the examiner has given guidance on how she wants candidates to answer Part (i), and has said that matters to consider will normally include risk, materiality, and accounting treatment. In many answers, there is also a requirement to comment on the type of audit report that would be needed if the company refuses to amend an erroneous treatment.

Deciding on audit evidence

For each scenario:

• Think about how the accountant would have calculated the numbers in the financial statements, the source documents used and the systems followed, and then write about the documents etc, that one would expect to see.
• Think about how to verify the other relevant facts in each case.
• Consider the accounting/disclosure requirements of each scenario, and say how one can check if they are being met.

Remember, as the question is about evidence, not procedures, I would advise candidates to begin their answers to each part with the words ‘I would expect to see’, and then list out the evidence as bullet points. This should stop candidates talking about procedures. Here is an example answer – the bracketed text in italics is not part of the answer, but simply explanation where required. (a) (Accounting issues in this scenario are subsequent events (adjusting) and impairment.) I would expect to see:

• extracts from the management accounts showing the performance of the Italian stores compared to budget, and the most recent budget for 2007
• a copy of the board minutes detailing management’s plans to improve performance or to sell the stores (if performance continues to be poor it could affect going concern, if stores are to be sold they may need to be re-categorised as assets held for sale)
• a schedule comparing the carrying value of the assets with the recoverable amount, annotated to show that carrying value has been agreed to the non-current/fixed assets register, and that any allocation of central assets and goodwill was reasonable
• a completed audit programme for non-current/fixed assets (as the appropriateness of the value of the assets has already been checked during the audit of non-current/fixed assets, there is no need to check it again)
• a calculation of value in use, annotated to show that the cash flows have been compared with budgets for 2007 and beyond, and with actual cash flows (to see if they are reasonable).

(b) (The obvious accounting issue is provisions, but issues which are not mentioned – but which are potentially relevant – include assets held for sale and discontinued operations.) I would expect to see:

• a copy of the announcement of the restructuring (has to be before the year end in order for a provision to be made)
• a working paper detailing whether redundancy payments are being made in accordance with contractual, statutory, or constructive obligations, and how the constructive obligations, if any, have been derived (in some countries, companies are required under statute to pay certain levels of compensation to redundant employees)
• a schedule detailing the amount to be paid to each redundant employee. This schedule should be annotated to show that all relevant employees have been included and that the calculations have been checked for a sample of employees, including agreement of their pay/service to their contracts where relevant
• a point in the management representation letter as to any other costs to be provided for in closing the factory (eg penalties for cancellation of leases) a point in the management representation letter detailing whether the factory is to be sold or abandoned (if a decision is made to sell, then assets are valued as assets held for sale, but not if it is to be abandoned)
• a copy of the invitation to tender for the outsourcing contract, and notes of discussions with management as to how the manufacturer was selected and how quality is to be assured.

(c) (Candidates need to focus on checking whether the leaseback is really an operating lease rather than a finance lease.) I would expect to see:

• a copy of the leasing contract
• a schedule comparing the present value of the minimum lease payments with the fair value of the leased assets
• a note comparing the length of the lease with the estimated useful life of the assets, and stating whether Yummy Mummy Co. is responsible for maintenance and insurance
• a schedule calculating the amounts that should appear in the financial statements, if the audit team believes this to be a finance lease
• an estimate of the carrying value of the assets at the date of sale, if the lease is an operating lease (if selling price is not fair value, it affects how profit on sale is recognised)
• a point in the management representation letter on the purchaser of these properties, and whether they are related to Yummy Mummy Co. and, if necessary, a draft of the related party disclosures that will appear in the financial statements.

This is just one possible answer – there are many other valid points that could be made. Notice that this sample answer reflects the three points mentioned above:

• Evidence to show that the accountant has worked out the figures correctly (eg the calculation of the redundancy payment, the calculation of value in use).
• Evidence to prove other relevant facts (eg performance in Italy, outsourcing contract, lease agreement).
• Evidence to prove that accounting standards have been complied with (eg date of closure announcement, comparison of payments, fair value of leased assets).

Connie Richardson is a lecturer at FTC Kaplan in Singapore

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