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1、7-1 Chapter 7 Audit Evidence The amount of time you spend on this chapter is mostly dependent on the emphasis you want to put on audit documentation.The topics to cover are:Chapter opening vignette Overview Audit evidence decisions Persuasiveness of evidence Types of evidence Terms used in audit pro
2、cedures Audit documentation Chapter Opening Vignette “CEO Confesses to Falsifying Documents to Hide Fraud for Over Twenty Years”This vignette describes the recent fraud involving Peregrine Financial.It illustrates the risks that auditors face that clients may produce fraudulent documentation to hide
3、 fraud.It also highlights how technology can enable fraud,but new audit technologies such as electronic confirmations can help detect fraud.We like to discuss whether electronic confirmations were necessary to detect the fraud,or whether traditional confirmations sent by mail could have detected the
4、 fraud if properly used.Overview It is useful to start by defining evidence and distinguishing among scientific,legal,and audit evidence.Table 7-1(page 174)is useful to do that.(See Table 7-1;shown on Slide 7-6)Audit Evidence Decisions(page 175)The four audit evidence decisions are explained through
5、out the course.List them for the class,and define and discuss them.(See OH-7-1;also shown on Slide 7-8)Also define an audit procedure.For the audit procedure,obtain accounts receivable confirmations,ask students to tell how and under what circumstances sample size,items to select,and timing should v
6、ary.The purpose is to get students to think about decision making.7-2 Persuasiveness of Evidence(page 176)We spend a few minutes discussing what persuasiveness means and its distinction from certainty(and conclusive).We then cover the distinction between appropriateness and sufficiency.We also discu
7、ss the factors affecting reliability.(See OH-7-2;also shown on Slide 7-12)It is also worthwhile to discuss the reliability of various types of evidence.Types of Audit Evidence(page 179)Define and distinguish between procedures,types of evidence,and generally accepted auditing standards using Figure
8、7-1(page 180).(See Figure 7-1;shown on Slide 7-17)At that point,list on the overhead,ask questions,or make observations about each type of evidence:(See OH-7-3)Physical Examination(page 180)Define Applies only to tangible assets Assets applicable to(cash,fixed assets,securities,etc.)Reliability For
9、what purposes it is useful and not useful Provides an opportunity to have direct contact with business With regard to the last point,a useful teaching technique is to select an industry(e.g.,cement manufacturing)and describe how it works and what assets the auditor might examine.The goal is to get t
10、he students to realize how important knowledge of the business is to performing rudimentary audit procedures in a proper fashion.Confirmation(page 180)Four characteristics:1.Receipt(Note negative confirmation of receivables as an exception.)2.Written we also note that they may be received electronic
11、ally 3.From independent third party 4.Information requested by auditor Type of information confirmed(Table 7-3 on page 181)Reliability and cost Why it is not usually used for tests of controls and substantive tests of transactions(See Table 7-3;shown on Slide 7-20)7-3 Inspection(page 182)Define Exam
12、ples Distinguish from physical examination Internal versus external documents Reliability Examples Where it is likely to be used Electronic evidence Problem 7-27 is useful at this point.Analytical Procedures(page 183)We believe analytical procedures are an essential part of auditing.Students are int
13、roduced to the purposes of analytical procedures in this chapter.More detailed coverage of ratios and the use of analytical procedures in understanding the clients business and assessing risk is included in the next chapter on audit planning.Analytical procedures for specific accounts are discussed
14、throughout subsequent chapters.Define When they are used Purposes(OH-7-4,OH-7-6)Examples(OH-7-5)Reliability(See OH-7-4,OH-7-5 and OH-7-6)For OH-7-6,the answers are:1.A,D 6.B 2.B 7.A,D 3.C 8.C 4.A,E 9.A,D 5.C 10.B Inquiries of the Client(page 184)Define Oral and written Examples Reliability Define le
15、tter of representation(which will be discussed in Chapter 24)Why they are used Legal implications if corroborative evidence not added Tie into BarChris case in Chapter 5 7-4 Recalculation(page 184)Define Examples Reliability Reperformance(page 184)Define Examples Reliability Need for other evidence
16、to test details even if no misstatements Observation(page 184)Define Distinguish from physical examination and documentation Reliability When it is used Define corroborative evidence and why needed Problem 7-28 is one we always use to test students knowledge of types of evidence.Problems 7-29,7-30,a
17、nd 7-34 are also good ones at this point.Problem 7-34 is especially useful to discuss reliability of evidence in different situations.If there is time,it is also useful to summarize this discussion by having the students develop a hierarchy of evidence in terms of its probable reliability.We suggest
18、 they should arrive at the three-level hierarchy shown in OH-7-7.(See OH-7-7)After discussing types of evidence,it is desirable to return to the appropriateness of each type of evidence.Table 7-4 on page 185 is useful for that.(See Table 7-4;shown on Slide 7-27)If you have time,relate the types of e
19、vidence to balance-related audit objectives in Chapter 6.This can be done conveniently with Problem 7-33.Terms Used in Audit Procedures(page 187)We cover the terms for definitional purposes.First,go over the terms briefly.Problem 7-35 is useful to help students learn the correct use of terms.Audit D
20、ocumentation(page 188)The end of the chapter vignette on page 194 “Will it Stand Up in Court?”is a good starting point for your discussion of audit documentation.The vignette is an excerpt from the deposition of an auditor who was in charge of an audit six years ago.It illustrates what can happen wh
21、en audit files do not adequately document the audit procedures performed.7-5 We spend little time on audit documentation format because firms have their own techniques.Students often have difficulty understanding what each type of audit schedule means.Briefly cover the following:Purposes Relationshi
22、p of audit documentation to financial statements Common characteristics of audit documentation Ownership of audit files Confidentiality of audit files If you wish to assign problem material for audit documentation,Problem 7-37 is a good one.We discuss how information technology has changed the natur
23、e of the evidence available to auditors,and the way audits are conducted and documented.We note that the term“audit documentation”is now used instead of the term“working papers,”although the latter term is still acceptable.We like to give a few examples of how information technology has made the aud
24、it more efficient.If many of the students in your class have internship experience,you can ask them to give examples of how they documented their audit testing.Requirements for Retention of Audit Documentation(page 189)We briefly discuss the SarbanesOxley requirements for auditors of public companie
25、s to prepare and retain audit working papers and other information related to any audit report for a period of seven years.This component of the SarbanesOxley Act is largely in response to the alleged document shredding by Andersen employees related to the Enron audit.We like to discuss the differen
26、t types of documentation that now must be maintained.Students find it interesting to learn that even email-related documentation may be subject to the retention requirements.CHAPTER 7 CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL LEARNING OBJECTIVES REVIEW QUESTIONS MULTIPLE CHOICE QUE
27、STIONS DISCUSSION QUESTIONS AND PROBLEMS ACL PROBLEM AND CASES 7-1 Contrast audit evidence with evidence used by other professions.7-1 7-2 Identify the four audit evidence decisions that are needed to create an audit program.7-2,7-3,7-4 7-3 Specify the characteristics that determine the persuasivene
28、ss of evidence.7-5,7-6,7-7 7-25 7-34 7-4 Identify and apply the eight types of evidence used in auditing.7-8,7-9,7-10,7-11,7-12,7-13,7-14 7-25 7-27,7-28,7-29,7-30,7-31,7-32,7-33,7-34,7-35,7-36 7-38,7-39 7-5 Understand the purposes of audit documentation.7-15,7-16,7-22 7-26 7-37 7-6 Prepare organized
29、 audit documentation.7-16,7-17,7-18,7-19,7-20,7-21 7-26 7-37 7-7 Describe how technology affects audit evidence and audit documentation.7-23,7-24 7-6 OH-7-1 FOUR EVIDENCE DECISIONS Audit procedures Sample size for a given procedure Items to select from the population Timing OH-7-2 FACTORS AFFECTING
30、RELIABILITY OF EVIDENCE Independence of provider Effectiveness of clients internal control Auditors direct knowledge Qualifications of provider Objectivity Timeliness OH-7-3 TYPES OF EVIDENCE Physical examination Confirmation Inspection Analytical procedures Inquiries of the client Recalculation Rep
31、erformance Observation OH-7-4 PURPOSES OF ANALYTICAL PROCEDURES Understand the clients business and industry Assess going concern Indicate possible misstatements (attention directing)Reduce detailed tests OH-7-5 USE OF INTERNAL RATIOS Explain how each of the following analytical procedures can be us
32、eful to the auditor in determining evidence to accumulate.When would each one be most and least relevant?1.Review(scan)the sales journal.2.Calculate the ratio of bad debt expense to sales for the past four years.3.Calculate interest income for the year by multiplying the prevailing interest rate tim
33、es average interest-bearing receivables.4.Compare the balance due each vendor for accounts payable with the balance in the previous year.5.Compare the total balance in depreciation expense with the previous year.6.Compare the budgeted amount of selling expense with the actual amount.OH-7-6 USE OF RA
34、TIO ANALYSIS For each ratio:Indicate whether it is primarily(A)an indicator of financial failure,(B)an indicator of potential misstatements,or(C)both.For each“A”answer,is it primarily(D)short-term or(E)long-term?For each“B”and“C”answer,state the potential misstatement 1.Quick ratio 2.Sales commissio
35、n/sales 3.Gross margin percentage 4.Debt/equity 5.Average days to collect receivables 6.Interest expense/average interest-bearing debt outstanding 7.Current ratio 8.Inventory turnover 9.Profit/tangible operating assets 10.Manufacturing repair and maintenance/manufacturing fixed assets OH-7-7 HIERARC
36、HY OF RELIABILITY OF EVIDENCE -LEVEL Physical examination ONE Confirmation Inspection external documentation Recalculation Reperformance -LEVEL Inspection internal TWO documentation under good internal control Observation Analytical procedures with adequate data -LEVEL Inspection internal THREE documentation where internal control is weak Inquiries of client Broad analytical procedures