CPA Exam AUD: Audit Evidence and Procedures Guide

Audit Evidence and Procedures: Essential Knowledge for the CPA Exam

Audit evidence is the information used by the auditor to arrive at the conclusions on which the audit opinion is based. AU-C Section 500 (Audit Evidence) establishes the requirements for the auditor to design and perform audit procedures to obtain sufficient appropriate audit evidence. Understanding what constitutes quality evidence and how to obtain it is critical for both the CPA exam and audit practice.

Sufficiency and Appropriateness of Audit Evidence

The two key qualities of audit evidence are sufficiency and appropriateness. Sufficiency is the measure of the quantity of audit evidence. The quantity needed is affected by the auditor's assessment of the risks of material misstatement (higher risk requires more evidence) and the quality of the evidence obtained (higher quality may allow less quantity). Appropriateness is the measure of the quality of audit evidence, including its relevance and reliability.

Relevance means the evidence relates to the assertion being tested. For example, a bank confirmation is relevant to the existence assertion for cash but not to the valuation assertion for inventory. Reliability is influenced by the source and nature of the evidence. Evidence is more reliable when it is obtained from independent sources outside the entity, when it is generated internally under effective internal controls, when it is obtained directly by the auditor, when it exists in documentary form, and when it consists of original documents rather than copies.

Types of Audit Procedures

Auditors use several categories of audit procedures to obtain evidence:

• Inspection of records or documents: Examining records or documents, whether internal or external, in paper or electronic form. Examples include inspecting shipping documents for the occurrence assertion or examining invoices for the accuracy assertion.
• Inspection of tangible assets: Physical examination of assets such as inventory or fixed assets. This provides reliable evidence about existence but not necessarily about rights and obligations or valuation.
• Observation: Watching a process or procedure being performed by others. Observation provides evidence about the performance of the process at the point in time of observation but is limited because behavior may change when people know they are being observed.
• Inquiry: Seeking information from knowledgeable persons inside or outside the entity. Inquiry may be formal or informal, written or oral. While inquiry provides useful evidence, it generally does not provide sufficient evidence by itself for any assertion or for testing the operating effectiveness of controls.
• Confirmation: A specific type of inquiry that involves obtaining a representation directly from a third party. Confirmations are particularly useful for the existence assertion (accounts receivable confirmations) and the completeness assertion (accounts payable confirmations). AU-C Section 505 covers the use of external confirmations.
• Recalculation: Checking the mathematical accuracy of documents or records. This is a highly reliable procedure and can now often be performed electronically.
• Reperformance: The auditor's independent execution of procedures or controls that were originally performed by entity personnel. This provides direct evidence about the effectiveness of a control.
• Analytical procedures: Evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data. Analytical procedures are required during planning and the overall review stage and may be used as substantive procedures.

Management Assertions

Auditors design their procedures to address specific management assertions. The assertions are categorized as follows:

Assertions about classes of transactions and events: Occurrence (transactions actually occurred), completeness (all transactions are recorded), accuracy (amounts are recorded correctly), cutoff (transactions are recorded in the correct period), and classification (transactions are recorded in the proper accounts).

Assertions about account balances at period end: Existence (assets and liabilities exist), rights and obligations (the entity holds the rights to assets and owes the liabilities), completeness (all balances are recorded), and valuation and allocation (amounts are recorded at appropriate values).

Assertions about presentation and disclosure: Occurrence and rights and obligations (events and transactions disclosed have occurred and pertain to the entity), completeness (all required disclosures are included), classification and understandability (information is properly classified and clearly expressed), and accuracy and valuation (information is disclosed at appropriate amounts).

Designing Audit Procedures Responsive to Assessed Risks

Under AU-C Section 330, the auditor must design and implement overall responses to assessed risks at the financial statement level and design and perform further audit procedures responsive to assessed risks at the assertion level. Further audit procedures include tests of controls and substantive procedures. The nature, timing, and extent of these procedures are directly linked to the assessed risks. Higher assessed risk demands more persuasive evidence, which means more reliable procedures, procedures performed closer to year-end, and larger sample sizes.

Exam Tips for Audit Evidence and Procedures

• External evidence is generally more reliable than internal evidence.
• Inquiry alone is never sufficient audit evidence for any assertion.
• Confirmations are the primary procedure for accounts receivable existence.
• Physical inspection provides evidence of existence, not valuation or rights.
• Higher risk of material misstatement requires more and better evidence.