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 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?
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:
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:
(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:
(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:
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:
Connie Richardson is a lecturer at FTC Kaplan in Singapore