Auditing – Lecture 6
Part II. Audit process by phase: Phase III. Testing


Content
nReview process
nAnalytical procedures
nEvidence (sampling)
nRecommended reading
nAppendices: ISA 500, 501, 505, 520, 530, 540
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Review process*
nReview process – the process of planning, executing, and drawing conclusions from analytical
procedures. There are several views of the subprocesses (phases) involved in analytical review:
qExpectation - phase one of the analytical review process when the auditor develops expectations of
what amounts should appear in financial statement account balances based on prior year financial
statements, budgets, industry information and non-financial information. Expectations are the
auditor’s estimations of recorded accounts or ratios. The auditor develops his expectation in such
a way that a significant difference between it and the recorded amount will indicate a
misstatement.
nForming an expectation is the most important phase of the analytical procedure process. The closer
the auditor’s expectation is to the correct balance or relationship, the more effective the
procedure will be at identifying potential misstatements. Expectations are formed from a variety of
sources. The use of industrial, economic, or environmental
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*See Appendix: ISA 520

Review process*
ndata can improve the predictive ability of analytical procedures. Other resources include industry
data, data about similar businesses, and auditor experience. Expectations are also based on the
entities prior financial statements, same store sales, non-financial data, budgets and public
reports.
qIdentification - phase two of the analytical review process when the auditor compares his expected
value with the recorded amount. Audit efficiency and effectiveness depend on competency in
recognizing error patterns in financial data and in hypothesizing likely causes of those patterns
to serve as a guide for further testing.
nThe auditor must consider how large a difference between expected value and recorded amount he
will accept. In other words, at what point is the difference material (e.g. if the difference is 20
percent)? This point could be called a materiality threshold. In substantive testing, an auditor
testing for the possible misstatement of the book value of an account determines whether the audit
difference was less than the auditor’s materiality threshold. If the difference is less than
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*See Appendix: ISA 520

Review process*
nacceptable threshold, the auditor accepts the book value without further investigation. If the
difference is greater, the next step is to investigate the difference.
qInvestigation - phase three of the analytical review process when the auditor undertakes an
investigation of possible explanations for the expected-recorded amount difference. The difference
between an auditor’s expectation and the recorded book value of an account not subject to auditing
procedures can be due to misstatements, inherent factors that affect the account being audited, and
factors related to the reliability of data used to develop the expectation.
nThe greater the precision of the expectation, the more likely the difference between the auditor’s
expectation and the recorded value will be due to misstatements. Conversely, the less precise the
expectation, the more likely the difference is due to factors related to inherent factors, and the
reliability of data used to develop the expectation.
nWhere differences between expectation and recorded amounts
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*See Appendix: ISA 520

Review process*
nare found, the first step is usually to ask management for an explanation. However, it is
important that the auditor maintains his professional skepticism when considering these answers and
it is suggested that the auditor conduct other audit procedures to corroborate them.
qEvaluation - final phase (phase four) of the analytical review process, which involves evaluating
the impact on the financial statements of the difference between the auditor’s expected value and
the recorded amount. It is usually not practical to identify factors that explain the exact amount
of a difference investigated. The auditor attempts to quantify that portion of the difference for
which plausible explanations can be obtained and, where appropriate, corroborated. If the amount
that cannot be explained is sufficiently small, the auditor may conclude there is no material
misstatement.
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*See Appendix: ISA 520

Review process*
nFormulating expectations - expectations are developed by identifying plausible relationships that
are reasonably expected to exist based on the auditor’s understanding of the client and of his
industry. These relationships may be determined by comparisons with the following sources:
qcomparable information for prior periods;
qanticipated results (such as budgets and forecasts, or auditor expectations);
qsimilar industry information;
qnon-financial information.
nSources of information and precision of expectations - the source of information on which the
expectations are based determines, in part, the precision with which the auditor predicts an
account balance. For example, information from other, similar stores in the same retail chain is
more precise than general industry information. Recent years’ financial statements are more precise
a predictor of this year’s balance than older financial
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*See Appendix: ISA 500, 501, 540
The auditor can identify account balances that have changed significantly simply by comparing the
current client data with prior period data. He may compare the current year’s account balances with
that of the preceding year; the current trial balance with similar detail for the preceding year;
and ratios and percentage relationships between years. He compares current recorded account
balances of the entity with results expected by the entity. For example, company budgets may be
compared with actual results for indications of potential misstatements or the auditor calculates
the expected balance for interest expense (notes payable monthly balance times average monthly
interest rate) and compares this to recorded interest rates.
One of the standard bases of comparison is with like companies in the same industry. For example,
the auditor compares the gross margin of the industry to the client’s gross margin.
Analytical procedures may include consideration of relationships between financial information and
relevant non-financial information, such as payroll costs to number of employees. Another example
is the revenue of a hotel may be estimated by multiplying the average room rate times the number of
rooms times the average occupancy percentage (e.g. $100 average rate " 20 rooms " 60 percent
average occupancy). Similarly revenues may be calculated for school tuition (average number of
students enrolled times the average tuition cost), payroll, and cost of materials sold using
non-financial factors.

Review process*
nstatements. The desired precision of the expectation varies according to the purpose of the
analytical procedure. Precision is more important for analytical procedures used as substantive
tests than for those used in planning.
nNature of account and characteristics of data - the more reliable the source of the data, the more
precise the expectation will be. Reliability of data is determined by:
qEffectiveness - is a function of the nature of the account and the reliability and other
characteristics of the data. In determining the nature of the account the auditor considers whether
the balance is based on estimates or accumulations of transactions, the number of transactions
represented by the balance, and the control environment. Subjectively determined balances are more
easily manipulated than accumulations of transactions. If the characteristic of the account is that
it comprises millions of transactions (e.g. retail revenue, it should be more predictable than
those comprising a few transactions
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*See Appendix: ISA 500, 501, 540

Review process*
n(e.g. obsolete inventory). Fixed expenses (e.g. leases) are more predictable than variable
expenses (e.g. shipping).
qAggregation – is the level of detail on which the auditor is able to base his expectation and the
reliability of the data are key characteristics. In general, the more disaggregated the data, the
more precise the expectation. For example, the use of monthly instead of annual data tends to
improve the precision of the expectation. Preparing an expectation by division is also more precise
than an expectation based on consolidated data. Accounting researchers conclude that disaggregated
monthly, segment, or product line balances are required to implement reliable attention-directing
analytical procedures.
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*See Appendix: ISA 500, 501, 540

Analytical procedures*
nAnalytical procedures (AP) are defined by US GAAS and ISA as evaluations of financial information
made by a study of plausible relationships among financial and nonfinancial data involving
comparisons of recorded amounts to expectations developed by the auditor. Analytical procedures use
comparisons and relationships to assess whether account balances or other data appear reasonable
relative to the auditor’s expectations.
nTypes of AP:
qGeneral AP - trend analysis, ratio analysis, regression and statistical analysis, and
reasonableness tests. Determining which type of analytical procedure is appropriate is a matter of
professional judgment. A review of audit practice indicates that simple judgmental approaches (such
as comparison and ratio analysis) are used more frequently than complex statistical approaches
(such as time series modeling or regression analysis). These tests are generally carried out using
computer software (i.e. CAATs).
ØTrend analysis - is the analysis of changes in
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*See Appendix: ISA 520

Analytical procedures*
nan account balance or ratio over time. Trend analysis could compare last year’s account balance to
the current unaudited balance or balances in many time periods. Trend analysis works best when the
account or relationship is fairly predictable (e.g. rent expense in a stable environment). It is
less effective when the audited entity has experienced significant operating or accounting changes.
The number of years used in the trend analysis is a function of the stability of operations. The
more stable the operations over time, the more predictable the relations and the more appropriate
the use of multiple time periods. Trend analysis at an aggregate level (e.g. on a consolidated
basis) is relatively imprecise because a material misstatement is often small relative to the
aggregate account balance. The most precise trend analysis would be on disaggregated data (e.g. by
segment, product, or location, and monthly or quarterly rather than on an annual basis).
n
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Analytical procedures*
ØRatio analysis -  is the comparison of relationships between financial statement accounts, the
comparison of an account with non-financial data, or the comparison of relationships between firms
in an industry. Ratio analysis is most appropriate when the relationship between accounts is fairly
predictable and stable (e.g. the relationship between sales and accounts receivable). Ratio
analysis can be more effective than trend analysis because comparisons between the balance sheet
and income statement can often reveal unusual fluctuations that an analysis of the individual
accounts would not. Like trend analysis, ratio analysis at an aggregate level is relatively
imprecise because a material misstatement is often small relative to the natural variations in the
ratios.
nThere are five types of ratio analysis used in analytical procedures: (1) ratios that compare
client and industry data; (2) ratios that compare client data with similar prior period data; (3)
ratios that compare client data with
Ø
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qWhen to use AP – timing
qCAAT
nTypes of AP
qGeneral AP
qAP by phase
qAP – special (substantive tests)
qAP – Data mining and GAS
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Analytical procedures*
nclient-determined expected results; (4) ratios that compare client data with auditor-determined
expected results; (5) ratios that compare client data with expected results using non-financial
data.
Ø
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Analytical procedures*
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Analytical procedures*
ØReasonableness testing - is the analysis of account balances or changes in account balances within
an accounting period in terms of their “reasonableness” in light of expected relationships between
accounts. This involves the development of an expectation based on financial data, non-financial
data, or both. For example, using the number of employees hired and terminated, the timing of pay
changes, and the effect of vacation and sick days, the model could predict the change in payroll
expense from the previous year to the current balance within a fairly narrow dollar range.
nIn contrast to both trend and ratio analyses (which implicitly assume stable relationships),
reasonableness tests use information to develop an explicit prediction of the account balance. The
auditor develops assumptions for each of the key factors to estimate the account balance.
Considering the number of units sold, the unit price by product line, different pricing structures,
and an understanding of industry trends during the period
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Analytical procedures*
ncould explicitly form a reasonableness test for sales. This is in contrast to an implicit trend
expectation for sales based on last year’s sales. The latter expectation is appropriate only if
there were no other factors affecting sales during the current year, which is not the usual
situation.
nTrend analysis, ratio analysis, and reasonableness tests compared – differ as to the number of
independent predictive variables considered, use of external data, and statistical precision. Trend
analysis is limited to a single predictor, that is, the prior periods’ data for that account. Trend
analysis, by relying on a single predictor, does not allow the use of potentially relevant
operating data, as do the other types of procedures. Because ratio analysis employs two or more
related financial or non-financial sources of information, the result is a more precise
expectation. Reasonableness tests and regression analysis further improve the precision of the
expectation by allowing potentially as many variables (financial and non-financial)
n
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Analytical procedures*
nas are relevant for forming the expectation. Reasonableness tests and regression analysis are able
to use external data (e.g. general economic and industry data) directly in forming the expectation.
The most statistically precise expectations are formed using statistical and data mining analysis.
qAP by phase - AP are used: (a) to assist the auditor in planning the nature, timing, and extent of
audit procedures; (b) as substantive procedures; and (c) as an overall review of the financial
statements in the final stage of the audit. The auditor is required to apply analytical procedures
at the planning and overall review stages of the audit.
ØPlanning - AP performed in the planning stage are used to identify unusual changes in the
financial statements, or the absence of expected changes, and specific risks. During the planning
stage, analytical procedures are usually focused on account balances aggregated at the financial
statement level and
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Analytical procedures*
nrelationships between account balances. The auditor should apply analytical procedures at the
planning stage to assist in understanding the business and in identifying areas of potential risk.
ØSubstantive testing - During the substantive testing stage (phase III of the audit process),
analytical procedures are performed to obtain assurance that financial statement account balances
do not contain material misstatements. In substantive testing, analytical procedures focus on
underlying factors that affect those account balances through the development of an expectation of
how the recorded balance should look.
ØOverall review - AP performed during the overall review stage (phase IV of the audit process) are
designed to assist the auditor in assessing that all significant fluctuations and other unusual
items have been adequately explained and that the overall financial statement presentation makes
sense based on
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Analytical procedures*
nthe audit results and an understanding of the business. The auditor should apply analytical
procedures at or near the end of the audit when forming an overall conclusion as to whether the
financial statements as a whole are consistent with the auditor’s knowledge of the business.
Moreover, they assist in determining the reasonableness of the financial statements. They may also
identify areas requiring further procedures.
qSpecial AP (substantive tests - ST) - substantive procedures in the audit are designed to test for
dollar misstatements (often called monetary misstatements) that directly affect the correctness of
financial statement balances. Auditors rely on three types of substantive tests: substantive tests
of transactions, substantive analytical procedures, and tests of details of balances.
ØTests of details vs substantive AP – tests of details include agreeing the financial statements to
the accounting records, examining material adjustments made during the course of preparing the
financial
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Analytical procedures*
nstatements, and other procedures relating to the financial reporting closing process. Substantive
AP are generally more applicable to large volumes of transactions that tend to be predictable over
time. Tests of details are ordinarily more appropriate to obtain audit evidence regarding certain
financial statement assertions, including existence and valuation.
ØTiming of ST – there are several considerations in determining the timing of substantive
procedures. In some instances, primarily as a practical matter, substantive procedures may be
performed at an interim date. Only using interim testing procedures will increases the risk that
misstatements existing at the period end will not be detected. That risk increases the longer the
time between interim and period end.
ØExtent of ST – the greater the risk of material misstatement, the greater the extent of
substantive procedures. In planning tests of details of transactions or balances, the extent of
testing is ordinarily thought of in
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Analytical procedures*
nterms of the sample size, which is affected by the risk of material misstatement. The use of CAATs
(i.e. computer assisted audit techniques) may enable more extensive testing of electronic
transactions and files. For example, in performing audit procedures, such techniques may be used to
test an entire population instead of a sample. Because the risk of material misstatement takes
account of internal control, the extent of substantive procedures may be reduced if tests of
control show that controls are adequate.
ØTypes of ST:
üTests of transactions - they are used to determine whether all six transaction related audit
objectives have been satisfied for each class of transactions. When auditors are confident that all
transactions were correctly recorded in the journals and correctly posted, considering all six
transaction-related audit objectives, they can be confident that general ledger totals are correct.
ü
ü
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Analytical procedures*
üTests of details of balances – focus on the ending general ledger balances for both balance sheet
and income statement accounts. The primary emphasis in most tests of details of balances is on the
balance sheet. Examples include confirmation of customer balances for accounts receivable, physical
examination of inventory, and examination of vendors’ statements for accounts payable.
nTests of ending balances are essential because the evidence is usually obtained from a source
independent of the client, which is considered highly reliable. Much like for transactions, the
auditor’s tests of details of balances must satisfy all balance-related audit objectives for each
significant balance sheet account.
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*See Appendix: ISA 520

Analytical procedures*
nCAAT and data mining for AP - the use of computer assisted audit techniques (CAATs) may enable
more extensive testing of electronic transactions and account files. CAATs can be used to select
sample transactions from key electronic files, to sort transactions with specific characteristics,
or to test an entire population instead of a sample. CAATs generally include regression and
statistical analysis as well as the more widely used file interrogation techniques using
generalized audit software (GAS) such as data manipulation, calculation, data selection, data
analysis, identification of exceptions and unusual transactions.
qRegression and statistical analysis – it is the use of statistical models to quantify the
auditor’s expectation in financial (euro, dollar) terms, with measurable risk and precision levels.
For example, an expectation for sales may be developed based on management’s sales forecast,
commission expense, and changes in advertising expenditures.
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*See Appendix: ISA 520

Analytical procedures*
nRegression analysis provides a very high level of precision because an explicit expectation is
formed in which all relevant data can be incorporated in a model to predict current year sales.
qGeneralized audit software (GAS) packages - contain numerous computer-assisted audit techniques
for both doing analytical procedures and statistical sampling bundled into one piece of software.
There are widely used GAS packages such as ACL and Idea, and the Big Four audit firms have their
own software such as Deloitte and Touche’s STAR and MINI MAX. GAS packages provide the auditors
with the ability to access, manipulate, manage, analyze, and report data in a variety of formats.
This software allows the auditor to move from analytical procedures to statistical sampling for
analytical procedures fairly easily.
qData mining techniques - data mining is a set of computer-assisted techniques that use
sophisticated statistical
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q
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Analytical procedures*
nanalysis including artificial intelligence techniques, to examine large volumes of data with the
objective of indicating hidden or unexpected information or patterns. In database terms, data
mining is referred to as knowledge discovery in databases (KDD). Data mining can be used in all
types of databases or other information repositories. Data to be mined can be numerical data,
textual data or even graphics and audit.
nGAS’s capability to assist in the overall audit process while requiring little technical skill is
a major reason for its success. However, GAS has been criticized because it makes some tasks easier
but it cannot complete any data analysis by itself. Data mining, on the other hand, analyzes data
automatically but is more difficult to employ.
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*See Appendix: ISA 520
GAS vs Data mining
GAS’s capability to assist in the overall audit process while requiring little technical skill is a
major reason for its success. However, GAS has been criticized because it makes some tasks easier
but it cannot complete any data analysis by itself. Data mining, on the other hand, analyzes data
automatically but is more difficult to employ.
Data mining tools remain promising in a variety of application areas. With the development of
appropriate data mining tools for the auditing profession, it may be expected to replace some
professional expertise required in certain auditing processes. For now, although data mining
procedures are useful in almost all steps of the audit process, its most practical and useful
applications are in analytical procedures. Data mining may use many methods and techniques and
algorithms to analyze client data. Data mining methods include data description, dependency
analysis, classification and prediction, cluster analysis, outlier analysis and evolution analysis
The most frequently used algorithms are decision trees, apriori algorithms, and neural networks.
The purpose of dependency analysis is to search for the most significant relationship across large
number of variables or attributes. Classification is the process of finding models, also known as
classifiers, or functions that map records into one of several discrete prescribed classes.
The objective of data description is to provide an overall description of data, either in itself or
in each class or concept. There are two main approaches in obtaining data description – data
characterization and data discrimination. Data characterization is summarizing general
characteristics of data and data discrimination, also called data comparison, by comparing
characters of data between contrasting groups or classes. The objective of evolution analysis is to
determine the most significant changes in data sets over time. In other words, it is other types of
algorithm methods (i.e. data description, dependency analysis, classification or clustering) plus
time-related and sequence-related characteristics.
The objective of cluster analysis is to separate data with similar characteristics from the
dissimilar ones. The difference between clustering and classification is that while clustering does
not require pre-identified class labels, classification does. Outliers are data items that are
distinctly dissimilar to others and can be viewed as noises or errors. However, such noises can be
useful in some cases, such as fraud detection, where unusual items or exceptions are major
concerns.
An example of the use of the clustering method is when the auditor clusters accounting transactions
in such categories as assets, liabilities, revenue, expenses, etc. This might reveal those small
transactions that occur repeatedly in a certain period of the month or the same transactions
recorded in different account numbers. The auditor might find that sales in some months or
divisions are excessively higher or lower than the normal. Expenses that are highly variable during
the year might be found. Clustering might show the repeated purchase of the same fixed asset. Loans
that are transacted between related companies and subsidiaries may be uncovered.

Audit evidence (sampling)*
nEvidence can be defined as any information used by the auditor to determine whether the
information being audited is stated in accordance with the established criteria. The information
varies greatly in the extent to which it persuades the auditor whether financial statements are
fairly stated. Evidence includes information that is highly persuasive, such as the auditor’s count
of marketable securities, and less persuasive information, such as responses to questions of client
employees. The use of evidence is not unique to auditors. Evidence is also used extensively by
scientists, lawyers, and historians. In scientific experiments, researchers obtain evidence to test
hypotheses using controlled experiments, such as a drug trial to test the effectiveness of a new
medical treatment. Similarly, gathering evidence is a large part of what auditors do. Although
these professionals rely on different types of evidence, and use evidence in different settings and
in different ways, lawyers, scientists, and auditors all use evidence to help them draw
conclusions.
n
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*See Appendix: ISA 530

Audit evidence (sampling)*
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Audit evidence (sampling)*
nBasis of evidence - evidence for proof of audit assertions is different from evidence in a legal
sense. Audit evidence needs only to prove reasonable assurance, whereas in a legal environment
there is a more rigorous standard of proof and documentation.
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*See Appendix: ISA 530

Audit evidence (sampling)*
qDocumentary evidence - is gathered from written, printed or electronic sources. Documentary
evidence consists of computer files and records, e-mail, accounting records, paper (invoices,
writings, pictures), documents (contracts, deed, reports), commercial records (e.g. from banks,
brokerage, retailers, credit card) and government records (licenses, real estate, legal). The best
proof of the contents of a document is the original document itself. However, if the original has
been destroyed or is otherwise unavailable and the court accepts the explanation of its
unavailability, secondary evidence may be used. Secondary evidence may a copy of the evidence.
qElectronic evidence - some of the entity’s accounting data and other information may be available
only in electronic form. For example, entities may use electronic data interchange (EDI) or image
processing systems. In EDI, the entity and its customers or suppliers use communication links to
transact business electronically. In image processing
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Audit evidence (sampling)*
nsystems, documents are scanned and converted into electronic images to facilitate storage and
reference, and the source documents may not be retained after conversion. Certain electronic
information may exist at a certain point in time, but may not be retrievable after a specified
period of time if files are changed and if back-up files do not exist. The electronic nature of the
accounting documentation usually requires that the auditor use computer-assisted audit techniques
(CAATs).
n
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*See Appendix: ISA 530

Audit evidence (sampling)*
nPervasiveness of audit evidence - Audit standards require the auditor to accumulate sufficient
appropriate evidence to support the opinion issued. Because of the nature of audit evidence and the
cost considerations of doing an audit, it is unlikely that the auditor will be completely convinced
that the opinion is correct. However, the auditor must be persuaded that the opinion is correct
with a high level of assurance. By combining all evidence from the entire audit, the auditor is
able to decide when he or she is persuaded to issue an audit report. The two determinants of the
persuasiveness of evidence are appropriateness and sufficiency.
qAppropriateness - is a measure of the quality of evidence, meaning its relevance and reliability
in meeting audit objectives for classes of transactions, account balances, and related disclosures.
Note that appropriateness of evidence deals only with the audit procedures selected.
Appropriateness cannot be improved by selecting a larger sample size or different population items.
It can be improved only by selecting audit procedures that are
n
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Audit evidence (sampling)*
nmore relevant or provide more reliable evidence.
ØRelevance of evidence - evidence must pertain to or be relevant to the audit objective that the
auditor is testing before it can be appropriate. For example, assume that the auditor is concerned
that a client is failing to bill customers for shipments (completeness transaction objective). If
the auditor selects a sample of duplicate sales invoices and traces each to related shipping
documents, the evidence is not relevant for the completeness objective and therefore is not
appropriate evidence for that objective. A relevant procedure is to trace a sample of shipping
documents to related duplicate sales invoices to determine whether each shipment was billed. The
second audit procedure is relevant because the shipment of goods is the normal criterion used for
determining whether a sale has occurred and should have been billed. By tracing from shipping
documents to duplicate sales invoices, the auditor can determine whether shipments have been billed
to
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Audit evidence (sampling)*
ncustomers. In the first procedure, when the auditor traces from duplicate sales invoices to
shipping documents, it is impossible to find unbilled shipments.
nRelevance can be considered only in terms of specific audit objectives, because evidence may be
relevant for one audit objective but not for a different one. In the previous shipping example,
when the auditor traced from the duplicate sales invoices to related shipping documents, the
evidence was relevant for the occurrence transaction objective. Most evidence is relevant for more
than one, but not all, audit objectives.
ØReliability of evidence - refers to the degree to which evidence can be believable or worthy of
trust. Like relevance, if evidence is considered reliable it is a great help in persuading the
auditor that financial statements are fairly stated. For example, if an auditor counts inventory,
that evidence is more reliable than if management gives the auditor its own count amounts.
n
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Audit evidence (sampling)*
nReliability, and therefore appropriateness, depends on the following six characteristics:
üIndependence of provider - evidence obtained from a source outside the entity is more reliable
than that obtained from within. Communications from banks, attorneys, or customers is generally
considered more reliable than answers obtained from inquiries of the client. Similarly, documents
that originate from outside the client’s organization, such as an insurance policy, are considered
more reliable than are those that originate within the company and have never left the client’s
organization, such as a purchase requisition.
üEffectiveness of client’s internal controls - when a client’s internal controls are effective,
evidence obtained is more reliable than when they are weak.
üAuditor’s direct knowledge - evidence obtained directly by the auditor through physical
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Audit evidence (sampling)*
nexamination, observation, recalculation, and inspection is more reliable than information obtained
indirectly.
üQualifications of individuals providing the information - although the source of information is
independent, the evidence will not be reliable unless the individual providing it is qualified to
do so. Therefore, communications from attorneys and bank confirmations are typically more highly
regarded than accounts receivable confirmations from persons not familiar with the business world.
Also, evidence obtained directly by the auditor may not be reliable if the auditor lacks the
qualifications to evaluate the evidence. For example, examining an inventory of diamonds by an
auditor not trained to distinguish between diamonds and glass is not reliable evidence for the
existence of diamonds.
üDegree of objectivity - objective evidence is more reliable than evidence that requires
considerable
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*See Appendix: ISA 530

Audit evidence (sampling)*
njudgment to determine whether it is correct. Examples of objective evidence include confirmation
of accounts receivable and bank balances, the physical count of securities and cash etc. Examples
of subjective evidence include a letter written by a client’s attorney discussing the likely
outcome of outstanding lawsuits against the client, observation of obsolescence of inventory during
physical examination etc.
üTimeliness - can refer either to when it is accumulated or to the period covered by the audit.
Evidence is usually more reliable for balance sheet accounts when it is obtained as close to the
balance sheet date as possible. For example, the auditor’s count of marketable securities on the
balance sheet date is more reliable than a count 2 months earlier. For income statement accounts,
evidence is more reliable if there is a sample from the entire period under audit.
ü
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Audit evidence (sampling)*
n
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Audit evidence (sampling)*
qSufficiency - is measured primarily by the sample size the auditor selects. For a given audit
procedure, the evidence obtained from a sample of 100 is ordinarily more sufficient than from a
sample of 50. Several factors determine the appropriate sample size in audits. The two most
important ones are the auditor’s expectation of misstatements and the effectiveness of the client’s
internal controls.
nIn addition to sample size, the individual items tested affect the sufficiency of evidence.
Samples containing population items with large dollar values, items with a high likelihood of
misstatement, and items that are representative of the population are usually considered
sufficient. In contrast, most auditors usually consider samples insufficient that contain only the
largest dollar items from the population unless these items make up a large portion of the total
population amount.
nCombined effect - the persuasiveness of evidence can be evaluated only after considering the
combination of appropriateness and sufficiency, including the effects of the
Nov 2, 2015
38

*See Appendix: ISA 530

Audit evidence (sampling)*
nfactors influencing appropriateness and sufficiency. A large sample of evidence provided by an
independent party is not persuasive unless it is relevant to the audit objective being tested. A
large sample of evidence that is relevant but not objective is also not persuasive. Similarly, a
small sample of only one or two pieces of highly appropriate evidence also typically lacks
persuasiveness. When determining the persuasiveness of evidence, the auditor must evaluate the
degree to which both appropriateness and sufficiency, including all factors influencing them, have
been met.
nPervasiveness and cost – in making decisions about evidence for a given audit, both persuasiveness
and cost must be considered. It is rare when only one type of evidence is available for verifying
information. The persuasiveness and cost of all alternatives should be considered before selecting
the best type or types of evidence. The auditor’s goal is to obtain a sufficient amount of
appropriate evidence at the lowest possible total cost.
n
Nov 2, 2015
39

*See Appendix: ISA 530

Audit evidence (sampling)*
nAudit evidence decisions – design of the sample:
qSample size – when selecting and designing audit procedures, the auditor should determine
appropriate means of selecting items for testing. The means available to the auditor are: (1)
selecting all items (100% examination); (2) selecting specific items; and (3) audit sampling. The
decision as to which approach to use will depend on the circumstances. While the decision as to
which means, or combination of means, to use is made on the basis of audit risk and audit
efficiency, the auditor needs to be satisfied that methods used are effective in providing
sufficient appropriate audit evidence to meet the objectives of the test.
qTiming - an audit of financial statements usually covers a period such as a year. Normally an
audit is not completed until several weeks or months after the end of the period. The timing of
audit procedures can therefore vary from early in the accounting period to long after it has ended.
In part,
Nov 2, 2015
40

*See Appendix: ISA 530
Selecting of items:
Selecting all items - The auditor may decide that it will be most appropriate to examine the entire
population of items that make up an account balance or class of transactions (or a stratum within
that population). 100% examination is unlikely in the case of tests of control; however, it is more
common for substantive procedures. For example, 100% examination may be appropriate when the
population constitutes a small number of large value items, when both inherent and control risks
are high and other means do not provide sufficient appropriate audit evidence, or when the
repetitive nature of a calculation or other process performed by a computer information system
makes a 100% examination cost effective.
Selecting Specific Items - The auditor may decide to select specific items from a population based
on such factors as knowledge of the client’s business, preliminary assessments of inherent and
control risks, and the characteristics of the population being tested. The judgmental selection of
specific items is subject to non-sampling risk. Specific items selected may include:
• High value or key items. The auditor may decide to select specific items within a population
because they are of high value, or exhibit some other characteristic, for example items that are
suspicious, unusual, particularly risk-prone or that have a history of error.
• All items over a certain amount. The auditor may decide to examine items whose values exceed a
certain amount so as to verify a large proportion of the total amount of an account balance or
class of transactions.
• Items to obtain information. The auditor may examine items to obtain information about matters
such as the client’s business, the nature of transactions, accounting and internal control systems.
• Items to test procedures. The auditor may use judgment to select and examine specific items to
determine whether or not a particular procedure is being performed.

Audit evidence (sampling)*
nthe timing decision is affected by when the client needs the audit to be completed. In the audit
of financial statements, the client normally wants the audit completed 1 to 3 months after
year-end. The SEC currently requires that all public companies file audited financial statements
with the SEC within 60 to 90 days of the company’s fiscal year-end, depending on the company’s
size. However, timing is also influenced by when the auditor believes the audit evidence will be
most effective and when audit staff is available. For example, auditors often prefer to do counts
of inventory as close to the balance sheet date as possible.
qApproaches to sampling - the decision whether to use a statistical or non-statistical sampling
approach is a matter for the auditor’s judgment regarding the most efficient manner to obtain
sufficient appropriate audit evidence in the particular circumstances. For example, in the case of
tests of control the auditor’s analysis of the nature and cause of errors will often be more
important than the statistical analysis of the mere presence or absence (that is, the count) of
errors.
q
q
n
n
Nov 2, 2015
41

*See Appendix: ISA 530

Audit evidence (sampling)*
qSelecting the sample - the auditor should select items for the sample with the expectation that
all sampling units in the population have a chance of selection. Statistical sampling requires that
sample items are selected at random so that each sampling unit has a known chance of being
selected. The sampling units might be physical items (such as invoices) or monetary units. With
non-statistical sampling, an auditor uses professional judgment to select the items for a sample.
Because the purpose of sampling is to draw conclusions about the entire population, the auditor
endeavors to select a representative sample by choosing sample items which have characteristics
typical of the population, and the sample needs to be selected so that bias is avoided.
qDiscovering the errors - the auditor should consider the sample results, the nature and cause of
any errors identified, and their possible effect on the particular test objective and on other
areas of the audit.
qIn analyzing the errors discovered, the auditor may observe that many have a common feature, for
example, type of
Nov 2, 2015
42

*See Appendix: ISA 530

Audit evidence (sampling)*
ntransaction, location, product line or period of time. In such circumstances, the auditor may
decide to identify all items in the population that possess the common feature, and extend audit
procedures in that stratum. In addition, such errors may be intentional, and may indicate the
possibility of fraud.
nSometimes, the auditor may be able to establish that an error arises from an isolated event that
has not recurred other than on specifically identifiable occasions and is therefore not
representative of similar errors in the population (an anomalous error). To be considered an
anomalous error, the auditor has to have a high degree of certainty that such error is not
representative of the population.
qEvaluating sample results - the auditor should evaluate the sample results to determine whether
the preliminary assessment of the relevant characteristic of the population is confirmed or needs
to be revised. In the case of a test of
q
n
q
n
n
Nov 2, 2015
43

*See Appendix: ISA 530

Audit evidence (sampling)*
ncontrols, an unexpectedly high sample error rate may lead to an increase in the assessed level of
control risk, unless further evidence substantiating the initial assessment is obtained. In the
case of a substantive procedure, an unexpectedly high error amount in a sample may cause the
auditor to believe that an account balance or class of transactions is materially misstated, in the
absence of further evidence that no material misstatement exists.
nIf the total amount of projected error [plus anomalous error] is less than but close to that which
the auditor deems tolerable, the auditor considers the persuasiveness of the sample results in the
light of other audit procedures, and may consider it appropriate to obtain additional audit
evidence. The total of projected error plus anomalous error is the auditor’s best estimate of error
in the population. However, sampling results are affected by sampling risk. Thus when the best
estimate of error is close to the tolerable error, the auditor recognizes the risk that a different
sample would result in a different best
Nov 2, 2015
44

*See Appendix: ISA 530

Audit evidence (sampling)*
nestimate that could exceed the tolerable error. Considering the results of other audit procedures
helps the auditor to assess this risk, while the risk is reduced if additional audit evidence is
obtained.
nIf the evaluation of sample results indicates that the preliminary assessment of the relevant
characteristic of the population needs to be revised, the auditor may: (1) request management to
investigate identified errors and the potential for further errors, and to make any necessary
adjustments; and or (2) modify planned audit procedures.
nWhat do you have to do if you found (too many) errors? The first suggestion is to have the client
sort out his problems and clean up the mess before you can sign off. The second solution is to do
the cleaning yourself. It means more audit work and probably an adjustment of the population under
review on the basis of your sample findings. If both these solutions are not feasible, the ISA
suggests that you do not issue an unqualified opinion.
n
q
n
q
n
n
Nov 2, 2015
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*See Appendix: ISA 530

Recommended reading
nArens et al. (2015) – chosen chapters will be uploaded to IS
qCh. 7 (whole), 13 (whole).
nHayes et al. (2014) – chosen chapters will be uploaded to IS
qCh. 8 (whole), 10 (whole).
nISA 500, 501, 505, 520, 530, 540.
n
n
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Appendix: ISA 500 – Audit ev-ce
nScope:
qISA 500 explains what constitutes audit evidence in an audit of financial statements, and deals
with the auditor’s responsibility to design and perform audit procedures to obtain sufficient
appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s
opinion.
nObjective:
qThe objective of the auditor is to design and perform audit procedures in such a way as to enable
the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the auditor’s opinion.
nRequirements:
qISA 500 require auditor to Design and perform audit procedures that are appropriate in the
circumstances;
qWhen designing audit evidence consider the relevance and reliability of the information;
qISA 500 require auditor for management expert work:
q
Nov 2, 2015
47

ØEvaluate the competence, capabilities and objectivity of that expert;
ØObtain an understanding of the work of that expert; and
ØEvaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion.
qISA 500 require auditor for using information produced by the entity:
ØObtaining audit evidence about the accuracy and completeness of the information; and
ØEvaluating whether the information is sufficiently precise and detailed for the auditor’s
purposes.
qSelect the items for test of controls or test of details that are effective for meeting purpose.
q
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Appendix: ISA 500 – Audit ev-ce

nScope:
qISA 501 sets out guidance additional to the ones in ISA 500 Audit Evidence to help auditor to
obtain audit evidence with respect to the below certain specific financial statement account
balances and disclosures.
nObjective:
qAuditor should obtain external confirmations from third parties to corroborate the audit evidence
already available with the auditor. Auditor should determine whether positive or negative request
is appropriate given the condition. Responses or events of non-responses are required to be
evaluated. In events of non-responses or management refuse to permit auditor to seek confirmations,
auditor shall assess if modification in the auditor’s report is necessary.
nRequirements:
qUnderstanding external confirmations - Auditor is required to obtain sufficient appropriate audit
evidence to obtain reasonable assurance. In other words, audit evidence itself
Nov 2, 2015
49
Appendix: ISA 500 – Audit ev-ce

nplays an important role in audit engagement. To obtain the evidence that qualifies for both
sufficiency and appropriateness auditor is required to design and implement audit procedures in
this regard. ISA 500 states that audit evidence is more reliable if:
Øit is obtained from independent sources outside the entity
Øthe controls over its preparation and maintenance are effective
Øit is obtained by auditor directly
Øit is in documented form instead of verbal or oral evidence
Øit is original rather than photocopies etc.
nTo obtain information directly and independent of entity’s influence auditor has the right to
obtain confirmations from third parties outside the organization. Such confirmations are also
referred as external confirmations.
nThese external confirmations are used to corroborate the information auditor already has acquired
and increase the assurance of evidence already obtained.
Nov 2, 2015
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Appendix:ISA 501 – Audit ev-ce 2

nISA 505 provides guidance on how to use external confirmations to collect audit evidence.
qExternal confirmation procedures - Formally external confirmation is defined as: Audit evidence
obtained as a direct written response to the auditor from a third party (the confirming party), in
paper form, or by electronic or other medium. Two things to understand:
ØIt is served to the auditor directly by the third party
ØIt is a written response and may be in paper form (hard copy) or electronic form (soft copy) or
any other medium
nFew things auditor needs to decide regarding confirmation request include:
ØIdentify the information to be confirmed
ØIdentify the appropriate party for confirmation. Appropriate person is the one who has the
knowledge of information auditor is seeking
ØDetermine the nature of confirmation request which is appropriate in a given situation
q
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Appendix:ISA 501 – Audit ev-ce 2

ØMethod of sending initial and follow-up requests
nWhile designing the confirmation auditor considers:
ØThe relevant assertions
ØRisk of material misstatement
ØFormat of presentation
ØMethod and mode of communication
ØDegree of help third party can reasonably offer
ØWhether management’s authorization is necessary
ØAuditor’s experience with similar client or similar type of engagements
nWhile designing the confirmation, it is left on auditor to decide whether a positive confirmation
is appropriate or negative confirmation.
qPositive and Negative confirmation requests –
ØPositive confirmation request - A request that the confirming party respond directly to the
auditor indicating whether the confirming party agrees or disagrees with the
Nov 2, 2015
52
Appendix:ISA 501 – Audit ev-ce 2

qinformation in the request, or providing the requested information. In simple words under positive
confirmation requests third party is bound to respond notwithstanding if they agree to the
information sent or not. This confirmation method is suitable when auditor demands additional
information or the written confirmation from third party is necessary.
ØNegative confirmation request - A request that the confirming party respond directly to the
auditor only if the confirming party disagrees with the information provided in the request. In
simple words third party is required to respond only if they agree to the information sent. If they
don’t respond in stated time then it will be considered that third party agrees to the information
sent by the auditor.
qManagement’s refusal to permit external confirmations - If management refuses to permit auditor to
seek confirmation from third parties then auditor shall:
ØAsk management to know the reasons and determine if they are valid
q
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Appendix:ISA 501 – Audit ev-ce 2

ØAssess how management’s refusal will affect the work of auditor in obtaining sufficient
appropriate audit evidence
ØApply alternative procedures to obtain audit evidence
nManagement’s refusal is not always unreasonable. For example if client is in dispute with the
party from whom auditor intended a confirmation, then such request may hamper the dispute
resolution process.
nIf auditor concludes that the reasons of refusal are unreasonable then auditor shall communicate
the matter to those charged with governance and determine whether modification according the
provisions of ISA 705.
qResponses to confirmation requests - If auditor finds confirmation to be suspicious and its
reliability is doubtful then auditor shall seek additional audit evidence to clear the doubts. If
auditor concludes that response to confirmation is not reliable then he shall determine what
changes are necessary in terms of nature, timing and extent of additional audit procedures and also
assess if assessment of risk of material misstatement
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Appendix:ISA 501 – Audit ev-ce 2

qneeds revision.
nThe doubts may arise if:
ØConfirmation was received indirectly
ØManagement was involved in the receipt process
ØConfirmation is not from the intended source or person
ØConfirmation is sent by an unauthorized person
ØConfirmation has been compromised during transmission
qEvaluation of responses - The auditor shall evaluate if the responses to confirmation request
provide sufficient appropriate audit evidence or additional procedures are required. As discussed
above auditor categorizes the responses received as follows:
ØAppropriate response served by an appropriate party
ØUnreliable response
ØResponse with exceptions
ØNo response
q
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Appendix:ISA 501 – Audit ev-ce 2

Appendix:ISA 505 – Confirmations
nScope:
qISA 505 provides guidance on the auditor’s use of external confirmations as a means of obtaining
audit evidence.
nObjective:
qThe auditor should determine whether the use of external confirmations is necessary to obtain
sufficient appropriate audit evidence at the assertion level.
nRequirements:
qIt indicates that, while recognizing exceptions may exist, the following generalization about the
reliability of audit evidence may be useful:
ØAudit evidence is more reliable when it is obtained from independent sources outside the entity.
ØAudit evidence obtained directly by the auditor is more reliable than audit evidence obtained
indirectly or by inference.
ØAudit evidence is more reliable when it exists in documentary form.
q
n
n
n
n
q
n
Nov 2, 2015
56

ØAudit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles
qExternal confirmation is the process of obtaining and evaluating audit evidence through a
representation of information or an existing condition directly from a third party in response to a
request for information about a particular item affecting assertions in the financial statements or
related disclosures.
qExternal confirmations are frequently used in relation to account balances and their components,
but need not be restricted to these items. The following are examples of situations where external
confirmations may be used include the following:
ØBank balances and other information from bankers.
ØAccounts receivable balances.
ØStocks held by third parties at bonded warehouses for processing or on consignment.
ØProperty title deeds held by lawyers or financiers for safe
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

Øcustody or as security.
ØInvestments purchased from stockbrokers but not delivered at the balance sheet date.
ØLoans from lenders.
ØAccounts payable balances.
qAssertions Addressed by External Confirmations - External confirmation of an account receivable
provides reliable and relevant audit evidence regarding the existence of the account as at a
certain date.
nConfirmation also provides audit evidence regarding the operation of cutoff procedures. However,
such confirmation does not ordinarily provide all the necessary audit evidence relating to the
valuation assertion, since it is not
practicable to ask the debtor to confirm detailed information relating to its ability to pay the
account.
nSimilarly, in the case of goods held on consignment, external confirmation is likely to provide
reliable and relevant audit evidence to support the existence and the rights and
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

Øobligations assertions, but might not provide audit evidence that supports the valuation
assertion.
qDesign of the External Confirmation Request - The auditor should tailor external confirmation
requests to the specific audit objective. When designing the request, the auditor considers the
assertions being addressed and the factors that are likely to affect the reliability of the
confirmations.
nFactors such as the form of the external confirmation request, prior experience on the audit or
similar engagements, the nature of the information being confirmed, and the intended respondent,
affect the design of the requests because these factors have a direct effect on the reliability of
the audit evidence obtained through external confirmation procedures.
qUse of Positive and Negative Confirmations - A positive external confirmation request asks the
respondent to reply to the auditor in all cases either by indicating the respondent’s agreement
with the given information, or by asking the respondent to fill in information
q
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

nA negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request.
qManagement Requests - When the auditor seeks to confirm certain balances or other information, and
management requests the auditor not to do so, the auditor should consider whether there are valid
grounds for such a request and obtain audit evidence to support the validity of management’s
requests. If the auditor agrees to management’s request not to seek external confirmation regarding
a particular matter, the auditor should apply alternative audit procedures to obtain sufficient
appropriate audit evidence regarding that matter.
nIf the auditor does not accept the validity of management’s request and is prevented from carrying
out the confirmations, there has been a limitation on the scope of the auditor’s work and the
auditor should consider the possible impact on the auditor’s report.
qCharacteristics of Respondents - The reliability of audit evidence provided by a confirmation is
affected by the
q
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

nrespondent’s competence, independence, authority to respond, knowledge of the matter being
confirmed, and objectivity.
qThe External Confirmation Process - When performing confirmation procedures, the auditor should
maintain control over the process of selecting those to whom a request will be sent, the
preparation and sending of confirmation requests, and the responses to those requests. Control is
maintained over communications between the intended recipients and the auditor to minimize the
possibility that the results of the confirmation process will be biased because of the interception
and alteration of confirmation requests or responses.
qNo Response to a Positive Confirmation Request - The auditor should perform alternative audit
procedures where no response is received to a positive external confirmation request. The
alternative audit procedures should be such as to provide audit evidence about the assertions that
the confirmation request was intended to provide.
qCauses and Frequency of Exceptions - When the auditor forms a conclusion that the confirmation
process and alternative audit
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

nprocedures have not provided sufficient appropriate audit evidence regarding an assertion, the
auditor should perform additional audit procedures to obtain sufficient appropriate audit evidence.
In forming the conclusion, the auditor considers the:
ØReliability of the confirmations and alternative audit procedures;
ØNature of any exceptions, including the implications, both quantitative and qualitative of those
exceptions; and
ØAudit evidence provided by other audit procedures.
qEvaluating the Results of the Confirmation Process - The auditor should evaluate whether the
results of the external confirmation process together with the results from any other audit
procedures performed, provide sufficient appropriate audit evidence regarding the assertion being
audited.
qExternal Confirmations Prior to the Year-end - When the auditor uses confirmation as at a date
prior to the balance sheet to obtain audit evidence to support an assertion, the
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

nauditor obtains sufficient appropriate audit evidence that transactions relevant to the assertion
in the intervening period have not been materially misstated. Depending on the assessed risk of
material misstatement, the audit or may decide to confirm balances at a date other than the period
end, for example, when the audit is to be completed within a short time after the balance sheet
date. As with all types of pre-year-end work, the auditor considers the need to obtain further
audit evidence relating to the remainder of the period. ISA 330 provides additional guidance when
audit procedures are performed at an interim date.
q
q
q
n
n
n
n
q
n
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Appendix:ISA 505 – Confirmations

Appendix: ISA 520 - AP
nScope:
qISA 520 deals with the auditor’s use of analytical procedures as substantive procedures:
Øat the end of the audit that assist the auditor when forming an overall conclusion on the
financial statements;
Øuse of analytical procedures as risk assessment procedures; and
Øuse of substantive analytical procedures during the course of audit.
nObjective:
qThe objectives of the auditor are:
ØTo obtain relevant and reliable audit evidence when using substantive analytical procedures; and
ØTo design and perform analytical procedures near the end of the audit that assist the auditor when
forming an overall conclusion as to whether the financial statements are consistent with the
auditor’s understanding of the entity.
n
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Appendix: ISA 520 - AP
nRequirements:
qISA 520  require auditor in respect of designing and performing analytical procedures to:
ØDetermine the suitability of particular substantive analytical procedures for given assertions,
taking account of the assessed risks of material misstatement and tests of details, if any, for
these assertions;
ØEvaluate the reliability of data from which the auditor’s expectation of recorded amounts or
ratios is developed, taking account of source, comparability, and nature and relevance of
information available, and controls over preparation;
ØDevelop an expectation of recorded amounts or ratios and evaluate whether the expectation is
sufficiently precise to identify a misstatement that, individually or when aggregated with other
misstatements, may cause the financial statements to be materially misstated; and
ØDetermine the amount of any difference of
n
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Appendix: ISA 520 - AP
qrecorded amounts from expected values that is acceptable without further investigation.
qISA 520 require auditor to perform analytical procedure near the end of the audit that assist the
auditor when forming an overall conclusion as to whether the financial statements are consistent
with the auditor’s understanding of the entity.
qISA 520 require auditors to identify fluctuations or relationships that are inconsistent with
other relevant information or that differ from expected values by a significant amount, the auditor
shall investigate such differences by:
ØInquiring of management and obtaining appropriate audit evidence relevant to management’s
responses; and
ØPerforming other audit procedures as necessary in the circumstances.
Ø
n
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Appendix: ISA 530 - Sampling
nScope:
qISA 530 applies when the auditor has decided to use audit sampling in performing audit ISA 530
deals with the auditor’s use of statistical and non-statistical sampling when designing and
selecting the audit sample, performing tests of controls and tests of details, and evaluating the
results from the sample.
nObjective:
qThe objective of the auditor, when using audit sampling, is to provide a reasonable basis for the
auditor to draw conclusions about the population from which the sample is selected.
nDefinitions:
qAudit sampling (sampling) – 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 in order to
provide the auditor with a reasonable basis on which to draw conclusions about the entire
population.
qPopulation – the entire set of data from which a sample is
q
q
q
q
q
n
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Appendix: ISA 530 - Sampling
nselected and about which the auditor wishes to draw conclusions.
qSampling risk – the risk that the auditor’s conclusion based on a sample may be different from the
conclusion if the entire population were subjected to the same audit Sampling risk can lead to two
types of erroneous conclusions:
ØIn the case of a test of controls, that controls are more effective than they actually are, or in
the case of a test of details, that a material misstatement does not exist when in fact it does.
The auditor is primarily concerned with this type of erroneous conclusion because it affects audit
effectiveness and is more likely to lead to an inappropriate audit opinion.
ØIn the case of a test of controls, that controls are less effective than they actually are, or in
the case of a test of details, that a material misstatement exists when in fact it does This type
of erroneous conclusion affects audit efficiency as it would usually lead to additional work to
establish that initial conclusions were incorrect.
q
q
q
q
q
q
q
n
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Appendix: ISA 530 - Sampling
qNon-sampling risk – the risk that the auditor reaches an erroneous conclusion for any reason not
related to sampling risk.
qAnomaly – a misstatement or deviation that is demonstrably not representative of misstatements or
deviations in a population.
qSampling unit – the individual items constituting a population.
qStatistical sampling – an approach to sampling that has the following characteristics:
ØRandom selection of the sample items; and
ØThe use of probability theory to evaluate sample results, including measurement of sampling
qA sampling approach that does not have characteristics (i) and (ii) is considered non-statistical
sampling.
qStratification – the process of dividing a population into sub- populations, each of which is a
group of sampling units which have similar characteristics (often monetary value).
q
q
q
q
q
q
q
q
q
n
Nov 2, 2015
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Appendix: ISA 530 - Sampling
qTolerable misstatement – a monetary amount set by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is
not exceeded by the actual misstatement in the population.
qTolerable rate of deviation – a rate of deviation from prescribed internal control procedures set
by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance
that the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in
the population.
q
q
q
q
q
q
q
q
q
n
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70

Appendix: ISA 540 - Estimates
nScope:
qISA 540 sets requirements for obtaining an understanding of how management identifies those
transactions, events and conditions that may give rise to the need for accounting estimates to be
recognized or disclosed in the financial statements. It requires the auditor to make inquiries of
management about changes in circumstances that may give rise to new, or the need to revise
existing, accounting estimates.
nRequirements – under ISA 540 the auditor should:
qObtain an understanding of how management makes the accounting estimates, and of the underlying
data
ØThe method, including the model where applicable, used and changes in the method from the prior
period
ØRelevant controls
ØWhether an expert has been used
ØThe underlying assumptions
n
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Appendix: ISA 540 - Estimates
ØWhether and, if so, how management has assessed the effects of estimation uncertainty.
qReview outcome of previous accounting estimates.
qEvaluate the degree of “estimation uncertainty”; where there is a high level of uncertainty in an
estimate, consider whether this amounts to a significant risk.
qTo respond to assessed risks,
Øwhether management has appropriately applied the requirements of the applicable financial
reporting framework relevant to the accounting estimate; and
Øwhether the methods for making the accounting estimates are appropriate and have been applied
consistently, and whether changes, if any, in accounting estimates or in the method for making them
from the prior period are appropriate in the circumstances.
qIn response to assessed risks, consider whether specialized skills or knowledge in relation to
aspects of the accounting estimate are needed.
n
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Appendix: ISA 540 - Estimates
qUndertake one or more of the following specific procedures: reviewing events occurring up to the
date of the auditor’s report (i.e. after date payments, etc).
qTest how management made the accounting estimate and the data on which it is based. In doing so,
the auditor shall evaluate whether:
ØThe method of measurement used is appropriate in the circumstances; and
ØThe assumptions used by management are reasonable in light of the measurement objectives of the
applicable financial reporting framework.
qTest the operating effectiveness of controls over estimates, together with appropriate substantive
procedures.
qDevelop a point estimate or range to evaluate management’s point estimate.
qCarry out substantive procedures in relation to significant risks identified, including:
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Appendix: ISA 540 - Estimates
ØEvaluate how management has considered alternative assumptions or otherwise addressed estimation
uncertainty.
ØWhen management has not adequately addressed estimation uncertainty (through considering
alternative assumptions etc.), develop a range estimate.
qEvaluate if disclosures related to accounting estimates are reasonable within the requirements of
the applicable GAAP and obtain sufficient appropriate audit evidence related to accounting
estimates to determine the disclosures are in accordance with the applicable GAAP/IFRS.
qEvaluate disclosure of estimation uncertainty for significant risks.
qConsider whether management’s judgments and decisions indicate bias.
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