AA – L2 – Q42 – Audit Evidence

List and explain factors influencing the auditor's judgment on sufficiency of audit evidence. List substantive audit procedures for trade payables, accruals, and provision for legal action at Regent Co.

Question

ISA 500 Audit Evidence states that the 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’.

Required:

(a) List and explain the factors which will influence the auditor’s judgment concerning the sufficiency of audit evidence obtained.

You are the audit senior in charge of the audit of Regent Co, a company that has been trading for over 50 years. Regent Co manufactures and sells tables and chairs directly to the public. The company’s year-end is 31 March.
Current liabilities are shown on Regent Co’s statement of financial position as follows:

	20X8	20X7
	C	C
Trade payables	884,824	816,817
Accruals	56,903	51,551
Provision for legal action	60,000	–
	1,001,727	868,368

The provision for legal action relates to a claim from a customer who suffered an injury while assembling a chair supplied by Regent Co. The directors of Regent Co dispute the claim, although they are recommending an out of court settlement to avoid damaging publicity against Regent Co.

Required:
(b) List the substantive audit procedures that you should undertake in the audit of current liabilities of Regent Co for the year ended 31 March 20X8. For each procedure, explain the purpose of that procedure.
marks are allocated as follows:
(i) Trade payables (9 marks)
(ii) Accruals (3 marks)
(iii) The provision for legal action (4 marks)

Answer

(a) Factors affecting sufficiency of evidence
Assessment of inherent risk
As inherent risk increases, then more audit evidence will be required to reduce detection risk.

Materiality of the item
A decrease in materiality means that more audit evidence will be required to ensure that no material misstatement has occurred.

Nature of the accounting and control systems
Where the accounting and control systems are poor then more audit evidence is necessary as less reliance can be placed on those systems.

Control risk
Determine the extent to which the directors have implemented a sound system of internal control; poor internal controls increase control risk, decreasing reliance that can be placed on those controls.

Experience from previous audits
Good experience from previous audits will decrease the amount of evidence required as the auditor can place reliance on previous review of clients’ systems.

Result of audit procedures
Where the results of different audit procedures agree with each other, less evidence is needed – overall the evidence is more persuasive, however, where results are in conflict then more evidence is required.

Quality of information available
Some sources of audit evidence are more reliable than others – meaning less evidence is needed when relying on those sources, for example, documentary evidence is more reliable than oral evidence.

(b) Substantive procedures

(i) Trade payables

Audit procedure	Reason for procedure
Cast the list of trade payables and agree the total to the payables ledger and then to the general ledger.	To confirm that the list is complete, is accurately stated in the general ledger and contains no unusual or reconciling items which must be investigated.
Test, on a sample basis that payables on the list agree to the individual ledger balance and from the ledger to the list.	To confirm that the list agrees to the payables ledger.
Compare trade payables individually and in total to prior year balances and explain any unusual changes.	To explain changes in the balances. For example, the increase in payables could indicate cash flow problems and Regent Co is delaying payment to suppliers in response to this. Comparison may also indicate lack of completeness of the list where payables balances have been omitted.
Select a sample of individual payables accounts for testing, focusing on material balances, zero balances and a sample of other items.	Material balances should always be tested to ensure correctness and test a large amount of payables by value. Some zero balances are tested to ensure that invoices have not been omitted from one supplier.
Select population from purchase invoices received after the year-end. Trace to evidence of goods receipt and where goods received prior year-end, ensure invoice amount included in purchase accrual.	Confirm completeness of recording of purchase invoices.
Obtain year-end supplier statements (either from Regent Co or direct from the individual supplier via a circularisation letter). Agree the balance on the statement to the individual account in Regent Co’s payables ledger. Where necessary, reconcile the balances taking into account cash and invoices in transit.	Agree the payables balance to independent third party evidence to confirm accuracy, completeness and existence of the ledger balance.
Take a sample of purchase invoices recorded in the purchase day book (PDB) just prior to the year end and trace to goods received note (GRN), ensuring that the goods were received prior to the end of the year.	To ensure that liabilities recorded in the PDB are represented by goods received during that year, and recorded in the correct period (cut-off testing).
Take a sample of GRNs prior to the end of the year and trace to purchase invoice or the ‘goods received not invoiced’ accrual in the financial statements.	To ensure completeness of recording of amounts payable.
Take a sample of GRNs just after the end of the year and trace to purchase invoice. Ensure that the invoice is recorded in the PDB after the year-end.	To ensure that the purchases figure is not overstated in this year’s financial statements.
List all debit balances and obtain an explanation from the client.	To confirm why the balance arose and consider re-classifying the amounts as receivables. Debit balances may indicate a deficiency in internal control with additional implications for audit testing.

(ii) Accruals

Audit procedure	Reason for procedure
Compare individual accruals with amount in the prior year accounts.	Compare individual accruals amount in the prior year to account for unusual differences and identification of the amounts paid and confirm that the accruals are genuine.
Agree accruals to payments made after the end of the year for example, amounts payable for tax deducted from wages payments to remittance to the tax authority.	To confirm completeness of the accruals listing.
Review payments after the year-end to determine whether any accruals are required. Where the need for an accrual is identified, ensure this is included in the accruals list.	To confirm completeness of the accruals listing.
Check calculations of individual accruals to supporting documentation for example, tax deductions from wages to the amount shown on the payroll as deducted from wages for the last month of the year.	To check that the accrual has been calculated correctly and therefore testing for over or understatement of each accrual.

(iii) Provision for legal action

Audit procedure	Reason for procedure
Discuss the provision with the directors.	To attempt to confirm whether the company is liable for the payment and confirm that an out-of-court settlement is appropriate.
Obtain a letter from Regent Co’s lawyers.	To provide evidence on whether Regent may be liable for payment and check the amount provided is approximately correct.
Review any correspondence with the customer.	To help determine Regent Co’s liability and determine whether the customer may accept the out-of-court settlement.
Obtain a written representation letter from the directors.	To confirm that the directors are considering settlement out of court.
If possible, trace the payment made after the end of the year to receipt from the customer stating that the payment is accepted in ‘full and final settlement’ i.e. no other payments are expected to be made.	To confirm the accuracy of the amount stated in accruals.

Tags: Audit Evidence, Auditor Judgment, Risk Assessment, Sufficiency of Evidence
Level: Level 2

Topic: Audit Evidence

Uploader: Samuel Duah