Auditing — Audit Evidence and Audit Procedures: Management Assertions and Analytical Procedures

An audit opinion must rest on evidence. In line with the risk levels set in chapter 2, the auditor decides what evidence to gather and how much. This chapter covers what evidence proves (management assertions), what makes evidence good, and the procedures for obtaining it.

1. Management assertions

Every figure in the financial statements is an assertion by management. “Receivables of ₩15 billion” asserts that those receivables exist, belong to the company, are valued at the recoverable amount and are recorded completely (KSA 315).

Categories of management assertions
Category	Assertions	Questions
Transactions and events	Occurrence, completeness, accuracy, cut-off, classification	Did the recorded transactions actually happen, is anything missing, are they in the right period and account?
Account balances at period-end	Existence, rights and obligations, completeness, accuracy, valuation and allocation, classification	Do the assets exist, does the company own them, are they properly valued?
Presentation and disclosure	Occurrence and rights and obligations, completeness, classification and understandability, accuracy	Are the disclosures in the notes sufficient and understandable?

The direction of a procedure determines which assertion it tests. Starting from the records and going to supporting documents (ledger → invoices and shipping records) tests occurrence and existence; starting from the documents and going to the records (shipping records → ledger) tests completeness.

2. Sufficiency and appropriateness of evidence

Evidence must be sufficient (quantity) and appropriate (quality). Appropriateness means relevance and reliability. Reliability tends to follow these patterns:

Evidence from independent sources outside the company is more reliable than internal evidence.
Evidence obtained directly by the auditor (observing a count, recalculating) is more reliable than indirect evidence (inquiry).
Documentary evidence is more reliable than oral evidence, and originals more than copies.
Internal evidence generated when internal control is effective is more reliable.

3. Types of audit procedure

Audit procedures and the assertions they mainly test
Procedure	Content	Main assertions tested
Inspection	Examining records and documents or physically inspecting assets	Existence, occurrence, rights
Observation	Watching a process performed by others (attending an inventory count)	Operation of controls, existence
External confirmation	Obtaining a written response directly from a third party (bank and receivables confirmations)	Existence, rights and obligations
Recalculation	Checking the mathematical accuracy of calculations	Accuracy, valuation
Reperformance	The auditor independently re-executing controls or procedures performed by the company	Operation of controls
Analytical procedures	Building expectations from relationships among financial and non-financial data and comparing	Completeness, accuracy, valuation
Inquiry	Seeking information from management and staff	Supporting only (insufficient on its own)

4. Analytical procedures

Analytical procedures build an independent expectation and check whether the difference from the recorded amount exceeds an acceptable threshold. They are used in risk assessment, as substantive procedures and in the overall review at the end of the audit.

Substantive analytical procedure

\text{Expectation} = \text{Average borrowings} \times \text{Average interest rate}, \qquad \text{Difference} = \text{Recorded amount} - \text{Expectation}

If the difference exceeds the acceptable threshold (usually an amount below performance materiality), the auditor inquires into the cause and corroborates it with evidence.

AI’s recorded interest expense is ₩1.6 billion. The average of monthly borrowing balances is ₩30 billion and the average rate in the loan agreements is 4.5%. The expectation is $300 \times 4.5\% = 13.5$ (₩1.35 billion), ₩250 million less than recorded. With a threshold of ₩100 million, the difference is large. Investigation shows that ₩120 million of penalty interest for late payment and ₩130 million of interest that should have been capitalized into an asset under construction were expensed during the year. The first amount is explained, but the second is a misstatement — an error in capitalizing borrowing costs (Intermediate Accounting chapter 3).

The more reliable the data used to build the expectation, the more stable the relationship between accounts and the more precise the expectation, the more assurance an analytical procedure provides.

5. Audit documentation

The auditor documents the procedures performed, the evidence obtained and the conclusions reached in the audit working papers. An experienced auditor with no previous connection to the audit should be able to understand from the papers alone what was done and why (KSA 230). The file is assembled in final form on a timely basis after the date of the auditor’s report and is not deleted or discarded afterwards.

Check your understanding

AJ’s auditor is worried about unrecorded sales. Which of the following tests completeness? (1) Selecting a sample from the sales ledger and checking tax invoices and shipping records. (2) Selecting a sample from shipping records and checking that they are recorded in the sales ledger. Also, AJ averages 40 stores a month, historical trends put annual sales per store at about ₩500 million, and recorded sales are ₩17 billion. What conclusion can an analytical procedure support?

(2) is the completeness procedure, because it starts from shipments that actually happened and checks that they all reached the books. (1) is an occurrence procedure, checking that recorded sales actually took place. The analytical procedure’s expected sales are $40 \times 5 = 200$ (₩20 billion), ₩3 billion more than the ₩17 billion recorded. The cause — unrecorded sales, weak store performance, price cuts — must be established. The difference is large, so completeness risk may indeed be high.

References

Korean Institute of CPAs, Korean Standards on Auditing, KSA 500 Audit Evidence, KSA 505 External Confirmations and KSA 520 Analytical Procedures
Korean Institute of CPAs, Korean Standards on Auditing, KSA 230 Audit Documentation
Alvin Arens, Randal Elder and Mark Beasley, Auditing and Assurance Services, ch. 6–7