Uses of ACL for Audit Evidence

Uses of ACL for Audit Evidence

Using the the guidance on sampling, we will have a large sample to acquire data from.  With ACL and the sample, we are able to use multiple types of tests to test for materiality or any other issues we might find as audit-relevant.


Tests:

• Z-Score
•  Some of the tests we can use to find significance are using a Z-Score analysis.  Using the Z-Score, we can find which numbers are significant and can potentially be inaccurate or fraudulent.
• Statistics
• We are able to see the range of transactions, highs and lows, the median, and the average.  This just gives us an idea of what are the common numbers.
• Stratification
• Using stratification, we can find intervals and see where most of the charges occur.
• Classification
• Using classification, we are able to go through charges and test and see if those charges are potentially fraudulent.
• Either through:
• Dates
• Vendors
• Benford Analysis
• We can also use a Benford Analysis along with the Z-Score to find out which starting digits, either 1 or 2 digit tests, are statistically significant.

Guidance on Sampling

Considering the guidance on sampling, the sampling used by us depends on the assertions being tested, the nature of the population and our assessment of the risk material misstatement. Examples that involve sampling include samples of:

• weekly sales report and review management's response to potential problems in the process
• purchase requisitions and verify proper authorizations
• locations and observe inventory count procedures executed by client personnel
• shift changes within the factory and observe employees clocking in and out
• sales invoices and test the accuracy of individual transactions by verifying quantities and prices against appropriate supporting documentation
• accounts receivable to be confirmed with customers

Although the increased use of  different tests enables us to examine all items in a population and reduces the need for sample based tests, there are many process controls that cannot be tested through tests such as ACL which can consist of the manager actually reviewing the report, a discrepancy, and that the sales system is under control.

As auditors we must address the the size of the population to use when gathering evidence from a larger population because we can't test every single item that we come across. The sample size will depend on two main factors: the assertions being tested and the assessment of risk. Once the sample size is determined, we choose the items or transactions to examine from the population. Common attributes that we would consider when selecting a sample include (similar to what we did in ACL):

• the magnitude of the transaction
• date of a transaction
• parties to the transaction
• nature of underlying assets and liabilities.

References:

• Auditing Assurance & Risk by Knechel, Salterio and Ballou

Substantive Analytical Procedures: Revenue, Cash, and A/R

Substantive Analytical Procedures – the comparison of quantitative relationships among account balances and other indicators to an auditor’s expectations.

If auditor expectations are not met, additional evidence is gathered to identify possible misstatements. (Knechel)

Documentation of Substantive Analytical Procedures (PCAOB):

a.       Form expectation

b.      Results of comparison

c.       Additional procedures to be performed

Expectations:

Revenue - $222,086

Cash - $14,176.25

Accounts Receivable – $4,609

Results:

Account	2011(Unaudited)	Auditor’s Expectations	Expectation Gap
Revenue	$352,523	$222,086	$130,437
Cash	$9,347	$14,176.25	$4,829
Accts. Receivable	$10,846	$4,609	$6,237

 

Expectations were formed based on linear progression.  Information from the Balance Sheet and Income Statement balances to form expectations.

Additional Procedures to be performed:

·         Inquiry

·         Recalculation and re-performance

·         Tests of transactions – verification of details and occurrence of transactions

·         Tests of accounts – test details of year-end balance through test of existence and valuation

·         Tests of presentation and disclosure – examine footnotes and disclosure for better understandability of financial statements

·         Inspection of records and documents – helps support all assertions in financial statements

·         Analytical evidence – examination of relationships among importance account balances, percentages and ratios for unexplained variations

References:

 Linda S. McDaniel and William R. Kinney, Jr. Expectation-Formation Guidance in the Auditor's Review of Interim Financial Information. https://webvpn.ucr.edu/+CSCO+0h756767633A2F2F6A6A6A2E77666762652E626574++/stabe/-CSCO-3p--pdfplus/2491292.pdf?acceptTC=true

AU Section 329 Substantive Analytical Procedure. PCAOB. http://pcaobus.org/Standards/Auditing/Pages/AU329.aspx#ps-pcaob_88942dde-5310-4f3e-88a9-fd8f8a478f54

Presentation 3/22/2012

Dear team, here is our presentation for tomorrow. comments & suggestions are welcome. And our Server Database, hosted in Microsoft Azure.

I hope it will work tomorrow. If not, well, i've wasted five hours working on it... But we still have our Website and this blog to document stuff. Good luck in finals week.
Best regards, Andreas

Tolerable Error and Materiality

As auditors we need to understand that tolerable error can differ from each account because some accounts are more susceptible to error or are more significant to the overall financial results of the organization. Since we do not have formal rules for determining tolerable error for account balances two generally accepted guidelines that we will use are: tolerable error should be less than the overall materiality level, and the sum of tolerable error across all accounts may equal materiality or may exceed materiality.

Materiality is subject to a great deal of judgment so as auditors we have to develop numerous rules of thumbs for setting an initial quantitative materiality level. Since every person looking at financial statements will have a different idea to what constitutes as a material misstatement we will use what is generally suggested for net income or net assets as the base for establishing quantitative materiality with percentages between 5 and 10 for net income and 1 and 3 for percent of net sales.

As auditors, rather than increase the sum of allocated tolerable errors and tolerating a larger error in some accounts we will instead decrease the sum of allocated tolerable errors because we want to decrease the overall risk that a material misstatement will remain undetected. So when all audit procedures are considered, we can conclude with reasonable assurance that the financial statements are not materially misstated. Looking at the audit documentation requirement we see that we have complied with most of them, therefore we should not have as many errors since we have documentation that would support our conclusions with respect to financial statement assertions and documentation that show that accounting records agree with financial statements, etc. Since our audit team also uses ACL to detect potential fraud, material misstatements and weaknesses this should also help keep the tolerable error and materiality low.

The tolerable error level for an account reflects the maximum size of a misstatement that could exist before the auditor would conclude that the account is materially misstated. As auditors we can set tolerable errors in one of two ways: by directly allocating a portion of overall materiality to the account in dollar terms; or calculating TEL as a specified percentage of the account where the smaller values of TEL are associated with lower detection risk.

References:

·         http://www.hkicpa.org.hk/file/media/section6_standards/standards/sas430.pdf

·         Auditing Assurance & Risk by Knechel, Salterio and Ballou

 

Calculator

Here are two simple calculators that allow us to calculate AR and DR. Or you can download the excel file below.

Audit Risk Calculator

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Enter Detection Risk:

Click this button to calculate audit risk:

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Detection Risk Calculator

Enter Audit Risk:

Enter Inherent Risk:

Enter Control Risk:

Click this button to calculate detection risk:

The detection risk is:

file upload

Material Weakness Detection Risk

Material weakness detection risk should not be a significant risk due our audit team’s checklist of things to look out for when auditing a client and ACL. When analyzing the material weakness detection risk that our audit team faces, our audit team concludes that the likelihood of a major material weakness not being detected is unlikely due our team’s auditing procedures. To see our audit team’s checklist and auditing procedures, refer to our internal control checklist located in our blog. When plotting material weakness detection risk on a risk map, we can conclude that the likelihood of a major missed material weakness not being detected is not likely going to occur; however, the impact of a major material weakness not being detected could moderately impact SDE’s financial reports. Figure 1A shows the impact and likelihood of material weakness detection risk.

Figure 1A

Material weakness detection risk would be located in the low likelihood and the moderate impact box. 

Material Weakness Detection Using ACL

Temecula Auditors, like many other auditing firms, use Auditing Computing Language (ACL), because ACL is one of the most widely used auditing products for fraud detection and prevention. Not only can our audit team use ACL to detect potential fraud, but also material misstatements and weaknesses. ACL would allow our audit team to view SDE’s numerous accounts and to see if there are any accidental double account transactions that were created. For example, an accountant who is in charge of SDE’s journal entries could have accidently made a double entry of a certain transaction. Auditors analyze payment amounts to test duplicate payments, missing check amounts, and incorrect invoice numbers. Not only can our audit team detect material errors in certain accounts, but can also detect unusual transactions. ACL has many options the auditor can use when trying to discover any unusual material misstatements in accounts. One of the tools that ACL offers is Benford’s Analysis. This allows the auditor to look at an entire account to determine if the account’s numbers fall into an expected distribution. One of the major potential material weaknesses is accidental duplicate accounts with shipped products. Our team will need to look closely to the product transactions, because SDE has been having trouble with over and under shipments of products.

Audit Sampling

Another way that our audit firm can lower the risk of not detecting material weaknesses is by conducting audit sampling. To conduct audit sampling for an account that deals with shipped products, our team will need to follow these standard audit sampling procedures:

1)      Audit less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance.

2)      The auditor needs to be aware of account balances and transactions that may be more likely to contain misstatement.

3)      There are two general approaches to audit sampling: non-statistical and statistical. Both approaches require that the auditor use professional judgment in planning, performing, and evaluating a sample and in relating the audit evidence produced by the sample to other audit evidence when forming a conclusion about the related account balance or class of transactions.

4)      The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.

5)      The sufficiency of audit evidence is related to the design and size of an audit sample, among other factors. The size of a sample necessary to provide sufficient audit evidence depends on both the objectives and the efficiency of the sample.

6)      Evaluating the appropriateness of audit evidence is solely a matter of auditing judgment and is not determined by the design and evaluation of an audit sample. In a strict sense, the sample evaluation relates only to the likelihood that existing monetary misstatements or deviations from prescribed controls are proportionately included in the sample, not to the auditor's treatment of such item.¹

Works Cited

¹“Audit Sampling.” AICPA website.

http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments