Statement on Auditing Standards, Audit Evidence (Study Guide Part 4)

Obtaining an Understanding of the Work of the Management’s Specialist (Ref: par. .26b) .A79 An understanding of the work of the management’s specialist includes an understanding of the relevant field of expertise. An understanding of the relevant field of expertise may be obtained in conjunction with the auditor’s determination of whether the auditor has the expertise to evaluate the work of the management’s specialist or whether the auditor needs an auditor’s specialist for this purpose. fn 13 .A80 Aspects of the field of the management’s specialist relevant to the auditor’s understanding may include • whether that specialist’s field has areas of specialty within it that are relevant to the audit. • whether any professional or other standards and regulatory or legal requirements apply. • what assumptions and methods are used by the management’s specialist and whether they are generally accepted within that specialist’s field and appropriate for financial reporting purposes. • the nature of internal and external data or information the management’s specialist uses. .A81 In the case of a management’s specialist engaged by the entity, there will ordinarily be an engagement letter or other written form of agreement between the entity and that specialist. Evaluating that agreement when obtaining an understanding of the work of the management’s specialist may assist the auditor in determining for the auditor’s purposes the appropriateness of fn 13 • the nature, scope, and objectives of that specialist’s work; • the respective roles and responsibilities of management and that specialist; and • the nature, timing, and extent of communication between management and that specialist, including the form of any report to be provided by that specialist. Paragraph .07 of section 620, Using the Work of an Auditor’s Specialist. .A82 In the case of a management’s specialist employed by the entity, it is less likely that there will be a written agreement of this kind. Inquiry of the specialist and other members of management may be the most appropriate way for the auditor to obtain the necessary understanding. Evaluating the Appropriateness of the Work of the Management’s Specialist (Ref: par. .26c) .A83 Considerations when evaluating the appropriateness of the work of the management’s specialist as audit evidence for the relevant assertion may include • the relevance and reasonableness of that specialist’s findings or conclusions, their consistency with other audit evidence, and whether they have been appropriately reflected in the financial statements; • if that specialist’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods; and • if that specialist’s work involves significant use of source data, the relevance, completeness, and accuracy of that source data. AU-C Section 530, Audit Sampling [No amendment to paragraph .01. Footnote intentionally omitted.] .02 This section complements section 500, Audit Evidence, which addresses the auditor’s responsibility to design and perform audit procedures to obtain explains what constitutes sufficient appropriate audit evidence and addresses how an auditor evaluates information to be used as audit evidence.to be able to draw reasonable conclusions as a basis for forming the auditor’s opinion. Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained, provides guidance on the means available to the auditor for selecting items for testing, one of which is audit sampling. [No further amendment to AU-C section 530.] AU-C Section 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures [No amendment to paragraphs .013.A27. Paragraph .A28 shown for contextual purposes.] Management’s Use of Specialists fn 11 .A28 Management may have, or the entity may employ individuals with, the experience and competence necessary to make estimates. In some cases, however, management may need to engage a specialist to make estimates or assist in making them. This need may arise because of, for example, • the specialized nature of the matter requiring estimation (for example, the measurement of mineral or hydrocarbon reserves in extractive industries). • the technical nature of the models required to meet the relevant requirements of the applicable financial reporting framework, as may be the case in certain measurements at fair value. • the unusual or infrequent nature of the condition, transaction, or event requiring an accounting estimate. fn 11 See AU-C section 501, Audit Evidence 4 Specific Considerations for Selected Items. See Paragraph .08 of section 500, Audit Evidence, which addresses management’s specialists. [No amendment to paragraphs .A293.A69.] .A70 In accordance with AU-C section 500, Audit Evidence, the auditor is required to evaluate information to be used as audit evidence by taking into account, among other things, the relevance and reliability of the information, including its source. The auditor’s evaluation of such information to be used as audit evidence is required to include evaluating whether the information is sufficiently precise and detailed for the auditor’s purposes and obtaining audit evidence about the accuracy and completeness of the information, as necessary. fn 18 evaluate whether the data on which the estimate is based is sufficiently reliable for the auditor’s purposes, including, as necessary. a. obtaining audit evidence about the accuracy and completeness of the data. b. evaluating whether the data is sufficiently precise and detailed for the auditor’s purposes. fn 18 Paragraphs .09 .07 and .08 of section 500. [No further amendment to AU-C section 540.] A69. Exhibit A 4 Using ADAs to Simultaneously Accomplish Multiple Audit Procedures (Ref: par. A46 and par. A61) This exhibit illustrates the use of an audit data analytic (ADA) that simultaneously accomplishes the objectives of both risk assessment and substantive audit procedures. Background The fact pattern in this example, in which the auditor uses a revenue transaction scoring model, will focus on the audit of an entity that recognizes revenue when control of the product (or satisfaction of the performance obligation) transfers at a specific point in time,1 such as a manufacturer of external data storage devices. For purposes of this example, assume the following: 1 • Revenue was determined to be a material account during initial planning and scoping with the occurrence (including cut-off) and accuracy assertions being more susceptible to misstatement. • The ADA was performed after initial planning and scoping as part of the ongoing and iterative risk assessment process. • All transactions within the account were subject to the same processes and controls. • The purpose of the ADA was to design the nature, timing, and extent of the audit procedures and to obtain audit evidence. • Based on the understanding of controls, the auditor has concluded that the controls over revenue were effectively designed and have been implemented, the auditor has tested certain relevant controls and determined they are operating effectively, and the auditor is otherwise satisfied the entity has appropriately applied the requirements of the applicable financial reporting framework (for example, FASB Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers). • Data used in the ADA are relevant and reliable and have been tested for accuracy and completeness. • Customers tend to purchase consistent quantities throughout the year, with the exception of purchases just prior to major retail holidays, such as Memorial Day, Black FASB Accounting Standards Codification 606-10-25-30. Friday, and Christmas. • Some customers only purchase in bulk a few times a year, but most customers consistently purchase quantities one to two times a month. • The customer base does not fluctuate significantly from period to period. • Revenue is recognized when control transfers at a free-on-board (FOB) shipping point. • Invoicing occurs the day the product ships from the entity’s warehouse. • Warehouse personnel typically do not work weekends. • The company does not sell product to any related parties. All items that are determined to be individually material were excluded from the ADA and substantively tested separately. The remaining population that was subject to the ADA comprised routine, non-complex transactions with third parties. The processing and recording of transactions are highly automated and less likely to be susceptible to management override. Description of the ADA ADA Scoring Model 4 A complete population of transactions (at the individual item level) for one material account (excluding individually significant items) was subjected to an ADA designed to identify and assess risk and obtain audit evidence specific to a relevant assertion using different routines. The scoring of each routine is based on the evidence expected to be provided by that routine in relation to the auditor’s assessment of the risks of material misstatement. The routines were as follows: Routine Description 1 Identify customers with infrequent revenue activity (less than X transactions) 2 3 4 5 Identify customers with a significant fluctuation in volume of products purchased (item level) on a periodover-period basis Identify activity for new customers Identify all transactions recorded within X days of quarterend. Identify revenue transactions with an invoice date on Characteristic Volume Volume Volume Timing Timing Transaction Scoring Model Risk Score Less than 6 transactions 2 6312 transactions 1 More than 12 transactions 0 Greater than 70% variance 2 30% to 70% variance 1 Less than 30% variance Customer for 6 months or less Customer for greater than 6 months Within 3 days of quarter end Greater than 3 days of quarter end Transaction on a Relevant Fact Pattern Some customers only purchase in bulk a few times a year, but most customers consistently purchase quantities one to two times a month. Some customers only purchase in bulk a few times a year, whereas others purchase smaller quantities one to two times a month. Customers tend to purchase consistent quantities throughout the year, with the exception of purchases just prior to major retail holidays, such as Memorial Day, Black Friday, and Christmas. Some customers only purchase in bulk a few times a year, but most customers consistently purchase quantities one to two times a month. 0 1 The customer base does not fluctuate significantly from period to period. 0 1 Revenue is recognized when control transfers at FOB shipping point. 0 2 Invoicing occurs the day the product ships from the company’s warehouse. Routine Description Characteristic an unusual date (for example, weekend or holiday) 6 Identify instances in which the shipping document date and invoice date do not match. Timing Transaction Scoring Model weekend/holid ay Transaction on a weekday Invoice and shipping document do not match, and invoice date is before shipping date. Invoice and shipping document do not match, and shipping date is before invoice date. Invoice and shipping document match. Risk Score Relevant Fact Pattern Warehouse personnel typically do not work weekends. 0 4 Revenue is recognized when control transfers at FOB shipping point. 2 Invoicing occurs the day the product ships from the company’s warehouse. 0 Running the revenue transaction level detail through the ADA routines produces a total score for each transaction. The auditor then groups each transaction into a sub-population based on the individual transaction score. The number of sub-populations may differ depending upon the type of ADA developed, the scores produced by the ADA, and the auditor’s assessment of those scores. For purposes of this example, the auditor grouped the population of the account into subpopulations as follows: Assessed Risk Group 8312 A Moderate risk 437 B Low risk 033 C High risk • Total Risk Score Group A 3 High risk - Comprises items with characteristics deemed to present a higher risk of material misstatement. Approach - The auditor would perform additional substantive procedures to provide more persuasive audit evidence for the items identified by the ADA. For example, the nature of the substantive procedure may be confirmation as opposed to inspection; the extent of testing may be greater (larger proportionate sample size); or the timing of the procedure may be at or near the financial statement date as opposed to earlier in the period. • Group B 3 Moderate risk - Comprises items that warrant further procedures but do not have characteristics of those in the higher risk group. Approach - The auditor would perform substantive procedures appropriate for the items identified by the ADA in less depth relative to the higher risk population. For example, the nature of the substantive procedure may be limited to inspection of documents and records; the extent of testing may be less (smaller proportionate sample size); and the timing of the procedure may be earlier in the period. • Group C 3 Low risk - Comprises items that demonstrate no unusual characteristics based on the procedure performed using the ADA. Approach - The results of other audit procedures performed throughout the audit would be evaluated for contradictory information regarding the assessed risk of material misstatement. In the absence of contradictory information, as the routines of the ADA are sufficiently precise for the auditor to conclude that the risks of material misstatement have been addressed, no additional substantive procedures may be warranted for any reason other than to incorporate an element of unpredictability in the selection of auditing procedures to be performed from year to year. As a result of the previous procedures, the auditor concluded • Groups A, B, and C comprise a material account in the aggregate for which each group has differing risks. • for Group C, the audit evidence provided over the transactions (within the population analyzed by the ADA in combination with the audit evidence provided by testing of certain key controls over revenue as determined by the auditor and the absence of contradictory audit evidence from the testing of related accounts) was sufficiently persuasive for the auditor to conclude that the risk of material misstatement was addressed. • for Groups A and B, the audit evidence provided by the ADA was not sufficiently persuasive, and further substantive procedures were required to address the risk of material misstatement.