Auditing: accounts payable, inventory, subsequent events, evidence

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Auditing:

1. Discuss the auditors' approach to the verification of liabilities and assets.

The auditors' approach to the verification of liabilities and assets in an audit is said to substantially TEST existence, ownership, and valuation of liabilities and assets. Examples of the approach as referenced by C.M. Chartered Accountants are:

1. Obtaining evidence
The auditor's job, in short, is to provide a professional opinion on the relationship between the assertions in the financial statements and those embodied by generally accepted accounting principles. The auditor must obtain evidence to support his or her opinion on these financial statement assertions. Evidence can come in many forms including:

Evidence Example
? physical evidence ? bank statements and cheques
? testing of calculations to ensure accuracy ? checking of payroll withholding tax calculations
? internal documentary evidence ? minutes of meetings
? accounting records and reports ? general ledger and trial balance
? statements and representations by management and employees ? the letter of representation
? external documentary evidence ? confirmation of accounts receivable with debtors
? statements and representations by third parties ? documents from lawyers
? consistency with other evidence ? ratios and comparisons with industry norms

An auditor does not obtain all of these types of evidence for every financial statement assertion. For example, when attempting to verify an amount receivable the auditor may rely on direct confirmation from the debtor and evidence of payment made after the year end to provide assurance that the receivable both existed and was collectable. The auditor might decide that additional evidence would not be required to prove the assertions.

An auditor's goal is to reduce the risk of audit failure to an appropriately low level. Auditors must use professional judgment in selecting appropriate verification techniques to reach their goal all within an acceptable level of risk. Auditing procedures are designed to minimize three types of risk:

1. Inherent risk
Inherent risk relates to the nature of the transactions, assets and liabilities being audited. Some financial statement items are inherently more susceptible to error or fraud. For example, cash is more susceptible to theft than prepaid expenses or goodwill. Inherent risk is generally identified during the planning process by obtaining or updating knowledge of the organization's business and industry and significant events and transactions occurring during the year under audit.

2. Control risk
Control risk relates to the effectiveness of the organization's internal controls and financial reporting. The organization has the responsibility for establishing sufficient internal control to prevent or detect, on a timely basis, errors resulting from problems in the processing of transactions and the maintenance of accounting records. If the auditor identifies effective internal controls and performs tests to provide evidence of the effectiveness of those controls then he or she can reduce the amount of verification on detailed balances and transactions. The auditor will typically only test internal controls where doing so would reduce the cost of performing the audit or where testing of detailed transactions and balances is not feasible.

3. Detection risk
Detection risk is the risk that the auditor will not identify misstatements in the financial statements. An auditor only reviews a sample of transactions and balances as to test all would be both impractical and prohibitively expensive. ...