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Dec 1990

Practice problems involving documentary evidence. ( Auditing)

by Carmichael, Douglas R.

    Abstract- Auditors should consider several factors when examining documents. Auditors can discourage fraud by insisting that organizations provide them with original documents. Auditors can then reasonably rely on the authenticity of the documents, unless their investigation suggests otherwise. The need for presenting documents such as certificates of deposit in their original form depends on the circumstances involved, but an original is preferable to a copy. Auditors should also be careful not to rely on notarized copies because notaries are not usually authorized to notarize authenticity.

Important Questions

In a typical year, S&J's sales transactions are relatively few and all are usually individually significant. Obtaining a letter of credit is S&J's customary practice for ensuring collectibility. S&J provides no allowance for uncollectible accounts. Anderson calls the manager on the engagement and asks, What do we know about this bank that issued the letter of credit on the $2.5 million sale? Have we seen audited financial statements? I've never heard of this bank."

These are important questions. An auditor should assess the reputation and viability of a bank in these circumstances, particularly a foreign bank. Some foreign banks are "off-shore" banks, i.e., they are not licensed to accept deposits or conduct other banking business with citizens of the domicile country, but can only do business off-shore. This situation should set off an audit alarm.

Missing Info

The auditor needs to investigate such banks when they are involved as principals or intermediaries in material, uncompleted transactions. However, Mr. Anderson is missing an equally important review point. Suppose he is told by the manager that based on inquiries of accountants and lawyers in the foreign country, the bank has a solid reputation and its audited financial statements present a strong financial position. Is the audit evidence adequate?

The Unasked Question

One question Mr. Anderson should have asked is, "Have we seen the original letter of credit?" it is customary to place copies of important documents reviewed in the workpapers, but the auditor should insist on inspecting the original document. When the auditor fails to insist on seeing an original document, it is too easy for dishonest management to create false support for material transactions.

Auditors are Being Duped ! The SEC staff working on accounting and auditing enforcement matters has noted with concern that auditors are being too easily duped by doctored copies of documents. This has been an element in certain SEC actions; but the risks of accepting a false document in support of a significant transaction is by no means confined to public companies. It is a real and serious risk in audits of both public and private companies.

Detecting False Documents--Sensitivity and Skepticism

The auditor should be sensitive to the possibility that a copy of a document is false. In some cases, it is possible to see lines around key areas, such as signatures, where a document has been pieced together from legitimate and falsified components and then copied. Copying machines have facilitated workpaper preparation, but they can also be readily used by a dishonest management to prepare false transaction support. By insisting on seeing the original, the auditor can avoid being deceived in a thinly disguised attempt to misstate financial statements.

Insist on the Original

If the auditor insists on seeing an original, won't the dishonest client simply provide a more convincing forgery? Is it reasonable to expect an auditor to detect such a forgery? While the auditor is not an expert in detecting false business documents, insisting on seeing the original will often thwart a fraudulent scheme. The client, having presented a copy of a document to the auditor, cannot suddenly supply a carefully prepared forgery. It is relatively easy to cut up documents, assemble them as a false single document, and make a copy to be supplied to the auditor. However, the document copied will not withstand even casual scrutiny.

Limitations of an Audit

Can the auditor automatically accept the authenticity of documents presented? SAS 16 (AU 327.12) states in discussing the inherent limitations of an audit: "Unless the auditor's examination reveals evidential matter to the contrary, his reliance on the truthfulness of certain representations and on the genuineness of records and documents obtained during his examination is reasonable."

Errors and Irregularities

SAS 53, which superseded SAS 16, abandons the notion of inherent limitations, but describes the characteristics of errors and irregularities, including concealment. An aspect of concealment indicates (AU 316.34, paragraph 8), Forgery may be used to create false signatures, other signs of authenticity, or entire documents." The effect of concealment on ability to detect is described as follows: "The auditor's ability to detect a concealed irregularity depends on the skillfulness of the perpetrator, the frequency and extent of manipulation, and the relative size of individual amounts manipulated." This means, among other things, that the auditor should be more skeptical of single documents supporting material transactions than of numerous, routine documents supporting normal, recurring transactions. However, it should be noted that both SASs 16 and 53 refer to the authenticity of original documents. The auditor may be deceived by a cleverly forged original but should not ordinarily accept a copy as a substitute for first-hand inspection of an original document.

A Copy is Not Competent Evidence

In some cases, the document in question may evidence an intangible asset rather than a supporting document, such as a security, certificate of deposit, or commodity futures contract. Must the auditor insist on seeing the original in these circumstances? The need to inspect the asset depends on consideration of audit risk and materiality in the circumstances, but seeing a copy is never a substitute for seeing the original. Confirmation with an independent custodian may be appropriate, but a copy is not competent evidence.

What About a Notarized Copy?

Suppose that instead of inspecting the original document the auditor is given a copy, but the copy bears the notation, "It is hereby certified that the foregoing is a true and correct copy of description of document." The document bears the stamp, seal, and signature of a notary public licensed by the state.

An auditor should be aware that a notarized copy of a document is not competent evidential matter. First, a notary's viewing of a document is not a substitute for inspection by the auditor. Second, a notary is not commonly authorized to notarize authenticity of documents.

A Notary's Authority is a Matter of Law

A notary public only has the authority prescribed by the provisions of law in the notary's state. To engage in any specific practice, a notary must have specific statutory authority. In New York, for example, a notary is not authorized by statute to issue certified copies of documents. Because the issuance of a certified copy of a document by a notary is an unauthorized act, it is not legal proof of the correctness or authenticity of a document. An auditor should never accept a notarized copy as evidence of the existence or validity of an original. In fact, presentation of a notarized copy for this purpose should arouse the auditor's professional skepticism.

Thus, neither a copy nor a notarized copy of a document should be considered competent evidential matter. SAS 31 (AU 326.19) provides the following guidance on the competence of evidential matter: "The independent auditor's direct personal knowledge, obtained through physical examination, observation, computation, and inspection, is more persuasive than information obtained indirectly." The direct personal knowledge obtained by inspecting an original document cannot be obtained by alternative means.

Is the Document Also Relevant?

By insisting on inspecting the original document, the auditor may be able to avoid being deceived by a dishonest management. However, in evaluating the acceptability of a document as competent evidential matter, the auditor also needs to consider whether the document corroborates the financial statement assertion it is intended to support. A client, for example, may record a receivable that represents a claim for a refund of duty paid on imported steel. Government regulations provide that if the steel is imported, modified in a production process, and then exported, a refund of the import duty can be obtained. In support of the receivable, the client presents a document from a duty claims specialist that indicates that based on the quantity of steel imported, the client is eligible for a certain amount refund. The amount equals the recorded receivable.

To receive the refund, the client has to submit a claim based on evidence of quantity imported, converted, and exported. Has the client converted and exported all the foreign steel imported? if the document does not support the existence and valuation of the receivable, the auditor would need to obtain additional information and evidential matter.


* Insist on inspecting the original document; seeing a copy is not valid alternative.

* A notarized copy of document is not competent evidence of the existence or validity of the document.

* In evaluating the competence of a document as evidential matter, consider its relevance to financial statement assertions as well as its authenticity.

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