AUDIT EVIDENCE (ISA 500)

Audit evidence refers to the information obtained by the auditor in arriving at the conclusions on which audit
opinion on the financial statements is based. Audit evidence comprises of source documents and accounting
records underlying the financial statements. The accounting records generally include:
• records of initial entries and supporting records
• records of electronic fund transfers, invoices, contracts and cheques.
• General and subsidiary ledgers, journal entries and other adjustments to the financial statements
not reflected in the journal entries
• records such as work sheets and spread sheets supporting cost allocations, computations and
reconciliations. other information the auditor can use as audit evidence are:
• minutes of meetings
• Confirmations form third parties
• analysis reports
• Comparable data about competitors.
• Control annuals.
• information obtained by auditor from audit procedure such as observation and enquiries.
The sources and amount of evidence needed to achieve the required level of assurance is determined by the
auditor’s judgment. The auditor’s judgment will be influenced by the materiality of item being examined, the
relevance and reliability of evidence available from each source and cost involved in obtaining it. audit evidence
is obtained through an appropriate mix of tests of controls and substantive procedures where internal control
system is considered weak; evidence may be obtained entirely from substantive procedures.
Substantive tests are procedures carried out to test the accuracy and validity of accounting records. They are
of two types i.e. analytical review procedure and test of detail.

Qualities of audit evidence

ISA 500 requires that ‘the auditor should obtain sufficient audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.’ What do we mean by:
a) Sufficiency
b) appropriate
Sufficient means that there needs to be enough evidence. What is enough is a matter of professional judgment.
appropriate break down into:
a) relevance.
relevance of audit evidence should be considered in relation to the overall audit objective of forming an
opinion and reporting on financial statements. It therefore refers to the ability of the evidence to assist the
auditor in testing management assertions.
b) reliability
Reliability of audit evidence refers to the credibility of that evidence the credibility is influenced by its source
and its nature

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Methods of obtaining audit evidence

The auditor may rely on sufficient appropriate evidence obtained by substantive testing to form his opinion.
Alternatively, he may be able to obtain assurance from presence of a reliable internal contrast system and
therefore reduce the extent of substantive testing the auditor obtains evidence in performing compliance and
substantive procedures using the following methods.
a) Inspection.
This consists of examining records, documents or tangible assets. The reliability of the evidence obtained from
inspection depends on nature, source and effectiveness of the internal control system. inspection of tangible
assets provides evidence with the respect to the existence but not to their value and ownership.

b) Observation
This involves looking at procedures being performed by others e.g. stock counting by client personnel.

c) Inquiry and confirmation.

inquiry consists of seeking information from knowledgeable persons inside and outside the company. it ranges
from formal written inquires addressed to the third parties to oral inquiries addressed to persons within the entity.
The information may be new to the auditor or may corroborate evidence from other sources. Confirmation is the
response to inquiry to corroborate information contained in financial statements e.g. debtors circularization.

d) Recalculation and re-performance

This involves checking the arithmetic accuracy of source documents and accounting records or performing
independent computations e.g. re-computing amount of provision for depreciation and comparing this against
that computed by client.

e) Analytical procedures.
This is the analysis of relationships such as between items of financial data to identify consistency and predicted
patterns or significant fluctuations, unexpected relationships and results of investigations thereof.

AUDIT SAMPLING (ISA 530)

ISA 530 (audit sampling and other selective testing procedures) defines auditing sampling as application audit
procedures to less than 100% of the items within an account balance or class of transactions to enable the
auditor obtain and evaluate audit evidence about some characteristics of the items selected in order to form or
amidst in forming a confusion concerning

Definition of terms
Population
The population is the entire set of data from which the auditor wishes to sample in order to reach a conclusion
e.g. all items in an account balance or class of transactions. The individual items that make up a population are
called sampling units. The essential feature of population is that it must be homogenous i.e. must be composed
of similar or uniform sampling units.
Sampling risk

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because auditors do not examine all the items in the population when applying audit sampling, there is a risk
that is that the conclusion they draw may be different from which they would have drawn had they examined the
entire population. This risk is called sampling risk. The auditor should use rational basis for planning, selecting
and testing samples to ensure that he has reasonable assurance that sample used is to representative of the
population.
Non-sampling risk
This risk arises from factors that because the auditor to reach an erroneous conclusion for any reason not related
to sample size e.g. use of inappropriate audit procedures leading to failure to identify an error. This risk can be
minimized by improving training and review procedures.
Tolerable error
This refers to the maximum error in the population that the auditor is willing to accept and still to conclude that
the results from the sample have achieved the audit objective. Tolerable error is considered during planning
stage and for substantive procedures, is related to auditor’s judgment on materiality. The smaller the tolerable
error expected in a balance, the larger sample size must be.
Confidence level
This refers to the degree of confidence the auditor requires that shows the results of the sample to be indicative
of actual error in the population.
Stratification
This is the process of dividing population into sub populations so that items within each subpopulation are
expected to have similar characteristics in certain aspects e.g. high value items should be grouped separately
from low value items. In cases where auditors are concerned with discoveries of overstatement errors and
consider that the largest monetary errors are likely to occur in the large items, they will stratify the population by
value and then direct their audit procedures on items with largest individual values.

Expected errors
if the auditor expects errors in the population, a larger sample size than when no error is expected ordinary
needs to be examined to conclude that the actual error in the population is not greater than the planned tolerable
error. Smaller sample sizes are justified when the population is expected to be error free.
Reasons for sampling

i. a complete check for all transactions and balances a business is no longer possible owing to the
numerous numbers of transactions.
ii. Time factor. Examining all the transactions will take a lot of time. The cost of doing this will be
prohibitive because audit fees are largely based on amount of time spent on assignment also a
complete check will take so long that the accounts will be ancient history before users saw them.
iii. The objective of an audit is to express an opinion as to whether the financial statements show a
true and a fair view. it is possible for the auditor to obtain the assurance without examining all
transactions. The use of sampling with properly set out objectives and properly constructed tests allows
more valid conclusions to be reached than when many transactions as possible are tested. This is
because detailed testing is done on a sample.
iv. a complete check would bore the audit staff so much that their work would become ineffective
and errors would remain unidentified.

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Cases where sampling is inappropriate

i. When population is small, statistical sampling will create an unacceptable margin of error. If the
population is not sufficiently large, then statistical methods are invalid. instances where transactions
or balances are small in number but material in relation to financial statements e.g. directors’ fees
should never be sampled and any transactions involving a large capital expenditure.
ii. Any situation where the auditor is put on high alert a result of earlier tests or information is
received indicating material fraud in a certain accounting area.
iii. For statutory disclosure items such as director’s salaries, a full audit check is desirable because
materiality consideration does not apply in this case.
iv. Where population is not homogenous and requires stratification, it is not possible to select a
representative sample.
v. When the population has not been maintained in a manner suitable for audit sampling
e.g. if sales invoices are filed according to customer name as opposed to a numerical order.

Stages in audit sampling

a) Planning the sample

When planning how to carry out sampling, the auditor considers the following:
i. Objectives of tests and combinations of audit procedures which are likely to achieve the
objectives e.g. objective to verify compliance of the debtor’s balances.
ii. The population and sampling units should be appropriate to the objectives of sampling e.g. if
auditor’s objective is to test overstatement of debtors, an appropriate population would be a list of total
debtors.
iii. Definition of errors is substantive testing and deviation in compliance testing. Before performing
testing on a chosen sample, the auditor should define clearly test results and conditions that will be
considered errors or deviations by reference to audit objective. For substantive testing, the auditor
should project errors found in the sample to population and consider the effect of projected errors on
a particular test objective.

b) Determination of sample size.

The auditor needs to determine the appropriate size of the sample on which audit procedures will be applied.
Sample size is determined by;
i. The tolerable error. The larger the tolerable error, the smaller the sample size required for a given
test.
ii. auditor’s assessment of the inherent risk. The higher the assessment of inherent risk, the larger
the sample size is required. higher inherent risk implies that there is a greater risk of an account
balance being misstated and this may be reduced by testing a larger sample.
iii. auditor’s assessment of control risk. a higher control risk implies that little reliance can be placed
on effectiveness of operations of internal controls and the sample size needs to be increased.
iv. Auditor’s required confidence level. The greater the degree of confidence level the auditor
requires, the larger the sample size needs to be so that the results of the sample are in fact
representative of the actual amount of error in the population.

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 c) Selecting items to be tested.

The sample selected should be a true representative of the population so that the auditor can draw conclusions
about the entire population. all sampling units should have an equal chance of being selected. Common
sampling methods are;
i. Random sampling.
This is done by use of random number tables or use computers to select sampling units
ii. Systematic selection.
In this type of sampling, units in the population are divided by the sample size to give sampling intervals
e.g. if the population to be sample has 600 items and sample size is 50, the sampling interval will be
12. One of the first 12 items will be selected as the starting point and thereafter, every twelfth item will
be selected i.e. if the first item selected is third item, every 15th, 27th, 39th and so on items will be picked.
however, the auditor needs to determine that sampling units within the population are not structured
in a way that sampling intervals corresponds to a particular pattern in the population.
iii. Haphazard selection.
The auditor selects a sample without following structured techniques. The auditor should avoid
conscious bias and predictability in selecting items in attempt to ensure that all items in the population
have a chance of being selected. This technique is not suitable for statistical sampling.
iv. Block selection. This involves selecting a group of continuous items within the population e.g.
all sales transactions for august. block sampling cannot be ordinarily used in audit sampling because
most populations are structured such that items in a sequence can be expected to have similar
characteristics therefore the sample selected may not be representative of the population.

d) Testing.

After selecting the sample items the auditor should carry out the predetermined test on each item.

e) Evaluating results of the test.

The following procedures should be followed.

i. The auditor should estimate the expected error or deviation rate in the whole population by
projecting the results of the sample to the population. This is then compared with the tolerable error.
ii. The auditor should assess the risk of an incorrect conclusion. in general, expected error is rarely
a precise measure of the actual error in the population. actual error may be greater or smaller than
projected error. The auditor most therefore considers on the basis of his sample results and relevant
evidence from other sources, the possible levels which actual error or deviation might take.

Main approaches to Audit Sampling

a) judgmental sampling

This is also called non-statistical sampling. it involves using experience and knowledge of client’s business and
circumstances to select and taste a sample without using any mathematical of or statistical tools. The auditor
does not rely on probability theory and uses judgment in making sampling decisions.

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b) Statistical sampling.

This involves two steps;

i. Use of random selection to pick a sample.
ii. Use of probability theory to determine the sample size, evaluate quantitatively the sample results
and measure sampling risk. Statistical sampling differs from non-statistical sampling in that the auditor
uses probability theory to measure the sampling risk and evaluate the sample results.
Qualities of a good sample
i. it should be representative of the population. The sample should be representative of the differing
items in the whole population.
ii. The size of the sample should be appropriate given the various risk considerations i.e. where the
expected error is high, a large sample is chosen.
iii. Unpredictable. The client should not be able to know in advance which items will be examined.