Chapter 5: Audit Evidence

SA 500
SA 501
505
510: Intial audit engagement
520
530
540
550
SA 501: Audit Evidence—Specific Considerations for Selected Items

Objective:
To provide auditors with guidelines on obtaining sufficient and appropriate
audit evidence regarding specific elements:

1. Existence and condition of inventory.

2. Completeness of litigation and claims involving the entity.
3. Presentation and disclosure of segment information in accordance with
the applicable financial reporting framework.

INVENTORY
A. SAAE Regarding Existence and condition of Inventory
When the inventory is material to the FS, the auditor to obtain SAAE
regarding existence and condition by
1. Attendance at Physical Inventory Counting unless impracticable to
i. Evaluate management's procedures for recording & controlling inventory.
ii. Observe how management performs inventory counting.
iii. Inspect the inventory for damage or obsolescence.
iv. Perform Test Counts to verify accuracy.

2. Performing Audit Procedures on Final Inventory Records to determine

whether they accurately reflect the actual inventory count.

B. Physical inventory counting is conducted at a date other than the

date of FS
When inventory counting is conducted at a date other than the date of FS,
the auditor should
1. Perform additional audit procedures to obtain evidence that changes in
inventory levels are properly recorded between the count date and the FS
date
2. Consider designing following audit procedures
a. Proper adjustment of perpetual inventory records
b. Reliability of those records
c. Reasons for any significant differences btw physical count info and
the perpetual inventory record
If Auditor Cannot Attend Physical Count due to Unforeseen Circumstances:
1. Attend on an alternative date.
2. Apply audit procedures for the intervening period.
If Attendance is Impractical:
1. Apply alternative audit procedures to obtain sufficient evidence.
2. If not possible, modify the opinion as per SA 705
(Qualified/Disclaimer Opinion).
When is Attendance Impractical?
 Due to nature or location of inventory (e.g., military zones, restricted
areas).
 General inconvenience (time, cost, difficulty) is NOT a valid reason to skip
inventory count.

C. When the inventory held by a third party:

 If material, auditor must obtain sufficient audit evidence.
 By performing one or both:
1. Request confirmation from the third-party as to the quantities and
condition of the inventory held on the behalf of the entity.
2. Perform Inspection or other audit procedures appropriate in the
circumstances.
Where information is obtained that raises doubt over the integrity and
objectivity of the third party, the auditor should consider performing other
audit procedures:
1. Attending or arranging another auditor to attend the third party’s physical
inventory count.
2. Obtaining service auditor’s report on the adequacy of the third-party’s
internal control reports.
3. Inspecting documentation regarding inventory held by the third party
(warehousing receipts.)
4. Requesting confirmation from the other parties when the has inventory
has been pledged.
 D. Matters relevant in planning attendance at physical inventory
counting
1. Nature of Inventory
2. Stages of completion of WIP
3. The ROMM related to inventory
4. The nature of IC related to inventory
5. The timing of physical inventory counting
6. The locations at which inventory is held and the materiality and ROMM at
different locations, in deciding at which locations attendance is
appropriate
7. Whether the assistance of an auditor’s expert is needed
8. Whether the entity maintains perpetual inventory system.
9. Whether adequate procedures are expected to be established and proper
instructions are issued.

2. Litigation & Claims

Auditor - identify and assess risk of material misstatement due to
litigation & claims.
The AP include:
Inquiry with management, TCWG & in-house legal counsel.
Review: Minutes of Meetings of those charged with governance (TCWG)
and correspondence between entity & external legal counsel.
Inspect Legal Expense Account.
If Undisclosed Litigation is Found: Auditor may directly communicate
with external legal counsel via a
letter of inquiry: Prepared by management, sent by the auditor.
If direct communication is prohibited by law, auditor performs alternative
procedures.

Letter of Specific Inquiry

Meeting with External Legal Counsel:

 Can be held in certain cases, e.g.:

o Significant risk (SA 315)
o Complex legal matters
o Disagreements between management & legal counsel
If Management Restricts Auditor from Legal Counsel Access:
 Auditor modifies opinion under SA 705.

SA 501: Audit Evidence – Specific Considerations for Selected Items

Completeness of Litigation and Claims Involving the Entity
1. Objective
The objective of the auditor is to obtain sufficient and appropriate audit
evidence regarding the completeness of litigation and claims involving the
entity to ensure that all material legal matters have been identified and
properly accounted for in the financial statements.

2. Auditor’s Responsibilities
The auditor must determine whether:
 All material litigation and claims involving the entity are identified.
 Proper accounting and disclosure of such litigation and claims are
made in the financial statements.

3. Procedures to Ensure Completeness

(a) Inquiry with Management and Those Charged with Governance
 Discuss with management and legal advisors about ongoing and
potential legal matters.
 Understand the process followed by management to identify and
record such litigation and claims.
(b) Reviewing Board Minutes and Correspondence
 Examine minutes of Board meetings, shareholder meetings, and
correspondence with legal advisors.
 Review regulatory communications and correspondence with
authorities.
(c) Obtaining Written Representations
 Obtain a written representation letter from management stating:
o All known litigation and claims have been disclosed.
o Proper accounting and disclosure have been made as per
applicable financial reporting framework.
(d) External Confirmation from Legal Counsel
 The auditor may send a legal confirmation letter to the entity’s
external legal counsel, requesting:
o Details of pending legal cases.
o Likelihood of an unfavorable outcome.
o Estimated financial impact.
(e) Reviewing Legal Expense Accounts
 Analyze legal expense accounts in the general ledger to identify
significant transactions related to litigation..
 Discussion with Those Charged with Governance (TCWG)
 Assess management’s bias in recognizing or disclosing litigation risks.
 Evaluate whether management’s legal assessments align with external
counsel’s opinion.
Professional Skepticism & Written Representations
 Challenge management’s assumptions regarding probable outcomes.
 Obtain a written representation that all material litigation has been
disclosed.

5. Reporting Considerations
(a) If RoMM is Addressed and No Misstatements Found:
 Issue an unmodified opinion.
(b) If Litigation or Claims Are Not Properly Recognized or Disclosed:
 Issue a qualified or adverse opinion based on the materiality of
misstatement.
(c) If the Auditor Cannot Obtain Sufficient Evidence:
 Issue a disclaimer of opinion due to scope limitation.

6. Documentation Requirements
The auditor should document:
1. Discussions with management and legal advisors regarding
litigation and claims.
2. Responses from external legal counsel, if any.
3. Written representations obtained from management.
4. Assessment of contingent liabilities and provisions in financial
statements.
5. Basis for the auditor’s conclusion on the completeness of litigation
and claims.

4. Segment Information:
 Understanding Requirements:
o Gain an understanding of the methods used by management to prepare
segment information.
 Audit Procedures:
o Evaluate whether the segment information is in line with the applicable
financial reporting framework.
o Perform analytical procedures to assess the reasonableness of the disclosed
information.
SA 505: External Confirmation
Audit Evidence
 Direct Written Response: To – Andrew /From-Third Party (confirming
party)
 Paper form/Electronic Form
Procedure of External Confirmation to Obtain Audit Evidence
 How Auditor will maintain control over EC request?
 Information - to be Confirmed/Requested
 Party - confirming Party
 Design - Confirmation Request
 Addressed
 Return information for responses directly to auditor
 Sending & follow-up (if applicable)
Determining the Information to be Confirmed
 Generally - Balances
 May also be used
 Terms of Agreement or contract
 Transaction
 Absence of certain conditions
Selecting Appropriate Confirming Party
 Response to EC provides more relevant/reliable evidence, provided
that confirming party is KNOWLEDGEABLE.
 Most appropriate confirming party
Design of External Confirmation Requests
 Design has a direct impact on Confirmation Response Rate, Reliability,
and Nature of Audit Evidence.
 Factors to be considered while designing the external confirmation
requests:
o Assertion - Addressed
o ROMM
 o Presentation - Layout/Presentation
o Prior Experience
o Method - Paper/Electronic
o Management Authorisation - Will impact willingness to reply
o Ability of confirming party to confirm or send the requested
information
Positive Confirmation Request
 Ask confirming party to reply to the auditor in all cases: agreement,
disagreement, or providing information requested.
 Provides reliable audit evidence.
 Risk -> Reply without verification; risk reduces by sending request
without stating the amount or a request to furnish information
(Confirmation Response Rate may decline).
 Properly Addressed: Ensure requests are properly addressed and check
validity of some addresses before sending confirming requests.
Follow-up Procedures
 Additional confirmation requests if no reply is received in a reasonable
time.
Management’s Refusal to Allow Confirmation Requests
 Auditor inquiries about reasons.
 Seeks audit evidence for validity & reasonableness.
 Evaluates impact of refusal on ROMM (fraud or error) & NET of AP.
 Performs alternative audit procedures to obtain relevant and reliable
audit evidence.
 Common reason: Legal dispute/negotiation - External Confirmation
might affect the outcome.
 Auditors must verify management's reasons for limiting access to
evidence, as this may be an attempt to conceal fraud or errors.
Alternative Audit Procedures - Examples
 For Account Receivables - Examine subsequent cash receipts, shipping
documents.
 For Account Payables - Examine subsequent cash disbursement, GNR.
Actions When Management’s Refusal is Unreasonable or Audit
Evidence is Insufficient
 Auditor shall communicate with TCWG (Those Charged with
Governance) in accordance with SA 260.
 Determine the implications for the audit.
 Determine the implications for the auditor’s opinion in accordance with
SA 705.
Negative Confirmation Request
 Respond only if the confirming party disagrees with the information
provided in the request.
 Provides less persuasive audit evidence.
 Shall not be used as the sole substantive audit procedure to address
ROMM unless conditions are met.
 If all conditions are present, Negative Confirmation Request can be
used as a Substantive Procedure (SP) to address ROMM:
o Low ROMM risk required.
o Sufficient Appropriate Audit Evidence (SAAE).
o Operating effectiveness of relevant controls must be present.
o Items should be small and homogeneous.
o A low exception rate is expected.
o No circumstances or conditions to disregard the request.
Negative Confirmation - Other Points
 No response doesn’t prove receipt or accuracy verification.
 Provides less persuasive evidence than positive confirmations.
 Recipients are more likely to respond if they disagree with the
information provided.
 Example: Bank account holders may respond to understated balances
but ignore overstated ones.
 Can be useful for detecting understated balances but are ineffective
for finding overstated amounts.
Evaluating the Evidence Obtained
 Results of EC Procedures
 Doubts about the reliability of audit evidence -> Need to obtain further
audit evidence to resolve doubts.
 If response is not reliable -> Determine implications on the audit:
o Assessment of Risk of Material Misstatement (ROMM), including
ROMM due to fraud.
o Nature, Extent, and Timing (NET) of audit procedures.
Non-Response Handling
 Perform alternative audit procedures.
 Response to positive confirmation is necessary.
 Alternative audit procedures may not provide sufficient audit evidence.
 If no response from confirmation request -> Determine implications for
the audit and opinion in accordance with SA 705.
External Confirmation as a Substantive Procedure
 Factors to be considered:
o Confirming party's knowledge of the subject matter.
o Ability or willingness of the confirming party (may not accept
responsibility, may consider confirmation costly or time-
consuming, may have concerns about legal liability).
o May account for the transaction in different currencies.
o May operate in an environment where responding to a
confirmation request is not considered a significant aspect.