Chapter 5: Audit Evidence

INTRODUCTION

Audit evidence was any information used

by the auditor to determine whether the
information being audited is stated in
accordance with the established criteria.
 Cont,d
• Audit evidence- is the information obtained by
the auditor in arriving at conclusions on which
their reports are based.
• During financial statement audits, the auditors
gather and evaluate evidence to form an opinion
about whether the financial statements follows
the appropriate criteria, usually, GAAP or IFRS.
• The auditors must gather sufficient competent
evidence to provide an adequate basis for their
opinion on the financial statements.
 Cont,d
• Sufficient evidential matter is a measure of the
quantity of the evidence required whereas the
competency of evidential matter relates to its
quality.
• The requirement to obtain sufficient competent
evidence is reflected in the third standard of field
work as:
• Sufficient competent evidential matter is to be
obtained through inspection, observation, inquires,
and confirmation to afford a reasonable basis for an
opinion regarding the financial statements under
audit.
 Cont,d
• The auditors should document the evidence
they have obtained.
• Papers that document the evidence gathered by
the auditors
 to show the work they have done,
 the methods and procedures they have
followed, and
 the conclusions they have developed are
called working papers.
 MANAGEMENT ASSERTIONS
• Assertions are expressed or implied representations by
management that are reflected in the financial statement
components.
• Financial statement assertions: The conformity of a
client's financial statements to IFRS is judged
according to five different financial statement
assertions:
 existence or occurrence,
 completeness,
 rights and obligations,
 valuation or allocation,
 presentation, and disclosure
 AUDIT OBJECTIVES
• In obtaining evidence to support the assertions
contained in the financial statements, the
auditor develops specific audit objectives that
relate to each management assertion.
• Audit objectives test the assertions contained
in the components of the financial statements.
• Once the auditor has sufficient evidence that
the set of audit objectives is met, he or she has
reasonable assurance that the financial
statements are fairly presented.
 Cont,d
• For any given class of transactions, there are several audit
objectives that must be met before the auditor can conclude that
the transactions are properly recorded. They are called
transaction-related audit objectives.
• For example, there are specific sales transaction related audit
objectives and specific sales returns and allowances transaction
related audit objectives.
• Similarly, there are several audit objectives that must be met for
each account balance. They are called balance-related audit
objectives.
• For example, there are specific account receivable balance-related
audit objectives and specific accounts payable balance-related
audit objective. The transaction related and balance related audit
objectives are somewhat different but closely related.
 General transaction-related audit objectives
• Existence-Recorded Transactions are Exist
• Completeness -Existing Transactions Are Recorded
• Accuracy-Recorded Transactions Are Stated at the
Correct Amounts
• Classification-Transactions Included in the Clients
Journals Are Properly Classified.
• Timing-Transactions Are Recorded on the Correct
Dates
• Posting and Summarization-Recorded Transactions
Are Properly Included in the Master Files and Are
Correctly Summarized
 General balance-related audit objectives
1. Existence-Amounts Included Exist
2. Completeness-Existing Amounts are included.
3. Accuracy-Amounts Included Are Stated at The Correct
Amounts .
4. Classification-Amounts Included in the Clients Listing Are
Properly Classified
5. Cut-off-Transactions Near the Balance Sheet Date Are
Recorded in the Proper Period
6. Detail Tie-In-Details in the Account Balance Agree with
Related Master File Amounts,
7. Realizable Value-Assets Are Included at the Amounts
Estimated to Be Realized
8. Rights and Obligations
9. Presentation and Disclosure
 AUDIT EVIDENCE DECISION
•A major decision facing every auditor is
determining the appropriate types and amounts of
evidence needed to be satisfied that the client’s
financial statements are fairly stated.
•There are four decisions about what evidence to
gather and how much of it to accumulate:
1. Which audit procedures to use?
2. What sample size to select for a given procedure
3. Which items to select from the population
4. When to perform the procedures
 1. Audit Procedures
• An audit procedure is the detailed instruction that
explains the audit evidence to be obtained during the
audit.
• It is common to spell out these procedures in
sufficiently specific terms so an auditor may follow
these instructions during the audit.
• For example, the following is an audit procedure for
the verification of cash disbursements:
 Examine the cash disbursements journal in the
accounting system and compare the payee, name,
amount, and date with online information provided
by the bank about checks processed for the account.
 2. Sample Size
• Once an audit procedure is selected, auditors can vary
the sample size from one to all the items in the
population being tested.
• In an audit procedure to verify cash disbursements,
suppose 6,600 checks are recorded in the cash
disbursements journal.
• The auditor might select a sample size of 50 checks for
comparison with the cash disbursements journal.
• The decision of how many items to test must be made
by the auditor for each audit procedure.
• The sample size for any given procedure is likely to
vary from audit to audit.
 3. Items to Select
After determining the sample size for an audit procedure, the
auditor must decide which items in the population to test.
If the auditor decides, for example, to select 50cancelled checks
from a population of 6,600 for comparison with the cash
disbursements journal, several different methods can be used to
select the specific checks to be examined.
 The auditor can
 (1) select a week and examine the first 50 checks,
 (2) select the 50 checks with the largest amounts,
 (3) select the checks randomly, or
 (4) select those checks that the auditor thinks are most
likely to be in error. Or, a combination of these methods can
be used
 4. Timing
• An audit of financial statements usually covers a period
such as a year. Normally an audit is not completed until
several weeks or months after the end of the period.
• In the audit of financial statements, the client normally
wants the audit completed 1 to 3 months after year-end.
• However, timing is also influenced by when the auditor
believes the audit evidence will be most effective and
when audit staff is available.
• For example, auditors often prefer to do counts of
inventory as close to the balance sheet date as possible.
Audit procedures often incorporate sample size, items
to select, and timing into the procedure.
 PERSUASIVENESS OF EVIDENCE
• Audit standards require the auditor to accumulate sufficient
appropriate evidence to support the opinion issued.
• Because of the nature of audit evidence and the cost
considerations of doing an audit, it is unlikely that the auditor
will be completely convinced that the opinion is correct.
• However, the auditor must be persuaded that the opinion is
correct with a high level of assurance. By combining all
evidence from the entire audit, the auditor is able to decide
when he or she is persuaded to issue an audit report.
• The two determinants of the persuasiveness of evidence are
appropriateness and sufficiency.
 Appropriateness
• Appropriateness of evidence is a measure of the quality
of evidence, meaning its relevance and reliability in
meeting audit objectives for classes of transactions,
account balances, and related disclosures.
• If evidence is considered highly appropriate, it is a great
help in persuading the auditor that financial statements are
fairly stated.
• Note that appropriateness of evidence deals only with the
audit procedures selected.
• Appropriateness cannot be improved by selecting a larger
sample size or different population items. It can be
improved only by selecting audit procedures that are more
relevant or provide more reliable evidence.
 Relevance of Evidence
• Relevance of Evidence: evidence must pertain to
or be relevant to the audit objective that the auditor
is testing before it can be appropriate.
• For example, assume that the auditor is concerned
that a client is failing to bill customers for
shipments (completeness transaction objective). If
the auditor selects a sample of duplicate sales
invoices and traces each to related shipping
documents, the evidence is not relevant for the
completeness objective and therefore is not
appropriate evidence for that objective.
 Reliability of Evidence
• Reliability of Evidence: reliability of evidence
refers to the degree to which evidence can be
believable or worthy of trust. Like relevance, if
evidence is considered reliable it is a great help
in persuading the auditor that financial
statements are fairly stated.
• For example, if an auditor counts inventory,
that evidence is more reliable than if
management gives the auditor its own count
amounts.
 Cont,d
• Reliability, and therefore appropriateness,
depends on the following six characteristics of
reliable evidence:
Independence of provider
Effectiveness of client’s internal controls
Auditor’s direct knowledge
Qualifications of individuals providing the
information
Degree of objectivity
Timeliness
 Sufficiency
• The quantity of evidence obtained determines its
sufficiency. Sufficiency of evidence is measured
primarily by the sample size the auditor selects.
• For a given audit procedure, the evidence obtained
from a sample of 100 is ordinarily more sufficient
than from a sample of 50.
• Several factors determine the appropriate sample size
in audits.
• The two most important ones are
 the auditor’s expectation of misstatements and
 the effectiveness of the client’s internal controls.
 Cont,d
Audit Evidence Qualities Affecting Persuasiveness of
Evidence
Decisions
Audit procedures Appropriateness
Relevance
and timing Reliability
Independence of provider
Effectiveness of internal controls
Auditor’s direct knowledge
Qualifications of provider
Objectivity of evidence
Timeliness
When procedures are performed
Portion of period being audited
Sample size and Sufficiency
Adequate sample size
items to select Selection of proper population
items
 TYPES OF AUDIT EVIDENCE
• In deciding which audit procedures to use, the auditor can
choose from eight broad categories of evidence, which are
called types of evidence. Every audit procedure obtains
one or more of the following types of evidence:
• 1. Physical examination
• 2. Confirmation
• 3. Documentation
• 4. Analytical procedures
• 5. Inquiries of the client
• 6. Recalculation
• 7. Re performance
• 8. Observation
 Physical Examination
• Physical examination is the inspection or count by the
auditor of a tangible asset.
• This type of evidence is most often associated with
inventory and cash, but it is also applicable to the
verification of securities, notes receivable, and
tangible fixed assets.
• There is a distinction in auditing between the physical
examination of assets, such as marketable securities and
cash, and the examination of documents, such as
cancelled checks and sales documents.
• For example, before a check is signed, it is a document;
after it is signed, it becomes an asset; and when it is
cancelled, it becomes a document again.
 Confirmation
• Confirmation describes the receipt of a direct written
response from a third party verifying the accuracy of
information that was requested by the auditor.
• The response may be in electronic or paper form.
• The request is made to the client, and the client asks the
third party to respond directly to the auditor. Because
confirmations come from sources independent of the client,
they are a highly regarded and often-used type of evidence.
• However, confirmations are relatively costly to obtain and
may cause some inconvenience to those asked to supply
them. Therefore, they are not used in every instance in
which they are applicable.
Information Cont,d
Information Often Confirmed
Source
Assets
Cash in bank Bank
Marketable securities Investment custodian
Accounts receivable Customer
Notes receivable Maker
Owned inventory out on consignment Consignee
Inventory held in public warehouses Public warehouse
Cash surrender value of life insurance Insurance company

Liabilities
Accounts payable Creditor
Notes payable Lender
Advances from customers Customer
Mortgages payable Mortgagor
Bonds payable Bondholder

Owners’ Equity
Shares outstanding Registrar and transfer agent

Other Information
Insurance coverage Insurance company
Contingent liabilities Bank, lender, and client’s legal counsel
Bond indenture agreements Bondholder
Collateral held by creditors Creditor
 Documentation
• Documentation is the auditor’s inspection of the
client’s documents and records to substantiate
the information that is, or should be, included in
the financial statements.
• The documents examined by the auditor are the
records used by the client to provide information
for conducting its business in an organized
manner, and may be in paper form, electronic
form, or other media.
• Documents can be conveniently classified as
internal and external.
 Cont,d
• An internal document has been prepared and used
within the client’s organization and is retained without
ever going to an outside party. Internal documents
include duplicate sales invoices, employees’ time
reports, and inventory receiving reports.
• An external document has been handled by someone
outside the client’s organization who is a party to the
transaction being documented, but which are either
currently held by the client or readily accessible.
 Analytical Procedures
• Analytical procedures use comparisons and
relationships to assess whether account
balances or other data appear reasonable
compared to the auditor’s expectations.
• For example, an auditor may compare the
gross margin percent in the current year with
the preceding year’s.
• Analytical procedures are used extensively in
practice, and are required during the planning
and completion phases on all audits.
 Inquiries of the Client
• Inquiry is the obtaining of written or oral information
from the client in response to questions from the
auditor.
• As an illustration, when the auditor wants to obtain
information about the client’s method of recording and
controlling accounting transactions, the auditor usually
begins by asking the client how the internal controls
• Later, the auditor performs audit tests using
documentation and observation to determine whether
the transactions are recorded (completeness objective)
and authorized (occurrence objective) in the manner
stated.
 Recalculation
• Recalculation involves rechecking a sample of
calculations made by the client.
• Rechecking client calculations consists of
testing the client’s arithmetical accuracy and
includes such procedures as extending sales
invoices and inventory, adding journals and
subsidiary records, and checking the calculation
of depreciation expense and prepaid expenses.
• A considerable portion of auditors’
recalculation is done by computer assisted audit
software.
 Re-performance
• Re performance is the auditor’s independent tests of
client accounting procedures or controls that were
originally done as part of the entity’s accounting and
internal control system.
• Whereas recalculation involves rechecking a computation,
re performance involves checking other procedures.
• For example, the auditor may compare the price on an
invoice to an approved price list, or may re perform the
aging of accounts receivable.
• Another type of re performance is for the auditor to recheck
transfers of information by tracing information included in
more than one place to verify that it is recorded at the same
amount each time.
 Observation
• Observation is the use of the senses to assess client
activities. Throughout the engagement with a client,
auditors have many opportunities to use their senses
sight, hearing, touch, and smell to evaluate a wide range
of items.
• The auditor may tour the plant to obtain a general
impression of the client’s facilities, or watch individuals
perform accounting tasks to determine whether the
person assigned a responsibility is performing it
properly.
• Observation is rarely sufficient by itself because of the
risk of client personnel changing their behavior because
of the auditor’s presence.
 AUDIT DOCUMENTATION
• Auditing standards state that audit documentation
is the principal record of auditing procedures
applied, evidence obtained, and conclusions
reached by the auditor in the engagement.
• Audit documentation should include all the
information the auditor considers necessary to
adequately conduct the audit and to provide
support for the audit report.
• Audit documentation may also be referred to as
working papers, although audit documentation is
often maintained in computerized files.
 Purposes of Audit Documentation
• The overall objective of audit documentation is to aid the
auditor in providing reasonable assurance that an adequate
audit was conducted in accordance with auditing standards.
• More specifically, audit documentation, as it pertains to the
current year’s audit, provides:
 A Basis for Planning the Audit
 A Record of the Evidence Accumulated and the Results of
the Tests
 Data for Determining the Proper Type of Audit Report
 A Basis for Review by Supervisors and Partners
 Ownership of Audit Files
 Confidentiality of Audit Files
Requirements for Retention of Audit Documentation
• Auditing standards require that records for audits of private
companies be retained for a minimum of five years.
• The law makes the knowing and willful destruction of audit
documentation within the seven-year period a criminal offense
subject to financial fines and imprisonment up to ten years.
• SEC rules require public company auditors to maintain the
following documentation:
 Working papers or other documents that form the basis for the
audit of the company’s annual financial statements or
 review of the company’s quarterly financial statements are
memos, correspondence, communications, other documents
and records, including electronic records, related to the audit
or review.
 Permanent Files
• Permanent files contain data of a historical or continuing
nature pertinent to the current audit. These files provide a
convenient source of information about the audit that is of
continuing interest from year to year. The permanent files
typically include the following
 Extracts or copies of such company documents of continuing
importance as the articles of incorporation, bylaws, bond
indentures, and contracts
 Analyses from previous years of accounts that have
continuing importance to the auditor
 Information related to understanding internal control and
assessing control risk
 The results of analytical procedures from previous years’
audits
 Current Files
• The current files include all audit documentation
applicable to the year under audit. There is one set
of permanent files for the client and a set of current
files for each year’s audit.
• The following are types of information often
included in the current file:
 Audit Program
 General Information
 Working Trial Balance
 Adjusting and Reclassification Entries
 Supporting Schedules
THANKS!!!