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Audit Evidence

Week 11

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Audit evidenceWhat evidence is

required? Auditors should obtain sufficient

appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion (SAS 400.1)

Audit evidence is obtained in a number of ways

Including an appropriate mix of tests of control and substantive procedures

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Assertions in Financial statements

The auditor is making an opinion on the assertions made in the financial statements

These then must be The evidence collected and

evaluated must therefore be Sufficient Appropriate

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Assertions

Assertions and the implications of those assertions are as shown

These can be evidenced by substantive testing

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Sufficiency & Appropriateness

Sufficiency is the measure of the quantity of evidence

Appropriateness is the measure of the quality of reliability of audit evidence

and its relevance to a particular assertion Whilst sufficiency and appropriateness are interrelated, various

factors including risk of misstatement and materiality need to be considered when judging as to what is sufficient appropriate audit evidence

But there are two major constraining factors in seeking evidence Time: an audit timetable is normally agreed with the

management of the entity giving a deadline date for the conclusion of the audit.

Cost: the fee for an audit assignment is normally agreed in advance. Thus, effective use of audit resources is crucial if commercial viability is to be maintained

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Quantity Quantity of evidence Is a function of the methods adopted

to collect evidence from the population of a class of transactions

This relates to an assessment of risk and The employment of sampling

techniques

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Reliability Reliability of audit evidence is influenced by

individual circumstances, but Audit evidence from external sources is more

reliable than that obtained from the entity’s records

Evidence from entity’s records is more reliable when internal controls work effectively

Direct evidence by auditors is more reliable than that obtained from entity

Written evidence is more reliable than oral Original documents are more reliable then

photocopies,etc SAS 400.16

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Obtaining evidence

Evidence may be obtained by Inspection Observation Enquiry and confirmation Computation Analytical procedures

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Analytical procedures Identification of relationships Between items of financial data in the

same period Between comparable financial data

from different periods In order to Identify consistencies and predicted

patterns of significant fluctuations and The results of investigations thereof.

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The role of analytical procedures

Analytical procedures can themselves provide sufficient audit evidence where an item can be verified directly by reference to another item

Eg commission on sales or bank interest receivable

Analytical procedures may also be effective in testing for understatement (i.e., completeness)

Eg in predicting sales from purchases and known margins

But sufficient substantive evidence is not obtained by analytical procedures alone, some tests of detail will also be required

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Circumstances where appropriate

Analytical procedures are most likely used

With existing well-established clients In well-known, stable industries Where predictive information is

readily available Where accounting and internal

control systems are effective

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Audit of accounting estimates

These are such items as Adjustments for stock and debtors

to net realisable value Depreciation Accrued income Provision for deferred taxation General provisions made

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Accounting Estimates

Frequently complex Business specific Maybe based on formula Subject to certain internal

controls May require specialist

knowledge

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Accounting EstimatesCollection of evidence

Confirmation of estimates by combination of Review and test of process used to develop

estimate Evaluation of data & consideration of the

assumptions Testing calculations Comparison of estimates made for prior

periods Consideration of directors’ review procedures

Use of independent estimate Review of subsequent events

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Opening balances and comparatives

Auditors need to obtain sufficient audit evidence that

Opening balances have been appropriately brought forward

Opening balances do not contain errors or misstatements

Appropriate accounting policies have been consistently applied

Changes in accounting policies have been correctly applied

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Comparatives Same rules apply Comparatives must be free from

error Comparatives must incorporate

correctly applied accounting policies If a new auditor May require substantive testing to

provide adequate assurance of opening balances and comparatives

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Confirmation as evidence There are instances where

knowledgeable third parties may be asked to provide corroborative evidence of assertions

This generally relates to requesting written evidence in relation to account balances

This sort of evidence is a confirmation

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Situations where appropriate

Confirmation used where there exists: knowledgeable party independent of the entity where alternative reliable evidence is not readily

available

Knowledgeable parties usually in a commercial relationship with the entity holding reciprocal information as to entity balances

Debtors Creditors Banks Lenders, etc

It is in the interest for such parties to maintain reliable records of their relationship with the entity

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Extent of evidence by confirmation

Where confirmations relate to reciprocal balances they provide persuasive evidence as to rights and obligations

Confirmations also provide strong evidence of ownership where the other party is acting as custodian

But confirmations may not provide persuasive evidence of accuracy where the entity’s balance is in error in the other party’s favour

an understatement of debtors an overstatement of creditors

Confirmations provide reliable evidence of the valuation of assets

Where the other party is a debtor or borrower further evidence is required of their ability to pay

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Interpretation

Reliability is high when There is assurance of responsibility

and sound internal controls on the part of the third party

Can provide useful evidence where Entity’s internal controls are weak It is supportive of material

misstatement