Reference should be made to ISA 500- Audit evidence
“ The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion”
Audit evidence refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion on the financial statements is based.
Audit evidence comprises source documents and accounting records underlying the financial statements and corroborating information from other sources.
The sources and amount of evidence needed to achieve the required level of assurance is determined by the auditor’s judgment. His judgment will be influenced by the materiality of the item being examined, the relevance and reliability of evidence available from each source and the time and cost involved in obtaining it.
Audit evidence is obtained from an appropriate mix of tests of controls and substantive procedures. Where the internal control system is considered weak, evidence maybe obtained entirely from substantive procedures.
Tests of controls
Compliance tests are procedures performed to obtain audit evidence about the effectiveness of the:
- Design of the accounting and internal control system i.e. whether it is suitably designed to prevent and correct material misstatements.
- Operation of the internal controls throughout the period.
These are audit tests carried out to test the accuracy and validity of the accounting records. Substantive procedures are mainly of two types i.e. analytical review procedures and tests of details.
Meaning of sufficient appropriate audit evidence
Sufficiency is the measure of the quantity of audit evidence.
Appropriateness is the measure of the quality of audit evidence and its relevance to a particular assertion and its reliability. In forming an opinion the auditor does not examine all the information available but uses judgmental or statistical sampling procedures to form conclusions on account balances, class of transactions or controls.
Factors influencing the auditor’s judgment as to what is sufficient appropriate audit evidence.
- The degree of risk of misstatement- this may be affected by;
- The nature of the item e.g. cash has a greater degree of misstatement than fixed assets
- Strength of the internal control system, where the system is weak there is a greater risk of misstatement.
- Nature and size of business being carried out.
- Financial position of the company.
- Materiality of the item being examined in relation to the financial statements as a whole.
- The auditor’s experience with the client gained during the previous audits e.g. the reliability ofmanagement and accounting records.
- Results of other audit procedures including fraud or error, which may have been detected.
- Sources and reliability of information available.
Meaning of relevance of audit evidence
Relevance of audit evidence should be considered in relation to the overall audit objective of forming an opinion and reporting on the financial statements. To achieve this objective the auditor needs to obtain evidence to enable him to draw reasonable conclusions on various management assertions made in preparing the financial statements. Relevance therefore refers to the ability of the evidence to assist the auditor in testing management’s assertions.
Refer latter on in this lesson for the meaning of management’s assertions.
Reliability of audit evidence
The reliability of audit evidence refers to the credibility of the source of the evidence.
This credibility is influenced by its source; whether from internal sources or external sources and by its nature; whether visual, documentary or oral. Reliability of the evidence depends on individual circumstances but we can make the following generalizations:
- Audit evidence from external sources e.g. a third party (e.g. a debtor) confirming amount owing to the company is more reliable than evidence generated internally.
- Audit evidence generated internally e.g. from accounting records is more reliable when the related accounting and internal controls are effective.
- Evidence obtained by the auditor himself is more reliable than that obtained from the entity.
- Evidence in the form of documents and written representations is more reliable than oral representations.
The auditor seeks evidence from different sources. Evidence is more persuasive when evidence from different sources is consistent. Conversely, when audit evidence obtained from one source is inconsistent with that obtained from another, the auditor should perform further procedures to resolve the inconsistency.
When in doubt as to any assertion of material significance, the auditor should attempt to obtain sufficient appropriate evidence to remove such doubt. If he is unable to obtain sufficient appropriate evidence, he should express a qualified or a disclaimer of opinion.
Obtaining audit evidence
Audit evidence is obtained by carrying out compliance (tests of control) and substantive tests. In carrying out compliance tests (tests of controls), the auditor is concerned with;
- Whether controls exists
- The effectiveness of those controls.
Substantive procedures are defined as those tests of transactions and account balances, which seek to provide audit evidence as to the completeness, accuracy and validity of information contained in the accounting records or in the financial statements. Substantive tests sre of two types;
- Tests of details- these are designed to substantiate individual items in the accounts and to gain assurance about their validity or the details that underlies the account balances.
- Analytical review procedures
When preparing financial statements the management is making certain explicit or implicit assertions about the financial affairs of the company. Consequently when the auditor is obtaining evidence from substantive procedures, he is concerned about testing or substantiating the truth of these assertions. These assertions are categorized as follows;
- Existence- that an asset or liability exists at a given date. E.g. that closing stock physically exists.
- Rights and obligations- an asset is a right of the entity and a liability is an obligation of the entity. E.g. land belongs to the company and the title documents are in the name of the company.
- Occurrence- that a transaction or event took place which pertains to the entity during the period.
- Completeness- there are no unrecorded assets, liabilities, transactions or undisclosed items.
- Valuation- that a transaction is recorded at an appropriate carrying value. E.g. that land and buildings are carried at an appropriate value.
- Measurement- that a transaction is recorded at the proper amount and revenue and expenses allocated to the proper period.
- Presentation and disclosure- an item is disclosed classified and described in accordance with the applicable with the applicable financial reporting framework.
The auditor seeks to obtain audit evidence to prove each financial statement assertion. The nature, timing and extent of substantive procedures to be carried out to prove the financial assertions varies. One substantive procedure can prove evidence about more than one assertion. E.g. collection of an amount owed by debtors may provide evidence as to both existence and valuation of the debt.