PA503 Fundamentals of Auditing

CHAPTER
6.1

6.0

Chapter 6

AUDIT EVIDENCE

Understand the nature of audit evidence (go)

6.1.1 Meaning of audit evidence (so)

INTRODUCTION
Audit evidence concept:
Evidence is all form of information or authoritative data that is used by parties that are
interested in making decision. Without solid evidence, decisions may become irrelevant or
bias. As auditor's opinion is the most important element in the audit process and can
substantially affect the clients financial statement, it is necessary for auditors to compile,
document and interpret various audit evidence satisfactorily before giving an audit opinion.
Definition:
Audit evidence is something that represents managements statement through financial
statement. It is also information obtained by auditors to back up his or her opinion. This proof
will be accessible through compliance and validity test by using methods such as physical
examination, observation, advocacy and confirmation. Audit evidence is gathered
information and used to support audit finding.

6.1.2 Purpose of having the audit evidence (so)

PURPOSE / IMPORTANCE OF AUDIT EVIDENCE
i. Audit evidence enables auditor to come up with an audit report completely and effective.
ii. It can also strengthen audit report that provided by auditor.
iii. Audit evidence can also prevent auditor from legal liability. For example, if there is a
court case that required auditor to become witness, auditor may make use of the audit
report which contains enough audit evidence.
iv. Audit evidence can enhance client's trust on auditor, who would ultimately give the
auditor the opportunity to audit that company in the future.
v. Good audit report from adequate audit evidence can improve auditors performance in
order to be an accredited/chartered auditor and obtain trust from external parties and
clients.

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6.1.3 Types of evidence (so)

In deciding the most suitable audit procedure to produce good evidence that can convince and
is economic, auditor may choose either, all or a combination between the following:
1. Physical Examination
It is evidence that is achieved from physical examination on physical assets conducted by
auditor. It is the strongest evidence to ensure the asset really exists. Although this method
of implementation is costly, sometimes it could assure certainty on authority and rights of
the asset, as well as in the event whereby the auditors do not have the expertise in asset
valuation method.
2. Verification
It is feedback in writing or orally from third party on auditors request. This type of
evidence is regarded as most trusted evidence because it is produced from independent
sources, especially in written form, as well as from sources that can surely be trusted.
This type of evidence is also costly, so the need for it will depend on the current situation.
There are two methods of evidence by verification, namely:
i. Positive verification third party is required to give feedback on any information
needed.
ii. Negative verification third party is required to give feedback ONLY on wrong or
false information.
3. Documentation
This form of evidence is examination on entitys transaction record to determine the
validity of the information in the financial statements. Documentation is divided into two
categories, as follows:
i. Internal document Document retrieved from inside the entity or client itself.
ii. External document Document retrieved from inside or outside but already used by
an outsider. Documents to support values recorded in any transaction is known as the
screening process or vouching.
4. Customers Feedback
This is a feedback from customers, i.e. the clients on questions put forth by auditors.
However, it cannot be assumed as valid evidence because the information came from a
party that has personal interest.
5. Reperformance
Auditor will recalculate figures, flow of the information or work that has been done by
the client to ensure the information is accurate and true, in recording aspect or arithmetic
aspect.
6. Observation
Auditors visually watch the implementation behaviours activity and then compare with
the procedures that must be used. It is a weak form of evidence and needs different forms
of other evidence to increase the confidence level obtained from such evidence.

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7. Verbal Form
This form of evidence is obtained through questions or discussions between auditors and
clients officers of any level. It will be needed particularly if the auditor is not successful
in obtaining evidence by using other techniques. Nonetheless, auditors would have to
make many considerations before accepting it as trusted evidence.
8. Internal Control System Structure
Auditors may accept internal control system as audit evidence if it is found that the client
has an internal control system that is designed almost perfectly. Adequacy in internal
control system is the main factor which determines the volume and scope of evidence that
needs to be gathered by auditors.
9. Records (ledger and journal)
Actual amounts in the financial statements must be tested through ledger and journal
record toward compiling documented evidence. It depends on the strength of internal
control system which ultimately controls the preparation of the recording process.

6.2

Aware of the audit evidence sources (go)

6.2.1 Audit evidence sources (so)

Sources of obtaining Audit Evidence
(i) Internal source
Information obtained from such sources is mostly from within the clients company itself
such as through accounting system, management, employees, and underlying
documentation.
(ii) External source
Such sources include information from third parties such as suppliers, the clients
customer, bankers, legal advisers and lawyers, as well as other parties who have
knowledge about the client itself.

6.2.2 Procedures to obtain the audit evidence sources (so)

Auditor performs audit procedures to obtain an understanding of the entity, its environment and to
assess risks of material misstatement. Procedures are also applied to test operating effectiveness of
internal controls and for detection of material misstatements at assertion level. The auditor always
performs risk assessment procedures to provide a satisfactory basis for assessment of risks at
financial statement level. In addition to these risk assessment procedures, which alone are not
sufficient, the auditor performs audit procedures in the form of tests of control and substantive
procedures.
Tests of controls are applied when auditor expects to rely on operating controls. Through tests of
controls, auditors test the controls to support the risk assessment. These are also applied when
substantive procedures alone do not provide sufficient appropriate audit evidence. Nature and timing
of audit procedures may be affected by the entitys data retention policies or their practice to convert
source documents into computer images through scanning as well as means of communication being
used by the entity such as electronic messaging rather than written purchase orders. The auditor uses
one or more types of audit procedures described below:
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a)

Inspection of Records or Documents

It consists of examining records or documents whether internal or external, in paper form,
electronic form, or other media. Inspection provides evidence of varying degrees of reliability
depending on their nature and source and in the case of internal records, on effectiveness of
controls over their production.

b)

Inspection of Tangible Assets

It consists of physical examination of the assets. It may provide reliable audit evidence of their
existence.

c)

Inquiry
It means seeking information from knowledgeable persons throughout the entity or outside the
entity. These may be in formal written or informal oral. It provides an auditor with new
information or corroborative evidences. It may also bring forth information different from the
one possessed by the auditor. Certain oral inquiries may be confirmed through written
representations.

d)

Confirmations
It is a specific type of inquiry. It is the process of obtaining a representation of information or
an existing condition directly from a third party. Confirmations are sought from debtors,
creditors, bankers, and even legal advisors.

e)

Recalculation
It consists of checking the mathematical accuracy of documents or records. It can be performed
through the use of information technology such as Microsoft excel spreadsheet or scientific
calculator.

f)

Re-performance
It is the auditors independent execution of procedures or controls that were originally
performed as part of the entitys internal control, either manually or through the use of CAATs,
for example, re-performing the aging of accounts receivable.

g)

Analytical procedures
It consists of evaluations of financial information made by a study of plausible relationship
among both financial and non-financial data. It includes investigation of significant or
unexpected fluctuations found and the relationship that are inconsistent.

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6.2.3 Factors to be considered when collecting the audit evidence (so)

FACTORS THAT AFFECT AUDIT EVIDENCE
Auditors seeking audit evidence would always be confronted with various restrictions. Limitations
that arise may be due to several factors:
i. Audit evidence is subjective, depending on the surrounding situation which influenced the audit
and depending upon auditors discretion. The implication is absolute audit evidence can never be
obtained.
ii. Evidence obtained may not have to be taken into account because the statement or matter
involved is not material.
iii. Auditors would usually have limited time period to finish up the audit work assigned. Due to
such time factor, auditor may be forced to accept audit evidence that not as perfect as they would
like them to be in order to meet the pre-determined dateline.
iv. Auditor would also have to consider the cost involved to gathering audit evidence. The quality of
an audit evidence may be compromised especially if the cost involved is too high
Usually in carrying out audits, examination will not be done for every single transaction in the
clients ledger. It is should be persuasive enough if auditors select random sample to carry out audit
tests instead of testing all the population.

6.3

Understand the financial statement assertions (go)

6.3.1 Purpose of setting the assertions (so)

Assertions are expressed or implied representations by management that are reflected in the financial
statement components. Financial statement assertions are the set of information that the preparer of
financial statements is providing to another party. Financial statements represent a very complex and
interrelated set of assertions. In general, the assertions relate to the requirements of generally
accepted accounting principles. ISA 500 classifies these assertions.

6.3.2 Categorising the financial assertions (so)

(i)

Assertions about classes of transactions and events for the period ended:
a. Occurrence
Assertions about occurrence address whether recorded transactions have occurred during
a given period. For example, management asserts that revenues reported in the income
statement represent valid sales that occurred during the period.
b. Completeness
Assertions about completeness deal with whether all transactions and accounts that
should be presented in the financial statements are included. For example, management
asserts that inventory represents all items on hand at the balance sheet date. Management
also implicitly asserts that the amount for account payable on the balance sheet includes
all such liabilities as of the balance sheet date.

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c. Cut Off
Assertions about cut off address whether a transaction have been recorded in the correct
accounting period. For example, management asserts that the sales figure for the financial
year ending 31st December consists of sales transactions made from 1st January up to 31st
December. Any sales made after is included in the next accounting period.
d. Measurement
Assertions about measurement address whether a transaction is recorded at the proper
amount and whether revenue or expense is allocated to the proper period. For example,
management asserts that the cost of property, plant and equipment is systematically
allocated to appropriate accounting periods by recognising depreciation charges.
(ii)

Assertions about account balances at the period end:

e. Existence
Assertions about existence address whether assets or liabilities of the entity actually exists
at a given date. For example, management asserts that inventory shown on the balance
sheet physically exists and is available for sale.
f. Rights and Obligations
Assertions about right and obligations address whether assets are the right of the entity
and liabilities are the obligations of the entity at a given date. For example, management
asserts that the entity has legal title or rights of ownership to the inventory shown on the
balance sheet. Similarly, amounts capitalised for lease liability represents an obligation of
the entity.
g. Valuation
Assertions about valuation address whether an asset or liability has been included in the
financial statements at an appropriate carrying value. For example, management asserts
that inventory is carried at the lower of cost or market value on the balance sheet.

(iii)

Assertions about presentation and disclosure:

h. Presentation and Disclosure
Assertions about presentation and disclosure address whether particular components of
the financial statements are properly disclosed, classified and described in accordance
with approved accounting standards and other legal and regulatory requirements. For
example, management asserts that the portion of long-term debt shown as a current
liability will mature in the current year. Similarly, management asserts, through notes
disclosure, that all major restrictions on the entity resulting from debt covenants are
disclosed.

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