Chapter 5 Audit Evidence

Introduction
- Once an auditor has identified the key risk factors for their client,
they will plan their audit to obtain sufficient appropriate audit
evidence to ensure that relevant accounts and related note
disclosers are reported accurately.
- Audit assertions: used when designing and conducting an audit.
Assertions
- Statements made by Management (those charged with
governance) regarding the recognition, measurement,
presentation, and discloser of the items included in the financial
statements.
- Responsibility of those charged with governance to ensure that
the f/s are prepared to give a fair representation of the
entity and its operations.
Transaction Based Assertions
Focus on the transactions that took place during the period as opposed
to the account balance.
Example) when auditing inventory, auditor will audit a sample of the
transactions that impact inventory account (purchases and sales) and
also conduct procedures on ending inventory balance (account
balance)
Occurrence
Transactions and events that have been recorded have
ACTUALLY occurred and pertain to the entity.

Completeness

Accuracy

Cut-of

Important when auditor believes there is misstatement

or if an underlying transaction did not actually occur
(to overstate profit and revenue)
All transactions and events that should have been
recorded are INDEED recorded.
Important when auditor believes there is
understatement (some transactions should have been
recorded but have not been to understate expenses
and to overstate revenue)
Amounts and other data relating to the recorded
transactions and events have been recorded
appropriately and at accurate amounts.
Important when client has complex discounting
systems or foreign exchange calculations where errors
can occur easily.
Transactions and events have been recorded in the

correct accounting period.

Important when transactions close near to year-end.
Classification
Transactions and events have been recorded in the
proper accounts.
Account Balance Assertions
Existence

Assets, liabilities, and equity interests exist

Rights and
Obligations

Important when auditor believes that is a chance for

overstatement.
The entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
Important when auditor believes there is a risk that
recorded assets/liabilities are not owned by the entity.

Completeness

Valuation and
allocation

Example) Inventory held on consignment (not owned

by entity) BUT recorded as an asset.
All assets, liabilities, and equity interests that should
be recorded are recorded.
Important when auditor believes there is a risk of
understatement and client has omitted items from the
balance sheet.
Assets, liabilities, and equity interests are included in
the financial statements at appropriate amounts
and any resulting valuation or allocation adjustments
are appropriately recorded.
- Checking inventory to check whether inventory
has been appropriate recorded at lower of Cost
or NRV.
- Auditor tests for the adequacy of the allowance
for doubtful accounts (risk of understatement)
- Auditor checks that transactions are allocated to
the correct account when auditing R+D
expenditure (risk of understatement of the
expense account)

Presentation and Disclosure Assertions

Ensures that all items included in the f/s are fairly presented and
disclosed properly. Check that disclosed items represent events and
transactions that occurred for the entity, are recorded at appropriate
amounts, and are described accurately.

Occurrence,
rights, and
obligations
Completeness

Classification
and
understandabil
ity
Accuracy and
valuation

Disclosed events, transactions, and other matters

have occurred and pertain to the entity.
All disclosures that should have been included in the
financial statements have been included
Include cost formulas (LIFO, FIFO, etc.)
Financial information is appropriately presented and
described, and disclosures are clearly expressed.
If entity does not disclose its raw materials and
finished goods separately, then this assertion is not
met.
Financial and other information is disclosed fairly and
at appropriate amounts.
If company used LIFO but presented notes saying it
uses Weighted, then assertion of accuracy is not met.

Types of Audit Evidence

Audit evidence: information that an auditor uses when arriving at their
opinion on the fair presentation of their clients financial statements.
Management (Those charged with governance)s responsibility
- Ensure that f/s are prepared in accordance with GAAP
- Ensure that accurate accounting records are maintained and any
potential misstatements are prevented, or detected, and
corrected.
Auditors responsibility
- Gather sufficient appropriate evidence to arrive at opinion
- Gather evidence to support the audit assertions for transactions
and account balances.
Sufficient Appropriate Evidence
- Sufficient: quantity
- Appropriate: quality of audit evidence gathered.
- Interrelated, as quality of evidence gathered will afect quantity
required.
Recall: Inherent Risk f/s has material misstatement without
considering internal controls so looking at nature of business,
industry, and previous experience with the client.
Control Risk Risk that clients system of Internal controls will
NOT prevent a material misstatement.

Detection Risk risk that an AUDITORs testing will NOT be

efective in detecting misstatements.
Audit Risk

Audit Risk

Inherent
Risk
High

Control Risk

Inherent
Risk
Low

Control Risk

High

Low

Detection
Risk
Low

Evidence

Detection
Risk
High

Evidence

More

Less

Appropriateness of audit evidence

- Relevance
o Provides confirmation about an assertion most at risk of
material misstatement.
o By identifying the key risk areas for the client, an auditor is
able to focus on gathering more sufficient high quality
evidence where risk of material misstatement is most
significant.
- Reliability
o Whether the evidence reflects the true state of the
information.
o Consider
Source of information
Should be unbiased
Banks and third parties are generally reliable
Expertise of the respondent
Consistency of the information
Evidence that is consistent from one source to
another is more reliable than inconsistent
evidence.
Sources of information and whether it is produced
where internal controls operate efectively.
Types of Audit Evidence
External Confirmations
- Evidence sent directly by an auditor to a third party, who is
asked to respond to the auditor on the matters included in the
confirmation letters
-

Bank confirmations
o Amount of cash held in bank or in overdraft
o Details of any loans with the bank

o Details of any pledges of assets made to guarantee loans

o Interest rates charged.
o Confirm that the asset cash at bank is recorded at the
appropriate amount (value and allocation assertion) and in
clients name (rights and obligations) and all loans are
recorded (completeness)
o Used when auditing interest income and interest expense
items (accuracy)
Payable Confirmations
o Confirm the details of amounts owed to creditors and
significant loans.
o Amounts outstanding at year end (completeness and
valuation and allocation)
o Interest rates charged on amounts (accuracy)
o Amounts owed are to be paid by client (rights and
obligations)
o Unreliable because you can discover omitted liabilities, not
confirming the existence of liabilities the client has already
disclosed to them.
Receivable Confirmation
o Consider materiality, age, and location
o Evidence of ownership of receivable (rights and
obligations)
o Only confirm amount owing, do not confirm intention to
pay the amount due (little valuation and allocation
assertion)

Positive
Confirmation
Negative
Confirmation

Ask the recipient to reply in all circumstances

Ask the recipient to reply ONLY if they disagree with the
information provided.
Limited benefit when the existence assertion is being
tested.
Good when used to corroborate with other evidence .

Documentary Evidence
- Information that provides evidence about details recorded in a
clients lists of transactions
- Invoices, suppliers statements, bank statements, minute of
meetings, correspondence, and legal agreements
- Can be internally or externally generated

Auditor can trace details recorded in a clients accounting

records to supporting external documents to verify the amount
recorded.

Representations
Legal letter
- A letter sent to a clients lawyer asking them to confirm the
details of legal matters outstanding identified by management
- Lawyers opinion on the clients description of any outstanding
legal matters and whether the clients evaluation of those
matters appears reasonable.
Management Representation letter
- An acknowledgement that management is responsible for
preparation of the f/s
- Include any written details of any verbal representations made
by management made during the course of the audit.
- Can include an undertaking that laws and regulations have been
complied with, internal controls are efective, auditors have had
all evidence as requested, etc.
Verbal Evidence
- Responses of key client personnel to auditor enquiries
throughout the course of the audit
- Can be used to corroborate with other evidence
Computational Evidence
- Gathered when an auditor checks the mathematical accuracy of
the numbers that appear in the f/s
Physical Evidence
- Inspection of clients tangible assets, such as its inventory or
fixed assets
- Completeness: count and trace back to clients records to make
sure records are complete
- Existence: trace recorded amounts to selected inventory
- Valuation and allocation: do assets values need to be written
down?!
Electronic Evidence
- Data held on clients computer, files sent by email to auditor,
and items scanned and faxed.
- The extent to which electronic evidence can be relied upon
depends on their internal control.
Persuasiveness of Audit Evidence
Internally Generated Evidence

Least persuasive, as it can only be used to verify that a client

has accurately converted this information into financial
statements.
As client generates and holds this evidence, it is possible that
evidence may be manipulated or omitted.

Externally generated evidence held by client

- Quite persuasive, as they are produced by third parties
- Possible for client to manipulate these documents, which
reduces their reliability to the auditor.
- Reliability is also reduced when photocopied documents are
used instead of the original
Externally generated evidence sent directly to the auditor
- Most reliable and best quality, as they are independent of the
client
Using the Work of an Expert
1. Assessing the need to use an expert
a. The less knowledge an audit team has of the item under
consideration, the greater the risk of material
misstatement and the less corroborating evidence
available, the more likely an auditor will conclude than an
expert opinion is required.
2. Determining the scope of the work to be carried out
3. Assessing the competence and the capability of the expert
4. Assessing the objectivity of the expert
5. Assessing the experts report
6. Responsibility for the Conclusion
Evidence Gathering Procedures
- Inspection
o Examining records and documents and physically
examining assets
- Observation
o An evidence gathering procedure that involves watching a
procedure being carried out by another party
- Enquiry
o Asking questions verbally or in written form to gain an
understanding of various matters throughout the audit.
- Recalculations
o Involves checking the mathematical accuracy of client
records
- Re-performance
o Involves redoing processes conducted by the client
- Analytical Procedures

o An evaluation of financial information by studying plausible

relationships among both financial and non financial data.
Drawing Conclusions
1. Sufficient appropriate audit evidence must be gathered to enable
an auditor to draw a conclusion on which to base their opinion
regarding the fair presentation of the clients financial
statements. (CAS 500)
2. Decide what constitutes to be appropriate audit evidence (using
professional judgment) and the significant risks identified when
planning the audit and evidence gathered when executing the
audit (CAS 315)
3. If an auditor believes that a client has internal controls that can
reduce the likelihood of a material misstatement for an identified
risk, they will test those controls.
a. Test of controls
4. If auditor decides that a client does not have in place appropriate
controls, auditor will adopt a predominantly substantive
approach.
a. Will increase reliance on evidence gathered through their
detailed substantive tests of transactions and account
balances.
Working Papers
- CAS 230 requires an auditor to document each stage of the audit
in their working papers to provide a record of work completed
and evidence gathered in forming their audit opinion
- Includes
o Names of the prepares of documentation
o Names of reviewers of the work performed by prepares
- Planning stage
o Document their understanding of the client, the identified
risks, analytical procedures used to aid in risk
identification, their materiality assessment, their
understanding of the clients internal controls, etc.
- Executive stage
o Document their audit program, details of tests undertaken,
copies of significant documents sighted, etc
Permanent Files
- Includes client information and documentation that apply to
more than one audit
- Information is checked and updated at the beginning of each
audit.
- Includes
o Key personnel

o Locations
o Contact details
o Long term contracts and agreements to calculate interest
payable
o Relevant documentation of long term commitments
o Key long term investments
o Clients BOD and sub committees
Current Files
- Includes client information and documentation that apply to the
current audit
- Contents of the current file will vary from client to client,
depending on the accounts in the clients f/s and the clients
activities.
- Engagement letter and management letter included
Chapter 5 Tutorial
Problem 5-1
a) Valuation
b) Rights and Obligations
c) Completeness
d) Completeness
e) Cut-of
f) Rights and Obligations
g) Cut-Of
h) Valuation
i) Existence
j) Completeness
Problem 5-3
a)
- External Confirmations 30% of which were positive confirmations
and 70% negative confirmations
- Documentary invoices, cash receipts, sales return vouchers
- Verbal interviews with A/R manager, CFO, A/R department
b)
- External Confirmations existence of A/R costumers reply and
confirm the owe client money for g/s
- Negative confirmations limited evidence customer does not reply to
state that they do not owe the client money
- Confirmations also provide evidence about rights and obligations
customer confirms that they owe the client
- Documentary Evidence existence and valuation and allocation
assertions when Jenna vouches balances back to underlying sales docs

- Relates to completeness when Jenna traces sales transactions to A/R

Balance
- Vouching of A/R back to sales returns and cash receipts docs
occurrence of these transactions and thus completeness of A/R
- Tracing of these transactions to A/R completeness of record of these
transactions and thus existence of A/R Balance
- Review of subsequent cash receipts existence and valuation and
allocation when customer pays account, confirming they owed the
balance on the balance date and were in position to make a payment
- Verbal evidence could relate to all assertions depending on topic of
conversation
Likely to ask about procedures used to
Identify potential bad debts (valuation and allocation)
Credit control (valuation and allocation)
Segregation of duties (primarily existence, rights and
obligations, completeness)
About control systems in general (Relate to all assertions)
Problem 5-7
a)
Oral holding conversations with staf
Discovering how they perform their duties
Whether there are staf shortages in certain areas at various
times
How management are communicating their attitudes towards
control systems and profit targets
Whether controls are overridden at various times
Physical evidence inspected physical assets of company
during tours
See if assets exist, whether they are being protected, their
condition, how they are used.
E.g. See if construction equipment appears to be new or well
maintained
Also observe staf performing their duties, both on the
construction sites and in the offices.
Computational Evidence calculating ratios and reviewing the
trial balance
Looking for indicators of problems, such as unusual fluctuations,
and whether the data appear to reflect the state of business as
described by management
b)
Spreadsheets reviewed to identify unusual patterns which could
indicate problem areas for further investigation, and to calculate

5.14
a)
b)
c)
d)

trends and ratios, including common size statements, to quantify

the fluctuations
Use results of analytical procedures to justify increased or
decreased focus on specific areas, and the nature, timing and
extent of further procedures.
This type of business, Susan will be using data to determine if
profitability is comparable to previous periods and with other
similar clients.
Analyze the specific movement of physical materials used in the
construction and whether this is consistent with the financial
data
E.g. if quantities of physical materials delivered to site are lower
because of slower construction progress, is cost of materials also
slower?
Is the progress of build consistent with use of labor and
machinery?
Is revenue recognized on building in progress consistent with
progress and cost of construction?
Computational, documentary
Documentary, computational
Physical, confirmation, computational
Computational, Documentary, Electronic