Audit Evidence

1 Gathering audit evidence

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The procedures for obtaining audit evidence are:

• Analytical procedures (to be explained shortly)
  

• Enquiry and confirmation. For example, asking client staff what checks they do when goods are received, or asking third parties (such as a bank) to confirm a balance.
  

• Inspection. For example, the physical condition of inventories or non-current assets
  

• Observation. For example, watch what staff do in the warehouse as deliveries are received.
  

• RecalcUlation and re-performance. For example, recalculate the wage calculations to confirm they are correct.
  

Note that these five procedures can be remembered by the vowels, A, E, I, O and U.

2 Sufficient, appropriate audit evidence

So now we know the various procedures to obtain audit evidence, but how much audit evidence is needed?

ISA 500 states that there should be:

• Sufficient
  

• Appropriate
  

audit evidence, to be able to draw reasonable conclusions on which to base an audit opinion.

Sufficient concerns the quantity of audit evidence.

Appropriate concerns the quality of audit evidence - its relevance and reliability. With respect to the reliability of audit evidence we can say that, in general:

• External evidence is better than the entity's records. For example, looking at a bank statement or a bank certificate is very good evidence about how much cash was in the bank account at a particular date.
  

• Evidence obtained directly by the auditor is better than evidence passed on by the clients. The problem is that if the evidence is passed on by the client you don’t know if it’s complete. The client could be suppressing information they don’t want you to see.
  

• Audit evidence is better if there is an effective system of internal control. This should mean that the checking performed by the client reduces the likelihood of fraud and error.
  

• Written evidence is much better than oral. Someone once said "oral evidence isn’t worth the paper it is written on”. If evidence is oral what evidence can you, the auditor, show to prove you actually received it?
  

• Originals are better than photocopies. Nowadays with scanners and graphics programs it’s very easy to alter documents and these alterations are very difficult to spot. Therefore original contracts and documents of title should be sighted. The auditors may take a photocopy to keep on their audit file, but they should be taken from the original documents.
  

3 Analytical procedures

Analytical procedures are used to evaluate plausible relationships between financial and non-financial data including, calculating ratios and then comparing the amounts and ratios to:

• Last year’s results
  

• Budgets
  

• Industry standards
  

Also the trends and changes in the company’s financial statements over time will be examined.

Analytical procedures may be used at three stages of the audit:

• Planning (ISAs 300 & 315) If last year’s inventory amounted to 34 days of supply and this year amounted to 97, then you have identified an area that will need attention during the audit. Why has inventory increased so much? Was this planned? Is there an error? Will it sell? What value should it have?
  

• Substantive procedures (ISA 520) If last year’s collection period was 32 days and this year’s is 31.5, then this gives some confidence that the figures this year are correct. Similarly if sales are very close to budget, this implies some support for the figures being correct.
  

• Final review (ISA 520) Here, near the end of the audit, the partner stands back and looks at the financial statements as a whole. Do the figures seem to make sense?
  

Analytical procedures must be used at the planning stage to assess whether or not the financial statements are consistent with the auditor's understanding of the entity. If they believed that the entity was substantially dealing in cash transactions yet it had a large receivables balance they might wonder why.

If the receivables balance changes dramatically from one year to the next, but sales hadn’t really changed, the auditors might begin to question the recoverability of those balances. If the days of inventory held by the organisation rapidly increased they might begin to worry about the valuation of inventory and whether or not it could all be sold at above cost.

Auditors can look at how expenses move. If a business keeps about the same level of activity you wouldn’t expect the expenses such as telephone, post, heating, and lighting to increase much more than the rate of inflation.

If, however, the telephone costs had increased markedly the auditors need to find out why. It might be because the company had gained an important overseas customer and there are now many high-cost overseas telephone calls. If the increase can’t be explained in a reasonable manner then an error may have been made and wrong amounts may have been posted to the telephone account.

In responding to assessed risks, the auditor may determine that only tests of details are appropriate. Therefore, substantive analytical procedures are not a requirement. However, analytical procedures must be performed as a review procedure when forming an overall conclusion on the financial statements.

4 The assertions

In Chapter 9, we talked about reducing the risks of misstatement to an acceptable level at both the financial statement level and the assertion level. Now, we return to look in more detail at what is meant by the assertions.

Essentially whenever a figure appears in the financial statements it is making certain claims, proclamations or assertions. It is for example saying, “Here I am, I am the receivables figure, and because I am included in the statement of financial position I am saying certain things”.

Amounts in the financial statements can say:

• Accurate.
  

• Complete. For example, that all receivables are included.
  

• Cut-off is correct. In other words, a receivable is present if a sale was made during the financial year and not yet paid for.
  

• Allocated. More to do with expense items that might need to be allocated properly into asset amounts (e.g. overheads included in inventory).
  

• Classification and presentation. The transactions giving rise to the receivable have been recorded in the proper accounts and are properly presented in the financial statements. For example trade receivables are distinguished from other receivables and any non-current portion disclosed in the notes.
  

• Occurrence. The sales giving rise to the receivable occurred in the period.
  

• Valuation. That the receivable has been appropriately measured, taking into account the risk of non-recoverability.
  

• Existence. That the receivable balance actually exists.
  

• Rights and obligations. That the client owns the receivable, that it hasn’t, for example, been assigned to a third party.
  

Note that these assertions can be remembered as ‘ACCA COVER’.

We return to assertions in Chapter 16.