Audit I Ch 4.2 Audit Evidence and Documentation.pptx

CHAPTER 4
4.2 Audit Evidence and
Documentation

Nature of Evidence
• Evidence is defined as any information used by the auditor to
determine whether the information being audited is stated in
accordance with the established criteria
– It is the foundation of any audit.
– Evidence varies greatly in the extent to which it persuades
the auditor whether financial statements are fairly stated.
– The use of evidence is not unique to auditors, different
professionals (Scientists, lawyers, researchers and
historians ) rely on different types of evidence, to support
their decisions.
– From an audit perspective, evidential matter consists of the
essential accounting data and all supporting information
available to the auditor.
– The auditor must have the knowledge and skill to
accumulate sufficient appropriate evidence on every audit
to meet the standards of the profession.

Table 7.1 Characteristics of Evidence for a
Scientific Experiment, Legal Case, and
Audit of Financial Statements
Basis of
Comparison
Scientific Experiment
Involving Testing a
Medicine
Legal Case Involving an
Accused Thief
Audit of Financial
Statements
Use of the
evidence
Determine effects of
using the medicine
Decide guilt or innocence
of accused
Determine whether
statements are fairly
presented
Nature of
evidence used
Results of repeated
experiments
Direct evidence and
testimony by witnesses
and parties involved
Various types of audit
evidence generated by
the auditor, third parties,
and the client
Party or parties
evaluating
evidence
Scientist Jury and judge Auditor

Table 7.1 Characteristics of Evidence for a
Scientific Experiment, Legal Case, and
Audit of Financial Statements
Basis of
Comparison
Scientific Experiment
Involving Testing a
Medicine
Legal Case Involving an
Accused Thief
Audit of Financial
Statements
Certainty of
conclusions
from evidence
Vary from uncertain to
near certainty
Requires guilt beyond a
reasonable doubt
High level of assurance
Nature of
conclusions
Recommend or not
recommend use of
medicine
Innocence or guilt of party Issue one of several
alternative types of audit
reports
Typical
consequences
of incorrect
conclusions
from evidence
Society uses ineffective
or harmful medicine
Guilty party is not
penalized or innocent
party is found guilty
Statement users make
incorrect decisions and
auditor may be sued

Audit Evidence Decisions
• There are four decisions auditor needs to make
about what evidence to gather and how much of it to
accumulate:
– Which audit procedures to use
– What sample size to select for a given procedure
– Which items to select from the population
– When to perform the procedures

Persuasiveness of Evidence
• Audit standards require the auditor to accumulate
sufficient appropriate evidence to support the opinion
issued
• The two determinants of the persuasiveness of
evidence are:
– Appropriateness
– Sufficiency

• Appropriateness of evidence is a measure of the
quality of evidence, which includes:
– Relevance—evidence must pertain to or be relevant to
the audit objective that the auditor is testing
– Reliability—the degree to which evidence can be
believable or worthy of trust

• The quantity of evidence obtained determines its
sufficiency. It is measured:
– Primarily by the sample size the auditor selects, which
is determined by
 Auditor’s expectation of misstatements
 The effectiveness of the client’s internal controls

• IAS 500 require the auditor to accumulate sufficient
appropriate evidence (persuading/convincing evidence) to
support the opinion issued.
• By combining all evidence from the entire audit, the
auditor is able to decide when he or she is persuaded to
issue an audit report.
• The two determinants of the persuasiveness of evidence
are :
1. Appropriateness (competence)
2. Sufficiency
• In making decisions about evidence for a given audit, both
persuasiveness and cost must be considered

1. Appropriateness (Competence)
• Appropriateness/competence of evidence is a measure of
the quality of evidence, ie., its relevance and reliability in
meeting audit objectives.
• Regardless of its form, evidence is considered
appropriate/competent, when it provides information that
is both reliable and relevant
• If evidence is highly appropriate (competent), i.e if it
provides relevant and reliable information, the auditor is
convinced that financial statements are fairly stated.

What does Relevance of Evidence mean?
• The relevance of evidence refers to whether a particular
type of evidence is pertinent/related to the audit objective
• If the auditor relies on evidence that is unrelated to the
audit objective, he/she may reach an incorrect conclusion
about a management assertion
Eg. assume an auditor wants to check the completeness
objective for recording sales transactions; ie., are all
goods shipped to customers recorded in sales journal?

….Relevance of Evidence
• A normal audit procedure for testing this objective is to
trace a sample of shipping documents (such as delivery
orders/bills of lading) to the related sales invoices and
entries in the sales journal.
• If the auditor samples the population of sales invoices
issued during the period, the evidence would not relate to
the completeness objective (ie., the auditor would not
detect shipments made but not billed/recorded. The
auditor should check pre-numbered delivery orders/bills of
lading after ascertaining that such documents were issued
for all customer shipments.

……Relevance of Evidence
• Relevance can be considered only in terms of specific
audit objectives, because evidence may be relevant for
one audit objective but not for another.
• In the previous shipping example, if the auditor use a
sample population of sales invoices and trace it to related
shipping documents, and this evidence is relevant for the
occurrence transaction objective.

What does Reliability /Validity of Evidence mean?
• The reliability of evidence refers to whether a particular
type of evidence can be relied upon to signal the true
state of an assertion or audit objective.
• It is about the degree to which evidence can be believable
or worthy of trust.
• Eg. if an auditor counts inventory, that evidence is more
reliable than if management gives the auditor its own
count amounts.

Six characteristics of a reliable/valid and appropriate
evidence:
1. Independence of provider: Evidence obtained from a source
outside the entity is more reliable than that obtained from within.
eg. – reliance on evidence obtained through confirmation from
bank, attorney, customers, and creditors than on inquiry of the
client
- reliance on documents such as insurance policy than using
documents that originate within the firm and never left the entity,
eg. purchase requisition
2. Effectiveness of client’s internal controls: When a client’s internal
controls are effective, evidence obtained is more reliable than
when they are weak.

Six characteristics of a reliable/valid and appropriate evidence:
Auditor’s direct knowledge: Evidence obtained directly by the auditor
through physical examination, observation, recalculation, and
inspection is more reliable than information obtained indirectly.
4. Qualifications of individuals providing the information:
Although the source of information is independent, the evidence will
not be reliable unless the individual providing it is qualified to do so.
eg. - accounts receivable confirmations from persons not familiar with
the business world will not provide reliable information
-auditor’s direct observation may not produce reliable information if
the auditor lacks the qualifications to evaluate the evidence. eg,
examining an inventory of diamonds by an auditor not trained to
distinguish between diamonds and glass is not reliable evidence for
the existence of diamonds.

5. Degree of objectivity: Objective evidence is more reliable than
evidence that
requires considerable judgment to determine whether it is correct.
Eg. of objective evidence include
-confirmation of accounts receivable and bank balances,
- the physical count of securities and cash, and
- adding (footing) a list of accounts payable to determine whether it
agrees with the balance in the general ledger.
Eg of subjective evidence include
- a letter written by a client’s attorney discussing the likely outcome of
outstanding lawsuits against the client,
- observation of obsolescence of inventory during physical
examination,
- inquiries of the credit manager about the collectibility of noncurrent
accounts receivable.
-In evaluating the reliability of subjective evidence, the auditors should
assess the qualifications of the person providing the evidence

6. Timeliness: The timeliness of audit evidence can refer either to
when it is accumulated or to the period covered by the audit.
Evidence is usually more reliable for balance sheet accounts when it
is obtained as close to the balance sheet date as possible.
Eg. the auditor’s count of marketable securities on the balance sheet
date is more reliable than a count 2 months earlier.
For income statement accounts, evidence is more reliable if there is
a sample from the entire period under audit, such as a random
sample of sales transactions for the entire year, rather than from only
a part of the period, such as a sample imited to only the first 6
months.

Sufficiency of Evidence-
Sufficiency is determined by:
1. the quantity of evidence obtained, ie. by the sample size the
auditor selects and
2. Selection of proper items :
– Sufficiency of evidence can also be affected by the individual
items tested
– Samples containing the following are usually considered
sufficient:
 items with large dollar values,
 items with a high likelihood of misstatement, and
 items that are representative of the population are
However, samples that contain only the largest dollar items from the
population may not be sufficient if these items do not make up a large
portion of the total population amount. In such cases, there will be a
risk that the sample may not be representative.

Table 7.2 Relationships Among Evidence
Decisions and Persuasiveness
Audit Evidence Decisions Qualities Affecting Persuasiveness of
Evidence
Audit procedures and timing Appropriateness
Relevance
Reliability
Independence of provider
Effectiveness of internal controls
Auditor’s direct knowledge
Qualifications of provider
Objectivity of evidence
Timeliness
When procedures are performed
Portion of period being audited
Sample size and items to select Sufficiency
Adequate sample size
Selection of proper population items

Types of Audit Evidence
• Physical examination
– The inspection or count by the auditor of a tangible
asset
• Confirmation
– The receipt of a direct written response from a third
party verifying the accuracy of information that was
requested
• Inspection
– The auditor’s examination of the client’s documents
and records

• Analytical procedures
– The evaluations of financial information through
analysis of plausible relationships among both
financial and nonfinancial data
• Inquiries of the client
– The obtaining of written or oral information from the
client in response to questions from the auditor

• Recalculation
– Rechecking a sample of calculations made by the
client
• Reperformance
– The auditor’s independent tests of client accounting
procedures or controls
• Observation
– Consists of looking at a process or procedure being
performed by others

Figure 7.1 Relationships Among Auditing
Standards, Types of Evidence, and the
Four Audit Evidence Decisions

Table 7.4 Appropriateness of Types
of Evidence

Analytical Procedures
• Analytical procedures may be performed at any of
three times during an engagement:
– In the planning phase (required)
– During the testing phase
– During the completion phase (required)

Analytical Procedures
• The usefulness of analytical procedures as audit
evidence depends significantly on appropriate
comparison data
• Auditors typically compare client data with:
– Industry data
– Similar prior-period data
– Client-determined expected results
– Auditor-determined expected results

Table 7.6 Internal Comparisons and
Relationships
Ratio or Comparison Possible Misstatement
Raw material turnover for a
manufacturing company
Misstatement of inventory or cost of goods
sold or obsolescence of raw material
inventory
Sales commissions divided by net sales Misstatement of sales commission
Sales return and allowances divided by
gross sales
Misclassified sales returns and allowances
or unrecorded returns or allowances
subsequent to year end
Bad debt expense divided by net sales Misstatement in the allowance for bad
debts
Each of the individual manufacturing
expenses as a percent of total
manufacturing expense
Significant misstatement of individual
expenses within a total

Audit Data Analytics
• Audit data analytics (ADA) are:
– The science and art of discovering and analyzing
patterns, identifying anomalies, and extracting other
useful information in data underlying or related to the
subject matter of an audit through analysis, modeling,
and visualization for purpose of planning or
performing the audit.

• Fundamental considerations that need to be made by
the auditor to evaluate the appropriate use of ADAs
as an audit evidence-gathering tool include:
– Accessing the data
– Preparing the data
– Evaluate the relevance and reliability of the data
– Address circumstances in which an ADA identifies a
large number of exceptions for further consideration
– Document use of ADA

• Other advanced technologies that auditors can
leverage to increase the effectiveness and efficiency
of their audit procedures include:
– Artificial intelligence
– Robotics
– Machine learning
– Deep learning

Common Financial Ratios
• Auditors’ analytical procedures often include the use of
general financial ratios during planning and final review
of the audited financial statements
• When using these ratios, auditors must be sure to make
appropriate comparisons

Common Financial Ratios
• Some widely used financial ratios categories include:
– Short-term debt-paying ability
– Liquidity activity ratios
– Ability to meet long-term debt obligations
– Profitability ratios

Audit Documentation
• Audit documentation is the record of the audit procedures
performed, relevant audit evidence obtained, and
conclusions the auditor reached
• It provides:
– A basis for planning the audit
– A record of the evidence accumulated and the results
of the tests
– Data for determining the proper type of audit report
– A basis for review by supervisors and partners

Audit Documentation
• Audit documentation is the property of the auditor
• A member in public practice shall not disclose any
confidential client information without the specific consent
of the client
• Auditing standards require that records for audits of:
– Private companies be retained for a minimum of 5
years
– Public companies to be retained for a period of not
less than 7 years

Contents and Organization
• There is logic to the type of audit documentation
prepared for an audit and the way it is arranged in the
files
• Audit files include:
– Permanent files
 Contain data of a historical or continuing nature
pertinent to the current audit
– Current files
 Include all audit documentation applicable to the
year under audit

Figure 7.3 Audit File Contents and
Organization

End of Chapter 4.2
Questions
Audit I YA AAUSC 2022

Audit I Ch 4.2 Audit Evidence and Documentation.pptx

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