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Fundamentals of Auditing

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Fundamentals of Auditing ­ACC 311
VU
Lesson 22
AUDIT EVIDENCE
Auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on
which to base the audit opinion.
Concept of Audit Evidence
Audit evidence is all the information used by the auditor in arriving at the conclusions on which his opinion
is based and includes the information contained in the accounting records underlying the financial
statements and other information. It is obtained from audit procedures performed during the course of
audit and may include audit evidence obtained from other sources such as pervious audits and a firm's
quality control procedures for client acceptance and continuance.
Accounting records generally include the records of initial entries and supporting records, such as checks
and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal
entries and other adjustments to the financial statements that are not reflected in formal cost allocations,
computations, reconciliations and disclosures. The entries in the accounting records are often initiated,
recorded, processed and reported in the electronic form. In addition, the accounting records may be part of
integrated systems that share data and support all aspects of the entity's financial reporting, operations and
compliance objectives.
Auditor obtains most of the audit evidence from accounting records of the entity. If accounting records do
not provide sufficient audit evidence, the auditor obtains other audit evidence.
Other information that the auditor may use as audit evidence includes:
 minutes of meetings;
 confirmations from third parties,
 analysis' reports;
 comparable data about competitors (benchmarking);
 controls manuals;
 information obtained by the auditor from such audit procedures as inquiry, observation; and
inspection;
 and other information developed by, or available to, the auditor that permits the auditor to reach
conclusions through valid reasoning.
Sufficient appropriate Audit Evidence
Sufficiency:
The measure of quantity of audit evidence.
Appropriateness:
The measure of quality i.e. relevance and reliability in providing support of
detecting misstatements in account balance classes of transactions and disclosures and relevant assertions.
The quantity of audit evidence needed is affected by:
-  the risk of misstatement (the greater the risk, the more audit evidence is likely to be required); and
-  the quality of such audit evidence (the higher the quality, the less may be required).
Accordingly sufficiency and appropriateness are interrelated.  However, merely obtaining more audit
evidence may not compensate for its poor quality.
Audit evidence obtained through same audit procedures may be relevant to certain assertions but not
relevant to other assertions.
The auditor often obtains evidence about an assertion from different sources or of different nature.
Evidence about an assertion is not a substitute for evidence regarding another assertion.
Sources of obtaining Audit Evidence
i)
Internal source - through accounting system, management, employees, underlying documentation
etc.
ii)
External source - third parties, i.e. suppliers, customers bankers legal advisers and other parties
who have knowledge of the enterprise.
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Fundamentals of Auditing ­ACC 311
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Nature of Audit Evidence
i)
Visual
ii)
Oral
iii)
Documentary
Reliability of Audit Evidence - Generalizations
Following generalizations are considered useful in assessing the reliability of audit evidence (subject to
certain important exceptions):
i)
Audit evidence obtained from independent sources outside the entity is more reliable.
ii)
Evidence generated internally is more reliable when related controls are effective.
iii)
Evidence obtained by an auditor directly is more reliable than that obtained indirectly or by
interference e.g. Bank balance confirmation certificate received by an auditor is more reliable than the bank
statement obtained from the management or observation of a control rather than making inquiry about the
application of a control.
iv)
Written evidence is more reliable than oral representation.
v)
Audit evidence provided by original documents is more reliable than that provided by
photocopies and facsimiles.
Other factors relating to Audit Evidence
i)
Information on which audit procedures are based should be sufficiently accurate and
complete. Therefore, auditor should also test the system for generating such information
while using it for his procedures.
ii)
Auditor's reliance increases when audit evidence obtained from one source is consistent
with another source; if it is inconsistent further procedures may be performed.
iii)
Cost of obtaining the audit evidence is also considered when obtaining it.
iv)
While forming an audit opinion, the auditor does not have to examine all the items or
obtain all the evidences which might be available. He can reach a conclusion by examining
a sample of such transactions. He also relies on persuasive evidences. However, if evidence
is less than persuasive, he does not consider it reliable.
Assertions in obtaining Audit Evidence
(a)
Assertions about classes of transactions and events for the period under audit;
(i)
Occurrence ­ transactions and events that have been recorded have occurred and
pertain to the entity;
(ii)
Completeness ­ all transactions and events that should have been recorded have
been recorded;
(iii)
Accuracy ­ amounts and other data relating to recorded transactions and events
have been recorded appropriately.
(iv)
Cutoff ­ transactions and events have been recorded in the proper period.
(v)
Classification ­ transactions and events have been recorded in the proper
accounts.
(b)
Assertions about account balances at the period end.
(i)
Existence ­ assets, liabilities, and equity interests exist;
(ii)
Rights and obligations ­ the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity;
(iii)
Completeness ­ all assets, liabilities and equity interests that should have been
recorded have been recorded;
(iv)
Valuation and allocation ­ assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
(c)
Assertions about presentation and disclosure:
(i)
Occurrence and rights and obligations ­ disclosed events, transactions and other
matters have occurred and pertain to the entity;
(ii)
Completeness ­ all disclosures that should have been included in the financial
statements have been included;
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Fundamentals of Auditing ­ACC 311
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(iii)
Classification and understandability ­ financial information is appropriately
presented and described, and disclosures are clearly expressed;
(iv)
Accuracy and valuation ­ financial and other information are disclosed fairly and
at appropriate amounts.
Audit procedures for obtaining audit evidence
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,
he tests 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 entity's data retention policies or their
practice to convert source documents into computer images through scanning, means of communication
being used by the entity e.g. electronic messaging rather than written purchase orders.
The auditor uses one or more types of audit procedures described below:
(i)
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.
(ii)
Inspection of Tangible Assets
It consists of physical examination of the assets. It may provide reliable audit evidence of their
existence cannot necessarily about other assertions.
(iii)  Inquiry
It means seeking information of knowledgeable persons throughout the entity or outside the entity.
Those may be formal written or informal oral. It provides an auditor with new information or
corroborative evidences. It may also bring to high information different from the one possessed by
the auditor. Certain oral inquiries might be got confirmed through written representations.
(iv)  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, legal advisors etc.
(v)
Recalculation
It consists of checking the mathematical accuracy of documents or records. It can be performed
through use of information technology.
(vi)  Re-performance
It is the auditor's independent execution of procedures or controls that were originally performed
as part of the entity's internal control, either manually or through the use of CAATs, for example,
re-performing the aging of accounts receivable.
(vii)  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 fluctuations found and
the relationship that are inconsistent.
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Table of Contents:
  1. AN INTRODUCTION
  2. AUDITORSí REPORT
  3. Advantages and Disadvantages of Auditing
  4. OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS
  5. What is Reasonable Assurance
  6. LEGAL CONSIDERATION REGARDING AUDITING
  7. Appointment, Duties, Rights and Liabilities of Auditor
  8. LIABILITIES OF AN AUDITOR
  9. BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
  10. Contents of Balance Sheet
  11. ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
  12. Business Operations
  13. Risk Assessment Procedures & Sources of Information
  14. Measurement and Review of the Entityís Financial Performance
  15. Definition & Components of Internal Control
  16. Auditing ASSIGNMENT
  17. Benefits of Internal Control to the entity
  18. Flow Charts and Internal Control Questionnaires
  19. Construction of an ICQ
  20. Audit evidence through Audit Procedures
  21. SUBSTANTIVE PROCEDURES
  22. Concept of Audit Evidence
  23. SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM
  24. Control Procedures over Sales and Debtors
  25. Control Procedures over Purchases and Payables
  26. TESTING THE PURCHASES SYSTEM
  27. TESTING THE PAYROLL SYSTEM
  28. TESTING THE CASH SYSTEM
  29. Controls over Banking of Receipts
  30. Control Procedures over Inventory
  31. TESTING THE NON-CURRENT ASSETS
  32. VERIFICATION APPROACH OF AUDIT
  33. VERIFICATION OF ASSETS
  34. LETTER OF REPRESENTATION VERIFICATION OF LIABILITIES
  35. VERIFICATION OF EQUITY
  36. VERIFICATION OF BANK BALANCES
  37. VERIFICATION OF STOCK-IN-TRADE AND STORE & SPARES
  38. AUDIT SAMPLING
  39. STATISTICAL SAMPLING
  40. CONSIDERING THE WORK OF INTERNAL AUDITING
  41. AUDIT PLANNING
  42. PLANNING AN AUDIT OF FINANCIAL STATEMENTS
  43. Audits of Small Entities
  44. AUDITORíS REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIALSTATEMENTS
  45. MODIFIED AUDITORíS REPORT