Chapter Seven

Audit Evidence

Any information used by the auditor to

determine whether the information being

audited is stated in accordance with the

established criteria. (GAAP)

The information varies greatly in the extent to

which it persuades the auditor whether F. S.

are fairly stated in accordance with GAAP.

Evidence:

Evidence includes information that is highly persuasive such as: the auditor’s count of Marketable securities and less persuasive information such as responses to questions of client employees

Evidence

a major decision facing every auditor is determining the appropriate type (quality) and amount of evidence (quantity) needed to be satisfied that the client’s F. S. are fairly stated.

Audit evidence decisions:

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?

There are four decisions about what evidence to gather and how much of it

to accumulate:

An audit procedure is the detailed

instruction for the collection of a type of

audit evidence that is to obtained.

Audit procedures:

They are the instructions to be

followed in accumulating evidence,

they must worded carefully to make

sure the instructions are clear.

The procedures Important

Once an audit procedure is

selected, auditors can vary the

sample size from one to all items in

the population being tested.

Sample size:

After determining the sample size for an audit procedure, the auditor must decide which items in population to test

Items to be selected

Timing

An audit of F.S. usually covers a period

such as a year normally, an audit is not

completed until several weeks or months

after the end of period.

The Timing decisions is affected by when

the client needs the audit to be completed.

List of audit procedures for an audit area or an entire audit, the audit program always includes audit procedures and may also include sample size, items to select, and timing of the tests.

Audit Program:

An audit program for AR is a list of audit procedures that will be used to audit accounts receivables for a given client, the audit procedures, sample size, items to select and timing should be included in the audit program.

Audit Program:

a. Appropriateness refers to the relevance and reliable of evidence, or the degree to which evidence can be considered believable or worthy trust.related to the audit procedures selected including the timing of when those procedures are performed .

b. Sufficiency refers to the quantity of evidence and it is related to sample size and item to select.

Persuasiveness

Evidence must pertain to the audit objective if it is to be persuasive, relevance must be considered in terms of specific audit objectives as an evidence may be relevant to one objective and not another.

The relevance of evidence:

The degree to which evidence can be believable or worthy of trust. Like relevance, if evidence is considered reliable it is a great help in persuading the auditor that financial statements are fairly stated.

The reliability of evidence:

A. Independence of provider.

B. Effectiveness of client’s internal controls.

C. Auditor’s direct knowledge.

D. Qualifications of individuals providing the information.

E. Degree of objectivity.

F. Timeliness.

Characteristics of reliable evidence:

Evidence obtained from a source outside the entity is more reliable than that obtained from within the company.

Independence of provider:

When a client’s internal controls are effective, evidence obtained is more reliable than when they are weak.

Effectiveness of client’s internal control:

Evidence obtained directly by the

auditor through physical examination,

observation, recalculation, and

inspection is more reliable than

information obtained indirectly.

Auditor’s direct knowledge:

Evidence obtained directly by the

auditor may not be reliable if the

auditor lacks the qualifications to

evaluate the evidence.

Qualifications of individuals providing the information:

Objective evidence is more reliable

than evidence that requires

considerable judgment to determine

whether it is correct.

Degree of objectivity:

The timeliness of audit evidence can

refer either to when it is accumulated

or to the period covered by the audit.

Timeliness:

Factor Determining Reliability

Examples of reliable evidence

1. Independence provider

Confirmation of a bank balance

2. Effectiveness of clients’ ICs

Use of sales invoices and shipping documents

3. Auditor’s direct knowledge

Physical examination of Inventory by the auditor

4. Qualification of Provider

Letter from an attorney dealing with the client’s affairs

5. Degree of objectivity

Count of cash on hand by auditor

6. Timeliness Observe inventory on the cost day of the fiscal year

It is measured primarily by the sample size the auditor selects, for a given audit procedure the evidence obtained from a sample of 100 is ordinarily more sufficient than from a sample of 50, the factors to determine the appropriate sample size in audits are:

The auditor’s expectations of misstatements.

The effectiveness of the client’s internal controls.

Sufficiency of evidence:

Combined Effect

The relationships among evidence decisions and persuasiveness, the persuasiveness of evidence can be evaluated only after considering the combination of appropriateness and sufficiency, including the effects of the factors influencing appropriateness and sufficiency.

Audit Evidence Decisions

Qualities affecting persuasiveness of Evidence

Audit Procedures and Timing

• Appropriateness• Relevance• Reliability• Independence of provider• Auditor’s direct Knowledge• Objectivity of evidence• Timeliness: when procedures are performed portion of period being audited.

Sample size and Items select

• Sufficiency: adequate sample size selection of proper population items

Persuasiveness & Cost

The persuasiveness and cost of all

alternatives should be considered before

selecting the best type or types of evidence.

The auditor’s goal is to obtain a sufficient

amount of appropriate evidence at the

lowest possible total cost.

A. Physical examination.

B. Confirmation.

C. Documentation.

D. Analytical procedures.

E. Inquiries of the client.

F. Recalculation.

G. Reperformance.

H. Observation.

Types of evidence used in auditing:

The auditor’s inspection or count of a

tangible asset. This type of evidence is

most often associated with inventory

and cash it is a direct means of

verifying that an asset actually exists

Physical examination:

The auditor’s receipt of a written or oral

response from an independent third party

verifying the accuracy information requested.

A confirmation is prepared specifically for the

auditor and comes from an external source

Confirmation:

External documentation is in the hands

of the client at the time of the audit

and was prepared by an External party

for the client’s use in the day-to-day

operation of the business

In order of competence, the three common types of confirmations used by auditors are:

Positive confirmation with a request for information to be supplied by the recipient.

Positive confirmation with the information to be confirmed included on the form.

Negative confirmation.

Types of confirmations used by auditors:

Notes: The positive confirmation with a request for

information to be supplied by the recipient must supply the information from his or her records.

The positive confirmation with the information to be confirmed included on the form is not as reliable as the first type because the recipient may sign and return the confirmation without carefully examining the information.

The negative confirmation is the least reliable because a non-response could be due to either the recipient agreeing with the information or the recipient ignoring the confirmation request.

The principal record of auditing

procedures applied, evidence

obtained, and conclusions reached

by the auditors in the engagement.

Audit documentation:

is the auditor’s examination of the client’s documents and records to substantive the information that either is included or should be included in the financial statements, documents that the auditor examines may either be classified as external documents or internal documents,external documents are considered more reliable evidence than internal ones

Inspection

Difference Between

Internal & External documentation:Internal

DocumentationExternal

Documentation

It is prepared and used within the client organization without ever going to an outside party

Either originated with an outside party or was an Internal document that went to an outside party and is now either in the hands of the client or is readily accessible

Examples

Internal & External documentation:Internal

DocumentationExternal

Documentation

• Inventory Receiving reports• Payroll time record• Adjusting Journal entry

• Vendor’s invoices• Insurance policies• Cancelled notes payables

The primary determinant of the auditor’s willingness to accept a document as reliable evidence is whether it is internal or external and when internal whether it was created and processed under conditions of effective internal control.

The auditor’s use of documentation as evidence:

The auditor’s inspection of the

client’s documents and records to

substantive the information that is or

should be included in the financial

statements.

Documentation:

Examples, of relatively reliable documents include vendor’s statements, cancelled notes payable, insurance policies and bank statements, examples of less reliable documents include duplicate sales invoices, employees time reports, inventory receiving reports, and internal memorandum.

Relatively reliable documents:

1. Receipt directly by auditor

2. Written or electronic response

3. From independent third party

4. Requested by the auditor

Characteristics of Documentations

Use of comparisons and relationships

to assess whether account balances

or other data appear reasonable.

Analytical procedures:

Analytical procedures are useful for indicating account

balances that may be distorted unusual or significant

transactions and that should be intensively

investigated, they are also useful in reviewing accounts

or transactions for reasonableness.

To corroborate tentative conclusions reached on the

basis of other evidence the important reasons for

performing analytical procedures:

Analytical procedures:

Understand the client’s industry and business.

Assess the entities’ ability to continue as a going concern.

Indicate the presence of possible misstatements in the financial statements.

Reduce detailed audit tests.

Different types of analytical procedures:

The obtaining of written or oral

information from the client in the

response to specific questions during

the audit. The auditor usually begins

by asking the client how the internal

controls operate

Inquiries of the client:

The rechecking of a sample of the computations made by the client, including mathematical accuracy of individual transactions and amounts and the addition of journals and subsidiary records.

Recalculation:

The auditor’s independent tests of client accounting procedures or controls that were originally done as part of the entity’s accounting and internal control system. For example the auditor normally makes limited tests to ascertain that the information in the sales journal has been included for the proper customer and at the correct amount in the subsidiary accounts receivables records and is accurately in the general ledger.

Reperformance:

The use of the senses to assess client activities. Consists of looking at a process or procedure being performed by others , observation is rarely sufficient by itself because of the risk of client personnel changing their behavior because the auditor presence.

Observation:

Types of audit evidence

Examples

1. Physical examination

• Count petty cash on hand• Examine fixed assets additions

2. Confirmation • Confirm accounts receivables (AR) of a sample of client customers• Confirm client’s cash balance with bank

3. Inspection • Examine copies of monthly bank statements• Examine vendor’s invoices supporting a sample of cash disbursement

4. Analytical Procedures

• Evaluate reasonableness of receivables by calculating and comparing ratios• Compare expenses as a percentage of Net Sales with prior year’s percentages.

5. Inquires of the client

• Inquire of management whether there is obsolete Inventory• Inquire of management regarding the collectability of large accounts receivable

6. Recalculation

• Recompute invoice total by multiplying item prices * Quantity Sold.• Foot the sales journal for a (one-month) period and compare all totals to the general Ledger.

7. Reperformance • agree sales invoice price to approved price list.• Match Quantity on purchase invoice to receiving report.

8. Observation • observe client employees in the process of counting inventory• observe whether employees are restricted from access to the check signing machine.

According to the relevance and timeliness, several observations appears

First, the effectiveness of a client’s internal controls

has a significant influence on the reliability of most

types of evidence. Obviously, internal documentation

from a company with effective internal control is

more reliable because the documents are more likely

to be accurate. Conversely, analytical procedures will

not be reliable evidence if the controls that produced

the data provide inaccurate information.

Second, both physical examination and recalculation

are likely to be highly reliable if the internal controls

are effective, but their use differs considerably. This

effectively illustrates that two completely different

types of evidence can be equally reliable.

Third, a specific type of evidence is rarely sufficient

by itself to provide appropriate evidence to satisfy

any audit objective.

Cost of Types of Evidence

High Expensive Types Moderate cost Types

1. Physical examination• Because it normally

requires the auditor’s presence when the client is counting the asset often on the B.S. date

1. Inspection• Inspection usually has a

fairly low cost, when auditors must find those documents themselves however inspection can be extremely costly

Cost of Types of Evidence

High Experience Types Moderate cost Types

2. Confirmation• Because the auditor must

follow careful procedures in the confirmation preparation, mailing or electronic transmittal receipt

2. Analytical procedures

• Most auditors prefer to replace tests of details with analytical procedures when possible

Cost of Types of Evidence

Moderate cost Types

3. Reperformance• The cost of reperformance tests depends on the

nature of the procedure being tested.

Examine: A reasonably detailed study of a

specific document or record to determine specific

facts about it.

Scan: A less detailed examination of a document

or record to determine whether there is something

unusual warranting further investigation.

Concepts

Compute: A calculation done by the auditor independent of the

client.

Compare: A comparison of information in two different locations.

Count: A determination of assets on hand at a given time, this is

associated with evidence defined as physical examination.

Vouch: The use of documents to verify recorded transactions or

amounts.

tracing; the auditor traces from receiving reports to acquisitions

journal to satisfy the completeness objective.

Terms & Types of Evidence

Terms Types of EvidenceExamine DocumentationScan Analytical proceduresRead DocumentationCompute Analytical proceduresRe-compute RecalculationFoot Recalculation

Terms & Types of Evidence

Terms Types of EvidenceTrace Documentation / ReperformanceCompare DocumentationCount Physical examinationObserve ObservationInquire Inquires of clientVouch Documentation

Summary

Internal documentation differ from external documentation in that internal documentation involves the auditor’s examination of documents that have been prepared and used within the client’s organization and are retained without ever going to an outside party. Examples would duplicate sales invoices, employees’ time report, and inventory receiving reports.

External documentation involves the auditor’s examination of documents that have been in the hands of someone outside the client’s organization. Examples include vendors’ invoices, cancelled checks, cancelled notes payable, and insurance policies.

1

The three common types of confirmations used by auditors:

Positive confirmation with request for information to be supplied by the recipient.

Positive confirmation with the information to be confirmed included on the form.

Negative confirmation.

2

The positive confirmation with a request for information to be supplied by the recipient is the most reliable because the recipient must supply the information from his or her records. If this information agrees with the information in the client’s records, the likelihood that the information is correct is high. The positive confirmation with the information to be confirmed included on the form is not as reliable as the first type because the recipient may sign and return the confirmation without carefully examining the information. The negative confirmation is the least reliable because a nonresponse could be due to either the recipient agreeing with the information or the recipient ignoring the confirmation request.

The following items influence the persuasiveness of the evidence through:

Relevance: evidence must pertain to the audit objective if it is to be persuasive. Relevance must be considered in terms of specific audit objectives as evidence may be relevant to one objective and not another.

Independence of the provider: evidence obtained from a source outside the entity is more reliable and persuasive than that obtained from within.

3

Effectiveness of client’s internal controls: when a client’s internal controls are effective evidence obtained is more reliable than when they are weak.

Auditor’s direct knowledge: evidence obtained directly by the auditor through physical examination, observation, computation, and inspection is more competent than information obtained directly.

Degree of objectivity: objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct.

The relatively reliable documents include vendors’ statements, cancelled notes payable, insurance policies, and bank statements.

Examples of less reliable documents include duplicate sales invoices, employees’ time reports, inventory receiving reports, and internal memoranda.

4

The primary characteristic that distinguishes the two is whether the document is an external document (the document has been in hands of someone outside the client’s organization who is party to the transaction), or an internal document. External documents are considered to be more reliable than internal documents.

4

Documentation is the auditor’s examination of the client’s documents and records to substantiate the information that either is included or should be included in the financial statements. Documents that the auditor examines may either be classified as external documents or internal documents. External documents are those that have been in the hands of someone outside the client’s organization who is a party to the transaction being documented.

Internal documents are those that have been prepared and used within the client’s organization without ever being in the custody of an external party. The primary determinant of the auditor’s willingness to accept a document as reliable evidence is whether it is internal or external, and, when internal, whether it was created and processed under conditions of effective internal control.

5

The remaining three audit evidence decisions are:

What sample size to select for a given procedure. This decision relates to the extent of testing to be performed. Once the auditor has identified which procedure to perform, he or she needs to decide the appropriate number of items in the population to test ranging from one to all items in the population.

Which item to select from the population. Once the auditor has decided the appropriate number of items to test, he or she needs to decide which particular items in the population to examine.

6

The remaining three audit evidence decisions are:

When to perform the procedures. This decision relates to the timing of the testing to be performed. Audit procedures related to balance sheet accounts which are performed close to the balance sheet date are generally considered more reliable than procedures performed during the interim period.

6

Thank You…Dr. Gamal