CHAPTER 5: EVIDENCE AND DOCUMENTATION

1) THE RELATIONSHIP OF AUDIT EVIDENCE TO THE AUDIAT REPORT

- The auditor gathers evidence by conducting audit procedures to test management assertions.

- This evidence serves as the support for the auditor’s opinion about whether the financial statements are fairly presented.

- Examining business processes and their related accounts allows the auditor to gather evidence by understanding the
processing of related transactions through the information system from their origin to their ultimate disposition in the
accounting journals and ledgers.

2) MANAGEMENT ASSERTIONS

Under current auditing standards, management assertions fall into the following categories:

- Assertions about classes of transactions and events for the period under audit ∙

- Assertions about account balances at the period end

- Assertions about presentation and disclosure

- The assertions collectively provide a road map for the auditor in determining what evidence to collect regarding various
transactions, account balances, and required financial statement disclosures.

- Management assertions also guide the auditor in designing audit procedures to collect the needed evidence, as well as
assisting the auditor in evaluating the appropriateness and sufficiency of the evidence.

3) THE CONCEPTS OF OF AUDIT EVIDENCE

a) The Nature of Audit Evidence

- The nature of the evidence refers to the form or type of information, which includes accounting records and other available
information.

o Accounting records: 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 journal entries; and records such as work sheets and
spreadsheets supporting cost allocations, computations, reconciliations, and disclosures.

o Other information: minutes of meetings; confirmations from third parties; industry analysts’ reports; comparable
data about competitors (benchmarking); controls manuals; information obtained by the auditor from such audit
procedures as inquiry, observation, and inspection.

- electronic evidence may exist at only a certain point in time and may not be retrievable later. This may require the auditor
to select sample items several times during the year rather than at year-end.

b) The Sufficiency and Appropriateness of Audit Evidence

- Sufficiency: the measure of the quantity of audit evidence.

 o The quantity of audit evidence needed is affected by the risk of material misstatement (the higher the more
quantity) and by the quality of the audit evidence gathered (the higher the less quality).

 Accordingly, there is an inverse relationship between the sufficiency and appropriateness of audit evidence.

- The auditor relies on evidence that is persuasive rather than convincing

o First, because an audit must be completed in a reasonable amount of time and at a reasonable cost, the auditor
examines only a sample of the transactions.

o Second, due to the nature of evidence, auditors must often rely on evidence that is not perfectly reliable. Even
highly reliable evidence has weaknesses.

- Appropriateness: a measure of the quality of audit evidence. Evidence is considered appropriate when it provides
information that is both relevant and reliable.

o Relevance: The relevance of audit evidence refers to its relationship to the assertion being tested.

o Reliability: The reliability of evidence refers to whether a particular type of evidence can be relied upon. It’s
influenced by its source and by its nature and is dependent on the individual circumstances

 Independent source outside the entity: more reliable than evidence obtained solely from within the entity
(bank confirmation). Additionally, evidence that is obtained from the entity, but that has been subjected
to verification by an independent source, is viewed as more reliable.

 Effectiveness of internal control: When the auditor assesses internal control as effective (that is, low
control risk), evidence generated by that accounting system is viewed as reliable.

 Auditor’s direct personal knowledge: Evidence obtained directly by the auditor is generally considered to
be more reliable (inventory physical inspection)

 Documentary evidence: more reliable when it exists in documentary form, whether paper, electronic, or
other medium.

- Original documents: provided by original documents is more reliable than audit evidence provided by photocopies or
facsimiles

c) The Evaluation of Audit Evidence

- Proper evaluation of evidence requires that the auditor understand the types of evidence that are available and their relative
reliability or diagnosticity.

- An auditor should be thorough in searching for evidence and unbiased in its evaluation

4) AUDIT PROCEDURES FOR OBTAINING AUDIT EVIDENCE

- Audit procedures are specific acts performed by the auditor to gather evidence about whether specific assertions are being
met.

- three categories of audit procedures.

o Risk assessment procedures. Used to obtain an understanding of the entity and its environment, including its
internal control, to assess the risks of material misstatement at the financial statement and relevant assertion
levels.

o Tests of controls. Used to test the operating effectiveness of controls in preventing, or detecting and correcting,
material misstatements at the relevant assertion level.

o Substantive procedures. Used to detect material misstatements at the relevant assertion level. Substantive
procedures include tests of details and substantive analytical procedures.

- Audit Program: A set of audit procedures prepared to test assertions for a component of the financial statements.

Example: audit procedure for each assertion related to the audit of accounts receivable
- The following types of evidence may be gathered during the application of risk assessment procedures, tests of controls, or
substantive procedures.

a) Inspection of Records or Documents

- Inspection consists of examining internal or external records or documents that are in paper form, electronic form, or other
media.

- Two issues are important:

o Reliability of Records or Documents: evidence obtained from a source outside the entity is generally considered
more reliable than evidence obtained solely from within the entity

 Internal documents are generated and maintained within the entity.

 External documents are of two forms: documents originating within the entity but circulated to
independent sources outside the entity (remittance advices returned with cash receipts from customers
and payroll check) and documents generated outside the entity but included in the entity’s accounting
records (bank statements and vendors’ invoices).

o Relationship of Documentary Evidence to Assertions: The direction of testing between the accounting records
and source documents (such as sales invoices or shipping documents) is important when testing the occurrence
and completeness assertions

 Vouching: selecting an item for testing from the accounting journals or ledgers and then examining the
underlying source document  occurrence.

 Tracing: first selecting a source document and then following it into the journal or ledger. 
completeness

b) Inspection of Tangible Assets

- consists of physical examination (count and inspect) of the assets.

Example: counting cash on hand, examining inventory or marketable securities, and examining tangible fixed assets

 Existence or Valuation BUT no rights and obligations assertion.

c) Observation

- Observation consists of looking at a process or procedure being performed by others

Example: observation of the performance of control activities and the observation of the counting of inventories by the entity’s
personnel.

- Observation provides audit evidence about the performance of a process or procedure but is limited to the point in time at
which the observation takes place. It is also limited by the fact that the entity’s personnel may act differently when the
auditor is not observing them.

 Observation is useful in helping auditors understand the entity’s processes but is generally not considered very reliable and
thus generally requires additional corroboration by the auditor.

d) Inquiry

- Inquiry consists of seeking information of knowledgeable persons (both financial and nonfinancial) within the entity or
outside the entity.
 - Responses to inquiries may provide the auditor with information not previously possessed or with corroborative audit
evidence. Alternatively, responses might provide information that differs significantly from other information that the
auditor has obtained.

- The reliability of audit evidence obtained from responses to inquiries is also affected by the training, knowledge, and
experience of the auditor performing the inquiry.

e) Confirmation

- A confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third
party (the confirming party) in paper form or by electronic or other medium.

- Auditors usually use the term inquiry to refer to unwritten questions asked of the entity’s personnel or of a third party, and
the term confirmation to refer to written requests for a written response from a third party.

- The reliability of evidence obtained through external confirmations may be affected by factors such as

o The form of the confirmation.

o Prior experience with the entity.

o The nature of the information being confirmed.

o The intended respondent.

 Existence, completeness, rights and obligations assertion (inventory consignment)

f) Recalculation

- Recalculation consists of checking the mathematical accuracy of documents or records

Example: recalculation of depreciation expense on fixed assets and recalculation of accrued interest. Recalculation also includes
footing, crossfooting, reconciling subsidiary ledgers to account balances, and testing postings from journals to ledgers.

- Highly reliable

g) Reperformance

- Independent execution by the auditor of procedures or controls that were originally performed by company personnel

Example: aging receivables

- Highly reliable

h) Analytical Procedures

- evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.
 Example: the current-year accounts receivable balance can be compared to the prior-years’ balances after adjusting for any
increase or decrease in sales and other economic factors.

- Analytical procedures can be used by an auditor to accomplish three purposes:

o 1. Risk assessment procedures to assist the auditor to better understand the business and to plan the nature,
timing, and extent of audit procedures (sometimes referred to as planning or preliminary analytical procedures).

o 2. Substantive analytical procedures are used as a substantive procedure to obtain evidential matter about
particular assertions related to account balances or classes of transactions.

o 3. Final analytical procedures are used as an overall review of the financial information in the final review stage of
the audit

- The reliability of analytical procedures is a function of (1) the availability and reliability of the data used in the calculations,
(2) the plausibility and predictability of the relationship being tested, and (3) the precision of the expectation and the rigor
of the investigation.

i) Scanning

- Exercise of professional judgment to review accounting data to identify significant or unusual items to test.

Example: searching for large and unusual items in the accounting records (e.g., nonstandard journal entries), as well as
reviewing transaction data (e.g., expense accounts, adjusting journal entries) for indications of errors.

5) RELIABLITY OF THE TYPES OF EVIDENCE

- The reliability of the types of evidence may vary considerably across entities, and it may be subject to a number of
exceptions

6) THE AUDIT TESTING HIEARARCHY: the thought process auditors use in choosing audit tests and the order in which they are
to be performed.

- the audit testing hierarchy starts with tests of controls and substantive analytical procedures. More effective and efficient
than start with test of detail because:

o Effective: The auditor’s understanding and testing of controls influence the scope (nature, timing, and extent) of
substantive testing and enhance the auditor’s ability to hone in on areas where misstatements are more likely to be
found. Similarly, substantive analytical procedures can direct attention to higherrisk areas where the auditor can
design and conduct focused tests of details

o Efficient: tests of controls and substantive analytical procedures are less costly to perform than are tests of
details. This is usually because tests of controls and substantive analytical procedures provide assurance on
multiple transactions. But tests of details often only obtain assurance related to one or two specific assertions
pertaining to the specific transaction(s) or balance tested.

- Auditing standards require that auditors perform substantive procedures for significant account balances and classes of
transactions regardless of the assessed risk of material misstatement. In other words, assurance obtained solely from
testing controls is not sufficient for significant balances and classes of transactions. For high-risk areas or highly material
accounts, the auditors will almost always perform some tests of details.
- for some assertions, tests of details may be the only form of substantive evidence used because in some cases it may be
more efficient and effective to move directly to tests of details.

- Example: low volume of large transaction

a) An “Assurance Bucket” Analogy

- The assurance bucket must be filled with sufficient appropriate evidence to obtain the level of assurance necessary to
support the auditor’s opinion
- For lower-risk, well-controlled accounts, the assurance bucket may be entirely filled with tests of controls and substantive
analytical procedures. For other accounts or assertions, the bucket may be filled primarily with tests of details.

- The size of the assurance bucket can vary, depending on the auditor’s risk assessment and the assertion being tested.
Certain assertions will be more important or present bigger risks for some accounts than for others.

Example: Existence is important for AR. Completeness is important for AP.