Chapter 4 Audit Evidence

LEARNING OBJECTIVES

1. Explain the nature of audit evidence.

2. Determine the factors affecting the persuasiveness of audit evidence.
3. Discuss the use of the work of others as audit evidence.
4. Describe the methods for obtaining audit evidence.
5. Consider how to collect audit evidence on specific items.

A u d it
E v id e n c e

N a t u r e o f A u d it A u d it E v id e n c e Q u a lity o f P ro c e d u re s fo r O b t a i n i n g A u d it
E v id e n c e D e c is io n s A u d it E v id e n c e O b t a i n i n g A u d it E v id e n c e -
E v id e n c e S e le c te d Ite m s

D e fin itio n A u d it C h a ra c te ris tic s 1 . In s p e c tio n P h y s ic a l I n v e n to ry

A s s e rtio n s 2 . O b s e rv a tio n C o u n tin g
3 . E n q u irie s
4 . C o n firm a tio n

P u rp o s e o f F o u r A u d it F a c to rs A ffe c tin g 5 . R e c a lc u la tio n L itig a tio n a n d

C o lle c tin g E v id e n c e E v id e n c e D e c is io n s P e rs u a s iv n e s s o f 6 . R e p e rfo rm a n c e C la im s
A u d it E v id e n c e 7 . A n a ly tic a l
p ro c e d u re s

W o rk o f
In te rn a l A u d ito rs

W o rk o f
A u d i t o r 's E x p e r t

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1. Nature of Audit Evidence (審計證據)
1.1 Audit evidence defined

1.1.1 Definition

Audit evidence is the information obtained by the auditors in arriving at the

conclusions on which the audit opinion is based. (是指註冊會計師為了得出審計
結論、形成審計意見而使用的所有資訊，包括財務報表依據的會計記錄中含有
的資訊和其他資訊。)

Audit evidence includes both information contained in the accounting records

underlying the financial statements and other information.

1.1.2 Examples of audit evidence include:

(a) Information from client’s internal documents, for example, purchase orders,
sales invoices, copies of receipts issued, production records, accounting
records and vouchers, and asset registry.
(b) Information from external sources such as suppliers’ invoices,
acknowledgement receipts from customers, bank statements, bank letters and
customer orders.
(c) Information produced by the auditor himself, for example, reports from
observation of stocktaking, recalculation of depreciation and accruals, and
reports on physical inspection of assets.
(d) Information gained from the auditor’s observations, for example, the
auditor attending and observing the client’s inventory count.
(e) Legal documents such as contracts with suppliers and customers and title
deed.

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1.2 Purpose of collecting audit evidence

1.2.1 Purpose of obtaining audit evidence

The objective of the auditor in obtaining audit evidence is to have reasonable

assurance that the financial statements:
(a) as a whole are free from material misstatement, in all material respects, in
accordance with an applicable financial reporting framework.
(b) comply with the Companies Ordinance and other relevant legislation.

1.2.2 The auditor should design and perform appropriate audit procedures to collect audit
evidence to confirm the fair presentation of financial statements. He/she should
perform audit procedures to obtain the following information so as to draw reasonable
conclusions on which to base the audit opinion:
(a) Understand client’s business and risks assessment procedures
The understanding of the entity, including its business environment and
internal control, helps the auditor to assess risks at assertion level.
(b) A test of control effectiveness
After the preliminary assessment of the risks level, the auditor tests the
operating effectiveness of controls in preventing or detecting material
misstatements at the assertion level.
(c) Substantive tests to detect material misstatements
The auditor uses assertions in assessing risks by considering the misstatements
in classes of transactions, account balances and disclosures and presentation
that may occur. Therefore, the auditor should design audit procedures:
(i) to collect sufficient appropriate audit evidence that is responsive to the
assessed risks.
(ii) to detect material misstatements at the assertion level regarding classes
of transactions, account balances and disclosures.

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2. Audit Evidence Decisions

2.1 Audit assertions

2.1.1 Audit objectives may provide a satisfactory way of enabling auditors to satisfy
themselves that the planned work will result in appropriate evidence being obtained,
provided that the objectives cover all the relevant financial statement assertions made
by directors.
2.1.2 Assertions used by the auditor are categorized into:

(A) Classes of transactions and events for the period under audit

Assertions Descriptions
Occurrence A transaction or event took place which pertains the entity during
the relevant period.
Completeness There are no unrecorded assets, liabilities, transactions or events,
or undisclosed items.
Accuracy Amounts of the recorded transactions and events have been
recorded accurately and appropriately.
Cut-off Transactions and events have been recorded in the correct period
and revenue or expense is allocated to the proper period.
Classification Transactions and events have been properly classified and are
included in the correct accounts.

(B) Account balances at the period-end

Assertions Descriptions
Existence Assets, liabilities and equity interests are in existence at the year-
end date.
Rights and obligations The controls and rights to assets, and obligations of liabilities are
possessed by the entity have been recorded.
Completeness All assets, liabilities and equity interests that are in existence and
are owned by the entity have been recorded.
Valuation and allocation All assets, liabilities and equity interests are included in the
financial statements at appropriate carrying amounts and
allocation adjustments are appropriately recorded.

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(C) Presentation and disclosures

Assertions Descriptions
Occurrence All transactions, events and other matters that have controlled and
pertain to the entity are disclosed.
Accuracy and valuation Financial and other information is disclosed on a fair basis and at
appropriate amounts.
Accuracy Amounts of the recorded transactions and events have been
recorded accurately and appropriately.

2.2 Four audit evidence decisions

2.2.1 Every auditor has to determine the appropriate type and amount of audit evidence to
accumulate to be satisfied that the client’s financial statements are fairly presented.
This judgement is important because cost of examining and evaluating all available
evidence is too high. The auditor’s decisions on evidence accumulation involve the
following aspects.
(a) Audit procedure
In deciding which audit procedures are to be used, it is common to put them
down in sufficiently specific terms to be used as instructions during the audit.
(b) Sample size
Once the audit procedure is selected, it is possible to vary the sample size from
one to all the items in the population being tested. The sample size for any
given procedure is likely to vary from different audit assignments.
(c) Items to be selected
After the sample size has been determined for an audit procedure, it is still
necessary to decide which items in the population are to be tested.
(d) Timing
An audit of financial statements usually covers a period such as a year, and an
audit is usually not completed until several weeks or months after the end of
the period. The timing of audit procedures can therefore vary from early in the
accounting period to long after it has ended.

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3. Quality of Audit Evidence

3.1 Characteristics of quality audit evidence

3.1.1 HKSA 500 (clarified) Audit Evidence states that the auditor should obtain “sufficient
appropriate audit evidence to be able to draw reasonable conclusions on which to
base the audit opinion”.

3.1.2 Definitions

Sufficiency (充分性) and appropriateness (適當性) are interrelated and apply to both
tests of controls and substantive procedures.
(a) Sufficiency is the measure of the quantity of audit evidence. (審計證據的充
分性是對審計證據數量的衡量，主要與註冊會計師確定的樣本量有關。)
(b) Appropriateness is the measure of the quality or reliability of the audit
evidence. (審計證據的適當性是對審計證據品質的衡量，即審計證據在支
援各類交易、帳戶餘額、列報（包括披露，下同）的相關認定，或發現其
中存在錯報方面具有相關性和可靠性。)

3.1.3 The auditor’s judgement as to what is sufficient appropriate audit evidence is

influenced by a number of factors.
(a) Experience from previous audit including knowledge of business;
(b) The degree of audit risk which results from the assessment of inherent risk
and control risk;
(c) The persuasiveness (証據 的說 服力 ) of the evidence which depends on the
source and reliability of the available information;
(d) Materiality of the item involved; and
(e) Results of audit procedures.

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3.1.4 Reliability of evidence

Quality or reliability of evidence

External Audit evidence from external sources is more reliable than that
obtained from the entity’s records.
Auditor Evidence obtained directly by auditors is more reliable than that
obtained by or from the entity.
Entity Evidence obtained from the entity’s records is more reliable when
accounting and internal control system operates effectively.
Written Evidence in the form of documents or written representation are
more reliable than oral representations.
Originals Original documents are more realistic than photocopies, or facsimiles.

Question 1
Audit evidence is obtained from an appropriate mix of control tests and substantive
procedures. Sufficiency and appropriateness are interrelated and apply to audit evidence
obtained from both control tests and from substantive procedures.

Required:

(a) Briefly describe “sufficiency” and “appropriateness” in the context of audit evidence.
(2 marks)
(b) Will a large sample of low quality evidence be persuasive to an auditor? Give an
example to illustrate your answer. (2 marks)
(c) Discuss the general consideration of reliability of audit evidence.
(5 marks)
(HKIAAT Paper 8 Auditing December 2000)

Question 2
Describe the reliability of a number of items of audit evidence relating to non-current assets.
These items are:
(a) an invoice from a supplier of an item of plant to the client.
(b) a calculation of the depreciation for the year prepared by the auditor.
(c) a verbal statement from the managing director of the client that the market value of
the company’s factory premises amounts to $20 million.

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3.2 Factors affecting the persuasiveness of audit evidence

3.2.1 The factors are as follows:

(a) Competence of evidence
Competence of evidence refers to the degree to which evidence can be
considered reliable and relevant.
(b) Relevance to the audit objective
Audit evidence must be relevant to the audit objective that the auditor is
testing before it can be reliable. Relevance should be considered in terms of
specific audit objectives.
(c) Timeliness
For example, evidence obtained from physical inventory count is usually more
reliable for balance sheet value when it is obtained as close to the balance
sheet date as possible.
(d) Sufficiency of evidence – it is measured primarily by:
(i) adequate sample size
(ii) appropriate sampling method – samples containing large value items,
high likelihood of misstatements, and representative to the population
are usually considered to be sufficient.

3.3 Work of internal auditors

3.3.1 When determining whether and to what extent the work done by the internal auditors
is adequate as audit evidence, the external auditors have to determine:
(a) whether the work is adequate for the purposes of the audit.
(b) the effect on the nature, timing and extent of the audit procedures, if
internal auditor’s work serves as part of the audit evidence.
3.3.2 Determination of whether internal auditor’s work is adequate for audit purposes –
the external auditor must evaluate:
(a) the degree of objectivity of the internal audit function and this usually relates
to its status within the organization.
(b) whether the work done by the internal auditors is done in a manner of due
professional care.
(c) whether the internal audit function is performed by persons with sufficient
technical training and proficiency.
(d) whether the communication between internal auditors and external
auditors is effective.

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3.3.3 Determination of the effect of internal auditor’s work on audit procedures – the
external auditor must evaluate:
(a) whether the nature and scope of work done by internal auditors is relevant
to their audit objectives.
(b) the assessed level of risks of material misstatement in the transactions,
balances and disclosures.
(c) the degree of objectivity in the evidence gathered by the internal auditors
to support the relevant assertions.

3.4 Work of an auditor’s expert

3.4.1 An auditor’s expert is an individual or organization possessing expertise in a field

other than accounting or auditing, whose work in that field is used by the auditor to
assist the auditor in obtaining sufficient appropriate audit evidence.

Example 1
Examples of the use of an expert’s work by external auditors are:
 Legal opinions from solicitors or barristers.
 Surveyor’s report on the valuation of land and building.
 Actuarial valuation on pension schemes.
 Expert’s report on assessing the degree of completion on a project of construction
contract.

3.4.2 It is necessary for the auditor to use the work of an auditor’s expert in order to obtain
sufficient appropriate audit evidence, then the auditors must determine whether:
(a) they should use the expert’s work in view of:
(i) the quality of the expert, which relates to the reliability of evidence to
the audit.
(ii) the agreement of nature, scope and responsibilities with the expert,
which relates to the relevance of evidence to the audit.
(b) the expert’s work is adequate for audit purposes by considering:
(i) the materiality of the item.
(ii) the risks of misstatement of the items depend on its nature and
complexity.
(iii) the quantity and quality of other evidence available.

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4. Procedures for Obtaining Audit Evidence

4.1 Means of obtaining audit evidence

4.1.1 HKSA 500 (clarified) states that the methods of collecting audit evidence include the
followings:

Inspection of assets Inspection of assets that are recorded in the accounting

records confirms existence, give evidence of valuation, but
does not confirm rights and obligations.

Confirmation that assets seen are recorded in accounting

periods gives evidence of completeness.
Inspection of Confirmation to documentation of items recorded in
documentation accounting records confirms that an asset exists or a
transaction occurred. Confirmation that items recorded in
supporting documentation are recorded in accounting records
tests completeness.

Inspection also provides evidence of valuation/

measurement, rights and obligations and the nature of
items (presentation and disclosure). It can also be used to
compare documents and confirm authorization.

Documentary Evidence
Tracing ( 追 蹤 ) – establishing the completeness of
transaction processing by following a transaction of forward
through the accounting records. For example, comparing
information on selected receiving reports to the purchases
journals.
Vouching (憑 單 核 對 証 明 ) – establishing the existence or
occurrence of recorded transactions by following a
transaction back to supporting documents from a
subsequent processing step (also referred to as “tracing
back”). For example, comparing recorded purchase

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 transactions in the purchases journal to supporting evidence
such as invoices, paid cheques, and receiving reports.
Observation Involves watching a procedure being performed (for
example, attendance of stocktake by auditors).
Enquiries Seeking information from client staff or external sources.
External confirmation Seeking confirmation from another source of details in
client’s accounting records, for example, confirmation from
bank of bank balances.
Computations or Checking arithmetic of client’s records, for example, adding
recalculation up ledger account.
Reperformance It is the auditor’s independent execution of procedures or
controls that were originally performed as part of the entity’s
internal controls.
Analytical procedures It is the evaluations of financial information through an
(分析性程序) analysis of plausible relationships among both financial
and non-financial data.

Analytical procedures also encompass such investigation as

is necessary of identified fluctuations or relationships that
are inconsistent with other relevant information or that
differ from expected values by a significant amount.

For example, compare the client’s gross profit margin with

that of the industry average and investigate any significant
differences between them.

4.2 External confirmation

4.2.1 Main objective of external confirmation

(a) External confirmation can provide reliable and relevant audit evidence
regarding the existence of the account as at a certain date.
(b) However, such confirmation does not ordinarily provide all necessary audit
evidence relating to the valuation assertion, since it is not practicable to ask
the debtor, for example, to confirm detailed information relating to its ability
to pay the account.

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4.2.2 Types of external confirmation

(a) Positive confirmation

This is a request asking the respondent to reply to the auditor in all cases
by either of the following:
(i) indicating the respondent’s agreement with the given information.
(ii) asking the respondent to fill in information.
(b) Negative confirmation
This is a request asking the respondent to reply only in the event of
disagreement with the information provided in the request and auditors will
use this type of confirmation when:
(i) the risk of material misstatement is assessed as low.
(ii) there is a large number of small balances in the population.
(iii) it is expected that the number of errors is not substantial.
(iv) there is no reason that the auditors believe that respondents will
disregard these requests.

Advantage – it can reduce the auditor’s workload in handling a large number

of small balances.
Disadvantage – it gives no explicit audit evidence that intended third parties
have received the confirmation requests and verified that the information
contained therein is correct.
(c) Blank confirmation – It requires the respondent to fill in the amount or
furnish other information.

Advantage – it reduces the risk of the respondent replying to the

confirmation without verifying that the information is correct.
Disadvantage – it may result in lower response rates because additional
effort is required of the respondents.

4.2.3 Examples of external confirmation:

(a) Receivables confirmation
(b) Payables confirmation
(c) Bank confirmation
(d) Inventory confirmation – inventory held by third parties

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 (e) Property title deeds held by lawyers or financiers for safe custody or as
security
(f) Shares confirmation – investments purchased from stockbrokers
(g) Loans from lenders
4.2.4 Alternative audit procedures where no response is received to a positive
confirmation request from a trade debtor:
(a) Examination of subsequent cash receipts to provide audit evidence of the
existence assertion.
(b) Examination of shipping documentation or other client documentation to
provide audit evidence of the existence assertion.
(c) Examination of sales near the period-end to provide audit evidence of the cut-
off assertion.
4.2.5 Alternative audit procedures where no response is received to a positive
confirmation request from a trade creditor:
(a) Examination of subsequent cash disbursements to provide audit evidence of
the existence assertion.
(b) Examination of correspondence from third parties to provide audit evidence
of the existence assertion.
(c) Examination of other records, such as goods received notes to provide audit
evidence of the completeness assertion.

5. Procedures for Obtaining Audit Evidence in Selected Items

5.1 Attendance of physical inventory counting

5.1.1 Audit procedure for physical inventory count

Stocktaking Audit Procedures

1. Before the stocktaking  Consider the risk of material misstatement related to
inventory
 Consider the nature of internal control
 Whether adequate procedures are established and proper
instructions issued? (Appendix I)
 The timing of the count
 The locations at which inventory is held
 Whether an expert’s assistance is needed
 Materiality of the inventory and the sample size

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2. During the stocktaking  Obtain evidence whether the management’s control
activities are adequately carried out
 Perform test count over both the completeness and the
accuracy of the count records by tracing items from those
records
 For cut-off test, obtain necessary information of
documentation regarding the details of movement of
inventory just prior to, during and after the count for
subsequent checking
 Consider whether the procedures for identifying
obsolete, damaged or slow moving items are operated
properly
 Consider whether the overall stocktaking has been
properly carried out and is sufficiently reliable as a basis
for determining the existence of inventories
3. After the stocktaking  Follow up the matters recorded in working papers at time
of count
 Test the final inventory schedules to assess whether they
accurately reflect the actual inventory counts
 Obtain copies of inventory sheets with count results
and use them to validate the final inventory balance
 Ensure the differences between the stock sheets and
physical counts have been investigated and solved

5.2 Litigation and claims

5.2.1 The auditor needs to perform procedures to ensure the client’s litigation and claims
are completely disclosed and accounted for:

Procedures Audit Procedures

1. Inquiry of client’s staff The auditor seeks information about the occurrence of litigation
and claims from knowledgeable persons within the entity,
including:
 The management of the company.
 Others within the entity, e.g. the in-house legal counsel.
2. Inquiry of external legal With the client’s permission, the auditor may have direct
counsel communication with the entity’s external legal counsel to

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 identify and evaluate whether:
 There are potentially material litigation and claims and
their nature and implications on the presentation of
financial statements.
 The client management’s estimates of the financial
implications of the litigation and claims are reasonable.
3. Inspection of documents The auditor identifies the existence of litigation and claims by
and records reviewing:
 Minutes of meetings of those charged with governance.
 Correspondences between the entity and its external legal
counsel.
 Related accounting records such as legal expense
accounts.
4. Recalculation The auditor checks the arithmetic accuracy of the calculation
of legal expenses after examining related source documents for
legal expenses.

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Appendix I – Instructions for Physical Inventory
ABC Department Stores
Instructions for Physical Inventory
July 26, 2013

To All Supervisors
A complete physical inventory of all departments in each store will be taken Sunday, August
5, 2013, beginning at 8:30 am and continuing until completed. Employees are to report at
8:15 am to receive their final briefing on their instructions, which are appended hereto.

Within one week prior to August 5, supervisors should make sure that merchandise in
departments is well organized. All merchandise with the same stock number should be
located together. Merchandise that is damaged should be segregated for separate listing on
inventory sheets.

Each count team should be formed and started by a supervisor, and should be periodically
observed by that supervisor to assure that instructions are being complied with in the
counting and listing processes.

A block of sequential prenumbered inventory sheets will be issued to each supervisor at

8:00 am August 5, for later issuance to count teams. Each supervisor is to account for all
sheets – used, unused, or voided. In addition, each supervisor will be furnished at that
time with a listing of count teams under his or her supervision.

When a count team reports completion of a department, that team’s supervisor should
accompany a representative of the independent auditors, McDonald & Company, in
performing test counts. A space is provided on each inventory sheet for the supervisor’s
signature as reviewer. When the independent auditors have “cleared” a department, the
supervisor responsible should take possession of the count sheets. All completed count sheets
are to be placed in numerical sequence and turned over to me when the entire inventory has
been completed.

Before supervisors and employees leave the stores Saturday evening, August 4, they are to
make certain that “housekeeping” is in order in each department, and that all merchandise
bears a price ticket.

If you have any questions about these instructions or any other aspect of the physical
inventory, please see me.

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 Multiple Choice Questions

1. Which of the following does NOT describe the characteristics of a competent audit
evidence?

A Sample size of the source document to be selected.

B Degree of objectivity
C Independence of the information provider.
D Auditor’s direct knowledge about the audit evidence collected.

2. Which of the following is NOT one of the components of an audit evidence decision?

A Timing of collecting audit evidence.

B Internal control procedures that should be improved.
C Sample size of the audit procedures to be performed.
D Items to be selected as audit evidence.

3. In relation to the competence of audit evidence, which of the following statements is

true?

A Audit evidence that is competent must be both reliable and relevant.

B Audit evidence collected from sources external to the audit client must be
reliable.
C Oral representations made by management must be unreliable.
D The effectiveness of the internal control system of the audit client affects the
relevance of audit evidence.

4. Which of the following statements is correct in describing the technique of

observation for collecting audit evidence?

A It is not sufficient by itself.

B It needs the support of corroborative evidence before an audit conclusion can
be drawn.
C It involves asking the client’s staff about the company policy.
D It is limited to what auditors see or watch only.

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5. Physical inspection is the examination or the counting performed by the auditor of
items such as:

(i) Cash
(ii) Inventory
(iii) Sales invoice and sales ledger
(iv) Plant and equipment
(v) Securities

A (i), (ii) and (iii)

B (ii), (iii) and (iv)
C (i), (ii), (iv) and (v)
D All of the above

6. During an attendance of a physical inventory count, which of the following is NOT

an example of an audit evidence of the auditor’s direct knowledge?

A Test count of the physical inventories at client’s premises.

B Calculation of the value of inventory in existence during the physical count.
C Observation of how the client’s staffs carry out inventory counting procedures
in accordance with the management’s stocktaking instructions.
D Inquiry of how the client controls the movements of inventories during the
physical count.

7. Which of the following statements about analytical procedures is correct?

A Analytical procedures use comparisons to determine which account balance

has errors.
B Analytical procedures are used for identifying accounts or transactions that
should be investigated more extensively.
C Analytical procedures may be the only audit evidence to be collected for
verifying the effectiveness of internal control system.
D Since analytical procedures are conducted by the auditors, such a type of
evidence should be regarded as sufficient appropriate audit evidence.

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8. Physical inspection of tangible assets provides evidence for auditors to determine:

(i) Existence of the asset

(ii) Condition of the asset
(iii) Ownership of the asset
(iv) Realisable value of the asset
(v) Quantity of the asset

A (i), (ii) and (iv)

B (i), (iv) and (v)
C (i), (ii) and (v)
D (i), (iii) and (iv)

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 Additional Examination Style Questions

Question 3
The objective of the auditor is to design and perform audit procedures in such a way as to
enable the auditor to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the auditor’s opinion.

Required:

(a) Define audit evidence.

(b) Briefly describe “sufficiency” and “appropriateness” in the context of audit
evidence.
(c) Give FIVE circumstances under which evidence gathered is in general considered
to be reliable.
(d) In planning attendance at the physical inventory count, what should be considered
by the auditors?
(e) Give FOUR audit procedures that can be followed in order to enable auditors to
become aware of any litigation and claims involving the audit client which may
result in material misstatement of the financial statements.
(Modified HKIAAT P8 Principles of Auditing and MISs December 2006 B2)

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