CHAPTER FOUR

AUDIT EVIDENCE
LEC 10
 TYPES OF AUDIT EVIDENCE
1. Physical examination.
2. Confirmation.
3. Inspection.
4. Analytical procedures.
5. Inquiries of the client.
6. Recalculation.
7. Reperformance.
8. Observation.
 1. PHYSICAL EXAMINATION :

The inspection or count of a tangible asset by the

auditor.
This type of evidence is most often associated with inventory
and cash, but it is also applicable to the verification of
securities, notes receivable, and tangible fixed assets.
 1. PHYSICAL EXAMINATION (CONT.)
Physical examination is a direct means of verifying that an asset actually exists
(existence objective) .

Physical examination is considered one of the most reliable and useful types of
audit evidence.

However, physical examination is not sufficient evidence to verify that existing

assets are owned by the client (rights and obligations’ objective), and proper
valuation for financial statement purposes usually cannot be determined by
physical examination (accuracy and realizable value objectives).
 2. CONFIRMATION :

The receipt of a direct written response from a third party

verifying the accuracy of information that was requested
by the auditor.
The response may be in paper form or electronic or other
medium, such as the auditor’s direct access to information
held by the third party.
 2. CONFIRMATION (CONT.)

Because confirmations come from third-party sources instead

of the client, they are a highly regarded and often used type of
evidence. However, confirmations are relatively costly to obtain
and may cause some inconvenience to those asked to supply
them. Therefore, they are not used in every instance in which
they are applicable.
 2. CONFIRMATION (CONT.)
There are two common types of confirmation requests:

a. Positiveconfirmations: Ask the recipient to respond in all

circumstances.

A positive confirmation may request the recipient to provide the

information (a blank form), or the confirmation may include the
information and request the respondent to indicate whether he or she
agrees with the information. This latter type is often used because the
response rate is higher than for the blank form.
 2. CONFIRMATION (CONT.)

b. Negative confirmations: The recipient is asked to respond

only when the information is incorrect.

Because confirmations are considered significant evidence only

when returned, negative confirmations are less competent than
positive confirmations.
 2. CONFIRMATION (CONT.)
Limitations of confirmation :
Confirmation as a type of evidence could have some limitations include the following :
❑ Confirmation from debtors may provide audit evidence for existence and right and
obligation assertions, but not for valuation, The external auditor should be alert of the
possibility that the customer may sign the confirmation without verification form the
books.
❑ Confirmation from creditors may not be effective verify completeness assertion (The
completeness assertion is an auditing concept that ensures all transactions and events
that should be recorded have been recorded. )
❑ Confirmation request should be directed to appropriate individual .
 2. CONFIRMATION (CONT.)
❑ Certain parties may not provide objective or unbiased response to a
confirmation request.
❑ The external auditor should also consider the respondent’s competence,
knowledge, ability and desire to respond to confirmation request.
❑ The external auditor should be alert whether there are any indications that
the confirmation received may not be reliable. The reliability of response
should be considered and external audit procedures should be performed
to dispel any concern. The external auditor may choose to verify the source
and contents of a response in a telephone call to the purported sender.
 3. INSPECTION

❑ The auditor’s examination of the client’s documents and records to

substantiate the information in the financial statements.

❑ Documents can be internal or external .

An internal document has been prepared and used within the client’s
organization and is retained without ever going to an outside party.
Internal documents include duplicate sales invoices, employees’ time
reports, and inventory receiving reports.
 3. INSPECTION

An external document has been handled by someone outside

the client’s organization who is a party to the transaction being
documented, but that is either currently held by the client or
easily accessible. In some cases, external documents originate
outside the client’s organization and end up in the hands of the
client. Examples of external documents include vendors’
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invoices, cancelled notes payable, and insurance policies.

 3. INSPECTION

When auditors use documentation to support recorded transactions or

amounts, the process is often called vouching. To vouch recorded
acquisition transactions, the auditor might, for example, verify entries in
the acquisitions journal by examining supporting vendors’ invoices and
receiving reports and thereby satisfy the occurrence objective. If the
auditor traces from receiving reports to the acquisitions journal to satisfy
the completeness objective, this latter process is called tracing.
 4. ANALYTICAL PROCEDURES

The evaluation of financial information through analysis of

reasonable relationships among financial and nonfinancial
data are required during planning and completion phases
of all audits ( For example, an auditor may compare the
gross margin percent in the current year with the
preceding year’s gross margin).
 4. ANALYTICAL PROCEDURES

Purposes of analytical procedures include:

❑ Understand the Client’s Industry and Business
Auditors must obtain knowledge about a client’s industry and
business as a part of planning an audit. By conducting analytical
procedures in which the current year’s unaudited information is
compared with prior years’ audited information or industry data,
changes are highlighted.
 4. ANALYTICAL PROCEDURES

❑ Assess the Entity’s Ability to Continue as a Going Concern:

Analytical procedures are often a useful indicator for determining whether

the client company has financial problems.

❑ Indicate the Presence of Possible Misstatements in the Financial

Statements:

Significant unexpected differences between the current year’s unaudited

financial data and other data used in comparisons are commonly called
unusual fluctuations.
 4. ANALYTICAL PROCEDURES

❑ Provide Evidence Supporting an Account Balance:

In many cases, an analytical procedure can be used to provide evidence

supporting recorded account balances.
Limitations of Analytical procedures :
Analytical procedures as type of evidence have some limitations including
the following :

❑ When information produced by the organization is used by the external

auditor to perform analytical procedures, the external auditor should be
alert about completeness and accuracy of the information.
 4. ANALYTICAL PROCEDURES
❑ Reliance should not be placed on analytical procedures only in case of material
accounts.
❑ The external auditor should be alert that analytical procedures may identify
relationships as expected, when, in fact, a material misstatement may exist.

❑ Analytical procedures are usable only when the accuracy with which expected
results may be predicted. For example, analytical procedures are no appropriate
in comparing research and development or advertising expenses from one period
to another.

❑ A comparison with budget is not appropriate if budgets are not attainable but
have been set as goals to be achieved.
 5. Inquiry
Obtaining written or oral information from the client in response to auditor
questions. ( Usually not considered conclusive because It is not from an
independent source).

Inquiry as a type of evidence has some limitations including considering

integrity and specialization of management regarding responses received,
Response from attached parties are not as strong evidence as responses from
independent third party , Inquiry alone does not provide adequate audit
evidence to detect a material misstatement and Also, inquiry alone is not
adequate for performing test of controls.
 6. RECALCULATION

Rechecking a sample of calculations made by the client

Rechecking client calculations consists of testing the client’s
arithmetical accuracy and includes such procedures as extending
sales invoices and inventory, adding journals and subsidiary records,
and checking the calculation of depreciation expense and prepaid
expenses.
 7. Reperformance

The auditor’s test of client accounting procedures or controls that

were originally done as part of the entity’s accounting and internal
control system.
 8. Observation
 Watching a process or procedure being performed by others

 The auditor may tour the plant to obtain a general impression of the
client’s facilities, or watch individuals perform accounting tasks to
determine whether the person assigned a responsibility is performing it
properly.

 Limitations of observation include being limited to the point in which the

observation takes place, and the external auditor should be alert that the
act of being observed may affect how the process is performed.
 Cost of Types of Evidence:
• Most expensive:
• Physical examination
• Confirmation

• Moderately costly:
• Inspection
• Analytical procedures
• Reperformance

• Least expensive:
• Observation
• Inquiries of the client
• Recalculation
 OBJECTIVE 5
Understand the purposes of audit
documentation.
 AUDIT DOCUMENTATION
Audit documentation is the record of the audit procedures performed,
relevant audit evidence, and conclusions the auditor reached.

 Purposes of audit documentation:

❑ A basis for planning the audit :

If the auditor is to plan an audit adequately, the necessary reference information

must be available in the audit files. The files may include such diverse planning
information as descriptive information about internal control, a time budget for
individual audit areas, the audit program, and the results of the preceding year’s
audit.
 AUDIT DOCUMENTATION ( CONT.)
❑ A record of the evidence accumulated and the results of the tests

Audit documentation is the primary means of documenting that an adequate

audit was conducted in accordance with auditing standards.

Audit documentation should identify the items tested, any significant audit
findings or issues, actions taken to address them, and the basis for the conclusions
reached.
❑ Data for determining the proper type of audit report

Audit documentation provides an important source of information to assist the

auditor in deciding whether sufficient appropriate evidence was accumulated to
justify the audit report in a given set of circumstances.
 AUDIT DOCUMENTATION ( CONT.)

❑ A basis for review by supervisors and partners

The audit files are the primary frame of reference used by supervisory personnel to
review the work of assistants.

Ownership of audit files:

Audit documentation prepared during the engagement, including schedules prepared by
the client for the auditor, is the property of the auditor. The only time anyone else, including
the client, has a legal right to examine the files is when they are subpoenaed by a court as
legal evidence or when they are examined by approved peer reviewers or regulatory
inspectors.
 AUDIT DOCUMENTATION ( CONT.)

Confidentiality of audit files:

A member in public practice shall not disclose any confidential client information
without the specific consent of the client.

Requirements for retention of audit documentation:

Auditing standards require that records for audits of private companies be retained
for a minimum of five years. The Sarbanes–Oxley Act requires auditors of public
companies to prepare and maintain audit files and other information related to any
audit report in sufficient detail to support the auditor’s conclusions, for a period of
not less than seven years.
 OBJECTIVE 6
Prepare organized audit documentation.
 AUDIT DOCUMENTATION (CONT.)

The type of audit documentation and the way it is arranged in the files is logical
although firms may vary in their approaches.

Permanent Files: Contain data of a historical or continuing nature. These provide a

suitable source of information that is used from year to year as:
❑ Copies of company documents such as articles of incorporation, bylaws, bond
indentures, and long-term contracts.
❑ Analyses of accounts from previous years that have continuing importance.
❑ Information related to understanding internal controls and assessing control risk.
❑ Results of analytical procedures from prior years’ audits for comparison.
 AUDIT DOCUMENTATION (CONT.)
❑ Current Files: Includes all documentation for the current year audit including:
❑ Audit Program
❑ Working Trial Balance (unadjusted trial balance)
❑ Adjusting Entries: Auditors propose adjusting entries for material
misstatements.
❑ Supporting Schedules: Major types include the following:(largest portion of audit
documentation)
o Analysis
o Trial balance or list
o Reconciliation of amounts
o Substantive analytical procedures
o Summary of procedures
o Examination of supporting documentation
o Outside documentation