Audit evidence

CHAPTER CONTENTS

THE USE OF ASSERTIONS BY AUDITORS ------------------------------ 85

THE PROFIT OR LOSS ASSERTIONS 85
THE STATEMENT OF FINANCIAL POSITION ASSERTIONS 86

AUDIT PROCEDURES ---------------------------------------------------- 87

ISA 500 AUDIT EVIDENCE 87
SUFFICIENCY 88
RELIABILITY 88
RELEVANCE 88
EVIDENCE GATHERING AT SMALLER AUDIT CLIENTS 88

THE USE OF ASSERTIONS BY AUDITORS

There are many reasons why the financial statements may have errors, deliberate or
accidental, including things such as:
● Transactions missed out.
● Fake transactions recorded.
 ● Transactions recorded at the wrong value.
● Transactions recorded in the wrong accounting period.
As a result, the auditors must test a number of things (assertions) about each
balance in the financial statements. These assertions are different depending upon
whether you are testing a number in the Profit or Loss, or a balance on the Statement
of Financial Position.

The profit or loss assertions

The auditors must test the transactions in the Profit or Loss for:

Occurrence Auditors must devise tests to ensure that the

transactions in the Profit or Loss actually took place

Completeness Auditors must devise tests to ensure that all of the

transactions that took place during the year have
actually been recorded in the Profit or Loss

Accuracy Auditors must devise tests to ensure that all of the

transactions that took place during the year have been
recorded at the correct amounts

Cut off Auditors must devise tests to ensure that the

transactions that take place just before and just after
the year end have been recorded in the correct
accounting period

Classification Auditors must devise tests to ensure that the

transactions have been recorded in the correct
account balances, eg interest payments recorded as
‘finance costs’ and not ‘admin expenses’

Presentation and Auditors must devise tests to ensure that the

Disclosure transactions have been presented and disclosed in
accordance with the relevant financial reporting
framework
The statement of financial position assertions

The auditors must test items on the statement of financial position for:

Existence Auditors must devise tests to ensure that the items on

the Statement of Financial Position actually exist in real
life

Completeness Auditors must devise tests to ensure that all of the

items pertaining to the company (its assets, liabilities
etc.) have been recorded on the Statement of
Financial Position

Rights and Auditors must devise tests to ensure that all of the
Obligations assets on the Statement of Financial Position are
(OWNERSHIP) owned by the company and all of the liabilities are an
obligation of the company

Valuation Auditors must devise tests to ensure that the balances

are recorded at the correct value

Presentation and Auditors must devise tests to ensure that the

Disclosure transactions have been presented and disclosed in
accordance with the relevant financial reporting
framework

In the exam, you will be asked to devise audit tests for certain items in the financial
statements, eg trade receivables, purchases, non-current assets. Use the
assertions to help you generate ideas. To help you remember some of the
assertions, you can use simple but effective mnemonic, PROVE:
P Presentation and Disclosure
R Records must be accurate and complete
O Ownership
V Valuation
E Existence
Also, bear in mind that some items have a lot of disclosure requirements (eg loans),
and others are pure disclosure items (eg contingent liabilities), so checking the
written disclosure notes are COMPLETE, ACCURATE and UNDERSTANDABLE to
shareholders is also important.
AUDIT PROCEDURES

In order to perform substantive tests and tests of control, auditors can use a
variety of techniques. These are:
● Inspection (examining records, documents or assets).
● Observation (Watching a process or procedure being performed by
someone else).
● External Confirmation (confirming something with a third party).
● Re-calculation (checking the mathematical accuracy of documents or
records).
● Re-performance (auditor independently re-performs procedures or
controls originally performed by the client).
● Analytical procedures (making comparisons of financial information to try
to identify fluctuations or unusual results).

Exam hint
You can remember some of these techniques by using the mnemonic AEIOU.
A analytical
Procedures E External
Confirmation I
inspection
O observation
Recalc U
lation.

Analytical Procedures are based on COMPARING information in the Financial

Statements with other useful information, e.g. similar companies, or with your
client’s budgets, or prior year information. Where information is easily comparable
(because company activities are repetitive, similar competitors exist etc) and
detailed company data is reliable (e.g. because internal controls are strong),
analytical procedures can be a very efficient way to get evidence that figures
appear materially correct.
 Examples
To test the Existence of an asset, the auditor will select some assets from the client’s
list (asset register) and then physically inspect the asset in use by the company.
To test the Occurrence of a sale, the auditor will inspect the sales invoice, goods
despatch note, and maybe the original order (documents) to make sure that the
sale has taken place, and cannot be cancelled / returned by the customer.

ISA 500 audit evidence

ISA 500 (Audit Evidence) states that audit evidence should have certain
characteristics. It should be:
● Sufficient;
● Reliable; and
● Relevant

Sufficiency

Sufficiency is a measure of quantity, i.e. auditors must obtain enough evidence to

form their opinion. Sufficiency is affected by:
● Risk. The riskier an item is, the more evidence the auditors should obtain
over that item.
● Materiality. The more material an item is, the more evidence the auditors
should obtain.
● Reliability. The less reliable audit evidence is, the more if it is needed and
vice versa.

Reliability
To be useful, audit evidence must be reliable in terms of its source and its nature.
The following generalisations about the reliability of audit evidence are useful.
● Auditor generated evidence is more reliable than client generated evidence.
● Third party (independent) evidence is more reliable than client generated
evidence.
● Original documents are more reliable than photocopies.
● Written evidence is more reliable than oral evidence.
Evidence from well controlled systems is more reliable than evidence from poorly
controlled systems

Relevance

Audit evidence is relevant if it proves (or goes some way to proving) one or more
of the financial statement assertions.
Evidence gathering at smaller audit clients
The accounting and internal control systems at smaller companies are often not as
sophisticated or as complex as those in larger companies. This will have some effect
on the type of audit evidence that can be gathered when auditing a smaller company.
At smaller companies, the ownership and management tends to be concentrated
amongst a small number of individuals who are very often actively involved in
managing the company on a day-to-day basis.
On one hand, this can improve the control environment of the company, as the
managers will be on hand to resolve any issues on a timely basis.
On the other-hand, however, the dominant position of management could be open
to abuse – leading to override of controls and inaccurate accounting records.
The lack of staff at smaller companies can also lead to an issue with segregation of
duties so often auditors will rely on substantive tests of detail when auditing smaller
clients, rather than tests of control.