4.

Nature and Type of Audit Evidence

References:
a. PSA 230 (Redrafted), Audit Documentation
b. PSA 500 (Redrafted), Audit Evidence
Definition of Audit Evidence
Audit evidence is all information used by the auditor on which the audit opinion is based. The
gathering and evaluation of audit evidence is a cumulative and iterative process.

Types of Audit Evidence

The auditor obtains two types of audit evidence such as:
1. Underlying accounting records - The records of initial accounting 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 journal entries; and records such as work sheets and spreadsheets supporting cost
allocations, computations, reconciliations and disclosures.
2. Other information1 – All other evidence obtained by the auditor such as minutes of meetings,
confirmation from third parties and information obtained from such audit procedures as inquiry,
observation, and inspection. The auditor must obtain the two types of audit evidence above, which
must be consistent with each other and not doubtful as to its reliability. Underlying accounting records
alone cannot constitute sufficient audit evidence. (Formerly called as corroborating evidence)

Sources of Audit Evidence

The following are the list of sources of audit evidence:
• Performance of audit procedures. (Primary source)
• Previous audits.
• Firm’s quality control procedures for client acceptance and continuance
• Work of a management’s expert.
• Management representations.
• Other sources inside and outside the entity.

Primary Source of Audit Evidence: Audit Procedures

Types of audit procedures
1. Risk assessment procedures (RAP)—are the audit procedures performed to obtain an
understanding of the entity and its environment, including the entity’s internal control, to identify and
assess the risks of material misstatement, whether due to fraud or error, at the financial statement
and assertion levels, thereby providing a basis for designing and implementing responses to the
assessed risks of material misstatement;
2. Further audit procedures which comprise:
• Tests of controls (ToC)—an audit procedure designed to evaluate the operating effectiveness of
controls in preventing, or detecting and correcting, material misstatements at the assertion level; and
• Substantive procedures (SP), comprising tests of details and substantive analytical procedures—an
audit procedure designed to detect material misstatements at the assertion level.; and
3. Other planned audit procedures

Types of Audit Evidence

1. Inquiry—consists of seeking information of knowledgeable persons, both financial and nonfinancial,
within the entity or outside the entity.
2. Inspection—involves examining records or documents, whether internal or external, in paper form,
electronic form, or other media, or a physical examination of an asset.
3. Observation—consists of looking at a process or procedure being performed by others, for
example, the auditor’s observation of inventory counting by the entity’s personnel, or of the
performance of control activities.
4. Analytical Procedures—consist of evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass the
investigation of identified fluctuations and relationships that are inconsistent with other relevant
information or deviate significantly from predicted amounts.
5. External Confirmation—a direct written response to the auditor from a third party (the confirming
party), in paper form, or by electronic or other medium.
6. Recalculation—consists of checking the mathematical accuracy of documents or records.
7. Reperformance—involves the auditor’s independent execution of procedures or controls that were
originally performed as part of the entity’s internal control.

Relationship among audit procedures and types of audit evidence

Audit procedure

Types Further audit

RAP procedures
ToC SP
Inspection X X X
Observation X X X
External confirmation X
Recalculation X
Re-Performance X
Analytical procedures X X
Inquiry X X X

Reliability and Cost of Audit Procedures

The most reliable evidence gathering techniques (audit procedures) should be used whenever they
are cost effective. The quality of internal controls has a significant effect on reliability. Furthermore, a
specific substantive audit procedure is rarely sufficient by itself to provide competent evidence to
satisfy the audit objective. However, assuming good internal controls and the ability to choose a
specific method, a list of the most reliable to the least reliable evidence-gathering techniques are in
general:
1. recalculation, (most reliable)
2. inspection,
3. reperformance,
4. observation,
5. confirmation,
6. analytical procedures,
7. inquiry (least reliable)

The evidence-gathering procedures in order of cost from most costly to least costly are in general:
1. confirmation (most costly),
2. inspection,
3. recalculation,
4. reperformance,
5. observation,
6. analytical procedures,
7. inquiry (least costly).
Inquiry is the most extensively used audit procedures. Although inquiry may provide important audit
evidence, and may even produce evidence of a misstatement, inquiry alone ordinarily does not
provide sufficient audit evidence of the absence of a material misstatement at the assertion level, nor
of the operating effectiveness of controls.

Sufficiency and Appropriateness of Audit Evidence

The auditor shall design and perform audit procedures to enable the auditor to obtain sufficient
appropriate audit evidence (SAAE) to be able to draw reasonable conclusions on which to base the
auditor’s opinion. The sufficiency and appropriateness of audit evidence are interrelated.

Sufficiency
Sufficiency is the measure of the quantity of evidence. The quantity of audit evidence needed is
affected by the auditor’s assessment of the risks of misstatement (the higher the assessed risks, the
more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher
the quality, the less may be required). Obtaining more audit evidence, however, may not compensate
for its poor quality.
Extent of Testing to Obtain Sufficient Evidence
An effective test provides appropriate audit evidence to an extent that, taken with other audit
evidence obtained or to be obtained, will be sufficient for the auditor’s purposes. In selecting items for
testing, the auditor determines the relevance and reliability of information to be used as audit
evidence; the other aspect of effectiveness (sufficiency) is an important consideration in selecting
items to test. The means available to the auditor for selecting items for testing are:
• All items (100% examination)
• Specific items
• Audit sampling
The application of any one or combination of these means may be appropriate depending on the
particular circumstances, for example, the risks of material misstatement related to the assertion
being tested, and the practicality and efficiency of the different means.

Appropriateness (Formerly called competence of audit evidence)

Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability
in providing support for the conclusions on which the auditor’s opinion is based. When designing and
performing audit procedures, the auditor shall consider the relevance and reliability of the information
to be used as audit evidence. The quality of all audit evidence is affected by the relevance and
reliability of the information upon which it is based.

Relevance
Relevance deals with the logical connection with, or bearing upon, the purpose of the audit
procedure, direction of testing and, where appropriate, the assertion under consideration.

Purpose of Audit Procedure

Audit procedures classified according to purpose are risks assessment procedures (RAP), test of
controls (ToC) and substantive procedures (SP). These three procedures have different purposes
such as, to obtain understanding the entity and its environment, including internal control, to test the
operating effectiveness of entity’s internal control and to detect material misstatements in the financial
statements, respectively.

Assertion
Audit evidence, to be relevant, must link directly to relevant assertions. The auditor uses assertions in
considering different types of potential misstatements that may occur in the financial statements. It is
the reason why audit objectives follow and are closely related to assertions. In other words,
assertions guide the auditor in the performance of auditor procedures as to what appropriate audit
evidence to obtain.
A given set of audit procedures may provide audit evidence that is relevant to certain assertions, but
not others. For example, inspection of documents related to the collection of receivables after the
period end may provide audit evidence regarding existence and valuation, but not necessarily cutoff.

Direction of Testing
The relevance of information to be used as audit evidence may be affected by the direction of testing.
For example, if the purpose of an audit procedure is to test for overstatement in the existence or
valuation of accounts payable, testing the recorded accounts payable may be a relevant audit
procedure. On the other hand, when testing for understatement in the existence or valuation of
accounts payable, testing the recorded accounts payable would not be relevant, but testing such
information as subsequent disbursements, unpaid invoices, suppliers’ statements, and unmatched
receiving reports may be relevant.

Reliability
The reliability of information to be used as audit evidence, and therefore of the audit evidence itself, is
influenced by its source and its nature, and the circumstances under which it is obtained, including
the controls over its preparation and maintenance where relevant.
Evidence is general more reliable when:
1. Obtained from independent sources;
2. The related controls are effective;
3. Obtained directly than indirectly or by inference;
4. In documentary form than oral; and
5. In original state than by photocopies or facsimiles.
Inconsistency in, or Doubts over Reliability of, Audit Evidence
Obtaining audit evidence from different sources or of a different nature may indicate that an individual
item of audit evidence is not reliable, such as when audit evidence obtained from one source is
inconsistent with that obtained from another. This may be the case when, for example, responses to
inquiries of management, internal audit, and others are inconsistent, or when responses to inquiries
of those charged with governance made to corroborate the responses to inquiries of management are
inconsistent with the response by management. Specific documentation requirement if the auditor
identified information that is inconsistent with the auditor’s final conclusion regarding a significant
matter.

Audit documentation
Audit documentation (a.k.a. “working papers” or “workpapers”) is the record of audit procedures
performed, relevant audit evidence obtained, and conclusions the auditor reached.
The auditor shall prepare documentation to provide:
1. A sufficient and appropriate record of the basis for the auditor’s report; and
2. Evidence that the audit was planned and performed in accordance with PSAs and applicable legal
and regulatory requirements.

Audit documentation serves a number of additional purposes, including the following:

• Assisting the audit team to plan and perform the audit.
• Assisting members of the audit team responsible for supervision to direct and supervise the audit
work, and to discharge their review responsibilities.
• Enabling the audit team to be accountable for its work.
• Retaining a record of matters of continuing significance to future audits.
• Enabling the conduct of quality control reviews and inspections.
• Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other
requirements.

Auditor’s documentation is normally stored in an audit file.

Audit file refers to one or more folders or other storage media, in physical or electronic form,
containing the records that comprise the audit documentation for a specific engagement.

Timely Preparation of Audit Documentation

Preparing sufficient and appropriate audit documentation on a timely basis helps to enhance the
quality of the audit and facilitates the effective review and evaluation of the audit evidence obtained
and conclusions reached before the auditor’s report is finalized.

Form, Content and Extent of Audit Documentation

The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor,
having no previous connection with the audit, to understand:
1. The nature, timing, and extent of the audit procedures performed to comply with the PSAs and
applicable legal and regulatory requirements;
2. The results of the audit procedures performed, and the audit evidence obtained; and
3. Significant matters arising during the audit, the conclusions reached thereon, and significant
professional judgments made in reaching those conclusions.

In documenting the nature, timing and extent of audit procedures performed, the auditor shall record:
1. The identifying characteristics of the specific items or matters tested;
2. Who performed the audit work and the date such work was completed; and
3. Who reviewed the audit work performed and the date and extent of such review.

Audit documentation, however, is not a substitute for the entity’s accounting records. Oral
explanations by the auditor, on their own, do not represent adequate support for the work the audit.

Types of Audit Documentation

Auditors generally classify audit documentation into two types:
1. Current files—Relate specifically to the current period's audit. They often include
• Reconciliation of accounting records to financial statements
• Lead schedules of major components of amounts in the financial statements and supporting detailed
schedules
• Documentation of substantive procedures performed providing evidence corroborating or
contradicting management's assertions
• The attorney's letter and management's representation letter
• Audit programs

2. Permanent (continuing) files—Relate to the company and contain information with long-term
significance. They are of ongoing interest in any period under audit and often include
• Debt agreements and pension contracts
• Articles of incorporation
• Flowcharts of internal control
• Bond indenture agreements and lease agreements
• Analyses of capital stock & owners’ equity accounts

Departure from a Relevant Requirement

If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement
in a PSA, the auditor shall document how the alternative audit procedures performed achieve the aim
of that requirement, and the reasons for the departure.

Assembly and Retention of the Final Audit File

The auditor shall assemble the audit documentation on a timely basis, ordinarily not more than 60
days after the date of the auditor’s report. After the assembly, the auditor shall not delete or discard
audit documentation before the end of its retention period, which ordinarily is no shorter than five
years from auditor’s report date in the absence of any specific rules or regulation. However, in the
Philippines, the Philippine SEC requires a retention period of seven years from audit report date
under its rules for accreditation of external auditors.