Chapter 4

Audit Responsibility,
Objectives, Evidence and
Documentation
4.2 Audit Evidence and
Documentation
Learning Objectives
4.2.1 Contrast audit evidence with evidence used by other
professions
4.2.2 Identify the four audit evidence decisions that are needed
to create an audit program
4.2.3 Specify the characteristics that determine the
persuasiveness of evidence
4.2.4 Identify and apply the different types of evidence used in
auditing
4.2.5 Know the types of analytical procedures and their
purposes
4.2.6 Identify how auditors incorporate data analytics and other
advanced technologies in an audit
4.2.7 Compute common financial ratios
4.2.8 Understand the purposes of audit documentation
4.2.9 Prepare organized audit documentation
Nature of Evidence
• Evidence is defined as any information used by
the auditor to determine whether the information
being audited is stated in accordance with the
established criteria
– It is the foundation of any audit.
– Evidence varies greatly in the extent to
which it persuades the auditor whether
financial statements are fairly stated.
– The use of evidence is not unique to
auditors, different professionals (Scientists,
lawyers, researchers and historians ) rely on
different types of evidence, to support their
decisions.
– From an audit perspective, evidential matter
consists of the essential accounting data and
all supporting information available to the
auditor.
– The auditor must have the knowledge and
skill to accumulate sufficient appropriate
evidence on every audit to meet the standards
of the profession.
Table 7.1 Characteristics of Evidence for a
Scientific Experiment, Legal Case, and
Audit of Financial Statements
Scientific Experiment
Basis of Legal Case Involving an Audit of Financial
Involving Testing a
Comparison Accused Thief Statements
Medicine
Use of the Determine effects of Decide guilt or innocence Determine whether
evidence using the medicine of accused statements are fairly
presented

Nature of Results of repeated Direct evidence and Various types of audit

evidence used experiments testimony by witnesses evidence generated by
and parties involved the auditor, third parties,
and the client
Party or parties Scientist Jury and judge Auditor
evaluating
evidence
Table 7.1 Characteristics of Evidence for a
Scientific Experiment, Legal Case, and
Audit of Financial Statements
Scientific Experiment
Basis of Legal Case Involving an Audit of Financial
Involving Testing a
Comparison Accused Thief Statements
Medicine
Certainty of Vary from uncertain to Requires guilt beyond a High level of assurance
conclusions near certainty reasonable doubt
from evidence

Nature of Recommend or not Innocence or guilt of Issue one of several

conclusions recommend use of party alternative types of audit
medicine reports
Typical Society uses ineffective Guilty party is not Statement users make
consequences or harmful medicine penalized or innocent incorrect decisions and
of incorrect party is found guilty auditor may be sued
conclusions
from evidence
Audit Evidence Decisions
• There are four decisions auditor needs to
make about what evidence to gather and how
much of it to accumulate:
1. Which audit procedures to use
2. What sample size to select for a given
procedure
3. Which items to select from the population
4. When to perform the procedures
Persuasiveness of Evidence
Audit standards require the auditor to accumulate
sufficient appropriate evidence to support the
opinion issued
• The two determinants of the persuasiveness
of evidence are:
– Appropriateness
– Sufficiency
Persuasiveness of Evidence
Appropriateness of evidence is a measure of:

-The quality of evidence, which includes:

– Relevance—evidence must pertain to or be
relevant to the audit objective that the
auditor is testing
– Reliability—the degree to which evidence can
be believable or worthy of trust
Persuasiveness of Evidence
• The quantity of evidence obtained determines
- its sufficiency.
 It is measured:
– Primarily by the sample size the auditor
selects, which is determined by
 Auditor’s expectation of misstatements
 The effectiveness of the client’s internal
controls
Persuasiveness of Evidence
 IAS 500 requires- the auditor to accumulate sufficient
appropriate evidence (persuading/convincing
evidence) to support the opinion issued.
- By combining all evidence from the entire audit, the
auditor is able to decide when he or she is persuaded
to issue an audit report.
 The two determinants of the persuasiveness of
evidence are :
1. Appropriateness (competence)
2. Sufficiency
• In making decisions about evidence for a given audit,
both persuasiveness and cost must be considered
Persuasiveness of Evidence
1. Appropriateness (Competence)
• Appropriateness/competence of evidence is a measure of
the quality of evidence, I e.,:
- its relevance and reliability in meeting audit
objectives.
-regardless of its form, evidence is considered
appropriate/competent, when it provides
information that is both reliable and relevant
• If evidence is highly appropriate (competent), i.e
• if it provides relevant and reliable information, the
auditor is convinced that financial statements are fairly
stated.
Persuasiveness of Evidence
What does Relevance of Evidence mean?
• The relevance of evidence refers to -whether a particular
type of evidence is pertinent/related to the audit
objective
• If the auditor relies on evidence that is unrelated to the
audit objective, he/she may reach an incorrect
conclusion about a management assertion
Ex: assume an auditor wants to check the completeness
objective for recording sales transactions; I e., are all
goods shipped to customers recorded in sales journal?
Persuasiveness of Evidence
….Relevance of Evidence
• A normal audit procedure for testing this objective
is to trace a sample of shipping documents
(such as delivery orders/bills of lading) to the
related sales invoices and entries in the sales
journal.
o If the auditor samples the population of sales
invoices issued during the period, the evidence
would not relate to the completeness objective
(I e., the auditor would not detect shipments
made but not billed/recorded.
 Persuasiveness of Evidence
• The auditor should check pre-numbered delivery
orders/bills of lading after ascertaining that such
documents were issued for all customer shipments.
• Relevance- can be considered only in terms of
specific audit objectives, because evidence may
be relevant for one audit objective but not for
another.
• In the previous shipping example, if the auditor use
a sample population of sales invoices and trace it
to related shipping documents, and this evidence is
relevant for the occurrence transaction objective.
Persuasiveness of Evidence
What does Reliability /Validity of Evidence
mean?
• The reliability of evidence - refers to whether a
particular type of evidence can be relied upon
to signal the true state of an assertion or audit
objective.
• It is about the degree to which evidence can be
believable or worthy of trust.
- Eg. if an auditor counts inventory, that
evidence is more reliable than if management
gives the auditor its own count amounts.
 Persuasiveness of Evidence
Six characteristics of a reliable/valid and appropriate evidence:
1. Independence of provider: Evidence obtained from a source
outside the entity is more reliable than that obtained from
within.
eg. – reliance on evidence obtained through confirmation from
bank, attorney, customers, and creditors than on inquiry of the
client
- reliance on documents such as insurance policy than using
documents that originate within the firm and never left the
entity, eg. purchase requisition
2. Effectiveness of client’s internal controls: When a client’s internal
controls are effective, evidence obtained is more reliable than
when they are weak.
Persuasiveness of Evidence
3. Auditor’s direct knowledge: Evidence obtained directly by
the auditor through physical examination, observation,
recalculation, and inspection is more reliable than information
obtained indirectly.
4. Qualifications of individuals providing the information:
- Although the source of information is independent, the
evidence will not be reliable unless the individual providing
it is qualified to do so.
eg. - accounts receivable confirmations from persons not
familiar with the business world will not provide reliable
information
-
 - Auditor’s direct observation may not produce reliable
information if the auditor lacks the qualifications to
evaluate the evidence.
eg, examining an inventory of diamonds by an auditor
not trained to distinguish between diamonds and glass is
not reliable evidence for the existence of diamonds.
Persuasiveness of Evidence
What does Reliability /Validity of Evidence mean?
5. Degree of objectivity: Objective evidence is more
reliable than evidence that requires considerable
judgment to determine whether it is correct.
Eg. of objective evidence include
-confirmation of accounts receivable and bank
balances,
- the physical count of securities and cash, and
- adding (footing) a list of accounts payable to
determine whether it agrees with the balance in the
general ledger.
Eg of subjective evidence include
- a letter written by a client’s attorney discussing the
likely outcome of outstanding lawsuits against the
client,
- observation of obsolescence of inventory during
physical examination,
- inquiries of the credit manager about the collectibility
of noncurrent accounts receivable.

-In evaluating the reliability of subjective evidence, the
auditors should assess the qualifications of the person
providing the evidence
Persuasiveness of Evidence
What does Reliability /Validity of Evidence mean?
6. Timeliness: The timeliness of audit evidence can refer either to:
• when it is accumulated or
• the period covered by the audit.
 Evidence is usually more reliable for balance sheet accounts
when it is obtained as close to the balance sheet date as possible.
Eg. the auditor’s count of marketable securities on the balance sheet
date is more reliable than a count 2 months earlier.
Ex. For income statement accounts, evidence is more reliable if there
is a sample from the entire period under audit, such as a random
sample of sales transactions for the entire year, rather than from only
a part of the period, such as a sample limited to only the first 6 months.
Persuasiveness of Evidence
2. Sufficiency of Evidence-
Sufficiency is determined by:
1. the quantity of evidence obtained, ie. by the sample
size the auditor selects and
2. Selection of proper items :
– Sufficiency of evidence can also be affected by the
individual items tested
– Samples containing the following are usually
considered sufficient:
 items with large dollar values,
 items with a high likelihood of misstatement, and
 items that are representative of the population
•
-However, samples that contain only the largest dollar
items from the population may not be sufficient if these
items do not make up a large portion of the total
population amount.
•
In such cases, there will be a risk that the sample may
not be representative.
Table 7.2 Relationships Among Evidence
Decisions and Persuasiveness
Audit Evidence Decisions
Audit procedures and timing
Sample size and items to select
Qualities Affecting Persuasiveness of
Evidence
Appropriateness
Relevance
Reliability
Independence of provider
Effectiveness of internal controls
Auditor’s direct knowledge
Qualifications of provider
Objectivity of evidence
Timeliness
When procedures are performed
Portion of period being audited
Sufficiency
Adequate sample size
Selection of proper population items
Types of Audit Evidence
• Physical examination
– The inspection or count by the auditor of a
tangible asset
• Confirmation
– The receipt of a direct written response from
a third party verifying the accuracy of
information that was requested
• Inspection
– The auditor’s examination of the client’s
documents and records
Types of Audit Evidence
• Analytical procedures
– The evaluations of financial information
through analysis of plausible relationships
among both financial and nonfinancial data
• Inquiries of the client
– The obtaining of written or oral information
from the client in response to questions from
the auditor
Types of Audit Evidence
• Recalculation
– Rechecking a sample of calculations made
by the client
• Reperformance
– The auditor’s independent tests of client
accounting procedures or controls
• Observation
– Consists of looking at a process or
procedure being performed by others
Figure 7.1 Relationships Among Auditing
Standards, Types of Evidence, and the
Four Audit Evidence Decisions
Table 7.4 Appropriateness of Types
of Evidence
Analytical Procedures
• Analytical procedures may be performed at
any of three times during an engagement:
– In the planning phase (required)
– During the testing phase
– During the completion phase (required)
Analytical Procedures
• The usefulness of analytical procedures as audit
evidence depends significantly on appropriate
comparison of data
• Auditors typically compare client data with:
– Industry data
– Similar prior-period data
– Client-determined expected results
– Auditor-determined expected results
Table 7.6 Internal Comparisons and
Relationships
Ratio or Comparison
Raw material turnover for a
manufacturing company
Sales commissions divided by net sales
Sales return and allowances divided by
gross sales
Bad debt expense divided by net sales
Each of the individual manufacturing
expenses as a percent of total
manufacturing expense
Possible Misstatement
Misstatement of inventory or cost of goods
sold or obsolescence of raw material
inventory
Misstatement of sales commission
Misclassified sales returns and allowances
or unrecorded returns or allowances
subsequent to year end
Misstatement in the allowance for bad
debts
Significant misstatement of individual
expenses within a total
Audit Data Analytics
• Audit data analytics (ADA) are:
– The science and art of discovering and
analyzing patterns, identifying anomalies, and
extracting other useful information in data
underlying or related to the subject matter of
an audit through analysis, modeling, and
visualization for purpose of planning or
performing the audit.
Audit Data Analytics
• Fundamental considerations that need to be made by
the auditor to evaluate the appropriate use of ADAs
as an audit evidence-gathering tool include:
– Accessing the data
– Preparing the data
– Evaluate the relevance and reliability of the data
– Address circumstances in which an ADA identifies a
large number of exceptions for further consideration
– Document use of ADA
Audit Data Analytics
• Other advanced technologies that auditors can
leverage to increase the effectiveness and efficiency
of their audit procedures include:
– Artificial intelligence
– Robotics
– Machine learning
– Deep learning
Common Financial Ratios
• Auditors’ analytical procedures often include the use of
general financial ratios during planning and final review of
the audited financial statements
• When using these ratios, auditors must be sure to make
appropriate comparisons
Common Financial Ratios
• Some widely used financial ratios categories include:
– Short-term debt-paying ability
– Liquidity activity ratios
– Ability to meet long-term debt obligations
– Profitability ratios
Audit Documentation
• Audit documentation is the record of the audit procedures
performed, relevant audit evidence obtained, and
conclusions the auditor reached
• It provides:
– A basis for planning the audit
– A record of the evidence accumulated and the results
of the tests
– Data for determining the proper type of audit report
– A basis for review by supervisors and partners
Audit Documentation
• Audit documentation is the property of the auditor
• A member in public practice shall not disclose any
confidential client information without the specific consent
of the client
• Auditing standards require that records for audits of:
– Private companies be retained for a minimum of 5
years
– Public companies to be retained for a period of not
less than 7 years
Contents and Organization
• There is logic to the type of audit documentation
prepared for an audit and the way it is arranged in the
files
• Audit files include:
– Permanent files
 Contain data of a historical or continuing nature
pertinent to the current audit
– Current files
 Include all audit documentation applicable to the
year under audit
Figure 7.3 Audit File Contents and Organization
 End of Chapter 4.2

Questions

Audit I YA AAUSC 2022