In auditing, an auditor cannot just form an opinion on the state of a company’s financial statements without first gathering information and analyzing if the information gathered corroborates with the assertions by the company’s management in the financial statement of the company.
What is Audit Evidence?
Audit evidence consists of information that auditors come across in the course of an audit In order to assist in the process of forming an independent opinion on an enterprise’s financial statements. The primary objective of an auditor is to express an opinion on the truth and fairness of a client’s financial statements. To successfully discharge his duties and auditor must endeavor to generate sufficient evidence to back up the facts and figures in the financial statement presented to the users of the account.
Types of Audit Evidence
- Self-generated audit evidence: Audit evidence generated by auditors during the process of auditing a company’s financial statements can be classified as self-generated audit evidence. Self-generated audit evidence can arise as a result of physical inspection of procedures, for example attendance at a client’s stock taking, enquiries to responsible officials and performing calculations including analytical review of procedures.
- Internally generated audit evidence: As the name implies, internally generated audit evidence is generated from the client’s environment. Internally generated audit evidence can be gotten from interim management accounts, cash flows and profit forecasts, accounting records, internal audit reports etc.
- Externally generated audit evidence: As you guessed, externally generated audit evidence is the exact opposite of internally generated audit evidence. It is simply any evidence generated outside the client’s environment. Such audit evidence can be gotten from third parties with business relationships with the company. Third parties mentioned above may include suppliers, banks, customers and solicitors. Aside third parties, audit evidence may also be derived from journals, newspapers, magazines etc. Where two types of audit evidence are contradictory in material respect, the auditor is advised to investigate and reconcile them. If on the other hand, two types of evidence are in agreement with one another, the cumulative degree of assurance to the auditor is far higher than the sum of the assurance that will be derived from each type of evidence when taken separately. This is known as the synergy effect of audit evidence.
An auditor according to the international standard of accounting No 500 is required to obtain sufficient, appropriate audit evidence to be able to base the audit opinion on. What is sufficiency and appropriateness as it relates to audit evidence? In simple terms, sufficiency is the measure of the quality of audit evidence. To ascertain if the audit evidence is appropriate, we check its relevance or reliability.
Let’s briefly take a look at each of the key terms. i.e. sufficiency of audit evidence, relevance of audit evidence and reliability of audit evidence.
Audit evidence sufficiency
As already established above, sufficiency is the measure of the quantity of audit evidence. For an audit evidence to be deemed sufficient, the following issues would have to be addressed by the auditors.
- Materiality: In accounting, materiality is the threshold above which any distorted, missing and incorrect information in the financial statement is considered to have an impact on decision making by the users of accounting information. In auditing, it is important for the auditor to determine at the planning stage, the level at which occurrence of errors would be unacceptable to the auditor. If an auditor assumes a particular transaction to be material either in absolute or relative terms, the auditor should perform more substantive test so as to satisfy the auditor as to the completeness, accuracy and validity of the transaction.
- Audit risk assessment: It is almost impossible, no matter how hardworking and adept an auditor is, to verify every single transaction that takes place in a client’s book. For a more practicable approach, auditors usually select a sample of the population that contains those characteristics that are general to the entire transaction in the population. The objective of embarking on sampling audit test is to reduce errors to an acceptable level and at the same time recognize the fact that errors cannot be completely eliminated.
- Economy: When embarking on gathering audit evidence, the auditor should consider whether or not it is feasible to generate a particular audit evidence by comparing the cost of gathering such audit evidence to the benefits or value sought to be added to the audit process as a whole.
Audit Evidence Relevance
Audit evidence is said to be relevant if the audit evidence in question will assist the auditor in forming an opinion on the client’s financial statements to meet the audit’s objective.
To determine the relevance of a particular audit evidence, the auditor should give consideration to the following:
- If the audit evidence in question meets more than one audit test objective
- If the least time consuming source is being used when there are alternative sources of evidence.
Audit Evidence Reliability
The reliability of audit evidence is influenced by its source and its nature, and also on the individual circumstances under which it is obtained. In the ranking order of audit evidence, a documentary evidence is believed to be more reliable than oral evidence, so also is a self-generated evidence more reliable than evidence gathered elsewhere. Externally generated evidence is more reliable than internally generated evidence as internally generated evidence are more susceptible to manipulations by employees of the company.
Sources of Audit Evidence
In this section, we would look at some viable sources for gathering audit evidence by the auditor. Audit evidence can be derived from the following sources:
- Customers: Customers of the company are those the company sells its goods and services to. When a sale is made, it is normal for both the seller (the company) and buyer (the customer) to have the transaction recorded in their accounting books. This would therefore constitute a major source of audit evidence in confirming balances due to the company at the year end by carrying out a circularization of the customers.
- Management and employees: An auditor has the right to interview and make enquiries to employees or management when carrying out his duty. The auditor may need to clarify a certain transaction by making enquiries to the above parties. Their replies thereof would constitute a major source of audit evidence
- Accounting systems and documentation: Accounting systems may be computerized or manual. They show the flow of transactions leading to the preparation of financial statement. This is a major source of evidence because it shows documentary evidence of transactions. As such an auditor has a duty to access its adequacy as a basis for preparing the financial statements. The auditor will need to carry out walk through tests on the accounting systems in order to provide evidence that the system works in practice as documented.
- Suppliers: Suppliers like customers have business relationships with the company, and in authenticating the validity of purchases made from them, and the balance due to them by the client, they can also be circularized by the auditors.
Methods of Generating Audit Evidence
Audit evidence can be gathered through the following methods:
- Observation: The auditor observes operations or procedures being performed by others with the aim of determining the manner of its performance only at that particular time.
- Inspection: The auditor physically inspects what the company asserted to be true in the financial statement. For this, the auditor inspects records and documents to provide evidence of varying degrees of reliability depending on their nature and source. It should be noted that the inspection of tangible assets provides evidence as to their existence but not necessarily as to their ownership, cost or value.
- Analytical review: This involves the auditor reviewing relationships between two or more financial data, non-financial data or a mixture of both. Unusual variations are flagged for further audit investigations.
- Computations: Here, the auditor checks the arithmetical accuracy of accounting records, or performs independent calculations.
- Enquiry: Here the auditor seeks to gather audit evidence by interviewing knowledgeable persons or corporate entities either within or outside the company being audited. Enquiries can be either formal or informal, oral or written.
O. Ray Whitting.,Wiley CPAexcel Exam Review: Auditing and Attesting