Chapter five

5. Audit Evidence
5.1 Meaning of audit evidence

It is defined as any information used by the auditor to determine whether the information being
audited is established in accordance with the established criteria.
The information varies greatly in the extent to which it persuades the auditor whether financial
statements are fairly stated. Evidence includes information that is highly persuasive, such as the
auditor’s count of marketable securities, and less persuasive information, such as responses to
questions of client employees.
5.2 Financial statement assertions (Management Assertions)
Management assertions are implied or expressed representations by management about classes
of transactions and the related accounts and disclosures in the financial statements.
The most common five management assertions are
1. Existence or occurrence;

Occurrence: The occurrence assertion concerns whether recorded transactions included in the
financial statements actually occurred during the accounting period. For example, management
asserts that recorded sales transactions represent exchanges of goods or services that actually
took place.
2. Completeness;
Completeness: This assertion addresses whether all transactions that should be included in the
financial statements are in fact included. For example, management asserts that all sales of goods
and services are recorded and included in the financial statements. The completeness assertion
addresses matters opposite from the occurrence assertion. The completeness assertion is
concerned with the possibility of omitting transactions that should have been recorded, whereas
the occurrence assertion is concerned with inclusion of transactions that should not have been
recorded.
3. Rights and obligations;
Rights and Obligations: This assertion addresses whether assets are the rights of the entity and
whether liabilities are the obligations of the entity at a given date. For example, management
asserts that assets are owned by the company or that amounts capitalized for leases in the balance

1
Audit Evidence
sheet represent the cost of the entity’s rights to leased property and that the corresponding lease
liability represents an obligation of the entity.
4. Valuation or allocation; and
Valuation and Allocation: The valuation and allocation assertion deals with whether assets,
liabilities, and equity interests have been included in the financial statements at appropriate
amounts, including any valuation adjustments to reflect asset amounts at net realizable value. For
example, management asserts that property is recorded at historical cost and that such cost is
systematically allocated to appropriate accounting periods through depreciation. Similarly,
management asserts that trade accounts receivable included in the balance sheet are stated at net
realizable value.
5. Classification and disclosure.
The classification assertion addresses whether transactions are recorded in the appropriate
accounts. Recording administrative salaries in cost of sales is one example of a violation of the
classification assertion. And further is assures that disclosures are clearly expressed

5.3 Audit evidence decision

A major decision facing every auditor is determining the appropriate types and amounts of evidence
needed to be satisfied that the client’s financial statements are fairly stated. There are four decisions about
what evidence to gather and how much of it to accumulate:
1. Which audit procedures to use
An audit procedure is the detailed instruction that explains the audit evidence to be obtained
during the audit. It is common to spell out these procedures in sufficiently specific terms so an
auditor may follow these instructions during the audit. For example, the following is an audit
procedure for the verification of cash disbursements:
o Examine the cash disbursements journal in the accounting system and compare the payee,
name, amount, and date with online information provided by the bank about checks
processed for the account.

2. What sample size to select for a given procedure

Once an audit procedure is selected, auditors can vary the sample size from one to all the items
in the population being tested. In an audit procedure to verify cash disbursements, suppose 6,600
checks are recorded in the cash disbursements journal. The auditor might select a sample size of
50 checks for comparison with the cash disbursements journal. The decision of how many items
to test must be made by the auditor for each audit procedure. The sample size for any given
procedure is likely to vary from audit to audit.

2
Audit Evidence
 3. Which items to select from the population
After determining the sample size for an audit procedure, the auditor must decide which items in
the population to test. If the auditor decides, for example, to select 50 cancelled checks from a
population of 6,600 for comparison with the cash disbursements journal, several different
methods can be used to select the specific checks to be examined. The auditor can (1) select a
week and examine the first 50 checks, (2) select the 50 checks with the largest amounts, (3)
select the checks randomly, or (4) select those checks that the auditor thinks are most likely to be
in error. Or, a combination of these methods can be used.

4. When to perform the procedures

An audit of financial statements usually covers a period such as a year. Normally an audit is not
completed until several weeks or months after the end of the period. The timing of audit
procedures can therefore vary from early in the accounting period to long after it has ended. In
part, the timing decision is affected by when the client needs the audit to be completed. In the
audit of financial statements, the client normally wants the audit completed 1 to 3 months after
year-end. The SEC currently requires that all public companies file audited financial statements
with the SEC within 60 to 90 days of the company’s fiscal year-end, depending on the
company’s size. However, timing is also influenced by when the auditor believes the audit
evidence will be most effective and when audit staff is available. For example, auditors often
prefer to do counts of inventory as close to the balance sheet date as possible.

5.4 Persuasiveness of Audit Evidence

Audit standards require the auditor to accumulate sufficient appropriate evidence to support the
opinion issued. Because of the nature of audit evidence and the cost considerations of doing an
audit, it is unlikely that the auditor will be completely convinced that the opinion is correct.
However, the auditor must be persuaded that the opinion is correct with a high level of
assurance. 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.

3
Audit Evidence
The two determinants of the persuasiveness of evidence are:
1. Appropriateness of evidence
Appropriateness of evidence is a measure of the quality of evidence, meaning its relevance
(evidence must pertain to or be relevant to the audit objective that the auditor is testing before it
can be appropriate) and reliability (the degree to which evidence can be believable or worthy of
trust) in meeting audit objectives for classes of transactions, account balances, and related
disclosures. If evidence is considered highly appropriate, it is a great help in persuading the
auditor that financial statements are fairly stated.

Reliability, and therefore appropriateness, depends on the following six characteristics of reliable
evidence:

1. Independence of provider. Evidence obtained from a source outside the entity is more
reliable than that obtained from within. Communications from banks, attorneys, or customers
is generally considered more reliable than answers obtained from inquiries of the client.
Similarly, documents that originate from outside the client’s organization, such as an
insurance policy, are considered more reliable than are those that originate within the
company and have never left the client’s organization, such as a 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. For example, if internal controls
over sales and billing are effective, the auditor can obtain more reliable evidence from sales
invoices and shipping documents than if the controls were inadequate.
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. For example, if the auditor calculates the gross margin as a percentage of
sales and compares it with previous periods, the evidence is more reliable than if the auditor
relies on the calculations of the controller.
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. Therefore, communications from attorneys and bank confirmations are typically
more highly regarded than accounts receivable confirmations from persons not familiar with
the business world. Also, evidence obtained directly by the auditor may not be reliable if the
auditor lacks the qualifications to evaluate the evidence. For example, examining an

4
Audit Evidence
 inventory of diamonds by an auditor not trained to distinguish between diamonds and glass is
not reliable evidence for the existence of diamonds.
5. Degree of objectivity. Objective evidence is more reliable than evidence that requires
considerable judgment to determine whether it is correct. Examples 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. Examples 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, and
inquiries of the credit manager about the collectability of noncurrent accounts receivable.
When the reliability of subjective evidence is being evaluated, it is essential for auditors to
assess the qualifications of the person providing the evidence.
6. Timeliness. The timeliness of audit evidence can refer either to when it is accumulated or to
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. For example, the auditor’s
count of marketable securities on the balance sheet date is more reliable than a count 2
months earlier. 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.
2. Sufficiency.

The quantity of evidence obtained determines its sufficiency. Sufficiency of evidence is

measured primarily by the sample size the auditor selects. For a given audit procedure, the
evidence obtained from a sample of 100 is ordinarily more sufficient than from a sample of 50.
Several factors determine the appropriate sample size in audits. The two most important ones
are:
1. The auditor’s expectation of misstatements
2. The effectiveness of the client’s internal controls.

5
Audit Evidence
5.5 Types of Audit evidence
In deciding which audit procedures to use, the auditor can choose from eight broad categories of
evidence, which are called types of evidence. Every audit procedure obtains one or more of the
following types of evidence:
1. Physical examination
It is the inspection or count by the auditor of a tangible asset. 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. There is a distinction in auditing between the physical
examination of assets, such as marketable securities and cash, and the examination of documents,
such as cancelled checks and sales documents. If the object being examined, such as a sales
invoice, has no inherent value, the evidence is called documentation. For example, before a
check is signed, it is a document; after it is signed, it becomes an asset; and when it is cancelled,
it becomes a document again. For correct auditing terminology, physical examination of the
check can occur only while the check is an asset. Physical examination is a direct means of
verifying that an asset actually exists (existence objective), and to a lesser extent whether
existing assets are recorded (completeness objective). It is considered one of the most reliable
and useful types of audit evidence. Generally, physical examination is an objective means of
ascertaining both the quantity and the description of the asset. In some cases, it is also a useful
method for evaluating an asset’s condition or quality. However, physical examination is not
sufficient evidence to verify that existing assets are owned by the client (rights and obligations
objective), and in many cases the auditor is not qualified to judge qualitative factors such as
obsolescence or authenticity (realizable value objective). Also, proper valuation for financial
statement purposes usually cannot be determined by physical examination (accuracy objective).
2. Confirmation
Confirmation describes 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 electronic or
paper form. The request is made to the client, and the client asks the third party to respond
directly to the auditor. Because confirmations come from sources independent 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.

6
Audit Evidence
 3. Documentation

Documentation is the auditor’s inspection of the client’s documents and records to substantiate
the information that is, or should be, included in the financial statements. The documents
examined by the auditor are the records used by the client to provide information for conducting
its business in an organized manner, and may be in paper form, electronic form, or other media.
Documents can be conveniently classified as internal and 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. An external document has been handled by someone outside the
client’s organization who is a party to the transaction being documented, but which are either
currently held by the client or readily accessible.
4. Analytical procedures
Analytical procedures use comparisons and relationships to assess whether account balances or other
data appear reasonable compared to the auditor’s expectations. For example, an auditor may compare the
gross margin percent in the current year with the preceding years. Analytical procedures are used
extensively in practice, and are required during the planning and completion phases on all audits.
Examples
A. Understand the Client’s Industry and Business
B. Assess the Entity’s Ability to Continue as a Going Concern
C. Indicate the Presence of Possible Misstatements in the Financial Statements
D. Reduce Detailed Audit Tests
5. Inquiries of the client
Inquiry is the obtaining of written or oral information from the client in response to questions
from the auditor. Although considerable evidence is obtained from the client through inquiry, it
usually cannot be regarded as conclusive because it is not from an independent source and may
be biased in the client’s favor. Therefore, when the auditor obtains evidence through inquiry, it is
normally necessary to obtain corroborating evidence through other procedures. (Corroborating
evidence is additional evidence to support the original evidence.) As an illustration, when the
auditor wants to obtain information about the client’s method of recording and controlling
accounting transactions, the auditor usually begins by asking the client how the internal controls
operate. Later, the auditor performs audit tests using documentation and observation to determine

7
Audit Evidence
whether the transactions are recorded (completeness objective) and authorized (occurrence
objective) in the manner stated.
6. Recalculation
Recalculation involves 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 sub sidiary records,
and checking the calculation of depreciation expense and prepaid expenses. A considerable
portion of auditors’ recalculation is done by computer assisted audit software.
7. Reperformance
Reperformance is the auditor’s independent tests of client accounting procedures or controls
that were originally done as part of the entity’s accounting and internal control system. Whereas
recalculation involves rechecking a computation, reperformance involves checking other
procedures. For example, the auditor may compare the price on an invoice to an approved price
list, or may reperform the aging of accounts receivable. Another type of reperformance is for the
auditor to recheck transfers of information by tracing information included in more than one
place to verify that it is recorded at the same amount each time. For example, the auditor
normally makes limited tests to ascertain that the information in the sales journal has been
included for the proper customer and at the correct amount in the subsidiary accounts receivable
records and is accurately summarized in the general ledger.
8. Observation
Observation is the use of the senses to assess client activities. Throughout the engagement with
a client, auditors have many opportunities to use their senses sight, hearing, touch, and smell to
evaluate a wide range of items. 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. Observation is rarely sufficient by
itself because of the risk of client personnel changing their behavior because of the auditor’s
presence. They may perform their responsibilities in accordance with company policy but
resume normal activities once the auditor is not in sight. Therefore, it is necessary to follow up
initial impressions with other kinds of corroborative evidence. Nevertheless, observation is
useful in most parts of the audit.

8
Audit Evidence