1. finance
2. accounting and auditing

Chapter
7
Introduction to audit evidence and
FS assertions
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CHAPTER CONTENTS
 Audit Evidence
 Financial Statement Assertions
 Audit procedures to obtain audit evidence
 Reliance on the work of others
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Audit Evidence
 What is Audit Evidence
Audit evidence is all of the information used by the auditor in arriving
at the conclusions on which the audit opinion is based
• 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
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Audit Evidence
 Sufficiency
• Sufficiency is affected by:
 Risk
o The riskier an item is, the more evidence the auditors should obtain
over that item.
 Materiality
o The more material an item is, the more evidence the auditors should
obtain.
 Reliability
o The less reliable audit evidence is, the more if it is needed and vice
versa.
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Audit Evidence
 Reliability and relevance
To be useful, audit evidence must be reliable in terms of its source and
its nature.
Audit evidence is relevant if it proves (or goes some way to proving) one
or more of the financial statement assertions.
With respect to the relevance and reliability of audit evidence we can say
that:
 Third party (independent) evidence is more reliable than client
generated evidence
o External evidence is better than the entities records. For example,
looking at a bank statement or a bank certificate is very good
evidence about how much cash was in the bank account to particular
date.
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Audit Evidence
 Reliability and relevance
 Auditor generated evidence is more reliable than client generated
evidence
o Evidence obtained directly by the auditor is better than evidence
passed on by the clients. The problem is that the evidence is passed
on by the client you don’t know it’s complete. The client could be
suppressing information they don’t want you to see.
 Evidence from well controlled systems is more reliable than evidence
from poorly controlled systems
o Audit evidence is better if there is a good internal control system. A
good internal control system should mean that the checking
performed by the client reduces a likelihood of errors been made.
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Audit Evidence
 Reliability and relevance
 Written evidence is more reliable than oral evidence
o Written evidence is much better than oral. Someone once said oral
evidence isn’t worth the paper it is written on. If evidence is oral
what evidence do you, the auditor, have you actually received it..
 Original documents are more reliable than photocopies
o Originals are better than photocopies. Nowadays with scanners and
graphics programs it’s very easy to alter documents and these
alterations are very difficult to spot. Therefore originals contracts
and documents of title should be cited. The auditor may take a
photocopy to keep on their audit file, but they should be taken from
the original documents.
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Financial Statement Assertions
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 Income
Statement or a balance on the Statement of Financial Position.
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Financial Statement Assertions
The income statement assertions
 The auditors must test the transactions in the Income Statement for:
 Occurrence
o Auditors must devise tests to ensure that the transactions in the
income statement actually took place during that year
 Completeness
o Auditors must devise tests to ensure that all of the transactions that
took place during the year have actually been recorded in the
income statement
 Accuracy
o Auditors must devise tests to ensure that all of the transactions that
took place during the year have been recorded at the correct
amounts
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Financial Statement Assertions
The income statement assertions
 Cut off
o 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
o Auditors must devise tests to ensure that the transactions have been
recorded in the correct account balances e.g. interest payments
recorded as ‘finance costs’ and not ‘admin expenses’
 Presentation and Disclosure
o Auditors must devise tests to ensure that the transactions have been
presented and disclosed in accordance with the relevant financial
reporting framework
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Financial Statement Assertions
The statement of financial position assertions
 The auditors must test items on the statement of financial position for:
 Existence
o Auditors must devise tests to ensure that the items on the balance
sheet actually exist in real life
 Completeness
o Auditors must devise tests to ensure that all of the items pertaining to
the company (its assets, liabilities etc) have been recorded on the
balance sheet
 Rights and Obligations (OWNERSHIP)
o Auditors must devise tests to ensure that all of the assets on the
balance sheet are owned by the company and all of the liabilities are
an obligation of the company
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Financial Statement Assertions
The statement of financial position assertions
 Valuation
o Auditors must devise tests to ensure that the balances are recorded at
the correct value
 Presentation and Disclosure
o Auditors must devise tests to ensure that the transactions have been
presented and disclosed in accordance with the relevant financial
reporting framework
Essentially a financial statement assertion means whenever a figure
appears in the financial statements it is making certain claims,
proclamations or assertions. It is for example saying, “Here I am, I am
the receivables figure, and because I am printed in the balance sheet I
am saying certain things”.
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Financial Statement Assertions
I am saying that I am:
 Accurate.
 Complete. That all receivables are included
 Cut-off is correct. In other words, a receivable is present if a sale was
made during the financial year and not yet paid for, that the
receivables are
 Allocated. More to do with expense items that might need to be
allocated properly into inventory values.
 Classification and understandability, the transactions giving rise to
the receivable have been recorded in the proper accounts and are
properly presented in the financial statements
 Occurrence that the sale giving rise to the receivable occurred in the
period
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Financial Statement Assertions
 Valuation. That the receivable is properly valued, taking into account
the risk of non-recoverability.
 Existence. That the receivable balance actually exists.
 Rights and obligations. That we own the receivable, that we haven’t,
for example, assigned that debt to some third party
 Note that these assertions form the phrase ‘ACCA COVER’
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Audit procedures to obtain audit
evidence
The auditor obtains audit evidence by undertaking audit procedures to do
the following:
 Obtain an understanding of the entity and its environment to assess
risks (risk assessment procedures).
 Test operating effectiveness of controls (tests of controls).
 Detect misstatements (substantive procedures).
Substantive Tests
 Substantive Tests – where the contents of the FS are checked by
looking for evidence that proves the figures and words are correct
Tests of Controls
 where the systems that produce and protect the contents of the FS are
checked. If the systems work, then the resulting FS should be
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accurate.
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Audit procedures to obtain audit
evidence
 Evidence gathering techniques
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)
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Audit procedures to obtain audit
evidence
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.
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 /
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returned by the customer.
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Reliance on the work of others
Auditors may choose not to do audit work themselves, but rely on work
carried out by others:
 Experts, such as:
 lawyers
 valuers
 industry experts
 The client's Internal auditors
 Another firm of external auditors.
Sometimes, in specialist areas, the auditor may have no choice but to use
the advice of experts
In the case of the client's internal auditors, it is more likely a matter of
efficiency – internal and external auditors perform some similar tasks,
and if the internal auditors have already performed work that the
external auditors want to do themselves, it may make sense to check the
internal auditors have done their work properly, then place reliance on
it.
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Reliance on the work of others
But ...
The External Auditor keeps full responsibility for their audit opinion ...
so when relying on the work of others, it is essential to make sure these
people's work is RELIABLE:
 Are they suitably qualified?
 Do they have the experience?
 Are they independent of the client
 Did they carry out their work in a professional manner, planning and
documenting their process and following professional standards where
appropriate?
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