AUDIT EVIDENCE

Introduction
The foundation of any audit is the evidence gathered and evaluated by the auditor. The auditor
must have the knowledge and skill to accumulate sufficient and competent evidence to every
audit to meet the standards of profession. This chapter deals with the types of evidence decisions
auditor make, the evidence available to auditors, and the use of that evidence in performing an
audit.
5.1. Nature of Evidence
Audit evidence is any information used by the auditor to determine whether the information
being audited is stated in accordance with the established criteria. The information varies greatly
in the extent to which it persuades the auditor whether the financial statements are stated in
accordance with Generally Accepted Accounting Principles. Evidence includes information that
is highly persuasive, such as the auditor's count of marketable securities, and less persuasive
information, such as response to questions of client employees.

5.2. The Audit Evidence Decision

A major decision facing every auditor is determining the appropriate types and amounts of
evidence to accumulate to be satisfied that the components of the client's financial statements are
fairly stated. This judgment is important because of the prohibitive cost of examining and
evaluating all available evidence. For example, in an audit of financial statement, of most
organizations, it is impossible for CPA firm to examine the contents of all computer files or
available evidence such as cancelled checks, vendors' invoices, customer orders, payroll time
cards, and the many other types of documents and orders. The auditor's decision on evidence
accumulation can be broken down into the following four sub decisions.
1) Which audit procedure 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 procedure
1. Audit Procedure: an audit procedure is the detailed instruction for the collection of audit evidence
that is to obtain at some time during the audit. In designing audit procedures, it is common to spell
them out in sufficiently specific to permit their use as instructions during the audit. For example,
the following is an audit procedure for the verification of cash disbursements:
 Obtain the cash disbursements journal and compare the payer name, amount, and date on
the cancelled checks with the disbursements journal
2. Sample size: Once an audit procedure is selected, it is possible to vary the sample size from one to
all the items in the population being tested. In the audit procedure above, suppose 6,600 checks are
recorded in the cash disbursement journal. The auditor may select a sample size of 200 checks for
comparison with the cash disbursement 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.
3. Items to select: After the sample size has been determined for an audit procedure, it is still
necessary to decide which items in the population to test. If the auditor decides, for example, to
select 200 cancelled checks from population of 6,600 for comparison with the cash disbursement
journal, several deferent methods can be used to select the specific checks to be examined. The
auditor could (1) select a week and examine the first 200 checks (2) select the 200 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 could be used.

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4. Timing: Auditor of financial statements usually covers a period such as a year, and an audit is
usually 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.

Activity
1. Define the audit evidence
2. Describe the four basic audit evidence decisions

5.3. Persuasiveness of Evidence

The third standard of fieldwork requires the auditor to accumulate sufficient and competent
evidence to support the opinion issue. Because of the nature of the audit evidence and the cost
consideration 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 his/her 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/she is persuaded to issue and audit report.
The two determines of the persuasiveness of evidence are Competence and sufficiency, which
are taken directly from the third standard of fieldwork.
5.3.1. Competence: Competence of evidence refers to the degree to which evidence can be
considered believable or worthy of trust. If evidence is considered highly competent, it is a great
help in persuading the auditor that financial statements are fairly stated. For example, if an
auditor counted the inventory, that evidence would be more competent than if management gave
the auditor its own figure. In most cases, the term reliability of evidence is being used
synonymously with competence.
Competence of evidence deals only with the audit procedures selected. Competence cannot be
improved by selecting a larger sample size or different population items. It can be improved only
by selecting audit procedures that contain a higher quality of one or more of the following seven
characteristics of the competent evidence: Relevance, independence of provider, effectiveness of
client's internal control, auditor's direct knowledge, qualification of individuals proving the
information, degree of objectivity, and timeliness.
1. Relevance: Evidence must pertain to or be relevant to the audit objective that the auditor is
testing before it can be reliable. For example, assume that the auditor is concerned that a client is
failing to bill customers for shipments (completeness objective). If the auditor selected a sample
of duplicate sales invoices and traced each to related shipping document s, the evidence would
not be relevant for the completeness objective and therefore, would not be considered reliable
evidence for that objective. A relevant procedure would be to trace a sample of shipping
documents to related duplicate sales invoice to determine whether each had been billed. The
second audit procedure is relevant and the first is not because the shipment of goods is the
normal criterion used for determining whether a sale has occurred and should have billed. By
tracing from shipping, documents to duplicate sales invoices, the auditor can determine whether
shipment have been billed to customers. When the auditor traces from duplicated sales invoices,
to shipping documents, it is impossible to find unbilled shipments. Relevance can be considered
only in terms of specific audit objectives. Evidence may be relevant to one audit objective but
not to a different one.
1. Independence of provider: Evidence obtained from a source outside the entity is more
reliable than that obtained from within. For example, external evidence such as

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 communication 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 are considered more reliable than are those that originate
within the company and have never left the client's organization.
2. Effectiveness of client's internal control: When a client's internal controls are effective,
evidence obtained is more reliable than when they are weak. For example, if internal control
over sales and bills are effective, the auditor could obtain more competent evidence from
sales invoices and shipping documents than if the controls were independent.
3. Auditor's direct knowledge: Evidence obtained directly by the auditor through physical
examination, observation, computation, and inspection is more competent 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 would be more reliable than if the
auditor relied on the calculations of the controller.
4. Qualification 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 he/she lacks the qualification to evaluate the evidence.
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
includes confirmation of accounts receivables 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. Example of subjective evidence include a letter
written by clients attorneys discussing the likely outcome of outstanding lawsuit against the
client, observation obsolescence of inventory during physical examination, and inquires of
the credit manager about the collectability of non current account receivable when the
reliability of subjective evidence is began evaluated, the qualification of the person providing
the evidence are important.
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 would be more reliable than the
count two months earlier. For income statement accounts, evidence is more reliable if there is
a sample from the entire period under audit rather than from only a part of the period.

Activity
1. What kind of information is considered to be persuasive?
2. Discuss factors that increase the competence of audit evidence
5.3.2. 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 size of 200 would ordinarily be more sufficient
than from a sample of 100. Several factors determine the appropriate sample size in audit.
The two most important ones are:
1. The auditor's expectation of misstatement

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2. Effectiveness of internal control
If the auditor concludes that there is a high likelihood of obsolete inventory because of the nature
of the client's industry, the auditor would sample more inventories for obsolescence in an audit
such as this than one where the likelihood of obsolescence was low. Similarly, if the auditor
concludes that the client's internal control is effective, over fixed assets, a smaller sample size in
the audit of acquisition of fixed assets is warranted.

In addition to sample size, the individual items tested affect the sufficiency of evidence.
Samples containing population items with larger dollar values, items with a large likelihood of
misstatement, and items that are representative of the population are usually considered
sufficient. In contrast, most auditors would usually consider samples insufficient that contain
only the largest dollar items from the population unless these items make up a large portion of
the total population amount.
Persuasiveness of evidence can be evaluated only after considering the combination of
competence and sufficiency, including the effects of the factors influencing competence and
sufficiency. A large sample of evidence provided by an independent party is not persuasive
unless it is relevant to the audit objective being tested. A large sample of evidence that is relevant
but not objective is not persuasive. Similarly, a small sample of only one or two piece of highly
competent evidence also typically lacks persuasiveness. The auditor must evaluate the degree to
which both competence and sufficiency, including all factors influencing them, have been met
when determining the persuasiveness of evidence.

Persuasiveness and cost: in making decisions about evidence for a given audit, both
persuasiveness and cost must be considered. It is rare when only one type of evidence is
available for varying information. The persuasiveness and cost of all alternatives should be
considered before selecting the best type. The auditor's goal is to obtain a sufficient amount of
competent evidence at the lowest possible total cost. However, cost is never an adequate
justification for omitting a necessary procedure or not gathering sample size.

5.4. Types of Audit Evidence

In making which audit procedures to use, the auditor can choose from seven broad categories of
evidence. These categories, called types of evidence, are listed below and defines are discussed
in this section.
1. Physical examination 2, Confirmation 3, Documentation
4, Observation 5, Inquiry of the client 6, Re-performance 7, Analytical Procedure
5.4.1. Physical Examination: Is the inspection or count by the auditor of tangible assets. 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. The distinction between the
physical examination of assets, such as marketable securities and cash, and the examination of
documents such cancelled checks and sales documents, is important for auditing purpose. If the
object being examined; such as a sales invoices, has no inherent value, the evidence is called
documentation. For example, before check is signed, it is documented; after it is signed, it
becomes an asset; and when it is cancelled, it becomes a document again. Typically, physical
examination of the checks can occur only while the check is an asset. Physical examination,
which is a direct means of verifying that an assets actually exists (existence objective), is
regarded as one of the most reliable and useful types of audit evidence. Generally, physical
examination is an objective means of ascertaining both the quality and the description of the

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assets. In some case, 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 (net realizable value objective).
Also, proper valuation for financial statement purpose usually cannot be determined by physical
examination (accuracy objective).
5.4.2. Confirmation: Describes the receipt of a written or oral response from an independent
third party verifying the accuracy of information that was required by the auditor. The request is
made to the client, and the client asks the independent third party to respond directly to the
auditor. Because the confirmation comes from sources independent of 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. Because of the high reliability of confirmations,
auditors typically obtain written response rather than oral ones when it is practical. Written
confirmations are easier for supervisors to review, and they provide better support if it is
necessary to demonstrate that a confirmation was received.

Whether or not confirmations should be used depends on the reliability needs of the situation as
well as the alternative evidence available. Traditionally, confirmations are seldom used in the
audit of fixed asset additions because these can be verified adequately by documentation and
physical examination. Similarly, confirmations are ordinarily not used to verify individual
transactions between the organizations, such as sales transactions, such as sale transactions,
because the auditor can use documents for that purpose.

SAS 67 (AU 330) identifies three common types of confirmation used by auditors.
2.1. A Positive confirmation with a request for information to be supplied by the
recipient. A positive confirmation means that the recipient is requested to return
confirmation in all circumstances. When the auditor does not receive a response to a positive
confirmation, it is common to send a second or third request and in some cases even request
the client to contact the independent third party and ask for a response to the auditor. If other
efforts failed, or are considered too costly, the auditor may be able to use different evidence
to satisfy the audit objective. This evidence is called alternate procedure.
2.2. Positive confirmation with the information to be confirmed includes on the form.
This type of confirmation is considered less reliable than the first one because the recipient
may sign the confirmation and return it without carefully examining the information
2.3. Negative confirmation. A negative confirmation means that the recipient is requested to
respond only when the information is incorrect. Because the confirmations are considered
significant evidence only when returned, negatives are considered less competent than
positive confirmations.
Note although confirmation is not required for any accounts other than account receivable, this
type of evidence is useful in varying many type of information. This major types of information
that are often confirmed, along with the source of confirmation are indicated as follows.
Information Source
Cash in bank Bank
Accounts receivable Customers

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Notes Receivable Maker
Owned inventory on Consignment Consignee
Accounts Payable Creditor
Notes Payable Lender
Advance from Customers Customer
Mortgage Payables Mortgager
Bonds Payable Bondholder
Shares Outstanding Register and transfer agent
Insurance Coverage Insurance company
Contingent Liabilities Bank, Lender and Client's legal counsel
Bond Issuance agreements Bondholder
Collateral held by Creditors Creditor

To be considered reliable evidence, confirmations must be controlled by the auditor from the
time they are prepared until they are returned. If the clients controls the preparation of the
confirmation, does the mailing, or, receives the responses, the auditor has lost control and with it
independence; thus, the reliability of the evidence is reduced.
5.4.3. Documentation: Documentation is the auditor's examination 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. Because each transaction in the client's
organization is normally supported by at least one document, there is a large volume of this type
of evidence available. For example, the client often retains a customer order, a shipment
document, and duplicate sales invoices for each sales transaction. These same documents are
useful evidence for verification by the auditor of the accuracy of the client's records for sales
transaction. Documentation is form evidence widely used in every audit because it is usually
readily available to the auditors at a relatively lower cost. Sometimes it is the only reasonable
type of evidence available.
Documents can be conveniently classified as internal and external.
An internal documents is one that has been prepared and used within the client's organization and
is retained without ever going to outside party such as a customer or a vendor. Examples of
internal documents include duplicate sales invoices, employees' time reports, and inventory
receiving reports.
An external document is one that has been in the hands of some one outside the client's
organization who is a party to the transaction being documented, but which is either currently in
the hands of the client or readily accessible. Example of this type of external documents
vendors' invoices, cancelable notes payable and insurance policies.
The primary determinants of the auditor's willingness to accept a document as reliable evidence
is whether it is internal or external and, when internal, whether it was created and processed
under condition of good internal control . Internal documents created and processed under
condition of weak internal control may not constitute reliable evidence.
Because external documents have been in the hands of both the client and another party to the
transaction, there is some indication that both members are in agreement about the information
and the condition stated on the documents. Therefore, external documents are considered more
reliable evidence than internal once.

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When auditors use documentation to support recorded transactions or amounts it is often called
Vouching.

Activity
1. What are the major factors that affect the sample size?

2. Differentiate between physical examination from confirmation

3. Discuss the three types of confirmation used by auditors

5.4.4. Observation: Is the use of the senses to assess certain activities. Throughout the audit,
there are many opportunities to exercise sight, hearing, touch, and smell to evaluate a wide
range of items. For example, the auditor may tour the plant to obtain a general impression of
the client's facilities, observe whether equipment is rusty to evaluate whether it is obsolete,
and which watch individuals perform accounting tasks to determine whether the person
assigned responsibility is performing it. Observation is rarely sufficient by itself because,
there is a risk that the client personnel involved in those activities are aware of the auditor's
presence. Therefore, they may perform their responsibilities in accordance with company
policy, but resume normal activities once the auditor is not incite.
5.4.5. 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 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 further
corroborating evidence though other procedures.
5.4.6. Re-performance: As the word implies, re-performance involves rechecking a sample of
the computations and transfer of information made by the client during the period under
audit. Rechecking of computation consists of testing the client's arithmetical accuracy. It
includes such procedures as extending sales invoices and inventory, adding journals and
subsidiary records, and checking the calculation of depreciation expense and prepaid
expenses. Rechecking of transparence of information consists of tracing amounts to be
confident that when the same information is included in more than one place, it is recorded at
the same amount each time.
5.4.7Analytical Procedures: Analytical procedures are defined by SAS (AU 329) as evaluations
of financial information made by a study of relationships among financial and non financial
data…..involving comparisons of recorded amounts to expressions developed by auditors. It
uses comparisons and relationships to assess whether account balances or other data appears
reasonable. An example is comparing the gross margin percent in the current year with the
preceding years. The auditing standard board has concluded that analytical procedures are so
important that they required during the planning and completion phase on all audit.
Importance of Analytical Procedures
1. Enable to understand client's industry and business
Generally, an auditor considers knowledge and experience about a client company obtained in
prior years as a starting point for planning the audit for the current year. By conducting analytical

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procedures in which the current year's unaudited information is compared with prior years'
audited information, changes are highlighted. The changes represent important trends or specific
events, all of which will influence audit planning.
For example, a decline in gross margin percentages overtime may indicate increasing
competition in the company's market area, and the need to consider inventory pricing more
carefully during the audit. Similarly, an increase in the balance in fixed assets may indicate a
significant acquisition that must be reviewed.
2. Enable to assess the entity's ability to continue as going concern
Analytical procedures are often useful as an indication that the client company encountering
severe financial difficulty. The likelihood of financial failure must be considered by the auditor
in the assessment of audit related risks, as well as in connection with management's use of the
ongoing concern assumptions in preparing the financial statements. For example, if a higher than
normal ratio of long-term debt to net worth is combined with a lower than average ratio, of
profits to total assets, a relatively high risk of financial failure may be indicated. Not only would
such condition affect the audit plan, they may indicate that substantial doubt exists about the
entity's ability to continue as going concern, which could require a report modification.

3. It indicates the presence of possible misstatement in the financial statements

Significant unexpected difference between the current year's unaudited financial data and other
data used in comparisons are commonly called unusual fluctuations. Unusual fluctuations occur
when significant difference are not expected but do exist or when significant differences are
expected but do not exist. In either case, one of the possible reasons for unusual fluctuations is
the presence of an accounting misstatement. Thus, if the unusual fluctuation is large, the auditor
must determine the reason for it and must be satisfied that the cause is a valid economic event
and not a misstatement. For example, in comparing the ratio of the allowance for uncollectible
accounts receivable to gross accounts receivable, with that of the previous year, suppose that the
ratio had decreased while, at the same time, accounts receivable turnover also decreased. The
combination of these two pieces of information would indicate a possible understatement of the
allowance. This aspect of analytical process is often called attention directing because it results
in more detailed procedures in the specific audit areas where misstatements might be found.

4. Reduced Detailed audit test: When the analytical procedure reveals no unusual fluctuations,
the implication is that the possibility of a material misstatement is minimized. In that case, the
analytical procedure constitutes substantive evidence in support of the fair statement of the
related account balances, and it is possible to perform fewer detailed tests in connection with
those accounts.

Activity
1. What are the difference between observation and performance?
2. What is analytical procedure and discuss its main purposes

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Summary

The opinions to be provided by the independent auditor highly depend on the audit evidence
accumulated. Therefore, the auditor is expected to accumulate sufficient and competent evidence
to know the financial statement of a client is free of material misstatement caused either by error
or fraud.
Sufficiency of information refers to the quantity of information, implying that the auditor is
expected to accumulate appropriate amount of evidence (neither to large nor too low) to satisfy
his/ her audit objective.
Competency of information is related to the quality of information and is the degree to which
evidence can be believable. To be believable, evidence should be relevant- pertinence to the
audit objective and valuable.
There are different types of evidences used by the auditor. These are: Physical examination,
Confirmation, Documentation, Observation, Inquiry of the client, Re-performance, and
Analytical Procedure. The usefulness of analytical procedures as audit evidences significantly on
the auditors developing an expectation of what a record account balance or ratio based account
balance should be, regardless of the type of analytical procedures used.
The auditor typically compares the client's balance and ratios with the expected balances and
ratios using one or more of the following types of analytical procedures:
1. Compare client and industry data
2. Compare client data with similar prior period data
3. Compare client data with client determined expected results
4. Compare client data with auditor-determined expected results
5. Compare client data with expected results, using non financial data

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