Topic: Characteristics of Audit Evidence Do you think audit evidence has to be a
ID: 2581857 • Letter: T
Question
Topic: Characteristics of Audit Evidence
Do you think audit evidence has to be all of these things (appropriate, sufficient, relevant, and reliable) to be used? Why or why not?
Are any two of these adjectives (sufficient, relevant, reliable, and appropriate) ever mutually exclusive? Why or why not?
What should an auditor do if she is unable to find evidence that is sufficient, appropriate, relevant, and reliable? Why?
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Explanation / Answer
1. Yes, audit evidence have to be all of these things (appropriate, sufficient, relevant, and
reliable) to be used due to the below reasons:-
a) Sufficiency is the measure of the quantity of audit evidence. The quantity of audit
evidence needed is affected by the following:
Risk of material misstatement (in the audit of financial statements) or the risk
associated with the control (in the audit of internal control over financial reporting). As
the risk increases, the amount of evidence that the auditor should obtain also
increases. For example, ordinarily more evidence is needed to respond to significant
risks.
Quality of the audit evidence obtained. As the quality of the evidence increases, the
need for additional corroborating evidence decreases. Obtaining more of the same type
of audit evidence, however, cannot compensate for the poor quality of that evidence.
b) Appropriateness is the measure of the quality of audit evidence, i.e., its relevance and
reliability. To be appropriate, audit evidence must be both relevant and reliable in
providing support for the conclusions on which the auditor's opinion is based.
c) Relevance - The relevance of audit evidence refers to its relationship to the assertion or
to the objective of the control being tested. The relevance of audit evidence depends on:
i) The design of the audit procedure used to test the assertion or control, in
particular whether it is designed to (1) test the assertion or control directly
and (2) test for understatement or overstatement; and
ii) The timing of the audit procedure used to test the assertion or control.
d) Reliability. The reliability of evidence depends on the nature and source of the evidence
and the circumstances under which it is obtained. For example, in general:
• Evidence obtained from a knowledgeable source that is independent of the
company is more reliable than evidence obtained only from internal company
sources.
• The reliability of information generated internally by the company is increased
when the company's controls over that information are effective.
• Evidence obtained directly by the auditor is more reliable than evidence obtained
indirectly.
• Evidence provided by original documents is more reliable than evidence provided
by photocopies or facsimiles, or documents that have been filmed, digitized, or
otherwise converted into electronic form, the reliability of which depends on the
controls over the conversion and maintenance of those documents.
2. Yes, sufficient and appropriate are two adjectives which are mutually exclusive. The term,
which is a combination of two, “sufficient appropriate” requires auditor to obtain audit
evidence which is sufficient enough and also so appropriate that it can back up the conclusions
reached and opinions formed by the auditor.
Sufficiency is the measure of quantity of audit evidence i.e. the amount of evidence obtained
must be enough that it can be used and considered by the auditor. The quantity of audit
evidence required depends on the assessment of risk conducted by the auditor. If the risk of
material misstatement is high then higher quantity of audit evidence is required to establish
(confirm) by the application of audit procedures.
Appropriateness on the other hand is the measure of quality of audit evidence. Audit
evidence is said to be appropriate if it is relevant and reliable in the given set of circumstances.
However, the appropriateness of audit evidence is affected by the time, source and the
circumstances under which such evidence is obtained.
However, the two features of evidence are NOT independent and isolated rather they
are closely interrelated. A quality audit evidence, even if it is in small quantity, might be
enough in some situation i.e. higher the quality lesser the amount of evidence required,
however, a large quantity of audit evidence cannot be a substitute for inappropriateness of
audit evidence i.e. poor quality of audit evidence cannot be rectified by merely
increasing the amount of evidence.
3. An auditor should increase the audit procedures if she is unable to find evidence that is
sufficient, appropriate, relevant, and reliable.
Auditor should perform the below mention audit procedures:-
• Inspection is an audit procedure based on the examination of records or
documents, whether internal or external, that could be held in various forms, ie
paper, electronic or similar, or on the physical assessment of an asset. The
inspection of records and documents provides audit evidence whose reliability
depends on their nature and source. Inspecting certain documents may provide
direct audit evidence of the existence of an asset, for instance a financial instrument
like a share or a bond where the document itself constitutes the asset. At the same
time the inspection of the document may not provide evidence in respect of the
assertions of ownership and valuation of the asset. Similarly the inspection of
tangible assets may provide reliable audit evidence about their existence but not
about the entity’s rights and obligations or the valuation of the assets. Another
example may be the inspection of an executed contract that may provide evidence in
respect of the entity’s application of accounting policies like revenue recognition.
• Observation is instead an audit procedure that consists of looking at a process or
procedure being performed by others so that evidence about the actual performance
is obtained. However observation provides evidence that is limited to the point in
time when it takes place and by the fact that being observed may influence how the
process or procedure is performed on such occasion. Examples of observation are
the auditor’s attendance at the inventory counting by the entity’s staff and observing
the performance of control activities.
• External confirmation procedures may be an important source of relevant and
reliable audit evidence. External confirmation is audit evidence that is obtained as a
direct written response to the auditor from a third party (the confirming party) in
paper form, electronic medium or other medium. External confirmations are normally
used when confirming assertions relating to account balances, like payables and
receivables, but should not be restricted to such items only. The auditor may ask
confirmation of the terms of agreements and transactions with third parties, whether
any changes to existing agreements has occurred or whether no additional conditions
are attached to an agreement, perhaps in a separate document.
• Recalculation is a procedure that consists of checking the mathematical accuracy of
documents or records and that can be used to verify the accuracy of the recording of
transactions or of the application of accounting policies, for example by recalculating
depreciation of tangible assets. Recalculation however does not provide evidence of
the accuracy of the estimated rate of depreciation charged in relation to each class of
assets.
• Reperformance instead involves the independent execution by the auditor of
procedures or controls that were originally performed as part of the entity’s internal
control.
• Analytical procedures can or should be used at various stages of an audit
engagement: at the risk-assessment stage, as substantive audit procedures to verify
financial statements assertions and towards the end of the audit to corroborate
whether the financial statements are consistent with the auditor’s understanding of
the entity. Analytical procedures involve evaluations of financial information through
analysis of plausible relationships among both financial and non-financial data. They
also include investigation of fluctuations and relationships that are inconsistent with
other relevant information or that differ from expected values by a significant
amount. At the assertion level, analytical procedures may be used as substantive
procedures either on their own or in conjunction with tests of details. Substantive
analytical procedures are generally more applicable to large volumes of transactions
that tend to be predictable over time and for which there is an expectation that the
relationships among data exist and will continue in the absence of indications to the
contrary. Sometimes a simple model may work out as effective analytical
procedures. For instance if an entity has a stable number of employees at fixed rates
of pay during a period, then the auditor may estimate the total payroll costs for the
period with a high level of accuracy, therefore obtaining audit evidence for a
significant item in the accounts and reducing the need to perform tests of details on
the payroll. In other cases analytical procedures may provide less persuasive
evidence, for instance when gross margin percentages are calculated and compared
in order to confirm a revenue amount, that may in any case be relevant if used with
other procedures. An example of effective combination of substantive analytical
procedures and tests of details could be in respect of the valuation assertion for
accounts receivable, where the auditor may perform analytical procedures on an
aged list of debtors in addition to tests of detail on subsequent cash receipts to verify
collectability of the receivables.
• Inquiry is a type of audit procedure that is used extensively during the performance
of an audit in addition to other procedures. It consists of seeking both financial and
non-financial information of knowledgeable persons within or outside the entity.
Inquiries are important as they may provide new information to the auditor or
corroborative audit evidence or, on the contrary, information that differs significantly
from other information obtained by the auditor.