AUDIT EVIDENCE

Definition
Audit evidence pertains to all information used by the auditor in arriving at the conclusions on which
the auditor’s opinion is based. Audit evidence includes both information contained in the accounting
records underlying the financial statements and other information.

From the above definition, two major concepts can be drawn. These are (1) objective of auditor when
gathering evidence, and (2) the two classification of audit evidence.
1. Objective of auditor when gathering evidence.
The auditor designs and performs audit procedures in order to gather audit evidence. Such evidence
will enable the auditor to have a basis in arriving at the conclusions on which the audit opinion is
based. 
2. The two classification of audit evidence.
Audit evidence pertains to all the information used by the auditor in arriving at the conclusions on
which the audit opinion is based, and includes:

a. Information contained in the accounting records underlying the financial

statements (underlying accounting data) – it generally includes information that supports
and corroborates management’s assertions and any information that contradicts such
assertions.

Accounting records generally include 

o the records of initial accounting entries (book of accounts)

o supporting records
 checks and records of electronic fund transfers;
 invoices;
 contracts;
 the general and subsidiary ledgers, journal entries and other adjustments to
the financial statements that are not reflected in formal journal entries; and
 records such as work sheets and spreadsheets supporting cost allocations,
computations, reconciliations and disclosures.
b. Other information (corroborating information).
This may include information obtained from audit procedures performed during the course
of the audit and audit evidence obtained from other sources such as previous audits and a
firm’s quality control procedures for client acceptance and continuance.

Other information that the auditor may use as audit evidence includes 

o Minutes of meetings;
o Confirmations from third parties;
o Analysts’ reports;
o Comparable data about competitors (benchmarking);
o Controls manuals;
o Information obtained by the auditor from such audit procedures as inquiry,
observation, and inspection;
o Other information developed by, or available to, the auditor that permits the auditor
to reach conclusions through valid reasoning.

SUFFICIENT APPROPRIATE EVIDENCE

PSAs require the auditor to design and perform audit procedures that are appropriate in the
circumstances for the purpose of obtaining sufficient appropriate audit evidence. When designing
and performing audit procedures, the auditor shall consider the relevance and reliability of the
information to be used as audit evidence.

Sufficiency of audit evidence

It is the measure of the quantity of audit evidence. The quantity of the audit evidence needed is
affected by

1. the auditor’s assessment of the risks of material misstatement; and

2. the quality of such audit evidence.

Appropriateness of audit evidence

It is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing
support for the conclusions on which the auditor’s opinion is based.

a. Relevance of evidence
Evidence is regarded as relevant if it relates to the assertion. Relevance deals with the logical
connection with, or bearing upon, the purpose of the audit procedure and, where
appropriate, the assertion under consideration.

The relevance of information to be used as audit evidence may be affected by the direction

of testing.

Moreover, a given set of audit procedures may provide audit evidence that is relevant to
certain assertions, but not others.

b.  Reliability of evidence
Evidence is regarded as reliable if it is dependable to signal the true state of an assertion, it is
influenced by
0. a. its source;
a. its nature; and
b. the individual circumstances under which it is obtained.

Authentication of documentation
An audit rarely involves the authentication of documentation, nor is the auditor
trained as or expected to be an expert in such authentication.

Inconsistency in, or doubts over reliability, of audit evidence

Obtaining consistent information from different sources or of a different nature increases the
reliability of the individual item of audit evidence. 

 However, when audit evidence obtained from one source is inconsistent with that obtained
from another, or the auditor has doubts over the reliability of information to be used as audit
evidence, the auditor shall determine what modifications to or additional audit procedures
are necessary to resolve the matter.

Moreover, while recognizing that exceptions may exist, the following generalizations about
the reliability of audit evidence may be useful:

o Audit evidence is more reliable when it is obtained from independent sources outside
the entity.
 o Audit evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective.
o Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or by
inference (for example, inquiry about the application of a control).
o Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium (for example, a contemporaneously written record of a
meeting is more reliable than a subsequent oral representation of the matters
discussed).
o Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.

Relationship of sufficiency and appropriateness of audit evidence

The sufficiency and appropriateness of audit evidence are interrelated. The quantity of audit
evidence needed is affected by the auditor’s assessment of the risks of misstatement (the higher the
assessed risks, the more audit evidence is likely to be required) and also by the quality of such audit
evidence (the higher the quality, the less may be required).

Obtaining more audit evidence, however, may not compensate for its poor quality.

OBTAINING AUDIT EVIDENCE

The Use of Assertions in Obtaining Audit Evidence
Management implicitly or explicitly makes assertions regarding the recognition,
measurement, presentation and disclosure of the various elements of financial statements and
related disclosures.

 Management assertions, which were discussed in the “Introduction to Auditing” are used by the
auditor in formulating audit procedures. These assertions serve as “targets” over which audit
procedures to be formulated should be directed.

AUDIT PROCEDURES
The auditor obtains audit evidence to draw reasonable conclusions on which to base the audit
opinion by performing the following audit procedures:
A. MAJOR AUDIT PROCEDURES 

1. Risk assessment procedures (RAPs) – (discussed in Audit Planning)

RAPs by themselves do not provide sufficient appropriate audit evidence on which
to base the audit opinion, however, and are supplemented by further audit procedures in the
form of tests of controls, when necessary, and substantive procedures.

1. Test of controls (TOC) - (discussed in Internal Control Consideration)

2. Substantive test (ST)
ST is an audit procedure designed to detect material misstatements at the assertion level.
Substantive procedures comprise:
0. Tests of details (of classes of transactions, account balances, and disclosures), and
a. Substantive analytical procedures.

ST for material classes of transactions, account balances, and disclosures are always
required to be performed to obtain sufficient appropriate audit evidence. Thus,
auditor will always perform ST when performing an audit of financial statements.

B. SPECIFIC AUDIT PROCEDURES 

Specific types of audit procedures include
 1. Inspection of Records or Documents Types of Documents:
a. Internal – generated and maintained within the entity
b. External
o Originating within but circulated outside
o Originating outside but included in the client’s accounting records
Directional Testing:
0. Vouching – selecting an item for testing from the records to underlying
documents (addresses existence issues)
a. Tracing – selecting an item of transaction and following it into the records
(addresses completeness issues)
2. Inspection of Tangible Assets
3. Observation
4. Inquiry
5. Confirmation (see details below on the latter part of this handout)
6. Recalculation
7. Reperformance
8. Analytical Procedures

Applicability of specific audit procedures to major audit procedures

Below is a summary of specific audit procedures that may be applied when performing the different
major audit procedures.

Specific procedure RAPs TOC ST  

Inspection √ √ √
Observation √ √ √
Inquiry √ √ √
Confirmation     √
Recalculation     √
Reperformance   √  
Analytical procedures √   √
       

OTHER GENERAL CONCEPTS RELATED TO AUDIT EVIDENCE

1. Persuasiveness of evidence
2. Sources of audit evidence
3. Cost-benefit consideration and level of difficulty
4. Materiality
5. Audit risk
6. Professional skepticism

PERFORMANCE OF SUBSTANTIVE TESTING

Substantive tests are audit procedures designed to detect material misstatements at the assertion
level. Substantive procedures may be classified in the following types:

A. Tests of details (of classes of transactions, account balances, and disclosures), and
B. Substantive analytical procedures (discussed on the latter part of this handout).
TESTS OF DETAILS
Tests of details are procedures performed by the auditor to gather evidence that the actual details of
balances, disclosures, and underlying transactions associated with an entity's financial statements
are fairly stated. Test of details are considered to be the auditor's primary responses to risks of
material misstatement.  When performing test of details, the auditor may choose between

a. tests of transactions and events (TOTE); and

b. tests of balances (TOB).

TOTE is applied to account balances comprised of small volume of transactions representing

relatively material amounts. On the other hand, TOB is applied to account balances representing
comprised of large volume of transactions representing relatively immaterial amounts. Generally,
TOTE and TOB are applied to the following account balances

Nature, Timing and Extent of Substantive Procedures

The nature, timing and extent of substantive procedures to be applied by the auditor will be
dependent to the level of detection risk (DR) determined.

In summary, below is the effect of detection risk to nature, timing and extent of audit procedures

  Lower DR Above minimum DR

Nature (related to quality of Less effective procedures may
Apply more effective procedures
evidence to be obtained) be applied
Apply procedures closer or nearer to Procedures may be applied at
Timing
year end interim or several dates
Extent (related to quantity of Increase the extent of substantive The auditor may reduce the
evidence to be obtained) procedures to gather more evidence extent of substantive procedures

EXTERNAL CONFIRMATION
Objective
When using external confirmation procedures, the objective of the auditor is to design and perform
such procedures to obtain relevant and reliable audit evidence.

Definition
External confirmation is defined as audit evidence obtained as a direct written response to the
auditor from a third party (the confirming party), in paper form, or by electronic or other medium.

External confirmations are frequently used in relation to account balances and their components,
but need not be restricted to these items.  For example, the auditor may request external
confirmation of the terms of agreements or transactions an entity has with third parties.  The
confirmation request is designed to ask if any modifications have been made to the agreement, and if
so what the relevant details are.  Other examples of situations where external confirmations may be
used include the following.

 Property title deeds held by lawyers or financiers for safe custody or as security.
 Investments purchased from stockbrokers but not delivered at the reporting date.
 Bank balances and other information from bankers.
 Accounts receivable balances.
 Loans from lenders.
 Inventories held by third parties at bonded warehouses for processing or on consignment.
  Terms of agreements or transactions an entity has with third parties and details of
modifications, if any. ü Accounts payable balances.
 Absence of certain conditions, such as a “side agreement”

Types of external confirmation

POSITIVE NEGATIVE
As to responses from confirming party  
Confirming party respond directly to the auditor
Confirming party respond directly to the auditor
indicating whether the confirming party agrees or
only if the confirming party disagrees with the
disagrees with the information in the request, or
information provided in the request.  
providing the requested information.
The auditor has no reason to believe that
  recipients of negative confirmation requests will
disregard such confirmation requests

As to related risks of material

misstatements
 
The entity’s information systems and internal The auditor concluded that the risk of material
controls are unreliable or ineffective misstatement is low
Specific fraud risk factors prevent the auditor
Very few or no exceptions expected  
from relying on evidence from the entity
As to availability of sources  
The information available to corroborate The information available to corroborate
management’s assertion(s) is only available management’s assertion(s) is available within
outside the entity and outside the entity
As to characteristics of items involved  
The population of items comprises small number The population of items comprises a large
of large account balances number of small, homogenous, account balances

External Confirmation Procedures

1. Auditor requests the management to prepare and sign confirmation request.

2. Management prepares and signs the confirmation request.
3. Auditor controls the sending of the request to the confirming party.
4. Confirming party sends response directly to the auditor.

Evaluating the Evidence Obtained

When evaluating the results of individual external confirmation requests, the auditor may categorize
such results as follows.

a. In case of response indicating an exception, the auditor shall investigate exceptions to

determine whether or not they are indicative of misstatements.
A response indicating an exception
b. A non-response
In the case of each non-response, the auditor shall perform alternative audit procedures to
obtain relevant and reliable audit evidence.
 c. A response deemed unreliable
If the auditor identifies factors that give rise to doubts about the reliability of the response to
a confirmation request, the auditor shall obtain further audit evidence to resolve those
doubts.
d. A response without exception
A response by the appropriate confirming party indicating agreement with the information
provided in the confirmation request, or providing requested information without exception.

a.  

ANALYTICAL PROCEDURES
As previously discussed in “Audit Planning”, the auditor should apply analytical procedures at the
planning and overall review stages of the audit. Analytical procedures may also be applied at other
stages, specifically during substantive testing.

Uses of analytical procedures

Below is a summary of phases where analytical procedures may be applied.

Phase Objective Outcome Required

Assists the auditor in planning Identification of items that may
the nature, timing and extent represent specific risks relevant to the
Planning of other auditing procedures audit (e.g. relationships of accounts YES
thru enhancing auditor’s that are not plausible; unusual
understanding of the entity’s transactions and events).
Identification of fluctuations or
relationships that are inconsistent
Assists the auditor in
leading to auditor’s investigation by:
designing and performing so
a. Inquiry to management and
that they are effective in
obtaining appropriate audit evidence
Substantive responding to assessed risks
relevant to management’s response; NO
Testing of material misstatements in
and
the financial statements at the
b. Performing other audit procedures
assertion level; and arriving at
as necessary in the circumstances such
the overall conclusions
as corroboration of management
responses.
Relationships between accounts are
Assists in arriving at the
consistent with the understanding of
overall conclusions as to
the auditor.
whether the financial
Review In case of unexpected relationship, YES
statements as a whole are
determination whether or not
consistent with the auditor’s
additional procedures should be
understanding of the entity
performed.

AUDITING ACCOUNTING ESTIMATES

Definition
Accounting estimate means an approximation of the amount of an item in the absence of a precise
means of measurement.  This term is used for an amount measured at fair value where there is
estimation uncertainty, as well as for other amounts that require estimation.
For PSAs purposes, when the estimate only involves measurement at fair value, the term “fair value
accounting estimates” is used.

Management’s Responsibility
Management is responsible for making accounting estimates and disclosures included in
financial statements. 

Auditor’s Responsibility
Risk of material misstatement is greater when accounting estimates are involved.  Thus, PSA 540
requires the auditor to obtain sufficient appropriate audit evidence regarding accounting
estimates.  The auditor should determine whether accounting estimates included in the financial
statements are:

a. Reasonable in the circumstances

To be considered reasonable in the circumstances, an estimate shall possess the below
characteristics. Assumptions deviating from at least one of the above characteristics will
require the auditor to pay particular attention to such assumptions.
o Objective and not susceptible to bias
o Consistent with historical patterns (accounting policies adopted by the entity are
consistently applied)
o Consistent with industry guidelines
b. Properly accounted for and appropriately disclosed as required

Audit Procedures
To plan the nature timing and extent of the audit procedures, the auditor uses his understanding of
the procedures and methods, including the accounting and internal control systems, used by
management in making the accounting estimates.

The auditor should adopt one or a combination of the following approaches in the audit of an
accounting estimate:

a. review and test the process used by management to develop the estimate (performed as part
of risk assessment procedures and test of controls)
o evaluation of the data and consideration of assumptions on which the estimate is
based
o testing of the calculations involved in the estimate
o comparison, when possible, of estimates made for prior periods with actual results of
those periods
o consideration of management’s approval procedures
b. use an independent estimate for comparison with that prepared by management (performed
as part of substantive testing)
c. review subsequent events which confirm the estimate made

Additional consideration: Indicators of Possible Management Bias

Management bias pertains to a lack of neutrality by management in the preparation and presentation
of information.

The auditor shall review the judgments and decisions made by management in the making of
accounting estimates to identify whether there are indicators of possible management bias. However,
indicators of possible management bias do not themselves constitute misstatements for the purposes
of drawing conclusions on the reasonableness of individual accounting estimates.
Written Representations
The auditor shall obtain written representations from management whether management believes
significant assumptions used by it in making accounting estimates are reasonable.

Documentation
The audit documentation shall include:

a. The basis for the auditor’s conclusions about the reasonableness of accounting estimates and
their disclosure that give rise to significant risks; and
b. Indicators of possible management bias, if any.