F8-15 Audit Evidence

Session 15
Audit Evidence
FOCUS
This session covers the following content from the ACCA Study Guide.
D. Audit Evidence
1. Financial statement assertions and audit evidence
a) Explain the assertions contained in the financial statements about:
(i) Classes of transactions and events;
(ii) Account balances at the period end;
(iii) Presentation and disclosure.
b) Describe audit procedures to obtain audit evidence, including inspection,
observation, external confirmation, recalculation, reperformance, analytical
procedures and enquiry.
c) Discuss the quality and quantity of audit evidence.
d) Discuss the relevance and reliability of audit evidence.
2. Audit procedures
a) Discuss substantive procedures for obtaining audit evidence.
e) Discuss the difference between tests of control and substantive
procedures.
Session 15 Guidance
Understand the need to obtain sufficient appropriate evidence to be able to reach an audit
opinion (s.1.1).
Learn the different sources of audit evidence and attempt Example 1.
Understand the distinction and relationship between sufficiency, relevance and reliability and the
factors which affect these qualities (s.2, s.3).
Learn the meaning of each of the financial statement assertions and understand how they relate
to profit or loss, the statement of financial position and notes to the financial statements (s.3.2).
(continued on next page)
F8 Audit and Assurance (INT) Becker Professional Education | ACCA Study System
Ali Niaz - ali.niaz777@gmail.com

VISUAL OVERVIEW
Objective: To identify the financial statement assertions, sources of evidence and their
relationship to critical audit objectives.
AUDIT EVIDENCE
• Basic Principle
• Sources
SUFFICIENT APPROPRIATE
• Factors • Interrelationship
• Relevance
• Reliability
• Direction of Testing
OBTAINING
• Where From
• Procedures for Gathering
Evidence
• Examination Skills
TESTS OF SUBSTANTIVE
UNDERSTANDING CONTROL PROCEDURES
THE ENTITY
• Sessions 12 • Aim
• Sessions 8 and 9
• Nature, Timing and
Extent
• Hybrid Approach
Session 15 Guidance
Understand that the risk of understatement or overstatement influences the direction
of testing (s.3.4).
Learn the types of procedure for gathering evidence and attempt Example 3.
Practice the exam techniques using the Examples and Illustrations provided (s.4.3).
Understand the purpose, nature, timing, and extent of substantive procedures (s.5).
© 2013 DeVry/Becker Educational Development Corp. All rights reserved. 15-1

Session 15 • Audit Evidence F8 Audit and Assurance (INT)
1 Audit Evidence (ISA 500)
1.1 Basic Principles
The auditor's main objective is to design and perform audit *Sufficiency relates
procedures with the aim of obtaining sufficient appropriate audit to the quantity of
evidence from which reasonable conclusions can be drawn on which evidence required.
to base the audit opinion.* Appropriateness
Audit evidence is necessary to support the auditor's opinion and relates to the quality
report. It is cumulative in nature and is primarily obtained from of that evidence.
audit procedures performed during the course of the audit. The quantity of audit
evidence relates to the
risk of misstatement
and to the quality of
1.2 Sources that evidence:
< the higher the risk,
< Audit evidence is all the information used by the auditor in the more audit
arriving at the conclusions on which the audit opinion is based. evidence required
All evidence will have a source. Sources may be: (which does not
= internal or external to the entity (e.g. originated in the mean that more is
entity or externally); better—quality is
important as well);
= oral or written;
< the higher the
= direct or indirect (direct to the auditor from an external
quality of the
source or via the client); or evidence, the
= generated by the auditor (e.g. analytical procedures). less that may be
< For example, documentary evidence may be: required to confirm
an objective.
= Generated and provided to auditors by a third party (i.e.
external and independent (direct) of the entity). For
example, bank confirmation letters which are sent direct
to the auditor.
= Generated by a third party and held by the entity (i.e.
external but not independent (indirect) of the entity).
For example, bank statements.
= Generated and held by the entity (i.e. internal and indirect).
For example, bank reconciliations carried out every month
by the cashier.
15-2 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

F8 Audit and Assurance (INT) Session 15 • Audit Evidence
Example 1 Sources of Evidence for Tangible Assets

Use the following ideas list to generate examples of sources of evidence relevant to the audit of
tangible non-current assets.
Solution
Nature of evidence Examples
Accounting systems
Documentation
Tangible assets
Management and employees
Customers and suppliers
Other third parties (e.g. banks,

solicitors)
Analytical procedures
This "ideas list" is a useful memory jogger for planning an

examination answer.

2 Sufficient
2.1 Factors to Consider* *How long is a piece

of string? That will
< Factors to consider in assessing the sufficiency (i.e. quantity) depend on the job
of audit evidence include:* it is required to do.
= audit (and engagement) risk; Too short and the job
= the nature of internal control; cannot be completed.
Too long and resources
= reliance on effective controls;
have been wasted.
= Cumulative Audit Knowledge and Experience ("CAKE");
Think of an audit as a
= the materiality of items; jigsaw—all the pieces
= audit findings; and fit together to show a
picture. But the whole
= the source and reliability of information
picture is unnecessary.
(i.e. persuasiveness). By correctly joining
< Audit risk—derived from understanding the business, together sufficient
its environment and controls (e.g. the higher the risk of "quality" pieces it is
a material misstatement, the more evidence that may be possible to say, with
required (extent, nature and timing)). reasonable certainty
(assurance), what the
< Nature of internal control—computerised or manual (e.g. picture is.
if programmed, a control will be consistently applied, but
*Difficulty or expense
manual controls may be inconsistently applied and more
is not a valid reason
testing therefore required). Conversely, testing 100% in a
for omitting a
computerised system through using CAATs (see Session 21) necessary procedure.
will be very cost and time effective. If audit evidence
< Reliance on effective controls—this includes preliminary is insufficient, the
understanding and its evaluation (following tests). If controls implications for the
cannot be relied on, a greater level of substantive procedures audit opinion must
will be required. be considered.
For example, if
< "CAKE"—for example, a first year audit will always be high inspecting assets
risk, but as a greater understanding and experience of the (existence assertion)
client are gained and a more effective and efficient audit is considered
approach is developed, the level and detail of evidence difficult (e.g. if in
required may reduce in subsequent years. transit on a ship)
other evidence should
< Materiality—immaterial items require little, if any, evidence
be obtained (e.g.
(e.g. "reasonableness test"). But remember, for example,
loading documents,
that although IFRS only applies to material items, what is insurance documents,
not material to one client may be very material to another. confirmation from
Materiality is a relative term. shipping agents
< Audit findings—errors may, for example, require further or inspection when
audit work to be carried out. Other audit evidence may be landed).
found not to be as reliable as expected, thus further evidence
will be required.
< Source and reliability of information—how persuasive
is the evidence? Does all the evidence point to the same
conclusion?

3 Appropriate
3.1 Interrelationship
< Appropriateness is interrelated with sufficiency (if evidence is
not appropriate, sufficiency cannot be achieved) and has two
aspects in the context of audit evidence:
APPROPRIATE
RELEVANT RELIABLE
3.2 Relevance
< Evidence is required to support the financial statement
assertions of management (explicit or otherwise) regarding
recognition, measurement, presentation and disclosure of the
various elements of the financial statements. These assertions
are split into three categories:
1. account balances (i.e. mainly statement of financial
position);
2. classes of transactions and events (i.e. mainly statement
of comprehensive income); and
3. presentation and disclosures.
< All tests in an audit programme should aim to obtain evidence
on one (or more) assertion. The worth of tests that do not
provide such evidence should be carefully considered.
When answering an examination question based on audit tests to

be carried out, it is important to ensure that your answer includes
the reasons why that test is necessary (i.e. the assertion that is
being tested). For example, "inspect purchase invoice to agree
correct classification of the non-current asset and the accurate and
correct treatment of cost and VAT".

3.2.1 Assertions
Financial statement assertions—the implicit and explicit claims and

representations made by management about the elements of financial
statements and related disclosures.
Occurrence < Transactions, events, disclosures and other matters that have
been recorded did occur and relate to the entity (e.g. sales
and purchases recorded in an entity's books and records
belong to that entity and not a third party).
Completeness < Transactions, events, assets, liabilities, equity interests and
disclosures that should have been recorded, have actually
been recorded or disclosed (e.g. all sales and liabilities have
been recognised and recorded).
Accuracy < Amounts and other data (e.g. values, costs, descriptions,
analysis) relating to recorded transactions and events
have been appropriately recorded and disclosed fairly;
financial and other information are disclosed fairly and at
appropriate amounts.
Cut-off < Transactions and events have been recorded in the correct
accounting period (e.g. post year-end sales not recorded as
pre year-end).
Classification < Transactions and events have been recorded in the proper
accounts (e.g. expenses as expenses and not assets).
Understandability < Financial information is appropriately presented and
described and disclosures are clearly expressed (e.g.
according to IFRS).
Existence < Assets, liabilities and equity interests exist as recorded
in the financial statements actually exist (e.g. land and
buildings exist).
Rights and < The entity holds or controls the rights to assets recognised
obligations in the financial statements (i.e. future economic benefit will
flow to the entity).
< Recognised liabilities are the obligations of the entity (e.g.
there is a current obligation, because of a past event, to
future economic outflow).
Valuation and < Assets, liabilities and equity interests are included
allocation in the financial statements at appropriate amounts
and any resulting valuation or allocation adjustments
are appropriately recorded (e.g. asset impairment,
NRV, depreciation).

3.2.2 Assertions Mnemonic
< To remember the list of all of the assertions, use the

mnemonic ACCA COVER U:
ACCA COVER U
< Accuracy < Classification < Understandability
< Completeness < Occurrence
< Cut-off < Valuation
< Allocation < Existence
< Rights and obligations
3.2.3 Assertions by Category*
Account Balances Transactions and Presentation and

("CARE") Events ("COCOA") Disclosure ("COCOA")
Completeness Completeness Completeness
Valuation and Allocation Occurrence Occurrence
Rights and Obligations Classification Classification and
Understandability
Existence Cut-Off
Rights and Obligations
Accuracy
Accuracy and Valuation
*The mnemonic for Balances is CARE. The mnemonic COCOA can Do not write out
be used for both transactions and events and for presentation and mnemonics in the
disclosure. Note the similarities and differences in the assertions exam; use only as a
included in the COCOA mnemonics. "memory jogger".

3.3 Reliability
< The key assertions for any information used by the auditor
when considering reliability of audit evidence are the accuracy
and completeness of that information (e.g. completeness
of a population of documents that are to be sampled; the
accuracy of the inventory records when considering reliance on
perpetual inventory systems).
< Obtaining evidence about the completeness and accuracy of
information may be obtained concurrently when carrying out
other audit procedures, or, for example, by using alternative
techniques (e.g. CAATs).
3.3.1 General Presumptions ("Rules of Thumb")

< A number of general assumptions can be made about the
reliability of audit evidence depending on whether it is:
= external or internal;
= direct or indirect;
= written or oral; and
= consistent.
External v internal < External (independent) sources are more reliable than entity
(internal) sources.
< Information generated by the entity (e.g. accounting records)
is more reliable when related internal controls are effective.
Direct v indirect < Auditor obtained information is more reliable than information
that is indirectly obtained (e.g. direct observation by the
auditor of the operation of a control, rather than inquiry about
the application of that control).
Written v oral < Documentary/written information is more reliable than
verbal/oral.
< Any oral representation that is to be relied on must be
obtained in writing.
< Original documents are more reliable than photocopies,
scans, faxes, etc.
Consistency < Consistency from different sources increases persuasiveness
(e.g. internal evidence corroborated by external sources).
< Any inconsistency creates doubt (giving rise to further work)
until resolved.

3.3.2 Exceptions
< There will always be exceptions to the generalisations above,
and care must be taken when considering the reliability of
audit evidence. For example:
= evidence obtained from an independent external source
may not be that reliable if the source is not knowledgeable
or has little experience of the specific matter being
considered; and
= original documents may not be available, only their
electronic copies. But if the controls over creation,
maintenance and security of the copies are strong, the
copies become more reliable. (Otherwise, consider the
implications for the audit opinion.)
Example 2 Ranking Evidence

Rank the following items of audit evidence concerning the ownership
of land, using a scale of 1 (for worst) to 4 (for best).
Solution
Rank
1. Ask management if the client company owns
the land.
2. Phone the bank and ask if it holds title deeds on
the client's behalf.
3. Visit the bank and examine title deeds.
4. Ask the bank for written confirmation that it holds
title deeds.
3.4 Direction of Testing

< The assertion(s) for which evidence is sought influences the
source of evidence and direction of testing. It is important to
understand the source of evidence required and the direction
of the test to ensure the evidence obtained is reliable.
3.4.1 Overstatement
< If the audit risk assessment considers overstatement of a
balance (e.g. an asset) or class of transactions (e.g. sales
revenue) to be a possibility, then the direction of testing will
be from the financial statements (where the overstated item is
presented) to the supporting evidence.
< Tests for overstatement of amounts in the financial statements
are effective in addressing more than one financial statement
assertion. For example:
= occurrence, cut-off, accuracy and classification of
transactions;
= existence, valuation and rights to assets; and
= occurrence, accuracy, valuation, classification and
understandability of presentation and disclosures.

Illustration 1 Existence of Plant and Equipment
A financial statement assertion is that plant and equipment as presented in the financial
statements exist. Therefore:
< Agree balance in financial statements to an independent analysis such as a plant register (i.e.
from the statement of financial position).
< Select material items (plus selection of others) from the register (as if a material item does
not exist, or a material error has been found) and trace to the physical asset (i.e. to evidence
that the asset exists). If the asset cannot be found, there is an overstatement in the financial
statements.
This will mean that there is a corresponding error in another account or accounts. In this case,
there could be understatement of cash (e.g. if the asset was sold without authorisation and cash
proceeds have been stolen) an overstatement of accumulated depreciation (as the asset does not
exist) or a misstatement in profit or loss (on disposal of the asset).
3.4.2 Understatement
< If the risk is understatement of a balance or class of
transactions, the direction of testing is from the source to
the financial statements.
The most complete
< Testing for understatement is more difficult, as an appropriate
source is often not
source must be identified. of monetary amount
< Tests for understatement are effective in addressing (e.g. goods despatch
assertions relating to the completeness, accuracy and notes).
cut-off in the financial statements (including presentation
and disclosure).
Illustration 2 Disposal of Non-current Assets*
The client may provide a list of non-current assets disposed of showing carrying amount and
value received. As disposals are credit items, disposals should not be selected from the list and
traced to evidence of that disposal (i.e. overstatement testing). By definition, any disposal that
is not recorded on the list (i.e. an understatement) cannot be selected, as it is not recorded on
the list. A reciprocal population has to be found from which to start the test.
< Select a sample of assets (including all material items) from the opening year asset register
plus additions in the year. If no assets were disposed of during the year, all of these assets
should exist at the year end.
< Inspect for existence. If the asset cannot be found, agree if recorded on the list of disposals
provided by client. If not on the list, seek evidence of sale after year end.
< If no such evidence, then disposals are understated and further investigation will be
necessary.
< Note that this test can be combined with the test for physical existence (see Illustration 1).
*Note that this test covers both elements (existence and

completeness of disposal recording) from one source (the asset
register) by selecting items and testing for existence (overstatement
if not found) and if they cannot be found, following through to
disposals (understatement of disposals if not on the list). This will
not usually be the case for other audit areas, and care must be taken
in selecting the correct approach, direction and items.

3.4.3 Understanding the Test Objective

< It is important to understand the objective of the test to be
carried out (e.g. over or understatement):
= For example, if information is provided by the client, it is the
objective of the testing of that information to see if anything
is missing (understatement) or if something is there that
should not be (overstatement).
= If understatement exists, the auditor must determine the
source of that information (or an independent source) and
test to see that everything from that source, that should be
included in the financial statements, has been. This is not
the same as agreeing what is on the list back to supporting
evidence (i.e. overstatement testing).
Illustration 3 Sales Transaction Testing
Testing sales for Sales system Testing receivables

completeness for existence
Order
Goods Despatch
Note
Invoice
Sales Day Book

(Journal)
Ledger Account(s)
< A typical sales system has controls in place to ensure that all goods
and services provided will be correctly invoiced and recorded. A test of
transactions for understatement of sales revenue needs to start from the
source, in this case the sales order or despatch note.*
< Where the risk assessment shows that overstatement of sales throughout
the year is a high risk, then the direction of the transaction test would be
from the financial statements (i.e. whether the sale actually took place and is
supported by an invoice, despatch note and entry in the inventory records).
< If the risk of overstatement is primarily due to cut-off (e.g. January sales
being recorded as December year-end sales), then the auditor would also
derive audit evidence from standard cut-off testing of year-end balances.
*In other situations, the inventory records may be a more effective

place to identify goods despatched, or, if the goods are unique and
have to be purchased when a sales order is received (e.g. motor
vehicles), then tracing the sale from a purchase invoice would be the
most effective way to test sales.

4 Obtaining Audit Evidence
4.1 Where Evidence Is Obtained From
UNDERSTANDING TESTS OF SUBSTANTIVE

THE ENTITY CONTROL PROCEDURES
… risk assessment … effectiveness of … to detect material

procedures include operation … misstatements in
understanding internal financial statements …
control … suitability
of design and
implementation …
< Tests may be "dual purpose" (i.e. tests of control carried out
at the same time as substantive transaction tests).
4.1.1 Understanding the Entity

< Risk assessment procedures alone do not provide sufficient
appropriate audit evidence. They must be supplemented with
tests of control and/or substantive procedures.
4.1.2 Tests of Control

< Tests of controls are necessary in two circumstances:
= when the auditor's risk assessment includes an expectation
of the operating effectiveness of controls; or
= when substantive procedures alone do not provide sufficient
appropriate audit evidence (e.g. highly automated systems).
4.1.3 Substantive Procedures
< Sufficiency and appropriateness should be considered in
relation to:
= evidence from risk assessment procedures;
= evidence from tests of control effectiveness (if any); and
= financial statement assertions.
< As there are always inherent limitations in controls (e.g.
human error), substantive procedures for material classes
of transactions, account balances and disclosures are always
required to ensure sufficient appropriate audit evidence will
be obtained.

4.2 Procedures for Gathering Evidence

< These are:
= inspection and observation;
= inquiry and confirmation;
= recalculation and reperformance; and
= analytical procedures.
Example 3 Procedures
Distinguish between and give examples of the following procedures.
Solution Description/Examples
Inspection
Observation
Inquiry
Confirmation
Recalculation
Reperformance
Analytical procedures

4.3 Examination Skills

< There are four techniques to help generate "client-specific"
audit evidence—assertions, direction of testing, accounting
entries, procedures.
4.3.1 Financial Statement Assertions

< Consider "relevant" audit evidence.
Example 4 Additions to Plant and Equipment

Suggest substantive audit evidence for additions to plant and equipment.
Solution
Completeness –
Occurrence –
Classification –
Cut-off –
Accuracy –
4.3.2 Direction of Testing and Assertions

< Consider the flow of accounting information and the assertion
objectives.
*So do not just say
"inspect invoice".
(Clearly you would
not mean that you
are inspecting it to
When stating a test, always explain the assertion(s) being tested—
determine its colour.)
always say why the test is being carried out; give its objective.*
Specify what it is on
the invoice that is
to be inspected and
why—what is being
achieved (in terms of
the assertions).

Example 5 Factory Payroll

Suggest audit tests for a factory payroll expense.
Solution
If the assertion objective is that the expense is not overstated (i.e.
payment is only made for services received), then consider:
Financial statements –
–
Ledger account(s)
–
–
Payroll/payslips
–
Clockcards –
4.3.3 "T" Account

< Consider the accounting entries:
Illustration 4 Receivables
Control Account
Receivables Control
$ $
Opening balance x Cash received x
Sales x Bad debts written off x
Closing balance x
x x
< Establish the assertion objectives. For example, overstatement

of receivables or understatement of irrecoverable debts
(if irrecoverable debts are understated, receivables will be
overstated).
< Devise substantive procedures for each element considering
direction of testing. For example, overstatement of sales
and understatement of bad debts.

< A key assertion for the sales and trade receivables accounts is
occurrence (i.e. that they are not overstated).
< Sales and accounts receivable are tested for both
overstatement and understatement in testing for cut-off.
Illustration 5 Receivables
Cut-off
From the control account, trace sales before the year end back
to despatch evidence (sales invoice, despatch note, inventory
records) to ensure goods were sold, despatched and correctly
recorded before the year end. If not, there will be overstatement
of receivables and sales.
From cash receipts records, agree that cash received before the
year end is recorded before the year end in the control account.
If entered in the control account after the year end, receivables
are overstated.
A bad debt write-off may be used to conceal a misappropriation
of cash received from credit customers (i.e. cash is understated).
Tracing all write-offs to the receivable control account (via
correct supporting documentation and authorisation) to ensure
that they are recorded in the correct period is a test for
receivables overstatement (if the bad debt is not recorded
in the correct period).
4.3.4 Procedures
Example 6 Trade Receivables

Suggest audit procedures for trade receivables.
Solution
Analytical procedure –
Inquire –
Inspect –
Observe –
Recalculation –
Confirmation –

5 Substantive Procedures
5.1 Aim
Substantive procedures are those procedures performed to detect

material misstatements at the assertion level. They include:
< tests of detail of transactions;
< tests of detail on account balances;
< tests of detail on disclosures; and
< substantive analytical procedures.
Full (100%) substantive procedures must be considered when:
< it will be more effective (e.g. low-volume, high-value,
non-homogenous items, such as non-current assets);
< the effectiveness of internal controls is not to be relied upon; or
< tests of controls show them to be ineffective.
5.2 Nature, Timing and Extent

5.2.1 Nature
< Substantive analytical procedures are generally more
applicable to large volumes of transactions that tend to be
predictable over time and are often used in conjunction with
a strong control environment and where audit evidence has
been obtained from testing the effectiveness of controls (e.g.
computer information systems). See Session 16 for further
detail on substantive analytical review.
< Tests of detail on transactions are used to obtain audit
evidence regarding the assertions related to transactions (i.e.
COCOA—completeness, occurrence, classification, cut-off and
accuracy). These will be on manual systems or CISs where it
is easy to trace a transaction through the system.
< Tests of details of transactions trace a transaction through a
system, for example to ensure that a despatch is correctly
recorded as a sale or that a purchase entry recorded in the
daybook is supported by a purchase invoice, goods received
note and purchase order.
< If no reliance is placed on controls, the level (i.e. sample size)
of transaction testing will be high. If reliance can be placed
on controls, the level of transaction testing will be lower (and
usually conducted as a hybrid test (see s.3) alongside the
control testing).
< The auditor may assess that audit risk can be reduced to
an acceptable level by reliance on controls and substantive
analytical review, rather than transaction testing (as above).
< Tests of detail on balances are used to obtain evidence about
the assertions related to account balances (i.e. CARE—
completeness, accuracy and valuation, rights and obligations
and existence).

Illustration 5 Substantive Test
After carrying out a risk assessment, an auditor decides that

substantive tests of detail on an entity's manual sales system are
required as part of his procedures to reduce audit risk. Reliance
cannot be placed on the effective operation of internal controls.
Transaction tests carried out include:
< Agreeing a despatch entry in the inventory records to a despatch
note, the related customer order (if any; it may be a web-based
order) and sales invoice.
< Agreeing details on the sales invoice to supporting sources
(e.g. customer name, address, unit prices, VAT) and checking the
arithmetical accuracy of the invoice.
< Agreeing that the invoice is correctly posted and analysed in the
sales day book (SDB) and agreeing the arithmetical accuracy of the
SDB.
< Agreeing the correct posting of the day book to the general ledger.
5.2.2 Timing
< Substantive transaction procedures may be carried out at
an earlier date than the entity's year-end and the final audit
(i.e. at an interim audit). If carried out at an interim date,
further tests must be carried out to cover the remaining
period. These tests (substantive and/or tests of control) must
be sufficient to ensure that the risk of misstatement does not
increase during this period.
< Unlike tests of control, where prior-year audit evidence
may be relied on under certain circumstances, prior-year
substantive evidence will be insufficient to address a risk of
material misstatement in the current period.
5.2.3 Extent
< Generally, the greater the risk of material misstatement, the
greater the extent of substantive procedures.
< For any one substantive procedure, the extent of testing
usually relates to sample sizes (e.g. increasing the extent
means increasing the sample size).
< However, the extent of substantive procedures may also be
considered in terms of:
= selecting large (e.g. material) or unusual items from a
population; or
= stratifying the population into homogeneous subpopulations
for sampling.
< It is not unusual in many substantive testing approaches that
all items greater than the materiality level (taking into account
performance materiality) are selected for testing. If an error
is found, that error is likely to be material to the financial
statement assertions.

5.3 Hybrid Approach

< In some cases, a single test approach can be used as a test of
control and a substantive procedure at the same time. This is
called a dual-purpose or hybrid test.
Illustration 6 Hybrid Tests
< The auditor decides to place reliance on internal controls in a sales

system and determines the sample sizes as 30 for control testing
and 30 for transaction testing. Without reliance on controls, a
sample size of 50 for transaction testing would be necessary.
< Rather than using two separate samples, one sample is used to
cover the transaction testing and control testing, as appropriate.
Those controls that cannot be tested during the transaction testing
are covered by other tests.
< The transaction is recognised on issue of inventory resulting in a
despatch document, sales invoice, sales day book entry and ledger
entries. Thirty inventory issues are selected (throughout the year)
and traced through the system to the general ledger.
< At the various stages of the sales system where controls have
been identified for testing, control testing is also carried out. For
example, the control of sales invoice authorisation requires that the
sales manager:
—has agreed the details to the authorised despatch note;
—has agreed the sales price and discounts to the customer
database;
—has checked the VAT and cross-cast the invoice;
—has signed all copies of the invoice as evidence of the checks.
< As part of the transaction test, each invoice for all of the above
sample would have been substantiated (inventory issue to despatch
note, despatch note to sales invoice, other details on invoice to
supporting evidence, calculations and casting).
< Thus the auditor effectively re-performs the control action of the
manager. Provided the manager's signature is on all invoices, the
control can be considered to be effective. If invoices were found
that did not have the manager's signature on them and the auditor
concludes (after further investigation) that the control cannot be
relied on (e.g. no alternative control), an additional 20 inventory
despatch items would be selected for further transaction testing.
< Every month a reconciliation is carried out between the control
account and sales ledger account. This does not form part of the
sales system transaction testing, so testing this procedure would be
dealt with separately, whatever approach is taken.

Summary
< The auditor must obtain sufficient appropriate audit evidence on which to base the
audit opinion.
< Audit evidence may be internal or external, oral or written, direct or indirect, or auditor-
generated.
< Sufficiency (concerning quantity) depends on the level of audit risk, reliance on effective
controls, the auditor's experience, materiality and audit findings. It also depends on the
quality (i.e. source and reliability) of the evidence.
< Appropriate evidence must be both relevant and reliable.
< Relevance means that the audit evidence supports management's financial statement
assertions:
• For transactions and events these are completeness, occurrence, classiﬁcation, cut-off,
and accuracy (COCOA).
• For balances these are completeness, valuation and allocation, rights and obligations, and
existence (CARE).
< Reliability is influenced by source (e.g. external is more reliable than internal and written is
more reliable than oral). Evidence is more persuasive if it is consistent with other evidence.
< When testing for overstatement, the direction of the testing is from the financial statements
to the supporting evidence.
< When testing for understatement, the direction of the testing is from the source to the
financial statements.
< Evidence is obtained in risk assessment procedures, tests of controls and substantive
procedures.
< Procedures to gather evidence include inspection, observation, inquiry, confirmation,
recalculation, re-performance and analytical procedures.
< Substantive procedures are performed to detect material misstatement at the assertion
level (i.e. classes of transaction, account balances and disclosures) and include:
• substantive analytical procedures; and
• tests of detail.
< The greater the reliance placed on controls, the lower the level of substantive procedures.
< The greater the risk of material misstatement, the greater the extent of substantive
procedures.

Session 15
Session 15 Quiz
Estimated time: 20 minutes
1. Identify the potential sources of audit evidence. (1.2)
2. Describe the factors that must be considered to determine if audit evidence is sufficient. (2.1)
3. List the financial statement assertions (covering 3 categories). (3.2)
4. Describe the basic procedures for gathering evidence. (4.2)
5. Describe the use of substantive procedures in testing transactions. (5)
Study Question Bank

Estimated time: 30 minutes
Priority Estimated Time Completed

Sources of Audit
Q19 30 minutes
Evidence

EXAMPLE SOLUTIONS
Solution 1—Sources of Evidence for Tangible Assets
Examples
< Accounting systems Tangible asset register
< Documentation Capital expenditure requisition (asserts authorisation),

purchase invoices (evidence of cost)
< Tangible assets "Kick it"—land and buildings, plant and equipment, motor
vehicles (confirms existence)
< Management and employees Board minutes (authorisation/capital commitments)
< Customers and suppliers Lessor (leased assets)
< Other third parties Bank (for mortgaged/securitised assets)

(e.g. banks, solicitors)
< Analytical procedures Depreciation "proof in total"
Solution 2—Ranking Evidence

Rank
1. Internal oral 1
2. External oral 2
3. Auditor obtained (on originals) 4
4. External documentary 3

Solution 3—Procedures
Description/Examples
Inspection (1) Records/documents—manual and electronic. Reliability depends
on source.
(2) Employees—existence.
(3) Tangible assets—non-current assets and inventory existence
(not necessarily ownership, cost or value).
Observation Of a process/procedure (e.g. mail opening, physical inventory count).

Evidence only reliable at that time.
Inquiry Of knowledgeable persons—written or oral/inside or outside (e.g. bank

request). Responses produce new information or corroborative evidence.
Confirmation Response to inquiry to corroborate info (e.g. confirmation of trade

accounts receivable by communication with credit customers).
Recalculation Checking arithmetical accuracy (e.g. source documents, accounting

records, analysis schedules). For example, using CAATs.
Reperformance Independent execution of procedures and controls that were originally

performed as part of the entity's internal control.
Use of CAATs to reperform receivables age analysis.
Analytical Study of plausible relationships among both financial and

procedures non-financial data.
Investigation of identified fluctuations and relationships that are
inconsistent from predictions and expectations.
Solution 4—Additions to Plant and Equipment

Completeness – Review repairs and renewals a/cs in general ledger
(for expense of capital nature)
Trace a sample of fixed asset purchases to receiving reports
and the fixed asset register
Occurrence – Agree a sample of fixed asset purchases to the receiving

report and invoice
Classification – Examine a sample of significant charges to repairs and

maintenance for items that should have been capitalised
(also a completeness test)
Review lease transactions for proper classification as
operating or finance
Cut-off – Review fixed asset purchases from shortly before and after
year-end for recording in the proper period
Accuracy – Recalculate depreciation expense, revaluation losses and

surplus, and impairment losses

Solution 5—Factory Payroll
Financial statements – Agree to general/(nominal) ledger a/cs (via trial
balance)—inclusion, completeness, classification.
– Check casts/balance—correct, accurate.
– Agree to payroll summaries—correct, complete.
Ledger account(s)
– Check (a sample of) casts/calculations—
valuation, correct.
– Agree hourly rate to personnel records—
correct, accurate.
Payroll/payslips
– Agree hours worked to clock cards—correct,
accurate, occurrence.
– Confirm authorised—occurrence, complete,
accurate.
– Check total hours—correct, accurate, complete.
Clockcards – Carry out employee existence tests—physically
inspect employee and/or HR records for evidence
of employee existences—existence.
Solution 6—Trade Receivables

Analytical – Calculate and compare average collection
procedure period (monthly).
Inquire – Ask credit controller "What problems are being

experienced in collecting amounts receivable?"
Inspect – Sales orders/sales invoices/remittance advices/cash

book receipts—alternative procedures.
Observe – Goods despatch to customers/mail opening procedures.
Recalculation – Sales' ledger balance (and control account balance)—

use of CAATs.
Confirmation – Receivables circularisation.

NOTES

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Session 15

Ali Niaz - ali.niaz777@gmail.com

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1 Audit Evidence (ISA 500)

1.1 Basic Principles

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Example 1 Sources of Evidence for Tangible Assets

Management and employees

Customers and suppliers

Other third parties (e.g. banks,

This "ideas list" is a useful memory jogger for planning an

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2.1 Factors to Consider* *How long is a piece

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When answering an examination question based on audit tests to

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Financial statement assertions—the implicit and explicit claims and

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3.2.2 Assertions Mnemonic

< To remember the list of all of the assertions, use the

3.2.3 Assertions by Category*

Account Balances Transactions and Presentation and

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3.3.1 General Presumptions ("Rules of Thumb")

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Example 2 Ranking Evidence

3.4 Direction of Testing

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Illustration 1 Existence of Plant and Equipment

Illustration 2 Disposal of Non-current Assets*

*Note that this test covers both elements (existence and

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3.4.3 Understanding the Test Objective

Illustration 3 Sales Transaction Testing

Testing sales for Sales system Testing receivables

Sales Day Book

*In other situations, the inventory records may be a more effective

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4 Obtaining Audit Evidence

4.1 Where Evidence Is Obtained From

UNDERSTANDING TESTS OF SUBSTANTIVE

… risk assessment … effectiveness of … to detect material

4.1.1 Understanding the Entity

4.1.2 Tests of Control

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4.2 Procedures for Gathering Evidence

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4.3 Examination Skills

4.3.1 Financial Statement Assertions

Example 4 Additions to Plant and Equipment