All you need to know about the Reliability of Audit Evidence
Audit Evidence and its reliability:
Audit evidence is the foundation based on which an audit is done. During the course of an audit, an auditor comes across various assertions made by his client’s management. He has to evaluate these assertions or claims so that he can provide an opinion on the financial statements. This evaluation is done in light of some facts and reasons. Such facts and reasons are called audit evidence.
Thus, audit evidence refers to the information gathered by the auditor for examining whether data contained in account books, as well as assertions of the management, are correct or not. It is the information that the auditor uses to judge the truthfulness of financial statements.
Just as evidence is crucial for the performance of every audit, so is its reliability.
Once the audit evidence is obtained, it is equally important for the auditor to assess its reliability. Reliability refers to the degree to which a particular piece of evidence can be believable or worthy of trust.
On the face of it, the reliability of audit evidence may be generalized by its source, i.e., whether it is internal or external, and by its nature, i.e., whether it is visual, documentary, or oral. External evidence is usually more reliable than internal evidence. Likewise, written evidence is more reliable than oral.
But besides this, several other factors also come into play. In this blog, we have discussed some factors that influence the reliability of audit evidence.
Determinants for evaluating the reliability of audit evidence
The reliability of information to be used as audit evidence is influenced by many factors such as its source and nature, the circumstances under which it is obtained, and the effectiveness of internal controls over its preparation and maintenance, among others.
Therefore, making generalizations about the reliability of different kinds of audit evidence may have some exceptions. Because even when audit evidence is obtained from sources external to the client’s entity, there might be circumstances that could affect its reliability.
For example, if the auditor obtains information from an independent external source, it may not be that reliable if the source is not knowledgeable or if the information is obtained from the management’s expert, it may not be free from bias.
Therefore, it is important that exceptions should be recognized, and to determine the extent of reliability of audit evidence, the factors and circumstances relevant to each individual case should be looked into.
Generally speaking, the following factors may help to evaluate the reliability of different kinds of audit evidence:
1. Independence of provider:
External evidence, for example, a confirmation received from a third party is generally considered to be more reliable than internal evidence gathered within the auditee’s company. Thus, independent sources outside the entity may increase the reliability of audit evidence.
2. Effectiveness of client’s internal controls:
When the internal controls imposed in the entity are satisfactory, internal evidence becomes more dependable. Thus, the auditors should have a good understanding of the internal controls of the entity. Especially when the auditor is satisfied with the internal controls over the preparation and maintenance of a particular piece of information, its reliability increases.
3. Oral and written evidence:
Oral evidence normally isn’t as reliable as evidence obtained in the form of documents and written statements. For example, a written record of a meeting is more reliable than an oral representation of the matters discussed thereat.
4. Auditor’s direct knowledge:
Evidence gathered by the auditor himself is more trustworthy than that gathered through the entity. For example, direct observation by the auditor, inspection/physical count of a tangible asset, and computation will give better evidence than the one obtained indirectly or by inference (e.g., through inquiry).
5. Consistency of evidence:
When the auditor obtains consistent evidence from different sources or sources of a different nature, the evidence is more reliable. This means that when the same information is obtained from a variety of sources, its reliability increases.
In contrast, if audit evidence obtained from one source is inconsistent with that obtained from another source, additional procedures may have to be performed by the auditor to resolve the inconsistency.
6. Original information:
Original documents are preferred over photocopies. Original documents are more reliable than evidence provided by photocopies, facsimiles, and digitized or otherwise transformed documents into electronic form. Again, the reliability of such electronic or digitized data may depend on the effectiveness of controls over their preparation and maintenance.
7. Qualification of individuals providing the information:
If the individual providing information to the auditor is qualified and competent and holds requisite knowledge about the information being confirmed, the validity of information supplied by him naturally increases.
8. Degree of objectivity
If the information supplied to the auditor is such that it lacks objectivity and needs considerable judgement to determine whether it is correct or not, its reliability decreases. This may be true for information supplied by a related party of the client who might not give an unbiased answer.
9. Timeliness
For balance sheet items, the evidence will be more reliable if it is obtained as close to the balance sheet date as possible. Similarly, for income statement items, the evidence will be more reliable if it is obtained from a sample of transactions that properly represent the entire period under audit.
To sum up the above discussion, it can be said that the reliability of audit evidence increases when:
- It is obtained from independent external sources.
- The related controls are effective.
- It is obtained directly by the auditor.
- It is obtained in documentary form.
- It is verified from a variety of different sources.
- It is provided by original documents.
- It is given by qualified and knowledgeable persons.
- It is objective.
- It is obtained on time.
These are also called determinants for evaluating the reliability of audit evidence.
Final thoughts
Evidence always varies in reliability. When the auditor recalculates certain figures, such as depreciation or inventory valuation, he may be entirely convinced of the reliability of the company’s figures. However, the information provided by an employee may not be as credible because he may be more interested in concealing rather than sharing the truth. This implies that we should always be aware of the relative reliability of various types of evidence. And the extent of reliability should be judged based on the source of evidence, the circumstances under which it is obtained, the internal controls of the client’s business, and other factors relevant to a given situation.
Another observation may be important here. Besides reliability, evidence also varies in the level of difficulty. Certain types of evidence may be more difficult to gather than others. It is pretty simple to ask questions from employees who are present in the company. It is simple to inspect inventory that is on hand, but it is more difficult to evaluate inventory that is held elsewhere.
Further, it may be important to note that most of the evidence obtained by an auditor is often persuasive rather than conclusive. This is so because auditors get the best evidence that is available to them and form their judgement accordingly. In fact, while carrying out an audit, it is sometimes very difficult and at times impractical to gather conclusive evidence. This can be both on account of time as well as cost constraints.
Even though they can’t give a 100% guarantee, but still, it is expected of auditors that they should be thorough in their efforts to obtain evidence. While performing their work, they should always recognize the possibility that the client’s financial information may be materially misstated due to fraud or errors.
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