Methods of obtaining audit evidence:
Before jumping onto the methods of obtaining audit evidence, let us see what constitutes audit evidence and how an auditor determines it to be sufficient and appropriate.
Audit evidence: Meaning
During the course of an audit, the auditor comes across various assertions made by the 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.
In other words, audit evidence provides grounds for checking whether a particular thing is true or not by providing support for a fact or a point in question. In this blog, we have explained the different methods of obtaining audit evidence by an auditor.
Sufficient and appropriate audit evidence
SA 500, Audit Evidence, issued by the Institute of Chartered Accountants of India (ICAI) deals with the basic principles relating to audit evidence. According to it, the sufficiency and appropriateness of audit evidence are important.
The auditor has to evaluate whether the evidence obtained by him is sufficient and appropriate so that reasonable conclusions can be drawn therefrom. Sufficiency and appropriateness are interrelated and should be applied to both: evidence obtained from substantive as well as compliance procedures. Audit procedures & methods to obtain audit evidence are discussed in the below sections.
The audit evidence is said to be sufficient if it is of adequate quantity. The term “sufficiency” relates to the quantum of audit evidence obtained and “appropriateness” relates to its relevance and reliability. The evidence should be relevant to the matter being checked and it should be reliable too.
An auditor should take into account the following factors while forming a judgment with regard to the sufficiency and appropriateness of audit evidence:
- the nature of the item
- whether internal controls are adequate
- the nature and size of the client’s business
- situations that may have an undue influence on the management
- the financial position of the business
- the materiality of the item (in general, the higher the level of significance or materiality, the higher shall be the standard that evidence will have to meet)
- the level of experience of the auditor (gained through previous audits)
- the results of auditing procedures performed and any fraud or errors detected
- the nature and type of information available
- the trend indicated by significant accounting ratios and their analysis
- the risk of reaching an invalid conclusion (for example, if the risk of legal action against the auditor or auditee’s company is high in case of negligence, the standard of evidence demanded will be high)
Types of audit evidence (Audit techniques or methods)
We know that an auditor has to collect evidence in support of his opinion. The auditor obtains this audit evidence by using compliance and substantive procedures. While compliance procedures are those tests that seek to examine the efficacy of internal controls operating in the client’s entity, substantive procedures are tests designed to check the accuracy and validity of an account balance, a transaction, or a specific financial statement assertion. Vouching of business transactions and verification of assets and liabilities also form part of substantive procedures. All these procedures of audit can be performed by the auditor by employing any one or more of the following methods:
Methods or techniques of obtaining audit evidence
- Analytical review
It involves examining records, documents, or physical assets. When records and documents are inspected, the evidence obtained can vary in terms of reliability. The degree of reliability depends on the nature and source of documents as well as the effectiveness of internal controls over their processing, preparation, and maintenance.
For instance, an auditor examines many documents such as title deed papers, investment certificates, etc. whether in possession of the entity or a third party.
It consists of witnessing a process or procedure while it is being performed by others.
“Physical verification and counting of inventory” is a good example of evidence obtained through observation. When an auditor observes a physical count of inventory, he can come to know whether obsolete or damaged inventory is properly identified by the staff of the client or not.
Inquiry entails seeking relevant information from a knowledgeable individual within or outside the entity. The auditor may enquire and seek appropriate written or oral information from the client, his staff, or third parties with respect to a particular item or activity of the client’s operations.
For example, the auditor may ask questions to the credit manager of the client regarding the realisability of receivables, to the supervisor of the store room regarding obsolete inventory items, or externally to a lawyer regarding the probable outcome of litigation.
Confirmation is the response to an inquiry so as to corroborate the information shown in the accounting records.
Many a time, the auditor may enquire or request a knowledgeable third party to substantiate the financial information contained in accounting records. Such confirmations can be taken for the following information:
It consists of checking the arithmetic accuracy of source documents and accounting records, as well as doing independent calculations by the auditor of important items of financial statements.
It includes analyzing significant ratios and patterns as well as looking into unexpected fluctuations and things. Analytical review procedures are different from computations. The former is related to the analysis of the relationship among different variables of financial & non-financial data whereas the latter merely checks arithmetical accuracy.
Reperformance is when an auditor independently executes a set of procedures or controls that were originally performed as part of the internal control system in the entity. For example, an auditor may reperform the aging of accounts receivable that was originally done manually by the entity’s staff or through the use of computer-aided tools or software.
Reliability of audit evidence
Once the audit evidence is obtained, it is equally important for the auditor to assess its reliability. The reliability of audit evidence is determined by its source, i.e., whether it is internal or external, and by its nature, i.e., whether it is visual, documentary, or oral. While the reliability of audit evidence shall depend on the situations under which the evidence is gathered, the following generalizations may be made when assessing the reliability of audit evidence:
1. 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.
2. When the internal controls 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.
3. Oral evidence normally isn’t as reliable as evidence obtained in the form of documents and written statements.
4. Evidence gathered by the auditor himself is more trustworthy than that gathered through the entity. For example, direct observation by the auditor, inspection, and computation will give better evidence than the one obtained indirectly.
5. When the auditor obtains consistent evidence from different sources or sources of a different nature, the evidence is more reliable.
6. 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.
Final thoughts on methods of obtaining audit evidence
To substantiate his opinion on the financial statements, it is critical that an auditor obtains sufficient and appropriate audit evidence. The evidence obtained by the auditor supports the contents of his audit report and his audit findings.
However, usually, the nature and extent of audit evidence will vary based on the auditing scenario. For example, in one case, the auditor may rely more on physical examination and confirmation from third parties, whereas in another, he may rely more on analysis of documentary evidence.
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