TANZANIA INSTITUTE OF ACCOUNTANCY

AUDIT EVIDENCE
ISA 500 Audit Evidence

1. Definition of Audit Evidence of

Audit risk
The risk that the auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated. Audit risk is a function of material misstatement detection risk.

The audit risk can be classified into the following three components:

a. Inherent risk
This is the susceptibility of an assertion about a class of transaction, account balance, or
disclosure to a misstatement that could be material, either individually or when aggregated with
other misstatements, before consideration of any related controls.

b. Control risk
This is the risk that a misstatement could occur in an assertion about a class of transaction,
account balance or disclosure, and that the misstatement could be material, either individually or
when aggregated with other misstatements, and will not be prevented or detected and corrected,
on a timely basis, by the entity’s internal control.

c. Detection risk
This is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably
low level will not detect a misstatement that exists and that could be material, either
individually or when aggregated with other misstatements.

Audit evidence
Audit evidence can be defined as the information obtained by the auditor in arriving at the
conclusion on which he /she bases his/her opinion on the financial statements.

Gathering audit evidence is a major decision facing every auditor this is because the auditor has
to determine the appropriate amount of evidence to be accumulated in order to be satisfied that
the components of the client’s financial statements are fairly stated the source and amount of
evidence to achieve the required level of assurance is the question of the auditor to determine by
exercising own judgment in the light of the opinion called under the terms of Audit engagement.

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This judgment is important because of the prohibitive cost of examining and evaluating all
available evidence
The auditory decision on evidence accumulation will be influenced by:
-Materiality of the matter being examined
-Relevance and reliability of the evidence and
-Cost and time involved in obtaining it

Why does the auditor need evidence?

AUDIT
OPINION ENHANCES USERS’ FINANCIAL STATEMENTS
CONFIDENCE IN
Financial statements are complex documents
They consist of:
• Statement of financial performance (Income statement, Profit and loss account)
• Statement of financial position (balance Sheet)
• Cash flow statement
• Notes.

3. Sources of Evidence
Often the auditor will obtain evidence from various sources which together will provide the basis
for the necessary assurance for the opinion on the financial statements

Sources of audit evidence include:

i. The accounting system and the underlying records and documentation of the entity.
These conclude books of original entry general and subsidiary ledger, accounting
manuals, informal and memorandum records such as work sheets reconciliation, and
documents such as cheques , involves etc
ii. Entity’s tangible assets
iii. Management and explanations
iv. Employees representations (both oral and written) and oral explanation
v. Customers, suppliers and other third parties who have dealings with or knowledge of the
entity or its business such as lawyers, advocates, banks etc. These parties will normally
give evidence on form of confirmations and other written representations.

4. Criteria for persuasiveness of Audit Evidence

(Desirable qualities of good audit evidence

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An auditor can rarely be certain of the validity of the financial statements (that is the reason the
auditor gives opinions and cannot issues a certificate

An auditor requires sufficient, relevant and reliable evidence to form a reasonable basis for the
audit opinion. In other words, the auditor should obtain sufficient appropriate audit evidence.
Appropriate audit evidence is a result of combined effect of its sufficiency relevance and
reliability.

Persuasive not conclusive

Audit evidence is persuasive not conclusive

Consider:
 The auditor gives an opinion about the financial statements not a certificate that the
financial statements are correct.
 The audit report gives reasonable not absolute assurance about the financial statements.
 Audit procedures are designed to reduce the risk that the financials statements contain
material misstatements not to eliminate all possibility of error.

The reason for all this lack of absolute, definitive certainly is the nature of audit evidence
which is gathered by human beings in real live organizations.
 The auditor gathers evidence on a test basis the sample may or may not be
representative).
 People make mistakes (both client and auditor).
 Documents could be forged (increasingly easy with digital technology).
 The client’s personnel may not always tell the truth.
 As a result, we have to say that audit evidence is persuasive rather than conclusive in
nature.
 This also means that the auditor will need to gather evidence from a variety of sources.

4.1 Sufficiency of Audit Evidence

Sufficiency deals with the quantity of evidence that can be considered adequate for drawing any
reasonable conculusion. The sufficiency and appropriateness of audit evidence to support the
auditor’s conclusions are a matter of professional judgment. The auditor’s judgment as to what
constitutes sufficient appropriate audit evidence is influenced by such factors as: -

1. The significance of the potential misstatement in the assertion and the likelihood of its
having a material effect, individually or aggregated with other potential misstatements, on
the financial statements: the more material the item, the greater the required sufficiency
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 and appropriateness of evidence;
2. The effectiveness of management’s responses and controls to address the risks: strong
controls reduce evidence requirements;
3. The experience gained during previous audits with respect to similar potential
misstatements: prior experience with the client will indicate how much evidence was taken
before and if that was enough or appropriate;
4. Results of audit procedures performed, including whether such audit procedures
identified specific instances of fraud or error;
5. Source and reliability of the available information;
6. Persuasiveness of the audit evidence;
7. Understanding of the entity and its environment, including its internal control (Auditor’s
degree of knowledge of the entity’s business and industry in which it operates)

(ii) Persuasiveness of the evidence itself

It is important therefore that the auditor selects a large enough sample size to arrive at sufficient
evidence. The decision as to how many items to test must be made by the auditors for each audit
procedure. Large sample sizes affect the sufficiency than smaller size. In addition, the particular
items tested affect the sufficiency criteria as well. Samples containing population item with
monetary values or/ and items with a high like hood of error and item that are representative of
the population are sufficient.

However, insufficient samples could be those containing only largest monetary values

4. 2 Relevance of Audit Evidence

The relevance of audit evidence should be considered in relation to the overall audit objectives
forming an opinion on the financial statements. Relevance can therefore be consideration in term
of specific audit objectives the auditors is testing. In relation to the financial statements several
examples are given below to illustrate this criterion

Relevance criteria related to audit objective in the financial statement items:

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 AUDIT OBJECTIVES FINANCIAL STATEMENTS ITEMS
Balance Sheet Item

1.Completeness 1. Have all the assets and liabilities been recorded?

2.Existence 2. Do the recorded assets and liabilities exist?

3.Ownership 3. Are the assets owned by the entity and are liabilities
properly recorded in the books of the entity?

4.Consistency 4. Have the amounts attributed to the assets and liabilities

been arrived at in accordance with the stated accounting
policies on an acceptable and consistent basis?
5. Have the assets and capital reserves been properly
5.Disclosure disclosed?

Items in the profit and Loss Account

1.Completeness 1. Have all the income and expenditure of the entity been
records?
2.Existence 2. Did the records income and expense transactions in fact
occur?
3.Consistency 3. Have the income and expenses been measured in
accordance with the sated accounting policies on an
acceptable and consistent basis?
4.Disclosures 4. Have income and expenses been properly disclosed?

4.3 Reliability of Audit Evidence

Reliability refers to the degree to which evidence can be considered to be relied upon or worthy
to trust.
The reliability of audit evidence depends on several factors such as:

Independence of the provider of such information: Following presumptions

Apply to the independence i.e. evidence obtained from source outside the entity is more reliable
than obtained from within. Similar evidence obtained directly by the auditor himself is more
reliable than that evidence upon which the client has an influence. For example, external
evidence such confirmation from banks on the bank balance or customers and debtors’ balances
is generally more reliable than the answer obtained from inquiries of the client.

Degree of objectivity: Objectives evidences is more reliable than that evidence that requires
consideration judgments to determine whether it is correct or not. In the case documentary
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evidence is more reliable than oral evidence. For example, the view of unreliable than the written
auditors’ analysis of the age of the debts

Qualifications of the individual providing the information

Although the sources of evidence may be independent the evidence itself may be less reliable
unless the individual providing it is qualified to do so. For this reason, evidence obtained by the
auditors may not be highly reliable if he lacks qualification to evaluate it. For example, an
auditor examining inventory of diamond without specialized knowledge to distinguish glass from
diamond may be unreliable if not misleading. The same applies to auditor performing an audit in
computerized accounting system without adequate knowledge of the computer system in
operation. Evidence obtained there from will also be unreliable.

Effectiveness of the internal control system: Evidence from an effective internal control
system is more reliable than when internal control system is weak.
The auditor’s direct knowledge: evidence originated by the auditors through physical
examination observation, computations and inspection is more reliable than evidence from other
sources.

5. Techniques of obtaining audit evidence

Audit evidence is obtained by performing audit tests. These are either compliance or substantive
tests. For this reason, techniques if obtaining audit tests as also referred to as techniques of audits
testing. There are several techniques which auditors make use in obtaining audit evidence these
include
1. Physicals verification
2. Confirmation
3. Documentation
4. Observation
5. Inquiry
6. Mechanical accuracy /computation
7. Analytical review

5.1 Physical Verification

This is the inspection or count of a tangible by the auditor it is mostly associated with stock or
cash, but also applicable to notes receiverable or other tangible fixed assets.
Physical examination is a direct means of verifying that an asset truly exists. It gives one of the
most reliable audit evidence because it ascertains the quality and description of an asset.
However, it is insufficient in verifying the ownership and obsolescence or paper values of the
existing by the client.

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5.2 Documentation
This refers to the physical examination of the documents and records to substantiate information
included in the financial statements.

Documents can originate from internal or external sources of the client. An internal document is
prepared and used within the client’s organization includes things such as copies of sales
invoices. An external document on the other hand is one that has been in the hands of someone
outside the client’s organization and who is party to the documented transaction, but which is
currently in the hands of the client. An example includes canceled cheques.
Under an effective internal control system, external documents are generally more reliable than
internal ones.

Inspection of records and documents provides audit evidence of varying degrees of reliability
depending on their nature, source, and the effectiveness of internal controls over their
processing:
1. The nature of documents includes quantity of information contained, the difficulty of
access to them, and who has custody.
2. The source of the documents may be from inside or outside the firm.
3. The source outside the firm may or may not be independent of the client.
4. The source may be competent or incompetent.
5. The controls over the recording process may be effective or ineffective.

External and Internal Documents

A document’s source may be internal or external to the organization. An internal document is
one that has been prepared and used within the client’s organization and is retained without ever
going to an outside party. An external document is one that has been in the hands of someone
outside the client’s organization who is a party to the transaction being documented. External
documents may originate outside the entity and end up in their hands such as insurance policies,
vendor’s invoices (bills), bank statements, and cancelled notes payable. Other external
documents originate inside the entity, go to a third party and are then returned to the entity.
Cancelled cheques are an example of client to third party and then to client documents.
Internal documents are less reliable than external documents. Internal documents processed
under good internal controls are more reliable than those processed under weak controls.
External documents may be processed by both internal and external parties and, therefore,
represent agreement over information contained in the document. Some external documents such
as title papers to property, insurance policies, and contracts are very reliable evidence because
they are prepared with considerable care and probably have been reviewed by lawyers.

Vouching
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The use of documentation to support recorded transactions or amounts is called “vouching.”
Vouching is an audit process whereby the auditor selects sample items from an account and goes
backwards through the accounting system to find the source documentation that supports the
item selected (e.g. a sales invoice). For example, to vouch the existence of recorded acquisition
transactions, the audit procedure would be to trace from the acquisitions journal to supporting
vendor’s invoices, cancelled checks or receiving reports.

5.3 Confirmation
This refers to the receipt of a written response from an independent third party vending the
accuracy of information request by the auditors.
Confirmation consists of the response to an inquiry of a third party to corroborate information
contained in the accounting records. For example, the auditor ordinarily seeks direct
confirmation of receivables by communication with debtors. Confirmation is the auditor’s receipt
of a written or oral response from an independent third party verifying the accuracy of
information requested. It is the act of obtaining audit evidence from a third party in support of a
fact or condition. Illustration 10.7 gives a summary of the characteristics of confirmation as an
evidence-gathering technique.

Confirmation procedures are typically used to confirm the existence of accounts receivable and
accounts payable, but they may be used to confirm existence, quantity and condition of inventory
held by third parties (e.g. public warehouse consignee) on behalf of the entity. They may be used
to verify bank balances with banks; cash surrender value of life insurance or insurance coverage
with insurers; notes payable with lenders or bondholders; shares outstanding with stock transfer
agents; liabilities with creditors; and contracts terms with customers, suppliers, and creditors.

Because confirmations from independent third parties are usually in writing, and are requested
directly by the auditor, they are highly persuasive evidence. The main disadvantage of
confirmations is that they are costly, time-consuming, and an inconvenience to those asked to
supply them.

Positive and Negative Confirmations

ISA 505 identifies two forms of confirmations: positive and negative confirmation. 18 The
request for positive confirmation asks the recipient (debtor, creditor, or other third party) to
confirm agreement or by asking the respondent to fill in information. A response to a positive
confirmation request is expected to provide reliable audit evidence. The auditor may reduce the
risk that a respondent reply to the request without verifying the information by using positive
confirmation requests that do not state the amount (or other information) on the confirmation
request, but asks the respondent to fill in the amount.

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However, using this type of “blank” confirmation request may result in lower response rates
because additional effort is required of the respondents. The positive form is preferred when
inherent or control risk is assessed as high because with the negative form no reply may be due
to causes other than agreement with the recorded balance.

A negative confirmation request, asks the respondent to reply only in the event of disagreement
with the information provided in the request. However, if there is no response to a negative
confirmation request, the auditor cannot be sure that intended third parties have received the
confirmation requests and verified that the information contained therein is correct. For this
reason, negative confirmation requests ordinarily provide less reliable evidence than the use of
positive confirmation requests, and the auditor may consider performing other substantive
procedures to supplement the use of negative confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level when:
1. The assessed level of inherent and control risk is low;
2. A large number of small balances is involved;
3. A substantial number of errors is not expected;
4. The auditor has no reason to believe that respondents will disregard these requests.

Confirmations and Information Often Confirmed

Information Source
Cash in bank (example) Bank
Accounts receivable Customer
Notes receivable Maker
Owned inventory out on consignment Consignee
Inventory held in public warehouses Warehouse
Cash surrender value of life insurance Insurance co.
Accounts payable Creditor
Notes payable Customer
Advances from customers Lender
Mortgages payable Mortgagor
Bonds payable Bondholder

5.4 Observation
This means looking at and assessing an operation or procedure while being performing
observation provides reliable evidence as to the manner of performing at the time of observation
but at any other time. It is therefore in itself insufficient and needs corroborative evidence.

5.5 Inquiry

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This is seeking relevant information from knowledgeable person inside or outside the entity,
whether formally, informally, oral or in writing.
The degree of reliability attached to the evidence obtained through inquiry is independent upon
the competence, experience, independence and integrity of the respondent evidence through
inquiry requires corroborating evidence through other procedures

5.6 Mechanical Accuracy /computation

This involves checking the arithmecal accuracy of the accounting records or performing
independent calculations. Such procedures extending sales invoices and inventory, adding
journals and subsidiary ledgers and checking the calculation of depreciation expenses, fall under
computational techniques.

5.7 Analytical Review

Analytical review procedures include calculating and studying significant ratios trends other
statistics and comparing them to previous year(s)
Though such companies the auditors may obtain unusual or unexpected variations which he /she
must investigate to obtain explanations from the client.

6. Letter of Representations: Evidence from client Managements

Letter of representation constitute confirmation received by the auditors from the officers of the
client. Its broad purpose is to place on record the confirmations from management on significant
maters directly affecting the accounts.

Letter of representations serves as a reminder to the management of their responsibility to ensure

that a true and fair view is given by the financial statements they have prepared and presented to
members

This letter forms part of the audit evidence from the highest authority within the client it should
be obtain as close as possible to the date of audit report and when all the work has been
completed including the events that occurs after the balance sheet date.

All maters contained in the letter should have been discussed between the auditor and
management such that letter merely formalizes them. It should not include those matters on
which the auditor is able to obtain evidence from independence sources.

Letter of representation should be signed by person whose authority is appropriate to the

significance of the representation. These are normally the Chief Executive Director and the
Financial Controller on behalf of the Board members

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Procedures for the Letters of representation
Procedures to obtain letter of representation should at an early stage in order to reduce possibility
of the auditor faced by refusal by management to cooperate in providing the representations.

If management refuses to issues the letter the auditor should prepare his /her own statements
setting out the understanding of the principle representation made during the audit work and
request management to confirm that understanding. The auditors should pursue the matters
through discussions with the management until correct understanding is obtained.

Failure to obtain required written representation either because of refusal or decline by

management may amount to the limitations in the scope of audit. The auditor will in this case fail
to obtain all the necessary information and explanation and a possible consequence is to
disqualify the audit report.

Contents of the Letter of Representation

Direct confirmation that might be sought by the auditor fall under four heading namely general,
assets, liabilities and profit and loss item; Examples under each heading are given hereunder: -

General contents:
 Disclosure of all accounts books record including minute books
 Consistency of application of the accounting policies
 Events occurring after that balance sheet date
 Compliance with the IFRS and other legislation
 Outstanding litigation
 Disclosure of all materials capital commitments

Assets
 Title to all the client’s assets
 Adequacy of depreciation charges
 Basis for valuing stocks
 Adequacy for provision for stock losses and obsolescence
 Reliability of certain assets
 Amount of capital expenditure authorized by the Board and the amount committed at the
balance sheet date.

Liabilities
 Provision for all known liabilities
 Disclosure of the nature and amount of contingent liabilities
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  Disclosure of all secured liabilities

Profits Loss Account

 Disclosure of all extra ordinary exceptional non- recurring and prior adjustments
 Disclosure of any change in the accounting policies

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