AUDITING TECHNIQUES AND THEIR LIMITATIONS, AUDIT EVIDENCE AND DOCUMENTATION

Audit Evidence

“Audit evidence” means the information obtained by the auditor in arriving at
the conclusions on which the audit opinion is based. Audit evidence
encompasses the quantity and quality (or reliability) of evidence to be obtained
by auditors. It is important for auditors to obtain sufficient, appropriate and
reliable audit evidence to enable them draw reasonable conclusions on which
to base their audit opinion.

Ways of obtaining audit evidence

The APB Statement of Auditing Standard No. 400 covers ‘audit evidence’. The
Standard provides guidance on the quantity and quality of evidence which
auditors should obtain and the procedures for obtaining the evidence. Audit
evidence may be obtained from:
(a) An appropriate mix of tests of control and substantive procedures; and
(b) Substantive procedures and enquiries made to ascertain the adequacy
of the accounting system as a basis for the preparation of the financial
statements.
An auditor should understand the following matters in relation to audit
evidence:
(a) The nature of audit evidence;
(b) The sufficiency of audit evidence;
(c) The appropriateness of audit evidence;
(d) The evaluation of audit evidence; and
(e) Reliability of audit evidence.

The nature of audit evidence

An auditor may use the following accounting data as sources of audit evidence
to test audit objectives:
(a) The books of original entry;
(b) Related accounting manuals; and
(c) Records, such as worksheets and spreadsheets which support the
amounts in the financial statements.
In recent times, there is a growing awareness of accounting data being kept in
the electronic form, but there are still cases of records kept manually. Audit
evidence should be corroborated. Corroborating audit evidence includes both
written and electronic information, for example;
(a) Cheques;
(b) Records of electronic transfers;
(c) Invoices;
(d) Contracts;
(e) Minutes of meetings; and
(f) Confirmations, and written representations.

Sufficiency of audit evidence

Sufficiency is the measure of the quantity of audit evidence. The auditor at
times relies on evidence that is persuasive rather than convincing in forming
an opinion on a set of financial statements. Relying on persuasive evidence
could be as a result of:
(a) Cost considerations
The auditor may examine a sample of the transactions that make up
the account balances or class of transactions. Examination of all the
transactions on a test basis would be convincing.
(b) The nature of evidence
The auditor may be presented with an inconclusive evidence which would
be conclusive, when taken in conjunction with other ones.
Consequently, the auditor often seeks audit evidence from different sources or
of a different nature to support the same assertion in order to provide reasonable,
but not absolute, assurance that the financial statements are free from material
mis-statement.

Appropriateness of audit evidence

There is a relationship between sufficiency and appropriateness of audit
evidence. Both sufficiency and appropriateness apply to audit evidence obtained
from tests of control and substantive procedures. Appropriateness is the measure
of the quality or reliability of audit evidence and its relevance to a particular
assertion while sufficiency is the measure of the quantity of audit evidence.
The auditor’s judgement as to what is sufficient and appropriate audit evidence
is influenced by such factors as:
(a) The auditor’s assessment of the nature and degree of risk of
mis-statement at both the financial statement level and the account
balance or class of transaction level;
(b) The nature of the accounting and internal control systems, including
the control environment;
(c) The materiality of the item being examined;
(d) The experience gained during previous audits and the auditor’s
knowledge of the business and industry;
(e) The findings from audit procedures, and from any audit work carried
out in the course of preparing the financial statements, including
indications of fraud or error; and
(f) The source and reliability of information available.
Auditors should consider the implications of their inability to obtain sufficient
appropriate audit evidence in their report.

The Evaluation of audit evidence

An evidence is considered appropriate when it is both relevant and reliable
(a) Relevance:
A relevant audit evidence should relate to the audit objective being
tested; and
(b) Reliability:
A useful audit evidence should be able to support the true state of an
assertion or audit objective.

Tests of control

Internal control is a means whereby an entity’s board or entity’s senior
management obtains a reasonable assurance that the entity’s set objectives
are achieved. These constitute all management mechanisms such as approved
authorisation process, policies and procedures that should be followed in
fulfiling organisational objectives, in order to give assurance that the procedures
are followed in conducting the business of the entity.
Auditors usually select a sample of transactions passing through the procedures
and test whether they were appropriately conducted in accordance with the
laid down guidelines. In conducting tests of control for the purpose of obtaining
audit evidence, the auditor should consider the sufficiency and appropriateness
of the audit evidence obtained to support the assessed level of control risk.
Audit evidence may be obtained from the accounting and internal control
systems in the following areas of design and operations:
(a) Design:
The accounting and internal control systems are capable of preventing
or detecting material mis-statements during the period covered by the
audit.
(b) Operation:
The systems exist and have operated effectively throughout the relevant
period covered by the audit.
The tests described above are referred to as `compliance testing’; which is test
of controls that provide audit evidence to ensure that they are working as
designed. This is different from substantive tests, which are designed to provide
audit evidence that transactions reported in the financial statements are
accurate, complete and valid.

Substantive procedures

In conducting substantive tests for the purpose of obtaining audit evidence,
auditors should consider the extent to which the evidence obtained from
substantive procedures together with any information obtained from tests of
controls support the relevant financial statements.
As a basis for the preparation of financial statements, the directors make certain
assertions. The assertions constitute representations of the directors that are
embodied in the financial statements. The directors, by approving the financial
statements, are making representations about the information therein.
The following matters constitute representations or assertions usually made
by the directors in approving financial statements:
(a) Existence:
An asset or a liability exists at a given date.
(b) Rights and Obligations:
An asset or a liability pertains to the entity at a given date.
(c) Occurrence:
A transaction or event took place which pertains to the entity during the
particular period.
(d) Completeness:
There are no unrecorded assets, liabilities, transactions or events, or
undisclosed items.
(e) Valuation:
An asset or liability is recorded at an appropriate carrying value.
(f) Measurement:
A transaction or event is recorded at the proper amount and revenue or
expense is allocated to the proper period.
(g) Presentation and Disclosure:
An item is disclosed, classified and described in accordance with the
applicable reporting framework (for example, relevant legislation and
applicable accounting standards).
The auditor should obtain evidence to support each financial statement
assertion. The audit evidence presented in support of one assertion (for example,
existence of stock) does not compensate for failure to obtain audit evidence
regarding another (for example, its valuation). Tests may, however, provide
audit evidence for more than one assertion (for example, testing subsequent
receipts from the entity’s debtors may provide some audit evidence regarding
both their existence and valuation).
In planning an assignment, the auditor prepares programmes comprising
detailed audit procedures and objectives. The objectives cover the financial
statement assertions made by the directors. The auditor seeks to ensure that
both the objectives and the audit programmes enable him to satisfy himself
that the planned work will result in the appropriate evidence being obtained.
In conducting substantive tests, the auditor should consider the nature, timing
and extent of substantive procedures. These may depend, amongst other factors,
on the following matters:
(a) The auditor’s assessment of the control environment and accounting
systems generally;
(b) The inherent and control risks relating to each assertion;
(c) Evidence obtained from audit work performed during the preparation
of the financial statements; and
(d) Where tests of control provide satisfactory evidence as to the effectiveness
of accounting and internal control systems, the extent to which relevant
substantive procedures may be reduced, but not entirely eliminated.

Reliability of Audit Evidence

The reliability of audit evidence is influenced by its source which may either
be internal or external; and by its nature which may be visual, documentary or
oral. The auditor must be aware of the following matters in assessing the
reliability of audit evidence:
(a) Audit evidence from external sources (for example, confirmation received
from a third party) is more reliable than that obtained from the entity’s
records;
(b) Audit evidence obtained from the entity’s records is more reliable when
the related accounting and internal control systems operate effectively;
(c) Audit evidence obtained directly by auditors is more reliable than that
obtained by or from the entity;
(d) Audit evidence in the form of documents and written representations
are more reliable than oral representations; and
(e) Original documents are more reliable than photocopies, telexes or
facsimiles.
When the audit evidence obtained from different sources are consistent with
one another, they become persuasive to the auditor. When the auditor’s
evaluation of audit evidence results in the fact that evidence from one source is
inconsistent with that from another, it is the responsibility of the auditor to
determine what additional procedures must be undertaken to resolve the
inconsistency.
Because of cost considerations, the auditor may examine a sample of the
transactions that make up the account balance or class of transactions. The
auditor must consider the relationship between the cost of obtaining audit
evidence and the usefulness of the information obtained. The auditor, however,
is not relieved of any blame if he omits a necessary procedure as a result of
any constraint.

Procedures for obtaining audit evidence

Auditors normally obtain audit evidence by inspection, observation, enquiry,
confirmation, computation and analytical procedures. The choice of one or a
combination of the procedures which the auditor may adopt is dependent, in
part, upon the period of time during which the audit evidence sought is available
and the form in which the accounting records are maintained.

Inspection

Inspection involves the following:
(a) Examination of records, documents or tangible assets;
(b) Provision of audit evidence of varying degrees of reliability depending
on their nature and source and the effectiveness of internal controls over
their processing;
Three major categories of documentary audit evidence are listed below in
descending degree of reliability as audit evidence:
(a) Evidence created and provided to auditors by third parties;
(b) Evidence created by third parties and held by the entity; and
(c) Evidence created and held by the entity.
Inspection provides reliable audit evidence about the existence of the tangible
assets inspected, but not necessarily as to the ownership or value of such assets.

Observation

The auditor by observation looks at a procedure being performed by others. For
example, the auditor observes the counting of stock by the entity’s staff or the
performance of internal control procedures as part of the conduct of an audit.

Enquiry and Confirmation

Enquiry involves seeking information within and outside the entity. Enquiry
may be formal or informal. Responses to enquiries obtained from third parties
may confirm or disprove information previously made available to the auditor.
Confirmation involves obtaining response to an enquiry to corroborate
information previously made available to the auditors in the course of the audit.
Examples of direct confirmation are as follows:
(a) Confirmation of debts by communication with debtors;
(b) Confirmation of legal cases by communication with the entity’s solicitors;
and
(c) Confirmation of bank balances by communication with the entity’s
bankers, etc.

Computation

The auditor uses computation to check the arithmetical accuracy of source
documents and accounting records. Computation also involves performing
independent calculations.

Analytical procedures

Analytical procedures consist of the analysis of relationship between:
(a) Items of financial data;
(b) Items of financial and non-financial data, derived from the same period;
and
(c) Comparable financial information deriving from different periods or
different entities.
Analytical procedures are used to identifying consistencies and predicted
patterns or significant fluctuations and unexpected relationships, and the results
of investigations performed.

Documentation

It is the duty of the auditor to document matters which are important in
providing evidence to support the audit opinion and evidence that the audit
was carried out in accordance with auditing standards, accounting standards
and relevant regulations.
The International Federation of Accountants (IFAC) published the International
Standard on Auditing titled ‘Documentation’ which establishes standards and
provides guidance regarding documentation in the context of the audit of
financial statements.
The Auditing Practices Board (APB) Statement of Auditing Standard 230 on
‘Working papers’ provides guidance on ‘Working papers’.
The Public Company Accounting Oversight Board (PCAOB) has also recently
issued Auditing Standard No. 3 - Audit Documentation. In this section,
‘documentation’ and ‘working papers’ are used interchangeably.
“Documentation” means the materials (working papers) prepared by and for,
or obtained and retained by the auditor in connection with the performance of
the audit. The PCAOB auditing standard No. 3 describes ‘audit documentation’
as ‘the written record of the basis for the auditor’s conclusions that provides
the support for the auditor’s representations, whether those representations
are contained in the auditor’s report or otherwise’. Working papers may be in
the form of data stored on paper, film, electronic media or other media.
Working papers:
(a) assist in the planning and performance of the audit;
(b) assist in the supervision and review of the audit work; and
(c) record the audit evidence resulting from the audit work performed to
support the auditor’s opinion.

Duties of Auditors on Working Papers

It is the duty of the Auditor to:
(a) Prepare working papers which are sufficiently complete and detailed to
provide an overall understanding of the audit;
(b) Record in the working papers information on planning the audit work,
the nature, timing and extent of the audit procedures performed, the
results thereof, and the conclusions drawn from the audit evidence
obtained;
(c) Record auditor’s reasoning on all significant matters which require the
exercise of judgement, together with the auditor’s conclusion thereon;
(d) Document areas involving difficult questions of principle or judgement;
and
(e) Record the relevant facts known to the auditor at the time the conclusions
were reached on matters of judgement or principles.
The extent of working papers to be prepared and retained is a matter of
professional judgement. In determining the extent of working papers to be
prepared and retained the auditor should consider:
(a) The legal and professional requirements; and
(b) What would be necessary to provide another auditor who has no previous
experience with the audit with an understanding of the work performed.

Form and Content of Working Papers

The following matters may affect the form and content of working papers:
(a) Nature of the engagement;
(b) Form of the auditor’s report;
(c) Nature and complexity of the business;
(d) Nature and condition of the entity’s accounting and internal control
systems;
(e) Needs in the particular circumstances for direction, supervision and
review of work performed by assistants;
(f) Specific audit methodology and technology used in the course of the
audit;
(g) Use of standardised working papers, for example, checklists, specimen
letters, standard organisation of working papers;
(h) Need to facilitate the delegation of work while providing a means to
control its quality; and
(i) Schedules, analyses and other documentation prepared by the entity
and the need to be satisfied that those materials have been properly
prepared.

Contents of Working Papers

The contents of working papers will generally include the following:
(a) Information concerning the legal and organisational structure of the
entity;
(b) Extracts or copies of important legal documents, agreements and
minutes;
(c) Information concerning the industry, economic and legislative
environment within which the entity operates;
(d) Evidence of the planning process including audit programmes and any
changes thereto;
(e) Evidence of the auditor’s understanding of the accounting and internal
control systems;
(f) Evidence of inherent and control risk assessments and any revisions
thereof;
(g) Evidence of the auditor’s consideration of the work of internal auditing
and conclusions reached;
(h) Analysis of transactions and balances;
(i) Analyses of significant ratios and trends;
(j) A record of the nature, timing and extent of audit procedures performed
and the results of such procedures;
(k) Evidence that the work performed by assistants was supervised and
reviewed;
(l) An indication as to who performed the audit procedures and when they
were performed;
(m) Details of procedures applied regarding components whose financial
statements are audited by another auditor;
(n) Copies of communications with other auditors, experts and other third
parties;
(o) Copies of letters or notes concerning audit matters communicated to or
discussed with the entity, including the terms of the engagement and
material weaknesses in internal control;
(p) Letters of representation received from the entity;
(q) Conclusions reached by the audit concerning significant aspects of the
audit, including how exceptions and unusual matters, if any, disclosed
by the auditor’s procedures were resolved or treated; and
(r) Copies of the financial statements and auditor’s report. (Chitty, 2004;
IFAC ISA 230).
(s) Checklists for compliance with statutory disclosure requirements and
accounting standards; and
(t) Management letter setting out internal control weaknesses in the system
to the client.

Confidentiality, Safe Custody, Retention and Ownership of Working

Papers
‘Working papers are the property of the auditors. Although portions of or extracts
from the working papers may be made available to the entity at the discretion
of the auditor, they are not a substitute for the entity’s accounting records’ (IFAC
ISA 230).
The auditor should therefore adopt appropriate procedures:
(a) For maintaining the confidentiality and safe custody of the working
papers; and
(b) For retaining the working papers for a period sufficient to meet the needs
of the practice and in accordance with legal and professional
requirements of record retention.

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