When auditors perform an audit of an entity’s financial report, the most important thing that is needed to support the audit opinion is always sufficient appropriate evidence.
We called this piece of evidence “audit evidence”.
So, what exactly is audit evidence?
To understand this, we need to know what is the standard that auditors use to audit the financial statements of the company. Generally, auditors use International Standards on Auditing or ISA to audit a general purpose financial reports.
ISA 500 explains that audit evidence is the “information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based”. It also explains that “audit evidence includes both information contained in the accounting records underlying the financial statements and other information”.
But why is this necessary? Can’t we just rely on what the management tells us?
To ensure a true and fair view of the financial statements, auditors have to be objective and cannot rely solely on management’s representation. Every claim presented by the entity to the auditor has to be cross-checked and verified. The only way to do it would be to check them against audit evidence.
Yet, not all evidence fits the bill as audit evidence.
Sufficient appropriate audit evidence
When we talk about sufficient appropriate audit evidence, it refers to both the measure of the quantity and the quality of the audit evidence. That means not every piece of information or supporting document is suitable to be used as audit evidence.
To be deemed sufficient, it all depends on the level of assurance required. For a reasonable level of assurance, correspondingly detailed audit evidence needs to be obtained whereas, in a lower-level assurance engagement, less evidence will be required.
On the other hand, we will assess the quality of the audit evidence based on its relevance and reliability, as discussed below:
- Entity’s internal records vs external sources: The reliability of audit evidence from external sources, i.e., third parties not related to the entity being audited is higher than that from the entity itself.
- Evidence obtained directly vs indirectly: A piece of evidence obtained directly by the auditors is more reliable than that obtained indirectly or by inference.
- Effective vs ineffective internal control: Effective internal control will make the entity’s own record a piece of more reliable evidence.
- Written vs oral representations: Written representations, which could be in either paper or electronic form, are more reliable and preferred over oral representations.
- Originals vs photocopies or facsimiles: An original document would be considered to have higher reliability than those photocopied or faxed.
Now that we know what makes audit evidence sufficient and appropriate for the audit opinion required, here are 8 types of audit evidence that auditors normally obtain for an audit:
1. Physical inspection
Physical inspection involves the physical examination of records, documents or assets by the auditors themselves.
For example, a physical inspection can be used to:
- Confirm the existence of an asset
- Verify the state or condition company’s asset
- Confirm a control has been performed following the entity’s policy
2. Observation
Auditors also use observation as a shred of audit evidence. This audit evidence is limited to the point in time at which the observation takes place and the fact that the procedure is being observed might affect how it is performed as well.
Observation is normally used to:
- Identify whether an entity performs the process in adherence to the entity’s policy
- Determine and identify if there is any deficiency in the entity’s control
3. External confirmation
An external confirmation is a written response obtained directly by the auditor from a third party.
It is commonly used to:
- Confirm the balance of an account (e.g. bank, payable or receivable confirmations)
- Confirm the existence of a contract or agreement and its terms
- Confirm if there is any litigation or claim against the entity that may give rise to potential liabilities
4. Recalculation
This is the most straightforward audit evidence. It is basically checking the mathematical accuracy of the documents or records obtained. It can either be performed manually or electronically.
For example:
- Recompute the entity’s working on a specific estimate
- Recalculate the total balance of a bank confirmation
5. Reperformance
Auditors will often choose to independently execute the procedures or controls that are normally performed as a part of the entity’s internal control. This allows the auditor to identify control risks and potential deficiencies that may arise from performing the control itself.
To evaluate if all relevant controls have been properly executed, the auditor may:
- Reperform the bank reconciliations
- Reperform the steps from purchase to payment
- Reperform the steps from record to report
6. Analytical procedures
Analytical procedures are one of the important procedures that involve the use of financial and non-financial data to support the analysis of financial information.
The need for further investigation of the financial information in question depends on whether any inconsistencies or abnormalities are detected through the analysis of relationships among the data.
One most common examples of analytical procedures is checking the three-way relationships between revenue, receivable, and cash.
7. Inquiry
Inquiry is used extensively during an audit to corroborate other audit evidence. The responses received from inquiries should also be evaluated as part of the inquiry process.
For example, inquiry provides the auditor:
- Information regarding potential management override of controls
- Basis to modify or the need for additional audit procedures
- Information on the business outlook that can affect the going concern basis assumption
- Insights to a potential contingent liability
8. Documentation
This refers to the entity’s own documents and records, which could either be internal or external. Internal documentation is produced by the entity whereas external documentation is produced by a third party not related to the entity.
Auditors will either vouch or trace such documentary evidence as a part of their audit procedures.
An example would be vouching the invoices received for purchases made.
That’s it for 8 types of audit evidence auditors normally use! Bear in mind that the exact type of audit evidence obtained for a specific financial statement line item depends on the line item itself, the assertion being tested, the business nature of the client, etc.