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Ch 7 Audit Evidence

Pengauditan I (Universitas Airlangga)

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Chapter 7
Audit Evidence

Nature of Evidence
Evidence  any information used by the auditor to determine whether the information
being audited is stated in accordance with the established criteria.

Audit Evidence Decisions

There are four decisions about what evidence to gather and how much of it to
accumulate:

1. Which audit procedures to use

2. What sample size to select for a given procedure
3. Which items to select from the population
4. When to perform the procedures

Audit procedure  the detailed instruction that explains the audit evidence to be
obtained during the audit.

Audit program  The list of audit procedures for an audit area or an entire audit.

Persuasiveness of Evidence
The degree to which the auditor is convinced that the evidence supports the opinion.

There are two determinants of persuasiveness:

1. Appropriateness : a measure of the quality of evidence, meaning its relevance and

reliability in meeting audit objectives for classes of transactions, account balances,
and related disclosures.
2. Sufficiency: the quantity of evidence, proper sample size.

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Appropriateness

Relevance of evidence  Evidence must pertain to or be relevant to the audit objective

that the auditor is testing before it can be appropriate.

Reliability of evidence  refers to the degree to which evidence can be believable or

worthy of trust.

Reliability depends on the following six characteristics:

1. Independence of provider
Evidence obtained from a source outside the entity is more reliable than that
obtained from within
2. Effectiveness of client’s internal controls.
When a client’s internal controls are effective, evidence obtained is more reliable
than when they are not effective.
3. Auditor’s direct knowledge
Evidence obtained directly by the auditor through physical examination,
observation, recalculation, and inspection is more reliable than information
obtained indirectly.
4. Qualifications of individuals providing the information
Although the source of information is independent, the evidence will not be
reliable unless the individual providing it is qualified to do so.
5. Degree of objectivity
Objective evidence is more reliable than evidence that requires considerable
judgment to determine whether it is correct.
6. Timeliness
The timeliness of audit evidence can refer either to when it is accumulated or to
the period covered by the audit.

Sufficiency

Factors determining sample size:

- Auditor’s expectation of misstatement

- Effectiveness of internal control

Combined Effect

The persuasiveness of evidence can be evaluated only after considering the combination of
appropriateness and sufficiency, including the effects of the factors influencing
appropriateness and sufficiency.

Example:

A large sample of evidence provided by an independent party is not persuasive unless it is

relevant to the audit objective being tested. A large sample of evidence that is relevant
but not objective is also not persuasive.

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Types of Audit Evidence

 Physical Examination
The inspection or count by the auditor of a tangible asset.
 Confirmation
The receipt of a direct written response from a third party verifying the accuracy
of information that was requested by the auditor.
 Inspection
The auditor’s examination of the client’s documents and records to substantiate
the information that is, or should be, included in the financial statements.
 Internal document  has been prepared and used within the client’s organization
and is retained without ever going to on outside party.
 External document  has been handled by someone outside the client’s
organization who is a party to the organization being documented, but that is
either currently held by the client or readily accessible.
 Vouching  when auditors use documentation to support recorded transactions or
amounts.
 Tracing  if the auditor traces from receiving reports to the acquisitions journal to
satisfy the completeness objectives
 Analytical Procedure
Evaluations of financial information through analysis of plausible relationship
among financial and non-financial data.
1. Understand the Client’s Industry and Business
2. Assess the entity’s ability to continue as going concern
3. Indicate the presence of possible misstatement in the financial statements

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4. Provides evidence supporting an account balance

 Inquiries of the Client
Obtaining of written or oral information from the client in response to questions
from the auditor.
 Recalculation
Rechecking a sample of calculations made by the client.
 Reperfomance
The auditor’s independent test of client accounting procedures or control that
were originally done as part of the entity’s accounting and internal control system.
 Observation
Looking at a process or procedures being performed by others.

Appropriateness of Types of Evidence

1. The effectiveness of a client’s internal control has significant influence on the

reliability of most types of evidence.
2. Both physical examination and recalculation are likely to be highly reliable if the
internal controls are effective, but their use differs considerably.
3. Inquiry alone is usually not sufficient to provide appropriate evidence to satisfy any
audit objective.

Cost of Types of Evidence

- Costly  physical examination & confirmation

- Moderate  analytical procedures, inspection, reperformance
- Least costly  observation, inquiries, recalculation

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Analytical Procedures
Purposes of analytical procedures during the audit engagement:

1. Analytical procedures are required in the planning phase as part of risk assessment
procedures to understand the client’s business and industry and to assist in
determining the nature, extent, and timing of audit procedures.
2. Analytical procedures are often done during the testing phase of the audit as a
substantive test in support of account balances.
3. Analytical procedures are also required during the completion phase of an audit 
serve as final review for material misstatements or financial problems and help the
auditor take a final objective look at the audited financial statements.

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Types of Analytical Procedures

1. Compare client and industry data

Advantage: to aid in understanding the client’s business and as an indication of the
likelihood of financial failure; can be used to identify potential misstatement.
Disadvantage : the difference between the nature of the client’s financial
information and that of the firms making up the industry totals

2. Compare client data with similar period data

o Compare the current year’s balance with that of the preceding year
o Compare the detail of a total balance with similar detail for the preceding
year
o Compute ratios and percent relationships for comparisons with previous
year

3. Compare client data with client-determined expected result

Investigate the most significant differences between budgeted and actual results.

4. Compare client data with auditor-determined expected result

The auditor develops an expectation of what an account balances should be by
relating it to some other balance sheet or income statement accounts or by making
a projection based on nonfinancial data or some historical trend.

Common Financial Ratios

 Short-term debt paying ability
Cash+marketable securities
Cash Ratio=
current liabilities

Cash+ marketable securities+ net account receivable

Quick Ratio=
current liabilities

C urrent Assets
Current Ratio=
current liabilities

 Lliquidityactivity ratios
Net Sales
Account Receivable Turnover=
Average Gross Receivables

365 days
Days ¿ Collect Receivables=
accounts receivable turnover

C ost of Goods Sold

Inventory Turnover =
Average Inventory

365 days
Days ¿ Sell Inventory=
inventory turnover

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 Ability to meet long-term debt obligations

Total Liabilities
Debt ¿ Equity=
Total Equity

Operating Income
¿ Interest Earned=
Interest Expense
 Profitability ratios
Net Income
Earnings per share=
Average Common SharesOutstanding

Net Sales−Cost of Goods Sold

Gross Profit Percent=
Net Sales

Operating Income
Profit Margin=
Net Sales

Income Before Taxes

Return on Assets=
Average Total Assets

Income Before Taxes−Preferred Dividends

Return on Common Equity=
Average Stockholder s' Equity

Audit Documentation
The record of the audit procedures performed, relevant audit evidence, and conclusions
the auditor reached.

Purposes of Audit Documentation

1. A basis for planning the audit

2. A record of the evidence accumulated and the results of the tests
3. Data for determining the proper type of audit report
4. A basis for review by supervisors and partners

Permanent Files  contain data of a historical or continuing nature pertinent to the

current audit.

- Extracts or copies of such company documents of continuing importance as the

articles of incorporation, bylaws, bond indentures, and contracts.
- Analyses from previous years of accounts that have continuing importance to the
auditor.
- Information related to understanding internal control and assessing control risk.
- The results of analytical procedures from previous years’ audits.

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Current Files  all audit documentation applicable to the year under audit.

- Audit program
- Working trial balance
- Adjusting entries
- Supporting schedules
o Analysis
o Trial balance or list
o Reconciliation of amounts
o Substantive analytical procedures
o Summary procedures
o Examination of supporting documents
o Informational
o Outside documentation

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