THE AUDIT EVIDENCE PROCESS: TESTS OF CONTROL

THE AUDIT EVIDENCE PROCESS: TESTS OF CONTROL

CHAPTER OBJECTIVE

1. THE CONCEPT OF AUDIT EVIDENCE
2. THE CHARACTERISTICS OF GOOD AUDIT EVIDENCE
3. SUFFICIENT , APPROPRIATE EVIDENCE
4. AUDIT TESTING PROCEDURES

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1. THE CONCEPT OF AUDIT EVIDENCE

Audit evidence can be defined in simple terms as any piece of information which assists the auditor to reach conclusion on the truth and fairness of the financial statements. Audit evidence might therefore include such items as:
 Documents such as purchase orders, invoices, receipts, employee time sheets, customer orders, letters, bank statements, contracts and other legal documents.
 Entries in accounting records
 Answers from management to questions raised by the auditor
 Information from external parties who enter into transactions with the company, such as customers and suppliers, the bank, solicitors, government agencies (the tax authorities)
 Computations produced by the client or by the auditor himself, for example, depreciation calculations, computations of accruals and prepayments.
 Information gained from the auditor’s observations. An example would be the auditor attending and observing the client’s inventory count.

2. THE CHARACTERISTICS OF GOOD AUDIT EVIDENCE

ISA 500 Audit Evidence requires that auditors obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion.
Sufficient relates to the quantity of evidence, appropriate relates to the quality or reliability and relevance of evidence.
Key questions for the auditor to consider therefore will be:
1. Do I have enough evidence to reach a conclusion on this audit area?
2. Is the evidence that I have reliable enough to allow me to reach a conclusion on this area of the audit?

3. SUFFICIENT , APPROPRIATE EVIDENCE

The auditor’s judgement as to what amounts to sufficient appropriate evidence is influenced by such factors as:
 The assessment of audit risk involved
 The nature of accounting and internal control system
 The materiality of the item
 The auditor’s knowledge and experience of the business
 the findings of audit procedures. If the audit procedures indicate problems, additional evidence will need.
 The source and reliability of the information
 Size of the organisation-a small company is less likely to have as tight controls are a large organisation.

In assessing the reliability of audit evidence, the auditor can be guided by the following general principles:
 Evidence is more reliable when it is obtained form independent source outside the entity.
 Evidence that is generated internally is more reliable when the related controls imposed by the entity are effective.
 Evidence obtained directly by the auditor is more reliable than evidence obtained indirectly or by inference ( for example, the auditor would prefer to actually observe the application of a control than to enquire about how it is applied).
 Written evidence is more reliable than verbal evidence.
 Evidence provided by original documents is more reliable than using photocopies or faxes of documents.
When using documents as a source of audit evidence, the auditor should always try to use original documents rather than photocopies or faxes of documents.

4. AUDIT TESTIING PROCEDURES

As we know, audit tests are procedures carried out by the auditor in order to generate audit evidence.
There are a number of audit testing procedures that may be available to the auditor. Which procedures are actually used will depend on the area that is being audited, and the evidence available to the auditor.
1.Inspection
This covers the physical review or examination of records, documents and tangible assets. An example in a test of controls is examining purchase invoices for evidence of authorisation.
2.Observation
This technique involves looking at a process or procedure being performed. An example is the distribution of wage packets to see that internal control procedures are adhered to or the observation by auditors of inventory being counted in accordance with inventory counting instructions.

3.Enquiry
seeking relevant information from knowledgeable persons inside or outside the enterprise.
An example in test of control is asking management for an explanation of the company’s policy for vetting credit customers. This would then be verified by reviewing documents completed during the vetting process for evidence of completion of the process.
4.Confirmation
Confirmation ( a specific type of enquiry) concerns obtaining a representation directly from a third party. For example, the auditor may seek direct confirmation of receivables balance by writing to the customers.
5.Recalculation
Checking the arithmetical accuracy of records or performing independent calculations (e.g. checking the addition of the trial balance).
6.Reperformance
Reperformance is the auditor carrying out procedures or controls that were originally performed as part of the entity’s internal control system, for example reperforming the aging of receivables balances in an aged debt analysis.
7.Analytical procedure
Analytical procedures can be defined as the evaluation of financial information by studying the relationships between both financial data and non-financial data.
Analytical procedures include. They also include comparison of financial information with prior periods, budgets and forecasts and similar industries consideration of predictable relationships such as the relationship of purchases to sales, and payroll costs to the number of employees.
These procedure are mainly used in substantive testing rather than as a test of controls.

Each major accounting system should have control objectives and control procedures. The auditor will then perform tests of control to ensure the controls are working.
 Control objectives- what objectives are the internal controls seeking to achieve?
 Control activities- the procedure that should be in place to ensure the control objectives are achieved?
 Tests of control- audit work performed to generate evidence as to whether the controls are operating.
The materiality concept does not apply to exceptions discovered in tests of controls. For example, it is just as significant if an auditor discovers that a purchase invoice with a value of $2 has not been authorised for payment as if the invoice had a value of $2. the auditor should not ignore exceptions where only small amounts are involved, it is the control that is being tested, not the transaction. He would need to assess why the control did not work in that instance and therefore whether he needs to extend his testing.

Source:

1. kaplan, FAU
2. Phnom Penh HR (www.pp-hr.com)