Pipara & Co LLP

Audit Evidence

Introduction

Scope of this SA
  1. This Standard on Auditing (SA) explains what constitutes audit evidence in an audit of financial statements, and deals with the auditor’s responsibility to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.

This SA is applicable to all the audit evidence obtained during the course of the audit. Other SAs deal with specific aspects of the audit (for example, SA 3151), the audit evidence to be obtained in relation to a particular topic (for example, SA 570(Revised)2), specific procedures to obtain audit evidence (for example, SA 5203), and the evaluation of whether sufficient appropriate audit evidence has been obtained (SA 200 and SA 3304).

Effective Date
This SA is effective for audits of financial statements for periods beginning on or after April 1, 2009.
Objective
The objective of the auditor is to design and perform audit procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.
Definitions
  1. For purposes of the SAs, the following terms have the meanings attributed below:
  1. Accounting records – The records of initial accounting entries and supporting records, such as checks and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal entries and other adjustments to the financial statements that are not reflected in journal entries; and records such as work sheets and spreadsheets supporting cost allocations, computations, reconciliations and disclosures.
  2. 1 SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment”.

2 SA 570(Revised), “Going Concern”.

3 SA 520, “Analytical Procedures”.

4 SA 330, “The Auditor’s Responses to Assessed Risks”.

  1. Appropriateness (of audit evidence) – The measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for the conclusions on which the auditor’s opinion is based.
  2. Audit evidence – Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and information obtained from other sources.
  3. Management’s expert – An individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements.

Sufficiency (of audit evidence) – The measure of the quantity of audit evidence. The quantity of the audit evidence needed is affected by the auditor’s assessment of the risks of material misstatement and also by the quality of such audit evidence.

Requirements
Inventory
  1. When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by:
  1. Attendance at physical inventory counting, unless impracticable, to: (Ref: Para. A1-A3)
    1. Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting; (Ref: Para. A4)   
    2. 1 SA 330, “The Auditor’s Responses to Assessed Risks”.

2 SA 500, “Audit Evidence”.

  1. Observe the performance of management’s count procedures; (Ref: Para. A5)
  2. Inspect the inventory; and (Ref: Para. A6)
  3. Perform test counts; and (Ref: Para. A7-A8)
  1. Performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.
  1. If physical inventory counting is conducted at a date other than the date of the financial statements, the auditor shall, in addition to the procedures required by paragraph 4, perform audit procedures to obtain audit evidence about whether changes in inventory between the count date and the date of the financial statements are properly recorded. (Ref: Para. A9-A11)
  2. If the auditor is unable to attend physical inventory counting due to unforeseen circumstances, the auditor shall make or observe some physical counts on an alternative date, and perform audit procedures on intervening transactions.
  3. If attendance at physical inventory counting is impracticable, the auditor shall perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory. If it is not possible to do so, the auditor shall modify the opinion in the auditor’s report in accordance with SA 705(Revised)3. (Ref: Para. A12-A14)
  4. When inventory under the custody and control of a third party is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following:
  1. Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity. (Ref: Para. A15)
  2. Perform inspection or other audit procedures appropriate in the circumstances. (Ref: Para. A16)
Litigation and Claims
  1. The auditor shall design and perform audit procedures in order to identify litigation and claims involving the entity which may give rise to a risk of material misstatement, including: (Ref: Para. A17-A19)

3 SA 705(Revised), “Modifications to the Opinion in the Independent Auditor’s Report”.

Handbook of Auditing Pronouncements-I.A

  1. Inquiry of management and, where applicable, others within the entity, including in-house legal counsel;
  2. Reviewing minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel; and
  3. Reviewing legal expense accounts. (Ref: Para. A20)
  1. If the auditor assesses a risk of material misstatement regarding litigation or claims that have been identified, or when audit procedures performed indicate that other material litigation or claims may exist, the auditor shall, in addition to the procedures required by other SAs, seek direct communication with the entity’s external legal counsel. The auditor shall do so through a letter of inquiry, prepared by management and sent by the auditor, requesting the entity’s external legal counsel to communicate directly with the auditor. If law, regulation or the respective legal professional body prohibits the entity’s external legal counsel from communicating directly with the auditor, the auditor shall perform alternative audit procedures. (Ref: Para. A21-A25)
  2. If:
  1. management refuses to give the auditor permission to communicate or meet with the entity’s external legal counsel, or the entity’s external legal counsel refuses to respond appropriately to the letter of inquiry, or is prohibited from responding; and
  2. the auditor is unable to obtain sufficient appropriate audit evidence by performing alternative audit procedures, the auditor shall modify the opinion in the auditor’s report in accordance with SA 705(Revised).
Written Representations

The auditor shall request management and, where appropriate, those charged with governance to provide written representations that all known actual or possible litigation and claims whose effects should be considered when preparing the financial statements have been disclosed to the auditor and appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

Segment Information
  1. The auditor shall obtain sufficient appropriate audit evidence regarding the presentation and disclosure of segment information in accordance with the applicable financial reporting framework by: (Ref: Para. A26)
  1. Obtaining an understanding of the methods used by management in determining segment information, and: (Ref: Para. A27)
    1. Evaluating whether such methods are likely to result in disclosure in accordance with the applicable financial reporting framework; and
    2. Where appropriate, testing the application of such methods; and
  2. Performing analytical procedures or other audit procedures appropriate in the circumstances.
Application and Other Explanatory Material
Inventory
Attendance at Physical Inventory Counting (Ref: Para. 4(a))

A1. Management ordinarily establishes procedures under which inventory is physically counted at least once a year to serve as a basis for the preparation of the financial statements and, if applicable, to ascertain the reliability of the entity’s perpetual inventory system.

A2.  Attendance at physical inventory counting involves:

  • Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
  • Observing compliance with management’s instructions and the performance of procedures for recording and controlling the results of the physical inventory count; and
  • Obtaining audit evidence as to the reliability of management’s count procedures.

These procedures may serve as test of controls or substantive procedures depending on the auditor’s risk assessment, planned approach and the specific procedures carried out.

A3. Matters relevant in planning attendance at physical inventory counting (or in designing and performing audit procedures pursuant to paragraphs 4-8 of this SA) include, for example:

  • Nature of inventory.
  • Stages of completion of work in progress.
  • The risks of material misstatement related to inventory.
  • Handbook of Auditing Pronouncements-I.A
  • The nature of the internal control related to inventory.
  • Whether adequate procedures are expected to be established and proper instructions issued for physical inventory counting.
  • The timing of physical inventory counting.
  • Whether the entity maintains a perpetual inventory system.
  • The locations at which inventory is held, including the materiality of the inventory and the risks of material misstatement at different locations, in deciding at which locations attendance is appropriate. SA 600, “Using the Work of Another Auditor” deals with the involvement of other auditors and accordingly may be relevant if such involvement is with regards to attendance of physical inventory counting at a remote location.
  • Whether the assistance of an auditor’s expert is needed. SA 6204 deals with the use of an auditor’s expert to assist the auditor to obtain sufficient appropriate audit evidence.

Evaluate Management’s Instructions and Procedures (Ref: Para. 4(a)(i))

A4. Matters relevant in evaluating management’s instructions and procedures for recording and controlling the physical inventory counting include whether they address, for example:

  • The application of appropriate control activities, for example, collection of used physical inventory count records, accounting for unused physical inventory count records, and count and re-count procedures.
  • The accurate identification of the stage of completion of work in progress, of slow moving, obsolete or damaged items and of inventory owned by a third party, for example, on consignment.
  • The procedures used to estimate physical quantities, where applicable, such as may be needed in estimating the physical quantity of a coal pile.
  • Control over the movement of inventory between areas and the shipping and receipt of inventory before and after the cut off date.

Observe the Performance of Management’s Count Procedures (Ref: Para. 4(a)(ii))

A5. Observing the performance of management’s count procedures, for example those relating to control over the movement of inventory before, during and after the count, assists the auditor in obtaining audit evidence that management’s instructions and count procedures are adequately designed and implemented. In addition, the auditor may obtain copies of cut off information,

4 SA 620, “Using the Work of an Auditor’s Expert”.

such as details of the movement of inventory, to assist the auditor in performing audit procedures over the accounting for such movements at a later date.

Inspect the Inventory (Ref: Para. 4(a)(iii))

A6. Inspecting inventory when attending physical inventory counting assists the auditor in ascertaining the existence of the inventory (though not necessarily its ownership), and in identifying, for example, obsolete, damaged or ageing inventory.

Perform Test Counts (Ref: Para. 4(a)(iv))

A7. Performing test counts, for example by tracing items selected from management’s count records to the physical inventory and tracing items selected from the physical inventory to management’s count records, provides audit evidence about the completeness and the accuracy of those records.

A8. In addition to recording the auditor’s test counts, obtaining copies of management’s completed physical inventory count records assists the auditor in performing subsequent audit procedures to determine whether the entity’s final inventory records accurately reflect actual inventory count results.

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