Audit Evidence & Audit Documentation-Fundamental Necessity and Professionalism

About The Topic:

This is very important topic for students and professionals both. As far as for students of Ca-Final and CA-IEPCC (earlier called IPCC) it covers about 5 to 10 marks, for professional this topic is also very important. Even the professionals are known for proper documentation. Most of the CA-Firm does not follow SAs and legal requirements about this topic but this is followed impliedly. So read this with proper care.

As per Section 227 of the Companies Act 1956 it is the duty of auditor to express an opinion on the true and fair view of state of affairs of the company. Further the audit report should also state – he has obtained all information and explanations for the sake of his audit report.

As per Clause 8 Part-I of Second Shedule of Chartered Accountants Act 1949, if any Member in practice fail to obtain sufficient and appropriate audit evidence to express an opinion on financial statements it will amount to professional misconduct.   

As per SA-200(Revised) “Overall Objectives of the Independent Auditor and The Conduct of an Audit in Accordance with Standard on Auditing” issued By ICAI(old)  the auditor should obtain reasonable assurance about weather financial statements are free from material misstatement as a whole for the purpose of expressing an opinion on financial statements.  Reasonable assurance is obtained when auditor has obtained Sufficient Appropriate audit evidence to reduce audit risk to an acceptably low level.

Now the Question arises what is Audit Evidence? It is defined by SA 501(Revised) issued by Institute of Chartered Accountants of India.

Audit Evidence:

SA-500 (Revised) “Audit Evidence”  and SA501 (Revised) “Audit Evidence – Specific Considerations for Selected Items” deals with Audit Evidence as the Fact & Reasons (Information) used by auditor to express an opinion on financial statements. Audit Evidence are persuasive in nature. Audit Evidence is primarily obtained from Audit Procedure Performed. Audit Evidence comprises both information that support and corroborates management assertions and any information that contradicts such assertions. Sometimes absence of Information also consist audit evidence. Further SA says that the auditor should obtain sufficient appropriate audit evidence so as to enable himself to achieve his overall objective. SA defines Sufficiency and Appropriateness of Audit Evidence in such a way.

Sufficiency: Sufficiency of audit document refer to Quantity of Audit Evidence.

Appropriateness: It refers to the Quality of Audit Evidence.

These two words are interrelated; the Quantity of Audit Evidence totally depends upon the Quality of the Audit Evidence. In simple words the more rich the Quality of Audit Evidence the lower Quantity of Audit Evidence can be reliable. If you are obtaining Evidence of poor quality it can’t be compensated by high quantity of Evidence.

Source Of Audit Evidence: Sources of Audit Evidence can be:-

1. Internal: Minutes of meeting , Sale Invoice Or

External: External Confirmation (SA505), External Expert (SA-620) Purchase Invoice, Bank Statement.

2. Written: Management Representation Or

Oral:

3. Dependent: Internal control, Management Expert Or

Independent: Auditors Expert, Management Expert

Relevance & Reliability of Audit Evidence: In simple word every Audit Evidence which Increase the degree of reliability on financial statement is relevant. In technical term relevance deals with the logical connection with. Or bearing upon, the purpose of the audit procedure and, where appropriate, the assertion under consideration. Reliability is nothing but the measure of true and fairness of the information obtained.

SA 500Revised made some generalization for relevancy:

Audit Evidence obtained from Independent Source - More reliable

Audit Evidence obtained Internal Source when internal control is effective- More Reliable

Audit Evidence obtained directly by auditor- More Reliable 

Audit Evidence obtained in Written Form – More Reliable

Audit Evidence obtained in oral form- Less Reliable

Audit Evidence obtained in the form of original document rather than photocopy – More Reliable 

Reliability of Information Produced By Management Expert

Management Expert- SA-620 “Using the Work of an Expert” deals with External Expert. Whereas SA-500(Revised) deals with Management Expert as follows” An Individual or Organization possessing expertise in the field other than accounting or auditing, whose work in that field is used by entity to assist the entity in preparing the financial statements.

The nature, timing and extent of audit procedure to be applied on the basis of expert’s opinion is dependent upon following factors:

a. The nature and complexity of the matter to which the management’s expert relates.

b. The risks of material misstatement in the matter.

c. The availability of alternative sources of audit evidence.

d. The nature, scope and objectives of the management’s expert’s work.

e. Whether the management’s expert is employed by the entity, or is a party engaged by it to provide relevant services.

f. The extent to which management can exercise control or influence over the work of the management’s expert.

g. Whether the management’s expert is subject to technical performance standards or other professional or industry requirements.

h. The nature and extent of any controls within the entity over the management’s expert’s work.

i. The auditor’s knowledge and experience of the management’s expert’s field of expertise.

j. The auditor’s previous experience of the work of that expert.

Audit Procedures for Obtaining Audit Evidence:- Followings are the audit procedures that can be applied to obtain audit evidence –

i) Inspection- Inspection involve examining records or documents, weather internal or external, in paper form , electronic form, or other media or a physical examination of an asset.

ii) Observation- Observation consists of looking at a process of procedure being performed by others.

iii) External Confirmation- SA-505 “External Confirmation” define external confirmation as audit evidence obtained by the auditor from third party, in paper form, or by electronic or any other medium.

iv) Recalculation- Recalculation means checking mathematical accuracy of documents and records.

v) Reperformance- Reperformance involves the auditor’s independent execution of procedures or controls that were originally performed as a part of internal control of the entity.

vi) Analytical Procedures- evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data which involves comparing recorded amounts to expectations developed by the auditor.

vii) Inquiry- Inquiry consists of seeking information of knowledgeable person both financial and non financial, within the entity or outside the entity.

The Auditor should determine the Nature, Timing and Extent of Audit Procedure to be performed to comply with SAs and applicable legal & regulatory frame work.

Now question arises what is meant by Nature, Timing and Extent?

Nature – Means which audit procedure should be applied depending upon the situation i.e. Substantive Or Compliance.

Timing- Means when to apply an audit procedure i.e. Planning Stage, Substantive Testing Stage,  or Reporting Stage.

Extent – Means how much to apply i.e. Size Of Sample.

SA- 501(Revised) Audit Evidence—Specific Considerations for Selected Items

This SA deals with specific considerations by the auditor to obtain sufficient appropriate audit evidence regarding the:

(a) Existence and condition of inventory;

(b) Completeness of litigation and claims involving the entity; and

(c) Presentation and disclosure of segment information in accordance with the applicable financial reporting framework.

Common Points

·  Take Management Representation (SA) 580 (Revised) Written Representations

· If Unable to obtain audit evidence due to management refusal it will be considered as limitation on the scope of audit issue the report As Per SA-705 “Modifications to the Opinion in the Independent Auditor’s Report”

Existence and condition of inventory-

· When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attending physical inventory counting on the date of financial statements.

· If physical inventory counting is conducted at a date other than the date of the financial statements, - Ensure whether changes in inventory between the count date and the date of the financial statements are properly recorded by applying additional audit procedures.

· If unable to attend physical inventory counting- Do On Alternative day

· If attendance at physical inventory counting is impracticable- Alternative Audit Procedures.

· When inventory under the custody and control of a third party- take external confirmation

Existance of inventoy can be under stood by following flow chart:

Litigation and Claims –

· 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

· Inquiry of management and, where applicable, others within the entity, including inâ€house legal counsel;

· Reviewing minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel; and

· Reviewing legal expense accounts

· If indication of material litigation or claims exists, the auditor shall, in addition to the procedures required by other SAs, seek direct communication with the entity’s external legal counsel.

·  If law, regulation prohibits legal counsel from communicating directly – Perform alternative procedure.

Segment Information-

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:

· Evaluating whether methods and the application for disclosure of  Segment Information used  by management are in accordance with the applicable A S17 “Segment Reporting” and

· Performing analytical procedures or other audit procedures appropriate in the circumstances.

We have obtained Audit Evidence its time to assemble them in file.

SA-230 Audit Documentation

Audit Documentation- The record of:

· Audit procedures performed,

· Relevant audit evidence obtained and

· Conclusion the auditor reached.

Audit document is also known as working papers. Working papers helps in:

a. Planning and performing an audit.

b. Supervision of audit work.

c. Evidence that audit is actually performed.

d. Quality Control Review

e.  Conduct of External Inspection

The Form, Contents & Extent of Working Paper depend upon following-

a. Nature of engagement

b. Form of audit report

c. Nature & complexity of client’s business

d. Nature & Condition of client’s record

e. Adequacy of internal control

f. Work Performed by others

Audit documentation may be recorded in paper or on electronic mode or other media. It should be noted that it cannot be stored in electronic media before IT Amended Act 2000. Working paper may be –

a. Audit Programmes

b. Analyses

c. Issue Memoranda

d. Summaries of Significant Matters

e. Letters of Confirmation and Representation

f. Correspondence Concerning significant matters

g. Checklists

Documentation of Certain Matters

Departure from a Relevant Requirement- In exceptional circumstances, the auditor judges it necessary to depart from a relevant requirement in a SA, the auditor shall document how the alternative audit procedures performed achieve the aim of that requirement, and the reasons for the departure.

Matters Arising after the Date of the Auditor’s Report- If, in exceptional circumstances, the auditor performs new or additional audit procedures or draws new conclusions after the date of the auditor’s report, the auditor shall document-

· The circumstances encountered;

· The new or additional audit procedures performed, audit evidence obtained, and conclusions reached, and their effect on the auditor’s report; and

·  When and by whom the resulting changes to audit documentation were made and reviewed.

Documentation of Discussion

· Significant Matters Discussed with Management And TCWG.

· When and with whom the discussion took place.

· How the auditor address the inconsistency (if any detected during discussion)

Assembly of the Final Audit File

· Audit File- Refers to Audit Documentation prepare and maintained by the auditor

· SQC 1 requires firms to complete the assembly of the final audit file is ordinarily not more than 60 days after the date of the auditor’s report.

· The completion of the assembly of the final audit file after the date of the auditor’s report is an administrative process that does not involve the performance of new audit procedures or the drawing of new conclusions.

· Changes may, however, be made to the audit documentations if they are administrative in nature Example-Deleting or discarding superseded documentation etc.

· SQC 1 requires firms to retain audit engagements documents Seven years from the date of the auditor’s report.

Ownership of Audit Documentation

As per SA-230 and Chantrey Martin (A Firm) v Martin case Audit Working Papers Are the property of Auditor and it’s his will to provide the same to third party unless it requirement of any law.

Chantrey Martin (A Firm) v Martin Case-   Martin was the employee of Chantrey Martin , and has taken advance salary . Later on the company dismisses him for breach of contract and claim the advance paid to him Martin counter claim the irregularities in the books of accounts of the company. He made an application for the production of certain documents relating to the auditing of the client company’s accounts, but for which Chantrey Martin claimed privilege on the ground that they were the property of the company client. The judgment of the Court of Appeal was given by Jenkins LJ who, having discussed Leicestershire County Council and London School Board, concluded that apart from correspondence with the Inland Revenue and the client company’s own ledgers the documents were the property of Chantrey Martin.