CHAPTER 4- AUDIT EVIDENCE

Meaning of Audit Evidence as per SA 500

Audit evidence may be defined as the information used by the auditor in arrivingat the
conclusions on which the auditor’s opinion is based.

Audit evidence includes:

1. Information contained in the accounting records

Accounting records include

Subsidiary books, invoices, contracts, journal entries, ledger accounts and all calculations and
computations.

2. Other Information

• minutes of the meetings,

• written confirmations from trade receivables and trade payables,
• manuals containing details of internal control etc.

Relevance and Reliability of audit evidence

Relevance

Relevance deals with the logical connection with, or bearing upon, the purpose of
the audit procedure and, where appropriate, the assertion under consideration. The
relevance of information to be used as audit evidence may be affected by the direction of
testing.

A given set of audit procedures may provide audit evidence that is relevant to certain
assertions, but not others. For e.g.- Physical counting of inventory is relevant for verifying
existence but not value.

Reliability

Information to be used as audit evidence should be reliable. Reliability of information to be

used as audit evidence, and therefore of the audit evidence itself, is influenced by its source
and its nature.
Therefore, generalisations about the reliability of various kinds of audit evidence are
subject to important exceptions.

While recognising that exceptions may exist, the following generalisations about the
reliability of audit evidence may be useful:
1. External evidence > Internal evidence

2. Internal Evidence is reliable if controls are effective

3. Evidence obtained directly by auditor > Obtained indirectly, say, from the management.

4. Documentary evidence> Oral evidence

5. Original evidence> Duplicates/Photocopies

Obtaining Sufficient and appropriate Audit Evidence by the Auditor

Audit evidence is necessary to support the auditor’s opinion and report. It is cumulative
in nature and is primarily obtained from audit procedures performed during the course of the
audit. It may, however, also include information obtained from other sources such asprevious
audits.

Audit evidence comprises both information that supports and corroborates

management’s assertions, and any information that contradicts such assertions. Absence of
information also constitutes audit evidence.
Factors affecting auditor's judgement as to sufficiency ofaudit evidence

1. Materiality
2. ROMM
3. Size and characteristics of population

Audit procedures for obtaining audit evidence

1. Risk Assessment procedure

2. Further audit procedure

Audit procedures to obtain audit evidence can include: (OICAIRR)

(i) Inspection
(ii) Observation
(iii) External Confirmation
(iv) Recalculation
(v) Reperformance
(vi) Analytical Procedures

(vii) Inquiry
(i) Inspection
Inspection involves examining records or documents or a physical examination of an
asset.

An example of inspection used as a test of controls is inspection of records for evidence

of authorisation.

(ii) Observation

Observation consists of looking at a process or procedure being performedby others.

For example,
the auditor’s observation of inventory counting by the entity’s personnel, or of
the performance of control activities.

Observation provides audit evidence about the performance of a process or procedure, but is
limited to the point in time at which the observation takes place, and by the fact that the act
of being observed may affect how the process or procedure is performed.

(iii) External Confirmation

An external confirmation represents audit evidence obtained by the auditor as a direct
written response to the auditor from a third party (the confirming party)

(iv) Recalculation

Recalculation consists of checking the mathematical accuracy of documents or records.

Recalculation may be performed manually or electronically.

(v) Reperformance

Reperformance involves the auditor’s independent execution of proceduresor controls that

were originally performed as part of the entity’s internal control.

(vi) Analytical Procedures

Analytical procedures consist of evaluations of financial information made bya study of

plausible relationships among both financial and non-financial data.
(vii) Inquiry
Inquiry consists of seeking information of knowledgeable persons, both financial and non-
financial. Responses to inquiries may provide the auditor with information not previously
possessed or with corroborative audit evidence.

In the case of inquiries about management intent, the information available to support
management’s intent may be limited.

Although inquiry may provide important audit evidence, and may even produce evidence of a
misstatement, inquiry alone ordinarily does not provide sufficient audit evidence of the
absence of a material misstatementat the assertion level, nor of the operating effectiveness
of controls.

Nature and Timing of the Audit Procedures

The nature and timing of the audit procedures to be used may be affected by thefact that
some of the accounting data and other information may be available onlyin electronic form
or only at certain points or periods in time.

Audit Trail
An audit trail is a documented flow of a transaction. It is used to investigate howa source
document was translated into an account entry and from there it was inserted into
financial statement of an entity. It is used as audit evidence to establish authentication and
integrity of a transaction. Audit trails help inmaintaining record of system and user activity.

Audit trails (or audit logs) act as record-keepers that document evidence of certain events,
procedures or operations, because their purpose is to reduce fraud, material errors, and
unauthorized use.

However, audit trails involve costs.

Information to Be Used as Audit Evidence

Relying on the work of a management’s expert
a) Evaluate the competence, capabilities and objectivity of that expert;
b) Obtain an understanding of the work of that expert; and
c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevant
assertion.
When information to be used as audit evidence has been prepared using the work of a
management’s expert; the nature, timing and extent of audit procedures may be affected by
such matters;
➢ The nature and complexity of the matter

➢ The risks of material misstatement

➢ The nature, scope and objectives of the management’s expert’s work.
➢ Whether the management’s expert is employed by the entity, or is a party
engaged by it to provide relevant services.
➢ The extent to which management can exercise control or influence over the
work of the management’s expert.
➢ Whether the management’s expert is subject to technical performance
standards or other professional or industry requirements.
➢ The auditor’s knowledge and experience of the management’s expert’s field
 of expertise.
➢ The auditor’s previous experience of the work of that expert.

When using information produced by the entity, the auditor shall evaluate whether the
information is sufficiently reliable for the auditor’s purposes, including as necessary in the
circumstances:

(a) Obtaining audit evidence about the accuracy and completeness of the information;
and
(b) Evaluating whether the information is sufficiently precise and detailed for the
auditor’s purposes.

Selecting Items for Testing to Obtain Audit Evidence

The means available to the auditor for selecting items for testing are:
(a) Selecting all items (100% examination);
The auditor may decide that it will be most appropriate to examine the entire
population of items

(b) Selecting specific items;

Specific items selected may include:

• High value or key items.

• All items over a certain amount.

• Items to obtain information.

(c) Audit sampling.

Audit sampling is designed to enable conclusions to be drawn about an entire population on
the basis of testing a sample drawn from it. Audit sampling is discussed in subsequent
paragraphs.

Inconsistency in or Doubts over Reliability of Audit Evidence

If:

(a) audit evidence obtained from one source is inconsistent with that obtained from
another; or

(b) the auditor has doubts over the reliability of information to be used as audit evidence,
 the auditor shall determine what modifications or additions to audit procedures are
necessary to resolve the matter

USING THE WORK OF INTERNAL AUDITORS(SA 610)

Definition of Internal Audit Function

Internal audit function refers to

A function of an entity that performs assurance and consulting activities designed to

evaluate and improve the effectiveness of the entity’s governance, risk management and
internal control processes.

Activities Relating to Governance- The internal audit function may assess the
governance process in its accomplishment of objectives on ethics and values, Performance
management and accountability, communicating risk and control information and
effectiveness of communication among those charged with governance, external and internal
auditors, and management.

Activities Relating to Risk Management- The internal audit function may assist the entity
by identifying and evaluating significant exposures to risk and contributing to the
improvement of risk management.

Activities Relating to Internal Control

1. Evaluation of internal control- Reviewing controls, evaluating their operation, and

recommending improvements thereto. In doing so, the internal audit function
provides assurance on the control.
2. Examination of financial and operating information- Identify, recognize, measure,
classify and report financial and operating information
3. Review of operating activities. Review the economy, efficiency and effectiveness of
operating activities, including non- financial activities of an entity.

4. Review of compliance with laws and regulations. Review compliance with laws,
regulations, and other external requirements

Scope of SA 610
Standard on Auditing (SA) 610 deals with the external auditor’s responsibilities if using
the work of internal auditors. This includes

(a) Using the work of the internal audit function in obtaining audit evidence and
(b) Using internal auditors to provide direct assistance under the direction,
supervision and review of the external auditor.
Objectives of the external auditor, where the entity has an internal audit function

(a) To determine whether the work of the internal audit function or direct assistance
from internal auditors can be used, and if so, in which areas and to what extent;

(b) If using the work of the internal audit function, to determine whether that
work is adequate for purposes of the audit; and
(c) If using internal auditors to provide direct assistance, to appropriately direct,
supervise and review their work.

Evaluating the Internal Audit Function

Evaluating the following:
1. Objectivity of Internal Auditor
2. Competence
3. Whether the internal audit function applies a systematic and disciplined approach,
including quality control.

Objectivity and its evaluation

Factors that may affect the external auditor’s evaluation in relation to Objectivity
include the following:

i. Whether the organizational status supports the ability of the function to be free
from bias, conflict of interest or undue influence of others

ii. Whether TCWG oversee employment decisions related to the internal audit
function.

iii. Whether there are any constraints or restrictions placed on the internal audit function
by management or TCWG.

iv. Whether the IA function is free of any conflicting responsibilities

Competence and its evaluation

Factors that may affect the external auditor’s determination in relation to
competence include the following:
• Whether the internal audit function is adequately and appropriately resourced
relative to the size of the entity and the nature of its operations.

• Whether there are established policies for hiring, training and assigning internal
auditors
• Whether IA have adequate technical training and proficiency in auditing.
 • Whether IA possess knowledge relating to the entity’s financial reporting and the
applicable financial reporting framework.

Application of a Systematic and Disciplined Approach

Factors that may affect the external auditor’s determination of whether the internal
audit function applies a systematic and disciplined approach include the following:

• The existence, adequacy and use of documented internal audit procedures or

guidance covering such areas as risk assessments, work programs, documentation
and reporting
• Whether the internal audit function has appropriate quality control policies and
procedures.

Determining the Nature and Extent of Work of the Internal Audit Function that Can Be
Used

As a basis for determining the areas and the extent to which the work of the internal audit
function can be used, the external auditor shall consider the nature and scope of the work that
has been performed, or is planned to be performed, by the internal audit function and its
relevance to the external auditor’s overall audit strategy and audit plan.
Examples of work of the internal audit function that can be used by theexternal auditor
include the following:
1. Testing of the operating effectiveness of controls.
2. Substantive procedures involving limited judgment.

3. Observations of inventory counts.

Circumstances in which the external auditor shall plan to use less of the work of the
Internal audit function and perform more of the work directly
a. The more judgment is involved in:
• Planning and performing relevant audit procedures; and
• Evaluating the audit evidence gathered;
b. The higher the assessed risk of material misstatement at the assertion level, with
special consideration given to risks identified as significant;
c. The less the internal audit function’s organizational status and relevant policies and
procedures adequately support the objectivity of the internalauditors; and
d. The lower the level of competence of the internal audit function.
Using the Work of the Internal Audit Function

If the external auditor plans to use the work of the internal audit function, the external
auditor shall

(A) discuss the planned use of its work with the function

(B) Read the reports of the internal audit function to obtain an understanding of the nature
and extent of audit procedures perform sufficient audit procedures on the body of work
of the internal audit function as a whole that the external auditor plans to use to
determine its adequacy for purposes of the audit.
Discussion and Coordination with the Internal Audit Function
• The timing of such work.
• The nature of the work performed.
• The extent of audit coverage.
• Materiality for the financial statements as a whole
• Documentation of the work performed.
• Review and reporting procedures.
Determining Whether, in Which Areas, and to What Extent Internal Auditors Can Be
Used to Provide Direct Assistance

Direct assistance refers to the use of internal auditors to perform audit procedures
under the direction, supervision and review of the external auditor.

The external auditor shall not use an internal auditor to provide direct assistance if:
(a) There are significant threats to the objectivity of the internal auditor; or
(b) The internal auditor lacks sufficient competence to perform the proposedwork.
The external auditor shall not use internal auditors to provide direct assistance to perform
procedures that:
(a) Involve making significant judgments in the audit;
(b) Relate to higher assessed risks of material misstatement
(c) Relate to work with which the internal auditors have been involved
(d) Relate to decisions the external auditor makes in accordance with this SA
SA 530 Audit Sampling
Audit Sampling means the application of audit procedures to less than 100% of items within a
population of audit relevance.

The objective of the auditor is to provide a reasonable basis for the auditor to draw
conclusions about the population from which the sample is selected.

It is not obligatory that the auditor must adopt the sampling technique while auditing the
accounts. However, SA 530 will be applicable when auditor uses audit sampling for performing
audit procedures.

Traditional approach to audit is economically wasteful because all the efforts are
directed to check all transactions without any exception. It leads to more emphasis on
routine checking which seldom reveals anything material.

With increase in formal internal controls the possibilities of routine errors & frauds have
greatly diminished, i.e. there is Prevention, Detection and Correction of Frauds and Errors.
Thus, the auditors are also more focussed on checking of principles and controls rather than
extensive checking and vouching of all entries.

Population & its Characteristics

Population refers to the entire set of data from which a sample is selected and about which
the auditor wishes to draw conclusions. Population must be complete, reliable and
appropriate.

Samples is generated from the population and is representative of the entire population.
Characteristics of population are: (CAR)

1. Completeness: Ensure population is complete

2. Appropriateness: appropriate and relevant for the specific objective under audit
3. Reliable: it should be sufficiently complete and accurate.

Sample must be representative

Whatever may be the approach non-statistical or statistical sampling, the sample must
be representative.

Test of Control & Test of Details

Sampling process can be applied on both Test of controls (to find deviations) and test of
details. (to find misstatement)

Approaches to Sampling (Types of Sampling)

A) Non-statistical or
B) Statistical sampling approaches.
Statistical sampling is an approach to sampling that has the random selection of the sample
units; and the use of probability theory to evaluate sample results, including measurement of
sampling risk characteristics.

Selection of items for testing

Sampling can be statistical or non-statistical.

➢ Statistical sampling is an approach to sampling that has the random selection of the
sample items.
➢ Statistical sampling uses the scientific method of choosing samples from a given
population. Since the statistical theory of sampling is based on a scientific law, it can be
relied upon to a greater extent than any arbitrary technique which lacks in basis and
acceptability.
➢ Sampling other than statistical sampling is non-statistical sampling. Under non-statistical
sampling – samples are selected based on personal experience and knowledge; thus, it
is criticized on the grounds that it is neither objective nor scientific.
➢ Whatever may be the approach non-statistical or statistical sampling, the sample must
be representative.

Characteristics of statistical sampling

• It has random selection of samples

• Uses probability theory to evaluate sample results and
• Probability theory includes measurement of sampling risks

Advantages of statistical sampling may be summarized as follows:

• Sample size does not change with change in population

• Sample selection is more objective and defensible
• Calculate minimum sample size with specified risk and precision
• Provides a means for deriving a “calculated risk” & sampling error i.e. the probable
difference in result due to the use of a sample as against checking all records in the
group (universe), using same audit procedures
• Widely accepted way – since it is scientific and without personal biased

Factors considered for deciding upon the extent of checking on a sampling plan: a)
Size of the organisation under audit, b) state of the internal control, c) adequacy and
reliability of books and records, d) Tolerable error range and e) Degree of desired
confidence.

Sampling and Non-Sampling Risk

As per SA 530 “Audit Sampling”, sampling risk is the risk that the auditor’s conclusion based
on a sample may be different from the conclusion if the entire population were subjected to
the same audit procedure. If acceptable sampling risk is low, larger sample size is needed to
keep the risk at minimum level

Two types of errors which can happen in sampling risk are

➢ Risk of under reliance on Test on Controls and Risk of incorrect rejection in Substantive
Procedures- Leads to inefficiency in the conduct of audit. (means auditor based on its
procedure states that there is misstatement but actually there is no misstatement)
➢ Risk of over reliance on Test of Controls and Risk of incorrect acceptance in case of
substantive procedures - Effects the effectiveness of audit. It leads to erroneous audit
opinion. (means auditor based on its procedure states that there is no misstatement but
actually there is misstatement)
Non-Sampling Risk- The risk that the auditor reaches an erroneous conclusion for any reason
not related to sampling risk. For e.g. applying wrong audit procedure, working on wrong
information.
Examples of Non-Sampling Risk:
▪ Human Mistakes
▪ Misinterpreting the sample results
▪ Applying audit procedures not appropriate to the objectives of audit
▪ Relying on erroneous information e.g. erroneous confirmation

Sampling Process
1. Sample design, size and selection of items for testing

Sample design consideration

➢ Auditor’s consideration includes the specific purpose to be achieved and the

combination of audit procedures that is likely to best achieve that purpose.
➢ Consideration of the nature of the audit evidence sought and possible deviation or
misstatement conditions that audit evidence will assist the auditor in defining what
constitutes a deviation or misstatement and what population to use for sampling.
➢ When performing audit sampling, the auditor performs audit procedures to obtain
evidence that the population from which the audit sample is drawn is complete
➢ The auditor's consideration of the purpose of the audit procedure includes a clear
understanding of what constitutes a deviation or misstatement.
➢ It helps the auditor to determine which one stratification or value-weighted selection is
appropriate

Stratification and Value- Weighted Selection

Stratification refers to dividing a population into discrete sub population which have similar
characteristics. Each Sub population is called as Stratum and units under those sub population
are referred to as Strata.
 ▪ Under this conclusion drawn from individual units in stratum is extrapolated to stratum
and results of each stratum is used to analyses the entire population.
▪ Objective of stratification is to reduce variability of items within each stratum &
therefore allow sample size to be reduced without increasing sampling risk.
▪ When performing TODs, population is often stratified by monetary value. This allows
greater audit effort to be directed to the larger value items, as these items may contain
the greatest potential misstatement in terms of overstatement.
▪ Population may be stratified according to a particular characteristic that indicates a
higher ROMM, for example, when testing the allowance for doubtful accounts in the
valuation of accounts receivable, balances may be stratified by age.
▪ The results of AP applied to a sample of items within a stratum can only be projected to
the items that make up that stratum.
▪ To draw a conclusion on entire population, consider the ROMM in relation to whatever
other strata make up the entire population.

In value weighted selection, the sample size, its selection and evaluation will result in a
conclusion in monetary amounts.

When performing TODs, it may be efficient to identify sampling unit as the individual
monetary units that make up population. Having selected specific monetary units from within
the population, for example, the accounts receivable balance, examine the particular items, for
example, individual balances, that contain those monetary units.

One benefit of this approach to defining the sampling unit is that audit effort is directed to the
larger value items because they have a greater chance of selection, and can result in smaller
sample sizes.

This approach may be used in conjunction with the systematic method of sample selection
and is most efficient when selecting items using random selection

Sample Size
➢ A sample size should be sufficient to reduce sampling risk to acceptably low level.
➢ The lower the risk the auditor is willing to accept, greater will be sample size.

Factors influencing sample size for TOC

• For greater reliance on controls- greater will be TOC and greater will be sample size.
• Increase in tolerable rate of deviation- will decrease sample size and vice versa
• higher the expected rate of deviation, larger the sample size
• greater the level of assurance from samples- higher the sample size
• large population- has little effect on sample size and for small population- sample is not
required

Factors influencing sample size for TOD

 • higher assessment of the risk of material misstatement, the larger the sample size
• more the auditor is relying on other substantive procedures smaller the sample size
• greater the level of assurance from samples- higher the sample size
• Increase in tolerable misstatement- will decrease sample size and vice versa
• greater the amount of misstatement expected, the larger the sample size
• When stratification of the population is appropriate then sample size will decrease
• large population- has little effect on sample size and for small population- sample is not
required

Sample Selection Methods

1. Random Sampling- may involve use of random number, in this all item have equal
chance of selection.
➢ Simple Random Sampling- sample is selected by use of random number table either with
computer or picking up a number in a random way. Good for homogenous population.
➢ Stratified Sampling- It is used when the population is diversified, i.e. heterogeneous. The
objective of stratification is to reduce the variability of items within each stratum. In the case
of stratified sampling, the conclusions are drawn on the stratum.
2. Interval Sampling or Systematic Sampling- in this number of sampling units in the
population is divided by the sample size to give a sampling interval. First item is selected
in haphazard way and then item at regular intervals are selected.
3. Monetary Unit Sampling- type of value-weighted selection in which sample size,
selection and evaluation results in a conclusion in monetary amounts
4. Haphazard sampling- it has no structured approach, does not involve judgement and
does not even use the random number tables.
5. Block Sampling- involves the selection of blocks of contiguous items from within the
population. Block selection cannot ordinarily be used in audit sampling because most
populations are structured such that items in a sequence can be expected to have similar
characteristics to each other but different characteristics from items elsewhere in the
population.

Performing audit procedures

✓ Auditor to do audit procedures on all items selected.

✓ If the audit procedure is not applicable to the selected item, the auditor shall perform the
procedure on a replacement item.
✓ If auditor is not able to do audit procedure on a particular item- then it will be called
deviation for test of controls and misstatement for test of details.

Nature and cause of deviations and misstatements

 ✓ Auditor should analyze the deviations and try to observe any common feature and
evaluate their possible effect on the purpose of the audit procedure and on other
areas of the audit
✓ Auditor shall investigate the nature and causes of any deviations or misstatements
identified, and evaluate their possible effect on the purpose of the audit procedure
and on other areas of the audit.
✓ Auditor shall apply judgement and performing additional audit procedures to obtain
sufficient appropriate audit evidence to ensure that the misstatement or deviation
does not affect the remaining population
✓ Anomaly may be defined as a misstatement or deviation that is not representative of
misstatements or deviations in a population.

Projecting misstatements

✓ The auditor is required to project misstatements for the population to assess the
quantum of misstatement, but this projection is not sufficient evidence to determine
an amount to be recorded.
✓ Treatment of anomaly- it should be excluded for projection of misstatement
✓ For test of details- projections are done for misstatement whereas for test of
controls no projections is required since sample deviation rate is population
deviation rate.

Evaluating results of audit sampling

The results of the sample & decide whether the use of audit sampling has provided a
reasonable basis for conclusions about the population or not.

SA 501 Audit Evidence- Specific Considerations for Selected

Items
Objective of the auditor is to obtain SAAE 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
FRF.

Inventory
When inventory is material to the FS, the auditor shall obtain SAAE regarding the
existence & condition by:

a) Attendance at physical inventory counting, unless impracticable, to:

 (i) Evaluate management’s instructions and procedures for recording and controlling the
results of the entity’s physical inventory counting;
(ii) Observe the performance of management’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts.
b) Performing AP over the entity’s final inventory records to determine whether they
accurately reflect actual inventory count results.

Matters Relevant in Planning Attendance at Physical Inventory Counting

a) Nature of inventory.
b) Stages of completion of work in progress.
c) The ROMM related to inventory.
d) The nature of the IC related to inventory.
e) Whether adequate procedures are expected to be established and proper instructions
issued
f) The timing of physical inventory counting.
g) Whether the entity maintains a perpetual inventory system.
h) The locations at which inventory is held, including the materiality and the ROMM at
different locations, in deciding at which locations attendance is appropriate
i) Whether the assistance of an auditor’s expert is needed.

If physical inventory counting is conducted at a date other than the date of the FS, the
auditor shall, in addition to the above, perform AP to obtain audit evidence about whether
changes in inventory between the count date and the date of the FS are properly recorded.

Auditor is unable to attend physical inventory counting due to unforeseen

circumstances: make or observe some physical counts on an alternative date, and perform AP
on intervening transactions

Physical inventory counting is impracticable: Perform alternative AP to obtain SAAE

regarding the existence and condition of inventory. If it is not possible, modify the opinion as
per SA 705.

If above not possible, Modify the report as per SA 705.

Inventory in custody and control of a third party

Obtain SAAE regarding the existence & condition of that inventory by performing one or both
of the following:

a) Request confirmation from the third party as to the quantities and condition of
inventory held on behalf of the entity.
 b) Perform inspection or other AP appropriate in the circumstances.

Litigation and Claims

Design and perform AP to identify litigation and claims involving the entity which may give
rise to a ROMM, including:

a) Inquiry of management and, where applicable, others within the entity, including in-
house legal counsel;
b) Reviewing minutes of meetings of TCWG and correspondence between the entity and
its external legal counsel; and
c) Reviewing legal expense accounts.

If the auditor assesses ROMM regarding litigation or claims that have been identified, or
when AP 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.
Further if:

a) management refuses to communicate or meet with the entity’s external legal counsel, or
the entity’s external legal counsel refuses to respond to the letter of inquiry/is
prohibited from responding; and
b) the auditor is unable to obtain SAAE by performing alternative AP,

the auditor shall modify the opinion in the auditor’s report in accordance with SA 705.

Take Written Representation from mgmt. & TCWG that all known actual or possible litigation
and claims have been disclosed to the auditor and appropriately accounted for and disclosed
in FS.

Segment Information
The auditor shall obtain SAAE regarding the presentation and disclosure of segment
information in accordance with the applicable FRF by:

A. Obtaining an understanding of the methods used by mgmt. in determining segment

info. Further,
Evaluating whether such methods are likely to result in disclosure with the applicable
FRF; and where appropriate, testing the application of such methods; and
B. Performing analytical procedures or other AP appropriate in the circumstances
Example of matters that may be relevant when obtaining an understanding of the
methods
 • Sales, transfers and charges between segments, and elimination of intersegment
amounts.
• Comparisons with budgets & other expected results, for example, operating profits as
percentage of sales.
• The allocation of assets and costs among segments.
• Consistency with prior periods, and the adequacy of the disclosures with respect to
inconsistencies

SA 505 External Confirmation

Audit evidence obtained as a direct written response to the auditor from a third party (the
confirming party), in paper form, or by electronic or other medium.

The objective of the auditor is to design & perform procedures to obtain relevant & reliable
audit evidence

External Confirmation Procedures

The auditor shall maintain control over external confirmation requests, including:

a) Determining the information to be confirmed or requested;

b) Selecting the appropriate confirming party;
c) Designing the confirmation requests, including determining that requests are properly
addressed contain return information for responses to be sent directly to the auditor;
and
d) Sending the requests, including follow-up requests when applicable, to the confirming
party.

a) Determining the information to be confirmed or requested

External confirmation is for confirmation of account balance & their elements. It may be used
for confirm terms of agreements, contracts, or transactions between an entity & other parties,
or to confirm the absence of certain conditions, such as a “side agreement”.

b) Selecting the appropriate confirming party

Responses to confirmation requests provide more relevant & reliable audit evidence when
confirmation requests are sent to a confirming party the auditor believes is knowledgeable
about the information to be confirmed.

c) Designing Confirmation Requests - Factors

• Specific identified ROMM, including fraud risks.

• The layout and presentation of the confirmation request
 • Prior experience on the audit or similar engagements.
• The assertions being addressed.
• The method of communication (in paper form, or by electronic mode or other medium).
• Management’s authorization/encouragement to the confirming parties to respond to
the auditor.
• The ability of the intended confirming party to confirm or provide the requested
information

d) Follow-Up on Confirmation Requests

The auditor may send an additional confirmation request when a reply to a previous request
has not been received within a reasonable time.

Management’s Refusal to Allow the Auditor to Send a Confirmation Request

a) Inquire reasons for the refusal, and seek audit evidence as to their validity and
reasonableness;
b) Evaluate the implications of refusal on the auditor’s assessment of the relevant ROMM,
including the risk of fraud, and on the NTE of other AP; and
c) Perform alternative AP designed to obtain relevant and reliable audit evidence

If auditor conclude- unreasonable refusal or unable to obtain relevant & reliable audit
evidence from alternative AP- Communicate to TCWG (SA-260) & determine implications for
the auditor opinion (SA 705)

Other Important Terms

Positive confirmation request – Confirming party respond directly to the auditor indicating
whether the confirming party agrees/disagrees with the info. in the request, or providing the
requested information.

Negative confirmation request – Confirming party respond directly to the auditor only if the
confirming party disagrees with the info. provided in the request.

It provides less persuasive audit evidence than positive confirmations. Negative confirmation
requests not be used as the sole substantive audit procedure to address an assessed ROMM
at the assertion level unless all of the following are present:

• The auditor has assessed the ROMM as low and has obtained SAAE regarding the
operating effectiveness of controls relevant to the assertion;
• The population of items comprises a large number of small, homogeneous, account
balances, transactions or conditions;
• A very low exception rate is expected; and
 • The auditor is not aware of circumstances/conditions that would cause recipients of
negative confirmation requests to disregard such requests.

Non-response – A failure of the confirming party to respond/fully respond, to a positive

confirmation request

Exception – Response indicates a difference b/w info. requested to be confirmed/contained in

the entity’s records, and information provided by the confirming party.

Auditor to evaluate the results of the confirmation provide relevant and reliable audit
evidence, or whether performing FAP is necessary.

Evaluating the Evidence Obtained

When evaluating the results of individual external confirmation requests, the auditor may
categorize such results as follows:
(a) A response by the appropriate confirming party indicating agreement
(b) A response deemed unreliable;
(c) A non-response; or

(d) A response indicating an exception.

SA 510: Initial Audit Engagements- Opening Balances

Initial audit engagement in which either:

a) FS for the prior period were not audited; or

b) FS for the prior period were audited by a predecessor auditor.

Objective of Auditor with respect to Opening Balances – in conducting an Initial Audit

Engagement

To obtain SAAE about whether:

a) Opening balances contain misstatements that materially affect the current period’s FS;
b) Appropriate accounting policies reflected in the opening balances have been
consistently applied in the current period’s FS, or changes thereto are properly
accounted for and adequately presented and disclosed in accordance with the
applicable FRF.

Audit Procedures regarding Opening Balances

Read the most recent FS and the predecessor auditor’s report, if any, for information relevant
to opening balances, including disclosures.
 Obtain SAAE about whether the opening balances contain misstatements that materially
affect the current period’s FS by:

a) Determining whether the prior period’s closing balances have been correctly brought
forward to the current period or, any adjustments have been disclosed as prior period
items in the current year’s P&L;
b) Determining whether the opening balances reflect the application of appropriate
accounting policies;
c) Performing one or more of the following:
i) Where the prior year FS were audited, perusing the copies of the audited FS including
the other relevant documents relating to the prior period FS;
ii) Evaluating whether AP performed in the current period provide evidence relevant to the
opening balances; or
iii) Performing specific AP to obtain evidence regarding the opening balances

If misstatements obtained in opening balances that could materially affect the current
period’s FS, perform additional AP to determine the effect on the current period’s FS. If
auditor concludes that misstatement exist in current period’s FS, communicate to
management & TCWG

For current assets and liabilities

• Observing a current physical inventory count and reconciling it to the opening

inventory quantities.

• Performing audit procedures on the valuation of the opening inventory items.

• Performing audit procedures on gross profit and cut-off.

For non- current assets and liabilities

▪ examining the accounting records and other information

▪ through confirmation with third parties.
Consistency of Accounting Policies relating to opening balances

If the policies were not consistent or change was not properly accounted/presented/disclosed,
Auditor shall express a qualified opinion or an adverse opinion as per SA 705.

Audit Conclusions and Reporting in relation to Opening Balances

▪ If auditor unable to obtain SAAE regarding the opening balances, the auditor shall
express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance
with SA 705.
 ▪ If concluded that the opening balances contain a misstatement that materially affects
the current period’s FS, and the effect of the misstatement is not properly accounted
for/not adequately presented or disclosed, express a qualified opinion or an adverse
opinion, as appropriate, in accordance with SA 705.

SA 550- Related Parties

Related party is a party which is defined by applicable FRF. (Example AS 18 defined who is
related party)

If FRF do not prescribes, then following will be considered as related party to reporting entity:

▪ A person or other entity that has direct or indirect control(C) or significant influence;
▪ Another entity over which the reporting entity has direct or indirect control or
significant influence; or
▪ Another entity that is under common control with the reporting entity i.e. under
common controlling ownership or owners who are close family members; or common
key management.

Nature of Related Party Relationships and Transactions

Many Related party transactions are in the normal course of business, carrying no higher
ROMM of the FS. However, the nature of RPRT may, give rise to higher ROMM of the FS than
transactions with unrelated parties. Examples

✓ Related party transactions May operate through an extensive and complex range of
relationships and structures

✓ Information systems may be ineffective at identifying/summarizing transactions & O/s

balances.

✓ Related party transactions may not be conducted under normal market terms and
conditions.
Understanding the Entity’s Related Party Relationships& Transactions
The auditor shall inquire of management regarding:

(a) The identity of the entity’s related parties, including changes from the prior period

(b) The nature of the relationships between the entity and these related parties; and
(c) Whether the entity entered into any transactions with these related parties during the period and,
if so, the type and purpose of the transactions.

Obtain an understanding of the controls, if any, that management has established to -

(a) Identify, account for, and disclose related party relationships and transactionsin accordance
with the applicable financial reporting framework;

(b) Authorize and approve significant transactions and arrangements withrelated parties; and

(c) Authorize and approve significant transactions and arrangements outside thenormal course of
business.
Documents which provide evidence on existence of related party relationships and
transactions:

1) Entity income tax returns.

2) Information supplied by the entity to regulatory authorities.
3) Shareholder registers to identify the entity’s principal shareholders.
4) Statements of conflicts of interest from management and TCWG.
5) Records of the entity’s investments and those of its pension plans.
6) Contracts and agreements with key management or TCWG.
7) Significant contracts and agreements not in the entity’s ordinary course of business.
8) Specific invoices and correspondence from the entity’s professional advisors.
9) Life insurance policies acquired by the entity.
10) Significant contracts re-negotiated by the entity during the period.
11) Internal auditors’ reports.
12) Documents associated with the entity’s filings with a securities regulator e.g., prospectuses

SA 520 Analytical Procedure

It means the evaluation of financial information through analysis of both financial & non-financial
data. Application of AP helps the auditor to find the aspects of the business of which he was unaware.

AP include the consideration of comparisons of the entity’s financial information with as well as
consideration of relationships with:

• Comparable information for prior periods

• Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor
• Similar industry information, such as a comparison of the entity’s ratio of sales to accounts
receivable with industry averages or with other entities of comparable size in the same industry.

Objective as per SA 520

a) To obtain relevant and reliable audit evidence when using SAPs; and
b) To design and perform APs near the end of the audit that assist the auditor when forming an
overall conclusion as to whether the FS are consistent with the auditor’s understanding of the
entity.

Major Types of Analytical Procedures (Refer those 6 examples)

Analytical Procedures may be segregated into following Comparison of client with:
 ▪ Industry data,
▪ Similar prior period data,
▪ Client-determined expected results,
▪ Auditor-determined expected results and
▪ Expected results, using non-financial data

Substantive Analytical Procedure

Factors to be considered for Substantive Audit Procedures (SAP)

• Account Type - Income statement accounts tend to be more predictable because they reflect
accumulated transactions over a period, while balance sheet accounts represent the net effect
of transactions at a point in time. Balance sheet accounts are subject to greater management
judgment and are less subject to analysis by analysts.
• Inherent Risk or “WCGW” - When inherent risk is higher, we may design tests of details to
address the higher inherent risk. When significant risks have been identified, audit evidence
obtained solely from SAP is unlikely to be sufficient
• Nature of Assertion – SAP may be more effective in providing evidence for some assertions
(e.g., completeness or valuation) than for others (e.g., rights and obligations). Predictive
analytical procedures using data analytics can be used to address completeness,
valuation/measurement & occurrence
• Predictability – SAPs are more appropriate when an account balance or relationships between
items of data are predictable. A predictable relationship is one that may reasonably be expected
to exist and continue over time.
• Availability of Data – The availability of reliable and relevant data will facilitate effective
analytical procedures.
• Disaggregation – The degree of disaggregation in available data can directly affect the degree
of its usefulness in detecting misstatements.
• Source – Some classes of transactions tend to be more predictable because they consist of
numerous, similar transactions. Whereas the transactions recorded by non-routine and
estimation SCOTs are often subject to management judgment and therefore more difficult to
predict.

Techniques available as Substantive Analytical Procedures

• Trend analysis – Trend analysis is a commonly used technique. It is the comparison of current
data with the prior period balance or with a trend in two or more prior period balances. The
auditor evaluates whether the current balance of an account moves in line with the trend
established with previous balances for that account, or based on an understanding of factors
that may cause the account to change.
• Ratio analysis – Ratio analysis is useful for analyzing asset and liability accounts as well as
revenue and expense accounts. Ratios can also be compared over time or to the ratios of
separate entities within the group, or with the ratios of other companies in the same industry.
• Reasonableness tests – It does not rely on events of prior periods, but upon non-financial data
for the audit period under consideration. These tests are made by reviewing the relationship of
certain account balances to other balances for reasonableness of amounts.
• Structural modelling – A modelling tool constructs a statistical model from financial and/or
non-financial data of prior accounting periods to predict current account balances.
 Analytical Procedures used as Substantive Tests
1. Determine suitability of AP- consider based on assertion, risk of material misstatement
2. Evaluate reliability of data- based on source, comparability, nature, controls on information
3. Develop an expectation- of the account/assertion for comparison with the actual balances.
4. Determine acceptable difference- between the actual values and the expectation for analyzing the
unacceptable differences.

1. Suitability for Substantive analytical procedures (SAP)

▪ Generally, it is more applicable to large volumes of transactions.
▪ Application of planned analytical procedures is based on the expectation that relationships among
data exist and continue in the absence of known conditions to the contrary.
▪ In some cases, even an unsophisticated predictive model may be effective as an analytical procedure.

Example: If an entity has a known number of employees at fixed rates of pay throughout the period, it
may be possible for the auditor to use this data to estimate the total payroll costs for the period with
a high degree of accuracy, thereby providing audit evidence for a significant item in FS & reducing the
need to perform TODs on payroll.

▪ Different types of analytical procedures provide different levels of assurance

Example: Prediction of total rental income on a building divided into apartments, taking the rental
rates, the number of apartments and vacancy rates into consideration, can provide persuasive
evidence & may eliminate the need for further verification by means of TODs, provided the elements
are appropriately verified. In contrast, calculation & comparison of gross margin % as a means of
confirming a revenue figure may provide less persuasive evidence, but may provide useful
corroboration if used in combination with other AP.

▪ The determination of the suitability of particular SAP is influenced by the nature of the assertion and
the auditor’s assessment of the ROMM.

Example: Controls over sales order processing are weak, the auditor may place more reliance on TODs
rather than on SAP for assertions related to receivables.

2. Reliability of data
▪ Source of the information available.
For example, information may be more reliable when it is obtained from independent sources outside the
entity;
▪ Comparability of the information available.
For example, broad industry data may need to be supplemented to be comparable to that of an entity that
produces and sells specialized products;
▪ Nature and relevance of the information available.
For example, whether budgets have been established as results to be expected rather than as goals to be
achieved; and
▪ Controls over the preparation of the information that are designed to ensure its completeness,
accuracy and validity.
For example, controls over the preparation, review and maintenance of budgets.
 3. Evaluation of whether the expectation is sufficiently precise
• The accuracy with which the expected results of SAP can be predicted.
Example: Auditor may expect greater consistency in comparing gross profit margins from one period to
another than in comparing discretionary expenses, such as research or advertising
• The degree to which information can be disaggregated.
Example: SAP may be more effective when applied to financial information on individual sections of an
operation or to FS of components of a diversified entity, than when applied to FS of the entity as a
whole
• The availability of the information, both financial and non-financial.
Example: Auditor may consider whether financial information, such as budgets or forecasts, and non-
financial information, such as the number of units produced or sold, is available to design SAP. If the
information is available, the auditor may also consider the reliability of the information.

4. Amount of difference of recorded amounts from expected values that is acceptable

It is influenced by materiality level, desired level of assurance & taking account of the possibility that
misstatement, may cause the FS to be materially misstated.

SA 330 requires auditor to obtain more persuasive audit evidence the higher the auditor’s assessment
of risk. As the assessed risk increases, amount of difference considered acceptable without
investigation decreases in order to achieve the desired level of persuasive evidence

Investigating results of Analytical Procedures

If while applying analytical procedures, the statutory auditor identifies fluctuations or relationships
that are inconsistent with other relevant information, the auditor shall investigate such differences by:

• Inquiring of management and obtaining appropriate audit evidence relevant to management’s

responses.
• Performing other audit procedures as necessary in the circumstances