Chapter-4 Audit Evidence

SA 500 Audit Evidence

Topic-1 Meaning
Audit evidence may be defined as the information used by the auditor in arriving at the conclusions
on which the auditor‛s opinion is based. Audit Evidence includes
1. Information contained in the accounting records
Accounting records include
• the records of initial accounting entries and supporting records, such as cheques and records of
electronic fund transfers.
• Invoices
• contracts
• General and subsidiary ledgers, journal entries and other adjustments to the financial statements
that are not reflected in journal entries
• records such as work sheets and spreadsheets supporting cost allocations, computations,
reconciliations and disclosures.
2. Other information that authenticates accounting records
• minutes of meetings
• written confirmations from trade receivables and trade payables,
• manuals containing details of internal control etc.

Topic-2 Type of Audit Evidence

a. Depending upon nature:
• Visual: Eg, observing physical verification of inventory conducted by the client’s staff.
• Oral: Eg, discussion with the management and various officers of the client.
• Documentary: Eg, fixed deposit certificate, loan agreement, sales bill etc.

b. Depending upon Source

o Internal Evidence- Evidence which originates within the organisation being audited is internal
evidence. Ex- Sales related documents.
o External Evidence- The evidence that originates outside the client‛s organization is external
evidence. Ex- Purchase related documents.
Note- External evidence is typically more reliable since it comes from independent third parties
unlikely to manipulate another‛s accounting information. If auditor doubts third party's
independence, they should exercise increased vigilance.

Topic-3 Sufficient Appropriate Audit Evidence

a. Sufficiency
• Sufficiency is the measure of the quantity of audit evidence.
• The quantity of audit evidence needed is affected by the auditor’s assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required)
and also by the quality of such audit evidence (the higher the quality, the less may be required).
Factors affecting auditor's judgement as to sufficiency of audit evidence
1. Materiality:
• Less evidence is needed if assertions are less significant to financial statement users.
• More evidence is needed if assertions are highly significant.
2. Risk of Material Misstatement:
• Lower risk requires less evidence.
 • Higher risk requires more evidence.
3. Size & Characteristics of Business:
• Smaller, homogeneous populations need less evidence.
• Larger, heterogeneous populations need more evidence.

b. Appropriateness
Appropriateness is 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.
Reliability of Audit Evidence Increases When:
• The reliability of audit evidence is increased when it is obtained from independent sources
outside the entity.
• The reliability of audit evidence that is generated internally is increased when the related
controls, including those over its preparation and maintenance, imposed by the entity are
effective.
• Audit evidence obtained directly by the auditor (for example, observation of the application of
a control) is more reliable than audit evidence obtained indirectly or by inference (for example,
inquiry about the application of a control).
• Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable
than evidence obtained orally (for example, a contemporaneously written record of a meeting is
more reliable than a subsequent oral representation of the matters discussed).
• Audit evidence obtained as original documents is more reliable than audit evidence obtained as
photocopies or facsimiles or documents that have been filmed, digitised or otherwise
transformed into electronic form because in these cases the reliability of which may depend on
the controls over their preparation and maintenance.

Relevance of Audit Evidence

• It 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.
• Examples:
 To test for overstatement of accounts payable, check recorded accounts payable.
 To test for understatement of accounts payable, check subsequent disbursements, unpaid
invoices, suppliers' statements, and unmatched receiving reports.

Topic-4 Type of Audit Procedure

1. Inspection
• Inspection involves examining records or documents, whether internal or external, in paper form,
electronic form, or other media, or a physical examination of an asset.
• Inspection of records and documents provides audit evidence of varying degrees of reliability,
depending on their nature and source and, in the case of internal records and documents, on the
effectiveness of the controls over their production.
• An example of inspection used as a test of controls is inspection of records for evidence of
authorisation.
• Inspecting an executed contract may provide audit evidence relevant to the entity‛s application
of accounting policies, such as revenue recognition.
• Inspection of tangible assets may provide reliable audit evidence with respect to their existence,
but not necessarily about the entity‛s rights and obligations or the valuation of the assets.
Inspection of individual inventory items may accompany the observation of inventory counting.

2. Observation
Useful for obtaining evidence about the performance of a process or procedure but has limitations:
A. Time-bound – The evidence is only valid at the moment of observation.
B. Observer Effect – The presence of an auditor may influence how the process is performed, leading
to potential bias in the evidence collected.

3. Recalculation- Recalculation consists of checking the mathematical accuracy of documents or

records. Recalculation may be performed manually or electronically.

4. Reperformance- Reperformance involves the auditor’s independent execution of procedures or

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

5. Analytical Procedure (SA 520)

6. External Confirmation (SA 505)

7. Inquiry
• Inquiry involves seeking information from knowledgeable individuals
 both financial and non-financial
 within or outside the entity.
• It is widely used throughout the audit, complementing other audit procedures.
• Inquiries can vary from formal written requests to informal oral discussions. Evaluating the
responses obtained is a crucial part of the inquiry process.
• Responses to inquiries may:
 Provide auditors with new information or corroborative audit evidence.
 Reveal discrepancies compared to other audit findings, such as indications of management
override of controls.
 Form the basis for modifying or conducting additional audit procedures.
 For certain matters, auditors may need to obtain written representations from management
and those charged with governance to validate oral responses.
 While inquiry is valuable for gathering audit evidence and identifying misstatements, it alone
is not sufficient to confirm the absence of material misstatements at the assertion level or
to assess the operating effectiveness of controls.

Topic-5 Selecting Items for Testing to Obtain Audit Evidence

a. Selecting all items (100% examination)
• The population constitutes a small number of large value items;
• There is a significant risk and other means do not provide sufficient appropriate audit evidence.
• The repetitive nature of a calculation or other process performed automatically by an
information system makes a 100% examination cost effective.

b. Selecting specific items

The auditor may decide to select specific items from a population.
In making this decision, factors that may be relevant include
 the auditor’s understanding of the entity, • the assessed ROMM, and
 the characteristics of the population being tested.
The judgmental selection of specific items is subject to non-sampling risk.
Specific items selected may include:
o High value or key items- The auditor may decide to select specific items within a population
because they are of high value, or exhibit some other characteristic. For example items that are
suspicious, unusual, particularly risk-prone or that have a history of error.
o All items over a certain amount-The auditor may decide to examine items whose recorded values
exceed a certain amount so as to verify a large proportion of the total amount of a class of
transactions or account balance.
o Items to obtain information-The auditor may examine items to obtain information about matters
such as the nature of the entity or the nature of transactions.

c. Audit sampling.
 SA 501 Audit Evidence-Specific Considerations for Selected Items
Topic-1 Objective of Auditor
Obtain SAAE regarding the:
(A) Existence and condition of inventory;
(B) Completeness of litigation and claims involving the entity;
(C) Presentation and disclosure of segment information in accordance with applicable FRF.

Topic-2 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:
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 (SAMPLE)
B. Performing audit procedures 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 risks of material misstatement related to inventory.
D. The nature of the internal control related to inventory.
E. Whether adequate procedures are expected to be established and proper instructions issued
for physical inventory counting.
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 of the inventory and the ROMM
at different locations, in deciding at which locations attendance is appropriate.

Special Cases
1. Physical Inventory Counting Conducted other than at the Date of the Financial Statements
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.
Relevant matters for consideration when designing audit procedures include:
• Whether the perpetual inventory records are properly adjusted.
• Reliability of the entity’s perpetual inventory records.
• Reasons for significant differences between the information obtained during the physical count
and the perpetual inventory records.

2. Unable to Attend Physical Inventory Counting

the auditor shall make or observe some physical counts on an alternative date, and perform audit
procedures on intervening transactions.

3. Attendance at Physical Inventory Counting becomes impractical (location,nature)

• 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.
• Example of AAP-inspection of documentation of the subsequent sale of specific inventory items
acquired or purchased prior to the physical inventory counting, may provide sufficient appropriate
audit evidence about the existence and condition of inventory.

4. Inventory under the custody and control of a third party

The auditor shall obtain sufficient appropriate audit evidence regarding the existence and 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 audit procedures appropriate in the circumstances.
Other audit procedure may include -
• Inspecting documentation regarding inventory held by third parties, for example, warehouse
receipts.
• Requesting confirmation from other parties when inventory has been pledged as collateral.
• Attending, or arranging for another auditor to attend, the third party’s
• physical counting of inventory, if practicable.
• Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of the third
party’s internal control for ensuring that inventory is properly counted and adequately
safeguarded.

Topic-3 Litigation & 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:
(a) Inquiry of management and, where applicable, others within the entity, including in-house legal
counsel.
(b) Reviewing minutes of meetings of those charged with governance and correspondence between
the entity and its external legal counsel.
(c) Reviewing legal expense accounts.

Litigation and claims involving the entity may have a material effect on the financial statements and
thus may be required to be disclosed or accounted for in the financial statements.

Auditor Assesses a ROMM regarding Litigation or Claims

• 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 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.
• If it is considered unlikely that the entity’s external legal counsel will respond appropriately to
a letter of general inquiry, the auditor may seek direct communication through a letter of
specific inquiry. For this purpose, a letter of specific inquiry includes:
 (a) A list of litigation and claims;
(b) Where available, management’s assessment of the outcome of each of the identified
litigation and claims and its estimate of the financial implications, including costs involved;
and
(c) A request that the entity’s external legal counsel confirm the reasonableness of
management’s assessments and provide the auditor with further information if the list is
considered by the entity’s external legal counsel to be incomplete or incorrect.
• In certain circumstances, the auditor also may judge it necessary to meet with the entity’s
external legal counsel to discuss the likely outcome of the litigation or claims. for example,
where:
i) The auditor determines that the matter is a significant risk.
ii) The matter is complex.
iii) There is disagreement between management and the entity’s external legal counsel.
Ordinarily, such meetings require management’s permission and are held with a representative of
management in attendance.

Further if:
(a) 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
(b) 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.

Topic-4 Segment Reporting

Segment Information refers to information about different types of products and services of an
enterprise and its operations in different geographical areas.
The auditor shall obtain SAAE regarding the presentation and disclosure of segment information in
accordance with the applicable financial reporting framework by:
(a) Obtaining an understanding of the methods used by management in determining segment
information, and:
o Evaluating whether such methods are likely to result in disclosure in accordance with the
applicable financial reporting framework.
o Where appropriate, testing the application of such methods
(b Performing analytical procedures or other audit procedures appropriate in the circumstances.
The auditor‛s responsibility regarding the presentation and disclosure of segment information is in
relation to the financial statements taken as a whole.
Example of matters that may be relevant
1. Sales, transfers and charges between segments, and elimination of intersegment amounts.
2. Comparisons with budgets and other expected results, for example, operating profits as a
percentage of sales.
3. The allocation of assets and costs among segments.
4. Consistency with prior periods, and the adequacy of the disclosures with respect to
inconsistencies.
 SA 505 EXTERNAL CONFIRMATION
Topic-1 Definition and Types
Meaning
Defined as 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.

Types
1. Positive confirmation request
A request that the confirming party respond directly to the auditor indicating whether the
confirming party agrees or disagrees with the information in the request, or providing the requested
information.
Note
 A positive external confirmation request requires the confirming party to respond, either by
agreeing with the provided information or furnishing their own details.
 Responses to such requests typically offer reliable audit evidence.
 However, there is a risk that confirming parties may respond without verifying the accuracy of
the information.
 To mitigate this, auditors can use "blank" confirmation requests, where the confirming party fills
in the details. While this approach reduces the risk, it may lead to lower response rates due to
the extra effort involved.

2. Negative confirmation request

A request that the confirming party respond directly to the auditor only if the confirming party
disagrees with the information provided in the request.
Imp Note
Negative confirmations provide less persuasive audit evidence than positive confirmations.
The auditor shall not use negative confirmation requests as the sole substantive audit procedure to
address an assessed risk of material misstatement at the assertion level unless all of the following
are present:
1. The risk of misstatement is assessed as low, with sufficient evidence of control effectiveness.
2 The population consists of numerous small, homogeneous items.
3. A very low exception rate is expected.
4. There are no conditions that would cause recipients to ignore the requests.
Lack of response to a negative confirmation does not confirm receipt or accuracy, making it less
reliable than a positive confirmation response.

Topic-2 External Confirmation Procedures

When using external confirmation procedures, the auditor shall maintain control over external
confirmation requests, including:
a) Determining the information to be confirmed or requested
(Information regarding account balances and their elements. They may also be used to confirm
terms of agreements, contracts, or transactions between an entity and other parties, or to
confirm the absence of certain conditions, such as a “side agreement”)
b) Selecting the appropriate confirming party.
c) Designing the confirmation requests, including determining that requests are properly addressed
and contain return information for responses to be sent directly to the auditor (NOTE-1)
d) Sending the requests, including follow-up requests when applicable, to the confirming party.
(NOTE-1) Factors to be considered by auditor when designing confirmation request
a. The assertions being addressed.
b. Specific identified ROMM, including fraud risks.
c. The layout and presentation of the confirmation request.
d. Prior experience on the audit or similar engagements.
e. The method of communication (for example, in paper form, or by electronic or other medium)
f. Management’s authorisation or encouragement to the confirming parties to respond to the
auditor. Confirming parties may only be willing to respond to a confirmation request containing
management’s authorisation.
g. The ability of the intended confirming party to confirm or provide the requested information
(for example, individual invoice amount versus total balance).

Topic-3 Management’s refusal confirmation request- Steps of Auditor

(a) Inquire as to management’s reasons for the refusal, and seek audit evidence as
to their validity and reasonableness
(b) Evaluate the implications of management‛s refusal on the auditor‛s assessment of the relevant
ROMM, including the risk of fraud, and on the nature, timing and extent of other audit procedures
(c) Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

If the auditor concludes that management’s refusal to allow the auditor to send a confirmation
request is unreasonable, or the auditor is unable to obtain relevant and reliable audit evidence from
alternative audit procedures,
the auditor shall communicate with those charged with governance in accordance with SA 260.
The auditor also shall determine the implications for the audit and the auditor’s opinion in accordance
with SA 705.
Examples of alternative audit procedures
• For accounts receivable balances – examining specific subsequent cash receipts, shipping
documentation, and sales near the period-end.
• For accounts payable balances – examining subsequent cash disbursements or correspondence from
third parties, and other records, such as goods received notes.

NOTE-A common reason advanced is the existence of a legal dispute or ongoing negotiation with the
intended confirming party, the resolution of which may be affected by an untimely confirmation
request.

Topic-4 Evaluating the Evidence Obtained

• The auditor must assess whether external confirmation results provide sufficient and reliable
audit evidence or if further procedures are needed.
• Results from confirmation requests may be categorized as:
 Agreement or requested information without exception.
 Unreliable response.
 Non-response.
 Response indicating an exception.
The auditor’s evaluation, combined with other audit procedures, helps determine if adequate audit
evidence has been obtained or further action is required, per SA 330.

NOTE- Non-response: Failure to respond or fully respond to a positive confirmation request, or when
a request is undelivered.
 SA 510 Initial Audit Engagement- Opening Balances
Topic-1 Definition
Opening balances are the account balances carried forward from the previous period, reflecting
past transactions, events, and applied accounting policies.
They also include prior period disclosures like contingencies and commitments.

Initial audit engagement refers to an engagement in which either:

(i) The financial statements for the prior period were not audited; or
(ii) The financial statements for the prior period were audited by a predecessor auditor.

Predecessor auditor – Auditor from a different audit firm, who audited the financial statements of
an entity in the prior period and who has been replaced by the current auditor.

Topic-2 Objective
To obtain SAAE whether
(a) Opening balances contain misstatements that materially affect the current period’s financial
statements; and
(b) Appropriate accounting policies reflected in the opening balances have been consistently applied
in the current period’s financial statements, or changes thereto are properly accounted for and
adequately presented and disclosed in accordance with the applicable FRF.

Topic-3 Audit Procedures for Obtaining SAAE about opening balance (Imp)
The auditor shall obtain SAAE about whether the opening balances contain misstatements that
materially affect the current period‛s financial statements by:
• Determining whether the prior period‛s closing balances have been correctly brought forward to
the current period or, when appropriate, any adjustments have been disclosed as prior period
items in the current year‛s Profit and Loss
• Determining whether the opening balances reflect the application of appropriate accounting
policies
• Performing one or more of the following:
(i) Where the prior year financial statements were audited, perusing the copies of the audited
financial statements including the other relevant documents relating to the prior period
financial statements;
(ii) Assess if current audit procedures provide evidence for opening balances.
(iii) Conduct specific audit procedures to verify opening balances.
• If opening balances have misstatements that may materially impact current financial
statements, the auditor must perform further audit procedures to assess their effect.
• If misstatements affect current financials, the auditor must inform management and those
charged with governance.
• Reporting on Opening Balances (SA 705):
 If sufficient evidence on opening balances is unavailable, the auditor should issue a qualified
or disclaimer of opinion.
 If material misstatements in opening balances are uncorrected or undisclosed, a qualified or
adverse opinion should be issued.

NOTE- If the prior period’s financial statements were audited by a predecessor auditor, the
current auditor can obtain sufficient evidence on opening balances by reviewing audited financial
statements and related documents, such as supporting schedules.
Reliance can typically be placed on the prior period’s closing balances unless current audit procedures
indicate possible misstatements in opening balances.

Topic-4 Nature & extent of Audit Procedures depends on

The nature and extent of audit procedures necessary to obtain sufficient appropriate audit
evidence regarding opening balances depend on such matters as:
 Accounting Policies followed by the entity.
 The nature of the account balances, classes of transactions and disclosures and ROMM in the
current period’s financial statements.
 The significance of the opening balances relative to the current period’s financial statements.
 Whether the prior period’s financial statements were audited and, if so, whether the
predecessor auditor’s opinion was modified.

Topic-5 Consistency of Accounting Policies

Auditor must obtain sufficient audit evidence to ensure that accounting policies in the opening
balances are consistently applied in the current period and that any changes are properly accounted
for, presented, and disclosed as per the applicable financial reporting framework.
If the auditor concludes that
(a) the current period‛s accounting policies are not consistently applied in relation to opening
balances in accordance with the applicable financial reporting framework; or
(b) a change in accounting policies is not properly accounted for or not adequately presented or
disclosed in accordance with the applicable financial reporting framework,
the auditor shall express a qualified opinion or an adverse opinion as appropriate in accordance with
SA 705.

Topic-6 Examples
For Current Assets and Liabilities:
- Audit evidence for opening balances of current assets and liabilities can often be obtained during
the current period's audit.
Example: Collection of opening accounts receivable or payment of accounts payable provides
evidence of their existence, rights, obligations, completeness, and valuation.

Inventories: Closing inventory procedures offer limited evidence for opening balances, requiring
additional steps such as:
- Observing a current physical inventory count and reconciling it to opening quantities.
- Auditing the valuation of opening inventory items.
- Reviewing gross profit margins and cut-off procedures.

For Non-Current Assets and Liabilities:

For items like property, plant, equipment, investments, and long-term debt:
- Review accounting records and supporting documents related to opening balances.
- Obtain confirmations from third parties, where applicable.
Example: Verifying opening balances of long-term loans through confirmation from lenders or
examining prior year fixed asset registers for property details.
 SA 550 Related Party
Topic-1 Definition
 Related Party
A party that is either:
(i) A related party as defined in the applicable financial reporting framework
or
(ii) Where the applicable financial reporting framework establishes minimal or no related party
requirements:
a. A person or other entity that has control or significant influence, directly or indirectly through
one or more intermediaries, over the reporting entity.
Example: A parent company (Party A) directly controls the reporting entity (Company X) and
influences its financial and operational decisions.
b. Another entity over which the reporting entity has control or significant influence, directly or
indirectly through one or more intermediaries.
Example: The reporting entity (Company X) owns 30% of another company (Company Y), granting
it significant influence over Company Y’s strategic decisions.
c. Another entity that is under common control with the reporting entity through having:
i. Common controlling ownership;
ii. Owners who are close family members;
iii. Common key management.
Example: The reporting entity (Company X) and another company (Company Z) are sister
companies under the same controlling ownership and share key management personnel.

Important Note: Entities under common control by a state (i.e., a national, regional, or local
government) are not considered related unless they engage in significant transactions or share
resources to a significant extent with one another.

 Control and Significant Influence

(a) Control is the power to govern the financial and operating policies of an entity to obtain benefits
from its activities.
Example: A holding company has control over its subsidiary by owning more than 50% of its voting
shares, allowing it to determine financial and operational policies.
(b) Significant influence (which may be gained by share ownership, statute, or agreement) is the
power to participate in the financial and operating policy decisions of an entity but not control over
those policies.
Example: A company with a 25% stake in another entity can influence decisions like dividend policies
but cannot make unilateral decisions.

Relationships Indicating Control or Significant Influence:

i. Direct or indirect equity holdings or other financial interests in the entity.
Example: An investor holding a 40% equity stake in the reporting entity.
ii. The entity’s holdings of direct or indirect equity or other financial interests in other entities.
Example: The reporting entity owns 30% of another company, allowing significant influence
over its financial policies.
iii. Being part of those charged with governance or key management
Example: A director of the reporting entity who participates in strategic decisions such as
mergers or acquisitions.
iv. Being a close family member of any person referred to in subparagraph (iii).
 Example: The spouse or sibling of a key management personnel actively involved in the
reporting entity’s operations.
v. Having a significant business relationship with any person referred to in subparagraph (iii).
Example: A major supplier owned by a key management personnel of the reporting entity.

Topic-2 Nature of Related Party Relationships & Transactions

Many related party transactions occur in the normal course of business and may carry no higher risk
of material misstatement than similar transactions with unrelated parties (at arm's length).
However, certain related party relationships and transactions can increase the risk of material
misstatements in financial statements due to:
a. Complex Relationships: Extensive and complex structures increase transaction complexity.
b. Ineffective Information Systems: Inadequate Information systems may fail to identify or
summarize transactions and balances with related parties.
c. Non-Market Terms: Transactions may deviate from standard market terms, e.g., conducted
without consideration.

Topic-3 Auditor Responsibility-Understanding Entity‛s R.P. Relationships & Transactions

Inquiries to Management:
- Identify the entity’s related parties, including changes from prior periods.
- Understand the nature of relationships with these parties.
- Confirm transactions during the period, including their type and purpose.

Inquiry and Understanding of Management Controls:

- Assess controls to identify, account for, and disclose related party relationships and
transactions as per financial reporting standards.
- Evaluate the authorization and approval process for significant transactions and arrangements
with related parties.
- Review controls over non-standard transactions outside normal business operations.

Topic-4 Verify the existence of related party relationships and transactions

During the audit, the auditor should maintain alertness for related party information while reviewing
records and documents.
He may inspect the following records or documents that may provide information about related party
relationships and transactions,
for example:
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 those charged with governance.
5 Records of the entity’s investments and those of its pension plans.
6 Contracts and agreements with key management or those charged with governance.
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 610 Using the Work of Internal Auditors
Topic-1 Internal Audit Function
It refers to function of entity that performs assurance and consulting activities designed to evaluate
& improve the effectiveness of entity’s governance, risk management and internal control processes.
The objectives and scope of internal audit functions typically include assurance and consulting
activities designed to evaluate and improve the effectiveness of the entity’s governance processes,
risk management and internal control such as the following:
1. 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 to appropriate areas of the organization and effectiveness of communication among
those charged with governance, external and internal auditors, and management.

2. 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 and internal control (including
effectiveness of the financial reporting process).
The internal audit function may perform procedures to assist the entity in the detection of fraud.

3. Activities Relating to Internal Control

• Evaluation of internal control- The internal audit function may be assigned specific responsibility
for reviewing controls, evaluating their operation, and recommending improvements thereto. In
doing so, the internal audit function provides assurance on the control.
• Examination of financial and operating information. -It may be assigned to review means used to
identify, recognize, measure, classify & report financial & operating information, to make specific
inquiry into individual items, including detailed testing of transactions, balances and procedures.
• Review of operating activities- It may be assigned to review the economy, efficiency and
effectiveness of operating activities, including non- financial activities of an entity.
• Review of compliance with laws and regulations - The internal audit function may be assigned to
review compliance with laws, regulations, and other external requirements, and with management
policies and directives and other internal requirements.

Topic-2 Scope and Objective of Internal Audit Function

The external auditor may make use of the function for purposes of the audit in one or more ways
1. to obtain information that is relevant to the external auditor’s assessments of the risks of
material misstatement due to error or fraud.
2. Unless prohibited, or restricted to some extent, by law or regulation, the external auditor, after
appropriate evaluation, may decide to use work that has been performed by the internal audit
function during the period in partial substitution for audit evidence to be obtained directly by
the external auditor.
3. Unless prohibited, or restricted to some extent, by law or regulation, the external auditor may
use internal auditors to perform audit procedures under the direction, supervision and review of
the external auditor (referred to as “direct assistance”).

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

Scope of SA 610
It 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.

Topic-3 Evaluating the Internal Audit Function

The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:
(A) The extent to which the internal audit function’s organizational status and relevant policies and
procedures support the objectivity of the internal auditors;
(B) The level of competence of the internal audit function; and
(C) Whether the internal audit function applies a systematic and disciplined approach, including
quality control.

Objectivity
Objectivity refers to the ability to perform those tasks without allowing bias, conflict of interest
or undue influence of others to override professional judgments.
Factors that may affect the external auditor’s evaluation in relation to Objectivity include the
following:
• Whether the organizational status of the internal audit function, including the function’s
authority and accountability, supports the ability of the function to be free from bias, conflict
of interest or undue influence of others to override professional judgments.
For example whether the internal audit function reports to those charged with governance or an
officer with appropriate authority, or if the function reports to management, whether it has
direct access to those charged with governance
• Whether TCWG oversee decisions related to the internal audit function.
For example determining the appropriate remuneration policy.
• Whether there are any constraints or restrictions placed on the internal audit function by
management or those charged with governance, for example, in communicating the internal audit
function’s findings to the external auditor.
• Whether the internal audit function is free of any conflicting responsibilities, for example,
having managerial or operational duties or responsibilities that are outside of the internal audit
function.

Competence and its evaluation

Competence of the internal audit function refers to the attainment and maintenance of knowledge
and skills of the function as a whole at the level required to enable assigned tasks to be performed
diligently and in accordance with applicable professional standards.
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 to
internal audit engagements.
• Whether the internal auditors have adequate technical training and proficiency in auditing.
• Whether the internal auditors possess the required 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, the nature and
extent of which is commensurate with the size and circumstances of an entity.
• Whether the internal audit function has appropriate quality control policies and procedures.

Topic-4 Circumstances in which the external auditor shall plan to use less of the work of the
Internal audit function
• The more judgment is involved in:
 Planning and performing relevant audit procedures and
 Evaluating the audit evidence gathered
• The higher the assessed risk of material misstatement at the assertion level, with special
consideration given to risks identified as significant
• The less the internal audit function’s organizational status and relevant policies and procedures
adequately support the objectivity of the internal auditors
• The lower the level of competence of the internal audit function.

Topic-5 Examples of work of the internal audit function that can be used by the external
auditor include the following:
1. Testing of the operating effectiveness of controls.
2. Substantive procedures involving limited judgment.
3. Observations of inventory counts.
4. Tracing transactions through the information system relevant to financial reporting.
5. Testing of compliance with regulatory requirements.

Topic-6 Using the Work of the Internal Audit Function

If the external auditor plans to use work of the internal audit function, the external auditor shall
a. discuss the planned use of its work with the function as a basis for coordinating their respective
activities.
b. read the reports of the internal audit function relating to the work of the function that the
external auditor plans to use to obtain an understanding of the nature and extent of audit
procedures it performed and the related findings.
c. 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

It may be useful to address the following:
1. The timing of such work.
2. The nature of the work performed.
3. The extent of audit coverage.
4. Materiality for the financial statements as a whole (and, if applicable, materiality level or levels
for particular classes of transactions, account balances or disclosures), and performance
materiality.
5. Proposed methods of item selection and sample sizes.
6. Documentation of the work performed.
7. Review and reporting procedures.

Coordination between the external auditor and the internal audit function is effective when, eg
1. Discussions take place at appropriate intervals throughout the period.
2. The external auditor informs the internal audit function of significant matters that may affect
the function.
3. The external auditor is advised of and has access to relevant reports of the internal audit
function and is informed of any significant matters that come to the attention of the function
when such matters may affect the work of the external auditor so that the external auditor is
able to consider the implications of such matters for the audit engagement.

Topic-7 Using Internal Control to provide direct assistance

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 proposed work.

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 where the judgment required in
performing the relevant audit procedures or evaluating the audit evidence gathered is more than
limited;
(c) Relate to work with which the internal auditors have been involved and which has already been,
or will be, reported to management or those charged with governance by the internal audit
function;
(d) Relate to decisions the external auditor makes in accordance with this SA regarding the internal
audit function and the use of its work or direct assistance.

Prior Using internal auditors to provide direct assistance for purpose of audit, External auditor shall:
(a) Obtain written agreement from an authorized representative of the entity that the internal
auditors will be allowed to follow the external auditor’s instructions, and that the entity will not
intervene in the work the internal auditor performs for the external auditor;
(b) Obtain written agreement from the internal auditors that they will keep confidential specific
matters as instructed by the external auditor and inform the external auditor of any threat to
their objectivity.
 SA 520 Analytical Procedures
Topic-1 Overview
• It means evaluations of financial information through analysis of plausible (acceptable)
relationships among both financial and non-financial data.
• It encompass such investigation as is necessary of identified fluctuations or relationships that
are inconsistent with other relevant information or that differ from expected values by a
significant amount.
• Analytical procedures include the consideration of comparisons of the entity’s financial
information with as well as consideration of relationships.
Examples of Analytical Procedures having consideration of comparisons of the entity’s financial
information are:
 with industry averages or with other entities of comparable size in the same industry Comparable
information for prior periods.
 Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor,
such as an estimation of depreciation.
 Similar industry information, such as a comparison of the entity’s ratio of sales to accounts
receivable.
Examples of Analytical Procedures having consideration of relationships are:
 Among elements of financial information that would be expected to conform to a predictable
pattern based on the entity’s experience, such as gross margin percentages.
 Between financial information and relevant non-financial information, such as payroll costs to
number of employees.
Analytical Procedures may be segregated into the following major types:
• as comparison of client and industry data,
• comparison of client data with similar prior period data,
• comparison of client data with client-determined expected results,
• comparison of client data with auditor-determined expected results and
• comparison of client data with expected results, using non financial data.

Topic-2 Objective & Purpose

The objectives of the auditor are:
(a) To obtain relevant and reliable audit evidence when using substantive analytical procedures
(b) To design and perform analytical procedures near the end of the audit that assist the auditor
when forming an overall conclusion as to whether the financial statements are consistent with
the auditor’s understanding of the entity.

Purpose Of A.P
• Analytical procedures may help identify the existence of unusual transactions or events, and
amounts, ratios, and trends that might indicate matters that have audit implications.
• Unusual or unexpected relationships that are identified may assist the auditor in identifying risks
of material misstatement, especially risks of material misstatement due to fraud.

Topic-3 Timing of A.P.

a. Planning Phase
o In the planning stage, analytical procedures assist the auditor in understanding the client’s
business and in identifying areas of potential risk by indicating aspects of and developments in
the entity’s business of which he was previously unaware.
o This information will assist the auditor in determining the nature, timing and extent of his other
audit procedures.
o Analytical procedures in planning the audit use both financial data and non-financial information,
such as number of employees, square feet of selling space, volume of goods produced and similar
information.
o For example: Analytical procedures may help the auditor during the planning stage to determine
the nature, timing and extent of audit procedures that will be used to obtain audit evidence for
specific account balances or classes of transactions.

b. Testing Phase- Use as Substantive procedure to obtain relevant and reliable audit evidence.
c. Completion Phase-Use when forming an opinion on f.s.

Topic-4 Substantive Analytical Procedures

 Factors to be considered for Substantive Audit Procedures
i. Availability of Data – The availability of reliable and relevant data will facilitate effective
analytical procedures.

ii. Disaggregation – The degree of disaggregation in available data can directly affect the degree
of its usefulness in detecting misstatements.

iii. Account Type – Substantive analytical procedures are more useful for certain types of accounts
than for others. Income statement accounts tend to be more predictable because they reflect
accumulated transactions over a period, whereas balance sheet accounts represent the net
effect of transactions at a point in time or are subject to greater management judgment.

iv. Source – Some classes of transactions tend to be more predictable because they consist of
numerous, similar transactions, (e.g., through routine processes). Whereas the transactions
recorded by non-routine and estimation SCOTs (Significant Classes of Transactions) are often
subject to management judgment and therefore more difficult to predict.
Example
Transactions of routine nature like transactions related to sales and purchases are predictable
and repetitive in nature. Therefore, on such data analytical procedures can be efficiently applied.
However, Significant Classes Transactions are those classes of transactions in a company’s
operations that are key to the financial statements and are not frequent in nature. Example:
Expenditure on Research & Advertisement is not of routine nature and are subject to
management judgement and therefore more difficult to predict.

v. Predictability – Substantive analytical procedures are more appropriate when an account balance
or relationships between items of data are predictable (e.g., between sales and cost of sales or
between trade receivables and cash receipts). A predictable relationship is one that may
reasonably be expected to exist and continue over time.

vi. Nature of Assertion – Substantive analytical procedures 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 and occurrence.

vii. Inherent Risk or “What Can Go Wrong” – When we are designing audit procedures to address an
inherent risk or “what can go wrong”, we consider the nature of the risk of material misstatement
 in order to determine if a substantive analytical procedure can be used to obtain audit evidence.
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 substantive
analytical procedures is unlikely to be sufficient.

 Techniques for Substantive A.P.

i) Trend analysis –
o It is the comparison of current data with the prior period balance or with a trend in two or more
prior period balances.
o 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.
o In other words, trend analysis implies analysing account fluctuations by comparing current year
to prior year information and, also, to information derived over several years.
o Eg- Comparision of salary payment from last year.

ii) Ratio analysis –

o Ratio analysis is useful for analysing asset and liability accounts as well as revenue and expense
accounts.
o An individual balance sheet account is difficult to predict on its own, but its relationship to
another account is often more predictable (e.g., the trade receivables balance related to sales).
o 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.
o Financial ratios may include:
o Trade receivables or inventory turnover
o Freight expense as a percentage of sales revenue
Eg- The statutory auditor can review the Gross profit ratio of the company for the year under audit.
The auditor can further compare such GP ratio with the GP ratio of the company in the earlier years
or the GP ratio of the other companies in the sameindustry for the year under audit.

iii) Reasonableness tests –

Unlike trend analysis, this analytical procedure does not rely on events of prior periods, but upon
non-financial data for the audit period under consideration (e.g., occupancy rates to estimate rental
income or interest rates to estimate interest income or expense). These tests are generally more
applicable to income statement accounts and certain accrual or prepayment accounts. These tests
are made by reviewing the relationship of certain account balances to other balances for
reasonableness of amounts.
Example
o Interest expense against interest bearing obligations
o Raw Material Consumption to Production (quantity)
o Wastage & Scrap % against production & raw material consumption (quantity)
o Work-in-Progress based on issued of materials & Sales (quantity)
o Sales discounts and commissions against sales volume
o Rental revenues based on occupancy of premises

iv) 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 (e.g., linear regression).

Topic-6 Analytical Procedures used as Substantive Tests ([Link])

When designing and performing substantive analytical procedures, either alone or in combination
with tests of details, as substantive procedures in accordance with SA 330, the auditor shall ([Link])
OVERVIEW
A. Determine the suitability of particular substantive analytical procedures for given assertions,
taking account of the assessed risks of material misstatement and tests of details, if any, for
these assertions
B. Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or
ratios is developed, taking account of source, comparability, and nature and relevance of
information available, and controls over preparation
C. Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is
sufficiently precise to identify a misstatement that, individually or when aggregated with other
misstatements, may cause the financial statements to be materially misstated
D. Determine the amount of any difference of recorded amounts from expected values that is
acceptable without further investigation.

A. Determine suitability of analytical procedure

1. Substantive analytical procedures are generally more applicable to large volumes of transactions
that tend to be predictable over time.
2. The 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.
3. However, the suitability of a particular analytical procedure will depend upon the auditor’s
assessment of how effective it will be in detecting a misstatement that, individually or when
aggregated with other misstatements, may cause the financial statements to be materially
misstated.
4. In some cases, even an unsophisticated predictive model may be effective as an analytical
procedure.
The determination of the suitability of particular substantive analytical procedure is influenced by
the nature of the assertion and the auditor’s assessment of the risk of material misstatement. For
example, if controls over sales order processing are weak, the auditor may place more reliance on
tests of details rather than on substantive analytical procedures for assertions related to
receivables

B. Evaluate Reliability of Data

a. Source of the information available. For example, information may be more reliable when it is
obtained from independent sources outside the entity
b. 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 specialised products
c. 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.
d. 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.

The auditor may consider testing the operating effectiveness of controls, if any, over the entity’s
preparation of information used by the auditor in performing substantive analytical procedures in
response to assessed risks.
When such controls are effective, the auditor generally has greater confidence in the reliability of
the information and, therefore, in the results of analytical procedures.
C. Evaluation of whether the expectation is sufficiently precise
Matters relevant to the auditor’s evaluation of whether the expectation can be developed sufficiently
precisely to identify a misstatement that, when aggregated with other misstatements, may cause
the financial statements to be materially misstated, include:
i) The accuracy with which the expected results of substantive analytical procedures can be
predicted.
For example, the 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.
ii) The degree to which information can be disaggregated.
For example, substantive analytical procedures may be more effective when applied to financial
information on individual sections of an operation or to financial statements of components of a
diversified entity, than when applied to the financial statements of the entity as a whole.
iii) The availability of the information, both financial and non-financial. For example, the 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 substantive
analytical procedures. If the information is available, the auditor may also consider the reliability
of the information.

D. Determine acceptable difference

• The auditor’s determination of the amount of difference from the expectation that can be
accepted without further investigation is influenced by materiality and the consistency with the
desired level of assurance, taking account of the possibility that a misstatement, individually or
when aggregated with other misstatements, may cause the financial statements to be materially
misstated.
• SA 330 requires the auditor to obtain more persuasive audit evidence the higher the auditor’s
assessment of risk. Accordingly, as the assessed risk increases, the amount of difference
considered acceptable without investigation decreases in order to achieve the desired level of
persuasive evidence.

Topic-5 Investigating results of Analytical Procedures

If analytical procedures performed in accordance with SA 520 identify fluctuations or relationships
that are inconsistent with other relevant information or that differ from expected values by a
significant amount, the auditor shall investigate such differences by:
(i) Inquiring of management and obtaining appropriate audit evidence relevant to management’s
responses: Audit evidence relevant to management’s responses may be obtained by evaluating those
responses taking into account the auditor’s understanding of the entity and its environment, and with
other audit evidence obtained during the course of the audit.

(ii) Performing other audit procedures as necessary in the circumstances:

The need to perform other audit procedures may arise when, for example, management is unable to
provide an explanation, or the explanation, together with the audit evidence obtained relevant to
management’s response, is not considered adequate.
 SA 530 Audit Sampling
Topic-1 Overview
• Audit sampling refers to the, such that all sampling units (i.e. all the items in the population) have
equal chance of selection. This is to ensure that items selected represent entire population which
enables auditor to draw conclusions and express his opinion based on a pre-determined objective.
• The objective of the auditor when using audit sampling is to provide a reasonable basis for the
auditor to draw conclusions about the population from which the sample is selected.
• This standard deals with the auditor’s use of Statistical and Non-statistical sampling
when designing and selecting the-
(i) audit sample,
(ii) performing tests of controls and tests of details, and
(iii) evaluating the results from the sample.

Topic-2 Population
• Population refers to the entire set of data from which a sample is selected and about which the
auditor wishes to draw conclusions.
• The auditor should select sample items in such a way that the sample can be expected to be
representative of the population.
• This requires that all items in the population have an opportunity of being selected.
Characteristics of Population
 Appropriateness - It means population from which the samples are drawn shall be relevant for
the specific objective under audit. This is because when the samples are drawn, the audit
procedures are applied on the sample and the conclusions are projected on the population.
 Completeness- The population also needs to be complete, which means that if the auditor intends
to use the sample to draw conclusions about whether a control activity is operated effectively
during the financial reporting period, the population needs to include all relevant items
 Reliable- Information upon which the audit sampling is performed is sufficiently complete and
accurate.

Topic-3 Sampling Unit

The individual items that make up the population are known as sampling units. The population can be
divided into sampling units in a variety of ways. Eg- If the auditor’s objective were to test the validity
of accounts receivables, the sampling unit could be defined as customer balances or individual
customer invoices.
Whatever may be the approach non-statistical or statistical sampling, the sample must be
representative.
Sampling process is performed on
 Tests of controls-to identify deviations from expected internal controls
 Tests of details-to identify misstatements of account balances and class of transactions.

Topic-4 Approaches to Sampling (Types)

a. Statistical Sampling ([Link])
Characteristics
 An approach to sampling that has the random selections of the sample items
 Use of probability theory to evaluate sample results, including measurement of sampling risk
characteristics.
Scientific Approach
 Audit testing done through this approach is more scientific than testing based entirely on the
auditor’s own judgment because it involves use of mathematical laws of probability in determining
the appropriate sample size in varying circumstances.
 Statistical sampling has reasonably wide application where a population to be tested consists of
a large number of similar items and more in the case of transactions involving compliance testing,
trade receivables’ confirmation, payroll checking, vouching of invoices and petty cash vouchers.
 There is no personal bias of the auditor in case of statistical sampling. Since it is scientific, the
results of sample can be evaluated and projected on the whole population in a more reliable
manner

Benefits
o The amount of testing (sample size) does not increase in proportion to the increase in the size
of the area (universe) tested.
o The sample selection is more objective and thereby more defensible.
o The method provides a means of estimating the minimum sample size associated with a specified
risk and precision.
o It provides a means for deriving a “calculated risk” and corresponding precision (sampling error)
i.e. the probable difference in result due to the use of a sample in lieu of examining all the
records in the group (universe), using the same audit procedures.
o It may provide a better description of a large mass of data than a complete examination of all
the data, since non-sampling errors such as processing and clerical mistakes are not as large.
o It is widely accepted way of sampling as it is more scientific, without personal bias and the result
of sample can be evaluated and projected in more reliable way.

b. Non-Statistical
• Under this approach, the sample size and its composition are determined on the basis of the
personal experience and knowledge of the auditor.
• This approach has been in common application for many years because of its simplicity in
operation.
• Traditionally, the auditor on the basis of his personal experience will determine the size of the
sample and express it in terms that number of pages or personal accounts in the purchases or
sales ledger to be checked.
• For example, March, June and September may be selected in year one and different months
would be selected in the next year, On basis of value of items, top 10 highest value. Etc.
Note- The non-statistical sampling is criticized on the grounds that it is neither objective nor
scientific. The expected degree of objectivity cannot be assured in non- statistical sampling because
the risk of personal bias in selection of sample items cannot be eliminated.

Topic-5 Sampling Process

Sampling Process
1. Sample Design
2. Sample Size
3. Sample Selection
4. Audit Procedures
5. Nature and Cause of Deviation
6. Projecting
7. Evaluating Results of Audit

Topic-6 Sample Design

 When designing an audit sample,
i. the auditor’s consideration includes the specific purpose to be achieved and the combination of
audit procedures that is likely to best achieve that purpose.
ii. Consideration of the nature of the audit evidence sought and possible deviation or misstatement
conditions or other characteristics relating to that audit evidence will assist the auditor in
defining what constitutes a deviation or misstatement and what population to use for sampling.
iii. In fulfilling the requirement of SA 500 “Audit Evidence”, 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 must clearly understand what constitutes a deviation or misstatement to ensure only
relevant conditions are considered when evaluating deviations or projecting misstatements.
Example: In testing accounts receivable existence, payments received soon after the confirmation
date or mispostings between customer accounts do not impact the total balance. While these may
affect fraud risk or allowance for doubtful accounts, they may not be misstatements for this
procedure.
Conceptual Understanding:
• For tests of controls, the auditor assesses the expected deviation rate based on control
understanding or a small sample. If deviations are too high, testing controls may be
unnecessary.
• For tests of details, expected misstatements guide sample size. If misstatements are high,
a larger sample or full examination may be needed.

Stratification and Value-Weighted Selection

In considering the characteristics of the population from which the sample will be drawn, the auditor
may determine that stratification or value-weighted selection is appropriate

Stratification
 Dividing a population into discrete (Seperate) sub population which have identifying
characteristics is called as Stratification.
• Each Sub population is called as Stratum and units under those sub population are referred to as
Strata.
 The objective of stratification is to reduce the variability of items within each stratum and
therefore allow sample size to be reduced without increasing sampling risk.
 When performing tests of details, the 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.
 Similarly, a population may be stratified according to a particular characteristic that indicates a
higher risk of misstatement, for example, when testing the allowance for doubtful accounts in
the valuation of accounts receivable, balances may be stratified by age.
 The results of audit procedures 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 the entire population,
the auditor will need to consider the risk of material misstatement in relation to whatever other
strata make up the entire population.
 The results of samples from the units drawn under each sub population are projected to that
respective stratum. In order to draw an opinion on the overall population, the auditor needs to
combine the results of all the stratum to check for possible deviation or risk of material
misstatement.
 Projected misstatements of each stratum will be combined together to consider the possible
effect of misstatement in the account balances and class of transaction.
Value-Weighted Selection
 When performing tests of details, it may be efficient to identify the sampling unit as the
individual monetary units that make up the population. Having selected specific monetary units
from within the population, for example, the accounts receivable balance, the auditor may then
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.
• In value weighted selection, the sample size, its selection and evaluation will result in a conclusion
in monetary amounts.

Topic-7 Sample Size

• The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low
level.
• The level of sampling risk that the auditor is willing to accept affects the sample size required.
• The lower the risk the auditor is willing to accept, the greater the sample size will need to be.

Examples of Factors Influencing Sample Size for Tests of Controls

a. Greater the reliance the auditor places on the operating effectiveness of controls in the risk
assessment, the greater is the extent of the auditor‛s tests of controls. Thus, sample size will
increase.
b. If there is an increase in the tolerable rate of deviation. Then sample size will decrease.
c. When there is Increase in the expected rate of deviation of the population to be tested then
sample size will increase.
d. An increase in the auditor’s desired level of assurance that the tolerable rate of deviation is not
exceeded by the actual rate of deviation in the population will increase the sample [Link], the
greater the level of assurance that the auditor desires that the results of the sample are in fact
indicative of the actual incidence of deviation in the population, the larger the sample size needs
to be.
e. In case of large populations, the actual size of the population has little, if any, effect on sample
size. For small populations however, audit sampling may not be as efficient as alternative means
of obtaining sufficient appropriate audit evidence. Therefore, there will be negligible effect on
sample size due to increase in the number of sampling units in the population

In case of Test of Details

a. The higher the auditor‛s assessment of the risk of material misstatement, the larger the sample
size needs to be.
b. The more the auditor is relying on other substantive procedures (tests of details or substantive
analytical procedures) to reduce to an acceptable level the detection risk regarding a particular
population, the less assurance the auditor will require from sampling and, therefore, the smaller
the sample size can be.
c. Increase in the auditor‛s desired level of assurance that tolerable misstatement is not exceeded
by actual misstatement in the population, will increase the sample size.
d. An increase in tolerable misstatement will decrease the sample size as lower the tolerable
misstatement, the larger the sample size needs to be.
e. The greater the amount of misstatement the auditor expects to find in the population, the larger
the sample size. Factors relevant to the auditor’s consideration of the expected misstatement
amount include the extent, to which item values are determined subjectively, the results of risk
 assessment procedures, the results of tests of control, the results of audit procedures applied
in prior periods, and the results of other substantive procedures.
f. When stratification of the population is appropriate then sample size will decrease as when there
is a wide range (variability) in the monetary size of items in the population, it may be useful to
stratify the population. When a population can be appropriately stratified, the aggregate of the
sample sizes from the strata generally will be less than the sample size that would have been
required to attain a given level of sampling risk, had one sample been drawn from the whole
population.
g. There will be negligible effect on sample size due to number of sampling units in the population.
For large populations, the actual size of the population has little, if any, effect on sample size.
Thus, for small populations, audit sampling is often not as efficient as alternative means of
obtaining sufficient appropriate audit evidence. However, when using monetary unit sampling, an
increase in the monetary value of the population increases sample size, unless this is offset by a
proportional increase in materiality for the financial statements as a whole

Topic-8 Sampling Methods

a. Random Sampling
All items in the population or within each stratum have a known chance of selection. It may involve
use of random number tables. Random sampling includes two very popular methods which are
discussed below–
1. Simple Random Sampling
• In this method, every unit in the population (e.g., invoices) has an equal chance of selection,
ensuring no auditor bias.
• Random number tables or computerized tools are used to select items.
• This approach is suitable for homogeneous populations, where units are reasonably similar and
fall within a consistent range.
• Example: Trade receivables balances ranging from ₹55,000 to ₹2,25,000 are homogeneous, unlike
balances ranging from ₹525 to ₹10,50,000.

2. Stratified Sampling
• It involves dividing a heterogeneous population into homogeneous groups (strata) and selecting
samples from each stratum proportionally.
• Each stratum is treated as separate population, ensuring diverse representation.
• Purpose: It helps allocate weights to reflect population differences, making it an extension of
simple random sampling.
• Example:
Trade receivables can be grouped as:
Balances above ₹10,00,000: Examine all items.
₹7,75,001 to ₹10,00,000: Select 25%.
₹5,50,001 to ₹7,75,000: Select 10%.
₹2,25,001 to ₹5,50,000: Select 2%.
₹2,25,000 and below: Select 2%.
Samples from each stratum are selected randomly, ensuring a balanced analysis.

b. Interval Sampling or Systematic Sampling

• Population size is divided by the sample size to determine the sampling interval (e.g., 50).
• Starting from a random point within the first 50, every 50th item is then selected.
• The starting point can be haphazard, but using random number generators ensures randomness.
• Caution: Systematic sampling can overlook key items if population structure aligns with the
sampling interval.
• Example: If Accountant A records transactions in alternate months and Accountant B in the
others, selecting transactions from alternate months would result in testing only one
accountant's work, leaving the other unchecked and ROMM.
• Solution:To mitigate this, the auditor should:
- Assess population structure to ensure fair representation.
- Use multiple starting points to minimize risk.

c. Monetary Unit Sampling

It is a type of value-weighted selection in which sample size, selection and evaluation results in a
conclusion in monetary amounts.

d. Haphazard sampling
It involves the auditor choosing samples without a structured technique, aiming to avoid conscious
bias or predictability.
Example: An auditor randomly selects invoices from a file drawer without following any systematic
pattern but ensures all invoices have a chance of being selected.
Haphazard selection is unsuitable for statistical sampling as it lacks randomness essential for
statistical inferences.

e. Block Sampling
• It involves choosing contiguous items within a population.
• While it may sometimes be an appropriate audit procedure for examining specific blocks, it is
generally unsuitable for audit sampling.
• Because populations are often structured such that items in a sequence share similar
characteristics, which may differ from those in other parts of the population.
• Example: An auditor selects invoices numbered 101 to 150 for testing. If these invoices relate
to a specific time period (e.g., a peak sales season), they may exhibit similar characteristics, such
as higher sales volume or discounts, which may not represent entire year's population of invoices.
• Consequently, block selection rarely provides a valid basis for drawing inferences about the
entire population. Notably, this method shares similarities with non-statistical sampling.

Topic-9 Performing Audit Procedures

1. Performing Procedures:
The auditor must perform audit procedures suitable to the purpose on every selected item.
2. Replacement Items:
If the procedure cannot be applied to a selected item, a replacement may be used.
Example 1: A cancelled cheque selected during testing for payment authorization can be replaced
with another cheque if it is confirmed as properly cancelled.
Example 2: A manual billing item mistakenly selected while testing computerized sales can be
replaced after verifying its correctness with supporting documents.
If replacement is not feasible, alternative procedures must be applied.
3. When Procedures Cannot Be Applied:
If neither the designed audit procedure nor an alternative procedure can be applied, the auditor
must treat the item as: A deviation for tests of controls, or A misstatement for tests of details.
Example: If sales documentation is lost (e.g., invoice, dispatch record), confirmation from the debtor
(SA 505) or verification of cash book records can be performed.
Alternative Example: If no reply is received for a confirmation request, the auditor can examine
subsequent cash receipts and their source for validation.
Topic-10 Nature and Cause of Deviations and Misstatements
1. In analyzing the deviations and misstatements identified, the auditor may observe that many
have a common feature, for example, type of transaction, location, product line or period of time.
2. In such circumstances, the auditor may decide to identify all items in the population that possess
the common feature, and extend audit procedures to those items. In addition, such deviations or
misstatements may be intentional, and may indicate the possibility of fraud.
3. Therefore, the 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.
4. In the extremely rare circumstances when the auditor considers a misstatement or deviation
discovered in a sample to be an anomaly, the auditor shall obtain a high degree of certainty that
such misstatement or deviation is not representative of the population.
5. The auditor shall obtain this degree of certainty by performing additional audit procedures to
obtain sufficient appropriate audit evidence that the misstatement or deviation does not affect
the remainder of the population.

Topic-11 Projecting Misstatements

• Purpose of Projection: Auditors project sample misstatements to estimate the scale of
misstatements in the population. However, projections alone may not suffice to determine a
precise amount for recording.
• Anomalies: Identified anomalies can be excluded from projections. However, their uncorrected
effects must still be considered alongside non-anomalous projections. Anomaly may be defined
as a misstatement or deviation that is demonstrably not representative of misstatements or
deviations in a population.
• Tests of Details vs. Controls:
 For tests of details, misstatements in the sample are projected to the population.
 For tests of controls, no explicit projection is needed as the sample deviation rate applies to
the entire population.

Topic-12 Evaluating Results of Audit Sampling

The auditor shall evaluate- The results of the sample and Whether the use of audit sampling has
provided a reasonable basis for conclusions about the population that has been tested.

Tolerable misstatement – A monetary amount set by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not
exceeded by the actual misstatement in the population.

Tolerable rate of deviation – A rate of deviation from prescribed internal control procedures set by
the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that
the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the
population.