Understanding Audit Evidence - A Guide for Accountants when Drafting Financials
Accountants play a central role in financial reporting, with the responsibility of compiling annual financial statements (AFS) as stipulated by section 29 of the Companies Act, 2008:
"accurately represent the company's current situation and operations, and clarify the dealings and financial status of the company's business"
— Companies Act, 2008
Creating financial statements involves keeping a file with important documents that can be checked during an audit.
It's imperative for all accountants to grasp the idea of audit evidence. This is because it guarantees the precision and verifiability of financial statements, thereby satisfying both regulatory norms and the anticipations of auditors.
Audit evidence under ISA 500 helps accountants improve financial reporting by providing practical insights and guidance for better practices.
Understanding Audit Evidence
Audit evidence refers to the data that auditors rely on to determine the fairness and accuracy of financial statements. As per the International Standards on Auditing (ISA 500), such evidence should be both adequate (sufficient in volume) and suitable (pertinent and dependable) to back up the auditor's findings.
Sufficient Evidence
Sufficiency means having enough proof to back up the auditor's opinion on financial statements. Sufficiency means having enough proof to support the auditor's opinion on financial statements. Auditors decide how much proof is needed based on risk levels.
They require more evidence for high-risk areas and less for low-risk ones. Accountants play a key role in this process. They maintain detailed documents and records that support the financial statements.
They also assist auditors in gathering the right amount and type of evidence for each area. Accountants are important in this process because they keep detailed documents and records that support the financial statements. They also help auditors gather the right amount and type of evidence needed for each area.
Appropriate Evidence
Appropriateness is about the quality of audit evidence. It looks at two main things: relevance and reliability. Relevance means the evidence is connected to what the auditor is checking. Reliability is about how trustworthy the evidence is.
Evidence can come from different places. This includes a company’s accounting records, bank statements, and customer confirmations.
Observations can also be a source of evidence. The type and amount of evidence depend on the details and risks of each financial statement. Accountants must make sure the evidence is convincing.
They should provide documents that relate to the audit goals. The evidence must also be reliable. This helps support a strong and trustworthy opinion on the financial statements.
Relevant and reliable evidence is more convincing. It gives auditors confidence in their conclusions. For example, evidence collected directly by the auditor is stronger.
This includes physical inspections or direct confirmations from a third party, like a bank or customer. Such evidence is usually more persuasive than information obtained from the client through questions.
Different types of audit evidence and their effectiveness.
The ISA 500 standards identify different types of evidence and how persuasive they are.
1. Physical Evidence
Physical evidence is what auditors see or check themselves, like counting inventory or looking at assets. Physical evidence is what auditors can see or verify themselves. This includes counting inventory or examining assets. This type of evidence is reliable because the auditor observes it directly. This reduces the chances of errors or false information.
2. Confirmations
This means getting direct proof from another source. This could be bank confirmations or confirmations from customers about what they owe. These confirmations are strong evidence because they come from outside sources. They help verify the information independently.
3. Documentation
This includes papers from both inside and outside the company. Examples are invoices, contracts, and meeting notes. The value of these papers depends on their source. External documents, especially from independent sources, are more reliable than internal ones.
4. Analytical Procedures
Analytical procedures look at reasonable connections between financial and non-financial data. They can be helpful, but they are usually less convincing than direct evidence. This is because they rely on inference instead of direct observation or confirmation.
5. Inquiries
This means asking questions to people who have a lot of knowledge. These people can be from inside or outside the organization. Questions can sometimes be less convincing. This is because they may be based on personal opinions. However, when supported by other facts, they can provide helpful insights.
Here are some practical examples. Accountants can make sure the evidence they give is enough and suitable. This helps meet audit requirements.
1. Inventory Valuation
When making financial statements, accountants need to value inventory accurately. This requires keeping detailed records, like purchase invoices and inventory counts. Accountants must accurately value inventory when preparing financial statements.
To do this, they need to keep detailed records, such as purchase invoices and inventory counts. Auditors may check the inventory in person. They might also ask for external confirmations, like supplier statements, to verify ownership and purchase details.
By providing thorough documentation, accountants ensure there is enough reliable evidence to support the inventory's value. Accountants must accurately value inventory when preparing financial statements. To do this, they need to keep detailed records, such as purchase invoices and inventory counts.
Auditors may check the inventory in person. They might also ask for external confirmations, like supplier statements, to verify ownership and purchase details. By providing thorough documentation, accountants ensure there is enough reliable evidence to support the inventory's value.
2. Receivables Confirmation
For receivables, accountants should ensure that customer balances are accurate and that supporting evidence, such as sales invoices, payment records, and aging analysis reports, is on file. Auditors may seek direct confirmations from customers to verify the existence and accuracy of receivables reported in the financial statements. Since these confirmations come from independent third parties, they are highly persuasive evidence. By ensuring that the initial records and reconciliations are accurate and complete, accountants help make the audit evidence both sufficient and appropriate.
3. Internal Controls Documentation
Accountants are important for keeping track of financial rules. They help with tasks like dividing duties, getting approvals, and checking records. Auditors check these rules by looking at documents, watching how things are done, and going through transactions.
This helps them see how the rules work in real life. By keeping clear and current records, accountants help evaluate how well these financial rules are working.
Accountants can make audits easier by gathering clear and organized documents. This helps provide enough proof for the audit. Good documentation makes the audit process smoother and more effective.
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