Evidence

 Evidence is any information used by the auditor to determine

whether the information being audited is stated in accordance
with the established criteria.
 It is the foundation of any audit.
 Evidence varies greatly in the extent to which it persuades the auditor
whether financial statements are fairly stated.
 Thus, evidence includes information that is:
 highly persuasive, such as information obtained by auditor’s physical
count
 less persuasive, such as information obtained by inquiries of client
employees and management.
 Evidence also include information in electronic form

Auditing Part I By Yetnayet Ayele, AAUSC 2015 1

 The use of evidence is not unique to auditors, different
professionals rely on different types of evidence, to support their
decisions.
 Eg Scientists, lawyers, researchers and historians are examples
of professionals other than auditors who use evidence
extensively.
 From an audit perspective, evidential matter consists of the
essential accounting data and all supporting information available
to the auditor.
 The auditor must have the knowledge and skill to accumulate
sufficient appropriate evidence on every audit to meet the
standards of the profession.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 2

 Audit risk is the probability that an auditor will give
inappropriate opinion on financial statements.
 auditors reduce uncertainty by collecting evidences. Auditing
standards also require auditors to accumulate sufficient and
competent evidence to support their opinion. This implies the fact
that the use of sufficient and competent evidence reduces audit
risk ( the probability that an auditor will give inappropriate
opinion on financial statements).

Auditing Part I By Yetnayet Ayele, AAUSC 2015 3

 Management of a company is responsible for
Designing and implementing internal control
systems effectively, and adopting sound
accounting policies,
making fair representations in the financial
statements (preparing financial statements of
the entity genuinely)

Auditing Part I By Yetnayet Ayele, AAUSC 2015 4

Auditing Standards stated that the overall
objectives of the auditor are:
(a) To obtain reasonable assurance about whether the
financial statements as a whole are free from
material misstatement, whether due to fraud or error,
thereby enabling the auditor to express an opinion
whether the financial statements are prepared, in all
material respects, in accordance with an applicable
financial reporting framework; and
(b) To report on the financial statements, and
communicate as required by auditing standards, in
accordance with the auditor’s findings.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 5

Major points emphasized in the auditors
responsibilities:
Auditors are responsible for
1. Detecting material misstatements in the
financial statement
2. Identifying material weaknesses in internal
control over financial reporting
3. Providing reasonable assurance on the fairness
of financial statements and about control
systems
Auditing Part I By Yetnayet Ayele, AAUSC 2015 6
Errors Versus Fraud
Auditing standards distinguish between two types of misstatements: errors
and fraud. Either type of misstatement can be material or immaterial.
 An error is an unintentional misstatement of the financial statements,
whereas fraud is intentional.
 Fraud has been classified in to two:
1.Misappropriation of assets, often called defalcation or
employee fraud
eg. misappropriation of assets is a clerk taking cash at the time a
sale is made and not entering the sale in the cash register
2. Fraudulent financial reporting, often called management
fraud.
eg. fraudulent financial reporting is the intentional overstatement
of sales near the balance sheet date to increase reported earnings.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 7

Professional Skepticism
 Auditing standards require that an audit be designed to
provide reasonable assurance of detecting both material
errors and fraud in the financial statements.
To accomplish this, the audit must be planned and performed
 with an attitude of professional skepticism in all aspects of the
engagement.
 Professional skepticism is an attitude that includes a questioning
mind and a critical assessment of audit evidence.
 Auditors should not assume that management is dishonest, but
the possibility of dishonesty must be considered.
 At the same time, auditors also should not assume that
management is unquestionably honest.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 8

Auditor’s Responsibilities for Detecting
Material Errors
 Auditors spend a great portion of their time in
planning and performing audits to detect errors in
financial statements.
 Auditors find a variety of errors resulting from
such things as mistakes in calculations,
omissions, misunderstanding and misapplication
of accounting standards, and incorrect
summarizations and descriptions.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 9
Auditor’s Responsibilities for Detecting
Material Frauds
 Auditing standards make no distinction between the
auditor’s responsibilities for searching for errors and fraud.
 In either case, the auditor must obtain reasonable assurance
about whether the statements are free of material
misstatements.
 The standards also recognize that fraud is often more
difficult to detect because management or the employees
perpetrating the fraud attempt to conceal the fraud.
 Still, the difficulty of detection does not change the auditor’s
responsibility to properly plan and perform the audit to
detect material misstatements, whether caused by error or
fraud, so proper planning is essential
Auditing Part I By Yetnayet Ayele, AAUSC 2015 10
….Auditor’s Responsibilities for Detecting
Material Frauds
 An important part of planning every audit is to
assess the risk of errors and fraud.
 The auditor’s risk assessment requirements for
fraud focuses on two characteristics:
1. Pressure or incentive to commit the fraud
2. Perceived opportunity to commit the fraud

Auditing Part I By Yetnayet Ayele, AAUSC 2015 11

ASSESSING RISK of FRAUD
 The risk factors for fraudulent financial reporting are different than
those for misappropriations of assets because the nature of the fraud is
different
 The three SAS 82 categories of risk factors for fraudulent financial
reporting are:
Category 1: Managements’ characteristics and influence over the
Control Environment.
These pertain to management’s abilities, pressures, style and attitude
relating to internal control and the financial reporting process.
Category 2: Industry conditions
These involve the economic and regularity environment in which
the entity operates.
Category 3: Operating characteristics and financial stability
These pertain to the nature and complexity of the entity and its
transactions, financial condition, and probability.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 12

 There are also two risk factors for misappropriations outlined
by SAS 82
Category 1: Susceptibility of assets to misappropriations
These pertain to the nature of an entity’s assets and the
degree to which they are subject to theft.
Category 2: Lack of controls designed to prevent or
detect misappropriations of assets
 For both fraudulent financial reporting and misappropriations
of assets, the auditor must do the following:
1. Make inquiries of management about their assessment of
the likelihood of fraud and whether they have knowledge
of fraud that has occurred.
2. Evaluate the risk of fraud as the audit proceeds.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 13

Illegal acts: are violations of laws or government regulations other
than fraud.
Two examples of illegal acts are:
 violation of federal tax laws
 violation of the federal environmental protection laws.

Direct-Effect Illegal Acts: Certain violations of laws and

regulations have a direct
financial effect on specific account balances in the financial
statements.
eg. a violation of federal tax laws directly affects income tax
expense and income taxes payable.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 14

……direct-effect illegal acts
 The auditor’s responsibility for these direct-effect
illegal acts is the same as for errors and fraud.
 On each audit, the auditor should evaluate whether or
not there is evidence indicating material violations of
tax laws.
 Discussions with client personnel and examining
reports issued by auditors from Internal Revenue
Service (after the completion of an examination of
the client’s tax return) are helpful for the auditor to
see if there is material violation of tax laws .
Auditing Part I By Yetnayet Ayele, AAUSC 2015 15
Indirect-Effect Illegal Acts: These are illegal acts that
affect the financial statements only indirectly.
eg. if a company violates environmental protection
laws, financial statements are affected only if there is
a fine or sanction.
 Potential material fines and sanctions indirectly
affect financial statements by creating the need to
disclose a contingent liability for the potential
amount that might ultimately be paid. This is called
an indirect-effect illegal act.
 Civil rights laws and employee safety requirements
can also be sources of indirect effect legal acts
Auditing Part I By Yetnayet Ayele, AAUSC 2015 16
…..indirect-effect illegal acts
 Auditing standards state that the auditor provides no
assurance that indirect-effect illegal acts will be
detected, due to the following reasons:
1. Auditors lack legal expertise,
2. The frequent indirect relationship between illegal
acts and the financial statements
 So it is it impractical for auditors to assume
responsibility for discovering indirect-effect illegal
acts.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 17

How do Auditors perform an audit, a task with all
the mentioned responsibilities?
 Audits are performed by dividing the
financial statements into smaller segments or
components.
 The division is needed:
▪ To make the audit more manageable and
▪ To facilitate the assignment of tasks to different
members of the audit team.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 18
 There are different ways of segmenting an
audit.
1. To treat every account balance on the statements as
a separate segment.
 Segmenting in this way is usually inefficient.
 It would result in the independent audit of such closely
related accounts as inventory and cost of goods sold.
2. To use Cycle Approach to Segment an Audit
 It is a common way to divide an audit
 It involves keeping closely related types (or classes) of
transactions and account balances in the same segment
Auditing Part I By Yetnayet Ayele, AAUSC 2015 19
 The cycle approach divides financial statement
items in to five cycles
1. Sales and collection cycle
2. Acquisition and payment cycle
3. Payroll and personnel cycle
4. Inventory and warehousing cycle
5. Capital acquisition and repayment cycle

Auditing Part I By Yetnayet Ayele, AAUSC 2015 20

….using the Cycle Approach to Segment an Audit
 It is logical to use the cycle approach since it ties transactions
recorded in different journals with the general ledger
balances that result from those transactions
 eg, Sales, Sales returns, Cash receipts, and Write-
offs of Uncollectible accounts are the four classes
of transactions that cause accounts receivable to
increase and decrease. Therefore, they are all parts of
the sales and collection cycle.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 21

Identifying account balances belonging to different
transaction cycles
 It is known that a trial balance is the starting point to
prepare financial statements, so is a primary focus of
every audit.
 The letter representing a cycle is shown for each
account in the left column beside the account name.
 Note: each account has at least one cycle associated
with it, and only cash and inventory are a part of two or
more cycles.
 Links Ch 4\ch 4 link 2 Trial balance showing accout
balances falling in each transaction cycles.doc
Auditing Part I By Yetnayet Ayele, AAUSC 2015 22
 Management assertions
 Assertions are expressed or implied representations by
management that are reflected in the financial statement
components.
 Thus, financial statements represent management's assertions
 Management is responsible for the preparation of financial
statements that give a true and fair view.
 Thus for each item in the financial statements, management is
making assertions like:
▪ Receivables balance on the balance sheet are originated from credit sales,
and are reported at realizable amount
▪ Reported inventory physically exist and is available for sale;
▪ Payroll related expenses are paid for genuine employees working on a
company’s business

Auditing Part I By Yetnayet Ayele, AAUSC 2015 23

 In general assertions relate to the requirements of
GAAPs.
 Management assertions are classified in to three
categories:
1. Transaction –related assertions- Assertions about
transactions and events
2. Balance –related assertions- Assertions about account
balances
3. Disclosure –related assertions- Assertions about
Disclosures

Auditing Part I By Yetnayet Ayele, AAUSC 2015 24

 Management’s assertions about transactions,
balances and disclosures can be summarized
in to the following five components:
1. Existence or occurrence
2. Completeness
3. Rights and obligations
4. Valuation or allocation
5. Presentation and Disclosure

Auditing Part I By Yetnayet Ayele, AAUSC 2015 25

1. Existence/occurrence: the assets and liabilities reported on
F/Ss actually exist on that given date, and the recorded
transactions have occurred during the period
Eg: Inventories, fixed assets reported on balance sheet
physically exists
Reported revenue represents valid sales occurred during
the period
2. Completeness: The transactions and accounts that should be
included are included, thus the financial statements re complete
eg. inventories include those counted in the store, on
consignment ;
all liabilities, accruals are recorded

Auditing Part I By Yetnayet Ayele, AAUSC 2015 26

3. Rights and Obligations: it is about whether
the assets are rights of the entity, and the
liabilities are its obligations
eg. management asserts that the entity has
legal rights of ownership for the inventory
shown on the balance sheet.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 27

4. Valuation or allocation: It is about whether
assets, liabilities, equity, revenue and expenses
appear at proper amounts/properly valued/ and
are allocated to the proper accounting period
Eg. management asserts that inventories are
reported at LCM; cost of fixed assets is
systematically allocated over its useful life

Auditing Part I By Yetnayet Ayele, AAUSC 2015 28

5. Presentation and disclosure: It is about the proper
classification and presentation of amounts on
financial statements.
 Management asserts that amounts shown in the
financial statements are properly presented and
disclosed.
 Eg. Current maturities of long term loan are reported as
current liability
 On the footnotes, all major restrictions on the entity in
relation to the debt are disclosed

Auditing Part I By Yetnayet Ayele, AAUSC 2015 29

 Why Assertions matter for the Auditor?
 Audit aims at expression opinions on financial
statements which contains management assertions, thus
audit objectives are highly related to management’s
assertions
 The auditor chooses suitable procedures based on the
nature of the item in the financial statements being
audited
 The procedures will be refined further depending on
which assertion about the item the auditor is testing

Auditing Part I By Yetnayet Ayele, AAUSC 2015 30

Audit Objectives
 The overall audit objective is providing an opinion on the
financial statements
 Auditors need evidence to support management assertions
contained in financial statements
 Thus, they develop audit objectives that relate to each
management assertions
 Audit objectives test the assertions contained in the
components of the financial statements
 Auditors need sufficient evidence that enables to met the
stated audit objectives to have reasonable assurance that the
financial statements are fairly presented

Auditing Part I By Yetnayet Ayele, AAUSC 2015 31

The overall audit objective of expressing opinion on financial
statement is achieved by setting two objectives:
1. Transaction-Related Audit objective- These help auditors to
accumulate sufficient competent evidence for each classes of
transactions and reach a conclusion that transactions are
properly recorded
2. Balance-Related Audit Objective- These help auditors to
accumulate sufficient competent evidence for account balances
and reach a conclusion that balances are properly stated in
financial statements

Auditing Part I By Yetnayet Ayele, AAUSC 2015 32

 For each classes of transactions there are:
1. General transaction-related audit objectives
2. Specific transaction-related audit objectives
The General transaction-related audit objectives
▪ These are applicable to every classes of transactions
▪ They are stated in broad terms
The Specific transaction-related audit objectives
▪ These are also applicable to each classes of transactions
▪ They are tailored to each class of transactions eg. for
sales transactions

Auditing Part I By Yetnayet Ayele, AAUSC 2015 33

 There are six general transaction-related audit
objectives
1. Existence-related transactions exist
2. Completeness-existing transactions are recorded
3.Accuracy-recorded transactions are stated in accurate
amounts
4.Classifications-recorded transactions are properly classified
5.Timining-transactions are recorded on the correct date
6. Posting and summarization-recorded transactions are

Auditing Part I By Yetnayet Ayele, AAUSC 2015 34

1. Existence-related transactions exist
 This objective deals with whether recorded
transactions have actually occurred
 Eg. inclusion of payment for expenses in cash
disbursement journal when the event does not
occur violates the existence objectives
 This objective corresponds with management
assertion of existence or occurrence

Auditing Part I By Yetnayet Ayele, AAUSC 2015 35

2. Completeness-existing transactions are recorded
 This objective deals with whether all transactions that
should be included in the journals have actually been
included
 Eg. Failure to include a sales in a sales journal and
general ledger when a sale occurred violates the
completeness objectives
 This objective corresponds with management assertion
of completeness
▪ Existence is checked to see if there is overstatement
▪ Completeness is checked to see if there is understatement due
to unrecorded transactions
Auditing Part I By Yetnayet Ayele, AAUSC 2015 36
3.Accuracy-recorded transactions are stated in accurate amounts
 This objective deals with the accuracy of
information for accounting transactions
 Eg. in recording sales, it the quantity shipped is
different from what is billed, or if wrong selling
price is used, if wrong amount is recorded in sales
journal, it is considered as a violation of the
accuracy objectives
 This objective is one part of management’s
assertion of valuation or allocation
Auditing Part I By Yetnayet Ayele, AAUSC 2015 37
 4.Classifications-transactions included in the client’s journal
are properly classified
 This objective involves determining whether transactions
are properly coded
 Eg. error in classifying cash sales as credit sales, recording
collections from sale of operating fixed assets as revenue, is
violation of the classification objectives
 This objective is also one part of management’s assertion
of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 38

5.Timining-transactions are recorded on the correct date
 This objective involves determining whether the
transactions are recorded in the correct date the transaction
take place
 Eg. A sales transaction should be recorded at the time of
shipment (when title passes)
 This objective is also one part of management’s assertion
of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 39

6. Posting and summarization-recorded transactions are
 This objective involves determining whether transactions
recorded in journals are transferred to the appropriate general
and subsidiary ledger accounts
 Eg. if a receivable from customer “A” is recorded in Customer
“B”s subsidiary ledger, or if the control ledger shows an
amount different from the summary of subsidiary ledgers, it is
considered as violation of the posting and summarization
objectives
 This objective is also one part of management’s assertion of
valuation or allocation
 The use of computerized system usually reduce this problem
Auditing Part I By Yetnayet Ayele, AAUSC 2015 40
Specific Transaction-Related Audit Objectives
 The general transaction related audit objectives must
be applied for each material type/classes of
transactions
 Such transactions include: sales, cash receipt,
acquisition of goods and services, payroll and so on
 Links Ch 4\Ch 4 Link 5 Specific Transaction Related
Objectives for Sales Transactions.docx

Auditing Part I By Yetnayet Ayele, AAUSC 2015 41

 Balance-Related Audit Objectives
 These are similar to the transaction-related
objectives;
 The also follow from management assertions
 They are helpful in accumulating sufficient
competent evidence
 Balance-Related Audit Objectives are also
divided in to two:
1. General balance-related audit objectives
2. Specific balance-related audit objectives
Auditing Part I By Yetnayet Ayele, AAUSC 2015 42
 Two major differences between transaction-
related and balance-related audit objectives:
1. balance related audit objectives apply to balances
whereas transaction-related objectives apply to
classes of transactions such as sales transactions,
cash payment transaction etc
2. There are more audit objectives for account
balances than for classes of transactions
There are nine balance-related audit objectives

Auditing Part I By Yetnayet Ayele, AAUSC 2015 43

 Balance-related objectives are almost always applied
to the ending balances in balance sheet accounts
 Some balance-related audit objectives are applied to
certain income statement accounts of non-routine
nature, and unpredictable expenses such as legal
expense or repairs and maintenance
 Income statement accounts closely related to balance
sheet accounts are tested simultaneously such as
(Dep. exp with Acc dep. , interest expense with notes
payable).
Auditing Part I By Yetnayet Ayele, AAUSC 2015 44
 When using balance-related audit objectives in
auditing, the auditor accumulates evidence to verify
detail that supports the account balance rather than
verifying the account balance itself.
 Eg. checking accounts receivable subsidiary ledger balances
to verify the accounts receivable general ledger balance

Auditing Part I By Yetnayet Ayele, AAUSC 2015 45

1. Existence-amounts included exist
2. Completeness-existing amounts are included
3. Accuracy-Amount included are stated at the correct
amount
4. Classification-Amounts are properly classified
5. Cutt-off-Transactions near the balance sheet date
are recorded in the proper period
6. Detail Tie-In-Details in the account balance agree
with related master file amounts, foot to the total in
the account balance, and agree with the total in the
general ledger.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 46
7. Realizable value-assets dare included at the
amounts estimated to be realizable
8. Rights and obligations-rights for assets and
obligations for liability
9. Presentation and Disclosure-account balances
and related disclosures are properly presented
in the financial statements

Auditing Part I By Yetnayet Ayele, AAUSC 2015 47

1. Existence-amounts included exist
 This objective deals with whether the amounts
included in the financial statements should actually
be included
 Eg. inclusion of an accounts payable to a supplier
that doesn’t exist in the accounts payable ledger
violates the existence objectives
 This objective corresponds with management
assertion of existence or occurrence

Auditing Part I By Yetnayet Ayele, AAUSC 2015 48

2. Completeness-existing amounts are included
 This objective deals with whether the amounts that
should be included have actually been included
 Eg. Failure to include an accounts payable to a
supplier in the accounts payable ledger when a
payable exists violates the completeness objectives
 This objective corresponds with management
assertion of completeness

Auditing Part I By Yetnayet Ayele, AAUSC 2015 49

3. Accuracy-Amount included are stated at the
correct amount
 This objective deals with the arithmetic accuracy of
amounts enter in the financial statements
 Eg. Failure to state inventory items’ correct
quantity, unit cost or total cost violates the
accuracy objectives
 This objective corresponds to part of
management’s assertion of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 50

 4.Classifications-recorded transactions are properly classified
 This objective involves determining whether the amounts
that enter in client’s listings/classifications are in correct
accounts
 Eg. reporting short-term investment balance under the
caption ‘Receivable’ is violation of the classification
objective
 This objective also corresponds to part of management’s
assertion of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 51

5. Cutt-off-Transactions near the balance sheet
date are recorded in the proper period
 This objective aims to determine whether transactions are
recorded in the proper period
 Transactions occurring near the end of accounting period
are likely to be misstated
 This objective corresponds to part of management’s
assertion of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 52

6. Detail Tie-In-Details in the account balance agree with
related master file amounts, foot to the total in the
account balance, and agree with the total in the general
ledger.
 This objective deals about the agreement of balances in
subsidiary accounts with that of the general ledger accounts
 Eg. if the total of subsidiary ledgers for accounts receivable
do not agree with that of the accounts receivable general
ledger , the detail tie-in objective is violated
 This objective corresponds to part of management’s
assertion of valuation or allocation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 53

7. Realizable value-assets dare included at the
amounts estimated to be realizable
 This objective is concerned whether asset
accounts are properly valued, ie whether
declines from historical costs are adequate .
 Eg. if the allowance for uncollectible account is not
adequate, if inventory write-downs for obsolete
stock is not adequate this objective is not met
 This objective corresponds to part of
management’s assertion of valuation or allocation
Auditing Part I By Yetnayet Ayele, AAUSC 2015 54
8. Rights and obligations-rights for assets and
obligations for liability
 Existence is not sufficient for an asset to be
included in balance sheet, it has to be owned
by the client’s organization
 Similarly, liabilities should belong to the entity
 This objective corresponds to management’s
assertion of rights and obligation

Auditing Part I By Yetnayet Ayele, AAUSC 2015 55

9. Presentation and Disclosure-account balances
and related disclosures are properly presented
in the financial statements
 This objective is concerned whether all
components of financial statements are
properly described in the body of the financial
statements and in foot notes.
 This objective corresponds to part of
management’s assertion of presentation and
disclosure
Auditing Part I By Yetnayet Ayele, AAUSC 2015 56
 Understanding the general balance-related audit
objectives help to develop the specific balance-
related audit objectives for each account balance on
the financial statement.
 There should be at least one specific balance-related
audit objective for each general balance-related
objective, unless it is believed that the general
balance-related audit objective is not important for
the circumstance Links Ch 4\Ch 4 Link 6 Specific
Balance related audit objectives.doc
Auditing Part I By Yetnayet Ayele, AAUSC 2015 57
How Audit Objectives are met?
 The auditor must obtain sufficient appropriate audit
evidence to support all management assertions in the
financial statements.
 This is done by accumulating evidence in support of
some appropriate combination of transaction-related
audit objectives and balance-related audit objectives.
 The auditor must decide the appropriate audit
objectives and the evidence to accumulate, to meet
those objectives on every audit
Auditing Part I By Yetnayet Ayele, AAUSC 2015 58
 Audit Evidence Decisions
 A major decision facing every auditor is determining
the appropriate types and amounts of evidence
needed to be satisfied that the client’s financial
statements are fairly stated.
 There are four decisions about what evidence to
gather and how much of it to accumulate:
1. Which audit procedures to use
2. What sample size to select for a given procedure
3. Which items to select from the population
4. When to perform the procedures
Auditing Part I By Yetnayet Ayele, AAUSC 2015 59
 An audit procedure is the detailed instruction that explains
the audit evidence to be obtained during the audit, in order
to meet the audit objectives.
 Audit procedures often incorporate sample size, items to
select, and timing into the procedure
 These procedures are stated clearly so that an auditor may
follow them during the audit.
Eg of an audit procedure
 Obtain the October cash disbursements journal and compare
the payee name, amount, and date on the cancelled check with
the cash disbursements journal for a randomly selected sample
of 40 check numbers.
 Note: this audit procedure contains issues like sample size,
items to select, and timing
Auditing Part I By Yetnayet Ayele, AAUSC 2015 60
 Audit procedures are related to and are designed to
response to each audit objective.
 But there may no a one-to-one relationship between
audit objectives and audit procedures.
 In some instances, more than one audit procedures
are required to meet an audit objective
 Or in other times an audit procedure provides
evidence to more than one audit objective.
 Audit objectives will not change whether
information is processed manually or electronically,
however, the method of applying audit procedures
may be influenced by the method of information
processing
Auditing Part I By Yetnayet Ayele, AAUSC 2015 61
 An audit program is the list of audit
procedures for an audit area or an entire audit
 It consists a set of audit procedures prepared
to test audit objectives for a component of the
financial statement.
 Normally, there is an audit program, including
several audit procedures, for each component
of the audit.
 Eg audit program for A/R, for Inventory etc
.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 62

 Audit standards require the auditor to accumulate
sufficient appropriate evidence (persuading/convincing
evidence) to support the opinion issued.
 By combining all evidence from the entire audit, the
auditor is able to decide when he or she is persuaded to
issue an audit report.
 The two determinants of the persuasiveness of evidence
are :
1. Appropriateness (competence)
2. Sufficiency

Auditing Part I By Yetnayet Ayele, AAUSC 2015 63

 1. Appropriateness (Competence)
 Appropriateness/competence of evidence is a measure of
the quality of evidence, ie., its relevance and reliability in
meeting audit objectives.
 Regardless of its form, evidence is considered
appropriate/competent, when it provides information that
is both reliable and relevant
 If evidence is highly appropriate (competent), i.e if it
provides relevant and reliable information, the auditor is
convinced that financial statements are fairly stated.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 64

……Appropriateness(Competence)
Note:
 Appropriateness/competence of evidence deals
only with quality/reliabilility and relevance of
evidence; not about amount/quantity of evidence.
 Appropriateness/competence cannot be improved
by selecting a larger sample size or different
population items, but only by selecting audit
procedures that are more relevant or provide
more reliable evidence.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 65

What does Relevance of Evidence mean?
 The relevance of evidence refers to whether a particular
type of evidence is pertinent/related to the audit
objective
 If the auditor relies on evidence that is unrelated to the
audit objective, he/she may reach an incorrect
conclusion about a management assertion
Eg. assume an auditor wants to check the completeness
objective for recording sales transactions; ie., are all
goods shipped to customers recorded in sales journal?
Auditing Part I By Yetnayet Ayele, AAUSC 2015 66
….Relevance of Evidence
 A normal audit procedure for testing this objective is to
trace a sample of shipping documents (such as delivery
orders/bills of lading) to the related sales invoices and
entries in the sales journal.
 If the auditor samples the population of sales invoices
issued during the period, the evidence would not relate to
the completeness objective (ie., the auditor would not
detect shipments made but not billed/recorded. The
auditor should check pre-numbered delivery orders/bills
of lading after ascertaining that such documents were
issued for all customer shipments.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 67
……Relevance of Evidence
 Relevance can be considered only in terms of
specific audit objectives, because evidence
may be relevant for one audit objective but not
for another.
 In the previous shipping example, if the
auditor use a sample population of sales
invoices and trace it to related shipping
documents, and this evidence is relevant for
the occurrence transaction objective.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 68

What does Reliability /Validity of Evidence
mean?
 The reliability of evidence refers to whether a
particular type of evidence can be relied upon to
signal the true state of an assertion or audit
objective.
 It is about the degree to which evidence can be
believable or worthy of trust.
 Eg. if an auditor counts inventory, that evidence
is more reliable than if management gives the
auditor its own count amounts.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 69
..Reliability /Validity of Evidence
Six characteristics of a reliable/valid and appropriate
evidence:
1. Independence of provider: Evidence obtained from a source
outside the entity is more reliable than that obtained from
within.
eg. – reliance on evidence obtained through confirmation from
bank, attorney, customers, and creditors than on inquiry of the
client
- reliance on documents such as insurance policy than
using documents that originate within the firm and never left
the entity, eg. purchase requisition
2. Effectiveness of client’s internal controls: When a client’s
internal controls are effective, evidence obtained is more
reliable than when they are weak.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 70
3. Auditor’s direct knowledge: Evidence obtained directly by the
auditor through physical examination, observation, recalculation,
and inspection is more reliable than information obtained
indirectly.
4. Qualifications of individuals providing the information:
Although the source of information is independent, the evidence
will not be reliable unless the individual providing it is qualified to
do so.
eg. - accounts receivable confirmations from persons not familiar
with the business world will not provide reliable information
-auditor’s direct observation may not produce reliable
information if the auditor lacks the qualifications to evaluate the
evidence. eg, examining an inventory of diamonds by an auditor not
trained to distinguish between diamonds and glass is not reliable
evidence for the existence of diamonds.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 71

5. Degree of objectivity: Objective evidence is more reliable than evidence that
requires considerable judgment to determine whether it is correct.
Eg. of objective evidence include
-confirmation of accounts receivable and bank balances,
- the physical count of securities and cash, and
- adding (footing) a list of accounts payable to determine whether it agrees
with the balance in the general ledger.
Eg of subjective evidence include
- a letter written by a client’s attorney discussing the likely outcome of
outstanding lawsuits against the client,
- observation of obsolescence of inventory during physical examination,
- inquiries of the credit manager about the collectibility of noncurrent
accounts receivable.
-In evaluating the reliability of subjective evidence, the auditors should assess
the qualifications of the person providing the evidence.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 72

6. Timeliness: The timeliness of audit evidence can refer
either to when it is accumulated or to the period covered by
the audit.
Evidence is usually more reliable for balance sheet
accounts when it is obtained as close to the balance sheet
date as possible.
Eg. the auditor’s count of marketable securities on the
balance sheet date is more reliable than a count 2 months
earlier.
For income statement accounts, evidence is more reliable
if there is a sample from the entire period under audit, such
as a random sample of sales transactions for the entire year,
rather than from only a part of the period, such as a sample
limited to only the first 6 months.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 73
2. Sufficiency of Evidence:
 Sufficiency is determined by:
`1. the quantity of evidence obtained, ie. by the sample size
the auditor selects and
2. by the selection of proper individual items to be tested
with in the sample.
Sample size (quantity of evidence):
 Eg. For a given audit procedure, the evidence obtained
from a sample of 100 is ordinarily more sufficient than
from a sample of 50. (larger sample size is preferable)
Auditing Part I By Yetnayet Ayele, AAUSC 2015 74
Two major factors considered in determining the
appropriate sample size in audits:
1. the auditor’s expectation of misstatements –if larger
misstatements are expected larger sample size is
needed
2. Effectiveness of the client’s internal controls –if
client’s internal control system is effective, lower
sample size is sufficient

Auditing Part I By Yetnayet Ayele, AAUSC 2015 75

Selection of proper items :
 Sufficiency of evidence can also be affected by the
individual items tested
 Samples containing the following are usually considered
sufficient:
▪ items with large dollar values,
▪ items with a high likelihood of misstatement, and
▪ items that are representative of the population are
However, samples that contain only the largest dollar
items from the population may not be sufficient if
these items do not make up a large portion of the
total population amount. In such cases, there will be
a risk that the sample may not be representative.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 76
Consideration of Combined Effect in Evaluating Persuasivness
 The persuasiveness of evidence can be evaluated only after considering:
 the combination of appropriateness and sufficiency,
 the effects of the factors influencing appropriateness and sufficiency
In evaluating persuasiveness it is essential to consider the following:
 A large sample of evidence provided by an independent party is not
persuasive unless it is relevant to the audit objective being tested.
 A large sample of evidence that is relevant but not objective is also not
persuasive.
 A small sample of only one or two pieces of highly appropriate evidence also
lacks persuasiveness.
Thus, in evaluating persuasiveness of the evidence, the auditor must evaluate
the degree to which both appropriateness and sufficiency, including all
factors influencing them, have been met.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 77
 In making decisions about evidence for a
given audit, both persuasiveness and cost must
be considered.
 The auditor’s goal is to obtain a sufficient
amount of appropriate evidence at the lowest
possible total cost.
 However, cost is never an adequate
justification for omitting a necessary
procedure or not gathering an adequate sample
size.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 78
Eight broad categories of evidence (types of evidence)
1. Physical examination
2. Confirmation
3. Documentation
4. Analytical procedures
5. Inquiries of the client
6. Recalculation
7. Reperformance
8. Observation
 In deciding which audit procedures to use, the auditor
can choose from these categories of evidence
 Every audit procedure obtains one or more of these
evidence

Auditing Part I By Yetnayet Ayele, AAUSC 2015 79

1. Physical examination is the inspection or count of a tangible asset by the
auditor.
 It is a direct means of verifying that an asset actually exists (existence
objective), and to a lesser extent whether existing assets are recorded
(completeness objective).
 It is considered as one of the most reliable and useful types of audit evidence.
 It is also a useful method for evaluating an asset’s condition or quality.
 Eg. verification of inventory and cash, securities, notes receivable, and
tangible fixed assets
 In verifying signed check (an asset) the process in known as physical
examination (since it has inherent value)
 In verifying paid check, sales invoices and other similar documents the
process in known as documentation (since these documents have no
inherent value)
Auditing Part I By Yetnayet Ayele, AAUSC 2015 80
 However, physical examination is not sufficient
evidence to verify that existing assets are owned by
the client (rights and obligations objective), and in
many cases the auditor is not qualified to judge
qualitative factors such as obsolescence or
authenticity (realizable value objective).
 Also, proper valuation for financial statement
purposes usually cannot be determined by physical
examination (accuracy objective).

Auditing Part I By Yetnayet Ayele, AAUSC 2015 81

2. Confirmation it is the receipt of a direct written response from
a third party verifying the accuracy of information that was
requested by the auditor.
 The request may be in electronic or paper form
 The request is made to the client, and the client asks the third party
to respond directly to the auditor.
 Auditors usually receive written response/confirmation than oral,
sine written is more reliable
 Since confirmations come from sources independent of the client,
they are a highly regarded and often-used type of evidence.
 However, they are relatively costly to obtain and may cause some
inconvenience to those asked to supply them.
 Therefore, they are not used in every instance in which
they are applicable.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 82
 The decision to use confirmation depends on :
 the reliability needs of the situation and
 the alternative evidence available.
Issues that can be verified using physical examinations and
documentations (eg,. Verification of additions to fixed
assets) do not require confirmation
 Similarly, individual sales transactions do not need
confirmation, but exceptions such as sales involving
extraordinarily large amount recorded 2 or 3 days before
the end of the accounting period need confirmation
Auditing Part I By Yetnayet Ayele, AAUSC 2015 83
 To be considered reliable evidence, confirmations must
be controlled by the auditor from the time they are
prepared until they are returned.
 If the client controls the preparation of the confirmation,
does the mailing, or receives the responses, the auditor
has lost control and with it independence; thus reducing
the reliability of the evidence.
 Auditors often attempt to authenticate the identity of the
confirmation respondent, especially for facsimile or
electronic confirmation responses.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 84
Positive and Negative Confirmation
 A positive confirmation asks the recipient to respond in
all circumstances
 A negative confirmation asks the recipient only when the
information is incorrect
 Since confirmation are considered reliable when
returned, positive confirmation are more competent than
the negative confirmation
 Forms of positive confirmation:
 Blank form-asks recipient to provide information (not widely
used due to relatively low response)
 Agree/disagree -asks recipient to agree/disagree on the
information provided (preferable due to relatively faster
response)

Auditing Part I By Yetnayet Ayele, AAUSC 2015 85

3. Documentation – is the auditor’s inspection/examination of
the client’s documents and records to substantiate the
information that is, or should be, included in the financial
statements.
 The documents examined by the auditor are the records used by
the client in conducting its business
 Since each transaction in client’s record is supported by at least
one document, a large volume of this type of evidence is
available
 In audits, documentation is widely used as evidence since it is
readily available at a relatively low cost, and sometimes, it is
the only reasonable type of evidence available.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 86

 Documents can be classified as internal or external:
 An internal document is one that has been prepared and used
within the client’s organization and is retained without ever
going to an outside party such as a customer or a vender
(never leaves the organization)
▪ Eg. store requisition, employees time reports, inventory
receiving reports
 An external document is one that has been in the hands of
someone outside the client’s organization who is a party to the
transaction being documented, but which is either currently in
the hands of the client or readily accessible
▪ Eg of External documents include vendors’ invoices,
and insurance policies.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 87

Factors considered by auditors in accepting documentation
as reliable evidence:
1. Whether the document is internal or external
External document is preferable since it is considered
to be more reliable
2. Client's internal control system
When the document is internal, auditors check whether it was
created and processed under conditions of good internal
control. Thus, the reliability of internal documents depend
more on the strength of the client’s internal control system.
Weak internal control system usually generates unreliable
internal document
3. Whether the document is original or not
Original documents are considered more reliable than
photocopies or facsimiles.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 88
 Auditors are required to consider the reliability of
documentation, however, they may not be expected to verify
the authenticity of documentation, since their expertise is not
in document authentication.
Vouching and Tracing
 Vouching- When auditors use documentation to support
recorded transactions or amounts, the act is called Vouching.
Eg Vouching purchase transactions involve verifying
entries in the purchase journal by examining supporting
vendors’ invoices and receiving reports and thereby satisfy
the occurrence objective.
 Tracing: This term is used for eg. if the auditor traces from
receiving reports to the acquisitions journal to satisfy the
completeness objective
Auditing Part I By Yetnayet Ayele, AAUSC 2015 89
4. Analytical Procedures
 Analytical procedures involve the use of comparisons
and relationships to assess whether account balances
or other data appear reasonable compared to the
auditor’s expectations.
Eg. comparisons of gross margin percent in the
current year the preceding years.
 Analytical procedures are used widely since they are
helpful to obtain useful information in the planning
and completion (report) phases on all audits.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 90
Purpose of using analytical procedures:
1. To have an understanding of the nature of the Client’s
Industry and Business
eg. computing gross margin percentage of the current year
(unaudited data) and comparing it to previous years may
reveal a decline in gross margin percentages over periods.
This decline may indicate the increasing competition in the
industry in which the client operates.
-Then the auditor will decide to focus on how selling price
were set (the pricing aspect)
-Similarly a significant increase in the balance of fixed asset
account indicates the need for review of major acquisitions

Auditing Part I By Yetnayet Ayele, AAUSC 2015 91

…….Purpose of using analytical procedures:
2. To assess Entity’s Ability to Continue as a Going Concern
(Remember, the auditor is expected to modify the audit
report if there is doubt in the entity’s ability to continue as
going concern)
 Analytical procedures are good indicators of whether the
client company has financial problems.
Eg. if a higher-than-normal ratio of long-term debt to net
worth (indicator of long-term solvency problem) is
combined with a lower-than-average ratio of profits to total
assets (indicator of inefficient utilization of asset), a
relatively high risk of financial failure may be indicated.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 92

…….Purpose of using analytical procedures:
3. To check the Presence of Possible Misstatements in the Financial Statements
 Significant unexpected differences between the current year’s unaudited
financial data and other data used in comparisons are commonly called
unusual fluctuations.
 Unusual fluctuations occur when significant differences are not expected
but do exist, or when significant differences are expected but do not
exist.
 The existence of large unusual differences call the attention of the
auditor to the issue since accounting misstatement
(overstatement/understatement) could be one possible reason for the
unusual fluctuation.
 Thus, the auditor must investigate the reason for unusual fluctuation and
be satisfied that the cause is a valid economic event and not a
misstatement.
 This aspect of analytical procedures is often called “attention directing”
because it results in more detailed procedures in the specific audit areas
where misstatements might be found.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 93
 …….Purpose of using analytical procedures:
4. To reduce detailed audit tests
 When an analytical procedure reveals no
unusual fluctuations, this implies the possibility
of a material misstatement is minimized.
 It may also lead to the decision to eliminate
some audit procedures, to reduce sample sizes,
and to adjust the timing of the use of procedures

Auditing Part I By Yetnayet Ayele, AAUSC 2015 94

5. Inquiries of the client
 Inquiry is the obtaining of written or oral information from the client
in response to questions from the auditor.
 It helps to obtain lots of information however, it cannot be regarded as
conclusive because it is not from an independent source and may be
biased in the client’s favor.
 Therefore, when the auditor obtains evidence through inquiry, it is
essential to obtain corroborating evidence (additional supporting
evidence) through other procedures
Eg. when the auditor wants to obtain information about the client’s
method of recording and controlling accounting transactions, the auditor
usually begins by asking the client how the internal controls operate.
Later, the auditor performs audit tests using documentation and
observation to determine whether the transactions are recorded
(completeness objective) and authorized (occurrence objective) in the
manner stated.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 95

 6. Recalculation
 Recalculation involves rechecking a sample of
calculations made by the client.
 Rechecking focuses on testing the client’s
arithmetical accuracy
 Eg. checking the accuracy of calculations of sales invoices
and inventory, depreciation and prepaid expenses, adding
journals and subsidiary records and so on.
 A considerable portion of auditors’ recalculation is done by
computer assisted audit software.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 96

 7. Reperformance
 It is the auditor’s independent tests of client accounting
procedures or controls that were originally done as part of
the entity’s accounting and internal control system.
 Note: recalculation involves rechecking a computation, but
reperformance involves checking procedures.
Eg. the auditor may compare the price on an invoice to
an approved price list, or may reperform the aging of
accounts receivable.
 the auditor may test the flow of information in accounting
records
▪ Eg. the auditor may make limited tests to ascertain that the information in
the sales journal has been recorded in the proper customer’s account, at the
correct amount, included in the subsidiary accounts receivable records and
is accurately summarized in the general ledger.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 97
8. Observation
 It is the use of the senses to assess client activities.
Eg. the auditor may visit the plant to obtain a general
impression of the client’s facilities, or watch individuals
perform accounting tasks to determine whether the person
assigned a responsibility is performing it properly.
 Observation is rarely sufficient by itself because of the risk that
client personnel can change their behavior due to the auditor’s
presence. (In the presence of the auditor, they may perform in
accordance with company policy but may change once the
auditor is not in sight).
 Therefore, it is essential to follow up initial impressions and
support with other kinds of corroborative evidence.
 Even if there are risks, observation is useful in most parts of the
audit.
Auditing Part I By Yetnayet Ayele, AAUSC 2015 98
Costs of Evidences
 Physical examination and confirmation-most expensive
 These two types of evidence involve high cost because:
 Physical examinations requires the presence of auditors on counting the
assets on balance sheet date (requires auditors to travel to different
geographical area)
 Confirmation requires auditors to follow up processes in confirmation
such as the preparation, mailing or electronic transmittal, receipt, and in
the follow-up of non-responses and exceptions.
 Documentation, analytical procedures, and reperformance
 These three types of evidence are moderately costly.
Costs related to Documentation:
- Assistance of client's personnel in terms of organizing, providing files
and explanation will reduce the time (cost)
-However, the cost will be very high if auditors find client’s documents by
themselves
Auditing Part I By Yetnayet Ayele, AAUSC 2015 99
Costs related to analytical procedures:
 Because analytical procedures are considerably less
expensive than confirmations and physical examination, in
detailed tests, auditors may save costs by using analytical
procedures instead of confirmations and physical examination
Costs related to reperformance :
 The cost of reperformance tests depends on the nature of the procedure being
tested.
 Some reperformaces take minimum time (eg. the comparison of invoices to
price lists), however, reperforming procedures such as the client’s bank
reconciliation are likely to take considerable time.
 The three least-expensive types of evidence are observation,
inquiries of the client, and recalculation. Observation is normally
done concurrently with other audit procedures (eg with physical
examination).

Auditing Part I By Yetnayet Ayele, AAUSC 2015 100

 Inquiries of clients are used on every audit and normally
have a low cost, although certain inquiries may be costly,
(eg. obtaining written statements from the client,
documenting discussions throughout the audit is costly).
 Recalculation is usually low cost because it involves
simple calculations and tracing that can be done at the
auditor’s convenience. Often, the auditor’s computer
software is used to perform many of these tests.

Auditing Part I By Yetnayet Ayele, AAUSC 2015 101