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When external auditors are employed to express an opinion on the financial statements of an entity, they must ensure that they have sufficient appropriate evidence on which to base such an opinion. To answer the question "what constitutes sufficient appropriate evidence?" we need to re-examine the basic auditing premise that the financial statements of an entity merely embody the assertions of the management of that entity.

Audit evidence

When external auditors are employed to express an opinion on the financial statements of an entity, they must ensure that they have sufficient appropriate evidence on which to base such an opinion. To answer the question “what constitutes sufficient appropriate evidence?” we need to re-examine the basic auditing premise that the financial statements of an entity merely embody the assertions of the management of that entity. These assertions can be summarised as in Table 1.

Table 1

AssertionImplicationExample
Existencean asset or a liability exists at a given datea motor car included in the fixed assets section of the balance sheet, existed at the balance sheet date
Rights and obligationsan asset or liability pertains to the entity at a given datethe motor car (above) was owned by the entity at the balance sheet date
Occurrencea transaction or event took place which pertains to the entity during the relevant perioda sales transaction reflected in the profit and loss account for a given period actually occurred during that period
Completenessthere are no unrecorded assets, liabilities, transactions or events or undisclosed itemsthe trade creditors figure included in the balance sheet includes all trade creditors of the entity at the balance sheet date
Valuationan asset or liability is recorded at an appropriate carrying valuethe trade debtors figure included in the balance sheet is net of all bad debt provisions and is all collectible
Measurementa transaction or event is recorded at the proper amount and revenue or expense is allocated to the proper periodan advance rental payment relating to rental expenses partly for the period under review and partly to the next period is correctly recorded in the accounting records. Being reflected partly as a rental expanse in the period under review and partly as a prepaid expense at the balance sheet date
Presentation and disclosurean item is disclosed, classified and described in accordance with the applicable reporting frameworka motor car owned by the entity is classified as a fixed asset, properly disclosed and described as such in the balance sheet

As a consequence of these assertions, from the audit perspective, figures, notes and information included in the financial statements are transformed into specific representations. Crucially, before forming an opinion on the financial statements, auditors must collect evidence relevant to these representations.

Sufficiency, as applied to audit evidence, is the measure of the quantity of evidence. Appropriateness is the measure of the quality of reliability of audit evidence and its relevance to a particular assertion.

It is important to note that whilst sufficiency and appropriateness are interrelated, various factors including risk of misstatement and materiality need to be considered when judging as to what is sufficient appropriate audit evidence. However, it is not practical for auditors to search endlessly for audit evidence. There are two major constraining factors in this respect:

Time: an audit timetable is normally agreed with the management of the entity giving a deadline date for the conclusion of the audit.

Cost: the fee for an audit assignment is normally agreed in advance. Thus, effective use of audit resources is crucial if commercial viability is to be maintained.

Therefore, whilst working within the constraints mentioned above, an effective auditor will strike an appropriate balance between quantity and the quality and reliability of audit evidence, when seeking to verify particular assertions contained in the financial statements. For example, audit procedures to be carried out in verifying a trade debtors figure with a high volume of trade debtor balances, should include tests to verify:

(i) existence of trade debtors;

(ii) valuation of trade debtors.

Given that it would not be practical to test every balance for the assertions of existence and valuation, the effective auditor may select a sample of balances to include in a debtors circularisation (particularly relevant for 'existence'), whilst separately testing for subsequent payment from specific debtors (particularly relevant for 'valuation'). Clearly the source and nature of evidence deriving from each of these tests would have high reliability factors.

The procedures by which auditors obtain evidence comprise:

  • Inspection;
  • Observation;
  • Enquiry and confirmation;
  • Computation;
  • Analytical procedures.

From my experience of teaching auditing, it seems that while most students are able to recite the above procedures, many have difficulty in being able to differentiate between them. To illustrate: 'observation' consists of looking at a process or procedure being performed by others, for example observation of goods being dispatched by an entity's staff. Typically, however, many students confuse the procedure of 'observation' with that of 'inspection' which consists of examining records, documents or tangible assets. Given that audit evidence is a core topic in auditing it really is imperative that students have a full understanding of the procedures for obtaining audit evidence.

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