Relevance means that the audit procedure should be relevant to assertion. For example, confirmation of balance from a customer is a relevant evidence as regards existence of receivable, but it may not be relevant as regards collectability of the balance due from customer Also, physical observation of inventories is relevant evidence relating to existence, but is not appropriate evidence to ensure that the entity owns the inventories. Similarly, when carrying out a completeness test, the auditor will not test sales invoices to delivery notes as it does not constitute a relevant evidence to ensure that all shipment have been billed to customers.
It is difficult to set out precisely as to what constitutes sufficient audit evidence. The Standard sets out certain indicators to judge the sufficiency and appropriateness of audit evidence:
• Audit risks and materiality
• Experience gained in previous audit
• Results of audit procedures
• Reliability of audit “evidence.
FACTORS WHICH AFFECT THE RELIABILITY OF AUDIT EVIDENCE.
a) External documentary evidence obtained by auditor from unrelated parties generally represents most reliable audit evidence.
Accounts receivable confirmations
Communication from entity’s lawyers
Fixed assets or inventories held by third party.
Loans receivable and payable
Other information known to outsiders
The frauds under two court cases Ultramares and Mcksson & Robbins could not be detected by ·auditor if independent outside confirmation of accounts receivable and inventories were not obtained.
b) The more effective is the design and operation of the internal controls, the more reliable will be the audit evidence.
c) Reliability of evidence from external sources is enhanced if the evidence is obtained directly by the auditor rather than that obtained through the entity. For example, the bank confirmations obtained by the auditor directly from the bank are more reliable than the bank statements received from the entity Likewise, confirmation received directly from suppliers are more reliable than the suppliers statements obtained from the entity.
d) Audit evidence received in response to oral inquiries from management is generally least reliable evidence.
COST VS USEFULNESS OF THE EVIDENCE
Assume that the total account receivable of company are as follows:
If the auditor decides to send confirmation to all receivable over Rs. 10,000 he may get 90% confidence level; if he increases to all accounts over Rs. 6,000 he may get a confidence level of95%; still an increase in all accounts over Rs. 1,000 will make the confidence level at 98%; and sending confirmations to 100% receivable will result in a confidence level of over 99%.
In this case, the auditor would probably decide to send confirmation to all account over Rs. 6,000. In this way, just by selecting 100 accounts he will achieve a confidence level of 95%. An increase of another 100 accounts will result in an increase of 3% in confidence level. In order to achieve another 2% confidence level, additional 400 confirmations will have to be sent.
Obviously the cost of obtaining additional 400 confirmations will be out of proportion to the usefulness of such evidence.
The ISA 500 sets out six means of gathering audit evidence. Generally all these six techniques will be not be applied to all account balances. However, in verifying some of the accounts, the auditor would use all the techniques. For example, inventory verification will involve:
The auditor should relate the above procedures to management assertions. To continue the example of inventories, a relationship of assertions and procedures for gathering evidence is demonstrated as follows: