The audit process includes auditors applying different audit procedures to test the assertions of the financial statements. These assertions vary according to whether the auditors are performing procedures on account balances or transactions. These audit procedures allow auditors to form an opinion related to whether the financial statements of the client are free from material misstatement, and represent a true and fair view. To express an opinion, auditors must draw conclusions related to various items of financial statements. However, auditors cannot reach a conclusion related to financial statements in the absence of audit evidence.
Audit evidence represents all the accounting records related to the financial statements and other information gathered by auditors for the purpose of their audit. However, when it comes to obtaining audit evidence, there are some rules by which auditors must abide. The International Standard on Auditing that deals with Audit evidence is ISA 500.
ISA 500 states that the responsibility of the auditor during an audit is to “design and perform audit procedures in such a way to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion”.
Therefore, it is crucial to understand what the standard means by sufficient appropriate audit evidence.
What Does Sufficient and Appropriate Audit Evidence Mean?
While the standard refers to it as sufficient appropriate audit evidence, these are two different things. Therefore, to understand what they mean, it is critical to look at both of them separately.
The sufficiency of audit evidence is the measure of the quantity of audit evidence that auditors must obtain. While the volume of audit evidence is subjective, the standard allows auditors to use their professional judgment in determining the sufficiency of audit evidence. Similarly, the standard states that the sufficiency of the audit evidence depends on the audit procedures that are appropriate in the circumstances.
To ensure the sufficiency of audit evidence, auditors must obtain and evaluate audit evidence using various audit procedures. These procedures include analytical procedures, confirmation, inquiry, inspection, observation, recalculation, and re-performance. Among the other procedures, the standard states that inquiry may not form sufficient audit evidence. However, it can still be useful in the appropriateness of evidence.
ISA 500 also states that the sufficiency of audit evidence depends on the auditor’s assessment of the risk of misstatement. Therefore, the higher the perceived risks of an audit assignment are, the more quantity of the audit evidence auditors will collect. Similarly, if the risks are lower, the quantity of audit evidence they will gather be lower.
However, the standard also states that the quality and quantity of audit evidence are interrelated. Therefore, the sufficiency of audit evidence also relates to its appropriateness. It says that the sufficiency of audit evidence cannot compensate for its lack of appropriateness. In other words, the standard says that auditors cannot use the quantity of audit evidence as a basis to justify low-quality evidence.
While sufficiency relates to the quantity of audit evidence, appropriateness relates to its quality. Therefore, appropriate audit evidence refers to the measure of the quality of audit evidence. The standard also defines what it means by quality. The quality of audit evidence represents its relevance and reliability in providing support for the conclusion on which auditors’ base their opinion. Therefore, the appropriateness of audit evidence depends on its relevance and reliability differentiation between which is critical.
The relevance of audit evidence depends on the connection between the purpose of the audit procedure performed by the auditor and the assertion they are testing. Usually, the direction of testing dictates the relevance of the information used as audit evidence. For example, to verify the existence of an asset, inspection of assets may be considered relevant audit evidence. Similarly, when testing the rights and obligations of an asset, an inspection may be futile.
Furthermore, the audit procedure that auditors use dictates the assertion that it can verify, therefore, affecting its relevance. For example, auditors cannot use recalculation to verify the cut-off assertion of transactions. For each assertion, auditors must identify and design audit procedures accordingly. Using added procedures for one assertion to compensate for the absence of another is not considered relevant audit evidence.
The next factor in determining the appropriateness of audit evidence is its reliability. The reliability of audit evidence depends on its source, nature, and the circumstances in which auditors obtain it. In the reliability of audit evidence, all three factors play a vital role. In the absence of one of these factors, the reliability of audit evidence may not meet the required standards for audit evidence.
There are a few generalizations when it comes to audit evidence reliability. These include the following.
- Audit evidence obtained from independent sources outside the client is more reliable than that generated internally. However, these must come from knowledgeable external sources.
- When audit evidence comes from within the client, the reliability depends on the controls in place related to the evidence. These controls also define the circumstances factor in the reliability of audit evidence.
- Audit evidence obtained directly by the auditor, for example, through observation, inspection, or inquiry is more reliable than audit evidence obtained indirectly or through the client’s involvement.
- Audit evidence in written form, whether paper, electronic or any other medium is more reliable than audit evidence obtained orally. It is the reason why the standard considers inquiry as insufficient on its own.
- Audit evidence that is in the form of original documents rather than photocopies or scans is considered more reliable than other forms of audit evidence. In the case of unoriginal audit evidence, the reliability depends on the circumstances or controls in place at the client.
Factors Affecting Sufficient Appropriate Audit Evidence
Several factors can affect whether auditors can obtain sufficient appropriate audit evidence. Some of these factors include the following.
Risk of material misstatement
The risk of material misstatement of an audit client dictates the sufficiency and appropriateness of audit evidence. The risk of material misstatement further consists of two types, inherent and control risks. Therefore, the nature of the client, especially its industry, procedures, processes, etc., and its internal controls influence whether the audit evidence obtained by auditors can be considered sufficient and appropriate.
The materiality of the audit engagement also affects the sufficiency and appropriateness of audit evidence obtained by auditors. In case the materiality of an audit engagement is higher, auditors also need to increase the quality and quantity of audit evidence they must gather. For lower materiality clients, auditors may need fewer procedures.
Auditors’ prior experience of a client also dictates sufficient appropriate audit evidence. When auditors continue an audit engagement into next year, they must determine if any changes took place at the client and how these changes affect the audit procedures they perform. Therefore, through assessing the changes, auditors can also determine what they consider as sufficient appropriate audit evidence for the upcoming period.
Source of evidence
As mentioned above, the source of audit evidence also plays a critical role in whether it can be considered sufficient and appropriate. Auditors can refer to the generalizations given above to determine whether a source of audit evidence can produce sufficient, appropriate evidence.
Reliability of evidence
The reliability of audit evidence also factors in when it comes to sufficient appropriate audit evidence. As mentioned above, the reliability of evidence directly affects appropriateness, which in turn is related to the sufficiency of audit evidence. As stated above, auditors must refer to the above reliability points when evaluating audit evidence.
Audit evidence is the documentation, and other information auditors obtain as a result of their audit procedures. It is the basis used by auditors to reach conclusions and form an opinion related to the financial statements of a client. When it comes to audit evidence, auditing standards require auditors to obtain sufficient appropriate audit evidence. The sufficiency of audit evidence relates to its quantity while its appropriateness relates to its quality. The appropriateness of audit evidence further depends on two factors, relevance, and reliability. There are several factors given above that influence audit evidence.