ISA 500, also known as “Audit Evidence,” is a standard issued by the International Auditing and Assurance Standards Board (IAASB) that provides guidance to auditors on obtaining and evaluating audit evidence. Audit evidence is the information obtained by auditors during an audit, which is used to support their audit opinion on the financial statements of an entity.
Definitions:
Audit Evidence:
Audit evidence refers to the information obtained by auditors during the audit process. It includes both the information contained in the accounting records of the entity and other corroborating information obtained by the auditor, such as documents, management representations, and observations.
Sufficient Appropriate Audit Evidence:
Sufficient appropriate audit evidence refers to the quantity and quality of evidence obtained by the auditor that is adequate to support their audit opinion. The auditor needs to obtain enough evidence that is relevant and reliable to draw reasonable conclusions on which to base their opinion.
Explanations:
Audit evidence is crucial in forming the basis for the auditor’s opinion on the financial statements. The auditor needs to gather sufficient appropriate audit evidence to support their opinion. The evidence obtained should be relevant, reliable, and obtained from independent sources. The auditor uses various audit procedures to obtain audit evidence, such as inspection, observation, confirmation, recalculation, reperformance, and analytical procedures.
Examples:
Inspection:
The auditor may inspect the entity’s accounting records, documents, and physical assets to obtain evidence. For example, the auditor may review the purchase invoices, sales contracts, bank statements, and inventory records to verify the completeness and accuracy of the financial statements.
Observation:
The auditor may observe the entity’s processes and procedures to obtain evidence. For example, the auditor may observe the entity’s inventory counting procedures, cash handling procedures, or internal control activities to assess their effectiveness.
Confirmation:
The auditor may obtain written confirmations from third parties to obtain evidence. For example, the auditor may send confirmation requests to the entity’s customers, suppliers, or banks to verify the balances and transactions recorded in the financial statements.
Recalculation:
The auditor may recompute the mathematical accuracy of the entity’s financial records to obtain evidence. For example, the auditor may recalculate the depreciation expense, interest expense, or payroll expenses to verify their accuracy.
Reperformance:
The auditor may perform procedures to reperform certain activities or transactions to obtain evidence. For example, the auditor may reperform the bank reconciliation or test the calculation of the payroll tax to verify their accuracy.
Analytical Procedures:
The auditor may perform analytical procedures to obtain evidence. Analytical procedures involve the evaluation of financial information through analysis of plausible relationships and trends. For example, the auditor may compare the current year’s financial ratios with the prior year’s ratios or industry benchmarks to assess the reasonableness of the financial statements.
Case Studies:
XYZ Inc. is a manufacturing company, and the auditor is performing an audit of its financial statements. The auditor decides to inspect the entity’s inventory records and physically count the inventory to obtain evidence regarding the existence and completeness of inventory. The auditor also performs analytical procedures to compare the current year’s inventory turnover ratio with the prior year’s ratio and industry benchmarks to assess the reasonableness of inventory balances.
ABC Bank is being audited by an external auditor. The auditor decides to send confirmation requests to the bank’s customers and obtain written confirmations to verify the accuracy of the loan balances recorded in the financial statements. The auditor also performs reperformance procedures to reperform certain loan calculations, such as interest accruals and loan payments, to verify their accuracy.
DEF Ltd. is a software company, and the auditor is performing an audit of its financial statements. The auditor decides to observe the entity’s internal control procedures related to revenue recognition, such as the segregation of duties between sales and accounting departments, to obtain evidence regarding the effectiveness of the internal controls. The auditor also performs recalculation procedures to verify the accuracy of revenue recognition calculations, such as the recognition of software license fees and maintenance revenues.
GHI Corp. is a construction company, and the auditor is performing an audit of its financial statements. The auditor decides to inspect the entity’s contract files and review the contract terms, change orders, and progress billings to obtain evidence regarding the completeness and accuracy of revenue recognition. The auditor also performs confirmation procedures to obtain written confirmations from the entity’s customers regarding the contract amounts and payment terms to verify the accuracy of revenue recognition.
JKL Ltd. is a retail company, and the auditor is performing an audit of its financial statements. The auditor decides to perform analytical procedures to compare the entity’s sales and gross profit margins with industry benchmarks and prior year’s ratios to assess the reasonableness of the financial statements. The auditor also performs inspection procedures to review the entity’s sales invoices, sales contracts, and other sales-related documents to obtain evidence regarding the completeness and accuracy of sales transactions.
In all the above case studies, the auditors are using various audit procedures to obtain sufficient appropriate audit evidence to support their audit opinion on the financial statements. They are inspecting documents, observing processes, obtaining confirmations, recalculating financial figures, reperforming procedures, and performing analytical procedures to obtain relevant and reliable evidence to form their conclusions.
In conclusion, ISA 500 “Audit Evidence” is a crucial standard that guides auditors on obtaining and evaluating audit evidence. Auditors need to obtain sufficient appropriate audit evidence that is relevant, reliable, and obtained from independent sources to support their audit opinion on the financial statements. Audit evidence can be obtained through various procedures such as inspection, observation, confirmation, recalculation, reperformance, and analytical procedures. Case studies provide practical examples of how auditors can apply these procedures in real-world scenarios to obtain audit evidence. By following the guidance of ISA 500 and obtaining appropriate audit evidence, auditors can enhance the reliability and credibility of their audit opinions.