‘Audit evidence’ must be reviewed critically with respect to its validity and pertinence as evidence before it is permitted to influence the mind of the auditor with respect to the assertion at issue’.
i) An Auditor is considering using a copy of credit sale invoices on a file as evidence for the credit sales figure in the accounts. How would he assess the validity and pertinence of this file as audit evidence? (3 marks)
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The file of copy credit sales invoices is the most pertinent evidence which the auditor can obtain of the credit sales figure in the accounts. This is because the sales figure is built up from the individual sales which the copy sales invoices represent.
The auditor’s assessment of its validity as evidence will however depend upon the degree to which it is supported by other evidence. It is a general rule that documents created within the organization, such as the copy invoices, form weak audit evidence.
The auditor may for example assess the internal controls designed to ensure the completeness, accuracy and validity of sales invoices in the file or seek evidence from outside the organization such as customers’ remittance advices.
ii) A mail order company invoices its customers with up to five ladies’ dresses. Most customers accept and pay for one or two dresses and return the rest. A credit note is then issued. The accounts incorporate a provision for returnable dresses at the year end. The audit is completed very quickly and post-balance sheet events are not usable by the auditor as evidence. What evidence would the auditor regard as valid and pertinent in respect of the provision? (3 marks)
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The most pertinent evidence which the auditor could seek would be stock returned and credit notes issued after the year end in relation to the garments in the hands of customers at the year end. However, because of the tight deadline for the audit the auditor will have to rely on calculations of expected returns based on previous experience. In order to accept the validity of this evidence the auditor would check the calculations and confirm that they were made on reasonable assumptions about trends in the numbers of dresses accepted by customers and any problematical styles.
iii) What factors would influence an auditor in considering the acceptability as evidence of certificates received from third parties? (3 marks)
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When considering the acceptability of a certificate from a third party as audit evidence the auditor would be influenced by the following.
1) the fact that the evidence is documentary;
2) the fact that it has come from a third party, particularly if it has been sent directly to the auditor by the third party;
3) the integrity of the third party implied by his status or by his membership of a profession. For example an auditor would place more reliance on a statement from a bank manager than one from a member of the general public;
4) the qualification of the third party relating to the subject on which he certifies;
5) the independence of the third party from the client;
6) any unusual disclaimer made in the certificate;
7) the extent to which the certificate is supported by other evidence.
iv) A building contracting company has constructed an office block on its own land for its own use. State the evidence the auditor would require on the cost of the building. (3 marks)
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1) the controls operating over the costing records;
2) documents such as purchase invoices supporting material individual entries in the costing record for the office;
3) the calculation of overheads included in the cost of the office, which must not include any element of profit;
4) an independent valuer’s opinion may be obtained if other evidence is not sufficiently reliable;
5) the amount for which the building is insured;
6) confirmation of cost and method of costing in the letter of representation.
v) Discuss the different forms of audit evidence that would be available to auditors of very small companies and of very large companies. (3 marks)
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(1) Internal Control
In a large company audit it will normally be possible to rely extensively upon internal controls as a sophisticated internal control system will exist. On the other hand a small company will not need such a complex system so the auditor will not be able to obtain evidence from the operation of internal controls.
(2) Substantive testing
Large companies will have a very large number of transactions, so it will not be practicable to rely entirely on substantive tests. A small company will, however have a small number of transactions and the auditor will be able to rely on the evidence of substantive tests.
(3) Involvement of directors
The directors of a large company will not be involved in the detail of the operation. Therefore in order to assess the reliability of any representations they make the auditor must assess the reliability of the reports they receive from the managers.
In a small company the directors will be involved in the day to day running of their company, so their representation will be based on a detailed knowledge and understanding. It may also be possible to rely to some extent on the supervision they exercise over the company’s accounting. An assessment of evidence from the directors of a small company will therefore depend among other things upon an assessment of their integrity, and on supporting evidence from other sources.