Assertions and audit evidence

Everything you do in the evidence stage of an audit answers one question: has the auditor collected enough good evidence that each figure and disclosure in the financial statements is not materially misstated? Assertions give that question a shape, because they break "is receivables right?" into separate claims you can test one at a time. The rules on sufficient and appropriate evidence tell you when you have done enough. This lesson is the foundation for every procedure you will write in the rest of area D. In the exam it appears in Section A objective test questions (which assertion does this procedure test, which evidence is most reliable) and, constantly, in Section B, where every substantive procedure you describe should be aimed at an assertion.

What audit evidence is for

ISA 500 Audit Evidence sets the auditor's objective: to design and perform procedures that give sufficient appropriate evidence to reach reasonable conclusions on which to base the opinion. Audit evidence is all the information the auditor uses to reach those conclusions: the entity's accounting records, and information from other sources such as the auditor's own observations and replies from third parties.

Two ideas sit behind every evidence question. First, an audit gives reasonable assurance, not absolute assurance: most evidence is persuasive rather than conclusive, so the auditor builds a case from several pieces that point the same way. Second, evidence is gathered assertion by assertion. Physically inspecting a machine proves it exists; it says nothing about who owns it or whether its carrying amount is too high.

The assertions

When directors present financial statements, they are implicitly making claims about every figure in them. ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement calls these claims assertions and groups them in two sets. The auditor uses them to think about what could go wrong, and then designs procedures to test each relevant one.

Classes of transactions and events, and related disclosures, for the period (revenue, purchases, wages, depreciation expense):

Account balances, and related disclosures, at the period end (receivables, inventory, payables, share capital):

Use "occurrence" for transactions and "existence" for balances. The two most important for designing tests are existence (or occurrence) and completeness, because they decide the direction in which you test:

You cannot find an unrecorded item by testing only what was recorded. That one sentence explains half the procedures in this course.

Sufficient and appropriate evidence

ISA 500 asks for evidence that is both sufficient and appropriate:

• Sufficiency is the quantity of evidence.
• Appropriateness is its quality, which has two parts: relevance (does it address the assertion being tested?) and reliability (can it be trusted?).

The two interact. Better-quality evidence means less is needed, but piling up more poor evidence never makes up for its poor quality. A hundred oral assurances from the sales director are still oral assurances from an interested party.

The quantity needed depends on the auditor's judgement of:

• the assessed risk of material misstatement: the higher the risk, the more evidence;
• the materiality of the item;
• the quality of the evidence available;
• the results of tests of controls: effective controls allow less substantive evidence;
• the size and nature of the population; and
• what was found in previous audits.

Relevance depends on the assertion and on the direction of the test. Selecting balances from the payables ledger and agreeing them to supplier statements is relevant to existence, but not to completeness. Reliability depends on the source and nature of the evidence. ISA 500's general guidance, in our words:

These are generalisations, and they have exceptions. A confirmation from a customer who is related to the directors is external but not independent. A document can be forged. That is why the auditor applies professional scepticism to every piece of evidence.

When the auditor relies on information produced by the entity, such as an aged receivables listing, ISA 500 requires the auditor to check that it is accurate and complete enough for the purpose: for example, by casting it, agreeing its total to the ledger and testing the ageing of a sample of items. If evidence from one source contradicts another, or the auditor doubts a document, the auditor must change or add procedures until the matter is resolved, and consider the effect on the rest of the audit.

The seven types of audit procedure

Every procedure you write is one of these seven, or a combination:

Enquiry is used throughout the audit, but on its own it never provides sufficient appropriate evidence for an assertion. Written representations (lesson E3) are a formal record of enquiries, and the same limit applies to them.

Worked example

Benue Agro Co sells tractors and farm equipment. Its year end is 30 June 20X6. The audit senior has gathered the evidence below. For each item, identify the type of procedure and the main assertion it supports, and comment on its reliability.

Ranking by reliability. Items 3 and 5 (obtained directly by the auditor) and item 1 (external, written, direct) are the strongest, each for its own assertion. Item 6 is supportive but imprecise. Item 4 is weaker because it is a copy from management. Item 2 is the weakest: oral, internal and possibly biased.

The lesson in the ranking. Reliability is always reliability for an assertion. Item 3 is excellent evidence that the tractors exist and no evidence at all that Benue owns them. When you assess evidence in an answer, say what it proves and what it does not.

Common mistakes

• Getting the direction wrong: selecting from the asset register and inspecting the asset tests existence, not completeness. For completeness, start with the physical asset or the source document.
• Writing vague procedures such as "check receivables" or "verify inventory", with no document, no direction and no purpose.
• Treating enquiry, or a written representation, as enough on its own.
• Believing that more evidence makes up for poor-quality evidence.
• Confusing recalculation (checking arithmetic) with reperformance (redoing a control or procedure).
• Using "existence" for a transaction (it is occurrence) or "occurrence" for a balance.

Exam technique

When a requirement asks you to describe substantive procedures, write each one as an instruction a junior could follow: a verb, the item, the source or document, and the purpose. "Select a sample of assets from the non-current asset register and physically inspect them to confirm existence" can be performed; "check assets exist" cannot. Markers reward procedures that are specific to the scenario, so use the names, documents and figures given. In objective test questions on reliability, look first for evidence obtained directly by the auditor or from an independent external source, and be suspicious of oral, internal or copied evidence.

Study with AI

I am studying ACCA Audit and Assurance (AA), assertions and audit evidence under
ISA 500 and ISA 315 (Revised 2019). Give me eight short audit procedures, one at a
time, for receivables, inventory, payables and PPE. For each, ask me which assertion
it tests, which type of procedure it is, and how reliable the evidence is. Wait for
my answer before giving yours, and tell me whether the direction of testing suits
the assertion. Use $ and a fictional company.

AI assistants can misstate the assertions or confuse the direction of testing: check every answer against these notes before you rely on it.

Lecturer's note: Before you write any procedure, ask yourself one question: "Am I worried that this figure is too big, or too small?" If too big, you start from the figure in the records and look for the evidence behind it (existence, occurrence). If too small, you start from the evidence outside the records and look for its entry (completeness). Students who ask that question first rarely get the direction wrong, and the direction is where most marks for procedures are lost.

Key points

• Assertions are management's implicit claims about each figure: occurrence, completeness, accuracy, cut-off, classification and presentation for transactions; existence, rights and obligations, completeness, accuracy valuation and allocation, classification and presentation for balances.
• Audit evidence must be sufficient (enough) and appropriate (relevant and reliable); more evidence never cures poor quality.
• External, auditor-obtained, documentary and original evidence is generally more reliable than internal, indirect, oral or copied evidence.
• Test for overstatement from the records to the evidence, and for understatement (completeness) from the evidence to the records.
• The seven procedures are inspection, observation, external confirmation, recalculation, reperformance, analytical procedures and enquiry; enquiry alone is never enough.

Quick check

1. The auditor selects ten machines from the non-current asset register and physically inspects them. Which assertion does this test, and which does it not test?
2. Which is more reliable evidence of a bank balance: the original bank statement handed over by the client, or a bank confirmation letter received directly from the bank? Why?
3. The auditor selects goods received notes dated in the last two weeks before the year end and traces them to the payables ledger. Which assertions does this test?

Answers

1. It tests existence of property, plant and equipment. It does not test completeness (the direction is from the register to the asset), rights and obligations (the entity may not own them) or valuation.
2. The bank confirmation: it comes from an independent external source directly to the auditor, so the client has had no opportunity to alter it. The statement is still external evidence, but it has passed through the client's hands.
3. Completeness of payables (and of purchases), and cut-off of purchases: the test runs from the source document to the records, so it looks for liabilities that were missed.