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audit_evidence

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audit_evidence

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     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     TRAINING MATERIAL AUDIT EVIDENCE INTRODUCTION Audit evidence refers to the testimonial materials that the audit institution and its auditors have obtained for the purpose of explaining the truth of audit items and forming the basis for audit conclusions. Audit itself is the process of collecting, certifying and analyzing audit evidence and judge the nature of audit items according to such evidence. The audit program is the arrangement necessary for the collection of audit evidence; the conduct of audit is the process of obtaining audit evidence; the preparation of the audit report, the production of the audit opinion and the making of audit decisions are the utilization of audit evidence. Therefore, the collection, certification and analysis of such evidence are the essence and key of the overall process of audit.

     CLASSIFICATION OF AUDIT EVIDENCE Due to their different testimonial force, different types of audit evidence are collected by different methods. The study of the classification of audit evidence will help auditors adopt reasonable methods for evidence collection so as to obtain reliable, relevant, lawful and sufficient audit evidence. Such evidence can be classified according to its form, source and degree of completeness. Audit evidence classified according to form According to form, audit evidence can be classified into physical evidence, documentary evidence, audio and video evidence, oral evidence, and evidence by authentication. ? Physical evidence Physical evidence refers to audit evidence that exists in the form of physical articles capable of testifying audit items. It usually refers to evidence that is obtained through on-spot observation by auditors or monitoring of physical checking of assets (such as stocktaking) by entity staff. This class of evidence serves to prove the existence of physical assets. Such physical articles include fixed assets, inventory, stocks and stores. It can also be obtained in situations where it is necessary to verify the physical existence of assets such as negotiable bonds, promissory notes and cash on hand. Physical evidence is a powerful proof SECTION 10 Page 1 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     of the audit items. While collecting such evidence, auditors should pay attention to its quantity and quality and to indications of ownership by the audited entity. ? Documentary evidence Documentary evidence refers to audit evidence that exists in the form of documents capable

    of testifying to audit items, including vouchers, accounts, books, statements and other accounting information of the audited body, correspondence in the course of confirmation done by auditors and written documents produced by entity personnel. Documentary evidence is a major component of audit evidence characterized by large quantity and variety of sources. Therefore, auditors need to identify whether it is true or false in the collection process. ? Audio-video evidence Audio-video evidence refers to audit evidence that exists in the form of tape recordings, video tapes and computer discs capable of testifying to existence and value of audit items. For example, records of talks given by interest parties related to the audit items, and on-spot video records of economic transactions. Such evidence is a powerful proof of the audit items. ? Oral (verbal) evidence This refers to responses of the audited body or individuals related to the audit items to questions put forward by auditors. In general, verbal evidence itself is not adequate for proof of the audit items. However, such evidence can provide traces for testimonial audit evidence with support rendered by other types of evidence. ? Authentication evidence Authentication evidence refers to audit evidence formed through certification of certain specialized issues by experts in the concerned fields who are appointed or invited by the audit institution as is specially required by the audit. For instance, experts authenticate handwritings on vouchers and identify whether checks are fake. Their conclusions reported to the audit team become audit evidence.

     SECTION 10 Page 2 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     QUALITATIVE FEATURES OF AUDIT EVIDENCE Audit evidence is the basis for audit conclusions. Therefore, the support of sufficient and strong audit evidence is essential for drawing correct audit conclusions. In general, audit evidence has the following qualitative features. ? Reliability Reliability of audit evidence refers to the extent to which audit evidence reflects the facts about audit items. The more objective the audit evidence is in reflecting audit items, the more reliable it is and the stronger its testimonial force. Reliability of audit evidence is influenced by its sources. In general, documentary evidence is more reliable than verbal evidence obtained through interview; external evidence is more reliable than internal evidence; evidence collected by auditors is more reliable than that provided by the audited body; audit evidence coming from different sources capable of mutual confirmation is more reliable than that obtained through a single channel. ? Relevance Relevance of audit evidence refers to the interrelations between audit evidence, audit objectives and audit items. Only when closely related to objectives and items of audit can audit

    evidence possess sufficient testimonial force. The more interrelated, the stronger the testimonial force and vice versa. Information with no relation to audit objectives or items can not be regarded as audit evidence. For instance, the results of inventory stocktaking can only be used to prove the existence of inventory and indicate whether there are defects or shortage of items. They can be used neither to prove the ownership and pricing of inventory nor to testify audit items other than inventory. While obtaining audit evidence, auditors should mainly consider the following relevant items: o whether assets or liabilities exist on a certain date; o whether assets or liabilities belong to the audited body on a certain date; o whether economic transactions already taken place are related to the audited body; o whether there are assets, liabilities or other transaction items that are not posted to accounts; o whether amounts recorded in accounts are correct; o whether assets or liabilities are correctly priced; SECTION 10 Page 3 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     o whether the proportion of incomes to expenses is appropriately set; o whether subsidiary disclosure of accounting items is correct and consistent. ? Lawfulness Lawfulness of audit evidence refers to the binding force possessed by audit evidence, which requires that auditors obtain audit evidence through lawful procedures and approaches. For instance, while doing interviews, auditors should take written notes simultaneously and request the interviewee to sign the records. For another instance, while collecting important audit evidence, auditors should ask the evidence provider to sign or stamp the photocopies, facsimile reprint, handwritten copies or print out copies. ? Sufficiency Sufficiency of audit evidence means that the amount of audit evidence collected by auditors is sufficient enough to support their audit conclusions. Therefore, it is the minimum quantitative requirement on audit evidence for auditors to form audit opinions. Objective and fair audit opinions must be based on sufficient audit evidence. However, this does not mean that the more audit evidence collected, the better the results. The principle of costs and benefits should be applied. Auditors should not only establish their audit opinions on a reliable basis but wherever possible reduce the required amount of audit evidence to the minimum. The actual amount of audit evidence required by an audit assignment depends on the actual situation of the assignment. Where auditors cannot obtain the most ideal audit evidence due to constraints of time, space or cost, they can consider replacing it with other types of audit evidence. Only when auditors can obtain evidence that is sufficient to the assignment can they draw audit conclusions accordingly.

     METHODS FOR COLLECTING AUDIT EVIDENCE The methods for collecting

    audit evidence vary according to the types of evidence to be collected. In general, such methods include documentary review, observation, inquiry and confirmation, computation, analytical review and stocktaking.

     Documentary review SECTION 10 Page 4 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     Documentary review is a method of collecting audit evidence through review and consultation of written information. This method can be used for examination of historical transaction vouchers, accounting vouchers, books of account, statements, budgets, contracts and plans. ? Historical vouchers are reviewed in order to determine whether contents reflected by the vouchers comply with relevant stipulations and whether the title, timing, numbering and handling procedure of transactions are complete. ? Accounting vouchers are reviewed to determine whether extracts, amounts and accounting treatments are correct, whether they are consistent with historical vouchers, and whether requisite procedures are complete. ? ? Auditors review books of account in order to determine whether economic transactions reflected in journals, subsidiaries and reference books are normal. Review of statements is done for the purpose of determine whether their preparation, formats and contents comply with financial systems and accounting policies. ? Auditors review forecasts, plans, programs, contracts and other written materials in order to determine whether their sources are reliable, whether their data computation is correct and whether their business items are lawful. Analytical review Analytical review is an audit method that breaks down components of the audit items to find out the nature of these elements and their interrelationship. Such analytical review serves the following three purposes: ? ? ? To analyze and review the components of audit items and their interrelationship; To analyze and review elements influencing audit items; To analyze and review debit/credit amounts and balances.

     Inquiry Inquiry refers to the audit method used to investigate into and inquire about internal and external aspects of the audited body in order to understand the concerned audit items. Usually inquiries are made only when other audit methods such as documentary review, verification and re-computation are inadequate for understanding the truth of relevant facts. Written records should be made about the results of inquiry with the inquired signing or stamping such records. Re-computation SECTION 10 Page 5 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     Re-computation is an audit method used to recalculate data reflected in accounting information. It is mainly used for the following

    purposes: ? ? ? ? To review the product of unit price and quantity, subtotals and totals in historical vouchers; To review totals of subsidiary items recorded in accounting vouchers; To review the subtotals, totals, balances and brought-forward amounts of various items on each page in books of account; To review forecasted, budgeted or planned data.

     Verification Verification is an audit method used to review whether consistency exists between accounting documents, between accounting and other documents. In other words, auditors should verify voucher with voucher, voucher with account, account with account, statement with statement, and accounting documents with other documents. ? Voucher-to-voucher verification refers to verification of historical vouchers with accounting vouchers and of individual accounting vouchers with consolidated accounting vouchers focusing on the consistency of dates, contents, quantity and amounts. ? Voucher-to-account verification refers to the verification of historical vouchers and accounting vouchers with relevant books of account focusing on the consistency of dates, contents, quantity and amounts and the consistency of amounts on brought-forward pages and carried-forward pages. ? Account-to-account verification refers to the verification of subsidiary accounts with general ledgers focusing on the consistency among beginning balances, current-period amounts and year-end balance. ? Account-to-statement verification refers to the verification of subsidiary accounts and general ledgers with financial statements focusing on the consistency of posting time, accounting items and amounts posted. ? Statement-to-statement verification refers to the verification of subsidiary statements with other relevant statements focusing on the consistency of contents, time and amounts. ? Verification of accounting information with other information mainly examines whether contents of accounting information can be confirmed by other information SECTION 10 Page 6 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     Confirmation With confirmation, auditors obtain audit evidence by seeking confirmation of entity relationships and items with relevant external organizations. This method is usually used for confirming transaction amounts and balances such as bank accounts and debts. Confirmation can be both positive and negative. Positive confirmations require the recipient to respond whether the information available to the auditor conforms with records of the external organization. Though complex in procedure, such confirmation is capable of obtaining written evidence and is therefore adopted for most transactions that are of larger amounts. For negative confirmations, the recipient only responds when it finds that the items under confirmation do not conform to facts;

    otherwise, there is no need to respond. If no response is received after the deadline, auditors can regard that items under confirmation conform to relevant facts. Negative confirmation is not as reliable as positive confirmation. When the positive method is adopted, auditors should require the recipient to send the response directly to them. Monitoring stocktaking Stocktaking is a method to confirm the existence of cash, negotiable securities, inventories and fixed assets. There are two kinds of stocktaking: direct stocktaking and monitoring stocktaking. During direct stocktaking, relevant individuals participate in the stocktaking of physical articles to confirm that written records are in accordance with relevant assets. When monitoring stocktaking, auditors do not participate in the stocktaking of properties or physical assets but monitor the process of stocktaking by entity staff. Monitoring stocktaking is applicable to materials, work-in-progress, finished products and fixed assets.

     ANALYSIS AND UTILIZATION OF AUDIT EVIDENCE Information collected in the process of audit only has the potential to become audit evidence. To transform the potential audit evidence into actual audit evidence with testimonial force, auditors need to analyze and sort out such information. Such analysis and sorting out work consists of two parts: analysis of audit evidence and utilization of audit evidence. Analysis of audit evidence

     SECTION 10 Page 7 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     Analysis of audit evidence refers to the review of the relevance, reliability, lawfulness and sufficiency of audit evidence in order to screen the information collected in the course of audit and select evidentiary materials capable of providing support for the existence and value of audit items and accounts. Analysis of relevance For a great amount of information collected in the course of audit, its relevance and interrelationship to the audit items is of great significance. Therefore, auditors should analyze such information, exclude information that has no or little relation with the audit items and take up the evidence that is of relevance to the audit items. Analysis of reliability Reliability of audit evidence is influenced by many elements, among which potential manipulation and impact of interested parties are the most important. The lower is the extent of such manipulation and impact, the smaller is the possibility of information being falsified and altered, and the higher is the degree of confidence, and vice versa. In general, information produced by a sound and effective internal control system is more reliable than that produced by an unsound or ineffective internal control system; business vouchers generated in the course of economic activities are more reliable than information

    that is obtained separately; information obtained outside the audited body is more reliable than that obtained inside the audited body. Auditors should analyze the reliability of audit information, exclude the non-truthful elements and base their audit conclusions on reliable audit evidence. Analysis of significance Whether and to what extent audit evidence can testify the audit items depends on the contents, nature of problems and amounts disclosed by such evidence. In other words, auditors need to analyze and evaluate the significance of audit evidence to the audit items. The greater the significance/the more serious the problems/the larger the amounts as reflected by the evidence, the more capable the evidence is of testifying the audit items. However, while analyzing and evaluating the importance of audit evidence, auditors should pay attention to those errors that appear to be of an ordinary nature but actually are of a serious nature. Analysis of lawfulness The collection of audit evidence should follow audit laws and regulations, audit procedures and relevant formalities. Analysis of the lawfulness of audit evidence SECTION 10 Page 8 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     refers to the review and assessment of whether evidence is obtained in accordance with stipulated procedures and formalities. The audit team leader should review audit evidence collected in the course of audit and hand over such evidence to the responsible persons or internal organizations of the audited body to sign or stamp. Where the audited body or the relevant individuals refuse to do so, auditors should note the reasons for and date of such refusal on the audit evidence or on materials attached to the evidence, the process of which should be examined and analyzed by the audit team leader with signature or stamp provided for relevant documents. Analysis of sufficiency Sufficiency of audit evidence refers to the extent the audit evidence can prove the audit items. It is a quantitative requirement on audit evidence, i.e., the amount of evidence requisite for testifying the audit items. Auditors need sufficient audit evidence to draw their audit conclusions. Therefore, in addition to analyzing other features of the audit evidence, the audit team leader should also pay attention to the quantity of evidence judging whether the evidence is sufficient to prove the audit items. If audit evidence is found to be insufficient, the team leader should organize the auditors to collect additional information.

     SORTING OUT AND UTILIZATION OF AUDIT EVIDENCE Audit evidence collected and analyzed in a piecemeal manner is of considerable testimonial force if taken separately. However, the integrated effect might not be so satisfying. Therefore, it is necessary for auditors to classify, sum up and sort out audit evidence. After the conclusion of audit field work, auditors should hand their audit evidence over

    to the team leader for summary and preparation of the list of testimonial materials. The team leader should sign or stamp the completed documents. A list of testimonial materials should be included in the audit working papers together with the attached audit evidence for uniform usage and management. The audit team leader should classify, summarize and sort out such evidence according to the audit items and nature of disclosed problems in order to find out the interrelations among different items of audit evidence and to improve the testimonial force of the evidence. At this stage, auditors should carry out supplementary audit work if the audit evidence is found to be insufficient in quantity or inadequate in quality. SECTION 10 Page 9 of 10

     2001 NOVEMBER

     KPMG ?C BARENTS GROUP LLC ADB CNAO AUDIT STANDARDS PROJECT

     After the classification, summarization and sorting out of audit evidence, auditors should integrate and consolidate the evidence so as to draw audit conclusions on individual audit items and their integration. In this process, auditors must discard conflicting/false evidence or evidence that is not interrelated. Because individual items of audit evidence may not be sufficient for auditors to form conclusions on an entire group of audit items, auditors must consolidate all evidence into an organic whole to support the audit conclusions. This important process lays down a solid foundation for auditors to improve their understanding of audit items from an individual to a comprehensive perspective and from surface to nature, draw appropriate audit conclusion in a gradual manner, prepare the audit report, produce the audit opinion and make audit decisions.

     SECTION 10 Page 10 of 10

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