Welcome to the Core of Auditing: Audit Evidence!
Hello there! Welcome to one of the most important chapters in your HKICPA QP journey. Think of an auditor as a detective. A detective cannot just "guess" who committed a crime; they need fingerprints, DNA, and witness statements. In the same way, an auditor cannot just "guess" that the financial statements are correct. We need Audit Evidence.
In this chapter, we will explore what counts as "good" evidence and the different tools you have in your auditor’s toolkit to collect it. Don't worry if this seems like a lot of technical rules at first—once you see the logic behind it, it will become second nature!
1. The Golden Rule: Sufficient and Appropriate
The standard HKSA 500 Audit Evidence tells us that auditors must obtain Sufficient Appropriate Audit Evidence (SAAE) to support their opinion. Let's break that down into two simple parts:
A. Sufficiency = The Quantity
This is about how much evidence you have. If a company has 1,000 bank accounts, checking just one isn't enough. The quantity needed depends on the risk of material misstatement.
Analogy: If you are trying to prove it's raining outside, seeing one drop on a window might not be enough. Seeing hundreds of drops and people holding umbrellas is much more sufficient.
B. Appropriateness = The Quality
Quality is split into two further categories: Relevance and Reliability.
• Relevance: Does the evidence actually prove what you are looking for? If you want to check if a car exists, looking at the insurance document is okay, but physically seeing the car is much more relevant.
• Reliability: Can you trust the evidence? Evidence is generally more reliable when it is:
- Obtained from independent external sources (e.g., a bank statement from the bank is better than a spreadsheet made by the client).
- Generated under effective internal controls.
- Obtained directly by the auditor (e.g., seeing it yourself rather than being told about it).
- In documentary form (written/electronic) rather than oral.
- Original documents rather than photocopies.
Quick Review:
Sufficient = Quantity (Numbers)
Appropriate = Quality (Relevance & Reliability)
2. Financial Statement Assertions: What is Management "Claiming"?
When management gives you a set of accounts, they are making "assertions" (claims). As an auditor, you use audit evidence to test these claims. We usually group these into two categories:
Claims about Transactions (Income Statement items)
• Occurrence: Did the sale actually happen?
• Completeness: Are all sales recorded, or are some missing?
• Accuracy: Is the math correct?
• Cut-off: Is the sale recorded in the right year?
• Classification: Is it in the right account (e.g., is it "Sales" or "Other Income")?
Claims about Balances (Balance Sheet items)
• Existence: Does the building actually exist?
• Rights and Obligations: Does the company actually own the building?
• Completeness: Are all debts included?
• Valuation and Allocation: Is the asset recorded at the right value (e.g., after depreciation)?
Common Mistake to Avoid: Confusing Existence and Completeness.
- Existence is checking if what is in the books is real (testing for "overstatement").
- Completeness is checking if everything real is in the books (testing for "understatement").
3. Your Audit Toolkit: The AEIOU Mnemonic
How do we actually get this evidence? We use these procedures. A great way to remember them is the AEIOU mnemonic:
A - Analytical Procedures: Looking at ratios and trends. If sales went up 50% but the industry is in a recession, that’s a red flag!
E - Enquiry: Asking questions of management or staff. (Note: Enquiry alone is never enough evidence!)
I - Inspection: Physically looking at an asset (like a machine) or examining documents (like a contract).
O - Observation: Watching a process being performed by others (e.g., watching the client's staff count inventory).
U - Re-calcUlation / Re-performance: Checking the client's math (Recalculation) or independently doing a process the client did to see if you get the same result (Re-performance).
Plus two more:
• External Confirmation: Writing to a third party (like a bank or a customer) to confirm a balance. This is very high-quality evidence!
Example: If you want to check if a client's "Cash at Bank" is correct, you would use External Confirmation (sending a letter to the bank) and Recalculation (checking the bank reconciliation math).
4. Specific Situations (HKSA 501 & 505)
Sometimes, generic procedures aren't enough. The curriculum highlights a few special areas:
Inventory Count (HKSA 501)
If inventory is material, the auditor must attend the physical inventory counting unless it is impracticable.
What do you do there?
1. Evaluate management’s instructions for the count.
2. Observe the performance of the count.
3. Inspect the inventory (Check condition - is it broken?).
4. Perform test counts (Audit staff counts a few items to see if they match the client's records).
External Confirmations (HKSA 505)
This is when you ask a third party to "confirm" information. There are two types:
1. Positive Confirmation: The third party must reply whether they agree or disagree with the balance. This is stronger evidence.
2. Negative Confirmation: The third party only replies if they disagree. This is weaker because if they don't reply, you don't know if they agree or if the letter just got lost in the mail!
Did you know? Auditors must maintain control over the confirmation process. You should never let the client mail the letters for you, or they might "adjust" the results!
5. Using the Work of Others
Sometimes, an auditor isn't an expert in everything. You might need to hire an Auditor’s Expert (like a jewelry appraiser or a property valuer).
If you use an expert, you must evaluate:
- Their Competence (Are they qualified?)
- Their Capabilities (Do they have the resources?)
- Their Objectivity (Are they independent of the client?)
Summary & Key Takeaways
• Audit evidence must be Sufficient (quantity) and Appropriate (relevance and reliability).
• Evidence from outside the company is usually more reliable than evidence from inside.
• Use the AEIOU mnemonic to remember your procedures: Analytical, Enquiry, Inspection, Observation, and Recalculation/Re-performance.
• For Inventory, you physically go and watch the count.
• For Confirmations, the auditor must keep control of the letters to ensure the client doesn't interfere.
Don't worry if this seems like a lot to memorize. Just keep asking yourself: "If I were a judge, would this piece of paper convince me that the accounts are true?" If the answer is yes, you've found good audit evidence!