Evidence generated by auditors is considered one of the most reliable forms of audit evidence, as it results from procedures directly performed by the auditor rather than relying on information provided by the entity. This type of evidence is crucial in supporting the auditor’s opinion on the financial statements and helps reduce the risk of material misstatement. The International Standard on Auditing (ISA) 500, “Audit Evidence,” emphasizes the importance of obtaining sufficient and appropriate audit evidence, highlighting the reliability of evidence generated through independent auditor procedures. This article explores the different types of evidence generated by auditors, their significance in the audit process, and how they contribute to the overall audit quality.
1. Understanding Evidence Generated by Auditors
Evidence generated by auditors refers to information obtained through direct auditor actions, such as recalculations, reperformance, observations, and physical inspections. This type of evidence is typically more reliable because it is obtained independently of the entity’s internal processes and controls.
A. Definition of Auditor-Generated Evidence
- Direct Evidence from Auditor Procedures: Auditor-generated evidence results from procedures directly performed by the auditor, such as recalculations, observations, and inspections.
- Independence and Objectivity: Because this evidence is created independently of the entity’s influence, it is generally more objective and reliable.
B. Importance of Auditor-Generated Evidence
- High Reliability: Auditor-generated evidence is among the most reliable types of audit evidence, providing strong support for the auditor’s conclusions.
- Reducing Audit Risk: By independently verifying key financial information, auditor-generated evidence helps reduce the risk of undetected material misstatements.
2. Types of Evidence Generated by Auditors
Auditors use various techniques to generate their own evidence during the audit process. These techniques include recalculations, reperformance, observations, and physical inspections.
A. Recalculation
- Definition: Recalculation involves the auditor independently verifying the mathematical accuracy of documents or records.
- Purpose: To confirm the accuracy of financial figures and calculations reported in the financial statements.
- Examples:
- Recalculating depreciation expenses to ensure they are computed correctly according to the entity’s accounting policies.
- Verifying the accuracy of tax computations by recalculating tax liabilities based on the applicable tax rates.
B. Reperformance
- Definition: Reperformance involves the auditor independently executing procedures or controls originally performed by the entity.
- Purpose: To verify that internal controls are operating effectively and that transactions are processed accurately.
- Examples:
- Reperforming a bank reconciliation to verify the entity’s cash balances.
- Reperforming inventory counts to ensure the accuracy of physical inventory records.
C. Observation
- Definition: Observation involves the auditor watching processes or procedures being performed by the entity’s personnel.
- Purpose: To verify that procedures, such as internal controls, are being followed correctly and consistently.
- Examples:
- Observing the inventory count process to ensure it is conducted in accordance with the entity’s policies.
- Observing the segregation of duties in cash handling to verify that controls are in place to prevent fraud.
D. Physical Inspection
- Definition: Physical inspection involves the auditor examining tangible assets to verify their existence and condition.
- Purpose: To confirm the existence and valuation of physical assets reported in the financial statements.
- Examples:
- Inspecting fixed assets, such as machinery or buildings, to verify their existence and assess their condition.
- Examining inventory in warehouses to confirm quantities and identify potential obsolescence.
3. Significance of Auditor-Generated Evidence in the Audit Process
Evidence generated by auditors plays a vital role in ensuring the accuracy and reliability of financial reporting. This type of evidence enhances the auditor’s ability to form well-supported conclusions and reduces reliance on management-provided information.
A. Enhancing Audit Quality and Reliability
- Direct Verification: Auditor-generated evidence provides direct verification of financial data, reducing reliance on potentially biased information from management.
- High Reliability: Because this evidence is independently created, it is less susceptible to manipulation and provides a strong foundation for audit conclusions.
B. Addressing High-Risk Areas
- Application in High-Risk Areas: Auditor-generated evidence is particularly important in high-risk areas, such as revenue recognition or asset valuation, where the risk of material misstatement is greater.
- Example: In cases where management estimates are subjective or prone to bias, auditors may perform independent calculations to verify the accuracy of those estimates.
C. Reducing Audit Risk and Increasing Assurance
- Minimizing Detection Risk: By generating their own evidence, auditors reduce detection risk, the risk that material misstatements will go undetected.
- Providing Strong Support for Audit Opinions: High-quality, auditor-generated evidence provides a solid basis for issuing audit opinions, enhancing the credibility of the financial statements.
4. Examples of Auditor-Generated Evidence in Practice
The following examples illustrate how auditors generate their own evidence in various audit scenarios, enhancing the reliability and sufficiency of audit conclusions.
A. Recalculating Depreciation Expenses
- Scenario: The auditor recalculates the depreciation expense for fixed assets to ensure that it aligns with the entity’s accounting policies and useful life estimates.
- Outcome: By performing independent calculations, the auditor verifies the accuracy of depreciation expenses reported in the financial statements.
B. Reperforming Bank Reconciliations
- Scenario: The auditor re-performs the bank reconciliation process to verify the accuracy of cash balances reported in the entity’s financial statements.
- Outcome: The auditor identifies any discrepancies between the bank statements and the entity’s records, ensuring the accuracy of reported cash balances.
C. Observing Inventory Counts
- Scenario: The auditor observes the physical inventory count conducted by the entity’s staff to ensure that it is performed according to established procedures.
- Outcome: The auditor confirms the existence and condition of inventory, reducing the risk of misstatement in the financial statements.
D. Physically Inspecting Fixed Assets
- Scenario: The auditor conducts a physical inspection of fixed assets, such as machinery or vehicles, to verify their existence and assess their condition.
- Outcome: The auditor ensures that the assets reported in the financial statements exist and are accurately valued.
5. Limitations and Challenges of Auditor-Generated Evidence
While evidence generated by auditors is highly reliable, it is not without limitations. Auditors must be aware of the potential challenges and address them appropriately during the audit process.
A. Resource and Time Constraints
- Time-Intensive Procedures: Generating evidence through procedures like recalculations or physical inspections can be time-consuming and resource-intensive.
- Balancing Efficiency and Thoroughness: Auditors must balance the need for thorough evidence with practical considerations of time and budget constraints.
B. Scope Limitations
- Limited Scope of Certain Procedures: Some auditor-generated evidence, such as observations, may only provide information about the specific time and place of the observation, limiting its applicability to the broader audit.
- Example: Observing an inventory count on a specific date may not provide evidence about the accuracy of inventory management throughout the year.
C. Need for Corroborative Evidence
- Supplementing with Additional Evidence: While auditor-generated evidence is highly reliable, it often needs to be corroborated with other forms of evidence, such as external confirmations or documentary records.
- Example: Recalculating interest expense may need to be supported by reviewing loan agreements to verify the applicable interest rates.
6. Documentation Requirements for Auditor-Generated Evidence
Proper documentation of auditor-generated evidence is essential for demonstrating the procedures performed and supporting the audit conclusions in compliance with professional standards.
A. Documenting Procedures and Results
- Details of Procedures Performed: Auditors should document the specific procedures they performed, such as recalculations, inspections, or observations.
- Results of Procedures: The auditor must record the outcomes of the procedures, including any discrepancies identified and how they were resolved.
- Example: Documenting the steps taken to recalculate depreciation expenses and recording any adjustments made to align with accounting policies.
B. Linking Evidence to Financial Statement Assertions
- Connecting Evidence to Assertions: Auditors should clearly link the evidence generated to the specific financial statement assertions it supports, such as existence, completeness, or valuation.
- Example: Documenting how a physical inspection of inventory supports the existence assertion for reported inventory balances.
The Critical Role of Auditor-Generated Evidence in the Audit Process
Evidence generated by auditors is a cornerstone of the audit process, providing highly reliable, independent verification of financial information. Techniques such as recalculations, reperformance, observations, and physical inspections allow auditors to directly confirm the accuracy and completeness of financial statements. While auditor-generated evidence is among the most reliable, it often needs to be supplemented with corroborative evidence from external sources or internal documentation. By thoroughly documenting the procedures and linking the evidence to financial statement assertions, auditors ensure that their conclusions are well-supported and credible, contributing to the overall integrity of the audit process and enhancing stakeholder confidence in the financial statements.