Question

You have reviewed the work performed by your assistant, Raymond Snow, on the audit of Tin Ltd for the year ended 30 June 2008 and have noted the following two independent matters:

1.       In testing investments in listed securities, Raymond selected all shareholdings with a market value above $200,000 and checked them to the closing market value reported by the Australian Stock Exchange to determine the net realisable value of each shareholding. The items tested totalled $5,500,000 or 60% of the total balance. Of the items tested, only one error of $110,000 was discovered. Raymond concluded that the error was not itself material, as it was only 2% of the balance tested. He extrapolated this error to the total population and estimated that the error for the total population would be $185,000, which was also immaterial. Therefore, he concluded that the investments in listed securities were fairly stated at the lower of cost or net realisable value.

2.     Tin Ltd has 1,000 stock lines that are maintained on a perpetual inventory system. Stock is counted on a cyclical basis so that all lines are covered at least once per year. Raymond attended the March stocktake to observe the counting procedures and conducted 20 test counts from the floor to the client’s count sheets and 20 from the client’s count sheets to the floor. He uncovered two minor discrepancies of one item each, which he considered to be immaterial. The client also uncovered five minor discrepancies between the perpetual records and the actual quantity on hand. None of these discrepancies were adjusted on the perpetual records, as the amounts involved only totalled $50,000 and were considered to be immaterial. Raymond concluded that no further work was considered necessary on stock quantities at year end.

b)         Explain whether sufficient appropriate audit evidence has been obtained for each of the above situations. Give reasons for your answer.

Answer 1

Basics of Audit Evidence:-

Audit Evidence:-

Auditor expresses his opinion (whether the financial statements of an entity are giving a true and fair view or not) on the basis of audit evidence collected by him.

An auditor applies various audit procedure to obtain audit evidence which enables him to form an opinion whether the financial statements of an entity are free from material misstatement and state a true and fair view or not.

Audit Evidence is the information that the auditor uses in arriving at a conclusion on the basis of which he forms his opinion.

Suficiency of Audit Opinion:

The auditor should obtain sufficient and appropriate evidence which enables the auditor to arrive at a conclusion and supports his opinion. Audit evidence forms the basis for forming an opinion whether the financial statements of an entity state true and fair view or not.

Evidence collected by the auditor should support the contents of its audit report. Sufficiency of audit evidence is the measure of the quantity of audit evidence. Appropriateness of evidence is the quality of the evidence, i.e., its relevance and reliability to support the auditor’s opinion.

Audit evidence includes information provided in books of accounts as well as information from other sources. For Example – Purchase invoice and material received note prepared by the store’s department are evidence to support the purchase.

Essentials of good audit evidence:-

1. Sufficient: Sufficiency is the measure of quantity. Audit evidence is sufficient when they are available in adequate quantity. An auditor applies different audit procedures to obtain sufficient audit evidence like test checking.
2. Reliable: Evidence obtained by the auditor is persuasive rather than conclusive. We cannot consider such evidence 100% reliable for forming an opinion. Reliability of audit evidence depends on its source and nature of such evidence.
3. Source: Audit evidence obtained within the enterprise is known as the internal source. Evidence obtained from an outside enterprise like confirmation from the third party is known as the external source. We consider the external source to be more reliable.
4. Nature: Can be documentary (like bills, vouchers), visual (like the physical verification of fixed assets), or oral (confirmation from employees)
5. Relevant: Whether the audit evidence obtained by the auditor is relevant or not depends on the purpose of audit procedures.

There are some thumb rules which helps in identifying the appropriateness of evidence

1. Written (documentary) evidence is better than testimonial evidence.
2. Evidence from external sources is more reliable.
3. Original documents are preferable over their photocopies.
4. The auditor should have a good understanding of internal control of the organization as it enables him to obtain relevant evidence.
5. Evidence obtained by auditor through direct observation, inspection, physical verification, and computations are better than the evidence obtained indirectly.

(i) Audit of Investments:

Raymond performend te audit of Value of $55,00,000 only or 60% of the total popultation which is not sufficient in nature.As Investestments in Listed securities is highly risky item and 100% of the audit population should be examined in details. Also, there is an error of $110000 even though the error is of 2% only but any error in risk items should be evaluated in details. Raymon checked only 60% and extrapolated this error to the total population and estimated that the error for the total population would be $185,000, which was also immaterial. Such conclusions re not sufficient and appropriate in nature. Hence we can conclude that sufficient appropriate audit evidence has not been obtained in this case.

(ii) Audit of Inventories:

Raymond attended March counting and did the check of 20 test counts from the floor to the client’s count sheets and 20 from the client’s count sheets to the floor. Raymond physically verified the inventories which is a suffient audit evedence. Error of $50000 is imaterial in nature. Company follows perpetual inventory system i.e it is recoded in real time basis that means the degree of error is very less in nature. As the degree of error is very low the sampling can be low. So, the conclusion drwan by Raymond that the ear end quantities is appropiate. Hence, we can conclude that sufficient appropriate audit evidence has been obtained in this case.