Audit evidence

Habari Year 4! Unlocking the Secrets of Audit Evidence

Welcome, future audit champions! Imagine you are a detective, not at a crime scene, but in the boardroom of a major Kenyan company. Your mystery? To figure out if the company's financial story—their financial statements—is true and fair. What's your most important tool? Your magnifying glass? No! It's Audit Evidence. This is the 'proof' you gather to solve the case. Without solid evidence, your audit report is just an opinion, like guessing who will win the Mashemeji Derby. With it, it's a professional, respected conclusion.

In this lesson, we'll dive deep into International Standard on Auditing (ISA) 500, which is all about Audit Evidence. Let's get started!

Kenyan Scenario: Imagine you're auditing a local flower farm in Naivasha that exports roses to Europe. Their financial statements show a huge increase in sales revenue right at the year-end. Is this a genuine boom in business, or are they 'cooking the books' to look good for a bank loan? Your job is to gather the evidence—shipping documents, sales invoices, foreign currency bank statements, and correspondence with European customers—to find out the truth!

What Exactly is Audit Evidence?

According to ISA 500, audit evidence is all the information used by the auditor in arriving at the conclusions on which the auditor's opinion is based. It includes information from accounting records and other sources.

Think of it as two baskets of information:

• Accounting Records: This is the internal stuff. The general ledger, subsidiary ledgers, journal entries, and supporting records like invoices, contracts, and cheques.
• Other Information: This can be anything else! Minutes of meetings, confirmations from third parties (like banks), industry reports, and even conversations with management and staff.

The Two Pillars: Sufficiency and Appropriateness

For your evidence to be convincing, it must have two key qualities. Think of them as the two legs of a strong stool. If one is weak, the whole thing collapses!

1. Sufficiency (The QUANTITY of Evidence)

This simply means: "Have you gathered enough evidence?" There's no magic number. The amount you need depends on:

• The risk of material misstatement: If you are auditing a department in a county government known for procurement scandals, you'll need a mountain of evidence. If you're auditing a small, stable Sacco with strong internal controls, you'll need less. Higher risk = More evidence.
• The quality of the evidence: A single, high-quality piece of evidence (like a direct confirmation from KCB Bank) is worth more than ten low-quality internal documents.

2. Appropriateness (The QUALITY of Evidence)

This is about how good your evidence is. It's broken down into two critical components:

• Relevance: Does the evidence actually prove what you're trying to prove? If you want to confirm a vehicle exists (the existence assertion), you need to physically see it. Looking at its logbook only proves ownership (the rights assertion), not that it hasn't been sold or wrecked.
• Reliability: Can you trust the source of the evidence? There's a clear hierarchy here.

    -- Reliability of Evidence Pyramid --
    
           /\\          <-- Most Reliable
          /  \\
         /____\\        1. Auditor's direct knowledge 
        /      \\          (e.g., Physical observation)
       /________\\      2. External evidence sent directly to you
      /          \\        (e.g., Bank confirmation)
     /____________\\    3. External evidence held by the client
    /              \\      (e.g., Bank statement from their file)
   /________________\\  4. Internal evidence from the client
  /__________________\\    (e.g., Sales invoice)
 /____________________\\   (e.g., Oral evidence from staff) <-- Least Reliable

Testing the Assertions: What Are We Trying to Prove?

We don't just gather evidence randomly. We gather it to test management's financial statement assertions. These are the claims, explicit or otherwise, made by management in the financial statements. Let's break them down using a familiar company, Safaricom PLC.

Assertions about Classes of Transactions (Income Statement items)

• Occurrence: Did the transaction actually happen? Example: Did Safaricom really make that KShs 10 million sale, or is it a fake entry? We check by looking at a signed contract and M-Pesa transaction record.
• Completeness: Are all transactions that should have been recorded, actually recorded? Example: Has Safaricom recorded all its expenses for data centre maintenance, or are some missing, making profits look higher?
• Accuracy: Are the amounts recorded correctly? Example: A foreign currency transaction was converted to KShs using the correct exchange rate.
• Cut-off: Are transactions recorded in the correct financial period? Example: Was an M-Pesa agent commission expense for December 2023 recorded in December, not pushed to January 2024?
• Classification: Is it in the right account? Example: Was the cost of a new software license recorded as an asset (capital expenditure) instead of an expense (operating expenditure)?

Assertions about Account Balances (Balance Sheet items)

• Existence: Do the assets and liabilities actually exist? Example: Do the 5,000 communication masts listed on Safaricom's asset register physically exist? We can't check all, but we can sample and visit some sites.
• Rights and Obligations: Does the company own the assets and owe the liabilities? Example: Does Safaricom own the building for its headquarters, or is it leased? We inspect the title deed or lease agreement.
• Completeness: Are all assets and liabilities included? Example: Is a new loan from a foreign bank properly recorded as a liability?
• Valuation and Allocation: Are they recorded at the correct value? Example: Is the inventory of unsold phones valued at the lower of cost and net realisable value, especially if a new model has made them obsolete?

Image Suggestion: A dynamic image of a diverse group of young Kenyan auditors standing in a modern warehouse filled with boxes labeled 'Kenya Tea'. One auditor is holding a tablet, another is scanning a barcode, and a third is talking to a warehouse manager. The style should be realistic and professional, highlighting teamwork and technology in a local context.

Audit Procedures: How We Gather the Evidence

So, how do you actually get this evidence? You perform audit procedures. A great way to remember them is the mnemonic AEIOU (plus two more!)

• A - Analytical Procedures: Studying relationships in data. This is where we can use some math! For example, comparing the gross profit margin year-on-year. A sudden, unexplained jump could be a red flag.

    --- Gross Profit Margin Calculation ---
    
    Step 1: Get the data for two years.
    
    Year 2023:
    Revenue:      KShs 50,000,000
    Cost of Sales: KShs 30,000,000
    
    Year 2022:
    Revenue:      KShs 45,000,000
    Cost of Sales: KShs 28,000,000
    
    Step 2: Calculate Gross Profit for each year.
    Gross Profit = Revenue - Cost of Sales
    GP 2023 = 50M - 30M = KShs 20,000,000
    GP 2022 = 45M - 28M = KShs 17,000,000
    
    Step 3: Calculate Gross Profit Margin.
    GP Margin = (Gross Profit / Revenue) * 100
    GP Margin 2023 = (20M / 50M) * 100 = 40%
    GP Margin 2022 = (17M / 45M) * 100 = 37.8%
    
    Step 4: Analyse the result.
    The margin increased from 37.8% to 40%. Why?
    Is it due to better pricing? Lower costs? Or a potential overstatement of revenue or understatement of costs? This calculation doesn't give the answer, but it tells us exactly where to look for more evidence!

• E - Enquiry: Asking questions of knowledgeable people inside and outside the company. It's more than just a chat; it's a formal process of seeking information.
• I - Inspection: Examining records, documents, or tangible assets. This is the classic "show me the papers" part of auditing.
• O - Observation: Looking at a process or procedure being performed by others. The best example is observing the client's staff as they conduct the year-end inventory count. You watch to see if they are following their own procedures.
• U - Recalc-U-lation & Reperformance:
  • Recalculation: Checking the mathematical accuracy of documents. (e.g., Recalculating the depreciation charge for a delivery truck).
  • Reperformance: Independently executing procedures or controls that were originally performed by the client. (e.g., Re-performing a bank reconciliation to see if you get the same result).
• Confirmation: This is a big one! It's obtaining evidence directly from a third party in written form. For example, sending a letter to the company's bank to confirm their loan balances and bank account balances. This is highly reliable evidence because it doesn't pass through the client's hands.

Image Suggestion: An overhead shot of an auditor's desk in a Nairobi office. On the desk is a laptop showing a spreadsheet, a printed financial report with highlighted figures, a calculator, a cup of Kenyan coffee, and a formal letter with the logo of a major Kenyan bank (like Equity or KCB), representing a bank confirmation.

Conclusion: Evidence is Everything

As you can see, audit evidence is the foundation upon which your entire audit opinion rests. It’s a systematic process of asking the right questions (assertions) and using the right tools (procedures) to get reliable answers. Your ability to gather and evaluate sufficient and appropriate evidence is what will make you a sharp, effective, and respected auditor.

Keep asking 'why?' and 'how do I know this is true?' and you'll be well on your way. You've got this! Now, let's prepare to put this knowledge into practice.