Audit evidence is necessary to support your audit opinion and lack of evidence raises questions regarding the reliability of the audit report. Audit evidence is a piece of information that an auditor uses to support their conclusion of an item of the financial statements or the audit opinion as a whole.
The seemingly straightforward procedure of obtaining audit evidence has a lot of complications that you need to understand. ie; what makes evidence good enough to be considered as reliable audit evidence? What makes audit evidence unreliable or worthless? To answer these and a lot of other questions regarding the hierarchy of audit evidence, let me first explain how the audit evidence is obtained.
How Audit Evidence is Obtained?
Primarily, audit evidence is obtained by performing substantive audit procedures and tests of controls. However, it can also be obtained from the client’s internal control system. That means, auditors either perform thorough substantive procedures, perform tests on the client’s control system or take the data from the client’s internal systems to use it as proof to justify their opinion.
The Red color of substantive procedures indicates the factor that it is the most reliable source of obtaining audit evidence as the auditors perform thorough procedures without relying on the client’s system or any other external factor. Then comes tests of controls; yet another reliable source to obtain audit evidence but is lesser reliable than substantive audit procedures.
Data taken from the client’s system depends on the reliability of the system itself. If the client’s internal controls are found to be strong in the assessment phase, the auditor may choose to rely on the controls but the evidence obtained from the system would still be considered less reliable than substantive audit procedures and tests of controls.
The above was just a rough overview of how evidence is obtained in an audit and how reliable each procedure is. Now let me outline some sources from which audit evidence is obtained. They are:
- External organizations like the client’s bank or insurance providers
- Employees at the client explaining a control system
- Results of the inventory counts of the client
- Observing the live inventory counts
- Placing a sale to test whether the client’s system records it appropriately
- Monitoring the client’s credit control system
- etc etc…
In the above, can you identify reliable sources? Let’s first discuss the criteria for the reliability of audit evidence and then move on to identifying the reliable ones. Primarily, the audit evidence is categorized into THREE different types.
Hierarchy of Audit Evidence
- Weak
- Good
- Best
Weak evidence comes from informally inquiring about the client, inspecting internal documentation of the client when the internal controls are weaker, and performing analytical review procedures. The key thing is the control system of the client; Think about it. The auditor will be relying on information generated by a control system that doesn’t have the ability to keep misstatements to a minimum. Therefore, any evidence taken from a weaker control system is considered weak and unreliable.
Good evidence is an enhanced form of weak evidence and is generated when the internal controls are strong. Under a strong control system, analytical review procedures and inspecting the documentation generated internally would be somewhat reliable and the auditor may choose to rely on the evidence. In addition, good evidence also comes from rigorously inquiring about the client, and observing activities like year-end inventory count.
The Third and most reliable form of audit evidence comes from performing thorough substantive audit procedures and tests of controls. Evidence in an audit is considered best and most reliable when it comes from sources like inspections (ie inspecting tangible assets) and confirmations. Externally generated evidence is also considered reliable evidence and it could be the client’s transaction history taken from their bank or the auditor reperforming or recalculating certain activities to ensure they have been performed accurately.
| Hierarchy of Audit Evidence | Controls | ||||
| Best | – | Physical evidence – inspecting intangibles and confirmations | External Documentation; Recalculation/Reperformance | ||
| Good | Strong IC | Inspecting Documentation and Analytical Review Procedures | Observation and Rigorous inquiry | ||
| Weak | Weak IC | Inspecting Documentation and Analytical Review Procedures | Informal inquiry of the client |
The reliability being explained, can you now identify the weak, good, and best evidence forms from the list?
The first one, evidence from external organizations, comes from an external source and is considered the best form of evidence. Inquiring the employees depend on how they are being inquired. If they are inquired informally, it’s going to generate weaker evidence and a rigorous inquiry will result in good evidence being formulated.
