Question

Arisha & Co., was hired as the auditor for Bunga-bunga Mesin Sdn. Bhd., a company that manufactured high-precision, computer operated machines. The owner, Al-Naim, hired Arisha & Co. to conduct the upcoming audit for the company. Because Bunga-bunga Mesin's computer operated machines were large and complex, they were expensive. Each sale was carefully negotiated individually by Al-Naim, and the sales often transpired over several months. As a result, improper recording of one or two machines could represent a material misstatement of the financial statements. The engagement partner in charge of the Bunga-bunga audit was Razin, who had significant experience auditing manufacturing companies. He recognized the risk for improper recording of sales, and he insisted that his staff confirm all receivables at year-end directly with customers. Razin saw that a receivable for a major sale at year-end was supported by fax, rather than the usually written confirmation reply. Towards the end of the audit engagement, however, Razin signed off on an unqualified audit opinion for the company. In the subsequent years, Bunga-bunga Mesin Sdn. Bhd. issued a statement indicating that its revenues for the prior year had been overstated because of improperly recorded sales, including the sale supported by the fax confirmation. The Securities Commission (SC) investigation uncovered that the fax had been sent by Al-Naim, himself, not the customer. As a result, Arisha & Co. was forced to pay substantial damages, and Razin was forbidden to practice before the SC. Formulate at least 5 types of evidence that Razin can use in his audit job and provide an example for each type of audit evidence (In auditing and verifying revenue made by Bunga- bunga Mesin Sdn. Bhd.). Identify and explain at least five (5) characteristics which influence the reliability of audit evidence. For each of characteristics, provide an example of reliable audit evidence.

Answer 1

Types of evidences

1. Physical evidence

Physical verification of machine by auditor, provide an assurance of actual existence of machine. Physical verification gives an auditor evidence regarding entity actually spent on tangible assets.

Example verification of inventory, intangible asset and surprise checking of cash.

2. External confirmation

External confirmation is an evidence that sourced from external party of the organization to confirm year end balances. Example Confirmation from Creditors, debtors, financial institutions.

This type of evidence is useful to check accuracy of records and books of accounts.

3. Documentary evidence

Documentary evidence is an important form of evidence available in form of documents, it useful for recording of transactions of sales, purchase, expenditure.

Example , purchase invoice, sales invoice, sales order, delivery challan.

4. Oral evidence

This type of evidence is generated by way of interpersonal communication and discussion with staff members and owners, officers of the entity. Carefull observation required by auditor.

Example, discussion with management on the affairs of the company and its objectives, strategy provides an evidence to compliance with this.

5. Journals and ledgers

Journals are used to recording transactions and ledger used to posting of particular transactions to particular account. This an evidence of all transactions entered by an organization.

Characteristics which influence reliability of evidence

1. Authenticity

Information that the auditor using should be authentic, proper and reliable.

Example, evidence obtained from outside and through discussion should be reliable.

2. Clients internal control system

Effectiveness of internal controls within organization affects the reliability of evidence.

Internal control means the rules, policies, regulations of the organization. Weak internal controls may impact reliability of evidence.

3. Timeliness of evidence

Evidence should be available at the right time.

Example is getting of evidence during audit and investigation.

4. Auditors knowledge, skill

Auditors knowledge, skill, experience is important part of audit , because evidence generation is the skill of auditor.

Example inability of auditor to generate conclusive evidence if inexperienced and low level of knowledge to the auditor.

5. Evidence gathered should be objective

Evidence gathered should be to the point and objective. It should be an evidence without any dought.

Example

Any evidence obtained externally from creditor for verification of balance should be to the point.