Audit evidence forms the foundation of the financial audit process, enabling auditors to draw informed conclusions about an entity’s financial statements. In Kenya, where regulatory compliance and financial transparency are paramount for both public and private sector entities, gathering reliable audit evidence is critical. This chapter explores the nature and sources of audit evidence, and the diverse types of evidence auditors rely upon to support their opinions. Mastering this knowledge equips accountancy professionals to conduct audits that meet international standards and local regulatory expectations.

5.1 Nature and source of audit evidence

In the Kenyan audit environment, understanding what constitutes audit evidence and where it originates is essential for effective audit planning and execution. Audit evidence must be relevant, reliable, and sufficient to substantiate audit findings, especially given the complexity of financial activities in institutions like county governments or commercial banks. This section unpacks the intrinsic characteristics of audit evidence and identifies typical sources auditors tap into during fieldwork.

5.1.1 Characteristics of audit evidence

Audit evidence must possess certain qualities to be useful in forming an audit opinion. These qualities ensure the evidence can withstand scrutiny during regulatory reviews or legal challenges.

Relevance

Audit evidence must directly pertain to the audit objective or assertion under examination. For instance, verifying the existence of fixed assets at a retail business requires evidence specifically related to asset ownership, such as title deeds or physical inspection reports.

Reliability

Reliable evidence is trustworthy and free from bias or error. Evidence obtained from independent third parties, like confirmation letters from banks, is generally more reliable than internally generated documents prone to manipulation.

Sufficiency

Sufficiency refers to the quantity of evidence collected. An auditor at a cooperative society must gather enough transactions or document samples to confidently conclude on the financial statement assertions.

Timeliness

Evidence must be current and relevant to the audit period. For example, bank statements dated within the fiscal year under audit provide timely confirmation of cash balances.

Understandability

Audit evidence should be clear and comprehensible to the auditor. Complex financial instruments require documentation that explains terms and conditions to facilitate proper evaluation.

5.1.2 Sources of audit evidence

Audit evidence is derived from various internal and external origins, each offering different levels of assurance.

Internal sources

These originate within the audited entity and include accounting records, internal reports, and minutes of meetings. For example, a county government’s payroll records provide evidence for salary expense verification.

External sources

Evidence received from outside the entity, such as bank confirmations, supplier invoices, or legal correspondence, often carries higher reliability due to external validation.

Physical sources

Physical inspection of assets like inventory at a manufacturing firm or cash on hand at a retail shop provides tangible evidence of existence and condition.

Analytical sources

Data obtained through analytical procedures, such as ratio analysis or trend comparisons, helps identify unusual transactions or balances requiring further investigation.

5.1.3 Methods of obtaining audit evidence

Auditors employ diverse techniques to collect evidence, adapting to the specific audit context.

Inspection

Reviewing documents or tangible assets to verify accuracy and existence, for example, examining supplier invoices for proper authorization.

Observation

Watching processes or procedures being performed, such as observing the cash counting process at a hotel to assess controls.

Inquiry

Seeking information through discussions with management or staff to clarify or corroborate audit findings.

Confirmation

Obtaining direct verification from third parties, like requesting confirmation of loan balances from banks.

Recalculation

Checking mathematical accuracy of documents, such as recalculating depreciation schedules for a hospital’s fixed assets.

5.1.4 Factors affecting the reliability of audit evidence

Several aspects influence how much trust an auditor can place in evidence.

Source of evidence

Evidence from independent external sources is generally more reliable than internally produced documents.

Nature of evidence

Physical evidence and original documents are more dependable than electronic copies or oral statements.

Circumstances of collection

Evidence gathered under controlled conditions, such as during an unannounced inventory count, tends to be more reliable.

Auditor’s expertise

The auditor’s skill in interpreting evidence affects its usability; for example, understanding complex financial derivatives in a SACCO’s portfolio.

Consistency with other evidence

Evidence that aligns with other findings strengthens overall audit conclusions.

Chapter Summary

This chapter explores the nature and sources of audit, emphasizing how auditors obtain information to assess financial statements accurately. It then examines various types of audit evidence, highlighting their importance in supporting audit conclusions. The process of gathering audit evidence is detailed, outlining methods auditors use to collect relevant and reliable data. The chapter also discusses the reliance on the work of internal auditors, explaining when and how their findings can be integrated into the external audit process. Attention is given to the contents of audit working papers, which document the evidence and procedures applied during the audit. Finally, the chapter distinguishes between compliance tests, which assess adherence to policies and regulations, and substantive tests, which verify the accuracy of financial information, providing a comprehensive understanding of audit tests essential for effective financial auditing.