Audit Evidence: External confirmations and surprise inventory
Audit Evidence (Audit Evidence): External Confirmations and Physical Counts
Audit Evidence: A practical guide explaining the Sufficiency and Appropriateness of evidence, bank and external confirmations, physical and surprise counts, and how to document to reduce audit findings—Digital Salla.
- Fundamental definition: What constitutes Sufficient Appropriate Evidence?
- Hierarchy of Evidence: From the most reliable to the least reliable.
- Managing External Confirmations (Banks, Customers, and Vendors).
- The Physical Inventory Count: The auditor’s role and observation.
- Techniques for Gathering Evidence: Inspection, Observation, and Inquiry.
- Preparing the “Audit File” to ensure a smooth year-end process.
1) The Concept of Audit Evidence (ISA 500)
According to International Standard on Auditing 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 both information contained in the accounting records and other information (like third-party confirmations).
2) Sufficiency vs. Appropriateness
Auditors judge evidence based on two criteria:
- Sufficiency (Quantity): Is there enough evidence? (e.g., checking 100 invoices instead of 5).
- Appropriateness (Quality): Is the evidence Relevant and Reliable?
3) Hierarchy of Evidence Reliability
Not all evidence is equal. Auditors follow this hierarchy of trust:
| Rank | Source | Example |
|---|---|---|
| High | Direct External | Bank confirmation sent directly to the auditor. |
| Medium-High | Direct Auditor Observation | Auditor physically watching the inventory count. |
| Medium | Indirect External | A vendor invoice found inside the company’s files. |
| Low | Internal Oral | A verbal explanation from the CEO or Accountant. |
4) The Verification Path (Visual Logic)
How an auditor uses different sources to “Triangulate” the truth?
Bank Reconciliation Template - Excel Template
5) External Confirmations (ISA 505)
This is one of the most powerful tools in auditing. The auditor asks a third party to confirm a balance or a contract term.
- Bank Confirmations: To verify cash balances, loans, and contingent liabilities.
- Accounts Receivable: Asking customers if they really owe the company money.
- Legal Letters: Asking the company’s lawyer about pending lawsuits.
6) Physical Count: The Ultimate Proof of Existence
Management is responsible for the count; the auditor’s role is to Observe.
The Auditor’s Checklist during Count
- Are count instructions clear to all staff?
- Are items being “Tagged” to prevent double counting?
- Sheet-to-Floor: Selecting an item from the list and finding it in the warehouse.
- Floor-to-Sheet: Selecting an item from the shelf and finding it on the count list.
- Performing Surprise spot checks on high-value items.
7) Analytical Procedures and Ratios
Auditors use “The Big Picture” to find anomalies. If sales went up by 50% but electricity costs stayed the same, this is a Red Flag requiring more evidence.
8) Operational Controls & Readiness Checklist
To ensure your entity is ready for the auditor’s evidence request:
Audit Evidence Quality Gate
- Are Original Invoices organized by month and easily accessible?
- Is there a formal Authorized Signatory List for the auditor to verify approvals?
- Are digital records (PDFs) stored in a way that prevents alteration?
- Is the Bank Reconciliation for December 31st signed and verified?
- Are “Third Party Assets” (items held but not owned) clearly marked?
9) Common Errors and How to Prevent Them
- Relying only on Inquiry: Accepting management’s “Word” without document proof. Fix: Always follow up an interview with a Document Request.
- Weak Confirmation Control: Allowing the company accountant to mail the bank confirmation letters (High fraud risk).
- Ignoring “Negative” Confirmations: Assuming that if a customer doesn’t respond, their balance is correct. Non-response is not evidence.
- Poor Cut-off: Recording January sales in December to inflate numbers. Fix: The auditor must check the last 5 invoices of Dec and the first 5 of Jan.
10) Frequently Asked Questions
What is a Positive Confirmation?
It is a request that the third party respond to the auditor in all cases, whether they agree with the balance or not.
What if I cannot observe the year-end inventory count?
The auditor must perform Alternative Procedures, such as inspecting subsequent sales records or performing a count on a different date and “rolling back” the balance.
Does the auditor keep all the evidence?
The auditor keeps copies of the most important evidence in the Audit Working Papers file. This file is the auditor’s property and is kept for legal protection.
11) Conclusion
Audit Evidence is the currency of the audit profession. By understanding the hierarchy of reliability and mastering the process of External Confirmations and Physical Verification, you ensure that the auditor’s report is grounded in indisputable facts. For management, providing high-quality, organized evidence is the fastest way to reduce audit time, lower professional fees, and achieve a Clean Opinion that builds institutional trust.
Action Step Now (30 minutes)
- Pick your largest Accounts Receivable customer.
- Find the last 3 invoices and the Proof of Payment (Bank receipt) for each.
- Check if you have their correct contact person for a Balance Confirmation. You are now prepared for the next audit.