Close-Up on Sources of Substantive Audit Evidence
March 21, 2023

Organizations that understand how auditors verify account balances and transactions can minimize disruptions during audit fieldwork and maximize the effectiveness of financial statement audits. Here’s a summary of the types of “substantive evidence” auditors gather to help them form opinions regarding your financial statements.

Original Source Documents

Auditors can verify an account balance or record by vouching (or comparing) it to third-party documentation. For example, an auditor might verify the existence of a machine on your company’s fixed asset register by reviewing the invoice from the seller. Vouching enables an auditor to evaluate the accuracy of the amount recorded and whether the transaction was entered correctly in the accounting system.

Physical Observations

Seeing is believing. Auditors sometimes verify the existence of assets through physical observations and inspections. For example, inventory audit procedures typically include observing or conducting a physical inventory count, inspecting the process to record incoming and outgoing inventory, and analyzing the inventory obsolescence process.

Confirmation Letters

Auditors send letters to third parties — such as customers, banks or vendors — asking them to verify amounts recorded in a company’s books. There are two types of confirmations: A positive confirmation requests that the recipient complete a form confirming account balances (for example, how much a customer owes the company). A negative confirmation requests that the recipient respond only if the balance is inaccurate.

Comparisons to External Market Data

For assets actively traded on the open market, auditors may research pricing data to confirm the amounts claimed on the company’s financial statements. For example, if a company invests in marketable securities that it plans to sell within the year, the auditor could analyze the prevailing market prices to confirm their book value. Likewise, a random sample of parts inventory could be compared to online pricing sheets to confirm that items are reported at the lower of cost or market value.

Independent Calculations

Auditors may verify internally prepared schedules and reports by re-creating them. If the auditor’s work matches the client’s version, it confirms that the underlying accounts appear reasonable. Auditors often rely on this procedure for such items as bank reconciliations and schedules of payroll-related expenses (for example, overtime, benefits and tax payments).

Collaboration Is Critical

An effective audit requires coordination between the audit team and the client. As we wrap up the audit of your 2022 financials, let’s work together to review the types of substantive evidence that were used for each major financial statement category. This process can identify potential bottlenecks in the auditing process and help you anticipate document requests and inquiries, making your next audit more efficient.

© 2023

 

You might also like

Getting a Handle on Inventory

Getting a Handle on Inventory

Inventory is a key balance sheet item for many companies. Depending on the nature of your operations, inventory may include raw materials, work-in-progress (WIP) inventory and finished goods. While you need to have enough inventory on hand to meet your customers’...

read more
How to Minimize Billing Bottlenecks

How to Minimize Billing Bottlenecks

Managing accounts receivable can be challenging, especially in an uncertain economy. To keep your company financially fit, it’s a good idea to occasionally revisit your billing and collections processes to ensure they’re as efficient and effective as possible....

read more