Assertions and evidence - Reliability hierarchy of evidence ...

Learning Outcomes

After reading this article, you will be able to:

• Explain what financial statement assertions are and recognise their role in audit procedures.
• Identify the factors which affect the reliability of audit evidence and outline the generally accepted order of reliability.
• Apply the evidence reliability hierarchy and select the most appropriate audit procedures in exam scenarios.
• Discriminate between routine, persuasive, and conclusive evidence—essential for ACCA exam success.

ACCA Audit and Assurance (AA) Syllabus

For ACCA Audit and Assurance (AA), you are required to understand how the assertions in the financial statements drive audit evidence gathering, and how to evaluate the reliability of various types and sources of evidence. Focus on these areas in your revision:

• Define and distinguish between assertions at the classes of transactions and account balances level.
• Identify and describe audit procedures used to gather evidence: inspection, observation, external confirmation, recalculation, re-performance, enquiry, and analytical procedures.
• Explain and evaluate the reliability hierarchy of evidence sources.
• Assess the sufficiency and appropriateness (quality and quantity) of audit evidence gathered.
• Apply the reliability hierarchy in selecting procedures and forming an audit opinion.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Place the following sources of audit evidence in order from most to least reliable:

   • Written evidence from a bank
   • Verbal explanation from a manager
   • Supplier invoice
   • Internally produced report

2. Why are external confirmations generally considered more reliable than evidence from client management?

3. Which assertion does testing after-date cash received for trade receivables support most?

4. A draft inventory listing is provided by the client. Which evidence procedure could improve the reliability of this evidence, and why?

Introduction

Audit evidence must be sufficient and appropriate to support the auditor’s conclusion. The International Standards on Auditing (ISA 500) require the auditor to gather evidence that addresses relevant assertions about the financial statements—such as existence, completeness, accuracy, rights and obligations, and valuation.

Not all evidence is equally trustworthy. Some forms—especially those obtained directly by the auditor from outside parties—are superior to written statements from management. Understanding the reliability hierarchy is essential for planning and performing effective evidence gathering and critical for choosing responses to audit risks in exam scenarios.

Key Term: assertion
A claim or statement made by management regarding recognition, measurement, presentation, or disclosure of financial statement items.

Types of Assertions

Auditor tests focus on management’s assertions, split between:

• Assertions about transactions and events (e.g., sales, payroll):

  • Occurrence, completeness, accuracy, cut-off, classification, presentation

• Assertions about account balances (e.g., inventory, receivables):

  • Existence, rights and obligations, completeness, accuracy/valuation/allocation, classification, presentation

Key Term: sufficient appropriate evidence
The combination of enough quantity (sufficiency) and adequate quality (appropriateness, meaning relevance and reliability) of audit evidence to draw reasonable conclusions.

The Hierarchy of Evidence Reliability

Not all audit evidence is of equal weight. The ISAs establish a generally accepted evidence hierarchy, which orders sources by reliability:

1. Evidence obtained directly by the auditor from independent external sources (e.g., bank confirmations, supplier statements mailed to the auditor).
2. Evidence obtained from external sources but provided via the client (e.g., supplier invoices sent by the client, external legal correspondence presented by management).
3. Evidence obtained directly by the auditor from the client (inspection of physical assets, direct observation).
4. Evidence generated and provided by the client (internal evidence) (management accounts, schedules prepared by the entity, oral explanations).

Key Term: reliability hierarchy of audit evidence
A ranking of types and sources of audit evidence, guiding auditors to prefer the most trustworthy sources in support of conclusions.

Key Term: external confirmation
Audit evidence obtained as a direct written response to the auditor from a third party, in paper, electronic, or other medium.

Factors Affecting Reliability

Even within categories, certain factors can alter reliability:

• Independence: Evidence from third parties outside the entity is more reliable than that from within.
• Directness: Evidence obtained personally by the auditor is better than that delivered through management.
• Form: Written is more reliable than verbal; original documents trump copies.
• Source: Evidence produced under effective client controls is more reliable than that from weakly controlled environments.

Worked Example 1.1

Scenario:
The auditor of Oak Ltd requests a year-end bank confirmation directly from the company’s main bank. Oak Ltd's finance director also provides bank statements and reconciliations prepared internally.

Question:
Which evidence is most reliable for confirming the year-end cash balance, and why?

Answer:
The bank confirmation sent to and received directly by the auditor is most reliable, as it comes from an independent external party and bypasses any management involvement. Internal reconciliations and bank statements support but cannot substitute this external confirmation.

Practical Applications

• Always seek evidence from the highest point available on the reliability hierarchy relevant to your objective.
• Use corroborative evidence where primary evidence does not reach the top of the hierarchy.
• If evidence is only available from less reliable sources, increase coverage or combine types (e.g., internal report plus after-date external proof).

Worked Example 1.2

Scenario:
You are testing the valuation assertion for inventory in a warehouse. Management presents an internally generated inventory listing and a supplier invoice for goods purchased in December. The auditor also attends the year-end count.

Question:
Which piece(s) of evidence offer(s) the highest reliability for the quantity of inventory at year-end?

Answer:
Observation of the physical inventory count by the auditor is highly reliable for existence and completeness. The supplier invoice supports the cost but not the existence of inventory. The internally generated listing has the lowest reliability for existence.

Exam Warning

The exam may ask you to comment on the reliability of specific evidence or ask which further procedures are needed. Always explain why one type is more reliable than another, not just “external is best”—give reasons tied to independence, directness, and form.

Applying the Hierarchy to Audit Procedures

Each audit procedure can be mapped to the hierarchy:

• Inspection of Third-Party Documents: e.g., contracts, title deeds, bank letters (high reliability if obtained directly).
• Observation: e.g., auditor attends an inventory count (direct evidence but cannot provide assurance over periods not observed).
• External Confirmation: e.g., receivable confirmations sent by the auditor (top reliability).
• Recalculation and Reperformance: auditor’s own calculations or duplicated procedures (reliable, especially where objective).
• Enquiry and Analytical Procedures: e.g., asking management to explain a fluctuation, or performing ratio analysis (lowest reliability unless supported by further evidence).

Key Term: analytical procedures
Evaluation of financial information through analysis of plausible relationships among data and investigation of significant variances.

Limitations and Combining Evidence

Relying on a single type of evidence—especially if low in the hierarchy—may not provide sufficient appropriate evidence. A combination of evidence sources is often required to support a conclusion.

For example, for the valuation of receivables:

• External confirmation supports existence, but not necessarily recoverability.
• After-date cash receipt is direct external proof of valuation.

Revision Tip

In question scenarios, always specify the audit assertion being tested, select the procedure providing the most reliable evidence available for that assertion, and justify your choice by the source type.

Summary

Assertions are specific statements management makes about figures and disclosures in the financial statements. The auditor must gather sufficient appropriate evidence to support or refute these claims. The reliability hierarchy ranks evidence by source and form; direct, external, written evidence is best. Understanding which procedures yield the strongest evidence for different assertions is critical for audit effectiveness and exam performance.

Key Point Checklist

This article has covered the following key knowledge points:

• Define assertions and distinguish types for transactions and balances.
• Explain what is meant by sufficient appropriate evidence.
• State the reliability hierarchy of audit evidence and factors affecting reliability.
• Apply evidence reliability rankings to audit procedures and scenario questions.
• Recognise typical limitations and the need to combine evidence sources.
• Identify and justify evidence best suited to particular audit assertions.

Key Terms and Concepts

• assertion
• sufficient appropriate evidence
• reliability hierarchy of audit evidence
• external confirmation
• analytical procedures