Audit procedures and confirmations - Inspection, observation...

Learning Outcomes

By studying this article, you will confidently identify, explain, and apply the audit procedures of inspection, observation, inquiry, recalculation, and reperformance. You will distinguish when to use each method, understand their strengths and weaknesses, and connect them to relevant audit assertions. On completion, you will be ready to select and justify procedures to obtain sufficient appropriate audit evidence for various account balances and transactions.

ACCA Audit and Assurance (AA) Syllabus

For ACCA Audit and Assurance (AA), you are required to understand how auditors obtain and evaluate evidence using a range of audit procedures. This article focuses on:

• The definition and purpose of key audit procedures: inspection, observation, inquiry, recalculation, and reperformance (ISA 500).
• How to apply these procedures to gather sufficient appropriate audit evidence over assertions in classes of transactions, account balances, and disclosures.
• The strengths, limitations, and examples of each procedure.
• The appropriateness of external confirmations in the context of audit evidence (ISA 505).
• Linking procedures to the relevant assertions (existence, rights and obligations, completeness, accuracy, valuation, cut-off, classification, and presentation).
• Selecting and designing suitable procedures for audit scenarios as required in the ACCA AA exam.

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. Which audit procedure is most appropriate to test the existence of inventory:
   1. Observation
   2. Inquiry
   3. Inspection
   4. Recalculation

2. Describe the difference between inspection and observation as audit procedures. Give an example of each.

3. For which assertion is recalculation most likely to provide audit evidence?

4. True or false: Inquiry alone provides conclusive evidence for the valuation of receivables.

Introduction

Auditors must gather sufficient appropriate audit evidence to form an opinion on the financial statements. International Standards on Auditing (ISA) require the use of various audit procedures to evaluate assertions and address the risk of material misstatement. This article examines five common procedures—inspection, observation, inquiry, recalculation, and reperformance—and explains their use in acquiring reliable evidence.

Key Term: Audit procedure
A technique or action performed by the auditor to obtain audit evidence, such as inspection, observation, inquiry, recalculation, reperformance, or confirmation.

Audit Procedures: Definitions and Applications

ISA 500 outlines several methods for obtaining audit evidence. Each serves a distinct purpose and is suited to particular audit assertions.

Inspection

Inspection involves examining records, documents, or tangible assets, in either physical or electronic form. This can verify rights, existence, completeness, and support other assertions.

Key Term: Inspection
The auditor's examination of records, documents, or tangible assets to obtain audit evidence about specific assertions.

Inspection can include reviewing invoices, board minutes, contracts, title deeds, or physically examining inventory or property, plant, and equipment.

Observation

Observation means watching a process or procedure performed by others, such as witnessing an inventory count or control activity. It is usually used to confirm procedures (e.g., controls) are followed as stated.

Key Term: Observation
Watching a process or procedure performed by others to obtain evidence about whether a control or process is being executed as described.

Observation provides evidence only at the time of the activity and may be influenced if staff know they are being observed.

Inquiry

Inquiry refers to seeking information from knowledgeable persons within or outside the entity. This may be oral or written and covers both financial and non-financial matters.

Key Term: Inquiry
Seeking information from knowledgeable individuals, either orally or in writing, to obtain audit evidence.

Inquiry is often used in combination with other procedures because alone it is not considered sufficient evidence; people may be biased or mistaken.

Recalculation

Recalculation is checking the mathematical accuracy of documents or records, either manually or using software. It is highly effective for numerical accuracy.

Key Term: Recalculation
Checking the mathematical accuracy of documents or records by independently performing calculations.

It may involve recalculating depreciation, provisions, payroll, or other computations.

Reperformance

Reperformance involves the auditor independently executing procedures or controls originally performed as part of the client’s internal process. It tests the operating effectiveness of a control or process.

Key Term: Reperformance
The independent execution by the auditor of procedures or controls initially performed by the client, to verify accuracy and effectiveness.

Reperformance validates that controls operate as intended, such as reperforming a bank reconciliation.

External Confirmation (Overview)

ISA 505 addresses external confirmations—obtaining a direct, written response from a third party (such as confirming a bank balance or debt).

Key Term: External confirmation
Audit evidence obtained as a direct written response from a third party to the auditor’s request for information relating to a particular item.

External confirmation is often used for bank balances, receivables, payables, and legal matters.

Linking Procedures to Audit Assertions

Each audit assertion—such as existence, completeness, or valuation—may require a combination of these procedures for evidence.

Worked Example 1.1

A manufacturing company claims to have machinery valued at £800,000. What procedure(s) would you use to test the existence and valuation of these assets?

Answer:
Inspect the fixed asset register and physically examine a sample of machines (inspection) to test existence. Recalculate depreciation on a sample to check the mathematical accuracy of the carrying value (recalculation).

Strengths and Limitations

• Inspection: Strong for verifying existence, rights, and completeness, but less useful for valuation unless accompanied by appraisals or other evidence.
• Observation: Good for assessing controls at a point in time, but staff may change behaviour when observed.
• Inquiry: Readily performed but always seek corroboration; not reliable alone.
• Recalculation: Strong for numerical accuracy, limited to mathematical assertions.
• Reperformance: Robust for control effectiveness; not feasible for all processes.
• Confirmation: Highly persuasive where available, but timing and non-responses can limit reliability.

Worked Example 1.2

You are auditing payroll expenses. List and briefly explain one procedure you would use to test the accuracy of the payroll figure.

Answer:
Recalculate a sample of payroll calculations using employment contracts and timesheets to confirm the net pay is accurate (recalculation).

Worked Example 1.3

During an audit, you observe warehouse staff performing a year-end physical inventory count. What assertion and procedure are you testing, and what is a limitation of this method?

Answer:
Assertion: Existence and completeness; Procedure: Observation of the count process. Limitation: Observation only gives evidence for the period of the count—staff might be more diligent when watched.

Exam Warning

A frequent error is to rely solely on inquiry for evidence—remember, statements from management or staff must be corroborated wherever possible. Do not accept verbal explanations alone as sufficient evidence for key assertions.

Designing Effective Procedures

Be precise in your audit programs. State the action, the source, and the objective. For example:

• "Inspect (action) the supplier’s invoice (source) to agree the cost of goods purchased (objective—accuracy assertion)."
• "Reperform the year-end bank reconciliation to check if reconciling items are correctly treated (objective—completeness and accuracy)."

Summary

Audit procedures are selected based on the assertion under assessment and the availability and quality of evidence. Inspection, observation, inquiry, recalculation, and reperformance each contribute to obtaining sufficient appropriate audit evidence. Combining these procedures, and using confirmation when necessary, is central to forming an audit opinion that is robust and defensible.

Key Point Checklist

This article has covered the following key knowledge points:

• Define and explain the audit procedures: inspection, observation, inquiry, recalculation, reperformance, and external confirmation.
• Identify the strengths, limitations, and best uses for each procedure.
• Link each procedure to appropriate financial statement assertions.
• Write effective audit procedures stating action, source, and objective.
• Understand that inquiry alone is insufficient and should be corroborated.
• Know when to use confirmations for external evidence and what makes them reliable.
• Apply these techniques to scenario-based ACCA AA exam questions.

Key Terms and Concepts

• Audit procedure
• Inspection
• Observation
• Inquiry
• Recalculation
• Reperformance
• External confirmation