Internal Control and Audit Evidence Standards

The Elements of Internal Control

Internal control consists of the following components:

• Organizational Plan: Defines and delimits responsibilities through the segregation of duties and coordination.
• Strategic Planning and Budgets: Determines business objectives and financial targets.
• Authorization and Recording Systems: Procedures for transaction approval and documentation.
• Information Channels: Hierarchical communication systems to facilitate appropriate decision-making.
• Personnel Management: Quantitative and qualitative staffing requirements.

Materiality in Auditing

When an auditor issues an unqualified report, it assumes the company's annual accounts are free of material errors. To render an opinion, the auditor analyzes the concept of relative importance (materiality) throughout the audit process:

• Planning Phase: The auditor determines significant amounts, establishing a threshold known as precision.
• Implementation Phase: The auditor sets a ceiling for acceptable errors in specific subject areas, known as tolerable error.
• Reporting Phase: The auditor evaluates circumstances such as scope limitations or breaches of accounting standards. If effects are significant, a qualified opinion is issued; if very significant, the auditor may issue an adverse opinion or a disclaimer.

Methods of Obtaining Audit Evidence

An auditor's opinion must be supported by sufficient evidence to provide confidence that financial statements are true and correct. While absolute certainty is difficult to achieve, the auditor must obtain sufficient professional evidence.

Quality of Evidence

• Evidence from external sources is more reliable than internal sources.
• Internal evidence is more reliable when supported by a strong internal control system.
• Evidence obtained directly by the auditor through observation is more reliable than indirect evidence.
• Documentary evidence is superior to oral evidence.

Amount and Collection of Evidence

The volume of evidence depends largely on the internal control system. Technical rules require evidence through compliance and substantive tests using these methods:

• Inspection: Physical stocktaking.
• Observation: Verifying that internal controls are functioning.
• Inquiry: Questionnaires and interviews with internal and external parties.
• Confirmations: One of the strongest forms of audit evidence.
• Analytical Procedures: Technical calculations and examination of accounting records and important documents.