ISA 501

Audit Evidence: Specific Considerations for Selected Items

1Objective and scope

ISA 501 deals with specific considerations in obtaining sufficient appropriate audit evidence, in accordance with ISA 330, ISA 500 and other relevant ISAs, with respect to three items: the existence and condition of inventory, the completeness of litigation and claims involving the entity, and the presentation and disclosure of segment information in accordance with the applicable framework. Each carries a prescribed procedure that the auditor must perform where the item is material, and each has a defined alternative when the prescribed procedure is impracticable.

The objective is to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory, the completeness of litigation and claims, and the presentation and disclosure of segment information.

2Key definitions

3Requirements

Inventory

If inventory is material to the financial statements, the auditor obtains evidence of its existence and condition by attending physical inventory counting, unless impracticable, to evaluate management's instructions and procedures for recording and controlling the results of the count, observe the performance of management's count procedures, inspect the inventory, and perform test counts. The auditor also performs procedures over the entity's final inventory records to determine whether they accurately reflect the actual count results.

• Before the count: review prior-year working papers and the count instructions; consider the risks (obsolescence, third-party locations, work in progress, high-value items), the timing, the locations to attend, and whether an expert is needed for specialised inventory (livestock, minerals, chemicals).
• During the count: observe that instructions are followed (teams of two, count sheets pre-numbered, tags used, no movement during the count, damaged and slow-moving items segregated and identified), perform test counts in both directions and record them, record cut-off details (the last goods received note and dispatch note numbers), and note the condition of inventory.
• After the count: trace the test counts into the final inventory listing, confirm cut-off using the numbers recorded, follow up on count sheet changes, and evaluate whether the final records reflect the count.
• If the count is conducted at a date other than the date of the financial statements, perform procedures to obtain evidence about whether changes in inventory between the count date and the period end are properly recorded (roll-forward or roll-back of receipts and issues).
• If unable to attend because of unforeseen circumstances, make or observe some physical counts on an alternative date and perform procedures on intervening transactions. If attendance is impracticable (a location too remote or dangerous, inventory held in a way that prevents counting), perform alternative procedures such as inspection of documentation of the subsequent sale of specific items; if that is not possible, modify the opinion for a limitation on scope.
• For inventory under the custody and control of a third party (a bonded warehouse, a public warehouse, consignment stock), request confirmation from the third party as to quantities and condition, and/or perform inspection or other procedures appropriate in the circumstances, considering the integrity and independence of the third party, attending its count, or obtaining another auditor's report on its controls.

Litigation and claims

• Design and perform procedures to identify litigation and claims that may give rise to a risk of material misstatement: inquiry of management and, where applicable, others within the entity including in-house legal counsel; review of minutes of meetings of those charged with governance and of correspondence between the entity and its external legal counsel; review of legal expense accounts and the invoices behind them.
• If the auditor assesses a risk of material misstatement regarding identified litigation or claims, or the procedures indicate that other material litigation may exist, seek direct communication with the entity's external legal counsel through a letter of inquiry prepared by management and sent by the auditor, requesting counsel to communicate directly with the auditor. Where law, regulation or the legal profession's rules prohibit direct communication, perform alternative procedures.
• If management refuses permission to communicate or meet with external legal counsel, or counsel refuses to respond appropriately and the auditor cannot obtain sufficient appropriate evidence by alternative procedures, modify the opinion under ISA 705 (a qualified opinion or a disclaimer, depending on pervasiveness).
• Request written representations that all known actual or possible litigation and claims whose effects should be considered in preparing the financial statements have been disclosed to the auditor and accounted for and disclosed in accordance with the applicable framework (IAS 37 for provisions and contingent liabilities).

Segment information

The auditor obtains sufficient appropriate evidence regarding the presentation and disclosure of segment information in accordance with the applicable framework by obtaining an understanding of the methods used by management in determining segment information (the identification of operating segments, the chief operating decision maker, the measurement basis and the aggregation criteria), evaluating whether those methods are likely to result in disclosure in accordance with the framework, and where appropriate testing the application of those methods; and by performing analytical procedures or other procedures appropriate in the circumstances. The auditor is not required to perform procedures that would be necessary to express an opinion on the segment information presented on a stand-alone basis.

4Documentation and reporting

The count attendance file records the locations attended, the evaluation of management's instructions, the observations made, the test counts performed with their identifying details and their tracing to the final records, the cut-off information, notes on condition, and the roll-forward where the count date differed from the period end. The legal letters, responses and management's written representation on litigation are filed with the evaluation of each matter against IAS 37. Failure to attend the count where it was practicable, or an unresolved refusal by management or legal counsel, is a limitation on scope: a qualified opinion or a disclaimer under ISA 705. Litigation whose outcome is uncertain and material may also warrant an Emphasis of Matter paragraph or a key audit matter where the disclosure is adequate, and a qualified or adverse opinion where it is not.

5Examinable focus