ISA 501 (CONFORMED)1
INTERNATIONAL STANDARD ON AUDITING 501
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
FOR SPECIFIC ITEMS
(This Standard is effective, but contains conforming amendments that become
effective at a future date)*
CONTENTS
Paragraph
Introduction ................................................................................................... 1-3
Attendance at Physical Inventory Counting ................................................... 4-18
Superceded by ISA 505
Procedures Inquiry Regarding Litigation and Claims .................................... 31-37
Valuation and Disclosure of Long-term Investments .................................... 38-41
Segment Information ..................................................................................... 42-45
International Standard on Auditing (ISA) 501, “Audit Evidence—Additional
Considerations for Specific Items” should be read in the context of the “Preface to the
International Standards on Quality Control, Auditing and Assurance,” which sets out
the application and authority of ISAs.
* TheAudit Risk Standards, comprising ISA315, “Understanding the Entity and Its Environment andAssessing
the Risks of Material Misstatement,” ISA330, “TheAuditor’s Procedures in Response toAssessed Risks,” and
ISA 500 (Revised), “Audit Evidence,” gave rise to conforming amendments to ISA 501. These amendments
are effective for audits of financial statements for periods beginning on or after December 15, 2004.
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
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ISA 501 (CONFORMED) 2
Introduction
1. The purpose of this International Standard on Auditing (ISA) is to establish
standards and provide guidance additional to that contained in ISA 500, “Audit
Evidence” with respect to certain specific financial statement account balances
amounts and other disclosures.
2. Application of the standards and guidance provided in this ISA will assist the
auditor in obtaining audit evidence with respect to the specific financial
statement account balances amounts and other disclosures addressed.
3. This ISA comprises the following parts:
(a) Attendance at Physical Inventory Counting
(b) Superceded by ISA 505—Part B has been deleted.
(c) Inquiry Regarding Litigation and Claims
(d) Valuation and Disclosure of Long-term Investments
(e) Segment Information
Attendance at Physical Inventory Counting
4. Management ordinarily establishes procedures under which inventory is
physically counted at least once a year to serve as a basis for the preparation of
the financial statements or to ascertain the reliability of the perpetual inventory
system.
5. When inventory is material to the financial statements, the auditor should
obtain sufficient appropriate audit evidence regarding its existence and
condition by attendance at physical inventory counting unless
impracticable. The auditor’s attendance serves as a test of controls or
substantive procedure over inventory depending on the auditor’s risk
assessment and planned approach. Such attendance will enables the auditor to
inspect the inventory, to observe compliance with the operation of
management’s procedures for recording and controlling the results of the count
and to provide audit evidence as to the reliability of management’s procedures.
6. If unable to attend the physical inventory count on the date planned due
to unforeseen circumstances, the auditor should take or observe some
physical counts on an alternative date and, when necessary, perform audit
procedures on tests of intervening transactions.
7. Where attendance is impracticable, due to factors such as the nature and
location of the inventory, the auditor should consider whether alternative
procedures provide sufficient appropriate audit evidence of existence and
condition to conclude that the auditor need not make reference to a scope
limitation. For example, documentation of the subsequent sale of specific
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
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ISA 501 (CONFORMED)3
inventory items acquired or purchased prior to the physical inventory count
may provide sufficient appropriate audit evidence.
8. In planning attendance at the physical inventory count or the alternative
procedures, the auditor would considers the following:
• The risks of material misstatement related to inventory.
• The nature of the accounting and internal control related to systems used
regarding inventory.
• Inherent, control and detection risks, and materiality related to inventory.
• Whether adequate procedures are expected to be established and proper
instructions issued for physical inventory counting.
• The timing of the count.
• The locations at which inventory is held.
• Whether an expert’s assistance is needed.
9. When the quantities are to be determined by a physical inventory count and the
auditor attends such a count, or when the entity operates a perpetual system
and the auditor attends a count one or more times during the year, the auditor
would ordinarily observe count procedures and perform test counts.
10. If the entity uses procedures to estimate the physical quantity, such as
estimating a coal pile, the auditor would need to be satisfied regarding the
reasonableness of those procedures.
11. When inventory is situated in several locations, the auditor would consider at
which locations attendance is appropriate, taking into account the materiality
of the inventory and the risk of material misstatement at assessment of inherent
and control risk at different locations.
12. The auditor would review management’s instructions regarding:
(a) The application of control activitiesprocedures, for example, collection
of used stocksheets, accounting for unused stocksheets and count and
re-count procedures;
(b) Accurate identification of the stage of completion of work in progress,
of slow moving, obsolete or damaged items and of inventory owned by
a third party, for example, on consignment; and
(c) Whether appropriate arrangements are made regarding the movement
of inventory between areas and the shipping and receipt of inventory
before and after the cutoff date.
13. To obtain audit evidence assurance that management’s control activities
procedures are adequately implemented, the auditor would observe employees’
procedures and perform test counts. When performing test counts, the auditor
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
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performs procedures over would test both the completeness and the accuracy
of the count records by tracing items selected from those records to the
physical inventory and items selected from the physical inventory to the count
records. The auditor would considers the extent to which copies of such count
records need to be retained for subsequent audit procedures testing and
comparison.
14. The auditor would also considers cutoff procedures including details of the
movement of inventory just prior to, during and after the count so that the
accounting for such movements can be checked at a later date.
15. For practical reasons, the physical inventory count may be conducted at a date
other than period end. This will ordinarily be adequate for audit purposes only
when the entity has designed and implemented controls over changes in
inventorycontrol risk is assessed at less than high. The auditor would
determine assess whether, through the performance of appropriate audit
procedures, changes in inventory between the count date and period end are
correctly recorded.
16. When the entity operates a perpetual inventory system which is used to
determine the period end balance, the auditor would evaluate assess whether,
through the performance of additional procedures, the reasons for any
significant differences between the physical count and the perpetual inventory
records are understood and the records are properly adjusted.
17. The auditor performs audit procedures over would test the final inventory
listing to determine assess whether it accurately reflects actual inventory
counts.
18. When inventory is under the custody and control of a third party, the auditor
would ordinarily obtain direct confirmation from the third party as to the
quantities and condition of inventory held on behalf of the entity. Depending
on materiality of this inventory the auditor would also consider the following:
• The integrity and independence of the third party.
• Observing, or arranging for another auditor to observe, the physical
inventory count.
• Obtaining another auditor’s report on the adequacy of the third party’s
accounting and internal control systems for ensuring that inventory is
correctly counted and adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties, for
example, warehouse receipts, or obtaining confirmation from other parties
when such inventory has been pledged as collateral.
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
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ISA 501 (CONFORMED)5
Superceded by ISA 505—PART B (paragraphs 19-30) has been
deleted.
Procedures Inquiry Regarding Litigation and Claims
31. Litigation and claims involving an entity may have a material effect on the
financial statements and thus may be required to be disclosed and/or provided
for in the financial statements.
32. The auditor should carry out audit procedures in order to become aware
of any litigation and claims involving the entity which may result in have a
material misstatement of effect on the financial statements. Such
procedures would include the following:
• Make appropriate inquiries of management including obtaining
representations.
• Review board minutes of those charged with governance and
correspondence with the entity’s legal counsellawyers.
• Examine legal expense accounts.
• Use any information obtained regarding the entity’s business including
information obtained from discussions with any in-house legal
department.
33. When the auditor assesses a risk of material misstatement regarding
litigation or claims that have been identified or when the auditor believes
they may exist, the auditor should seek direct communication with the
entity’s legal counsellawyers. Such communication will assist in obtaining
sufficient appropriate audit evidence as to whether potentially material
litigation and claims are known and management’s estimates of the financial
implications, including costs, are reliable. When the auditor determines that the
risk of material misstatement is a significant risk, the auditor evaluates the
design of the entity’s related controls and determines whether they have been
implemented. Paragraphs 108-114 of ISA 315, “Understanding the Entity and
Assessing the Risks of Material Misstatement” provides further guidance on
the determination of significant risks.
34. The letter, which should be prepared by management and sent by the
auditor, should request the entity’s legal counsel lawyer to communicate
directly with the auditor. When it is considered unlikely that the entity’s
legal counsel lawyer will respond to a general inquiry, the letter would
ordinarily specify the following:
• A list of litigation and claims.
• Management’s assessment of the outcome of the litigation or claim and its
estimate of the financial implications, including costs involved.
AUDIT EVIDENCE—ADDITIONAL CONSIDERATIONS
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• A request that the entity’s legal counsel lawyer confirm the
reasonableness of management’s assessments and provide the auditor with
further information if the list is considered by the entity’s legal counsel
lawyer to be incomplete or incorrect.
35. The auditor considers the status of legal matters up to the date of the audit
report. In some instances, the auditor may need to obtain updated information
from entity’s legal counsellawyers.
36. In certain circumstances, for example, where the auditor determines that the
matter is a significant risk, the matter is complex or there is disagreement
between management and the entity’s legal counsellawyer, it may be necessary
for the auditor to meet with the entity’s legal counsel lawyer to discuss the
likely outcome of litigation and claims. Such meetings would take place with
management’s permission and, preferably, with a representative of
management in attendance.
37. If management refuses to give the auditor permission to communicate
with the entity’s legal counsellawyers, this would be a scope limitation and
should ordinarily lead to a qualified opinion or a disclaimer of opinion.
Where the entity’s legal counsel a lawyer refuses to respond in an appropriate
manner and the auditor is unable to obtain sufficient appropriate audit evidence
by applying alternative audit procedures, the auditor would consider whether
there is a scope limitation which may lead to a qualified opinion or a
disclaimer of opinion.
Valuation and Disclosure of Long-term Investments
38. When long-term investments are material to the financial statements, the
auditor should obtain sufficient appropriate audit evidence regarding
their valuation and disclosure.
39. Audit procedures regarding long-term investments ordinarily include obtaining
audit considering evidence as to whether the entity has the ability to continue
to hold the investments on a long term basis and discussing with management
whether the entity will continue to hold the investments as long-term
investments and obtaining written representations to that effect.
40. Other audit procedures would ordinarily include considering related financial
statements and other information, such as market quotations, which provide an
indication of value and comparing such values to the carrying amount of the
investments up to the date of the auditor’s report.
41. If such values do not exceed the carrying amounts, the auditor would consider
whether a write-down is required. If there is an uncertainty as to whether the
carrying amount will be recovered, the auditor would consider whether
appropriate adjustments and/or disclosures have been made.
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Segment Information
42. When segment information is material to the financial statements, the
auditor should obtain sufficient appropriate audit evidence regarding its
presentation and disclosure in accordance with the applicable identified
financial reporting framework.
43. The auditor considers segment information in relation to the financial statements
taken as a whole, and is not ordinarily required to apply auditing procedures that
would be necessary to express an opinion on the segment information standing
alone. However, the concept of materiality encompasses both quantitative and
qualitative factors and the auditor’s procedures recognize this.
44. Audit procedures regarding segment information ordinarily consist of
analytical procedures and other audit procedures as tests appropriate in the
circumstances.
45. The auditor would discuss with management the methods used in determining
segment information, and consider whether such methods are likely to result in
disclosure in accordance with the applicable financial reporting framework and
perform audit procedures over test the application of such methods. The
auditor would consider sales, transfers and charges between segments,
elimination of inter-segment amounts, comparisons with budgets and other
expected results, for example, operating profits as a percentage of sales, and
the allocation of assets and costs among segments including consistency with
prior periods and the adequacy of the disclosures with respect to
inconsistencies.