Advanced Audit and Assurance (International) · Evidence and testing considerations

Specific Audit Evidence: Inventory, Confirmations, Related Parties and Laws

Updated 11 October 2026 · Fact-checked

Specific audit evidence covers areas where ISAs demand particular procedures: attending inventory counts (ISA 501), external confirmations (ISA 505), related party identification and testing (ISA 550) and compliance with laws and regulations (ISA 250). In AAA you score by naming the procedure, linking it to the risk in the scenario and explaining why it gives reliable evidence.

Understand Specific Evidence: Inventory, Confirmations, Related Parties and Laws

Most audit evidence is general. Some areas carry higher risk or are hard to verify, so the ISAs give specific requirements. Four come up again and again: inventory, confirmations, related parties and laws and regulations.

Inventory (ISA 501). If inventory is material, the auditor must obtain sufficient appropriate evidence on its existence and condition. This usually means attending the physical count. At the count you observe management's instructions being followed, inspect the inventory, and perform test counts. Select items from the count sheets and agree them to the floor to test existence; select items from the floor and agree them to the count sheets to test completeness. The two-way test counts therefore also give evidence on completeness. You also note cut-off details and damaged or obsolete items. If attendance is impracticable, you perform alternative procedures. If you cannot obtain enough evidence, you have a scope limitation.

External confirmations (ISA 505). A confirmation is evidence obtained as a direct written response from a third party to the auditor. It is usually more reliable than internal evidence because it comes from outside the entity. The auditor keeps control over selecting, sending and receiving requests. Typical uses are receivables, bank balances, and inventory held by third parties. If management asks you not to confirm, you must ask why and seek evidence on the validity of the reasons. If management's refusal is unreasonable, or alternative procedures do not provide relevant and reliable evidence, you communicate with those charged with governance and determine the implications for the audit and the opinion under ISA 705. You also evaluate the effect on the assessed risks of material misstatement, including fraud risk.

Related parties (ISA 550). Related party transactions carry risk because they may not be on arm's length terms and may be hidden. The auditor must understand the entity's related party relationships and transactions, stay alert for undisclosed ones throughout the audit, and discuss the risk of fraud within the team. Where the financial statements include an assertion that a transaction was on arm's length terms, you obtain evidence to support that assertion. You also check that disclosure is adequate under the applicable framework. You obtain written representations on related parties and communicate significant related party matters to those charged with governance.

Laws and regulations (ISA 250). Management is responsible for compliance. The auditor is not responsible for preventing non-compliance and is not expected to detect all of it. The auditor must obtain a general understanding of the legal framework, perform specified procedures to identify non-compliance that may affect the financial statements (enquiry of management and those charged with governance, inspection of correspondence with regulators), obtain written representations, and respond to any suspected or identified non-compliance. Some laws have a direct effect on the financial statements, such as tax and pensions. Others do not, but compliance may be fundamental to the business or avoiding penalties.

Key rules to remember

ISA 501: inventory attendance: Observe instructions + inspect inventory + perform test counts (both directions) + cut-off and condition; If attendance is impracticable, perform alternative procedures. If still no evidence, consider a modified opinion.
Test count direction: Sheets to floor = existence; Floor to sheets = completeness; A frequent exam point. Do both.
ISA 505: control of confirmations: Auditor selects, sends, receives; management does not handle the request or reply; Non-response: perform alternative procedures, such as subsequent cash receipts for receivables.
ISA 550: core requirements: Understand relationships → identify transactions → assess risk → obtain evidence on any arm's length assertion made in the financial statements → check disclosure → obtain written representations → communicate significant matters to those charged with governance; Treat identified significant related party transactions outside the normal course of business as significant risks. Obtain evidence about arm's length terms only where the financial statements include such an assertion.
ISA 250: auditor's approach: Understand framework → enquire → inspect regulator correspondence → obtain representations → respond to non-compliance; Distinguish laws with a direct effect on the financial statements from those without.

How to solve Specific Evidence: Inventory, Confirmations, Related Parties and Laws questions

Use this approach for any scenario question on specific evidence. It keeps you on the requirement and earns professional skills marks.

1Read the requirement. Decide whether it asks for risks, procedures, implications or a report to someone.
2Identify which area applies: inventory, confirmations, related parties, or laws and regulations. Some scenarios mix them.
3Pick the scenario facts that matter, such as a large inventory balance, a new director, a regulator letter or a blocked confirmation.
4Link each procedure to a specific risk or assertion. Say what you do, then why it gives evidence.
5State what you do if the evidence is not obtained: alternative procedures, then the effect on the opinion.
6Add the communication or reporting point: management, those charged with governance, or the regulator where required.
7Conclude briefly on the effect on the audit and the opinion. Keep the answer sized to the marks.

Quickest way: Area, risk, procedure, fallback

When to use it: Use when time is short and the question lists several issues in one scenario.

Write a one-word label for each issue: inventory, confirmation, related party, law.
Under each label write the risk from the scenario in a short phrase.
Add two or three procedures per issue, each with its purpose.
Add the fallback: alternative procedures or modified opinion.
Finish each issue with who you tell.

Common mistakes in Specific Evidence: Inventory, Confirmations, Related Parties and Laws

Listing generic count steps without using the scenario facts.
Students memorise a checklist and recite it.
Fix: Tie each step to a fact, such as high-value items, third-party locations or a new count system.
Saying the auditor counts the inventory for the client.
Confusion between the auditor's role and management's responsibility.
Fix: Management counts. You observe, inspect and test count. Your evidence supports existence and condition.
Letting management send or collect confirmation requests.
It seems efficient.
Fix: State that the auditor controls the process. Management involvement weakens reliability.
Accepting management's statement that a transaction is arm's length without evidence.
Students treat management representations as sufficient.
Fix: Obtain independent evidence, such as market prices, valuations or comparable contracts.
Saying the auditor must detect all non-compliance.
Mixing up auditor and management responsibilities.
Fix: State that management is responsible. The auditor performs specified procedures and responds to what is found or suspected.
Forgetting the opinion consequence when evidence cannot be obtained.
Focus stays on procedures.
Fix: Always end with the effect: scope limitation and a qualified or disclaimed opinion if the effect is material or pervasive.

Worked examples

Example 1

You are the audit senior on a manufacturer with a material inventory balance held at three warehouses. One warehouse is overseas and the client says you cannot attend its count. Explain the procedures you would perform and the effect if you cannot obtain enough evidence. (10 marks style)

Show the solution

Inventory is material, so ISA 501 requires evidence on existence and condition. Attendance at the count is the normal approach.
At the two accessible warehouses, observe whether staff follow count instructions, inspect items for damage or obsolescence, and perform test counts in both directions. Select items from the count sheets and agree them to the floor to test existence. Select items from the floor and agree them to the count sheets to test completeness.
Record cut-off details, including the last goods received and dispatched numbers, so you can test cut-off later.
For the overseas warehouse, first ask why attendance is impracticable. Consider whether a component auditor or another firm office could attend, with proper instructions and review of their work.
If nobody can attend, perform alternative procedures: for example, a count at a later date with roll-back to the year end through sales and purchases records, or inspect documents for goods received and dispatched, and consider a confirmation from the warehouse if held by a third party.
Evaluate whether the alternative evidence is sufficient and appropriate.
If not sufficient, there is a scope limitation. Modify the opinion: qualified if the possible effect is material but not pervasive, disclaimer if pervasive. Tell those charged with governance.

Answer: Attend the accessible counts and perform observation, inspection and two-way test counts (sheets to floor for existence, floor to sheets for completeness). For the overseas site use another attender or alternative procedures such as a later count with roll-back. If evidence remains insufficient, issue a modified opinion for scope limitation (qualified or disclaimer depending on pervasiveness).

Example 2

During the audit of a trading company you notice a large sale to a company owned by the finance director's spouse. It is not in the related party list. The sale was made on 90 days' credit. Explain the audit implications and procedures. (8 marks style)

Show the solution

Under ISA 550 a transaction with an entity controlled by a close family member of key management is a related party transaction. It has been omitted from the list, so there is a risk of incomplete identification and disclosure.
The finance director is involved, so there is also a fraud risk and a scepticism point. Raise it with the audit team and consider whether other undisclosed relationships exist.
Enquire of management and those charged with governance about the relationship. Do not rely only on the finance director's answer.
Obtain the contract and approvals. If the financial statements assert that the sale was on arm's length terms, test that assertion by comparing price and credit terms with sales to unrelated customers or market evidence.
Check recoverability of the receivable: send a confirmation, test post year end cash receipts and review the customer's ability to pay.
Check disclosure in the financial statements: nature of the relationship, amount, balance outstanding and terms.
If management will not disclose, the financial statements are materially misstated. Give a qualified ('except for') opinion if the misstatement is material but not pervasive. Give an adverse opinion only if it is material and pervasive. Where practicable, include the omitted information in the basis for modification paragraph of the report. Communicate with those charged with governance.

Answer: Treat the sale as an undisclosed related party transaction and a possible fraud indicator. Enquire widely, test any arm's length assertion, confirm and test recoverability of the balance, and check disclosure. If disclosure is refused, issue a qualified ('except for') opinion, or an adverse opinion only if the misstatement is material and pervasive. Give the omitted information in the report where practicable and report to those charged with governance.

Exam tips

Always give the purpose of each procedure. Marks are usually for procedure plus reason.
Use the scenario's facts: who is involved, the amounts, and the dates. Generic lists score poorly.
When a confirmation is not returned, state the alternative procedure and say what it proves.
For laws and regulations, state first that management is responsible, then describe what the auditor does.
Finish with the consequence for the report. Professional skills marks reward a clear conclusion and sensible communication.

Practice questions from Evidence and testing considerations

Specific Evidence: Inventory, Confirmations, Related Parties and Laws in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

ACCA Applied SkillsSpecific Evidence: Inventory, Receivables and Estimates

Specific Evidence: Inventory, Confirmations, Related Parties and Laws: frequently asked questions

Must the auditor always attend the inventory count?

If inventory is material, ISA 501 requires you to attend unless it is impracticable. If you cannot attend, you perform alternative procedures to get sufficient appropriate evidence. If you still cannot, you have a scope limitation.

Why are external confirmations considered reliable?

They come directly from a third party, outside the entity's control. The auditor controls the request and the reply, so the risk of manipulation is lower. Reliability still depends on the respondent's competence and independence.

What should I do if management refuses to let me send a confirmation?

Ask why and seek evidence that the reasons are valid. If they are valid, perform alternative procedures. If the refusal is unreasonable, or alternative procedures do not give reliable evidence, communicate with those charged with governance. Evaluate the implications for the assessed risks of material misstatement, including fraud risk, and determine the effect on the audit and the opinion under ISA 705.

Is the auditor responsible for detecting all non-compliance with laws?

No. Management and those charged with governance are responsible for compliance. The auditor performs specified procedures and responds to non-compliance that is identified or suspected, especially where it affects the financial statements.