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SA 501 Specific Items

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SA 501*
Audit Evidence - Specific Considerations
for Selected Items
(Effective for audits of financial statements for periods
beginning on or after April 1, 2010)

Contents
Paragraph(s)
Introduction
Scope of this SA ....................................................................................... 1
Effective Date ........................................................................................... 2
Objective ................................................................................................. 3
Requirements
Inventory ............................................................................................... 4-8
Litigation and Claims ........................................................................... 9-12
Segment Information .............................................................................. 13
Application and Other Explanatory Material
Inventory ........................................................................................ A1-A16
Litigation and Claims .................................................................... A17-A25
Segment Information .................................................................... A26-A27
Modifications vis-a-vis ISA 501, “Audit Evidence—Specific
Considerations for Selected Items”

Standard on Auditing (SA) 501, “Audit Evidence—Specific
Considerations for Selected Items” should be read in the context of the
“Preface to the Standards on Quality Control, Auditing, Review, Other
Assurance and Related Services”, which sets out the authority of SAs
and SA 200, “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”.

* Published in March, 2010 issue of the Journal.
Handbook of Auditing Pronouncements-I.A

Introduction
Scope of this SA
1. This Standard on Auditing (SA) deals with specific considerations by
the auditor in obtaining sufficient appropriate audit evidence in accordance with
SA 3301, SA 5002 and other relevant SAs, with respect to certain aspects of
inventory, litigation and claims involving the entity, and segment information in an
audit of financial statements.
Effective Date
2. This SA is effective for audits of financial statements for periods beginning
on or after April 1, 2010.

Objective
3. The objective of the auditor is to obtain sufficient appropriate audit
evidence regarding the:
(a) Existence and condition of inventory;

(b) Completeness of litigation and claims involving the entity; and
(c) Presentation and disclosure of segment information in accordance with the
applicable financial reporting framework.

Requirements
Inventory
4. When inventory is material to the financial statements, the auditor shall
obtain sufficient appropriate audit evidence regarding the existence and condition
of inventory by:
(a) Attendance at physical inventory counting, unless impracticable, to: (Ref:
Para. A1-A3)
(i) Evaluate management’s instructions and procedures for recording
and controlling the results of the entity’s physical inventory counting;
(Ref: Para. A4)

1 SA 330, “The Auditor’s Responses to Assessed Risks”.
2 SA 500, “Audit Evidence”.

SA 501 2
(ii) Observe the performance of management’s count procedures; (Ref:
Para. A5)
(iii) Inspect the inventory; and (Ref: Para. A6)
(iv) Perform test counts; and (Ref: Para. A7-A8)
(b) Performing audit procedures over the entity’s final inventory records to
determine whether they accurately reflect actual inventory count results.
5. If physical inventory counting is conducted at a date other than the date of
the financial statements, the auditor shall, in addition to the procedures required
by paragraph 4, perform audit procedures to obtain audit evidence about whether
changes in inventory between the count date and the date of the financial
statements are properly recorded. (Ref: Para. A9-A11)
6. If the auditor is unable to attend physical inventory counting due to
unforeseen circumstances, the auditor shall make or observe some physical
counts on an alternative date, and perform audit procedures on intervening
transactions.
7. If attendance at physical inventory counting is impracticable, the auditor
shall perform alternative audit procedures to obtain sufficient appropriate audit
evidence regarding the existence and condition of inventory. If it is not possible to
do so, the auditor shall modify the opinion in the auditor’s report in accordance
with SA 705(Revised)3. (Ref: Para. A12-A14)
8. When inventory under the custody and control of a third party is material to
the financial statements, the auditor shall obtain sufficient appropriate audit
evidence regarding the existence and condition of that inventory by performing
one or both of the following:
(a) Request confirmation from the third party as to the quantities and condition
of inventory held on behalf of the entity. (Ref: Para. A15)
(b) Perform inspection or other audit procedures appropriate in the
circumstances. (Ref: Para. A16)
Litigation and Claims
9. The auditor shall design and perform audit procedures in order to identify
litigation and claims involving the entity which may give rise to a risk of material
misstatement, including: (Ref: Para. A17-A19)

3 SA 705(Revised), “Modifications to the Opinion in the Independent Auditor’s Report”.

3 SA 501
Handbook of Auditing Pronouncements-I.A

(a) Inquiry of management and, where applicable, others within the entity,
including in-house legal counsel;
(b) Reviewing minutes of meetings of those charged with governance and
correspondence between the entity and its external legal counsel; and
(c) Reviewing legal expense accounts. (Ref: Para. A20)
10. If the auditor assesses a risk of material misstatement regarding litigation
or claims that have been identified, or when audit procedures performed indicate
that other material litigation or claims may exist, the auditor shall, in addition to the
procedures required by other SAs, seek direct communication with the entity’s
external legal counsel. The auditor shall do so through a letter of inquiry, prepared
by management and sent by the auditor, requesting the entity’s external legal
counsel to communicate directly with the auditor. If law, regulation or the
respective legal professional body prohibits the entity’s external legal counsel
from communicating directly with the auditor, the auditor shall perform alternative
audit procedures. (Ref: Para. A21-A25)
11. If:
(a) management refuses to give the auditor permission to communicate or
meet with the entity’s external legal counsel, or the entity’s external legal
counsel refuses to respond appropriately to the letter of inquiry, or is
prohibited from responding; and
(b) the auditor is unable to obtain sufficient appropriate audit evidence by
performing alternative audit procedures, the auditor shall modify the opinion
in the auditor’s report in accordance with SA 705(Revised).
Written Representations
12. The auditor shall request management and, where appropriate, those
charged with governance to provide written representations that all known actual
or possible litigation and claims whose effects should be considered when
preparing the financial statements have been disclosed to the auditor and
appropriately accounted for and disclosed in accordance with the applicable
financial reporting framework.
Segment Information
13. The auditor shall obtain sufficient appropriate audit evidence regarding the
presentation and disclosure of segment information in accordance with the
applicable financial reporting framework by: (Ref: Para. A26)

SA 501 4
(a) Obtaining an understanding of the methods used by management in
determining segment information, and: (Ref: Para. A27)
(i) Evaluating whether such methods are likely to result in disclosure in
accordance with the applicable financial reporting framework; and
(ii) Where appropriate, testing the application of such methods; and
(b) Performing analytical procedures or other audit procedures appropriate in
the circumstances.
***
Application and Other Explanatory Material
Inventory
Attendance at Physical Inventory Counting (Ref: Para. 4(a))
A1. 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 and, if applicable, to ascertain the reliability of the entity’s
perpetual inventory system.
A2. Attendance at physical inventory counting involves:
 Inspecting the inventory to ascertain its existence and evaluate its
condition, and performing test counts;
 Observing compliance with management’s instructions and the
performance of procedures for recording and controlling the results of the
physical inventory count; and
 Obtaining audit evidence as to the reliability of management’s count
procedures.
These procedures may serve as test of controls or substantive procedures
depending on the auditor’s risk assessment, planned approach and the specific
procedures carried out.
A3. Matters relevant in planning attendance at physical inventory counting (or
in designing and performing audit procedures pursuant to paragraphs 4-8 of this
SA) include, for example:
 Nature of inventory.
 Stages of completion of work in progress.
 The risks of material misstatement related to inventory.

5 SA 501
Handbook of Auditing Pronouncements-I.A

 The nature of the internal control related to inventory.
 Whether adequate procedures are expected to be established and proper
instructions issued for physical inventory counting.
 The timing of physical inventory counting.
 Whether the entity maintains a perpetual inventory system.
 The locations at which inventory is held, including the materiality of the
inventory and the risks of material misstatement at different locations, in
deciding at which locations attendance is appropriate. SA 600, “Using the
Work of Another Auditor” deals with the involvement of other auditors and
accordingly may be relevant if such involvement is with regards to
attendance of physical inventory counting at a remote location.
 Whether the assistance of an auditor’s expert is needed. SA 6204 deals
with the use of an auditor’s expert to assist the auditor to obtain sufficient
appropriate audit evidence.
Evaluate Management’s Instructions and Procedures (Ref: Para. 4(a)(i))
A4. Matters relevant in evaluating management’s instructions and procedures
for recording and controlling the physical inventory counting include whether they
address, for example:
 The application of appropriate control activities, for example, collection of
used physical inventory count records, accounting for unused physical
inventory count records, and count and re-count procedures.
 The 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.
 The procedures used to estimate physical quantities, where applicable,
such as may be needed in estimating the physical quantity of a coal pile.
 Control over the movement of inventory between areas and the shipping
and receipt of inventory before and after the cut off date.
Observe the Performance of Management’s Count Procedures (Ref: Para.
4(a)(ii))
A5. Observing the performance of management’s count procedures, for
example those relating to control over the movement of inventory before, during
and after the count, assists the auditor in obtaining audit evidence that
management’s instructions and count procedures are adequately designed and
implemented. In addition, the auditor may obtain copies of cut off information,

4 SA 620, “Using the Work of an Auditor’s Expert”.

SA 501 6
such as details of the movement of inventory, to assist the auditor in performing
audit procedures over the accounting for such movements at a later date.
Inspect the Inventory (Ref: Para. 4(a)(iii))
A6. Inspecting inventory when attending physical inventory counting assists
the auditor in ascertaining the existence of the inventory (though not necessarily
its ownership), and in identifying, for example, obsolete, damaged or ageing
inventory.
Perform Test Counts (Ref: Para. 4(a)(iv))
A7. Performing test counts, for example by tracing items selected from
management’s count records to the physical inventory and tracing items selected
from the physical inventory to management’s count records, provides audit
evidence about the completeness and the accuracy of those records.
A8. In addition to recording the auditor’s test counts, obtaining copies of
management’s completed physical inventory count records assists the auditor in
performing subsequent audit procedures to determine whether the entity’s final
inventory records accurately reflect actual inventory count results.
Physical Inventory Counting Conducted Other than At the Date of the
Financial Statements (Ref: Para. 5)
A9. For practical reasons, the physical inventory counting may be conducted at
a date, or dates, other than the date of the financial statements. This may be done
irrespective of whether management determines inventory quantities by an annual
physical inventory counting or maintains a perpetual inventory system. In either
case, the effectiveness of the design, implementation and maintenance of controls
over changes in inventory determines whether the conduct of physical inventory
counting at a date, or dates, other than the date of the financial statements is
appropriate for audit purposes. SA 330 establishes requirements and provides
guidance on substantive procedures performed at an interim date5.
A10. Where a perpetual inventory system is maintained, management may
perform physical counts or other tests to ascertain the reliability of inventory
quantity information included in the entity’s perpetual inventory records. In some
cases, management or the auditor may identify differences between the perpetual
inventory records and actual physical inventory quantities on hand; this may
indicate that the controls over changes in inventory are not operating effectively.
A11. Relevant matters for consideration when designing audit procedures to
obtain audit evidence about whether changes in inventory amounts between the

5 SA 330, paragraphs 22-23.

7 SA 501
Handbook of Auditing Pronouncements-I.A

count date, or dates, and the final inventory records are properly recorded include:
 Whether the perpetual inventory records are properly adjusted.
 Reliability of the entity’s perpetual inventory records.
 Reasons for significant differences between the information obtained during
the physical count and the perpetual inventory records.
Attendance at Physical Inventory Counting Is Impracticable (Ref: Para. 7)
A12. In some cases, attendance at physical inventory counting may be
impracticable. This may be due to factors such as the nature and location of the
inventory, for example, where inventory is held in a location that may pose threats
to the safety of the auditor. The matter of general inconvenience to the auditor,
however, is not sufficient to support a decision by the auditor that attendance is
impracticable. Further, as explained in SA 2006, the matter of difficulty, time, or
cost involved is not in itself a valid basis for the auditor to omit an audit procedure
for which there is no alternative or to be satisfied with audit evidence that is less
than persuasive.
A13. In some cases where attendance is impracticable, alternative audit
procedures, for example inspection of documentation of the subsequent sale of
specific inventory items acquired or purchased prior to the physical inventory
counting, may provide sufficient appropriate audit evidence about the existence
and condition of inventory.
A14. In other cases, however, it may not be possible to obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by
performing alternative audit procedures. In such cases, SA 705(Revised) requires
the auditor to modify the opinion in the auditor’s report as a result of the scope
limitation7.
Inventory under the Custody and Control of a Third Party
Confirmation (Ref: Para. 8(a))
A15. SA 5058 establishes requirements and provides guidance for performing
external confirmation procedures.
Other Audit Procedures (Ref: Para. 8(b))
A16. Depending on the circumstances, for example where information is
obtained that raises doubt about the integrity and objectivity of the third party, the

6 SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance

with Standards on Auditing”, paragraph A48.
7 SA 705(Revised), paragraph 13.
8 SA 505, “External Confirmations”.

SA 501 8
auditor may consider it appropriate to perform other audit procedures instead of,
or in addition to, confirmation with the third party. Examples of other audit
procedures include:
 Attending, or arranging for another auditor to attend, the third party’s
physical counting of inventory, if practicable.
 Obtaining another auditor’s report, or a service auditor’s report, on the
adequacy of the third party’s internal control for ensuring that inventory is
properly counted and adequately safeguarded.
 Inspecting documentation regarding inventory held by third parties, for
example, warehouse receipts.
 Requesting confirmation from other parties when inventory has been
pledged as collateral.
Litigation and Claims
Completeness of Litigations and Claims (Ref: Para. 9)
A17. Litigation and claims involving the entity may have a material effect on the
financial statements and thus may be required to be disclosed or accounted for in
the financial statements.
A18. In addition to the procedures identified in paragraph 9, other relevant
procedures include, for example, using information obtained through risk
assessment procedures carried out as part of obtaining an understanding of the
entity and its environment to assist the auditor to become aware of litigation and
claims involving the entity.
A19. Audit evidence obtained for purposes of identifying litigation and claims
that may give rise to a risk of material misstatement also may provide audit
evidence regarding other relevant considerations, such as valuation or
measurement, regarding litigation and claims. SA 5409 establishes requirements
and provides guidance relevant to the auditor’s consideration of litigation and
claims requiring accounting estimates or related disclosures in the financial
statements.
Reviewing Legal Expense Accounts (Ref: Para. 9(c))
A20. Depending on the circumstances, the auditor may judge it appropriate to
examine related source documents, such as invoices for legal expenses, as part
of the auditor’s review of legal expense accounts.

9 SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related

Disclosures”.

9 SA 501
Handbook of Auditing Pronouncements-I.A

Communication with the Entity’s External Legal Counsel (Ref: Para. 10-11)
A21. Direct communication with the entity’s external legal counsel assists the
auditor 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 reasonable.

A22. In some cases, the auditor may seek direct communication with the entity’s
external legal counsel through a letter of general inquiry. For this purpose, a letter
of general inquiry requests the entity’s external legal counsel to inform the auditor
of any litigation and claims that the counsel is aware of, together with an
assessment of the outcome of the litigation and claims, and an estimate of the
financial implications, including costs involved.
A23. If it is considered unlikely that the entity’s external legal counsel will
respond appropriately to a letter of general inquiry, for example if the professional
body to which the external legal counsel belongs prohibits response to such a
letter, the auditor may seek direct communication through a letter of specific
inquiry. For this purpose, a letter of specific inquiry includes:
(a) A list of litigation and claims;
(b) Where available, management’s assessment of the outcome of each of
the identified litigation and claims and its estimate of the financial
implications, including costs involved; and
(c) A request that the entity’s external legal counsel confirm the
reasonableness of management’s assessments and provide the auditor
with further information if the list is considered by the entity’s external legal
counsel to be incomplete or incorrect.
A24. In certain circumstances, the auditor also may judge it necessary to meet
with the entity’s external legal counsel to discuss the likely outcome of the
litigation or claims. This may be the case, for example, where:
 The auditor determines that the matter is a significant risk.
 The matter is complex.
 There is disagreement between management and the entity’s external legal
counsel. Ordinarily, such meetings require management’s permission and
are held with a representative of management in attendance.
A25. In accordance with SA 700(Revised)10, the auditor is required to date the

10 SA 700(Revised), “Forming an Opinion and Reporting on Financial Statements”, paragraph 48.

SA 501 10
auditor’s report no earlier than the date on which the auditor has obtained
sufficient appropriate audit evidence on which to base the auditor’s opinion on the
financial statements. Audit evidence about the status of litigation and claims up to
the date of the auditor’s report may be obtained by inquiry of management,
including in-house legal counsel, responsible for dealing with the relevant matters.
In some instances, the auditor may need to obtain updated information from the
entity’s external legal counsel.
Segment Information (Ref: Para. 13)
A26. Depending on the applicable financial reporting framework, the entity may
be required or permitted to disclose segment information in the financial
statements. The auditor’s responsibility regarding the presentation and disclosure
of segment information is in relation to the financial statements taken as a whole.
Accordingly, the auditor is not required to perform audit procedures that would be
necessary to express an opinion on the segment information presented on a
stand alone basis.
Understanding of the Methods Used by Management (Ref: Para. 13(a))
A27. Depending on the circumstances, example of matters that may be relevant
when obtaining an understanding of the methods used by management in
determining segment information and whether such methods are likely to result in
disclosure in accordance with the applicable financial reporting framework include:
 Sales, transfers and charges between segments, and elimination of inter-
segment amounts.
 Comparisons with budgets and other expected results, for example,
operating profits as a percentage of sales.
 The allocation of assets and costs among segments.
 Consistency with prior periods, and the adequacy of the disclosures with
respect to inconsistencies.
Modifications vis-a-vis ISA 501, “Audit Evidence—Specific
Considerations for Selected Items”
SA 501, “Audit Evidence—Specific Considerations for Selected Items” does not
contain any modifications vis-à-vis ISA 501.

11 SA 501