HKSA 501 - Audit Evidence - Specific Considerations

HKSA 501 - Audit Evidence - Specific Considerations for Selected Items

Overview and Scope

HKSA 501 (Hong Kong Standard on Auditing 501) deals with specific considerations by the auditor in obtaining sufficient appropriate audit evidence in accordance with HKSA 330, HKSA 500, and other relevant HKSAs, with respect to certain aspects of:

Inventory - Existence and condition

Litigation and Claims - Completeness

Segment Information - Presentation and disclosure

Effective Date: Audits of financial statements for periods beginning on or after 15 December 2009.

Latest Revision: March 2025

Objective (Paragraph 3)

The objective of the auditor is to obtain sufficient appropriate audit evidence regarding:

Area	Specific Focus
(a) Inventory	Existence and condition
(b) Litigation and Claims	Completeness of litigation and claims involving the entity
(c) Segment Information	Presentation and disclosure in accordance with the applicable financial reporting framework

REQUIREMENTS - INVENTORY (Paragraphs 4-8)

Paragraph 4 - Attendance at Physical Inventory Counting

If 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:

Procedure	Description	Reference
(i) Evaluate	Management's instructions and procedures for recording and controlling the results of the entity's physical inventory counting	Para. A4
(ii) Observe	The performance of management's count procedures	Para. A5
(iii) Inspect	The inventory	Para. A6
(iv) Perform test counts	Test counts to verify accuracy	Para. A7-A8

(b) Performing audit procedures over the entity's final inventory records to determine whether they accurately reflect actual inventory count results.

Paragraph 5 - Counting at a Date Other Than Financial Statement Date

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)

Paragraph 6 - Unforeseen Circumstances Preventing Attendance

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

Paragraph 7 - Attendance Impracticable

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 HKSA 705 (Revised) (Ref: Para. A12-A14)

Paragraph 8 - Inventory Under Custody and Control of a Third Party

If 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)

REQUIREMENTS - LITIGATION AND CLAIMS (Paragraphs 9-12)

Paragraph 9 - Procedures to Identify Litigation and Claims

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:

Procedure	Description	Reference
(a) Inquiry	Of management and, where applicable, others within the entity, including in-house legal counsel	Para. A17-A19
(b) Review	Minutes of meetings of those charged with governance AND correspondence between the entity and its external legal counsel	Para. A17-A19
(c) Review	Legal expense accounts	Para. A20

Paragraph 10 - Direct Communication with External Legal Counsel

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 HKSAs:

Seek direct communication with the entity's external legal counsel

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)

Paragraph 11 - Refusal or Inability to Communicate

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 HKSA 705 (Revised).

Paragraph 12 - Written Representations

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 accounted for and disclosed in accordance with the applicable financial reporting framework.

REQUIREMENTS - SEGMENT INFORMATION (Paragraph 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:

(a) Obtaining an understanding of the methods used by management in determining segment information, AND:

(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 (Ref: Para. A27)

(b) Performing analytical procedures or other audit procedures appropriate in the circumstances (Ref: Para. A26)

APPLICATION AND OTHER EXPLANATORY MATERIAL

INVENTORY - Detailed Guidance

Attendance at Physical Inventory Counting (Ref: Para. 4(a)) - A1 to A3

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

- Obtaining audit evidence as to the reliability of management's count procedures

These procedures may serve as tests 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 include:

Matter	Description
Risks of material misstatement	Related to inventory
Nature of internal control	Related to inventory
Adequacy of procedures	Whether adequate procedures are expected to be established and proper instructions issued
Timing	Of physical inventory counting
Perpetual inventory system	Whether the entity maintains one
Locations	Where inventory is held, including materiality and risks at different locations
Auditor's expert	Whether assistance is needed (HKSA 620)

Evaluate Management's Instructions and Procedures (Ref: Para. 4(a)(i)) - A4

Matters relevant in evaluating management's instructions and procedures include whether they address:

Application of appropriate controls - e.g., collection of used physical inventory count records, accounting for unused records, count and re-count procedures

Accurate identification of:

Stage of completion of work in progress

Slow moving, obsolete or damaged items

Inventory owned by a third party (e.g., on consignment)

Procedures to estimate physical quantities where applicable (e.g., estimating physical quantity of a coal pile)

Control over movement of inventory between areas and the shipping and receipt of inventory before and after the cutoff date

Observe the Performance of Management's Count Procedures (Ref: Para. 4(a)(ii)) - A5

Observing the performance of management's count procedures assists the auditor in obtaining audit evidence that management's instructions and count procedures are adequately designed and implemented. The auditor may obtain copies of cutoff information, such as details of the movement of inventory, to assist 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)

Identifying obsolete, damaged or aging inventory

Perform Test Counts (Ref: Para. 4(a)(iv)) - A7 to A8

A7: Performing test counts provides audit evidence about the completeness and accuracy of those records by:

Tracing items selected from management's count records to the physical inventory

Tracing items selected from the physical inventory to management's count 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 to A11

A9: For practical reasons, physical inventory counting may be conducted at a date, or dates, other than the date of the financial statements. The effectiveness of the design, implementation and maintenance of controls over changes in inventory determines whether this is appropriate for audit purposes.

A10: Where a perpetual inventory system is maintained, management may perform physical counts or other tests to ascertain the reliability of inventory quantity information. Differences between perpetual inventory records and actual physical quantities may indicate that controls over changes in inventory are not operating effectively.

A11: Relevant matters when designing audit procedures to obtain audit evidence about whether changes in inventory amounts between the count date and the final inventory records are properly recorded include:

Matter	Description
Perpetual inventory records	Whether properly adjusted
Reliability	Of the entity's perpetual inventory records
Significant differences	Reasons for differences between physical count and perpetual records

Attendance at Physical Inventory Counting Is Impracticable (Ref: Para. 7) - A12 to A14

A12: Attendance may be impracticable due to factors such as the nature and location of the inventory (e.g., inventory held in a location that may pose threats to the safety of the auditor). However:

- General inconvenience is NOT sufficient to support a decision that attendance is impracticable

- Difficulty, time, or cost involved is NOT in itself a valid basis to omit an audit procedure for which there is no alternative or to be satisfied with less than persuasive audit evidence

A13: Alternative audit procedures may include inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting.

A14: If it is not possible to obtain sufficient appropriate audit evidence through alternative procedures, HKSA 705 (Revised) requires the auditor to modify the opinion due to a scope limitation.

Inventory under the Custody and Control of a Third Party - A15 to A16

A15 (Confirmation): HKSA 505 establishes requirements and provides guidance for performing external confirmation procedures.

A16 (Other Audit Procedures): Depending on circumstances (e.g., where information raises doubt about the integrity and objectivity of the third party), the auditor may consider other audit procedures:

Procedure	Description
Attend third party's physical counting	Or arrange for another auditor to attend, if practicable
Obtain another auditor's report	Or a service auditor's report on the adequacy of the third party's internal control
Inspect documentation	Regarding inventory held by third parties (e.g., warehouse receipts)
Request confirmation from other parties	When inventory has been pledged as collateral

LITIGATION AND CLAIMS - Detailed Guidance

Completeness of Litigations and Claims (Ref: Para. 9) - A17 to A19

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.

A18: Other relevant procedures include using information obtained through risk assessment procedures carried out as part of obtaining an understanding of the entity and its environment.

A19: Audit evidence obtained for identifying litigation and claims may also provide audit evidence regarding other relevant considerations, such as valuation or measurement. HKSA 540 (Revised) establishes requirements relevant to accounting estimates or related disclosures.

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.

Communication with the Entity's External Legal Counsel (Ref: Para. 10-11) - A21 to A25

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

Management's estimates of the financial implications, including costs, are reasonable

A22 - Letter of General Inquiry: Requests the entity's external legal counsel to inform the auditor of:

Any litigation and claims the counsel is aware of

An assessment of the outcome

An estimate of the financial implications, including costs

A23 - Letter of Specific Inquiry: If it is considered unlikely that external legal counsel will respond appropriately to a letter of general inquiry (e.g., if the professional body prohibits response), the auditor may seek direct communication through a letter of specific inquiry, which includes:

(a) A list of litigation and claims

(b) Where available, management's assessment of the outcome and estimate of financial implications, including costs

(c) A request that external legal counsel confirm the reasonableness of management's assessments and provide further information if the list is considered incomplete or incorrect

A23-1 - Hong Kong Specific Guidance: The following form of wording, appropriate to specific enquiries, has been agreed with the Council of the Law Society of Hong Kong:

"In connection with the preparation and audit of our accounts for the year ended ...... the directors have made estimates of the amounts of the ultimate liabilities (including costs) which might be incurred, and are regarded as material, in relation to the following matters on which you have been consulted. We should be obliged if you would confirm that in your opinion these estimates are reasonable.

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Matter Estimated liability including costs"

A23-2: The Council of the HKICPA understands the reasons for the view of the Council of the Law Society of Hong Kong regarding non-specific enquiries, but nevertheless believes there may be circumstances in which it is necessary as an audit procedure for an enquiry of a general nature to be addressed to external legal counsel to confirm that the information provided by the directors is complete in all material particulars.

A23-3: It may be necessary for the auditor to make reference to local requirements if making enquiries of overseas external legal counsel, as different forms of wording for the enquiry letter might have been agreed between local professional accountants and legal counsel associations.

A24: The auditor may judge it necessary to meet with the entity's external legal counsel to discuss the likely outcome, for example where:

The auditor determines that the matter is a significant risk

The matter is complex

There is disagreement between management and external legal counsel

Ordinarily, such meetings require management's permission and are held with a representative of management in attendance.

A25: In accordance with HKSA 700 (Revised), the auditor is required to date the auditor's report no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence. 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. In some instances, the auditor may need to obtain updated information from the entity's external legal counsel.

SEGMENT INFORMATION - Detailed Guidance (Ref: Para. 13) - A26 to A27

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 standalone basis.

A27: Examples of matters that may be relevant when obtaining an understanding of the methods used by management in determining segment information include:

Matter	Description
Sales, transfers and charges between segments	And elimination of inter-segment amounts
Comparisons with budgets and other expected results	E.g., operating profits as a percentage of sales
Allocation of assets and costs among segments	How these are determined
Consistency with prior periods	And adequacy of disclosures with respect to inconsistencies

Conformity and Compliance (Paragraphs 14-15)

Paragraph 14: As of March 2025, this HKSA conforms with ISA 501, Audit Evidence—Specific Considerations for Selected Items. Compliance with the requirements of this HKSA ensures compliance with ISA 501.

Paragraph 15: Additional local guidance is provided in footnote 10a and paragraphs A23-1, A23-2 and A23-3.

Key Takeaways Summary Table

Area	Key Requirements	Key Considerations
Inventory	Attend physical counting; evaluate instructions; observe procedures; inspect; perform test counts	Materiality; impracticability; third-party custody; alternative procedures
Litigation & Claims	Inquire management; review minutes & correspondence; review legal expense accounts; direct communication with external legal counsel	Completeness; risk of material misstatement; written representations; modification of opinion
Segment Information	Understand methods used; evaluate methods; test application; perform analytical procedures	Financial statements as a whole; not standalone opinion