Auditing and Assurance Principles

Audit Objectives, Procedures, Evidences and Documentation

Objectives:
1. Explain the relationship between audit risk, audit evidence, and financial statement assertions.
2. Identify and explain the components of audit risk
3. Distinguish between the concepts of sufficient and appropriate as they apply to audit evidence.
4. List and describe types of audit procedures.
5. Describe the purposes of audit documentation.
6. Identify matters that should be included in audit working papers.

Introduction
Using the information obtained in audit planning and consideration of internal control, the auditor
performs substantive test to determine whether the entity’s financial statements are presented fairly in
accordance with financial reporting standards. These procedures involve examination of the documents and
evidence supporting the amounts and disclosures in the financial statements.

The extent of the substantive tests is highly dependent on the results of the auditor’s consideration of
internal control. If based on the internal control, the auditor has obtained evidence that the internal control
is functioning effectively, the scope of the auditor’s substantive tests can be reduced. Otherwise, if it is weak,
the auditor will compensate for his weakness by performing more extensive substantive procedures.

The decision about which audit procedures to use is based on the auditor’s judgment about the
expected effectiveness and efficiency of such procedures in satisfying the audit objective.

In this module, we will learn about the relevant considerations affecting auditor’s judgment in
obtaining audit evidence.

Analysis
1. Describe the relationship between detection risk and audit risk.
2. Can the auditors reduce inherent risk by performing audit procedures?
3. What are audit objectives?
4. What are assertions?
5. What are the types of audit procedures?
6. Distinguish among routine, nonroutine, and estimation transactions.
7. When in the course of an audit might the auditor find it useful to apply analytical procedures?
8. What are related party transactions?
9. What disclosures should be made in the financial statements regarding material related party
transactions?
10. What are the major functions of audit working papers?
11. Why are the prior year’s audit working papers a useful reference to staff assistants during the current
audit?
12. Explain the meaning of the term permanent file as used in connection with audit working papers.
What kinds of information are usually included in the permanent file?

Abstraction
APPLICABLE STANDARDS:
 PSA 230 (Redrafted) – Audit Documentation
 PSA 330 (Redrafted) – The Auditor's Responses to Assessed Risks
 PSA 500 (Redrafted) – Audit Evidence
 PSA 501 (Redrafted) – Audit Evidence – Additional Considerations on Specific Items
 PSA 505 (Revised and Redrafted) – External Confirmations
 PSA 510 (Redrafted) – Initial Audit Engagements-Opening Balances
 PSA 520 (Redrafted) – Analytical Procedures
 PSA 540 (Revised and Redrafted) – Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures
 PSA 550 (Revised and Redrafted) – Related Parties
 PSA 620 (Revised and Redrafted) – Using the Work of an Expert

Page | 1
RELATIONSHIP AMONG AUDIT RISK, AUDIT EVIDENCE, AND FINANCIAL STATEMENT ASSERTIONS

As discussed in previous module, the term audit risk refers to the possibility that the auditors may
unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. In
other words, it is the risk that the auditors will issue an unmodified opinion on financial statements that contain
a material departure from generally accepted accounting principles.

The quantity of audit evidence needed is affected both by the risk of misstatement (the greater the risk,
the more audit evidence required) and also by the quality of the audit evidence (the lower the quality, the more
evidence required). Auditors should obtain sufficient appropriate audit evidence to reduce audit risk to a low
level in every audit. When auditors have less than that level of audit evidence, an obvious solution is to increase
the extent of the audit procedures: that is, obtain more evidence. However, another approach that is often
possible is to perform more effective audit procedures. For example, externally generated evidence may in
some circumstances be obtained instead of internally generated evidence, or evidence may be obtained by
performing procedures closer to (or after) the balance sheet date rather than at an earlier date.
MEASURING AUDIT RISK

Auditors may either consider the risk of material misstatement directly, or separately consider its
components of inherent risk and control risk. For purposes of considering the relationships among the risks,
we provide a separate assessment approach. Auditing standards allow either a quantified or nonquantitative
approach, but they also include the following formula to illustrate the relationships among audit risk, inherent
risk, control risk, and detection risk:

AR = IR × CR × DR

Where:
AR = Audit risk
IR = Inherent risk
CR = Control risk
DR = Detection risk

Assume that the auditors have assessed inherent risk for a particular assertion at 50 percent and control
risk at 40 percent. In addition, they have performed audit procedures that they believe have a 20 percent risk
of failing to detect a material misstatement in the assertion.

The audit risk for the assertion may be computed as follows:

AR = IR × CR × DR = .50 × .40 × .20 = .04

Thus, the auditors face a 4 percent audit risk that material misstatement has occurred and evaded both
the client’s controls and the auditors’ procedures. However, that the model expresses general relationships
and is not necessarily intended to be a mathematical model to precisely consider the factors that influence
audit risk in actual audit situations.

It is important to realize that while auditors gather evidence to assess inherent risk and control risk,
they gather evidence to restrict detection risk to the appropriate level. Inherent risk and control risk are a
function of the client and its operating environment. Regardless of how much evidence the auditors gather,
they cannot change these risks. Therefore, evidence gathered by the auditors is used to assess the levels of
inherent and control risk.

On the other hand, detection risk is a function of the effectiveness of the audit procedures performed.
If the auditors wish to reduce the level of detection risk, they simply obtain additional appropriate evidence.
As a result, detection risk is the only risk that is completely a function of the sufficiency of the procedures
performed by the auditors.

ASSERTIONS AND AUDIT OBJECTIVES

Nature of Assertions:

Financial statements are not statements of facts. They are a collection of claims and assertions, made
implicitly or explicitly by the entity’s management, about the recognition, measurement, presentation, and
disclosure of information in the financial statements.
Assertions (or management assertions) are representations by management, explicit or otherwise, that
are embodied in the financial statements. These assertions relate to the fairness of presentation of the financial
statements, thus, they are directly related to applicable financial reporting framework.

Examples of assertions:

 All the assets exist. (Existence)

Page | 2
  All sales transactions have been recorded. (Completeness)
 Inventories are properly valued. (Valuation)
 All amounts are properly presented and disclosed in the financial statements. (Accuracy)

Levels of Assertions:

1. Financial statement level – entity’s management representation that the financial statements as a whole
are presented fairly, in all material respects, in accordance with the applicable financial reporting
framework
 For example, management asserts the financial statements are free from material misstatements.

2. Account balance or class of transactions level – entity’s management representation that the underlying
account balances and class of transactions, including related disclosures, are free of material
misstatements
 For example, when considering the sales balance, management is asserting that sales revenue is
complete (completeness assertion), the transactions occurred (occurrence assertion), and transactions
have been appropriately recorded in the accounting records (accuracy assertion).

Categories of Assertions used by the Auditor:

1. Assertions about classes of transactions and events for the period under audit
a. Occurrence – recorded transactions and events have occurred and pertain to the entity
b. Completeness – all transactions and events that should have been recorded have been recorded
c. Accuracy – amounts and other data relating to recorded transactions and events have been recorded
appropriately
d. Cutoff (proper period) – transactions and events have been recorded in the correct accounting period
e. Classification – transactions have been recorded in the proper accounts

2. Assertions about account balances at the period end

a. Existence – assets, liabilities, and equity interests exist
b. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the
obligations of the entity
c. Completeness – all assets, liabilities and equity interests that should have been recorded have been
recorded
d. Valuation and allocation – assets, liabilities, and equity interests are included in the FS at appropriate
amounts and any resulting valuation or allocation adjustments are appropriately recorded

3. Assertions about presentation and disclosure

a. Occurrence and rights and obligations – disclosed events, transactions, and other matters have
occurred and pertain to the entity
b. Completeness – all disclosures that should have been included in the financial statements have been
included
c. Classification and understandability – financial information is appropriately presented and
described, and disclosures are clearly expressed
d. Accuracy and valuation – financial and other information are disclosed fairly and at appropriate
amounts
The existence and completeness objectives emphasize opposite audit concerns. Existence deals
with overstatements and completeness deals with understatements (such as due to unrecorded
transactions).

Auditor’s Use of Relevant Assertions:

The auditor uses relevant assertions in developing audit objectives that will be the basis for designing audit
procedures. Relevant assertions are assertions that have a meaningful bearing on whether an account is fairly
stated. For example:

 Existence assertion, not valuation, is typically relevant to the audit of cash account.
 The valuation assertion would be relevant to assessing the inventory balance than assessing sales
balance.

The auditor should use relevant assertions to:

a. Consider the types of potential misstatements that may occur
Examples include:

 Does the asset exist? (Existence)

 Are all sales transactions recorded? (Completeness)
 Is inventory properly valued? (Valuation)
 Did the transaction occur? (Occurrence)
 Are amounts properly presented and disclosed in the financial statements? (Accuracy)

Page | 3
 b. Assess the risks of material misstatement – The auditor should identify what controls have been
implemented to address the relevant assertions.
Examples:

 How does management ensure transactions are recorded? (Completeness)

 How does management ensure that significant estimates are based on reasonable assumptions
and properly recorded in the financial statements? (Accuracy)

c. Design audit procedures that are responsive to the assessed risks

Examples:

 If the risk is high that receivables are being overstated, the audit procedures should be
designed to specifically address the valuation assertion.
 When the auditor designs tests of controls, emphasis should be placed on testing controls over
the relevant assertions rather than just significant controls.
 An audit procedure may provide evidence supporting more than one assertion. For
example, when an auditor obtains confirmation of inventories held at outside locations,
evidence is obtained not just about completeness, but also about the existence of
inventory.
 More than one procedure may be required to fully support an assertion. For example,
in order to be reasonably certain that inventory quantities include all inventories on hand
at year-end, the auditor should also inspect receiving transactions near year-end for
recording in the proper period.

Audit Objectives:

The auditor develops audit objectives that relate to management assertions about the financial statement
components. To achieve audit objectives, the auditor shall design audit procedures and gather sufficient
appropriate audit evidence whether the assertions are in accordance with the applicable financial reporting
framework.

Audit objectives are used to verify management assertions. Thus, there should be proper matching
of auditor’s objectives with management assertions.

Types of Audit Objectives:

1. Whether general or specific:

a. General audit objectives – are broad objectives of auditing an account balance or class of
transactions
 Examples of general audit objectives include existence, completeness, valuation,
classification, cut-off, accuracy, presentation and disclosure, validity, ownership, and overall
reasonableness

b. Specific audit objectives – audit objectives stated in terms tailored to the specific audit
engagement
 The general audit objectives remain the same for every audit engagement, but the evidence
varies, depending on the circumstances. The general audit objectives are applicable to
every account balance on the financial statements.
 After the general objectives are understood, specific objectives for each account balance
on the financial statements can be developed. There should be one specific audit objective
for each relevant general objective.

2. Whether substantive or compliance

a. Substantive audit objectives – objectives that relate to the determination of the validity of
assertions on account balances or class of transactions or disclosures found in the financial
statements

b. Compliance audit objectives – objectives that relate to the degree of entity’s compliance with
relevant controls

AUDIT PROCEDURES

Based on audit objectives, the auditor should plan and perform audit procedures. Audit procedures are
the means for obtaining sufficient appropriate audit evidence to satisfy financial statement assertions and to
support audit opinion on the fairness of the financial statements. They are the detailed instructions for the
collection of a particular type of evidence that is to be obtained during the audit. Since audit procedures are
performed to verify management assertions, they would differ depending on the particular assertion or account
audited.

Page | 4
Primary Purpose of Audit Procedures:

Audit procedures are performed to gather necessary (not all) corroborative evidence to achieve audit
objectives in order to result to sufficient appropriate audit evidence on the fairness of the presentation of the
entity’s financial statements.
Audit procedures distinguished from audit standards and audit techniques:

 Audit standards – measure of the quality of the audit performance; they are set by the AASC, thus, they
remain the same from one audit engagement to another
 Audit procedures – performed to meet the audit standards; determined by the auditor, thus, they vary
from audit to audit; although they vary from audit to audit, the auditor should perform relevant essential
audit procedures provided by the audit standards (PSAs)
 Audit techniques – methods used by the auditor or the details of the audit procedures; they also vary
from audit to audit

Nature, Timing and Extent of Audit Procedures:

a. Nature of an audit procedure – refers to:

(1) Its purpose (i.e., test of controls or substantive procedure) and
(2) Its type (i.e., inspection, observation, inquiry, confirmation, recalculation, reperformance, or
analytical procedures)
When RMM is assessed at high level it affects the types of audit procedures to be performed
and their combination.

b. Timing of an audit procedure – refers to when to perform the audit procedure, or the period or date
to which the audit evidence applies
Audit procedures are normally performed:

a. Early in the accounting period being examined

b. Throughout the accounting period being examined, but with emphasis of the
transactions near the end
c. Within one to three months after the close of the accounting period
Audit procedures performed before period end are known as interim work.

The nature and timing of the audit procedures to be used may be affected by the fact that some
of the accounting data and other information may be available only in electronic form or only
at certain points or periods in time.
c. Extent of an audit procedure – refers to the quantity to be performed or the extent of testing or the
number of items to be examined (for example, a sample size, or the number of observations of a control
activity)

Audit Procedures for Obtaining Audit Evidence:

1. Risk assessment procedures – procedures to obtain an understanding of the entity and its environment,
including its internal control, in order to identify and assess the risks of material misstatement (RMM)
Risk assessment procedures include:

a. Inquiry of management and other personnel

b. Analytical procedures (as a planning tool)
c. Observation and inspection
Risk assessment procedures alone do not provide audit evidence sufficient to support an audit opinion.
Risk assessment procedures must be supplemented by tests of controls, when necessary, and
substantive procedures.

2. Further audit procedures – The auditor shall design and perform audit procedures whose nature, timing,
and extent are based on and are responsive to the assessed RMM at the assertion level.
 Further audit procedures are actually audit procedures classified according to purpose
 In designing the further audit procedures to be performed, the auditor shall:
(1) Consider the assessed RMM
(2) Obtain more persuasive audit evidence the higher the auditor’s assessment of risk by:
a. Increasing the quantity of evidence; or
b. Obtain evidence that is more relevant or reliable (such a obtaining third party evidence or by
obtaining corroborating evidence from a number of independent sources)

Auditor’s responses to assessed risks of material misstatements (RMM) include both:

a. Overall responses – The auditor shall design and implement overall responses to address
the RMM at the financial statement level.

Page | 5
 Overall responses may include:

 Emphasizing to the audit team the need to maintain professional skepticism

 Assigning more experienced staff or those with special skills or using experts
 Providing more supervision
 Incorporating additional elements of unpredictability in the selection of further audit
procedures to be performed
 Making general changes to the nature, timing, or extent of audit procedures (such as
performing substantive procedures at the period end instead of at an interim date)
Overall responses affect auditor’s general approach:

 Substantive approach – an approach whose emphasis is on substantive procedures

 Combined approach – an approach that uses both tests of controls and substantive
procedures
b. Further audit procedures

Further audit procedures include:

(1) Tests of controls (compliance tests) – audit procedures designed to evaluate the operating
effectiveness of relevant controls in preventing, or detecting and correcting material misstatements
at the assertion level
 In designing and performing tests of controls, the auditor shall obtain more persuasive audit
evidence the higher/greater reliance the auditor places on the effectiveness of a control.
 Test of controls, although not intended to detect material misstatements, may provide evidence
that a misstatement is likely to occur.
When to perform tests of controls:

a. When the auditor intends to rely on the operating effectiveness of relevant controls in
determining the nature, timing and extent of substantive procedures; or
 Tests of controls are performed only on those controls that the auditor has
determined are suitably designed to prevent, or detect and correct, a material
misstatement in an assertion.
b. When substantive procedures alone cannot provide sufficient appropriate evidence at
the assertion level
 For example, an entity conducts its business using IT and no documentation of
transactions is produced or maintained, other than through the IT system.

Dual purpose test:

 The auditor may design a test of controls to be performed concurrently with a test of
details on the same transaction. Although the purpose of a test of controls is different
from the purpose of a test of details, both may be accomplished concurrently by
performing test of controls and test of details on the same transaction, also known as a
dual-purpose test.

(2) Substantive procedures – audit procedures designed to detect material misstatements at the
assertion level
Other best descriptions: Substantive procedures may also be described as audit procedures that
are designed to:

 Detect material peso/monetary errors or fraud

 Substantiate the validity of management's assertions regarding the financial statements.
Thus, substantive procedures are sometimes called validation procedures because they
provide evidence about the existence of misstatement.
 Gather evidence in respect to all material classes of transactions, account balances, and
disclosures.
 Be performed in response to the assessment of the risks of material misstatement at the
assertion level, which includes the results of tests of controls, if any. In other words,
substantive procedures are performed in response to the planned level of detection risk.

Substantive procedures are mandatory:

Irrespective of the assessed risks of material misstatement, substantive procedures are

required for all relevant assertions related to each material class of transactions, account
balance, and disclosure. This requirement reflects the fact that:

a. The auditor’s assessment of risk is judgmental and so may not identify all risks of
material misstatement; and
b. There are inherent limitation to internal control

Page | 6
 Substantive testing cannot be eliminated. However, it may be reduced by auditor’s
reliance on entity’s effective internal control.
Nature, timing and extent of substantive tests:

When internal control is not reliable, the auditor will have to perform extensive
substantive tests. Thus, the result of test of controls is a major factor in determining the
nature, timing and extent of substantive tests.

1. Nature: relates the quality of audit evidence (performing more effective or less
effective audit procedures)
2. Timing: also relates to the quality of evidence (performing the audit procedures at
year-end or at interim date)
3. Extent: relates to the quantity of audit evidence (using larger sample size or smaller
sample size)
Reliance on substantive tests:

The reliance placed on substantive tests in relation to the reliance placed on internal
control has an inverse relationship.

Types of substantive procedures:

Whether or not to use substantive analytical procedures or to perform tests of details of

transactions and balances, the auditor usually consider the relative effectiveness and efficiency of
the tests.
1. Tests of details – examining or obtaining audit evidence on the actual details of account
balance, class of transactions, and disclosure
 The objective of tests of details is to substantiate or identify misstatements in the recorded
amounts.
Directional testing – refers to the direction of an audit test

a. Tracing – if the auditor starts from original source documents and traces forward to
the accounting records, this tests the assertion of completeness. This helps the
auditor identify understatement errors.
b. Vouching – If the auditor starts from the accounting records and vouches backwards
to the original source documents, this tests the assertion of existence or
occurrence. This helps the auditor identify overstatement errors.

a) Test of details of transactions – testing of transactions which give rise to the ending
balance of a given account; these involve examining authorization, recording and posting
of transactions (such as examining receipts or disbursements of Cash account)
 Applicability of test of details of transactions: It is used when the account being
substantiated has relatively few or smaller volume of transactions of relatively material
amounts occurring during the year (for example, PPE, intangibles, bonds payable and
stockholders’ equity accounts)
 Test of transactions are often performed several months prior to the balance sheet date.
 Tests of details of transactions primarily involve tracing and vouching.

b) Tests of details of balances – direct testing of accounts ending balance

 Tests of details of balances focus on obtaining evidence directly about an account
balance.
 More types of evidence are obtained using tests of details of balances than by using
any other type of test.
 Test details of balances is usually the most costly to perform.
 Applicability of test of details of balances:
 For accounts whose balances are affected by large volume transactions of relatively
immaterial amounts (such as cash, accounts receivable and inventories).
 If an account has a high turnover rate with many transactions occurring during the
year, the auditor generally will concentrate more on the ending balance total.
 It is used when the auditor is satisfied that internal control is strong.

2. Substantive analytical procedures – these are analytical procedures performed during testing
phase to substantiate predictable relationships among both financial and non-financial data
 Analytical procedures are evaluations of financial information made by a study of plausible
relationships among both financial and nonfinancial data. Analytical procedures generally
involve comparisons of recorded amounts to independent expectations developed by the
auditor.

Page | 7
  The application of planned analytical procedures is based on the expectation that
relationships among data exist and continue in the absence of known conditions to the
contrary.
 Analytical procedures will result to circumstantial evidence rather than conclusive
evidence.
 Results of substantive analytical procedures would entail additional tests to be performed.
 Analytical procedures are the audit tests that are usually the least costly to perform.

Applicability of substantive analytical procedures:

 Generally more applicable to large volume of transactions that tend to be

predictable over time
 Not required substantive procedures during testing phase (but are required
during audit planning and final or overall review stages)
 When appropriate, they are used on accounts that are predictable and
plausible.

Limitations of analytical procedures: Since analytical procedures are based on

expected plausible relationships among data, differences do not necessarily indicate
errors or fraud, but simply indicate the need for further investigation. Changes in an
account, changes in accounting principle, and inherent differences between industry
norms and the client all contribute to fluctuations in expected amounts.

Audit Procedures According to Types:

The following procedures, individually or in combinations, may be used as risk assessment procedures,
test of controls, or substantive procedures, depending on the context in which they are applied by the auditor:
1. Inspection – consists of examining records or documents (whether internal or external, in paper form,
or other media), or a physical examination of an asset
 For example, an inspection of records or documents for evidence of authorization is a test of
controls.
2. Observation – consists of viewing/looking at a process or procedure being performed by others.
Examples:

 Observation of the counting of inventories by the entity’s personnel

 Observation of the performance of control activities that leave no audit trail
3. External confirmation – represents audit evidence obtained by the auditor as a direct written response
to the auditor from a third party (the confirming party) in paper form, or by electronic or other medium
 Confirmation is a specific type of inquiry that involves the process of obtaining a
representation of information or of an existing condition about account balances and
transactions or events directly from independent third parties.
 Confirmations are controlled by the auditor because the auditor:
a. Selects the parties to be contacted
b. Prepares and mails the confirmation requests, and
c. Receives the confirmation replies directly from the third parties
 External confirmations frequently are relevant when addressing assertions associated with
certain account balance and their elements. However, they are not restricted to account
balances only.
Examples of external confirmation:

 Confirmation of accounts receivable balances:

a. Positive confirmation – customers should reply whether or not they agree with their
respective balances; it is considered more effective than negative confirmation
b. Negative confirmation – customers should reply if there are discrepancies
 Bank confirmation of account balances (including amount of loan outstanding)
 Suppliers’ confirmation of accounts payable
 Confirmation from lenders
 Inventory confirmation when inventory is under custody and control of a third party
 Confirmation from lawyers or financiers who have custody over client’s property title deeds
 Confirmations of the terms of agreements or transactions an entity has with third parties
 Confirmation about the absence of certain conditions, for example, the absence of a “side
agreement” that may influence revenue recognition
d. Recalculation (computation) – consists of checking the mathematical accuracy (manually or
electronically) of documents or records
Examples:

 Auditor’s recalculation of depreciation, interest expense or earnings per share

Page | 8
 e. Reperformance – involves the auditor’s independent execution of procedures or controls that were
originally performed (by the client’s staff) as part of the entity’s internal control
f. Analytical procedures – consist of evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data
Analytical procedures also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant information or deviate significantly from
predicted amounts.

g. Inquiry – consists of seeking information of knowledgeable persons, both financial and non-financial,
within the entity or outside the entity.
 Inquiry is used extensively throughout the audit in addition to other audit procedures.
 Inquiries may be formal written inquiries or informal oral inquiries.
 Evaluating responses to inquiries is an integral part of the inquiry process.
 Evidence obtained from inquiry can be gathered with every type of audit test.
In respect of some matters, the auditor may consider it necessary to obtain written
representation from management and, where appropriate, those charged with governance to
confirm responses to oral inquiries.

Audit Techniques:

The auditor applies audit techniques (methods) to gather corroborative evidence and uses his professional
judgment to determine which audit techniques would best result to the audit evidence he needs.

Examples of audit techniques:

1. Confirm – to obtain information directly from an independent third party
2. Inspect – to obtain evidence through physical examination
3. Count – physical examination of assets (such as cash count or petty cash count)
4. Compare – technique used after count of assets; also used to compare current period balances with
those of prior periods
5. Inquire – asking questions, whether oral or written, directed to the client or to third parties
6. Trace – to determine whether transactions supported by source documents are properly recorded and
posted
7. Vouch – examine and authenticate of underlying evidential papers
8. Verify – to prove the accuracy of extensions, footings, postings, ownership and existence
9. Reconcile – to bring into agreement information obtained from two groups of related, but independent,
figures
Reconciliation involves comparing financial amounts from two independent sources for
agreement, such as:

 Reconciling the cash balance per the books with the balance per bank
 Reconciling the physical inventory count with the perpetual inventory records
 Reconciling lead schedules to general ledger amounts
10. Analysis of accounts – to detail the composition of an account or to detail the individual debits and
credits in the account in a chronological sequence
11. Review – perform to obtain evidence of authoritative documentation to support certain transactions
12. Extend – to prove the accuracy of multiplications (on invoices, payroll records, etc.)
13. Foot – to prove the accuracy of vertical or horizontal additions
14. Scan – looking for evidence of unusual amounts/items, which, if found, would be further investigated
 Scanning may also be considered an analytical procedure, as the auditor uses professional
judgment to search for large, significant, or unusual items in the accounting records.

AUDIT PROGRAM

An audit program is a detailed listing of the nature, timing and extent of planned audit procedures (tests
of controls and/or substantive tests) that the auditor will perform to gather sufficient appropriate evidenced. It
is a set of instructions to assistants involved in the audit and as a means to control and record the proper
execution of work.

AUDIT EVIDENCE

The auditor shall design and perform audit procedures that are appropriate in the circumstances for the
purpose of obtaining reasonable assurance or sufficient appropriate audit evidence to reduce audit risk at
acceptably low level thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s
opinion.

Page | 9
 Most of the auditor's work in forming the auditor's opinion consists of obtaining and evaluating audit
evidence. The auditor shall conclude whether sufficient appropriate audit evidence has been obtained based
on his professional judgment.
Audit Evidence, Defined:

 Audit evidence refers to all the information used by the auditor in arriving at the conclusions on which
the audit opinion is based. Thus, audit evidence supports the opinion and the auditor's report.
 Sometimes called as evidential matter, it is the main output/product of performing audit procedures.

Audit Evidence Relationship with Assertions: Audit evidence comprises both:

a. Information that supports and corroborates management's assertions, and

b. Information that contradicts such assertions.

Nature of Audit Evidence:

Audit evidence includes both information contained in the accounting records underlying the financial
statements and other information:
1. Accounting records (Underlying data) – accounting records/data prepared by the client’s personnel
and from which financial statements are prepared
a. Records of initial accounting entries
b. Supporting records, such as checks and records of electronic fund transfers, invoices and contracts
c. General and subsidiary ledgers
d. Journal entries and other adjustments to the financial statements that are not reflected in formal
journal entries
e. Records such as worksheets and spreadsheets supporting cost allocations, computations,
reconciliation and disclosures

2. Corroborating evidence – corroborating information that are used by the auditor to verify the fairness
of the accounting records
a. Documents (such as checks, bank statements, contracts and minutes of meetings)
b. Information/evidence from other sources such as:
 Previous audits
 Quality control procedures for client acceptance and continuance
 Confirmations from third parties
 Industry analysts’ reports
 Comparable data about competitors (benchmarking)
 Client written representation
c. Information obtained by he auditor from audit procedures such as inquiry, observation, inspection
and computation
d. Other information developed by, or available to, the auditor that permits the auditor to reach
conclusions through valid reasoning

Types of Audit Evidence:

1. Physical evidence – obtained by physical examination of assets (such as count of stock certificates in
support of stock investment account or observation of client’s processes or procedures)
2. Mathematical recomputations – auditor’s recomputation of the accuracy of client’s computations such
as depreciation, amortization, doubtful accounts, etc.
3. Documentation – examination of the supporting documents of recorded transactions and balances
appearing in the financial statements
4. Representation by third parties (or confirmation) – a document originating from independent outside
party and sent directly to the auditor
5. Representation by client personnel – statements from client personnel in response to queries posed by
the auditor
6. Results of analytical procedures
7. Internal control – existence of effective internal control may be regarded as a strong evidence of the
validity of the accounts and amounts found in the financial statements
8. Subsequent events – they provide additional evidence regarding conditions that already existing on
the balance sheet that and affect accounting estimates

Sources of audit evidence:

 Audit evidence is cumulative in nature and is primarily obtained from audit procedures
performed during the course of the audit. However, it may also include information obtained
from other sources such as:

Page | 10
  Previous audits (where the auditor performs audit procedures to establish its continuing
relevance)
 Firm's quality control procedures for client acceptance and continuance
 Audit evidence may come from:
a. Internal sources (inside the entity) – generated internally, such as evidence existing within
the accounting records, minutes of meetings, or a management representation
b. External or independent sources (outside the entity) – for example, confirmations from
third parties analysts’ reports, and comparable data about competitors (benchmarking
data)
c. Direct knowledge of the auditor
 Audit evidence may also come from:
a. Information obtained from testing the accounting records (accounting records are an
important source of audit evidence) – for example, through analysis and review,
reperforming procedures followed in the financial reporting process, and reconciling
related types and application s of the same information
b. Non-financial original records
 Audit evidence may include information prepared using the work of a management’s expert.
 In some cases the absence of information (for example, management's refusal to provide a
requested representation) is used by the auditor, and therefore, also constitutes audit
evidence.

Information to Be Used as Audit Evidence

 When designing and performing audit procedures, the auditor shall consider the relevance and
reliability of the information to be used as audit evidence.
 When information to be used as audit evidence has been prepared using the work of a management's
expert, the auditor shall, to the extent necessary, having regard to the significance of that expert's work
for the auditor's purposes:
a. Evaluate the competence, capabilities and objectivity of that expert;
b. Obtain an understanding of the work of that expert; and
c. Evaluate the appropriateness of that expert's work as audit evidence for the relevant assertion.
 When using information produced by the entity, the auditor shall evaluate whether the information is
sufficiently reliable for the auditor's purposes, including as necessary in the circumstances:
a. Obtaining audit evidence about the accuracy and completeness of the information; and
b. Evaluating whether the information is sufficiently precise and detailed for the auditor's purposes.

Sufficient Appropriate Audit Evidence:

The auditor shall design and perform audit procedures that are appropriate in the circumstances for the
purpose of obtaining sufficient appropriate audit evidence.

1. Sufficiency – the measure of the quantity or amount of audit evidence that the auditor shall accumulate
 Sufficiency is determined based on the auditor’s professional judgment.
 Audit evidence is sufficient if there is enough of it to afford a reasonable basis for an audit opinion
on the financial statements.
Factors affecting sufficiency of audit evidence:

Auditor’s judgment as to the quantity of audit evidence is influenced by:

a. Auditor’s assessment of the risks of misstatement – the higher the assessed risks, the more audit
evidence is likely to be required
 For example, as risk of material misstatement increases in Accounts Receivable, audit
evidence required also increases.
b. Quality or competence of audit evidence – the higher the quality, the less may be required.
Obtaining more audit evidence, however, may not compensate for its poor quality.
c. Materiality of item being examined – more material amounts, more evidence to support its
validity
d. Experience gained during previous audit may indicate the amount of evidence taken before
and whether such evidence was enough
e. Type of information available
Merely obtaining more audit evidence may not compensate for audit evidence of lower quality.
The auditor should exercise professional judgment and professional skepticism in evaluating the
sufficiency and appropriateness of audit evidence to support the audit opinion.

The sufficiency and appropriateness of audit evidence are interrelated.

2. Appropriateness – measures the quality of audit evidence, that is, its relevance and its reliability in
providing support for the conclusions on which the auditor's opinion is based
a. Relevance – deals with the logical connection with, or bearing upon, the purpose of audit
procedures and the assertion under consideration

Page | 11
  Audit evidence is considered relevant if it pertains to the assertions being evaluated or
to the specific audit objective being tested. For example:
 Obtaining audit evidence relating to the physical existence of inventory is not
relevant in obtaining audit evidence relating to the valuation of inventory.
 Accounts receivable confirmations are relevant to the existence of receivables, but
not to their valuation (i.e., a customer can confirm that a receivable exists, but this
does not necessarily imply that the customer has the intent or the ability to pay).
 The relevance of information to be used as audit evidence may be affected by the
direction of testing.
 A given set of audit procedures may provide audit evidence that is relevant to certain
assertions, but not to others.
 Obtaining audit evidence regarding a particular assertion, for example, the existence of
inventory, is not a substitute for obtaining audit evidence regarding another assertion.
 Audit evidence from different sources or of a different nature may often be relevant to
the same assertion.

b. Reliability – objectivity of evidence

Reliability of evidence is influenced by:

 Its source (external or internal)

 Its nature (visual, documentary, or oral)
 The circumstances under which it is obtained
 Where relevant, the controls over its preparation and maintenance

Generalizations about the reliability of audit evidence:

1. The reliability of audit evidence is increased when it is obtained from knowledgeable

independent sources outside the entity.
 Examples of information from sources independent of the entity may include
confirmations from third parties, analysts' reports, and comparable data about
competitors (benchmarking data).
2. The reliability of audit evidence that is generated internally is increased when the
related controls, including controls over its preparation and maintenance, imposed by
the entity are effective. (Effective internal control provides more reliable audit
evidence than ineffective internal control.)
3. Audit evidence obtained directly by the auditor is more reliable than evidence
obtained indirectly or by inference.
 For example, observation of the application of a control is more reliable than
inquiry about the application of a control).
4. Audit evidence in documentary form (whether paper, electronic, or other medium) is
more reliable than evidence obtained orally.
 For example, a contemporaneously written record of a meeting is more reliable
than a subsequent oral representation of the matters discussed.
5. Evidence provided by original documents is more reliable than evidence provided by
photocopies or facsimiles.

The above generalizations should be considered in determining which evidence is

persuasive or least persuasive.

Generalizations about reliability are subject to important exceptions, for example, even
when the information to be used as audit evidence is obtained from sources external to the
entity, circumstances may exist that could affect its reliability (such as if the source is not
knowledgeable or a management’s expert may lack objectivity).

More assurance is ordinarily obtained from consistent audit evidence obtained from
different sources or of a different nature than from items of audit evidence considered
individually.

Hierarchy of reliability of evidence: (from most reliable to least reliable)

1. Direct evidence or personal observation and knowledge (such as physical observation)

2. Externally generated evidence sent directly to the auditor (such as confirmations from banks
and customers and bank statements and cut-off bank statements received from banks)
3. Externally generated evidence kept by the client (such as vendor’s invoices, bank statements
received from the client)
4. Internally generated evidence circulated externally (such as sales invoices from sale to
customers and paid checks and cost allocations)

Page | 12
 5. Internally generated evidence not circulated externally (such as purchase requisitions,
customer’s order and cost allocations)
6. Oral evidence

Persuasive Evidence:

Audit evidence is persuasive if it is sufficient both in quantity and quality to support audit opinion. Thus,
sufficiency and appropriateness of audit evidence are the determinants of persuasiveness of audit evidence.
The auditor may need to rely on audit evidence that is persuasive rather than conclusive. However, to obtain
reasonable assurance, the auditor must not be satisfied with audit evidence that is less than persuasive.
Cost-benefit considerations:

The auditor should consider the relationship between the cost of obtaining audit evidence and the
usefulness of the information obtained.

The valid bases for omitting an audit test/procedure for which there is no alternative are:

a. Relative risk (or inherent risk) involved

b. Relationship between the cost of obtaining audit evidence and the usefulness of the information
obtained
c. Degree of reliance on the relevant internal controls (or Assessment of control risk at a low level)

Difficulty and expense involved in testing a particular item is not a valid basis for an auditor of
deciding to omit an audit procedure.

Information produced by a management expert as audit evidence:

A management expert is an individual or organization possessing expertise in a field other than accounting
or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial
statements.

When information to be used as audit evidence has been prepared using the work of a management’s
expert, the auditor shall, to the extent necessary, having regard to the significance of that expert’s work for the
auditor’s purposes:
1. Evaluate the competence, capabilities and objectivity of that expert
a. Competence – relates to the nature and level of expertise of the management’s expert
b. Capability – relates to the ability of the management’s expert to exercise that competence in the
circumstances
c. Objectivity – relates to the possible effects that bias, conflict of interest or the influence of others
may have on the professional or business judgment of the management expert

Sources of information regarding competence, capabilities and objectivity of a management’s

expert:

 Personal experience with previous work of that expert

 Discussions with that expert
 Discussions with others who are familiar with that expert’s work
 Knowledge of that expert’s qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition
 Published papers or books written by that expert
 An auditor’s expert, if any, who assists the auditor regarding the information produced
by the management expert

2. Obtain an understanding of the work or field of expertise of that management’s expert

Aspects of the management’s expert’s filed relevant to the auditor’s understanding may include:

 Whether that expert’s field has areas of specialty within it that are relevant to the audit.
 Whether any professional or other standards, and regulatory or legal requirements apply.
 What assumptions and methods are used by the management’s expert, and whether they are
generally accepted within that expert’s filed and appropriate for financial reporting purposes.
 The nature of internal and external data or information the auditor’s expert uses

3. Evaluate the appropriateness of that expert’s work as audit evidence for relevant assertion
The auditor shall consider:

a. The relevance and reasonableness of that expert’s findings or conclusions, their consistency with
other audit evidence, and whether they have been appropriately reflected in the financial

Page | 13
 statements;
b. If the expert’s work involves use of significant assumptions and methods, the relevance and
reasonableness of those assumptions and methods; and
c. If that expert’s work involves significant use of source data the relevance, completeness, and
accuracy of that source data

Evaluating the Sufficiency and Appropriateness of Audit Evidence:

Based on the audit procedures performed and the audit evidence obtained, the auditor shall evaluate
before the conclusion of the audit whether the assessments of the RMM at the assertion level remain
appropriate.
Factors affecting sufficient appropriate audit evidence:

The auditor’s judgment as to what constitutes sufficient appropriate audit evidence is influenced by
such factors as the following:

 Significance of the potential misstatement in the assertion and the likelihood of its having a material
effect on the financial statements.
 Effectiveness of management’s responses and controls to address the risks.
 Experience gained during previous audits with respect to similar potential misstatements.
 Results of audit procedures performed, including whether such audit procedures identified
specific instances of fraud or error.
 Source and reliability of the available information.
 Persuasiveness of audit evidence.
 Understanding of the entity and its environment, including internal control.

AUDIT EVIDENCE FOR SUBJECTIVE AREAS

Evidence Regarding Accounting Estimates (PSA 540)

Some financial statement items cannot be measured precisely, but can only be estimated. For purposes
of this PSA, such financial statement items are referred to as accounting estimates. The nature and reliability of
information available to management to support the making of an accounting estimate varies widely, which
thereby affects the degree of estimation uncertainty associated with accounting estimates. The degree of
estimation uncertainty affects, in turn, the risks of material misstatement of accounting estimates, including
their susceptibility to unintentional or intentional management bias.

When performing risk assessment procedures and related activities to obtain an understanding of the
entity and its environment, including the entity’s internal control, as required by PSA 315 (Redrafted), the
auditor shall obtain an understanding of the following in order to provide a basis for the identification and
assessment of the risks of material misstatement for accounting estimates:

(a) The requirements of the applicable financial reporting framework relevant to accounting estimates,
including related disclosures.
(b) How management identifies those transactions, events and conditions that may give rise to the need
for accounting estimates to be recognized or disclosed in the financial statements. In obtaining this
understanding, the auditor shall make inquiries of management about changes in circumstances that may give
rise to new, or the need to revise existing, accounting estimates.
(c) How management makes the accounting estimates, and an understanding of the data on which they
are based, including:
(i) The method, including where applicable the model, used in making the accounting estimate;
(ii) Relevant controls;
(iii) Whether management has used an expert;
(iv) The assumptions underlying the accounting estimates;
(v) Whether there has been or ought to have been a change from the prior period in the
methods for making the accounting estimates, and if so, why; and
(vi) Whether and, if so, how management has assessed the effect of estimation uncertainty.

When using the audit approach of reviewing management’s process, the auditors consider
whether the assumptions used by management are reasonable, whether the valuation model seems
appropriate, and whether management has used all relevant information that is reasonably available. The
second approach, which involves developing the auditors’ own estimate, offers the advantage of allowing
the auditors to compare that estimate with the estimate developed by management. Often auditors will use
a combination of these two approaches and also may decide to employ the assistance of a valuation
specialist. The third audit approach involves the use of information obtained subsequent to yearend to help
evaluate the reasonableness of management’s estimate. For example, the sale of an investment property
shortly after the year-end may provide evidence on its value as of year-end. Yet, even in this situation,
auditors should carefully consider the audit evidence since the sale might be impacted by circumstances
that changed subsequent to year-end. For example, the prices of actively traded marketable securities that
change after the year-end may not constitute appropriate evidence of values that existed at yearend.

Page | 14
 Regardless of the approach or approaches followed, the auditors should evaluate whether the required
disclosures related to fair values have been properly presented.

Evidence Regarding Related Party Transactions (PSA 550)

How should auditors react if a corporation buys a parcel of real estate from one of its executive officers
at an obviously excessive price? This situation illustrates the type of problem that may arise for auditors when
the client company enters into related party transactions.
The term related parties refers to individuals or entities who may have dealings with the client in which
one party is significantly influenced by the other such that it may not pursue its separate interests. Examples of
related parties include officers, directors, principal owners, and members of their immediate families; and
affiliated companies, such as subsidiaries.
A related party transaction is any transaction between the company and these parties, other than
normal compensation arrangements, expense allowances, and similar transactions arising in the ordinary
course of business. Since transactions with related parties are not conducted at “arm’s length,” the auditors
should be aware that the economic substance of these transactions might differ from their form. Related party
transactions have often been used to facilitate fraudulent financial reporting. Accordingly, auditors should
determine the business purpose of any significant and unusual related party transactions that they encounter.
Even if the transactions are recorded appropriately, the auditors also must be concerned that material
related party transactions are adequately disclosed in the client’s financial statements or the related notes.
Disclosure of related party transactions should include the nature of the relationship; a description of the
transactions, including dollar amounts; and amounts due to and from related parties, together with the terms
and manner of settlement. The primary challenge for the auditors is identifying any related party transactions
that management has not disclosed, because they may be recorded in the accounting records with all other
transactions. Common methods of determining related parties include making inquiries of management and
reviewing SEC filings, stockholders’ listings, and conflict-of-interest statements obtained by the client from its
executives. A list of all known related parties should be prepared at the beginning of the audit so that the audit
staff may be alert for related party transactions throughout the engagement. This list is retained in the auditors’
permanent file for reference and updating in successive engagements. As they perform the audit, the auditors
will be alert for transactions with these parties and for any transactions with unusual terms that might be
indicative of related party negotiations.

AUDIT DOCUMENTATION/WORKING PAPERS

AUDIT DOCUMENTATION

The auditor should prepare, on a timely basis, audit documentation that provides:

a. A sufficient and appropriate record of the basis for the auditor’s report; and
b. Evidence that the audit was performed in accordance with PSAs and applicable legal and regulatory
requirements.
Audit documentation:

 It refers to the documentation of audit evidences collected and evaluated by the auditor to support the
audit opinion.
 The records kept by the auditor that documents:
a. The procedures applied
b. The tests performed
c. The information or evidenced obtained, and
d. The conclusions the auditor reached in the engagement
 Also called “working papers” or “workpapers” or audit file

Purposes / functions of audit documentation:

File documentation plays a critical role in the planning and performance of the audit. During an audit
engagement, data are compiled and included in the audit working papers. It provides the record that work
was in fact performed and it forms the basis for the auditor’s report. It will also be used for quality control
reviews, monitoring of adherence to the accounting firm’s standards, and possibly inspections by third parties.
1. Primary
 To support the auditor's conclusions/opinion/report on the financial statements (and not to support
the FS).
 To provides a basis for determining the appropriate audit report.
 To support the auditor's representation that an adequate audit was conducted in accordance with
PSA/GAAS
 To provide evidence of the audit work performed
 To assist the auditor in the planning, performance, review, supervision and coordination of the
engagement and in preparation of the audit report
 To show that the accounting records agree or reconcile with the financial statements
 Provide supervisory personnel the opportunity to assess the sufficiency of evidence obtained
during the audit

Page | 15
 2. Other objectives:
 To assist the auditor in planning future audits
 To enable the audit team to be accountable for its work
 To provide information useful in rendering other services (MAS or tax consulting)
 To provide adequate defense in case of litigation
 To enable an experienced auditor to conduct quality control reviews and inspections in accordance
with quality control standards
 To enable an experienced auditor to conduct external inspections in accordance with applicable
legislation, regulations or other requirements

To comply with the quality control standards, firms should have policies and procedures that
specifically address engagement documentation. These documentation policies should be
documented and communicated to all staff.

Design of audit documentation:

 When preparing working papers, the auditor should remember that working papers should be
designed to meet the circumstances and the auditor's needs on each engagement.

Form, content and extent of audit documentation:

 Form, content and extent of audit documentation depend on auditor’s judgment – since it is neither
necessary nor practical to document every matter.
 Audit documentation should be complete in itself and should not require subsequent or additional oral
explanation.
 Audit documentation should be concise and limited only to essentials.
 Audit documentation should be appropriately organized to provide a clear link to the significant
matters
 Experienced auditor: The audit documentation should be in such form, content and extent of audit
documentation that would enable an experienced auditor, having no previous connection with the
audit, to understand:
a. The nature, timing, and extent of the audit procedures performed to comply with PSAs and
applicable legal and regulatory requirements
b. The results of the audit procedures and the audit evidence obtained, and
c. Significant matters arising during the audit and the conclusions reached thereon.

Factors to consider by the auditor in deciding the form, content and extent of audit documentation:

a. Nature of the audit procedures to be performed;

b. Risks of material misstatement;
c. Extent of judgment required in performing the work and evaluating the results;
d. The significance of the audit evidence obtained;
e. Nature and extent of exceptions identified;
f. The need to document a conclusion or the basis for a conclusion not readily determinable from the
documentation of the work performed or audit evidence obtained; and
g. Audit methodology and tools used

Classification and composition of auditor’s working papers:

A. Continuing engagement (recurring audit):

1. Permanent file – contains information of continuing or long-term significance/interest to the
auditor in performing recurring audits, such as:
a. Information
 Organizational chart
 Analysis of business and industry
 Analyses of long-term accounts (such as PPE, long-term liabilities and of stockholders'
equity accounts)
 Analyses of internal control (flowchart, narrative descriptions, etc.)
b. Copies or extracts of entity’s important legal documents and agreements:
 Corporate charter or articles of Incorporation (or articles of co-partnership) and by-laws
 Major contracts (such as bond and note indentures)
 Pension plans, stock option plans, profit-sharing plans and employee bonus
 Terms of share capital and bond issues
 Engagement letter

Page | 16
 2. Current audit file – contains evidence gathered and conclusions reached relevant to the audit of
a particular year. It is designed to support management assertions. Includes all papers
accumulated during the current year’s audit:
 Copy of the financial statements
 Audit plan and audit programs
 Working (top) trial balance – listing of unadjusted ending balances of accounts (contains
columns for adjusting and reclassifying entries)
 Adjusting and reclassifying entries – adjustments are made to correct material errors while
reclassifications are made to properly present information in the financial statements
 Lead or top schedule (assembly sheet) – shows the major components of an amount
reported in the financial statements; this working paper show the grouping of related
accounts; it eliminates voluminous details from the auditor’s working trial balance by
classifying and summarizing similar or related items
 Supporting schedules – schedules that support specific amounts on the financial statements;
usually the largest portion of the audit file
 Audit memoranda – includes documentation on discussions of certain items such as internal
control, inventory observation, errors identified, and problems encountered
 Account analysis – shows the activity during the period in a particular short-term account
 Correspondence with other parties such as lawyers, customers, banks, and management
 Audit notes – used to record items of work to be done and questions concerning the audit
investigation
 Abstract or copies of minutes of board of directors’ meeting

B. One-time engagement – no distinction as to permanent or current file

Other types of files:

1. Tax files – contain file of information on client’s current and income taxes and other business taxes that
may be used as bases for:
a. Preparing current year’s tax returns
b. Preparing other tax-related services
c. Representing the client in tax assessment case
2. Correspondence file – contains all correspondence/letters to or from (or in behalf of) a client
3. Completion memorandum – a summary that describes the significant matters identified during the
audit and how they are addressed

Ownership of working papers or audit documentation:

Legal provision on ownership of working papers (Sec. 29 of RA 9298 – Ownership of Working Papers):
All working papers, schedules and memoranda made by a CPA and his staff in the course of an examination,
including those prepared and submitted by the client, incident to or in the course of an examination, by such
CPA, except reports submitted by a CPA to a client shall be treated confidential and privileged and remain the
property of such CPA in the absence of a written agreement between the CPA and the client, to the contrary,
unless such documents are required to be produced through subpoena issued by any court, tribunal, or
government regulatory or administrative body.

 Audit documentation or working papers are the property of the auditor/audit firm and the client
has no right to the working papers prepared by the auditor.
 Confidentiality of working papers: Although working papers are the personal property of the
auditor, they can not be shown to third parties under the rule on confidentiality unless it falls
under the certain exceptions such as production of documents through subpoena issued by any
court, tribunal, or government regulatory or administrative body.
 Although certain working papers may sometimes serve as a useful reference source for his client,
auditor’s working papers should not be regarded as part or substitute for the client's accounting
records.
 The audit documentation for a specific audit engagement is assembled in an audit file.

Auditor/CPA firm’s responsibility on audit documentation:

1. Policies and procedures: Establishment of policies and procedures on audit documentation

2. Confidentiality and safe custody: Adopt appropriate procedures for maintaining confidentiality and
safe custody of working papers and
3. Retention of audit documentation: Working papers should be retained by the auditor for a period of
time sufficient to meet the needs of his practice and to satisfy any pertinent legal requirements of record
retention. Retention period should be no shorter than 5 years from the date of the auditor’s report, or,
if later, the date of the group auditor’s report. The auditor should not delete or discard audit
documentation before the end of its retention period.
4. Completion of final audit file: within 60 days after the date of the auditor’s report

Page | 17
Deletion from/changes to audit documentation:

 After completion date: Not allowed

 During assembly process: Allowed but limited to changes that are administrative in nature, such as:
1. Deleting or discarding superseded documentation
2. Sorting, collating and cross-referencing working papers
3. Signing off on completion checklists relating to the file assembly process
4. Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant
members of the audit team before the date of the auditor’s report.

Elements of working papers:

Working papers should be properly organized to facilitate their review. Working papers should have the
following elements:
1. Heading – used to properly identify each working paper; it includes the name of the client, type/title
of working paper, description of its content, and the date or period covered by the examination.
2. Dates and initial of staff and reviewers
3. Indexing – use of lettering or numbering system to aid in cross-referencing to other working papers
4. Cross-indexing / cross referencing – Audit working papers are indexed by means of reference
numbers. The primary purpose of cross-indexing audit working papers is to permit cross-referencing
and simplify supervisory review by providing a trail useful to the auditor and supervisors in reviewing
the working papers. (For example, reported findings should be adequately cross-referenced to
supporting documentation.)
Audit working papers should have an indexing system that shows the relationship between
findings, conclusions, and the related facts. The main advantage of properly indexed working papers
is to better organize the working papers.
5. Tick marks – symbols that describe the audit procedures performed. Tick marks are explained in
working papers.

Using electronic tools in working papers:

There are three important principles to note when using electronic tools in working paper preparation:

 All the requirements of the PSAs still apply;

 Electronic files require electronic document management. This addresses matters such as
accessibility (such as password access), data security, application management (including training),
back-up routines, edit rights, storage locations, review procedures, and decisions on what changes to
files will be tracked to provide the necessary audit trail; and
 Final documents (all documents that are required to be maintained to support the audit opinion) must
be retained and be accessible in accordance with the firm’s file retention policies.

POINTS TO REMEMBER

1. Audit evidence is gathered by the auditors to reduce audit risk—the risk that the auditors may fail to
modify their opinion on financial statements that are materially misstated. Since financial statements
consist of a series of assertions by management, the auditors should obtain sufficient appropriate audit
evidence about each significant financial statement assertion.
2. At the account balance, class of transaction, and disclosure levels, audit risk consists of (a) the risk that
a material misstatement in an assertion has occurred (composed of inherent risk and control risk) and
(b) the risk that the auditors will not detect the misstatement (detection risk). Audit evidence is gathered
by the auditors to assess the risk of material misstatement and to restrict detection risk.
3. Auditors perform audit procedures to obtain audit evidence that will allow them to draw reasonable
conclusions as to whether the client’s financial statements follow generally accepted accounting
principles.
An audit consists of
(a) risk assessment procedures (to obtain an understanding of the client and its environment),
(b) tests of controls (to test the operating effectiveness of controls), and
(c) substantive procedures (to detect material misstatements in relevant assertions).
Tests performed in response to the auditors’ risk assessments are referred to as further audit
procedures.
4. Substantive procedures include tests of details and analytical procedures. Tests of details ordinarily
involve testing recorded support for account balances, transactions, and disclosures. Substantive
analytical procedures often provide evidence about account balances, transactions, and disclosures
through analyzing relationships among data. Analytical procedures are also performed to assist the
auditor in risk assessment and as an overall review of the financial information near completion of the
audit.

Page | 18
 5. Auditors should be especially careful in considering financial statement accounts that are affected by
estimates made by management, such as the allowance for doubtful accounts. The inherent risk of these
types of accounts is generally much greater than for other financial statement accounts.
6. Audit documentation is the connecting link between the client’s accounting records and the auditors’
report. Such documentation is the property of the auditors and is primarily used to illustrate the
auditors’ compliance with professional standards and to support the auditors’ opinion. Other functions
of audit documentation include providing assistance in planning and performing the audit; facilitating
supervision and review of audit work; providing a record of matters relevant to future audits; enabling
other auditors to conduct peer reviews and inspections; and assisting successor auditors.

Activity/ Application
4-1. Carl Watson & Co., CPAs, is planning its audit procedures for its tests of the valuation of inventories of
East Coast Manufacturing Co. The auditors on the engagement have assessed inherent risk and control risk
for valuation of inventories at 100 percent and 50 percent, respectively.

a. Calculate the appropriate level of detection risk for the audit of this assertion, given that the
auditors wish to restrict audit risk for the assertion to 3 percent.

b. Calculate the appropriate level of detection risk for the audit of this assertion, given that the
auditors wish to restrict audit risk for the assertion to 5 percent.
(6%, 10%)

4-2. Auditors consider financial statement assertions to identify appropriate audit procedures. For items a
through f, match each assertion with the statement that most closely approximates its meaning. Each
statement may be used only once.
Assertion Statement
a. Completeness 1. There is such an asset.
b. Cutoff 2. The company legally owns the assets.
c. Existence and occurrence 3. All assets have been recorded.
d. Presentation and disclosure 4. Transactions are recorded in the correct
e. Rights and obligations accounting period.
f. Valuation 5. Assets are recorded at proper amounts.
6. Assets are properly classified.

4-3. Auditors perform audit procedures to obtain audit evidence that will allow them to draw reasonable
conclusions as to whether the client’s financial statements follow generally accepted accounting principles.
Match each audit procedure with its type. Each type of audit procedure is used; one is used twice.

Audit Procedures Type of Audit Procedures

g. Prepare a flowchart of internal control over sales. 7. Analytical procedures
h. Calculate the ratio of bad debt expense to credit 8. Tests of controls
sales. 9. Risk assessment procedures (other than analytical
i. Determine whether disbursements are properly procedures)
approved. 10. Test of details of account balances, transactions,
j. Confirm accounts receivable. or disclosures
k. Compare current financial information with
comparable prior periods.

4-4. State whether each of the following statements is correct or incorrect concerning audit risk and its
components—inherent risk, control risk, and detection risk.

a. The risk of material misstatement is composed of the three components of audit risk.
b. Inherent risk is the possibility of material misstatement before considering the client’s internal
control.
c. Less control risk means an increase in the risk of material misstatement.
d. Detection risk does not exist when no audit is performed.
e. Rather than restrict detection risk through the performance of more substantive procedures,
auditors assess it.
f. Absent any other changes, an increase in the risk of material misstatement results in an increase in
audit risk.
g. Audit risk refers to the possibility that the auditors may unknowingly fail to appropriately modify
their opinion on financial statements that are materially or immaterially misstated.
h. Both inherent risk and control risk exist independently of the audit of financial statements.
(Incorrect: A C E G)

Page | 19
4-5. Items a through l represent possible errors and fraud that you suspect may be present at Rex Company.
The accompanying List of Auditing Procedures represents procedures that the auditor would consider
performing to gather evidence concerning possible errors and fraud. For each item, select one or two
procedures, as indicated, that the auditor most likely would perform to gather evidence in support of that
item. The procedures on the list may be selected once, more than once, or not at all.

List of Audit Procedures

A. Compare the details of the cash receipts journal L. Examine the entity’s shipping documents to
entries with the details of the corresponding daily verify that the merchandise that produced
deposit slips. the receivable was actually sent to the
B. Scan the debits to the fixed asset accounts and customer.
vouch selected amounts to vendors’ invoices and M. Inspect the entity’s correspondence fi les for
management’s authorization. indications of customer disputes for
C. Perform analytical procedures that compare evidence that certain shipments were on
documented authorized pay rates to the entity’s consignment.
budget and forecast. N. Perform edit checks of data on the payroll
D. Obtain the cutoff bank statement and compare the transaction tapes.
cleared checks to the year-end bank O. Inspect payroll check endorsements for
reconciliation. similar handwriting.
E. Prepare a bank transfer schedule. P. Observe payroll check distribution on a
F. Inspect the entity’s deeds to its real estate. surprise basis.
G. Make inquiries of the entity’s attorney concerning Q. Vouch data in the payroll register to
the details of real estate transactions. documented authorized pay rates in the
H. Confirm the terms of borrowing arrangements human resources department’s fi les.
with the lender. R. Reconcile the payroll checking account and
I. Examine selected equipment repair orders and determine if there were unusual time lags
supporting documentation to determine the between the issuance and payment of
propriety of the charges. payroll checks.
J. Send requests to confirm the entity’s accounts S. Inspect the fi le of prenumbered vouchers for
receivable on a surprise basis at an interim date. consecutive numbering and proper
K. Send a second request for confirmation of the approval by an appropriate employee.
receivable to the customer and make inquiries of T. Determine that the details of selected
a reputable credit agency concerning the prenumbered vouchers match the related
customer’s creditworthiness. vendors’ invoices.
U. Examine the supporting purchase orders and
receiving reports for selected paid
vouchers.

Possible Misstatements Due to Errors and Fraud

a. The auditor suspects that a kiting scheme exists because an accounting department employee who can
issue and record checks seems to be leading an unusually luxurious lifestyle. (Select only 1 procedure.)

b. An auditor suspects that the controller wrote several checks and recorded the cash disbursements just
before year-end but did not mail the checks until after the first week of the subsequent year. (Select only 1
procedure.)

c. The entity borrowed funds from a financial institution. Although the transaction was properly recorded, the
auditor suspects that the loan created a lien on the entity’s real estate that is not disclosed in its financial
statements. (Select only 1 procedure.)

d. The auditor discovered an unusually large receivable from one of the entity’s new customers. The auditor
suspects that the receivable may be fictitious because the auditor has never heard of the customer and
because the auditor’s initial attempt to confirm the receivable has been ignored by the customer. (Select only
2 procedures.)

e. The auditor suspects that fictitious employees have been placed on the payroll by the entity’s payroll
supervisor, who has access to payroll records and to the paychecks. (Select only 1 procedure.)

f. The auditor suspects that selected employees of the entity received unauthorized raises from the entity’s
payroll supervisor, who has access to payroll records. (Select only 1 procedure.)

g. The entity’s cash receipts of the first few days of the subsequent year were properly deposited in its
general operating account after the year-end. However, the auditor suspects that the entity recorded the cash
receipts in its books during the last week of the year under audit. (Select only 1 procedure.)

h. The auditor suspects that vouchers were prepared and processed by an accounting department employee
for merchandise that was neither ordered nor received by the entity. (Select only 1 procedure.)

Page | 20
i. The details of invoices for equipment repairs were not clearly identified or explained to the accounting
department employees. The auditor suspects that the bookkeeper incorrectly recorded the repairs as fixed
assets. (Select only 1 procedure.)

j. The auditor suspects that a lapping scheme exists because an accounting department employee who has
access to cash receipts also maintains the accounts receivable ledger and refuses to take any vacation or sick
days. (Select only 2 procedures.)

k. The auditor suspects that the entity is inappropriately increasing the cash reported on its balance sheet by
drawing a check on one account and not recording it as an outstanding check on that account and
simultaneously recording it as a deposit in a second account. (Select only 1 procedure.)

l. The auditor suspects that the entity’s controller has overstated sales and accounts receivable by recording
fictitious sales to regular customers in the entity’s books. (Select only 2 procedures.)

ANSWER:

a. E. Kiting involves manipulations causing an amount of cash to be included simultaneously in the

balance of two or more bank accounts. Kiting schemes are based on the float period—the time necessary for a
check deposited in one bank to clear the bank on which it was drawn. To detect kiting, a bank transfer schedule
is prepared to determine whether cash is improperly included in two accounts.

b. D. A comparison of the cleared checks to the year-end bank reconciliation will identify checks that
were not mailed until after the first week of the subsequent year because most of those checks will not be
returned with the cutoff statement and will appear to remain outstanding an abnormally long period of time.

c. H. Among the terms confirmed for such a borrowing arrangement will be information on liens.

d. K, L. A reply to the second request, or information from the credit agency, may confirm the existence
of the new customer. Also, examination of shipping documents will reveal where the goods were shipped, and
ordinarily to which party.

e. P. Observing the payroll check distribution on a surprise basis will assist in detection since the
auditor will examine details related to any paychecks not picked up by employees.

f. Q. Vouching data in the payroll register to document authorized pay rates will reveal situations in
which an employee is earning income at a rate that differs from the authorized rate.

g. A. A comparison of the details of the cash receipts journal to the details on the daily deposit slips will
reveal a circumstance since the details will have been posted to accounts during the last week of the year under
audit.

h. U. When vouchers are processed for merchandise not ordered or received, there will be no
supporting purchase orders and receiving reports and this will alert the auditor to the problem.

i. B. Scanning the debits to the fixed asset accounts and vouching selected amounts will reveal repairs
that have improperly been capitalized.

j. A, J. Lapping involves concealing a cash shortage by delaying the recording of journal entries for
cash receipts. Since lapping includes differences between the details of postings to the cash receipts journal
and corresponding deposit slips, comparing these records will reveal it. Also, confirmation requests may
identify lapping when payments of receivables (as indicated by confirmation replies) appear to have taken too
much time to be processed.

k. E. Increasing cash by drawing a check in this manner is a form of kiting (see answer 1). Preparation
of a bank transfer schedule will assist the auditor in identifying such transaction

l. J, L. Confirmations will identify overstated accounts receivable when customers disagree with the
recorded balance due. Also, the related overstated sales will not have shipping documents indicating that a
shipment has occurred.

Assessment

Instruction: Online quiz will be available on Moodle (Tentative). The quiz will be around 70-
100 items. The quiz will be available from 8AM to 8PM. However, you only have 2 hours to answer
the quiz once started. Tentative date: October 19, 2020, Monday.

Page | 21
Page | 22