De Guzman Module 7

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1. What is audit evidence?

Audit evidence is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based, and includes the information
contained in the accounting records underlying the financial statements and the
other information. It is necessary to support the auditor’s opinion and report. The
purpose of gathering and evaluating audit evidence is to acquire data and
information as a basis for concluding whether an entity’s financial statements are
presented fairly in accordance with an identified financial framework.

2. What are the factors that affect sufficiency and appropriateness of audit
evidence?

The auditor’s judgement as to what is sufficient appropriate evidential matter is


influenced by such factors as:

a. The degree of risk of misstatement- may be affected by the nature of the item,
the adequacy of internal control, the nature of the business carried on by the
entity, situations which may exert an unusual influence on the management,
and the financial position the entity;

b. The materiality of the item in relation to the financial statements taken as a


whole;

c. The experience gained during the previous audit;

d. The result of auditing procedures, including fraud or error which may have
been found; and

e. The type of information available

3. An auditor typically works within economic limits. Explain this statement.

An auditor typically works within economic limits, his opinion, to be economically


useful, must be performed within reasonable length of time and at reasonable
cost. As a guiding rule, there must be a rational relationship between the cost of
obtaining evidence and the usefulness of the information obtained.
4. What are the generalizations on reliability of audit evidence?

Generalization on reliability of audit evidence consist of the following:

a. Independence of the source- evidence obtained from independent sources


outside the client is usually more reliable than that from within the client.

b. Qualification of the sources- evidence must be obtained from people who are
competent and have the qualifications to make the information free from error.

c. Internal Control- audit evidence that is generated internally is more reliable


when the related controls imposed by the entity are effective. Also, the auditor
does not accept management’s description of the client’s internal control
without corroboration.

d. Nature of Evidence- audit evidence obtained directly by the auditor is more


reliable than audit evidence obtained indirectly (for example, inquiry about the
application of control.

e. Form of the evidence- audit evidence is more reliable when it exists in


documentary form, whether paper, electronic, or other medium. Also, audit
evidence provided by the original documents is more reliable than provided
by photocopies or facsimiles.

5. Explain the relationship between assertions, audit objectives, and audit evidence.

In obtaining evidential matter in support of financial statement assertions, the


auditor develops specific audit objectives in the light of those assertions. In
developing the audit objectives of a particular engagement, the auditor should
consider the specific circumstances of the entity, including the nature of its
economic activity and the accounting practices unique to its industry.

6. Enumerate, and explain, each audit procedure classified according to purpose


and according to nature.

Audit procedures according to purpose includes:


a. Risk assessments procedure- obtain an understanding of the entity and its
environment, including its internal control, to assess the risk of material
misstatement at the financial statement and assertion levels.

b. Test of controls- when necessary or when the auditor has determined to do


so, test the operating effectiveness of controls in preventing, or detecting, and
correcting, material misstatements at the assertion level.

c. Substantive procedures- detecting material misstatements at the assertion


level.

Audit procedures according to nature includes:

a. Inspection of records or documents- inspection consists of examining


records or documents, whether internal or external, in paper form, electronic
form, or other media.

b. Inspection of tangible assets- consists of physical examination of the


assets. It may provide reliable audit evidence with respect to their existence.

c. Direction test- is important in establishing assertion being tested by a certain


procedure.

d. Observation- looking at a process or procedure being performed by others.

e. Inquiry- consists of seeking information of knowledgeable persons both


financial and non-financial, throughout the entity or outside the entity. It is an
audit procedure that is used extensively throughout the audit and often
complementary to performing other audit procedures.

f. Recalculation- consists of checking the mathematical accuracy of


documents or records.

g. Re- performance- is the auditor’s independent execution of procedures or


controls that were originally performed as part of the entity’s internal control,
either manually or using CAAts.
h. Confirmation- is the process of obtaining a representation of a information or
of an existing condition directly from a third party.

i. Analytical procedures- consist of evaluation of financial information made


by a study of plausible relationships among both financial and non-financial
data. It also encompasses the investigation of identified fluctuations and
relationships that are consistent with other relevant information or deviate
significantly from predicted amounts.

j. Other terms of Audit Procedures- numerous other terms for audit


procedures have been used in both the professional standards and in auditing
texts.

7. Define external confirmation. Give examples of situations involving external


confirmation.

External confirmation is the process of obtaining and evaluating audit evidence


through a representation of information or an existing condition directly from a
third party in response to a request for information about a particular item
affecting assertions in the financial statements or related disclosures. External
confirmation can be used in bank balances and other information from bankers,
accounts receivable balances, stocks held by third parties at bonded warehouses
for processing or on consignment and accounts payable balances.

8. What are the different forms of confirmation request? What are the situations
where each type may be used?

The auditor may use negative or positive form of confirmation request or a


combination of both.

a. Positive confirmation- It is a confirmation request that asks the


respondent to reply to the auditor in all cases either by indicating the
respondent’s agreement with the given information, or by asking the
respondent to fill in the information. A response to positive confirmation
request is ordinarily expected to provide reliable audit evidence. There is a
risk, that a respondent may reply to confirmation request without verifying
that the information is correct. The auditor is not ordinarily able to detect
whether this has occurred. The auditor may reduce this risk, by using
positive confirmation request that do not state the amount on the
confirmation request but ask the respondent to fill in the amount or furnish
other information. On the other hand, the use of this type of ‘blank’
confirmation request may result in lower response rates because
additional effort is required of the respondents.

b. Negative Confirmations- It is a confirmation request that asks the


respondents to reply only in the event of disagreement with the information
provided in the request. However, when no response has been received to a
negative confirmation request, the auditor remains aware that there will be no
explicit audit evidence that intended third parties have received the
confirmation requests and verified that the information contained therein is
correct. Accordingly, the use of negative confirmation requests ordinarily
provides less reliable audit evidence than the use of positive confirmation
requests, and the auditor considers performing other substantive procedures
to supplement the use of negative confirmations.

9. Explain the typical approach followed in performing analytical procedures.

The typical approach are:

a. Develop an expectation for the account balance.


b. Determine the amount of difference from the expectation that can be
accepted without investigation
c. Compare the company’s account balance with the expected account
balance
d. Investigate significant differences from the expected amount balance.
When developing an expectation, the auditor must attempt to identify plausible
relationships. These expectations may be derived from the information itself in
prior periods, anticipated results such as budgets and forecasts, relationships
among elements of financial information within the period, industry information
and relevant non-financial information.

10. Define substantive tests. What are the different types of substantive tests?

Substantive procedures are those activities performed by the auditor during the
substantive testing stage of the audit that gather evidence as to the
completeness, validity and/or accuracy of account balances’ and underlying
classes of transactions. Account balances and underlying classes of the
transaction must not’ contain any material misstatements. They must be
materially complete, valid, and accurate. There are two general types of
substantive tests: test of details of transaction, balances and disclosures and
analytical review procedure. The tests of details are used to examine the actual
details making up the various account balances.

11. Differentiate fraud from error.

Errors refers to unintentional misstatements in the financial statement, on the


other hand fraud refers to an intentional act by one or more individuals among
management, those charged with governance, employees or third parties involving
the use of deception to obtain an unjust or illegal advantage.

12. What are the auditor's responsibilities regarding fraud? Regarding error?

The primary responsibility for the prevention and detection of fraud and
error rests with both those charged with governance and the management of an
entity. An audit conducted in accordance with PSAs is designed to provide
reasonable assurance than the financial statements taken as a whole are free
from material misstatements, whether caused by error or fraud. The auditor is
noy and cannot be held responsible for the prevention of fraud and error.
The auditor’s procedures related to fraud and error are summarized as follows:
1. Identify if there are circumstances that indicates a possible misstatement in
the financial statements.
2. Determine whether the financial statements are materially misstated.
3. If misstatements are identified, the auditor should consider whether such a
misstatement may be indicative of fraud, if yes the auditor should consider the
implications on the audit.
4. In evaluating and disposing misstatements, consider materiality. The effect on
the auditor’s report depends on the evaluation and disposition of these
misstatements.
5. The auditor should document the fraud risk factors identified during the
performance of the audit and the auditor’s responses to the fraud risk factors

13. What are accounting estimates? How are accounting estimates audited?

It means an approximation of the amount of an item in the absence of a


precise means of measurement. This term is used for an amount measured at
fair value where there is estimation uncertainty, as well as for other amounts that
require estimation. Management is responsible for making accounting estimates
included in the financial statements. These estimates are often made in
conditions of uncertainty regarding the outcome of events that have occurred or
are likely to occur and involve the use of judgement. As a result, the risk of
material misstatement is greater when accounting estimates are involved and in
some cases the auditor may determine that the risk of material misstatement
related to an accounting estimate is a significant risk that requires special audit
consideration. To determine the reasonable amount or range of amounts for an
accounting estimate, the auditor must first understand how the client developed
the estimate. The auditor may then evaluate the estimate by the following means;
test the process used by management to develop the estimate, develop an
independent expectation and review subsequent events or transactions. The
auditor shall evaluate, based on the audit evidence, whether the accounting
estimates in the financial statements are either reasonable in the context of the
applicable financial reporting, framework or are misstated.
14. What is audit documentation? What are the purposes of audit documentation?

Audit documentation or working papers are the record of audit procedures


performed, relevant audit evidence obtained, and conclusions the auditors
reached. Working papers should include all the information the auditor considers
necessary to conduct the audit adequately and to provide support for the audit
report.
The audit documentation has the following functions or purposes:
a. Serve as evidence of the auditor’s basis for a conclusion about the
achievement of the overall objective of the auditor
b. Provide evidence that the audit was performed in accordance with PSAs
and applicable legal and regulatory requirements
c. Assist the audit team to plan and perform the audit
d. Assist the members of the audit team responsible for supervision to direct
and supervise the audit work and to discharge their review responsibilities
in accordance with PSA 220.
e. Enable the audit team to be accountable for its work
f. Retain a record of matters of continuing significance to future audits
g. Enable an experienced auditor to conduct quality control reviews and
inspections in accordance with PSQC 1
h. Enable an experienced auditor to conduct external inspections in
accordance with applicable legal, regulatory or other requirements.

15. Give examples of factors that affect the form and content of audit documentation.

The factors affecting the form, content and extent of audit documentation

a. The nature of the audit procedures to be performed


b. The identified risk of material misstatement
c. The extent of judgement required in performing the work and evaluating the
results
d. The significance of the audit evidence obtained
e. The 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
g. The audit methodology and tools used

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