SUBSTANTIVE TESTING PROCEDURES

AUDIT EVIDENCE
Most of the auditor’s work involves obtaining and evaluating evidences using procedures such as
inspection of records and confirmations to test the fair presentation of the financial statements. To
perform this task effectively and efficiently, an auditor must understand thoroughly the important
aspects of audit evidence. This includes understanding how audit evidence relates to financial statement
assertions and the auditor’s report, the sufficiency and appropriateness of evidence, types of audit
procedures and the documentation of evidence in the working papers.
PSA 500 as revised provides the basic framework for the auditor’s understanding of evidence and
its use to support the auditor’s opinion on the financial statements. The auditor gathers evidence by
conducting audit procedures to test management assertions in expressing an opinion on the financial
statements. The evidence gathered from the audit procedures is used to determine the fairness of the
financial statements and the type of audit report to be issued. The financial statements reflect
management’s assertions about the various financial statement components. The auditor conducts audit
procedures to gather evidence regarding whether each relevant management assertion is being
supported. The application of audit procedures provides the evidence that supports the auditor’s report.
The concept of audit evidence is that, all 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 other information. Auditors are not expected
to examine all information that may exist. Audit evidence, which is cumulative in nature, includes audit
evidence obtained from audit procedures performed during the course of the audit and may include audit
evidence obtained from other sources such as previous audits and a firm's quality control procedures for
client acceptance and continuance.

NATURE OF AUDIT EVIDENCE

Accounting records generally include the records of initial entries and supporting records, such as
checks and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers,
journal entries, and other adjustments to the financial statements that are not reflected in formal journal
entries; and records such as worksheets and spreadsheets supporting cost allocations, computations,
reconciliations, and disclosures. The entries in the accounting records are often initiated, authorized,
recorded, processed, and reported in electronic form. In addition, the accounting records may be part of
integrated systems that share data and support all aspects of the entity's financial reporting, operations,
and compliance objectives.
Management is responsible for the preparation of the financial statements based on the
accounting records of the entity. The auditor should obtain audit evidence by testing the accounting
records, for example, through analysis and review, reperforming procedures followed in the financial
reporting process, and reconciling related types and applications of the same information. Through the
performance of such audit procedures, the auditor may determine that the accounting records are
internally consistent and agree to the financial statements. However, because accounting records alone
do not provide sufficient appropriate audit evidence on which to base an audit opinion on the financial
statements, the auditor should obtain other audit evidence.
 minutes of meetings
 confirmations from third parties
 industry analysts' reports
 comparable data about competitors (benchmarking)
 controls manuals
 information obtained by the auditor from such audit procedures as inquiry, observation, and
inspection
 other information developed by or available to the auditor that permits the auditor to reach
conclusions through valid reasoning.

THE APPROPRIATENESS OF AUDIT EVIDENCE

Appropriateness is the measure of the quality of audit evidence, that is, its relevance and its
reliability in providing support for, or detecting misstatements in, the classes of transactions, account
balances, and disclosures and related assertions.
1. Relevance - The definition of relevance emphasizes the need for engagement work to be restricted
to achieving the engagement objectives. However, evidence also should be gathered on “all
matters” within the engagement scope. Relevant information has a logical relationship to what it
purports to prove.
 A given set of audit procedures may provide audit evidence that is relevant to certain assertions
but not to others. For example, inspection of records and documents related to the collection of
receivables after the period end may provide audit evidence regarding both existence and
valuation, although not necessarily the appropriateness of period-end cutoffs. On the other hand,
the auditor often obtains audit evidence from different sources or of a different nature that is
relevant to the same assertion. For example, the auditor may analyze the aging of accounts
receivable and the subsequent collection of receivables to obtain audit evidence relating to the
valuation of the allowance for doubtful accounts. Furthermore, obtaining audit evidence relating
to a particular assertion, for example, the physical existence of inventory, is not a substitute for
obtaining audit evidence regarding another assertion, for example, rights and obligations.
2. Reliability - The reliability of audit evidence is influenced by its source and by its nature which is
dependent on the individual circumstances under which it is obtained. Generalizations about the
reliability of various kinds of audit evidence can be made; however, such generalizations are
subject to important exceptions. Even when audit evidence is obtained from sources external to
the entity, circumstances may exist that could affect the reliability of the information obtained. For
example, audit evidence obtained from an independent external source may not be reliable if the
source is not knowledgeable. While recognizing that exceptions may exist, the following
generalizations about the reliability of audit evidence are useful:
 Audit evidence is more reliable when it is obtained from knowledgeable independent
sources outside the entity.
 Audit evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective.
 Audit evidence obtained directly by the auditor (for example, observation of the application
of a control) is more reliable than audit evidence obtained indirectly or by inference (for
example, inquiry about the application of a control).
 Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium (for example, a contemporaneously written record of a
meeting is more reliable than a subsequent oral representation of the matters discussed).
 Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
The auditor should consider the reliability of the information to be used as audit evidence, for
example, photocopies; facsimiles; or filmed, digitized, or other electronic documents, including
consideration of controls over their preparation and maintenance where relevant. However, an
audit rarely involves the authentication of documentation, nor is the auditor trained as or
expected to be an expert in such authentication.
When information produced by the entity is used by the auditor to perform further audit
procedures, the auditor should obtain audit evidence about the accuracy and completeness of the
information. In order for the auditor to obtain reliable audit evidence, the information upon which
the audit procedures are based needs to be sufficiently complete and accurate. For example, in
auditing revenue by applying standard prices to the records of sales volume, the auditor should
consider the accuracy of the price information and the completeness and accuracy of the sales
volume data. Obtaining audit evidence about the completeness and accuracy of the information
produced by the entity's information system may be performed concurrently with the actual audit
procedure applied to the information when obtaining such audit evidence. In other situations, the
auditor may have obtained audit evidence of the accuracy and completeness of such information
by testing controls over the production and maintenance of the information. However, in some
situations the auditor may determine that additional audit procedures are needed. For example,
these additional procedures may include the use of computer-assisted audit techniques (CAATs)
to recalculate the information.
The auditor ordinarily obtains more assurance from consistent audit evidence obtained
from different sources or of a different nature than from items of audit evidence considered
individually. In addition, obtaining audit evidence from different sources or of a different nature
may indicate that an individual item of audit evidence is not reliable. For example, corroborating
information obtained from a source independent of the entity may increase the assurance the
auditor obtains from a management representation. Conversely, when audit evidence obtained
from one source is inconsistent with that obtained from another, the auditor should determine
what additional audit procedures are necessary to resolve the inconsistency.
SUFFICIENCY OF AUDIT EVIDENCE
Sufficiency is the measure of the quantity of audit evidence. The auditor should consider
the sufficiency and appropriateness of audit evidence to be obtained when assessing risks and designing
further audit procedures. The quantity of audit evidence needed is affected by the risk of misstatement
(the greater the risk, the more audit evidence is likely to be required) and also by the quality of such audit
evidence (the higher the quality, the less the audit evidence that may be required). Accordingly, there is
an inverse relationship between the sufficiency and appropriateness of audit evidence.
The auditor may consider the relationship between the cost of obtaining audit evidence and the
usefulness of the information obtained. However, the matter of difficulty or expense involved is not in
itself a valid basis for omitting an audit procedure for which there is no appropriate alternative.
In forming the audit opinion, the auditor does not examine all the information available (evidence)
because conclusions ordinarily can be reached by using sampling approaches and other means of
selecting items for testing. Also, the auditor may find it necessary 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. The auditor should use professional judgment
and should exercise professional skepticism in evaluating the quantity and quality of audit evidence, and
thus its sufficiency and appropriateness, to support the audit opinion. Determining the sufficiency of
evidence is one of the more critical decisions the auditor faces on an engagement.

EVALUATION OF AUDIT EVIDENCE

The auditor should be thorough in searching for evidence and unbiased in its evaluation. The
auditor must be capable of assessing when a sufficient amount of appropriate evidence has been obtained
in order to determine whether the fairness of management’s assertions can be supported.
It is stated in PSA 500 that the auditor should use assertions for classes of transactions, account
balances, and presentation and disclosures in sufficient detail to form a basis for the assessment of risks
of material misstatement and the design and performance of further audit procedures. The auditor uses
assertions in assessing risks by considering potential misstatements that may occur, and thereby
designing audit procedures that are responsive to the particular risks.
Assertions used by the auditor fall into the following categories:

Assertions about classes of transactions and events for the period under audit
Transactions and events that have been recorded have occurred and pertain to the
Occurrence
entity.
Completeness All transactions and events that should have been recorded have been recorded.
Amounts and other data relating to recorded transactions and events have been
Accuracy
recorded appropriately.
Cutoff Transactions and events have been recorded in the correct accounting period.
Classification Transactions and events have been recorded in the proper accounts.

Assertions about account balances at the period end

Existence Assets, liabilities, and equity interests exist.
Rights and The entity holds or controls the rights to assets, and liabilities are the obligations of the
obligations entity.
All assets, liabilities, and equity interests that should have been recorded have been
Completeness
recorded.
Assets, liabilities, and equity interests are included in the financial statements at
Valuation and
appropriate amounts and any resulting valuation or allocation adjustments are
allocation
appropriately recorded.

Assertions about presentation and disclosure

Occurrence and Disclosed events and transactions have occurred and pertain to the entity.
rights and
obligations
All disclosures that should have been included in the financial statements have been
Completeness
included.
Classification and Financial information is appropriately presented and described and disclosures are
understandability clearly expressed.
Accuracy and Financial and other information are disclosed fairly and at appropriate amounts.
valuation
 Relevant assertions are assertions that have a meaningful bearing on whether the account is fairly
stated. For example, valuation may not be relevant to the cash account unless currency translation is
involved; however, existence and completeness are always relevant. Similarly, valuation may not be
relevant to the gross amount of the accounts receivable balance but is relevant to the related allowance
accounts. Additionally, the auditor might, in some circumstances, focus on the presentation and disclosure
assertion separately in connection with the period-end financial reporting process.
The assertions are not individually assessed but quite often at the same time. For example, to
ensure completeness of electricity expense, the auditor ensures that the 12 months of payments were
booked. Since the client may record the bills paid on a cash basis, electricity expense of a month of
previous basis period might be entered in the current year. Electricity expense of last month of current
year might be recorded next year. If the monthly fluctuation is immaterial, the auditor always ignores the
cut-off issue. In case where electricity is a material expense, the auditor considers preparing adjustments
for year ended cut-off purpose so that the profit or loss would not be materially misstated.

AUDIT PROCEDURES
Audit procedures are specific acts or methods performed by the auditor to gather evidence to
determine if specific assertions are being met. The auditor should obtain audit evidence to draw
reasonable conclusions on which to base the audit opinion by performing audit procedures to:
 Obtain an understanding of the entity and its environment, including its internal control, to assess
the risks of material misstatement at the financial statement and relevant assertion levels (audit
procedures performed for this purpose are referred to as risk assessment procedures)
 When necessary, or when the auditor has determined the need to do so, test the operating
effectiveness of controls in preventing or detecting material misstatements at the relevant assertion
level (audit procedures performed for this purpose are referred to as tests of controls)
 Detect material misstatements at the relevant assertion level (audit procedures performed for this
purpose are referred to as substantive procedures and include tests of details of classes of
transactions, account balances, and disclosures, and substantive analytical procedures).
The auditor must perform risk assessment procedures to provide a satisfactory basis for the assessment
of risks at the financial statement and relevant assertion levels. Risk assessment procedures by
themselves do not provide sufficient appropriate audit evidence on which to base the audit opinion and
must be supplemented by further audit procedures in the form of tests of controls, when relevant and
substantive procedures.

1. Inspection of records or documents

 Vouching refers to first selecting an item for testing from the underlying accounting data
and then examining the source document (corroborating information). This procedure is
used to establish the existence or occurrence of the selected item. For example, to verify the
occurrence of sales transactions, recorded sales transactions in the sales journal maybe
compared to supporting documents such as invoices and shipping documents.
 Tracing refers to selecting an accounting transaction (corroborating information) and
tracing it into the journal or ledger (underlying accounting data). This procedure
establishes the completeness of transactions. For example, to ensure that the selected
shipping documents occurred are recorded, the auditor compares/traces shipping
documents to sales invoice then to sales journal.
2. Inspection of tangible assets - consists of physical examination of the assets. Inspection of tangible
assets may provide appropriate audit evidence with respect to their existence, but not necessarily
about the entity's rights and obligations or the valuation of the assets. Inspection of individual
inventory items ordinarily accompanies the observation of inventory counting. For example, when
observing an inventory count, the auditor may inspect individual inventory items (such as opening
containers included in the inventory count to ensure that they are not empty) to verify their
existence.
 Underlying accounting data consist of the book of original entry (e.g., journals and
registers), the general and subsidiary ledgers, related accounting manuals, and records
such as worksheets supporting cost allocations, computations and reconciliations.
 Corroborating evidence includes both written and electronic information (e.g., checks,
invoices, contracts, and minutes of meetings); confirmations and other written
representations by knowledgeable people; information obtained by the auditor from
inquiry, observation, inspection, and physical examination; and other information
developed by, or available to, the auditor that permits conclusions through valid reasoning.
3. Observation - Observation consists of looking at a process or procedure being performed by
others. Examples include observation of the counting of inventories by the entity's personnel and
 observation of the performance of control activities. Observation provides audit evidence about
the performance of a process or procedure but is limited to the point in time at which the
observation takes place and by the fact that the act of being observed may affect how the process
or procedure is performed.
4. Inquiry - Inquiry consists of seeking information of knowledgeable persons, both financial and
nonfinancial, inside or outside the entity. Inquiry is an audit procedure that is used extensively
throughout the audit and often is complementary to performing other audit procedures. Inquiries
may range from formal written inquiries to informal oral inquiries. Evaluating responses to
inquiries is an integral part of the inquiry process.
5. Confirmation - Confirmation, which is a specific type of inquiry, is the process of obtaining a
representation of information or of an existing condition directly from a third party. For example,
the auditor may seek direct confirmation of receivables by communication with debtors.
Confirmations are frequently used in relation to account balances and their components but need
not be restricted to these items. A confirmation request can be designed to ask if any modifications
have been made to the agreement, and if so, what the relevant details are. For example, the auditor
may request confirmation of the terms of agreements or transactions an entity has with third
parties. Confirmations also are used to obtain audit evidence about the absence of certain
conditions, for example, the absence of a ‘side agreement’ that may influence revenue recognition.
PSA 505, External Confirmations, requires that the auditor should determine whether the
use of external confirmation is necessary to obtain sufficient appropriate audit evidence to
support specific assertions. There are two common types of confirmation requests:
 A positive confirmation asks the recipient to respond in all circumstances. It may request
the recipient to provide the information (called a blank form), or the confirmation may
include the information and request the respondent to indicate whether he agrees with the
information. The latter type of positive confirmation is often used because the response
rate is higher than the blank form. However, because recipients may sign the request
without verifying the information, there is a risk that the information is incorrect and tends
to be less reliable.
 In negative confirmation, the recipient is asked to respond only when the information is
incorrect. Because confirmations are considered significant evidence only when returned,
this type of confirmation is less competent than positive confirmation. To be considered
reliable, confirmations must be controlled by the auditor from the time they are prepared
until they are returned.
6. Recalculation - recalculation consists of checking the mathematical accuracy of documents or
records. Recalculation can be performed through the use of information technology, for example,
by obtaining an electronic file from the entity and using CAATs to check the accuracy of the
summarization of the file.
7. Reperformance - reperformance 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 through
the use of CAATs, for example, reperforming the aging of accounts receivable.
8. Analytical Procedures - Analytical procedures consist of evaluations of financial information made
by a study of plausible relationships among both financial and nonfinancial 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. PSA
520, Analytical Procedures, provides further guidance on analytical procedures.
9. Journal-entry testing - Examining journal entries and other adjustments for evidence of material
misstatement due to fraud. Material misstatements of financial statements due to fraud often
involve the manipulation of the financial reporting process by recording inappropriate journal
entries or adjustments. Therefore, the auditors should review such entries and adjustments for
suspicious characteristics, such as entries made to unrelated, unusual, or seldom-used accounts;
entries recorded at the end of the period or as post-closing entries that have little or no
explanation or description; or entries made either before or during the preparation of the financial
statements that do not have account numbers.

AUDIT DOCUMENTATION/WORKING PAPERS

Audit documentation is the principal record of auditing procedures applied, relevant audit
evidence obtained, and conclusions reached by the auditor in the engagement. PSA 230 (revised) Audit
Documentation, requires the auditor to document matters that are important tosupport an opinion and
evidence that the audit was conducted in accordance with Philippine Standards on Auditing and
applicable legal and regulatory requirements.
 Audit documentation is also referred to as working papers or the audit file. Some working papers
are prepared in hard-copy format, but, nowadays, audit software is normally used to prepare and store
them.

Working papers are prepared mainly to

a. Assist the auditor in planning, performance, review and supervision of the engagement.
b. Support the auditor’ representation as to compliance with Philippine Standards on Auditing.
c. Support the auditor’s opinion on financial statements.
Working papers also assist the auditor in
a. Planning future audits.
b. Providing information useful in rendering other services.
c. Providing adequate defense in case of litigation.

The auditor should prepare the audit documentation so as to enable an experienced auditor, having no
previous connection with the audit, to understand:
a. The nature, timing, and extent of 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;
c. Significant matters arising during the audit and the conclusions reached thereon.

The auditor must document significant findings or issues, actions taken to address them (including
additional evidence obtained), and the basis for the conclusions reached in connection with each
engagement. Judging the significance of a matter requires an objective analysis of the facts and
circumstances. Significant findings or issues are substantive matters that are important to the procedures
performed, evidence obtained, or conclusions reached, and include, but are not limited to, the following:
a. Significant matters involving the selection, application, and consistency of accounting principles,
including related disclosures. Significant matters include, but are not limited to, accounting for
complex or unusual transactions, accounting estimates, and uncertainties as well as related
management assumptions.
b. Results of auditing procedures that indicate a need for significant modification of planned auditing
procedures, the existence of material misstatements, omissions in the financial statements, the
existence of significant deficiencies, or material weaknesses in internal control over financial
reporting.
c. Audit adjustments. An audit adjustment is a correction of a misstatement of the financial
statements that was or should have been proposed by the auditor, whether or not recorded by
management that could, either individually or when aggregated with other misstatements, have a
material effect on the company's financial statements.
d. Disagreements among members of the engagement team or with others consulted on the
engagement about final conclusions reached on significant accounting or auditing matters.
e. Circumstances that cause significant difficulty in applying auditing procedures.
f. Significant changes in the assessed level of audit risk for particular audit areas and the auditor's
response to those changes.
g. Any matters that could result in modification of the auditor's report.

It is not practical to document every matter the auditor considers. In deciding the extent of working
papers is a matter of professional judgment by the auditor. The form and content of working papers
depend on factors such as:
 Nature of the engagement.
 Form of the auditor’s report.
 Nature and complexity of the business.
 Nature and condition of the entity’s accounting and internal control systems.
 Needs in the particular circumstances for direction, supervision, and review of work performed by
assistants.
 Specific audit methodology and technology used in the course of the audit.

Type of Files
Permanent files contain information about the client that are of continuing relevance to the audit.
These files provide a convenient source of information about the audit that is of continuing significance
from year to year. Current files include all the information applicable to the year under audit.
 Permanent File Current File
 Copies of the corporate charter/by-laws  Audit program
 Copies of contracts  Working trial balance
 Chart of accounts  Copies of minutes of meetings
 Organizational chart  Copy of financial statement
 Accounting manuals  Copy of auditor’s report
 Information relating to the understanding  Working papers supporting financial
the internal control statement accounts (lead and detailed
 Terms of stock and bond issues schedules)
 The results of analytical procedures from
prior year’s audit

Audit Program
An audit program contains the detailed audit procedures that will be conducted by the auditor. It
is normally maintained in a separate file to improve the coordination and integration of all parts of the
audit. As the audit progresses, each auditor initials the program for the audit procedures conducted and
indicates the date of completion.

Working Trial Balance/Lead Schedule

The working trial balance is a listing of the general accounts with its year-end balances as
unadjusted amount directly obtained from client, proposed audit adjustment, and the audited balance
amount. Each line item on the trial balance is supported by a lead schedule. Lead (Top) schedule contains
the detailed accounts from the general ledger making up the line item total. Each detailed account on the
lead schedule is supported by appropriate schedules supporting the audit work performed and the
conclusion reached. For example, the trial balance would contain only one line for cash and the lead
schedule would list all general ledger cash accounts (e.g., Petty Cash, Cash in Bank A, Cash in Bank B) and
each detailed account on the lead schedule for cash is supported by appropriate schedules (Cash count
for Petty Cash, Bank Reconciliation for Cash in Bank).

Supporting Schedules
These are the largest portion of audit documentation prepared by auditors in support of specific
amounts on the financial statements. For example, aging of receivables, bank reconciliations, and lapsing
schedule/listing for property and equipment.

Adjusting and Reclassification Entries

Adjusting entries are made to correct the discovered misstatement in the client’s records.
Reclassification entries are made in the financial statements to present the accounting information
properly. It should be noted that only those adjusting and reclassification entries that significantly affect
the fair presentation of financial statements must be made. The determination of when misstatement
should be adjusted is based on materiality.

Working Papers Format

Working papers may be prepared in both manually and electronically. Whether these were prepared
manually or electronically, the manner in which it is formatted usually contains the following
characteristics:
 Heading - all working papers should have a proper heading such as the name of the client, the title
of the working paper and the date covered by the examination.
 Indexing and Cross-Referencing - indexing is the use of lettering or numbering system in the
working paper. For example, cash may be labeled as A for its lead schedule. When auditor
conducts audit work on one working paper and the supporting information is obtained from
another working paper, the auditor cross-references the information on each working paper. This
is important to provide a trail useful in reviewing the working papers.
 Tick Marks - the auditors use tick marks to document work performed. These are the symbols that
describe the audit procedures performed by the auditor.

Ownership of Working Papers

According to PAS 230, working papers are the property of the auditor. Portions of working papers
may be made available to the client at the discretion of the auditor, but they should not be considered as
part or as substitute for the client’s records. The Philippine Accountancy Act of 2004, Section 29 specifies
the legal provision on ownership of audit working papers.
Confidentiality of Working Papers
Although the auditor owns the working papers, they cannot be shown, except under certain
circumstances, to anyone without the client’s consent. Section 4 of the Code of Ethics for Professional
Accountants in the Philippines provides guidance for the confidentiality of information obtained during
the course of audit. One of the guidance is that the auditor can disclose confidential information even
without the client’s consent when:
1. Disclosure is required by law.
a. To produce documents or to give evidence in the course of legal proceedings.
b. To disclose to the appropriate public authorities the infringements of law which come to
light.
2. There is a professional duty or right to disclose.
a. To comply with technical standards and ethics requirements.
b. To protect professional interest of a professional accountant in legal proceedings.
c. To comply with the quality review of a member body or professional body. To respond to
an inquiry or investigation by a member body or regulatory body.