AUDITING

ACCOUNTING
ESTIMATES
 According to PSA 540, ACCOUNTING ESTIMATE
is an approximation of the amounts of an item
in the absence of a precise means of
measurement. This is made in conditions of
uncertainty regarding the outcome of events
that have occurred or are likely to occur and
involve the use of judgment.
 Allowance for uncollectible accounts

 Depreciation and amortization

 Accrued revenue

 Deferred taxes

 Loss contingencies

 Percentage of completion income on construction contracts

 Warranty claims
 AUDITOR’S RESPONSIBILITY

 Accounting estimate is properly accounted and disclosed;

 Accounting estimate is reasonable in the circumstances.

The auditor may:

1. Review and test the process used by management to
develop the estimate.
2. Make an independent estimate
3. Review subsequent events which confirm the estimate
made.
 RELATED PARTIES

 persons or entities that may have dealings with one another in

which one party has the ability to exercise significant influence or
control over the other party in making financial and operating
decisions.
Auditors should be aware of:
a. GAAP require disclosure in the financial statements of certain
related party relationships and transactions.
b. A relates party transaction may be motivated by other than
ordinary business considerations such as profit sharing or even
fraud.
c. The existence of related parties or related party transactions
may affect the financial statements and the reliability of audit
evidence.
MANAGEMENT’S RESPONSIBILITY

 management is responsible for the identification and disclosure

of related parties and transactions with such parties. It requires
management to implement adequate accounting and internal
control systems to ensure that transactions with related parties
are appropriately identified in the accounting records and
disclosed in the financial statements.
 AUDITOR’S RESPONSIBILITY

 to obtain and review the information provided by the directors and

management. And identifying the names and transactions of all related
parties.
Identifying related parties:
a. Review prior-year working papers for names
b. Review the entity’s procedures
c. Inquire as to affiliation of the directors and officers with other entities
d. Review shareholder records
e. Review minutes of meetings of shareholders and the board of directors
f. Inquire of the other auditors currently involved with the audit
g. Review the entity’s income tax returns and other information supplied to
regulatory agencies
Identifying related party transactions:
a. Performing detailed tests of transactions and balances
b. Reviewing minutes of meetings of shareholders and directors
c. Reviewing accounting records for large or unusual
transactions or balances
d. Reviewing confirmations of loans receivable and payable and
banks
e. Reviewing investment transactions like purchase or sale of an
equity interest
Related party transactions:
a. Transactions of abnormal terms of trade. (unusual prices,
interest rates, guarantees, repayment terms)
b. Transactions which lack an apparent logical business reason
for their occurrence
c. Transactions in which substance differs from form
d. Transactions of unbiased manner
e. High volume or significant transactions with certain
customers or suppliers
f. Unrecorded transactions (receipt or provision of management
services at no charge)
 USING THE WORK OF AN
AUDITOR’S EXPERT
Expert- a person or firm possessing special skill, knowledge and
experience in a particular field other than accounting and auditing.
Expert’s work:
1. Valuations of precious stones, works of arts, real estate and
other specialized assets.
2. Determination of amounts using specialized techniques like
actuarial computations.
3. Interpretation of technic requirements, regulations or
contracts such as legal documents or legal title to property.
Auditor’s expert- an expert whose work in his/her field
of specialization is used by the auditor to assist the
auditor in obtaining sufficient appropriate audit
evidence.

Management’s expert- an expert whose work in

his/her field of expertise, is used by the entity to assist
the entity in preparing financial statements.
DETERMINING THE NEED FOR AN
AUDITOR’S EXPERT
Auditor must consider:
a. Whether the management has used a management’s expert
in preparing the financial statement.
b. The nature and significance of the matter, including its
complexity.
c. The risk of material misstatement in the matter.
d. The expected nature of procedures to respond to identified
risks.
 EVALUATING THE AUDITOR’S
EXPERT
1. Assess the competence and objectivity of the expert.
• Professional certification or licensing by, or membership in,
and appropriate professional body
• Experience and reputation in the field in which the auditor is
seeking audit evidence.
2. Understand the field of the expertise of auditor’s expert.
3. Establish the terms of the agreement with the expert.
4. Evaluate the results of the work of the expert.
 EFFECT OF THE RELIANCE ON
EXPERT’S WORK ON THE AUDIT
REPORT
 The auditor has sole responsibility for the audit opinion and must
not refer to the work of an auditor’s expert containing an
unmodified opinion. But if it has modified opinion, the auditor can
refer to the work of an expert auditor.
 CONSIDERING THE WORK OF
INTERNAL AUDITORS
 Internal auditing- appraisal activity established within an entity
as a service to the entity.
 The external auditor should obtain a sufficient understanding of
the internal audit activities to assist in planning the audit and
developing an effective audit approach. An effective internal
auditing will often affect the nature timing and extent of the
external auditor’s procedures.
TWO IMPORTANT PHASES:
1. Making a preliminary assessment of internal auditing
2. Evaluating and testing the work of internal auditing
PRELIMINARY ASSESTMENT PF
INTERNAL AUDITING

1. Competence

2. Objectivity

3. Due professional care

4. Scope of function
EVALUATING AND TESTING THE
WORK OF INTERNAL AUDITORS
The external auditor will use the work of internal auditor to
confirm its adequacy for the external auditor’s purposes. This also
considers whether the work is performed by competent persons;
sufficient appropriate evidence is obtained; appropriate conclusions
are reached; and exceptions are properly resolved.

External auditor can also use the internal auditor’s assistance to

perform the routine or mechanical audit procedures.
 AUDIT SAMPLING

the application of audit procedures to less than 100% of the

items within an account balance or class of transactions such that
all sampling units have a chance of selection.

performed on the assumption that the sample selected for

testing is representative of the population.
 RISK IN SAMPLING

 SAMPLING RISK
possibility that the auditor’s conclusion based on a sample may
be different from the conclusion reached if the entire population
were subjected to the same audit procedures.
sample selected for testing may not be truly representative of a
population
TWO TYPES OF SAMPLING RISK
1. Alpha Risk- the risk the auditor will conclude
a. in the case of tests of control, that internal control is not
reliable when in fact it is effective and can be relied upon. (Risk of
underreliance)
b. in the case of substantive test, that the material
misstatement exists in an account balance or transaction class
when in fact such misstatement does not exist. (Risk of incorrect
rejection)
2. Beta Risk- the risk the auditor will conclude
a. in the case of test of control, that internal control is reliable
when in fact it is not effective and cannot be relied upon (Risk of
overreliance)
b. in the case of substantive test, that material misstatement
does not exist when in fact material misstatement does exist (Risk
of incorrect acceptance)
 NON SAMPLING RISK

risk that the auditor may draw incorrect conclusions about the
account balance or class of transactions because of human errors.