Audit Objectives, Procedures, Evidences and

Documentation
Auditing Theory
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.
Types of Audit Objectives
• 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
Financial Statements Assertion
Financial Statements Assertions
Financial Statements Assertions
Types of Audit Objectives
• 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
• 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.
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 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
Audit Procedures for Obtaining Audit Evidence (as to purpose)
• 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
▫ Risk assessment procedures include:
 a) Inquiry of management and other personnel
 b) Analytical procedures (as a planning tool)
 c) Observation and inspection
Audit Procedures for Obtaining Audit Evidence (as to purpose)
• Tests of controls
▫ Audit procedures designed to evaluate the operating effectiveness of
relevant controls in preventing or detecting and correcting material
misstatements at the assertion level.
• Substantive procedures
▫ Audit procedures designed to detect material misstatements at the
assertion level.
▫ Used to substantiate the account balances or to detect material
misstatements in the financial statements
▫ May be performed using analytical procedures or test of details
Types of Substantive Procedures
• Test of details- examining or obtaining audit evidence on the actual
details of account balance, class of transactions, and disclosure
▫ Test of details of transactions
▫ Tests of details of balances
• Substantive analytical procedures – these are analytical procedures
performed during testing phase to substantiate predictable relationships
among both financial and nonfinancial data
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).
Test 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.
Substantive Analytical Procedures
• An optional substantive procedure
• Uses the steps as follows:
▫ Develop expectations about the financial statements
▫ Compare financial statements with the developed expectations
▫ Check if the difference is significant/material
 If significant/material – conduct further investigation
 If insignificant/immaterial – accept account as reasonable
• Analytical procedures are more effective to those accounts that are
predictable
Typical Types of Substantive Test Procedures
Typical Types of Substantive Test Procedures
Directional Testing
• Tests designed to discover errors
▫ Will start with the accounting records to the supporting documents or
other evidence
▫ Should detect any overstatement and also any understatement through
causes other than omission
• Tests designed to discover omissions
▫ Will start outside the accounting records and then matched back to the
accounting records
▫ Detect understatement though omission
Nature, Timing, and Extent of Audit Procedures
• Nature of an audit procedure – refers audit to:
▫ (1) Its purpose (i.e., test of controls or substantive procedures) and
▫ (2) Its type (i.e., inspection, observation, inquiry, confirmation,
recalculation, reperformance, or analytical procedures)
• Timing of an audit procedure – refers to when to perform the audit
procedure, or the period or date to which the audit evidence applies
• 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. Normally
increased if risk of material misstatements increases
Timing of Substantive Tests
• May be performed at interim date or at year-end
• Interim procedures are generally less effective due to incremental audit
risk involved; the higher the risk of material misstatements, the more
likely it is that the auditor will perform substantive tests at year-end
• Interim procedures assist the auditor in
▫ Identifying significant matters at an early stage and consequently resolving
them
▫ Spreading the workload, minimizing the load during the peak period (i.e.
year-end)
Audit Sampling
• Testing the whole population might be impractical or inefficient
• Audit sampling is performed on the assumption that the sample
selected for testing is representative of the population
Risks in Sampling
• Sampling risk and non-sampling risk
• Sampling Risk
▫ The conclusion reached in testing the sample might be different to the conclusion reached if the whole
population was tested
▫ Exists when the sample is not representative of the whole population
▫ Two types:
 Alpha Risk
 Underreliance in tests of controls
 Incorrect rejection in substantive tests
 Beta Risk
 Overreliance in tests of controls
 Incorrect acceptance in substantive tests
• Non-Sampling Risk
▫ Incorrect conclusion is based on those other that the risk in sampling (e.g., human errors, professional
judgment)
Controlling the Risk
• Increasing the sample size reduces sampling risk
• Proper planning and adequate supervision reduces non-sampling risks
General Approaches
• Statistical sampling – uses statistical tools
• Non-statistical sampling – primarily uses auditor’s judgment
Audit Sampling Plans
• Attribute sampling – used in tests of controls to estimate rate of
deviations
• Variable sampling – used in substantive tests to estimate amount of
misstatements
Basic Steps in Audit Sampling
• 1. Determine the objective of the test
• 2. Determine the audit procedure to be performed
• 3. Determine sample size
• 4. Select the sample
• 5. Apply procedures
• 6. Evaluate sample results
Tests of Controls
• Determining the Sample Size
▫ Consider the following factors:
 Acceptable sampling risk – inverse relationship with sample size
 Tolerable deviation rate – inverse relationship with sample size
 Expected deviation rate – direct relationship with sample size
Tests of Controls
• Selecting the Sample
▫ Random number selection – choosing samples randomly
▫ Systematic selection – every nth number
▫ Haphazard selection – without following an organized or structured
technique
▫ Sequential sampling/Stop-or-go sampling – used when an auditor expects
very few deviations; no fixed sample size
▫ Discovery sampling – used when no deviations are expected; one deviation
would result to a conclusion that control risk is at maximum
Tests of Controls
• Evaluating the Results
▫ 1. Determine the sample deviation rate
▫ 2. Compare the sample deviation rate with the tolerable deviation rate and draw
overall conclusion about the population
 a. If the sample deviation rate exceeds tolerable deviation rate – control risk is at
maximum level
 b. If the sample deviation rate does not exceed tolerable deviation rate, identify the
significance of difference
 i. If difference is significant – control risk is at below maximum level
 ii. If difference is not significant
 If statistical method is used, compare maximum deviation rate with tolerable rate. If maximum
deviation rate is less than tolerable rate, control risk is at below maximum level
 If non-statistical method is used, control risk is at maximum level
Substantive Tests
• Determining the Sample Size
▫ Consider the following factors:
 Acceptable sampling risk – inverse relationship with sample size
 Tolerable misstatement – inverse relationship with sample size
 Expected misstatement – direct relationship with sample size
 Variations in the population – direct relationship with sample size
Substantive Tests
• Selecting the Sample
▫ Stratified sampling – grouped according to peso amounts to reduce
variance
▫ Value weighted selection – higher value items have higher chances of being
selected
Substantive Tests
• Evaluating the Results
▫ 1. Project misstatement to the population using ratio estimation or difference
estimation
 a. Ratio estimation – base projection from peso amount
 b. Difference estimation – base projection from items
▫ 2. Compare projected misstatements together with the tolerable misstatements
and draw a conclusion
 a. If projected is less than tolerable, accept balance as reasonable
 b. If projected is more than tolerable
 i. Examine additional units
 ii. Perform suitable alternative procedures
 iii. Request the client to adjust the account balance
Audit Procedures (as to nature)
Audit Procedures (as to nature)
Summary of Procedures Classified as to Purpose and Nature
Auditing Accounting Estimates
• Auditor must consider that the risk of material misstatement is greater
when accounting estimates are involved
• Auditor’s responsibility is to obtain evidence as to whether
▫ The estimate is properly accounted for and disclosed
▫ The estimate is reasonable
• The audit approaches, or a combination of such, include:
▫ Reviewing and testing the process used by management to develop the
estimate
▫ Making an independent estimate
▫ Reviewing subsequent events which confirm the estimate made
Related Parties
• Management’s responsibility is to identify and disclose such related party transactions
• Auditor’s responsibility is to obtain and review information provided by the directors
and management, identifying all known related parties and related party transactions
• The following procedures may assist the auditor to identify related party transactions
▫ Performing detailed tests of transactions and balances
▫ Reviewing minutes of meetings of shareholders and directors
▫ Reviewing accounting records for large or unusual transactions or balances, paying
particular attention to transactions recognized at or near the end of the reporting period
▫ Reviewing confirmations of loans receivable and payable
▫ Reviewing investment transactions
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.
Nature of Evidence
• Accounting records (Underlying data) – accounting records/data prepared
by the client’s personnel and from which financial statements are prepared
▫ Records of initial accounting entries
▫ Supporting records, such as checks and records of electronic fund transfers,
invoices and contracts
▫ General and subsidiary ledgers
▫ Journal entries and other adjustments to the financial statements that are not
reflected in formal journal entries
▫ Records such as worksheets and spreadsheets supporting cost allocations,
computations, reconciliation and disclosures
Nature of Evidence
• Corroborating evidence – corroborating information that are used by
the auditor to verify the fairness of the accounting records.
▫ Documents (such as checks, bank statements, contracts and minutes of
meetings)
▫ 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)
Audit Evidence Relationship with Assertions
• Audit evidence comprises both:
▫ Information that supports and corroborates management's assertions, and
▫ Information that contradicts such assertions.
Quality of Evidence
• When obtaining evidence, the auditor should consider sufficiency and
appropriateness of the audit evidence
Quality of Evidence
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
• To be appropriate audit evidence must be:
▫ Relevance - pertains to timeliness of evidence and its ability to satisfy the
audit objective; deals with the logical connection with, or bearing upon,
the purpose of audit procedures and the assertion under consideration
▫ Reliability- objectivity of evidence
Relevance
• 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).
Reliability
• Principles—Audit evidence is ordinarily more reliable when it is
▫ Obtained from knowledgeable independent sources outside the company
rather than non independent sources
▫ Generated internally through a system of effective controls rather than
ineffective controls.
▫ Obtained directly by the auditor rather than indirectly or by inference
▫ Documentary in form rather than oral
▫ Provided by original documents rather than copies
Reliability
• RELIABILITY TYPE EXAMPLE
• High Physical Inventory Observation
Documentary
External Cutoff Bank Statement
External/Internal Purchase Invoice
Internal Sales Invoice
• Low Client Management
Representations RepresentationLetter
Sufficient Appropriate Audit Evidence
• There are two dimensions to audit evidence: sufficient (quantity) and
competent (quality/reliability)
• Reliability depends on the circumstances under which
• evidence is gathered:
▫ Evidence obtained from independent outside sources is more reliable than
evidence obtained from the client
▫ Evidence obtained from auditor's direct knowledge is more reliable than
evidence obtained indirectly
▫ Evidence obtained from client with strong internal controls is more reliable
than evidence obtained from client with weak internal controls
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
• 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.
• 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.
• Materiality of item being examined – more material amounts, more evidence to
support its validity
• Experience gained during previous audit may indicate the amount of evidence taken
before and whether such evidence was enough
• Type of information available
Gathering Sufficient, Competent Evidence
• Because each audit is unique, there is no set amount or type of
evidence that must be gathered
• When considering the best approach to gather evidence, the auditor
needs to consider factors affecting the reliability of the financial data:
▫ Management integrity
▫ Client economic risk
▫ Quality of client's information system
▫ Client's control structure
▫ Current market conditions and competitor actions
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 Consideration
• 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:
▫ Relative risk (or inherent risk) involved
▫ Relationship between the cost of obtaining audit evidence and the
usefulness of the information obtained
▫ Degree of reliance on the relevant internal controls (or Assessment of
control risk at a low level)
Types of Audit Evidence
• 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)
• Mathematical recomputations – auditor’s re-computation of the accuracy
of client’s computations such as depreciation, amortization, doubtful
accounts, etc.
• Documentation – examination of the supporting documents of recorded
transactions and balances appearing in the financial statements
• Representation by third parties (or confirmation) – a document originating
from independent outside party and sent directly to the auditor
Types of Audit Evidence
• Representation by client personnel – statements from client personnel
in response to queries posed by the auditor
• Results of analytical procedures
• 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
• Subsequent events – they provide additional evidence regarding
conditions that already existing on the balance sheet that affect
accounting estimates
Documentation
• The record of audit procedures performed, relevant audit evidence
obtained, and conclusions reached
• PSA 230 requires auditors to prepare audit documentation on a timely
basis
Working Papers
• Refers to the audit documentation of an auditor in the course of an
audit
• These would support the opinion on the financial statements
Functions of Working Papers
• Primarily to
▫ Support the auditor’s opinion
▫ Support the auditor’s representation as to compliance with PSAs
▫ Assist the auditor in planning, performing, reviewing, and supervising the
engagement
• Secondarily to
▫ Plan future audits
▫ Provide information useful in rendering other services
▫ Provide adequate defense in case of litigation
Form, Content, and Extent
• It is not practical to document every matter
• In deciding on the form, content, and extent of audit documentation, an
auditor considers what would enable an experienced auditor, having no
previous connection with the audit, to understand:
▫ The nature, timing and extent of audit procedures performed
▫ Results of the audit procedures
▫ Audit evidence obtained
▫ Significant matters and conclusions reached
Form, Content, and Extent
• Although audit documentation depends on the auditor’s judgment, the
following would normally require documentation:
▫ Discussions of significant matters with management
▫ Judgment to depart from a basic principle or an essential procedure in
exceptional circumstances
▫ In documenting the nature, timing and extent of audit procedures,
document:
 Who performed the audit work, and the date the work was completed
 Who reviewed the audit work and the date and extent of such review
Guidelines for the Preparation of Working Papers
• The following parts may be used to facilitate easier preparation of
working papers:
▫ Heading – proper identification; includes name of client, type of working
paper, description of the content, and the date or period covered
▫ Indexing – use of letters or numbering system
▫ Cross-indexing or cross-referencing
▫ Tick marks – using symbols to describe the audit procedures
Classifications
• Permanent file – information of continuing significance (e.g.
engagement letter, major contracts, organizational chart)
• Current file – information relevant to the current period only (e.g.
working trial balance, lead schedules)
Ownership of Working Papers
• The auditor owns the working papers and the client has no right over
the working papers prepared by the auditor
Retention of Working Papers
• Complete the assembly of the final audit file 60 days after the date of
the auditor’s report
• Should be retained for a period of time sufficient to meet the needs of
the auditor’s practice
• No shorter than seven (7) years from the date of the auditor’s report or,
if later, the date of the group auditor's report, unless a longer period of
time is required by law
Revenue Regulation No. 5-2014
• Issued on July 30, 2014 amends Revenue Regulations No. 17-2013, which deals with the
“Preservation of Books of Accounts and Other Accounting Records.”
• All taxpayers are required to preserve their books of accounts, including subsidiary books and
other accounting records, for a period of 10 years reckoned from the day following the
deadline in filing a return, or if filed after the deadline, from the date of the filing of the return,
for the taxable year when the last entry was made in the books of accounts: Provided that,
within the first five (5) years reckoned from the day following the deadline in filing a return, or
if filed after the deadline, from the date of the filing of the return, for the taxable year when
the last entry was made in the books of accounts, the taxpayer shall retain hardcopies of the
books of accounts, including subsidiary books and other accounting records. Thereafter, the
taxpayer may retain only an electronic copy of the hardcopy of the books of accounts,
subsidiary books and other accounting records in an electronic storage system, which complies
with the requirements set forth under Section 2-A of this Regulations.
Revenue Regulation No. 5-2014
• Finally, unless a longer period of retention is required under the
National Internal Revenue Code or other relevant laws, the independent
Certified Public Accountant (CPA) who audited the records and certified
the financial statements of the taxpayer, equally as the taxpayer, has the
responsibility to maintain and preserve electronic copies of the audited
and certified financial statements, including the audit working papers,
for a period of 10 years from the due date of filing the annual Income
Tax return or the actual date of filing thereof, whichever comes later.