Audit Evidence and Documentation
Substantive Testing (Evidence-Gathering and Documentation)
Slide 5- #
1
#
Success is often viewed as something that happens overnight.
Nothing can be further from the truth. In reality, a seemingly
overnight success had, in its wake, the evidence of long and hard
preparation and the hope that the day of victory will
come.-Anonymous
Slide 5- #Audit Evidence-What is it?It is all the information
used by the auditor in arriving at the conclusions on which the
audit opinion is based. It includes the information contained in
the accounting records underlying the financial statements and
other information or corroborating information.
Slide 5- #
#
Why Gather Audit Evidence?A professional requirement by PSA
500It is necessary to support the auditors opinion and report.
Slide 5- #
#
How is Audit Evidence
Accumulated?CategoryDescription/PurposeRisk Assessment
ProceduresUsed for obtaining an understanding of the client entity
and its environment, including internal control. They are performed
during the audit planning and internal control phases of the
audit.Test of ControlsUsed to test the operating effectiveness of
controls in preventing, or detecting and correcting, material
misstatements.Substantive testsUsed to detect material
misstatements in account balances, classes of transactions and
disclosures.
PSAs describe three categories of procedures for gathering audit
evidence.
Slide 5- #
#
Nature of EvidenceIt is cumulative in nature and is primarily
obtained from audit procedures performed during the course of the
audit.
Slide 5- #
5
#
Main sources of evidenceEvidential matter supporting the
financial statements consists of the accounting records and other
information. Accounting records are those which underlie the
financial statements.Other information (corroborating information)
supports the underlying accounting data obtained from client and
other sources.
Slide 5- #
5
#
Main sources of evidenceEvidential matter supporting the
financial statements consists of the accounting records and other
information. Accounting records are those which underlie the
financial statements.Other information (corroborating information)
supports the underlying accounting data obtained from client and
other sources.
Slide 5- #
5
#
Relationship of Audit Evidence to Management AssertionsAudit
evidence is gathered as a basis for expressing an opinion on
whether the assertions of management are fairly stated.A given set
of procedures may provide audit evidence that is relevant to
certain assertions, but not others.
Slide 5- #
#
Relationship of Audit Evidence to Management AssertionsFor
example:Inspection of records and documents related to the
collection of receivables after the period end may provide evidence
regarding both existence and valuation, although not necessarily
the appropriateness of period-end cutoffs.
Slide 5- #
#
Sufficiency and Appropriateness of Evidential MatterThe auditors
judgment as to what is sufficient appropriate evidence is
influenced by such factors as:The degree of risk of
misstatement;The materiality of the item in relation to the
financial statements taken as a whole;The experience gained during
the previous audits;The result of auditing procedures, including
fraud or errors which may have been found; andThe type of
information available
Slide 5- #
#
SufficiencyIt is the measure of the quantity of evidence.It is
affected by:the risk of misstatement (the greater the risk, the
more audit evidence is likely to be required);the quality of audit
evidence (the higher the quality, the less may be required);The
materiality of the item being examined (the more material the FS
being examined, the more evidence); andExperience gained during
previous audit may indicate the amount of evidence taken before and
whether such evidence was enough.
Slide 5- #
#
AppropriatenessTo be appropriate, evidence must be both valid
and relevant.The validity of evidential matter is so dependent on
the circumstances under which it is obtained that generalizations
about the reliability to various types of evidence are subject to
important exceptions.
Slide 5- #
#
AppropriatenessRelevanceEvidence must affect the auditors
ability to accept or reject a specific financial statement
assertion.It relates to the timeliness of evidence and its ability
to satisfy the audit objective.
Slide 5- #
#
AppropriatenessRelevanceEvidence obtained is evaluated in terms
of its usefulness either in corroborating or contradicting an
assertion.Evidence is relevant to the extent that it serves either
of those purposes.
Slide 5- #
#
AppropriatenessReliabilityIt is the quality of information that
assures that information is reasonably free from error and bias and
faithfully represents what it purports to represent.It is
influenced by its source and by its nature and is dependent on the
individual circumstances under which it is obtained.
Slide 5- #
#
AppropriatenessGeneralizations about the reliability of evidence
Evidence obtained by the auditor from independent sources outside
the client is usually more reliable than that from within the
client.Evidence is more reliable when it exists in documentary
form.
Slide 5- #
#
AppropriatenessGeneralizations about the reliability of evidence
It must be obtained from people who are competent and have the
qualifications to make the information free from error. However,
the auditor should not conclude that the higher a persons position
in the client, the better qualified that person is to provide
evidence.
Slide 5- #
#
AppropriatenessGeneralizations about the reliability of evidence
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 is more reliable than
that obtained indirectly or by inference.
Slide 5- #
#
Cost-benefit considerationsAn auditors opinion, to be
economically useful, must be formed within a reasonable length of
time and at reasonable cost.The auditor must decide, exercising
professional judgment, whether the evidential matter available to
him within the limits of time and cost is sufficient to justify
expression of an opinion.
Slide 5- #
#
Relationships Among Assertions, Objectives and ProceduresIn
obtaining evidential matter in support of financial statement
assertions, the auditor develops specific audit objectives in the
light of those assertions.After setting audit objectives, the
auditor considers the type of evidence to be obtained, and the
audit procedures necessary to obtain this evidence.
Slide 5- #
#
Sample AssertionsAudit ObjectivesAudit Procedures1. Existence
and OccurrenceTo determine the validity of recorded stockholders
equity balances and whether the transactions actually
occurredObtain schedules of stockholders equity accounts and
reconcile to the general ledger balances.Review authorizations and
terms of stock issues.2.CompletenessTo determine whether recorded
stockholders equity accounts reflect all data that should be
recorded3. Perform analytical review procedures3.Rights and
obligationsTo determine whether the entity has the authority to
execute stockholders equity transactions4. Review articles of
incorporation and the related by-laws.
Example: Audit Program for Owners Equity
Slide 5- #Audit Procedures1. Inspection of Records or
DocumentsThis consists of examining records or documents, whether
internal or external, in paper form, electronic form, or other
media.
Slide 5- #
#
Audit Procedures2. Inspection of Tangible AssetsThis consists of
physical examination of the assets. This may provide reliable audit
evidence with respect to their existence, but not necessarily about
the entitys rights and obligations or the valuation of the
assets.
Slide 5- #
#
Direction of the Test - VouchingExamination of documents that
support a recorded transaction or amount.The direction of testing
must be from the recorded item to the supporting documents.Tests
existence or occurrence.Also tests if transaction was properly
authorized.
Slide 5- #
#
Direction of the Test - TracingThe primary test for unrecorded
items and therefore tests the completeness assertion.The direction
of testing must be from the supporting document to the recorded
item.Also used to test if transactions were recorded in rightful
accounts.
Slide 5- #
#
Audit Procedures3. ObservationAuditor witnesses the physical
activities of the client.Useful in obtaining evidence that controls
which leave no documentary evidence of application or existence are
in operation.Differs from physical examination because physical
examination counts assets, while observation focuses on client
activities e.g. inventory counting.
Slide 5- #
#
Audit Procedures4. InquiryThis consists of seeking information
of knowledgeable persons, both financial and non-financial,
throughout the entity or outside the entity. It may range from
formal written inquiries to informal oral inquiries.
Slide 5- #
#
Audit Procedures5. RecalculationThis consists of checking the
mathematical accuracy of documents or records.This can be performed
through the use of information technology, for example, by
obtaining an electronic file from the entity and using
Computer-Assisted Auditing Techniques (CAATs) to check the accuracy
of the summarization of the file.
Slide 5- #
#
Audit Procedures6. ReperformanceIt is the auditors independent
execution of procedures or controls that were originally performed
as part of the entitys internal control, either manually or through
the use of CAATs, for example, reperforming the aging of accounts
receivable.
Slide 5- #
#
Audit Procedures7. ConfirmationIt is the process of obtaining
and evaluating audit evidence through the receipt of a written or
oral response from an independent third party. Customers confirm
A/C receivable balancesSuppliers confirm A/C payable balancesBanks
confirm account/loan balancesLawyers confirm contingent
liabilities
Slide 5- #
#
Audit Procedures7. ConfirmationThis provides reliable and
relevant audit evidence regarding the existence of the account as
at a certain date. It also provides audit evidence regarding the
operation of cutoff procedures. However, it does not ordinarily
provide all the necessary evidence regarding valuation
assertion.
Slide 5- #
#
Audit Procedures7. Confirmation (FORMS)a. Positive
Confirmation-Asks the respondent to reply in all cases either by
indicating the respondents agreement with the given information, or
by asking the respondent to fill in information.-There is a risk
that a respondent may reply without verifying that the information
is correct.
Slide 5- #
#
Audit Procedures7. Confirmation (FORMS)a. Positive Confirmation-
Auditor may reduce this risk by not stating the amount and asking
the respondent to fill in the amount or furnish other information.
-However, this may result in lower response rates because
additional effort is required of the respondents.
Slide 5- #
#
Audit Procedures7. Confirmation (FORMS)b. Negative Confirmation-
Asks the respondent to reply only in the event of disagreement with
the information provided in the request. -This provides less
reliable audit evidence than in positive confirmation.
Slide 5- #
#
Audit Procedures7. Confirmation (FORMS)b. Negative Confirmation-
When no response is received to the request, the auditor does not
have assurance that the intended third parties have received the
confirmation requests and verified that the information therein is
correct. -Accordingly, other substantive procedures are performed
as supplement.
Slide 5- #
#
Audit Procedures7. Confirmation (FORMS)b. Negative Confirmation-
This may be used when:Assessed risk of material misstatement is
lower;A large number of small balances is involved;A substantial
number of errors is not expected; andThe auditor has no reason to
believe that respondents will disregard these requests.
Slide 5- #
#
Audit Procedures7. ConfirmationWhen the auditor seeks to confirm
certain balances or other information, and management requests the
auditor not to do so, the auditor should consider whether there are
valid ground for such a request and obtain evidence to support the
validity of managements requests.
Slide 5- #
#
Audit Procedures7. ConfirmationIf the auditor agrees to
managements request not to seek external confirmation regarding a
particular matter, the auditor should apply alternative audit
procedures to obtain sufficient appropriate audit evidence
regarding that matter.
Slide 5- #
#
Audit Procedures7. ConfirmationIf the auditor does not accept
the validity of managements request and is prevented from carrying
out the confirmations, there has been a limitation on the scope of
the auditors work and the auditor should consider the possible
impact on the auditors report.
Slide 5- #
#
Audit Procedures8. Analytical ProceduresAuditors study the
plausible relationships among financial and non-financial
data.These also encompass the investigation of identified
fluctuations and relationships that are inconsistent with other
relevant information or deviate significantly from predicted
amounts.
Slide 5- #
#
Audit ProceduresWhen the aforementioned audit procedures (1
through 8) are used to detect material misstatements in account
balances, classes of transactions and disclosures, or to
substantiate the account balances, these are used as substantive
audit procedures.
Slide 5- #
#
Substantive ProceduresSubstantive procedures provide direct
evidence as to the validity of a transaction or balance in the
records.There are two general types of substantive tests: test of
details of transactions, balances and disclosures and analytical
review procedures.
Slide 5- #
#
Analytical ProceduresData interrelationships (i.e., analytical
procedures) rely on plausible relationships among financial and
non-financial data.Effective for testing reasonableness of certain
account balancesCan be used as primary or corroborating evidence,
depending on the nature of account
Slide 5- #
#
Analytical ProceduresAnalytical Procedures are useful in
identifying among other things:Differences that are not
expected.The absence of differences when they are
expected.Potential errors, irregularities or illegal acts.Other
unusual or non recurring transactions or events.
Slide 5- #
#
Analytical ProceduresIf a change in one area would naturally
lead to a change in some other area, the absence of the expected
change should lead to a further study in search of the cause.Ex. If
commissions paid to sales representatives rise in one quarter, it
would be reasonable to expect a correspondence increase in sales
revenue.
Slide 5- #
#
ExamplesRelationship of marketing expenditure to
sales.Relationship of interest income to interest earning
assets.Relationship of interest expense to debt balances.Such
relationships are assumed to remain the same unless some unknown
condition causes a change.
Slide 5- #
#
Forms of Analytical ProceduresComparisons:Current period
information with similar information for prior periods.Current info
with budgets or forecasts.Info for the audited unit with info for
other organisational units.Information for the audited unit with
similar information for the industry in which the organisation
operates.
Slide 5- #
#
Analytical ProceduresRelationships:Study of relationships of
financial info with appropriate non financial info e.g. changes in
payroll expense compared to changes in average number of
employees.Study relationships among elements of information.
Slide 5- #
#
Analytical ProceduresWhen analysis uncovers unexpected results,
auditors should undertake further study e.g. making inquiries to
management & applying other audit procedures. The explanation
may lie in errors, irregularities or illegal acts.Further study
should continue until the auditor is satisfied that the results
have been sufficiently explained.
Slide 5- #
#
Analytical ProceduresWhen intending to perform the analytical
procedures as substantive tests, the auditor should focus on the
accounts that are predictable.
Slide 5- #
#
Analytical ProceduresRelationships differ in their
predictability. Accordingly:Relationships in a dynamic or unstable
environment are less predictable than those in a stable
environment.Relationships involving balance sheet accounts are less
predictable than income statement accounts (because balance sheet
accounts represent balances at any one arbitrary point in
time).Relationships involving management discretion are sometimes
less predictable (e.g. decision to incur maintenance expense rather
than replace plant).
Slide 5- #
#
Analytical ProceduresLIMITATIONS:The guidelines for evaluation
may be inadequate (e.g. Why is an industry average good? Why should
the ratio be the same as last year?It is difficult to determine
whether a change is due to a misstatement or is the result of
random changes in the account.Analytics present only circumstantial
evidence in that a significant evidence will lead to additional
audit procedures as opposed to direct detection of a
misstatement.
Slide 5- #
#
Test of DetailsTest of details involves examining the actual
details making up the various account balances. Test of balances v.
Test of transactionsTest of balances involves direct testing of the
ending balance of an account.Test of transactions involves testing
the transactions which give rise to the ending balance of an
account.
Slide 5- #
#
Test of DetailsTest of details involves examining the actual
details making up the various account balances. Test of balances v.
Test of transactionsTest of balances involves direct testing of the
ending balance of an account.Test of transactions involves testing
the transactions which give rise to the ending balance of an
account.
Slide 5- #
#
Test of DetailsTest of balances will be used when account
balances are affected by large volume of relatively immaterial
transactions, e.g. cash, receivables, and inventory.Test of
transactions is useful if account balances are comprised of a
smaller volume of transactions representing relatively material
amounts, e.g. property and equipment, intangibles, bonds payable,
and stockholders equity accounts.
Slide 5- #
#
Effectiveness of Substantive TestsNature of Substantive
TestsThis relates to the quality of evidence. The appropriate
quality of evidence needed to support the desired level of
detection risk. Although the auditor would normally prefer high
quality evidence, it is important to realize the high quality
evidence would also involve high cost.
Slide 5- #
#
Effectiveness of Substantive TestsTiming of Substantive
TestsInterim procedures are generally considered less effective due
to incremental audit risk involved when auditing interim
balances.Thus, the higher the risk of misstatement, the more likely
it is to perform substantive tests nearer to, or at year end.
Slide 5- #
#
Effectiveness of Substantive TestsTiming of Substantive
TestsTest of details before year-end (Early substantive testing) is
desirable if the client wants the audit to be completed shortly
after year-end. When considering early substantive testing of a
specific account, the auditor should consider the relationship of
that account to others in the financial statements and the extent
to which a single substantive test may apply to more than one
account. For example, a cutoff test of shipments relates to sales,
accounts receivable, cost of sales, and inventory accounts.
Slide 5- #
#
Effectiveness of Substantive TestsTiming of Substantive
TestsWhen considering early substantive testing of a specific
account, the auditor should have to obtain satisfaction that, for
the balances tested early, the risk of material misstatement is low
during the intervening period between the early testing date and
year-end. Generally the auditor obtains that satisfaction by
performing test of controls directed at the design and operation of
relevant control structure policies and procedures during
intervening period.
Slide 5- #
#
Effectiveness of Substantive TestsExtent of Substantive
TestsThis relates to the amount of evidence needed to satisfy a
particular objective.This is based on the auditors judgment after
considering the materiality, the assessed risk, and the degree of
assurance the auditor plans to obtain. In particular, the auditor
ordinarily increases the extent of substantive procedures as the
risk of material misstatement increases.
Slide 5- #
#
Relationship between ST and TOCTest of Controls provides
evidence that indicates a misstatement is likely to
occur.Substantive Tests provide evidence about the existence of
misstatement in an account balance.The result of tests of control
is a major factor in determining the nature, timing, and extent of
substantive tests. If a misstatement is likely to occur due to an
ineffective internal control, the auditor will then perform
substantive tests to determine whether material misstatements
actually do exist.
Slide 5- #
#
Selection of Audit ProceduresThe criteria for selection of the
most suitable technique can be based on the following:Will the
technique meet the objectives of the audit stage or phase?Has the
auditor the skills to use the procedure?Is the material to be
audited available and in a condition to be used with the audit
procedure.
Slide 5- #
#
Selection of Audit ProcedureWill the procedure be cost
effective? E.g. will the time and effort to perform the procedures
far exceed the benefit of using it?Will the conclusions reached
after using the procedure be valid?
Slide 5- #
#
Audit DocumentationAudit documentation is the principal record
of auditing procedures applied, evidence obtained, and conclusions
reached by the auditor.Audit Evidence is documented in Audit
working papers.
Slide 5- #
#
Working Papers - FunctionsAudit working papers achieve following
primary functions:Support the auditors opinion on financial
statements;Support auditors representation as to compliance with
PSA; andAssist the auditor in the planning, performance, review and
supervision of the engagement.
Slide 5- #
#
Working Papers - FunctionsSecondarily:Plan future audits;Provide
information useful in rendering other services; andProvide adequate
defense in case of litigation.
Slide 5- #
#
Key Characteristics of Work
PapersCompleteConciseAccurateOrganized
Slide 5- #
#
CharacteristicsCompleteness:Each Working paper should be
completely self standing and self explanatory. All questions must
be answered, all points raised by the reviewer must be cleared and
a logical, well thought-out conclusion reached for each audit
segment.
Slide 5- #
#
CharacteristicsAccurate:High quality work papers include
statements and computations that are accurate and technically
correct.
Slide 5- #
#
CharacteristicsOrganization:Work papers should have a logical
system of numbering and a reader friendly layout so a technically
competent person unfamiliar with the project could understand the
purpose, procedures performed, and results.
Slide 5- #
#
CharacteristicsRelevance & Conciseness:Audit work papers and
items included on each work paper should be relevant to meeting the
applicable audit objective. Work papers must be confined to those
that serve a useful purpose.
Slide 5- #
#
Form, Content, and Extent of Audit DocumentationThe auditor
should consider what would an experienced auditor, having no
previous connection with the audit, to understand:The nature,
timing, and extent of the audit procedures performed to comply with
PSAs and applicable legal and regulatory requirements.The results
of the audit procedures and the audit evidence obtained;
andSignificant matters arising during the audit and the conclusions
reached thereon.
Slide 5- #
#
Form, Content, and Extent of Audit DocumentationSignificant
matters include, amongst others:Matters that give rise to
significant risks.Results of audit procedures indicating that the
financial information could be materially misstated, or a need to
revise the auditors previous assessment of the risks of material
misstatements and the auditors response to those risksCircumstances
that cause the auditor significant difficulty in applying necessary
audit procedures.Findings that could result in a modification to
the auditors report.
Slide 5- #
#
Form, Content, and Extent of Audit DocumentationFactors
affecting the form, content and extent of audit
documentation:Nature of the audit procedures to be
performed;Identified risks of material misstatements;Extent of
judgment required in performing the work and evaluating the
results;
Slide 5- #
#
Form, Content, and Extent of Audit DocumentationFactors
affecting the form, content and extent of audit documentation:d.
Significance of the audit evidence obtained;e. Nature and extent of
exceptions identified;f. 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; andg. Audit
methodology and tools used.
Slide 5- #
#
Classification of Work PapersPermanent File:Keeps information
that is relevant for multiple years on recurring
engagements.Current File:Information relevant for a given audit
project/engagement.
Slide 5- #
#
Classification of Work PapersPermanent File:Copies of the
articles of incorporation and by-lawsMajor contractsEngagement
letterOrganizational chartAnalyses of long-term accounts such as
plant assets, long-term liabilities and stockholders
accountsInternal control analyses
Slide 5- #
#
Classification of Work PapersCurrent File:A copy of the
financial statementsAudit programWorking trial balanceLead
scheduleDetailed schedulesCorrespondence with other parties such as
lawyers, customers, banks, and management. (and other confidential
letters)
Slide 5- #
#
Working Paper StorageCan be stored in manual or electronic
form.For electronic files:Back up frequently.Include the file name
in the footer.Develop an organisation method.
Slide 5- #
#
Ownership of Working PapersThey are the property of the auditor
and the client has no right to the working paper prepared by the
auditor.They nay sometimes serve as a reference source for the
client (at the discretion of the auditor) but they should not be
considered as part or as a substitute for the clients records.
Slide 5- #
#
Assembly of Working PapersThe auditor is required to complete
the administrative process of assembling the final audit file on a
timely basis after the date of the auditors report. The time limit
within which to complete the assembly of the audit file is
ordinarily not more than 60 days after the date of the auditors
report.
Slide 5- #
#
Confidentiality of Working PapersAlthough they are the personal
property of the auditor, working papers can not be shown to third
parties without the clients permission.Section 4 of the Philippine
Code of Professional Ethics requires the CPA to respect the
confidentiality of information obtained during the course of
performing professional services.
Slide 5- #
#
Confidentiality of Working PapersHowever, in some instances the
duty of confidentiality is overridden by the statute of law. For
example, the auditor can disclose confidential information to third
parties even without the clients consent under the following
circumstances:When disclosure is required by law or when the
working papers are subpoenaed by a courtWhen there is professional
right to disclose information such as when the auditor uses his
working papers to defend himself when sued by the client for
negligence.
Slide 5- #
#
Retention of Working PapersThey should be retained by the
auditor for a period of time sufficient to meet the needs of the
auditing practice and to satisfy any pertinent legal requirements
of record retention.
Slide 5- #
#
Guidelines for Preparation of Working PapersHeadingEach working
paper must be properly identified with such information as the name
of the client, type of working paper, a description of its content,
and the date or period covered by the examinationIndexingRefers to
the use of lettering or numbering systems. This is to aid in
cross-referencing essential information.
Slide 5- #
#
Guidelines for Preparation of Working PapersCross-indexing/
cross referencingThis is important to provide a trail used in
reviewing the working papers.Tick marksThey must include symbols
that describe the audit procedures performed.
Slide 5- #
#
AUDITING ACCOUNTING ESTIMATESAccounting estimate is an
approximation of the amounts of an item in the absence of a precise
means of measurement. Examples include:Allowance for doubtful
accountsDepreciation and amortizationLoss contingenciesWarranty
claimsThe risk of material misstatements is greater when accounting
estimates are involved.
Slide 5- #
#
AUDITING ACCOUNTING ESTIMATESMaking estimates is the
responsibility of management. The auditors responsibility is to
obtain sufficient appropriate evidence as to whether:the estimate
is properly accounted for and disclosedThe estimate is reasonable
in the circumstances
Slide 5- #
#
AUDITING ACCOUNTING ESTIMATESThe auditor may evaluate the
estimates by the following means:Review and test the process used
by management to develop the estimate. This will often
involve:Evaluating data and management assumptions;Testing of
calculations;Comparing prior period estimates with actual results,
andConsidering management approval procedures.
Slide 5- #
#
AUDITING ACCOUNTING ESTIMATESThe auditor may evaluate the
estimates by the following means:b. Make an independent estimateThe
auditor may make or obtain an independent estimate and compare it
with the accounting estimate prepared by management.c. Review
subsequent events which confirm the estimate madeTransactions and
events which occur after period end, but prior completion of the
audit, may provide sufficient appropriate evidence regarding an
accounting estimate made by management.
Slide 5- #
#
END
QUESTIONS?
Slide 5- #
#
END
THANK YOU!
Slide 5- #
#
