Substantive Testing & Documentation Bautista | Laureano | Marzan | Vedania 01 02 Learning Objectives Define Audit Evidence. Identify Attributes of Audit Evidence. 03 Enumerate the factors affecting Audit Evidence. 04 Understand the relationship between assertions, audit objectives, and audit procedures. 05 List down and explain the different types of audit procedures according to purpose and according to nature. 06 Give the different type of confirmation request. Learning Objectives 07 Describe how analytical procedures are used as substantive tests. 08 Define Substantive Test 09 Classify the different substantive procedures performed in an audit 10 Contrast fraud against error. 11 Define Audit Documentation and list down the factors which affect the form and content of audit documentation. 12 Classify working papers and enumerate the elements of working papers The Auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate evidence. When designing and performing audit procedures, the auditor shall consider the relevance and reliability of the information to be used as audit evidence. -PSA 500 (Redrafted), Audit Evidence AUDIT EVIDENCE all the information used by the auditor in arriving at the conclusions on which the audit opinion is based, and includes the information contained in the accounting records underlying the financial statements and other information. HOW AUDIT EVIDENCE ACCUMULATED? Category Description/Purpose Risk Assessment Procedure Used for obtaining an understanding of the client entity and its environment, including internal control. Tests of Controls Used to test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements Substantive Tests Used to detect material misstatements in account balances, classes of transactions and disclosures. NATURE OF AUDIT EVIDENCE • Audit evidence is cumulative in nature and is primarily obtained from audit procedures performed during the course of the audit. • It may also include information obtained from other sources such as previous audits or firms quality control procedures for client acceptance and continuance. ACCOUNTING RECORDS & OTHER INFORMATION Accounting Records • The records of initial entries • Supporting records • Checks and records of electronic fund transfers; • Invoices; • Contracts; • The general and subsidiary ledgers, • Journal entries Other Information Minutes of meetings; Confirmations from third parties; Analysts’ report; Comparable data about competitors (benchmarking); • Control manuals; • Information obtained by the auditor from such • audit procedures as inquiry, observation, and inspection • • • • CORROBORATING EVIDENCE refers to evidence which complements or supports an assertion which is already supported by another type of evidence. Examples of Corroborating Evidence • • • • Authoritative documents Internal controls Calculations by Auditor Physical Existence CORROBORATING EVIDENCE Examples of Corroborating Evidence • Analytical Review Procedures • Confirmation Replies • Representation Letters • Subsequent Events RELATIONSHIP OF AUDIT EVIDENCE TO MANAGEMENT ASSERTIONS • A given set of audit procedures may provide audit evidence that is relevant to certain assertions, but not for others. • On the other hand , the auditor often obtains audit evidence from different sources or of different nature that is relevant to the same assertion. SUFFICIENCY AND APPROPRIATENESS OF EVIDENTIAL MATTER Sufficiency • The quantity of audit evidence needed is affected by the risk of misstatement and also by the quality of such audit evidence. Appropriateness • It is the measure of the quality of audit evidence • To be appropriate, evidence must be both reliable and relevant. DIRECTION OF TESTING Tracing Source Documents Accounting Record Vouching GENERALIZATIONS ABOUT THE RELIABILITY OF EVIDENCE Category Description/Purpose Independence of the source Evidential matter obtained by the auditor from independent sources outside the client is usually more reliable than that from within the client. Qualifications of the source It must be obtained from people who are competent and have the qualifications to make the information free from error. Internal control Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective. GENERALIZATIONS ABOUT THE RELIABILITY OF EVIDENCE Category Nature of evidence Description/Purpose Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference. Audit evidence is more reliable when it exists in Form of the evidence documentary form, whether paper, electronic, or other medium. SUFFICIENCY AND APPROPRIATENESS OF EVIDENTIAL MATTER Factors that influence sufficient appropriate evidential matter: •The degree of risk of misstatement •Materiality of an item in relation to FS taken as a whole •Experience •Results of auditing procedures, including fraud or error •Type of information available SUFFICIENCY AND APPROPRIATENESS OF EVIDENTIAL MATTER Cost-Benefit Considerations • As a guiding rule, there should be a rational relationship between the cost of obtaining evidence and the usefulness of the information obtained. AUTHENTICATION OF DOCUMENTATION An audit rarely involves the authentication of documentation nor trained as or expected to be expert in such authentication. INFORMATION PRODUCED BY THE ENTITY a. Evaluate the competence, capabilities and objectivity of that expert; b. Obtain an understanding of the work of that expert; and c. Evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion. INFORMATION PRODUCED BY THE ENTITY When using the information produced by the entity, the auditor shall evaluate whether the information is sufficiently reliable for the auditor’s purposes, including as necessary in the circumstances: a. Obtaining audit evidence about the accuracy and completeness of the information. b. Evaluating whether the information is sufficiently precise and detailed for the auditor’s purposes. OTHER CONSIDERATIONS Two-fold goal in performing an audit • To achieve the necessary assurance to support the audit opinion • To perform the audit as efficiency as possible Thus, in addition to considering the relevance and reliability of evidence, auditor must also consider the availability, timeliness, and cost of gathering evidence. EVALUATING AUDIT EVIDENCE 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. NATURE, TIMING, AND EXTENT OF PROCEDURES • The nature and timing of the audit procedures to be used may be affected by the fact that some of the accounting data and other information may be available only on electronic form or only at certain points or periods in time. • When the information is in electronic form, the auditor may carry out certain of the audit procedures through CAATs Audit Procedures according to PURPOSE • Risk assessment procedure • Test of Control – are necessary in two circumstances a. When the auditor relies on the effectiveness of the management’s internal control b. When substantive procedures alone do not provide sufficient appropriate audit evidence 3. Substantive Procedure – always required to obtain sufficient appropriate evidence Audit Procedures according to NATURE • Inspection of Records and Documents Inspection consists of examining records or documents, whether internal or external, in paper form, electronic form, or other media. Inspection provides audit evidence of varying degrees of reliability, depending on the nature and source and, in the case of internal records and documents, on the effectiveness of the controls over their production. Direction of Test • Vouching - involves examination of supporting documents and it tests the assertion of existence and occurrence. • Tracing - involves tracing of documents to the accounting records and it tests completeness assertion. Audit Procedures according to NATURE • Inspection of Tangible Assets It consists of physical examination of the assets. Inspection of tangible assets may provide reliable audit evidence with respect to their existence, but not necessarily about the entity’s rights and obligation or the valuation of the assets Audit Procedures according to NATURE • Observation It consists of looking at a process or procedure being performed by others. But it 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. Audit Procedures according to NATURE • Inquiry Inquiry consists of seeking information of knowledgeable persons, both financial and nonfinancial, throughout the entity or outside the entity. Evaluating responses to inquiries is an integral part of the process. Audit Procedures according to NATURE • Recalculation It consists of checking the mathematical accuracy of documents of records. • Re-performance It is the auditor’s independent of procedures or controls that were originally performed as part of the entity’s internal control. Audit Procedures according to NATURE • Analytical Procedure It consists of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data • Confirmation It is a specific type of inquiry which is the process of obtaining a representation of information or of an existing condition directly from a third party. EXTERNAL CONFIRMATION It is the process of obtaining and evaluating audit evidence through a representation of information or an existing condition directly from a third party in response to a request for information about a particular item affecting assertions in the financial statements or related disclosures Forms of Confirmation Requests • Positive Confirmation Request asks the respondent to reply to the auditor in all cases either by indicating the respondent’s agreement with the given information, or by asking the respondent to fill in information. Forms of Confirmation Requests • Negative Confirmation Request asks the respondent to reply only in the event of disagreement with the information provided in the request. It may be used to reduced the risk of material misstatement to an acceptable level when: • the assessed risk of material misstatement is lower • a large number of small balances is involved • a substantial number of errors is not expected Relationship among assertions, objectives, and procedures The auditor develops specific audit objectives in the lights of financial statement assertions of the management. After setting the audit objectives, the auditor considers the type of evidence to be obtained and the audit procedures necessary to obtain this evidence. Assertion Audit Objectives Audit Procedure Completeness Inventory quantities include all products, materials and supplies on hand. Obtain a copy of the inventory listing and agree the total to the general ledger and the financial statements Inventories included in the balance sheet physically exists. attend and observe the client's physical inventory count to determine if it exists and is accurately recorded. Existence or Occurrence ANALYTICAL REVIEW PROCEDURES Analytical procedures consist of evaluation of the financial information made by a study of plausible relationships among financial and non-financial data. ANALYTICAL REVIEW PROCEDURES The typical approach is: 1. Develop an expectation for the account balance. 2. Determine the amount of difference from the expectation that can be accepted without investigation. 3. Compare the company’s account balance (or ratio) with the expected account balance. 4. Investigate significant differences from the expected account balance. ANALYTICAL REVIEW PROCEDURES Generalizations on Plausible Relationships Relationships differ in their predictability. Accordingly: 1. Relationships in a dynamic or unstable environment are less predictable than those in a stable environment. 2. Relationships involving balance sheet accounts are less predictable than income statement accounts. 3. Relationships involving management discretion are sometimes less predictable. ANALYTICAL REVIEW PROCEDURES Summary of procedures classified as to type and as to nature: SUBSTANTIVE PROCEDURES (SUBSTANTIVE TESTS) Two general types of substantive tests: • test of details of transaction, balances and disclosures a • analytical review procedures. FRAUD AND ERROR Error • Mistake in gathering or processing data from which the FS is prepared. • Incorrect accounting estimate arising from oversight or misinterpretation of facts. • A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation, or disclosure. FRAUD AND ERROR Fraud – refers to an intentional act by one or more individuals among management, TCWG, employees, or third parties involving the use of deception to obtain an unjust or illegal advantage. • Management fraud • Employee fraud FRAUD AND ERROR Responsibilities The primary responsibility for the prevention and detection of fraud and error rests with both TCWG and management of the entity. Inherent Limitation of an Audit • • • • A failure to obtain reasonable assurance Inadequate planning, performance or judgement The absence of professional competence and due care, or A failure to comply with PSAs FRAUD AND ERROR Professional skepticism • Matters that increase the risk of material misstatement (management’s characteristics and influence over the control environment, industry conditions, operating characteristics, and financial stability). • Circumstances that make the auditor suspect that the FS are materially misstated. • Evidence obtained (from current and previous audits) that brings into question the reliability of management representations. FRAUD AND ERROR Examples of Circumstances that Indicate the Possibility of Fraud • Discrepancies in the accounting records, including the following: • Transactions that are not recorded in a complete or timely manner or are improperly recorded as to amount, accounting period, classifications, or entity policy. • Unsupported or unauthorized balances or transactions. • Last-minute adjustments that significantly affect financial results. • Missing documents. FRAUD AND ERROR Problematic or unusual relationships between the auditor and management, including the following: • Denial of access to records. • Undue time pressures imposed by management to resolve complex or contentious issues. • Unusual delays by entity in providing requested information. • Unwillingness to add or revise disclosures in the financial statements to make them more complete and understandable. • Unwillingness to address identified weaknesses in internal control on a timely basis. FRAUD AND ERROR Actions to be taken related to fraud and error • Identify if there are circumstances that indicate a positive misstatement in the financial statement. • Determine whether the financial statement are materially misstated • If misstatements are identified, the auditor should consider whether such a statement may be indicative of fraud. If indicative of fraud, the auditor should consider the implications on the audit (particularly the reliability of managements representations). FRAUD AND ERROR 4. In evaluating and disposing of misstatements, consider, materiality (PSA 450, Evaluation of Misstatements Identified During The Audit). The effect on the auditor’s report depends on the evaluation and disposition of these statements. 5. The auditor should document: • Fraud risk factors identified as being present during the risk assessment process, and during the performance of the audit. • The auditor’s responses to the fraud risk factors. FRAUD AND ERROR Communication Matters to be Communicated Regarding Fraud • Questions regarding management competence and integrity. • Fraud involving management. • Other fraud that results in a material misstatement of the financial statements. • Material misstatements resulting from the error. • Misstatements that indicate material weaknesses in internal control • Misstatement that may cause future financial statements to be materially misstated. AUDITING ACCOUNTING ESTIMATES Accounting estimate – approximation of amount of an item in the absence of precise means of measurement. Examples of Accounting Estimates: 1. Allowances to reduce inventory and accounts receivable to their NRV and amortized cost, respectively 2. Provisions to allocate the cost of fixed assets over estimated useful lives. 3. Accrued revenue. 4. Deferred tax. 5. Provision for the loss from a lawsuit. 6. Losses on construction contracts in progress. 7. Provisions to meet warranty claims. AUDITING ACCOUNTING ESTIMATES Nature of Accounting Estimate • The determination of accounting estimate may be simple or complex depending upon the nature of the item • Accounting estimates may be determined as part of the routine information system relevant to financial reporting operating on a continuing basis, or may be non-routine, operating only at the period end. AUDITING ACCOUNTING ESTIMATES Procedures in testing accounting estimates The auditor may then evaluate the estimate by the following means: 1. Test the process used by the management a. identify controls relating to the estimate b. evaluate the sources of data used to determine accrual c. determine if the assumptions are reasonable and consistent d. test the calculations management used to translate these assumptions into accounting estimate AUDITING ACCOUNTING ESTIMATES Procedures in testing accounting estimates 2. Develop an independent expectation. 3. Review subsequent events and transactions. The auditor shall evaluate, based on the audit evidence, whether the accounting estimates in the financial statements are either reasonable in the context of the applicable financial reporting framework, or are misstated. PREPARING THE SUBSTANTIVE TEST AUDIT PROGRAM The auditor should consider two possible approaches for auditing an account: 1. direct test of ending balance and 2. tests of inputs and outputs during the year (test of details of transaction) AUDIT DOCUMENTATION (WORKING PAPERS) Audit documentation (working papers) - are the record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached. Functions of Audit Documentation: 1.Serve as evidence of the auditor’s basis for a conclusion about the achievement of the overall objective of the auditor; 2.Provide evidence that the audit was performed in accordance with PSAs and applicable legal and regulatory requirements. 3.Assist the audit team to plan and perform audit; AUDIT DOCUMENTATION (WORKING PAPERS) 4. Assist members of the audit team responsible for supervision to direct and supervise the audit work, and to discharge their review responsibilities in accordance with PSA 220 5. Enable the audit team to be accountable for its work; 6. Retain a record of matters of continuing significance for future audits; 7. Enable an experienced auditor to conduct quality control reviews and inspections in accordance with PSQC 1, and 8. Enable an experienced auditor to conduct external inspections in accordance with applicable legal, regulatory or other requirements. AUDIT DOCUMENTATION (WORKING PAPERS) Form and Content of Audit Documentation The auditor should prepare the audit documentation so as to enable an experienced auditor, having no previous connection with the audit, to understand: 1.nature, timing and extent of audit procedures; 2.results of audit procedures and the audit evidence obtained; and 3.significant matters arising during audit and the conclusions reached thereon, and significant judgement made in reaching those conclusions. AUDIT DOCUMENTATION (WORKING PAPERS) Factors Affecting the Form, Content and Extent of Audit Documentation 1.The nature of audit procedures to be performed; 2.The identified risk of material misstatement; 3.The extent of judgement required in performing the work and evaluating the results; 4.The significance of the audit evidence obtained; 5.The nature and extent of exceptions identified; 6.The need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or audit evidence obtained; 7. The audit methodology and tools used. AUDIT DOCUMENTATION (WORKING PAPERS) Classification of Audit Documentation 1.Permanent File a. extracts or copies of such company document b. analyses, from previous years, of accounts that have continuing importance to the auditor c. information related to the understanding of the internal control structure and assessment of control risk 2. Current File a. Working (Top) Trial Balance b. Proposed adjusting and reclassifying entries c. Lead Schedules d. Supporting Schedules WORKING PAPER ELEMENTS AND CONSIDERATION Working Paper Elements 1. Heading, showing the name of the client, title of the working paper, and the date or period of time to which the audited financial information pertains. 2. Dates and initials of the staff and reviewers. 3. Indexing numbers and appropriate cross-referencing to other working papers. 4. Tick marks and legends. WORKING PAPER ELEMENTS AND CONSIDERATION Significant Matters 1.Matters that give rise to significant risks. 2.Results of audit procedures indicating that the financial information could be materially misstated, or a need to revise the auditor’s previous assessment of the risks of material misstatement and the auditor’s responses to those risks. 3.Circumstances that cause the auditor significant difficulty in applying necessary audit procedures 4.Findings that could result in a modification to the auditor’s report. WORKING PAPER ELEMENTS AND CONSIDERATION Documentation of Inconsistencies If the auditor has identified information that contradicts or is inconsistent with the auditor’s final conclusion regarding a significant matter, the auditor should document how the auditor addressed the contradiction or inconsistency in forming final conclusion. WORKING PAPER ELEMENTS AND CONSIDERATION Working Paper vs Audit Program Working Paper Audit Program Cover documentation of the whole audit engagement Pertain only to the audit procedures performed by the engagement team to gather sufficient appropriate evidence as a basis of opinion OWNERSHIP, CUSTODY AND CONFIDENTIALITY • Audit documentation are property of the auditor. The auditor’s rights of ownership, however, are subject to ethical limitations relating to the confidential relationships with clients. Other requirements •The auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file in timely basis after the date of the auditor’s report. •Changes may, however, be made to the audit documentation during the final assembly process if they are administrative in nature. OWNERSHIP, CUSTODY AND CONFIDENTIALITY Examples of changes include: 1.Deleting or discarding superseded documentation 2.Sorting, collating and cross-referencing working papers 3.Signing off on completion checklists relating to the file assembly process 4.Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant members of the audit team before the date of the auditor’s report.
