Module 7: Audit Planning

Introduction

▪ Audit planning involves developing a general audit strategy and detailed approach
for the expected conduct of the audit.
▪ The auditor’s main objective in planning the audit is to determine the scope of the
audit procedures to be performed.
▪ The auditor should plan the audit work so that the audit will be performed in an
effective and efficient manner.
▪ The extent of planning will vary according to the size of the entity , the complexity of
the audit and the auditor’s experience with the entity, and knowledge of the
business.

Learning Objectives:

After completing this module, you should be able to:

▪ Discuss the importance of understanding the client’s business industry.

▪ Understand and explain the objective in planning an audit.
▪ Describe the standard planning procedures.
▪ Define analytical procedures and explain why they are important at the planning
stage of the audit.
▪ Discuss the contents of the audit plan and the audit program.

Importance of Adequate Planning of the Audit Work

• Planning helps ensure that appropriate attention is devoted to important areas of the
audit.

• It helps identify potential problems.

• It allows the work to be completed expeditiously.

• It assists in the proper assignment and coordination of work.

• It helps ensure that the audit is conducted effectively and efficiently.

PSA 315 – Obtain sufficient understanding of the entity and its environment including
its internal control

▪ The auditor should obtain a sufficient knowledge of the entity’s business to identify and
understand the events, transactions and practices that may have a significant effect on the
financial statements.

▪ If the auditor understand the operations of the client, the auditor is often able to evaluate
the reasonableness of the client’s estimate.

▪ Procedures can be selected with more assurance or applicable procedures can be

designed.

▪ Knowledge of the entity also includes understanding of the entity’s objectives and
strategies and the related business risks.

▪ Understanding business risks increases the likelihood of identifying risk of material

misstatement and helps the auditor design appropriate audit procedures.

▪ The auditor should also obtain an understanding of the entity’s measurement of

performance as this create pressures on the entity that may either motivate management
to take action to improve the business performance or to manipulate the financial
statements.

Sources of Information

▪ The auditor can obtain knowledge of the industry and entity from the following:

✓ Review of prior year’s working papers

✓ Tour of client’s facilities

✓ Discussion with people within and outside the entity

✓ Reading books, periodicals and other publications related to the client’s industry

✓ Reading corporate documents and financial reports.

▪ The auditor should also ensure that assistants assigned to an audit engagement obtain
sufficient knowledge of the client’s business and industry to enable them to carry out the
work delegated to them.
Uses of information Obtained

▪ Understanding the business and using this information appropriately assists the auditor
in:

✓ Assessing risk and identifying potential problems

✓ Planning and performing the audit effectively and efficiently

✓ Evaluating audit evidence as well as the reasonableness of the client’s representations

and estimates

✓ Providing better service to the client.

▪ To make effective use of the knowledge, the auditor should consider how it affects the
financial statements and whether the assertions in the financial statements are consistent
with the auditor’s knowledge of the business.

▪ Obtaining understanding of the client’s business is a continuous and cumulative process.

For continuing engagements, the auditor should be update and re-evaluate information
gathered previously, including information in the prior year’s working papers.

Additional Consideration on New Engagement

▪ A first-time audit requires more work than a repeat engagement because of the problem
associated with the verification of the opening balances of the balance sheet accounts.

▪ In this regards, PSA 510 requires the auditor to obtain sufficient appropriate audit
evidence that:

✓ The opening balances do not contain misstatements that materially affect the current
year’s financial statements.

✓ The prior period’s closing balances have been correctly brought forward to the current
period or when appropriate have been restated

✓ Appropriate accounting policies are consistently applied or changes in accounting

policies have been properly accounted for and adequately disclosed.

▪ This can be done by reviewing the predecessor auditor’s working paper or consider the
independence and professional reputation of the predecessor auditor.
Understanding the Internal Control

▪ Another important step in planning an audit is to obtain an understanding on the entity’s

accounting and internal control systems.

▪ The auditor should obtain an understanding whether accounting and internal control
system sufficient to plan the audit and develop an effective audit approach.

Developing an Overall Audit Strategy

▪ Once the auditor has gained a sufficient understanding about the entity and its
environment including internal control, the auditor should formulate an overall audit
strategy for the upcoming engagement.

▪ The best audit strategy is the approach that results in the most efficient auditthat is an
effective audit performed at the least possible cost.

▪ An audit plan should be made regarding:

✓ How much evidence to accumulate

✓ How and when this should be done

▪ When developing an audit strategy, the auditor may consider carefully the appropriate
levels of materiality and audit risks.

Materiality

▪ Information is material if its omission or misstatement could influence the economic

decision of users taken based on financial statements.

▪ In designing an audit plan, the auditor should make a preliminary estimate of materiality
for use during the examination.

▪ The concept of materiality recognizes that some matters are important for fair
presentation of financial statements while other matters are not important.

▪ Materiality may be viewed as:

✓ The largest amount of misstatement that the auditor could tolerate in the financial
statements.

✓ The smallest aggregate amount that could misstate the financial statement.

▪ Materiality is a matter of professional judgment and necessarily involves quantitative

factors (amount of the item in relation to the financial statements) and qualitative factors (
the nature of misstatement).
Importance of Materiality in Planning an Audit

▪ The auditor should make a preliminary estimate of the materiality to determine the
amount of evidence to accumulate.

▪ There is inverse relationship between materiality and evidence.

▪ More evidence will be required for a low peso amount of materiality than for a high peso
amount.

Uses of Materiality

▪ According to PSA 320, materiality should be considered by the auditor:

✓ In the planning stage, to determine the scope of audit procedures

✓ In the completion phase of the audit, to evaluate the effect of misstatement on the
financial statements.

Using Materiality Levels

▪ The following steps may be used as a guide when using materiality levels:

➢ Steps 1 and 2 are performed in planning stage.

➢ Step 3 is performed in the completion phase of audit.

✓ Step 1 – Determine the Overall Materiality – Financial Statement Level

❖ Determine the amount of misstatement that could be material to the financial statement
taken as a whole.

❖ If the materiality level is set too low, auditor will be wasting time auditing accounts that
are not important.

❖ If the materiality level is too high, auditor may not detect misstatements that could be
material to the readers of the financial statement.

❖ Consider that financial statements are interrelated- that misstatement in balance sheet
usually affects the income statement.

❖ A common method of estimating materiality at the financial statement level is to

multiply a statement base 9 total assets, sales, or net income) by a certain percentage.
✓ Step 2 – Determine the Tolerable Misstatement-Account Balance Level

❖ Once the overall materiality is established, the auditor determines materiality at the
account balance level.

❖ Allocate the overall materiality to the financial statement account balances.

❖ This allow the auditor to determine the audit procedures that will be applied to specific
accounts.

❖ The allocated materiality to an account is called tolerable misstatement for the account
(performance materiality)

▪ The professional standards do not provide specific guidelines as to how the allocation
should be done. This process is highly subjective and requires the exercise of great deal of
judgement by the auditor.

✓ Step 3 – Compare the Aggregate Sum Total of Uncorrected Misstatements with the
Overall Materiality.

❖ After performing audit procedures, the auditor will have to compare the aggregate
uncorrected misstatements to determine whether the financial statements are materially
misstated.

Bases that can be used to Determine the Materiality Level

• Since audit planning is often performed before year-end, annual financial statements are
usually not available.

• As a results, the auditor uses alternative bases to compute the materiality level, such as:
✓ Annualized interim financial statements

✓ Prior year’s financial statements

✓ Budgeted financial statements of the current year

Summary of Materiality in an Audit

Planning Stage:

• Determine the overall materiality – Financial Statement Level

• Determine the tolerable misstatement – Account Balance Level

Completion Stage:

▪ Compare the aggregate total of misstatement with overall materiality

Audit Risk

▪ After determining the materiality level, the auditor should design the audit to provide a
reasonable assurance that the financial statements taken are free from material
misstatements.

▪ Reasonable assurance means that the auditor cannot possibly expect to detect all
material misstatement.

▪ Instead, the auditor should perform audit procedures to increase the likelihood of
detecting these misstatements.

▪ The auditor should use professional judgement when designing substantive audit
procedures, anchored on the three (3) main issues:

✓ What level of assurance does the auditor wish to attain that FS do not contain material
misstatements? As this level of assurance increases, the scope of auditor’s substantive
test also increase.

✓ How susceptible is the account to material misstatement? As the susceptibility of

account to misstatement increases, the scope of auditor’s substantive tests also
increases.

✓ How effective is the client’s internal control in preventing or detecting misstatements? As

the effectiveness of the client’s internal control increase, the scope of the auditor’s
substantive test decreases.

Audit Risk Model

• These three issues are the preliminary basis for the development of the risk mode:

Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Audit Risk

✓ Refers to the risk that the auditor that the auditor gives an inappropriate audit opinion on
the financial statements.

✓ This occurs because the auditor believes that the financial statements are fairly stated
when the fact the financial statement are materially misstated.

✓ Audit risk is the complement of audit assurance.

✓ If the auditor is willing to accept 5% audit risk, he must design the audit to have a 95%
assurance or confidence level that his opinion is correct.
✓ Because of the inherent limitation of the audit, the auditor cannot eliminate the audit
risk.

✓ Therefore, the auditor should perform audit procedures to limit his exposure to this risk
to a low level.

✓ As the desired level of audit risk decreases, the auditor should design more effective
substantive procedures.

Audit Risk Model

• These three issues are the preliminary basis for the development of the risk mode:

Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Inherent Risk

✓ Is the susceptibility of an account balance or class of transactions to a material

misstatement assuming that there was no related internal control.

✓ This concept recognizes that some account balances, by nature, are more susceptible to
misstatement than others.

✓ PSA 315 requires the auditor to assess inherent risk at the financial statement and
account balance or transaction class levels.

✓ Factors that affect the risk of misstatement at the financial statement level include:

❖ The management integrity

❖ Management characteristics (aggressive attitude toward financial reporting)

❖ Operating Characteristics (profitability of the entity relative to its industry)

❖ Industry characteristics (industry is experiencing large number of business failures)

Audit Risk Model

• These three issues are the preliminary basis for the development of the risk mode:

Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Inherent Risk

✓ Factors that affect the risk of misstatement at the account balance level include:

❖ Susceptibility of the account to theft

❖ Complexity of calculation related to account

❖ The complexity underlying transactions and other events

❖ The degree of judgement involved in determining account balances.

✓ As the assessed level of inherent risk increases, the auditor should design more effective
substantive procedures

• These three issues are the preliminary basis for the development of the risk mode:

Audit Risk = Inherent Risk * Control Risk * Detection Risk

• Detection Risk

✓ Risk that an auditor’s substantive procedure will not detect a material misstatement.

✓ Detection risk is a function of the effectiveness of the auditor’s substantive procedures.

✓ As the acceptable level of detection risk decreases, the assurance directly provided from
substantive tests increases.

✓ Hence, auditor should design more effective audit procedures in order to achieve the
desired level of assurance. The acceptable level of detection risk is inversely related to the
assessed level of both inherent and control risks.

Steps in Using the Audit Risk Model

• Step 1 - Set the desired level of Audit Risk

✓ There is no specific guidelines for setting audit risk.

✓ The auditor uses his judgment in determining the risk that he is willing to take of
accepting an assertion as fairly stated when in fact it is materially misstated.

✓ The auditor should plan the audit in such a way that, after performing audit procedures,
an opinion can be issued on the financial statement at a low level of audit risk.

• Step 2 - Assess the Level of Inherent Risk

✓ When assessing inherent risks for each account, the auditor must consider specific
factors related to the client that may affect the risk of material misstatement for a
particular account.

✓ In making this assessment, the auditor will rely on his knowledge of the client’s business
industry, and the results of his preliminary analytical procedures.

• Step 3 - Assess Level of Control Risk

✓ Assess the control risk by studying and evaluating the effectiveness of the client’s
accounting and internal control system.

✓ When assessing the level of control risk, the auditor should recognize that some control
risk will always be present because of the inherent limitation of the internal control.

✓ If the client maintains effective control system, the risk of material misstatement in the
financial statements can be minimized.

• Step 4 - Determine the Acceptable Level of Detection Risk

✓ Based on the desired audit risk level (step 1) and the auditor’s assessment of inherent
and control risks (steps 2 & 3), the auditor determines the acceptable level of detection
risk. By rearranging the audit risk model, the acceptable level of detection can be
determined as follows:

Detection Risk = Audit risk / Inherent Risk * Control Risk

• Step 5 - Design Substantive Test

✓ Unlike inherent risk and control risk, detection risk can be increased or decreased by the
auditor by performing substantive tests.

✓ Detection risk can be looked at as the complement of the assurance provided by

substantive tests.

✓ A 10% acceptable level of detection risk means that substantive tests must be designed
to provide a 90% assurance of detecting material misstatements.

✓ Thus, a lower acceptable level of detection risk increases the assurance to be provided
by substantive tests.

✓ To obtain a greater assurance, the auditor will modify the scope of his substantive test
such as:

❖ Performing more effective substantive procedures (Nature)

❖ Performing year-end procedures (timing)

❖ Using larger sample size (extent)

✓ If the acceptable level of detection risk is high, the assurance provided by substantive
tests will decrease. As a result, the auditor could reduce the scope of his substantive
procedures like:
❖ Performing less effective substantive procedures (nature)
❖ Performing the test at interim (timing)

❖ Using smaller sample size (extent)

Summary Steps in Using the Audit Risk Model

• Audit Planning

✓ Set Desired Level of Audit Risk

✓ Assess Inherent Risk

• Consideration of Internal Control

✓ Assess Control Risk

• Performing Substantive Tests

✓ Determine Acceptable Level of Detection Risk

Relating Inherent, Control and Detection Risk to Overall Audit Risk

• The inherent, control and detection risk is the components of the overall audit risk.

• An increase or decrease in any components would cause a corresponding increase or

decrease in the overall risk.

• Of the three (3) components, only the detection risk can be controlled by the auditor.

• Inherent and control risks are functions of the management and its environment, and
such the auditor cannot change the levels of inherent and control risks.

• The auditor can only assess their levels.

• On the other hand, the detection risk can be controlled by the auditor by performing
substantive procedures.

• For example, if the assessed level of inherent and control risk is high, the auditor should
minimize the level of detection risk to be able to maintain the planned overall audit risk
level.

• Conversely, if the assessed level of inherent and control risk is low, the auditor could
accept a high level of detection risk and still maintain the desired audit risk level.
Relationship Between Materiality and Risk

• When planning the audit, the auditor considers what would make the financial
statements materially misstated.

• The auditor’s assessment of materiality related to specific account helps the auditor
select audit procedures that can be expected to reduce audit risk to an acceptable level.

• The is an inverse relationship between materiality and the level of audit risk, that is, the
higher the materiality level, the lower the audit risk and vice versa.

• For example, if, after planning for specific audit procedure, the auditor determines that
the acceptable materiality level is lower, audit risk is increased.

• The auditor would compensate for this by either:

❖ Reducing the assessed level of control risk by carrying out extended or additional tests
of control

❖ Reducing detection risk by modifying the nature, timing and extent of planned
substantive procedures.

Effect of Materiality on Audit Risk and Planned Audit Procedures

Materiality Audit Risk - Risks of Planned Audit

Material Error Occurring
Planning Materiality and/or not being Procedures
and/or Tolerable Error determined

LOW HIGH More Extensive

HIGH LOW Less Extensive

Risk Assessment Procedures

• The procedures performed by auditors to obtain an understanding of the entity and its
environment including its internal control and to assess the risks of material misstatement
in the financial statements are called “risk assessment procedures”. These include:

❖ Inquiries of management and others within the entity

❖ Analytical procedures

❖ Observation and inspection

• Information obtained in performing these risk assets procedures may be used by the
auditor as evidence to support assessment risk of material misstatement.

• The auditor may obtain audit evidence about fair presentation of financial statements or
about the operating effectiveness of internal control even though such procedures were
not specifically planned as substantive tests or tests of control.

Analytical Procedures

• Analytical procedures involve analysis of significant ratios and trends, including resulting
investigation of fluctuations and relationships that are consistent with other relevant
information or deviate from predicted amounts.

• A basic premise underlying the use of analytical procedures is that plausible relationship
among data may reasonably be expected to exist and continue in the absence of knowns to
the contrary.

• PSA 250 requires the auditor to use analytical procedures in the planning and overall
review stages of the audit.

• The application of analytical procedures helps the auditor assess the risk of material
misstatements in the financial statements.

• Analytical procedures also helps the auditor in identifying unusual transactions and
events that may affect the fair presentation of financial statements.

Steps in Applying Analytical Procedures

Step – 1 Develop expectations regarding financial statement using:

❖ Prior year’s financial statements

❖ Anticipated results such as budgets or forecasts

❖ Industry average

❖ non-financial information

❖ Typical relationship among financial statement account balances

Step – 2 Compare the expectation with financial statement under audit

❖ The auditor compares the financial statements with his expectations to identify
significant fluctuations that are inconsistent with the auditor’s knowledge or that deviate
from predicted amounts.

Step – 3 Investigate significant unexpected differences (unusual fluctuations) to determine

whether financial statements contain material misstatements.

❖ It begins with inquiries of management, followed by corroborations of management

responses and applying other appropriate audit procedures.

Uses of Analytical Procedures

Analytical procedures may be used for the following purposes:

• As a planning tool, to determine the nature, timing, and extent of other auditing
procedures.

• As a substantive test to obtain corroborative evidence about particular assertions related

to the account balance or transaction class.

• As an overall review of the financial statements in the completion phase of the audit.

Uses of Analytical Procedures in an Audit

Documenting The Audit Plan

The final step in the planning process is the documentation of the audit plan process by
preparing an overall audit plan, audit program, and time budget.

• Audit Plan

✓ An audit plan is an overview of the expected scope and conduct of the audit.

✓ The overall audit plan sets out in broad terms the nature, timing and extent of the audit
procedures to be performed.

✓ While the audit plan varies for each client, it should be sufficiently detailed to guide in
the development of an audit program.

• Audit Program

✓ The auditor should develop and document an audit program setting out the nature,
timing and extent of the planned audit procedures required to implement the overall audit
plan.

✓ It sets out in detail the audit procedures to be performed in each segment of the audit.

✓ The form and content of the audit program may vary for each engagement, but is should
always include a detailed list of audit procedures that the auditor believes are necessary to
accomplish the audit objectives.

• Time Budget

✓ A time budget is an estimate of the time that will be spent in executing the audit
procedures listed in the audit program.

✓ This provides a basis for estimating audit fees and assists the auditor in assessing the
efficiency of the assistants.

• Changes Audit Plan and Program

✓ Planning continuous throughout the engagement because of changes in conditions or

unexpected results of audit procedures.

✓ The overall audit plan and the audit program should be revised as necessary during the
audit and the reasons for significant changes would be recorded.
 Module 8: Consideration of Internal Control

Nature of Internal Control

• When an entity is small, its owner or manager can personally perform, or

directly oversee, all is functions.

• However, as the entity grows larger, it becomes necessary to delegate

functional responsibilities to employees.

• Once this occurs, mechanism need to be introduced which enable the

performance of the employees to be checked, to ensure that they are fulling
their responsibilities as intended.

• According to PSA 315, internal control is the process designed and effected
by those charged with governance, management and other personnel to
provide reasonable assurance about the achievement of the entity’s
objectives about the reliability of financial reporting, effectiveness and
efficiency of operations and compliance with the applicable laws and
regulations.

The definition embodies four (4) essential concepts:

• Internal control is a process- Internal control is not an end. Instead, it is a

means of achieving the entity’s objective.

• Internal control is performed by those charged with governance,

management and other personnel

It is the responsibility of the management to establish a control

environment and maintain policies and procedures to assist in
achieving the entity’s objectives.

Those charged with governance, on the other hand, ensure the

integrity of accounting and financial reporting system through
oversight of the management.

Staff personnel should also perform their respective functions in

order to accomplish the objectives of the entity.

The definition embodies four (4) essential concepts:

Internal control can be expected to provide reasonable assurance of achieving the

entity’s objectives
 - Internal control can only provide reasonable assurance that the entity’s objective
will be achieved, not absolute assurance.
- This is because of the inherent limitation such as:

- Management usual requirement that the cost of internal control should not
exceed the expected benefits to be derived.

- Most internal controls tend to be directed at routine transactions rather

than non-routine transactions.

- The potential for human error due to carelessness, distractions, mistakes of

judgment and the misunderstanding of instructions.

- The possibility of circumvention of internal controls through the collusion

among employees.

- The possibility of management overriding the internal control.

- The possibility that procedures may become inadequate due to changes in

conditions, and compliance with procedures may deteriorate.

The definition embodies four (4) essential concepts:

Internal control is designed to help achieve the entity’s objectives

❖ Internal control is geared towards the achievement of the

entity’s objectives in the following categories:

➢ Effectiveness and efficiency of operations.

➢ Compliance with laws and regulations

➢ Reliability of financial reporting

❖ In the audit of financial statements, the auditor is only

concerned with those policies and procedures within the
accounting and internal control system that are relevant to the
financial statement assertions.

❖ Therefore, the objective that is most important to the audit is

the financial reporting objective.

❖ Operational and compliance objectives may be relevant to the

audit only if they relate to the data auditor evaluates to
determine the reliability of some financial statement
assertions.
Components of Internal Control

▪ Although internal control policies and procedures vary significantly from one
entity to another, there are essential components of internal control that
must be established to provide a reasonable assurance that the entity’s
objectives will be achieved.

▪ There are five (5) interrelated components of the entity’s internal control,
namely:

Control Environment:

✓ The control environment includes attitudes, awareness, and actions

of management and those charged with governance concerning the
entity’s internal control and its importance in the entity.

✓ The internal control environment also includes the governance, and

management functions and sets the tone of an organization,
influencing the control consciousness of its people.

✓ It is the foundation for effective internal control, providing discipline

and structure.

There are five (5) interrelated components of the entity’s internal control, namely:

Control Environment:

Factors reflected in the control environment include:

❖ Integrity and ethical values – ethical standards that

discourage dishonesty or illegal acts

❖ Management philosophy and operating style – attitudes

towards financial reporting

❖ Active participation of those charged with governance –

overseeing financial reporting policies and practice

❖ Commitment to competence – competence required for

each task, knowledge and skills

❖ Personnel policies and procedures- policies in hiring,

training, evaluating and promoting

❖ Methods in assigning responsibilities to minimize

possibility of errors.
Risk Assessment:

✓ An entity’s business objectives cannot be achieved without some

risks.

✓ Business risks is the risk business objectives will not be attained as a

result of internal and external factors such as technological
development, changes in customers demand and other economic
changes.

✓ Business risks are crucial to every organization. Thus, management

should adopt policies and procedures that are designed to identify
and analyze the risk affecting the business and take the appropriate
action to manage these risks.

✓ For audit purposes, the auditor is concerned only with those risks that
are relevant to the preparation of a reliable financial statement.

Information and Communicating System:

✓ Effective internal control system must provide timely information and

communication.

✓ The information system relevant to financial reporting objectives

consists of the procedures and records established to initiate, record,
process and report entity transactions and to maintain accountability
for the related assets, liabilities and equity.

✓ Information system encompasses methods and records that:

❖ Identify and record all valid transactions

❖ Describe on a timely basis the transaction in detail to permit

proper classification for financial reporting

❖ Measure value of transaction in a manner that permits

recording their proper monetary value

❖ Determine the time in which the transaction occurred

❖ Present properly the transactions and related disclosures in

the financial statements.
Control Activities:

- Control activities are policies and procedures that help ensure the management
directives are carried out.
- Specific control procedures that are relevant to financial statement audit would
include:

Performance Reviews

- These control activities include reviews and analyses of actual performance versus
budgets, forecasts and prior period performance; relating different sets of data to
one another.

Information Processing

- A variety of controls are performed to check accuracy, completeness and

authorization of transactions.
- When computer processing is used in significant accounting application, internal
control procedures can be classified into two types: General and applications
controls.

Physical Controls

- These activities encompass the physical security of assets, including adequate

safeguards such as secured facilities over access to assets and records;
authorizations for access to computer programs and data files and periodic
counting and comparison with amounts shown on control accounts.

Segregation of Duties

- Assigning different people, the responsibilities of authorizing transactions,

recording and maintaining custody of assets intended to reduce opportunities to
both perpetrate and conceal errors or fraud.

Monitoring:

Monitoring is a process of assessing the quality of internal control performance over time.

It involves assessing the design and operation controls on a timely basis and taking
necessary corrective actions.

Monitoring is done to ensure that controls continue to operate effectively.

Monitoring of controls is accomplished through ongoing monitoring activities, separate

evaluations, or a combination of two.
Consideration of Internal Control

- The auditor are not responsible for establishing and maintaining entity’s accounting
and internal control systems.
- Nevertheless, the auditor should consider these control because the quality of the
entity’s internal control system can have a significant impact on the audit.
- Consideration of the entity’s internal control system involves the following steps:

Obtain understanding of the internal control

▪ Obtaining an understanding of internal control involves evaluating the design of a

control and determining whether it has been implemented.

▪ An initial understanding of the design is ordinarily obtained by making inquiries of

appropriate individuals, inspecting documents and records and observing of entity’s
activities and operations.

▪ To determine whether these controls have been implemented, the auditor

accomplished this by performing a “walk-through test. This task involves tracing one
or two transactions through the entire accounting system, from initial recording at
source to their final destination as component of an account balance in the
financial statements.

Document the understanding of accounting and internal control systems.

✓ Documentation is done thru narrative description of the entity internal control,

flowchart that diagrams the flow of transactions and documents and by providing
the management an internal control questionnaires and securing responses from
the appropriate officers and employees.

Assess the level of control risk

✓ The auditor’s preliminary assessment of the control risk may be at a high level
(100%) or less than high level. When the auditor’s knowledge indicates that internal
control related to a particular assertion are not effective, the auditor may simply
assess control risk at a high level. Hence, no test of controls need to be performed
and the auditor will rely primarily on the substantive tests.

✓ On the other hand, if the auditor believes that controls appear to be reliable, the
auditor should determine whether it is efficient to obtain evidence to justify an
assessment of control risk at a lower level.
Perform tests of controls

✓ Irrespective of how effective internal control procedures may appear, the auditor
must test this control to obtain evidence that they are working effectively as the
preliminary assessment suggests (Design and Operation).

✓ It is important to note that the auditor will test the operating effectiveness of
controls that he plans to rely upon.

✓ The greater the reliance the auditor plans to place on internal control, the more
extensive the test of those controls that need to be performed.

Document the assessed level of control risks

✓ After evaluating the results of test of control and assessing the control risk, the
auditor should document his assessment of control risk.

✓ If the control risk is assessed at a high level the auditor should document his
conclusion that the control risk is at a high level.

✓ If control risk is assessed at less than high level, the auditor should document his
conclusion that control risk is less than high and the basis for that assessment base
on the actual results of tests of control.
 Module 9: Performing Substantive Test

Substantive Test

• Are audit procedures designed to substantiate the account balances or to detect material
misstatements in the financial statement.

• There are two types of substantive test, namely analytical procedures and test of details.
• The decision which procedures to use is based on the auditor’s judgment about the
expected effectiveness and efficiency of such procedures in satisfying the audit objective.

Analytical Procedures

▪ Analytical procedures may be used in planning, testing and overall review stages of the
audit.

▪ Analytical procedures applied as substantive tests enable the auditor obtain

corroborative evidence about a particular account.

▪ This approach involves comparison of financial information with the auditor’s expectation
to determine the reasonableness of an account balance reported in a financial statement.

▪ When analytical procedures identify significant fluctuations, the auditor should conduct
further investigation to determine whether the financial statements are materially
misstated.

▪ This investigation ordinarily begins with inquiries of management followed by

corroboration of the management’s responses and other audit procedures based on the
results of these inquiries

Analytical Procedures

▪ The effectiveness of analytical procedures applied as substantive tests is affected by

many factors such as:

✓ Nature of the assertions

✓ Reliability of the data used to develop expectations

✓ Precision of expectations

✓ Predictability of the account balances

▪ When intending to perform analytical procedures as substantive tests, the auditor should
focus on those accounts that are predictable.
▪ The following generalizations may be helpful in assessing the predictability of the
accounts:

✓Income statement accounts are more predictable compared to balance sheet

accounts.

✓Accounts that are not subject to management discretion are generally predictable
✓Relationship in a stable environment are more predictable than those in a
dynamic or unstable environment.

Test of Details

▪ It involves examining the actual details making up the various account balances.

▪ This approach may take the form of test of details of balances or test of details of
transactions.

▪ Test of details of balances involves direct testing of the ending balance of an account,
while test of details of transaction involves testing the transaction which give rise to the
ending balance of an account.

▪ In general, test of balances will be used when account balances are affected by large
volume of relatively immaterial transactions such as cash, receivable and inventory.

▪ On the other hand, test of transaction is useful if account balances are comprised of
smaller volume of transactions representing relatively material amounts such as PPE,
intangibles, bonds, equity accounts.

Effectiveness of Substantive Test

Nature of Substantive Test

▪ The nature of substantive test relates to the quality of evidence.

▪ The auditor should determine the appropriate quality of the evidence needed to support
the desired level of detection risk.

▪ Although the auditor would normally prefer high quality evidence, it is important to realize
that it would also involve high cost.

Timing of Substantive Test

▪ Substantive test may be performed at interim date which will assists the auditor in
identifying significant matters at an early stage of the audit and consequently resolving
them with the help of the management or developing an effective approach to address
such matters. The higher the risk of material misstatement, the more likely it is that the
auditor may decide to perform substantive test closer to year-end.

Extent of Substantive Test

▪ The nature of substantive test relates to the amount of evidence needed to satisfy a
particular objective.

▪ The extent of substantive test is based on the auditor’s judgment after considering the
materiality, the assed risk, and the degree of assurance the auditor plans to obtain.

▪ The auditor ordinarily increases the extent of substantive procedures as the risk of
material misstatement increases.

Audit Evidence

• The auditor should obtain sufficient appropriate evidence to be able to draw reasonable
conclusion on which to base the audit opinion.

• Evidence refers to the information obtained by the auditor in arriving at the conclusions
on which the audit opinion is based.

• Audit evidence consists of the underlying accounting data and corroborating information.

Underlying Accounting Data

✓ Refers to the accounting records underlying financial statements such as books

of accounts, accounting manuals, worksheet, and reconciliation prepared by client
personnel.

Corroborating Information

✓ Supporting the underlying accounting data obtained from client and other
sources. This includes documents such as invoices, bank statements, purchase
orders, contracts, etc.

• Accounting data alone cannot be considered sufficient evidence to support an opinion on

the financial statements. Accordingly, the auditor must obtain corroborative information to
support his audit report.

Qualities of Evidence

▪ Audit evidence is typically obtained as a result of performing tests of control and

substantive tests.
▪ In cases where control cannot rely upon, evidence maybe obtained entirely from
substantive tests.

▪ When obtaining audit evidence from either test of control or substantive tests, the auditor
should consider the sufficiency and appropriateness of the audit evidence obtained.

▪ When performing test of control, audit evidence must support the assessed level of
control risk.

▪ When performing substantive test, audit evidence must support the acceptable level of
detection risk.

Sufficiency of Evidence

▪ Refers to the amount of evidence that the auditor should accumulate.

▪ Because of the cost/benefit consideration, the auditor does not examine all evidence
available.

▪ The auditor uses his judgment to determine the amount of evidence needed to support an
opinion on the financial statements.

▪ The following factors may be considered in evaluating the sufficiency of evidence:

✓ Competence of evidence- more competent evidence, less amount of evidence

needed.

✓ Materiality of item examined – more evidence will be needed to support its

validity.

✓ Risk involved account- more evidence will be needed

✓ Experience gained during previous audit – indicate the amount of evidence

taken before and whether such evidence was enough.

Appropriateness of Evidence

▪ Refers to the measure of the quality of audit evidence and its relevance to a particular
assertion and its reliability.

▪ Relevance relates the timeliness of evidence and its ability to satisfy the audit objective.

▪ Reliability relates to the objectivity of evidence and is influenced by its source and by its
nature.

▪ While reliability of audit evidence is dependent on individual circumstances, the following

could help in assessing the reliability of the audit evidence:
✓ From independent outside source

✓ When related accounting and internal control system are effective

✓ Obtained directly by the auditor

✓ In form of documents and written representations

Cost/Benefit Consideration when Obtaining Evidence

▪ As a guiding rule, there should be a rational relationship between the cost of obtaining
evidence and the usefulness of the information obtained.

▪ The auditor uses his professional judgment in determining the appropriate type be
obtained.

▪ Audit evidence does not have to be conclusive to be useful

Audit Documentation/Working Papers

▪ The sufficient appropriate evidence required by the professional standards must clearly
documented in the auditor’s working papers.

▪ Working papers are records kept by the auditor that documents the audit procedures
applied, information obtained, and conclusion reached.

▪ PSA 230 requires the auditor to document matters that are important to support an
opinion of financial statements, and the evidence that the audit was conducted in
accordance with PSA

Classification of Working Papers

Permanent File

➢ Copies of Articles of Incorporation and by laws

➢ Major contracts

➢ Engagement letter

➢ Organizational chart

➢ Analyses of long-term accounts such as PPE, long-term liabilities and stockholders’

equity

➢ Internal control analyses

Current File

➢ Copy of financial statements

➢ Audit program

➢ Working Trial Balance

➢ Lead schedules

➢ Detailed schedules

➢ Correspondence with other parties such as lawyers, customers, banks and

management

Audit Documentation/Working Papers

▪ Ownership of Working Papers

- Working papers are the property of the auditor and the client has no right to the
working papers prepared by the auditor.

▪ Confidentiality of Working Papers

- Although the working papers are personal property of the auditor, these working
papers cannot be shown to third parties without the client’s permission. Section 4
Code of Ethics requires the CPA to respect confidentiality of information obtained
during the performance of professional services but overridden by the statute of
law.

▪ Retention of Working Papers

- Should be retained by the auditor for a period sufficient to meet the needs of his
practice and to satisfy any pertinent legal requirements of record retention.

▪ Guideline for the Preparation of Working Papers

- Heading, Indexing, Cross-indexing, Tick Marks

Auditor’s Responsibility

▪ Management is responsible for making accounting estimates included in the financial

statements.

▪ The auditor responsibility is to obtain sufficient appropriate evidence as to whether:

✓ Accounting estimate is properly accounted for and disclosed

 ✓ Accounting estimate is reasonable in the circumstances

▪ Determining whether accounting estimates are properly accounted for and disclosed
requires knowledge of the client’s business and application of relevant financial reporting
standards.

▪ When evaluating reasonableness, the auditor should obtain an understanding of the

procedures and methods, including the accounting and internal control system used by
management in making accounting estimates.

▪ The auditor may use one or combination of approaches to evaluate the reasonableness:

✓ Review and test the process used by the management to develop estimate.

➢ Evaluate data and assumptions

➢ Testing calculation

➢ Comparing prior period estimates with actual results

➢ Considering management approval procedures

✓ Make an independent estimate

✓ Review subsequent events which confirm the estimate made

Related Parties

▪ The term related party refers to persons or entities that may have dealings with one
another in which one party can exercise significant influence or control over the other party
in making financial and operating decisions.

▪ While the existence of related parties and transactions between them, the auditor needs
to be aware of them because:

✓ Require disclosure in the financial statements

✓ Motivated by other than ordinary business considerations such as profit sharing

or even fraud

✓ May affect the financial statements and the reliability of the audit evidence.

Management’s Responsibility

▪ The management is responsible for the identification and disclosure of related parties
and transactions with such parties.
▪ This responsibility requires management to implement adequate accounting and internal
control system to ensure that transactions with related parties are appropriately identified
in the accounting records and disclosed in the financial statements.

Auditor’s Responsibility

▪ The auditor should obtain, and review information provided by the directors and
management in identifying the names of all known related parties and related party
transactions. The following procedures may assist the auditor in identifying related parties:

✓ Review prior-year working papers for the names of known related parties

✓ Review the entity’s procedures for identification

✓ Inquire as to affiliation of directors and officers

✓ Review shareholder records to determine names of principal shareholders

✓ Inquire of other auditors currently involved in the audit

✓ Review entity’s income tax returns and other information supplied to regulatory
agencies.

Auditor’s Responsibility

▪ When related party transactions are identified, the auditor should obtain sufficient
appropriate evidence that these are properly accounted for and disclosed in the financial
statements.

▪ The auditor should also obtain a written representation from the management concerning
the completeness of information provided regarding the identification of related parties
and adequacy of related party disclosures in the financial statements.

Using the Work of an Auditor’s Expert

▪ The auditor’s education and experience enable the auditor to be knowledgeable about
business matters in general.

▪ However, the auditor is not expected to have experience required to practice other
profession and occupation.

▪ During the audit, the auditor may need to obtain audit evidence in the form of reports,
opinions, valuations and statements of an expert.
▪ An expert is a person or firm possessing special skill, knowledge and experience in a
particular field other than accounting and auditing. Common examples of expert’s work
include:

✓ Valuation of precious stone, work of arts, real estate

✓ Determination of amounts like actuarial computations

✓ Interpretation of technical requirements, regulations or contracts such as legal

documents or legal title to property.

▪ PSA 620 identifies two kinds of experts, namely:

❖ Auditor’s Expert

➢ An expert, whose work in the 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 field of expertise, is used by the entity to assist

the entity in preparing the financial statement

➢ The auditor’s education and experience enable the auditor to be

knowledgeable about business matters in general.

▪ Determining the need for an Auditor’s Expert

❖ Not all engagements would require the help of an expert.

❖ When determining the need to use the work of expert, the auditor would consider:

➢ Whether management has used a management’s expert in preparing the

financial statements

➢ The nature and significance of the matter, including its complexity

➢ The risks of material misstatement in the matter

➢ The expected nature of procedures to respond to identified risks, including

the auditor’s knowledge of and experience with the work of experts in relation
to such matters

➢ Availability of alternative sources of audit evidence

Evaluating the Auditor’s Expert

▪ After concluding that the help of the auditor’s expert is needed to assists the auditor in
obtaining sufficient appropriate evidence, the auditor must:

❖ Assess the competence and objectivity of the expert. The following factors must
be considered:

✓ Professional certifications or licensing

✓ Experience and reputation in the filed in which the auditor is seeking audit
evidence

❖ Understand the field of the expertise of auditor’s expert

❖ Establish the terms of the agreement with the expert

❖ 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 expressed and that responsibility
is not reduced by the auditor’s use of the work of expert.

▪ Thus, the auditor should not refer to the work of an auditor’s expert in auditor’s report
containing an unmodified opinion

▪ When an auditor’s report contains a modified opinion, the auditor can refer to the expert’s
work if the auditor believes that such reference is necessary for the readers to understand
the reason for expressing a modified opinion.

▪ When this happens, the auditor should indicate in his report that such reference does not
reduce the auditor’s responsibility for that opinion.

Considering the Work on Internal Auditor

▪ Internal auditing is an 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 effective audit approach.

▪ An effective internal auditing will often affect the nature timing and extent of the external
auditor’s procedures.

▪ Considering the work of internal auditor involves 2 important phases:

 ✓ Making a preliminary assessment of internal auditing

✓ Evaluating and testing the work of internal auditing

Preliminary Assessment of Internal Auditing

• When planning the audit, the external auditor should make a preliminary assessment of
the internal audit function when it appears that internal auditing is relevant to the external
audit of financial statements in specific audit areas.

• For this purpose, the external auditor should consider the internal auditor’s:

✓ Competence – professional qualification and experience

✓ Objectivity – consider the organizational level

✓ Due Professional Care – consider proper planning, supervision and

documentation

✓ Scope of function – nature and extent of internal auditor’s assignment

Evaluating and Testing the Work of Internal Auditors

▪ If the external auditor decides to use the work of internal auditor, he will have to evaluate
and test the internal auditor’s work to confirm its adequacy for the external auditor’s
purposes.

▪ This evaluation may include whether the work is performed by competent persons,
sufficient appropriate evidence is obtained, and appropriate conclusion are reached.

▪ External auditor may also request the assistance of the internal auditor in performing
routine and mechanical audit procedures

▪ But it is important to recognize that all judgment relating to the audit of financial
statement are those of the external auditor.

▪ The auditor’s responsibility for audit opinion is not reduced by any use made of internal
auditing.

▪ And accordingly, the auditor’s report should not include any reference to the work
performed by internal auditors
 Module 10: Audit Sampling

Audit Sampling

• The professional standards require the auditor to obtain sufficient appropriate evidence
to be able to draw reasonable conclusions on which to base the audit opinion.

• In forming such opinion, the auditor does not normally examine all evidence available.

• Auditors usually draw conclusions about the account balance or transaction class by
examining only sample of evidence.

• PSA 530 defines audit sampling as “ 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”.

• Audit sampling is performed on the assumptions that the sample selected for testing is
representative of the population.

• Thus, an inference or conclusion can be drawn about the characteristics of the

population based on the sample results.

• Not all testing procedures performed by auditors involve audit sampling.

• The auditor may decide that it would be appropriate to examine the entire population
(100% examination) of items that make up an account balance since the population
constitutes a small number of large value items.

• Likewise, the auditor may decide to apply audit procedures only to those items which
have particular significance (selective testing).

• Regardless of the approach used, the auditors needs to be satisfied that sufficient
appropriate evidence is obtained to meet the objectives of the test.

Risk in Sampling

▪ When performing audit procedures, the auditor is faced with an uncertainty of not
detecting material errors in an account balance or class of transaction. This uncertainty
arises because of sampling and non-sampling risk:

Sampling Risk

• The 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.
• This exist because the sample selected for testing may not be truly representative of a
population.

Alpha Risk

• Test of Controls – That internal control is not reliable when in fact it is effective and can be
relied upon (Risk of Under Reliance).

• Substantive Tests – That material misstatements exists in an account balance or

transaction class when in fact such misstatement does not exist (Risk of Incorrect
Rejection)

• This type of sampling results in an auditor performing audit procedures more than what is
necessary, thus affecting audit efficiency.

▪ When performing audit procedures, the auditor is faced with an uncertainty of not
detecting material errors in an account balance or class of transaction. This uncertainty
arises because of sampling and non-sampling risk:

Beta Risk

• Test of Controls – That internal control is reliable when in fact it is not effective and can be
relied upon (Risk of Over Reliance).

• Substantive Tests – That material misstatements do not exists in an account balance or

transaction class when in fact such misstatement does exist (Risk of Incorrect
Acceptance)

• This type of sampling results in an auditor performing audit procedures less than what is
necessary, thus affecting audit effectiveness.

▪ When performing audit procedures, the auditor is faced with an uncertainty of not
detecting material errors in an account balance or class of transaction. This uncertainty
arises because of sampling and non-sampling risk:

Non- Sampling Risk

• Refers to the risk the auditor may draw incorrect conclusion about the account balance
or class of transactions because of human errors.

• Such as, inappropriate audit procedures, failure to recognize errors in the sample tested,
and misinterpretation of evidence obtained.

• This includes all aspects of audit risk that are not due to sampling.
Controlling the Risk

▪ The only way to eliminate sampling risk is to examine the entire population.

▪ Doing this, however, would not be feasible because of time and cost constraints.

▪ Accordingly, auditors do not normally attempt to eliminate sampling risk. Instead,

auditors control sampling risk by:

- Increasing the sample size

- Using an appropriate sample selection method

▪ By increasing the sample size and carefully selecting the sample, the sample become
more representative of the population, thus decreasing the sampling risk.

▪ Non-sampling risk, on the other hand, is something that cannot be eliminated even if the
auditor examines the entire population. This risk however can be minimized by:

- Proper planning
- Adequate direction, review and supervision of the audit team

General Approaches to Audit Sampling

▪ Statistical Sampling

- Uses random based selection of sample

- Uses law of probability to measure sampling risk and evaluate sample results

▪ Non-Statistical Sampling

- Approach that purely uses auditor’s judgment in estimating sampling risks,

determining sample size and evaluating sample results

Audit Sampling Plans

▪ Audit sampling may be used when performing tests of controls or substantive tests.
When statistical sampling is used, the auditor may use either attribute or variable sampling
plan.

Attribute Sampling

▪ Tis is sampling plan used to estimate the frequency of occurrence of a certain

characteristic in a population (Occurrence Rate).

▪ It is generally used when performing tests of controls to estimate the rate of deviations
from prescribed internal control policies or procedures.
Variable Sampling

▪ This is sampling plan used to estimate a numerical measurement of a population such as

peso value.

▪ It is generally used in performing substantive tests to estimate the number of

misstatements in the financial statements.

Basic Steps in Audit Sampling

▪ Define the objective of the test

- The audit objective largely determines the audit procedures to be applied.

- Hence, before deciding on the nature of the audit procedures to be performed, the
auditor must define the specific objective of the test.

▪ Determine the audit procedure to be performed

- After defining the public objective, the next step is to determine the specific audit
procedure that will be performed to satisfy the objective.
- This step also involves the defining the population and the characteristics to be
tested.

▪ Determine the Sample size

- Once the auditor has decided to apply a certain audit procedure to a sample of
items in a population, the auditor must decide how many sample units to include in
the sample.
- When statistical sampling is used, the auditor determines the sample size using
statistically based formula.
- With non-statistical sampling, the sample size is determined by relying primarily on
the auditor’s professional judgment.

▪ Select the Sample

- Another problem the auditor faces after determining the sample size is the method
of selecting the sample from the total populations.
- A sample selection technique must be designed in such a way that all items in the
population will have an opportunity to be selected.
- Statistical sampling requires that sample items be selected at random so that each
sampling unit has a known chance of being selected.
▪ Apply the Procedures

- After the sample items have been selected, the auditor applies the planned audit
procedure to the sample.

▪ Evaluate the Sample Results

- Once audit procedures have been performed on all sample items, the sample
results must be evaluated to determine whether sufficient evidence has been
obtained to satisfy the objective.

Sampling for Tests of Controls

▪ Audit sampling for tests of controls is generally appropriate when application of control
leaves evidence of performance.

▪ For those controls that leave no documentary evidence of performance, non-sampling

procedures such as inquiries and observation would be appropriate.

▪ Determination of Sample Size

- There are three factors affecting the determination of sample size for tests of
controls:
▪ Acceptable Sampling Risk
➢ Sampling risk is inherent in an audit sampling application.
➢ A sample drawn can only be expected to be representative of the population.
➢ The size of the sample is affected by the level of the sampling risk the auditor is
willing to accept.
➢ The is an inverse relationship between the acceptable sampling risk and
sample size.
➢ The smaller the sampling risk the auditor is willing to accept, the larger the
sample size to be (and vice versa).
▪ Tolerable Deviation Rate
➢ The maximum rate of deviations the auditor is willing to accept, without
modifying the planned degree of reliance on the internal control.
➢ The tolerable deviation rate is inversely related to sample size. Therefore, a
decrease in tolerable deviation rate will cause the sample size to increase
▪ Expected Deviation Rate
➢ The rate of deviations the auditor expects to find in the population before the
testing begins.
 ➢ This expectation is based on the prior year’s results or by examining few items
in the population

Sample Selection Method

▪ PSA 530 has identified three principal methods of selecting samples.

▪ Random Number Selection

➢ The auditor selects the sample by matching random numbers, generated by

random number table with the population numbering system such as document number.

➢ An advantage of this selection technique is that it gives each item in the

population an equal opportunity to be selected.

▪ Systematic Selection

➢ Determining a constant sampling interval and then selects the sample based
on the size of that interval.

➢ Example: 20,000/100 = 200. first item #25, then next 200 + 25 = 225th, 425th,
625th and so on.

▪ Haphazard Selection

➢ The sample is selected without following an organized or structured technique.

➢ The selection is useful for non- statistical sampling but is not used for statistical
sampling because the auditor cannot measure the probability of an item being
selected when using this method.

❖ Voided Documents – Such document should be replaced. By another sample

item.

❖ Missing Documents – Such item should be treated as a deviation for the purpose
of evaluating sample results.

▪ Evaluation of Results

- When evaluating sample results, both the qualitative and the quantitative factors of
deviations should be considered. Here are the guidelines:
- Determine the Sample Deviation Rate
➢ The rate is computed by dividing the number of deviations found in the samples
by sample size.
 ➢ For example, if found 4 deviations out of the 200 sample items, the sample
deviation rate is: 4/200 = 2%
➢ This sample deviation rate represents the auditor’s best estimate of the deviation
rate in the population.

▪ Other Sampling Applications for Tests of Controls

▪ Sequential Sampling

- The auditor does not use fixed sample size

- It is sometimes called stop-or-go sampling because after testing the sample, the
auditor makes a decision of whether to stop or to go on with the sampling plan.
- If no deviations are found in the sample, the auditor may conclude that the internal
control procedure is reliable and therefore may stop the sampling plan.

▪ Discovery Sampling

- This form of attribute sampling is most appropriate when no deviation are expected
in the population and therefore even one deviation would cause concern.
- This normally use when the auditor suspects that an irregularity might have been
committed.

Sampling for Substantive Tests

▪ Substantive tests are concerned with amounts reported in the financial statements.

▪ The two types of tests are Analytical Procedure and Test of Details of Transactions and
Balances
 Module 11: Completing the Audit

Completing the Audit

• After the fieldwork is almost complete, a series of procedures are generally carried out to
complete the audit. These procedures include:

- Identifying subsequent events that may affect the financial statements under audit.
- Identifying contingencies such as litigation, claims and assessment
- Obtaining written management representation.
- Performing wrap-up procedures

Subsequent Events

- Events or transactions that occur subsequent to the balance sheet date that may
affect the financial statements and the auditor’s report.
- For audit purposes, the auditor is only concerned with those events that occur after
the balance sheet but before the date of the auditor’s report.

• Requiring Adjustment – those that provide further evidence of condition that existed at
the balance sheet date such as:

- Settlement of litigation in excess of the recorded liability

- Loss on uncollectible receivables as a result of customer’s deteriorating financial
condition

• Requiring Disclosure- those that are indicative of conditions that arose subsequent to the
balance sheet date such as:

- Issuance of stocks or bonds after the balance sheet date

- Loss of inventory due to fire that occurred in the subsequent period
- Loss of uncollectible receivable because of major casualty suffered by the
customer after balance sheet date.

Procedures to Identify Subsequent Events

• According to PSA 560, “The auditor should perform procedures designed to obtain
sufficient appropriate evidence, that all events up to the date of the auditor’s report that
may require adjustment of, or disclosure in the financial statements have been identified”

• These procedures would ordinarily include:

- Inquiring of management about any subsequent events.

- Reviewing procedures management has established to identify subsequent events.
- Reviewing the minutes of the board of directors and stockholders’ meeting
 - Reading the latest available interim financial statements as well as management
reports such as budgets and forecasts.
- Inquiring of entity’s lawyers concerning litigation, claims and assessments.

Litigation, Claims and Assessment

• It is the management’s responsibility to adopt policies and procedures that will identify,
evaluate and account for the litigation, claims and assessment as a basis for the
preparation of financial statements in conformity with the applicable reporting framework.

• However, PSA 501 requires the auditor to carry out procedures in order to become aware
of any litigation and claims involving the entity which have material effect on the financial
statements.

• The auditor corroborates the information obtained from the management by asking client
to send letters of audit inquiry to lawyers handling these matters and communicate directly
to the auditor.

• If the management refuses to give the auditor permission to communicate with the
entity’s lawyer, this is considered a scope limitation that would require the auditor to issue
either qualified or disclaimer of opinion.

Written Management Representation

• PSA 580 requires the auditor to obtain sufficient appropriate audit evidence that the
entity’s management:

- Has acknowledged that it has fulfilled its responsibility for the preparation and
presentation of fair financial statements; and
- Has approved the financial statements.

• Such evidence is acquired by obtaining a written representation from management.

• The auditor shall request written representation from the management with appropriate
responsibilities for the financial statements and knowledge of the matters concerned.

Written representations as Audit Evidence

• If management modifies or does not provide requested written representations, it may

alert the auditor about other issues affecting the financial statements.

• Although written representation provides the necessary audit evidence, they do not
provide sufficient appropriate evidence on their own about any matters with which they
deal.
Form and Content of Written Representations

• The written representations shall be in the form of representation letter from

management and shall include representation on:

- Fulfillment of its responsibility for the preparation and presentation of the financial
statements as set out in the terms of the engagement.
- That the financial statements are prepared and presented in accordance with the
applicable financial reporting framework

Basic Elements of a Written Representations

• The written representations should be address to the auditor.

• The date of the written representations shall be as near as practicable to, but not after,
the date of the auditor’s report.

Wrap-up Procedures

• Wrap procedures are those procedures done at the end of the audit that generally cannot
be performed before the other audit work is complete.

Final Analytical Procedures

• According to PSA 520, the auditor shall apply analytical procedures at or near the end of
the audit when forming an overall conclusion as to whether the financial statements as a
whole are consistent with the auditor’s knowledge of business.

Post Audit Responsibilities

• Ordinarily, the auditor does not have the responsibility to perform additional procedures
after the financial statements are issued.

• However, when the auditor becomes aware that the audit report issued in connection
with the financial statements may be inappropriate, he must take steps to prevent future
reliance on such report.

Subsequent Discovery of Facts

• The auditor has no obligation to make any inquiry regarding previously issued financial
statements unless the auditor becomes aware of a material fact:

- Which existed at the date of the auditor’s report

- Which, if known at that date, may cause the auditor to modify the report.