I.

Introduction In planning a financial statement audit, auditors should develop an overall

program for considering a clients internal control which is technically called risk assessment procedures and performing substantive tests. This chapter focuses on the second plan; constructing a program to perform substantive tests in gathering evidences. Substantive tests, in the financial audit world, are series of sequential procedures by which an auditor gathers competent evidences that support his/her opinion on fairness of clients financial statements, as it is required by the generally accepted fieldwork standard after the auditor acquires professional judgment about clients internal control. Performing substantive tests is not easy. It is daunting task that even senior auditors would definitely need a sound substantive tests program to accomplish the task. An auditor constructs the program during the audit planning session and probably need some revisions along the way. The main question is how the auditors construct substantive tests program. Based on the assessed level of control and inherent risk for assertions within the transaction cycles, an auditor determines the acceptable levels of detection risk and then designs substantive test for the major financial statement accounts possessed by the cycle. Substantive testing is the stage of an audit when the auditor gathers evidence as to the extent of misstatements in client's accounting records or other information. This evidence is referred to as substantive evidence and is an important factor in determining the auditor's opinion on the financial statements as a whole. The audit procedures used to gather this evidence are referred to as substantive procedures, or substantive tests.Substantive testing involves performing audit procedures that are designed to detect material misstatements at the audit assertion level.

The auditor must obtain sufficient, appropriate evidence to be able to express an audit opinion on the truth and fairness of the financial statements. Evidence can be gained over the controls within a company, but there are limitations to controls, consequently the auditor must perform at least some substantive testing on every statutory audit. Substantive testing is predominantly performed on the year-end financial statements and underlying records. Consequently it is usually performed post- year end when the year-end figures have been produced by the client. The auditor will need to perform an audit visit to undertake the work and this visit is commonly described as the final audit. Most of the auditors work in forming his opinion on financial statements consists of obtaining and evaluating evidential matter concerning the assertions in such financial statements. This chapter provides a detailed discussion of audit evidence and introduces some of the substantive tests the auditor can perform to test the balance sheet, income statement and disclosures in the financial statements. The examples of substantive tests in this chapter are not a finite listing of all the tests that would be performed during an audit. In practice, an audit work programme would be produced for each material financial statement heading that would be tailored to the specific risks and circumstances at the client. With this, the key skill you must develop is an understanding of what the audit assertions are and how these can be practically applied to the audit in the form of a substantive test. II. Statement of the Problem Define audit evidence. Identify the attributes of audit evidence. Enumerate the factors affecting the reliability of audit evidence. Understand the relationship between assertions, audit objectives, and audit procedures. List down and explain the different types of audit procedures according to purpose and according to nature.

Give the different types of confirmation request. Describe how analytical procedures are used as substantive tests. Define substantive tests. Classify the different substantive procedures performed in an audit. Contrast fraud against error. Explain how CPAs audit accounting estimates. Define audit documentation and list down the factors which affect the form and content the audit documentation. Classify working papers and enumerate the elements of working papers. Know the pertinent considerations regarding the ownership, custody and confidentiality of working papers.

III.

Analysis

Audit Risk The possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. This is the risk that the auditors will issue an unqualified opinion on financial statements that contain a material departure from GAAP. Auditors must obtain sufficient appropriate audit evidence to reduce audit risk to a low level in every audit. PSA 500 (Redrafted), Audit Evidence, states that: The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. The Concept of Audit Evidence Audit Evidence refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence is necessary to support the auditors opinion and report. It is cumulative in nature and is primarily

obtained form audit procedures performed during the audit and may include audit evidence obtained from other sources such as previous audits and a firms quality control procedures for client acceptance and continuance. What Constitutes Audit Evidence Audit evidence consists of accounting records and other corroborating information. Accounting records are the clients record of transactions and events underlying the financial statements. These include books of accounts, related accounting manuals, worksheet supporting cost allocations and

reconciliations prepared by the client personnel. Management is responsible for the preparation of the financial statements based upon the accounting records of the entity. The auditor obtains some audit evidence by testing the accounting records, for example through analysis and review, reperforming the procedures followed in the financial reporting process, and reconciling related types and applications of the same information. Through the reperformance of such audit procedures, the auditor may determine that the accounting records are internally consistent and agree to the financial statements. However, because

accounting records alone do not provide sufficient audit evidence on which to base an audit opinion on the financial statement, the auditor obtains other audit evidence. Other corroborating information refers to documents and information supporting the entitys accounting records. This includes document such as invoices, bank statements, purchase orders, contracts, checks and other information obtained or developed by the auditor through inquiry, observation, and inspection. Attributes of Audit Evidence Reasonable assurance is attained when the auditor has obtained sufficient appropriate evidence to reduce audit risk to an acceptable level. Audit evidence is

typically obtained by performing risk assessment procedures, tests of control and substantive test. When performing risk assessment procedures and test of controls, audit evidence obtained enables the auditor to support the assessed level of inherent and control risk. In contrast, audit evidence obtained when performing

substantive test supports the desired level of detection risk. At the conclusion of the audit, the auditor should apply his judgment in determining whether the audit evidence obtained as a result of those procedures is sufficient and appropriate enough to support the auditors opinion. Set Desired Level of Audit Risk There are no specific guidelines for setting individual audit risk. The auditor uses his judgement in determining the risk 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 statements at a low level of audit risk. Assess the Level of Inherent Risk Every account or assertion has a built-in risk of being misstated. However, there are some accounts that, by nature, are more likely to be misstated compared to other accounts. These are the accounts that have high inherent risks. When assessing inherent risk for each account, the auditor must consider specific factors related to the client that may affect the risk of a material misstatement for a particular account. In making this assessment, the auditor will rely primarily on his knowledge of the clients business and industry, and the results of his preliminary analytical procedures. Assess the Level of Control Risk As stated earlier, control risk is the risk that the clients internal control may not detect or prevent a material misstatement. Assessment of control risk would involve studying and evaluating the effectiveness of the clients accounting and internal control systems.

Determine the Acceptable Level of Detection Risk Based on the desired audit risk level and the auditors assessment of inherent and control risks, the auditor determines the acceptable level of detection risk. By rearranging the audit risk model, Detection Risk = Audit Risk/Inherent Risk*Control Risk 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 misstatements in the financial statements are called risk assessment procedures. These include a. Inquiries of the management and others within the entity b. Analytical procedures and c. Observation and inspection Information obtained in performing these risk assessment procedures may be used by the auditor as evidence to support assessment of risk of material misstatement. In addition, in performing risk assessment procedures, the auditor may obtain audit evidence about the 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. Design Substantive Tests 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 risks 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 test. To obtain greater assurance, the auditor will have to modify the scope of his substantive tests such as: performing more effective substantive procedures (nature) performing year-end procedures (timing) using larger sample size (extent) On the other hand, if the acceptable level of detection risk is high, the assurance provided by substantive test will decrease. As a result, the auditor could reduce the scope of his substantive procedures like: performing less effective substantive procedures (nature) performing the tests at interim (timing) using smaller sample size (extent)

Overview of Sufficient Appropriate Audit Evidence The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. Sufficiency and appropriateness are interrelated and apply to audit evidence obtained from both tests of control and substantive procedures. Sufficiency is the measure of the quantity of audit evidence; appropriateness is the measure of the quality of audit evidence and its relevance to a particular assertion and its reliability. The auditors judgment as to what is sufficient appropriate audit evidence is influenced by such factors as the: Auditors assessment of the nature and level of inherent risk at both the financial statement level and the account balance or class of transactions level. Nature of accounting and internal control systems and the assessment of control risk. Materiality of the item being examined.

Experience gained during previous audits. Results of audit procedures, including fraud or error which may have been found. Source and reliability of information available When obtaining audit evidence from tests of control, the auditor should

consider the sufficiency and appropriateness of the audit evidence to support the assessed level of control risk. The aspects of the accounting and internal control systems about which the auditor would obtain audit evidence are: (a) design: the accounting and internal control systems are suitably designed to prevent and/or detect and correct material misstatements and (b) operation: the systems exist and have operated effectively throughout the relevant period. After assessing the inherent risk and control risk, the auditor performs substantive tests to reduce the level of detection risk to an acceptable level. Substantive tests are audit procedures designed to substantiate the account balances or designed to detect material misstatements in the financial statements. Sufficiency of Evidence Sufficiency refers to the amount of evidence that the auditor should accumulate. The concept of sufficiency recognizes that the accumulation of

evidence should be persuasive rather than conclusive. This concept is consistent with the idea that the auditor is not free to collect unlimited amounts of evidences since he must work within economic limits. Hence, because of the cost/befit

consideration the auditor does not examine all evidence available. Furthermore, the auditors are not expected to address all information that may exist. In forming the audit opinion the auditor does not examine all the information available because conclusions ordinarily can be reached by using sampling approaches and other means of selecting items for testing. Also, the auditor ordinarily finds it necessary to rely on audit evidence that is persuasive than conclusive.

Evidence obtained by the auditor does not consist of hard facts which prove or disprove the accuracy of the financial statements. Instead, it comprises pieces of information and impressions which are gradually accumulated during the course of an audit and which, when taken together, persuade the auditor about the fairness of the financial statements. Thus, audit evidence is generally persuasive rather than conclusive in nature. The following factors may be considered in evaluating the sufficiency of evidence: o The competence of evidence The amount of evidence that is sufficient in a given situation varies inversely with the competence of evidence. Thus, the more competent the evidence, the less amount of evidence is needed to support the auditors opinion. o The materiality of the item being examined The more material the financial statement amount being examined, the more evidence will be needed to support its validity. Conversely, if the account is not material to the financial statements, the auditor does not have to perform any procedure related to the account o The risk involved in a particular account As the risk of misstatement in a particular account increases, the more evidence will be needed. o Experience gained during previous audits It may indicate that the amount of evidence taken before and whether such evidence was enough. Accordingly sufficiency and appropriateness of audit evidence are

interrelated. However, merely obtaining more audit evidence may not compensate for its poor quality.

Appropriateness is the measure of the quality of audit evidences and its relevance to a particular assertion and its reliability. It refers to the trustworthiness or

believability. The factors that determine the competence of evidence are: 1. Relevance of the evidence to the particular assertion being tested Relevance relates the timeliness of evidence and its ability to satisfy the audit objective. Evidence must be relevant to the assertion being tested. For example, observing the taking of inventory, but it is not relevant to determining ownership. 2. Objectivity of the evidence Evidence can be objective or subjective. In general, the more objective the evidence, the more reliable and competent it is. Conversely, the more subjective evidence is, the less reliable it is. The greater the judgment required on the part of the provider of the information, the more subjective the information will be. An example of objective evidence is information obtained by physically counting cash or footing the accounts receivable subsidiary ledger. Examples of subjective evidence are an attorneys statement about a clients contingency and a credit managers statement about the collectability of an account. The more subjective the evidence, the more important the auditors experience in evaluating it. 3. Qualification of the provider of the evidence Reliability relates to the objectivity of evidence and is influenced by its source and by its nature. Generalizations about the reliability of various kinds of audit evidence can be made; however, such generalizations are subject to important exceptions. Even when audit evidence is obtained from sources external to the entity, circumstances may exist that could affect the reliability of the information obtained. For example, audit evidence obtained form an independent external

source may not be reliable if the source is not knowledgeable. While reliability of audit evidence is dependent on individual circumstance, the following generalizations could help the auditor in assessing the reliability of audit evidence recognizing that exceptions may exists:

Audit evidence obtained from independent outside sources (for example, confirmation received from a third party) is more reliable than that generated internally.

Audit evidence generated internally is more reliable when the related accounting and internal control systems are effective. Audit evidence obtained directly by the auditor is more reliable than that obtained from the entity. Audit evidence in the form of documents and written representations is more reliable than oral representations.

4. Timeliness of Evidence Timeliness particularly important with respect to accounts that change rapidly (either because the total balance changes or because the peso value of the transactions that flow into and out of the account is large). Evidence gathered about a year-end account balance provides more evidence about a year-end balance than does evidence gathered about the balance at another date. When in substantial doubt as to a material financial statement assertion, the auditor would attempt to obtain sufficient appropriate audit evidence. The auditor may have to express a qualified opinion or a disclaimer of opinion if he is unable to gather such evidence. Cost/benefit consideration when obtaining evidence An auditor works within economic limits. The auditors opinion to be

economically useful must be formed within a reasonable period of time and based on evidence obtained at a reasonable cost. As a guiding rule, there should be a rational relationship between the cost of obtaining evidence and the usefulness of the evidence obtained. The auditor uses his professional judgment in determining the appropriate type of evidence that should be obtained. However, the matter of difficulty and expense involved is not in itself a valid basis for omitting a necessary procedure.

Evaluation of Evidence The auditor ordinarily obtains more assurance from consistent audit evidence obtained from different sources or of different nature than from items of audit evidence considered individually. In addition, obtaining audit evidence from different sources or of a different nature may indicate that an individual item of audit evidence is not reliable. For example, corroborating information obtained from a source of independent of the entity may increase the assurance the auditor obtains from a management representation. Conversely, when audit evidence obtained from one source is inconsistent with that obtained from another, the auditor determines what additional audit procedures are necessary to resolve the inconsistency. As required by PSA 300, the auditor, based on the audit procedures performed and the audit evidence obtained, evaluates whether assessments of the risks of material misstatement at the assertion level remain appropriate. This evaluation is primarily a qualitative matter based on the auditors judgment. Such an evaluation may provide further insight about the risks of material misstatement due to fraud and whether there is and to perform additional or different audit procedures. As part of this evaluation, the auditor considers whether there has been appropriate communication with other engagement team members throughout the audit regarding the information or conditions indicative of risks of material misstatement due to fraud. The auditor should consider whether analytical procedures that are performed at or near the end of the audit when forming an overall conclusion as to whether the financial statement as a whole are consistent with the auditors knowledge of the business indicate a previously unrecognized risk of material misstatement due to fraud. Determining which particular trends and relationship may indicate a risk of material misstatement due to fraud requires professional judgment. Unusual

relationships involving year-end revenue and income are particularly relevant. These might include, for example uncharacteristically large amounts of income being reported in the last few weeks of the reporting period or unusual transactions; or income that is inconsistent with trends in cash flow from operations.

II. Audit Procedures Relationship among Assertions, Objectives and Procedures Financial Statements Assertions Assertions are representations made by the management explicit or otherwise embodied in the financial statement components. They may be implied or expressed. Assertions used by the auditor fall into the followingcategories: a. Assertions about classes of transactions and events for the period underaudit: i. Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity. ii. Completeness. All transactions and events that should have been recorded have been recorded. iii. Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately. iv. Cutoff. Transactions and events have been recorded in the correct accounting period. v. Classification. Transactions and events have been recorded in the proper accounts.

b. Assertions about account balances at the period end: i. Existence. Assets, liabilities, and equity interests exist. ii. Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. iii. Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded. iv. Valuation and allocation. Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

c. Assertions about presentation and disclosure: i. Occurrence and rights and obligations. Disclosed events and transactions have occurred and pertain to the entity. ii. Completeness. All disclosures that should have been included in the financial statements have been included. iii. Classification and understandability. Financial information is appropriately presented and described and disclosures are clearly expressed. iv. Accuracy and valuation. Financial and other information are disclosed fairly and at appropriate amounts.

Objectives Identify the standards for good evidence, the methods for obtaining and presenting the audit evidence. They are conception basis to determine the nature and extent of the auditing procedures necessary to satisfy audit standard;determine the validity of the assertions in specific account balances found in the financial statements( substantive audit objectives) and verify the degree of the entity's compliance with internally prescriber policies and internal control (compliance audit objectives)

Audit Procedures are acts or methods used to gather the validity of the assertions. Using Assertion to Determine the Audit Procedure to be performed The auditor should use assertions for classes of transactions, account balances and presentation and disclosures in sufficient detail to form a basis for the assessment of risks of material statement, identify first their audit objectives or goals for each financial statement assertions; andthen identify the audit procedures to fulfil that objective

Example of Assertions and Audit Objectives Table 1. Audit objectives for debtors and related transaction classes Assertion category Existence or occurrence Transaction objectives Recorded sales transactions Debtors represent amounts owed represent goods shipped by customers at the balance sheet class audit Account balance audit objectives

during the period. Recorded date. cash receipts transactions received

represent

cash

during the period. Completeness All sales and cash receipts Debtors transactions that include all claims on

occurred customers at the balance sheet

during the period have been date. recorded. Rights and obligations The entity has rights to the Debtors at the balance sheet date debtors and cash resulting represent legal claims of the entity from recorded sales and cash on customers for payment. receipts transactions. Valuation or measurement All sales and cash receipts Debtors transactions are represent claims on

correctly customers at the balance sheet

journalised, summarised and date and agree with the sum of the posted. sales subsidiary ledger. The

provision for bad debts represents a reasonable estimate of the

difference between gross debtors and their net realisable value.

Disclosure

The details of sales and cash Debtors are properly identified and receipts transactions support classified in the balance sheet. their presentation in the

financial statements including their classification and related disclosures.

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 in electronic form or only at certain points or periods in time. Timing refers to when audit procedures are performed or the period or date to which the audit evidence applies. ExtentIncludes the quantity of a specific audit procedure to be performed

Effect of E-commerce Audit evidence is increasingly in electronic form.Auditors must evaluate how electronic information affects their ability to gather evidence.Auditors use computers to read and examine evidence. Audit Procedures for Obtaining Audit Evidence

A. Audit Procedure According to Purpose The auditor should obtain audit evidence to draw reasonable conclusions on which to base the audit opinion by performing audit procedures to: a. Obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement at the financial statement and relevant assertion levels (risk assessment procedures);

b. When necessary, or when the auditor has determined to do so, test the operating effectiveness of controls in preventing or detecting material misstatements at the relevant assertion level (tests of controls) c. Detect material misstatements at the relevant assertion level (substantive procedures).

The auditor obtains sufficient understanding of the entity and its environment to understand the transaction and events affecting the financial statements and identify the potential problems. A preliminary assessment of risks and materiality is made develop an audit strategy.

The auditor must also consider the internal control of the entity because the condition of the entitys internal control affects the reliability of the financial statements. The stronger the internal control and more assurance it provides about reliability of the financial statements. The understanding of the internal control helps the auditor in assessing the level of control risk. The auditor should gather sufficient evidence to determine if the internal control is functioning effectively and can be relied upon. This evidence can be obtained by performing tests of controls.

The auditor should perform substantive procedure because Risk assessment procedures by themselves do not provide sufficient appropriate audit evidence on which to base the audit opinion and must be supplemented by further audit procedures in the form of tests of controls, when relevant or necessary and substantive procedures. And there are inherent limitations to internal control. Therefore substantive procedures about material transactions, account balances and disclosures are required to obtain sufficient appropriate evidence

Entity and Its Environment and Assessing the Risks of Material Misstatement provides guidance to the auditor to perform a combination of audit procedures when performing risk assessment procedures. In addition, a combination of two or more of these audit procedures may be necessary to obtain sufficient appropriate audit

evidence when performing tests of controls or substantive procedure at the relevant assertion level. In certain circumstances, audit evidence obtained from previous audits may provide audit evidence where the auditor should perform audit procedures to establish its continuing relevance.

B. Audit Procedure According to Nature Inspection of Records or Documents Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or physically examining an asset. Inspection of records and documents provides audit evidence of varying degrees of reliability, depending on their nature and source and, in the case of internal records and documents, on the effectiveness of the controls over their production. Types of Documents Internal Documents Prepared and used within client company. Does not go outside the client.

External Documents Document has been in hands of an outside party to the transaction. More reliable than internal documents.

Inspection of Tangible Assets Inspection of tangible assets consists of physical examination of the assets. Inspection of tangible assets may provide appropriate audit evidence with respect to their existence, but not necessarily about the entity's rights and obligations or the valuation of the assets. Inspection of individual inventory items ordinarily

accompanies the observation of inventory countingDifferent from examining documentation is that the asset has inherent value. Direction of the Test is important in establishing the assertion being tested by a certain procedure. Again, for existence or occurrence, the audit procedure is to work from the records to the asset and, if the procedure is to provide evidence as to completeness, from the asset to the records. Vouching Vouching is the examination of documents that support a recorded transaction or amount.The direction of testing must be from the recorded item to the supporting document. It tests existence or occurrence. (Recorded Item to Supporting Document) Tracing The primarytest for unrecorded items and therefore tests the completeness assertion. The direction of testing must be from the supporting document to the recorded item. (Supporting Document to Recorded Item) Observation Observation consists of looking at a process or procedure being performed by others. Observation provides audit evidence about the performance of a process or procedure but 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. Auditor witnesses the physical activities of the client. Differs from physical examination because physical examination counts assets, while observation focuses on client activities. Useful in obtaining evidence that controls which leave no documentary evidence of application or existence are in operation.

Inquiry Inquiry consists of seeking information from knowledgeable persons in financial or nonfinancial roles within the company or outside the company. Inquiry may be performed throughout the audit in addition to other audit procedures. Inquiries may range from formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an integral part of the inquiry process. Auditor obtains information from the client in response to questions. Responses to inquiries may provide the auditor with information not previously possessed or with corroborative audit evidence. Alternatively, responses might provide information that differs significantly from other information that the auditor has obtained, for example, information regarding the possibility of management override of controls. In some cases, responses to inquiries provide a basis for the auditor to modify or perform additional audit procedures. The auditor should resolve any significant inconsistencies in the information obtained. The auditor should perform audit procedures in addition to the use of inquiry to obtain sufficient appropriate audit evidence. Inquiry alone ordinarily does not provide sufficient appropriate audit evidence to detect a material misstatement at the relevant assertion level. Moreover, inquiry alone is not sufficient to test the operating effectiveness of controls.

Recalculation Recalculation consists of checking the mathematical accuracy of documents or records.

Reperformance Reperformance is the auditor's independent execution of procedures or controls that were originally performed as part of the entity's internal control, either manually or through the use of Computer Assisted Audit Technique

Analytical Procedures Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. Analytical procedures also encompass the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. Auditors study relationships among

data.Unusual fluctuations occur when significant difference are not expected but do exist or when significant differences are expected but do not exist. Analytical Procedures are required during the planning stage.

Confirmation Confirmation, which is a specific type of inquiry, is the process of obtaining a representation of information or of an existing condition directly from a third party.

Information Assets Cash in bank (example) Accounts receivable Notes receivable Owned inventory out on consignment Inventory held in public warehouses Cash surrender value of life insurance

Source

Bank Customer Maker Consignee Warehouse Insurance co.

Liabilities Accounts payable Notes payable Advances from customers Mortgages payable Bonds payable Creditor Lender Customer Mortgagor Bondholder

Owners Equity Shares outstanding Other Information Insurance coverage Contingent liabilities Insurance co. Bank, lender and clients legal counsel Bond indenture agreements Collateral held by creditors Bondholder Creditor Registrar andtransfer agent

External Confirmation External Confirmation 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.

Positive Confirmations The auditor asks for response even if balance is correct.

Positive Confirmations 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. It is- ordinarily expected to provide reliable audit evidence however there is a risk may reply to the request without verifying the information. These may result to lower response rates

Negative Confirmations The auditor asks for a response only if balance is incorrect. Respondents reply only in the event of disagreement with the information provided in the request Negative Confirmations ordinarily provides less reliable audit evidence

Sample of Positive Confirmation

Sample of Negative Confirmation Request- Receivables

Please examine this statement carefully If it does not agree with your records, report any difference in writing to our auditorsWho are auditing our financial statements. If no differences are reported to them, this statement will be considered correct. Payments should not be sent to Ireneo, Ireneo and James, CPAs, but should be made to us in the usual manner

Ireneo, Ireneo and James, CPAs Makaty City

Management Request Not to Confirm Information The auditor shouldconsider whether there are valid grounds for such request: andobtain audit evidence to support the validity of management requests If the auditor accepts the managements requests not to seek external confirmations the auditor should apply alternative audit procedures to obtain sufficient appropriate audit evidence. If the auditor does not accept the validity of managements request and is prevented from carrying out the confirmations. There is a limitation of scope and auditor should consider the possible effect on the auditors report.

Auditor Control The auditor should maintain controlon the process of selecting people to whom request will be sent, preparation and sending information requests, and responses to those requests

Substantive tests Substantive tests (also known as substantive procedures) are procedures designed to test for errors or irregularities directly affecting the correctness of financial statement balances. Auditors perform substantive tests in an audit to detect material misstatement at the assertion level. Substantive tests of transactions emphasize the verification of transactions recorded in the journals and then posted in the general ledger. Analytical procedures emphasize the overall reasonableness of transactions and the general ledger balances. Tests of details of balances consider the closing balances in the general ledger. Relationship between tests of controls and substantive tests In tests of controls, an exception is only an indication of the likelihood of errors or irregularities affecting the dollar value of the financial statements, whereas an exception in substantive tests is a financial statement misstatement. Exceptions in tests of controls are significant only if they occur with sufficient frequency to cause the auditors to believe that there may be material dollar misstatements in the financial statements. Auditors would then need to plan to perform substantive tests to determine whether dollar misstatements have actually occurred. Substantive test are designed to provide evidence about to fair presentation of management's assertions in the financial statements. Substantive test include: 1. Initial procedures that involve understanding the economic substance of the account balance or transaction being audited and agreeing on detailed information about an account to general ledger (such as comparing an accounts receivable subsdiary ledger to the general ledger)

2. Substantive analytical procedures are used to examine specific relationships

among accounts and operating data in order to provide indications of the accuracy of specific account balances. Often applied to accounts in the income statement, these procedures are particularly useful for testing estimates based on future events. These involve the use of comparisons to assess the fairness of an assertion. For example, the auditor might evaluate sales per square foot or retail space in testing the reasonableness of revenues.

3. Test of detail Test of details of transactions involves examining documentary support for transactions. This is performed to test whether individual transactions have been correctly recorded. For example, an auditor might inspect sales orders and a bill of landing behind a recorded sales invoice. Test of details of balance is performed to directly test whether a specific account is correctly stated in total. This also involved examining support for a general ledger balance. For example, the auditor might send confirmations to customers to obtain evidence that they owe receivables. Test of detail accounting estimates that involve obtaining evidence in support of the client's estimations process and ensuring that the estimation process is applied consistently from period to period. Test of details of disclosures that involve examining support for financial statement disclosures. For example, the auditor might read a loan contract to ascertain the maturity schedule and debt covenants for the loan

Substantive test provide the evidence that allows the auditor to achieve the desired detection risk and ensure that overall audit risk and ensure that overall audit risk is reduced to an appropriately low level. Recall the risk assessment, for example. For assertion 1, the existence of inventory, the nature of auditor's evidence would include significant test of controls (testing of effectiveness of the client's perpetual inventory system) as well as some limited substantive test (direct observation of inventory). For assertion 2, the valuation of inventory, auditor would perform few test of controls because controls are not

expected to be effective. However, the auditor would plan to obtain significant evidence by testing the pricing of inventory to underlying vendor's invoices (substantive test of balances). In addition, the auditor would obtain evidence about sales price after years-end to support a conclusion about the lower of cost of market objective (substantive test of an accounting estimate). Analytical procedures Bright readers may have noticed that analytical procedures serve as both audit tests and audit procedure. Lets study the roles of analytical procedures in an audit. Analytical procedures refers to the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts. Nature of analytical procedures These may be achieved through the consideration of comparisons of the entitys financial information with, for example: Comparable information for prior periods The entitys anticipated results Similar industry information. When performing analytical procedures, the auditors examine both financial data and nonfinancial data, such as the number of employees. Before starting their analytical procedures, auditors estimate the expected value (of the ratio/ trend/ account balance/ transaction, etc.) before calculating the actual value so as to avoid the actual value being biased for the auditors estimate of the expected value. The expected results are estimated based on preliminary discussions with the clients. After having performed their analytical procedures, the auditors then compare the actual results with those expected and look for reasons for any significant variations. Unexplained variations may indicate a misstatement in the figures in that area, which would lead the auditors to plan their audit work to devote more time and resources to

those areas. When the application of analytical procedures does not identify any unusual or unexpected differences, the results provide evidence in support of managements assertions. Timing and purpose of analytical procedures Analytical procedures may be performed at any of all three stages in the audit process: the planning phase, the testing phase and the completion phase. During the planning phase, analytical procedures can be used as risk assessment procedures. They help auditors identify significant matters requiring special consideration later in the audit engagement, such as to: understand the clients industry and business assess going concern indicate possible misstatements reduce detailed tests.

During the testing phase, analytical procedures can be used as substantive procedures in collecting appropriate audit evidence. They can be performed together with other substantive procedures (substantive tests of transactions and tests of details of balances) and they help to indicate possible misstatements and reduce detailed tests. During the completion phase, analytical procedures can be used as part of an overall review of the financial statements for the auditors to reach conclusions about the fair presentation of the financial statements. The analytical procedures help the auditors to take a final review of the audited financial statements objectively and help to assess going concern and indicate possible misstatements. Limitation of analytical procedures as substantive procedures Analytical procedures only provide conclusions on reasonableness of data rather than precision and cannot easily be linked to specific assertions (i.e. the nature or cause of a difference); therefore analytical procedures are less persuasive than tests

of details of balances. The substantive evidence gathered using analytical procedures is thus generally used to corroborate other substantive evidence gathered, rather than being used as a sole source of evidence. Cost-benefit of analytical procedures Analytical procedures cost the least because of the relative ease of making calculations and comparisons. It is quite often easier for auditors to obtain considerable information about potential misstatements by simply comparing two or three numbers. Tests of controls are low cost because auditors simply make inquiries and observations and examine the evidence of the performance of controls, such as initials on documents. These tests can be done on a large number of items within a short period of time. However, substantive tests of transactions are more expensive because they may include re-performance, which involves re-calculation and tracing. Tests of details of balances are often the most expensive because of the cost involved in sending confirmations and performing physical counts. Design of analytical procedures as substantive procedures The expected effectiveness and efficiency of an analytical procedure in identifying potential misstatements depends on: the nature of the assertion the plausibility and predictability of relationship the availability and reliability of the data used to develop the expectation the precision of the expectation.

Test of Details Tests of details of transactions primarily involve tracing and vouching to test for understatements and overstatements, respectively. Other procedures may also be used such as inquiring and reperforming calculations. b. Tests of details of transactions are typically more time consuming and thus more costly to perform than analytical procedures, but less costly than tests of details of

balances. Their cost-efficiency is enhanced when performed concurrent with tests of controls as dual-purpose tests. c. Tests of details may be applied directly to income statement accounts when evidence obtained from tests of related balance sheet accounts does not reduce detection risk to an acceptably low level. This may include situations in which: Inherent risk is high, such as when (1) nonroutine transactions or (2) managements judgments and estimates affect assertions. Control risk is high either because (1) related internal controls for nonroutine and routine transactions are ineffective, or (2) the auditor elects not to test the internal controls. Analytical procedures reveal unusual relationships and unexpected fluctuations. An account requires analysis because it (1) requires special disclosures in the income statement, (2) contains information needed in preparing tax returns or reports for regulatory agencies such as the SEC, or (3) has a general account title that suggests the likelihood of misclassifications and errors. a. Tests of details of balances focus on obtaining evidence directly about an account balance (e.g., accounts receivable) rather than the individual debits and credits comprising the balance. Testing the individual debits and credits is a test of transactions. b. Tests of details of balances often involve the use of external documentation and/or the direct personal knowledge of the auditor. Therefore, they can be very effective. They also tend to be the most costly to perform. a. Tests of accounting estimates involve understanding the entitys process of estimating future outcomes (e.g., the receivables that will not be collected in the future or the costs of providing warranty coverage in the future) of past transactions. This requires significant knowledge of the business, industry, and economy.

b. When evaluating the reasonableness of an accounting estimate the auditor should determine that All accounting estimates that could be material to the financial statements have been developed. The accounting estimates are reasonable in the circumstances. The accounting estimates are presented in conformity with applicable accounting principles and are properly disclosed. FRAUD AND ERROR Misstatements in the financial statements can arise from either fraud or error. The distinguishing factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is intentional or unintentional. The term error refers to unintentional misstatement in financial statements, including the omission of an amount or disclosure, such as: (1) Misstatement in gathering or processing data from which the financial statements are prepared; (2) Incorrect accounting estimate arising from oversight or misinterpretation of facts; (3) A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation, or disclosure. Fraud refers to intentional act by one or more individuals among management those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. It involves motivation to commit fraud Two types of intentional misstatements are relevant to the auditor misstatements resulting from fraudulent financial reporting or the management fraud fraud involving one or more members of management or those charged with governance and misstatementsresulting from misappropriation of assets or the employee fraud fraud involving only employees of entity. Fraud, whether fraudulent financial reporting or misappropriation of assets,involves incentive or pressure to commit fraud, a perceived opportunity to do soand some rationalization of the act.For example: (a) Incentive or pressure to

commit fraudulent financial reporting may exist whenmanagement is under pressure, from sources outside or inside the entity, toachieve an expected (and perhaps unrealistic) earnings target or financialoutcome. (b) A perceived opportunity to commit fraud may exist when an individualbelieves internal control can be overridden. (c) Individuals may be able to rationalize committing a fraudulent act. Someindividuals possess an attitude, character or set of ethical values that allowthem knowingly and intentionally to commit a dishonest act. However, evenotherwise honest individuals can commit fraud in an environment thatimposes sufficient pressure on them. Fraudulent financial reporting often involves management override of controlsthat otherwise may appear to be operating effectively. While, misappropriation of assets involves the theft of an entitys assets and is oftenperpetrated by employees in relatively small and immaterial amounts.

RESPONSIBILITIES Responsibility for the Prevention and Detection of Fraud The primary responsibility for the prevention and detection of fraud rests withboth those charged with governance of the entity and management. It is important that management, with the oversight of those charged with governance, place astrong emphasis on fraud prevention, which may reduce opportunities for fraudtotake place, and fraud deterrence, which could persuade individuals not to commitfraud because of the likelihood of detection and punishment. This involves acommitment to creating a culture of honesty and ethical behavior which can be reinforced by an active oversight by those charged with governance. Responsibilities of the Auditor An auditor conducting an audit in accordance with PSAs is responsible forobtaining reasonable assurance that the financial statements taken as a whole arefree from material misstatement, whether caused by fraud or error. As

describedin PSA 200, Objective and General Principles Governing an Audit of FinancialStatements, owing to the inherent limitations of an audit, there is an unavoidablerisk that some material misstatements of the financial statements will not bedetected, even though the audit is properly planned and performed in accordancewith the PSAs. The auditor is no and cannot be held responsible for prevention of fraud or error. INHERENT LIMITATIONS OF AUDIT The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. This is because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery,deliberate failure to record transactions, or intentional

misrepresentations being made to the auditor. Such attempts at concealment maybe even more difficult to detect when accompanied by collusion. Collusion maycause the auditor to believe that audit evidence is persuasive when it is, in fact,false.The auditors ability to detect a fraud depends on factors such as theskillfulness of the perpetrator, the frequency and extent of manipulation, thedegree of collusion involved, the relative size of individual amounts manipulated,and the seniority of those individuals involved. Furthermore, the risk of the auditor not detecting a material misstatement resulting from management is fraud is in greater a than to for employee or fraud,

becausemanagement

frequently

position

directly

indirectly

manipulateaccounting records, present fraudulent financial information or override controlprocedures designed to prevent similar frauds by other employees. The subsequent discovery of a material misstatement of financial statement of the financial statements resulting from fraud or error, does not, in and of itself, indicate: 1. A failure to obtain reasonable assurance 2. Inadequate planning, performance or judgment

3. The absence of professional competence and due care 4. A failure to comply with PSA PROFESSIONAL SKEPTICISM Professional skepticism is an attitude that includes a questioning mind and acritical assessment of audit evidence. Maintaining an attitude of

professionalcskepticism requires an ongoing questioning of whether the information and auditevidence obtained suggests that a material misstatement due to fraud may exist. Itincludes considering the reliability of the information to be used as audit evidenceand the controls over its preparation and maintenance where relevant. Due to thecharacteristics of fraud, the auditors attitude of professional skepticism is particularly important when considering the risks of material misstatement due tofraud. Professional skepticism is necessary for the auditor to identify and properly evaluate: (1) matters that increase the risk of material misstatement; (2)

circumstances that make the auditor suspect that financial statements are materially misstated; (3) evidence obtained (from current and previous audits) that brings into question the reliability of management representations. EFFECT ON RISK ASSESSMENT In considering risk resulting from fraud, the auditor should consider whether fraud risk factors are present because these factors could affect inherent risk and control risk. Fraud risk factors are considered using professional judgment. Fraud risk factors refer to events or conditions that provide an opportunity, a motive or a means to commit fraud, or indicate that the fraud may already have occurred. Risk Factors Relating to Misstatements Arising from Fraudulent FinancialReporting and Misappropriation of Assets Fraud risk factors cannot easily be ranked in order of importance. Thesignificance of fraud risk factors varies widely. Some of these factors will

bepresent in entities where the specific conditions do not present risks of materialmisstatement. Examples of fraud risk factors related to fraudulent financial reporting andmisappropriation of assets are: 1. Incentives/Pressures Financial stability or profitability is threatened by economic, industry, or entity operating conditions. Excessive pressure exists for management to meet the requirements or expectations of third parties. Information available indicates that the personal financial situation of management or those charged with governance is threatened by the entitys financial performance. 2. Opportunities A strong financial presence or ability to dominate a certain industry sector thatallows the entity to dictate terms or conditions to suppliers or customers that mayresult in inappropriate or non-arms-length transactions. Domination of management by a single person or small group (in a non owner managed business) without compensating controls. Difficulty in determining the organization or individuals that have

controllinginterest in the entity.

Attitudes/Rationalizations Communication, implementation, support, or enforcement of the entitys values orethical standards by management, or the communication of inappropriate values or ethical standards, that are not effective. Nonfinancial managements excessive participation in or preoccupation with theselection of accounting policies or the determination of significant estimates. Known history of violations of securities laws or other laws and regulations, or

claims against the entity, its senior management, or those charged withgovernance alleging fraud or violations of laws and regulations. The size, complexity, and ownership characteristics of the entity have asignificant influence on the consideration of relevant fraud risk factors. Fraud factors do not necessarily indicate the existence of fraud, however they often have present in circumstances where frauds have occurred. Examples of circumstances that indicative of fraud are the following: Discrepancies in the accounting records, including: Transactions that are not recorded in a complete or timely manner or areimproperly recorded as to amount, accounting period, classification, or entitypolicy. Unsupported or unauthorized balances or transactions. Last-minute adjustments that significantly affect financial results. Evidence of employees access to systems and records inconsistent with thatnecessary to perform their authorized duties. Tips or complaints to the auditor about alleged fraud.

Conflicting or missing evidence, including: Missing documents. Documents that appear to have been altered. Unavailability of other than photocopied or electronically transmitted documentswhen documents in original form are expected to exist. Significant unexplained items on reconciliations. Unusual balance sheet changes, or changes in trends or important financialstatement ratios or relationships for example receivables growing faster thanrevenues. Inconsistent, vague, or implausible responses from management or employeesarising from inquiries or analytical procedures.

Unusual discrepancies between the entity's records and confirmation replies.

Problematic or unusual relationships between the auditor and management, including: Denial of access to records, facilities, certain employees, customers, vendors, orothers from whom audit evidence might be sought. Undue time pressures imposed by management to resolve complex or contentiousissues. Complaints by management about the conduct of the audit or managementintimidation of engagement team members, particularly in connection with theauditors critical assessment of audit evidence or in the resolution of potentialdisagreements with management. Unusual delays by the entity in providing requested information. Unwillingness to facilitate auditor access to key electronic files for testingthrough the use of computer-assisted audit techniques. Unwillingness by management to permit the auditor to meet privately with thosecharged with governance. Accounting policies that appear to be at variance with industry norms. Frequent changes in accounting estimates that do not appear to result fromchanged circumstances. Tolerance of violations of the entitys Code of Conduct.

Actions to be taken related to Fraud and Error The auditors procedures related to fraud or error are summarized as follows: 1. Identify if there are circumstances that indicate a possible misstatement in the financial statements. 2. Determine whether statements are materially misstated.

3. If misstatements are identified, the auditor should consider whether such misstatement may be indicative of fraud. If indicative of fraud, the auditor should consider the implications on audit. 4. In evaluating and disposing of misstatements, consider materiality. The effect on the auditors report depends on the evaluation and disposition of these statements. 5. The auditor should document: (1) Fraud risk factors identified as being present during the risk assessment process and during the performance of audit; (2) the auditors responses to the fraud risk factors. COMMUNICATION Communication to Management When the auditor has obtained evidence that fraud exists or may exist, it isimportant that the matter be brought to the attention of the appropriate level ofmanagement as soon as practicable. This is so even if the matter might beconsidered inconsequential (for example, a minor defalcation by an employee at allows level in the entitys organization). Communication with Those Charged With Governance The auditors communication with those charged with governance may be madeorally or in writing. Due to the nature andsensitivity of fraud involving senior management, or fraud that results in amaterial misstatement in the financial statements, the auditor reports such matterson a timely basis and may consider it necessary to also report such matters inwriting. Communication of Misstatement resulting from error and fraud The auditor should communicate to management (and to those charge with governance, when necessary) any identified material misstatements resulting from error. In addition, the auditor should communicate also those uncorrected

misstatements aggregated by the auditor during audit were deemed by management as immaterial to financial statements. Whether misstatement due to fraud is material

or not, the auditors should report the same to the appropriate level of management and those charge with governance. The auditor should communicate the questions regarding management competence and integrity, misstatement that indicate material weaknesses in internal control and may cause future financial statements to be materially statements to be materially misstated. Communications to Regulatory and Enforcement Authorities The auditors professional duty to maintain the confidentiality of client information may preclude reporting fraud to a party outside the client entity. However, in certain circumstances, the duty of confidentiality may be overridden by regulatory requirements, statute, the law or courts of law. For example, under a BSP requirement, the auditor of a financial institution has a statutory duty to report the occurrence of fraud to the BSP. Also, under an SEC requirement, the auditor has a duty to report material audit findings, such as those involving fraud or error, in those cases where management and those charged with governance fail to report those findings to the SEC within the prescribed period. Auditor Unable to Continue the Engagement If, as a result of a misstatement resulting from fraud or suspected fraud, theauditor encounters exceptional circumstances that bring into question theauditors ability to continue performing the audit, the auditor shall: (a) Determine the professional and legal responsibilities applicable in thecircumstances, including whether there is a requirement for the auditor toreport to the person or persons who made the audit appointment or, in somecases, to regulatory authorities; (b) Consider whether it is appropriate to withdraw from the engagement, wherewithdrawal from the engagement is legally permitted; and (c) If the auditor withdraws:(i) Discuss with the appropriate level of management and those chargedwith governance the auditors withdrawal from the engagement and thereasons for the withdrawal; and(ii) Determine whether there is a

professional or legal requirement to report to the person or persons who made the audit appointment or, in somecases, to regulatory authorities, the auditors withdrawal from theengagement and the reasons for the withdrawal. AUDITING ACCOUNTING ESTIMATES Accounting estimates means an approximation of the monetary amount in the absence of a precise means of measurement. Accounting estimates are often made in conditions of uncertainty regarding the outcome of events are likely to occur and involved the use of judgment. Examples of situations where accounting estimates may be required include: Allowance for doubtful accounts Inventory obsolescence Warranty obligations Depreciation Impairment loss Fair value determination

Some accounting estimates involve relative low estimation of uncertainty and may give rise to lower of material misstatements. For some accounting estimates, however, there may be relatively high estimation of uncertainty, particularly when they are based on significant assumptions like accounting estimates relating to the outcome of litigation; or fair value estimates of financial instruments that are not publicly traded. The auditor must be specifically careful in considering accounts that are affected by accounting estimates because the risk of material misstatement is greater when accounting estimates are involved. The auditors responsibility is to obtain sufficient appropriate evidence as to whether accounting estimate is properly accounted for and disclosed and accounting estimate is reasonable in the circumstances. However, the responsible for making accounting estimates included in the financial statements is the management.

When assessing the risk of material misstatement relating to accounting estimates, the auditor should understand the degree of uncertainty involved the requirement of the standards and the procedures used by the client in making these estimates. When evaluating the reasonableness of accounting estimates, 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. In evaluating estimates, the auditor may use these approaches, first is the review and test the process used by management to develop the estimate which involved evaluating the data and management assumptions, testing of calculations, comparing prior period estimates with actual results and considering management approval procedures. Second is making independent estimate and lastly reviewing subsequent events which confirm estimate made. Some estimates, such as a potential loss from litigation, are very difficult estimate because there are no relevant historical data or transaction in subsequent period. In these cases, disclosure may be all that is required by generally accepted accounting principle. IV. Findings and Conclusions

Findings Audit Evidence refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Reasonable assurance is

attained when the auditor has obtained sufficient appropriate evidence to reduce audit risk to an acceptable level. Sufficiency refers to the amount of evidence that the auditor should accumulate. The concept of sufficiency recognizes that the

accumulation of evidence should be persuasive rather than conclusive. On the other hand, 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 circumstance, the following generalizations could help the auditor in assessing the reliability of audit evidence recognizing that exceptions may exists: Audit evidence obtained from independent outside sources (for example, confirmation received from

a third party) is more reliable than that generated internally.

Audit evidence

generated internally is more reliable when the related accounting and internal control systems are effective. Audit evidence obtained directly by the auditor is more

reliable than that obtained from the entity. Audit evidence in the form of documents and written representations is more reliable than oral representations. For the auditor to provide a reasonable assurance he must understand the relationship of the assertions, audit objectives and procedures the auditor should use assertions to form a basis for the assessment of risks of material statement. Then the auditor should identify their audit objectives or goals for each financial statement assertions and finally, identify the audit procedures to fulfil that objective. The different types of audit procedures are classified as according to nature and according to purpose. The procedures according to purpose are risk assessment procedure, test of controls and substantive procedures. In the risk assessment procedure the auditor obtains sufficient understanding of the entity and its environment to understand the transaction and events affecting the financial statements and identify the potential problems. Test of controls the auditor must also consider the internal control of the entity because the condition of the entitys internal control affects the reliability of the financial statements. The understanding of the internal control helps the auditor in assessing the level of control risk. The substantive procedures the auditor should perform substantive procedure because Risk assessment procedures by themselves do not provide sufficient appropriate audit evidence on which to base the audit opinion and must be supplemented by further audit procedures in the form of tests of controls, when relevant or necessary and substantive procedures. The different types according to nature are inspection of documents, inspection of tangible assets, observation, inquiry, recalculation, reperformance, analytical procedure and confirmations The two types of confirmation request are positive and negative confirmation request. The 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. While the negative confirmation request respondents reply only in the event of disagreement with the information provided in the request During the testing phase, analytical procedures can be used as substantive procedures in collecting appropriate audit evidence. They can be performed together with other substantive procedures and they help to indicate possible misstatements and reduce detailed tests. Substantive tests are procedures designed to test for errors or irregularities directly affecting the correctness of financial statement balances. Auditors perform substantive tests in an audit to detect material misstatement at the assertion level. Substantive Tests are primarily classified into two: Substantive Analytical Procedures and Test of Details. Substantive analytical procedures are used to examine specific relationships among accounts and operating data in order to provide indications of the accuracy of specific account balances. Often applied to accounts in the income statement, these procedures are particularly useful for testing estimates based on future events. These involve the use of comparisons to assess the fairness of an assertion. Test of details are further classified into the following: Test of details of transactions involves examining documentary support for transactions. This is performed to test whether individual transactions have been correctly recorded. Test of details of balance is performed to directly test whether a specific account is correctly stated in total. This also involved examining support for a general ledger balance. Test of detail accounting estimates that involve obtaining evidence in support of the client's estimations process and ensuring that the estimation process is applied consistently from period to period.

Test of details of disclosures that involve examining support for financial statement disclosures. The distinguishing factor between fraud and error is whether the underlying

action that results in the misstatement of the financial statements is intentional or unintentional. The term error refers to unintentional misstatement in financial

statements, including the omission of an amount or disclosure while fraud refers to intentional act by one or more individuals among management those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. When assessing the risk of material misstatement relating to accounting estimates, the auditor should understand the degree of uncertainty involved the requirement of the standards and the procedures used by the client in making these estimates. When evaluating the reasonableness of accounting estimates, 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. In evaluating estimates, the auditor may use these approaches, first is the review and test the process used by management to develop the estimate which involved evaluating the data and management assumptions, testing of calculations, comparing prior period estimates with actual results and considering management approval procedures. Second is making independent estimate and lastly reviewing subsequent events which confirm estimate made. Conclusions Entitys accounting records alone cannot be considered sufficient evidence to support an opinion on the financial statements. When auditing financial statements, the auditor should go beyond the accounting records. Auditor should obtain other corroborative information to support his opinion. The auditor must understand the relationship of assertions, audit objectives and audit procedures to obtain sufficient appropriate audit evidence to provide reasonable assurance. There are different audit procedures that the auditor can to

obtain appropriate audit evidence for certain assertions and objectives. The audit procedures are classified according to purpose and nature. The auditor uses his judgment on what procedures he should apply. Analytical procedures only provide conclusions on reasonableness of data rather than precision and cannot easily be linked to specific assertions; therefore analytical procedures are less persuasive than tests of details of balances. The substantive evidence gathered using analytical procedures is thus generally used to corroborate other substantive evidence gathered, rather than being used as a sole source of evidence. Although the nature of substantive tests is a matter of professional judgment, effective client internal control is a positive influence. For that reason, an auditor may decide to decrease the amount of substantive testing, omit certain procedures, and/or schedule interim testing. Weak internal control will, conversely, result in increased substantive testing, the need for additional audit procedures, and/or scheduling testing at or after year-end. Intention is the primary factor in distinguishing fraud and error. The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. Due to the characteristics of fraud, the auditors attitude of professional skepticism is particularly important when considering the risks of material misstatement due to fraud. The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. Furthermore, the risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud. When assessing the risk of material misstatement relating to accounting estimates, the auditor should understand the degree of uncertainty involved the requirement of the standards and the procedures used by the client in making these estimates.

Summary

Bibliography A. Books Ireneo, Jose M., et al., (2012) Auditing and Assurance Principles, FC Arellano Publishing, Cainta, Rizal, Philippines Salosagcol, Jekell G., et al., (2009) Auditing Theory, A Guide in understanding the AASC Pronouncements PSA, PSRE, PSAE & PSRS, GIC Enterprises & Co., Inc., Manila Philippines

B. Philippine Standards on Auditing PSA 240 (Redrafted), Application and Other Explanatory Materials A1, A2 and A5 C. Websites http://accounting-financial-tax.com/2012/08/audit-planning-how-auditors-constructsubstantive-tests-program/ http://www.swlearning.com/pdfs/chapter/0324117760_10.PDF http://www.extension.org/pages/30494/what-the-audit-should-include http://pcaobus.org/standards/auditing/pages/auditing_standard_15.aspx http://www2.accaglobal.com/archive/sa_oldarticles/49867 http://www.mccc.edu/~horowitk/documents/arens12e_07.pdf

PSA 500 (Redrafted) p.9 Assurance Principles, Professional Ethics and Good Governance, p. 613