SUBSTANTIVE PROCEDURES -

AUDIT EVIDENCE
 DEFINITION OF TERMS
• Audit evidence
• Information used by the auditor in arriving at the conclusions on which the auditor’s
opinion is based. Audit evidence includes both information contained in the accounting
records underlying the financial statements and other information.
• Management’s expert
• An individual or organization possessing expertise in a field other than accounting or
auditing, whose work in that field is used by the entity to assist the entity in preparing the
financial statements
• Accounting records
• The records of initial accounting entries and supporting records, such as checks and
records of electronic fund transfers; invoices; contracts; the general and subsidiary
ledgers, journal entries and other adjustments to the financial statements that are not
reflected in journal entries; and records such as work sheets and spreadsheets
supporting cost allocations, computations, reconciliations and disclosures
 DEFINITION OF TERMS
• Sufficiency (of audit evidence)
• The measure of the quantity of audit evidence. The quantity of the audit evidence
needed is affected by the auditor’s assessment of the risks of material misstatement and
also by the quality of such audit evidence.
• Appropriateness (of audit evidence)
• The measure of the quality of audit evidence; that is, its relevance and its reliability in
providing support for the conclusions on which the auditor’s opinion is based.
• PSA 500 – AUDIT EVIDENCE
ASSERTIONS ABOUT CLASSES OF TRANSACTIONS
• Occurrence
• Transactions and events that have been recorded have occurred and
pertain to the entity
• Completeness
• All transactions and events that should have been recorded have been
recorded
• Accuracy
• Amounts and other data relating to recorded transactions and events
have been recorded appropriately
• Cutoff
• Transactions and events have been recorded in the correct accounting
period.
• Classification
• Transactions and events have been recorded in the proper accounts
 ASSERTIONS ABOUT
ACCOUNT BALANCES AT PERIOD - END
• Existence
• Assets, liabilities, and equity interests exist
• Rights and Obligations
• The entity holds or controls the rights to assets, and liabilities are the
obligations of the entity.
• Completeness
• All assets, liabilities, and equity interests that should have been recorded
have been recorded.
• 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.
 ASSERTIONS ABOUT PRESENTATION AND DISCLOSURE
• Occurrence and rights and obligations
• Disclosed events, transactions, and other matters have occurred and
pertain to the entity
• Completeness
• All disclosures that should have been included in the financial statements
have been included.
• Classification and Understandability
• Financial information is appropriately presented and described, and
disclosures are clearly expressed
• Accuracy and Valuation
• Financial and other information are disclosed fairly and at appropriate
amounts.
 WHAT CONSTITUTES AUDIT EVIDENCE
• Accounting records are internally consistent and agree to the financial statements.
• Accounting records alone do not provide sufficient audit evidence on which to
base an audit opinion on the financial statements, the auditor obtains other
evidence.
• Minutes of meetings
• Confirmations from third parties
• Analyst’s reports
• Comparable data about competitors
• Controls manuals
• Information obtained from inquiry, observation and inspection
• Other information developed by, or available to, the auditor.
 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.
• The auditor’s judgment as to what is sufficient appropriate audit evidence is
influenced by such factors as the:
• Auditor’s 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 the 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.
 SUFFICIENT APPROPRIATE AUDIT EVIDENCE
• While the reliability of audit evidence is dependent on individual circumstance, the
following generalizations will help in assessing the reliability of audit evidence:
• Audit evidence is more reliable when it is obtained from independent sources outside
the entity
• Audit evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective
• Audit evidence obtained directly by the auditor (observation) is more reliable than audit
evidence obtained indirectly or by reference (inquiry)
• Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium.
• Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
• Audit evidence is more persuasive when items of evidence from different sources or
of a different name are consistent.
 COMPETENCE AND APPROPRIATENESS OF
AUDIT EVIDENCE
• Relevance of the evidence to the particular assertion being tested
• Objectivity of the evidence
• The more objective the evidence, the more reliable and competent it is
• The greater the judgment required on the part of the provider of the
information, the more subjective the information will be.
• Qualifications of the provider of the evidence
• Evidence obtained from independent external sources has greater
reliability than evidence obtained within the entity
• Timeliness of the evidence
• Important with respect to accounts that change rapidly.
 COMPETENCE AND APPROPRIATENESS OF
• Hierarchy of evidential matter:
AUDIT EVIDENCE
• An auditor’s direct, personal knowledge, obtained through physical
observation and his or her own mathematical computations, is generally
considered the most competent evidence
• Documentary evidence obtained directly from independent external
sources (external evidence) is considered competent
• Documentary evidence has originated outside the client’s data processing
system but which has been received and processed by the client is
generally considered competent. However, the circumstances of internal
control quality are important.
• Internal evidence consisting of documents that are produced, circulated,
and finally stored within the client’s information system is generally
considered low in competence.
• Verbal and written representations given by the client’s officers, directors,
owners, and employees are generally considered the least competent
evidence. Such representations should be corroborated with other types of
evidence.
PROCEDURES FOR OBTAINING AUDIT EVIDENCE
• Inspection
• Observation
• Inquiry and confirmation
• Recalculation
• Reperformance; and
• Analytical procedures
 INSPECTION
• 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.
• Some documents represent direct audit evidence of the existence of an asset.
Inspection of such documents may not necessarily provide audit evidence about
ownership or value.
• Internal and External documents
• Inspection of tangible assets
• may provide reliable 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 may accompany the observation of
inventory counting.
• Vouching (Documentation)
• Auditor’s examination of the client’s documents and records to substantiate the
information that is or should be included in the financial statement.
 OBSERVATION
• Observation
• Consists of looking at a process or procedure being performed by others,
for example, the auditor’s observation of inventory counting by the
entity’s personnel, or of the performance of control activities.
• 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.
 CONFIRMATION
• External confirmation
• Audit evidence obtained as a direct written response to the auditor from a third party
(the confirming party), in paper form, or by electronic or other medium.
• Positive confirmation request
• A request that the confirming party respond directly to the auditor indicating whether the
confirming party agrees or disagrees with the information in the request, or providing the
requested information.
• Negative confirmation request
• A request that the confirming party respond directly to the auditor only if the confirming
party disagrees with the information provided in the request.
• Non-response
• A failure of the confirming party to respond, or fully respond, to a positive confirmation
request, or a confirmation request returned undelivered.
• Exception
• A response that indicates a difference between information requested to be confirmed,
or contained in the entity’s records, and information provided by the confirming party.
 CONFIRMATION
• Examples of situations where external confirmations may be used include the
following:
• Bank balances and other information from bankers
• Accounts receivable balances
• Inventories held by third parties at bonded warehouses for processing or
on consignment
• Property title deeds held by lawyers or financiers for safe custody or as
security
• Investments purchased from stockholders but not delivered at the
statement of financial position date
• Loans from lenders
• Accounts payable balances
 CONFIRMATION
• Positive confirmation request
• A request that the confirming party respond directly to the auditor indicating whether the
confirming party agrees or disagrees with the information in the request, or providing the
requested information.
• There is a risk that a respondent may reply to the confirmation request without verifying
that the information is correct.
• The auditor may use positive confirmation requests that do not state the amount or other
information on the confirmation request, but ask the respondent to fill in the amount
• Negative confirmation request
• A request that the confirming party respond directly to the auditor only if the confirming
party disagrees with the information provided in the request.
• Provides less reliable evidence that positive confirmation.
• Negative confirmation may be used when:
• The assessed level of inherent and control risk is low
• A large number of small balances is involved
• A substantial number of errors is not expected; and
• The auditor has no reason to believe that respondents will disregard these requests
 INQUIRY
• Inquiry
• Consists of seeking information of knowledgeable persons, both financial
and nonfinancial, within the entity or outside the entity.
• is used extensively throughout the audit in addition to other audit
procedures.
• May range from formal written inquiries to informal oral inquiries.
• Evaluating responses to inquiries is an integral part of the inquiry process.
• Responses to inquiries may provide the auditor with information not
previously possessed or with corroborative audit evidence.
• Evidence obtained from the client through inquiry usually cannot be
considered conclusive because it is not from an independent source and
may be biased in the client’s favor.
 WRITTEN REPRESENTATIONS
• Written Representations
• Provides that audit evidence is all the information used by the auditor in
arriving at the conclusions on which the audit opinion is based.
• Do not provide sufficient appropriate evidence on their own about any of
the matters with which they deal.
• The auditor shall request written representations from management with
appropriate responsibilities for the financial statements and knowledge of
the matters concerned.
• written representations may be obtained for limited representations such as:
• Accounts receivable
• Inventories
• Liabilities
 RECALCULATION
• Recalculation
• consists of checking the mathematical accuracy of documents or
records.
• may be performed manually or electronically.
 REPERFORMANCE
• Reperformance
• involves the auditor’s independent execution of procedures or controls
that were originally performed as part of the entity’s internal control.
 ANALYTICAL PROCEDURES
• Analytical procedures
• consist of evaluations of financial information made by a study of
plausible relationships among both financial and non-financial data.
• also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant information or
deviate significantly from predicted amounts
 ACCOUNTING ESTIMATES
• “Accounting estimate” means an approximation of the amount of an item in the
absence of a precise means of measurement. Examples are:
• Allowances to reduce inventory and accounts receivable to their estimated realizable
value.
• Provisions to allocate the cost of fixed assets over their estimated useful lives.
• Accrued revenue.
• Deferred tax.
• Provision for a loss from a lawsuit.
• Losses on construction contracts in progress.
• Provision to meet warranty claims.
• Management is responsible for making accounting estimates included in financial
statements.
• The risk of material misstatement is greater when accounting estimates are involved.
 THE NATURE OF ACCOUNTING ESTIMATES
• The determination of an accounting estimate may be simple or complex depending
upon the nature of the item.
• In complex estimates, there may be a high degree of special knowledge and
judgment required.
• Accounting estimates may be determined as part of the routine accounting system
operating on a continuing basis or may be nonroutine, operating only at period end.
• In many cases, accounting estimates are made by using a formula based on
experience, such as the use of standard rates for depreciating each category of
fixed assets or a standard percentage of sales revenue for computing a warranty
provision.
• The formula needs to be reviewed regularly by management, for example, by
reassessing the remaining useful lives of assets or by comparing actual results with
the estimate and adjusting the formula when necessary.
• The uncertainty associated with an item, or the lack of objective data may make it
incapable of reasonable estimation, in which case, the auditor needs to consider
whether the auditor’s report needs modification
 AUDIT PROCEDURES - ACCOUNTING ESTIMATES
• The auditor should obtain sufficient appropriate audit evidence as to whether
an accounting estimate is reasonable in the circumstances and, when
required, is appropriately disclosed.
• The auditor should adopt one or a combination of the following approaches in
the audit of an accounting estimate:
• (a) review and test the process used by management to develop the
estimate;
• (b) use an independent estimate for comparison with that prepared by
management; or
• (c) review subsequent events which confirm the estimate made.
 REVIEWING AND TESTING
THE PROCESS USED BY MANAGEMENT
• The steps ordinarily involved in reviewing and testing of the process used by
management are:
• (a) evaluation of the data and consideration of assumptions on which the
estimate is based;
• (b) testing of the calculations involved in the estimate;
• (c) comparison, when possible, of estimates made for prior periods with
actual results of those periods; and
• (d) consideration of management’s approval procedures.
• The auditor would evaluate whether the data on which the estimate is based
is accurate, complete and relevant.
• The auditor may also seek evidence from sources outside the entity.
• The auditor would evaluate whether the data collected is appropriately
analyzed and projected to form a reasonable basis for determining the
accounting estimate.
 EVIDENCE FOR RELATED PARTY TRANSACTION
• Related Parties
• Client entity and any other party with which the client may deal where one
party has the ability to influence the other to the extent that one party to
the transaction may not pursue its own separate interests
• Since transactions with related parties are not conducted at arm’s length, the
auditors should be aware that the economic substance of these transactions
may differ from their form.
• The primary concern of the auditors is that material related party transactions
are adequately disclosed in the client’s financial statements or the related
notes.