Auditing

-"An audit is a systematic process of objectively obtaining and evaluating

evidence regarding assertions about economic actions and events to ascertain the
degree of correspondence between these assertions and established criteria and
communicating the results to internal users".(AAA)

-Primary function of an independent audit is to lend credibility to the financial

statements prepared by the entity.

Types of Audit
Financial statement audit
-Audit conducted to determine whether the financial statements of an
entity are fairly presented in accordance with an identified financial
reporting framework.
Compliance Audit
-review of an organization's procedure to determine whether the
organization has adhered to specific procedures, rules and regulations.
Operational audit (Performance/Management audit)
-study of a specific unit of an organization for the purpose of measuring
its performance.
Types of Auditors
External Auditors
-independent CPAs who offer their professional service to different
client. (FS audit)
Internal Auditors (Operational Audit)
-entity's own employees who investigate and appraise the
effectiveness and efficiency of operations and internal control.
Government Auditors (Compliance Audit)
-government employees whose main concern is to determine whether
persons or entities comply with government laws and regulations.

Independent FS Audit
-enable the auditor to express an opinion whether the financial statements are
prepared, in all material respects. In accordance with an identified financial reporting
framework.
-management is responsible for preparing and presenting the FS in
accordance with the framework.
-provide only reasonable assurance.
Limitations
1. The use of testing/Sampling Risk
-auditors do not examine all evidence available.
2. Error in application of judgment/Non-sampling Risk
-human weakness can cause auditors to commit mistakes in the
application of audit procedures and evaluation of evidence.
3. Reliance on Management's representation
-if management lacks integrity, management may provide the auditor
with false representations causing the auditor to rely on unreliable
evidence.
4. Inherent limitations of the client's accounting and internal control system
-cannot detect all fraud like collusion between employees
5. Nature of evidence
-evidence does not contain "hard facts" and generally persuasive
rather than conclusive in nature.

Reasons for an independent financial statement audit

1. Conflict of interest between management and users of financial statement.
2. Expertise
3. Remoteness
4. Financial consequences
Theoretical framework of auditing
1. Audit function operates on the assumption that all financial data are verifiable.
2. The auditor should always maintain independence with respect to the financial
statement under audit
3. There should be no long-term conflict between the auditor and the client
management.
4. Effective internal control system reduces the possibility of errors and fraud
affecting the financial statement.
5. Consistent application of GAAP and PFRS results in fair presentation of
financial statements.
6. What was held true in the past will continue to hold true in the future in the
absence of known condition to the contrary.
7. An audit benefits the public.

*Standards –are established to measure the quality of performance of individuals

and organizations.
Generally Accepted Auditing Standard (GAAS)
-represents measures of the quality of the auditor's performance.
General Standards
o Technical training and proficiency.
o Independence
o Professional care
Standards of Fieldwork
o Planning
o Internal control consideration
o Evidential matter
 Standards of Reporting
o GAAP
o Inconsistency
o Disclosure
o Opinion
*The Auditing and Assurance Standard Council has been given the task to
promulgate auditing standards, practices and procedures which shall be generally
accepted by the accounting profession in the Philippines.

*Quality Control –are policies and procedures adopted by CPAs to provide

reasonable assurance of conforming with professional standards in performing audit
and related services.

Ethical Requirements
 Integrity
 Objectivity
 Professional competence and due care
 Confidentiality
 Professional behavior

Acceptance and Continuance of Client Relationships (Engagement Partner)

 Has considered the integrity of the client.
 Is competent to perform the engagement and has the capabilities, time and
resources to do so.
 Can comply with ethical requirements.
*The firm should establish policies and procedures designed to provide it with
reasonable assurance
 That engagements are performed in accordance with professional standards
and other regulatory and legal requirements.
 That the audit report issued is appropriate in the circumstances.
*The Engagement Partner should take responsibility for the direction, supervision,
review and overall performance of the audit engagement.

Engagement Quality Control Review

This requires the engagement partner:
a) To determine that an engagement quality control reviewer has been
appointed.
b) To discuss significant matters arising during the audit engagement, including
those identified during the quality control review, with the engagement quality
control reviewer.
c) Not to issue the auditor's report until the completion of the engagement
quality control review.
*Monitoring –the continued adequacy and operational effectiveness of quality
control policies and procedures is to be monitored.

Misstatements may emanate from:

1. Error
-refers to unintentional misstatement in the financial statement,
including the omission of an amount or a disclosure, such as
 Mathematical or clerical mistakes in the underlying records and
accounting data.
 An incorrect accounting estimates arising from oversight or
misinterpretation of facts.
 Mistake in the application of accounting policies.
2. 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. Types of fraud are:
 Fraudulent financial reporting –involves intentional
misstatement or omission of amounts or disclosure in the fs to
deceive fs user. Also known as management fraud.
 Misappropriation of assets or employee fraud –involves theft
of an entity's asset committed by the entity's employees
 3. Non-compliance with Laws and Regulations
-acts of omission or commission by the entity being audited, either
intentional or unintentional which are contrary to the prevailing laws
and regulations.
 Tax evasion
 Violation of environmental protection laws
 Inside trading of securities

*Fraud risk factors relating to Misstatements resulting from Fraudulent

Financial Reporting
 Management's Characteristics and Influence over the Control Environment.
 Industry Conditions.
 Operating Characteristics and Financial Stability.
*Fraud risk factor relating to Misstatement resulting from Misappropriation of
Assets
 Susceptibility of Assets to Misappropriation
 Controls
Assertions
 Assertions about classes of transactions and events for the period
under audit.
o Occurrence –transactions and events that have been recorded have
occurred and pertain to the entity.
o Completeness –all transactions and events that should have been
recorded have been recorded.
o Accuracy –amounts and other data relating to recorded transactions
and events have been recorded appropriately.
o Cut-off –transactions and events have been recorded in the correct
accounting period.
o Classification –transactions and events have been recorded in the
proper accounts.
 Assertions about account balance at the period end:
o Existence –assets, liabilities, and equity interest exist.
o Rights and obligations –the entity holds or controls the right to assets
and liabilities are the obligation of the entity.
o Completeness –all assets, liabilities and equity interest that should
have been recorded have been recorded.
o Valuation and Allocation –assets, liabilities and equity interest are
included in the financial statements at appropriate amounts and any
resulting valuation or allocation adjustment are appropriately recorded.
  Assertions about presentation and disclosure:
o Occurrence and rights and obligations –disclosed events,
transactions, and other matter have occurred and pertain to the entity.
o Completeness –all disclosure that should have been included in the
financial statement have been included.
o Classification and understandability –financial information is
appropriately presented and described, and disclosures are clearly
expressed.
o Accuracy and Valuation –financial and other information are
disclosed fairly and at appropriate amounts.

Audit Procedures –means used to by the auditor to obtain sufficient appropriate

evidence.
 Inspection –involves examining of records, documents or tangible assets.
 Observation –consists of looking at a process or procedure being performed
by others.
 Inquiry –consists of seeking information from knowledgeable persons inside
or outside the entity.
 Confirmation –consists of response to an inquiry to corroborate information
contained in the accounting records.
 Computation –consists of checking the arithmetical accuracy of source
documents and accounting records or performing independent calculation.
 Analytical Procedures –consist of the analysis of significant ratios and
trends including the resulting investigation of fluctuations and relationships
that are inconsistent with other relevant information or deviate from predicted
amounts.
The Audit Process
• Accepting an Engagement
1
• Audit Planning
2
• Considering Internal Control
3
• Performing Substantive Tests
4
• Completing the Audit
5
• Issuing a Report
6
*Accepting the Engagement
-procedures performed at this stage of the audit are referred to in PSA 300 as
"preliminary planning activities". This involves:
 Performing procedures regarding the continuance of the client relationship
and the specific audit engagement.
 Evaluating compliance with ethical requirements, including independence.
 Establishing an understanding of the terms of the engagement.
-in making the decision to accept the engagement, the firm should consider:
 Its competence
 Its independence
 Its ability to serve the client properly
 The integrity of the prospective client's management.
o Making inquiries of appropriate parties in the business community
o Communicating with the predecessor auditor
 Must be allowed by the client first.

Engagement Letter –this serves as the written contract between the auditor and the
client.
 The objective of the audit of financial statements which is to express an
opinion on the financial statements.
 The management's responsibility for the fair presentation of the financial
statement.
 The scope of the audit.
 The forms or any reports or other communication that the auditor expects to
issue.
 The facts that because of the limitations of the audit, there is an unavoidable
risk that material misstatements may remain undiscovered.
 The responsibility of the client to allow the auditor to have unrestricted access
to whatever records, documentation and other information requested in
connection with the audit.
Importance of the engagement letter
 Avoid misunderstandings with respects to the engagement.
 Document and confirm the auditor's acceptance of the appointment.
*does not need to send another engagement letter for a recurring audits to the same
client unless needed.
Audit Planning
-involves developing a general audit strategy and a detailed approach
for the expected conduct of the audit.

Sources of information about the entity

a. Review of prior years' working paper
b. Tour of client's facilities
c. Discussion with people within and outside the entity.
d. Reading books, periodicals, and other publications related to the client's
industry.
e. Reading corporate documents and financial reports.
*An audit plans should be made regarding:
 How much evidence to accumulate
 How and when this should be done
*When developing an audit strategy, the auditor must consider carefully the
appropriate levels of materiality and audit risk.

Materiality
-information is material if its omission or misstatement could influence
the economic decision of the users taken on the basis of the financial statements.
Materiality may be viewed as:
 The largest amount of misstatement that the auditor could tolerate in the
financial statement.
 The smallest aggregate amount that could misstate the financial statement.
-have inversed relationship with evidence.
Uses of Materiality
 In the planning stage, to determine the scope of audit procedure.
 In the completion phase, to evaluate the effect of misstatement on the
financial statement.

Using Materiality Levels

1. Step 1 Determine the Overall Materiality / Financial Statement Level
-smallest aggregate amount that the financial could misstate
2. Step 2 Determine the Tolerable Misstatement / Account Balance Level
-determine the audit procedure that will be applied to specific accounts
-also known as "performance materiality"
3. Step 3 Compare the aggregate amount of uncorrected misstatement with the
overall materiality
 Determine the Overall Materiality
Planning Stage
Determine the tolerable misstatement
Perform audit procedures
Compare the aggregate amount of
Completion Stage
misstatements with the overall materiality

Audit Risk Model

Audit Risk = Inherent Risk * Control Risk * Detection Risk

Audit Risk -refers to the risk that the auditor gives an inappropriate audit opinion on
the financial statements.
Inherent Risk –is the susceptibility of an account balance or class of transactions to
a material misstatement assuming there were no related internal controls.
Control Risk –is the risk that a material misstatement that could occur in an account
balance or class of transactions will not be prevented or detected and corrected on a
timely basis by accounting and internal control system.
Detection Risk –is the risk that an auditors' substantive procedure will not detect a
material misstatement. The only risk that can be control by the auditor by performing
more effective substantive test.

Steps in Using the Audit Risk Model

1. Set the desired level of Audit Risk
2. Assess the level of the Inherent Risk
3. Assess the level of Control Risk
4. Determine the Acceptable level of Detection Risk
-detection risk = Audit Risk / (Inherent Risk * Control Risk)
5. Design Substantive Test –based on the acceptable detection risk.
-ex. A 10% acceptable detection risk means that the substantive test
must be designed to provide a 90% assurance of detecting material
misstatements.
Modifying the scope of substantive test maybe done through:
 Performing more or less effective substantive procedure.
 Performing year-end or interim procedures.
 Using a larger or smaller size.
Factor that affect the risk(inherent) of misstatement at the financial statement
level:
a) The management integrity
b) Management Characteristics
c) Operating Characteristics
d) Industry Characteristics
Factors affecting inherent risk at the account balance level:
a) Susceptibility of the account to theft
b) Complexity of calculations related to account
c) The complexity underlying transactions and other events.
d) The degree of judgment involved in determining account balances.

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 FS.
 Inquiries of management and others within the entity
 Analytical Procedures –involves analysis of significant ratios and trends,
including the resulting investigation of fluctuations and relationships that are
inconsistent with other relevant information or deviate from predicted
amounts.
 Observation and Inspection
Steps in Applying Analytical Procedures
1. Develop expectations regarding financial statement using:
a. Prior years' financial statement
b. Anticipated results such as budgets and forecasts
c. Industry averages
d. Non-financial information
e. Typical relationships among financial statement account balances
2. Compare the expectations with the financial statements under audit.
3. Investigate significant unexpected differences to determine whether
financial statements contain material misstatement

Uses of Analytical Procedures

 As a planning tool, to determine the nature, timing, and extent of other
auditing procedures.
 As a substantive test to obtain corroborative evidence about particular
assertions related to the account balance or transactions class.
 As an overall review of the financial statements in the completion phase of
the audit.
Documenting the Audit Plan
 Overall audit plan –is an overview of the expected scope and conduct of the
audit.
 Audit Program –setting out the nature, timing and extent of planned audit
procedures required to implement the overall audit plan.
 Time Budget –an estimates of the time that will be spent in executing the
audit procedures listed in the audit program.

Internal Control –is the process designed and effected by those charged with
governance, management, and other personnel to provide reasonable assurance
about the achievement of the entity's objectives with regard to reliability of financial
reporting, effectiveness and efficiency of operations and compliance with applicable
laws and regulations.
Types of Objectives
 Effectiveness and efficiency of operations
 Compliance with laws and regulations
 Reliability of financial reporting –most relevant to the audit

Components of Internal Control

 Control Environment –includes the attitudes, awareness, and actions of
management and those charged with governance concerning the entity's
internal control and its importance to the entity. Factors reflected in the control
environment include:
o Integrity and ethical values
o Management philosophy and opening style
o Active participation of those charged with governance
o Commitment to competence
o Personnel policies and procedures
o Assignment of responsibility and authority/ Organizational
structure
 Risk Assessment –business objectives cannot be achieved without some
risks. Business risk is the risk that the entity's business objectives will not be
attained as a result of internal and external factors such as technological
developments, changes in customers demand and other economic changes.
 Information and Communications Systems –effective internal control must
provide timely information and communication.
 Control Activities –are the policies and procedures that help ensure that
management directives are carried out. Specific control procedures that are
relevant to financial statement audit would include:
 o Performance Reviews –includes reviews and analyses of actual
performance versus budgets, forecast, and prior period performance;
relating different sets of data to one another. Together with analyses of
the relationships and investigate and corrective actions.
o Information Processing –a variety of controls are performed to check
accuracy, completeness, and authorization of transactions.
o Physical Controls –encompass the physical security of assets,
including adequate safeguards such as secured facilities over access
to assets and records; authorization for access to computer programs
and data files; and periodic counting and comparison with amounts
shown on control records.
o Segregation of Duties –assigning different people the responsibilities of
authorizing transactions, recording transactions, and maintaining
custody of asset is intended to reduce the opportunities to allow any
person to be in a position to both perpetrate and conceal errors and
fraud in the normal course of person's duties.
 Monitoring –is the process of assessing the quality of internal control
performance over time.
o Ongoing Monitoring –activities built into the normal recurring activities
of an entity and include regular management and supervisory activities
such as preparation of monthly bank reconciliation.
o Separate Evaluation –are monitoring activities that are performed on a
non-routine basis, such as functions performed by internal auditors.
o Combination of two

*Consideration of the entity's internal control systems involves the following steps:
1. Obtain Understanding of the Internal Control –Obtaining an understanding
of internal controls involves:
a. Evaluating the design of a control –involves considering whether the
control, individually or in combination with other controls, is capable of
effectively preventing, or detecting and correcting, material
misstatement. Obtained by:
i. Making inquiries of appropriate individuals
ii. Inspecting documents and records
iii. Observing of entity's activities and operations
b. Determining whether it has been implemented –means that the
control have been placed in operation. Accomplished by:
i. "Walk-through" test –involves tracing one or two transactions
through the entire accounting systems, from their initial
 recording at source to their final destination. ("cradle to grave" /
sample of one test)

*The auditor is not required to obtain knowledge about the operating

effectiveness of the internal control when obtaining an understanding of the entity's
internal control system.

Uses of understanding the internal control:

 Identify types of potential misstatements that can occur
 Consider factors that affect the risk of material misstatements
 Design the nature, timing, and extent audit procedures to be performed.

2. Documenting the auditor's understanding of internal control –need not

be in any particular form. Examples are:
a. Narrative description of the entity's internal control
b. Flowchart that diagrams the flow of transactions and documents.
c. Internal control questionnaire providing management's responses to
questions about internal control.
3. Assessment of Control Risk –the auditor should make a preliminary
assessment of control risk, at the assertion level, for each material account
balance or class transactions. The auditor's preliminary assessment may be
high level (100%) then no test of controls need to be performed and the
auditor will rely primarily on substantive test , or less than high level then the
auditor should determine whether it is efficient to obtain the evidence to justify
an assessment of control risk at lower level. For this purpose the auditor
should:
a. Identify specific internal control policies or procedures that are likely to
prevent or detect and correct material misstatement relevant to
financial statement assertion
b. Perform tests of control to determine the effectiveness of such policies
or procedures.
4. Performing tests of controls –are performed to obtain evidence about the
effectiveness of the:
a. Design of the accounting and internal control systems
b. Operation of the internal controls throughout the period
*the auditor will only test those controls he plans to rely on.
*the lower the assessment of control risk, the more support the auditor should obtain
Nature of Test of Controls
 Inquiry –consist of searching for the appropriate information about the
effectiveness of internal control from knowledgeable person inside or outside
the entity.
 Observation –refers to looking at the process being performed by others.
 Inspection –involves the examination of documents and records to provide
evidence of reliability depending on their nature and source and the
effectiveness of internal control over their processing.
 Reperformance –involves repeating the activity performed by the client to
determine whether proper results were obtained.
*Auditor usually perform tests of controls during an interim visits in advance of period
end.
*In determining whether or not to test the remaining period, the following factors
must be considered:
 The results of the interim tests
 The length of the remaining period
 Whether changes have occurred have occurred in the accounting and internal
control systems during the remaining period.

5. Documenting the Assessed level of Control Risk

a. If the control risk is assessed at a high level the auditor should
document his conclusion that control risk is at high level.
b. If control risk is assessed at less than high level, the auditor should
document his conclusion that control risk is less than high and the
basis for that assessment.
*The auditors are not required to search for and/or identify internal control weakness.
The auditor must, however, communicate internal control weaknesses to the client
when they come to their attention during the course of the audit. These internal
control weaknesses together with other matters of concern are documented ina
formal management letter.

Characteristics of Computer Information System (CIS)

 Lack of visible transaction trails –data can be entered directly into the
computer system without supporting documents.
 Consistency of performance –if the computer is programmed to perform a
specific data processing task, it will never get tired of performing the assigned
task in the same manner.
  Ease of access to data and computer programs –data and computer
programs may be accessed and altered by unauthorized persons leaving no
visible evidence.
 Concentration of duties –there are functions that are normally segregated in
manual processing that are combined in a CIS environment.
 System generated transactions –certain transactions may be initiated by
the CIS itself without the need for an input document.
 Vulnerability of data and program storage media –information on the
computer can be easily changed, leaving no trace of the original content.

Internal Control Procedures

 General Controls –those control policies and procedures that relate to the
overall computer information system. This includes:
o Organizational Controls –just as in a manual system, there should be a
written plan of the organization, with clear assignment of authority and
responsibility.
 Segregation between the CIS department and user
department –CIS department must be independent of all
departments within the entity that provide input data or that use
output generated by the CIS.
 Segregation of duties within the CIS department –functions
within the CIS department should be properly segregated for
good organizational control.
CIS Director –Exercise control over the CIS operation
System Development Operations Other Functions
Systems Analyst –design Computer Operator –using Librarian –maintains
new system, evaluates and the program and detailed custody of systems
improves existing systems, and operating instructions prepared documentation, programs
prepares specifications for by the programmer, computer and files
programmers. operator operates the computer
to process transactions
Programmers –Guided by Data Entry –prepares and Control Group –
the specifications of the system verifies input data for processing Reviews all input
analyst, the programmers writes procedures, monitors
a program. Test and debug such computer processing,
programs, and prepares the follow-up data processing
computer operating instructions errors, reviews the
reasonableness of output
and distributes output to
authorized personnel
 o Systems Development and Documentation Controls –software
development as well as changes thereof must be approved by the
appropriate level of management and the user department.
o Access Control –every computer system should have adequate security
controls to protect equipment, files and programs. (password)
o Data Recovery Controls –because of the vulnerability of the data in the
computer, the survival of an entity affected by such disaster depends
on its ability to recover the files on a timely basis. (Grand-father, father,
son in using magnetic tape)
o Monitoring Controls –are designed to ensure that CIS controls are
working effectively as planned.
 Application Controls –those policies and procedures that relate to specific
use of the system. These includes:
o Controls over input –are designed to provide reasonable assurance
that data submitted for processing are complete, properly authorized
and accurately translated into machine readable form. Example of input
controls:
 Key verification –this requires data to be entered twice to
provide assurance that there are no key entry errors committed.
 Field Check –this ensures that the input data agree with the
required field format.
 Validity Check –information entered are compared with valid
information in the master file to determine the authenticity of the
input.
 Self-checking Digit –this is a mathematically calculated digit
which is usually added to a document number to detect common
transposition errors in data submitted.
 Limit Check –is designed to ensure that data submitted for
processing do not exceed a pre-determined limit or reasonable
amount. (reasonable check)
 Control Totals –these are computed based on the data
submitted for processing. Includes:
 Financial Total –sum of amount
 Hash Total –sum of voucher numbers
 Record Counts –sum of total vouchers
o Controls over Processing –provide reasonable assurance that input
data are processed accurately, and that data are not lost, added,
excluded, duplicated or improperly changed.
 o Controls over Output –are designed to provide reasonable assurance
that the results of processing are complete, accurate, and that these
outputs are distributed only to authorized personnel.

Testing of Controls in CIS environment

General Controls
o Observing client's personnel in performing their duties
o Inspecting program documentation
o Observing the security measures in force.
Application Controls
o Audit around the computer –the auditor ignores the client's data
processing procedures, focusing solely on the input documents and the
CIS output. It can only be used if there are visible input documents
and detailed output that will enable the auditor to trace individual
transaction back and forth. (black box approach)
o Computer Assisted Audit Techniques (CAATs) –computer programs
and data which the auditor uses as part of the audit significance
contained in an entity's information system. (white box
approach)Example are:
 Test Data –primarily designed to test the effectiveness of the
internal control procedures which are incorporated in the client's
computer program. The auditor prepares test data that consist of
valid and invalid conditions. The auditor enters the data and
compares the result with his expected output.

Auditor's Test
Data

Processed using
clients program

Output Compare Auditor's

Manually Expected Output
  Integrated Test Facility (ITF) –the auditor creates dummy or
fictitious employee or other appropriate unit for testing within the
entity's computer system. The resultant output, relating to the
dummy unit, is then compared with the predetermined results to
evaluate the reliability of the client's program.

Auditor's Test Client's Data

Data

Processed
using client's
program

Compare Auditor's Expected

Output
Manually Output

 Parallel Simulation –requires the auditor to write a program

that simulates key features or processes of the program under
review. The simulated program is then used to reprocess
transactions that were previously processed by the client's
program. The auditor compares the results obtained from the
simulation with the client's output to be able to draw conclusion
about the reliability of the client's program. May used
Generalized audit software which consist of generally
available computer packages which have been designed to
perform common audit task or Purpose-written programs
which are design to perform audit task in specific circumstances.
 Client's Data Client's Data

Processed Processed
using client's using auditor's
program program

Output Compare Output

Manually

o Other CAATs –highly complicated computerized systems sometimes do

not retain permanent audit trails and would require capturing of audit
data as transactions are processed. This include:
 Snaphots –involves taking picture of a transaction as it flows
through the computer systems.
 Systems control audit review files (SCARF) –this involves
embedding audit software modules within an application system
to provide continuous monitoring of the systems transactions.

Substantive Test –are audit procedures designed to substantiate the account

balance or to detect material misstatements in the financial statements. Types of
substantive test:
 Analytical Procedures –used to obtained corroborative evidence about a
particular account. When intending to perform analytical procedures as
substantive tests, the auditor should focus on those accounts that are
predictable like:
o Income Statement accounts which are more predictable compared to
balance sheets accounts.
o Accounts that are not subject to management discretion
o Relationships in a stable environment than those in dynamic or
unstable environment
 Test of Details –involves examining the actual details making up the various
account balances. This may take the form of:
 o Test of details of balances –involves direct testing of the ending
balance of an account.
o Test of details of transactions –involves testing the transactions which
give rise to the ending balance of an account.

Effectiveness of Substantive Tests

 Nature of substantive test –relates to the quality of evidence.
 Timing of substantive test –substantive test may be performed at interim
period or year-end but as the time close by to the year end, it is becoming
more effective and vice versa.
 Extent of substantive test –relates to the amount of evidence needed to
satisfy a particular objective.

Audit Evidence –refers to the information obtained by the auditor in arriving at the
conclusions on which the audit opinion is based
*the auditor should obtain sufficient appropriate evidence to be able to draw
reasonable conclusions on which to base the audit. Audit evidence consists of:
 Underlying accounting data –refers to the accounting records underlying
the financial statements.
 Corroborating information –supporting the underlying accounting data
obtained from client and other sources.
Qualities of Evidence
 Sufficiency –refers to the amount of evidence that the auditor should
accumulate. Factors may be considered in evaluating the sufficiency of
evidence because an auditor cannot examine all evidence because of
cost/benefit consideration:
o Competence of evidence –the more competent the evidence, the less
amount of evidence is needed to support the auditor's opinion. (inverse
relationship)
o Materiality of the item being examined –the more material the FS
amount being examined, the more evidence will be needed to support
its validity.
o 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 audit may indicate the amount of
evidence taken before and whether such evidence was enough.
 Appropriateness –measure of the quality of audit evidence and its relevance
to a particular assertion and its reliability.
o Relevance –relates the timeliness of evidence and its ability to satisfy
the audit objective.
 o Reliability –relates to the objectivity of evidence and is influenced by its
sources and by its nature.
 Audit evidence obtained from independent outside sources 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 obtained from the entity.
 Audit evidence in the form of documents and written
representation is more reliable than oral representations.

Audit Documentation/Working Paper –records kept by the auditor that documents

the audit procedures applied, information obtained and conclusions reached.
Functions of Working Paper
 Primary
o Support the auditor's opinion on financial statements
o Support the auditor's representation as to compliance with PSA
o Assist the auditor in the planning, performance, review and supervision
of the engagement
 Secondary
o Planning future audit
o Providing information useful in rendering other services
o Providing adequate defense in case of litigation

*Audit documentation depends upon the auditor's judgment, but the following
important items would normally require audit documentation:
 Significant matters discussed with the management
 Reason for departure from a basic principle or an essential procedure and
other necessary items.
 Nature, timing, and extent of audit procedures performed, the auditor should
record:
o Who performed the audit work and the date such work was completed
o Who reviewed the audit work performed and the date and extent of such
review

Classification of working papers

 Permanent File –contains information of continuing significance to the auditor
in performing recurring audits.
o Copies of the article of incorporation and by-laws
 o Major contracts
o Engagement letter
o Organizational chart
o Analyses of long term accounts
o Internal control analyses
 Current File –contains evidence gathered and conclusions reached relevant
to the audit of a particular year.
o A copy of the FS
o Audit program
o Working trial balance
o Lead schedule
o Detailed schedules
o Correspondence with other parties such as lawyers, customers, banks
and management
*Working papers are property of the auditor and not by the client but the auditor
should not disclose it to third parties without client's permission unless it is ordered
by the law or it is used to defend himself.

Guidelines for the preparation of working paper

 Heading –each working paper must be properly identified with such
information as the name of the client, type of working paper, a description of
its content, and the date or period covered by the examination.
 Indexing –refers to the use of lettering or numbering system.
 Cross-indexing/ Cross-referencing –important to provide a trail useful to
supervisors in reviewing the working paper
 Tick marks –working papers must include symbols that describe the audit
procedures performed.

*Primarily, management is responsible for making accounting estimates included in

the financial statement.
*The responsibility of the auditor is to obtain sufficient appropriate evidence as to
whether:
 Accounting estimate is properly accounted for and disclosed
 Accounting estimate is reasonable in the circumstances, may use:
o Review and test the process used by the management to develop the
estimate
o Make an independent estimate
o Review subsequent events which confirm the estimate made
Related Parties
*Management is responsible for the identification and disclosure of related party and
transactions with such party
*Auditor should obtain and review information provided by the director and
management identifying the names of all known related parties and transactions.

Expert –is a person or a firm possessing special skill, knowledge and experience in
a particular field other than accounting and auditing.
 Auditor's Expert –expert whose work in his/her field of specialization, is used
by the auditor to assist in obtaining sufficient appropriate evidence
 Management's Expert –expert whose work in his/her field of expertise, is
used by the entity to assist the entity in preparing the financial statements.
Determining the need for an Auditor's Expert
 Whether management has used a management's expert in preparing the FS
 The nature and significance of the matter, including its complexity
 The risk of material misstatement in the matter
 The expected nature of procedures to respond to identified risks, including the
auditor's knowledge of and experience with the work of experts in relation to
such matters; and the availability of alternative sources of audit evidence

Evaluating the Auditor's Expert

1. Assess the competence and objectivity of the expert –factor are:
a. Professional certification or licensing by, or membership in an
appropriate professional body(competence)
b. Experience and reputation in the field which the auditor is seeking audit
evidence(competence)
c. Inquiry regarding interest and relationship that may create a threat to
expert's objectivity(objectivity)
2. Understand the field of the expertise of the auditor's expert –this
understanding should enable the auditor to determine the nature, scope and
objectives of that expert's work and evaluate the adequacy of that work for the
auditor's purposes.
3. Establish the terms of the agreement with the expert –if appropriate, it
should be in writing.
4. Evaluate the results of the work of the expert –auditor should assess the
appropriateness of the expert's work.

*The auditor has sole responsibility for the audit opinion expressed and that
responsibility is not reduced by the auditor's use of the work of an expert.
*Using the work of an expert is only permitted when issuing a modified opinion, but
not in unmodified opinion.

Internal Auditing –is an appraisal activity established within an entity as a service to

the entity. Considering the work of internal auditor involves two phases:
1. Making a preliminary assessment of internal auditing –the auditor should
consider the internal auditor's:
a. Competence
b. Objectivity
c. Due professional care
d. Scope of function –consider the nature and extent of the internal
auditor's assignment
2. Evaluating and testing the work of internal auditing –this may include:
a. Considering whether the work is performed by competent person
b. Sufficient appropriate evidence is obtained
c. Appropriate conclusions are reached
d. Exceptions are properly resolved
*The external auditor can request assistance of the internal auditor in performing
routine/mechanical audit procedures with supervision and reviews.
*The responsibility of the auditor is not reduce by using the work of an internal
auditor.

Audit Sampling –the application of audit procedures to less than 100% of the items
within an account balance or class of transactions such that all sampling units have a
chance of selection (PSA 530)
*sampling is performed on the assumption that the sample selected for testing is
representative of the population.

Sampling Risk –risk that the sample selected for testing may not be truly
representative of the population. Two types of sampling risk are:
 Alpha Risk –risk the auditor will conclude, (affects efficiency)
o In the case of test of control, that internal control is not reliable when in
fact it Is effective and can be relied upon. (risk of under reliance)
o In the case of substantive test, that material misstatement exists in an
account balance or transaction class when in fact such misstatement
does not exist. (risk of incorrect rejection)
 Beta Risk –is the risk the auditor will conclude, (affects effectiveness)
o In the case of test of control, that the internal control is reliable when in
fact it is not effective and cannot be relied upon. (risk of over reliance)
 o In the case of substantive test, that material misstatement does not exist
when in fact material misstatement does exist. (risk of incorrect
acceptance)
Non-Sampling Risk –risk that the auditor may draw incorrect conclusions about the
account balance or class transactions because of human errors.
*Sampling risk can be eliminated by examining the whole population but it is not
feasible.
*Auditors can control sampling risk by:
 Increasing the sample size
 Using an appropriate sample selection method
*Non-sampling risk cannot be eliminated but can be minimized by:
 Proper planning
 Adequate direction, review, and supervision of the audit team

General Approaches to Audit Sampling

Statistical Sampling –sampling approach that;
o Uses random based selection of sample
o Uses the law of probability to measure sampling risk and evaluate
sample results (mathematical formula)
Non-statistical Sampling –approach that purely uses auditor's judgment in
estimating sampling risks, determining sample size and evaluating sample
results.
*Statistical sampling helps the auditor to
 Design an efficient sample
 Measure the sufficiency of evidence obtained
 Objectively evaluate the sample results

Audit Sampling Plans –when statistical sampling is used, the auditor may use
either:
Attribute Sampling –used to estimate the frequency of occurrence of a
certain characteristic in a population. (occurrence rate) It is generally used
when performing test of controls to estimate the rate of deviation from
prescribed internal control policies.
Variable Sampling – this is a sampling plan used to estimate a numerical
measurement of a population such as peso value. It is generally used in
performing substantive tests to estimate the amount of misstatements in
the FS.
Basic Steps in Audit Sampling
Steps Basic Steps in Audit Sampling
1 Define the Objective
2 Determine the procedure
3 Determine the sample size
4 Select the sample
5 Apply the procedures
6 Evaluate the results

Sampling for Test of Controls

*Audit sampling of test of control is generally appropriate when application of the
control leaves evidence of performance but for those that leave no documentary
evidence, non-sampling procedures such as inquiries and observation would be
more appropriate.

Determination of Sample Size –factor affecting the determination of sample size:

 Acceptable Sampling Risk –inverse relationship with sample size, as the
sampling risk become small, the greater evidence needed.
 Tolerable Deviation Rate –is the maximum rate of deviations the auditor is
willing to accept, without modifying the planned degree of reliance on the
internal control. Have inverse relationship with sample size.
 Expected Deviation Rate –is the rate of deviations the auditor expects to find
in the population before testing begins. Have direct relationship with sample
size. As the expected deviation rate increase, the sample size increase.
Acceptable Tolerable Expected
Sample Size
Sampling Risk Deviation Rate Deviation Rate
Small High High Low
Large Low Low High

Sample Selection Method

Random Number Selection –the auditor selects the sample by matching
random numbers, generated by a random number table or a computer
software generator, with the population numbering system such as document
number,
Systematic Selection –involves determining a constant sampling interval and
then selects sample based on the size of that interval
Haphazard Selection –the sample is selected without following an organized
or structured technique. (non-statistical)
*Voided Documents –if the document has been properly voided, such document
should be replaced by another sample item
*Missing Documents –if the auditors encounters missing document and he is
unable to determine whether the control has been properly performed, such item
should be treated as a deviation for the purpose of evaluating sample result.

Evaluation of Results –both qualitative and the quantitative factors of deviation

should be considered. Guidelines that may be used when evaluating sample results
for test of controls:
1. Determine the sample deviation rate –computed by dividing the number of
deviations found in the sample by the sample size. This represents the
auditor's best estimate of the deviation rate in the population.
a. Example, if the auditor found 4 deviations out of the 200 sample size,
the sample deviation rate is 4/200 = 2%
2. Compare the sample deviation rate with the tolerable deviation rate and
draw an overall conclusion about the population –may result to:
a. The sample deviation rate exceeds the tolerable deviation rate –
that means the sample results do not support the auditor's planned
degree of reliance on internal control. Hence control risk will be
assessed at high level.
b. The sample deviation rate is less than the tolerable deviation rate
–the auditor should consider the allowance for sampling risk- that is ,
the possibility that these sample result could have occurred even if the
actual population deviation rate is higher than the tolerable.
i. If the sample deviation rate is considerably lower than the
tolerable rate (2% as against 10% tolerable rate), there is a low
risk that the actual population deviation rate will exceed the
tolerable deviation rate.
ii. If the sample deviation rate is barely lower than the tolerable
rate (8% against 10% tolerable rate), there is a high possibility
that the actual deviation rate will exceed the tolerable rate.
1. When using non-statistical sampling, the auditor will most
likely conclude that the sample results do not justify his
preliminary assessment of control risk
2. When statistical sampling is used, the auditor determines
the maximum population deviation rate by using a
sampling table or statistical formula. If it exceed the
tolerable rate then he will conclude that the sample
results do not support the auditor's preliminary
 assessment of control risk and therefore the scope of
substantive test should be increased. (vise versa)

Other Sampling Applications for Test of Controls

Sequential Sampling –can be used as an alternative form of testing controls
when an auditor expects very few deviations within the population. This
method does not use fixed sample size and also called stop-or-go sampling.
o For example, if no deviation are found in the sample, the auditor may
conclude that the internal control procedure is reliable and therefore
may stop the sampling plan. Also, if the auditor observes many
deviations, the auditor may also terminate the sampling plan and
conclude that the planned degree of reliance on internal control is not
justified. On the other hand if one or few are found, the auditor may
decide to go on with the examination of another set of sample to obtain
more evidence to support the planned assessed level of control risk.
Discovery Sampling –most appropriate when no deviation are expected in
the population and therefore even one deviation would cause concern.

Sampling for Substantive Test

*Audit sampling is appropriate when performing test of details to estimate the
amount of misstatements in the FS

Determination of sample size –following factors must be considered:

 Acceptable Sampling Risk –auditor should consider the components of
audit risk. For practical purpose, the auditor uses the acceptable level of
detection risk as the acceptable sampling after giving adequate
consideration to the risk that analytical procedures may fail to detect material
misstatement in account balance. Have inverse relationship with sample size.
 Tolerable Misstatement –is the maximum amount of misstatement that the
auditor will permit in the population and still be willing to conclude that the
account balance is fairly stated. Have inverse relationship with sample size.
 Expected Misstatement –amount of misstatement that the auditor believes
exist in the population. Have direct relationship with sample size.
 Variation in the Population –when using statistical sampling, the variability
is measured by the standard deviation. When a population consists of highly
variable recorded amounts, it is difficult to select a representative sample.
Consequently, a larger sample size is required as the degree of variability
within the population increases.
Sample Selection Method –the auditor may use any one of the sample selection
earlier or:
 Stratified Sampling –stratify the population into meaningful groups in order
to decrease the effect of variance within the population. Example, the
customers' account may be stratified as follows:
Account No. of
Stratum Sample Size
Balance Customers
More than 100%
1 40
P1,000,00 examination
P100,000 to
2 170 50 customers
P1,000,000
3 Below P100,000 2040 100 customers
It is useful to the auditor when performing substantive tests because
 It decreases the effect of variance in the population and as a result,
decreases the sample size
 It allows the auditor to give more emphasis to those items with higher
monetary value
 Value weighted selection –the probability of an item to be selected in this
method is directly proportional to the monetary value of such item.(monetary
unit sampling)

Evaluating the results –involves the following steps:

1. Project the misstatements to the population –projecting misstatements in
the population can be accomplished by;
a. Ratio Estimation
b. Difference Estimation
Example
In terms of In terms of number Amount of
value of customer misstatement
Population P10,000,000 200 ?
Sample Size P1,000,000 24 P48,000
Using ratio estimation approach the projected misstatements is determined
as follows P48,000 x (P10,000,000 / P1,000,000) = P480,000

Using the difference estimation the projected misstatements will be

P48,000 x (200 customers / 24 customers) = P400,000
*general formula
Projected Misstatement = Amount of Misstatement * (population size / sample size)
 2. Compare the projected misstatements together with the tolerable
misstatements and draw an overall conclusion
a. If the projected misstatement is greater than the tolerable
misstatement, the auditor will conclude that the account balance is
materially misstated. In this case, the auditor may:
i. Examine additional units
ii. Perform suitable alternative procedures
iii. Request the client to adjust the account balance
b. If the projected misstatement is less than the tolerable misstatement,
the auditor should consider the allowance for sampling risk. The auditor
should recognize that sampling risk increases as the projected
misstatement approaches the tolerable misstatement

*Anomalous Errors –arise from isolated events that has not recurred other than
specifically identifiable occasions and are therefore not representative of errors in the
population. Such error should be excluded when projecting sample error to the
population. However, the effect of such error must be considered together with
projected error in order to determine the combined effect of the errors on the account
balance or transaction class.

Procedures generally carried out to complete the audit:

 Identifying subsequent events that may affect the FS under audit –
subsequent events are those events that occur subsequent to the balance
sheet date that may affect the FS and auditor's report.
-auditor is only concerned with those that occur subsequent to the
balance sheet date but before the auditor's report. It can be classified as:
 Requiring Adjustment –those that provide further evidence of
conditions that existed at the balance sheet date such as:
o Settlement of litigation in excess of the recorded liability
o Loss in uncollectible receivable as a result of customer's
deteriorating financial condition
 Requiring Disclosure –those that are indicative of conditions that
arose subsequent to the balance sheet s date such as:
o Issuance of stocks or bonds after the balance sheet date
o Loss on inventory due to fire that occurred in the subsequent
period
o Loss on uncollectible receivable because of a major casualty
suffered by that customer after the balance sheet date.
*The auditor should perform procedures designed to obtain sufficient appropriate
evidence that all events up to the date of the auditor's report that may require
adjustment of or disclosure in, the financial statements have been identified.
*It is the management responsibility to inform the auditor of the subsequent events
that may affect the FS after the date of the auditor's report but before the issuance of
FS.
Effects of subsequent events occurred after the auditor's report
 Requiring Adjustment –bear the original date of the report
 Requiring Disclosure –either
o As of the date of the subsequent event –his responsibility will extend up
to the subsequent date
o Dual date the report (e.g. March 15, 2018 except for Note 10 as to which
the date is March 31, 2018.)

 Litigation, Claims, and Assessment –management is the responsible to

adopt policies and procedures that will identify, evaluate, and account for
litigation, claims and assessment but the auditor should carry out procedures
in order to become aware of any litigation and claims involving the entity
which may have material effect on the financial statement.
o The letter of audit inquiry shall be sent to the lawyer of the client, the
letter shall be prepared by the management and sent by the auditor
requesting the lawyer to communicate directly to the auditor.
o If management refuses the auditor shall issue either a qualified or
disclamer of opinion and an emphasis of matter paragraph to an
unmodified report
 Written Management Representation –management representation are
normally requested from the entity's chief executive officer or other equivalent
that include that entity's management:
o Has acknowledged that it has fulfilled its responsibility for the preparation
and presentation of fair FS
o Has approved the financial statement.
*Management written representation complement the audit evidence but they
do not substitute for the performance of audit procedures,
Form and Content of Written Representation
 A representation that the management has fulfilled its responsibility for
the preparation and presentation of the financial statements as set out
in the terms of the engagement
 A representation that the FS are prepared and presented in
accordance with the applicable financial reporting framework
  A representation that the management has provided the auditor with
all relevant information agreed in the terms of the engagement, and
that all transactions have been recorded and reflected in the financial
statements
 A representation that describes management's responsibilities as
described in the terms of the engagement
 Other representation required by other PSAs.
*Written representation shall be in the form of representation letter.
Basic Elements of a Written Management Representation
 The written representation should be addressed to the auditor
 The date of the written representations shall be as practicable to, but not after,
the date of the auditor's report
 The written representation should be signed by the appropriate level of
management who has the primary responsibility for the financial statements.
Ordinarily, written representation is signed by the chief executive officer and
the chief financial officer or their equivalent because they are usually the ones
responsible for the preparation and fair presentation of the FS.

 Wrap-up Procedures –those procedures done at the end of the audit that
generally cannot be performed before the other audit work is complete. These
include:
o Final Analytical Procedures –this should focus on
 Identifying unusual fluctuations that were not previously
identified
 Assessing the validity of the conclusions reached and evaluating
the overall financial statement presentation.
o Evaluation of the entity's ability to continue as a going concern –
auditor's responsibility is to consider the appropriateness of
management's use of the going concern assumption in the preparation
of FS. For this purpose:
 The auditor should consider whether there are events or
conditions which may cast significant doubt on the entity's ability
to continue as a going concern.
 In addition, the auditor should evaluate management's
assessment of the entity's ability to continue as a going concern
*If there is a reasonable assurance that the entity is a going concern, the auditor
should express an unmodified audit report.
*If there is an uncertainty about the entity's ability to continue as going concern, the
auditor's report will depend on whether this uncertainty is adequately disclosed
  Adequately disclosed –auditor should issue an unmodified opinion with
emphasis of a matter paragraph
 Not Adequately disclosed –auditor should issue either qualified or adverse
opinion
*If going concern is not appropriate, the financial statements should be prepared
using other appropriate basis otherwise the auditor will issue a adverse opinion.

 Evaluating audit findings and preparing a list of potential adjusting

entries –material misstatement discovered during the audit must be corrected
by recommending appropriate adjusting entries.
o If management accepts the entries propose by the auditor –
unmodified report is issued
o If management refuses to correct the FS –auditor should issue a
qualified or an adverse opinion

*The auditor has no obligation to make any inquiry regarding previously issued
financial statements unless he became aware of a material fact,
 Which existed at the date of the auditor's report; and
 Which, if known at that date, may have caused the auditor to modify the report

*When auditor becomes aware of this type of information, he should:

1. Discuss the matter with appropriate level of management and consider
whether the financial statement need revision
2. Advise management to take the necessary steps to ensure that the users of
the previously issued FS are informed of the situation
a. If management makes the appropriate revisions and disclosure –
auditor should issue a new audit report that includes an emphasis
of a matter paragraph to highlight the reason for the revision of the
previously issued financial statement
b. If management refuse –auditor should notify those persons ultimately
responsible for the direction of the entity about the management's
refusal and about his intent to prevent users from relying on the audit
report.

Subsequent discovery of omitted procedures –in this situation the auditor should
follow these guidelines:
 Assess the importance of the omitted procedures to the auditor's ability
to support his opinion –results of other audit procedures that were applied
may compensate for or make the omitted procedures less important.
Evaluating such results may involve:
 o Reviewing the working paper
o Discussing the circumstances with the engagement personnel
o Reevaluating the scope of the audit
 Undertake to apply the omitted procedures or the corresponding
alternative procedures –this is done when the auditor determines that the
omission of the procedures impairs his current ability to support his opinion. If
after the procedures taken the auditors determined that the FS is materially
misstated and that the auditor's report is inappropriate, the auditor should
discuss the matter with the management and take steps to prevent future
reliance on the report.

Unmodified Opinion –this type of opinion is issued when the auditor concludes,
based on audit evidence obtained, that the FS are fairly presented.
Basic Elements of the Unmodified Report
1. Title –title of the report should clearly indicate that it is the report of an
independent auditor. This is done in order to:
a. To emphasize the independence of the auditor with respect to the
client being audited
b. To distinguish the auditor's report from the reports that might be issued
by others
2. Addressee –the report should be addressed to those parties for whom the
report is prepared.
3. Introductory Paragraph –introductory paragraph should:
a. Identify the name of the entity whose FS have been audited
b. State that the FS have been audited
c. Identify the title of each of the FS audited including the date and
period covered by the FS
d. Refer to the summary of significant accounting policies and
explanatory notes.
4. Management's Responsibility for the Financial Statements –this section
should describe management's responsibility:
a. for the preparation and fair presentation of the FS in accordance
with applicable financial reporting framework
b. for the design, implementation and maintenance of such internal
control relevant to the preparation and fair presentation of financial
statement that are free from material misstatement, whether due to
fraud or not
5. Auditor's Responsibility –this section should:
 a. State that the responsibility of the auditor is to express an opinion
on the FS based on the audit in order to contrast it to management's
responsibility for the preparation of the FS
b. State that the audit was conducted in accordance with Philippine
Standards on Auditing (PSAs) to inform the users that the auditor
has complied with the standard of performance established by the
profession.
c. Give a general description of an audit
d. State that the auditor believes that the audit evidence obtained is
sufficient and appropriate to provide a basis for the auditor's opinion.
6. Auditor's Opinion –state that the financial statement are presented fairly in
all material respects in accordance with the applicable financial reporting
framework
7. Other Reporting Responsibilities –auditor may have additional
responsibilities to report on other matter that are supplementary to the
auditor's responsibility under PSA. If it have a separate section, it should have
a sub-title of "Report on the Financial Statements"
8. Auditor's Signature –report should be signed in the name of the audit firm
and/or the personal name of the auditor as appropriate. However report to
be submitted to the SEC requires that the related auditor's report be signed in
the personal name of the partner
9. Date of the Report –it is important because it informs the readers that the
auditor has considered the FS effects of subsequent events that occurred up
to this date.
10. Auditor's address –name of the location in the jurisdiction where the auditor
maintains his office
Modification to the Opinion

Modification to the opinion

Material Misstatement Scope Limitation

Material Material Material Material

but not and but not and
Pervasive Pervasive Pervasive Pervasive

Qualified Adverse Qualified Disclaimer

Opinion Opinion Opinion of opinion

Material Misstatements –departure from the specific requirements of these

standards will cause the financial statement to contain material statement. May arise
from:
 Inappropriate accounting policy selected
 Misapplication of selected accounting policy
 Inappropriate or inadequate disclosure

Scope Limitation –arises when the auditor is unable to perform necessary audit
procedures or the auditor is unable to obtain sufficient appropriate evidence. This
may be imposed by the client or by circumstances:
 Circumstances beyond the control of the entity such as inadequacy of
accounting record
 Circumstances relating to the nature or timing of the auditor's work like
when the auditor is engaged only after client's fiscal period ends.
 Limitations imposed by management like when management prevents the
auditor from requesting external confirmation of specific accounts.

Basis for modification paragraph

*When the auditor modifies the opinion on the financial statement, the auditor should
include a separate paragraph in the auditor's report that provide a description of
the matter giving rise to the modification.
*If there is a material misstatement that relates to specific amount or disclosure in
the financial statement, the auditor should include in the paragraph:
 A description of the nature of misstatements or an explanation of how the
disclosure is misstated
  A quantification of the financial effects of the misstatement or a disclosure of
omitted information, if practicable
*If the modification results from an inability to obtain sufficient appropriate audit
evidence, the basis for modification paragraph shall only explain the reason for
that inability.

*In addition to the Basis for the Modification paragraph, the following modification
should be observed when issuing a modified opinion:
Opinion paragraph
1. The auditor's opinion paragraph should use the heading "Qualified
Opinion", "Adverse Opinion" , or "Disclaimer of opinion" as appropriate.
2. When the auditor expresses a qualified opinion due to material misstatement,
the auditor should use the phrase "except for the effects of the matter
described in the Basis for Qualified Opinion paragraph, the financial statement
present fairly…"
3. When the auditor expresses a qualified opinion due to scope limitation, the
auditor should use the phrase "except for the possible effects of the matter
described in the Basis for Qualified Opinion paragraph, the FS present fairly.."
4. When the auditor expresses an adverse opinion, the auditor should state that
in the auditor's opinion, because of the significance of the matter described in
the Basis for adverse Opinion paragraph, the financial statements do not
present fairly…
5. When the auditor disclaims an opinion, the auditor should state that because
of the significance of the matter described in the Basis for Disclaimer of
Opinion paragraph, the auditor has not been able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion; and,
accordingly, the auditor does not express an opinion on the FS.
Auditor's Responsibility paragraph
6. When qualified or adverse opinion is expressed the last sentence of the
auditor's responsibility paragraph should be modified to state that the auditor
believes that the audit evidence the auditor has obtained is sufficient and
appropriate to provide a basis for the auditor's qualified or adverse opinion
7. When the auditor disclaims an opinion, the auditor should amend the
description of the auditor's responsibility such as this: "Our responsibility is to
express an opinion on the FS based on conducting the audit in accordance
with the Philippine Standards on Auditing. Because of the matter described in
the Basis for Disclaimer of Opinion paragraph, however, we were not able to
obtain sufficient appropriate evidence to provide basis for an audit.

Piecemeal Opinion –an unmodified opinion expressed on one or more components

of the financial statement while expressing an adverse or disclaimer of opinion on
the financial statement taken as a whole. PSA 705 does not allow this reporting
practice.

Emphasis of Matter –paragraph included in the report to draw the reader's attention
to a matter presented or disclosed in the financial statement that, in the auditor's
judgment is of such importance that it is fundamental to the readers' understanding,
the auditor.
  Uncertainty –is a matter whose outcome depends on future actions or events
not under the direct control of the entity that may affect the FS.
 Going Concern Uncertainty – a material uncertainty exist when the impact
of the going concern problem is significant such that, in the auditor's
judgment, clear disclosure of the nature and implications of the uncertainties
is necessary for the fair presentation of the FS.
o If going concern uncertainty is adequately disclosed, the auditor should
express an unmodified opinion with emphasis of matter paragraph
o If the going concern uncertainty is not adequately disclosed, a
qualified or an adverse opinion will be issued.
 Early application of new accounting standard –standard setting bodies
sometimes allow or even encourage entities to apply a new accounting
standard prior to its mandatory date.
 Major catastrophe –that has, or continues to have, a significant effect on the
entity's financial position will have to be disclosed.
 Subsequent discovery of facts that affect the auditor's opinion -
discussed earlier
 Financial statement prepared using a special purpose framework –
preparing FS using cash basis of accounting and other bases of accounting
*When multiple uncertainties affect the financial statement, the auditor may consider
to issue a disclaimer of opinion to be more appropriate.

Other Matter Paragraph –when it is necessary to communicate a matter other

than those that are presented or disclosed in the FS that is in the judgment of the
auditor is relevant. Circumstances which require Other Matter paragraph:
 Reporting on comparative information –PSA 710 has identified two
financial reporting frameworks for comparatives, namely:
o Comparative Financial Statements –where amount and other
disclosures for the preceding period are included for comparison with
the FS of the current period, but do not form part of the current period
FS.
*Reports on comparative FS can be illustrated under the following
scenarios:
 Prior Period Financial Statement were audited by a continuing
auditor –the auditor should not simply reissue his prior year's report
but he should update his report. This involves either:
o Re-expressing the opinion originally issued
o Expressing an opinion different from the one originally
issued –the Other Matter paragraph should state:
 The fact that the updated report is different from the
previous opinion
 The date of the prior year's report
 The type of opinion previously issued
 The reasons for changing the auditor's opinion
 Prior Period Financial Statements audited by another Auditor –there
will be two alternatives:
o The predecessor auditor reissues the audit report on the
prior period financial statements
 o The predecessor auditor does not want to reissue his
report on the prior period FS –this should include Other
matter paragraph stating:
 The fact that the prior period financial statements
were audited by another auditor
 The date of the predecessor auditor's report
 The type of opinion issued by the predecessor auditor
and if the opinion is modified, the reasons thereof.
 Prior period Financial Statements not Audited –the auditor should
state that the comparative FS are not audited and should provide
reasonable assurance that the FS do not contain material
misstatement.
o Corresponding Figures –where amounts and other disclosures for
the preceding period are included as part of the current period
financial statement, and are intended to be read in relation to the
amounts and other disclosures relating to the current period.
*When the comparatives are presented as corresponding figures, the
auditor should issue a report that refers only to the FS of the current
period.

*The auditor has no responsibility to corroborate the other information. However, the
auditor should read the other information to determine that it is not materially
inconsistent with the audited financial statements.
*Effects when the other information has material inconsistencies with the FS
 If amendment is necessary in the audited financial statements –if the
entity refuses to make the amendment, the auditor should express a qualified
or an adverse opinion
 If the amendment is necessary in the other information –if the entity
refuses to eliminate the material consistency, the auditor should consider:
o Adding an Other Matter Paragraph to describe the material
inconsistency
o Withholding the auditor's report
o Withdrawing from the engagement

 Financial Statement prepared using more than one financial framework

–If the auditor has determined that the frameworks are acceptable in the
respective circumstances, the auditor may include an Other Matter
paragraph in the auditor's report, referring to the fact that another set of FS
has been prepared in accordance with another general purpose framework
and that the auditor has issued a report on those FS.
 Limiting the Use of the Auditor's Report –the auditor may include Other
matter paragraph stating that the auditor's report is intended solely for the
intended users and should not be distributed to or used by other parties.
 Subsequent discovery of facts

Group Auditor –is the auditor with responsibility for reporting on the FS of an entity
when those FS include financial information of one or more components audited by
another auditor.
Consideration need to be consider when acting as a group auditor
 The materiality of the portion of the FS audited
 The auditor's knowledge of the overall FS
 The importance of the components audited by another auditor

Consideration need to be considered when judging whether to rely on the

work of other auditors or not:
 Whether the component auditor understands and will comply with the ethical
requirements particularly the independence requirements
 The component auditor's professional competence
 Whether sufficient appropriate evidence about the work of the component
auditor can be obtained
*if the group auditor has not become satisfied about the professional competence
and independence of the component auditor, the group auditor should obtain
sufficient appropriate audit evidence relating to the financial information of the
component.

When accepting an Audit of Single FS or Specific Element of a FS:

1. The auditor may need to examine other related accounts to be able to
express opinion on a specific component of FS
2. Materiality should be related to the specific account rather than to the
financial statements as a whole and accordingly the auditor's examination will
ordinarily be more extensive than if the same component were to be audited
in connection with a report on the entire FS
3. The auditor's report on a component of FS should not accompany the FS
of the entity to avoid giving the user the impression that the report relates to
the entire FS.
*Engagement like this is most likely accepted if the auditor is also the auditor of the
complete set of FS

Reporting Responsibility on Single FS –auditor should express a separate opinion

for each engagement
 If the opinion the auditor's report on an entity's complete set of FS is
modified, the auditor shall determine whether it is also necessary to modify
the opinion or include an emphasis of matter or other matter paragraph on
the report on specific element of a FS
 If the opinion of the auditor on the complete set is adverse or disclaimer the
opinion on the single FS cannot be unmodified because it will contradict the
opinion on the complete set.
 But if the auditor considers it is appropriate to express an unmodified opinion
on that element, the auditor shall only do so provided:
o The auditor is not prohibited by law or regulation from doing so
o The report on specific element is not published together with the
auditor's report on the complete set of FS
o The specific element does not constitute a major portion of the
entity's complete set of FS
Reporting on Summary FS –must be accepted only if the auditor is also the one
who audit the complete set of FS where the summary FS is derived. The auditor
should express an opinion on whether (1) The summary FS are consistent with
the audited FS or (2) whether the summary financial statements are a fair
summary of the audited FS.
*If the audited FS contain adverse opinion or disclaimer of opinion, it is not
appropriate for the auditor to express an opinion on the summary FS.
*If the audited FS contain qualified opinion, emphasis of matter or other matter
paragraph, this should be stated in the report on the summary of FS.

Types of services that are normally performed in connection with the entity's
FS:
 Audit –conducted primarily to enable the auditor to express an opinion on the
entity's FS. Provides reasonable or high level of assurance that the FS is
free from material misstatement. (positive assurance)
 Review –objective is to enable auditor to state whether, on basis of
procedures which do not provide all the evidence that would be required in an
audit, anything has come to the auditor's attention that causes the auditor to
believe that the FS are not prepared in all material respect, in accordance with
an identified financial reporting framework.
o Can only provide moderate level of assurance (negative
assurance).
o Consist principally of inquiry and analytical procedures.
Reporting Responsibility –the auditor may issue a :
 Unmodified Review Report –issued when the auditor believes, based
on the evidence obtained, that there are no material modifications that
should be made to the FS.
 Modification of the Review Report
o Material Misstatement –when the modification is because of
material misstatement the report should describe those
matter that impair a fair presentation of FS, including, unless
impracticable, a quantification of the possible effect(s) on the
FS and either:
 Express a qualification of the negative assurance
 When the effect of the matter is material and pervasive
to the FS that the auditor concludes that a qualification is
not adequate to disclose the misleading or incomplete
nature of the FS, give an adverse statement that the FS
are not presented fairly.
o Scope Limitation –the report should describe the limitation either
 Express a qualification of the negative assurance
regarding the possible adjustment to the financial
statements that might have been determined to be
necessary had the limitation not existed
 When the possible effect of the limitation is material and
pervasive that the auditor concludes that no level of
assurance can be provided, the auditor should not
provide any assurance
  Compilation –provide assistance to the entities in the preparation and
presentation of their FS. Objective of this engagement is for the accountant to
use accounting expertise, as opposed to auditing expertise, to collect,
classify and summarize financial information.
o This engagement is not designed and do not enable the accountant to
express any assurance
o The accountant should read the compiled information and consider
whether it appears to be appropriate in form and free from obvious
material misstatement
o The accountant is not ordinarily
 Make inquiries of management to assess reliability and
completeness of the information
 Assess internal control
 Verify any matter
 Verify any explanation
*The financial information compiled by the accountant should contain a
reference such as "Unaudited", "Compiled without audit or revie"
or "Refer to Compilation Report" on each page.
Modification of the compilation report
 Material Misstatement –the accountant should disclose the nature of the
misstatement in a separate paragraph of the report although their effect do
not have to be quantified. If the accountant feels that modification of the report
is not sufficient and the client is not willing to correct the deficiencies, the
accountant may withdraw.
 Scope Limitation –normally cause the accountant to withdraw

 Agreed-Upon Procedures Engagement –apply agreed upon procedures on

specific elements or account of the FS. This may be accepted provided:
o The client takes full responsibility for the adequacy of the procedures to
be performed
o The distribution of the report is limited only to those parties who have
agreed about the procedures to be performed
*No assurance is expressed in this engagement
*There are still procedures but applied only to specific accounts,
example of procedures are:
 Inquiry and analysis
 Recomputation, comparison, and other clerical accuracy check
 Observation
 Inspection
 Obtaining Confirmation

Elements needed to be an assurance engagement

 A three party relationship
o Professional accountant
o Party responsible for the subject matter (management)
o Intended User
 An appropriate subject matter –may take forms of:
o Data (for example, financial and non-financial information)
 o Systems and Processes (ex. Internal control)
o Behavior (ex. Entity's compliance with laws and regulations)
o Physical characteristics (ex. Capacity of a plant facility)
Types of engagement using valuation and measurement of subject
matter:
 Assertions-based engagement –the evaluation or measurement of
the subject matter is performed by the responsible party and the
outcome is in the form of an assertion that is made available to the
intended user
 Direct Reporting Engagement –the practitioner either directly
performs the evaluation of the subject matter or obtains a
representation from the responsible party that has performed the
evaluation that is not made available to the intended users.
 Suitable criteria –are the standards or benchmark used to evaluate or
measure the subject matter of an assurance engagement.
 Sufficient appropriate evidence –must be sufficient and appropriate
 A written assurance report

Engagements not included as assurance

 Agreed-upon procedures
 Compilation
 Preparation of tax returns when no conclusion is expressed and tax consulting
 Management consulting
 Other advisory services

Reports on Prospective Financial Information –two general types are:

Forecast –prepared on the basis of the assumptions as to future events
which management expects to take as of the date the information is
prepared (best-estimate assumption)
Projection –prepared on the basis of hypothetical assumptions or a
mixture of best-estimate and hypothetical assumptions

*When examining prospective financial information, according to PSAE 33400, the

auditor should obtain sufficient appropriate evidence that:
 Management's best-estimate assumptions are reasonable and, in the case of
hypothetical assumptions, such assumptions are consistent with the purpose
of the information
 The prospective financial information is properly prepared in the basis of the
assumptions
 The prospective financial information is properly presented and all material
assumptions are adequately disclosed
 The prospective financial information is prepared in an consistent basis with
historical financial statements
*when reporting on the reasonableness of management's assumptions, the auditor
normally provides only a moderate level of assurance

Auditing Theory -2014 Edition by Salosagcol and Company

Does not include the Code of ethics and Republic Act 9298
Does not also include revisions and other new topics