Gathering and Evaluating Audit Evidences

Lesson overview:
I. Audit Process – Accepting an Engagement
II. Audit Evidence
III. Audit Documentation

Lesson 1: Audit Process

PSA 200- OVERALL OBJECTIVE OF THE INDEPENDENT AUDITOR AND THE

CONDUCT OF AN AUDIT IN ACCORDANCE WITH INTERNATIONAL STANDARDS
ON AUDITNG

PSA 210- AGREEING THE TERMS OF AUDIT ENGAGEMENT

PSA 500- AUDIT EVIDENCE

o Generally, an audit of financial statements starts with the preparation of the

financial statements by the management.

General Approach when Auditing Financial Statements

Entity
prepares and
presents the Audit
Financial Procedures
Statements

Audit Audit
Opinion Evidence

Financial Statement Assertion

o Management is responsible for the fair presentation of financial statements that
reflects the nature and operations of the entity. And must be in accordance with
the financial reporting framework.
o Financial Statements are considered as assertions and representation made by
the entity. These assertions may be explicitly or implicitly included in the
financial statements.
These assertions may fall into the following categories:
Previous Categories (TAP)

Classes of √ Occurrence- transactions and events that have been recorded

Transactions have occurred and pertain to the entity.
and events for √ Completeness- all transactions and events that should have been
the period recorded have been recorded,
under audit √ Cutoff-transactions and events have been recorded in the correct
(TOCCAC) accounting period.
√ Accuracy- amounts and other data relating to recorded
transactions and events have been recorded appropriately.
√ Classification- transactions and events have been recorded in the
proper accounts.
Account √ Completeness- all assets, liabilities, and equity interests that
balances at should have been recorded have been recorded.
the period end √ Existence- assets, liabilities, and equity interests exist.
(ACERV) √ Rights and Obligations- the entity holds or controls the rights to
assets, and liabilities are the obligations of the entity.
√ 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.
Presentation √ Occurrence and rights and obligations- disclosed events,
and disclosure transactions, and other matters have occurred and pertain to the
(POCAC) entity.
√ Completeness- all disclosures that should have been included in
the financial statements have been included.
√ Accuracy and Valuation- financial and other information are
disclosed fairly and at appropriate amounts.
√ Classification and understandability- financial information is
appropriately presented and described, and disclosures are clearly
expressed.

New set of Categories (PSA 315)

Classes of √ Presentation- transactions and events are appropriately

Transactions aggregated or disaggregated and clearly described, and related
and events for disclosures are relevant and understandable in the context of the
the period underrequirements of the applicable financial reporting framework.
audit (POCCAC) √ Occurrence- transactions, and events that have been recorded
or disclosed have occurred, and such transactions and events
pertain to the entity.
√ Completeness- all transactions and events that should have
been recorder have been recorded, and all disclosures that should
have been included in the financial statements have been
included.
√ Cutoff- transactions and events have been recorded in the
correct accounting period.
√ Accuracy- amounts and other data relating to recorded
transactions and events have been recorded appropriately, and
related disclosures have been appropriately measured and
described.
√ Classification- transactions and events have been recorded in
the proper accounts.
Account √ Presentation- - transactions and events are appropriately
balances at the aggregated or disaggregated and clearly described, and related
period end disclosures are relevant and understandable in the context of the
(PACERV) requirements of the applicable financial reporting framework.
√ Accuracy, 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, and financial and other
information are disclosed fairly and at appropriate amounts.
√ 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.
√ Classification- transactions and events have been recorded in
the proper accounts.

Audit Objectives
a. To obtains reasonable assurance about whether the financial statements as a
whole are free from material misstatements, whether due to fraud or error,
thereby enabling the auditor to express an opinion on whether the financial
statements are prepared, in all material aspects, in accordance with an
applicable financial reporting framework.

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 b. To report on the financial statements, and communicate as required by the
PSAs, in accordance with the auditor’s findings.
c. Audit Procedure
o The auditors should use assertions for classes of transactions, accounts
balances, and presentation and disclosures in sufficient detail to form a basis
for the assessment of risks of material misstatements, and the design and
performance of further audit procedures.
o The procedures selected should enable the auditor to gather sufficient
appropriate evidence about a particular assertion. This evidence will be used as
a basis for expressing the opinion required by the audit of financial statements.

Some of the audit procedures used by the auditor to gather sufficient appropriate
evidence include:

Major Audit Procedure

1. Risk assessment procedures
2. Test of controls
3. Substantive procedure

Specific Audit Procedure

1. Inspection – involves examining of records, documents, or tangible assets.

2. Observation- consists of looking at a process or procedure being performed by
others.
3. Inquiry – consist of seeking information from knowledgeable person inside or
outside the entity.
4. Confirmation – consists of the response to an inquiry to corroborate information
contained in the accounting records.
5. Recalculation/ Computation – consists of checking mathematical accuracy of
documents or records.
6. Reperformance – involves the auditor’s independent execution of procedures or
controls that were originally performed as part of the entity’s internal control/
7. Analytical Procedures – consists 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.

Audit Evidence

o Through the procedures performed, the auditor obtains sufficient appropriate

audit evidence to be able to draw reasonable conclusions on which to base the
audit opinion.
o Audit evidence will comprise source documents and accounting records
underlying the financial statements and corroborating information from other
sources. This evidence about the financial statements will either prove or
disapprove the validity of management assertions.

Audit Opinion

o The auditor provides a written audit report containing a conclusion or an

opinion regarding the fairness of preparation and presentation of financial
statements in accordance with the applicable financial reporting framework.
2 Types of Opinion Expressed by the Auditor

a) Unmodified Opinion/ Unqualified Opinion - this opinion is expressed when the

auditor concludes that the financial statements are prepared in accordance with
the applicable financial reporting framework.
b) Modified Opinion - it is a qualified opinion, an adverse opinion, or a disclaimer of
opinion.

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The auditor shall modify the opinion in the auditor’s report when:
1. A choice between Qualified and Adverse - The auditor concludes that, based on
the audit evidence obtained, the financial statements as a whole are not free from
material misstatements.
2. A choice between Qualified and Disclaimer of opinion - The auditor is unable to
obtain sufficient appropriate audit evidence to conclude that the financial
statements as a whole are free from material misstatement.

Sub-phases of the Audit Process

1) Investigative Phase - performance of audit procedures and gathering of evidence.
2) Reporting Phase - expression of opinion, preparing the report, and
communication of the result to the different users of the audited financial
statement.

AUDIT PROCESS: A MORE DETAILED APPROACH

Phase Description
This phase requires a decision from the auditor whether or not
to accept a new client or continue a relationship with an
existing one. This would require evaluation not only of the
auditor’s qualification, but also the integrity and auditability
1.Preliminary
of the client’s financial statements.
engagement
Consideration an audit must consider in accepting
activities
engagement:
(Accepting an
1. Competence
Engagement)
2. Independence
3. Ability to serve the client properly.
4. Integrity of management.

This phase involves the development of an overall sudit

strategy, audit plan, and audit program. The auditor usually
obtained more detailed knowledge about the client’s business
Audit and industry to understand the transactions and events
affecting the financial statements.
Planning
A preliminary assessment of risk and materiality is also made
during this phase.

Since an entity’s internal control directly affects the reliability

4.Performing of the financial statements, it is appropriate to study and
Considering
Substantive evaluate these controls.
Testing The stronger the internal control, the more assurance it
The Internal
provides about the reliability of accounting data and financial
Control
statements.

Using the information obtained in audit planning and

consideration of internal controls, the auditor performs a
substantive test to determine whether the entity’s financial
statements are presented fairly in accordance with financial
reporting standards.

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6.Issuing a Report Wrapping-up procedures are performed; conclusions reached
are reviewed, and an overall opinion is formed during this
5.Completing the phase.
Audit

In this stage, the auditor prepares and issues an audit report

which describes the scope of the audit and states the auditor’s
7.Post-audit conclusion regarding the fairness of the financial statements.
Responsibilities

After completion of the audit engagement, the auditor

performs procedures that will enable him/her to identify areas
for improvement in the current and future engagement.

ACCEPTANCE OF ENGAGEMENT
Objective:
The objective of the auditor is to accept or continue an audit engagement only when
the basis upon which it is to be performed has been agreed, through:
a. Establishing whether the preconditions for an audit are present
b. Confirming that there is a common understanding between the auditor and
management and, where appropriate, those charged with governance of the
audit engagement.

A. Preconditions for an Audit

⮚ The use by management of an acceptable financial reporting framework in the
preparation of the financial statements; and
⮚ The agreement of management and, where appropriate, those charged with
governance to the premise on which an audit is conducted.

To establish whether preconditions for an audit are present, the auditor shall:
1. Determine whether the financial reporting framework to be applied in the
preparation of the financial statements is acceptable; and
2. Obtain the agreement of management that it acknowledges and understands its
responsibility:
a) For the preparation of the financial statements in accordance with the
applicable financial reporting framework, including where relevant their fair
presentation
b) For such internal control as management determines is necessary to enable
the preparation of financial statements that are free from material
misstatement, whether due to fraud or error

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 c) To provide the auditor with:
o Access to all information of which management is aware that is
relevant to the preparation of the financial statements such as
records, documentation, and other matters
o Additional information that the auditor may request from the
management for the purpose of the audit
o Unrestricted access to persons within the entity from whom the
auditor determines it necessary to obtain audit evidence.

Limitation on Scope Prior to Audit Engagement Acceptance

If the management or those charged with governance impose a limitation on the
scope of the auditor’s work in the terms of a proposed audit engagement such that the
auditor believes the limitation will result in the auditor disclaiming an opinion on the
financial statements, the auditor shall not accept such limited engagement as an
audit engagement, unless required by law or regulation to do so.
Other Factors Affecting Audit Engagement Acceptance
If the preconditions for an audit are not present, the auditor shall discuss the
matter with the management. Unless required by law or regulation to do so, the
auditor shall not accept the proposed audit engagement:
a. If the auditor has determined that the financial reporting framework to be
applied in the presentation of the financial statements is unacceptable; or
b. If the agreement of management that it acknowledges and understands its
responsibility has not been obtained.

B. AGREEING TO THE TERMS OF AUDIT ENGAGEMENT

The agreed terms shall be recorded in an audit engagement letter or other

suitable form of written agreement.
It is in the interest of both the entity and the auditor that the auditor sends an
engagement letter, preferably before the commencement of the audit to help avoid
misunderstandings with respect to the audit.
Form and Content of Engagement Letter
a. The objective and scope of the audit of the financial statements
b. The responsibilities of the auditor
c. The responsibilities of the management
d. Identification of the applicable financial reporting frameworks for the
preparation of the financial statements; and
e. Reference to the expected form and content of any reports to be issued by the
auditor and a statement that there may be circumstances in which a report
may differ from its expected form and content.

IMPORTANT NOTES

⮚ If law or regulation prescribes in sufficient detail the terms of the audit

engagement, the auditor need not record them in a written agreement, except
for the fact that such law or regulation applies and that management
acknowledges and understands its responsibilities.
⮚ Even if the objective and scope of an audit and the responsibilities of
management and the auditor may be sufficiently established by the law of a

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 particular country, the auditor many nevertheless consider it appropriate to
include the matters in an engagement letter for the information of management.

An audit engagement letter may make reference to RA FORMS

a. The presence of audit Risk (unavoidable risk because of inherent limitations of
audit)
b. Unrestricted Access to whatever records
c. The financial reporting Framework used
d. The Objective of the audit
e. The form of any Reports or other communication
f. Management’s responsibility
g. Elaboration of the Scope of the audit

The auditor may also include in the letter: (FRAP Reports)

a. Basis in which Fees are computed and any billing arrangements
b. The expectation of receiving Representation letter
c. Acknowledgement of management of terms of agreement
d. Arrangements regarding the Planning of the audit
e. Description of any other letters or Reports

When relevant, the ff. points could also be made:

a. Arrangements concerning the involvement of other auditors and experts in
some aspects of the audit.
b. Arrangements concerning the involvement of internal auditors and other staff of
the entity.
c. Arrangements to be made with the previous auditor, if any, in the case of the
initial audit.
d. Any restriction of the auditor’s liability when such possibility exists.
e. A reference to any further agreements between the auditor and the entity.
f. Any obligations to provide audit working papers to other parties.

Audit of Components
When the auditor of a parent entity is also the auditor of its subsidiary, branch, or
division (component), the factors that influence the decision whether to send a
separate engagement letter to the component include the ff (CLOSI):
a. Who appoints the Component auditor
b. Legal requirements in relation to audit appointments
c. Degree of Ownership by parent
d. Whether a Separate auditor’s report is to be issued on the component
e. Degree of Independence of the component’s management from the parent
entity.

Recurring Audits
The auditor may not send a new engagement letter each period. However, the send a
new letter because of the following factors:

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 a. Any indication that the client misunderstands the objective and scope of the
audit.
b. Any revised or special terms of the engagement
c. A recent change of management, board of directors or ownership
d. A significant change in ownership
e. A significant change in the nature or size of the client’s business
f. A change in legal or regulatory requirements
g. A change in financial reporting framework adopted in the preparation of the
financial statements
h. A change in other reporting requirements

Acceptance of a change in engagement

The auditor shall not agree to a change in the terms of the audit engagement
where there is no reasonable justification for doing so.

Circumstances Reasonably
Justifiable
Change in circumstances affecting the need for the service Yes
A misunderstanding as to the nature of an audit or related Yes
services originally requested
A restriction on the scope of the management, whether imposed No
by management or caused by circumstances
If the change relates to information that is incorrect, incomplete, No
or otherwise unsatisfactory
The auditor is unable to obtain sufficient appropriate audit No
evidence regarding assertions

Auditor’s Response for a Change in Engagement

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 Stop performing the old engagement

Stop referring to the old enaggaement, ecxept

when the new engagement involves agreed-upon
procedure
Yes

Start performing the new engagement. Alll

procedures to be performed, information to
be obtained, and reports to be issued should
Is there a be related to new engagement.
reasonable
justification?
Continue the original audit engagamet

When prohibited to continue, withdraw from

No the audit engagement.

Note: Everytime withdrwal is made, the

auditor should consider the necessity of
communicatig the reaosn to appropariate
level of management.