Substantive Testing

(Evidence-Gathering and
Documentation)

Slide 5- 1

Success is often viewed as something

that happens overnight. Nothing can be
further from the truth. In reality, a
seemingly overnight success had, in its
wake, the evidence of long and hard
preparation and the hope that the day of
victory will come.
-Anonymous
Slide 5- 2

Audit Evidence-What is it?

It is all the information used by the auditor in
arriving at the conclusions on which the audit
opinion is based.
It includes the information contained in the
accounting records underlying the financial
statements and other information or
corroborating information.

Slide 5- 3

Why Gather Audit

Evidence?
A professional requirement by PSA 500
It is necessary to support the auditors
opinion and report.

Slide 5- 4

How is Audit Evidence

Accumulated?
PSAs describe three categories of procedures for gathering
audit evidence.
Category

Description/Purpose

Risk Assessment
Procedures

Used for obtaining an understanding of the client

entity and its environment, including internal
control. They are performed during the audit
planning and internal control phases of the audit.

Test of Controls

Used to test the operating effectiveness of

controls in preventing, or detecting and
correcting, material misstatements.

Substantive tests

Used to detect material misstatements in account

balances, classes of transactions and disclosures.

Slide 5- 5

Nature of Evidence

Slide 5- 6

It is cumulative in nature and is primarily

obtained from audit procedures
performed during the course of the
audit.

Main sources of evidence

Evidential matter supporting the
financial statements consists of the
accounting records and other
information.
Accounting records are those which
underlie the financial statements.
Other information (corroborating
information) supports the underlying
accounting data obtained from client
and other sources.

Slide 5- 7

Main sources of evidence

Evidential matter supporting the
financial statements consists of the
accounting records and other
information.
Accounting records are those which
underlie the financial statements.
Other information (corroborating
information) supports the underlying
accounting data obtained from client
and other sources.

Slide 5- 8

Relationship of Audit
Evidence to Management
Assertions
Audit evidence is gathered as a basis
for expressing an opinion on whether
the assertions of management are fairly
stated.
A given set of procedures may provide
audit evidence that is relevant to certain
assertions, but not others.

Slide 5- 9

Relationship of Audit
Evidence to Management
Assertions
For

example:

Inspection of records and documents

related to the collection of receivables
after the period end may provide
evidence regarding both existence and
valuation, although not necessarily the
appropriateness of period-end cutoffs.

Slide 5- 10

Sufficiency and
Appropriateness of Evidential
Matter

The auditors judgment as to what is sufficient

appropriate evidence is influenced by such
factors as:
The degree of risk of misstatement;
The materiality of the item in relation to the financial
statements taken as a whole;
The experience gained during the previous audits;
The result of auditing procedures, including fraud or
errors which may have been found; and
The type of information available

Slide 5- 11

Sufficiency

It is the measure of the quantity of evidence.

It is affected by:
the risk of misstatement (the greater the risk, the more
audit evidence is likely to be required);
the quality of audit evidence (the higher the quality, the
less may be required);
The materiality of the item being examined (the more
material the FS being examined, the more evidence);
and
Experience gained during previous audit may indicate
the amount of evidence taken before and whether such
evidence was enough.

Slide 5- 12

Appropriateness

To be appropriate, evidence must be both valid

and relevant.
The validity of evidential matter is so dependent
on the circumstances under which it is obtained
that generalizations about the reliability to various
types of evidence are subject to important
exceptions.

Slide 5- 13

Appropriateness

Relevance
Evidence must affect the auditors ability to
accept or reject a specific financial
statement assertion.
It relates to the timeliness of evidence and
its ability to satisfy the audit objective.

Slide 5- 14

Appropriateness

Relevance
Evidence obtained is evaluated in terms of
its usefulness either in corroborating or
contradicting an assertion.
Evidence is relevant to the extent that it
serves either of those purposes.

Slide 5- 15

Appropriateness

Reliability
It is the quality of information that assures
that information is reasonably free from
error and bias and faithfully represents
what it purports to represent.
It is influenced by its source and by its
nature and is dependent on the individual
circumstances under which it is obtained.

Slide 5- 16

Appropriateness

Generalizations about the reliability of

evidence
Evidence obtained by the auditor from
independent sources outside the client is
usually more reliable than that from within
the client.
Evidence is more reliable when it exists in
documentary form.

Slide 5- 17

Appropriateness

Generalizations about the reliability of

evidence
It must be obtained from people who are
competent and have the qualifications to
make the information free from error.
However, the auditor should not conclude
that the higher a persons position in the
client, the better qualified that person is to
provide evidence.

Slide 5- 18

Appropriateness

Generalizations about the reliability of

evidence
Audit evidence that is generated internally
is more reliable when the related controls
imposed by the entity are effective.
Audit evidence obtained directly by the
auditor is more reliable than that obtained
indirectly or by inference.

Slide 5- 19

Cost-benefit considerations

Slide 5- 20

An auditors opinion, to be economically

useful, must be formed within a reasonable
length of time and at reasonable cost.
The auditor must decide, exercising
professional judgment, whether the evidential
matter available to him within the limits of time
and cost is sufficient to justify expression of an
opinion.

Relationships Among
Assertions, Objectives and
Procedures

Slide 5- 21

In obtaining evidential matter in support of

financial statement assertions, the auditor
develops specific audit objectives in the light
of those assertions.
After setting audit objectives, the auditor
considers the type of evidence to be obtained,
and the audit procedures necessary to obtain
this evidence.

Example: Audit Program for Owners Equity

Sample
Assertions

Audit Objectives

Audit Procedures

1. Existence and
Occurrence

To determine the validity

of recorded stockholders
equity balances and
whether the transactions
actually occurred

1. Obtain schedules of
stockholders equity
accounts and reconcile
to the general ledger
balances.
2. Review authorizations
and terms of stock
issues.

2.Completeness

To determine whether
recorded stockholders
equity accounts reflect all
data that should be
recorded

3. Perform analytical
review procedures

3.Rights and
obligations

To determine whether the

entity has the authority to
execute stockholders
equity transactions

4. Review articles of
incorporation and the
related by-laws.

Slide 5- 22

Audit Procedures
1. Inspection of Records or Documents
This consists of examining records or
documents, whether internal or external,
in paper form, electronic form, or other
media.

Slide 5- 23

Audit Procedures
2. Inspection of Tangible Assets
This consists of physical examination
of the assets.
This may provide reliable audit
evidence with respect to their existence,
but not necessarily about the entitys
rights and obligations or the valuation of
the assets.
Slide 5- 24

Direction of the Test Vouching

Examination of documents that support
a recorded transaction or amount.
The direction of testing must be from the
recorded item to the supporting
documents.
Tests existence or occurrence.
Also tests if transaction was properly
authorized.

Slide 5- 25

Direction of the Test Tracing

The primary test for unrecorded items
and therefore tests the completeness
assertion.
The direction of testing must be from the
supporting document to the recorded
item.
Also used to test if transactions were
recorded in rightful accounts.

Slide 5- 26

Audit Procedures
3. Observation

Auditor witnesses the physical activities of the

client.
Useful in obtaining evidence that controls which
leave no documentary evidence of application or
existence are in operation.
Differs from physical examination because
physical examination counts assets, while
observation focuses on client activities e.g.
inventory counting.

Slide 5- 27

Audit Procedures
4. Inquiry

This consists of seeking information of

knowledgeable persons, both financial and nonfinancial, throughout the entity or outside the
entity.
It may range from formal written inquiries to
informal oral inquiries.

Slide 5- 28

Audit Procedures
5. Recalculation

This consists of checking the mathematical

accuracy of documents or records.
This can be performed through the use of
information technology, for example, by obtaining
an electronic file from the entity and using
Computer-Assisted Auditing Techniques (CAATs)
to check the accuracy of the summarization of the
file.

Slide 5- 29

Audit Procedures
6. Reperformance

It is the auditors independent execution of

procedures or controls that were originally
performed as part of the entitys internal control,
either manually or through the use of CAATs, for
example, reperforming the aging of accounts
receivable.

Slide 5- 30

Audit Procedures
7. Confirmation
It is the process of obtaining and evaluating audit
evidence through the receipt of a written or oral
response from an independent third party.

Customers confirm A/C receivable balances

Suppliers confirm A/C payable balances
Banks confirm account/loan balances
Lawyers confirm contingent liabilities

Slide 5- 31

Audit Procedures
7. Confirmation
This provides reliable and relevant audit
evidence regarding the existence of the
account as at a certain date. It also provides
audit evidence regarding the operation of
cutoff procedures. However, it does not
ordinarily provide all the necessary evidence
regarding valuation assertion.
Slide 5- 32

Audit Procedures
7. Confirmation (FORMS)
a. Positive Confirmation
-Asks the respondent to reply in all cases
either by indicating the respondents
agreement with the given information, or by
asking the respondent to fill in information.
-There is a risk that a respondent may reply
without verifying that the information is
correct.
Slide 5- 33

Audit Procedures
7. Confirmation (FORMS)
a. Positive Confirmation
- Auditor may reduce this risk by not stating
the amount and asking the respondent to fill in
the amount or furnish other information.
-However, this may result in lower response
rates because additional effort is required of
the respondents.
Slide 5- 34

Audit Procedures
7. Confirmation (FORMS)
b. Negative Confirmation
- Asks the respondent to reply only in the
event of disagreement with the information
provided in the request.
-This provides less reliable audit evidence
than in positive confirmation.

Slide 5- 35

Audit Procedures
7. Confirmation (FORMS)
b. Negative Confirmation
- When no response is received to the
request, the auditor does not have assurance
that the intended third parties have received
the confirmation requests and verified that the
information therein is correct.
-Accordingly, other substantive procedures
are performed as supplement.
Slide 5- 36

Audit Procedures
7. Confirmation (FORMS)
b. Negative Confirmation
- This may be used when:
Assessed risk of material misstatement is lower;
A large number of small balances is involved;
A substantial number of errors is not expected;
and
The auditor has no reason to believe that
respondents will disregard these requests.
Slide 5- 37

Audit Procedures
7. Confirmation
When the auditor seeks to confirm certain
balances or other information, and
management requests the auditor not to do
so, the auditor should consider whether there
are valid ground for such a request and obtain
evidence to support the validity of
managements requests.
Slide 5- 38

Audit Procedures
7. Confirmation
If the auditor agrees to managements
request not to seek external confirmation
regarding a particular matter, the auditor
should apply alternative audit procedures to
obtain sufficient appropriate audit evidence
regarding that matter.

Slide 5- 39

Audit Procedures
7. Confirmation
If the auditor does not accept the validity of
managements request and is prevented from
carrying out the confirmations, there has been
a limitation on the scope of the auditors work
and the auditor should consider the possible
impact on the auditors report.

Slide 5- 40

Audit Procedures
8. Analytical Procedures
Auditors study the plausible relationships
among financial and non-financial data.
These also encompass the investigation
of identified fluctuations and relationships
that are inconsistent with other relevant
information or deviate significantly from
predicted amounts.
Slide 5- 41

Audit Procedures
When the aforementioned audit
procedures (1 through 8) are used to
detect material misstatements in
account balances, classes of
transactions and disclosures, or to
substantiate the account balances,
these are used as substantive audit
procedures.
Slide 5- 42

Substantive Procedures
Substantive procedures provide direct
evidence as to the validity of a
transaction or balance in the records.
There are two general types of
substantive tests: test of details of
transactions, balances and
disclosures and analytical review
procedures.

Slide 5- 43

Analytical Procedures
Data interrelationships (i.e., analytical
procedures) rely on plausible
relationships among financial and nonfinancial data.

Effective for testing reasonableness of

certain account balances
Can be used as primary or corroborating evidence,
depending on the nature of account

Slide 5- 44

Analytical Procedures
Analytical Procedures are useful in identifying
among other things:
Differences that are not expected.
The absence of differences when they are
expected.
Potential errors, irregularities or illegal acts.
Other unusual or non recurring transactions
or events.
Slide 5- 45

Analytical Procedures
If a change in one area would naturally lead
to a change in some other area, the
absence of the expected change should
lead to a further study in search of the
cause.
Ex. If commissions paid to sales
representatives rise in one quarter, it would
be reasonable to expect a correspondence
increase in sales revenue.

Slide 5- 46

Examples
Relationship of marketing expenditure to
sales.
Relationship of interest income to interest
earning assets.
Relationship of interest expense to debt
balances.
Such relationships are assumed to remain
the same unless some unknown condition
causes a change.

Slide 5- 47

Forms of Analytical
Procedures

Comparisons:
Current period information with similar
information for prior periods.
Current info with budgets or forecasts.
Info for the audited unit with info for other
organisational units.
Information for the audited unit with similar
information for the industry in which the
organisation operates.

Slide 5- 48

Analytical Procedures

Relationships:
Study of relationships of financial info with
appropriate non financial info e.g. changes
in payroll expense compared to changes in
average number of employees.
Study relationships among elements of
information.

Slide 5- 49

Analytical Procedures
When analysis uncovers unexpected results,
auditors should undertake further study e.g.
making inquiries to management & applying
other audit procedures. The explanation may
lie in errors, irregularities or illegal acts.
Further study should continue until the
auditor is satisfied that the results have been
sufficiently explained.

Slide 5- 50

Analytical Procedures

When intending to perform the analytical

procedures as substantive tests, the auditor
should focus on the accounts that are
predictable.

Slide 5- 51

Analytical Procedures

1.
2.

3.

Relationships differ in their predictability. Accordingly:

Relationships in a dynamic or unstable environment are
less predictable than those in a stable environment.
Relationships involving balance sheet accounts are less
predictable than income statement accounts (because
balance sheet accounts represent balances at any one
arbitrary point in time).
Relationships involving management discretion are
sometimes less predictable (e.g. decision to incur
maintenance expense rather than replace plant).

Slide 5- 52

Analytical Procedures

1.

2.

3.

LIMITATIONS:
The guidelines for evaluation may be inadequate (e.g.
Why is an industry average good? Why should the ratio
be the same as last year?
It is difficult to determine whether a change is due to a
misstatement or is the result of random changes in the
account.
Analytics present only circumstantial evidence in that a
significant evidence will lead to additional audit
procedures as opposed to direct detection of a
misstatement.

Slide 5- 53

Test of Details

Test of details involves examining the actual details

making up the various account balances.
Test of balances v. Test of transactions
Test of balances involves direct testing of the
ending balance of an account.
Test of transactions involves testing the
transactions which give rise to the ending balance
of an account.

Slide 5- 54

Test of Details

Test of details involves examining the actual details

making up the various account balances.
Test of balances v. Test of transactions
Test of balances involves direct testing of the
ending balance of an account.
Test of transactions involves testing the
transactions which give rise to the ending balance
of an account.

Slide 5- 55

Test of Details

Test of balances will be used when account

balances are affected by large volume of relatively
immaterial transactions, e.g. cash, receivables,
and inventory.
Test of transactions is useful if account balances
are comprised of a smaller volume of transactions
representing relatively material amounts, e.g.
property and equipment, intangibles, bonds
payable, and stockholders equity accounts.

Slide 5- 56

Effectiveness of
Substantive Tests

Nature of Substantive Tests

This relates to the quality of evidence. The

appropriate quality of evidence needed to
support the desired level of detection risk.
Although the auditor would normally prefer
high quality evidence, it is important to
realize the high quality evidence would
also involve high cost.
Slide 5- 57

Effectiveness of
Substantive Tests

Timing of Substantive Tests

Interim procedures are generally

considered less effective due to
incremental audit risk involved when
auditing interim balances.
Thus, the higher the risk of misstatement,
the more likely it is to perform substantive
tests nearer to, or at year end.
Slide 5- 58

Effectiveness of
Substantive Tests

Timing of Substantive Tests

Test of details before year-end (Early substantive

testing) is desirable if the client wants the audit to be
completed shortly after year-end.
When considering early substantive testing of a
specific account, the auditor should consider the
relationship of that account to others in the financial
statements and the extent to which a single
substantive test may apply to more than one account.
For example, a cutoff test of shipments relates to
sales, accounts receivable, cost of sales, and
inventory accounts.
Slide 5- 59

Effectiveness of
Substantive Tests

Timing of Substantive Tests

When considering early substantive testing of a
specific account, the auditor should have to obtain
satisfaction that, for the balances tested early, the
risk of material misstatement is low during the
intervening period between the early testing date
and year-end.
Generally the auditor obtains that satisfaction by
performing test of controls directed at the design
and operation of relevant control structure policies
and procedures during intervening period.

Slide 5- 60

Effectiveness of
Substantive Tests

Extent of Substantive Tests

This relates to the amount of evidence needed to
satisfy a particular objective.
This is based on the auditors judgment after
considering the materiality, the assessed risk, and
the degree of assurance the auditor plans to obtain.
In particular, the auditor ordinarily increases the
extent of substantive procedures as the risk of
material misstatement increases.

Slide 5- 61

Relationship between ST
and TOC

Test of Controls provides evidence that indicates a

misstatement is likely to occur.
Substantive Tests provide evidence about the
existence of misstatement in an account balance.
The result of tests of control is a major factor in
determining the nature, timing, and extent of
substantive tests.
If a misstatement is likely to occur due to an ineffective
internal control, the auditor will then perform
substantive tests to determine whether material
misstatements actually do exist.

Slide 5- 62

Selection of Audit
Procedures

The criteria for selection of the most

suitable technique can be based on the
following:
Will the technique meet the objectives of the
audit stage or phase?
Has the auditor the skills to use the procedure?
Is the material to be audited available and in a
condition to be used with the audit procedure.

Slide 5- 63

Selection of Audit
Procedure
Will the procedure be cost effective?
E.g. will the time and effort to perform
the procedures far exceed the benefit of
using it?
Will the conclusions reached after using
the procedure be valid?

Slide 5- 64

Audit Documentation
Audit documentation is the principal record
of auditing procedures applied, evidence
obtained, and conclusions reached by the
auditor.
Audit Evidence is documented in Audit
working papers.

Slide 5- 65

Working Papers - Functions

Audit working papers achieve following

primary functions:
Support the auditors opinion on financial
statements;
Support auditors representation as to
compliance with PSA; and
Assist the auditor in the planning,
performance, review and supervision of
the engagement.

Slide 5- 66

Working Papers - Functions

Secondarily:
Plan future audits;
Provide information useful in rendering other
services; and
Provide adequate defense in case of litigation.

Slide 5- 67

Key Characteristics of
Work Papers
Complete
Concise
Accurate
Organized

Slide 5- 68

Characteristics

Completeness:
Each Working paper should be completely
self standing and self explanatory. All
questions must be answered, all points
raised by the reviewer must be cleared and
a logical, well thought-out conclusion
reached for each audit segment.

Slide 5- 69

Characteristics

Accurate:
High quality work papers include
statements and computations that are
accurate and technically correct.

Slide 5- 70

Characteristics

Organization:
Work papers should have a logical system
of numbering and a reader friendly layout
so a technically competent person
unfamiliar with the project could understand
the purpose, procedures performed, and
results.

Slide 5- 71

Characteristics

Relevance & Conciseness:

Audit work papers and items included on
each work paper should be relevant to
meeting the applicable audit objective.
Work papers must be confined to those that
serve a useful purpose.

Slide 5- 72

Form, Content, and Extent

of Audit Documentation

a)

b)
c)

Slide 5- 73

The auditor should consider what would an

experienced auditor, having no previous
connection with the audit, to understand:
The nature, timing, and extent of the audit
procedures performed to comply with PSAs and
applicable legal and regulatory requirements.
The results of the audit procedures and the audit
evidence obtained; and
Significant matters arising during the audit and
the conclusions reached thereon.

Form, Content, and Extent

of Audit Documentation
Significant matters include, amongst others:
1. Matters that give rise to significant risks.
2. Results of audit procedures indicating that the
financial information could be materially
misstated, or a need to revise the auditors
previous assessment of the risks of material
misstatements and the auditors response to
those risks
3. Circumstances that cause the auditor significant
difficulty in applying necessary audit procedures.
4. Findings that could result in a modification to the
auditors report.
Slide 5- 74

Form, Content, and Extent

of Audit Documentation
Factors affecting the form, content and
extent of audit documentation:
a. Nature of the audit procedures to be
performed;
b. Identified risks of material misstatements;
c. Extent of judgment required in performing
the work and evaluating the results;

Slide 5- 75

Form, Content, and Extent

of Audit Documentation
Factors affecting the form, content and extent of audit
documentation:
d. Significance of the audit evidence obtained;
e. Nature and extent of exceptions identified;
f. Need to document a conclusion or the basis for a
conclusion not readily determinable from the
documentation of the work performed or audit evidence
obtained; and
g. Audit methodology and tools used.

Slide 5- 76

Classification of Work
Papers

Permanent File:
Keeps information that is relevant for
multiple years on recurring engagements.

Current File:
Information relevant for a given audit
project/engagement.

Slide 5- 77

Classification of Work
Papers

Permanent File:
Copies of the articles of incorporation and bylaws
Major contracts
Engagement letter
Organizational chart
Analyses of long-term accounts such as plant
assets, long-term liabilities and stockholders
accounts
Internal control analyses

Slide 5- 78

Classification of Work
Papers

Current File:
A copy of the financial statements
Audit program
Working trial balance
Lead schedule
Detailed schedules
Correspondence with other parties such as
lawyers, customers, banks, and management.
(and other confidential letters)

Slide 5- 79

Working Paper Storage

Can be stored in manual or electronic
form.
For electronic files:

Back up frequently.
Include the file name in the footer.
Develop an organisation method.

Slide 5- 80

Ownership of Working
Papers
They are the property of the auditor and the
client has no right to the working paper
prepared by the auditor.
They nay sometimes serve as a reference
source for the client (at the discretion of the
auditor) but they should not be considered
as part or as a substitute for the clients
records.

Slide 5- 81

Assembly of Working
Papers

The auditor is required to complete the

administrative process of assembling the
final audit file on a timely basis after the date
of the auditors report. The time limit within
which to complete the assembly of the audit
file is ordinarily not more than 60 days after
the date of the auditors report.

Slide 5- 82

Confidentiality of Working
Papers
Although they are the personal property of
the auditor, working papers can not be
shown to third parties without the clients
permission.
Section 4 of the Philippine Code of
Professional Ethics requires the CPA to
respect the confidentiality of information
obtained during the course of performing
professional services.

Slide 5- 83

Confidentiality of Working
Papers

However, in some instances the duty of

confidentiality is overridden by the statute of law.
For example, the auditor can disclose confidential
information to third parties even without the clients
consent under the following circumstances:
When disclosure is required by law or when the working
papers are subpoenaed by a court
When there is professional right to disclose information
such as when the auditor uses his working papers to
defend himself when sued by the client for negligence.

Slide 5- 84

Retention of Working
Papers

They should be retained by the auditor for a

period of time sufficient to meet the needs of
the auditing practice and to satisfy any
pertinent legal requirements of record
retention.

Slide 5- 85

Guidelines for Preparation

of Working Papers

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 systems. This
is to aid in cross-referencing essential information.

Slide 5- 86

Guidelines for Preparation

of Working Papers

Cross-indexing/ cross referencing

This is important to provide a trail used in reviewing the
working papers.

Tick marks
They must include symbols that describe the audit
procedures performed.

Slide 5- 87

AUDITING ACCOUNTING
ESTIMATES

Accounting estimate is an approximation of the

amounts of an item in the absence of a precise
means of measurement. Examples include:

Allowance for doubtful accounts

Depreciation and amortization
Loss contingencies
Warranty claims

The risk of material misstatements is greater when

accounting estimates are involved.

Slide 5- 88

AUDITING ACCOUNTING
ESTIMATES

Making estimates is the responsibility of

management.
The auditors responsibility is to obtain sufficient
appropriate evidence as to whether:
the estimate is properly accounted for and
disclosed
The estimate is reasonable in the circumstances

Slide 5- 89

AUDITING ACCOUNTING
ESTIMATES
The auditor may evaluate the estimates by the
following means:
a. Review and test the process used by
management to develop the estimate. This will
often involve:
. Evaluating data and management assumptions;
. Testing of calculations;
. Comparing prior period estimates with actual
results, and
. Considering management approval procedures.

Slide 5- 90

AUDITING ACCOUNTING
ESTIMATES

The auditor may evaluate the estimates by the

following means:

b. Make an independent estimate

The auditor may make or obtain an independent estimate
and compare it with the accounting estimate prepared by
management.
c. Review subsequent events which confirm the estimate
made
Transactions and events which occur after period end, but
prior completion of the audit, may provide sufficient
appropriate evidence regarding an accounting estimate
made by management.
Slide 5- 91

END

QUESTIONS?

Slide 5- 92

END

THANK YOU!

Slide 5- 93