RISK

RESPONSE
PART II
01. INTRODUCTION 05. RELATIONSHIP
TO OBJECTIVES
OF EVIDENCE

02. SUFFICIENT APPROPRIATE

AUDIT 06. EVIDENCE ABOUT
ACCOUNTING ESTIMATE

INTERRELATIONSHIP BETWEEN RISK,

03. APPROPRIATENESS & SUFFICIENCY
OF AUDIT EVIDENCE 07. EVIDENCE FOR RELATED
PARTY TRANSACTION

04. PROCEDURES FOR

OBTAINING AUDIT EVIDENCE
01.

INTRODUCTION
IMPLEMENTING THE DESIGNED RISK RESPONSE
AND OBTAINING AUDIT EVIDENCE

⚬ This phase involves implementing the designed risk response and

accumulating evidence about internal control effectiveness, accounts,
disclosures, and assertions.

⚬ PSA 500, "Audit Evidence" explains what constitutes audit evidence in an

audit of financial statements, and deals with the auditor's responsibility to
design and perform audit procedures to obtain sufficient appropriate
audit evidence to be able to draw reasonable conclusions on which to
base the auditor's opinion.
 Nature and Significance of Audit Evidence

⚬ Audit evidence encompasses all information used by the auditor to form

conclusions for their audit opinion. This includes data from accounting
records and other relevant information.
⚬ Audit evidence is cumulative and may include data from previous audits and
a firm's quality control procedures.
⚬ Sometimes called as evidential matter, which is the main output/product of
performing audit procedures.
What Constitutes Audit Evidence
⚬ Accounting records generally include the records of initial
entries and supporting records (checks and records of
electronic fund transfer, invoices, contracts), the general and
subsidiary ledgers, journal entries, and supporting worksheets.

⚬ Other information that the auditor may use as audit evidences

includes minutes of meetings, confirmations from third parties,
analysts’ reports, and comparative data.

⚬ Information that contradicts management assertions.

Nature of Audit Evidence

ACCOUNTING RECORDS CORROBORATING

(UNDERLYING DATA) EVIDENCE

• Record of initial accounting • Documents e.g. checks, bank statements,

entries. contracts, minutes of the meeting.
• Supporting records e.g. checks, • Information obtained from other sources
records of electronic transfers, e.g. previous audits, confirmation from third
invoices and contracts. parties, industry analysts’ reports,
• General and subsidiary ledgers. comparable data from competitors, client
• Journal entries and other written representation.
adjustments to in formal journal • Information obtained from audit
entries. procedures e.g. inquiry, observation, etc.
• Records e.g. worksheets and • Other information developed by, or
spreadsheets supporting cost available to, the auditor that permits the
allocations, computations, etc. auditor to reach conclusions through valid
reasoning.
Types of Audit Evidence

• Physical Evidence
• Mathematical Re-computations
• Documentation
• Representation by third parties (or confirmation)
• Representation by client personnel
• Results of Analytical Procedures
• Internal Control
• Subsequent events
02.

SUFFICIENT
APPROPRIATE
AUDIT
 Sufficient Appropriate Audit Evidence

⚬ Auditors must obtain sufficient appropriate audit evidence

to draw reasonable conclusions and base their audit opinion
on it.

⚬ Sufficiency and appropriateness apply to both tests of

control and substantive procedures, emphasizing the need
for persuasive rather than conclusive evidence.
 The auditor’s judgment regarding
sufficient appropriate audit evidence
is influenced by factors such as:

⚬ Assessment of inherent risk levels

⚬ Nature of accounting and internal control systems

⚬ Materiality of the item examined

⚬ Experience from previous audits

03.
INTERRELATIONSHIP
BETWEEN RISK,
APPROPRIATENESS &
SUFFICIENCY OF
AUDIT EVIDENCE
 APPROPRIATENESS

Relevance Reliability

Quality of Evidence
that the auditor collects

RISK
that account is
Materially Misstated

Inherent Risk Control Risk

SUFFICIENCY
Quantity of Evidence
that the auditor collects
 APPROPRIATENESS
Appropriateness of audit evidence is the
measure of the quality - the relevance and
reliability in providing support for the
conclusionn which the auditor’s opinion is based.

SUFFICIENCY
Sufficeincy of audit evidence refers to the
measure of the quantity of audit evidence. The
quantity is affected by the auditor’s assessment
of the risk of material misstatement and the
quality of such audit evidence
 AUDITOR’S RESPONSIBILITIES AND CONSIDERATIONS
IN GATHERING & EVALUATING AUDIT EVIDENCE
Persuasive Audit Evidence
• Evidence is more convincing when consistent across different sources or types.
• Combining consistent evidence gives a stronger level of confidence than considering
each item separately.
• If evidence from different sources conflicts, the auditor must perform additional
procedures to resolve the inconsistency.
Cost vs. Usefulness
• Auditors should consider the cost of gathering evidence vs. how useful the information is.
• However, cost or difficulty is not an excuse to skip necessary procedures.
Sufficient Appropriate Audit Evidence
• If there is serious doubt about a material financial statement assertion, the auditor
should seek more evidence.
• If the auditor cannot obtain enough evidence, they may need to issue a qualified opinion
(limited assurance) or a disclaimer of opinion (no opinion given) if he is unable to gather
such evidence
 APPROPRIATENESS

RELIABILITY RELEVANCE
dependent on individual
influenced circumstance
by: its
its Assessing Audit Evidence’s Reliability
SOURCE NATURE Audit evidence is more reliable when:
• Internal • Visual
• obtained from independent sources outside the entity
• External • Documentary • related controls over internally generated evidence are
• Oral effectively imposed by the entity
• obtained directly by the auditor than obtained indirectly
or by inference
• it exists in documentary form (paper, electronic, or other
medium) than oral
• provided by original documents than photocopies or
facsimile
 Competence or Appropriateness
of Evidence
• competence and appropriateness of evidence referes to trustworthiness
or believability

Factors that determine the Competence of Evidence

1. Relevance of the evidence to the particular assertion being tested
[Link] of evidence
[Link] of the provider of the evidence
[Link] of the evidence
 Hierarchy of Evidential Matter
Auditor’s direct, personal knowledge,
physical observation, and own
mathematical computation

External evidence

External-internal evidence

Internal evidence

Verbal and written

representations from
client’s officers
 Sufficiency of Evidence
• sufficiency of evidence referes to the amount or quantity of evidence
gathered

Concept of Sufficiency
• accumulation of evidence should be persuasive rather than convincing
• consistent with the idea that auditor is not free to collect unlimited amounts of evidence
since he must work within economic limits
• Auditor’s use professional judgement to determine the extent of tests necessary to obtain
sufficient evidence, considering:
1. materiality of the item in question; and,
[Link] risk of the item

Since the competency of evidence depends upon the financial

statement assertion under consideration, the auditor should attempt
to gather sufficient quantity of competent evidence at a minimum cost.
04.

PROCEDURES
FOR OBTAINING
AUDIT
EVIDENCE
 Auditor obtains evidence by one or
more of the following procedures:

1. Inspection
2. Observation
3. Inquiry and Confirmation
4. Recalculation
5. Reperformance
6. Analytical Procedures
Inspection of Records or
Documentations
• It consists of examining records, documents, and
tangible assets.

• Documents can be either internal or external.

Internal Documents External Documents

-prepared and used -in the hands of
within the client’s someone outside
organization client’s organization

INSPECTION
Inspection of Tangible Assets

Physical examination of tangible assets

provides reliable audit evidence with
respect to their existence but not as to
their ownership.

INSPECTION
Confirmation
A process of obtaining a representation of
information or an existing condition
directly from a third party.
External confirmation describes the
receipt of a written response from an
independent third party, in a paper form,
or by electronic or other medium, verifying
the accuracy of information that was
requested by auditor.
Types of External Confirmation
1. Positive Request
[Link] Request

INSPECTION
Confirmation
Examples of situations where external
confirmation may be used includes the
following:
• Bank balances and other information
from bankers
• Accounts Receivables balances
• Inventories held by third parties at
bonded warehouses for processing or
on consignment
• Property title deeds held by lawyers or
financiers for safe custody or as
security
INSPECTION
Positive External Confirmation
Request
A request that the third party responds directly to
the auditor indicating whether they agree with the
information in the request.
This type of confirmation is necessary when:
• The available information to corroborate
management's assertion is only available outside
the entity.
• The entity's information system and internal
controls are unreliable or ineffective.
• Specific fraud risk factors, such as the risk of
management override of internal controls, prevent
the auditor from relying on evidence from the
entity.
INSPECTION
Negative External Confirmation
Request
A request that the third party responds directly to
the auditor only if they disagree with the
information provider in the request
This type of information is normally used
when:
• assessed level of inherent and control risk
is low
• large number of small balances is involved
• substantial numbers of errors is not
expected
• auditor has no reason to believe that
respondents will disregard these requests.
INSPECTION
Inquiry
Seeking information both financial and
nonfinancial of knowledgeable persons
inside or outside the entity.

The obtaining of written or oral information

from the client in response to questions
from the auditor.

INSPECTION
Written Representation
• Provides that audit evidence is all the information
used by the auditor in arriving at the conclusions
on which the audit opinion is based.
• The auditor shall request written
representation from the management with
appropriate responsibilities for the FS and
knowledge of the matters concerned.
• Representation letters may be obtained for
general representation, as described in PSA
580. It may also be obtained for limited
representations such us:
a. Accounts Receivable
b. Inventories
c. Liabilities
INSPECTION
Purpose of Management Representation
Letter
A. To document the management’s acknowledgment of its
responsibilities

B. To support the audit evidence relevant to the FS

C. To respond appropriately to written representations

received from management

INSPECTION
Observation consists of looking at a
process or procedure being performed by
others.

Limited to the time at which the

observation takes place and by the fact
that the act of being observed may affect
how the process or procedure is
performed.

OBSERVATION
Recalculation consists of checking
the mathematical accuracy of
source documents and accounting
records or performing independent
calculations.

RECALCULATION
Reperformance is the auditor’s
independent execution of procedures
or controls originally performed as
part of the entity’s internal control,
either manually or through computer
assisted audit techniques (CAAT).

REPERFORMANCE
Analytical Procedure consists of
evaluation of financial information made by
a study of plausible relationships among
both financial and nonfinancial data.

It encompass the investigation of

identified fluctuations and relationships
that are inconsistent with other relevant
information or deviate significantly from
predicted amounts.

ANALYTICAL
PROCEDURES
 The auditor shall apply analytical procedures at the
planning and overall review stages of the audit.
Analytical procedures may also be applied to other
stages, especially during substantive testing.

Analytical Procedures as used in substantive

testing
This procedure may be less effective compared to the
test of details but may apply to some account
balances. Moreover, it may enable the auditor to gather
sufficient appropriate evidence.

ANALYTICAL
PROCEDURES
 Analytical Procedures as Substantive
Procedures in Response to assessed Risks

• The auditor shall determine the suitability of using

substantive analytical procedures given the
assertion, assessed risks of material misstatement,
and test of details.
• Develop an expectation of recorded amounts or
ratios.
• Evaluate the reliability of internal or external data.
• Evaluate whether the expectations are sufficiently
precise to identify a misstatement.
• Determine the amount of any difference between
recorded amounts from expected values that are
accepted without further investigation.

ANALYTICAL
PROCEDURES
Investigating Results of Analytical Procedure

• The auditor shall investigate differences by

inquiring to the management and obtaining
appropriate audit evidence relevant to
management's response.
• Performing other audit procedures necessary in
the circumstances of corroboration of
management responses.

ANALYTICAL
PROCEDURES
Analytical Procedures in the overall review.

>The Objective of the Auditor

>Analytical procedures that assist in arriving at
the auditor's overall conclusion in an audit of
financial statements

>Performance of additional procedures

ANALYTICAL
PROCEDURES
SUMMARY
SUMMARY
05.

RELATIONSHIP
OF EVIDENCE
TO OBJECTIVES
 Relationship of Types of
Evidence to Audit Objectives
Since the auditor’s evaluation of the
fairness of the presentation of the financial
statements heavenly depends upon the
evidence of their fairness, care must be
taken to obtain as much evidence as is
needed to make a proper evaluation.
 Relationship of Types of
Evidence to Audit Objectives
It is important to have an understanding of the relationship of the type of
evidence to audit objectives. The audit objectives can be accomplished
with the use of the seven types of evidence.
1. Information Frequently Confirmed
[Link] Accounts Receivable Confirmation
[Link] Accounts Receivable Confirmation
[Link] Payable Confirmation
[Link]’s General Representation Letter
[Link]’s Representation Letter for Accounts Receivable
7. Client’s Representation Letter for Invetory

For a given account and related accounts in a Web, the auditor selects
evidence to accomplish all the objectives at minimum cost.
06.

EVIDENCE
ABOUT
ACCOUNTING
ESTIMATE
• Careful consideration must be given by the auditor on
financial statement accounts that are affected by
estimates made by management (often referred to as
accounting estimates), particularly those for which a wide
range of accounting methods are considered acceptable.

• Accounting estimate means an approximation of the

amount of an item in the absence of a precise means of
measurement.

• The auditor should obtain sufficient appropriate audit

evidence regarding accounting estimates.
 Examples of
Accounting Estimates

• Allowances to reduce inventory and accounts receivable

to their estimated realizable value.

• Provisions to allocate the cost of fixed assets over their

estimated useful lives.

• Accrued revenue.
 Nature of Accounting Estimates

• The determination of an accounting estimate may be

simple or complex depending upon the nature of the item.

• In complex estimates, there may be a high degree of

special knowledge and judgment required.

• Accounting estimates may be determined as part of the

routine accounting system operating on a continuing
basis, or may be non-routine, operating only at period end.
 Audit Procedures

"The auditor should obtain sufficient appropriate audit

evidence as to whether an accounting estimate is reasonable
in the circumstances and, when required, is appropriately
disclosed."
 The auditor should adopt one or a combination of the
following approaches in the audit of an accounting estimate:

(a) Review and test the process used by management to

develop the estimate.

(b) Use an independent estimate for comparison with that

prepared by management.

(c) Review subsequent events which confirm the estimate

made.
 Reviewing and Testing
the Process Used
by Management

The steps ordinarily involved in reviewing and testing of the process

used by management are:

(a) Evaluation of the data and consideration of assumptions on

which the estimate is based.

(b) Testing of the calculations involved in the estimate.

(c) Comparison, when possible, of estimates made for prior periods

with actual results of those periods.

(d) Consideration of management’s approval procedures.

 Evaluation of Results of Audit Procedures

"The auditor should make a final assessment of the

reasonableness of the estimate based on the auditor’s
knowledge of the business and whether the estimate is
consistent with other audit evidence obtained during the
audit."
 The evidence about accounting estimates is critical for
ensuring the reliability and accuracy of financial statements.
Since accounting estimates often involve subjective
judgment and uncertainty, auditors must gather sufficient
and appropriate evidence to assess the reasonableness of
the assumptions, methods, and data used in making those
estimates. The evidence should include a thorough
evaluation of historical data, management’s assumptions,
external information, and relevant calculations. The goal is to
ensure that the estimates are free from material
misstatements and that they appropriately reflect the
entity's financial position.
07.

EVIDENCE FOR
RELATED PARTY
TRANSACTIONS
 The term related parties refers to the client entity and any
other party with which the client may deal where one party
has the ability to influence the other.

Examples:
• Officers
• Directors
• Principal Owners
• Members of their immediate families
• Affiliated companies (subsidiaries)
 A related party transaction is any transaction between the
company and these parties (except for normal compensation
arrangements, expense allowances, and similar transactions
arising in the ordinary course of the business).

Auditors should be aware of the economic substance of

related party transactions because transactions with related
parties are not conducted at arm's length.
Common methods of identifying related parties include:

• Making inquiries of management and reviewing SEC

filings

• Stockholders' listings

• Conflict-of-interest statements.
Auditors will be alert for transactions with these
parties and any transactions with unusual terms
that might be indicative of related party
negotiations.
 Disclosure of Related Party Transactions

"The primary concern of the auditors is that material related

party transactions are adequately disclosed in the client’s
financial statements or the related notes."
Disclosure of related party transactions should include:

• The nature of the relationship

• A description of the transactions, including peso

amounts

• Amounts due to and from related parties, together with

terms and manner of settlement
 The evidence for related party transactions is essential for
ensuring transparency and fairness in financial reporting.
Since these transactions may not occur at arm's length, there
is a higher risk of bias or manipulation. Auditors must gather
sufficient and appropriate evidence to determine whether
the transactions are properly identified, disclosed, and
carried out on terms that reflect their economic reality. The
goal is to ensure that related party transactions are not used
to misstate financial statements or obscure the entity's true
financial position.