AUDIT THEORY
RESPONSE
PART 1
[Link]
AUDIT
THEORY
02. 03.
Introduction Types of Response
04. 05.
Nature of Audit The Relationship of Audit
Procedures Techniques, Audit
Procedures and Assertions
06.
Deciding the Number
of Items to Audit
AUDIT
THEORY
INTRODUCTION
RISK RESPONSE refers to the actions
and strategies that auditors employ
to address the risks identified during
the risk assessment phase of the
audit.
The Risk Response Phase in the Risk-Based
Audit Approach includes the following steps:
Designing the overall
audit responses and Performance of further
further audit procedures audit proceudres.
1. Performing planned
1. Updating overall audit
procedures.
strategy.
[Link] results and
[Link] response to
evidence obtained.
assess risks.
[Link] findings
[Link] team on audit
and conclusion
plans as required
Recap of Previous Topics
If there the
Designing are overall
further audit procedures (FAPs) in the risk response stage,
there
audit were risk
responses Performance
and assessment procedures of further
(RAPs) during the risk
further audit procedures
assessment stage. audit proceudres.
(RAPs) typically include:
RAPs are used by the auditors to
identify, evaluate and respond to - Understanding the entity and its environment
potential risks that may impact the including its internal control (through inquiry,
FS of the audit process itself. analytical procedures, observation,
inspection, etc.)
- Identifying and assessing RMM
- Preliminary assessment of risks
AUDIT
THEORY
Auditors need to design and implement overall responses to address the risks
identified and assessed at both the financial statement level and the assertion level
for financial statements and disclosures because these risks can lead to material
misstatements that may affect the reliability of the financial statements.
• Professional Skepticism: Reinforce the importance of applying professional
skepticism throughout the audit.
• Staffing: Determine the appropriate staff assignment, including specialists or
external experts if needed.
• Supervision: Assess the level of supervision required for the audit team.
• Unpredictability: Incorporate elements of unpredictability in selecting audit
procedures to reduce the risk of fraud detection evasion.
• Audit Procedure Adjustments: Make any necessary adjustments to the nature,
timing, or extent of audit procedures, such as shifting from interim to period-end
testing or expanding procedures to address specific risks like fraud.
AUDIT TYPES OF RESPONSE
THEORY
Auditor’s Response to Assessed Risks
The auditor’s overall response is determined at two levels:
1. Financial Statement Level - refers to risks that could have a pervasive impact
on the overall financial statements, affecting multiple accounts or disclosures,
such as issues related to management integrity, company-wide internal
controls, or accounting policies
2. Assertion Level - refers to the specific representations made by
management regarding individual financial statement components (such as
account balances, transactions, or disclosures) that auditors must test to
ensure the accuracy and completeness of the financial statements.
AUDIT TYPES OF RESPONSE
THEORY
To address these assessed risks, the auditor takes specific actions:
1. Overall Response which involves:
• Applying professional skepticism.
• Deciding the level of staff assignment, considering the need for special
skills or expertise.
• Ensuring ongoing supervision of staff.
• Evaluating accounting policies for appropriateness.
• Adjusting the nature, extent, and timing of audit procedures, and
incorporating elements of unpredictability.
AUDIT TYPES OF RESPONSE
THEORY
To address these assessed risks, the auditor takes specific actions:
2. Further Audit Procedures which are categorized into two types:
1. Substantive Procedures:
• Tests of Detail: In-depth checks of financial data. Further classified either
test of transactions and test of balances.
• Substantive Analytical : Analytical review to identify any irregularities.
2. Tests of Control: Evaluating the effectiveness of internal controls.
Result:
The combination of these responses ensures that sufficient appropriate audit
evidence is obtained to reduce audit risk to an acceptably low level.
AUDIT
NATURE OF AUDIT
THEORY
PROCEDURES
Audit procedures are the methods or acts that
auditors use to gather evidence to determine the
validity of financial statement assertions.
The various types of an audit procedures available
to the auditor are categorized as follows:
1. Test of Controls or Compliance Tests
[Link] Procedures
AUDIT TEST CONTROLS OR
THEORY
COMPLIANCE TESTS
These are audit procedures designed to evaluate the operating effectiveness
of controls in preventing, or detecting and correcting, material misstatements
at the assertion level.
Types of Compliance Tests:
1. NO TRAIL
• This type of compliance test does not leave a visible trail in supporting
documents.
• The auditor gives evidence through inquiries and observationof the client’s
personnel and routines to assess how control procedures are executed and
by whom.
AUDIT TEST CONTROLS OR
THEORY
COMPLIANCE TESTS
Types of Compliance Tests:
2. DOCUMENTARY TRAIL
• This type leaves a visible audit trail through supporting documents.
• The auditor inspects these documents to confirm whether control
procedures (such as approvals or authorizations) were properly applied
during transactions. Both methods help auditors evaluate the effectiveness
of internal controls in preventing or detecting material misstatements.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
These are audit procedures designed to detect material misstatements
at the assertion level. Substantive procedures comprise:
(i) Tests of details (of classes of transactions, account balances and
disclosures), and
(ii) Substantive analytical procedures.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
The auditor applies compliance tests when the purpose is to see
whether prescribed accounting control procedures are being followed.
This evaluation identifies the control procedures that can be relied
on in performing restricted substantive tests.
Substantive tests are applied when the auditor's purpose is to see
whether the peso amount of an account is properly stated.
Thus, there is a relationship between the amount of reliance and
the amount of additional work that will be needed.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
• Placed to detect material peso/monetary errors or fraud. Gather
evidence in respect to all material classes of transactions, account
balances or disclosures.
• Supports the validity of management’s assertions regarding the
financial statements.
• Frequently referred to as validation procedures because they provide
evidence about the existence of misstatement.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
• Are MANDATORY. These are required for all relevant assertions
relating to each material class of transactions, account balance, and
disclosure, regardless of the assessed risk of material misstatement.
• Because the auditor’s risk assessment is subjective, it may not
identify all risks of material misstatement.
• Substantive testing cannot be eliminated. However, it may be reduced
by auditor’s reliance on entity’s effective internal control.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
NATURE TIMING EXTENT
• Relates to the • Relates to the • Relates to the
quality of audit quality of audit quantity of audit
evidence. evidence. evidence.
• Performing more • Performing at year- • Using larger sample
effective or less end or interim size or smaller
effective audit dates. sample size.
procedures.
AUDIT SUBSTANTIVE PROCEDURES
THEORY
AND TEST OF CONTROL
NOTE:
• The reliance placed on substantive tests in relation to the reliance
placed on internal control has an inverse relationship.
• Test of control provides evidence that indicates a misstatement is
likely to occur while substantive test provides evidence about the
existence of misstatement in an account.
AUDIT SUBSTANTIVE PROCEDURES
THEORY
AND TEST OF CONTROL
EXAMPLE:
If the test of control results show that the internal control procedures
are not working properly, the auditor will assume that material
misstatements are likely to occur. The auditor will then conduct
extensive substantive tests to determine whether there are any material
misstatements.
AUDIT SUBSTANTIVE PROCEDURES
THEORY
AND TEST OF CONTROL
NOTE:
• The auditor uses the results of control and substantive tests to form
an opinion on the financial statements. If the internal control is
successful at preventing, detecting and correcting material
misstatements, the auditor may perform less substantive tests.
• If the internal control is unreliable, the auditor will have to
compensate for the weakness in internal control by conducting more
comprehensive substantive tests. As a result, the nature, timing and
extent of the auditor’s substantive tests are largely determined by the
results of the test of controls.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
TYPES OF SUBSTANTIVE TESTS
There are two general categories of substantive tests.
1. Tests of Details of Transactions or Balances; and
2. Analytical Review Procedures
Irrespective of the assessed risks of material misstatement, the auditor shall
design and perform substantive procedures for each material class of
transactions, account balance and disclosure.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
(a) Tests of Details
This type of substantive test involves obtaining
evidential matter on the items (details) involved in
an account balance and class of transaction.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
Tests of details are also referred to as follows:
• Tests of Transactions
These are tests of the processing of individual transactions by
inspection of the documents and accounting records involved in
processing.
EXAMPLE
tracing a sample of receiving reports to the purchase journal to
see whether receipts of merchandise have been recorded as
purchases.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
• Tests of Balances
These are tests applied directly to the details of balances in
general ledger accounts.
EXAMPLE
confirming the balances of accounts in the accounts payable
subsidiary ledger with individual customers.
• These tests have the objective of establishing the monetary
correctness of the accounts they relate to.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
• Tests of Balances
• Some auditors refer to tests of balances as direct tests of balances to
emphasize the substantive nature of the test as directly supporting an
account balance.
• It should be noted that substantive tests and compliance tests of
control procedures that leave a documentary trail both involve the
inspection of documents. These tests are often applied together to the
same group of documents.
• The test is referred to as a dual purpose test because it has both
compliance and substantive objectives.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
(b) Analytical Review Procedures
• Analytical types of tests involve study and comparison of relationships
among accounting data and related information.
• They identify unusual fluctuations for investigation and focus on the
rationale of relationship.
• Auditing standards require the application of analytical procedures at the
planning and overall final review stages of audits.
• The auditors may also decide to use them during the audit as
substantive tests.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
COMMON ANALYTICAL PROCEDURES THAT INVOLVE
COMPARISON
Analytical Procedure Example
1. Compare current financial information for prior Compare inventory levels for the current
periods. year to that of prior years.
2. Compare current financial information with Compare research and development expense to the
anticipated data budgeted amount.
3. Compare current financial information with known or Compare interest expense to the average outstanding
predictable relationships. balance of interest-bearing relationships debt.
AUDIT SUBSTANTIVE
THEORY
PROCEDURES
COMMON ANALYTICAL PROCEDURES THAT INVOLVE
COMPARISON
Analytical Procedure Example
4. Compare current financial information with industry Compare client's gross profit percentage to
information. published industry averages.
5. Compare current financial information with current
Compare production records in units to sales
nonfinancial information
AUDIT ANALYTICAL REVIEW
THEORY
PROCEDURES
Common Analytical Procedure that Involves Comparison
Compare the current financial information with the :
1. Prior periods
2. Anticipated data
3. Known or predictable relationships
4. Industry information
5. Current non-financial information
Relationships of
Audit Techniques, Audit
Procedures, and Assertions
Assertions
Substantiated
Audit techniques are the basic tools or means employed
to obtain audit evidences. The application of these
techniques constitutes the audit procedures.
Relationships of Audit Techniques, Audit
Procedures, and Assertions
Audit Application Assertions
technique of audit Substantiated
Procedures
1. Count 1. Counting of inventory, 1. Physical Existence
cash securities,
unmatured promissory
notes (to establish
existence and where
applicable. ownership and
condition of assets).
2. Obtaining confirmation
2. Confirm directly of details of [Link], Rights
account balances (to verify
validity and accuracy of
and Obligation
balances and other
information with outside
parties).
Relationships of Audit Techniques, Audit
Procedures, and Assertions
Audit Application Assertions
technique of audit Substantiated
Procedures
3. Inquire 3. Obtaining clients 3. Completeness
representation letter;
explanations to many diverse
questions raised during the
audit (to obtain knowledge).
4. Examining (or vouching)
[Link], Inspect, paid checks, vendor's 4. Occurence, and
Review, Trace and invoices, approved client
documents titles (vouchers, Measurement
Verify Vouch purchase orders, receiving
reports), contracts and other
documentary materials
Relationships of Audit Techniques, Audit
Procedures, and Assertions
Audit Application Assertions
technique of audit Substantiated
Procedures
5. Observe , 5. Observing the taking of 5. Existence
physical inventories by client
test, and Verify personnel; of actual
operation of internal control
(to determine compliance
with prescribed procedures).
6. Rechecking clerical
6. Extend and Foot determinations by client (to 6. Measurement
verify the accuracy of
computations and transfer of
information made by client).
Relationships of Audit Techniques, Audit
Procedures, and Assertions
Audit Application Assertions
technique of audit Substantiated
Procedures
7. Compare and 7. Comparing current period 7. Completeness
account balances or
Trace operating data with similar
information for prior "periods
and investigation of unusual
data relationship (to disclose
and determine the reasons
for significant changes).
8. Analytical review 8. Compare sales with 8. Completeness
sales budget.
AUDIT Timing of Testing
THEORY
Two different timing of testings
1. Interim work is an audit procedures performed before year-end
[Link]-end work are those performed between year-end and the completion of the
audit are referred to as year-end work.
The auditor should consider the following in deciding whether and when to perform
interim work in a particular account balance:
(1) the internal control associated with the account,
(2) how rapidly business conditions might change,
(3) management's predisposition to misstate the financial statements and the
potential impact of such misstatements on the account, and
(4) the predictability of the account balances at year-end.
TIMING OF TESTS OF
CONTROLS
The auditor shall perform test of controls for the particular time,
or throughout the period, for which the auditor intends to rely on
those controls.
Test of Controls are usually performed at an interim
date. The auditor, however, may decide to perform
additional tests of controls and gather further
evidence during the remaining period.
WHEN THE AUDITOR
OBTAINS AUDIT
EVIDENCE ABOUT 1) Obtain audit evidence about significant
THE OPERATING changes to those controls subsequent to
EFFECTIVENESS OF the interim period;
CONTROLS DURING
AN INTERIM PERIOD, 2) Determine the additional audit evidence
to be obtained for the remaining period.
THE AUDITOR SHALL:
Also, when using audit evidence obtained in previous
audits, the auditor should consider the following:
1) The effectiveness of other elements of internal control, including the control
environment, the entity's monitoring of controls, and the entity's risk assessment
process;
2) The risks arising from the characteristics of the control, including whether it
is manual or automated;
3) The effectiveness of general IT control;
4) The effectiveness of the control and its application by the entity, including the
nature and extent of deviations in the application of the control noted in previous
audits, and whether there have been personnel changes that significantly affect
the [Link] the control;
Also, when using audit evidence obtained in previous
audits, the auditor should consider the following:
5) Changing circumstances;
6) Whether the lack of a change in a particular control poses a risk due to
the risks of material misstatement and the extent of reliance on the control.
• When the auditor plans to rely on controls over a risk the
auditor has determined to be a significant risk, the auditor shall
test in the current period.
TIMING OF SUBSTANTIVE
PROCEDURES
The auditor shall design and perform substantive procedures for each material
class of transactions, account balance, and disclosure.
The auditor's substantive procedures should include those related to the financial
statement closing process.
2). Examining material journal
1). Agreeing or reconciling entries and other adjustments
the financial statements with made during the course of
the underlying records preparing the financial
statements.
TIMING OF SUBSTANTIVE
PROCEDURES
When the auditor has determined that an assessed risk of material misstatements at the
assertion level is a significant risk, the auditor shall perform substantive audit procedures
that are specifically responsive to that risk
(b) If the auditor determines that it is
(a) Substantive procedures, sufficient, further substantive
combined with tests of procedures only, that provide a
controls for the intervening reasonable basis for extending the
period; audit conclusions from the interim
date to the period end.
SELECTING THE AUDIT PROCEDURES
THAT WILL BE APPLIED
In determining which audit The selection of particular procedures to achieve
procedures to use to obtain specific audit objectives is influenced by the following
evidence, the auditor must considerations:
consider whether one or more
procedures will provide evidence
that can reduce the risk of that
1. The nature and materiality of the particular
assertion being misstated to an
component of the Financial statements (account
acceptable low level. I
balance or class of transaction).
n some cases however, an audit
procedure may provide evidence 2. The nature of the audit objective to be
about the validity of more than achieved.
one assertion.
SELECTING THE AUDIT PROCEDURES
THAT WILL BE APPLIED
The selection of particular procedures to achieve
specific audit objectives is influenced by the following
considerations:
The auditor's reliance on internal
controls and substantive tests
should provide a reasonable
basis for their opinion on the
4. The relative risk of material errors or irregularities. financial statements.
The kinds and competence of available evidence.
5. The expected efficiency and effectiveness of
possible audit procedures.