4.2 Audit Procedures
Summary
TLDRThis lecture delves into audit procedures, emphasizing the auditor's role in selecting methods to gather evidence for financial statement assertions. It distinguishes between risk assessment procedures, tests of controls, and substantive tests, highlighting the importance of substantive procedures in detecting material misstatements. The script also covers various audit techniques, such as confirmations, analytical procedures, and the auditing of accounting estimates, providing insights into the auditor's toolkit for evaluating financial data.
Takeaways
- đ The scope of an audit refers to the audit procedures deemed necessary to achieve the objective of an audit, giving auditors the freedom to choose any procedures they determine are necessary.
- đ Audit procedures are methods used by auditors to gather evidence to determine the validity of financial statement assertions, starting with assertions, leading to objectives, and then to the procedures performed.
- đ Risk assessment procedures (WP) and further audit procedures (FAP), including tests of controls and substantive procedures, are crucial for understanding the entity and its environment, and for assessing the risks of material misstatement.
- đ ïž Tests of controls assess the operating effectiveness of controls in preventing, detecting, and correcting material misstatements, while substantive procedures (test of assertions) are required to detect actual material misstatements.
- đ Substantive tests can be categorized into tests of details (transactions or balances) and substantive analytical procedures (SAP), with the former being required and the latter being optional.
- đ The difference between tests of transactions and tests of balances lies in whether the auditor is testing the debits and credits (process of individual transactions) or the ending balance (existence of account balance).
- đ Audit procedures according to nature include inspection, observation, inquiry, confirmation, computation or reperformance, tracing and vouching, reconciliation, and analytical procedures.
- đŹ External confirmations involve obtaining audit evidence from third parties through representations or information about specific items affecting financial statement assertions, with positive and negative confirmation being the two general categories.
- đ Substantive analytical procedures involve studying and comparing relationships among accounting data and related information to identify unusual fluctuations, with the predictability of relationships being a key factor in their effectiveness.
- đź Accounting estimates, such as allowances for doubtful accounts or inventory obsolescence, carry inherent risks due to their approximation nature, and testing these estimates involves understanding management's process, developing independent expectations, and reviewing subsequent events or transactions.
Q & A
What is the primary purpose of audit procedures?
-The primary purpose of audit procedures is for the auditor to gather evidence to determine the validity of the financial statement assertions.
Why is the scope of an audit important?
-The scope of an audit is important because it refers to the audit procedures deemed necessary in the circumstances to achieve the objective of an audit, allowing the auditor to give a positive conclusion and reasonable assurance.
What are the two main categories of audit procedures according to purpose?
-The two main categories of audit procedures according to purpose are risk assessment procedures (WP) and further audit procedures (FAP), which includes tests of controls and substantive procedures.
What is the difference between test of controls and substantive tests?
-Test of controls assess the operating effectiveness of the controls in preventing, detecting, and correcting material misstatements, while substantive tests (both tests of details and analytical procedures) are designed to detect material misstatements at the assertion level.
Why are substantive procedures required to be performed in every audit?
-Substantive procedures are required to be performed in every audit because they are essential in detecting material misstatements in the financial statements, which is the core objective of the audit.
What are the two general categories of substantive tests?
-The two general categories of substantive tests are tests of details and substantive analytical procedures (SAP).
What is the main difference between inspection and observation as audit procedures?
-Inspection involves examining records, documents, or tangible assets, while observation consists of watching a process or procedure being performed by others.
What is the significance of external confirmations in an audit?
-External confirmations are significant as they provide audit evidence directly from third parties, which helps in corroborating information contained in the accounting records and related disclosures.
What are the general rules for the predictability of relationships when using substantive analytical procedures?
-Relationships in stable environments and involving income statement accounts tend to be more predictable than those in unstable environments or involving balance sheet accounts. Additionally, relationships involving transactions subject to management discretion may be less predictable.
How do auditors test accounting estimates?
-Auditors test accounting estimates by understanding how management develops the estimates, testing the process used by management, developing an independent expectation, and reviewing subsequent events or transactions.
What are some examples of common financial statement estimates that auditors might encounter?
-Examples of common financial statement estimates include allowance for doubtful accounts, inventory obsolescence, depreciation, deferred taxes, provisions for losses, and warranty claims.
Outlines
đ Overview of Audit Procedures
This paragraph introduces the concept of audit procedures, emphasizing their importance in gathering evidence to support the auditor's opinion on financial statements. It revisits the scope of an audit, which refers to the necessary procedures to achieve audit objectives. The auditor has the flexibility to choose any procedures deemed necessary, such as observations, interviews, physical counts, and cash counts. The paragraph also distinguishes between risk assessment procedures (WP) and further audit procedures (FAP), which include tests of controls and substantive procedures. The focus is on understanding the entity, its environment, and internal controls to assess the risks of material misstatement.
đ Substantive Procedures and Their Categories
This section delves into the importance of substantive procedures in detecting material misstatements in financial statements. It outlines two main categories of substantive tests: tests of details and analytical procedures. Tests of details can further be divided into tests of transactions and tests of balances, focusing on verifying the accuracy of individual transactions or the correctness of account balances, respectively. The paragraph also explains the difference between testing transactions (debits and credits) and testing balances (ending balances), using the example of accounts receivable.
đ Nature of Audit Procedures
This paragraph discusses the nature of audit procedures as outlined in PSA 500, detailing seven types of procedures. These include inspection (of documents and tangible assets), observation, inquiry, confirmation, computation or reperformance, tracing and vouching, reconciliation, and analytical procedures. Each procedure is briefly explained, highlighting their unique applications and limitations. For instance, observation is useful when there is no audit trail, but it can be affected by the 'Hawthorne effect' where people behave differently when they know they are being observed.
đ Audit Procedures: Inquiry, Confirmation, and Computation
This section focuses on specific audit procedures such as inquiry, confirmation, and computation. Inquiry involves seeking information from knowledgeable persons, while confirmation is a more formal process that requires a written response to corroborate information. Computation or reperformance involves checking the mathematical accuracy of source documents and accounting records. The paragraph also distinguishes between tracing and vouching, explaining that tracing tests for completeness (starting from source documents to records) and vouching tests for existence (starting from records to source documents).
đ Audit Procedures: Analytical Review and External Confirmations
This paragraph discusses the use of analytical review procedures in the testing phase, emphasizing the importance of developing expectations and determining acceptable variations. It also covers external confirmations, which involve obtaining audit evidence directly from third parties. The paragraph explains the difference between positive and negative confirmations and the conditions under which negative confirmations may be used. Additionally, it highlights the importance of using the client's letterhead for confirmation requests and the auditor's role in controlling the mailing and responses.
đ Analytical Procedures and Their Predictability
This section explores the factors to consider when using substantive analytical procedures, such as the suitability of using analytics for specific assertions, the reliability of data, and the precision of expectations. It also discusses the predictability of relationships in stable versus dynamic environments and the differences between income statement and balance sheet accounts. The paragraph outlines the steps involved in using substantive analytical procedures, including developing expectations, determining acceptable variations, and investigating significant differences.
đŒ Auditing Accounting Estimates
This paragraph focuses on the auditing of accounting estimates, which are approximations made in the absence of precise measurement. It lists common examples of estimates, such as allowances for doubtful accounts and inventory obsolescence. The procedures for testing accounting estimates include understanding management's process for developing estimates, developing an independent expectation, and reviewing subsequent events or transactions to validate the estimates. The paragraph emphasizes the inherent risks associated with estimates and the importance of validating them through subsequent events.
đ Summary of Audit Procedures
In the final paragraph, the speaker summarizes the key points discussed in the lecture series on audit objectives, procedures, evidence, and documentation. The focus is on the importance of understanding management's process for developing estimates and the role of subsequent events in validating these estimates. The speaker also hints at the next topic in the series, which will be audit evidence and documentation, indicating a comprehensive approach to auditing financial statements.
Mindmap
Keywords
đĄAudit Procedures
đĄScope of an Audit
đĄRisk Assessment Procedures
đĄTests of Controls
đĄSubstantive Procedures
đĄAssertions
đĄAnalytical Procedures
đĄExternal Confirmations
đĄAccounting Estimates
đĄAudit Evidence
đĄTracing and Vouching
Highlights
Audit procedures are methods used by auditors to gather evidence to determine the validity of financial statement assertions.
The scope of an audit refers to the audit procedures necessary to achieve the audit objective.
Auditors have the freedom to choose any procedures they deem necessary for the audit.
Risk assessment procedures are crucial for understanding the entity and its environment, including internal controls.
Test of controls involves assessing the operating effectiveness of controls in preventing, detecting, and correcting material misstatements.
Substantive procedures are essential for detecting material misstatements at the assertion level.
Substantive tests of details involve obtaining evidence on items or details involved in an account balance or class of transactions.
Substantive analytical procedures involve studying and comparing relationships among accounting data to identify unusual fluctuations.
Risk assessment procedures are required in a risk-based audit approach, as are substantive procedures.
Inspection includes examining records, documents, or tangible assets.
Observation involves watching a process or procedure being performed by others and has strengths and weaknesses.
Inquiry is seeking information from knowledgeable persons, while confirmation is a more formal inquiry requiring a written response.
Recomputation or reperformance involves checking the mathematical accuracy of source documents or repeating a client's internal control activity.
Tracing and vouching are opposite audit procedures; tracing tests for completeness, while vouching tests for existence.
External confirmations involve obtaining audit evidence from third parties in response to a request for information.
Positive confirmation requires a response in all cases, while negative confirmation only requires a response if there is disagreement.
Substantive analytical procedures are used to develop expectations and identify material misstatements by comparing actual recorded amounts.
Accounting estimates carry inherent risk due to their approximation nature and require specific audit procedures to test their accuracy.
Transcripts
let's now talk about audit procedures
now if you have been religiously
following our lecture series then you
would feel some sense of deja vu and you
might feel like hey wait this is
familiar and this will particularly take
you back to the second installment that
we had when we gave the overview of the
fs audit process we did talk about audit
procedures also there but for this
particular segment we're going to INF
flesh those Concepts a bit more K I hope
you're ready you already know that when
we talk about scope of an audit it
mainly just refers to the audit
procedures deemed necessary in the
circumstances to achieve the objective
of an audit and early on we made mention
that when we talk about the scope of an
audit actually the auditor has the
chance to choose the chance and the
freedom to choose any and all procedures
that the auditor determines is necessary
for the auditor to give an opinion we
mentioned that the auditor can do
observation the auditor can talk to
people the auditor can interview the
auditor can observe physical counts the
auditor can you know pursue or conduct a
cash count all of these things are
available to the auditor these arsenal
of procedures are available to the
auditor which will later on allow the
auditor to give a positive conclusion
and a reasonable Assurance now speaking
of audit procedures since scope of an
audit refers to audit procedures audit
procedures are the methods or acts that
the Auditors use to gather evidence so
the very purpose of audit procedures is
for the auditor to gather evidence and
we gather evidence to determine the
validity of the fs assertions we go back
to the Storyteller and the story and
evaluating the story in the course of
evaluating the story we need to gather
evidence and to gather evidence we need
to perform audit procedures so if you
can picture it out in your mind right
now well it starts with the assertions
from the assertions we come up with
objectives and the objectives will lead
us to the procedures that we will be
performing let's now look at the audit
procedures according to purpose and this
is the part where where you will feel a
strong sense of deja vu these are the
audit procedures according to purpose we
already know that we have risk
assessment procedures or WP and then we
have fap or further audit procedures
which is further comprised of test of
controls and substantive
procedures when we talked about uh
preliminary engagement activities audit
planning
materiality risk assessment Pro and even
internal controls risk assessment
procedures really took the center stage
and we said risk assessment procedures
are procedures used to obtain an
understanding of the entity and its
environment including its internal
controls to assess the risks of material
misstatement at the fs and assertion
levels we also recall that in the 2019
revision of PSA 315 there has become
lesser of a focus on obtaining the
understanding although of course it's
important it's a crucial part and more
weight is then given to risk assessment
so risk assessment procedures are
intended to assess the risks of material
misstatement and we said this is where
the gtky getting to know you would come
in and the auditor will get to assess
both inherent and control risk of the
client and we also made mention that
under risk assessment procedures we
basically perform the big three IO
inquire inspect observe and of course
included to that is analytical
procedures if performed in the planning
phase in the third installment we also
made mention that if you want to take a
look at the design and implementation of
the control in you know your aim of
assessing control risk you look at
design and implementation under risk
assessment procedures we also mentioned
that for the implementation part you
could perform a walkthrough test now
let's now take a look at test of
controls and we know that test of
controls test the operating
effectiveness of the controls in prev
ing detecting and correcting material
misstatements at the assertion level we
then made in the last installment a very
clear distinction that when the auditor
considers internal controls the auditor
considers it at the risk assessment
phase by performing WAP looking into
design and implementation and if certain
conditions are met where such as when
you intend to rely on the controls or in
the case of rspa risk for substantive
procedures alone can I provide
sufficient and appropriate evidence um
it's found it's all found in our third
uh installment when we talked about
internal controls you may want to pay
that visit if you need to you know
review these Concepts if those if those
conditions are met then we perform test
of controls otherwise then we don't need
to if you don't intend to rely on the
controls you don't need to test the
controls lastly of course we have
substantive procedures and substantive
procedures are there to detect Mis
material misstatements at the assertion
level that's why they are called test of
assertion
we have also highlighted the importance
of substantive procedures because at the
end of the day our objective is to give
an opinion on whether the financial
statements are free from material
misstatements and it would be
substantive procedures that would detect
those material misstatements we also
remind ourselves that of the three audit
procedures categorized as to purpose
risk assessment procedures are required
to be performed more so since we are
using the risk-based audit approach and
substantive procedures are also required
to be performed as as what we have
mentioned they are the ones that
actually detect the misstatements okay
now putting our Focus now on substantive
tests there are two general categories
we can call them substantive test of
details and these substantive test of
details could either be details of
transactions or details of balances so
when we mention substantive test of
details this will involve obtaining
evidential matter on the items or
details involved in an account balance
or class of transactions so as mentioned
they can be referred to as test of
transactions or test of balances for
this I'd like you to picture in your
mind draw in your mind a t account have
you already drawn it need to remember
the t account very useful tool for us
right so imagine the t account and
imagine there entry entries to the debit
and credit side of the t account then we
know from those entries and of course
the beginning balance we come up with
the ending balance right so if you want
to test the
assertions if what you want to do is to
perform substantive test of sorry if you
want to test the transactions if you
want to do if what you want to do is a
substantive test of transactions then
you will be testing the debits and the
credits okay that's a test of
transactions you test the process
procing of the individual transactions
normally by inspection of documents and
accounting records involved in
processing test of transactions is test
of debits and credits but if you want to
perform substantive test of balances
then you test the ending balance take
note the ending balance not the
beginning balance because the beginning
balance has already been tested as the
begin as the ending balance of the prior
year so when we say test of balances
it's test of ending balances so if if
you can imagine for example accounts
receivable if you want to test the
balance of accounts receivable then you
would normally do this one by performing
confirmation and sending a confirmation
letter or a confirmation request to say
the customer of your client and asking
the customer of the client to confirm if
they truly have a payable to the client
amounting to let's say 10,000 pesos as
of a certain date that's a test of
balance now we know that an account that
an account's receivable balance is
affected or made up by sales and then
reduced by collections but if we test
the balance what we are interested in is
the ending balance so when we give the
confirmation request we ask the customer
to confirm the balance meaning the
unpaid amount okay but if we are testing
for
transactions we will test the debits and
credits so imagine the t account for a
accounts receivable what would go into
the debit side of an accounts receivable
we will debit the accounts receivable
every time there is a credit sale right
we debit AR and then credit sales and we
will credit accounts receivable Whenever
there is a a collection we will debit
cash and credit accounts receivable so
in this case if you are testing the
transactions then you will be testing
credit sales and collections in relation
to accounts receivable of course so that
is the difference between test of
transaction and test of balances okay
now the other category of substantive
test is what we call substantive
analytical procedures or sap or in this
case analytical review procedures this
would involve a study and comparison of
relationships among accounting data and
related information we are working on
the context that uh there are
predictable relationships in the
accounts and that we we should be able
to identify unusual fluctuations and
when we identify these unusual
fluctuations that breach a certain
threshold then we would of course have
to investigate and focus on the rational
of these unusual relationships or
fluctuations we will discuss uh
substantive analytical procedures in a
bit more detail a few slides from now
okay but again the general categories
would be test of details and analytical
procedures we are also reminded that
between the two it would be test of
details that would be required to
performed as sub as substantive
analytical procedures are
optional okay now I know that you
already know the difference between test
of controls and substantive tests
whereby we say if the test of controls
would reveal that the internal controls
are reliable then we will perform less
substantive tests but what I would like
for you to reflect on right now is the
fact that test of controls only provide
evidence that a misstatement is likely
to occur
okay likely to occur meaning to say test
of controls show you the red flags test
of controls show you the likely okay
that there is a likely misstatement that
could occur it does not give you direct
evidence about the actual misstatement
and we know this to be true because uh
in our discussion on internal controls
we said not all deviations would result
to a misstatement remember our example
on how one of the control activities
would always be the wearing of an ID
when you enter a workplace or your
school the wearing of the ID would
ensure that only enrolled students get
to enter the campus but then we must
have reflected that well we have tried
at least once or you know entering the
campus without wearing an ID we are a
deviation because we did not wear the ID
but were we a misstatement the answer is
not necessarily we could have been
officially enrolled but we just left our
IDs at home therefore a control
deviation does not necessarily equate to
a misstatement okay it will be the
substantive tests that will provide the
existence or that will provide rather
evidence about the actual existence of
the misstatement this is the reason why
between the two substantive tests are
the required procedures and not test of
controls all right so I hope you were
able to reflect on that let's now look
at the different audit procedures
according to Nature
uh if we look at PSA 500 there are
actually seven listed audit procedures
according to nature but we're expanding
it a little bit here just to give more
context so we have of course what is
called inspection or examination of
documents this would include examining
records documents or even tangible
assets so in PSA 500 inspection refers
to both inspection of documents and
physical examination of assets of course
we know that there is a difference in
the way we perform these two in in a way
that if we talk about inspection what
you will be looking at are records or
documents and notice that the record or
the document by themselves do not have
any inherent value what do I mean by
this if you are holding a sales invoice
and the sales invoice has reflected
there that it was for a sale amounting
to 1 million the invoice itself the
paper the document is not worth 1
million right it's not worth 1 million
you cannot uh you cannot sell the
invoice for 1 million okay you cannot
bring it to the pawn shop and have it
pawn for a million the document itself
is paper and it does not H hold any
inherent value so when you're inspecting
something with no inherent value you're
inspecting a document you're inspecting
a record so we call that inspection
inspection of documents but when you
inspect a tangible asset say for for
example when you inspect a new school
bus the new school bus has value right
you can sell the new school bus you can
Pawn the new school bus so when you are
physically inspecting or physically
examining a tangible asset you are
inspecting something with inherent value
so again we can call it inspection of
documents physical examination of assets
but in PSA or Isa 500 they are both
referred to as inspection the other one
is observation and I'm sure you have
done observation so many times in your
life so observation would consist of
looking at a process or procedure being
performed by others observation is
widely used and it's very useful but it
also has its strengths and its
weaknesses just like any other audit
procedure but if we reflect one of the
strengths of observation is that you
could readily use this one when there is
an absence of an audit Trail when there
is no trail of documentation so
therefore you cannot inspect any
document then you can perform
observation however the weakness to
observation is that well we all know
that people tend to act differently if
they know they are being observed and
this is what we call the hawor effect so
we know also that our observation
whatever the results of our observation
will only be true for that specific
point in time we do not know if the
moment we have stopped our observation
or have left the place if people started
acting differently or in their more
natural state right so that is of course
a weakness of observation nonetheless
observation is still another procedure
that is widely used and then there is
what we call inquiry when we say inquiry
we simply seek information of
knowledgeable persons but if you want to
level up that inquiry into a more formal
uh structure than what you are actually
doing is a form of confirmation
confirmation consists of a response to
an inquiry to corroborate information
contained in the accounting records and
this response is in the form of a
written response so that's why it's
called confirmation so inquiry is when
we ask where confirm whereas
confirmation is when we request for a
written response okay to a particular
information that we wish to corroborate
so confirmation is a more formal
structure of inquiry and then we have
what is called computation or
reperformance when we say recomputation
sometimes we call this one recalculation
we check the mathematical accuracy of
the source document okay and accounting
records but when we talk about
reperformance reperformance is repeating
a client activity normally repeating a
client's internal control activity okay
so recomputation or recalculation will
be of course more in the figures so more
related to a substantive test but
reperformance would be to reperform a
control or rep performing a control
activity so this will be a test of
control and then we have also talked
about tracing and vouching but we will
review these Concepts again here so
tracing would involve establishing
completeness of the transactions by
following through from uh through the
accounting records so our direction of
the testing here is from documents to
records if you're still a little bit
confused about this just hang in there
we will uh we will resurrect our
discussion for tracing versus vouching
in the next slide okay and then of
course when we talk about vouching it's
the opposite tracing and vouching
actually Test opposite assertions right
vouching tests for existence it involves
following a transaction back to the
supporting documents or we sometimes
even call this one tracing back now
while we are familiar we Endeavor to be
familiar with the technical terms we
also need to recognize that in
literature and in the questions that are
asked in The Lure examinations it is
very possible for the examiner to use
tracing and vouching interchangeably so
please make sure to read through the
substance of the question and not simply
the use of the terminology okay we also
have what we call reconciliation and
this would of course involve agreeing
two sets of independently maintained but
related records perhaps in Intermediate
Accounting you are familiar with bank
reconciliation right so in audit we also
perform reconciliation of Records okay
and then analytical procedures which we
have mentioned a while back back okay
would of course consist of comparing
relationships between data to determine
reasonableness again working on the
assumption that we expect some degree of
predictability okay so again to
reinforce vouching versus tracing we
always say that in a perfect world
whatever is in the records would have
also appeared in the source documents
the records would represent the client
records and eventually this is what will
go into the trial balance and the
financial statements The Source
documents here would refer to the actual
existence or actual occurrence okay of a
balance or a transaction so in a perfect
world whatever is in the records would
have also been in the source documents
but like what we have pointed out the
world is not perfect and sometimes what
is in the records cannot be found in the
source document meaning to say the
client has recorded something that did
not actually exist or did not actually
happen can you imagine for example the
presence of ghost employees okay or
bloated purchases or sales that did not
actually happen so there they are
included in the records They are
reflected in the trial balance and
eventually in the fs but they did not
actually happen and they do not actually
exist so if you reflect on this one it
is found in the fs or in the records but
they are not there that means the status
of our records is that it is overstated
the records are overstated it reflects
something that does not actually
exist and in this case when the status
of the records is overstated we get to
ask the question where do you start do
you start from the records or do you
start from the documents and we get to
realize that hey we cannot start from
the documents why because there are no
documents in the first place right you
cannot start from the documents because
the documents are absent they are not
there because they did not actually
happen and so therefore in this case you
should start from the records and when
we start from the records to the
documents this is what we technically
call vouching and the assertion we are
testing here is existence now some of my
students use the pneumonic over to
recall this one o for overstatement V
for vouching E for existence and then R
to start from the records and then they
just take the opposite when it comes to
tracing okay so that might be something
useful for you to remember this as well
then monic over okay testing for over
statements means we have to vouch we are
testing for violations of existence and
we will start from the records over now
the reverse but also on the contrary
it's also possible that they do not
appear in the records but they actually
happen so this is the case of unrecorded
transactions unrecorded liabilities for
example so whenever we say unrecorded
that means the records are not complete
the records are are kolang no the
records are incomplete and if the
records are incomplete then the records
are
understated and as to the question of
where should we start from again we
reflect on the fact that well hey there
are no records I cannot start from the
records because there are no records so
we will start from the source documents
and this is what we technically call as
tracing and tracing will be a test for
completeness so here you will get to see
that existence and complete are actually
opposing no they they are opposite they
go in opposite directions whereas
existence would be concerned about
overstatements completeness would be
concerned about understatements whereas
existence would mean we will start from
the records completeness would say would
start from the source documents okay so
this is the difference between tracing
and vouching well I know for most of you
you already know this one so I hope you
didn't mind if we reviewed it again such
an important concept now here other
terms for audit procedures that you may
come across when you look at an audit
program or when you follow an audit
program you may see the term for example
agree so we normally say agree the
scheduled balances to the general ledger
this is of course in answer to our audit
objective of detail tie-in right we may
analyze account transactions compare
beginning balance with last year's
audited figures of course last year's
ending balance should be this year's
beginning balance right we count cash we
count inventory we examine documents we
foot totals right we read minutes of
director's meetings we reconcile cash
balance okay balance per book and
balance per bank for example we review
disclosures we review legal documents
and we scan for unusual items so these
are common terms that we use in
reference to audit procedures I'm pretty
sure you might be encountering more than
one of this when you leave later on work
in external audit and see an audit
program or maybe even make an audit
program okay so let's now give a summary
of the procedures classified as to type
and as to Nature now I always invoke The
Big Three The Big Three is IO inquire
inspect observe and I call them the big
three because they are present in all
three categories okay inquiry inspection
observation they can be performed as
part of risk assessment procedures they
can be performed as part of test of
controls and they can be formed as part
of substantive tests whether rap or fap
you may perform the big three
reperformance is rep performing a
control activity so therefore that is
called test of controls okay when you
are
recalculating you are rep performing the
calculation you are
recalculating then that's a different
story and that should be substantive
test confirmation is a substantive test
again we'll talk a bit more about this
in a few recalculation as what we have
have mentioned is also a substantive
test analytical procedures may be a risk
assessment procedure if performed in the
planning phase and if performed in the
testing phase then they are also
substantive tests so you would notice of
all of the procedures only the big three
has has checked all three categories
right so that's why I call them the big
three now let's talk about external
confirmations external confirmations of
course incompass the process of
obtaining an evalu waiting audit
evidence through a representation or
information of an existing condition
okay directly from a third party in
response to a request for information
about a particular item affecting
assertions in the fs or related
disclosures as what we have mentioned
this is a more formal level of inquiry
where we request no for a written
response these are situations whereby
external confirmation is ordinarily used
uh like for example example confirmation
with bank balances and other information
we normally confirm as well accounts
receivable okay then stocks held by
Third parties property title Deeds we
can also confirm Investments that are
still in the hands of the stock Brokers
we can also compare liabilities like
loans payable and accounts payable so
these are just some of the situations
where confirmations may come in handy
there are two um General categories of
the form of confirmation there is what
we call positive confirmation and under
positive confirmation we ask the
respondent to reply in all cases whether
the respondent agrees with the
information or disagrees with the
information in all cases we ask the
respondents to reply whereas if we talk
about negative confirmation we only ask
the respondent to reply if and only if
the respondent disagrees with the
information therefore under negative
confirmation if we do not not receive
any response then we would assume that
the the information is correct right
with this you will get to to notice that
there is a higher risk associated with
using negative confirmation because we
cannot just readily assume that a
non-response means everything is okay
right what if the respondent did not
receive the confirmation letter what if
the respondent received it but did not
read it right what if the respondent
does not exist at all that's why the
respondent didn't reply so there are
certain conditions where negative
confirmation may be used okay like for
example when the assess risk of material
misstatement is low or when there are a
large number of small balances you have
accounts receivable for example totaling
1 million but there are also 1 million
customers in that accounts receivable so
on the average a peso per customer so a
large number of small balances or a
substantial number of Errors is not
expected or when you have no reason to
believe that the respondents will
disregard the request so when these
conditions are met if one or more of
these conditions are met then normally
the auditor will go for negative
confirmation the usual format though or
form though is a positive confirmation
there is also what we call a blank
confirmation blank okay meaning to say
we do not uh provide the information
okay we do not populate the letter with
or the information request with the
information that we have at hand we
leave it blank and we ask the respondent
to list down okay for example we
normally use this one for banks we ask
the banks for example to list down all
accounts that our client has with that
bank and any relevant other information
such as if there are any leans or
pledges and stuff like that so that is
what we what is called a blank
confirmation positive and negative
confirmation is generally used to test
for the assertion of EX existence okay
that's really the the usual assertion
tested by confirmation existence but
notice if you use blank confirmation a
blank confirmation can even test for
completeness but as I've mentioned we
normally use this one with banks we
don't normally use blank confirmation
with customers because I think you can
imagine how you would feel if you are a
customer and you receive a blank
confirmation it would just increase you
know instances of not non response okay
but it's there blank confirmation is a
type of confirmation let's reflect on
some general points to remember when it
comes to confirmation such as for
example have you ever wondered who
stationary or letterhead we will use
when we write the confirmation request
and who signs the confirmation request
right so here are some general points to
remember confirmation letter should be
printed on the client's letter head or
the client's faximile or email and
signed by the client officer not the
auditor okay remember that in the case
of AR the customers of the client are
not doing business with you they are not
doing business with the auditor for all
intents and purposes they do not know
the auditor and so therefore it should
be the client who will write the letter
to them use the client stationary use
the client's fact simul or email and
then let the client sign it the auditor
should be very careful that the
recipient's address is reliable and not
subject to alteration by the client in
such a way as to misdirect the
confirmation okay such as instances for
example of failure of delivery mainly
because the addresses have been altered
so we should be cautious about that one
the request should seek information that
the recipient can supply so do not make
it too overwhelming for the recipient
okay ask for information that they can
supply for example the amount of a
balance or the amount specified in
invoices or notes the confirmation
should be directly controlled by the
audit firm meaning to say while the
client signs the letter the audit firm
supervises the mailing of the said
confirmation request they should not be
given to the client Personnel for
mailing because in that case there's
always the risk that they may not
actually mail those confirmation
requests to customers which they know
will have disputed accounts or which
they know do not actually exist
right so the auditor should control The
Mailing and the responses should be
returned directly to the audit firm not
to the client okay so these are some
general points to remember for
confirmation request now very quickly
let's look at analytical review
procedures as well so particularly
analytics performed in the testing phase
so here are some factors to consider for
example is it suitable to use
substantive analytical procedures given
the assertions for example if you want
wanted to test for the assertion of
Rights and obligations I hardly think
substantive analytics would be a good
fit right so determine the suitability
of using the substantive analytics
second consider the reliability of the
data and we have talked you know in
detail about the hierarchy of evidence
reliability right so we consider the
reliability of the data whether they are
internal internally generated or
externally sourced okay and then from
which the expectation of recorded
amounts or ratios are developed later on
we get to see that when we perform
substantive analytics we develop an
expectation so we determine or we
consider the reliability of the data
that becomes the source of this
expectation and of course the subsequent
testing then we consider whether the
expectation is sufficiently precise to
identify a material misstatement at the
desired level of assurance take note
it's an expectation so it could never be
accurate that's why we're saying just
sufficiently precise to give us that
desired level of assurance okay and then
of course the amount of any difference
of recorded amounts from expected values
that is acceptable in other words we
determine the threshold okay
so because later on whatever would
breach the threshold is what we will
investigate so when more persuasive
audit evidence is desired from
substantive analytics more predictable
relationships are necessary to develop
this expectation let's look at some you
know general rules of sum when we talk
about predictability of relationships
for example relationships in stable
environments are definitely usually more
definitely usually are usually more
predictable than relationships in a
dynamic or unstable environment so if
you talk for example about an economy
that is in turmoil right so information
or relationships may appear to be less
predictable in those cases so
relationships in stable environment
usually more predictable also
relationships involving income statement
accounts tend to be more predictable
than balance sheet accounts why if you
can imagine the heading of an income
statement it says XYZ company income
statement for the year ended meaning to
say whatever happens or whatever is
reflected in the income statement is
only for a certain period only from the
start of the year to the end of the year
it will be quite easy for you to predict
what happened within a year right as
compared to a balance sheet notice the
header of the balance sheet XYZ company
statement of financial position for we
don't you don't say for the year ended
you say as of December 3120 whatever so
if you can imagine as of December 31
2024 for example that means from the
time of the Inception of the company
until 2024 imagine if the company was
you know if the company was organized or
was given birth to as late as not as
late as early as 1960 so that means from
1960 to
2024 that's quite a long period of time
and that's quite a lot of happenings in
in Filipino we say in our slang we say a
lot of gups from 1960 to 2024 right a
lot of things must have happened within
that period of time so because of that
income statement account accounts which
only cover one period is more
predictable than balance sheet accounts
which would be as of no a specific point
in time so there and then of course
relationships involving transactions
subject to management discretion may be
less predictable such as for example
estimates okay so these are some of our
general rules with regards
predictability let's now look at the
elements or steps when we use
substantive analytical procedures we
start by developing an expectation of
the recorded amount and then we
determine the amount of variation
between the expectation and our
threshold if the difference is material
we make inquiries of management so
investigation of variations that cannot
that cannot be accepted without
explanation if we cannot get the
explanation or the evidence is not
adequate then consider conducting other
audit procedures however let me point
out to you that when we use analytics a
substantive test okay like what we have
said we develop expectations about the
fs We compare the fs with the
expectations developed is a significant
is the differ significant no if not we
accept the account as reasonable meaning
to say not all differences will be
investigated that's why it's important
for us to develop the threshold okay so
if the difference breaches the threshold
then we conduct further investigation
okay allow me to backtrack a bit also by
saying that before before we develop any
expectation or compare the fs etc etc as
per usual we of course have to first
understand okay we first have to
understand how management came up with
the estimate how management uh came up
for example no with um these particular
information in the fs that's a given
right and then we understand the
industry we understand the environment
we understand the entity okay those
levels of understanding that gtky will
lead us to our expectations all right so
there that will be using analytics here
are some of the ratios commonly used now
this is I know a Management Services
topic but let's just very quickly run
through some of the ratios and what
could be its audit significance for
example one of your favorite ratios of
all time current ratio okay the audit
significance of the current ratio is
that if you have ever noticed a
significant increase in the current
ratio compared to last year here it may
indicate a completeness problem okay may
it may indicate however it may also be
influenced by changes in asset accounts
so therefore while we are aware of the
possibility that the completeness
assertion may have been violated that is
why there's a significant increase or
movement in the current ratio we also
acknowledge that there may be valid
reasons that's why we have to
investigate another favorite ratio used
in substantive analytics is the accounts
payable ter
uh days okay so prior experience in
account payable turn days or the turn uh
uh turn days no for accounts payable
combined with the knowledge of current
purchases can be used in estimating
current payables a shortening of this
period May indicate completeness
problems for the audit side as well okay
but again there may be valid reasons why
the ratios are changing another is
inventory growth to cost of sales growth
so if we have found ratios larger than
one it may indicate that inventories are
growing faster than sales the business
is amassing more inventories than they
can sell right large ratios may also
indicate possible inventory of solence
problems because it would seem like the
company is not able to sell okay their
inventories as quickly as we would have
expected them in case of fixed asset
turnover an unexpected increase in fixed
asset turnover May indicate the failure
to record or capitalize the aable assets
okay for in the case of free cash flow
negative free cash flows indicate the
need for expected financing it might
mean that the company might look into
debt financing okay in the future
drawing down on cash Investments so
there are uh implications to the ratios
that we have seen so in the case of
audit we are not super concerned with
the formula of course we need the
formula to come up with the correct
ratio but we are giving more emphasis on
its audit significance okay and then
lastly let's very quickly talk about
accounting audit estim auditing rather
accounting estimates we know that
estimates carry with them a certain
level of inherent risk so it's an
approximation of an amount or item in
the absence of a precise means of
measurement and it is this approximation
that makes it
vulnerable to risks here are some
examples of estimates I'm sure you have
met them at one point in time allowance
for doubtful accounts allowance for
inventory obsolesence your favorite
depreciation acels okay uh in the case
of deferred taxes Provisions for losses
and losses and Contra construction
contracts and even Provisions to meet
warranty claims so these are just some
of the many estimates that we will en
encounter in an audit of financial
statements so what are the procedures to
test accounting estimates similar to
everything else we of course always
start by an understanding of how
managements management comes up with
these estimates and then we test the
process used by management to develop
the estimate we develop our independent
expectation and then we review
subsequent events or transactions so
notice that just like analytical
procedures we also develop an
expectation for the estimates right so
in this case however we start by testing
managements process then developing our
independent expectation we could also
review subsequent events or transactions
such as for
example if you can reflect on scrap
value or salvage value being the
estimated uh value of the asset at the
end of its useful life right meaning to
say if you're going to take that
imagination a bit further if that's the
estimated value of the asset at the end
of its useful life then if you're able
to sell the asset at the end of its
useful life the proceeds should be the
same as a salvage value right in a
perfect world and so therefore one way
of testing the estimates is to look at
the subsequent event you look at an
actual sale of an asset that has reached
the end of its useful life and then
compare the proceeds with the salvage
value or if you talk about acral for
example acur expenses like acred
utilities okay in order to test that you
could always look at the subsequent
actual payment of the utilities that
were acur okay so that is what we mean
by review Subs quent events or
transactions all right so that's it for
audit procedures when we come back it
will be all about audit evidence and
documentation which will neatly you know
seal off this installment Series so I
mean this this lecture series on audit
objectives procedures evidence and
documentation so I hope to see you in
the next video to talk about audit
evidence and documentation
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