Chapter 8 PERFORMING SUBSTANTIVE TESTS Set Desired Assess Determine Level of [>| Inherent [>| Assess Acceptable Audit Risk pheregt Control Risk [>| Level of Detection Risk Yr 47 WH, Jo pont Consideration of Performing anning, internal control Substantive Tests (Chapter 5) (Chapter 6) (Chapter 8) After assessing inherent risk and control risk, the auditor performs substantive tests to reduce the level of detection risk to an acceptable level. Substantive tests are audit procedures designed to substantiate the account balances or designed to detect material misstatements in the financial statements. There are two types of substantive tests, namely analytical procedures and test of details. The decision about which procedures to use is based on the auditor's judgment about the expected effectiveness and efficiency of such procedures in satisfying the audit objective. ® Analytical Procedures (2g: yo gannieg 4 compen) As discussed in Chapter 5, analytical procedures may be used in the planning, testing and_ove es of the audit. Analytical procedures applied as substantive tests enable the auditor to obtain corroborative evidence about a particular assertion. Analytical review involves comparison of financial information with auditor’s expectations to evaluate the reasonableness of an account balance or transaction class. 719 Scanned with CamScannerWhen the application of analytical procedures identifies significant unusual or unexpected fluctuations, the auditor should conduct further investigation. This investigation ordinarily begins with inquiries from management followed by corroboration of management’s responses to inquiry. If the auditor is not satisfied with management's response, the auditor would normally alternative procedures to confirm or dispel his suspicion of whether material misstatements exist.. Figure 7.1- Using Analytical Procedures as Substantive Tests Develop Expectations about the Financial Statements ¥ Compare the Financial Statements with the Expectations Developed Is the difference significant? Conduct further investigation Accept the account as reasonable Scanned with CamScannerThe effectivens afected by many factors data used to develop predictabilit y of the of analytic vec Procedures applied as substantive tests is ch as, 8 Nt i inbol uch as the natute of the assertions, reliability of expectations, account balances precision of expectations, and When intending to perform auditor should focus following, gener of the accounts, analytical procedure ae On those accounts that Muations may be helpful in s substantive tests, the are predictable. ‘The ng the predictability » Income stateme ci i ned tatement accounts are more predictable compared to statement of financial position account’S) . C s that are * H i Accounts that are not subject to management discretion are generally predictable. . Relationships in a stable environment are more predictable than those in a dynamic or unstable environment. ® Test of details Test of details involves examining the actual details making up the various account balances. ‘This approach may take the form of test of details of balances or test of details of uansactions. Test of details of balances involves examining directly the balance of an account, while test of details-of transactions involves testing the transactions that give rise to the balance of an account. To illustrate the difference between the two, assume that the auditor wants to examine the cash account. Cash Beginning balance 7,000,000 ; x i Cash disbursements _during the year EEE) Ending balance 1,500,000 Scanned with CamScannerproach, hewn ver, will § wactions involving re sactions. Exarnp dan sAcuOns. 4 h, accounts receivable and invents Y. of accounts of this type includ On the other hand, test of transactions is useful if account balan: ‘ d of 2 smaller volume of transactions representing relatively material amounts. Examples of these accounts are propery and equipment, intangibles, bonds payable, and stockholders’ equity accounts, Effectiveness of Substantive Tests The potential effectiveness of the auditor’s substantive test is affected by its nature, timing, and extent, * Nature of substantive test ‘The nature of substantive test relates to the quali evidence. The auditor should determine the appropriate quality of evidence needed to support the desired level of detection risk, Although the auditor would normally prefer high quality evidence, it js important to understand that high quality evidence would also involve high cost. © Timing of substantive test Substantive tests may be performed Performing audit procedures at inte; identifying significant matters consequently resolving them with at interim date or at year end. Tim date assists the auditor in ¢ audit, and the help of management of 222 Scanned with CamScannerdeveloping an effect; a tive audi Additionally, performin, audi approach to address such matters spread the work ee procedures allows the auditor to i u Par, ees during the peak period ghout the year, thus, minimizing the load Interim procedure 7 end rredaes ia ae less effective than year whenever audit proced additional incremental risk that arises Consequently, as th ‘skola are applied to interim balances > risk of material misstatement increases, the more likely it is that auditor ; : may decide to perform substantive tests neares to, or at year end. perform substa e Extent of substantive test The extent of substantive test relates to the amount of evidence needed to satisfy a particular objective. The extent of substantive tests js based on the auditor's judgment after considering the materiality, the assessed risk, and the level of assurance the auditor plans to attain. In particular, the auditor ordinarily increases the extent ‘of substantive tests as the risk of material misstatement increases. Relationship between Substantive Test and Test of Control ‘An understanding of the nature of substantive tests and tests of control is essential in order to appreciate the relationship between the two tests. Tests of controls provide evidence that indicates a misstatement is likely to occur. Substantive tests, on the other hand, provide evidence about the existence of misstatement in an account balance. For example, if the results of te 1 a 1 procedures are not functioning effectively, the auditor will assume that material misstatements are likely to occur. The auditor will then perform substantive tests to be able to identify those misstatements. In expressing an opinion 00 the financial statements, the auditor relies on the effectiveness of the internal control to prevent material errors in the pstantive tests to verify the amounts in the accounting ess, and on sul \ : : financial eee If tests of controls indicate that the internal control is 223 Scanned with CamScanner sts of control indicate that the internal control , wweffective in preventing, detecting, and correcting material misstatements that may occur in the accounting process, the auditor may perform less substantive tests. Conversely, if the internal control is not reliable, the auditor will have to perform extensive substantive tests. Thus, the result of tests of control is a major factor in determining the nature, timing, and extent of the auditor's substantive tests. AUDIT EVIDENCE The auditor should obtain sufficient appropriate evidence to be able to draw reasonable conclusions on which to base the audit opinion. Evidence refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence is necessary to support the auditor's opinion and report. It is Cumulative in nature and is primarily obtained from audit procedures performed during the audit. Audit evidence consists of accounting records and other corroborating information. * Accounting records are the client’s record of transactions and events underlying the financial statements. These include books of accounts, related accounting manuals, worksheet supporting cost allocations and reconciliations prepared by the client personnel. * Other corroborating information refers to documents and information supporting the entity’s accounting records. This includes documents such as invoices, bank Statements, purchase orden, contracts, checks and other information obtained or developed by the auditor through confirmation, recalculation, observation and reconciliation. Entity’s accounting records alone cannot be considered sufficient evidence to support an opinion on the financial statements, When auditing financial statements, the auditor should go beyond the accounting records. Auditor should obtain other corroborative information to support his opinion, ‘ 224 Scanned with CamScannerAttributes of audit evidence Reasonable assurance oe ance is. attai . : sufficient appropriate e ned when the auditor has obtained level. Audit evidence eae 2 hoe audit nisk to an acceptable assessment procedures, tests An Neo ear, Patton es erforming risk assessment pr ontrol and substantive tests. When idence obtained enab procedures and tests of control, audit igherent and contrel bles the auditor to support the assessed level of performing See In contrast, audit evidence obtained when sek. At the conclusi €sts supports the desired level of detection A 1 conclusion of the audit, the auditor should apply his Sern determining whether the audit evidence obtained as a result of those procedures is sufficient and appropriate enough to support the auditor’s opinion. ++ Sufficiency refers to the amount of evidence that the auditor should accumulate. Because of the cost/benefit consideration the auditor does not examine all evidence available. The euditor uses his judgment to determine the amount of evidence needed to support an opinion on the financial statements. The following factors may be considered in evaluating the sufficiency of evidence: = ‘The competence of evidence Cael] The amount of evidence that is sufficient in a given situation varies inversely with the competence of evidence. Thus, the more competent the evidence, the less amount of evidence is needed to support the auditor's opinion. of the item being examined. ‘The more material the financial statement amount being more evidence will be needed to support its rsely, if the account is not material to the ents, the auditor does not have to perform any d to that account. ‘The materiality examined, the validity. Conve! financial statem procedure relate’ v nD a Scanned with CamScanner* The risk involved in a particular account. As the risk of misstatement in a particular account increases, the more evidence will be needed. = Experience gained during previous audit may indicate the amount of evidence taken before and whether such evidence was enough. ++ Appropriateness is the measure of the quality of audit evidence and its relevance to a particular assertion and its reliability. Relevance relates the timeliness of evidence and its ability to satisfy the audit objective. Reliability relates to the objectivity of evidence and is influenced by its source and by its nature. While reliability of audit evidence is dependent on individual circumstance, the following generalizations could help the auditor in assessing the reliability of audit evidence: * Audit evidence obtained from independent outside sources (for example, confirmation received from a third party) is more reliable than that generated internally. * Audit evidence generated internally is more reliable when the related accounting and internal control systems are effective. * Audit evidence obtained directly by the auditor is more reliable than that obtained from the entity. "Audit evidence in the form of documents and written representations is more reliable than oral representations. Cost/benefit consideration when obtaining evidence An auditor works within economic limits, The auditor’s opinion to be economically useful must be formed within a reasonable period of time, and based on evidence obtained at a reasonable eee Asa guiding rule, there should be a rational relationship between the cost of obtaining evidence and the usefulness of the evidence obtained. nae Scanned with CamScannerThe auditor uses his Professional ; ropniate d SSION; i rl approp! type of evidence that i judgment in determining the uld be obtained. Audit evidence d fa loes Ordinarily, the auditor finch have to be conclusive to be useful. is persuasive rather than c S necessary to rely on audit evidence that ‘onclusive in nature and will often seck audit evidence from diff bi SWerent sources or of a dif the same assertion. erent nature to support » AUDIT DOCUMENTATION/ WORKING PAPERS (adr) The sufficient appropriate evidence required by the professional standards must be clearly documented in the auditor’s working papers. Working papers are records kept by the auditor that document the audit procedures applied, information obtained and conclusions reached. PSA 230 requires the auditor to document matters that are important e to support an opinion on financial statements, and. e to support representation that the audit was conducted in accordance with PSA. = Bunctions of the working papers Working papers, are prepared primarily to support the au ditor’s opinion on financial statements; to__support the auditor's ith PSA; and to assist the auditor in representation as tO. , : pres’ review and supervision of the‘ the planning, performance, engagement. i auditor in planning future i ing papers also assist the auto ae and Secondary, er ation useful in rendering other services and tudits, provi > eel providing adequate defense in case of litigation. Scanned with CamScannertent of Audit Documentation Form, Content and E It is neither necessary nor practicable to document every matter the auditor considers during the audit. In deciding on the form, content and extent of audit documentation, the auditor should consider what would enable an experienced auditor, having no_ previous connection with the audit, to understand: (a) ‘The nature, timing, and extent of the audit procedures performed to comply with PSAs and applicable legal and regulatory requirements; . (b) The results of the audit procedures and the audit evidence obtained; and (c) Significant matters arising during the audit and the conclusions reached thereon. The form, content and extent of audit documentation depend on factors such as: ‘The size and complexity of the entity The nature of the audit procedures to be performed. * The identified risks of material misstatement. The significance of audit evidence obtained. * The nature and extent of exceptions identified. * The need to document a conclusion or the basis for a conclusion not readily determinable from the audit evidence obtained. * The audit methodology and tools used. Although audit documentation depends upon the auditor’s judgment, the following important items would normally require audit documentation: = Discussions of significant matters with management and others ona timely basis. = In exceptional circumstances, when the auditor judges it necessary to depart from a basic principle or an essential procedure that is relevant in the circumstances of the audit, the auditor should document how the alternative audit procedures performed achieve the objective of the audit, and, unless otherwise clear, the reasons for the departure. 228 Scanned with CamScanner» In documentin ng the procedures perio the nature, timing and extent of audit (a) Who vedtdeubig the autor should record ‘d the audit wor ij : completed: and dit work and the date such work was b) Who review wed the audi au extent of such revie it work performed and the date and Ww. 1 Classification of working papers In a continuing enga; : . . gement, workin; into permanent file or current working pepe oie typically classified ‘ + Pe fas i : oo Egmaneat fie contains information of continuing significance to the auditor in performing recurring audits. This file would most likely include copies of the articles of incorporation and by-laws = major contracts = engagement letter * organizational chart = analyses of long-term accounts such as plant assets, long-term liabilities and stockholders’ accounts. «= jnternal control analyses. ++ Current file contains evidence gathered and conclusions reached relevant to the audit of a particular year. This file would normally include : * acopyof the financial statements = audit program «© working trial balance « Jead schedules = detailed schedules ' = correspondence with other parties such as lawyers, customers, banks, and management. 229 Scanned with CamScannerOwnership of working papers Working papers are the property of the auditor and the client has no right to the working papers prepared by the auditor, Working papers may sometimes serve as a reference source for the client (at the discretion of the auditor) but they should not be considered as part oras a substitute for the client’s records. Confidentiality of working papers Although the working papers are the personal property of the auditor, these working papers can not be shown to third parties without the client’s permission. The Philippine Code of Professional Ethics requires the CPA to respect the confidentiality of information obtained during the course of performing professional services. Even so, the duty of confidentiality may be overridden by the statute of law, For example, the auditor can disclose confidential information to third parties even without the client’s consent under the following circumstances: * When disclosure is required by law or when the working papers are subpoenaed bya court. * When there is a professional right to disclose information such as when the auditor uses his working Papers to defend himself when sued by the client for negligence. * When the profession requires like the review of quality of audit conducted by the Board of Accountancy for the purpose of evaluating whether to grant a practitioner an accreditation to practice public accountancy. +s Retention of working papers Working papers should be retained by the auditor fora period of ime sufficient to meet the needs of his practice and to satisfy any pertinent legal requirements of record retention, The retention period aoe audit engagement must be at least 5 years from the date of the auditor's report. However, Securities Regulations Code No, 68 of the Securities and Exchange Gommissidn (SE FR . H be kept for arleast 7 woe GEQ requires that audit working papers Scanned with CamScanners AssetVLy OF Linal Working Paper File After tk F 7 changes eke ce has been issued, the auditor may need to make paper file that will b Ig Papers to come up with a final audit working Pe einen vill be archived. ‘The assembly of the final audit file is only administrative in nature and d a loes not require the auditor to erform add; aes : Pompletion oars audit procedures or draw new conclusions. The his administrative process is to be completed on a tumely basis not later than 60 days after the date of the auditor’s report. £3 Guidelines for the preparation of working papers Working papers should be properly organized to facilitate their review. The following techniques may be used by the auditor when preparing working papers. = Heading Each working paper must be properly identified with such information as the name of the client, type of working paper, a description of its content, and the date or period covered by the examination. = Indexing Indexing refers to the use of lettering or numbering system (for example “A” for Cash lead schedule). Each working paper must be indexed to aid in cross-referencing essential information. = Cross-indexing/ cross referencing Cross-referencing is important to provide a trail useful to supervisors in reviewing the working papers. * Tick marks Working papers must include symbols that describe the audit procedures performed. % AUDITING ACCOUNTING ESTIMATES | Some financial statement items cannot be measured precisely, but can only be estimated. As defined by PSA 540, ‘accounting, estimate’ means an approximation of the monetary amount in the absence of a precise 231 Scanned with CamScannermeans of measurement. Accounting estimates are often made in conditions of uncertainty regarding the outcome of events are likely to occur and involve the use of judgment. Examples of situations where accounting estimates may be required include: e — Allowance for doubtful accounts e — Inventory obsolescence e Warranty obligations e Depreciation e — Impairment loss e Fair value determination Some accounting estimates involve relatively low estimation of uncertainty and may give rise to lower risks of material misstatements. For some accounting estimates, however, there may be relatively high estimation of uncertainty, particularly when they are based on significant assumptions like accounting estimates relating “to the outcome of litigation; or fair value estimates of financial instruments that are not publicly traded. The auditor must be specifically careful in considering accounts that are affected by accounting estimates because the risk of material misstatement is greater when accounting estimates are involved. This can be attributed to the degree of subjectivity involved and the susceptibility of accounting estimates to management bias. &3 Auditor’s Responsibility Management is responsible for making accounting estimates included in the financial statements. The auditor’s responsibility is to obtain sufficient appropriate evidence as to whether . Accounting estimate 1s properly accounted for and disclosed = Accounting estimate is reasonable in the circumstances, When assessing the risk of material misstatement relating to accounting estimates, the auditor should understand degree of 7% Scanned with CamScanneris involved, . used by the the requirements of the standards and the re the chent in making these estimates. 1g whether account; : closed. sa ner accounting estimates are properly accounted for ation of eaters knowledge of the client’s business and 1 of relevant financial reporting framework. When evaluati aluating the reasonableness of accounting estimates, the fitor should obtain an understanding of the procedures and including the accounting and internal control systems, used y Management in making the accounting estimates. In addition, the auditor may use one or a combination of the following approaches: bs 1. Review and test the process used by management to develop the estimate. This will often involve: = evaluating data and management assumptions, ® testing of calculations, * comparing prior periods estimates with actual results, and = considering management approval procedures. 2. Make an independent estimate The auditor may make or obtain an independent estimate and compare it with the accounting estimate prepared by management. Review subsequent. events which confirm the estimate w made. Transactiogs and events which occur after period end, but prior to completion of the audit, may provide sufficient appropriate evidence regarding an accounting estimate made by management. After performing the above 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. Scanned with CamScanner¢ RELATED PARTIES The term related party refers to persons or entities that may have dealings with one another in which one party has the ability to exercise significant influence or control over the other party in making financial and operating decisions. These would include entity’s affiliates, subsidiaries, associates, principal owners, directors, officers including their immediate families. Many related party transactions are in the normal course of business. In such circumstances, they may carry no higher risk of material misstatement of the financial statements than similar transactions with unrelated parties. However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties. When auditing financial statements, the auditor needs to be aware of related party relationships and related party transactions because: * PERS and PFRS for SMEs require disclosure in the financial statements of certain related party relationships and transactions. * A related party transaction may be motivated by other than ordinary business considerations such as profit sharing or even fraud. = The existence of related parties or related party transactions may affect the financial statements and the reliability of audit evidence. — Responsibility of Management and Those Charged with Governance ‘The audit is conducted on the premise that management and, where appropriate, those charged with governance have responsibility for the preparation and presentation of the financial statements in accordance with the applicable financial reporting framework. ‘This includes the design, implementation and maintenance of adequate controls over related party relationships and transactions so that these are identified and appropriately accounted for and disclosed in accordance with the framework. 234 Scanned with CamScannerThose charged with 9 ‘1 itori ped with governance are responsible for monitoring how management is discharge 5 Spo! . ee ol discharging its responsibility for such controls. They need to obtain information from management to enable them to nderstan e < . . u | d the nature and business rationale of the entity’s related party relationships and transactions. et {3 Auditor’s responsibility It is important that related parties be identified early in the audit. Auditors: normally request the management to provide them with information identifying the names of all known related parties and related party transactions. As part of the auditor’s risk assessment procedures, the auditor should inquire of management regarding: (a) The identity of the entity’s related parties, including changes from the prior period; (b) The nature of the relationships between the entity and these related parties; and (©) Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the transactions. ‘The auditor should also obtain an understanding of the controls that management has established to identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework. If the auditor identifies significant transactions outside the entity’s normal course of business when performing the audit procedures, the auditor should inquire of management about the nature of these transactions and whether related parties could be involved. The following procedures may assist the auditor in identifying related parties: . = Review prior-year working papers for names of known related parties. Pes ; * Review the entity's procedures for identification of related parties. 235 Scanned with CamScannerInquire as to the affiliation of the directors and officers with other entities. . a Review shareholder records to determine the names of principal shareholders or, if appropriate, obtain a listing of shareholders from share register. Review minutes of the meetings of shareholders and the board of directors and other relevant statutory records such as the register of director’s interests : . Inquire of other auditors currently involved in the audit, or predecessor auditors, as to their knowledge of additional related parties. : : Review the entity’s income tax returns and other information supplied to regulatory agencies. The above procedures should be modified as appropriate if in the auditor's judgment the risk of significant related parties remaining undetected is low. During the course of the audit, the auditor may perform the following procedures in order to identify related party transactions: Performing detailed tests of transactions and balances. Reviewing minutes of meetings of shareholders and directors. Reviewing accounting records for large or unusual transactions or balances, paying particular attention to transactions recognized at or near the end of the reporting period. Reviewing confirmations of loans receivable and payable and confirmations from banks to identify the existence of guarantee and other related party transactions. Reviewing investment transactions like purchase or sale of an equity interest in a joint venture or other entity. An audit can not be expected to provide assurance that all related party transactions will be discovered. Nevertheless, the auditor should be alert for unusual transactions that may indicate the existence of related parties or related party transactions, Examples of conditions in which related party transactions are likely would include: Scanned with CamScanner‘Transactio vhi amnsual hie which have abnormal terms of trade, such as a" prices, interest rates, guarantees and repayment terms. ransactions whi a hich lack an ay i sin A a arent logica s reason for their occurrence. i gical business reas pee in which substance differs from form. Trapsactirs not processed in an unbiased manner. ig "i olume or significant transactions with certain customers or suppliers as compared with others. Unrecorded transactions such as the receipt or provision of management services at no charge. When related party transactions are identified, the auditor should obtain sufficient appropriate evidence that these are properly accounted for and disclosed in the financial statements. The auditor should also obtain a written representation from management concerning the completeness of information provided regarding the identification of related parties and the adequacy of related party disclosures in the financial statements. USING THE WORK OF AN EXPERT The auditor’s education and experience enable the auditor to be knowledgeable about business matters in general. However, the auditor is not expected to have the expertise required to practice other profession or occupation. During the audit, the auditor may need to obtain audit evidence in the form of reports, opinions, valuations, and statements of an expert. An expert is a person or firm possessing special skill, knowledge and experience ina particular field, other than accounting and auditing. Common examples of expert’s work include: * Valuation of precious stones, works of arts, real estate, and other specialized assets © Determination of amounts using specialized techniques like actuarial computations Interpretation. of technical requirements, regulations, or contracts such as legal documents or legal title to property 237 Scanned with CamScanner620 deals with the work of the auditor's expen, auditor’ following guideli using the work of an uditor or engag “2 Determining the need for an Expert Not all engagements would require auditor vill be able to obtain suffi account balance the help of an expen. Usually, the cient appropriate evidence about an or transaction class even without the help of an ‘zpen. In some instances however, the auditor cannot obtain faction about an assertion without seeking the assistance of an . When determining the need to use the work of an expert, the auditor would consider: a. the materiality of the financial statement item being considered b. the risk of misstaternent based on the nature and complexity of the matter being considered; and c. the quality and quantity of other audit evidence available. Using the work of an expert When the auditor concludes that the work of the suppor an assertion, the auditor should 1. + the expert's professional competence and objectivity; 2. Evaluate the scope of the expen’s works and 3. Assess the work of the expert expert is needed to 1. Assessing the expert’s competence and objectivity The following factors must be considered when asse sing the competence of the expert: 23% Scanned with CamScanner® Professi ificati icensi ip P ional certification or licensing by, or membership in, an appropriate professional body; and = Experi ion i ield i i itor i pe ence and reputation in the field in which the auditor is seeking audit evidence The objectivity of the expert may be impaired if the expert is: = Employed by the entity; or " Related in some other manner to the entity, for example, by being financially dependent upon or having an investment in the entity. If the auditor is concemed regarding the competence or objectivity of the expert, the auditor should discuss any reservations with management and should consider whether sufficient appropriate evidence can be obtained concerning the work of an expert. The auditor may need to undertake additional audit procedures or seek audit evidence from another expert. . Evaluating the scope of the expert’s work PSA 620 requires the auditor to obtain sufficient appropriate evidence that the scope of the auditor's work is adequate for the purpose of the audit. This understanding should cover: ® The objectives and scope of the expert’s work : ® Methods and assumptions to be used by the expert © The intended use by the auditor of the expert’s work * Form and content of the expert’s report « Expert’s relationship to the client . Assessing the work of the Expert The auditor should assess the appropriateness of the expert's work as audit evidence regarding the financial statement assertion being considered. This would require consideration of the expert's 239 Scanned with CamScannersource of data, assumptions and methods used by the expert, and the results of expert’s work in light of the auditor’s knowledge of the client’s business and the results of other audit procedures. Ordinarily, the auditor would rely on the work of the expen unless the auditor's procedures reveal that the expert’s findings are unreasonable, in which case, additional modified procedures should be applied. If the results of the expert’s work do not provide sufficient appropriate audit evidence or the results are not consistent with other evidence, the. auditor should resolve the matter by discussing it with the client and the expert or performing additional procedures, including possibly engaging the services of another expert. “% CONSIDERING THE WORK OF INTERNAL AUDITING Internal auditing is an appraisal activity established within an entity as a service to the entity. The extemal auditor should obtain a sufficient understanding of the internal audit activities to assist in planning the audit and developing an effective audit approach. An effective internal auditing will often affect the nature timing and extent of the external auditor’s procedures. Considering the work of internal auditor involves two important phases: 1. Making a preliminary assessment of internal auditing; and 2. Evaluating and testing the work of internal auditing 2 Preliminary assessment of internal auditing When planning the audit, the extemal auditor should make a preliminary assessment of the internal audit function when it appears that internal auditing is relevant to the external audit of the financial statements in specific audit areas. For this purpose, the external auditor should consider the internal auditor's: 1. Competence Consider the professional qualifications and experience of the internal auditors. 240 Scanned with CamScanner2. Objectivity Consider the organizational level to which the internal auditors report the results of their work. 3. Due professional care Consider prope: i aa 7 eed planning, supervision and documentation of internal auditor's work. 4, Scope of function Consider the nature and extent of the internal auditors’ assignment. Evaluating and testing the work of internal auditors If based on the foregoing assessment, the external auditor decides to use the work of the internal auditor, the external auditor will have to evaluate and test the internal auditors work to confirm its adequacy for the external auditor's purposes. This evaluation may include considering whether the work is performed by competent persons; sufficient appropriate evidence is obtained; appropriate conclusions are reached; and exceptions are properly resolved. Aside from using the work performed by the internal auditors, the external auditor may. also request the assistance of the internal auditors in performing routine or mechanical audit procedures. This is an acceptable practice provided the external auditor supervises and reviews the work performed by the internal auditors. nize that all judgments relating to the audit of those of the external auditor. The auditor's not reduced by any use made of he auditor’s report on financial ference to the work performed It is important to recog} financial statements are those Of responsibility for audit opimon +s internal auditing. Accordingly, u statements should not include any re! by internal auditors. Scanned with CamScanner