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Lesson Number 4: Phase II: Risk Response- Designing Overall Responses and Further Audit Procedures
and Audit of Liabilities

Lesson Objectives:
1. Understand the activities involved in designing the overall audit response and further audit procedures.
2. Know the general types of the auditor’s response to address the risk identified and assessed.
3. Explain the nature of audit procedures to be performed in conducting an audit.
4. Describe the auditors' objectives for the substantive audit of Liabilities.
5. Explain the nature of the appropriate audit procedures to accomplish the objectives for the audit of
Liabilities.
6. Understand the preparation of audit working papers to document the audit procedures for Liabilities.

Getting Started
The Risk Response Phase in the Risk-Based Audit Approach includes following steps:
a. Designing the overall audit responses and further audit procedures. This will require:
(i) Updating overall audit strategy
(ii) Developing responses to assessed risks.
(iii) Briefing team on audit plan as required.
b. Performance of further audit procedures. This step will involve:
(i) Performing planned procedures
(ii) Assessing results and evidence obtained
(iii) Document findings and conclusions.

OVERALL RESPONSE
The auditor shall design and implement overall responses to address the risks identified and assessed at the:
• financial statement level; and
• assertion level for financial statement areas and disclosures.

An assessment of the risks of material misstatement is required at the financial statement and assertion levels to
obtain evidence that addresses risk assessments developed for each relevant assertion.
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TYPES OF RESPONSE

Audit procedures are the methods or acts that auditor use to gather evidence to determine the validity of
financial statements assertions.
The various types of an audit procedures available to the auditor are categorized as follows:
1. Test of controls or 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. This is usually done using
walkthrough and/or inquiry procedures.
Types of Compliance testing
a. No trail
b. Documentary trail
2. Substantive procedures
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These are audit procedures designed to detect material misstatements at the assertion level. 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.

Types of Substantive Test

There are two general categories of substantive tests. 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.
a. Tests of Details
This type of substantive test involves obtaining evidential matter on the items (or details) involved in
an account balance or class of transactions. Tests of details are also referred to as follows:
• Test of transactions- These are test of the processing of individual transactions by inspection of
the document and accounting records involved in processing.
• Test of balances- These are tests applied directly to the details of the balances in general ledger
accounts.
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.

Audit of Long-term Liabilities

In determining the tests of detail of balances for long-term debts such as bonds payable, mortgage payable,
notes payable, the auditor considers tolerable misstatement, inherent risk, control risk, the results of tests of
controls and substantive tests of transaction and the results of analytical procedure. Tolerable misstatement if
often set a low level because it is often possible to completely audit the account balance or the transactions
affecting the account balance. Inherent risk is also typically set to a low level because it is usually easy to
determine the correct account value. Auditors are normally most concerned about the adequacy of disclosures
such as collateral and covenant restrictions for notes payable.

AUDIT OBJECTIVES AND PROCEDURES FOR LIABILITIES
The table below summarizes the financial statement assertions, specific audit objectives and the common audit
procedures traditionally used to audit liabilities.
Assertions
I. Existence or occurrence
II. Completeness
III. Rights and obligations
IV. Valuation and
allocation
V. Presentation and
disclosures
Audit Objectives
A. To determine that Long-term debt
exist at the end of the year.
B. To determine that all transactions
relating to long-term debts are properly subsidiary ledger
recorded.
C. To determine that long-term debts
represent valid obligation of the entity. off Procedures
D. To determine that long-term debts
are recorded at the proper amount.
E. To determine that long-term debts are - Reviewing compliance with terms of
presented and disclosed in accordance
with PAS/PFRS.
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Audit Procedures
- Purchase and Accounts Payable Cut-
off Procedures
- Confirmation
- Inspecting supporting documents
- Performing Analytical review
procedures
- Reconciling general ledger and
- Purchase and Accounts Payable Cut-
off Procedures
- Search for unrecorded liabilities
- Performing Analytical review
procedures
- Purchase and Accounts Payable Cut-
- Confirmation
- Inspecting supporting documents
- Search for unrecorded liabilities
- Performing Analytical review
procedures
- Reconciling general ledger and
subsidiary ledger
- Confirmation
- Inspecting supporting documents
- Testing the accuracy of interest
expense, interest payable, amortization
of discount and premium.
- Evaluating valuation of liabilities
denominated in foreign currencies.
- Performing Analytical review
procedures
debt agreements
- Evaluating proper financial statement
presentation and adequacy of
disclosures
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Problem
ELEANOR CORP. has been producing quality disposable diapers for more than two decades. The company's
fiscal year runs from April 1 to March 31. The following information relates to the obligations of Eleanor as of
March 31, 2014.
BONDS PAYABLE
Eleanor issued P10,000,000 of 10% bonds on July 1, 2012. The prevailing market rate of interest for these
bonds was 12% on the date of issue. The bonds will mature on July 1, 2022. Interest is paid semi-annually on
July 1 and January 1. Eleanor uses the effective interest rate method to amortize bond premium or discount.
NOTES PAYABLE
Eleanor has signed several long-term notes with financial institutions. The maturities of these notes are given in
the schedule below. The total unpaid interest for all these notes amounts to P600,000 on March 31, 2014.

ESTIMATED WARRANTIES
Eleanor has a one-year product warranty on some selected items in its product line. The estimated warranty
liability on sales made during the 2012-2013 fiscal year and still outstanding as of March 31, 2013 amounted to
P180,000. The warranty costs on sales made from April 1, 2013, through March 31, 2014, are estimated at
P520,000. The actual warranty costs incurred during the current 2013-2014 fiscal year are as follows:

OTHER INFORMATION
1. TRADE PAYABLES
Accounts payable for supplies, goods and services purchased on open account amount to P740,000 as of
March 31, 2014.
2. PAYROLL RELATED ITEMS
Accrued salaries and wages P300,000
Withholding taxes payable 94,000
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Other payroll deductions 10,000

Total P404,000
3. MISCELLANEOUS ACCRUALS
Other accruals not separately classified amount to P150,000 as of March 31, 2014.
4. DIVIDENDS
On March 15, 2014, Eleanor's board of directors declared a cash dividend of P0.20 per ordinary share
and a 10% share dividend. Both dividends were to be distributed on April 12, 2014, to the shareholders
of record at the close of business on March 31, 2014. Data regarding Eleanor ordinary share capital are
as follows:

Par value P5.00 per share

Number of shares issued and outstanding 6,000,000 shares
Market values of ordinary shares:
March 15, 2014 P22.00 per share
March 31, 2014 P21.50 per share
April 12, 2014 P22.50 per share

1. How much was received by Eleanor from the sale of the bonds on July 1, 2012?
a. P8,852,960
b. P10,000,000
c. P10,500,000
d. P10,647,040
2. What is the current portion of Eleanor's notes payable at March 31, 2014?
a. P2,800,000
b. P1,600,000
c. P1,300,000
d. P3,800,000
3. The balance of the estimated warranties payable at March 31, 2014, is
a. P342,000
b. P18,000
c. P520,000
d. P180,000
4. On March 31, 2014, Eleanor's statement of financial position would report total current liabilities of
a. P5,286,000
b. P4,386,000
c. P5,336,000
d. P5,642,000
5. On March 31, 2014, Eleanor's statement of financial position would report total noncurrent liabilities of
a. P14,389,350
b. Pl4,352,217
c. P14,370,783
d. P14,252,960