Auditing Theory (AT-8)

CKC- BSA 3

PSA 500(REVISED) AUDIT EVIDENCE

PSA 501 AUDIT EVIDENCE – ADDITIONAL CONSIDERATIONS ON SPECIFIC ITEMS

PSA 505 EXTERNAL CONFIRMATIONS
PSA 230 AUDIT DOCUMENTATION

PSA 500(REVISED)
AUDIT EVIDENCE
1. The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion
2. “Audit Evidence” is all the information used by the auditor in arriving at the conclusions on
which the opinion is based, and includes the information contained in the accounting records
underlying the financial statements and other information
3. Accounting records generally include:
 The records of initial entries and supporting records, such as checks and records
of electronic fund transfers;
 Invoices
 Contracts
 The general and subsidiary ledgers, journal entries and other adjustments to the
financial statements that are not reflected in formal journal entries; and
 Records such as work sheets and spreadsheets supporting cost allocations,
computations, reconciliations and disclosures
4. Other information that the auditor may use as audit evidence includes:
 Minutes of the meetings
 Confirmations from third parties
 Analysts’ reports
 Comparable data about competitors (benchmarking)
 Control manuals
 Information obtained by auditors from such audit procedures as inquiry,
observation, and inspection; and
 Other information developed by, or available to, the auditor that permits the
auditor to reach conclusions through valid reasoning

Sufficient appropriate evidence

1. Sufficiency is the measure of the quantity of audit evidence
2. Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its
reliability in providing support for, or detecting material misstatements in, the classes of
transactions, account balances, and disclosures and related assertions.
3. The following generalizations can be made about the reliability of audit evidence:
a. Audit evidence I more reliable when it is obtained from independent sources
outside the entity
b. Audit evidence that is generated internally is more reliable when the related
controls imposed by the entity are effective
c. Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or
by inference (for example, the inquiry about the application of control)
d. Audit evidence is more reliable when it exists in a documentary form, whether
paper, electronic, or other medium (for example, contemporaneously written
record of a meeting is more reliable than a subsequent oral representation of the
matters discussed)
e. Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles
4. An audit rarely involves the authentication of documentation, nor is the auditor trained as or
expected to be an expert in such authentication
 5. When information produced by the entity is used by the auditor to perform audit procedures,
the auditor should obtain audit evidence about the accuracy and completeness of the
information
6. In forming an audit opinion, the auditor does not examine all the information available because
conclusions ordinarily can be reached by using sampling approaches and other means of
selecting items for testing.

The use of assertions in obtaining audit evidence

1. Management is responsible for the fair presentation of financial statements that reflect the
nature and operations of the entity.
2. In representing that the financial statements are presented fairly, in all material respects, in
accordance with the applicable financial reporting framework, management implicitly or
explicitly makes assertions regarding the recognition, measurement, presentation, and
disclosure of the various elements of financial statements and related disclosures
3. The auditor should use assertions for classes of transactions, account balances, and
presentation and disclosures in sufficient detail to form a basis for the assessment of risks of
material misstatement and the design and performance of further audit procedures

CATEGORIES OF ASSERTIONS
a. Assertions about classes of transactions and events for the period under audit:
1. OCCURRENCE - transactions and events that have been recorded have
occurred and pertain to the entity
2. COMPLETENESS - all transactions and events that should have been recorded
have been recorded.
3. ACCURACY - amounts and other data relating to recorded transactions and
events have been recorded appropriately
4. CUTOFF - transactions and events have been recorded in the correct
accounting period
5. CLASSIFICATION - transactions and events have been recorded in the proper
accounts
b. Assertions about account balances at the period end:
1. EXISTENCE -assets, liabilities, and equity interests exist
2. RIGHTS AND OBLIGATIONS - the entity holds or controls the right to assets,
and liabilities are obligations of the entity
3. COMPLETENESS - all assets, liabilities, and equity interests that
should have been recorded have been recorded
4. VALUATION AND ALLOCATION - assets, liabilities and equity interests are
included in the financial statements at appropriate amounts and any resulting
valuation or allocation adjustments are appropriately recorded

c. Assertions about presentation and disclosure:

1. OCCURRENCE AND RIGHTS AND OBLIGATIONS
 Disclosed events, transactions, and other matters have occurred and
pertain to the entity
2. COMPLETENESS
 All disclosures that should have been included in the financial
statements have been included
3. CLASSIFICATION AND UNDERSTANDABILITY
 Financial information is appropriately presented and described and
disclosures are clearly expressed
4. ACCURACY AND VALUATION
 Financial and other information are disclosed fairly and at appropriate
amounts

Audit procedures for obtaining audit evidence

1. RISK ASSESSMENT PROCEDURES
Obtain an understanding of the entity and its environment, including its internal control,
to assess the risk of material misstatement at the financial statement and assertion
levels
2. TESTS OF CONTROLS
When necessary or when the auditor has determined to do so, test the operating
effectiveness of controls in preventing, or detecting and correcting, material
misstatements at the assertion level
 3. SUBSTANTIVE PROCEDURES
Detect material misstatements at the assertion level. These include analytical review
procedures and tests of details

Examples of audit procedures

1. INSPECTION
Consists of examining records and documents, whether internal or external in paper
form, electronic form, or other media. Inspection of tangible assets consists of physical
examination of the assets.
2. OBSERVATION
Consists of looking at a process or procedure being performed by others
3. INQUIRY
Consists of seeking information of knowledgeable persons, both financial and
nonfinancial, throughout the entity or outside the entity
4. CONFIRMATION
The process of obtaining a representation of information or of an existing condition
directly from a third party
5. RECALCULATION
Consists of checking the mathematical accuracy of documents or records
6. REPERFORMANCE
The auditor’s independent execution of procedures or controls that were originally
performed as part of the entity’s internal control, either manually or through the use of
CAATs
7. ANALYTICAL PROCEDURES
Consists of evaluations of financial information made by a study of plausible
relationships among both financial and nonfinancial data. It also encompasses the
investigation of identified fluctuations and relationships that are inconsistent with other
relevant information or deviate significantly from predicted amounts.

PSA 501
AUDIT EVIDENCE – ADDITIONAL CONSIDERATIONS ON SPECIFIC ITEMS

Attendance at Physical Inventory Counting

1. When inventory is material to the financial statements, the auditor should obtain sufficient
appropriate audit evidence regarding its existence and condition by attendance at physical
inventory counting unless impracticable.

2. If unable to attend the physical inventory count on the date panned due to unforeseen
circumstances, the auditor should take or observe some physical counts on an alternative date
and, when necessary, perform tests of intervening transactions.

3. Where attendance is impracticable, due to factors such as the nature and location of the
inventory, the auditor should consider whether alternative procedures provide sufficient
appropriate audit evidence of existence and condition to conclude that the auditor need not make
reference to a scope limitation.

4. In planning attendance at the physical inventory count or the alternative procedures, the auditor
would consider:
 The nature of the accounting and internal control systems used regarding inventory.
 Inherent, control, and detection risks, and materiality related to inventory.
 Whether adequate procedures are expected to be established and proper instructions issued
for physical inventory counting.
 The timing of the count.
 The locations at which inventory is held.
 Whether an expert’s assistance is needed.

5. The auditor would review management’s instructions regarding:

 The application of control procedures, for example, the collection of used stocksheets,
accounting for unused stocksheets, and count and recount procedures.
  Accurate identification of the stage of completion of work in progress, of slow moving,
obsolete or damaged items and inventory by a third party, for example, on consignment.
 Whether appropriate arrangements are made regarding the movement of inventory between
areas and the shipping and receipt of inventory before and after the cutoff date.

6. To obtain assurance that management’s procedures are adequately implemented the auditor
would observe employee’s procedures and perform test counts.

7. The auditor would also consider cutoff procedures including details of the movement of inventory
just prior to, during, and after the count so that the accounting for such movements can be
checked at a later date.

8. The auditor would test the final inventory listing to assess whether it accurately reflects actual
inventory counts.

9. When inventory is under the custody and control of a third party, the auditor would ordinarily
obtain direct conformation from the third party as to the quantities and condition of inventory
held on behalf of the entity. Depending on the materiality of this inventory, the auditor would
consider:
 The integrity and independence of the third party.
 Observing, or arranging for another auditor to observe, the physical inventory count.
 Obtaining another auditor’s report on the adequacy of third party’s accounting and internal
control systems for ensuring that inventory is correctly counted and adequately safeguarded.
 Inspecting documentation regarding inventory held by third parties, for example, warehouse
receipts, or obtaining confirmation from other parties when such inventory has been pledged
as collateral.

Procedures regarding litigation and claims

1. The auditor should carry out procedures in order to become aware of any litigation and claims
involving the entity, which may have a material effect on the financial statements.

Such procedures would include:

 Make appropriate inquiries of management including obtaining representations.

 Review board minutes and correspondence with the entity’s lawyers.
 Examine legal expense accounts.
 Use any information obtained regarding the entity’s business including information obtained
from discussions with any in–house legal department.

2. When litigation or claims have been identified or when the auditor believes they may exist, the
auditor should seek direct communication with the entity’s lawyers.

3. The letter, which should be prepared by management and sent by the auditor, should request the
lawyer to communicate directly with the auditor. When it is considered unlikely that the lawyer
will respond to a general inquiry, the letter would ordinarily specify:
 A list of litigation and claims.
 Management’s assessment of the outcome of the litigation or claim and its estimate of the
financial implications, including costs involved.
 A request that the lawyer confirms the reasonableness of management’s assessments and
provides the auditor with further information if the list is considered by the lawyer to be
incomplete or incorrect.

4. The auditor considers the status of legal matters up to date of the audit report.

5. If management refuses to give the auditor permission to communicate with the entity’s lawyers,
this would be a scope limitation and should ordinarily lead to a qualified opinion or a disclaimer of
opinion.
Valuation and disclosure of long-term investments

1. When long-term investments are material to the financial statements, the auditor should obtain
sufficient appropriate audit evidence regarding their valuation and disclosure.

2. Audit procedures ordinarily include considering evidence as to whether the entity has the ability
to continue to hold the investments on a long-term basis and discussing with management
whether the entity will continue to hold the investments as long-term investments and obtaining
written representations to that effect.

3. Other procedures would ordinarily include considering related financial statements and other
information, such as market quotations, which provide an indication of value and comparing such
values to the carrying amount of the investments up to the date of the auditor’s report.

Segment information

1. When segment information is material to the financial statements, the auditor should obtain
sufficient appropriate audit evidence regarding its disclosure in accordance with the applicable
financial reporting framework.

2. The auditor considers segment information in relation to the financial statements taken as a
whole, and is not ordinarily required to apply auditing procedures that would be necessary to
express an opinion on the segment information standing alone.

3. Audit procedures regarding segment information ordinarily consist of analytical procedures and
other audit test appropriate in the circumstances.

4. The auditor would discuss with management the methods used in determining segment
information, and consider whether such methods are likely to result in disclosure in accordance
with GAAP and test the application of such methods.

PSA 505
EXTERNAL CONFIRMATIONS
1. External confirmation is the process of obtaining and evaluating audit evidence through a direct
communication from a third party in response to a request for information about a particular item
affecting assertions made by management in the financial statements.

Use of positive and negative external confirmations

2. A positive external confirmation request asks the respondent to reply to the auditor in all cases
either by indicating the respondent’s agreement with the given information, or by asking the
respondent to fill in the information.

3. A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request.

4. Negative confirmation requests may be used to reduce the risk of material misstatement to
an acceptable level when:
 The assessed risk of material misstatement is lower.
 A large number of small balances are involved.
 A substantial number of errors are not expected.
 The auditor has no reason to believe that respondents will disregard these requests.

5. When performing confirmation procedures, the auditor should maintain control over the process
of selecting those to whom a request will be sent, the preparation and sending of confirmation
requests, and the responses to those requests.

6. The auditor should perform alternative procedures where no response is received to a positive
external confirmation request. The alternative audit procedures should be such as to provide the
evidence the evidence about the financial statement assertions that the confirmation request was
intended to provide.
 7. When the auditor forms a conclusion that the confirmation process and alternative
procedures have not provided sufficient appropriate audit evidence regarding an assertion,
the auditor should undertake additional procedures to obtain sufficient audit evidence.

8. The auditor should evaluate whether the results of the external confirmation process
together with the results from any other procedures performed, provide sufficient
appropriate audit evidence regarding the assertion being audited.

PSA 230 (Revised)

AUDIT DOCUMENTATION
1. The auditor should prepare, on a timely basis, audit documentation that provides:
 a sufficient and appropriate record of the basis for the auditor’s report; and
 evidence that the audit was performed in accordance with PSAs and applicable
legal and regulatory requirements
2. “Audit documentation” means the record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor reached (terms such as “working
papers” or “work papers” are also sometimes used).
3. “experience auditor” means an individual (whether internal or external to the firm) who has
reasonable understanding of
 Audit processes;
 PSAs and applicable legal and regulatory requirements
 The business environment in which the entity operates; and
 Auditing and financial reporting issues relevant to the entity’s industry
4. Audit documentation may be recorded on paper or on electronic or other media
5. The auditor should prepare the audit documentation so as to enable an experiences
auditor, having no precious connection with the audit, to understand:
 the nature, timing , and extent of the audit procedures performed to comply with
PSAs and applicable legal and regulatory requirements
 the results of the audit procedures and the audit evidence obtained; and
 significant matters arising during the audit and the conclusions reached thereon
6. in documenting the nature, timing and extent of audit procedures performed, the
auditor should record the identifying characteristics of the specific items or matters
beig tested
7. the auditor should document discussions of significant matters with management and
others on a timely basis
8. where, in exceptional circumstances, 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 achieved the
objective of the audit, and, unless otherwise clear, the reasons for the departure
9. the auditor should record:
 who performed the audit work and the date such work was completed
 who reviewed the audit work performed and the date and extent of such review

Assembly of the final audit file

10. The auditor should complete the assembly of the final audit file on a timely basis after the
date of the auditor’s report. As PSQC 1 indicates, 60 days after the date of the auditor’s
report is ordinarily an appropriate time limit within which to complete the assembly of the
final audit file