FRAUD AND ERROR

Definition

PSA 240. Auditor’s Responsibility relating to Fraud in an Audit of FS (expands PSA 315)

Fraud – intentional act by one or more individuals among management involving the use of deception to obtain an unjust or
illegal advantage; fraudulent acts that cause material misstatements

Fraudster – person committing fraudulent activity

Governing Body of Fraud

1. Compliance
2. Governance

Note: always practice professional skepticism

Error – unintentional misstatements in the FS including the omission of an amount or a disclosure

 A mistake in gathering or processing data from which financial statements are prepared.
 An incorrect accounting estimate arising from oversight or misinterpretation of facts.
 A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation,
or disclosure.

2 Types of Intentional Misstatements/Fraud

1) Misstatements resulting from fraudulent financial reporting. Intentional misstatements including omissions of
amounts or disclosures in FS to deceive FS users.

Accomplished by the following:

 Manipulation, falsification (forgery), alteration of acctg. records or supporting docu. from which FS are prepared
 Misrepresentation in FS, transactions, or other significant info.
 Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or
disclosure.

Involves management override of controls:

 Recording fictitious journal entries

 Inappropriately adjusting assumptions and changing judgments used to estimate account balances
 Omitting, advancing, or delaying recognition

2) Misstatements resulting from misappropriation of assets. Theft of an entity’s assets and is often perpetrated by
employees in immaterial amounts.

Accomplished by the following:

 Embezzling receipts
 Stealing physical assets or intellectual property
 Pay goods or services not received
 Usage of entity’s assets for personal use

Other types of fraud

3) Management fraud. One or more members of management or those charged with governance that is related to
fraudulent financial reporting
4) Employee fraud. Involves only employees related to misappropriation of assets in small or immaterial amounts; but
can sometimes commit fraudulent financial reporting

Note: accompanied by false or misleading records or docus. to conceal fraud

Responsibility for the prevention and detection of fraud

 - Lies to those charged with governance of the entity and management
- Creating a culture of honesty and ethical behavior which can be reinforced by an active oversight by those charged
with governance

Management/Those Charged with Governance

o Fraud prevention – reduce the opportunity for fraud

o Fraud deterrence – to persuade individuals not to commit fraud because of the likelihood of detection and
punishment
- Enable an environment where employees will not commit fraud/error = reward; commit = punishment

Auditor

o An auditor conducting an audit in accordance with PSAs is responsible for obtaining reasonable assurance that
the financial statements taken as a whole are free from material misstatement, whether caused by fraud or
error.
o The auditor's responsibility is to apply professional skepticism, and design audit procedures that effectively
address the risk of material misstatements, particularly those arising from fraud.
o The auditor is responsible for maintaining an attitude of professional skepticism throughout the audit,
considering the potential for management override of controls and recognizing the fact that audit procedures
that are effective for detecting error may not be effective in detecting fraud.

Responsibilities of the auditor

- Obtaining reasonable assurance that the FS taken as a whole are free from material misstatement

Risk assessment

- Assess risk of material misstatement and discovery of fraud and error

 Questions with respect to integrity or competence of management
 Unusual pressures within or on an entity
 Unusual transactions
 Problems in obtaining sufficient appropriate audit evidence.

Related activities

- Perform risk procedures to obtain understanding of the entity

 Management and others within the entity. Coordinate with the management to understand likelihood of risk to occur
In the entity and gather information.
 Those charged with governance (TCWG). Gain insight in oversight to respond to risk in relation to internal control
 Unusual or unexpected relationships identified.
 Other information. Additional information that pose significant risks
 Evaluation of fraud risk factors.

Detection

- For fraud and error not to occur

- Error detection is higher than detecting fraud (accompanied with acts of concealment)

Inherent limitations of an audit

- PSA 240. Auditor is not expected to reduce audit risk to 0 and can’t have absolute assurance
- The Subject to unavoidable risk that some material misstatements of the FS will not be detected
- Risk of not detecting material misstatement resulting from fraud is higher than the risk of not detecting a material
misstatement from error
- Fraud involves acts that are concealed, collusion, forgery, deliberate failure to record transactions, or intentional
misrepresentations being made to the auditor
- Professional skepticism, recognizing conditions or events that may be found that indicate that fraud or error may exist
 The nature of financial reporting
 The nature of audit procedures; and
 The need for the audit to be conducted within a reasonable period of time and at a reasonable cost.
Risk factors/Fraud Triangle

- Explain factors for someone to commit occupational fraud; Donald Cressey Hypothesis
I. Fraudulent Financial Reporting
A. Incentives/Pressures. Pressure from internal or external sources
1) Threatened financial stability or profitability brought about by economic, industry, or entity operating
condition
2) Excessive requirements from management to meet requirements or expectations of 3rd parties
3) Threatened personal financial situation
B. Opportunities. Internal control can be overridden
1) Opportunity to engage in fraudulent financial reporting
2) Ineffective monitoring of management
3) Complex and unstable organizational structure
4) Deficiency in internal control
C. Rationalization. Rationalize committing a fraudulent act
1) Implementations or enforcement of entity’s values or ethical standards by management or communication of
inappropriate values or ethical standards
2) Excessive interest in earnings
3) Management’s commitment
4) Management’s failure to correct known material weaknesses in internal control
5) Interest in employing inappropriate means for tax-motivated reasons
II. Misappropriated assets
A. Incentives/pressures
1) Personal financial obligation
2) Access to cash susceptible to theft
B. Opportunities
1) Large amounts of cash on hand or processed, inventory items, fixed assets without identification of ownership
2) Easily convertible assets
3) Inadequate internal control over assets
C. Rationalization
1) Disregard for internal control by management override or failure to correct internal control deficiencies
2) Tolerance of petty theft
3) Displeasure or dissatisfaction with the entity or its treatment of the employee

Procedures when errors or irregularities are suspected

Respond to elevated risk by altering the ff:

1. Engagement staffing
2. Extent of staff supervision
3. Degree of professional skepticism applied
4. Overall strategy for the expected conduct and scope of the engagement

Extent of modified or additional procedures depend on the auditor’s judgment as to:

1. Types of fraud and error indicated

2. Likelihood of occurrence
3. Likelihood of material effect on FS

Reporting of fraud and error

- Communication to management and with those charged with governance

a. Auditor suspects fraud may exist, even immaterial
b. Fraud or error exists

Documentation

- Required by PSA 315

a. Of significant decisions reached during the discussion among the engagement team regarding susceptibility to
material misstatement due to fraud
 b. Identified and assessed risks of material misstatement due to fraud at the FS level and at assertion level

Withdrawal from the engagement

- There are exceptional circumstances that questions the ability of the auditor to continue the audit
a. Determine professional and legal responsibilities applicable in the circumstances
b. Consider whether it is appropriate to withdraw from the engagement
c. If withdrawal is applied: discuss withdrawal and reasons and when there is a professional or legal requirement to
report to the person or persons who made the audit appointment

RISK RESPONSE (PART I)

Risk Response: Designing an Effective Response to Assessed Risk

- Develop appropriate responses in assessing risk material misstatement (ISA 315)

Objective of the Auditor:

1. Obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement
2. Design and implement appropriate responses to those risks

Risk response – actions taken by auditors to address and manage identified risks effectively throughout the audit process. It is
a critical phase that follows risk assessment and involves developing strategies to mitigate or respond to risks that could
impact the accuracy and reliability of financial statements;

A) Designing the overall audit responses and further audit procedures. Plans to deal risks

Listing of assessed risk that was developed at the conclusion of the risk assessment phase of the audit

Design responses to address risks identified and assessed at the FS level and assertion level for FS levels and disclosures to
obtain evidence

i. Updating overall audit strategy

ii. Developing response to assessed risks
iii. Briefing team on audit plans as required
B) Performance of further audit procedures. Checking alignment
i. Performing planned procedures
ii. Assessing results and evidence obtained
iii. Documenting findings and conclusions

Areas that the auditor would address in developing an overall response

 Extent that the audit team needs to be reminded about the use of professional skepticism
 Which staff to assign, including those with special skills, or whether to use experts
 Extent of supervision required throughout the audit
 Need for incorporating some elements of unpredictability in the selection of further audit procedures to be
performed. Throw unexpected twist in the audit process to improve keenness to details
 General changes that need to be made to the nature timing, or extent of audit procedures

Types of Response

Goal:

1. At financial statement level

2. At assertion level

Response:

1. Over all response

2. Further audit procedures
Designing an Effective Response to Assessed Risk

 Developing the Detailed Audit Plan: The auditor uses professional judgment to select the appropriate types of
possible audit procedures.
 Application of Audit Procedures: The auditor applies the audit procedures deemed appropriate based on professional
judgment and Philippine Standards on Auditing (PSAS).

Compliance: Audits should comply with each relevant PSAS to the audit.

Nature of Audit Procedures

- inherently dynamic and proactive. It involves a systematic approach to identifying, assessing, and responding to risks
that could impact the integrity and reliability of financial statements.
- Effective audit program will be based on an appropriate mix of procedures that collectively reduce audit risk to an
acceptably low level

Audit procedures – methods or acts that auditors use to gather evidence to determine the validity of FS assertions

Types of audit procedures

I. Test of Controls or Compliance Test. Evaluate the operating effectiveness of controls in preventing, or detecting,
and correcting, material misstatements at the assertion level. Check controls in place to prevent risks in place
Purpose: whether prescribed accounting control procedures are being followed; identifies control procedures that
can be relied on in performing restricted substantive tests
1) No trail. Does not leave a visible trail in supporting docus. of the performance of control procedure by the
client’s employee. The auditor makes inquiries and observation of office personnel and routines to determine
how control procedures are performed and who performs them. Walang clear evidence sa paperwork na
nagpapakita kung paano yung control procedure na ginawa nung employee ni client = auditor must observe
environment of the entity to obtain evidence; like forensic auditing
2) Documentary trail. Leaves a visible trail in the supporting docus. The auditor inspects the docus. supporting a
particular type of transaction to see whether a control procedure, such as approval or other checking, was
performed and who performance it as indicated by signatures or initials. Mayroong clear paper trail that
supports yung documentation, titignan na lang ni auditor yung docus. para malaman yung certain procedure
na ginagawa.
II. Substantive Procedures. Designed to detect material misstatement at the assertion level
Purpose: whether the peso amount of an account is properly stated; there is a relationship between the amount
of reliance and the amount of additional work that will be needed
1) Tests of details. Involves obtaining evidential matter on the items involved in an account balance or class of
transactions. Helps auditors assess the accuracy, completeness, and validity of reported transactions,
balances, and disclosures, ultimately supporting the audit opinion.
 Tests of Details. Obtaining evidential matter on specific items or transactions.
a) Test of transaction. Test of the processing of individual transactions by inspection of the documents and
accounting records involved in processing
b) Test of balances. Tests applied directly to the details of balances in general ledger accounts. Aims to
establish monetary correctness of the accounts they relate to; directly supporting an account balance.
Checks for material misstatements in account balances.

NOTE: dual purpose test – both have compliance and substantive objectives

2) Substantive analytical procedures. Critical for addressing identified risks effectively. They provide substantive
evidence to support audit conclusions and ensure the reliability of financial statements.
Types of Substantive Tests
(a) Tests of Details of Transactions or Balances. Defined previously.
(b) Analytical Review Procedures. Study and comparison of relationships among accounting data and related
information. They identify unusual fluctuations for investigation and focus on the rationale of relationship.
Tests to gather evidential matter regarding specific assertions related to account balances or transaction
classes. They involve comparing recorded amounts or ratios derived from recorded amounts to
expectations set by the auditor.
Analytical Procedure Example
Compare current financial information for prior Compare inventory levels for the current year to
periods that of prior years
Compare current financial information with Compare client’s gross profit percentage to
industry information published industry averages
Compare current financial information with Compare R&D expense to the budgeted amount
anticipated data
Compare current financial information with known Compare interest expense to the average
or predictable relationship outstanding balance of interest-bearing debt
Compare current financial information with Compare production records in units to sales
current non-financial information

The Relationship of Audit Techniques, Audit Procedures and Assertions

Audit techniques. Basic tools or means employed to obtain audit evidences

Audit technique Illustrative application of audit procedures Assertion

substantiated
Count Counting of inventory, cash securities, unmatured promissory notes—to Physical existence
establish existence and where applicable ownership and condition of
assets
confirm Obtaining information directly of details of account balances—to verify Existence: rights
validity and accuracy of balances and other information with outside and obligations
parties
Inquire Obtain client’s representation letter, explanations to many diverse Completeness
questions raised during the audit
Examine, inspect, Examine checks, invoices, client docus., titles, contracts and other docu. Occurrence,
review, trace, verify materials—to verify validity and propriety of accounting treatment of measurement
touch transactions and account balances and a compliance with internal control
Observe, test, verify Observe taking of physical inventories—to determine compliance with Existence
prescribed procedures
Extend, foot Rechecking clerical determinations by client—to verify accuracy of Measurement
computations and transfer of information made by client
Compare, trace Compare current period account balances or operating data with similar Completeness
information or prior periods and investigation of unusual data
relationship—to disclose and determine the reasons for significant
changes
Analytical review Compare sales with sales budget Completeness

Financial Statement Assertions

  Rights and obligations. The entity has rights over the reported assets and that it has valid obligation to settle the
reported liabilities.
 Valuation and allocation. Assets and liabilities are properly valued and that revenues and expenses are properly
measures; recalculation of FS values
 Presentation and disclosure. Assets and liabilities are properly classified and that disclosures in the notes to the FS are
adequate
 Existence or occurrence. Assets and liabilities exist as of the FS date and that revenues and expenses occurred during
the reporting period. Potential overstatement. Trade documents from acctg. records to supporting docus,
 Completeness. All items should be reported in the FS are included. Potential understatement. Trace items from source
documents to acctg. Records

Deciding the Number of Items to Audit

Decision on up to what extent of testing or number of items to audit. The sufficiency of evidence needed determines the
number of items to test.

Example: When auditing cash receipts, the auditor may decide to examine every cash disbursement or only a sample of them.

Timing of Testing

Timing is crucial to ensure accuracy and efficiency. When to perform each audit procedure:

Interim work – audit procedures performed before year-end; early detection of risk and enhance efficiency

Year-end work – audit procedures performed between year-end and completion; finalize FS and year-end balances; validate
year-end balances that enhances accuracy

Factors influencing timing:

1) Internal control associated with the account. Strength of internal control for interim work
2) How rapidly business conditions might change. How change impacts accuracy of FS
3) Management’s predisposition to misstate the FS and the potential impact of such misstatements on the account
4) Predictability of the account balances at year-end.

Timing of tests of controls

- For provision of appropriate basis for the auditor’s intended reliance.

Upon obtaining audit evidence about the operating effectiveness of controls during an interim period, the auditor shall:

a) Obtain audit evidence about significant changes to those subsequent to the interim period. Auditors must remain
vigilant for significant changes.
b) Determine the additional audit evidence to be obtained for the remaining period.

When using audit evidence obtained in previous audits, the auditor should consider the following:

a) Effectiveness of other internal control elements.

 b) Risk associated with control characteristics.
c) Effectiveness of general IT controls.
d) Effectiveness of control and its application by the entity; Previous deviations in control application; Impact of
personnel changes.
e) Lack of a change poses a risk due to changing circumstances
f) Risk of material misstatement and extent of reliance on controls.

NOTE: when the auditor plans to rely on controls over a risk the auditor has determined to be a significant risk. The auditor
shall test in the current period

Timing of Substantive Procedures

The auditor shall design and perform substantive procedures for each material class of transactions, account balance, and
disclosure

The auditor’s substantive audit procedures shall include the following audit procedures related to the financial statement
closing process:

a) Agreeing or reconciling the FS with the underlying records

b) Examining material journal entries and other adjustments made during the course of preparing the financial
statements.

NOTE: when the assessed risk at the assertion level is significant = performance of substantive audit procedure that are
specific, when the approach to a significant risk consists only of substantive procedures, those procedures shall include tests of
details.

When substantive procedures are performed at an-interim date, the auditor shall cover the remaining period by performing:

a) Substantive procedures, combined with test of controls for the intervening period; or
b) If the auditor determines that it is sufficient, further substantive procedures only, that provide a reasonable basis for
extending the audit conclusion from the interim date to the period end.

NOTE: when risks are identified at interim date, substantive procedures for the remaining period need to be modified

Selecting the Audit Procedures that will be Applied

Factors influencing Procedure Selection

 The nature and significance of financial components.

 The nature of the audit objectives.
 The extent of reliance on internal control structures.
 Assessment of the risk of errors or irregularities.
 The types and quality of available evidence.
 Anticipated efficiency and effectiveness of procedures.

RISK RESPONSE (PART II)

Risk Response: IMPLEMENTING THE DESIGNED RISK RESPONSE AND OBTAINING AUDIT EVIDENCE

This phase involves the implementation of the designed risk response and accumulation of evidence about internal control
operating effectiveness, accounts, disclosures and assertions.

PSA 500, "Audit Evidence" explains what constitutes audit evidence in an audit of financial statements, and deals with the
auditor's responsibility to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to
draw reasonable conclusions on which to base the auditor's opinion.

NATURE AND SIGNIFICANCE OF AUDIT EVIDENCE

Audit evidence is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based, and
includes both information contained in the accounting records underlying the financial statements and other information.

Auditors are not expected to address all information that may exist. Audit evidence, which is cumulative in nature, includes
audit evidence obtained from audit procedures performed during the course of the audit and may include-audit evidence
obtained from other sources such as previous audits and a firm's quality control procedures for client acceptance and
continuance.

The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining
sufficient appropriate audit evidence.

Appropriateness (of audit evidence) is the measure of the quality of audit evidence; that is, its relevance and its reliability in
providing support for the conclusions on which the auditor's opinion is based.

Sufficiency (of audit evidence) is the measure of the quantity of audit evidence, The quantity of the audit evidence needed is
affected by the auditor's assessment of the risks of material misstatement and also by the quality of such audit evidence.

The ultimate goal of an audit is to express an opinion as to whether the financial statements are presented fairly in accordance
with financial reporting standards. When management prepares financial statements which purport to be in conformity with
financial reporting standards, certain assertions (implicit or explicit) are made.

The auditor's opinion on financial statements is formulated on the basis of evidential matter supporting such statements.
Determination as to whether evidential matter is valid or competent for audit purposes rests on the auditor's professional
judgment giving due regard to the pertinence, objectivity, and timeliness of the evidence, and to the existence of other
evidential matter corroborating the conclusions to which it leads.

WHAT CONSTITUTES AUDIT EVIDENCE

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. The entries in the accounting records are often
initiated, recorded, processed and reported in electronic form. In addition, the accounting records may be part of integrated
systems that share data and support all aspects of the entity's financial reporting; operations and compliance objectives.

Other information that the auditor may use as audit evidence includes minutes of meetings; confirmations from third parties;
analysts* reports; comparable data about competitors (benchmarking); controls manuals; information obtained by the auditor
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 AUDIT EVIDENCE

The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base
the audit opinion.

Sufficiency and appropriateness are interrelated and apply to audit evidence obtained from both tests of control and
substantive procedures. Sufficiency is the measure of the quantity of audit evidence; appropriateness is the measure of the
quality of audit evidence and its relevance to a particular assertion and its reliability. Ordinarily, the auditor finds it necessary
to rely on audit evidence that is persuasive rather than conclusive and will often seek audit evidence from different sources or
of a different nature to support the same assertion.

In forming the audit opinion, the auditor does not ordinarily examine all of the information available because conclusions can
be reached about an account balance, class of transactions or control by way of using judgmental or statistical sampling
procedures

The auditor's judgment as to what is sufficient appropriate audit evidence is influenced by such factors as the:

 Auditor's assessment of the nature and level of inherent risk at both the financial statement level and the account
balance or class of transactions level
 Nature of the accounting and internal control systems and the assessment of control risk.
 Materiality of the item being examined.
 Experience gained during previous audits.

INTERRELATIONSHIP BETWEEN RISK, APPROPRIATENESS AND SUFFICIENCY OF AUDIT EVIDENCE

While the auditor is obtain sufficient appropriate evidence before issuing an opinion, determining what is "appropriate" and
"sufficient" is not an easy task. Appropriateness of audit evidence is the measure of the quality (that is, its relevance and
reliability in providing support for the conclusions on which the auditor's opinion is based while sufficiency of audit evidence
refers to the measure of the quantity of such. The quantity of the audit evidence needed is affected by the auditor's
assessment of the risk of material misstatement and also by the quality of such audit evidence.

The interrelationship between risk, appropriateness and sufficiency of audit evidence

The reliability of audit evidence is influenced by its source: internal or external, and by its nature: visual, documentary or oral.
While the reliability of audit evidence is dependent on individual circumstance, the following generalizations will help in
assessing the reliability of audit evidence:

 Audit evidence is more reliable when it is obtained from independent sources outside the entity.
 Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are
effective.
 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, inquiry about the application of a
control).
 Audit evidence is more reliable when it exists in documentary form, whether paper, electronic, or other medium (for
example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of
the matters discussed).
 Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or
facsimiles.

Audit evidence is more persuasive when items of evidence from different sources or of a different name are consistent. In
these circumstances, the auditor may obtain a cumulative degree of confidence higher than would be obtained from items of
audit evidence when considered individually. Conversely, when audit evidence obtained from one source is inconsistent with
that obtained from another, the auditor determines what additional procedures are necessary to resolve the inconsistency.

The auditor needs to consider the relationship between the cost of obtaining audit evidence and the usefulness of the
information obtained. However, the matter of difficulty and expense involved is not in itself a valid basis for omitting a
necessary procedure.

When in substantial doubt as to a material financial statement assertion, the auditor would attempt to obtain sufficient
appropriate audit evidence. The auditor may have to express a qualified opinion or a disclaimer of opinion if he is unable to
gather such evidence.

COMPETENCE OR APPROPRIATENESS OF EVIDENCE

The competence or appropriateness of evidence refers to its trustworthiness or believability. The factors that determine the
competence of evidence are:

1. Relevance of the evidence to the particular assertion being tested. Evidence must be relevant to the assertion being
tested. For example, observing the taking of inventory provides evidence concerning existence of the inventory, but it
is not relevant to determining ownership.
2. Objectivity of the evidence. Evidence can be objective or subjective. In general, the more objective the evidence, the
more reliable and competent it is. Conversely, the more subjective evidence is, the less reliable it is. The greater the
judgment required on the part of the provider of the information, the more subjective the information will be. An
 example of objective evidence is information obtained by physically counting cash or footing the accounts receivable
subsidiary ledger. Examples of subjective evidence are an attorney's statement about a client's contingency and a
credit manager's statement about the collectability of an account more subjective the evidence, the more important
the auditor's experience in evaluating it.
3. Qualifications of the provider of the evidence. Evidence obtained from independent external sources has greater
reliability than evidence obtained within the entity. Evidence an auditor obtains directly through his or her own work
is more reliable than information obtained through the work of others. Confirmation responses from a business are
more reliable than confirmations from a household. And accounting data and financial statements developed in an
entity in which internal control is satisfactory are more reliable than data and statements developed in an entity with
unsatisfactory internal control.
4. Timeliness of the evidence. Timeliness is particularly important with respect to accounts that change rapidly (either
because the total balance changes or because the peso value of the transactions that flow into and out of the account
is large). Evidence gathered about a year-end account balance provides more evidence about a year-end balance than
does evidence gathered about the balance at another date.

The following hierarchy of evidential matter will help one understand the relative competence and persuasive power of
different kinds of evidence. The hierarchy starts with the strongest form of evidence and proceeds to the weakest.

1. An auditor's direct, personal knowledge, obtained through physical observation and his or her own mathematical
computations, is generally considered the most competent evidence.
2. Documentary evidence obtained directly from independent external sources (external evidence) IS considered
competent.
3. Documentary evidence has originated outside the client's data processing system but which has been received and
processed by the client (external-internal evidence) is generally considered competent. However, the circumstances of
internal control quality are important
4. Internal evidence consisting of documents that are produced, circulated, and finally stored within the client's
information system is generally considered low in competence. However, internal evidence is used extensively when it
is produced under satisfactory conditions of internal control. Sometimes, internal evidence is the only kind available.
5. Verbal and written representations given by the client's officers, directors, owners, and employees are generally
considered the least competent evidence. Such representations should be corroborated with other types of evidence.

SUFFICIENCY OF EVIDENCE

Sufficiency of audit evidence refers to the amount or quantity of evidence gathered. The concept of sufficiency recognizes that
the accumulation of evidence should be persuasive rather than convincing.

This concept is consistent with the idea that the auditor is not free to collect unlimited amounts of evidence since he must
work within economic limits. Cost cannot, however be the sole basis for the quantity or quality of audit procedures. Auditors
use professional judgment to determine the extent of tests necessary to obtain sufficient evidence. In exercising their
professional judgment, auditors consider both the:

1) materiality (e.g., peso amount) of the item in question as well as the

2) relative risk of the item (e.g., cash due to its liquidity, may have a higher relative risk than certain property, plant and
equipment do).

Since the competency of evidence depends upon the financial statement assertion under consideration, the auditor should
attempt to gather sufficient quantity of competent evidence at a minimum cost.

PROCEDURES FOR OBTAINING AUDIT EVIDENCE

The auditor obtains audit evidence by one or more of the following procedures:

1. Inspection

Inspection of Records or Documents

Inspection involves the examination of records, documents, or tangible assets. Records and documents are inspected to
provide audit evidence of varying degrees of reliability depending on their nature and source and the effectiveness of internal
controls over their processing.
Documents can be either internal or external. Internal document is one that has. been prepared and used within the client's
organization and is retained without its ever going to an outside party such as a customer or a vendor. Examples are purchase
requisition, employees' time reports, inventory receiving reports, etc.

External document is one that has been in the hands of someone outside the client's organization who is a party to the
transaction being. documented but which is either currently in the hands of the client or readily accessible. Examples are
vendor's invoices, canceled notes payable and insurance policies, canceled checks, etc.

Inspection of Tangible Assets

Inspection or physical examination of tangible assets provides reliable audit evidence with respect to their existence but not
necessarily as to their ownership or value.

The inspection or count by the auditor of a tangible asset to determine its existence and qualitative characteristic is
considered one of the most reliable and useful types of audit evidence. This is applicable in the verification of inventory, cash,
fixed tangible assets, securities and notes receivable.

2. Observation,

Observation consists of looking at a process or procedure being performed by others. For example, the tour of the client's
plant will enable the auditor to obtain a general impression of the client's facilities; observation of inventory taking will enable
him to determine if there are obsolete items or he may watch personnel perform accounting duties to determine whether the
person assigned a responsibility is actually doing it. Observation provides audit evidence about the performance of a process
or procedure, but is limited to the point in time at which the observation takes place and by the fact that the act of being
observed may affect how the process or procedure is performed.

3. Inquiry and confirmation,

Confirmation

Confirmation, which is a specific type of inquiry, is the process of obtaining a representation of information or of an existing
condition directly from a third party. For example, the auditor may seek direct confirmation of receivables by communication
with debtors. Confirmations are frequently used in relation to account balances and their components, but need not be
restricted to these items.

Summary of information frequently confirmed and from whom confirmations are obtained.

Information Confirmed Confirmation Obtained From

Assets
Cash in bank; A/R; Notes Receivable; Inventory out on Bank, Customer, Maker, Consignee, Public warehouse,
Consignment; Inventory held in public warehouse; Cash Insurance company
surrender value of life insurance
Liabilities
A/P; Notes Payable; Advances from Customers; Mortgages Creditor/Supplier, Lender, Customer, Mortgagor, Issuer
Payable; Bonds Payable
Owner’s Equity
Shares outstanding Registrar and transfer agent
Other Information
Insurance Coverage; Contingent Liabilities; Bond Indenture Insurance Company, Company’s Legal Counsel,
Agreement; Collateral held by the Creditors Issuer/Trustee, Creditor
An external confirmation describes the receipt of a written response from an independent third party, in a paper from, or by
electronic or other medium, verifying the accuracy of information that was requested by the auditor. Other examples of
situations where external confirmations may be used include the following:

 Bank balances and other information from bankers.

 Accounts receivable balances.
 Inventories held by third parties at bonded warehouses for processing or on consignment.
 Property title deeds held by lawyers or financiers for safe custody or as security.

To be considered reliable, the auditor must control them from the time their preparation is completed until they are returned.
Figure 14.1 shows the major types of information that are frequently confirmed as well as their sources

In the confirmation of account balances, the auditor may use the following form of confirmation:
 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 information. A response to a
positive confirmation request is ordinarily expected to provide reliable audit evidence.
b) negative external confirmation request asks the respondent to reply only in the event of disagreement with the
information provided in the request. However, when no response has been received to a negative confirmation
request, the auditor remains aware that there will be no explicit evidence that intended third parties have received
the confirmation requests and verified that the information contained therein is correct. Accordingly, the use of
negative confirmation requests ordinarily provides less reliable evidence than the use of positive confirmation
requests, and the auditor considers performing other substantive procedures to supplement the use of negative
confirmations.

Negative confirmation requests may be used to reduce audit risk to an acceptable level when:

(a) the assessed level of inherent and control risk is low;

(b) a large number of small balances is involved;
(c) a substantial number of errors is not expected; and
(d) the auditor has no reason to believe that respondents will disregard these requests.

Inquiry

Inquiry involves seeking information both financial and nonfinancial of knowledgeable persons inside or outside the entity.
Inquiries may include formal written inquiries addressed to third parties to informal oral inquiries addressed to persons inside
the entity. The auditor could obtain information not previously possessed or corroborative audit evidence through the
responses to the inquiries posed by the auditor.

Inquiry is the obtaining of written or oral information from the client in response to questions from the auditor. Evidence
obtained from the client through inquiry usually cannot be considered conclusive because it is not from an independent
source and may be biased in the client's favor. The auditor should therefore obtain further corroborating evidence by other
procedures.

Written Representations

PSA 580, "Written Representations" provides that audit evidence is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based. Written representations are necessary information that the auditor requires
in connection with the audit of the entity's financial statements. Accordingly, similar to responses to inquiries, written
representations an audit evidence.

Although written representations provide necessary audit evidence they do not provide sufficient appropriate audit evidence
on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable
written representations does not affect the nature or extent of other audit evidence that the auditor obtains about the
fulfillment of management's responsibilities or about specific assertions.

The auditor shall request written representations from management with appropriate responsibilities for the financial
statements and knowledge of the matters concerned.

Written representations which will be obtained from management will depend upon the circumstances upon which such
letters are required.

Representation letters may be obtained for general representations, as described in PSA 580 (Figure 14-5). It may also be
obtained for limited representations such as:

a. Accounts Receivable
b. Inventories
c. Liabilities

4. Recalculation

Recalculation consists of checking the mathematical accuracy of source documents and accounting records or of performing
independent calculations. They can be performed through the use of information technology, for example, by obtaining an
electronic file from the entity and using CATs to check the accuracy of the summarization of the file.
 5. Reperformance

Reperformance is 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 CATs, for example, reperforming the aging of accounts
receivable.

6. Analytical procedures.

Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both
financial and non-financial data. Analytical procedures also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. See PSA
520, "Analytical Procedures" for further guidance on analytical procedures.

The timing of such procedures will be dependent, in part, upon the periods of time during which the audit evidence sought is
available. These procedures are introduced in the previous chapter and are discussed in this section in the context of how
audit evidence can be obtained through their application.

Commonly used audit procedures to gather evidence

Audit Procedure Definition Example of Application

Analyze Identify and classify items for further study Account transaction
Compare Observe similarities and differences between related items Beg. Balances with last year’s audit
figure
Confirm Communicate with outside parties to authenticate internal A/R; Cash in Bank; A/P
evidence
Count Enumerate a characteristic Cash; inventory
Examine Review critically Authoritative document such as
invoices, checks
Extend Multiply Inventory quantity
Foot Add a column Total cash received column
Inspect Scrutinize or critically Certificate of stock
Interrelate Examine a document Interest expense with liabilities
Observe Show relationship Inventory count
Reconcile Watch or test a client Cash balance per ledger with cash
balance per bank statement
Test Establish agreement between separate sources of information Cash transaction
Trace Sample to follow a transaction through the steps of the system Bookkeeping procedures
Verify Prove accuracy of numbers or existence of amount Rent income against lease contract
Vouch Prove accuracy of accounting entries by tracing to supporting Cash disbursement
documents
RELATIONSHIP OF TYPES OF EVIDENCE TO AUDIT OBJECTIVES

Since the auditor's evaluation of the fairness of the presentation of the financial statements heavenly depends upon the
evidence of their fairness, care must be taken to obtain as much evidence as is needed to make a proper evaluation.

It is also important to have an understanding of the relationship of the type of evidence to audit objectives. The audit
objectives can be accomplished with the use of the seven types of evidence. For a given account and related accounts in a
Web, the auditor selects evidence to accomplish all the objectives at minimum cost.

EVIDENCE ABOUT ACCOUNTING ESTIMATES

Careful consideration must be given by the auditor on financial statement accounts that are affected by estimates made by
management (often referred to as accounting estimates), particularly those for which a wide range of accounting methods are
considered acceptable.

The auditor should obtain sufficient appropriate audit evidence regarding accounting estimates. "Accounting estimate" means
an approximation of the amount of an item in the absence of a precise means of measurement.

Examples are:

 Allowances to reduce inventory and accounts receivable to their estimated realizable value.
 Provisions to allocate the cost of fixed assets over their estimated useful lives.
  Accrued revenue.

Management is responsible for making accounting estimates included in financial statements. These estimates are often made
in conditions of uncertainty regarding the outcome of events that have occurred or are likely to occur and involve the use of
judgment. As a result, the risk of material misstatement is greater when accounting estimates are involved. Nature of
Accounting Estimates The determination of an accounting estimate may be simple or complex depending upon the nature of
the item. For example, accruing a charge for rent may be a simple calculation, whereas estimating a provision for slow-moving
or surplus inventory may involve considerable analyses of current data and a forecast of future sales. In complex estimates,
there may be a high degree of special knowledge and judgment required.

Accounting estimates may be determined as part of the routine accounting system operating on a continuing basis, or may be
non-routine, operating only at period end. In many cases, accounting estimates are made by using a formula based on
experience, such as the use of standard rates for depreciating each category of fixed assets or a standard percentage of sales
revenue for computing a warranty provision. In such cases, the formula needs to be reviewed regularly by management, for
example, by reassessing the remaining useful lives of assets or by comparing actual results with the estimate and adjusting the
formula when necessary.

The uncertainty associated with an item, or the lack of objective data may make it incapable of reasonable estimation, in
which case, the auditor needs to consider whether the auditor's report needs modification to comply with PSA 700, "Forming
an Opinion and Reporting on Financial Statements."

Audit Procedures

The auditor should obtain sufficient appropriate audit evidence as to whether an accounting estimate is reasonable in the
circumstances and, when required, is appropriately disclosed. The evidence available to support an accounting estimate will
often be more difficult to obtain and less conclusive than evidence available to support other items in the financial
statements.

An understanding of the procedures and methods; including the accounting and internal control systems, used by
management in making the accounting estimates is often important for the auditor to plan the nature, timing and extent of
the audit procedures.

The auditor should adopt one or a combination of the following approaches in the audit of an accounting estimate:

(a) Review and test the process used by management to develop the estimate;
(b) Use an independent estimate for comparison 'with that prepared by management; or
(c) Review subsequent events which confirm the estimate made.

Reviewing and Testing the Process Used by Management

The steps ordinarily involved in reviewing and testing of the process used by management are;

(a) Evaluation of the data and consideration of assumptions on which the estimate is based:
(b) Testing of the calculations involved in the estimate;
(c) Comparison, when possible, of estimates made for prior periods with actual results of those periods;
(d) Consideration of management's approval procedures.

Evaluation of Results of Audit 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.

EVIDENCE FOR RELATED PARTY TRANSACTIONS

How should auditors react if a corporation buys a parcel of real estate from-one of its executive officers at an obviously
excessive price? This situation illustrates the problems that may arise for auditors when the client company enters into related
party transactions. The term related parties refers to the client entity and any other party with which the client may deal
where one party has the ability to influence the other to the extent that one party to the transaction may not pursue its own
separate interests. Examples of related parties include officers, directors, principal owners, and members of their immediate
families; and affiliated companies, such as subsidiaries.

A related party transaction is any transaction between the company and these parties (except for normal compensation
arrangements, expense allowances, and similar transactions arising in the ordinary course of the business). Since transactions
with related parties are not conducted at arm's length, the auditors should be aware that the economic substance of these
transactions may differ from their form. Common methods of identifying related parties include making inquiries of
management and reviewing SEC filings; stockholders’ listings, and conflict-of-interest statements obtained by the client from
its executives. A list of all known related parties should be prepared at the beginning of the audit so that the audit staff may be
alert for related party transactions throughout the engagement. This list is retained in the auditors' permanent file for
reference and updating in successive engagements. As they perform the audit, the auditors will be alert for transactions with
these parties and any transactions with unusual terms that might be indicative of related party negotiations.

The primary concern of the auditors is that material related party transactions are adequately disclosed in the client's financial
statements or the related notes. Disclosure of related party transactions should include: the nature Of the relationship; a
description of the transactions, including peso amounts; and amounts due to and from related parties, together with terms
and manner of settlement.

BASIC AUDIT SAMPLING CONCEPTS

PSA 530, "Audit Sampling establishes standards and provides guidance when the auditor has decided to use audit sampling in
performing audit procedures. It deals with the auditor's use of statistical and non-statistical sampling when designing and
selecting the audit sample, performing tests of controls and tests of details, and evaluating the results from the sample.

PSA 530 defines audit sampling as the application of a compliance or substantive procedure to less than 100% of the items
within an account balance or class of transactions to enable the auditor to obtain and evaluate evidence of some characteristic
of the balance or class and to form or assist in forming a conclusion concerning that characteristic. In most situations, the
volume of transactions processed is so great or the control systems in place are of such effectiveness that inspection of all
items is not feasible, economically justified or required, and the use of audit sampling is appropriate.

NATURE AND PURPOSE OF AUDIT SAMPLING

Sampling is a process whereby information is gained concerning the characteristics of population (universe or field) of items by
means of an examination of only a portion of the items composing that population. Sampling is therefore considered an
inferential technique and it allows an auditor to draw conclusions about transactions or account balances without sustaining
the time and cost of examining all available data.

WHY AUDITORS SAMPLE

Auditors use audit sampling when

(a) the nature and materiality of the balance or class does not demand a 100% audit;
(b) a decision must be made about the balance or class; and
(c) the time and cost to audit 100% of the population would be too great.

TESTING PROCEDURES WHICH DO NOT INVOLVE SAMPLING

It is important to recognize that certain testing procedures do not come within the definition of sampling. Examples of these
audit procedures are:

1) Tests performed on 100% of the items within a population. For example, some audit plans include the audit of all
"large" accounts and a portion of the small accounts. In such situations only the "small" accounts would be subject to
sampling. Applying audit procedures to all items within a population which have a particular characteristic (for
example, all items over a certain amount) does not qualify as audit sampling with respect to the portion of the
population examined nor with regard to the population as a whole, since the items were not selected from the total
population in a basis that was expected to be representative. Such items might imply some characteristics of the
remaining portion of the population but would not necessarily be the basis for a valid conclusion about the remaining
portion of the population.
2) Inquiry and observation
a) Procedures that depend on segregation of duties or that otherwise provide no documentary evidence.
b) Tracing one or a few transactions to obtain an understanding of an accounting system and its internal control.
Procedures performed to obtain an "understanding of the internal control structure sufficient to plan an audit" do
not involve sampling. However, many "tests of controls" used to assess control risk do involve sampling.
3) Analytical procedures. These involve the analysis of significant ratios and trends including the resulting investigation of
fluctuations and relationship that are inconsistent with other relevant information or deviate from predicted amounts.
SAMPLING VS. NON-SAMPLING RISK

In every audit engagement a degree of risk is always present even when all transactions and balances are tested 100 percent.
This uncertainty is referred to as ultimate risk and is a combination of sampling and non-sampling risks.

Sampling Risk

This refers to the risk that the auditor's conclusion based on a sample might be different from the conclusion they would reach
if they examined every item in the entire population. This is also the probability that a material error will occur during the
accounting process. Sampling risk is a function of a client's internal accounting system. In general, the stronger the internal
accounting control is, the lower the likelihood that a material error will occur.

There are two types of sampling risk.

(a) The risk the auditor will conclude, in the case of a test of control, that control risk is lower than it actually is, or in the
case of a substantive test, that a material error does not exist when in fact it does. This type of risk affects audit
effectiveness and is more likely to lead to an inappropriate audit opinion; and
(b) The risk the auditor will conclude, in the case of a test of control, that control risk is higher than it actually is, or in the
case of a substantive test, that a material error exists when in fact it does not. This type of risk affects audit efficiency
as it would usually lead to additional work to establish that initial conclusions were incorrect. The mathematical
complements of these risks are termed confidence levels.

Non-Sampling Risk

This refers to the probability that a material error will not be discovered by the auditor in the performance of the substantive
tests. Non-sampling risk arises from factors that cause the auditor to reach an erroneous conclusion for any reason not related
to the size of the sample. For example, most audit evidence is persuasive rather than conclusive, the auditor might use
inappropriate procedures, or the auditor might misinterpret evidence and fail to recognize an error. This risk is controlled to a
certain degree by the auditor's quality of performance in testing the details of transactions and balances and performing
analytical review procedures. Non-sampling risk can generally be reduced to low levels through implementation of
appropriately designed quality' control procedures by the CPA firm

If in detailed examination of the sample, material errors are discovered the auditor should decide whether they represent
unintentional clerical mistakes or they indicate attempts to conceal a defalcation or to misstate the financial statement.

If errors are material, the auditor cannot express an unqualified opinion unless the statements are corrected. If no errors are
found the auditor may consider the whole area subjected to the test as acceptable without exception.

NONSTATISTICAL AND STATISTICAL SAMPLING

Nonstatistical Sampling

Nonstatistical or Judgment sampling procedures are designed and executed on the basis of the auditor's sound objective
reasoning judgment.

Although judgment sampling out involve arithmetic concepts, subjective influence and probabilities reasoning, they are not
formally derived from mathematical sampling proofs and theorems. Findings from judgment sampling must always be
interpreted subjectively in the professional judgment of the auditor.

Although sampling risk exists with nonstatistical sampling, no method for objectively measuring it is available. However,
properly designed nonstatistical sampling methods can provide results as effective as those obtained from statistical sampling
methods.

Three common variations of nonstatistical sampling are block sampling, haphazard sampling, and judgmental sampling. The
succeeding sections examine each of these.

1) Haphazard Sampling. A haphazard sample consists of sampling units without any conscious bias that is without any
special reason for including or omitting items from the sample. If used, a haphazard sample should not consist of items
selected in a careless manner; the sample should be expected to be a representative of the population. For example, a
haphazard sample of vouchers contained in a file drawer might be selected by pulling vouchers from the drawer
without regard for the vouchers' size, shape or location of the drawer.
2) Block Selection. A block sample consists of all items in a selected time period, numerical sequence or alphabetical
sequence. For example, the auditor might examine all cash disbursement transaction in the first week of June or the
 last week of December. Due to the relatively large number of blocks needed to form a reasonable audit conclusion
block sampling cannot generally be relied upon to efficiently produce a representative sample and therefore is not
acceptable for statistical or nonstatistical audit sampling.
3) Judgmental Sampling. Under this selection method, the auditor selects large or unusual items from the population and
uses some other judgmental criterion for selection. Obviously, this selection method has a conscious bias and cannot
be considered a representative selection method.

The fact that judgmental selection is not appropriate for audit sampling does not mean that auditors should stop using
judgment in selecting items to be examined. The point is that the items selected using judgmental criteria are not necessarily
representative of the population, and conclusions based on items selected judgmentally should not be extended to the
population.

Statistical Sampling

Statistical sampling is a mathematically derived tool which provides the auditor with an objective basis for expressing
conclusions about population characteristic based upon a sample of items from the population. Statistical sampling means any
approach to sampling that has the following characteristics:

(a) Random selection of a sample;

(b) Use of probability theory to evaluate sample results, including measurement of sampling risk.

A sampling approach that does not have characteristics (a) and (b) is considered non-statistical sampling.

Auditors can use statistical sampling when performing test of controls for which documentary evidence exists that a procedure
was performed. Examples of controls for which documentary evidence exists are (1) those that are related to approving
transactions such as sales order that bears the credit manager's signature indicating approval of credit, (2) keeping adequate
documents and records, and (3) making independent checks on performance.

The choice between statistical and nonstatistical sampling thniques depends on the purpose of the procedures and on other
factors. For example, when obtaining an understanding of internal control, auditors may select a single transaction Or a few
transactions to walk through the System. When auditing additions to property, plant and equipment, an auditor might
examine all individual material transactions and select a sample of others.

Auditors must take into account many of the same factors when performing statistical and nonstatistical sampling. The
primary difference is that some aspects of the procedures are quantified if statistical sampling is used. Nonstatistical sampling
does not provide quantified measures of risk comparable to those provided in statistical sampling by the laws of probability.

Selecting Items for Testing Lo Gather Audit Evidence

When designing audit procedures the auditor should determine appropriate means of selecting items for testing. The means
available to the auditor are:

(a) Selecting all items (100% examination);

(b) Selecting specific items, and
(c) Audit sampling.

Whether auditors use statistical sampling or nonstatistical sampling methods, auditors must decide on:

(1) selecting all items (100% examination),

(2) selecting specific items
(3) which sampling techniques to use

and they must draw conclusions from their sampling. By using statistical sampling, an auditor can use probability theory to
make statements about controls for a class of transactions and measure sampling risk. Likewise, statistical sampling assists the
auditor in determining sample size and in evaluating sample results.

Selecting All Items

The auditor may decide that it will be most appropriate to examine the entire population of items that make up an account
balance or class of transactions (dr a stratum within that population). 100% examination is unlikely in the case of tests of
control: however, it is more common for substantive procedures. For example, 100% examination may be appropriate when
the population constitutes a small number of large value items, when both inherent and control risks are high and other
means do not provide sufficient appropriate audit evidence, or when the repetitive nature of a calculation or other process
performed by a computer information system makes a 100% examination cost effective.

Selecting Specific Items

The auditor may decide to select specific items from a population based on such factors as knowledge of the client's business,
preliminary assessments of inherent' and control risks, and the characteristics of the population being tested. The judgmental
selection of specific items is subject to non-sampling risk. Specific items selected may include:

 High value or key items. The auditor may decide to select specific items within a population because they are at high
value, or exhibit some other characteristic, for example items that are suspicious, unusual, particularly risk-prone or
that have a history of error.
 All items over a certain amount. The auditor may decide to examine items whose values exceed a certain amount so
as to verify a large proportion of the total amount of an account balance or class of transactions.
 Items to obtain information. The auditor may examine items to obtain information about matters such as the client's
business, the nature of transactions, accounting and internal control systems.
 Items to test procedures. The auditor may use judgment to select and examine specific items to determine whether or
not a particular procedure is being performed.

While selective examination of specific items from an account balance or class of transactions will often be an efficient means
of gathering audit evidence, it does not constitute audit sampling. The results of procedures applied to items selected in this
way cannot be projected to the entire population. The auditor considers the need to obtain appropriate evidence regarding
the remainder of the population when that remainder is material.

Audit Sampling

In performing audit tests in accordance with Standards on Auditing, the auditor may use either nonstatistical or statistical
sampling or both. Both sampling types require the exercise of professional judgment in planning, selecting the sample,
executing the sampling plan and evaluating the results. The primary benefit of statistical methods is the quantification of
sampling risk. For example, a 95% confidence level provides a 5% sampling risk. In nonstatistical sampling, the auditor does
not quantify sampling risk. Instead conclusions are reached about populations on a more judgmental basis. Figure 15-1 shows
the relationship between nonstatistical and statistical sampling.

Relationship between Nonstatistical and Statistical Sampling

ATTRIBUTE AND VARIABLES SAMPLING TECHNIQUES

The auditor may use sampling procedures to measure both qualitative and quantitative characteristics of a population.

Attribute Sampling Technique

Attribute estimation procedures measure qualitative characteristics, while variables estimation procedures measure
quantitative characteristics.

The auditor uses attribute estimation sampling when he or she is interested in measuring a qualitative feature such as the
presence or absence of internal control procedure. When conducting tests of controls, the auditor must consider both the risk
of overreliance and the risk of underreliance. The risk of overreliance is the risk that the sample supports reliance on internal
control when this reliance is unjustified. The risk of underreliance is the risk that the sample does not support reliance on
internal control when the true compliance rate suggests that the auditor should rely on internal control. If this happens, the
result will be decreased efficiency in the form of increased substantive testing procedures.

In compliance testing of an attribute, the auditor is interested in determining whether the population rate of occurrence
exceeds a tolerable rate. The tolerable rate is the maximum rate of exception that the auditor would be willing to accept in a
population without altering his or her reliance on the attribute. Once the auditor determines sample size using his or her
desired reliability, tolerable rate of occurrence and expected rate of occurrence and selects items for examination, he or she
classifies them as either possessing the attribute or not (deviations). Based on the number of sample items containing
'deviations the sample rate of occurrence can he calculated.

The auditor can determine the upper precision limit by considering the (1) sample size, (2) reliability, and (3) number of
observed deviations. The upper precision limit is a rate of occurrence which statistically exceeds the actual population error
rate. The auditor then compares the upper precision limit to tolerable error to determine whether he or she can rely on
internal controls related to the attribute(s) examined. If the upper precision limit is less than the tolerable error the sample
results suggest that the auditor should rely on the internal control(s) examined.

Variables Sampling Technique

Variables estimation sampling is used by the auditor during substantive testing. This provides an estimate of a peso range
within which the true audited value of the population lies. For example, the auditor uses variables estimation sampling to
determine whether the book value of an account balance is fairly stated.

As in sampling for attributes, variables estimation sampling exposes the auditor to two aspects of sampling risks: (1) the risk of
incorrect rejection and (2) the risk of incorrect acceptance.

The risk of incorrect rejection or alpha (a) risk is the risk that the sample supports the conclusion that the recorded account
balance is materially misstated when it is not materially misstated.

The risk of incorrect acceptance or beta (B) risk is the risk that the sample supports the conclusion that the recorded account
balance is not materially misstated. This is also referred to as detection risk.

Once the auditor plans the sampling procedures (including selecting appropriate levels of alpha and detection risk), he or she
then draws and appraises the sample the audit objective being to obtain an estimate of the total audited value. If this audited
valets falls within the decision internal, the auditor will conclude that the book balance is fairly stated.

Design of the Sample

The factors that the auditor should consider in designing an audit sample are:

1. Audit objectives

When designing an audit sample, the auditor should consider the objectives of the test and the attributes of the population
from which the sample will be drawn.

The auditor first considers the specific objectives to be achieved and the combination of audit procedures which is likely to
best achieve those objectives. Consideration of the nature of the audit evidence sought and possible error conditions or other
characteristics relating to that audit evidence will assist the auditor in defining what constitutes an error and what population
to use for sampling.

Furthermore, when audit sampling is appropriate, the nature of the audit evidence sought and possible error conditions or
other characteristics relating to that evidence will assist the auditor in defining what constitutes as error and what population
should be used for sampling. For example, when performing tests of controls over an entity's purchasing procedures, the
auditor will be concerned with matters such as whether an invoice was clerically checked and properly approved. On the other
hand, when performing substantive procedures on invoices processed during the period, the auditor will be concerned with
matters such as the proper reflection of the monetary amounts of such invoices in the financial statements.
 2. Population and its characteristics

It is important for the auditor to ensure that the population is:

(a) Appropriate to the objective of the sampling procedure, which will include consideration of the direction of testing.
For example, if the auditor's objective is to test for overstatement of accounts payable, the population could be
defined as the accounts payable listing. On the other hand, when testing for understatement of accounts payable, the
population is not the accounts payable listing but rather subsequent disbursements, unpaid invoices, suppliers'
statements, unmatched receiving reports or other populations that provide audit evidence of understatement of
accounts payable;
(b) Complete. For example, if the auditor intends to select payment vouchers from a file, conclusions cannot be drawn
about all vouchers for the period unless the auditor is satisfied that all vouchers have in fact been filed. Similarly, if the
auditor intends to use the sample to draw conclusions about the operation of an accounting and internal control
system during the financial reporting period, the population needs to include all relevant items from throughout the
entire period. A different approach may be to stratify the population and use sampling only to draw conclusions about
the control during, say, the first 10 months of a year, and to use alternative procedures or a separate sample regarding
the remaining two months.

The entire set of data from which the auditor desires to sample in order to reacts a conclusion constitutes the population. The
auditor should determine that the population from which he draws the sample is appropriate for the specific audit objectives.
For example, if the auditor's objective was to test for understatements of accounts payable, his population would be
subsequent payments, unpaid invoices, unmatched receiving reports or other population that would provide audit evidence of
understatement of accounts payable.

3. Risk and assurance

The auditor considers what conditions constitute an error by reference to the objectives of the test. A clear understanding of
what constitutes an error is important to ensure that all, and only, those conditions that are relevant to the test objectives are
included in the projection of errors. For example, in a substantive procedure relating to the existence of accounts receivable,
such as confirmation, payments made by the customer before the confirmation date but received shortly after that date by
the client are not considered an error. Also, a misposting between customer accounts does not affect the total accounts
receivable balance. Therefore, it is not appropriate to consider this an error in evaluating the sample results of this particular
procedure, even though it may have an important effect on other areas of the audit, such as the assessment of the likelihood
of fraud or the adequacy of the allowance for doubtful accounts.

In planning the audit, the auditor uses professional judgment to assess the level of audit risk that is appropriate. This audit risk
includes

 the risk that material errors will occur (inherent risk),

 the risk that the client's system of internal control will not prevent or correct such errors (control risk)
 the risk that any remaining material errors will not be detected by the auditor (detection risk).

Irrespective of audit sampling procedures applied inherent risk and control risk exist. Consideration should also be given to
detection risk arising from

(a) the uncertainties due to sampling (sampling risk),

(b) the uncertainties arising from factors other than sampling (non-sampling risk) such as use of inappropriate audit
procedures or misinterpretation of audit evidences.

Sampling risk arises from the probability that the auditor's conclusion based on a sample, may be different from the
conclusion that would be reached if the entire population were subjected to the same audit procedure.

The auditor is faced with sampling risk in both tests of control and substantive procedures as follows:

(a) Tests of Control.

(i) Risk of Underreliance: the risk that, although the sample result does not support the auditor's assessment of
control risk, the actual compliance rate would support such an assessment.
(ii) Risk of Overreliance: the risk that, although the sample result supports the auditor's assessment of control
risk, the actual compliance rate would not support such an assessment.
(b) Substantive Procedures.
 (i) Risk of Incorrect Rejection: the risk that, although the sample result supports the conclusion that a recorded
account balance or class of transactions is materially misstated, in fact it is not materially misstated.
(ii) Risk of Incorrect Acceptance: the risk that, although the sample result supports the conclusion that a recorded
account balance or class of transactions is not materially misstated, in fact it is materially misstated.

The risk of under reliance and the risk of incorrect rejection affect audit efficiency as they would ordinarily lead to additional
work being performed by the auditor, or the entity, which would establish that the initial conclusions were incorrect. The risk
of over reliance and the risk of incorrect acceptance affect audit effectiveness and are more likely to lead to an erroneous
opinion on the financial statements than either the risk of under reliance or the risk of incorrect rejection.

Sample size is affected by the level of sampling risk the auditor is willing to accept from the results of the sample. The lower
the risk the auditor is willing to accept, the greater the sample size will need to be.

4. Tolerable error

This is the maximum error in the population that the auditor would be willing to accept and still conclude that the result from
the sample has achieved his audit objective. There is an inverse relationship between the tolerable error and the required
sample size. The smaller the tolerable error, the larger sample size the auditor will require.

In compliance procedures the tolerable error is the maximum rate of deviation from a prescribed control procedure that the
auditor would be willing to accept without altering his planning reliance on the control being tested. In substantive
procedures, the tolerable error is the maximum monetary error in an account balance or class of transactions that the auditor
would be willing to accept so that he considers the results of all audit procedures he is able to conclude, with reasonable
assurance, that the financial information is not materially in error.

5. Expected error in the population

When performing tests of control, the auditor generally makes a preliminary assessment of the rate of error the auditor
expects to find in the population to be tested and the level of control risk. This assessment is based on the auditor's prior
knowledge or the examination of a small number of items from the population. Similarly, for substantive tests the auditor
generally makes a preliminary assessment of the amount of error in the population. These preliminary assessments are useful
for designing an audit sample and in determining sample sire. For example, if the expected rate of error is unacceptably high
tests of control will normally not be performed. However, when performing substantive procedures, if the expected amount of
error is high, 100% examination or the use of a large sample size may be appropriate.

If errors are expected to be present, the auditor would normally examine a larger sample to conclude whether the population
value is fairly stated to within the planned tolerable error or that the plan reliance on a relevant control is justified. Smaller
sample sizes are justified when the population is expected to be error free.

The following factors should be considered in determining the expected error in population:

a) error levels identified in previous audits,

b) changes in client procedures,
c) evidence available from his evaluation of the system of internal control and from results of analytical review
procedures.

6. Stratification

Stratification is the process of dividing a population into subpopulation, that is, a group of sampling units which have similar
characteristics (often monetary value). The reduction in variability within each 'stratum results in a smaller overall sample size.
Then one of the random selection methods is used to select sample items from each stratum. Stratification enables the
auditor to direct his efforts towards the items he considers would potentially contain the greater monetary error.

Audit efficiency may be improved if the auditor stratifies a population by dividing it into discrete sub-populations which have
an identifying characteristic. The objective of stratification is to reduce the variability of items within each stratum and
therefore allow sample size to be reduced without a proportional increase in sampling risk. Sub-populations need to be
carefully defined such that any sampling unit can only belong to one stratum.

When performing substantive procedures, an account balance or class of transactions is often stratified by monetary value.
This allows greater audit effort to be directed to the larger value items which may contain the greatest potential monetary
error in terms of overstatement. Similarly, a population may be stratified according to a particular characteristic that indicates
a higher risk of error, for example, when testing the valuation of accounts receivable, balances may be stratified by age.
The results of procedures applied to a sample of items within a stratum can only be projected to the items that make up that
stratum. To draw a conclusion on the entire population, the auditor will need to consider risk and materiality in relation to
whatever other strata make up the entire population. For example, 20% of the items in a population may make up 90% of the
value of an account balance. The auditor may decide to examine a sample of these items. The auditor evaluates the results of
this sample and reaches a conclusion on the 90% of value separately from the remaining 10% (on which a further sample or
other means of gathering evidence will be used, or which may be considered immaterial).

Value Weighted Selection

It will often be efficient in substantive testing, particularly when testing for overstatements, to identify the sampling unit as
the individual monetary units (e.g., pesos) that make up an account balance or class of transactions. Having selected specific
monetary units from within the population for example, the accounts receivable balance, the auditor then examines the
particular items, for example, individual balances, that contain those monetary units. This approach to defining the sampling
unit ensures that audit effort is directed to the larger value items because they have a greater chance of selection, and can
result in smaller sample sizes. This approach is ordinarily used in conjunction with the systematic method of sample selection
(described in Appendix 4 of PSA 530) and is most efficient when selecting from a computerized database.

Selecting the Sample

The auditor should select items for the sample with the expectation that all sampling units in the population have a chance of
selection. Statistical sampling requires that sample items are selected at random so that each sampling unit has a known
chance of being selected. The sampling units might be physical items (such as invoices) or monetary units. With non-statistical
sampling an auditor uses professional judgment to select the items for a sample. Because the purpose of sampling is to draw
conclusions about the entire population, the auditor endeavors to select a representative sample by choosing sample items
which have characteristics typical of the population, and the sample needs to be selected so that bias is avoided.

Sample Selection Methods

Sample items should be selected in such a way that the sample can be expected to be representative of the population.
Therefore, all items in the population should have an opportunity to be selected.

Most commonly used selection methods for Statistical and Nonstatistical Sampling are as follows:

a. Random Sampling
A simple random sample is a sample that is selected in such a way that every item in a population has an equal chance
of being selected. This is accomplished by using a printed table of random numbers or computer software that
generates random numbers. To use this method, it is necessary to establish correspondence between the population
and the random numbers. For example, if the auditor is selecting a sample of sales invoices, correspondence has to be
established between the invoice numbers and the digits in the random number table.
b. Systematic Sampling
In using this method, the auditor counts through the population and selects items on the basis of a sampling interval
which is determined by dividing the number of physical items in the population by sample size. The interval may also
be based on certain number of items (e.g. every 25th voucher number) or on monetary totals (e.g. every P1,500 in the
cumulative value of the population). The auditor should, however, exercise caution about the possibility of the
population being arranged in an order that corresponds to the size of the sampling interval. If this correspondence
exists, the sample will not be representative. One precaution that can be taken is to use several random starts.
c. Stratified Random Sampling
As previously explained, when a population is highly variable, sampling without stratification requires very large
sample size. To stratify, the auditor groups the population into subpopulation, or strata that are similar in amount.
Samples are then drawn from each stratum using one of the random selection methods.
d. Sampling with Probability Proportional to Size
This method of sampling emphasizes larger peso items within an account balance. The probability of an item being
selected in this method is directly proportional to its peso amount. For example, a P10,000 item has twice the chance
being selected as a P5,000 item and ten times the chance of a P1,000 item. Each individual peso in the account
balance has an equal chance of selection, but each physical unit does not.

Sample Size
In determining the sample size, the auditor should consider whether sampling risk is reduced to an acceptably low level.
Sample size is affected by the level of sampling risk that the auditor is willing to accept. The lower the risk the auditor is willing
to accept, the greater the sample size will need to be.

The sample size can be determined by the application of a statistically-based formula or through the exercise of professional
judgment objectively applied to the circumstances. Appendices 2 and 3 of P$A 530 indicate the influences that various factors
typically have on the determination of sample size, and hence the level of sampling risk. These are discussed in Chapters 18
and 19. The size of the sample has a direct effect upon both the (1) allowance for sampling risk. and (2) sampling risk.
Generally, with a very small sample, we cannot have low sampling risk unless we allow a very large allowance for sampling risk
(precision). As the sample size decreases, both the sampling risk and allowance for sampling risk increase.

Sample size is also affected by three (3) certain characteristics of the population being tested. As the population increases in
size, the sample size necessary to estimate the population with specified sampling risk and allowance for sampling risk
increases. In attributes sampling, sample size also increases as the expected population deviation rate increases.

Examples of Factors Influencing Sample Size for Tests of Control

The following are factors that the auditor may consider when determining the sample size for tests of controls. These factors,
which need to be considered together, assume the auditor does not modify the nature or timing of tests of controls or
otherwise modify the approach to substantive procedures in response to assessed risks.

Factor
An increase in the extent to
which the auditor’s risk
assessment takes into
account relevant controls
An increase in the tolerable
rate of deviation
An increase in the expected
rate of deviation of the
population to be tested
An increase in the auditor’s
desired level of assurance
that the tolerable rate of
deviation is not exceeded by
the actual rate of deviation
in the population
An increase in the number of
sampling units in the
population
Effect on
sample size
Increase The more assurance the auditor intends to obtain from the operating
effectiveness of controls, the lower the auditor’s assessment will the risk of
material misstatement will be, and the controls larger the sample size will
need to be. When the auditor’s assessment of the risk of material
misstatement at the assertion level includes an expectation of the operating
effectiveness of controls, the auditor is required to perform tests of controls.
Other things being equal, the greater the reliance the auditor places on the
operating effectiveness of controls in the risk assessment, the greater is the
extent of the auditor’s test of controls )thus, sample size is increase)
Decrease The lower the tolerable rate of deviation, the larger the sample size needs to
be
Increase The higher the expected rate of deviation, the larger the sample size needs to
be to that the auditor is in a position to make a reasonable estimate of the
actual rate of deviation. Factors relevant to the auditor’s consideration of the
expected rate of deviation include the auditor’s understanding of the business
(risk assessment procedures undertaken to obtain an understanding of
internal control), changes in personnel or in internal control, the results of
audit procedures applied in prior periods and the results of other audit
procedures. High expected control deviation rates ordinarily warrant little, if
any, reduction of the assessed risk of material misstatement.
increase The greater the level of assurance that the auditor desires that the results of
the sample size are in fact indicative of the actual incidence of deviation in the
population the larger the sample size needs to be.
Negligible For large populations, the actual size of the population has little, if any, effect
effect on sample size. For small populations, however, audit sampling may not be as
efficient as alternative means of obtaining sufficient appropriate audit
evidence.

Examples of Factors Influencing Sample Size for Tests of Details

The following are factors that the auditor may consider when determining the sample size for tests of details. These factors,
which need to be considered together, assume the auditor does not modify the approach to tests of controls or' otherwise
modify the nature or timing of substantive procedures in response to the assessed risks.
 Factor Effect on
sample size
An increase in the Increase The higher the auditor's assessment of the risk of material misstatement, the larger
auditor’s assessment the sample size needs to be. The auditor's assessment of the risk of material
of the risk of misstatement is affected by inherent risk and control risk. For example, if the
material auditor does not perform tests of controls, the auditor's risk assessment cannot be
misstatement reduced for the effective operation of internal controls with respect to the particular
assertion. Therefore, in order to reduce audit risk to an acceptably low level, the
auditor needs a low detection risk and will rely more on substantive procedures. The
more audit evidence that is obtained from tests of details (that is, the lower the
detection risk), the larger the sample size will need to be.
An increase in the Decrease The more the auditor is relying on other substantive procedures (tests of details or
use of other substantive analytical procedures) to reduce to an acceptable level the detection
substantive risk regarding a particular population, the less assurance the auditor will require
procedures directed from sampling and, therefore, the smaller the sample size can be
at the same
assertion
An increase in the Increase The greater the level of assurance that the auditor requires that the results of the
auditor’s desired sample are in fact indicative of the actual amount of misstatement in the
level of assurance population, the larger the sample size needs to be.
that tolerable
misstatement is not
exceeded by actual
misstatement in the
population
An increase in Decrease The lower the tolerable misstatement, the larger the sample size needs to be
tolerable
misstatement
An increase in the Increase The greater the amount of misstatement the auditor expects to find in the
amount of population, the larger the sample size needs to be in order to make a reasonable
misstatement the estimate of the actual amount of misstatement in the population. Factors relevant
auditor expects to to the auditor's consideration of the expected misstatement amount include the
find in the extent to which item values are determined subjectively, the results of risk
population assessment procedures, the results of tests of control, the results of audit
procedures applied in prior periods, and the results of other substantive procedures.
Stratification of the Decrease When there is a wide range (variability) in the monetary size of items in the
population when population, it may be useful to stratify the population. When a population can be
appropriate appropriately stratified, the aggregate of the sample sins from the strata generally
will be less than the sample size that would have been required to attain a given
level of sampling risk, had one sample been drawn from the whole population.
The number of Negligible For large populations, the actual size of the population has little, if any, effect on
sampling units in the effect sample size. Thus, for small populations, audit sampling is often not as efficient as
population alternative means of obtaining sufficient appropriate audit evidence. (However,
when using monetary unit sampling, an increase in the monetary value of the
population increases sample size, unless this is offset by a proportional increase in
materiality for the financial statements as a whole (and, if applicable, materiality
level or levels for particular classes of transactions. account balances or disclosures.)

Performing the Audit Procedure

The auditor-should perform audit procedures appropriate to the particular test objective on each item selected.

If a selected item is not appropriate for the application of the procedure, the procedure is ordinarily performed on a
replacement item. For example, a voided check may be selected when testing for evidence of payment authorization. If the
auditor is satisfied that the check had been properly voided such that it does not constitute an error an appropriately chosen
replacement is examined.

Sometimes however, the auditor is unable to apply the pictured audit procedures to a selected item because, for instance,
documentation relating to that item has been lost. If suitable alternative procedures cannot be performed on that item the
auditor ordinarily considers that item to be in error. An example of a suitable alternative procedure might be the examination
of subsequent receipts when no reply has been received in response to a positive confirmation request.

Evaluation of Sample Results

Having carried out, on each sample item, those audit procedures that are appropriate to the particular audit objective, the
auditor should:

 analyze any error detected in the sample,

 project the en-ors found in the sample to the population, and
 assess the sampling risk.

Analysis of Errors in the Sample

The auditor should consider the sample results, the nature and cause of any errors areas of the audit identified, and their
possible effect on the particular test objective and on other areas of the audit

When conducting tests of control, the auditor is primarily concerned with the design and operation of the controls themselves
and the assessment of control risk.

However, when errors are identified, the auditor also needs to consider matters such as:

(a) The direct effect of identified errors on the financial statements;

(b) The effectiveness of the accounting and internal control systems and their effect on the audit approach when, for
example, the errors result from management override of an internal control.

In analyzing the errors discovered, the auditor may observe that many have a common feature, for example, type of
transaction, location, product line or period of time. In such circumstances, the auditor may decide to identify all items in the
population that possess the common feature and extend audit procedures in that stratum. In addition, such errors may be
intentional, and may indicate the possibility of fraud.

Sometimes, the auditor may be able to establish that an error arises from an isolated event that has not recurred other than
on specifically identifiable occasions and is therefore not representative of similar errors in the population *(an anomalous
error). To be considered an anomalous error, the auditor has to have a high degree of certainty that such error is not
representative of the population. The auditor obtains this certainty by performing additional work. The additional work
depends on the situation, but is adequate to provide the auditor with sufficient appropriate evidence that the error does not
affect the remaining part of the population. One example is an error caused by a computer breakdown that is known to have
occurred on only one day during the period. In that case, the auditor assesses the effect of the breakdown, for example by
examining specific transactions processed on that day, and considers the effect of the cause of the breakdown on audit
procedures and conclusions. Another example is an error that is found to be caused by use of an incorrect formula in
calculating all inventory values at one particular branch. To establish that this is an anomalous error, the auditor needs to
ensure the correct formula has been used at other branches.

In analyzing the errors detected in the sample, the auditor should determine that item in question is in fact an error. In
designing the sample, the auditor will have defined those conditions that constitute an error by reference to his audit
objectives. For example, in a substantive procedure relating to the recording of accounts receivable, a misposting between
customer accounts does not affect the total accounts receivable. Therefore, it may be inappropriate to consider this an error
in evaluating the sample results of this particular procedure, even though it may have an impact on other areas of the audit,
such as the assessment of doubtful accounts.

When documentation in support of specific sample items cannot he located, the auditor may be able to obtain appropriate
audit evidence through performing alternative procedure related to the missing sample items. For example, if, a positive
confirmation has been circularized in respect to a customer account receivable and no reply was obtained, the auditor may be
able to obtain appropriate audit evidence that the customer receivable is valid by reviewing subsequent payments from the
customer. If the auditor does not or is unable to perform alternative procedures related to the missing sample item (customer
receivable), he should treat this item as an error for the purpose of his evaluation of audit evidence provided by the audit
sample.

The auditor also should consider the qualitative aspects of the errors. These include the nature and cause of the error and the
possible impact of the error on other phase of the audit, for example, the amount of planned reliance on internal control
procedures.
In assessing the errors discovered, the auditor may conclude that many have a common feature, for example, type of
transaction, location, product line, period of time or other relevant feature. In such circumstance, the auditor may decide to
identify all items in the population which possess the common feature, thereby producing a sub-population, and extend his
procedures in this area. He should then perform separate evaluations based on the items examined for each sub-population.

Projection of Errors

PSA 530 provides for guidance in projecting errors as follows:

 For substantive procedures, the auditor should project monetary errors found in the sample to the population, and
should consider the effect of the projected error on the particular test objective and on other areas of the audit. The
auditor projects the total error for the population to obtain a broad view of the scale of errors, and to compare this to
the tolerable error. For substantive procedures, tolerable error is the tolerable misstatement, and will be an amount
less than or equal to the auditor's preliminary estimate of materiality used for the individual account balances being
audited.
 When an error has been established as an anomalous error, it may be excluded when projecting sample errors to the
population. The effect of any such error, if uncorrected, still needs to be considered in addition to the projection of the
non-anomalous errors. If an account balance or class of transactions has been divided into strata, the error is
projected for each stratum separately. Projected errors plus anomalous errors for each stratum are then combined
when considering the possible effect of errors on the total account balance or class of transactions.
 For tests of control, no explicit projection of errors is necessary since the sample error rate is also the projected rate of
error for the population as a whole.

The auditor should project the error results of the sample to the population from which the sample was selected. There are
several acceptable methods of projecting the error results. However, in all cases the method of projection should be
consistent with the method used to select the sampling unit. When projecting error results, the auditor should keep in mind
the qualitative aspects of the errors found. When the population is divided into two or more sub-populations (stratification),
the projection of errors is done separately for each sub-population and the results are added together.

Assessing Sampling Risk

The auditor should evaluate the sample results to determine whether the preliminary assessment of the relevant
characteristic of the population is confirmed or needs to be revised. In the case of a test of controls, an unexpectedly high
sample error rate may lead to an increase in the assessed level of control risk, unless further evidence substantiating the initial
assessment is obtained. In the case of a substantive procedure, an unexpectedly high error amount in a sample may cause the
auditor to believe that an account balance or Class of transactions is materially misstated, in the absence of further evidence
that no material misstatement exists.

If the total amount of projected error plus anomalous error is less than but close to that which the auditor deems tolerable.
the auditor considers the persuasiveness of the sample results in the light of other audit procedures, and may consider it
appropriate to obtain additional audit evidence. The total of projected error plus anomalous error is the auditor's best
estimate of error in the Population. However, sampling results are affected by sampling risk. Thus, when the best estimate of
error is close to the tolerable error, the auditor recognizes the risk that a different sample would result in a different best
estimate that could exceed the tolerable error. Considering the results of other audit procedures helps the auditor to assess
this risk, while the risk is reduced if additional audit evidence is obtained.

If the evaluation of sample results indicates that the preliminary assessment of the relevant characteristic of the population
needs to be revised, the auditor may:

(a) request management to investigate identified errors and the potential for further errors, and to make any necessary
adjustments; and/or
(b) modify planned audit procedures. For example, in the case of a test of control, the auditor might increase the sample
size, test an alternative control or modify related substantive procedures; and/or
(c) consider the effect on the audit report.

The auditor should consider whether errors in the population might exceed the tolerable error. To accomplish this, the auditor
should compare the projected population error to the tolerable error and also then compare the sample results to the
evidence obtained from other relevant audit procedures when forming his conclusion about an account balance, class of
transactions or specific control. The projected population error used for this comparison should be net of adjustments made
by the client. As projected error approaches tolerable error, the risk of incorrect acceptance or over reliance increases. The
auditor should therefore reconsider the sampling risk and if he determines that the risk is unacceptable, he should consider
extending his audit procedures or performing alternative audit procedures.

In compliance procedures, the evaluation of the errors may result in the auditor concluding that the sample results do not
support his planned degree of reliance on a control procedure. In this case, he may ascertain that there is another appropriate
control on which he might rely after applying appropriate compliance procedures. Alternatively, he may modify the nature,
timing and extent of his substantive procedures.

Conclusion

Having evaluated the sampling result, the auditor should conclude as to the extent to which he has obtained sufficient
appropriate audit evidence in support of the particular characteristic of the account balance or class of transaction with which
he is concerned.

Detailed Audit Sampling Plans

Definition / Description of Audit Sampling Plans

Attributes Sampling Plan

This is used to test an entity's rate of deviation (also called rate of occurrence) from a prescribed control procedure. It is an
audit sampling in which auditors look for the presence or absence of a control condition. For example, an auditor might use an
attributes sampling plan to test controls for billing systems, disbursement processing, inventory pricing and depreciation
among other things.

Variables Sampling Plan

This is used to test whether recorded account balances are fairly stated. For example, an auditor might use a variables
sampling plan to test recorded peso amounts for receivables, inventory, fixed asset additions among others.

Statistical Sampling Plan

This is a sampling technique in which an auditor uses the laws of probability to select and evaluate a sample. When using
statistical sampling, auditors must select a random sample, which means every item in the population must have an equal
chance of being included in the sample.

Nonstatistical Sampling Plan

These plans rely exclusively on subjective judgment to determine sample size and to evaluate sample results.

Regular or Classical Attributes Sampling

This sampling plan enables the auditor to estimate the rate of occurrence of certain characteristics in the population. For
example, the auditor might use this plan to estimate the percentage of cash disbursements processed during the year that
were not approved.
Discovery Sampling

This form of attributes sampling is designed to locate at least one deviation (exception) in the population. Discovery sampling
is often used in situations in which the auditors expect a very low rate of occurrence of some critical deviation. The purpose of
a discovery sample is to detect at least one deviation, with a predetermined risk of assessing control risk too low, if the
deviation rate in the population is greater than the specified tolerable deviation rate. One important use of discovery sampling
is to locate examples of a suspected fraud. Example is when the auditor attempts to locate a fraudulent cash disbursement.

Sequential (Stop or Go) Sampling

This is a sampling plan for which the sample is selected in several steps, with the need to perform each step conditional on the
results of the previous steps. That is, the results may either be so poor as to indicate that the control may not be relied upon,
or so good as to justify reliance at each step.

Probability Proportional to Size (PPS)

This technique, which is also referred to as peso-unit sampling, applies attributes sampling theory to develop an estimate of
the total peso amount of misstatement in a population. Probability-proportional-to-sin sampling is used as an alternative to
classical variable sampling methods for performing substantive tests of transactions or balances. Unlike classical variable
sampling techniques that define the sampling unit as each transaction or account balance in the population, PPS sampling
defines the sampling unit as each individual peso making up the book value of the population. A transaction or account is
selected for audit if a peso from that transaction or account is selected from the population. Therefore, each transaction or
account has a probability proportional to its size of being selected for inclusion in the sample.

Classical Variables Sampling Models

These use normal distribution theory to evaluate selected characteristics of a population on the basis of a sample of the items
constituting the population. These sampling applications provide the auditors with an estimate of a numerical quantity such as
the peso balances of an account. This technique is primarily used by auditors to perform substantive tests.

Mean-per-unit Estimation

This is a classical variables sampling plan enabling the auditors to estimate the average peso value (or other variable) of items
in a population by determining the average value of items in a sample.

Difference Estimation

This is a sampling plan that uses the difference between the audited (correct) values and book values of items in a sample to
calculate the estimated total audited value of the population. Difference estimation is used in lieu of ratio estimation when
the differences are not nearly proportional to book values.

Ratio Estimation

This is a sampling plan that uses the ratio of audited (correct) values to book values of items in the sample to calculate the
estimated total audited value of the population. Ratio estimation is used in lieu of difference estimation when the differences
are nearly proportional to book values.

Regression

The regression approach is similar to the difference and ratio approaches. This approach has the effect of using both the
average ratio and the average difference in calculating an estimate of the total amount for the population.

AUDIT SAMPLING FOR TEST OF CONTROLS

Tests of Controls

Based on the auditor's understanding of the accounting and internal control systems, the auditor identifies the characteristics
or attributes that indicate performance of a control, as well as possible deviation conditions which indicate departures from
adequate performance. The presence or absence of attributes can then be tested by the auditor.

Audit sampling for tests of control is generally appropriate when application of the control leaves evidence of performance
(for example, initials of the credit manager on a sales invoice indicating credit approval, or evidence of authorization of data
input to a microcomputer based data processing system).

Steps in the Application of Sampling in Test of Controls

Audit sampling can be used as a method and plan for conducting the test of controls audit procedures. The application of
sampling in test of controls auditing is a structured formal approach embodied in ten steps. The nine-step framework helps
auditors plan, perform, and evaluate test of controls audit work. It also helps auditors accomplish a tenth step - careful
documentation of work - by showing each of the nine areas to be described in the working papers. The steps are:

1) Determine the control to be tested or audit objective of the test.

Test of controls is performed to provide evidence about the design or operating effectiveness of internal control structure
policies and procedures. It will also support the auditor's planned assessed level of control risk.

Application: Assume that the auditors wish to test the effectiveness of the client's internal control procedure of matching
receiving reports with purchase of invoices as a step in authorizing payments for purchases of merchandise. They are
interested in the clerical accuracy of the matching process and in determining whether the control procedure that requires the
matching of purchase invoices and receiving reports is operating effectively.

2) Define the attributes and deviation conditions.

Professional judgment is applied by the auditor in defining the attributes and deviation conditions for a particular test of
controls. Attributes are characteristics that provide evidence that an internal control procedure was actually performed.
Deviation occurs when a sample item does not have one or more of the identified attributes.

Application: In the example given in Step 1, the auditors define the deviation conditions as any one or more of the following
with respect to each invoice and related receiving report:

a) Any purchase invoice not supported by a receiving document.

b) Any invoice supported by a receiving document that is applicable to another invoice.
c) Any difference between the invoice and the receiving document as to quantities shipped. For this test, the only
procedure required is inspection of the documents and matching of the receiving reports with invoices
3) Define the population to be sampled and the sampling unit.

The auditor should determine that the population (field) from which the sample is to be selected is appropriate for the specific
audit objective.

Application: The client prepares a serially numbered voucher for every purchase of materials. The receiving report and
purchase invoice are attached to each voucher. Therefore, the sampling unit for the test is an individual voucher. Since the
test of controls is being performed during the interim period, the population to be tested consists of 6,350 vouchers
(assumed) for purchases of material during the first 10 months of the year under audit. If at any point the auditor determines
that the physical representation of the population (the 6,350 vouchers) has omitted vouchers that should be included in the
first 10 months, the auditors should also test those vouchers.

4) Specify the risk of assessing control risk too low (overreliance) and the tolerable deviation rate.

Auditors again apply professional judgment in determining the appropriate risk of assessing control risk too low and the
tolerable deviation rate for a test of a control. The risk of assessing control risk too low - that is, the risk that the actual
deviation rate exceeds the tolerable deviation rate - is a critical risk in tests of controls because this risk impacts the
effectiveness of the audit. Since the results of tests of controls play a major role in determining the nature, timing, and extent
of other audit procedures, auditors usually specify a low level of risk - 5 or 10 percent is often used.

Auditors specify the tolerable deviation rate based on (1) their planned assessed level of control risk, and (2) the degree of
assurance desired from the evidential matter in the sample. The lower the planned assessed level of control risk (or more
assurance desired from the sample), the lower the tolerable deviation rate. The AIPA's Audit Sampling Guide include the
following overlapping ranges to illustrate the relationship between the planned assessed level of control risk and the tolerable
deviation rate:

Planned Assessed Level of Control Risk Tolerable Deviation Rate

Low 2%-7%
Moderate 6%-12%
Slightly below the maximum 11%-20%
Maximum Omit test
Application: The auditors realize that errors in matching receiving reports with purchase orders can affect the financial
statements, through overpayments to vendors and misstatements of purchases and accounts payable. They also plan to assess
control risk at a low level for the assertions of existence, occurrence, and valuation of purchases, inventories, and accounts
payable. Based on these considerations, the auditors decide upon a tolerable deviation rate of 7 percent, with a 5 percent risk
of assessing control risk too low.

5) Estimate the expected population deviation rate.

Aside from the tolerable deviation rate and the risk of assessing control risk too low, the expected population deviation rate
also affects the sample size in attributes sampling. This expected deviation rate is significant because it represents the rate
that the auditors expect to discover in their sample from the population. In estimating the expected population deviation rate,
the auditors often use the sample results from prior years, as documented in their working papers. The auditors may also
estimate the rate based on their experience with similar tests on other audit engagements, or by examining a small pilot
sample.

Application: In the audits of the previous three years, the auditors observed that exceptions for the type described above
produced deviation rates of 1.2 percent, 1.3 percent, and 1.1 percent. Therefore, the auditors conservatively select an
expected deviation rate of 1.5 percent.

6) Determine the sample size.

In determining the sample size, the auditor should consider whether sampling risk is reduced to an acceptably low level.
Sample size is affected by the level of sampling risk that the auditor is willing to accept. The lower the risk the auditor is willing
to accept, the greater the sample size will need to be. The sample size can be determined by the application of a statistically-
based formula or through the exercise of professional judgment objectively applied to the circumstances.

Summary of Factors Influencing Compliance Test Sample Size Factors

Conditions Leading to
Factors Smaller Sample Size Larger Sample Size
Planned reliance on internal control* Lower reliance on internal control Higher reliance on internal control
Allowable rate of deviation (tolerable Higher acceptable rate of deviation for Lower acceptable rate of deviation for
error) planned reliance on internal control planned reliance on internal control
Likely rate of population deviation** Lower rate of population deviation Higher rate of population deviation
Required confidence level Decrease in required confidence level Increase in required confidence level
Number of items in population Virtually no effect on sample size unless population is small
*compliance tests are not performed when no reliance on internal controls is planned

**larger samples are necessary when deviations occur, in order to obtain more precise conclusions. However, high deviation
rate normally warrant little, if any, reliance on internal controls, and, therefore, compliance testing might be omitted.

PSA 530. Audit Sampling, illustrates the factors that the auditor considers when determining the sample size for a test of
control

Factor Effect on
sample size
An increase in the Increase The more assurance the auditor intends to obtain from the operating effectiveness
extent to which the of controls, the lower the auditor's assessment of the risk of material misstatement
auditor’s risk will be, and the larger the sample size will need to be. When the auditor's
assessment takes assessment of the risk of material misstatement at the assertion level includes an
into account expectation of the operating effectiveness of controls, the auditor is required to
relevant controls perform tests of controls. Other things being equal, the greater the reliance the
auditor places on the operating effectiveness of controls in the risk assessment, the
greater is the extent of the auditor's tests of controls (and therefore, the sample size
is increased).
An increase in the Decrease The lower the tolerable rate of deviation, the larger the sample size needs to be.
tolerable rate of
deviation
An increase in the Increase The higher the expected rate of deviation, the larger the sample size needs to be so
expected rate of that the auditor is in a position to make a reasonable estimate of the actual rate of
deviation of the deviation. Factors relevant to the auditor's consideration of the expected rate of
population to be deviation include the auditor's understanding of the business (in particular, risk
tested assessment procedures undertaken to obtain an understanding of internal control),
changes in personnel or in internal control, the results of audit procedures applied in
prior periods and the results of other audit procedures. High expected control
 deviation rates ordinarily warrant little, if any, reduction of the assessed risk of
material misstatement.
An increase in the Increase The greater the level of assurance that the auditor desires that the results of the
auditor’s desired sample are in fact indicative of the actual incidence of deviation in the population,
level of assurance the larger the sample size needs to be.
that the tolerable
rate of deviation is
not exceeded by the
actual rate of
deviation in the
population
An increase in the Negligible For large populations, the actual size number of population however, audit sampling
sampling units in the effect may not be as efficient as alternative means of obtaining sufficient appropriate audit
population evidence.
Figure 16-2 shows the Table that may be used to determine required sample sizes at 5 percent risk of assessing control risk too
low. Similar tables are available for other levels of risk, such as 1 percent and 10 percent. The horizontal axis of the table is the
tolerable deviation rate specified by the auditors. The vertical axis is the expected deviation rate estimated by the auditors to
exist within the population. The numbers in the body of the table indicate the required sample sizes. The number in
parentheses shown after the required sample size is the allowable number of deviations that may be observed in the sample
for the results to support the auditors' planned assessed level of control risk.

To use Figure 16-2, the auditors stipulate the expected deviation rate in the population and the tolerable deviation rate. Then,
the auditors read the sample size from the table at the intersection of the stipulated tolerable deviation rate, and the
expected population deviation rate. For example, assume the auditors expect the deviation rate in the population to be 1
percent and specify a 9 percent tolerable deviation rate to justify their planned assessed level of control risk related to this
control procedure. Figure 16-2 shows that these specifications result in a sample size of 51 items, which must contain no more
than I control procedure deviation if the auditors' planned control risk assessment is to be supported by the test.

Application: Since the stipulated risk of assessing control risk too low is 5 percent, Figure 16-2 is applicable. At the intersection
of the column for a tolerable deviation rate of 7 percent and the row for a 1.5 percent expected deviation rate, the sample size
is found to be 66 items. The allowable number of deviations in the sample is one.

7) Select the sample.

After determining the initial sample size, the auditor should select a random sample from the population. Random samples
may be selected using random number tables, random number generators or systematic sampling. A random sample is one in
which every sampling unit in the population has an equal chance of being included in the sample. The statistical sampling
tables auditors generally use such as the tables included in the Chapter are based on the assumption that the auditor is
sampling with replacement. Sampling which replacement means that after an item has been selected for inclusion in the
sample, it is placed back in the population so that it is subject to selection again. If an item is selected twice because the
random number is drawn twice, the item must be included twice. Sampling without replacement requires the selected items
be included in the sample only once. Random number generators are computer programs used to provide any length list of
random numbers applicable to a given population. A random number generator is a standard program in all generalized audit
software packages. Systematic sampling involves selecting every 21", item in the population following one or more random
starting points.

Application: Since the vouchers are serially numbered, the auditors decide to use a generalized audit software program to
generate a list of random numbers to select the sample for testing.

8) Perform the test of controls procedures on sample items.

When testing the sample items, an auditor examines each sample iter for the attributes of interest. Each item will be classified
as to whether it contains a deviation from the prescribed internal control procedure. The auditor performing the test should
also be alert for evidence of any unusual matters, such as evidence of fraud or related party transactions.

Application: The auditors proceed to examine the vouchers and supporting documents for each of the types of deviations
previously defined. As they perfonn the test, the auditors will be alert for any unusual matters, such as evidence of fraud

Compliance Test Risk Matrix

Compliance test risk matrix Relevant internal control is in fact:

 Compliance test indicates reliance on Adequate for Planned Reliance Inadequate for Planned Reliance
relevant internal control should be:
Accepted Correct Decision Risk of Overreliance
Rejected Risk of Underreliance Correct Decision
Application: The auditors proceed to examine the vouchers and supporting documents for each of the types of deviations
previously defined. As they perform the test, the auditors will be alert for any unusual matters, such as evidence of fraud

9) Evaluate the sample results.

After performing the sampling plan, the auditor summarizes and evaluates the results.

1. Determine the sample deviation rate by using the formula:

Sample Deviation Rate = No. of Deviations Observed
Sample Size
2. Determine the upper deviation rate and the allowance for sampling risk by using the following
relationship:
Upper Deviation Rate = Sample Deviation Rate + Allowance for Sampling Risk
3. Compare upper deviation rate and the tolerable rate of deviation and evaluate the ffectiveness of a
control accordingly
a) Under the statistical sampling plan if:
Upper deviation rate < tolerable deviation rate
It is implied that a control is effective and the results would support assessing control risk below the
maximum or 100%
Conversely, if
Upper deviation rate > tolerable deviation rate
It would suggest that a control is not effective and the results would support assessing control risk at
maximum or 100%
b) In a nonstatistical sampling application, sampling deviation rate is compared with tolerable rate or
expected population deviation rate if:
Sampling deviation rate < tolerable rate or Expected population deviation rate
Internal control is considered effective and would support assessing control risk below maximum
On the other hand. If:
Sampling deviation rate > Tolerable rate or Expected population deviation rate
Control is not considered effective and therefore the auditor would assess control risk to be maximum
4. Consider qualitative information such as evidence of deliberate manipulation or circumvention of internal
control.
5. Reach an overall conclusion. The auditor must relate the assessed control risk to detection risk for each
financial statement assertion.

Application: In evaluating sample results, the auditors consider not only the actual number of deviations observed, but also
the nature of the deviations. Evaluation of the results will be discussed under three possible scenarios:

(1) the actual number of deviations is equal to or less than, the allowable number;
(2) the actual number of deviations is more than the allowable number,; and
(3) one or more deviations observed contain evidence of a deliberate manipulation or circumvention of internal control!.

First, let us assume that one deviation has been identified and there is no evidence of a deliberate manipulation or
circumvention of the internal control structure. Recall that the allowable number of deviations from Figure 16-4 was one.
Because the number of deviations (here, one) did not exceed the allowable number, tie auditors may conclude that there is
less than 5 percent risk that the population deviation rate is greater than 7 percent. In this case, the sample results support
the auditors' planned assessed level of control risk.

Next, assume that the number of deviations observed in the sample is three, and none of the observed deviations indicate
deliberate manipulation or circumvention of internal control. Because this exceeds the allowable one deviation, the achieved
upper deviation rate is greater than 7 percent. Referring to Figure 16-4, for a sample size of 65 (the highest number is still less
than the actual sample size), the auditors find that when three deviations are observed, the achieved upper deviation rate is
11.5 percent. In light of these results, the auditors should increase the assessed level of control risk in this area and increase
the extent of substantive testing procedures (i.e., decrease detection risk). As a preliminary step to any modification of their
audit program, the auditors should investigate the cause of the unexpectedly high deviation rate.
Finally, assume that one or more of the deviations discovered by the auditors indicates an irregularity such as circumvention
of the internal control structure. In such a circumstance, other auditing procedures become necessary. The auditors must
evaluate the effect of the deviation on the financial statements and adopt auditing procedures that are specifically designed to
detect the type of deviation observed. Indeed, the nature of the deviation may be more important than its rate of occurrence.

10) Document the sampling procedure.

Finally, the auditors will document the significant aspects of the prior nine steps in the working papers.

Nonstatistical Attributes Sampling

In attributes sampling, the major differences between statistical and nonstatistical sampling are the steps for determining
sample size and for evaluating sample results. As in the case with statistical sampling, auditors who use nonstatistical sampling
need to consider the risk of assessing control risk too low and the tolerable deviation rate when determining the required
sample size. But these factors need not be quantified. When evaluating results, the auditors should compare the deviation
rate of the sample to the tolerable deviation rate. If the sample size was appropriate and the sample deviation rate is
somewhat lower than the tolerable deviation rate, the auditors can generally conclude that the risk of assessing control risk
too low is at an acceptable level. As the sample deviation rate gets closer to the tolerable deviation rate, it becomes less and
less likely that the population's deviation rate is lower than the tolerable level. The auditors must use their professional
judgment to determine the point at which the assessed level of control risk should be increased above the planned level.

AUDIT SAMPLING FOR SUBSTANTIVE TESTS

Substantive procedures are concerned with amounts and are of two types: analytical procedures and tests of details of
transactions and balances. The purpose of substantive procedures is to obtain audit evidence to detect material
misstatements in the financial statements. When performing substantive tests of details, audit sampling and other means of
selecting items for testing and gathering audit evidence may be used to verify one or more assertions about a financial
statement amount (for example, the existence of accounts receivable), or to make an independent estimate of some amount
(for example, the value of obsolete inventories).

Statistical sampling techniques that auditors use in performing substantive tests require testing a hypothesis. In making a
hypothesis test, an auditor estimates the account balance using sampling techniques, and in comparing the estimated amount
to a financial statement amount, determines whether the difference between the estimated amount and the recorded
amount allows the auditor to accept the recorded amount as fairly stated. To reach that conclusion, the auditor will consider
not only tolerable misstatement or materiality for a particular account but also the risks inherent in sampling.

RISKS IN SUBSTANTIVE TESTS

When performing substantive tests, auditors encounter nonsampling risk and sampling risk. Nonsampling risk is the risk that
arises from human error; it cannot be quantitatively measured. Adequate supervision, proper review of audit working papers
and adherence to quality control standards can all reduce nonsampling risk.

Sampling risk can be measured quantitatively and when performing substantive tests, an auditor encounters two types of
sampling risk:

 The risk of incorrect rejection (sometimes called alpha risk) is the risk that a sample supports the conclusion that a
recorded balance is materially misstated when it is not. This risk relates to efficiency because when an auditor
concludes that an account balance is misstated, the auditor and/or the client generally perform additional procedures
when in fact, it is not necessary.
 The risk of incorrect acceptance (also called beta risk) is the risk that a sample supports the conclusion that a recorded
account balance is not materially misstated when the account is actually materially misstated This risk relates to audit
effectiveness because an auditor who accepts a client's account balance that is materially misstated may express an
unqualified opinion on financial statements that do not warrant such an opinion.

Variables sampling plan techniques are:

1. Probability-proportional-to-size sampling technique, and

2. Classical variables sampling technique.

PROBABILITY-PROPORTIONAL-TO-SIZE SAMPLING (PPS)

PPS sampling is a sampling technique auditors use to estimate the maximum amount of overstatement of a recorded amount
with measurable level of risk of making a decision error.

PPS sampling sometimes referred to as peso-unit sampling (PU) or cumulative-monetary-amount sampling (CMA) uses
attribute sampling theory.

PPS sampling gets its name from the fact that the probability of an item's being selected for inclusion in the sample is equal to
its size in proportion to the size of the whole population. For example, the probability of selecting a P150,000 account for the
sample is 100 times the probability of selecting a P1,500 account from the same population.

The general approach to PPS sampling presented in this text includes the assumption that the audited amount of an item
should not be less than zero or greater than the recorded amount. When the auditor anticipates understatements or
situations in which the audited item will be less than zero, he or she should employ a specialized approach that is beyond the
scope of this text. Practically, auditors may use the approach presented in this text when auditing accounts receivable by
separating credit and zero-balance accounts.

PPS sampling techniques provide an auditor with an estimate of the maximum amount of overstatement of a recorded
amount with measurable levels of risk of incorrect acceptance. The auditor may use PPS sampling to conclude that an account
balance is fairly stated when the maximum overstatement is less than the tolerable misstatement.

Advantages and Disadvantages of PPS Sampling

PPS sampling has several advantages.

1. It increases the likelihood of including high peso-value items in the sample.

2. PPS allows auditors to compute the sample size and evaluate the results by hand or by means of tables.
3. PPS sampling is easy to use.
4. PPS sampling enables the auditor to state conclusion in a peso amount.

Some disadvantages of PPS sampling are:

1. The assumption of PPS sampling that the audited value of a sampling unit is neither less than zero nor greater than the
book value may not be consistent with the auditor's objective.
2. Negative balance or zero balances cannot be audited using PPS sampling.
3. When misstatements are found using PPS sampling, the upper misstatement limit may be too high to be useful.

CLASSICAL VARIABLES SAMPLING

Classical variables sampling models use normal distribution theory to evaluate selected characteristics of a population on the
basis of a sample of items constituting the population.

For any normal distribution, the following fixed relationships exist concerning the area under the curve and the distance from
the mean in standard deviations. This table assumes a two-trailed approach which is appropriate since classical variables,
sampling models generally test for both overstatement and understatement.
For large samples (greater than or equal to 30) the distribution of sample means tends to be normally distributed about its
own mean which is equal to the true population mean, even if the population is not normally distributed (Central Limit
Theorem). Since many populations sampled in auditing are not normally distributed, this is important.

The standard deviation in the above model measures the dispersion among the respective amounts of a particular
characteristic, for all items in the population for which a sample estimate is developed.

Variations of Classical Variables Sampling

(1) Mean- -per--unit estimation is a classical variables sampling technique that projects the sample average to the total
population by multiplying the sample average by the number of items in the population.
(a) Determine audit values for each sample item.
(b) Calculate the average audit amount.
(c) Multiply this average audit amount times the number of units in the population to obtain the estimated
population value.
(2) Difference estimation is a classical variables sampling technique that uses the average difference between audited
amounts and individual recorded amounts to estimate the total audited amount of a population and an allowance for
sampling risk.
(a) Determine audit values for each sample item.
(b) Calculate the difference between the audit value and book value for each sample item.
(c) Calculate the average difference.
(d) Determine the estimated population value by multiplying the average difference by the total population units and
adding or subtracting this value from the recorded book value.
(3) Ratio estimation is a classical variables sampling technique that uses the ratio of audited amounts to recorded
amounts in the sample to estimate the total peso amount of the population and an allowance for sampling risk.
(a) Determine audit values for each sample item.
(b) Calculate the ratio between the sum of sample audit values and sample book values.
(c) Determine the estimated population value by multiplying the total population book value times this ratio.
(4) The regression approach is similar to the difference and ratio approaches. This approach has the effect of using both
the average ratio and the average difference in calculating an estimate of the total amount for the population.
(5) Difference and ratio estimation are used as alternatives to mean-per-unit estimation. The auditor should use these
approaches when applicable because they require a smaller sample size (i.e., they are more efficient than mean-per-
unit estimation).
(a) One factor in the calculation of sample size for classical variables sampling models is the estimated standard
deviation. If the standard deviation of differences or ratios is smaller than the standard deviation of audit values,
these two methods will produce a smaller sample size.
1. Difference estimation will be used if the differences between sample audit values and book values are a
relatively constant peso amount, regardless of account size.
2. Ratio estimation will be used if the differences are a constant percentage of book values.
(b) In order to use either difference or ratio estimation, the following constraints must be met:
1. The individual book values must be known and must sum to the total book value.
2. There must be more than a few differences (20 is often suggested as a minimum) between audit and book
values.
(c) These two methods will usually be more efficient than mean-per-unit estimation when stratification of the
population is not possible.
(6) Stratification separates a population into relatively homogeneous groups to reduce the sample size by minimizing the
effect of variation of items (i.e., the standard deviation) in the population.
(a) Although stratification may be applied with any of the classical methods, it is most frequently used with the mean-
-per- unit estimation method.
(b) Know that the primary objective of stratification is to decrease the effect of variance in the total population and
thereby reduce sample size.

STEPS IN VARIABLES SAMPLING FOR SUBSTANTIVE TESTS

1. Determine the objective(s) of the test.

2. Define population and sampling unit
3. Determine the initial sample size.
4. Using random sampling techniques to identify the actual items to audit.
 5. Audit the selected items and identify misstatements.
6. Evaluate the sample results.
7. Document the sampling procedure.

APPLICATION OF THE STEPS IN VARIABLES SAMPLING PLAN USING PPS TECHNIQUE FOR SUBSTANTIVE TESTS

Step 1. Determine the objective(s) of the test or PPS sampling. Auditors typically use PPS sampling to obtain evidence that an
account balance is not materially misstated. The objective of the sampling technique must relate to the auditing procedure
being performed. For example, a sampling plan applied to substantive tests of details is designed either:

(1) to estimate an account balance that is not recorded within an entity's accounts (called peso-value estimation).
(2) to test the reasonableness of a recorded account balance (called hypothesis testing).

Once an objective is stated the auditor must then identify the characteristics of interest. For instance, if the auditor's objective
is to determine whether an account is fairly stated, the characteristics might be defined as monetary error, that is, monetary
difference between recorded and audited peso amount.

To illustrate PPS sampling, we shall use a running example of the Tripoli Corporation Case involving the audit of Accounts
Receivable.

Tripoli Corporation Case

Mark Cruz, a senior auditor of Cabrera & Associates, CPAs has been assigned the responsibility of auditing trade accounts
receivable as of December 31, 20X4 which amount to P1,200,000 and consisting of 400 accounts. The controls relating to the
existence of Tripoli's trade accounts receivable during November, 20X4 have been tested by Mark. After reviewing the work,
the audit manager agreed with Mark's assessment that assessing control risk at 80% was appropriate. The manager also
indicated that planned audit risk should be limited to 5%, inherent risk should be assessed to be 100% and the risk that
analytical procedures will not detect material misstatements should be assessed to be 60%. The manager decided that
P50,000 should be used as tolerable misstatement for purposes of confirming accounts receivable. During last year's audit, the
auditors found misstatements amounting to P5,000, which the manager suggests should also be used this year as an estimate
of misstatement for purposes of determining sample size. A review of the listing of accounts indicates that it includes no
accounts that have credit balances or zero balances.

Step 2. Define population and sampling unit. An audit population consists of all the items constituting an account balance or
class of transaction and should be defined by the auditor's characteristic of interest, since sample results can be generated
only 10 the population from which a sample is selected. For example, when auditing accounts receivable, the auditor may
decide to treat all accounts as a population or to treat debit-balance, credit balance and zero-balance accounts as individual
populations. Auditors generally should treat zero-balance and credit-balance accounts separately because they cannot be
audited effectively with PPS sampling.

The sampling unit is any of the individual elements constituting a population or in PPS sampling, the sampling is the individual
peso. For example, the population is composed of sampling units equal to the number of pesos in accounts receivable rather
than the number of. customer accounts. Although the peso is the sampling unit, each peso selected is associated with an
account or transaction, which is referred to as the logical sampling unit. Therefore, when an auditor selects a particular peso in
an account or transaction, the auditor selects the whole account or transaction.

When planning the audit, auditors determine the logical sampling unit, based on the audit objective. For example, the logical
sampling unit for accounts receivable may be either account balances or outstanding invoices comprising the account balance.

For Tripoli Corporation, the population is all 400 customer accounts with debit balance, and the recorded book value of the
accounts is P1,200,000. The audit manager decided that customers' accounts rather than individual invoices are to be
confirmed. Accounts receivable has 1,200,000 sampling units and 400 logical sampling units.

Step 3. Determine the initial sample size. In determining the sample size, the auditor should consider whether sampling risk is
reduced to an acceptably low level. Sample size is affected by the level of sampling risk that the auditor is willing to accept.
The lower the risk the auditor is willing to accept, the greater the sample size will need to be. The sample size can be
determined by the application of a statistically-based formula or through the exercise of professional judgment objectively
applied to the circumstances. The following are factors that the auditor considers when determining the sample size for tests
of details. These factors need to be considered together.
Factor Effect on
sample size
An increase in the Increase The higher the auditor's assessment of the risk of material misstatement, the larger
auditor’s assessment the sample size needs to be. The auditor's assessment of the risk of material
of the risk of misstatement is affected by inherent risk and control risk. For example, if the
material auditor does not perform tests of controls, the auditor's risk assessment cannot be
misstatement reduced for the effective operation of internal controls with respect to the particular
assertion. Therefore, in order to reduce audit risk to an acceptably low level, the
auditor needs a low detection risk and will rely more on substantive procedures. The
more audit evidence that is obtained from tests of details (that is, the lower the
detection risk), the larger the sample size will need to be.
An increase in the Decrease The more the auditor is relying on other substantive procedures (tests of details or
use of other substantive analytical procedures) to reduce to an acceptable level the detection
substantive risk regarding a particular population, the less assurance the auditor will require
procedures directed from sampling and, therefore, the smaller the sample size can be
at the same
assertion
An increase in the Increase The greater the level of assurance that the auditor requires that the results of the
auditor’s desired sample are in fact indicative of the actual amount of misstatement in the
level of assurance population, the larger the sample size needs to be.
that tolerable
misstatement is not
exceeded by actual
misstatement in the
population
An increase in Decrease The lower the tolerable misstatement, the larger the sample size needs to be
tolerable
misstatement
An increase in the Increase The greater the amount of misstatement the auditor expects to find in the
amount of population, the larger the sample size needs to be in order to make a reasonable
misstatement the estimate of the actual amount of misstatement in the population. Factors relevant
auditor expects to to the auditor's consideration of the expected misstatement amount include the
find in the extent to which item values are determined subjectively, the results of risk
population assessment procedures, the results of tests of control, the results of audit
procedures applied in prior periods, and the results of other substantive procedures.
Stratification of the Decrease When there is a wide range (variability) in the monetary size of items in the
population when population, it may be useful to stratify the population. When a population can be
appropriate appropriately stratified, the aggregate of the sample sins from the strata generally
will be less than the sample size that would have been required to attain a given
level of sampling risk, had one sample been drawn from the whole population.
The number of Negligible For large populations, the actual size of the population has little, if any, effect on
sampling units in the effect sample size. Thus, for small populations, audit sampling is often not as efficient as
population alternative means of obtaining sufficient appropriate audit evidence. (However,
when using monetary unit sampling, an increase in the monetary value of the
population increases sample size, unless this is offset by a proportional increase in
materiality for the financial statements as a whole (and, if applicable, materiality
level or levels for particular classes of transactions. account balances or disclosures.)
Sample size will increase if a low risk of incorrect acceptance is specified because the value of the numerator in the formula
will increase (reliability factor is greater) and the value of the denominator will decrease (expansion factor is larger). Although
the relationship between anticipated misstatement and sample size is direct, the relationship between the risk of incorrect
rejection and sample size is inverse because the factor values increase as the risk of incorrect acceptance declines.

Step 4. Select the sample. Systematic sampling with a sampling interval or random sampling to select the items to audit may
be employed when using PPS sampling. Systematic sampling means that an auditor selects every nth item for inclusion in the
population. The sampling interval (SI) is determined using the equation:

Sampling Interval = Book Value of Population / Sample Size

= 1,200,00 / 65 = 18, 462

A schedule of the customer's accounts (logical sampling units) with cumulative peso totals is then prepared. Although there
are computer softwares available for preparing such schedules, some auditors prepare them manually. To determine the
starting point for sampling, many auditors use a random number table, with the starting point being less than or equal to
sample interval.

Assuming that the auditor selects 4916 with a blind stab, the first item in the sample is the account balance containing a
cumulative total 4916 or account no. 521. The second item in the sample is account no. 528 because it includes 23,378 (the
first item - 4916 plus the sampling interval - 8462). The third item would be customer account no. 540. Account no. 540 will be
included in the sample regardless of where the account is located in the sequence of accounts because the recorded account
balance exceeds the sampling interval. All accounts with balances that exceed the sampling interval will be included in the
sample. However, although account no. 540 balance is twice the sampling interval, the account will be counted only once in
evaluating the results. The selection process would continue until all logical units have been identified.

Step 5. Audit the items in the PPS sample. The auditor now performs the audit procedures he/she deems to be appropriate in
the circumstances. If the audit procedure involves confirming accounts receivable, the auditor performs all procedures
involved in confirming accounts receivable, including following up requests for which no response was received. The auditor
then accumulates information about the recorded book value and" audited value for each item selected for audit.

Substantive Test Matrix

Evidence indicates relevant account balance should be: Relevant account balance is in fact:
Fairly Stated Not Fairly Stated
Accepted Correct Decision Risk of Incorrect Reliance
 Rejected Risk of Incorrect Rejection Correct Decision
Step 6. Evaluate the PPS sample results. The procedure for evaluating results depends on whether overstatement errors are
found in the sample.

If no errors are found in the sample, then the projected misstatement is zero, and the allowance for sampling risk is no more
than tolerable error. Therefore the upper misstatement limit is less than or equal to tolerable error that might make the
auditor to conclude that the recorded book value in the population is not overstated by more than tolerable error at a
specified risk of incorrect acceptance.

If overstatement errors are found where recorded book value exceeds the audited value, the auditor computes the projected
misstatement on projected population errors and the allowance for sampling risk.

To evaluate the results of a PPS sample, the auditor estimates the upper misstatement limit or upper error limit which is the
total of the projected risk in the sample and the allowance for sampling risk. The equation to compute for upper misstatement
limit is:

Allowance for Sampling Risk

Upper Misstatement Limit = Projected Misstatement + Basic Precision + Incremental Allowance
Projected misstatement is the auditor's best estimate of the amount of misstatement in the population. To compute the
projected misstatement, the auditor may follow this guideline:

For logical sampling units less than the sampling interval:

Tainting Percentage
Book Value - Audited Value x Sampling Interval = Projected Misstatement for each audited item
Book Value
For logical sampling units greater than or equal to the the sampling interval:

Book Value – Audited Value = Projected Misstatement for each audited

The projected misstatement equals the sum of the individual misstatements.

For Tripoli Corporation, three errors were found. Customer accounts 545 and 597 have book values less than the sampling
interval and customer account 613 is larger than the sampling unit. To compute the projected misstatement, the following
analysis is made:

Allowance for Sampling Risk. In PPS sampling, this is the sum of basic precision and an incremental allowance for sampling risk.
Basic precision is a measure of the closeness of the estimate of projected misstatement to the population misstatement. To
compute the basic precision, the following is done:

Sampling Interval x Reliability factor for risk of incorrect acceptance

Reliability factor for risk of incorrect acceptance can be obtained from a table, on page 117 of the 1983 AICPA Accounting and
Audit Guide: Audit Sampling.

Incremental allowance for sampling risk is an allowance in PPS sampling to incorporate risk arising from not auditing the entire
sampling interval. It is computed by
 1. Ranking in descending order the projected misstatements for logical sampling units less than the sampling interval,
2. Multiplying the ranked projected misstatements by the incremental change in reliability factor, and
3. Subtracting the projected misstatement for the logical units that are smaller than the sampling interval.

REACHING A CONCLUSION IN PPS SAMPLING

To reach a conclusion, the auditor must consider not only the statistical results but also the qualitative aspects of the findings:
The evidence an auditor gathers when sampling is only part of the evidence collected about an assertion. When the audit of
the sample and other evidence support the financial statement assertion, the auditor generally concludes that the assertion is
fairly presented. However, when the auditor finds, for example, that the upper misstatement limit exceeds tolerable error,
recorded book value may be overstated. If this occurs, the auditor could:

(1) examine additional logical units from the population,

(2) perform additional substantive tests directed toward the same audit objective, and
 (3) following the above steps, have the client correct the errors found, reduce the upper misstatement limit accordingly
and compare the revised upper misstatement limit with tolerable error.

If a client makes no adjustment to the financial statement found to have material misstatement, the auditor may be
compelled to modify the audit report. The auditor should also carefully evaluate whether misstatements are errors or
irregularities, how they might have occurred, and whether others may also exist.

From these results, the auditor may conclude with a 5% risk that the P1,200,000 book value is not overstated by more than
P47,090. It can be recalled that in designing the sampling plan, the auditor established P50,000 as the tolerable misstatement
at a 5% overall risk. Since the upper limit for overstatement (P47,090) is less than the tolerable misstatement (P50,000), the
audit results support that the recorded book value is not overstated by more than tolerable misstatement at the specified risk
of incorrect acceptance. However, when the upper misstatement limit exceeds the tolerable misstatement, the recorded value
may be misstated. Also, the auditor must remember that the risk of incorrect rejection exists and would propose adjustments
to the client only after obtaining more evidence of misstatements.

APPLICATION OF CLASSICAL VARIABLES SAMPLING PLAN USING CLASSICAL TECHNIQUES

Classical variables sampling plans enable auditors to estimate a numerical quantity such as the peso amount of an account
balance. This makes these techniques particularly useful for performing substantive tests. Classical variables sampling
methods include:

1. Mean-per-unit estimation
2. Ratio estimation
3. Difference estimation
4. Regression

Mean-per-unit Estimation

This technique enables auditors to estimate the mean audited value of the items in a population with specified sampling risk
and allowance for sampling risk (precision), by determining the mean audited value of the items in a sample. An estimate of
the total audited value of the population is obtained by multiplying audited value of the sample (the sample mean) times the
number of items in the population. The projected misstatement may then be calculated as the difference between the
estimated total audited value and the client's book value.

When using mean-per-unit estimation, auditors generally stratify the population to reduce the variations within homogeneous
subgroups. Stratifying a population means dividing it into subgroups. The purpose of stratification is to reduce the variability of
items within a subgroup so that the auditor can significantly reduce the required sample size. However, the required
calculations of the statistical results are so complex that auditors generally do not use stratified sampling techniques without
using computer programs.

For purposes of illustration, we will discuss the mean-per-unit estimation without stratification. The technique is
representative of the process used with stratification and the concepts introduced are also applicable in difference and ratio
estimation.

The steps presented will also be followed by the auditor when using mean-per-unit estimation. However, the following
equations are used for mean-per-unit estimation to determine sample size and evaluate audit results.
 (4) Because the interval calculated by using' the point estimate of the account's audited value and adjusted ASR of
P1,493,506 (P1,460,000 * P33,506) does not include the client's book value (P1,500,000) the auditor is unable to
accept the population as not including misstatement in excess of the tolerable limit.

Two alternatives in classical variables sampling are:

(a) Ratio Estimation

In ratio estimation, the auditors use a sample to estimate the ratio of the audited value of a population to its book value. The
ratio is estimated by dividing the total audited value of a sample by the total book value of the sample items. An estimate of
the correct population value is obtained by multiplying this estimated ratio by the total book value of the population.

To illustrate the application of Ratio Estimation Sampling Plan we shall use the following case:

Illustrative Case 3. Classical Variables Sampling using Ratio Estimation Bella Buenavista obtained the following data while
auditing inventory of Ballerina Bootery, a manufacturer of shoes:

Items in the population 11,500

Items in the sample 121
Book value of population $1,800,000
Audited value of sample items $18,095
Book value of sample items $18,700
REQUIRED: Calculate the estimated audited value using the ratio estimation.

SOLUTION:

$18,095 / $18,700 = 0.976

0.976 x P1,800,000 = P1,741,680

Difference Estimation

In applying difference estimation, the auditors use a sample to estimate the average difference between the audited value and
book value of items in a population. The average difference is estimated by dividing the audited value and book value of a
sample by the number of items in the sample. The total difference between the book value of the population and its estimated
correct value is determined by multiplying the estimated average difference by the number of items in the population.

Illustrative Case 4. Classical Variable Sampling

Using Difference Estimation Using the same data in Illustrative Case 3 - calculate the estimated audited value using difference
estimation.

SOLUTION:

P18,700 - P18,095 = P605

Average difference: P605 / 121 = P5

11,500 x P5 = P57,500

P1,800,000 - P57,500 = P1,742,500

CHOOSING BETWEEN RATIO ESTIMATION: AND DIFFERENCE ESTIMATION

In using ratio or difference estimation technique, the following are required:

a) each population item has a book value,

b) an audited value may be determined for each sample item, and
c) difference between audited and book values (misstatements)

When these requirements are met, ratio or difference estimation is often more efficient than mean-per-unit estimation. When
the size of misstatements is nearly proportional to the book values of the items, the use of ratio estimation is appropriate
because large accounts have large misstatements and smaller accounts have small misstatements.

The difference estimation technique is more appropriate when the size of misstatements is not approximately proportional to
book value

NONSTATISTICAL SAMPLING FOR SUBSTANTIVE TESTS

In substantive testing, the major differences between statistical and nonstatistical sampling are in the procedures used to
determine the sample size and evaluate the sample results. When using nonstatistical sampling the auditors may decide not to
quantify the factors used to arrive at the sample size, although they will consider the relationships that are summarized in
Figure 17-3. In evaluating the sample results, the auditors also project the misstatements found in the sample to the
population and consider sampling risk, but the level of risk is not quantified. While the auditors may use unassisted judgment
for determining the sample size and for evaluating the sample results, many CPA firms have adopted structured approaches to
nonstatistical sampling that are based on statistical methods. This increases the consistency of sampling judgments that are
made by various auditors throughout the firm.

Auditors using nonstatistical sampling techniques employ the following two methods to estimate the total misstatement in the
population: the ratio method and the average difference method. In the ratio method, they divide the sum of the
misstatements in the audited sample by the book value of the sample, and they then multiply the result by the book value of
the population. In the average difference method, auditors divide the sum of the misstatements, in the audited sample by the
number of items in the sample, and they then multiply the result by the number of items in the population.
Illustrative Case 5.

To test the pricing and mathematical accuracy of sales invoices, the auditors selected a sample of 200 sales invoices from a
total of 41,600 invoices that were issued during the year under audit. The 200 invoices represented total recorded sales of
P22,800. Total sales for the year amounted to PS million. The examination disclosed that of the 200 invoices audited, 5 were
not properly priced or contained errors in extensions and footings. The, five incorrect invoices represented P720 of the total
recorded sales, and the errors found resulted in a net understatement of these invoices by P300.

REQUIRED: Explain what conclusions the auditors may draw from the above information, assuming the sample was selected
using nonstatistical sampling.

SOLUTION: The auditors would project the misstatement found in the sample to the population using either the ratio or
difference approach. The ratio approach would result in a projected misstatement of P65,500. This may be computed by first
calculating the ratio of the audited to book value as 1.0131 (P23,180 / P22,800 [since there is a net understatement of P300,
the audited value is P23,180]) and estimating the audited value of the population as:

1.0131 x P5,000,000 = P5,065,500 (rounded)

The projected misstatement is thus P65,500 under the ratio method. The difference approach results in an average difference
of P1.50 (P300 net difference divided by 200 items). Multiplying by the 100,000 invoices indicates a projected misstatement of
P62,400 (P1.50 x 41,600).

AUDIT DOCUMENTATION

PSA 230, "Audit Documentation" establishes standards and provides guidance regarding audit documentation in the context of
the audit of financial statements.

The standard on documentation requires that the auditor should prepare on a timely basis, audit documentation that
provides:

(a) A sufficient and appropriate record of the basis for the auditor's report; and
(b) Evidence that the audit was performed in accordance with PAs and applicable legal and regulatory requirements.

"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).

"Audit file" means one or more folders or other storage media, in physical or electronic form, containing the records that
comprise the audit documentation for a specific engagement.

"Experienced auditor" means an individual (whether internal or external to the firm) who has practical audit experience, and a
reasonable understanding of:

(i) audit processes,

(ii) PSAs and applicable legal and regulatory requirements,
(iii) the business environment in which the entity operates, and
 (iv) auditing and financial reporting issues relevant to the entity's industry.

NATURE OF AUDIT DOCUMENTATION

Audit working papers are the records kept by the auditor of the procedures applied, the tests performed, the information
obtained and the pertinent conclusions reached in the engagement. They represent the documentation of audit evidences
collected and evaluated.

OBJECTIVES OF AUDIT DOCUMENTATION

The primary objective of audit documentation is preparing sufficient and appropriate, audit documentation on a timely basis
to help enhance the quality of the audit and to facilitate the effective review and evaluation of the audit evidence obtained,
and conclusions reached before the auditor's report is finalized. Documentation prepared at the time the work is performed is
likelv to be more accurate than documentation prepared subsequently.

The other objectives of audit documentation are:

a. Assisting the engagement team to plan and perform the audit.

b. Assisting members of the engagement team responsible for supervision to direct and supervise the audit work, and to
discharge their review responsibilities in accordance with PSA 220.
c. Enabling the engagement team to be accountable for its work.
d. Retaining a record of matters of continuing significance to future audits.
e. Enabling the conduct of quality control reviews and inspections in accordance with PSQC 1
f. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements

FORM, CONTENT AND EXTENT OF AUDIT DOCUMENTATION

The auditor shall prepare audit documentation that is sufficient to 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 the PAs and applicable legal and
regulatory requirements;
(b) The results of the audit procedures performed, and the audit evidence. obtained;
(c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments
made in reaching those conclusions.

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 the 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 documentation of
the work performed of audit evidence obtained.
 The audit methodology and tools used.

It is, however, neither necessary nor practicable to document every matter the auditor considers during the audit.

Oral explanations by the auditor, on their own, do not represent adequate support for the work the auditor performed or
conclusions the auditor reached, but may be used to explain or clarify information contained in the audit documentation.

In documenting the nature, timing and extent of audit procedures performed, the auditor shall record:

(a) The identifying characteristics of the specific items or matters tested;

(b) Who performed the audit work and the date such work was completed:
(c) Who reviewed the audit work performed and the date and extent of such review.

The auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the
final audit tile on a timely basis after the date of the auditor's report.

After the assembly of the final audit file has been completed, the auditor shall not delete or discard audit documentation of
any nature before the end of its retention period.
In circumstances other than those mentioned in paragraph 13 of PSA 230 where the auditor finds it necessary to modify
existing audit documentation or add new audit documentation after the assembly of the final audit tile has been completed,
the auditor shall, regardless of the nature of the modifications or additions, document:

(a) The specific reasons for making them;

(b) When and by whom they were made and reviewed.

CHARACTERISTICS OF QUALITY AUDIT DOCUMENTATION

Audit documentation is the record that forms the basis for the auditor's representations and conclusions. Audit
documentation facilitates the planning, performance, and supervision of the audit and forms the basis of the review of the
quality of the work performed. Audit documentation includes records of the planning and performance of the work, the
procedures performed, evidence obtained, and conclusions reached by the auditor.

Documenting Planning and Risk Assessment Procedures

The planning process and risk assessment procedures from the foundation for the audit and should be carefully documented.
The auditor should document the overall audit strategy and the audit plan. Further, the auditor should document the overall
planned responses to address the assessed risks of material misstatement, and the nature, timing, and extent of the further
audit procedures to be performed, as well as the linkage of those procedures with the assessed risks at the relevant assertion
level. The documentation serves an important planning function for the audit; it also serves as evidence that the auditors took
their responsibilities seriously in evaluating potential problems or special circumstances involved in. or related to, the audit.

Examples are:

 Interviews with key executives, with implications clearly drawn for the conduct of the audit.
 Business risk analysis, fraud risk analysis, and analytical procedures, with a clear identification of accounts and
assertions requiring special audit attention.
 The auditor's assessment of materiality, overall audit approach, and personnel needed.
 Evidence of planning (including identification of and response to risks of material misstatement), including the audit
program.
 Audit approach and basic data utilized to identify risk, including fraud risk.

Documenting Audit Work Performed

Documentation about audit work performed is critical in demonstrating at a later date that the audit was conducted in a
quality manner. The following are typical types of documentation used to demonstrate the audit work that was performed:

 The client's trial balance and any auditor-proposed adjustments to it

 Copies of selected internal and external documents.
 Auditor-generated analysis of account balances (for example, audit software analysis of accounts and relationships).

Documenting Significant Issues and Their Resolution

Significant issues or audit findings are defined as substantive matters that are important to the analysis of the fair
presentation of the financial statements. The following examples of significant issues or audit findings:

 Significant matters involving the selection, application, and consistency of accounting principles, including related
disclosure. Significant matters include, but are not limited to, accounting for complex or unusual transactions,
accounting estimates, and uncertainties, as well as related management assumptions.
 Results of auditing procedures that indicated a need for the modification of planned auditing procedures, or the
existence of material misstatements, omissions in the financial statements, significant deficiencies, or material
weakness in internal control over financial reporting.
 Audit adjustments. An audit adjustment is a correction of a misstatement of the financial statements that was or
should have been proposed by the auditor, whether or not recorded by management, which could, wither individually
or when aggregated with other misstatements, have a material effect on the company's financial statements.
 Circumstances that cause significant difficulty in applying auditing procedures
 Any matters that could result in the modification of the auditor's report.

Copies of Documentation. Some client documents are of such importance that a copy should be included in the audit
documentation. Such documents usually have legal significance, such as lease agreements, bon covenant agreements,
significant portions of the boards of directors' minutes, government correspondence regarding client investigations, and loan
agreements. Reponses to the auditor's confirmation requests for accounts receivable, pending litigation, or bank loans are
examples of documents from outside parties that are retained. Finally, management representations are formally documented
in a management representation letter, which is signed by management to acknowledge the accuracy of its verbal or written
assertions.

TYPES OF WORKING PAPERS

There are innumerable types of audit working papers since they contain a variety of information gathered by the auditors.
However, there are certain general categories in which most working papers may be grouped. These are:

1. Audit administrative working papers

These are working papers designed to aid the auditors in the planning and administration of engagements.
These include audit plans and programs, internal control questionnaires. and flowcharts, engagement letters,
and time budgets.
Audit program is a detailed list of procedures to be performed in an audit engagement.
Purposes of Audit Program include:
a. It serves as a procedural guide during the course of the audit.
b. It serves as a basis in dividing the audit work among staff members.
c. It serves as a basis of reviewing progress of audit work.
d. It enables the auditor to ensure that the program designed to substantiate amounts appearing in the
accounts and related notes have covered all material aspects thereof.

A well-designed audit program will provide evidence of:

a. Proper planning including assurance that important steps were not overlooked.
b. Coordination and monitoring the audit work.
c. Proper supervision and review of the audit.
d. Completion of all audit steps.
e. Compliance with the standards in performing an audit.

Types of Audit Programs

1) Standard all-purpose audit program - lists standard practices applicable to almost every engagement
2) Tailor-made audit program - lists the procedures to be followed on a specific audit engagement, indicating
any departure from normal practices and specifying the extent of the tests of transactions.
3) Modified standard form audit program - a preprinted program that outlines the usual audit procedures
common to most businesses and provides space for an auditor to indicate other specific procedures
applicable to the business under examination.
2. Working trial balance and lead schedule
Working Trial Balance
This is a list of the accounts in the client's general ledger with columns that, as a minimum include unadjusted
amounts directly from the client's accounting records, proposed adjusting entries, and adjusted (audited)
amounts. Often called the backbone of the working papers, the working trial balance
1) provides an overall index of the working papers,
2) aids in controlling and reviewing the examination as it progresses, and
3) serves as the base for accumulating and arranging account balances for financial statement presentation.

Lead or Top Schedule

This is a working paper that shows the grouping of related account balances. Each line item on the trial
balance is supported by a lead schedule, containing the detailed accounts from the general ledger making up
the line item total. Each detailed account on the lead schedule is, in turn, supported by appropriate supporting
schedules evidencing the audit work performed and the conclusions reached.

3. Supporting schedules and analysis

Supporting Schedules
These are the detailed schedules prepared by auditors in support of specific amounts on the financial
statements. For example, a cash count sheet is prepared to provide the details of the composition of cash on
hand and account as of a particular date.
 Account Analysis
This working paper shows the activity during the period in a particular statement of financial position account.
It starts with the beginning balance, shows the transactions (additions and reductions) that occurred during
the period, and concludes with the ending balance. This type of working paper schedule is often used for
notes receivable, marketable securities, property, plant and equipment, long-term debt and for all equity
accounts.
4. Adjusting and reclassifying entries
Adjusting Entries are corrections of material errors in the accounting records discovered by the auditor. These
entries must be approved by the client because management has primary responsibility for the fair
presentation of the statement. For example, if the client failed to provide allowance for doubtful accounts in
the accounts receivable, an adjusting entry can be made to reflect properly its realizable value.
Reclassifying Entries are made in the statements to present accounting information properly, even when the
general ledger balances are correct. For example, material credit balances in customers' accounts should be
reclassified to accounts payable for financial statement presentation purposes.

5. Audit memoranda and documentation of corroborating information

Audit Notes
This is the working paper used to note items of work to be done that cannot be completed by following the
usual sequence of audit procedures. This is also used to record questions concerning the audit investigation.
Outside Documentation
Much of the content of the working paper consist of the outside documentation gathered by auditors, such as
confirmation replies, and copies of client agreements. They are indexed and interfiled and procedures are
indicated on them in the same manner as on the other schedule.

RELATIONSHIP OF WORKING PAPERS TO FINANCIAL STATEMENTS

Relationship between an account (cash on hand and in bank) as eventually reflected in the financial statements and the
working papers that support its analysis and reflect the work performed by the auditor. Working Paper Files Each CPA firm
establishes its own approach to preparing and organizing working papers and the beginning auditor must adopt his or her
firm's approach.

Contents and organization of a typical set of working papers. In this illustration, the working papers start with more general
information such as corporate data in the permanent files and end with the financial statements and audit report. In between
 are the working papers evidencing and supporting the auditor's tests. (Current File)

There are two main divisions of audit working papers: the current audit file and the permanent file.

Current Audit File

The current year working paper tile is designed to support the assertion embodied in the financial statements. The financial
statements shown at the top of Current File are supported by working trial balance which shows the propose adjustments and
reclassification. Each account on the working trial balance is supported by lead and supporting schedules.

This file contains all papers accumulated during the current year's examination. The working papers normally included in the
current file are:

1. Original draft of the report

a. The financial statement
b. Draft of the auditor's report
c. Draft of income tax return
2. Audit plan and programs
3. Working trial balance
4. Adjusting and reclassifying journal entries
5. Lead and supporting schedules
6. General information, such as
a. Abstracts or copies of minutes of the board of directors' meetings
b. Abstracts of contracts or agreements not included in the permanent tiles
c. Notes on discussions with the client
d. Notes about impressions of the form of the-client's office and plant

Permanent File

Working papers in permanent files contain information of continuing interest to the auditor.

These are intended to contain data of a historical or continuing nature pertinent to the current examination. These files
provide a convenient source of information about the audit that is of continuing use from year to year.

The permanent files typically include the following:

1. Excerpts of the corporate charter or articles of co-partnership / bylaws

2. Analysis of business and industry
3. Copies of contracts (that affect future periods).
4. Chart of accounts and accounting procedure manuals
5. Flowcharts and notes on the accounting system and related controls from prior examination
6. Continuing analyses of fixed assets
7. Organization charts and excerpts from job manuals
8. Terms of capital stock and bond issues
9. Result of analvtical procedures from previous years' audit
10. Excerpts from minutes of meetings
11. Labor-management agreement
 12. Information concerning related parties
13. Description of complex business transactions and/or unique accounting treatments
14. Copies of pension plans, stock option plans, and employee bonus and profit-sharing plans

Other files may also be maintained such as:

1. Tax Files. These files contain information relevant to a client's current and past income tax and other business tax
obligations. They serve as basis for preparing current year's returns and performing other tax-related services such as
amending prior year returns or representing the client's tax assessment case.
2. Correspondence File. This file contains all correspondence or letters to, from or in behalf of a client.

CONTENTS OF A YEAR-END FILE INDEX

Index Year-end Audit File

Finalization of Audit
1. Audit file closing 6. Engagement partner/sole practitioner
2. Financial statements/auditor's report review
3. Final analytical review 7. Adjusting and closing journal entries
4. Reviewer's checklist Quality control review (if EQCR 8. Working trial balance
applicable) 9. Correspondence, discussions, and notes-
5. Financial statement presentation and disclosure review Representation letter
10. Discussions with management and others
Management letter Notes and queries
Audit Acceptance
11. Audit engagement acceptance checklist - New or continuing 12. Understanding the entity and its
client Information from predecessor's files* environment - Client profile Documents to
Engagement letter* request
Overall Audit Strategy
13. Establishing the overall audit strategy checklist 17. Assessing inherent risks
14. Determining materiality Evaluating misstatements 18. Determining whether the risks indicate the
15. Identifying risks using analytical procedures need for an ECQR
16. Conducting an audit team planning meeting 19. Audit budget - Time and Fees Schedule of
documents to be prepared by client
20. Overall audit strategy
Assessing Risks of Material Misstatement
21. Assessing the risks of material misstatement checklist 26. Testing controls**: Revenue, receivables,
22. Inquiries for management, for those responsible for and receipts Purchases, payable, and
governance, for those responsible for internal audit, and for payments Payroll Inventory, cost of sales
others in the entity and production Financing and equity
23. Evaluating control environment 27. Review of minutes of all meetings
24. Evaluating management's use of estimates, including fair appointment of auditor (AGM resolution)
value 28. Review of client's annual report or other
25. Information systems and internal control: General IT system document that will include the audited
and IT controls Revenue, receivables, and receipts financial statements
Purchases, payables, and payments Payroll Inventory, cost 29. Risk assessment summary
of sales, and production Financing and equity
Financial Statement Checklists, Analytical Procedures and Tests of Balances
MECHANICS OF WORKING PAPER PREPARATION

Good working papers should possess or show the following qualities:

1. Every working paper should be complete in itself and should not require subsequent or additional oral explanation.
2. Working paper should be factual, accurate and free from clerical and/or computational errors.
3. Working papers should clearly indicate the nature and extent of audit work performed.
4. Working papers should be concise and limited only to essentials.
5. Working papers should be prepared in a neat and orderly manner to facilitate review of work done.

Working papers in general should provide:

a. Evidence of compliance/with the standards of auditing.

b. Sufficient data to demonstrate that the financial statements or other information being reported on by the auditor
were in agreement or reconciled with the client's records.
c. Clear indication of the work performed. This may require (1) writing a memorandum, (2) initializing the appropriate
steps in the audit program, or (3) making notations called tick marks directly on the working papers and explaining the
notations.
d. Indication as to how the auditor resolved any exception or unusual matter disclosed by his examination.
e. Appropriate connections of the auditor on significant aspects of the engagement.

COMPUTER-GENERATED WORKING PAPERS

Working papers have been traditionally prepared in pencil by auditors on columnar paper. Today, many working papers are
prepared on portable personal computers carried by the auditors to the work site. Auditors use software when an adjustment
is entered on computer-based working papers, it appears instantly on the appropriate lead schedules, the adjustments
schedule, and the working trial balance. The necessary cross-references are automatically entered on each schedule. If the
adjustment affects taxable income, the income tax expense account and the tax liability are automatically adjusted using the
client's marginal tax rate. In addition, all of the subtotals, column totals, and cross-footings in the working papers are instantly
adjusted.

When working papers are maintained manually, all of these entries and changes must be made by hand with a pencil, an
eraser, and a calculator. With a personal computer, an adjustment that might take a half hour or more to "push through"
manual working papers can be entered in a few seconds. Thus, personal computers have taken much of the "pencil pushing"
and the "number crunching" out of working paper preparation.

OWNERSHIP AND CUSTODY OF WORKING PAPER

The Philippine Accountancy Act of 2004, Section 29 specifies the legal provision on ownership of audit working papers. It
provides:

"All working papers, schedules and memoranda made by a certified public accountant in public practice and his staff in the
course of an examination, including those prepared and submitted by the client, incident to or in the course of an
examination, by such certified public accountant, except reports submitted by a certified public accountant to a client shall be
treated confidential and privileged and remain the property of such certified public accountant in the absence of a written
agreement between the certified public accountant and the client, to the contrary, unless such documents are required to be
produced through subpoena issued by any court, tribunal, or government regulatory or administrative body."

CONFIDENTIALITY OF WORKING PAPERS

PSA 230 requires the auditor to adopt appropriate procedures for maintaining the confidentiality and safe custody of the
working papers and for retaining them for a period sufficient to meet the needs of the practice and ill accordance with legal
and professional requirements of record retention. Section 140 of the Revised Code of Ethics for Professional Accountants in
the Philippines enumerates the rules that should be observed relative to the CPAs observance of confidentiality of
information. These are as follows:

 The principle of confidentiality imposes an obligation on professional accountants to refrain from:

(a) Disclosing outside the firm or employing organization confidential information acquired as a result of professional
and business relationships without proper and specific authority or unless there is a legal or professional right or
duty to disclose; and
 (b) Using confidential information acquired as a result of professional and business relationships to their personal
advantage or the advantage of third parties
 A professional accountant should maintain confidentiality even in a social environment. The professional accountant
should be alert to the possibility of inadvertent disclosure, particularly in circumstances involving long association with
a business associate or a close or immediate family member.
 A professional accountant should also maintain confidentiality of information disclosed by a prospective client or
employer.
 A professional accountant should also consider the need to maintain confidentiality of information within the firm or
employing organization.
 A professional accountant should take all reasonable steps to ensure that staff under the professional accountants
control and persons from whom advice and assistance is obtained respect the professional accountant's duty of
confidentiality.
 The need to comply with the principle of confidentiality continues even after the end of relationships between a
professional accountant and a client or employer. When a professional accountant changes employment or acquires a
new client, the professional accountant is entitled to use prior experience. The professional accountant should not,
however, use or disclose any confidential information either acquired or received as a result of a professional or
business relationship.
 The following are circumstances where professional accountants are or may be required to disclose confidential
information or when such disclosure may be appropriate:
(a) Disclosure is permitted by law and is authorized by the client or the employer;
(b) Disclosure is required by law, for example:
(i) Production of documents or other provision of evidence in the course of legal proceedings; or
(ii) Disclosure to the appropriate public authorities of infringements of the law that come to light; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the quality review of a member body Or professional body;
(ii) To respond to an inquiry or investigation by a member body or regulatory body;
(iii) To protect the professional interests of a professional accountant in legal proceedings; or
(iv) To comply with technical standards and ethics requirements.
 In deciding whether to disclose confidential information, professional accountants should consider the following
points:
(a) Whether the interests of all parties, including third parties whose interests may be affected, could be harmed if
the client or employer consents to the disclosure of information by the professional accountant
(b) Whether all the relevant information is known and substantiated, to the extent it is practicable; when the
situation involves unsubstantiated facts, incomplete information or unsubstantiated conclusions, professional
judgment should be used in determining the type of disclosure to be made, if any; and
(c) The type of communication that is expected and to whom it is addressed; in particular, professional accountants
should be satisfied that the parties to whom the communication is addressed are appropriate recipients.

AUDIT DOCUMENTATION

Each audit is unique, but the approach to all audits is essentially the same. Management makes assertions in financial
statements about the existence, completeness, rights or obligations, valuation and presentation of financial data. Those
assertions are examined during an audit. The strength of an audit depends on the relevance and reliability of the evidence
gathered. Relevance is determined by the assertions tested; that is, some evidence will be relevant to an existence assertion
but only tangentially relevant to a valuation assertion. Reliability relates to the quality of the evidence gathered and is affected
by the independence of the evidence from the influence of the-client or by the quality of the client's overall control structure.
The auditor uses the risk assessments to assist in determining the potential reliance on internally generated audit evidence. An
effective audit combines relevant and persuasive audit evidence to provide reasonable assurance that the financial statements
are free of material misstatement when the auditor renders an opinion on the financial statements. It is also important to
perform each audit as efficiently as possible without jeopardizing quality. Determining the sufficiency and appropriateness of
evidence is a matter of professional judgment.

After the planned audit procedures have been performed an evaluation of the results will take place. This will include a review
of the audit documentation and discussion with the engagement team and any changes to the audit plans as a result of the
procedures performed.
The auditor should be satisfied that sufficient appropriate audit evidence has been obtained to support the conclusions
reached for the auditor's report to be issued.

Auditors should evaluate with professional skepticism the evidence obtained in relation to their accumulated knowledge of
the client and the industries in which it operates. Professional skepticism is especially important when management is
pressured for results and is also called for when the financial statements before they are audited show unusually favorable
results.

EVALUATING THE SUFFICIENCY AND APPROPRIATENESS OF AUDIT EVIDENCE

An audit of financial statements is a cumulative and iterative process. As the auditor performs planned audit procedures, the
audit evidence obtained may cause the auditor to modify the nature, timing, or extent of other planned audit procedures.
Information may come to the auditor's attention that differs significantly from the information on which the risk assessment
was based. For example:

 The extent of misstatements that the auditor detects by performing substantive procedures may alter the auditor's
judgment about the risk assessments and may indicate a material weakness in internal control.
 The auditor may become aware of discrepancies in accounting records. or conflicting or missing evidence.
 Analytical procedures performed at the overall review stage of the audit may indicate a previously unrecognized risk
of material misstatement.

In such circumstances, the auditor may need to reevaluate the planned audit procedures, based on the revised consideration
of assessed risks for all or some of the classes of transactions, account balances, or disclosures and related assertions.

The auditor cannot assume that an instance of fraud or error is an isolated occurrence. Therefore, the consideration of how
the detection of a misstatement affects the assessed risks of material misstatement is important in determining whether the
assessment remains appropriate. The auditor's judgment as to what constitutes sufficient appropriate audit evidence is
influenced by such factors as the following:

 Significance of the potential misstatement in the assertion and the likelihood of its having a material effect,
individually or aggregated with other potential misstatements, on the financial statements.
 Effectiveness of management's responses and controls to address the risks.
 Experience gained during previous audits with respect to similar potential misstatements.
 Results of audit procedures performed, including whether such audit procedures identified specific instances of fraud
or error.
 Source and reliability of the available information.
 Persuasiveness of the audit evidence.
 Understanding of the entity and its environment, including the entity's internal control.

The evaluation of the audit evidence obtained would address the following matters. 1

1. Materiality The auditor shall assess whether the amounts established for overall and performance materiality are still
appropriate in the context of the entity's actual financial results. If a lower materiality than that initially set is
appropriate, the auditor is required to determine:
 Whether it is necessary to revise performance materiality; and
 Whether the nature, timing and extent of the further audit procedures remain appropriate.
2. Risks The auditor shall determine whether in the light of the audit findings the assessed risks of material misstatement
at the assertion level is still appropriate. If not, the risk assessments would be revised and further planned audit
procedures modified.
3. Misstatements The auditor shall determine the effect on the audit of identified misstatements and whether there is a
need to perform additional audit procedures. Revisions to the audit strategy and detailed audit plans may be required
when:
 The nature or circumstances of identified misstatements indicate that other misstatements) may exist that, when
aggregated with known misstatements, could exceed performance materiality;
 The aggregate of identified and uncorrected misstatements comes close to or exceeds performance materiality.
4. Fraud The auditor through the performance of analytical procedures shall assess whether previously unrecognized
risks of material misstatement due to fraud are present. Also, he/she shall determine whether the identified
misstatements are indicatives of fraud.
 5. Evidence The auditor shall determine whether sufficient appropriate evidence has been obtained to reduce the risks
of material misstatement in the financial statements to an acceptably low level. He/she shall consider whether there is
a need for further procedures to be performed.
6. Analytical Procedures The auditor shall assess whether the analytical procedures performed at the final review stage
of the audit:
 Corroborate the audit findings;
 Identify previously unrecognized risks of material misstatement.

FACTORS TO CONSIDER

The following factors shall be considered in evaluating the sufficiency and appropriateness audit evidence:

(a) Materiality of misstatements Is a misstatement in the assertion being addressed significant, and what is the likelihood
of it having a materially affect (individually or combined with other potential misstatements) on the financial
statements?
(b) Management responses Is management responsive to audit findings, and how effective is the internal control in
addressing risk factors?
(c) Quality of information Are the sources of available information reliable and appropriate for supporting the audit
conclusions?
(d) Persuasiveness Is the audit evidence persuasive or convincing?
(e) Previous experience What has been the previous experience in performing similar procedures, and were any
misstatements identified?
(f) Results of performed audit procedures Do the results of performed audit procedures support the objectives, and is
there any indication of fraud or error?
(g) Understanding the entity Do the evidences obtained support or contradict the results of the risk assessment
procedures (which were performed to obtain an understanding of the entity and its environment, including internal
control)?

FINAL ANALYTICAL PROCEDURES

Analytical procedures help auditors assess the overall presentation of the financial statements. Auditing standards require the
use of analytical procedures in both the planning phase and the final review phase of the audit to assist in identifying account
relationships that are unusual. At the conclusion of the audit, the audit team analyzes the data from an overall business
perspective. The reviewers are not only looking at the trends and ratios but are asking hard questions about whether the
company's results make sense in relationship to industry and economic trends.

Analytical procedures are carried out to:

 Identify a previously unrecognized risk of material misstatement;

 Ensure that the conclusions formed during the audit on individual components or elements of the financial statements
can be corroborated; and
 Assist in arriving at the overall conclusion it's to the reasonableness of the financial statements.

DOCUMENTATION

The final step in the evaluation process is to record all the significant findings or, issues in an engagement completion
document. This document may include all information necessary to understand the significant findings or issues, as well as
cross-references, as appropriate to other available supporting audit documentation.

This document would also include conclusions about information the auditor has identified relating to significant matters that
are inconsistent with or contradict the auditor's final conclusions.

PSA 260, "Communication with Those Charged with Governance" requires that the auditor shall communicate on a timely
basis with those charged with governance the responsibilities of the auditor in relation to the financial statement audit,
including that:

(a) The auditor is responsible for forming and expressing an opinion of the financial statements that have been prepared
by management with the oversight of those charged with governance;
(b) The audit of the financial statements does not relieve management or those charged with governance of their
responsibilities.
 COMPLETING THE AUDIT AND POST-AUDIT RESPONSIBLITIES

Almost every audit engagement has a deadline for issuance of audit report and release of audited financial statements. Thus,
audit procedures need to be completed in time to allow for adequate review and evaluation of working papers and the
financial statements before the opinion is signed.

The various issues that the auditor considers in completing his audit examination include:

1. Related party transactions

PSA 550, "Related Parties" establishes standards and provides guidance on the auditor's responsibilities and audit
procedures regarding related parties and transactions with such parties.

As indicated in PSA 200, "Objective and General Principles Governing an Audit of Financial Statements," in certain
circumstances there are limitations that may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions. Because of the degree of uncertainty associated with the financial statement
assertions regarding the completeness of related parties, the procedures identified in PSA 550 will provide sufficient
appropriate audit evidence regarding those assertions in the absence of any circumstance identified by the auditor that:

(a) Increases the risk of misstatement beyond that which would ordinarily be expected;
(b) Indicates that a material misstatement regarding related parties has occurred.

Where there is any indication that such circumstances exist, the auditor should perform modified, extended or
additional procedures as are appropriate in the circumstances.

Definition of a Related Party

Many financial reporting frameworks discuss the concepts of control and significant influence. Although they may
discuss these concepts using different terms, they generally explain that:

(a) Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its
activities;
(b) Significant influence (which may be gained by share ownership. statute or agreement) is the power to participate
in the financial and operating policy decisions of an entity, but is not control over those policies.

The existence of the following relationships may indicate the presence of control or significant influence:

(a) Direct or indirect equity holdings or other financial interests in the entity
(b) The entity's holdings of direct or indirect equity or other financial interests in other entities.
(c) Being part of those charged with governance or key management (i.e., those members of management who have
the authority and responsibility for planning, directing and controlling the activities of the entity
(d) Being a close family member of any person referred to in subparagraph (c
(e) Having a significant business relationship with any person referred to in subparagraph (c).

In considering each possible related party relationship, attention is directed to the substance of the relationship, and
not merely the legal form

Transactions with related parties are important to auditors because they will be disclosed in the financial statements if
they are material. PFRS require disclosure of the nature of the related-party relationship, a description of transactions,
including peso amounts; and amounts due to and from related parties. Management is responsible for the
identification and disclosure of related parties and transactions with such parties. This responsibility requires
management to implement adequate accounting and internal control systems to ensure that transactions with related
parties are appropriately identified in the accounting records and disclosed in the financial statements.

The auditor needs to have a level of knowledge of the entity's business and industry that will enable identification of
events, transactions, and practices that may have a material effect on the financial statements. While the existence of
related parties and transaction between such parties are considered ordinary features of business, the auditor needs
to be aware of them because:

(a) the financial reporting framework may require disclosure in the financial statements of certain related party
relationships and transactions.
 (b) the existence of related parties or related party transactions may affect the financial statements. For example, the
entity's tax liability and expense may be affected by the tax laws in various jurisdictions which require special
consideration when related parties exist;
(c) the source of audit evidence affects the auditor's assessment of its reliability. A greater degree of reliance may be
placed on audit evidence that is obtained from or created by unrelated third parties;
(d) a related party transaction may be motivated by other than ordinary business considerations, for example, profit
sharing or even fraud.

Once related parties are identified, examination of related party transactions is pursued during examination of
relevant account balances or classes of transactions. The auditor should apply procedures to give adequate
consideration to the possibility that the other party to material transactions is related. An example which might
indicate the existence of a related party transaction is borrowing or lending on an interest-free basis or at a rate
significantly different than prevailing market rates at the time of the transaction.

Audit Procedures

The auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence regarding the
identification and disclosure by management of related parties and the effect of related party transactions that are material to
the financial statements. However, an audit cannot be expected to detect all related party transactions. Audit procedures that
may be adopted to determine the existence of related party transactions include making inquiries of management and
reviewing SEC filings, stockholders’ listings, and conflict-of-interest statements obtained by the client from its executives.
Through scanning and other analysis, transactions that materially affect the financial statements may be identified. The
possibility of relationships with related parties may also be evaluated. During the course of the audit, the auditor carries out
procedures which may identify the existence of transactions with related parties. Examples include:

 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. Such a review may indicate
guarantor relationship and other related party transactions.
 Reviewing investment transactions, for example, purchase or sale of an equity interest in a joint venture or other
entity

Based on the evidence obtained, the auditor can judge whether the financial statements appropriately describe and
disclose the nature of the relationship.

The auditor should review information provided by the directors and management identifying the names of all known
related parties and should perform the following procedures in respect of the completeness of this information:

(a) review prior year working papers for names of known related parties
(b) review the entity's procedures for identification of related parties
(c) inquire as to the affiliation of directors. and officers with other entities
(d) review shareholder records to determine the names of principal shareholders or, if appropriate, obtain a listing of
principal shareholders from the share register;
(e) review minutes of the meetings of shareholders and the board of directors and other relevant statutory records such
as the register of directors' interests;
(f) inquire of other auditors currently involved in the audit, or predecessor auditors, as to their knowledge of additional
related parties; and
(g) review the entity's income tax returns and other information supplied to regulatory agencies.

If, in the auditor's judgment, the risk of significant related parties remaining undetected is low, these procedures may be
modified as appropriate. 'The auditor should review information provided by directors and management identifying
related party transactions and should be alert for other material related party transactions.

When obtaining an understanding of the accounting and internal control systems and making a preliminary assessment of
control risk, the auditor should consider the adequacy of control procedures over the authorization and recording of
related party transactions
 During the course of the audit, the auditor needs to be alert for transactions which appear unusual in the circumstances
and may indicate the existence of previously unidentified related-parties. Examples include:

 Transactions which have abnormal terms of trade, such as unusual prices, interest rates, guarantees, and repayment
terms.
 Transactions which lack an apparent logical business reason for their occurrence.
 Transactions in which substance differs from form.
 Transactions processed in an unusual manner.
 High volume 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

During the course of the audit, the auditor carries out procedures which may identify the existence of transactions with
related parties. Examples include:

 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. Such a review may indicate
guarantor relationship and other related party transactions.
 Reviewing investment transactions, for example, purchase or sale of an equity interest in a joint venture or other
entity.

Examining Identified Related Party Transactions

In examining the identified related party transactions, the auditor should obtain sufficient appropriate audit evidence as to
whether these transactions have been properly recorded and disclosed.

Given the nature of related party relationships, evidence of a related party transaction may be limited, for example,
regarding the existence of inventory held by a related party on consignment or an instruction from a parent company to a
subsidiary to record a royalty expense. Because of the limited availability of appropriate evidence about such transactions,
the auditor would consider performing procedures such as:

 Confirming the terms and amount of the transaction with the related party.
 Inspecting evidence in possession of the related party.
 Confirming or discussing information with persons associated with the transaction, such as banks, lawyers, guarantors
and agents.

Management Representations

Where the applicable financial reporting framework establishes related party requirements, the auditor shall obtain written
representations from management and, where appropriate, those charged with governance that:

(a) They have disclosed to the auditor the identity of the entity's related parties and all the related party relationships and
transactions of which they are aware;
(b) They have appropriately accounted for and disclosed such relationships and transactions in accordance with the
requirements of the framework.

Disclosure Requirement

No disclosure of transactions is required:

(a) in consolidated financial statements in respect of intra-group transactions;

(b) in parent financial statements when they are made available or published with the consolidated financial statements:
(c) in financial statements of a wholly-owned subsidiary if its parent is incorporated in the same country and provides
consolidated financial statements in that country;
(d) in financial statements of state-controlled enterprises of transactions with other state-controlled enterprises.

Audit Conclusions and Reporting

If the auditor is unable to obtain sufficient appropriate audit evidence concerning related parties and transactions with such
parties or concludes that their disclosure in the financial statements is not adequate, the auditor should modify the audit
report appropriately.

2. Subsequent Events Review

PSA 560, "Subsequent Events" establishes standards and provides guidance on the auditor's responsibility regarding
subsequent events. In this standard, the term "subsequent events" is used to refer to both events occurring between period
end and the date of the auditor's report, and facts discovered after the date of the auditor's report.

The auditor has a responsibility to review transactions and events occurring after the statement of financial position date to
determine whether anything occurred that might affect the valuation or disclosure of the statements being audited.

Two types of subsequent events require consideration by management and evaluation by the auditor:

(1) those that provide further evidence of conditions that existed at period end;
(2) those that are indicative of conditions that arose subsequent to period end.

Examples of Each Type of Subsequent Event Examples of Events That Provide Evidence About Conditions That Existed at
Statement of Financial Position Date and Should Be Adjusted (Type 1)

 Loss on receivables resulting from the bankruptcy of a major customer that was in a deteriorating condition at year-
end

Example of Events That Do Not Provide Evidence About Conditions That Existed at Statement of Financial Position Date But
That Require Disclosure (Type 2)

 Sale of a bond or capital stock issue.

Events Occurring up to the Date of the Auditor's Report

The auditor should perform procedures designed to obtain sufficient appropriate audit evidence that all events up to the date
of the auditor's report that may require adjustment of, or disclosure in, the financial statements have been identified. These
procedures are in addition to routine procedures which may be applied to specific transactions occurring after period end to
obtain audit evidence as to account balances as at period end, for example, the testing of inventory cutoff and payments to
creditors. The auditor is not, however, expected to conduct a continuing review of all matters to which previously applied
procedures have provided satisfactory conclusions.

The procedures to identify events that may require adjustment of, or disclosure in, the financial statements would be
performed as near as practicable to the date of the auditor's report and ordinarily include the following:

(a) Obtaining an understanding of any procedures management has established to ensure that subsequent events are
identified
(b) Inquiring of management and, where appropriate, those charged with governance as to whether the subsequent
events have occurred which might affect the financial statements.
(c) Reading minutes, if any. of the meetings, of the entity's owners, management and those charged with governance,
that have been held after the date of the financial statements and inquiring about matters discussed at any such
meetings for which minutes are not yet available.
(d) Reading the entity's latest subsequent interim financial statements, if any.
(e) When as a result of the procedures performed. the auditor identities events that require adjustment of, or disclosure
in, the financial statements, the auditor shall determine whether each such event is appropriately reflected in those
financial statements.

The auditor shall request management and, where appropriate. those charged with governance, to provide a written
representation that all events occurring subsequent to the date of the financial statements and for which the applicable
financial reporting framework requires adjustment or disclosure have been adjusted or disclosed.

Facts Discovered After the Date of the Auditor's Report and Before the Financial Statements are Issued

The auditor ordinarily has no responsibility to perform procedures or make inquiry of subsequent events after the date of the
report. However, when after the date of the auditor's report but before the date the financial statements are issued, a fact
becomes known to the auditor that had it been known to the auditor at the date of the auditor's report, mas have caused the
auditor to amend the auditor's report, the auditor shall.
 (a) Discuss the matter with management and, where appropriate, those charged with governance
(b) Determine whether financial statements need amendment and, if so,
(c) Inquire how management intends to address the matter in the financial statements.

If management amends the financial statements, the auditor shall:

(a) Carry out the audit procedures necessary in the circumstances on the amendment.
(b) Extend the audit procedures to the date of the new auditor's report; and
(c) Provide a new auditor's report on the amended financial statements. The new auditor's report shall not be dated
earlier than the date of approval of the amended financial statements.

When management amends the financial statements, the auditor would carry out the procedures necessary in the
circumstances and would provide management with a new report on the amended financial statements. The new auditor's
report would be dated not earlier than the date of the amended financial statements are signed or approved, and accordingly,
the procedures referred to would be extended to the date of the new auditor's report.

When management does not amend the financial statements in circumstances where the auditor believes they need to be
amended and the auditor's report has not been released to the entity, the auditor should express a qualified opinion or an
adverse opinion.

When the auditor's report has been released to the entity, the auditor would notify those persons ultimately responsible for
the overall direction of the entity not to issue financial statements and the auditor's report thereon to third parties. If the
financial statements are subsequently released, the auditor needs to take action to prevent reliance on the auditor's report.
The action taken will depend on the auditor's legal rights and obligations and the recommendations of the auditor's lawyer.

Facts Discovered After the Financial Statements Have Been Issued

After the financial statements have been issued, the auditor has no obligation to make any inquiry regarding such financial
Statements.

When, after the financial statements have been issued, the auditor becomes aware of a fact which existed at the date of the
auditor's report the which, if known at that date, may have caused the auditor to modify the auditor's report, the auditor
should consider whether the financial statements need revision, should discuss the matter with management, and should take
the action appropriate in the circumstances

When management revises the financial statements, the auditor would carry out the audit procedures necessary in the
circumstances, would review the steps taken by management to ensure that anyone in receipt of the previously issued
financial statements together with the auditor's report thereon is informed of the situation, and would issue a new report on
the revised financial statements.

The new auditor's report should include an emphasis of a matter paragraph referring to a note to the financial statements that
more extensively discusses the reason for the revision of the previously issued financial statements and to the earlier report
issued by the auditor. The new auditor's report would be dated not earlier than the date the revised financial statements are
approved and, accordingly, the procedures referred to in paragraphs 4 and S of PSA 560 would ordinarily be extended to the
date of the new auditor's report. Local regulations of some countries permit the auditor to restrict the audit procedures
regarding the revised financial statements to the effects of the subsequent event that necessitated the revision. In such cases,
the new auditor's report would contain a statement to that effect.

When management does not take the necessary steps to ensure that anyone in receipt of the previously issued financial
statements together with the auditor's report thereon is informed of the situation and does not revise the financial
statements in circumstances where the auditor believes they need to be revised, the auditor would notify management and
unless all of those charged with governance are involved in managing the entity, those charged with governance, that the
auditor will seek to prevent future reliance on the auditor's report. If despite such notification, management or those charged
with governance do not take these necessary steps, the auditor shall take appropriate action to seek to prevent reliance on
the auditor's report

3. Letters of inquiry / review of contingent liabilities

PAS 37 defines a contingent liability as

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the control of the enterprise;
 (b) a present obligation that arises from past events but is not recognized because:
i. it is not probable that an outflow of resources embodying economic benefits will be required to settle the
obligation;
ii. the amount of the obligation cannot be measured with sufficient reliability.

PAS 37 requires that an enterprise should not recognize a contingent liability but should disclose such unless the possibility of
an outflow of resources embodying economic benefits is remote, in which case event disclosure is not necessary.

Potential contingent liabilities could arise from

(1) guarantees of indebtedness

(2) accommodation endorsement
(3) threat of expropriation of assets
(4) standby letters of credit
(5) risks due to hazards

Contingent losses that are deemed remote in terms of likelihood of occurrence are not accrued nor disclosed in the financial
statement.

Certain contingent liabilities are of considerable concern to the auditor:

Income tax disputes

Product warranties

Pending litigation for patent infringement, product liability or other actions

Notes receivable discounted

Guarantees of obligations or others

Unused balances in outstanding letters of credit

Chance of Material Loss Required Financial Disclosure

Remote: the chance that the future event will occur is slight None
Reasonably possible: the chance that the future event will Disclose in a note
occur is more than remote but less than likely
Probable: the future event is likely to occur If able to estimate, adjust. If unable to estimate, disclose
The most commonly used audit procedures used to search contingent liabilities include the following:

1. Inquire of management (orally and in writing) regarding the possibility of unrecorded contingencies.
2. Review current and previous year's BIR reports for income tax settlement.
3. Review the minutes of directors' and stockholders' meetings for indications of lawsuits or other contingencies.
4. Analyze legal expense for the period under review and review invoices and statements from legal counsel.
5. Obtain a confirmation from all major attorneys performing legal services for the client as to the status of pending
litigation or other contingent liabilities.
6. Review existing working papers for any information that may indicate a potential contingency.
7. Obtain letters of credit in force as of the statement of financial position date and obtain a confirmation of the used
and unused balance

Audit Inquiry Letter to Client's Lawyer

An audit inquiry letter (also called a lawyer's letter) is sent by the auditor to the client's lawyer as a primary means of
corroborating the information management provides about litigation, claims, and assessments. The objective of the letter is to
obtain information to facilitate the auditor's understanding of a client's contingencies.

Lawyers may be aware of two sources of contingencies their clients face:

1. Pending litigation, claims and assessments. Pending litigation, claims, and assessments are situations in which a
claimant has stated that it has suffered a loss and plans to seek remuneration, as well as situations in which a claimant
has filed a lawsuit.
o A list prepared by management that describes and evaluates pending or threatened litigation, claims, and
assessments to which the lawyer has devoted substantive attention. (Alternatively, the letter may request the
lawyer to prepare the list.
 o A request that the lawyer furnish information about or comment about each pending or threatened litigation,
claim or assessment on the list. The list should ask the lawyer to address the progress of the case, describe the
action the company plans to take, evaluate the likelihood of an unfavorable outcome, and estimate (if
possible) the range of any potential loss.
o request that the lawyer confirm that the list is complete and identify any items that have been omitted.
2. Unasserted claims. An unasserted claim is a potential legal claim that has not yet been made by a claimant: For
example, a manufacturer knowingly selling a faulty automobile may have unasserted claims from accident victims who
have not yet filed them.
o A list prepared by management describing and evaluating the items that the lawyer has devoted substantive
attention to, that management considers to be probable of assertion, and that, if asserted, would have a
reasonable possibility of an unfavorable outcome.
o A request that the lawyer comment if his or her views differ from management's description and evaluation of
the listed unasserted claims and assessments.
o A statement that the lawyer has a responsibility while performing services to inform the client of any matter
recognized to involve an unasserted claim or assessment that may call for financial statement disclosure
o A request that the lawyer confirm his or her responsibility to inform the client of unasserted claims or
assessments that should be disclosed in the financial statements.
3. Other matters
o A request that the lawyer specifically identify the nature of and any reasons for any limitation on his or her
response and reasons for those limitations.

Generally, a lawyer may identify an asserted claim not identified in the inquiry letter but may not disclose an unasserted claim.
Because an asserted claim (a legal claim made by a claimant) is usually general knowledge, the lawyer is not revealing a
confidential matter about a client when reporting information about asserted claims. Although the lawyer may not disclose an
unasserted claim to the auditor, she or he is expected to call to the client's attention any unasserted claims that should be
disclosed. If the client fails to inform the auditor about unasserted claim (by means of the inquiry letter), the lawyer is required
to consider resigning as the client's counsel. Therefore, a lawyer's resignation after receiving an inquiry letter should notify an
auditor of the possibility of inadequate disclosure.

Sometimes lawyers prefer not to respond to the inquiry letter. Their reasons may be that they have not pursued a legal matter
sufficiently to respond or that their policy is not to respond to audit inquiry letters. Auditors must obtain a response from the
lawyer that enables them to evaluate the accounting for and disclosure of contingencies, or they must modify their audit
report. Because they pay a fee to lawyers, clients can generally persuade their lawyers to respond. Not being involved with any
lawsuits or other matters relating to the client is an acceptable reason for a lawyer to decline to respond.

A letter is prepared, signed by the client and sent to the lawyers who are requested to respond shortly after year-end. The
lawyer is generally given two to four weeks within which to reply. The letter should include a section on each of the following:

4. Evaluating going concern status

PSA 570, "Going Concern" 'establishes the standards and provides guidance on the auditor's responsibility in the audit of
financial statements with respect to the going concern assumption used in the financial statements including considering
management's assessment of the entity's ability to continue as a going concern.

When planning and performing audit procedures and in evaluating the results thereof, the auditor should consider the
appropriateness of management's use of the going concern assumption in the preparation of the financial statements.

The auditor should evaluate whether there is a substantial doubt about a client's ability to continue as a going concern for at
least one year after statement of financial position date. This assessment is initially made as a part of planning but is revised
whenever significant new information is obtained.

Management's assessment of the going concern assumption involves making a judgment, at a particular point in time, about
the future outcome of events or conditions which are inherently uncertain. The following factors are relevant:

 In general terms, the degree of uncertainty associated with the outcome of an event or condition increases
significantly the further into the future a judgment is being made about the outcome of an event or condition. For that
reason, the finaneial reporting framework in the Philippines requiring an explicit management assessment specifies
the period for which management is required to take into account all available information.
 Any judgment about the future is based on information available at the time at which the judgment is made.
Subsequent events can contradict a judgment which was reasonable at the time it was made.
  The size and complexity of the entity, the nature and condition of its business and the degree to which it is affected by
external factors all affect the judgment regarding the outcome of events or conditions

Audit Procedures

PSA 570 states that it is not necessary to design audit procedures solely to identify conditions and events that, when
considered in the aggregate indicate there could be substantial doubt about the entity's ability to continue as a going concern
for a reasonable period of time. The following are examples of procedures that may identify such conditions and events:

 Analytical procedures
 Review of subsequent events
 Review of compliance with the terms of debt and loan agreements
 Reading of minutes of meetings of stockholders, board of directors, and important committees of the board
 Inquiring of an entity's legal counsel about. litigation, claims, and assessments
 Confirmation with related and third parties of the details of arrangements to provide or maintain financial support

In performing the above-mentioned audit procedures, the auditor may identify information about certain conditions or events
that, when considered in the aggregate, indicate there could be substantial doubt about the entity's ability to continue as a
going concern for a reasonable period of time. Examples of such conditions and events are as follows:

Financial indications

 Recurring operating losses

 Working capital deficiencies
 Negative cash flows from operating activities
 Adverse key financial ratios
 Net Liability or Net Current Liability portion
 Default on loan or similar agreements
 Arrearages or discontinuance of dividend
 Denial of usual trade credit from suppliers
 Restructuring of debt
 Noncompliance with statutory capital requirements
 Need to seek new sources of financing or to dispose of substantial asset

Operating Indications

 Work stoppages or other labor difficulties

 Uneconomic long-term commitments
 Need to significantly revise operations
 Substantial dependence on the success of a particular project
 Loss of Key Management without Replacement
 Legal proceedings legislation that might jeopardize an entity's ability to operate
 Loss of a key franchise, license, major market Loss of a principal customer or supplier
 Underinsured catastrophe such as a drought, flood or earthquake

Other

 Non-compliance with capital or other statutory requirements

 Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that are unlikely to
be satisfied
 Changes in legislation or government policy expected to adversely affect the entity

Auditor's Responsibility

The auditor's responsibility is to consider the appropriateness of management's use of the going concern assumption in the
preparation of the financial statements, and consider whether there are material uncertainties about the entity's ability to
continue as a going concern that need to be disclosed in the financial statements.
The auditor cannot predict future events or conditions that may cause an entity to cease to continue as a going concern.
Accordingly, the absence of any reference to going concern uncertainty in an auditor's report cannot be viewed as a guarantee
as to the entity's ability to continue as a going concern.

Planning Considerations

In planning the audit, the auditor should consider whether there are events or conditions which may cast significant doubt on
the entity’s ability to' continue as a going concern.

The auditor should remain alert for evidence of events or conditions which may cast significant doubt on the entity's ability to
continue as a going concern throughout the audit. If such events or conditions are identified, the auditor should, in addition to
performing the procedures in paragraph 26 of PSA 570, consider whether they affect the auditor's assessments of the
components of audit risk.

Evaluating Management's Assessment

The auditor should evaluate management's assessment of the entity's ability to continue as a going concern.

The auditor should consider the same period as that used by management in making its assessment under the financial
reporting framework. If management's assessment of the entity's ability to continue as a going concern covers less than
twelve months from the statement of financial position date, the auditor should ask management to extend its assessment
period to twelve months from the statement of financial position date.

Period Beyond Management's Assessment

The auditor should inquire of management as to its knowledge of events or conditions beyond the period of assessment used
by management that may cast significant doubt on the entity's ability to continue as a going concern.

The auditor is alert to the possibility that there may be known events, scheduled or otherwise, or conditions that will occur
beyond the period of assessment used by management that may bring into question the appropriateness of management's
use of the going concern assumption in preparing the financial statements. The auditor may become aware of such known
events or conditions during the planning and conduct of the audit, including subsequent events procedures.

Additional Audit Procedures When Events or Conditions are Identified

During the course of the audit, the auditor carries out audit procedures designed to obtain audit evidence as the basis for the
expression of an opinion on the financial statements. When a question arises regarding the going concern assumption, certain
of these procedures may take on additional significance or it may be necessary to perform additional procedures or to update
information obtained earlier. Procedures that are relevant in this connection may include:

 Analyze and discuss cash flow, profit and other relevant forecasts with management.
 Review events after period end for items affecting the entity's ability to continue as a going concern. Analyze and
discuss the entity's latest available interim financial statements.
 Review the terms of debentures and loan agreements and determine whether any have been breached.
 Read minutes of the meetings of shareholders, the board of directors and important committees for reference to
financing difficulties.
 Inquire of the entity's lawyer regarding litigation and claims.
 Confirm the existence, legality and enforceability of arrangements to provide or maintain financial support with
related and third parties and assess the financial ability of such parties to provide additional funds.

If after considering identified conditions and events and management's plans, the auditor concludes that substantial doubt
about the entity's ability to continue as a going concern for a reasonable period of time remains, the auditor should consider
the need for disclosure of the principal conditions and events in the financial statement and the report should include an
explanatory paragraph (following the opinion paragraph) to reflect the conclusion.

Going Concern Assumption Appropriate but a Material Uncertainty Exists

If adequate disclosure is made in the financial statements, the auditor should express an unqualified opinion but modify the
auditor's report by adding an emphasis of matter paragraph that highlights the existence of a material uncertainty relating to
the event or condition that may cast significant doubt on the entity's ability to continue as a going concern and draws
attention to the note in the financial statements that discloses the matters set out in paragraph 32 of PSA 570. In assessing.
the adequacy of the financial statement disclosure, the auditor considers whether the information explicitly draws the
reader's attention to the possibility that the entity may be unable to continue realizing its assets and discharging its liabilities
in the normal course of business. The following is an example of such a paragraph when the auditor is satisfied as to the
adequacy of the note disclosure:

"Without qualifying our opinion, we draw attention to Note X in the financial statements which indicates that the Company
incurred a net loss of ZZZ during the year ended December 31, 20X3 and, as of that date, the Company's current liabilities
exceeded its total assets by ZZZ. These conditions, along with other matters as set forth in Note X, indicate the existence of a
material uncertainty which may cast significant doubt about the Company's ability to continue as a going concem.”

In extreme cases, such as situations involving multiple material uncertainties that are significant to the financial statements,
the auditor may consider it appropriate to express a disclaimer of opinion instead of adding an emphasis of matter paragraph.

If the entity's disclosures with respect to its ability to continue as a going concern for a reasonable period of time are
inadequate, a departure from financial reporting standards exists. This may result in either a qualified (except for) or an
adverse opinion.

If adequate disclosure is not made in the financial statements, the auditor should express a qualified or adverse opinion, as
appropriate (PSA-701, "Modifications to the Independent Auditor's Report", paragraph 21). The report should include specific
reference to the fact that there is a material uncertainty that may cast significant doubt about the entity's ability to continue
as a going concern. The following is an example of the relevant paragraphs when a qualified opinion is to be expressed:

"The Company's financing arrangements expire and amounts outstanding are payable on March 19, 20X4. The Company has
been unable to re-negotiate or obtain replacement financing. This situation indicates the existence of a material uncertainty
which may cast significant doubt on the Company's ability to continue as a going concern and therefore it may be unable to
realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do
not disclose this fact.

In our opinion, except for the omission of the information included in the preceding paragraph, the financial statements
present fairly, in all material respects, the financial position of the Company at December 31, 20X3 and the results of its
operations and its cash flows for the year then ended in accordance with…”

The following is an example of the relevant paragraphs when an adverse opinion is to be expressed:

"The Company's financing arrangements expired and the amount outstanding was payable on December 31, 20X3. The
Company has been unable to re-negotiate or obtain replacement financing and is considering filing for bankruptcy. These
events indicate a material uncertainty which may cast significant doubt on the Company's ability to continue as a going
concern and therefore it may be unable to realize its assets and discharge its liabilities in the normal course of business. The
financial statements (and notes thereto) do not disclose this fact.

In our opinion, because of the omission of the information mentioned in the preceding paragraph, the financial statements do
not present fairly the financial position of the Company as at December 31, 20X3; and of its results of operations and its cash
flows for the year then ended in accordance with...(and do not comply with..)…”

Going concern Assumption Inappropriate

If, in the auditor's judgment, the entity will not be able to continue as a going concern, the auditor should express an adverse
opinion if the financial statements have been prepared on a going concern basis. If, on the basis of the additional procedures
carried out and the information obtained, including the effect of management's plans, the auditors judgment is that the entity
will not be able to continue as a going concern, the auditor concludes, regardless of whether or not disclosure has been made,
that the going concern assumption used in the preparation of the financial statements is inappropriate and expresses an
adverse opinion.

When the entity's management has concluded that the going concern assumption used in the preparation of the financial
statements is not appropriate, the financial statements need to be prepared on an alternative authoritative basis. If on the
basis of the additional procedures carried out and the information obtained the auditor determines the alternative basis is
appropriate, the auditor can issue an unqualified opinion if there is adequate disclosure but may require an emphasis of
matter in the auditor's report to draw the user's attention to that basis.

Management Unwilling to Make or Extend its Assessment

If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor should
consider the need to modify the auditor's report as a result of the limitation on the scope of the auditor's work. In certain
circumstances, such as those described in paragraphs 15,-18 and 24 of PSA 570, the auditor may believe that it is necessary to
ask management to make or extend its assessment. If management is unwilling to do so, it is not the auditor's responsibility to
rectify the lack of analysis by management, and a modified report may be appropriate because it may not be possible for the
auditor to obtain sufficient appropriate evidence regarding the use of the going concern assumption in the preparation of the
financial statements.

In some circumstances, the lack of analysis by management may not preclude the auditor from being satisfied about the
entity's ability to continue as a going concern. For example, the auditor's other procedures may be sufficient to assess the
appropriateness of management's use of the going concern assumption in the preparation of the financial statements because
the entity has a history of profitable operations and a ready access to financial resources. In other circumstances, however,
the auditor may not be able to confirm or dispel, in the absence of management's assessment, whether or not events or
conditions exist which indicate there may be a significant doubt on the entity's ability to continue as a going concern, or the
existence of plans management has put in place to address them or other mitigating factors. In these circumstances, the
auditor modifies the auditor's report as discussed in PSA 701, "Modifications to the Independent Auditor's Report."

Significant Delay in the Signature or Approval of Financial Statements

When there is significant delay in the signature or approval of the financial statements by management after the statement of
financial position date, the auditor considers the reasons for the delay. When the delay could be related to events or
conditions relating to the going concern assessment, the auditor considers the need to perform additional audit procedures,
as described in paragraph 26 (PS 570), as well as the effect on the auditor's conclusion regarding the existence of a material
uncertainty, as described in paragraph 30 of PSA 570.

5. Management Representations

PSA 580, "Management Representations* establishes standards and provides guidance for the use of management
representations as audit evidence, the procedures to be applied in evaluating and documenting management representations
and the action to be taken if management refuses to provide appropriate representations.

Obtaining appropriate management representation is also a subsequent evens procedure required in an audit examination.
The auditor should obtain evidence that management acknowledges its responsibility for the fair presentation of the financial
statements in accordance with the relevant financial reporting framework, and has approved the financial statements. The
auditor can obtain evidence of management's acknowledgment of such responsibility and approval from relevant minutes of
meetings of the board directors or similar body or by obtaining a written representation from management or a signed copy of
the financial statements

The auditor should obtain written representations from management on matters material to the financial statements when
other sufficient appropriate audit evidence cannot reasonably be expected to exist. The possibility of misunderstandings
between the auditor and management is reduced when oral representations are confirmed by management in writing.
Matters which might be included in a letter from management or in a confirmatory letter to management are contained in the
example of a management representation letter.

During the course of an audit, management makes many representations to the auditor, either unsolicited or in response to
specific inquiries. When such representations relate to matters which are material to the financial statements, the auditor will
need to:

(a) Seek corroborative audit evidence from sources inside or outside the entity;
(b) Evaluate whether the representations made by management appear reasonable and consistent with other audit
evidence obtained, including other representations;
(c) Consider whether the individuals making the representations can be expected to be well informed on the particular
matters.

Representations by management cannot be a substitute for other audit evidence that the auditor could reasonably expect to
be available. For example, a representation by management as to the cost of an asset is not a substitute for the audit evidence
of such cost that an auditor would ordinarily expect to obtain. If the auditor is unable to obtain sufficient appropriate audit
evidence regarding a matter which has, or may have, a material effect on the financial statements and such evidence is
expected to be available; this will constitute a limitation in the scope of the audit, even if a representation from management
has been received on the matter.

Documentation of Representations by Management

The auditor would ordinarily include in audit working papers evidence of management's representations in the form of a
summary of oral discussions with management or written representations from management.

A written representation is better audit evidence than an oral representation and can take the form of:

(a) a representation letter from management;

(b) a letter from the auditor outlining the auditor's understanding of management's representations, duly acknowledged
and confirmed by management; or
(c) relevant minutes of meetings of the board of directors or similar body or a signed copy of the financial statements

Basic Elements of a Management Representation Letter

When requesting a management representation letter, the auditor would request that it be addressed to the auditor, contain
specified information and be appropriately dated and signed.

A management representation letter would ordinarily be dated the same date, as the auditor's report. However, in certain
circumstances, a separate representation letter regarding specific transactions or other events may also be obtained during
the course of the audit or at a date after the date of the auditor's report, for example, on the date of a public offering.

A management representation letter would ordinarily be signed by the members of management who have primary
responsibility for the entity and its financial aspects (ordinarily the senior executive officer and the senior financial officer)
based on the best of their knowledge and belief. In certain circumstances, the auditor may wish to obtain representation
letters from other members of management. For example, the auditor may wish to obtain a written representation about the
completeness of al minutes of the meetings of shareholders, the board of directors and important committees from the
individual responsible for keeping such minutes.

There are two purposes of the client, letter of representation:

(a) It impresses upon management its responsibility for the assertions in the financial statements.
(b) It provides written representation to the auditor in support of oral responses from management to inquiries about
various aspects of the audit.

The following specific matters should be included, when applicable, in a client representation letter. These are:

1. Management acknowledgment of its responsibility for the fair presentation of the financial statements.
2. The availability of all financial records and any related data.
3. The completeness and availability of all minutes of meetings of stockholders, directors, and committees of directors.
4. The nonexistence of errors or unrecorded transactions in the financial statements. '
5. Information concerning:
a. Subsequent events.
b. Noncompliance with contracts that may affect the financial statements.
c. Losses from sales commitments.
d. Obligations to repurchase assets that were previously sold.
e. Related party transactions.
f. The reduction of excess or obsolete inventories to net realizable value.
6. Irregularities involving the client's management or employees.
7. Communications that client received from regulatory agencies relating to noncompliance with, or deficiencies in,
financial reporting practices.
8. The client's plans or intentions that may affect the carrying value or classification of assets or liabilities.
9. The disclosure of line-of-credit or similar arrangements.
10. The losses from purchase commitments for inventory quantities in excess of requirements or at prices in excess of
market.
11. Violations or possible violations of laws or regulations whose effects should be considered for disclosure in the
financial statements or as a basis for recording a loss contingency.
12. Other liabilities and. gain or loss contingencies that are required to be accrued or disclosed.
13. Unaudited replacement cost information and interim financial information included in audited financial statements.
14. Other matters that the auditor may determine, based on the circumstances of the engagement, should be included in
written representations from management.

A written representation is better audit evidence than an oral representation and can take the form of:
 (a) A representation letter from management
(b) A letter from the auditor outlining the auditor's understanding of management's representations, duly acknowledged
and confirmed by management; or
(c) Relevant minutes of meetings of the board of directors or similar body or a signed copy of the financial statements.

The written representations addressed to the auditor should be signed by members of management who the auditor feels are
responsible for the matters discussed. Generally, this will be signed by the client's financial officer and chief executive officer.
The representations are dated as of the date of the audit report.

Failure of management to comply with an independent auditor's request for written representations on material matters mas,
due to scone limitations, necessitate the auditor rendering either an opinion that is qualified or a - disclaimer of opinion.

6. Analytical Procedures

Analytical procedures were introduced and discussed in Chapter 9. Analytical procedures are normally used as a part of
planning the audit, during the performance of detailed tests in each cycle, and at the completion of the audit.

When intending to perform analytical procedures as substantive procedures, the auditor will need to consider a number of
factors such as the:

 Objectives of the analytical procedures and the extent to which their results can be relied upon (paragraphs 14-16 of
PSA 520).
 Nature of the entity and the degree to which information can be disaggregated, for example, analytical procedures
may be more effective when applied to financial information on individual sections of an operation or to financial
statements of components of a diversified entity, than when applied to the financial statements of the entity as a
whole
 Availability of information, both financial, such as budgets or forecasts, and nonfinancial, such as the number of units
produced or sold.
 Reliability of the information available, for example, whether budgets are prepared with sufficient care.
 Relevance of the information available for example, whether budgets have been established as results to be expected
rather than as goals to be achieved.
 Source of the information available, for example, sources independent of the entity are ordinarily more reliable than
internal sources.
 Comparability of the information available, for example, broad industry data may need to be supplemented to be
comparable to that of an entity that produces and sells specialized products.
 Knowledge gained during previous audits, together with the auditor's understanding of the effectiveness of the
accounting and internal control systems and the types of problems that in prior periods have given rise to accounting
adjustments.

Analytical Procedures in the Overall Review at the End of the Audit

The auditor should apply analytical procedures at or near the end of the audit when forming an overall conclusion as to
whether the financial statements as a whole are consistent with the auditor's knowledge of the business. The conclusions
drawn from the results of such procedures are intended to corroborate (sufficient/quantity and appropriate/quality)
conclusions formed during the audit of individual components or elements of the financial statements and assist in arriving at
the overall conclusion as to the reasonableness of the financial statements. However, they may also identify areas requiring
further procedures.

Extent of Reliance on Analytical Procedures

The application of analytical procedures is based on the expectation that relationships among data exist and continue in the
absence of known conditions to the contrary. The presence of these relationships provides audit evidence as to the
completeness, accuracy and validity of the data produced by the accounting system. However, reliance on the results of
analytical procedures will depend on the auditor's assessment of the risk that the analytical procedures may identify
relationships as expected when, in fact, a material misstatement exists.

Analytical procedures performed as part of the overall review assist the auditors in assessing the validity of the conclusions
reached, including the opinion to be issued. They are useful as a final review for material misstatements or financial problems
and to keep the auditor take a final "objective look" at the financial statements. It is usual for a partner to do the analytical
procedures during the final review of working papers and financial statements. Knowledge of the client's business combined
with, effective analytical procedures help identify possible oversights in "an audit."

Analytical review procedures that may be performed at the end of the year include the following:

 Compare financial statements subtotals and totals with corresponding prior period amounts and current year budget
data.
 Calculate relevant ratios and compare with (1) prior year and current year budgeted ratios and (2) current year ratios
of major competitors or composite industry data. (Current ratio, debt to equity ratio book value per share of common
stock, and rates of return on assets and common stock equity).
 Compare common-size statements to similar statements of prior years.

The overall analytical review should extend to the working papers to determine that there are adequate explanations of
unusual fluctuations found in making comparative analyses of individual account balances. Also, an overall analytical review
provides the auditor with a final opportunity to evaluate the fairness of the financial statements and investigate any unusual
fluctuations and questionable items.

Investigating Unusual Items

When analytical procedures identify significant fluctuations or relationships that are inconsistent with other relevant
information or that deviate from predicted amounts, the auditor should investigate and obtain adequate explanations and
appropriate corroborative evidence.

The investigation of unusual fluctuations and relationships ordinarily begins with inquiries of management, followed by:

(a) corroboration of management's responses, for example, by comparing them with the auditor's knowledge of the
business and other evidence obtained during the course of the audit; and
(b) consideration of the need to apply other audit procedures based on the results of such inquiries, if management is
unable to provide an explanation or if the explanation is not considered adequate.
7. Evaluating Findings, Formulating an Opinion and Drafting the Audit Report

Making a Final Assessment of Materiality and Audit Risk

The auditor's assessment of materiality and audit risk may be different at the time of initially planning the engagement from at
the time of evaluating the results of audit procedures. This could be because of a change in circumstances or because of a
change in the auditor's knowledge as a result of the audit.

When completing the audit, the auditor must reconsider materiality and determine a material amount to be used in evaluating
the estimated misstatement in the financial statement. Audit risk should also be reconsidered.

In evaluating whether the statements are presented fairly, an auditor should aggregate any uncorrected misstatement to be
able to consider them in relation to the financial statement as a whole. The aggregation should include not only the known but
also the likely misstatement. Known misstatements are individual misstatements specifically identified by an auditor. Likely
misstatements are an auditor's best estimate of misstatement based on a projection of the misstatements detected during
sampling.

If audit risk increases due to numerous events and conditions while the audit is being undertaken, the auditor should evaluate
whether additional substantive procedures need to be performed. The auditor then determines whether the accumulated
evidence indicates that the level of audit risk is appropriately low such that the auditor can render an opinion.

Working Paper Review

As the audit is being performed, the work of the staff auditors (in the form of audit working papers) has been reviewed by a
senior auditor, and sometimes by an audit manager. This review if performed on an account-by-account basis, is to evaluate
the procedures performed, evidence gathered, and conclusions reached by the preparers of the working paper. The reviewer
will ensure that all steps in the audit program have been "signed off and that the references from one working paper to
another are appropriate.

In contract, the final working paper review performed by the audit partner in charge of engagement and/or audit manager
focuses on the overall scope of the audit examination. This review addresses broader issues relating to the scope of the audit
examination, such as:

1. Has the audit examination been completed in accordance with the terms enumerated in the engagement letter?
 2. Has the firm complied with auditing standards during the examination?
3. Do the working papers contain a conclusion as to the fair presentation of each account examined? The partner's
review focuses on the following:
 The adequacy of the audit program
 The accuracy and completeness of subordinates' work
 The reasonableness of subordinates' judgments
 Consistency among the working paper evidence, the financial statements, and the auditor's opinion • Areas in which a
high risk of material misstatement, including fraud exists
 The resolution of significant accounting, auditing, and reporting questions raised during the audit.

Many firms also have a partner who is not associated with a particular engagement perform as additional review of the
working paper. This partner's review, commonly referred to as "second partner review" or "cold review" is similar to that
performed by the partners in charge of the audit engagement.

Evaluating the Results

As the completion of the application of all the specific audit procedures for each of the audit occurs, it is necessary to integrate
the results into "one overall conclusion." The auditor ultimately decides whether sufficient audit evidence has been obtained
to warrant the conclusion that the financial statements are stated in accordance with financial reporting standards
consistently applied with those of the preceding year.

Sufficiency of Evidence

The auditor reviews the adequacy of the audit evidence to determine whether all important aspects of the audit have been
adequately tested considering the circumstances of the engagement. He reviews the audit program to make sure that all parts
have been accurately completed and documented and that all audit objectives have been met.

If the auditor concludes that he or she has not obtained sufficient evidence to draw a conclusion about the fairness of the
client's representations he can either:

a) Obtain additional evidence

b) Issue either a qualified opinion or a disclaimer of opinion.

Evidence Supports Auditor's Opinion

To evaluate whether the financial statement are fairly stated, errors uncovered in the audit are summarized. Whenever the
auditor uncovers errors that are in themselves material, adjustments should be made on the trial balance to correct the
statement. There may also be a large number of immaterial errors discovered that are not adjusted at the time they are found.
It is necessary to combine individually immaterial error to evaluate whether the combined amount is material that may
require adjustment.

If the auditor believes that he or she has sufficient evidence, but it does not warrant a conclusion of fairly presented financial
statements, the auditor may either:

a. require the client to revise the statements to the auditor's satisfaction,

b. issue either a qualified or an adverse opinion.

In summary, the auditor evaluates the sufficiency of actual evidence by first evaluating achieved audit risk by account and by
cycle and then making the same evaluation for the overall financial statements. The auditor also evaluates whether the
evidence supports the audit opinion by first estimating errors in each account and then for the overall financial statements.
The auditor compares the amount of control error to the predetermined materiality threshold. If this comparison indicates
that the client's financial statements may be materially misstated, the auditor should propose an adjustment to the account
balance or chain of transactions. In practice, the evaluation of achieved audit risk and estimated error are made at the same
time. On the basis of these evaluations, the audit report is issued for the financial statements.

Other Communications with Clients

In addition to the audit report and a required communication if reportable conditions exist, auditors communicate with the
audit committee about matters related to the audit. They also often write a management letter.

POST-AUDIT RESPONSIBILITIES

Subsequent Discovery of Facts Existing at Report Date

In summary, the auditor's responsibility for subsequent events review begins as of the statement of financial position date and
ends on the date of the completion of the field work. Any pertinent information discovered as part of the review can be
incorporated in the financial statement before they are issued. But if the auditor discovers that issued financial statements are
improperly stated, he or she must take action to correct them.

When, after the financial statements have been issued, the auditor becomes aware of a fact which existed at the date of the
auditor's report and which, if known at that date, may have caused the auditor to modify the auditor's report, the auditor (1)
should consider whether the financial statements need revision, (2) should discuss the matter with management, and (3)
should take the action appropriate in the circumstances.

If the auditor becomes aware after the financial statements have been released that some information included in the
statements is materially misleading, the auditor has an obligation to make certain that users who are relying on the financial
statements are informed about the misstatements. Examples of possible causes of misstatements are inclusion of material
fictitious sales, the failure to write-off obsolete inventory, or the omission of an essential footnote. The auditor's responsibility
remains the same whether the failure to discover the misstatement was the fault of the auditor or the client. He must make
certain that the client, takes the appropriate steps in informing users of the misleading statements.

When management revises the financial statements, the auditor would (1) carry out the audit procedures necessary in the
circumstances, (2) review the steps taken by management to ensure that anyone in receipt of the previously issued financial
statements together with the auditor's report thereon is informed of the situation, and (3) issue a new report on the revised
financial statements.

The new auditor's report should include an emphasis of a matter paragraph referring to a note to the financial statements that
more extensively discusses the reason for the revision of the previously issued financial statements and to the earlier report
issued by the auditor. The new auditor's report would be dated not earlier than the date of the revised financial statements
are approved and accordingly, the procedures referred to would ordinarily be extended to the date of the new auditor's
report.

When management does not take the necessary steps to ensure that anyone in receipt of the previously issued financial
statements together with the auditor's report thereon is informed of the situation and does not revise the financial
statements in circumstances where the auditor believes they need, to be revised, the auditor would notify those persons
ultimately responsible for the overall direction of the entity that action will be taken by the auditor to prevent future reliance
on the auditor's report. The action taken will depend on the auditor's legal rights and obligations and the recommendations of
the auditor's lawyers.

It may not be necessary to revise the financial statements and issue a new auditor's report, when issue of the financial
statements for the following period is imminent, provided appropriate disclosures are to be made in such statements.

If the client refuses to make the necessary disclosures, the auditor should notify the board of directors that in the absence of
disclosure by the client, the auditor will take steps to prevent future reliance on the report.

Consideration of Omitted Procedures After the Report Date

Once an auditor has reported on audited financial statements, he has no responsibility to carry out any retrospective review of
his work. However, reports and working papers relating to particular engagements may be subjected to post issuance review
in connection with a firm's internal inspection program, peer review, or otherwise, and the omission of a necessary auditing
procedure may be disclosed. If such an omitted auditing procedure is disclosed or identified, the auditor should assess the
importance of the effect of the omitted procedure on the previously issued opinion.

If the auditor concludes that the omission of this procedure impairs the ability to support a previously expressed opinion
regarding the financial statements of the client, the auditor should attempt to either apply the omitted procedure or apply
alternative procedures in order to provide a satisfactory basis for the opinion. If the auditor is unable to apply either the
omitted procedure or alternative procedures, he or she should consult an attorney in order to determine responsibilities to
the client, regulating authorities having jurisdiction over the client, and persons relying, or likely to rely, or the report.

Figure 20-5 Procedures to Follow When an Auditor Discovers That an Audit Procedure Was Deemed Necessary but Was
Omitted
 Assess importance of omitted procedure to support previously expressed opinion. If omission of procedure impairs present
ability to support and persons are relying on it, action is necessary.

Perform omitted procedure or alternative procedures. (if unable, consult lawyer)

If evidence supports previosuly issued report, auditor has no If evidence would have affected the previously issued report,
further responsibility follow procedures to prevent further reliance on report.