CHAPTER 21

EVALUATION OF AUDIT
EVIDENCE AND
COMPLETION OF THE
AUDIT
Auditing and Assurance Concepts and Applications
 Expected Learning Outcomes
After studying this chapter, you should be able to:
1. Understand the need to evaluate audit evidence gathered to support
the conclusions for the auditor’s report.
2. Know how to evaluate audit evidence for sufficiency and
appropriateness.
3. Know the various issues that the auditor considers in completing the
audit.
4. Describe the letter of inquiry to client’s legal counsel.
5. Discuss the contents of the representation letter obtained from client
management.
 The reporting phase of the risk-based audit process involves:
A. Evaluating the audit evidence to determine what additional audit work (if any) is required (Chapter 21).
B. Forming an Opinion based on audit findings and preparing the auditor’s report (Chapter 22).

Chapter 21, covers the procedures in evaluating audit evidence that will serve as the basis in forming an opinion on the
financial statements.

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 assertion 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 judgement.
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 favourable results.
Evaluating the Sufficiency and Appropriateness of Audit Evidence
Sufficient and 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 judgemental or statistical sampling procedures.
The auditor’s judgement 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.
● Results of audit procedures, including fraud or error which may have been found.
● Source and reliability of information available.
When obtaining audit evidence from tests of control, the auditor should consider the
sufficiency and appropriateness of the audit evidence to support the assessed level of
control risk. The aspects of the accounting and internal control systems about which
the auditor would obtain evidence are:

a. Design: the accounting and internal control systems are suitably designed to
prevent and/or detect and correct material misstatements; and
b. Operation: the systems exist and have operated effectively throughout the
relevant period.

When obtaining audit evidence from substantive procedures, the auditor should
consider sufficiency and appropriateness of audit evidence from such procedures
together with any evidence from tests of controls to support financial statement
assertions.
 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

2. Objectivity of the evidence
3. Qualifications of the provider of the evidence
4. Timeliness of the evidence

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.

5. An auditor’s direct, personal knowledge, obtained through physical observation and his or her own mathematical
computations, is generally considered the most competent evidence.
6. Documentary evidence obtained directly from independent external sources (external evidence) is considered
competent.
7. 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.
8. Internal evidence consisting of documents that are produced, circulated, and finally stored within the client’s
information system is generally considered low in competence.
9. Verbal and written representations given by the client’s officers, directors, owners, and employees are generally
considered the least competent 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 judgement to determine the extent of tests necessary to
obtain sufficient evidence. In exercising their professional judgement, 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 statements

assertion under consideration, the auditor should attempt to gather sufficient
quantity of competent evidence at a minimum cost.
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 judgement 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 judgement 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. 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 assessment 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 misstatement(s)
may exist that, when aggregated with known misstatements, could exceed performance
materiality; or
● The aggregate of identified and uncorrected misstatements comes close to or exceeds
performance materiality.
The evaluation of the audit evidence obtained would address the
following matters.
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; or
● 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 the misstatement in the assertion being addressed significant,
and what is the likelihood of it having a materially effect (individually or combined with other
potential misstatements) on the financial statements?
(b) Management responses: Is the 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 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 the 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 as to the reasonableness of the financial
statements.
 Documentation
The final step in the evaluation process is to record all the significant finding 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.

Nature and Objective of 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 PSAs and applicable legal and
regulatory requirements.
 Documentation
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 on the financial statements that
have been prepared by management with the oversight of those charged with governance; and
(b) The audit of the financial statements does not relieve management or those charged with
governance of their responsibilities.

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.

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 likely to be more accurate than documentation prepared
subsequently.
 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 PSAs and
applicable legal and regulatory requirements;
(b) The results of the audit procedures performed, and the audit evidence obtained; and
(c) Significant matters arising during the audit, the conclusions reached thereon, and significant
professional judgements 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 or audit evidence obtained.
● The audit methodology and tools used.
 Form, Content and Extent of 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; and
(c) Who reviewed the audit work performed and the date and
extent of such review.

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 file has been completed auditor shall,
regardless of the nature of the modifications or additions, document:

(a) The specific reason for making them; and

(b) When and by whom the weremade and reviewed.
 Types of Working Papers
An example of a file index for a current-year audit is shown below.

INDEX- YEAR-END AUDIT FILE

Finalization of Audit

1) Audit file closing 6) Engagement partner/sole practitioner review

2) Financial statements/auditor’s report 7) Adjusting and closing journal entries

3) Final analytical review 8) Working trial balance

4) Reviewer’s checklist Quality control review 9) Correspondence, discussions, and notes-

(if EQCR applicable) Representation letter

5) Financial statement presentation and 10) Discussion with management and others
disclosure review Management letter
Notes and queries
 Types of Working Papers
Audit Acceptance

11) Audit engagement acceptance checklist- 12) Understanding the entity and its
New or continuing client information from environment- Client profile Documents to
predecessor’s files* request
Engagement letter*

Overall Audit Strategy

21) Establishing the overall audit strategy checklist 25) Assessing inherent risks

22) Determining materiality 26) Determining whether the risks indicate the
Evaluating misstatements need for an EQCR

23) Identifying risks using analytical procedures 27) Audit budget- Time and Fees Schedule of
documents to be prepared by client

24) Conducting an audit team planning meeting 28) Overall audit strategy
 Types of Working Papers
Assessing Risks of Material Misstatement

31) Assessing the risks of material 36) Testing controls**

misstatements checklist Revenue, receivables, and receipts
Purchases, payables, and payments
Payroll
Inventory, cost of sales, and production
Financing and equity

32) Inquiries for management, for those responsible 37) Review of minutes of all meetings
for governance, for those responsible for internal Appointment of auditor (AGM Resolution)
audit, and for others in the entity

33) Evaluating the control environment 38) Review of client’s annual report or other
document that will include the audited financial
statements
 Types of Working Papers

Assessing Risks of Material Misstatement

34) Evaluating management’s use of estimates, 39) Risk Assessment summary

including fair value

35) Information systems and internal control:

General IT system and IT controls
Revenue, receivables, and receipts
Purchases, payables, and payments
Payroll
Inventory, cost of sales, and production
Financing and equity
 Types of Working Papers
Financial Statement Checklists, Analytical Procedures and Tests of Balances

Balance Sheet/Statement of Financial Position

A Cash and cash equivalents NN Equity/Net assets

B Trade and other receivables SS Journal Entries

C Inventories TT Responding to indications of fraud

D Prepaid Expenses UU Going Concern

E Investments VV Foreign Currency translation

F Property, plant and equipment (BUS) WW Accounting estimates

G Capital Assets (NPO) Changes in accounting policies and

correction of prior period errors
 Types of Working Papers
Financial Statement Checklists, Analytical Procedures and Tests of Balances

Balance Sheet/Statement of Financial Position

H Goodwill and intangible assets XX Related party transactions

(BUS)

AA Short-term and long-term debt Significant transactions outside the

normal course of business

BB Accounts payable and accrued YY Contingencies and contractual

liabilities obligations

EE Taxes payable ZZ Economic dependence

HH Other liabilities
 Types of Working Papers
Financial Statement Checklists, Analytical Procedures and Tests of Balances

Income Statement/Statement of Operations

100 Revenue 300 Expenses

200 Cost of sale 400 Other income and expenses

Substantive Tests of Transactions **

Revenue, receivables, and receipts Inventory, cost of sales, and production

500 Purchases, payables, and payments Financing and equity
Payroll

*May be in permanent file

**May be in interim file
Figure 21-1: Illustrative Communication of Audit Matters of Governance Interest
 Completing the Audit
Almost every audit engagement has a deadline for issuance of audit report and release
of audited financial statements. The 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;

2. Subsequent events review;
3. Letters of inquiry/review of contingent liabilities;
4. Evaluating going concern status
5. Management representation;
6. Perform final analytical procedures;
7. Review the minutes of stockholders and Board of Directors; and
8. Evaluating findings, formulating an opinion and drafting the audit report.
 Related Party Transactions
Transactions with related parties are important to auditors because they will be disclosed in the financial
statements if they are material. PAS/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 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.
 Subsequent Events Review
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; and
2) Those that are indicative of conditions that arose subsequent to period end.

When the auditor becomes aware of events which materially affect the financial statements, the auditor should
consider whether such events are properly accounted for and adequately disclosed in the financial statements.

Figure 21-2 summarizes the auditors’ responsibilities for subsequent event with respect to the balance sheet
date, the date of the audit report, and the date the auditors grant the client permission to use the audit report- the
report release date.
Figure 21-2: Subsequent Events
 Letter of Inquiry/Review For Contingent Liabilities
A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from
activities that have already taken place. For a contingent liability to exist, the following three (3) conditions must be
present:

1. There is a potential future payment to an outside party that resulted from an existing condition;
2. There is uncertainty about the amount of the future payment; and
3. The outcome will be resolved by some future event or events.

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

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 facilitates the auditor’s understanding of a client’s contingencies.
 Evaluation of Going Concern Assumption
PSA 570 requires the auditor to 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.
A final assessment is desirable after all evidences has been accumulated and proposed audit
adjustments have been incorporated into the financial statements.
Analytical procedures are one of the most important types of evidence to assess going concern.
Discussions with management and a review of future plans are important considerations in evaluating
the analytical procedures. The knowledge of the client’s business gained throughout the audit is
important information used to assess the likelihood of financial failure within the next year.
 Management Representations
Obtaining appropriate management representation is also a subsequent events 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 of directors or similar body or by
obtaining a written representation from management or a signed copy of the financial statements.

The auditor would ordinarily include in audit working papers evidence of management’s representations in the form
of 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.
 Perform Final Analytical Procedures
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.
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.”
 Review the Minutes of Meetings
The auditors should review the minutes of meetings of stockholders and
directors, including important subcommittees of directors such as the audit
committee and the investment committee. This review includes meetings
held through the date of the audit report. In completing the audit, the
auditors should determine that they have considered all minutes, including
those for meetings subsequent to year-end. They also will obtain written
representation from management that all minutes have been made
available.
 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 anu uncorrected
misstatement. Known misstatement 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.
 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 errors 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 auditors may either:
(a) Require the client to revise the statements to the auditor’s satisfaction, or
(b) Issue either a qualified or an adverse opinion.
On the basis of these evaluations, the audit report is issued for the financial statements.
 END
OF
CHAPTER 21