Risk Response

PSA 330, The Auditor’s Responses to Assessed Risks

 Control Risk Therefore,
At Below Max before assessing
At Max if: CR at Below
if:
Max:
• IC not designed • IC design is
effectively, or effective, and • Understand IC
• Evaluate design
effectiveness and
• Evaluating • Auditor plans to
implementation
operating test its operating
effectiveness is effectiveness • Test operating
inefficient effectiveness

Documentation
• Understanding
• Assessment
• If below max: document also basis for conclusions
Assessing control risk (PSA 315 revised 2019)
If auditor plans to
test the operating
Assess control risk
effectiveness of
controls

If auditor does not plan Assessment of control

to test the operating risk is such that
effectiveness of
controls RMM = Inherent risk
Risk Response
 Overall response
a. More emphasis on maintaining professional skepticism
b. Using more experienced staff
c. More supervision
d. More unpredictable procedures
e. Making general changes to NTE of audit procedures
 Assertion level response
o Nature of audit procedures
 Purpose, type
o Timing of audit procedures
 When performed
o Extent of audit procedures
 Quantity
Tests of Controls vs. Substantive Tests
Tests of Controls Substantive Tests
 Designed to evaluate the operating  Designed to detect material misstatements at
effectiveness of controls the assertion level

 Specific TOC procedures:  Specific ST procedures

1. Inquiries of appropriate client  Inspection
personnel  Observation
2. Inspect documents, records, reports  Inquiry and confirmation
 Recalculation
3. Observe control-related activities
 Reperformance
4. Reperform client procedures  Analytical procedures

 If there is no documentary trail, can TOC

still be performed?
 Can inquiry alone suffice as TOC?
Tests of Controls vs. Substantive Tests
Tests of Controls Substantive Tests
 Designed to evaluate the operating  Designed to detect material
effectiveness of controls misstatements at the
assertion level

 Consist of:
1. Test of details
a. of transactions
b. of balances
2. Analytical procedures
Are the following statements correct? (Yes or No)
A. An auditor performs TOC when
1. controls are designed effectively and auditor’s risk assessment includes an expectation
that controls are operating effectively
2. auditor plans to rely on the controls
3. the auditor plans a reduction in substantive tests
4. substantive tests alone are not enough to obtain sufficient appropriate evidence

B. An auditor does not perform TOC when

1. controls are not designed effectively
2. even if controls are designed effectively, auditor does not plan to rely on controls
because it is not efficient to test their operating effectiveness
3. the auditor believes that significant reduction in substantive tests could be made if the
auditor performs TOC.
Yes or No
1. The auditor may plan to perform a purely test of controls approach (i.e. no
substantive tests)

2. The auditor may plan to perform a purely substantive tests approach (i.e. no tests
of controls)

3. The auditor may plan to perform a combination of test of controls and

substantive tests
Test of Controls (Compliance Tests)

 Auditor performs TOC when

a. auditor’s RMM includes an expectation that controls are operating
effectively; or
b. substantive tests alone cannot provide sufficient appropriate audit evidence

 Generally, the greater the reliance on controls, more persuasive the required
evidence from TOC should be.
Test of Controls (Compliance Tests)
Should tests of controls be performed in each of the following cases?

 Based on understanding the entity’s system of internal controls, the auditor

has concluded that controls are not designed effectively.

 Testing controls is inefficient.

Test of Controls
 Timing:
 For a particular time or throughout the period? Example:
Testing client’s inventory count procedures
vs.
Testing client’s control over approval of purchases

 When an auditor decides to perform TOC at an interim period, consider:

o significant changes after interim period
o need for additional evidence after interim period
Consider such factors as:
 Significant changes
 Length of time remaining after interim period
 Extent of planned further reduction in substantive tests
Test of Controls
 When obtaining evidence about operating effectiveness of controls, can the auditor
use audit evidence obtained from the prior year audit?
Where there Does the control
significant mitigate a
changes? significant risk?

If yes – do TOC in If yes – do TOC in

current audit current audit

If no – may test controls If no – may test controls

at least once every 3rd at least once every 3rd
audit; but still test some audit; but still test some
controls at each audit controls at each audit
Test of Controls
 Extent:

The more persuasive evidence needed, the more extensive TOC should be.

Consider also:
o Frequency of performance of the control by the entity
o Length of period the auditor plans to rely on internal controls
o Expected rate of deviation
o Quality of evidence to be obtained
o Extent to which evidence is obtained from test of other controls
Substantive Procedures Questions:
 Nature 1. Can substantive tests for a particular account
o Test of details balances involve analytical procedures only (i.e. no test
of details)?
o Tests of details of transactions • Yes. However if it relates to a significant risk
o Analytical procedures and the auditor’s approach is purely
substantive (no TOC), substantive tests should
include test of details.
 Timing 2. Can substantive tests for a particular account
o At interim or at year-end? involve test of details only (i.e. no analytical
procedures)?
3. Can substantive tests for particular account involve
 Extent both test of details and analytical procedures?
o Quantity
o Example: smaller sample size or larger
sample size?
Timing of substantive procedures –
Consider:
 Control environment and other relevant controls
 Availability at a later date of information necessary for the auditor’s procedures
 Purpose of the substantive procedure
 Assessed risk of material misstatement
 Nature of the class of transactions or account balance and related assertions
 Ability of the auditor to perform appropriate substantive tests or substantive tests
combined with TOC to cover the remaining period

Generally, the higher the risk of material misstatements, the more likely the auditor is to
design substantive procedures
A. closer to year-end.
B. at an interim date farther from year-end.
Substantive Procedures
Consider the following:

An auditor is engaged to audit the financial statements of a client as of

and for year ended December 31, 2023. The auditor has decided to
perform interim substantive tests of accounts receivable based on
September 30, 2023 balances by sending out confirmations to selected
client’s customers.

Does the auditor need to perform additional procedures at December

31, 2023?
Substantive Procedures
 When substantive procedures are performed at an interim date, the auditor shall
cover the remaining period by performing:
a. substantive procedures, combined with TOC for the intervening
period;
b. further substantive procedures only, that provide a reasonable basis for
extending the audit conclusions from the interim date to the period end.

 Performing substantive tests at an interim date without additional procedures at a

later date increases the risk that the auditor will not detect misstatements that may
exist at the period end (incremental audit risk).

 The risk increases as the remaining period is lengthened.

How do the following affect your decision
about whether to perform substantive
tests at an interim date or at year-end?
1. Internal control associated with the account
2. How rapidly business conditions might change
3. Management’s predisposition to misstate the financial
statements
4. Predictability of account balances at year-end
5. Availability of information necessary to perform
procedures at a later date (for roll-forward procedures).
Substantive Procedures
a. Can the auditor choose to perform all substantive procedures
at year end only and not to perform interim testing?

b. Can the auditor choose to perform all substantive procedures

at an interim date only and not to perform year-end testing?

c. Can substantive tests be eliminated?

d. If risk of material misstatement for an account or transactions

is very minimal, should substantive tests still be performed?
Substantive Procedures
 Irrespective of assessed risk of material misstatement, the auditor shall design
and perform substantive procedures for each material class of transactions,
account balance and disclosures.

 This is because
o risk assessment is judgmental and the auditor may not be able to identify
all RMM
o there are inherent limitations to internal control, including management
override
Substantive Procedures
 The auditor’s substantive procedures shall include the following audit
procedures related to the financial statement closing process:

a. Agreeing or reconciling the financial statements with the

underlying accounting records; and

b. Examining material journal entries and other adjustments made

during the course of preparing the financial statements
Dual purpose tests

 RAP and TOC

 TOC and Substantive tests of details of transactions
Significant risk
 Test of controls
o When the auditor plans to rely on controls over a significant risk, the auditor
shall test those controls in the current period.

 Substantive tests
o When the auditor has identified a significant risk, the auditor shall perform
substantive procedures that are responsive to that risk.
o When the auditor’s approach consists only of substantive procedures (no
TOC), those procedures shall include tests of details.
 Audit Evidence

PSA 500, Evidence

PSA 505, External Confirmations
PSA 520, Analytical Procedures
o Sources of audit evidence
o Characteristics of audit evidence
o Evaluation of audit evidence
o Substantive procedures
• Test of details
 Directional testing
 External confirmations (positive, negative, blank)
• Analytical procedures
o Standard auditing procedures
o Selecting items for testing
o Initial audit engagements
 Evidence and working papers  supports audit opinion

 Accounting records  supports financial statements

Evidence is gathered throughout the audit when
performing

 RAP
 TOC
 ST
 Other procedures – eg. subsequent events review
Some sources of evidence
 Accounting data
 Other information (corroborative information such as minutes of meetings,
contracts)
 Evidence in electronic form

 If audit evidence is not available, can the auditor still perform an audit?
 If audit trail is available only electronically, can the auditor still perform an
audit?
 If audit trail is available only electronically and is available only at certain
points or periods in time, can the auditor still perform an audit?
Reasonable basis for opinion

 Auditor obtains persuasive evidence not conclusive evidence.

 Cost-benefit relationship may be a valid reason for

performing only certain procedures.
However, cost alone or difficulty in obtaining evidence is not
a valid basis for omitting procedure for which there is no
appropriate alternative.
Audit Evidence
Sufficiency Appropriateness
Influenced by: Reliability
- RMM  Hierarchy:
1. Direct personal knowledge
- Quality of evidence
2. External
3. External-internal
4. Internal
5. Oral

Example: Relevance
What evidence might be  Evidence must relate to the
relevant to ownership of financial statement assertion
inventory? under consideration
Evaluation of Audit Evidence

Consider audit objective

o Test of controls (test operating effectiveness of controls)
o Substantive tests (detect material misstatements)

Consider consistency of audit evidence

Substantive Procedures
1. Test of Details

Types of test of details

Test of details of balances
Test of details of transactions
Or a combination of both
Substantive Procedures
1. Test of Details
Directional testing
Type of Risk of Account Balances/ FS Direction of
Material Transactions more Assertions Testing
Misstatement likely to be
misstated
Risk of overstatement Revenue Occurrence Vouch from
Assets Existence records to supporting
Equity docs
Risk of understatements Expenses Completenes Trace from
Liabilities s supporting docs to
records
 Why should testing for occurrence start from records?
 Why should testing for completeness start from supporting documents
evidencing actual transactions?
Substantive Procedures
1. Test of Details

External Confirmations
Positive vs. Negative confirmation
Positive Negative
Response of Asks confirming party Asks confirming party
confirming party: to respond whether to respond only if
he/she agrees or he/she disagrees
disagrees

Which is better? Why?

Which would provide the auditor with more persuasive evidence?
Substantive Procedures
1. Test of Details
External Confirmations
Positive vs. Negative confirmation
Positive Negative
Response of confirming Asks confirming party to Asks confirming party to
party: respond whether he/she respond only if he/she
agrees or disagrees disagrees
Considerations in choosing which type to use :
Level of risk of material
misstatement
Likelihood of consideration
by recipient
Materiality of specific
accounts
Substantive Procedures
1. Test of Details – External Confirmations
1. What are blank confirmations?
2. Can the client prepare the confirmation requests?
3. Who signs on the confirmation requests?
4. Who should send the confirmation requests?
5. Who controls the confirmation requests?
6. To whom should the confirmation reply be sent?
7. What happens if management does not want the auditor to send
confirmation requests?
8. What should the auditor do if confirmation replies are received with
exceptions/differences?
9. What happens if no response are received from negative confirmations?
10. What happens if no response are received from positive confirmations?
Substantive Procedures
1. Test of Details

External Confirmations

Alternative procedures:
1. Subsequent collections/payments
2. Examination of documents
Sample confirmations – Cash in Bank
 Confirmation of Shares Outstanding
(Company letterhead)

Valdez & Associates

No. 111 Rizal Street
Catarman, Northern Samar

Gentlemen:

In connection with your audit of the financial statements of Angeles Corp. as of and for the year
ended December 31, 2016, we certify to the best of our knowledge and belief the correctness of
the following information concerning our capital stock.
1. Authorized capital stock xxx
2. Number of shares issued and outstanding xxx
3. Names of stockholders with their respective stockholdings and paid-up portion
xxx xxx
xxx xxx
Very truly yours,

Corporate Secretary
 Case for electronic confirmations
o Lessens risk of fraud in confirmation responses Faster turnaround
o Higher response rate
Substantive Procedures
2. Analytical Procedures

1. Planning
o understand the entity

2. Substantive procedures
o obtain evidence about financial statement assertions

3. Overall review
o overall conclusion about whether the financial statements
are consistent with the auditor’s understanding of the
entity (assist overall reasonableness of balances)
Substantive Procedures
2. Analytical Procedures
Substantive Analytical Procedures
 Evaluate reliability of data from which auditor’s expectation is to be
developed
 Source
 Comparability of information available
 Nature and relevance
 Controls over preparation of financial information

 Develop expectations

 Perform analytical procedures and compare with expectations

 Investigate differences (inquiry and performing other audit

procedures)
Substantive Procedures
2. Analytical Procedures
Effectiveness and Efficiency of Analytical Procedures

Auditor considers:
 Nature of assertion being tested
 potential misstatements are not apparent from an examination of the
detailed evidence or when such detail is unavailable
 Plausibility and predictability of data relationships
 Predictability of account
 Level of management discretion

 Availability and reliability of data used to develop expectations

 Precision of expectation
Substantive Procedures
2. Analytical Procedures

Examples of accounts where substantive analytical procedures are performed:

1. Interest expense/income
2. Depreciation expense
3. Payroll expense

Limitations of analytical procedures

 Differences noted do not necessarily indicate misstatements but simply indicate a
need for further examination
Standard auditing procedures
1. Foot, crossfoot, extend, recalculation – test mathematical accuracy
2. Inquiry
3. Vouch
4. Inspection – of records, documents or tangible assets
5. Confirmation
6. Analytical procedures
7. Reperformance
8. Reconciliation – comparing financial amounts of two or more different sources
9. Observation
10. Tracing – starts with source documents and traces forward to books and records
Standard auditing procedures

11. Cut-off
o for transactions at or around year-end
o sales, purchases, cash receipts, cash disbursements
12. Auditing related accounts simultaneously
13. Written representation (Representation letter)
14. Subsequent events review