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ASSURANCE ENGAGEMENTS

Assurance Services/Engagements:
 Assurance services – independent professional services in which a practitioner issues a
written communication that expresses a conclusion designed to enhance the degree of
confidence of the intended users other than the responsible party about the outcome of
the evaluation or measurement of a subject matter against criteria
 Assurance engagement – an engagement in which a practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended users other than the
responsible party about the outcome of the evaluation or measurement of a subject
matter against criteria
Objective of an Assurance Engagement, In General:
Assurance engagements performed by professional accountants are intended to enhance the
credibility of information about the outcome of the evaluation or measurement of a subject
matter against criteria, thereby improving the likelihood that the information will meet the needs
of an intended user. Assurance engagements enhance the degree of confidence of the intended
user because the quality of information for decision making is improved.

Objective of Assurance Engagements:

According to the Philippine Framework for Assurance Engagements, an assurance engagement
is conducted:
a. To provide a high level of assurance that the subject matter conforms in all material
respects with identified suitable criteria; or
b. To provide a moderate level of assurance that the subject matter is plausible in the
circumstances.

Types of Assurance Engagements and their Objectives:

1. Reasonable assurance engagements – engagements that provide high, but not
absolute, level of assurance
 Also called high-level engagements
 The objective of a reasonable assurance engagement is a reduction in assurance
engagement risk to an acceptably low level as the basis for a positive form of
expression of the practitioner ‘s conclusion.
2. Limited assurance engagements – engagements that provide only a ―moderate‖ or ―limited‖
level of assurance
 The objective of a limited assurance engagement is a reduction in assurance
engagement risk
to an acceptable level as the basis for a negative form of expression of the practitioner
‘s conclusion. Thus, the risk in limited assurance engagement is greater than for a
reasonable assurance engagement.
Assurance Engagement Risk:
 Assurance engagement risk is the risk that the practitioner expresses an inappropriate
conclusion when the subject matter information is materially misstated.
 Components of assurance engagement risk:
1. Risk of material misstatement – the risk that the subject matter is materially
misstated
a. Inherent risk – the susceptibility of the subject matter information to a material
misstatement, assuming that there are no related controls
b. Control risk – the risk that a material misstatement that could occur will not be
prevented, or detected and corrected, on a timely basis by related internal
controls
2. Detection risk – the risk that the practitioner will not detect a material misstatement
that exists

Assertion-based and Direct Reporting Engagements:

1. Assertion based engagements – evaluation or measurement of the subject matter is
performed by the responsible party, and the subject matter information is in the form of
an assertion by the responsible party that is made available to the interested users
 Assertion-based engagements are also known as attestation engagements
 Examples of assertion-based engagements:
a. Audit engagements
b. Review engagements
2. Direct reporting engagements – the practitioner either directly performs the evaluation
or measurement of the subject matter, or obtains a representation from the responsible
party that has performed the evaluation or measurement that is not available to the
intended users
Range of Assurance Engagements:
a. Engagements to report on a broad range of subject matters covering financial and non-
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financial information
b. Attest and direct reporting engagements
c. Engagements to report internally and externally, and
d. Engagements in the private and public sector

Examples of Assurance Engagements:

1. Audits of financial statements
2. Examination of prospective financial statements
3. Reporting on compliance with laws, rules and regulations
4. Other assurance services:
a. CPA risk advisory
b. Business performance measurement services
c. Health care performance measurement services
d. Elder Care Plus
e. Risk Assessment Services
f. CPA Web Trust Service
g. Information Systems Reliability

Requirements before a practitioner can accept an assurance engagement:

Only where the practitioner ‘s knowledge of the engagement circumstances indicates that:
1. Relevant ethical requirements, such as independence and professional competence will be
satisfied; and
2. The assurance engagement exhibits all of the following characteristics:
a. The subject matter is appropriate
b. The criteria to be used are suitable and are available to the intended users
c. The practitioner has access to sufficient appropriate evidence to support the
practitioner ‘s conclusion;
d. The practitioner ‘s conclusion, in the form appropriate to either a reasonable
assurance engagement or a limited assurance engagement, is to be contained in a
written report, and
e. The practitioner is satisfied that there is a rational purpose for the engagement.

Elements of Assurance Engagements:

Not all engagements performed by practitioners are assurance engagements. An assurance
engagement must have the following elements:
1. Three party relationship (involving a practitioner, a responsible party and intended users)
2. Appropriate subject matter
3. Suitable criteria
4. Sufficient appropriate evidence
5. Written assurance report in the form appropriate to a reasonable assurance engagement
or a limited assurance engagement

Three Party Relationship:

a. Practitioner – CPA in public practice who performs the assurance engagement
b. Responsible party – person/s who is responsible for the subject matter or the assertion
(subject matter information)
For example, an entity ‘s management is responsible for the preparation and presentation
of financial statements or the establishment and implementation of internal control.

c. Intended user/s – person, persons or class of persons for whom the practitioner
prepares the assurance report; they are the users to whom the practitioner usually
addresses the report
Appropriate Subject Matter:
Subject matter refers to the information to be evaluated or measured against the criteria.
Subject matter information means the outcome of the evaluation or measurement of a
subject matter.
Subject matter in an audit of financial statements:
 Subject matter includes the financial position, financial performance and cash flows of the entity
 Subject matter information is the set of financial statements
Requirements for subject matter to be considered appropriate:
a. Identifiable
b. Capable of consistent evaluation and measurement against suitable criteria
c. In the form that can be subjected to procedures for gathering evidence to support that
evaluation or measurement

Forms of subject matter of an assurance engagement:

1. Financial performance or conditions (for example, historical or prospective
financial position, financial performance and cash flows) for which the subject matter
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information may
be the recognition, measurement, presentation and disclosure represented in the
financial statements
2. Non-financial performance or conditions (for example, performance indicators of
an entity) for which the subject matter information may be key indicators of efficiency
and effectiveness
3. Physical characteristics (for example, capacity of a facility) for which the subject
matter information may be a specifications document
4. Systems and processes (for example, entity ‘s internal control or IT system) for
which the subject matter information may be an assertion about effectiveness
5. Behavior (for example, corporate governance, compliance with regulation, human
resource practices) for which the subject matter information may be a statement of
compliance or a statement of effectiveness

Suitable Criteria:
Criteria refer to the standard or benchmark used to evaluate or measure the subject matter
of an assurance engagement, including, where relevant, benchmarks for presentation and
disclosure. Without frame of reference provided by suitable criteria, any conclusion is open to
individual interpretation and misunderstanding.

Five characteristics of suitable criteria:

a. Relevance – relevant criteria contribute to conclusions that assist decision-making by
the intended users
b. Completeness – criteria are sufficiently complete when relevant factors that could
affect the conclusions in the context of the engagement circumstances are not
omitted. Complete criteria include, where relevant, benchmarks for presentation and
disclosure.
c. Reliability – reliable criteria allow reasonably consistent evaluation or measurement
of the subject matter when used in similar circumstances by similarly qualified
practitioners
d. Neutrality – neutral criteria contribute to conclusions that are free from bias
e. Understandability – understandable criteria contribute to conclusions that are clear,
comprehensive, and not subject to significantly different interpretations

Two types of criteria:

1. Established criteria – are those criteria that are embodied in laws or regulations or
issued by authorized or recognized bodies of experts that follow a transparent due process
Examples:
2. Specifically developed criteria – those criteria specifically designed for the purpose of
the engagement

Whether criteria are established or specifically developed affects the work that the
practitioner carries out to assess their suitability for a particular engagement.
Examples of suitable criteria:
• Applicable financial reporting framework which is the Philippine Financial Reporting
Standards (PFRS) – in case of audit of financial statements
• Applicable law or regulation or contract – in case of compliance audit
• Established internal control framework or stated internal control criteria – in case
of report on internal control
Availability of criteria to intended users:
Criteria need to be made available to the intended users in one or more of the following
ways:
a. Publicly
b. Through inclusion in a clear manner in the presentation of the subject matter
information
c. Through inclusion in a clear manner in the assurance report
d. By general understanding, for example, the criterion for measuring time in
hours and minutes
Sufficient Appropriate Evidence:
The practitioner shall plan and perform the engagement with an attitude of professional
skepticism to obtain sufficient appropriate evidence that the assertions are free of material
misstatements.

 Sufficiency – refers to the measure of the quantity of evidence

 Appropriateness – refers to the measure of the quality of evidence, that is, its relevance and its
reliability
Written Assurance Report:
A written assurance report should be in the form appropriate to a reasonable assurance
engagement or a limited assurance engagement.
The practitioner should provide a written report containing a conclusion that conveys the
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assurance obtained about the subject matter information. In addition, the practitioner considers
other reporting responsibilities, including communicating with those charged with governance
when it is appropriate to do so.

Levels of assurance provided in the written report:

Type or level of Form of conclusions Example

assurance
Reasonable Positive form of ―In our opinion internal control is
assurance expression of the effective, in all material respects, based on
practitioner‘s conclusion XYZ criteria.
Limited assurance Negative form of ―Based on our work described in this report,
Expression of the nothing has come to our attention that causes
practitioner‘s conclusion us to believe that internal control is not
effective, in all material respects, based on XYZ
criteria.

Attestation Services:
An attestation service is a type of assurance service in which a practitioner is engaged to
issue a written communication that expresses a conclusion about the reliability of a written
assertion that is the responsibility of another party. Attestation generally refers to an expert's
written communication of a conclusion about the reliability of someone else's assertions.

The subject matter of attestation services includes:

 Financial and non-financial in nature
 Future-oriented financial information (such as the examination of prospective financial
information)
 Management's discussion and analysis
 Effectiveness of internal control
 Compliance with statutory, regulatory, and contractual obligations

Relationships among Auditing, Attestation, and Assurance Services:

a. Similarity: These services are often used interchangeably because they encompass the
same decision-process
b. Main difference/distinction: Scope of services
 ―Assurance services‖ is broader in scope and in concept than either auditing or
attestation. It encompasses both audit and attestation services. Otherwise stated,
attestation and audit services are subsets of assurance services.
 ―Attestation services‖ is broader than audit because attest function is beyond historical FS.
Attestation services cover even non-GAAP FS.
 Auditing, particularly FS audit, is a type of assurance and attestation service that
involves examination of historical FS prepared in accordance with GAAP.

Non-assurance Engagements:
Not all engagements are assurance engagements. Other engagements performed by
practitioners that do not meet the definition of assurance engagement are classified as non-
assurance engagements or services. Non-assurance engagements are those that do not
result in the practitioner ‘s expression of a conclusion that provides a level of assurance, whether
negative assurance or other form of assurance. The practitioner does not convey to the intended
users any assurance as to the relabel laity of an assertion.

The practitioner ‘s primary purpose for performing non-assurance services is to provide advice
and technical assistance that will enable a client to conduct its business more effectively.

Examples of non-assurance engagements:

1. Related services, such as:
a. Agreed-upon procedures engagements, and
b. Compilations of financial or other information engagements
2. Tax services (such as the preparation of tax returns where no conclusion conveying
assurance is expressed)
3. Consulting (or advisory) engagements, such as management and tax consulting
Agreed-upon Procedures Engagements:
 Objective of agreed-upon procedures engagements: For the auditor to carry out
procedures of an audit nature as agreed by the auditor and the entity and any appropriate
third parties and to report on factual findings
 No assurance is expressed in the report: The users/recipients of the report assess for
themselves the procedures and findings reported by the auditor and form their own
conclusions from the report by the auditor.
 Distribution of report is restricted: The report on agreed upon procedures
engagement is restricted to those parties that have agreed to the procedures to be
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performed since others who are unaware of the reasons for the procedures may
misinterpret the results.
 According to PSRS 4400, the report on an agreed-upon procedures engagement needs to
describe the purpose and the agreed-upon procedures of the engagement in sufficient
detail to enable the users of the report to understand the nature and extent of the work
performed.

Compilation of Financial or Other Information Engagements:

 Objective of compilation engagements: For the accountants to use accounting
expertise, as opposed to auditing expertise, to collect, classify and summarize financial
information. Compilation engagements ordinarily include preparation of financial
statements.
 No test of assertions: A compilation engagement ordinarily entails reducing detailed
data to a manageable and understandable form without a requirement to test the
assertions underlying that information.
 No assurance is expressed in the report: The procedures employed are not designed
to enable the accountant to express any assurance on the financial information.
 Benefit to users: Users of the compiled financial information derive some benefit as a
result of the accountant's involvement because the service has been performed with
professional competence and due care.

Tax Services:
1. Tax compliance – includes the preparation of tax returns (for individuals, corporations,
estates and trusts, and other entities) and acting as client ‘s representative to tax
authorities or in tax litigations
2. Tax planning – includes the determination of the tax consequences of planned or
potential transactions (legally minimizing client ‘s tax liability) followed by making
suggestions on the most desirable course of action

Management Consulting:
Management advisory (consulting) services – refers to the function of providing
professional advisory (consulting) services, the primary purpose of which is to improve client ‘s
use of its capabilities and resources to achieve the objectives of the organization. Advisory
(consulting) services are professional services that provide advice and assistance to clients by
improving their condition directly. Advice or assistance to clients may cover the entity ‘s
organization, operations, risk management, systems design and implementation, process
personnel, corporate finances, or other activities.

A pervasive characteristic of a CPA ‘s role in a consulting services engagement is that of

being an
objective advisor on the use of information.

Assurance Services vs. Consulting Services:

Although assurance services and consulting services have basic similarities in terms of
knowledge employed and exercise of skills, they can be distinguished as follows:

Points of distinction Assurance services Consulting services

Primary purpose To improve quality or context To recommend uses for information
of information by enhancing its for better outcomes
credibility
Number of parties 3 parties 2 parties: the CPA and the client
Focus Decision makers and
information they used for Outcomes
optimum decisions
Output’s objective Intended to improve decision Designed to improve client‘s
maker ‘s condition only condition directly through findings,
indirectly through the use of conclusions and recommendations
high-quality
information
Competing interests May exist between No competing interests
management and users of
financial statements
Form of communication Written report Either written or oral
with the client communication

Comparative Examples of Assurance and Non-Assurance Services:

Categories of Services / Engagements
Assurance Services Non-Assurance Services
Audit Review Other assurance
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1. Audit of 1. Review 1. Examination of 1. Agreed-upon procedures

FS of FS prospective FS 2. Compilation of financial or other
information
2. Audit of 2. Review 2. CPA risk 3. Preparation of tax returns when no
internal of advisory conclusion is expressed
control interim 4. Consulting or advisory services:
over financial  Tax consulting
financial informati  Management consulting
reporting on  Other advisory services

Levels of Assurance for Audit, Review, Agreed-upon Procedures and Compilation

The basic distinction between audit, review and related services is the level of assurance
provided by the auditor in the engagement.

Assurance refers to the practitioner ‘s satisfaction as to the reliability of an assertion being

made by one party for use by another party. The level of assurance is the degree of the
practitioner ‘s satisfaction or degree of certainty the practitioner has attained and wishes to
convey to intended users. Such level or degree of assurance depends on the procedures
performed and the evidence collected by the practitioner.
Engagements and level of assurance:
1. Audit: The auditor provides a reasonable (high, but not absolute) level of assurance that
the information subject to audit is free of material misstatement. This is expressed
positively in the audit report as reasonable assurance.
2. Reviews: The auditor provides a moderate/limited level of assurance that the information
subject to review is free of material misstatement. This is expressed in the form of
negative assurance.
3. Agreed-upon procedures: No assurance is expressed. The auditor simply provides a
report of the factual findings. Users of the report assess for themselves the procedures
and findings reported by the auditor and draw their own conclusions from the auditor's
work.
4. Compilation: Although the users of the compiled information derive some benefit from
the accountant's involvement, no assurance is expressed in the report.

Distinctions between Typical Assurance and Non-Assurance Services:

Point Non-Assurance Services (Related Services)

Assurance Services
of
Audit Review Agreed-upon Compilation
distin procedures
ction
Objecti To express To report whether To perform audit To assist the client in
ve opinion on anything has come procedures agreed on financial statements
fairness of to the auditor ‘s with the client and any preparation by using
financial attention that appropriate third accounting expertise as
statement causes him to parties identified in the opposed to auditing
believe that the report expertise
financial
statements are not
fair
Charac Audit opinion Substantially less Recipients of the report Accounting expertise,
teristic enhances the in scope of must form their own rather than auditing, is
s credibility of procedures than conclusions from the used
financial audit report Users derive some benefit
statements Report is restricted to because the service has
contracting parties been performed with due
professional skill and care
Eviden Risk Limited to: Reading of the FS for
ce assessment, Inquiry; and As agreed obvious misstatements
gatheri Tests of Analytical
ng controls and procedures
proced Substantive (The auditor
ures tests obtains an
understanding of
the entity and its
environment,
including internal
control, but no
evaluation of
internal
control is
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conducted.)

Level of Reasonable
assuran assurance Moderate (limited) No assurance No assurance
ce (High, but not assurance
provide absolute,
d by the assurance)
CPA
Report Audit Report Review Report Factual findings of Compilation Report which
provide containing containing negative procedures identify information
d positive assurance on compiled
assurance on assertion
assertion
Skills Audit skills Audit skills Audit skills Accounting skills
used
by the
auditor

Pronouncements on Assurance Engagements:

The following are the forms of pronouncements of the Auditing and Assurance Standards
Council (AASC):
AASC Engagement Applications Related Practice
Standards Statements
a. Philippine Standards on FS audit engagements Philippine Auditing Practice
Auditing (PSAs) Statements (PAPSs)
b. PSREs Review engagements Philippine Review Engagement
Practice Statements (PREPSs)

. Philippine Standards on Other assurance Philippine Assurance Engagement

Assurance Engagements engagements dealing with Practice Statements (PAEPSs)
(PSAEs) subject matters other than
historical financial
information
d. Philippine Standards on Related services Philippine Related Services
Related Services (PSRSs) Practice Statements (PRSPSs)

Other pronouncements:
e. Philippine Standards on Quality Control (PSQCs) – to be applied for all services that
fall under the AASC ‘s engagement standards, namely, audit, review, other assurance,
and related services
f. Philippine Framework for Assurance Engagements – to be applied for assurance
engagements
Philippine Framework for Assurance Engagements:
The Framework:
 Defines and describes the elements and objectives of an assurance engagement.
 Identifies engagements to which assurance engagement standards (PSAs, PSREs, and
PSAEs) apply
 Provides frame of reference for:
a. Practitioners who perform assurance engagements (such as audit and review
engagements)
b. Others involved with assurance engagements (such as the intended users and the
responsible party), and
c. The International Auditing and Assurance Standards Board (IAASB) in its development
of assurance engagement standards which will be adopted by the AASC for application
in the Philippines.
 Distinguishes assurance engagements and non-assurance engagements (non-assurance
engagements are not covered by the Framework).
 Sets out characteristics that must be exhibited before a practitioner can accept an
assurance engagement.
In addition to the Framework and PSAs, PSREs and PSAEs, practitioners who perform
assurance engagements are governed by:
• The Code of Ethics for Professional Accountants in the Philippines
• The Philippine Standards on Quality Control (PSQCs)
The Framework does not itself establish standards or provide procedural requirements for the
performance of assurance engagements.
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Reports on Non-Assurance Engagements:

a. Should not use the words ―assurance‖, ―audit‖ or ―review‖
b. Should not imply compliance with assurance engagement standards (PSAs, PSREs or
PSAEs)
c. Should not include a statement that may be misinterpreted as assurance engagements

Practitioner’s association with the subject matter: A practitioner is associated with financial
information when:
a. The practitioner reports on information about that subject matter, that is, the practitioner
attaches a report to that financial information; or
b. The practitioner consents to the use of his name in a professional connection with that
subject matter
If the practitioner is not associated in this manner, third parties can assume no responsibility
of the practitioner.

Remedies in case of inappropriate use of the practitioner’s name by other party:

If the practitioner learns that a party is inappropriately using the practitioner ‘s name in
association with a subject matter, the practitioner should:
 Require the other party (i.e., management) to cease associating the practitioner with the
subject matter
 Consider what other steps may be needed, such as informing any known third party users
of the inappropriate use of the practitioner ‘s name
 Seek legal advice

INTRODUCTION TO AUDITING

Auditing, Defined:

Auditing is ―a systematic process of objectively obtaining and evaluating evidence

regarding assertions about economic actions and events to ascertain the degree of
correspondence between those assertions and established criteria and communicating the results
to the interested users. ‖

Two processes of auditing:

a. Investigative process – involves the systematic gathering and evaluation of evidence as
a basis for determining whether assertions made by responsible person correspond with
the established criteria
b. Reporting process – involves communicating the audit opinion to interested users

Important Concepts:
1. Systematic process – auditing involves structured/logical series of sequential steps or
procedures known as the audit process
2. Objectively obtaining and evaluating evidence – auditing involves gathering and evaluating
sufficient appropriate audit evidence that will support the auditor ‘s opinion
• Objectivity refers to the combination of impartiality, intellectual honesty and freedom from
conflicts of interest.
• Audi evidence is the information obtained by the auditor in arriving at the conclusions on
which the audit opinion is based.
3. Assertions about economic actions and events – assertions are the subject matter of auditing
• In the context of audit of financial statements, assertions are representations of
management, explicit or otherwise, that are embodied in the financial statements. Assertions
include the accounts, balances/amounts and disclosures appearing on the face of the financial
statements (and in the notes to financial statements) and which the management claims to be
free of misstatements.
• Audit evidence gathered and evaluated by the auditor may support or contradict the
assertions of management.
4. Established criteria – the standards or benchmarks that are needed to judge the validity of the
assertions on the financial statements
• In the context of audit of financial statements, the established criteria are the applicable
financial reporting framework (for example, the PFRS).
5. Ascertain the degree of correspondence between assertions and established criteria – The
auditor ‘s objective is to determine whether the assertions conform with established criteria, that is,
whether the financial statements are prepared, in all material respects, in accordance with the
applicable financial reporting framework (such as the PFRS).
6. Communicating the results to the interested users – The ultimate objective of audit is the
communication of audit findings/opinion on the fairness of the financial statements to interested
users.
• Communicating results is achieved through issuance of a written audit report which contains
the audit opinion (or disclaimer of opinion).
• Interested users are the wide variety of financial statements users who rely on the auditor ‘s
opinion such as the stockholders, creditors, potential investors and creditors, management,
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government agencies, and the public (in general).

FS audit is an Assurance Engagement:
Financial statements audit engagement is an assurance engagement because it provides a
reasonable (high but not absolute) level of assurance that the subject matter conforms in all
material respects with identified suitable criteria. It has the elements of an assurance
engagement as follows:
1. Three Party Relationship:
a. Practitioner: Independent or External auditor
b. Responsible party: Client ‘s management
c. Intended users: Users of financial statements
2. Subject matter: Assertions/Financial statements of the client company
3. Criteria: Applicable financial reporting framework / GAAP in the Philippines (PFRS)
4. Sufficient appropriate evidence: Auditor obtains sufficient appropriate audit evidence as a
basis for audit conclusion/opinion
5. Written Assurance Report: Independent auditor ‘s report contains the audit
conclusion/opinion

Need for Independent Audit of Financial Statements:

The primary economic reason for an audit of financial statements is the demand by external
users for reliable or fairly stated financial statements that they will use in making economic
decisions. Thus, the market for auditing services is driven by demand by external financial
statements users.

An audit can help reduce information risk, that is, the risk that the financial statements that
will be used for decision-making are materially misleading, unreliable or inaccurate.

Four conditions/reasons that gave rise to a demand for independent audit of financial statements:
a. Potential conflict of interest between users and preparers of the financial
information can result in biased information – Client management may not be objective
in financial reporting. It may provide impressive but biased, unrealistic, or misleading
financial statements to obtain benefits that it seeks. On the other hand, financial statement
users need unbiased, realistic, or reliable financial statements.
b. Remoteness of users – Users do not have access to entity ‘s records to personally verify
the reliability of the financial information.
c. Complexity of subject matter requires expertise – Expertise is often required for
information preparation and verification. Users of financial statements are not equipped
with the necessary skills, competence, and knowledge of complexities of accounting and
auditing to determine whether the financial statements are reliable.
d. Consequence for decision making – Financial statements are used for important decisions
that involve significant amount of money. If a decision is based on misleading financial
information, it could have substantial financial or economic consequences on decision
makers.

Another condition that gave rise to demand for audit of financial statements is the stewardship
or agency theory which means that management wants the credibility an audit adds to the
financial statement to enhance stewardship of the financial statement and to lessen the owner‘s
mistrust of the management.
Elements of Theoretical Framework of Auditing:

Auditing concepts and standards are based on the following postulates and assumptions
which form part of the elements of theoretical framework of auditing:

1. An audit benefits the public. – the primary beneficiary of reliable financial statements
is the wide variety of users (intended users)
2. Financial data and statements to be audited are verifiable. – if financial statements
are not verifiable, there can be no audit
 Financial statements or data are verifiable if two or more qualified individuals, working
independently, each reach essentially similar conclusions.
3. The auditor should always maintain independence with respect to the client
whose financial statements are subject to audit. – audit opinion and the audit report
would be of little or no value if auditor is not independent
4. Effective internal control system reduces the possibility of errors and fraud
affecting the financial statements. – Internal control affects the reliability of the
financial statements. The stronger the internal control is, the lesser the possibility of
errors and fraud, and consequently, the more reliance on internal control can be placed or
assurance that it can generate reliable accounting data and financial statements.
5. There should be no long-term conflict between the auditor and the client
management.
– Short-term conflicts may exist between the management who prepare the data and
auditors who examine the data but such conflicts must be resolve since both must be
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interested in fairness of the financial statements.

6. Consistent application of GAAP results in fair presentation of FS. – The criterion in
financial statement audit is an identified or applicable financial reporting framework, which
is usually the PFRS.
7. What was held true in the past will continue to hold true in the future in the
absence of known conditions to the contrary. – Experience and knowledge
accumulated from auditing a client in prior years can be used to determine the
appropriate audit procedures that need to be performed.

Examples of Instances Requiring Independent Financial Statements Audit:

 Application for a bank loan
 Establishing credit worthiness for purchase of merchandise, equipment, or other assets
 Reporting financial position, operating results, and cash flows to absentee owners
(stockholders or partners)
 SEC requirements:
 Issuance of securities by a corporation
 Annual FS by a corporation with securities listed on a stock exchange or traded over
the counter
 Sale of a business (such as merger) requires due diligence audit
 Termination of a partnership
 Preparation of income tax returns
 Establishing losses from fire, theft and burglary
 Bankruptcy and insolvency cases

Audit of Financial Statements:

Audit of financial statements is the objective examination of financial statements to enable
the auditor to express an opinion on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting framework.

Audit of financial statements is sometimes called:

• Independent audit because in an audit of financial statements the auditor is independent
of the client subject to audit.
• External audit because it is performed by an external auditor who is not an employee of
the client subject to audit.
• Financial audit
Various descriptions:
Independent auditing has been described in a variety of ways, as follows:
• It involves objective examination of and reporting on financial statements prepared by
management
• It is a discipline which attests to the results of accounting and other functional
operations and data.
• It lends credibility to the financial statements.
• It provides increased assurance to users as to the fairness of the financial statements.
• Its essence is to determine whether the client ‘s financial statements are fairly stated.
• It enhances the degree of confidence of interested users in the financial statements.
• It provides reasonable assurance that the financial statements fairly reflect the economic
substance of the transactions and events reflected in those statements.
Purpose of an Audit of Financial Statements:
The purpose of an audit is to enhance the degree of confidence of intended users in the
financial statements. Such purpose is achieved by the expression of an opinion by the auditor on
whether the financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework.

Overall Objectives of the Independent Auditor:

a. To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error.
b. To report on the financial statements and to communicate such report in accordance with
the auditor ‘s findings.

Auditor’s opinion and reasonable assurance:

The auditor's opinion, as expressed in the auditor ‘s report, enhances the credibility of the
financial statements by providing a reasonable assurance that the financial statements are
fairly presented or free from material misstatement.

Audit opinion is based on whether reasonable assurance is obtained:

1. When reasonable assurance is obtained: Auditor shall express an unqualified opinion
2. When reasonable assurance cannot be obtained: The auditor is required to:
a. Express a qualified opinion in the auditor ‘s report
b. If qualified opinion is insufficient in the circumstances:
• Disclaim an opinion or
 11

• Withdraw from the engagement, where withdrawal is legally

permitted
Audit Opinion and Audit Report:
Audit opinion:
 In a financial statement audit, the auditor obtains sufficient appropriate audit evidence to
be able to draw conclusions on which to base that opinion. The auditor ‘s opinion is on the
fairness of the audited financial statements.
 The auditor's opinion helps establish the credibility of the financial statements.
Auditor’s report:
 the primary product of an audit engagement
 the end product of the audit process
 a written report that contains auditor ‘s opinion about the fairness of the FS
 the medium through which the auditor communicates the results of his or her work
Example of Standard Independent Auditor’s Report (pls. refer to PSA 700; pls.
memorize)
Importance of audit opinion/audit report:
 It lends credibility to the FS.
 It provides increased assurance (reasonable assurance) to users as to the fairness of the
FS.
An FS audit is:
 NOT a certification or guarantee as to accuracy or fairness of the FS.
 NOT an assurance as to future viability of the entity.
 NOT an assurance as to efficiency or effectiveness of the client ‘s business
operations.
 NOT attestation as to the financial strength of an entity, the wisdom of its
management decisions, or the risk of doing business with it.
Scope of an Audit of Financial Statements:
 The auditor ‘s opinion on the financial statements deals with whether the financial
statements are prepared, in all material respects, in accordance with the applicable
financial reporting framework.
 The auditor ‘s opinion or the audit of financial statements is:
 NOT an assurance as to future viability of the entity.
 NOT an assurance as to efficiency or effectiveness with which client ‘s management
has conducted the affairs of the entity.
 NOT attestation as to the financial strength of an entity, the wisdom of its
management decisions, or the risk of doing business with it.
 NOT a certification or guarantee as to accuracy or fairness of the financial statements.
 When an applicable law or regulation requires an auditor to provide opinions on other
specific matters (such as the effectiveness of internal control, or the consistency of a
separate management report with the financial statements) the auditor would be required
to undertake further work if he had additional responsibilities to provide such opinions.
Financial Statements:
 Financial statements are a structured representation of historical financial information
(including related notes which comprise a summary of significant accounting policies and
other explanatory information), intended to communicate an entity ‘s economic resources
or obligations at a point in time or the changes therein for a period of time in accordance
with a financial reporting framework.
 The term ―financial statements‖ ordinarily refers to a complete set of financial statements,
but can also refer to a single financial statement.
End Products of Audit Engagement:
a. Independent auditor ‘s report – the primary product of audit engagement
b. Certain other communication and reports – other communication and reporting
responsibilities to users, management, those charged with governance, or parties outside
the entity, in relation to matters arising from the audit (as may be required by the PSAs
or by applicable laws or regulations)
Examples:
 Communication with those charged with governance
 Auditor ‘s responsibilities relating to fraud in an audit of financial statements
Management Responsibility for the Financial Statements:
An audit in accordance with PSAs is conducted on the premise that management and, where
appropriate, those charged with governance have acknowledged and understand that they have
responsibility over the financial statements.

Management responsibility over the financial statements includes:

1. Responsibility for the preparation and presentation of the financial statements in
accordance with the applicable financial reporting framework which includes:
a. Identification of applicable financial reporting framework, in the context of any
relevant laws or regulations
b. Preparing the financial statements in accordance with that framework
 12

c. Adequate description of that framework in the financial statements

d. Making reasonable accounting estimates
e. Selecting and applying appropriate accounting policies
2. Responsibility for designing, implementing and maintaining internal control that is relevant
or necessary to enable the preparation of financial statements that are free from material
misstatement, whether due to fraud or error, and
3. Responsibility to provide the auditor with:
a. All information (such as records, documentation and other matters) that are relevant
to the preparation and presentation of the financial statements
b. Any additional information that the auditor may request from management for the
purpose of the audit; and
c. Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.

Auditor’s responsibility vs. client management’s responsibility:

• The client management, with oversight from those charged with governance, has the
responsibility for the preparation and presentation of the financial statements in accordance with
the applicable financial reporting framework. In other words, the management is primarily
responsible for the fairness of the financial statements.
• The auditor ‘s responsibility for the financial statements is confined to the expression of
opinion on them. The audit of the financial statements does not relieve management or those
charged with governance of their responsibilities over the financial statements because the
auditor merely audits the financial statements.
• However, an auditor may make suggestions on the form and content of financial statements
or may draft statement.
Applicable Financial Reporting Framework:
Applicable financial reporting framework means the financial reporting framework
adopted by management (and, where appropriate, those charged with governance) in the
preparation of the financial statements that is acceptable in view of the nature of the entity and
the objective of the financial statements, or that is required by law or regulation.
The applicable financial reporting framework often encompasses financial reporting standards
established by:
 An authorized or recognized standards setting organization (such as PFRS)
 Legislative or regulatory requirements

Requirements Relating to an Audit of Financial Statements:

1. Relevant ethical requirements – The auditor shall comply with relevant ethical
requirements, including those pertaining to independence, relating to financial statement
audit engagements.
Relevant ethical requirements ordinarily comprise:
a. Code of Ethics for Professional Accountants in the Philippines (the Code of
Ethics) promulgated by the Board of Accountancy
Compliance with the Code of Ethics is necessary in order to ensure the highest
quality of performance and to maintain public confidence in the profession and in the
context of audit of financial statements, maintain public confidence in the auditor ‘s
work.
(1) Part A of the Code of Ethics – establishes the fundamental principles of
professional ethics relevant to the auditor when conducting an audit of financial
statements and provides a conceptual framework for applying those principles
The fundamental principles of professional ethics are:
a) Integrity
b) Objectivity
c) Professional competence and due care
d) Confidentiality, and
e) Professional behavior
(2) Part B of the Code of Ethics – illustrates how the conceptual framework is to be
applied in specific situations
(3) Independence
Independence requirements comprise of both:
a) Independence of mind
b) Independence in appearance
b. National requirements that are more restrictive
c. Philippine Standard on Quality Control (PSQC) – require the CPA firm to establish
and maintain its system of quality control designed to provide it with reasonable
assurance that the firm and its personnel comply with relevant ethical requirements,
including those pertaining to independence
2. Professional skepticism – The auditor shall plan and perform an audit with professional
skepticism recognizing that circumstances may exist that cause the financial statements
to be materially misstated.
 13

Professional skepticism is an attitude that includes a questioning mind, a critical

assessment of validity of audit evidence, and being alert to conditions which may indicate
possible misstatement due to error or fraud.
Professional skepticism is necessary to the critical assessment of audit evidence. This
includes:
a. Questioning contradictory audit evidence
b. Considering the reliability of documents and responses to inquiries and other
information obtained from management and those charged with governance
c. Considering the sufficiency and appropriateness of audit evidence obtained in the light
of the circumstances (for example, in the case where fraud risk factors exist and a
single document, of a nature that is susceptible to fraud, is the sole supporting
evidence for a material financial statement amount)

Professional skepticism includes being alert to:

• Audit evidence that contradicts other audit evidence obtained.
• Information that brings into question the reliability of documents and responses to
inquiries to be used as audit evidence.
• Conditions that may indicate possible fraud.
• Circumstances that suggest the need for audit procedures in addition to those
required by the PSAs.

The auditor may accept records and documents as genuine unless the auditor has reason to
believe the contrary. In cases of doubt about the reliability of information or indications of
possible fraud, the PSAs require that the auditor investigate further and determine what
modifications or additions to audit procedures are necessary to resolve the matter.

Maintaining professional skepticism throughout the audit is necessary to reduce the risks of:
• Overlooking unusual circumstances.
• Over generalizing when drawing conclusions from audit observations.
• Using inappropriate assumptions in determining the nature, timing and extent of the
audit procedures and evaluating the results thereof.
The auditor cannot be expected to disregard past experience of the honesty and integrity of
the entity ‘s management and those charged with governance. Nevertheless, a belief that
they are honest and have integrity does not relieve the auditor of the need to maintain
professional skepticism in conducting the audit.
3. Professional judgement – The auditor shall exercise professional judgment in planning and
performing an audit of financial statements.

Professional judgment is essential to the proper conduct of an audit. This is because

interpretation of relevant ethical requirements and the PSAs and the informed decisions
required throughout the audit cannot be made without the application of relevant
knowledge and experience to the facts and circumstances.
Professional judgment needs to be exercised throughout the audit. It also needs to be
appropriately documented. In this regard, the auditor is required to prepare audit
documentation sufficient to enable an experienced auditor, having no previous connection
with the audit, to understand the significant professional judgments made in reaching
conclusions on significant matters arising during the audit. Professional judgment is not to
be used as the justification for decisions that are not otherwise supported by the facts and
circumstances of the engagement or sufficient appropriate audit evidence.

4. Sufficiency and appropriateness of audit evidence and audit risk – To obtain

reasonable assurance, the auditor shall obtain sufficient appropriate audit evidence to reduce
audit risk to an acceptably low level and thereby enable the auditor to draw reasonable
conclusions on which to base the auditor ‘s opinion.

a. Sufficiency and appropriateness of audit evidence

Audit evidence includes information used by the auditor in arriving at the

conclusions on which the auditor ‘s opinion is based. Audit evidence includes both:
 Information contained in the accounting records underlying the financial
statements and
 Other information
Sufficiency is the measure of the quantity of audit evidence. Sufficiency is
influenced or affected by:
(1) The auditor ‘s assessment of the risks of misstatement (the higher the assessed
risks, the more audit evidence is likely to be required) and
(2) The quality of such audit evidence (the higher the quality, the less may be
required)
Appropriateness 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
 14

auditor ‘s opinion is based. The reliability of evidence is influenced by its source and
by its nature, and is dependent on the individual circumstances under which it is
obtained.
Whether sufficient appropriate audit evidence has been obtained to reduce audit
risk to an acceptably low level, and thereby enable the auditor to draw reasonable
conclusions on which to base the auditor ‘s opinion, is a matter of professional
judgment.
Sources of audit evidence:
a. Primarily obtained from audit procedures performed during the course of the
audit
b. May be obtained from other sources such as:
• Previous audits (provided the auditor has determined whether changes have
occurred since the previous audit that may affect its relevance to the current audit)
or
• A firm ‘s quality control procedures for client acceptance and continuance
• The entity ‘s accounting records
• An expert employed or engaged by the entity
In some cases, the absence of information (for example, management ‘s refusal to
provide a requested representation) is used by the auditor, and therefore, also
b. Audit risk
Audit risk is the risk that the auditor expresses an inappropriate opinion when the
financial statements are materially misstated. Audit risk is a function of the risks of
material misstatement and detection risk.
Risk of material misstatements is the risk that the financial statements are
materially misstated prior to audit. Risk of material misstatement may exist at two
levels:
1. Overall financial statement level – refer to risks of material misstatement that
relate pervasively to the financial statements as a whole and potentially affect
many assertions
2. Assertion level – refer to risks of material misstatement that relate to classes of
transactions, account balances, and disclosures

Risk of material misstatement at the assertion level has two components:

(a) Inherent risk – the susceptibility of an assertion about a class of transaction,
account balance or disclosure to a misstatement that could be material, either
individually or when aggregated with other misstatements, before
consideration of any related controls
(b) Control risk – the risk that a misstatement that could occur in an assertion
about a class of transaction, account balance or disclosure and that could be
material, either individually or when aggregated with other misstatements, will
not be prevented, or detected and corrected, on a timely basis by the entity ‘s
internal control
Control risk is a function of the effectiveness of the design, implementation and
maintenance of internal control by management to address identified risks that
threaten the achievement of the entity ‘s objectives relevant to preparation of the
entity ‘s financial statements. However, internal control, no matter how well
designed and operated, can only reduce, but not eliminate, risks of material
misstatement in the financial statements, because of the inherent limitations of
internal control. Accordingly, some control risk will always exist.
(c) Detection risk is the risk that the procedures performed by the auditor to
reduce audit risk to an acceptably low level will not detect a misstatement that
exists and that could be material, either individually or when aggregated with
other misstatements.

Detection risk relates to the nature, timing and extent of the auditor ‘s procedures
that are determined by the auditor to reduce audit risk to an acceptably low level.
It is therefore a function of the effectiveness of an audit procedure and of its
application by the auditor.

For a given level of audit risk, the acceptable level of detection risk bears an inverse
relationship to the assessed risks of material misstatement at the assertion level. For
example, the greater the risks of material misstatement the auditor believes exists,
the less the detection risk that can be accepted and, accordingly, the more persuasive
the audit evidence required by the auditor.

The following matters assist to enhance the effectiveness of an audit procedure and of
its application and reduce the possibility that an auditor might select an inappropriate
audit procedure, misapply an appropriate audit procedure, or misinterpret the audit
results:
• Adequate planning
 15

• Proper assignment of personnel to the engagement team

• The application of professional skepticism, and
• Supervision and review of the audit work performed

Detection risk, however, can only be reduced, not eliminated, because of the inherent
limitations of an audit. Accordingly, some detection risk will always exist.
5. The auditor shall conduct an audit in accordance with PSAs
 PSAs contain basic audit principles and essential procedures together with related
guidance in the form of explanatory and other material which the auditor should
follow

An audit in accordance with PSAs includes:

a. Compliance with PSAs relevant to the audit
1) Compliance with all PSAs relevant to the audit (a PSA is relevant to the audit when
the PSA is in effect and the circumstances addressed by the PSA exist)
2) Having an understanding of the entire text of a PSA (including its application and
other explanatory material) to understand its objectives and to apply its
requirements properly
3) Prohibition from the auditor from representing compliance with PSAs in the auditor
‘s report when he has not complied with the requirements of PSAs relevant to the
audit
b. The use of the objectives stated in relevant PSAs in planning and performing the audit
to achieve the overall objectives of the auditor.
 In using the objectives, the auditor is required to have regard to the
interrelationships among the PSAs. This is because the PSAs deal in some cases
with general responsibilities and in others with the application of those
responsibilities to specific topics.
c. In addition, the auditor should also consider Philippine Auditing Practice Statements
(PAPSs). PAPSs provide interpretative guidance and practical assistance to auditors in
implementing the PSAs and to promote good practice in the accountancy profession.

GENERAL PRINCIPLES OF FINANCIAL STATEMENT AUDIT

The auditor should plan and perform the audit with an attitude of professional skepticism
recognizing that circumstances may exist that may cause the fs to be materially misstated.

Because of the possibility that the FS may be materially misstated, the auditor should conduct the
audit with an attitude of professional skepticism. For example, the auditor would ordinarily expect to
find evidence to support management representations and not assume they are necessarily correct.

Attitude of professional skepticism: means the practitioner makes a critical assessment, with a
questioning mind, of the validity of evidence obtained and is alert to evidence that contradicts or
brings into question the reliability of documents or representations by the responsible party. In
planning and performing the audit, the auditor neither assumes that the management is honest nor
assumes unquestioned honesty.

Concept of Reasonable Assurance:

Although an independent FS audit in accordance with PSAs lends credibility to the FS, such
audit is designed to provide only reasonable assurance, rather than absolute assurance, that the
FS taken as a whole are free from material misstatement, whether due to fraud or error. In other
words, the level of assurance provided by an audit of detecting a material misstatement is
referred to as reasonable assurance. Reasonable assurance means high, but not absolute,
assurance.

Reasonable assurance refers to the gathering of the audit evidence necessary for the auditor
to conclude that there are no material misstatements in the FS, taken as a whole. This concept
recognizes the existence of audit risk.

Notes on reasonable assurance:

 Reasonable assurance relates to the conclusion of the auditor that there are no material
misstatements in the FS taken as a whole.
 Reasonable assurance is achieved when the auditor has reduced audit risk to an
acceptably low level by designing and performing audit procedures to obtain sufficient
appropriate audit evidence to be able to draw reasonable conclusions on which to base an
audit opinion.
 Reasonable assurance relates to the whole audit process.
 Absolute assurance in audit of FS is not attainable. Accordingly, the audit opinion is not a
guarantee or certification that the financial statements are free from material
 16

misstatements.

When reasonable assurance cannot be obtained and a qualified opinion cannot be

expressed, the auditor should:
 Disclaim an opinion, or
 Withdraw from the engagement (if legally permitted)

As the basis for the auditor ‘s opinion, PSAs require the auditor to obtain reasonable assurance
about whether the financial statements as a whole are free from material misstatement, whether

The level of assurance provided by an audit of detecting a material misstatement is referred to as

Reasonable assurance.

Limitations of Financial Statements Audit: (Reasons why absolute assurance in auditing is

not attainable or why reducing audit risk to zero is not attainable)

Absolute assurance in auditing is not attainable because of inherent limitations in an audit

that affect the auditor ‘s ability to detect material misstatements. These limitations result from
factors such as:
1. Need for auditor’s judgment

The auditor ‘s work requires exercise of professional judgment such in the following
matters:
 Identifying and addressing risk factors
 Deciding what evidence to gather
 Making decisions about materiality and audit risk
 Gathering and evaluating audit evidence (for example, in deciding the nature, timing
and extent of audit procedures)
 Evaluating management ‘s judgments in applying the entity ‘s applicable financial
reporting framework.
 Assessing the sufficiency and appropriateness of audit evidence
 Drawing of conclusions based on the evidence gathered
 Forming an opinion (the phrase ―in our opinion‖ in the auditor ‘s report is intended
to inform that auditors based their conclusions on professional judgment)

2. Use of testing / sampling risk – An audit is conducted on a test basis or by examining

only sample of less than 100% of a population. This may introduce some risk that a
misstatement will not be detected.

3. Reliance on management representation – Some audit evidence must be obtained by

obtaining oral or written representations from management because many FS assertions
cannot be audited.

4. Inherent limitations of accounting and internal control – Although the auditor

performs audit procedures to detect material misstatements, such procedures may not be
effective in detecting misstatements resulting from the possibility of:
 management override of controls
 circumvention of internal control
 collusion among employees

5. Nature of audit evidence available – This is the fact that most of the evidence
available to the auditor is persuasive, rather than conclusive, in nature.

6. Undetected fraud – Fraud is specifically designed not to be detected. Thus, there is

always the possibility that fraud will not be detected.

7. Availability of audit evidence – Insufficient support may be available for drawing

absolute conclusions on specific assertions such as fair value estimates.

8. Other limitations may affect the persuasiveness of audit evidence available to

draw conclusions on particular assertions (for example, transactions between related
parties).

Not a limitation of audit: Physical limitations of auditors due to fatigue and stress.

Concept of Materiality and Audit Risk

1. Materiality: the magnitude of misstatement or omission; the ability to influence the

economic decision of reasonable FS user
 17

The auditor obtains and evaluates audit evidence to obtain reasonable assurance about
whether the FS are fair or are presented fairly, in all material respects, in accordance
with the applicable financial reporting framework.

When is a misstatement or omission material? It is material if it could influence the

economic decision of FS users. If it is probable that the judgment of a reasonable person
would have been changed or influenced by the omission or misstatement of information,
then that information is material.

Meaning of the term "present fairly, in all material respects": The auditor considers
only those matters that are significant to the FS users; the phrase refers to the auditor’s
expression of opinion

2. Audit Risk: the risk that audit opinion is inappropriate

 specifically, it is the risk that the auditor expresses an inappropriate (unqualified)
audit opinion when the FS are materially misstated
 concept of reasonable assurance acknowledges the existence of audit risk
General Types of Audit:
1. According to objectives or nature of assertion
a. Financial statement audit – an audit conducted to determine whether the financial
statements of an entity are fairly presented in accordance with an identified financial
reporting framework (or PFRS)
• An of financial statements is the type of audit most frequently performed by CPAs
(due to the widespread use of audited financial statements) on a fee basis and for
more than one client.
• Financial audit is also called:
 External audit – because it is performed by external auditors, whether
individual CPAs or CPA firms, who are not employees of the client
 Independent audit – because the auditor is independent of the client
subject to audit
 Financial audit
b. Compliance audit: a review of an entity ‘s degree of compliance with applicable laws
and rules/regulations or contracts; usually performed by government auditors
Examples: Examination conducted by:
i) BIR examiners: compliance of taxpayers with tax law, rules or regulations
ii) BSP examiners: compliance of banks with banking laws, rules or regulations
iii) COA auditors: compliance of government transactions/expenditures with
the requirements of applicable laws, rules or regulations
c. Operational audit involves a systematic review and evaluation of the specific
operating units (or procedures, methods or activities) of an organization in relation to
specified objectives for the purpose of measuring/assessing its performance in terms
of efficiency and effectiveness of operations, identifying opportunities for improvement
and making recommendations to improve performance (such as introduction of
controls to reduce waste).
 Also called performance audit or management audit
 Example: Evaluation of a company’s computerized accounting system
 Usually performed by internal auditors
 Efficiency relates to use of its resources, while effectiveness relates to
accomplishing objectives.

Internal auditor's responsibilities in operational audits:

In operational audits, the company's management is responsible for setting
operating standards. The internal auditor's responsibilities are to determine that:
a. Management has established such standards.
b. The standards are being met.
c. Deviations from established standards are being identified and corrected.
d. Corrective action has been taken.

Objective of operational auditing:

a. To assess performance in terms of efficiency and effectiveness of operations
(1) Effectiveness – To verify fulfillments of plans and sound business requirements
(2) Efficiency – To determine whether the entity is managing or utilizing its
resources economically and efficiently
b. To identify areas for improvement
c. To develop recommendations to improve performance (example of such as
introduction of controls to reduce waste)

Major differences between financial and operational auditing:

 The financial audit is oriented to the past whereas an operational audit
concerns performance for the future.
 18

 The financial audit report is distributed to many readers whereas the

operational audit report goes to a few managers.
 Financial audits are limited to matters that directly affect the financial
statements whereas operational audits cover any aspect of efficiency and
effectiveness.
2. According to types of auditor or their affiliation with the entity being examined:

a. External / Independent audit: performed by practitioners or independent CPAs who

offer their professional services for a fee to various clients on a contractual basis
 Independent or external auditors are not employees of the client
 External audit complements internal audit

b. Internal audit: audit performed by entity ‘s own employees known as internal

auditors; internal auditors investigate and apprise the effectiveness and efficiency of
operations and internal controls of the firm

Internal auditing is defined as "an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an organization
accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the
effectiveness of risk management, control, and governance processes."

Internal auditing includes the audit of:

 Financial and operating information;
 Compliance with policies, plans, procedures, laws, regulations, and contracts;
 The means of safeguarding assets and verifying their existence;
 The economy and efficiency with which resources are employed; and
 Operations or programs to ascertain whether results are consistent with established
objectives and goals and whether they are being carried out as prescribed.

Internal auditing is an appraisal control that measures and evaluates other controls. The
increased complexity and sophistication of business operations have required management to rely
on this appraisal control.

Internal auditors assist in the prevention of fraud by examining and evaluating the system of
internal control.

Internal auditors are required to review the means employed by the company to safeguard its
assets from various types of losses such as those resulting from fire, theft, unscrupulous or illegal
activities, and exposure to the elements.
c. Government auditing: audit performed by government employees whose main
concern is to determine whether persons or entities comply with government laws,
rules and regulations
Scope of government audit: may extend beyond FS audit to include:
i) FS audit
ii) Performance audit (includes (a) program results (effectiveness) audit and (b)
economy and efficiency audit)
iii) Compliance audit
A governmental audit is typically designed to determine whether the auditee has complied with
applicable laws and regulations.

The types of audits conducted by the Commission on Audit (COA) are financial audit and
performance audit. Performance audits include economy, efficiency, and program audits. Included
in the scope of financial and performance audits is determining whether the entity has complied
with applicable laws and regulations.

Government auditors are required to prepare a written report on the entity's internal control and
assessment of control risk made as part of a financial statement audit. The auditor's report
should include the following:

1. The scope of the auditor's work in obtaining an understanding of the entity's internal
control and in his/her assessment of control risk.

2. The entity's significant controls including those that are established to ensure
compliance with laws and regulations that have a material impact on the financial
statements.

3. The conditions, including the identification of material weaknesses, identified as a result of

the auditor's work.
 19

The Government Auditing Standards require auditors to prepare a written report on the entity's
internal control. This report should include the conditions, including the identification of material
weaknesses, discovered as a result of the auditor's work. However, the report should not give any
form of assurance on the design and effectiveness of the entity's internal control.

Government auditors are required to obtain an understanding of the possible financial statement
effects of laws and regulations having direct and material effects on amounts reported. Also, they
are required to make an assessment whether management has identified such laws that might
have such effects.

The audit of a government program involves obtaining information about the costs, outputs,
benefits, and effects of the program. Auditors attempt to measure the accomplishments and
relative success of the program based on the actual intent of the legislation that established the
program.

Types of Auditors:
1. Independent auditors or external auditors – are CPA firms and individual practitioners
who perform audit services on contractual basis for more than one client
 Independent auditor – because the auditor is independent with respect to the client
whose FS are being audited; External auditor – the auditor is an outsider (not an
employee of the client)
 Practitioners perform operational audits and compliance audits as part of consultancy
services
2. Internal auditors – they are employed by the entity thus they are not independent.
However, to operate effectively, an internal auditor must be independent of the line
functions of the entity. Internal auditors perform operational and compliance audits.
3. Government auditors – employed in government agencies
 BIR examiners perform compliance audits
 BSP examiners perform compliance and operational audits
 COA auditors perform compliance and operational audits

The relationship between an external auditor and an internal auditor is that both of them
use basically an identical approach; however, there are differences in the application of
auditing techniques.

The audit committee is composed of outside directors who are independent of management. The
primary purpose is to assure that the directors are exercising due care and external and internal
auditors are independent of management.

The following are some of the audit committee's functions:

 Select the external auditors.
 Review the external auditor's overall audit plan.
 Evaluate the results of external and internal audits.
 Review the internal auditing work schedule, budget, etc.
 Meet regularly with the internal auditing director.
 The above functions should increase public confidence on the fair presentation of the
company's financial statements.

Acceptability of the Financial Reporting Framework

The auditor should determine whether the financial reporting framework adopted by
management in preparing the FS is acceptable. An acceptable financial reporting framework is
what is referred to as the
―applicable financial reporting framework. ‖ The auditor determines whether the financial reporting
framework adopted by management is acceptable in view of the nature of the entity (for
example, whether it is a business enterprise, a public sector entity or a not for profit
organization) and the objective of the FS.

In FS audit, financial reporting frameworks that are acceptable as valid criteria include:
1. Philippine Financial Reporting Standards (PFRSs)
2. Philippine Accounting Standards (PASs)
3. International Accounting Standards (IASs)
4. Other authoritative basis

Financial statements need to be prepared in accordance with one, or a combination of the above-
cited financial reporting framework.

Distinction: Types of audit according to objectives or nature of assertion/data

Point of FS Audit Compliance audit Operational audit

distinction
 20

Primary To enable the auditor to To determine degree of To assess entity ‘s

objective express an opinion on compliance performance (in terms
the fairness of the FS of efficiency and
effectiveness)
Subject matter Assertion that the FS are Assertion that the Assertion that the
(Assertion) presented in accordance organization has organization ‘s
with identified financial complied with laws, activities/operations
reporting framework regulations and specific are conducted
(GAAP) procedures effectively and
efficiently in relation to
specified objectives
Established GAAP – Identified Applicable laws, Objectives (as set by
criteria financial reporting regulations and specific the board of directors)
framework (as by procedures (as set by
standard setting bodies) authoritative
bodies)
Sufficient Audit findings whether Findings on degree of Findings on
appropriate the FS are in accordance compliance assessment of
evidence / with Identified performance /
outcome financial reporting operations
framework (GAAP)
Communication Auditor‘s report Reports on the degree Recommendations or
of results to containing an opinion of compliance with suggestions on how to
intended users whether the FS are fairly applicable laws, improve operations
presented in accordance regulations or
with identified financial specific procedures
reporting framework
(GAAP)
Users of audit Different groups for Authoritative bodies Management of the
report different purposes; wide that sets down the entity
variety of users (both regulations, rules
internal and external and procedures
users)
Type of auditor Independent / external Government auditors Internal auditors
performing the auditors
audit – practitioners

GENERALLY ACCEPTED AUDITING STANDARDS

Auditing Standards:
Popularly known as the Generally Accepted Auditing Standards (GAAS)
The general guidelines that the auditors must follow in conducting the audit.
The minimum standards of auditor ‘s performance that must be achieved on each audit
engagement
The guidance for measuring the quality of the auditor ‘s performance

THE 10 GENERALLY ACCEPTED AUDITING STANDARDS (GAAS):

GENERAL STANDARDS – standards/criteria which present guidance in the personal qualifications

an auditor must possess to undertake the audit engagement

1. Adequate technical training a n d p r o f i c i e n c y : This

 Professional competence of the auditor is primarily met by having professional
education/training and practical experience in auditing
 Competence can also be acquired by the auditor through the following:
Continuing professional development
 Consulting others if additional technical information is eeded
 Coaching by more experienced staff
 Research to obtain knowledge of client business and industry
 Competence does not include warranting the infallibility of the work performed.
2. Independence: This standard requires that the auditor must be impartial when dealing
with the client or without bias with respect to the client entity. The auditor must be
independent in fact and in appearance.
a. Independence of mind – The state of mind that permits the expression of a conclusion
without being affected by influences that compromise professional judgment, allowing
an individual to act with integrity, and exercise objectivity and professional
skepticism; this is also known as―independence in fact‖ or independence in mental
attitude. ‖
 21

b. Independence in appearance – The avoidance of facts and circumstances or

situations that are so significant that would lead a reasonable and informed third party
or the public to believe or conclude that the auditor is not independent. In other
words, independence in appearance requires that activities or relationships that even
suggest or imply a possible lack of independence must be avoided by the auditor.
3. Due professional care: This standard requires that an auditor, in fulfilling his duties,
should act diligently and carefully, exercise reasonable prudence, and apply judgment in a
conscientious manner, carefully weighing the relevant factors before reaching a decision.
Exercise of due professional care in the performance of the audit requires:
 Observance of the standards of field work and reporting
 Critical review of the audit work performed at every level of supervision
 Degree of skill commonly possessed by others in the profession
 Exercise of the same components of professional care as a reasonable auditor would exercise
 Exercise of professional skepticism

STANDARDS OF FIELD WORK – the standards / criteria for planning and evidence-gathering

1. Adequate planning and proper supervision:

 Planning involves establishing the overall audit strategy for the engagement and
developing an audit plan. The auditor should also supervise the work of assistants.
Supervision is critical because of assistants ‘lack of experience.
 Audit programs are designed to enumerate appropriate action, and all work of staff
auditors should be reviewed by a qualified auditor. Audit program is developed
before substantive testing to ensure that adequate planning has occurred.

2. Sufficient understanding of the entity and its environment, including internal

control:
 As part of the planning activities, the auditor is required to obtain sufficient
understanding of the entity and its environment. This means that the auditor
should obtain a more detailed knowledge of the client's business and the
environment/industry in which the entity operates.
 A sufficient understanding of internal control is to be obtained to plan the audit.
Appropriate internal controls provide the auditor with confidence that material
misstatements will be prevented or detected on a timely basis.
 Strong internal control implies that the auditor will require less evidence.
 Weak internal control implies that the auditor will require more evidence.

3. Sufficient appropriate audit evidence:

 The auditor should obtain sufficient appropriate audit evidence by performing
audit procedures to be able to draw reasonable conclusions on which to base the
opinion regarding the financial statements under audit.
 Evidence gathering is sometimes called substantive testing. Any testing that
confirms the ending balance of an account is known as a test of a balance.
Evidence gathered to support an account by looking at the various transactions
that have affected it during the period is called a test of details.
 All specific audit work is performed in order to gather evidence.
 The quantity and quality of evidence to be gathered depends on the judgment of
the auditor.
 The decision as to how much evidence to be accumulated requires professional
judgment; not provided in the PSAs; the rule is; evidence must be sufficient to
afford a reasonable basis for opinion
STANDARDS OF REPORTING – standards on auditor ‘s expression of audit opinion through
a medium known as the auditor ‘s report

1. Whether the financial statements are in accordance with GAAP/PFRS:

Conformity with GAAP/PFRS is explicit in the auditor ‘s report
 Explicit statement means that the auditor should state whether or not the financial
statements subject to audit are prepared in accordance with GAAP/PFRS.
 When an overall opinion cannot be expressed, as where the auditor disclaims an
opinion, the reasons therefore should be stated.
2. Consistent application of GAAP/PFRS: Consistency is implicit in the auditor ‘s
report
 If there is no material consistency as to application of GAAP/PFRS, no statement
as to consistency is required in the auditor ‘s report. However, if a material
inconsistency exists, auditor shall identify such inconsistency in the auditor ‘s
report.
3. Adequacy of informative disclosures: Adequacy of disclosure is implicit in the
auditor ‘s report. If informative disclosure is adequate, no statement as to adequacy
of disclosure is required in the auditor ‘s report. However, if informative disclosure is
 22

inadequate, auditor must state such inadequacy in the auditor ‘s report.

4. Opinion regarding the financial statements taken as a whole: expression of

audit opinion is explicit in the auditor ‘s report

Objective of 4th standard of reporting:

 To indicate the character of the engagement and the degree of responsibility
assumed by the auditor. This would prevent FINANCIAL STATEMENTS users from
misinterpreting the degree of responsibility the auditor is assuming/taking.
 Reference to the expression "taken as a whole" in the fourth generally accepted
auditing standard of reporting means that the audit opinion applies equally to a
complete set of financial statements and to each individual financial statement.

Philippine Standards on Auditing (PSAs):

The PSAs are interpretations of GAAS, meaning, they are intended to clarify the meaning
of "generally accepted auditing standards."
The PSAs contains basic audit principles and essential procedures together with related
guidance in the form of explanatory and other material which the auditor should follow
when conducting financial statements audit.
Application of PSAs: PSAs apply to independent examination of (historical) financial
statements of any entity conducted for the purpose of expressing an opinion.
Compliance with PSA: The auditor should conduct an audit in accordance with PSA.
Compliance with PSAs means application of basic audit principles and performance of
essential audit procedures. Compliance with relevant PSAs is mandatory. Only in
exceptional instances where departure from relevant PSA is allowed such as when the
auditor believes that the:
 Amount involved is insignificant; or
 Requirement of the PSA is impractical to perform; or
 Requirement of the PSA is impossible to perform.

SYSTEM OF QUALITY CONTROL

NATURE OF SYSTEM OF QUALITY CONTROL:

One of the recognized objectives of the accountancy profession is to attain the highest levels
of performance. To achieve this objective, there is a need for assurance that all professional
services provided by CPAs are carried out to the highest quality or standards of performance.
Reasonable assurance of meeting such need is provided through a system of quality control.

A system of quality control refers to quality control policies and procedures adopted by CPA
firms that are designed to provide reasonable assurance that the firm and its personnel comply
with professional standards and regulatory and legal requirements and that reports issued by the
firm or engagement partners are appropriate in the circumstances.

System of Quality Control in an Audit Engagement: Policies and procedures to provide

reasonable assurance that all audits are conducted in accordance with PSAs and that audit reports
issued are appropriate in the circumstances

QC policies vs. QC procedures:

a. Quality control policies – are the objectives and goals to be achieved
b. Quality control procedures – are steps/procedures to be taken to:
 accomplish the policies adopted, or
 implement and monitor compliance with those policies

Mandatory requirement for CPA firms to establish SQC: Under Philippine Standard on
Quality Control 1 (PSQC 1) CPA firms are required to establish and implement a system of quality
control.
Nature and Extent of a System of Quality Control: The nature and extent of the SQC
developed by CPA firms vary from firm to firm due to various factors such as:
a. Size of the CPA firm
b. Nature of its practice
c. Operating characteristics
d. Its organization
e. Geographical dispersion
f. Cost-benefit consideration
g. Whether it is part of a network

Elements of System of Quality Control: Although the nature and extent of the system of
quality control developed by CPA firms vary from one firm to another, a system of quality control
 23

must have the following elements:

1. Leadership responsibilities for quality within the firm – The CPA firm should
establish policies and procedures that:
 Promote an internal culture based on recognition that quality is essential in the
performance of the engagements
 Require CPA firm ‘s leader (CEO/ managing board of partners or its equivalent), to
assume ultimate responsibility for the firm ‘s system of quality control.
2. Ethical requirements, including independence –
 The CPA firm should establish policies and procedures to provide reasonable assurance
that the firm and its personnel comply with relevant ethical requirements (including
independence):
3. Acceptance and continuance of client relationships and specific engagements –
The CPA firm should establish policies and procedures to provide reasonable assurance
that the CPA firm will only undertake or continue relationships and engagements where it:
a. Has considered the client ‘s integrity
b. Is competent to perform the engagement and has the capabilities, time and resources
to do so; and
c. Can comply with ethical requirements
4. Human resources – The CPA firm should establish policies and procedures to provide
reasonable assurance that it has sufficient personnel with the capabilities, competence,
and commitment to ethical principles necessary to perform the engagement.
5. Engagement performance – The CPA firm should establish policies and procedures to
provide reasonable assurance that engagements are performed in accordance with
professional standards and regulatory and legal requirements, and that the firm or
engagement partner issue reports that are appropriate in the circumstances.
6. Monitoring – The CPA firm should establish policies and procedures to provide
reasonable assurance that quality control is relevant, adequate and operating effectively
and complied with in practice and should include an ongoing consideration and evaluation
of the firm ‘s system of quality control, including a periodic inspection of a selection of
completed engagements.

The following shall also be included in the CPA firm’s SQC:

1. Complaints and Allegations: The firm should establish policies and procedures designed to
provide it with reasonable assurance that it deals appropriately with:
a. Complaints and allegations that the work performed by the firm fails to comply with
professional standards and regulatory and legal requirements; and
b. Allegations of non-compliance with the firm ‘s system of quality control.
2. Documentation: The firm should establish policies and procedures requiring appropriate
documentation to provide evidence of the operation of each element of its system of quality
control.

QUALITY REVIEW COMMITTEE:

 To ensure that CPAs work to the highest standards, the government thru the Professional
Regulatory Board of Accountancy (BOA) has required all CPA firms and individual CPAs in
public practice to obtain a certificate of accreditation to practice public accountancy. Such
certificate is valid for three
(3) years and can be renewed after complying with the requirements of the BOA.
 As a condition to the renewal of the certificate of accreditation to practice public
accountancy, the BOA requires individual CPAs and CPA firms to undergo a quality control
review to ensure that these CPAs comply with accounting and auditing standards and
practices.
 The BOA has created a Quality Review Committee (QRC) which shall conduct a quality review
on applicants for registration to practice public accountancy.
Functions of the Quality Review Committee:
 Conducts quality review on applicants for registration, or renewal thereof, to practice
public accountancy
 Render a report on such quality review, which shall be attached to the application for
registration
 Recommend to BOA revocation of registration and professional ID cards of CPAs for not
observing the SQC requirements

Quality review – an oversight into (or study or appraisal of) the quality of audit of FS through a
review of quality control measures established by CPA firms and individual CPAs in public practice to
ensure compliance with accounting and auditing standards and practices
 24

PRELIMINARY ENGAGEMENT ACTIVITIES (PRE-PLANNING ACTIVITIES)

Purpose of Preliminary Engagement Activities:

Preliminary engagement activities assist the auditor in identifying and evaluating events or
circumstances that may adversely affect the auditor ‘s ability to plan and perform the audit
engagement. Such activities help ensure that:
a. There are no issues with client management ‘s integrity that may affect the willingness to
continue the engagement
b. The auditor maintains the necessary independence and ability to perform the engagement
c. There is no misunderstanding with the client as to the terms of the engagement

Preliminary Engagement Activities:

1. Perform procedures regarding acceptance or continuance of the client

relationship

 Acceptance or selection procedures – in case of initial audit

(prospective/new client)

a. Evaluate integrity of the client ‘s management

 Evaluation of management integrity is necessary to avoid association with
clients whose management lacks integrity.
 Most of litigations involving CPAs are due to lack of integrity of client ‘s
management.
 Lack of management integrity usually results to high audit risk.
 Factors to consider in evaluating client ‘s integrity:
 Identity, attitude and business reputation of the client (such as its
principal owners, key management or those charge with corporate
governance, and related parties, if any)
 Nature of the client ‘s operations
 Indications of an inappropriate limitation in the scope of work
 Involvement in money laundering or other criminal activities
 The reasons for the proposed appointment of the CPA firm or auditor and
non- reappointment of the previous CPA firm or auditor

(1) Investigate/research the client’s background

 Internet searches
 Review the entity ‘s financial statements
 Consider engaging professionals/investigators to evaluate the principals associated
with the prospective client
 Obtain credit ratings and reports, if necessary

(2) Inquiring from other firm personnel or third parties (such as bankers, legal
counsel/advisors, industry peers and others in the financial or business community
who may have knowledge regarding the client)
(3) Communicate with prospective client’s predecessor auditor: Matters to be
inquired of or discussed with the predecessor (previous/former) auditor by the
incoming/successor auditor:
a) Facts/information that might bear on the integrity of the prospective client
b) Predecessor auditor ‘s understanding as to the reasons for the change of
auditors
c) Any disagreement between the predecessor auditor and the client regarding
accounting principles or auditing procedures or other similarly significant
matters
d) Communication to management, the audit committee, and those charged
with governance regarding fraud, illegal acts by the client, and matters
relating to internal control.

Under the Code of Ethics for CPAs, the successor auditor has the responsibility to
initiate communication with the predecessor auditor. However, the communication
requires prior client ‘s permission/consent (preferably in writing) to avoid violation of
confidentiality principle.
If the client is unwilling to agree to such communication (communication is not
permitted by the client or the client limits the responses of the predecessor auditor),
the successor auditor should:
 Consider the implications of such refusal/limitation, and
 Decide whether or not to accept the engagement.
 25

Continuance or retention procedures – in case of recurring audit (or existing

client) - To ensure the audit firm ‘s continuing compliance with acceptance and
continuance procedures, existing clients should be evaluated once a year or upon
occurrence of the following:
 Changes in management, directors or ownership
 Nature of client ‘s business

2. Evaluate compliance with ethical requirements, including independence

a. Independence – The CPA firm or auditor shall identify, evaluate and respond to any
threat to independence
 The CPA firm or auditor must be independent of the client whose financial
statements are subject to audit.
 Audit opinion is not credible or of little or no value if the auditor is not
independent.

b. Professional competence – determine if the CPA firm or auditor has the necessary
skills and competence
 Professional accountants should not portray themselves as having the required
expertise which they do not possess.
 The auditor should obtain preliminary understanding of prospective client ‘s
business
and industry to determine whether the auditor has the required degree of competence.
 If the auditor does not possess the industry expertise, he should obtain
knowledge of matters that relate to the nature of the entity ‘s business and
industry.
c. Ability to serve the client properly – the CPA firm or auditor must have capability,
time and resources to perform the audit

Examples:
 Availability of appropriately qualified staff when the work is
required
 The firm is able to complete the engagement within the reporting
deadline (proximity of the deadline)
 Consider the need for expert ‘s assistance and any conflicts of
interest
 Firm personnel have knowledge of relevant industries
 The firm has sufficient personnel with the necessary capabilities
and competence.

3. Establish an understanding of the terms of the engagement

 The CPA firm or auditor shall accept or continue an audit engagement only when: a. The
preconditions for an audit are present:
(1) Management has used acceptable financial reporting framework (or suitable criteria or
appropriate basis for) in the preparation of the financial statements
Factors to consider in determining the acceptability of the financial reporting
framework:
a. The nature of the entity (for example, whether it is a business enterprise, a public
sector entity or a not-for-profit organization);
b. The purpose of the financial statements (for example, whether they are prepared
to meet the common financial information needs of a wide range of users or the
financial information needs of specific users);
• Financial statements prepared in accordance with a financial reporting
framework designed to meet the common financial information needs of a wide
range of users are referred to as general purpose financial statements.
• Financial statements prepared in accordance with a financial reporting
framework designed to meet the financial information needs of specific users
are referred to as special purpose financial statements.
c. The nature of the financial statements (for example, whether the financial
statements are a complete set of financial statements or a single financial
statement); and
d. Whether law or regulation prescribes the applicable financial reporting framework.
Examples of financial reporting frameworks:
 IFRSs
 PFRSs
 IPSASs – International Public Sector Accounting Standards
 26

(2) Management agrees to the premise that it has acknowledged and understood its
responsibilities

If the preconditions for an audit are not present, the auditor shall not accept the proposed
audit engagement, unless acceptance is required by law or regulation. Preconditions for an
audit are within the control of the entity.

Preliminary conference: A preliminary conference with the client is scheduled after the
CPA has determined that:
The firm is independent
The firm is competent to perform the audit
The firm can serve the client properly, and
The client ‘s reputation is one of integrity

The terms of engagement are usually agreed with the client during a preliminary
conference with the client, and formalized through a signed engagement letter. During
the preliminary conference, the auditor and client agree on the following issues:
 The specific services to be rendered
 The cooperation and work expected to be performed by the client ‘s personnel
 Expected start and completion dates of the engagement
 The possibility that the completion date may be changed if unforeseen a unit
problems arise if unforeseen audit problems arise if adequate cooperation
from client ‘s personnel is not received
 The nature and limitations of the audit engagement
 An estimate of the fee to be charged for the engagement
Engagement letter – an agreement between the CPA firm or auditor and the client for
the conduct of the audit. It is a letter from the auditor to the client management, and
when signed by the client it serves as a formal written contract between them.

 Engagement letter documents and confirms the:

a. Auditor ‘s acceptance of the appointment
b. Client ‘s acceptance of the terms of the audit engagement
c. Responsibilities of both the client management and the auditor
d. Arrangements or agreed terms of the engagement (such as the objectives and scope of
the audit, the form of any reports, etc.)

Importance (primary reason) of an engagement letter: It clarifies the nature of the

engagement and the responsibilities of management and those of the auditor. This will help in
avoiding or minimizing or resolving future misunderstandings disagreement between the
auditor and the client with respect to the engagement.
 Engagement letter should be sent to the client preferably before the start of the engagement.
 An engagement letter is normally addressed to whoever hired the CPA.

Form and Contents of the Engagement Letter:

The form and content of engagement letters may vary for each client. Engagement letters
should be adapted according to individual requirements and circumstances of the engagement.
Generally, engagement letters should include reference to:

1. Principal Contents:
a. Objective and scope of the audit of the financial statements
b. Responsibilities of the auditor
c. Responsibilities of management
d. Identification of financial reporting framework for the preparation of the financial
statements
e. Reference to any form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its
expected form and content
2. In addition, and audit engagement letter may make reference to, for example:
 Elaboration of the scope of the audit, including reference to applicable legislation,
regulations, PSAs, and ethical and other pronouncements of professional bodies to
which the auditor adheres.
 The form of any other communication of results of the audit engagement
 The fact that because of the inherent limitations of an audit, together with the
inherent limitations of internal control, there is an unavoidable risk that some
material misstatement may not be detected, even though the audit was properly
planned and performed in accordance with the PSAs
 Arrangements regarding the planning and performance of the audit, including the
composition of the audit team
 27

 Expectation that management will provide written representations

 The agreement of management to make available to the auditor draft financial
statements and any accompanying other information in time to allow the auditor
to complete the audit in accordance with the proposed timetable
 The agreement of management to inform the auditor of facts that may affect the
financial statements, of which management may become aware during the period
from the date of the auditor ‘s report to the date the financial statements are
issued.
 Basis on which fees are computed and any billing arrangements
 A request for management to acknowledge receipt of the engagement letter and to
agree to the terms of the engagement outlined therein

3. Other arrangements, when relevant, such as:

 Involvement of other auditors and experts in some aspects of the audit
 Involvement of internal auditors and other staff of the entity
 Arrangements to be made with the predecessor auditor, if any, in the case of an
initial audit
 Any restriction of the auditor ‘s liability when such possibility exists
 A reference to any further agreements between the auditor and the client
 Any obligations to provide audit working papers to other parties
Audits of Components:
Factors to consider whether to send a separate engagement letter to the component when the
auditor of the parent company is also the auditor of its component (subsidiary, branch or
division):
1. Who appoints the auditor of the component?
2. Whether a separate auditor ‘s report is to be issued on the component
3. Legal requirements in relation to audit appointments
4. The extent of any work performed by other auditors
5. Degree of ownership by parent, and
6. Degree of independence of the component ‘s management from the parent entity

Audit Engagement in Recurring Audits:

1. The auditor may decide not to send a new engagement letter or other written agreement each
period.
2. The following factors may make it appropriate to send a new engagement letter:
a. Revision of the terms of audit engagement because:
 Any revised or special terms of the engagement
 A recent change of senior management or those charged with governance
 A significant change in ownership
 A significant change in nature or size of the client ‘s business
 A change in legal or regulatory requirements
 A change in the financial reporting framework adopted in the preparation the
financial statements
 A change in other reporting requirements
b. Reminder to the client of the existing terms of the engagement
 Any indication that the client misunderstands the objective and scope of the audit.
Audit procedures when the client requests for a change in engagement:
1. Consider the appropriateness of reasons for the engagement
2. If there is a reasonable justification for the change – stop the original engagement and
agree on the new terms of engagement. And then proceed with the new engagement
 To avoid confusing the users of the new report, do not mention the following in
the new report:
a. The original engagement
b. Any procedures that may have been performed in the original
engagement (except where
the engagement is changed to an engagement to undertake agreed- upon
procedures and thus the reference to the procedures performed is a normal part of
the report)
3. If there is no reasonable justification – refuse the client ‘s request, and continue to
perform the original engagement and issue the original report
 If the auditor is not permitted to continue the original engagement, the auditor
should withdraw from the engagement and consider reportorial responsibilities to
the BOD or shareholders of the client.

Whether or not to accept a change in engagement:

 28

 Change in the terms of the audit engagement: The auditor shall not agree where
there is no justification/basis for the change in the terms of the audit engagement.
Reasonable basis includes:
a. A change in circumstances affecting the entity ‘s requirements
For example, the client's bank required an audit before committing to a loan, but the
client subsequently acquired alternative financing.
b. A misunderstanding as to the nature of the service originally requested Not a reasonable
basis:
 Change that relates to information that is incorrect, incomplete or otherwise
unsatisfactory. For example, the entity asks for the audit engagement to be
changed to a review engagement to avoid a qualified opinion or disclaimer of opinion.
Change to a lower level assurance engagement: The auditor shall not agree where there
is no justification/basis for the change to a lower level assurance engagement.
1. The auditor should agree if there is reasonable basis, such as:
a. A change in circumstances affecting the entity ‘s requirements or need for the service
b. A misunderstanding as to the nature of an audit or related service originally requested
c. A restriction on the scope of the engagement, whether imposed by management or caused
by circumstances

If there is a reasonable change, no reference of the same shall be included in the

report.
2. Not agree if there is no reasonable justification – if the change relates to incorrect,
incomplete or otherwise unsatisfactory information.
For example, in an audit engagement, the auditor is unable to obtain sufficient appropriate
audit evidence regarding receivables and the client asks for the engagement to be changed to a
Revie w engagement to avoid a qualified audit opinion or a disclaimer of opinion.

Withdraw from the engagement – if the auditor is unable to agree to the change and is not
permitted/allowed to continue the original engagement because of his disagreement

CONSIDERATION OF INTERNAL CONTROL BASIC CONCEPTS AND ELEMENTS OF INTERNAL

CONTROL

Internal control (IC) – the process designed, implemented and maintained by those charged
with governance, management and other personnel to provide reasonable assurance about the
achievement of an entity ‘s objectives.

Essential concepts of internal control:

a. Internal control is a process. Internal control is not an end in itself but a means of achieving
the entity's objectives.
b. Internal control is effected by those charged with governance, management and other
personnel. Internal control is accomplished by people at every level of organization.
Responsibilities:
 Management: to design, implement and maintain internal control to assist in achieving
the entity's objectives
 Those charged with governance: to en
 Staff personnel: to perform their respective functions in order to accomplish the
objectives of the entity
c. Primary purpose/reason for establishing internal control is to provide reasonable assurance
about the achievement of an entity’s objectives.
d. Internal control can be expected to provide reasonable assurance of achieving the entity's
objectives – this is due to inherent limitations of any system of internal control; although
internal control is designed to prevent, detect and correct problems, an effective internal
control can only minimize but not eliminate material misstatements, whether due to fraud or
error.

Inherent limitations of internal control:

1. Management overriding the internal control.
2. Circumvention of internal controls through the collusion among employees.
3. The cost-benefit relationship is a primary criterion in designing internal control, that is, the cost of a
control should not exceed its expected benefits. This is known as the concept of reasonable
assurance.
4. Most internal controls tend to be directed at routine transactions rather than non-routine transactions.
5. The potential for human error due to carelessness, distraction, mistakes of judgment and the
misunderstanding of instructions. Human error may include errors in the design or use of automated
controls.
6. The possibility that procedures may become inadequate due to changes in conditions, and compliance
with procedures may deteriorate.
 29

7. Segregation of duties may be difficult to achieve in a smaller entity.

e. Internal control is designed to help achieve the entity's objectives. Internal control is geared
towards the achievement of the entity's objectives.

Entity’s objectives: what an entity strives to achieve Categories

of entity's objectives:
1. Financial reporting objective – this objective relates to reliability of financial reporting
2. Operational effectiveness objective – this objective is intended to enhance effectiveness and
efficiency of operations
3. Compliance objective – this objective relates to entity ‘s compliance with applicable laws and
regulations

Classification of internal control:

1. According to objectives:
a. Financial reporting controls – controls to achieve reliability of financial reporting
objective
b. Operational effectiveness controls – controls to achieve operational effectiveness
objective
c. Compliance controls – controls to achieve compliance objective

There is a direct relationship between the entity ‘s objectives and the internal control it implements to
provide reasonable assurance about their achievement. Both the entity ‘s objectives and controls relate
to financial reporting, operations and compliance.
2. According to functions:
a. Preventive controls – to deter problems before they arise Examples:
 Segregation of employee duties
 Control physical access to assets, facilities and information
b. Detective controls – to discover problems as they arise Examples:
 Preparing bank reconciliation
 Preparing monthly trial balance
c. Corrective controls – to remedy problems discovered with detective controls
Example:
 Maintaining backup copies of transactions and master files

Benefits of strong internal control:

 Reduced cost of an external audit
 Availability of reliable data for decision-making purposes
 Protection of important documents and records
 Assurance of compliance with applicable laws and regulations

Internal control objective relevant to the audit: not all entity ‘s objectives and internal
control are relevant to the auditor ‘s risk assessment

1. Relevant to the auditor – financial reporting objective Reasons:

 It is relevant to the financial statement assertions
 Pertain to the management of risk that may give rise to material misstatement to
financial statements

2. May be relevant to the auditor – operational and compliance objectives are not usually
relevant to the audit but may relevant to the auditor only if they relate to data the auditor
evaluates to determine the reliability of some financial statement assertions

Examples of operational controls that are not normally be relevant to the audit
production and staff scheduling, quality control, and employee compliance with health and
safety requirements. However, these may be relevant to the auditor if:

a. The information produced is used to develop an analytical procedure. For example:

 Controls pertaining to non-financial data that the auditor uses in analytical
procedures, such as production statistics
 Controls pertaining to detecting non-compliance with laws and regulations that
may have a direct and material effect on the financial statements, such as
controls over compliance with income tax laws and regulations used to
determine the income tax provision
b. The information is required for disclosure in the financial statements. Example,
 Controls to ensure the accuracy of such data to produce statistics that were
used as a basis for an analytical procedure
 Controls for detecting and reporting on non-compliance with certain laws and
regulations that has a direct and material effect on the financial statements
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Components of Internal Control: the interrelated components of internal control represent

means used by an entity to help it achieve its objectives (CRIME)

Five interrelated and essential components or aspects of internal control:

1. Control environment – the overall tone of the organization
2. Risk assessment – management ‘s identification and assessment of risks
3. Information, financial reporting and communication systems – a means of
recording transactions and communicating responsibilities
4. Monitoring the controls – assessment of internal control performance over time
5. Existing control activities – control policies and procedures

Component 1 – Control Environment:

 It sets the tone of an organization, influencing the control consciousness of its people.
 It includes the governance and management functions the attitudes, awareness, and
actions of those charged with governance and management concerning the entity ‘s
internal control and its importance in the entity.
 It is a set of characteristics that defined good control working relationships in an entity.
 It is the foundation for effective internal control for it provides an appropriate foundation
for other components of internal control.
Elements of control environment:
1. Integrity and ethical values – The entity should establish ethical standards. Ethical standards
influence the effectiveness of the design, administration and monitoring of controls.
2. Participation by those charged with governance (BOD and audit committee).
3. Management’s philosophy and operating style – Management ‘s approach to taking and managing
business risks, attitudes and actions toward financial reporting, and attitudes toward information
processing and accounting functions and personnel.
4. Assignment of authority and responsibility – How authority and responsibility for operating
activities are assigned and how reporting relationships and authorization hierarchies are established.
Appropriate methods of assigning responsibility must be implemented to avoid incompatible functions
and to minimize the possibility of errors because of too much work load assigned to an employee.
Commitment to competence – Management ‘s consideration of the competence levels for particular
jobs and how those levels translate into requisite skills and knowledge. Competence is the knowledge
and skills necessary to accomplish tasks that define the individual ‘s job.
6. Personnel or Human resource policies and procedures – The entity must implement appropriate
policies for recruitment/hiring, orientation, training, evaluating, counseling, promoting, compensating,
and remedial actions because the competence of the entity's employees will bear directly on the
effectiveness of the entity's internal control.
7. Organizational structure – The framework within which an entity ‘s activities for achieving its
objectives are planned, executed, controlled and reviewed. Establishing a relevant organizational
structure includes considering key areas of authority and responsibility and appropriate lines of
reporting. The appropriateness of an entity ‘s organizational structure depends, in part, on its size and
the nature of its activities.

Component 2 – Risk Assessment: An entity ‘s risk assessment for financial reporting purposes
is its identification, analysis, and management of risks relevant to the preparation of financial
statements that are fairly presented in conformity with generally accepted accounting principles.
(Note that this component concerns the assessment by management of risk facing the entity, not
the auditor's assessment of control risk.)

Matters the auditor should consider are how management:

a. Identifies business risks (inherent and residual risks) relevant to financial reporting;
b. Estimates the significance of the risks;
c. Assesses the likelihood of their occurrence; and
d. Decides upon actions to manage them.

Component 3 – Information and Communication System: Information and communication

systems support the identification, capture, and exchange of information in a timely and useful
manner.

The auditor shall obtain an understanding of the information system, including the related
business processes, relevant to financial reporting, including the following areas:

a. The classes of transactions in the entity ‘s operations that are significant to the financial
statements;
b. The procedures, within both information technology (IT) and manual systems, by which
those transactions are initiated, recorded, processed, corrected as necessary, transferred
to the general ledger and reported in the financial statements;
c. The related accounting records, supporting information and specific accounts in the
financial statements that are used to initiate, record, process and report transactions; this
includes the correction of incorrect information and how information is transferred to the
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general ledger.
d. The records may be in either manual or electronic form;
e. How the information system captures events and conditions, other than transactions, that
are significant to the financial statements;
f. The financial reporting process used to prepare the entity ‘s financial statements,
including significant accounting estimates and disclosures; and
g. Controls surrounding journal entries, including non-standard journal entries used to record
non- recurring, unusual transactions or adjustments.

The information system relevant to financial reporting objectives, which includes the
accounting system, consists of the methods and records established to record, process,
summarize, and report entity transactions (as well as events and conditions) and to maintain
accountability for the related assets, liabilities, and equity.

Communication involves providing an understanding of individual roles and responsibilities

pertaining to internal control over financial reporting. Communication may take such forms as
policy manuals and financial reporting manuals. Open communication channels help ensure that
exceptions are reported and acted on.

Component 4 – Control Activities: Control activities are the policies and procedures that
help ensure management ‘s directives are carried out and that necessary steps to address risks
are taken. Control activities address risks that if not mitigated would threaten the achievement of
the entity ‘s objectives.

The auditor should obtain a sufficient understanding of control activities to assess the risks of
material misstatement at the assertion level and to design further audit procedures responsive to
assessed risks.

Categories of Control activities: Categories of specific control activities that may be relevant to an audit:

1. Prenumbering of documents – helps to assure that:

a. All transactions are recorded (completeness).
b. No transactions are recorded more than once (existence).
2. Authorization of transactions – authorization should occur before commitment of resources
3. Independent checks to maintain asset accountability – independent checks involve the
verification of work previously performed by others
Examples include:
a. Review of bank reconciliations
b. Comparison of subsidiary records to control accounts
c. Comparison of physical counts of inventory to perpetual records
4. Documentation – provides evidence of the underlying transactions and is a basis for
establishing responsibility for the execution and recording of transactions
5. Performance reviews – includes review of the following:
a. Reviews and analyses of actual performance versus budgets, forecasts, and prior period
performance
b. Relating different sets of data to one another, together with analyses of the relationships
and investigative and corrective actions (for example, the management of a sports team
might use attendance data to ascertain the reasonableness of ticket sales).
c. Comparing internal data with external sources of information, and
d. Review of functional or activity performance (for example, sales reports, receivable reports,
etc., may be used to analyze performance and to identify errors).
6. Information processing controls – ensure that transactions are valid, properly
authorized, and completely and accurately recorded
a. Application controls – controls which apply to the processing of individual applications
Examples of application controls:
 Checking the arithmetical accuracy of records
 Maintaining and reviewing accounts and trial balance
 Automated controls such as edit checks of input data and numerical sequence
checks
 Manual follow-up of exception reports
 Controls surrounding receivables
 Controls surrounding payroll
b. General controls – which are controls that relate to many applications and support the
effective functioning of application controls by helping to ensure the continued proper
operation of information systems. General controls apply to information processing
throughout the company.
Examples of general controls:
 Program change controls
 Controls that restrict access to programs or data
 Controls over the implementation of new releases of packaged software
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applications
 Controls over system software that restrict access to or monitor the use of system
utilities that could change financial data or records without leaving an audit trail
 Controls over data center/network
7. Physical controls – are physical controls for safeguarding assets involve security devices
and limited access to programs and to restricted areas, including computer facilities
a. Physical segregation and security of assets, including adequate safeguards such secured
facilities over access to assets and records.
Examples of physical controls:
 Protective or security devices
 Bonded or independent custodians
 Physical and security of assets:
 Cash – placed in cash boxes, vault or safe deposit boxes
 Cash – deposited in a bank
 Inventory – placed in a warehouse
 PPE items – tagged with non-movable labels
b. Authorization for access to computer programs and data files (for example, requiring
password prior to access)
c. Authorized access to assets and records (such as through the use of computer access
codes, renumbered forms, and required signatures on documents for the removal
or disposition of assets)
d. Required signatures on documents for the removal or disposition of assets
e. Periodic counting and comparison with amounts shown on control records Examples:
 Comparing the results of cash, security and inventory counts with accounting
records
 Reconciliations
f. The extent to which physical controls intended to prevent theft of assets are relevant to
the reliability of financial statement preparation, and therefore the audit, depends on
circumstances such as when assets are highly susceptible to misappropriation.
8. Segregation of duties – involves ensuring that individuals do not perform incompatible duties.
Duties should be segregated such that the work of one individual provides a crosscheck on the
work of another individual.
A proper segregation of duties (or incompatible functions) requires that one person should
not be responsible for all phases of a transaction. It requires assigning different people the
responsibilities of:
 Authorizing transactions
 Recording transactions – recordkeeping
 Maintaining custody of assets involved in the transactions
This means that different employees authorize transactions in the asset, record the
transactions, and have custody of the asset.
Segregation of duties is intended to reduce the opportunities to allow any person to be in a
position to both perpetrate and conceal errors or fraud in the normal course of the person ‘s
duties.
Component 5 – Monitoring the Controls: Monitoring is a process that assesses the quality of
internal control performance on an ongoing basis. Management ‘s monitoring of controls includes
considering whether they are operating as intended and that they are modified as appropriate for
changes in conditions.

Monitoring assesses the effectiveness of the internal control ‘s performance over time. The
objective is to ensure the controls are working properly and, if not, to take necessary corrective
actions. Management accomplishes monitoring of controls through ongoing activities, separate
evaluations or a combination of the two.

Management ‘s monitoring activities may also include using information from external parties
such as complaints from customers or comments from regulatory bodies that may indicate
problems, highlight areas in need of improvement, or require communications relating to internal
control from external auditors.

CONSIDERING INTERNAL CONTROL

 Considering internal control – involves study and evaluation of internal control

 Reasons/purpose of the auditor’s study and evaluation of internal control:
1. Primary: to provide a basis for planning the audit to determine the nature, timing, and
extent of audit procedures
2. Secondary: to provide a basis for constructive suggestions to management about
improvements in internal control structure

 Steps in consideration of internal control:

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1. Obtain sufficient understanding of the internal control relevant to the audit – involves
obtaining understanding of the design and operation of internal control relevant to the audit
a. Evaluate the design of relevant control – involves determining whether the control,
individually or in combination with other controls, is capable of effectively preventing or
detecting and correcting material misstatements
Major emphasis in the design of effective control
a. Assets are properly protected
b. Duties are segregated
c. Transactions are authorized
b. Determine whether the control has been implemented – whether the control is placed
in operation; a control has been implemented if the control exists and is being used by the
entity
Procedures to obtain evidence about the design and implementation of controls:
 Inquiry of entity personnel (inquiry alone is not sufficient)
 Inspecting documents and records
 Observing of application of specific controls
 Performing a ―walk-through‖ test – tracing a transaction through the accounting
system, from initial recording to presentation in the financial statements
2. Perform preliminary assessment of control risk – the assessment of control risk is based
on understanding of internal control
a. Assess control risk at a high level:
(1) If internal control is poor or not effective, or
(2) If it is inefficient to rely on internal control (inefficient to perform tests of controls)
Auditor ‘s response if control risk is assessed at a high/maximum level:
 Skip or do not perform tests of controls
 Rely primarily on substantive tests
b. Assess control risk at less than high level:
(1) If internal control is effective or reliable, and
(2) If it is inefficient to obtain evidence to justify the assessment of control risk at less than
high level
Auditor ‘s response if control risk is assessed at less than high/maximum level:
 Perform tests of controls – to confirm operating effectiveness of controls
3. Perform tests of controls – tests of controls are performed when the auditor plans to rely on
internal control; the auditor will only test those controls that he plans to rely upon (controls that
are likely to prevent or detect and correct material misstatement relevant to the financial
statements)
a. Results of tests of controls does not confirm effectiveness of controls – the auditor should
revise the preliminary risk assessment of control risk from less than high to high level; the
auditor should also make the necessary revision on the overall audit strategy, audit plan and
preliminary audit program
b. Results of tests of controls confirm effectiveness of controls – the auditor may rely on entity
‘s internal control and decrease substantive testing

Tests of controls – Tests performed to test the operating effectiveness (as to design and operation) of
internal controls that are likely to detect or prevent material misstatements in support of a reduced
assessed level of control risk. Thus, tests of controls are performed to substantiate the reduced assessed
level of control risk
 Tests performed confirm that the controls tested are working effectively
 Unlike substantive tests of details, tests of controls are not required audit procedure.
 The greater the reliance the auditor plans to place on internal control, the more extensive the tests
of those controls that need to be performed.
 Tests of controls generally consist of one (or combination of the following evidence gathering
techniques:
a. Inquiry
b. Observation
c. Inspection
d. Reperformance

Required Documentation:

1. Document the understanding of accounting and internal control systems

2. Document the assessed level of control risk
 If the control risk is assessed at a high level, the auditor should document his
conclusion that control risk is at a high level.
 If the control risk is assessed at less than high level, the auditor should document:
a. His conclusion that control risk is at less than high level, and
b. The basis for that assessment – results of tests of controls confirming the
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assessment of control risk at below high/maximum level

Communicating with those charged with governance and management:

The auditor should communicate audit matters of governance interest arising from the audit
of financial statements with those charged with governance of an entity.

Governance refers to the role of persons entrusted with the supervision, control and direction
of an entity. Those charged with governance ordinarily are accountable for ensuring that the
entity achieves its objectives, financial reporting, and reporting to interested parties.

Reportable conditions are significant deficiencies/weaknesses in the design or operation of

the internal control which have come to the auditor‘s attention that should be reported to the
appropriate level of management such as the highest official of the company or those charged
with governance (usually to the entity‘s audit committee of the board of directors) in writing, in a
formal management letter (the by- product of the audit engagement) at the earliest
opportunity so that appropriate corrective actions may be taken as soon as possible.
A deficiency may be of such magnitude as to be considered a material weakness in internal
control. A material internal control weakness is a condition in which material errors or fraud
would ordinarily not be detected within a timely period by employees in the normal course of
performing their assigned functions.

No expression of opinion on entity’s internal control:

Consideration of internal control in financial statement audit is not sufficient to express an

opinion on an entity ‘s controls because only those controls on which an auditor intends to rely
are reviewed, tested, and evaluated. Moreover, the auditor is not required to identify or search
for internal control weaknesses.

Internal control weaknesses: Examples of significant weaknesses in internal control include:

 Weak control environment (such as ineffective oversight, poor attitude toward internal
control, or instances found of management override or fraud)
 Weaknesses in IT general controls.
 Significant business risks that have not been addressed by policies, procedures or internal
controls.
 Inadequate policies and procedures in place for:
 Appropriately assessing and applying accounting principles
 Determining accounting estimates and assessing their reasonableness
 Preparing the financial statements and the disclosures required, and
 Safeguarding assets
 Significant internal control activities or application controls not operating as designed, not
applied consistently by appropriate individuals, or not monitored by appropriate
individuals.
 Significant deficiencies previously communicated to management or those charged with
governance that remain uncorrected after some reasonable period of time.

ASSERTIONS, AUDIT PROCEDURES AND AUDIT EVIDENCE

ASSERTIONS AND AUDIT OBJECTIVES

Nature of Assertions:
Financial statements are not statements of facts. They are a collection of claims and
assertions, made implicitly or explicitly by the entity ‘s management, about the recognition,
measurement, presentation, and disclosure of information in the financial statements.

Assertions (or management assertions) are representations by management, explicit or

otherwise, that are embodied in the financial statements. These assertions relate to the fairness
of presentation of the financial statements, thus, they are directly related to applicable financial
reporting framework.
Examples of assertions:
 All the assets exist. (Existence)
 All sales transactions have been recorded. (Completeness)
 Inventories are properly valued. (Valuation)
 All amounts are properly presented and disclosed in the financial statements. (Accuracy)
Levels of Assertions:
1. Financial statement level – entity ‘s management representation that the financial
 35

statements as a whole are presented fairly, in all material respects, in accordance with the
applicable financial reporting framework
 For example, management asserts the financial statements are free from material
misstatements.
2. Account balance or class of transactions level – entity ‘s management representation
that the underlying account balances and class of transactions, including related disclosures,
are free of material misstatements
• For example, when considering the sales balance, management is asserting that sales
revenue is complete (completeness assertion), the transactions occurred (occurrence
assertion), and transactions have been appropriately recorded in the accounting records
(accuracy assertion).
(refer to acctng 9 modules)
Auditor’s Use of Relevant Assertions:
The auditor uses relevant assertions in developing audit objectives that will be the basis for
designing audit procedures. Relevant assertions are assertions that have a meaningful bearing
on whether an account is fairly stated. For example:
 Existence assertion, not valuation, is typically relevant to the audit of cash account.
 The valuation assertion would be relevant to assessing the inventory balance than
assessing sales balance.

The auditor should use relevant assertions to:

a. Consider the types of potential misstatements that may occur
Examples include:
 Does the asset exist? (Existence)
 Are all sales transactions recorded? (Completeness)
 Is inventory properly valued? (Valuation)
 Did the transaction occur? (Occurrence)
 Are amounts properly presented and disclosed in the financial statements?
(Accuracy)
b. Assess the risks of material misstatement – The auditor should identify what
controls have been implemented to address the relevant assertions.
Examples:
 How does management ensure transactions are recorded? (Completeness)
 How does management ensure that significant estimates are based on reasonable
assumptions and properly recorded in the financial statements? (Accuracy)
c. Design audit procedures that are responsive to the assessed risks
Examples:
 If the risk is high that receivables are being overstated, the audit procedures
should be designed to specifically address the valuation assertion.
 When the auditor designs test of controls, emphasis should be placed on testing
controls over the relevant assertions rather than just significant controls.
Audit Objectives:
The auditor develops audit objectives that relate to management assertions about the
financial statement components. To achieve audit objectives, the auditor shall design audit
procedures and gather sufficient appropriate audit evidence whether the assertions are in
accordance with the applicable financial reporting framework.
Types of Audit Objectives:
1. Whether general or specific:
a. General audit objectives – are broad objectives of auditing an account balance or
class of transactions
 Examples of general audit objectives include existence, completeness, valuation,
classification, cut-off, accuracy, presentation and disclosure, validity, ownership,
and overall reasonableness
b. Specific audit objectives – audit objectives stated in terms tailored to the specific
audit engagement

 The general audit objectives remain the same for every audit engagement, but the evidence varies,
depending on the circumstances. The general audit objectives are applicable to every account balance on
the financial statements.
 After the general objectives are understood, specific objectives for each account balance on the financial
statements can be developed. There should be one specific audit objective for each relevant general
objective.

2. Whether substantive or compliance

a. Substantive audit objectives – objectives that relate to the determination of the
validity of assertions on account balances or class of transactions or disclosures found
in the financial statements
b. Compliance audit objectives – objectives that relate to the degree of entity ‘s
 36

compliance with relevant controls

AUDIT PROCEDURES

Based on audit objectives, the auditor should plan and perform audit procedures. Audit
procedures are the means for obtaining sufficient appropriate audit evidence to satisfy financial
statement assertions and to support audit opinion on the fairness of the financial statements.
They are the detailed instructions for the collection of a particular type of evidence that is to be
obtained during the audit. Since audit procedures are performed to verify management
assertions, they would differ depending on the particular assertion or account audited.

Primary Purpose of Audit Procedures:

Audit procedures are performed to gather necessary (not all) corroborative evidence to
achieve audit objectives in order to result to sufficient appropriate audit evidence on the fairness
of the presentation of the entity ‘s financial statements.

Audit procedures distinguished from audit standards and audit techniques:

 Audit standards – measure of the quality of the audit performance; they are set by the
AASC, thus, they remain the same from one audit engagement to another
 Audit procedures – performed to meet the audit standards; determined by the auditor,
thus, they vary from audit to audit; although they vary from audit to audit, the auditor
should perform relevant essential audit procedures provided by the audit standards (PSAs)
 Audit techniques – methods used by the auditor or the details of the audit procedures;
they also vary from audit to audit

Nature, Timing and Extent of Audit Procedures:

a. Nature of an audit procedure – refers to:
Its purpose (i.e., test of controls or substantive procedure) and When RMM is assessed at high
level it affects the types of audit procedures to be performed and their combination.

b. Timing of an audit procedure – refers to when to perform the audit procedure, or

the period or date to which the audit evidence applies
Audit procedures are normally performed:
a. Early in the accounting period being examined
b. Throughout the accounting period being examined, but with emphasis of the transactions near the
end
c. Within one to three months after the close of the accounting period

Audit procedures performed before period end are known as interim work.
The nature and timing of the audit procedures to be used may be affected by the fact that some of the
accounting data and other information may be available only in electronic form or only at certain points or
periods in time.

c. Extent of an audit procedure – refers to the quantity to be performed or the extent

of
testing or the number of items to be examined (for example, a sample size, or the
number of observations of a control activity)

Audit Procedures for Obtaining Audit Evidence:

1. Risk assessment procedures – procedures to obtain an understanding of the entity and its
environment, including its internal control, in order to identify and assess the risks of material
misstatement (RMM)
Risk assessment procedures include:
a. Inquiry of management and other personnel
b. Analytical procedures (as a planning tool)
c. Observation and inspection

Risk assessment procedures alone do not provide audit evidence sufficient to support an audit opinion. Risk
assessment procedures must be supplemented by tests of controls, when necessary, and substantive
procedures.

2. Further audit procedures – The auditor shall design and perform audit procedures whose
nature, timing, and extent are based on and are responsive to the assessed RMM at the
assertion level.
Further audit procedures are actually audit procedures classified according to purpose
In designing the further audit procedures to be performed, the auditor shall:
(1) Consider the assessed RMM
 37

(2) Obtain more persuasive audit evidence the higher the auditor ‘s assessment of risk by:
a. Increasing the quantity of evidence; or
b. Obtain evidence that is more relevant or reliable (such an obtaining third party
evidence or by obtaining corroborating evidence from a number of independent
sources)

Auditor’s responses to assessed risks of material misstatements (RMM) include both:

a. Overall responses – The auditor shall design and implement overall responses to address the RMM at the
financial statement level.
Overall responses may include:
 Emphasizing to the audit team the need to maintain professional skepticism
 Assigning more experienced staff or those with special skills or using experts
 Providing more supervision
 Incorporating additional elements of unpredictability in the selection of further audit procedures to be
performed
 Making general changes to the nature, timing, or extent of audit procedures (such as performing
substantive procedures at the period end instead of at an interim date)
 Overall responses affect auditor ‘s general approach:
 Substantive approach – an approach whose emphasis is on substantive procedures
 Combined approach – an approach that uses both tests of controls and substantive procedures
b. Further audit procedures
Further audit procedures include:
(1) Tests of controls (compliance tests) – audit procedures designed to evaluate the
operating effectiveness of relevant controls in preventing, or detecting and correcting
material misstatements at the assertion level
 In designing and performing tests of controls, the auditor shall obtain more
persuasive audit evidence the higher/greater reliance the auditor places on the
effectiveness of a control.
 Test of controls, although not intended to detect material misstatements, may
provide evidence that a misstatement is likely to occur.

When to perform tests of controls:

a. When the auditor intends to rely on the operating effectiveness of relevant controls in determining the
nature, timing and extent of substantive procedures; or
 Tests of controls are performed only on those controls that the auditor has determined are suitably
designed to prevent, or detect and correct, a material misstatement in an assertion.
b. When substantive procedures alone cannot provide sufficient appropriate evidence at the assertion level
 For example, an entity conducts its business using IT and no documentation of transactions is produced
or maintained, other than through the IT system.

Dual purpose test:

 The auditor may design a test of controls to be performed concurrently with a test of details on the same
transaction. Although the purpose of a test of controls is different from the purpose of a test of details, both
may be accomplished concurrently by performing test of controls and test of details on the same transaction,
also known as a dual-purpose test.
(2) Substantive procedures – audit procedures designed to detect material
misstatements at the assertion level
Other best descriptions: Substantive procedures may also be described as audit
procedures that are designed to:
 Detect material peso/monetary errors or fraud
 Substantiate the validity of management's assertions regarding the financial
statements. Thus, substantive procedures are sometimes called validation
procedures because they provide evidence about the existence of
misstatement.
 Gather evidence in respect to all material classes of transactions, account
balances, and disclosures.
 Be performed in response to the assessment of the risks of material
misstatement at the assertion level, which includes the results of tests of
controls, if any. In other words, substantive procedures are performed in
response to the planned level of detection risk.

Substantive procedures are mandatory:

Irrespective of the assessed risks of material misstatement, substantive procedures are required for all
relevant assertions related to each material class of transactions, account balance, and disclosure. This
requirement reflects the fact that:
a. The auditor ‘s assessment of risk is judgmental and so may not identify all risks
of material misstatement; and
b. There are inherent limitation to internal control
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Substantive testing cannot be eliminated. However, it may be reduced by auditor ‘s reliance on

entity ‘s effective internal control.

Nature, timing and extent of substantive tests:

When internal control is not reliable, the auditor will have to perform extensive substantive tests. Thus, the
result of test of controls is a major factor in determining the nature, timing and extent of substantive tests.
1. Nature: relates the quality of audit evidence (performing more effective or less effective audit
procedures)
2. Timing: also relates to the quality of evidence (performing the audit procedures at year-end or at
interim date)
3. Extent: relates to the quantity of audit evidence (using larger sample size or smaller sample size)

Reliance on substantive tests:

The reliance placed on substantive tests in relation to the reliance placed on internal control has an inverse
relationship.
Types of substantive procedures:

Whether or not to use substantive analytical procedures or to perform tests of details of

transactions and balances, the auditor usually considers the relative effectiveness and efficiency of
the tests.
1. Tests of details – examining or obtaining audit evidence on the actual details of account
balance, class of transactions, and disclosure
 The objective of tests of details is to substantiate or identify misstatements in the recorded
amounts.
Directional testing – refers to the direction of an audit test
a. Tracing – if the auditor starts from original source documents and traces forward to the accounting
records, this tests the assertion of completeness. This helps the auditor identify understatement
errors.
b. Vouching – If the auditor starts from the accounting records and vouches backwards to the original
source documents, this tests the assertion of existence or occurrence. This helps the auditor
identify overstatement errors.
a) Test of details of transactions – testing of transactions which give rise to the ending
balance of a given account; these involve examining authorization, recording and posting of
transactions (such as examining receipts or disbursements of Cash account)
 Applicability of test of details of transactions: It is used when the account being
substantiated has relatively few or smaller volume of transactions of relatively material
amounts occurring during the year (for example, PPE, intangibles, bonds payable and
stockholders ‘equity accounts)
 Test of transactions are often performed several months prior to the balance sheet date.
 Tests of details of transactions primarily involve tracing and vouching.
b) Tests of details of balances – direct testing of accounts ending balance
 Tests of details of balances focus on obtaining evidence directly about an account
balance.
 More types of evidence are obtained using tests of details of balances than by using any
other type of test.
 Test details of balances is usually the costliest to perform.
 Applicability of test of details of balances:
 For accounts whose balances are affected by large volume transactions of relatively
immaterial amounts (such as cash, accounts receivable and inventories).
 If an account has a high turnover rate with many transactions occurring during the
year, the auditor generally will concentrate more on the ending balance total.
 It is used when the auditor is satisfied that internal control is strong.
2. Substantive analytical procedures – these are analytical procedures performed during testing
phase to substantiate predictable relationships among both financial and non-financial data
 Analytical procedures are evaluations of financial information made by a study of plausible
relationships among both financial and nonfinancial data. Analytical procedures generally
involve comparisons of recorded amounts to independent expectations developed by the
auditor.
 The application of planned analytical procedures is based on the expectation that
relationships among data exist and continue in the
 absence of known conditions to the contrary.
 Analytical procedures will result to circumstantial evidence rather than conclusive evidence.
 Results of substantive analytical procedures would entail additional tests to be performed.
 Analytical procedures are the audit tests that are usually the least costly to perform.
Applicability of substantive analytical procedures:
 Generally, more applicable to large volume of transactions that tend to be predictable over time
 Not required substantive procedures during testing phase (but are required during audit planning and
 39

final or overall review stages)

 When appropriate, they are used on accounts that are predictable and plausible.
Limitations of analytical procedures: Since analytical procedures are based on expected plausible
relationships among data, differences do not necessarily indicate errors or fraud, but simply indicate the need for
further investigation. Changes in an account, changes in accounting principle, and inherent differences between
industry norms and the client all contribute to fluctuations in expected amounts.
Audit Procedures According to Types:
The following procedures, individually or in combinations, may be used as risk assessment
procedures, test of controls, or substantive procedures, depending on the context in which they
are applied by the auditor:
1. Inspection – consists of examining records or documents (whether internal or external,
in paper form, or other media), or a physical examination of an asset
 For example, an inspection of records or documents for evidence of authorization is
a test of controls.
2. Observation – consists of viewing/looking at a process or procedure being performed by
others.
Examples:
 Observation of the counting of inventories by the entity ‘s personnel
 Observation of the performance of control activities that leave no audit trail
3. External confirmation – represents audit evidence obtained by the auditor as a direct
written response to the auditor from a third party (the confirming party) in paper form, or
by electronic or other medium
 External confirmations frequently are relevant when addressing assertions associated with certain
account balance and their elements.
However, they are not restricted to account balances only.
Examples of external confirmation:
 Confirmation of accounts receivable balances:
a. Positive confirmation – customers should reply whether or not they agree with
their respective balances; it is considered more effective than negative
confirmation
b. Negative confirmation – customers should reply if there are discrepancies
 Bank confirmation of account balances (including amount of loan outstanding)
 Suppliers ‘confirmation of accounts payable
 Confirmation from lenders
 Inventory confirmation when inventory is under custody and control of a third party
 Confirmation from lawyers or financiers who have custody over client ‘s property title
deeds
 Confirmations of the terms of agreements or transactions an entity has with third
parties
 Confirmation about the absence of certain conditions, for example, the absence of
a
―side agreement‖ that may influence revenue recognition
d. Recalculation (computation) – consists of checking the mathematical accuracy
(manually or electronically) of documents or records
Examples:
 Auditor ‘s recalculation of depreciation, interest expense or earnings per share
e. Reperformance – involves the auditor ‘s independent execution of procedures or controls
that were originally performed (by the client ‘s staff) as part of the entity ‘s internal
control
f. Analytical procedures – consist of evaluations of financial information made by a study of
plausible relationships among both financial and non-financial data

g. Inquiry – consists of seeking information of knowledgeable persons, both financial and

non-financial, within the entity or outside the entity.
 Inquiry is used extensively throughout the audit in addition to other audit
procedures.
 Inquiries may be formal written inquiries or informal oral inquiries.
 Evaluating responses to inquiries is an integral part of the inquiry process.
 Evidence obtained from inquiry can be gathered with every type of audit test.
Audit Techniques:
The auditor applies audit techniques (methods) to gather corroborative evidence and uses his
professional judgment to determine which audit techniques would best result to the audit
evidence he needs.
Examples of audit techniques:
1. Confirm – to obtain information directly from an independent third party
 40

2. Inspect – to obtain evidence through physical examination

3. Count – physical examination of assets (such as cash count or petty cash count)
4. Compare – technique used after count of assets; also used to compare current period
balances with those of prior periods
5. Inquire – asking questions, whether oral or written, directed to the client or to third
parties
6. Trace – to determine whether transactions supported by source documents are properly
recorded and posted
7. Vouch – examine and authenticate of underlying evidential papers
8. Verify – to prove the accuracy of extensions, footings, postings, ownership and existence
9. Reconcile – to bring into agreement information obtained from two groups of related, but
independent, figures
10. Analysis of accounts – to detail the composition of an account or to detail the
individual
debits and credits in the account in a chronological sequence
11. Review – perform to obtain evidence of authoritative documentation to support certain
transactions
12. Extend – to prove the accuracy of multiplications (on invoices, payroll records, etc.)
13. Foot – to prove the accuracy of vertical or horizontal additions
14. Scan – looking for evidence of unusual amounts/items, which, if found, would be further
investigated
 Scanning may also be considered an analytical procedure, as the auditor uses
professional judgment to search for large, significant, or unusual items in the
accounting records.

AUDIT PROGRAM
An audit program is a detailed listing of the nature, timing and extent of planned audit
procedures (tests of controls and/or substantive tests) that the auditor will perform to gather
sufficient appropriate evidenced. It is a set of instructions to assistants involved in the audit and
as a means to control and record the proper execution of work.

AUDIT EVIDENCE
The auditor shall design and perform audit procedures that are appropriate in the
circumstances for the purpose of obtaining reasonable assurance or sufficient appropriate audit
evidence to reduce audit risk at acceptably low level thereby enable the auditor to draw
reasonable conclusions on which to base the auditor ‘s opinion.
Most of the auditor's work in forming the auditor's opinion consists of obtaining and
evaluating audit evidence. The auditor shall conclude whether sufficient appropriate audit
evidence has been obtained based on his professional judgment.

Audit Evidence, Defined:

Audit evidence refers to all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based. Thus, audit evidence supports the opinion
and the auditor's report.
Sometimes called as evidential matter, it is the main output/product of performing audit
procedures.

Audit Evidence Relationship with Assertions: Audit evidence comprises both:

a. Information that supports and corroborates management's assertions, and
b. Information that contradicts such assertions.

Nature of Audit Evidence:

Audit evidence includes both information contained in the accounting records underlying the
financial statements and other information:

1. Accounting records (Underlying data) – accounting records/data prepared by the

client ‘s personnel and from which financial statements are prepared
a. Records of initial accounting entries
b. Supporting records, such as checks and records of electronic fund transfers, invoices
and contracts
c. General and subsidiary ledgers
d. Journal entries and other adjustments to the financial statements that are not
reflected in formal journal entries
e. Records such as worksheets and spreadsheets supporting cost
allocations, computations, reconciliation and disclosures
 41

2. Corroborating evidence – corroborating information that are used by the auditor to

verify the fairness of the accounting records
a. Documents (such as checks, bank statements, contracts and minutes of meetings)
b. Information/evidence from other sources such as:
 Previous audits
 Quality control procedures for client acceptance and continuance
 Confirmations from third parties
 Industry analysts ‘reports
 Comparable data about competitors (benchmarking)
 Client written representation
c. Information obtained by the auditor from audit procedures such as inquiry,
observation, inspection and computation
d. Other information developed by, or available to, the auditor that permits the auditor to
reach conclusions through valid reasoning

Types of Audit Evidence:

1. Physical evidence – obtained by physical examination of assets (such as count of stock
certificates in support of stock investment account or observation of client ‘s processes or
procedures)
2. Mathematical precomputations – auditor ‘s recomputation of the accuracy of client ‘s
computations such as depreciation, amortization, doubtful accounts, etc.
3. Documentation – examination of the supporting documents of recorded transactions and
balances appearing in the financial statements
4. Representation by third parties (or confirmation) – a document originating from
independent outside party and sent directly to the auditor
5. Representation by client personnel – statements from client personnel in response to
queries posed by the auditor
6. Results of analytical procedures
7. Internal control – existence of effective internal control may be regarded as a strong
evidence of the validity of the accounts and amounts found in the financial statements
8. Subsequent events – they provide additional evidence regarding conditions that already
existing on the balance sheet that and affect accounting estimates

Sources of audit evidence:

 Audit evidence is cumulative in nature and is primarily obtained from audit procedures performed during the
course of the audit. However, it may also include information obtained from other sources such as:
 Previous audits (where the auditor performs audit procedures to establish its continuing relevance)
 Firm's quality control procedures for client acceptance and continuance
 Audit evidence may come from:
a. Internal sources (inside the entity) – generated internally, such as evidence existing within the
accounting records, minutes of meetings, or a management representation
b. External or independent sources (outside the entity) – for example, confirmations from third party’s
analysts ‘reports, and comparable data about competitors (benchmarking data)
c. Direct knowledge of the auditor
 Audit evidence may also come from:
a. Information obtained from testing the accounting records (accounting records are an important source
of audit evidence) – for example, through analysis and review, reperforming procedures followed in the
financial reporting process, and reconciling related types and application s of the same information
b. Non-financial original records
 Audit evidence may include information prepared using the work of a management ‘s expert.
 In some cases, the absence of information (for example, management's refusal to provide a requested
representation) is used by the auditor, and therefore, also constitutes audit evidence.
Information to Be Used as Audit Evidence
When designing and performing audit procedures, the auditor shall consider the relevance
and reliability of the information to be used as audit evidence.
When information to be used as audit evidence has been prepared using the work of a
management's expert, the auditor shall, to the extent necessary, having regard to the
significance of that expert's work for the auditor's purposes:
a. Evaluate the competence, capabilities and objectivity of that expert;
b. Obtain an understanding of the work of that expert; and
c. Evaluate the appropriateness of that expert's work as audit evidence for the relevant
assertion.
When using information produced by the entity, the auditor shall evaluate whether the
information is sufficiently reliable for the auditor's purposes, including as necessary in the
circumstances:
a. Obtaining audit evidence about the accuracy and completeness of the information; and
 42

b. Evaluating whether the information is sufficiently precise and detailed for the auditor's
purposes.

Sufficient Appropriate Audit Evidence:

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

1. Sufficiency – the measure of the quantity or amount of audit evidence that the auditor
shall accumulate
 Sufficiency is determined based on the auditor ‘s professional judgment.
 Audit evidence is sufficient if there is enough of it to afford a reasonable basis for an
audit opinion on the financial statements.
Factors affecting sufficiency of audit evidence:
Auditor ‘s judgment as to the quantity of audit evidence is influenced by:
a. Auditor ‘s assessment of the risks of misstatement – the higher the assessed risks,
the more audit evidence is likely to be required
 For example, as risk of material misstatement increases in Accounts
Receivable, audit evidence required also increases.
b. Quality or competence of audit evidence – the higher the quality, the less may be
required. Obtaining more audit evidence, however, may not compensate for its
poor quality.
c. Materiality of item being examined – more material amounts, more evidence to
support its validity
d. Experience gained during previous audit may indicate the amount of evidence
taken before and whether such evidence was enough
e. Type of information available
2. Appropriateness – measures 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
a. Relevance – deals with the logical connection with, or bearing upon, the purpose of
audit procedures and the assertion under consideration
b. Reliability – objectivity of evidence Reliability of evidence is influenced by:
 Its source (external or internal)
 Its nature (visual, documentary, or oral)
 The circumstances under which it is obtained
 Where relevant, the controls over its preparation and maintenance

Generalizations about the reliability of audit evidence:

1. The reliability of audit evidence is increased when it is obtained from
knowledgeable independent sources outside the entity.
 Examples of information from sources independent of the entity may include
confirmations from third parties, analysts' reports, and comparable data
about competitors (benchmarking data).
2. The reliability of audit evidence that is generated internally is increased when
the related controls, including controls over its preparation and maintenance,
imposed by the entity are effective. (Effective internal control provides more
reliable audit evidence than ineffective internal control.)
3. Audit evidence obtained directly by the auditor is more reliable than evidence
obtained indirectly or by inference.
 For example, observation of the application of a control is more reliable than
inquiry about the application of a control).
4. Audit evidence in documentary form (whether paper, electronic, or other
medium) is more reliable than evidence obtained orally.
 For example, a contemporaneously written record of a meeting is more
reliable than a subsequent oral representation of the matters discussed.
5. Evidence provided by original documents is more reliable than evidence provided
by photocopies or facsimiles.

The above generalizations should be considered in determining which evidence is

persuasive or least persuasive.

Generalizations about reliability are subject to important exceptions, for example,

even when the information to be used as audit evidence is obtained from sources
external to the entity, circumstances may exist that could affect its reliability (such
as if the source is not knowledgeable or a management ‘s expert may lack
objectivity).

More assurance is ordinarily obtained from consistent audit evidence obtained from
different sources or of a different nature than from items of audit evidence
 43

considered individually.
Hierarchy of reliability of evidence: (from most reliable to least reliable)
1. Direct evidence or personal observation and knowledge (such as physical
observation)
2. Externally generated evidence sent directly to the auditor (such as confirmations
from banks and customers and bank statements and cut-off bank statements
received from banks)
3. Externally generated evidence kept by the client (such as vendor ‘s invoices, bank
statements received from the client)
4. Internally generated evidence circulated externally (such as sales invoices from
sale to customers and paid checks and cost allocations)
5. Internally generated evidence not circulated externally (such as purchase
requisitions, customer ‘s order and cost allocations)
6. Oral evidence
Persuasive Evidence:
Audit evidence is persuasive if it is sufficient both in quantity and quality to support audit
opinion. Thus, sufficiency and appropriateness of audit evidence are the determinants of
persuasiveness of audit evidence. The auditor may need to rely on audit evidence that is
persuasive rather than conclusive. However, to obtain reasonable assurance, the auditor must not
be satisfied with audit evidence that is less than persuasive.

Cost-benefit considerations:
The auditor should consider the relationship between the cost of obtaining audit evidence and
the usefulness of the information obtained.

The valid bases for omitting an audit test/procedure for which there is no alternative are:
a. Relative risk (or inherent risk) involved
b. Relationship between the cost of obtaining audit evidence and the usefulness of the
information obtained
c. Degree of reliance on the relevant internal controls (or Assessment of control risk at a low
level)
Information produced by a management expert as audit evidence:
A management expert is an individual or organization possessing expertise in a field other
than accounting or auditing, whose work in that field is used by the entity to assist the entity in
preparing the financial statements.

When information to be used as audit evidence has been prepared using the work of a
management ‘s expert, the auditor shall, to the extent necessary, having regard to the
significance of that expert ‘s work for the auditor ‘s purposes:
1. Evaluate the competence, capabilities and objectivity of that expert
a. Competence – relates to the nature and level of expertise of the management ‘s
expert
b. Capability – relates to the ability of the management ‘s expert to exercise that
competence in the circumstances
c. Objectivity – relates to the possible effects that bias, conflict of interest or the
influence of others may have on the professional or business judgment of the
management expert
Sources of information regarding competence, capabilities and objectivity of a management
‘s expert:
 Personal experience with previous work of that expert
 Discussions with that expert
 Discussions with others who are familiar with that expert ‘s work
 Knowledge of that expert ‘s qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition
 Published papers or books written by that expert
 An auditor ‘s expert, if any, who assists the auditor regarding the information produced by the
management expert
2. Obtain an understanding of the work or field of expertise of that management’s
expert
Aspects of the management ‘s expert ‘s filed relevant to the auditor ‘s understanding
may include:
 Whether that expert ‘s field has areas of specialty within it that are relevant to the
audit.
 Whether any professional or other standards, and regulatory or legal requirements
apply.
 What assumptions and methods are used by the management ‘s expert, and
whether they are generally accepted within that expert ‘s filed and appropriate for
 44

financial reporting purposes.

 The nature of internal and external data or information the auditor ‘s expert uses
3. Evaluate the appropriateness of that expert’s work as audit evidence for relevant
assertion
The auditor shall consider:
a. The relevance and reasonableness of that expert ‘s findings or conclusions, their
consistency with other audit evidence, and whether they have been appropriately
reflected in the financial statements;
b. If the expert ‘s work involves use of significant assumptions and methods, the
relevance and reasonableness of those assumptions and methods; and
c. If that expert ‘s work involves significant use of source data the relevance,
completeness, and accuracy of that source data

Evaluating the Sufficiency and Appropriateness of Audit Evidence:

Based on the audit procedures performed and the audit evidence obtained, the auditor shall
evaluate before the conclusion of the audit whether the assessments of the RMM at the assertion
level remain appropriate.

Factors affecting sufficient appropriate audit evidence:

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 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 audit evidence.
 Understanding of the entity and its environment, including internal control.

AUDIT SAMPLING

Definition of terms:

Sampling – testing of less than 100% of the items within a population to form a conclusion
about the population
Audit sampling – applying audit procedures to less than 100% of the items within an
account balance or class of transactions, such that all sampling units have a chance of
selection, to form a conclusion about the balance or class
Error – either control deviations, when performing tests of control, or misstatements, when
performing substantive procedures.
Total error – either the rate of deviation (in case of tests of control) or total misstatement
(in case of substantive procedures)
Anomalous error – means an error that arises from an isolated event that has not recurred
other than on specifically identifiable occasions and is therefore not representative of errors
in the population
Sampling risk – the possibility that the auditor ‘s conclusion, based on a sample may be
different from the conclusion reached if the entire population were subjected to the same
audit procedure.
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.
Population – the entire set of data from which a sample is selected and about which the
auditor wishes to draw conclusions. For example, all of the items in an account balance or a
class of transactions constitute a population. A population may be divided into strata, or
sub-populations, with each stratum being examined separately. The term population is used
to include the term stratum.
Confidence levels – the mathematical complements of sampling risks
Sampling unit – the individual items constituting a population, for example checks listed on
deposit slips, credit entries on bank statements, sales invoices or debtors ‘balances, or a
monetary unit
Stratification – the process of dividing a population into subpopulations, each of which is a
group of sampling units which have similar characteristics (often monetary value)
 45

Tolerable error
a. Tolerable error amount – in substantive procedures, it is the maximum total error in a
population that the auditor is willing to accept
b. Tolerable deviation rate – in tests of control, it is the maximum rate of deviation from
the prescribed control procedure the auditor is willing to accept without changing control
risk assessment or planned reliance on internal control.
Expected error –
a. Expected error amount – in substantive tests, it is the auditor's best estimate of the
amount of error the auditor expects to find in the population
b. Expected deviation rate – in tests of control, it is the auditor's best estimate of the
rate of deviation from a prescribed control procedure in the population

Whether audit sampling is a required: Audit sampling is not required part of any audit
procedure because when designing audit procedures, the auditor should determine appropriate
means of selecting items for testing as follows:

a. Selecting all items (100% examination)

b. Selecting specific items from a population judgmentally 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 (subject to non-sampling risk)

Specific items selected:

 High value or key items that 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.
c. Audit sampling: Sampling is essential throughout audits as auditors attempt to gather
sufficient appropriate evidence in a cost efficient manner.
When to use audit sampling:
 Where an auditor has no special knowledge about likely misstatements contained in account
balances and transactions
 When the auditor believes that the sample is to be a good representative of the population
(account balances and transactions)

Situations where sampling may not apply: Sampling concepts generally do not apply to:
a. Risk assessment procedures performed to obtain an understanding of internal control.
b. Tests of automated application controls when effective general controls are present. (Generally,
such controls would only be tested once or a few times.)
c. Analyses of security and access controls, or other controls that do not provide documentary
evidence of performance (e.g., controls related to segregation of duties).
d. Some tests related to the operation of the control environment or the accounting system (e.g.,
examination of the effectiveness of activities performed by those charged with governance).
Lists procedures that do not involve sampling:
a. Inquiry and observation
b. Analytical procedures
c. Procedures applied to every item in a population
d. Tests of controls where application is not documented
e. Procedures from which the auditor does not intend to extend a conclusion to the
remaining item in the account
f. Untested balances

Approaches to audit sampling:

1. Statistical sampling – any approach to sampling that has the following characteristics:
a. Random selection of a sample; and
b. Use of probability theory to evaluate sample results, including measurement of sampling
risk

In statistical sampling, auditors specify the sampling risk they are willing to accept and
then calculate the sample size that provides that degree of reliability. Results are evaluated
quantitatively. Statistical sampling measures quantitatively the risk from testing only part of
an audit population.
 46

a. Advantages of statistical sampling: Conclusions may be drawn in more precise ways when
using statistical sampling because it enables the auditor to:
a. Measure the sufficiency of the audit evidence obtained.
b. Provide an objective basis for quantitatively evaluating sample results.
c. Design an efficient sample.
d. Quantify sampling risk so as to limit/control risk to an acceptable level.

b. Random sample selection: Random sample selection methods should be used in statistical
sampling. Such methods give all items in the population an equal chance to be included in the
sample to be audited.
2. No statistical sampling – the sample size is not determined mathematically. Auditors use
their judgment in determining sample size, and sample results are evaluated judgmentally.
Conclusions may be drawn in more precise ways when using statistical sampling
methods.

 It is acceptable for auditors to use either or combination of statistical and nonstatistical sampling.
 Both sampling approaches involve judgment in planning, executing the sampling plan, and evaluating
the results of the sample.
 Both sampling approaches can provide sufficient competent evidence.
 Sampling methods are used by auditors in both control testing and substantive testing.
 Basic distinction between statistical sampling and nonstatistical sampling: Statistical sampling is a
mathematical approach to inference, whereas nonstatistical sampling is a more subjective approach.

Auditor’s professional judgment:

Although statistical sampling aids the auditor in quantitative ways, it is not a substitute for
professional judgment. The auditor must exercise professional judgment in both statistical and
nonstatistical sampling to:
a. Define the population and the sampling unit;
b. Select the appropriate sampling method;
c. Evaluate the appropriateness of audit evidence;
d. Evaluate the nature of deviations or errors;
e. Consider sampling risk; and
f. Evaluate the results obtained from the sample and project those results to the population.

Types of sampling:

Audit sampling is used for both tests of controls (attributes sampling) and for tests of details of
transactions and balances (usually, variables sampling). In both attributes sampling and variables
sampling, the plans may be either nonstatistical or statistical.

1. Attribute sampling – estimates the quality characteristic of a population; it estimates the

rate of deviation for internal controls that the auditor decides to rely upon
Applicability of attribute sampling: primarily used for test of controls because attribute
sampling deals with estimating deviation from internal control procedures
2. Variables sampling – estimates the numerical quantity of a population
Applicability of variable sampling: typically used in substantive testing of account
balances because variables sampling deal with peso balances

Sampling risk:
The possibility that the auditor ‘s conclusion, based on a sample may be different from the
conclusion reached if the entire population were subjected to the same audit procedure.
The risk that the sample is not representative of the population and that the auditor's
conclusion will be different from the conclusion had the auditor examined 100% of the
population.
The possibility that even though a sample is properly chosen, it may not be representative of
the population.

Two types of sampling risk:

1. Risk that affects audit effectiveness and may lead to an inappropriate audit opinion
(“Beta risk” or “Type II error‖) – the risk the auditor will conclude that:
a. In the case of a test of control, that control risk is lower than it actually is, or
b. In the case of a substantive test, that a material error does not exist when in fact it does

2. Risk affects audit efficiency as it would usually lead to additional work to establish
that initial conclusions were incorrect (“Alpha risk” or “Type I error”) – the risk the
auditor will conclude that:
a. In the case of a test of control, that control risk is higher than it actually is, or
 47

b. In the case of a substantive test, that a material error exists when in fact it does not

Aspects of audit risk: (Sampling risk and No sampling risk)

1. Sampling risk: aspects of audit risk that are due to sampling; the risk or the possibility
that, when a test of controls or a substantive test is restricted to a sample, the auditor's
conclusions may be different from the conclusions which would have been reached had the
tests been applied to all items in the account balance or class of transactions

a. Sampling risks in substantive testing: (Risk of incorrect acceptance and risk of

incorrect rejection)

1) Risk of incorrect acceptance – the risk that the recorded account balance (based
on the sample) is not materially misstated when in fact it is materially misstated
(i.e., sample results fail to identify an existing material misstatement).
 This means that the auditor wrongly concludes material error in an
account balance does not exist when in fact it does.

2) Risk of incorrect rejection – the risk that the recorded account balance (based on
the sample) is materially misstated when in fact it is not materially misstated (i.e.,
sample results mistakenly indicate a material misstatement).
 This means that the auditor wrongly concludes that material error in an
account balance exists when in fact it does not.

b. Sampling risks in tests of controls: (Risk of assessing control risk to low and
Risk of assessing control risk to high)

a. Risk of assessing control risk too low – the risk that the assessed level of control
risk (based on the sample) is lower than the true level of control risk (i.e., sample
results indicate a lower deviation rate than actually exists in the population).
 This means that the auditor wrongly concludes that the control risk is
low or that client’s internal control system can be relied upon.

b. Risk of assessing control risk too high – the risk that the assessed level of
control risk (based on the sample) is higher than the true level of control risk (i.e.,
sample results indicate a greater deviation rate than actually exists in the
population).
 This means that the auditor wrongly concludes that the control risk is
high or that the client’s internal control system cannot be relied upon.

Analysis of sampling risks:

Aspects of Auditor’s wrong Effect on audit work

sampling risks conclusion because of wrong Sacrificed
conclusion
Risk of incorrect Not materially Performance of less Effectiveness of the audit
acceptance misstated when in fact extensive substantive because it may lead to
materially misstated tests inappropriate opinion due to
inappropriate less
extensive substantive tests
Risk of incorrect Materially misstated Additional work Efficiency of the audit
rejection when in fact not (performance of because of unnecessary
materially unnecessary more additional work
misstated extensive substantive
tests)
Risk of ↓ CR than actual CR – Performance of tests of Effectiveness of the audit
assessing control internal control is controls and less because it may lead to
risk too low reliable extensive substantive inappropriate opinion due to
tests inappropriate less
extensive substantive tests
Risk of ↑ CR than actual CR – Additional work Efficiency of the audit
assessing internal (because non- because of unnecessary
control risk too high control is not reliable performance of tests of additional work
controls would lead to
the performance of
unnecessary more
extensive substantive
tests
 48

2. Nonsampling risk: all aspects of audit risk that are not due to sampling. Nonsampling
risk is the possibility that auditors will arrive at an erroneous conclusion not because of
the chosen sample but due to other factors.
 Nonsampling risk is always present and cannot be measured.
 Nonsampling risk can be controlled by adequate planning and supervision of audit
work and proper adherence to quality control standards.
 Examples of nonsampling risk:
 The auditor might use/select inappropriate procedures (audit procedures that are
not appropriate to achieve a specific objective)
 The auditor might misinterpret evidence or the results of audit tests
 and fail to recognize an error (for example, failure by the auditor to recognize
misstatements in documents examined)

Types of statistical plans:

1. Attribute sampling – sampling in tests of controls

Attribute sampling is a statistical sampling method used to estimate the rate (%) of
occurrence (exception) of a specific characteristic or attribute. Samples taken to test the
operating effectiveness of controls are intended to provide a basis for the auditor to
conclude whether the controls are being applied as prescribed. Attribute sampling generally
deals with yes/no questions. For example, "Are time cards properly authorized (i.e., to
assure recorded hours were worked)?", or "Are invoices properly voided (e.g., stamped
"paid") to prevent duplicate payments?"

Attribute sampling models:

a. Discovery sampling – a special type of attribute sampling appropriate when the auditor
believes the population deviation rate is zero or near zero. It is used when the auditor is looking
for a very critical characteristic or deviations (e.g., fraud). The auditor predetermines the
desired reliability (confidence) level (e.g., 95%) and the maximum acceptable tolerable rate
(e.g., 1%), and a table is then used to determine sample size. If no deviations are found in the
sample, the auditor can be 95% certain that the rate of deviation in the population does not
exceed 1%. If deviations are found, a regular attribute sampling table may be used to estimate
the deviation rate in the population, and audit procedures may need to be expanded.

b. Stop-or-go sampling (sequential sampling) – is designed to avoid oversampling for

attributes by allowing the auditor to stop an audit test before completing all steps. It is used
when few errors are expected in the population. Sequential sampling separates the sampling
process into several states. After a step, the auditor determines if it is warranted to accept or
increase the preliminary level of control risk.

2. Variables sampling – sampling in substantive tests:

a. Probability-proportional-to-size (PPS) sampling – sampling technique where the sampling

unit is defined as an individual peso in a population. Once a peso is selected, the entire account
(containing that peso) is audited.
 It is a sampling plan that automatically stratifies the population.

b. Classical variables sampling – a statistical sampling method used to estimate the numerical
measurement of a population, such as a peso value (e.g., accounts receivable balance). This
sampling method is used primarily in substantive testing. The objective of variables sampling is
to obtain evidence about the reasonableness of monetary amounts. The auditor estimates the
true value of the population by computing a point estimate of the population and
computing a precision interval around this point estimate. Classical variables sampling
measures sampling risk by using the variation of the underlying characteristic of interest.

Three commonly used classical variables sampling:

1. Mean-per-unit estimation – a sampling plan that uses the average value of the items in
the sample to estimate the true population value (i.e., estimate = average sample value x
number of items in population). MPU does not require the book value of the population to
estimate true population value.

2. Ratio estimation – a sampling plan that uses the ratio of the audited (correct) values of
items to their book values to project the true population value. Ratio estimation is a highly
efficient technique when the calculated audit amounts are approximately proportional to the
client's book amounts.

3. Difference estimation – a sampling plan that uses the average difference between the
 49

audited (correct) values of items and their book values to project the actual population
value. Difference estimation is used instead of ratio estimation when the differences are not
nearly proportional to book values.

Factors influencing determination of sample size for tests of control and substantive
procedures:

Factor Relation Required sample size Analysis

shi p to
sample
size
Tests of Substantive ↓ ↑
control procedures Smaller Larger
Assessed Direct ↓ Lower ↑Higher The higher the auditor ‘s
level of IR assessment of inherent risk and
and CR control risk, the larger the sample
size needs to be.
Acceptable Direct ↓ Lower ↑Higher Higher inherent risk and control
level of risk imply that a lower detection
detection risk is needed to reduce the audit
risk risk to an acceptable low level, and
lower
detection risk can be obtained by
increasing sample size.
Reliance on Inverse ↑ Higher ↓Lower The more the auditor is relying on
other other substantive procedures to
substantive reduce to an acceptable level the
procedures detection risk, the less assurance
the auditor will require from
sampling and, therefore, the
smaller the sample size can be.
Expected Expected Direct ↓ Lower ↑ Higher  The higher the rate of deviation
deviation error that the auditor expects, the
rate larger the sample size needs to
be so as to be in a position to
make a reasonable estimate of
the actual rate of deviation.
 The greater the amount of
error the auditor expects to
find in the population, the
larger the sample size needs to
be in order to make a
reasonable
estimate of the actual amount
of error in the population.
Degree/lev Degree/level Direct ↓ Lower ↑Higher  The more assurance the auditor
el of of confidence intends to obtain from
intended accounting and internal control
reliance systems, the lower the auditor
‘s assessment of control risk
will be, and the larger the
sample size will need to be.
 The greater the degree of
confidence that the auditor
requires that the results of the
sample are in fact indicative of
the actual incidence of error in
the population, the larger the
sample size needs to be.
Tolerable Tolerable Inverse and ↑ Higher ↓  The lower the rate of deviation
deviation error indirect Lower that the auditor is willing to
rate accept, the larger the sample
size needs to be.
 The lower the total error that
the auditor is willing to accept,
the larger the sample size
needs to be.
 50

Risk of Inverse ↑ Higher ↓ The more assurance the auditor

assessing Lower intends to obtain from accounting
control and internal control systems, the
risk too lower the auditor ‘s assessment of
low control risk will be, and the larger
the sample size will need to be.
This is a sampling risk and
sampling risk is reduced by
increasing the
sample size.
Risk of Inverse ↑ Higher ↓ Lower The greater the degree of
incorrect confidence that the auditor
acceptance requires that the results of the
sample are in fact indicative of the
actual incidence of error in the
population, the larger the sample
size needs to be. This is a sampling
risk and sampling risk is reduced
by increasing the sample size.
Number of items in the Negligible effect, that is, virtually no For large populations, the actual
population effect on sample size unless the size of the population has little, if
population is very small. In other any, effect on sample size. For
words, population size is not an issue small populations however, audit
provided the population is large. sampling is often not as efficient as
alternative means of obtaining
sufficient appropriate audit
evidence.

 When the deviation in the sample is at the expected deviation rate or less, the auditor can continue using his
planned assessment of control risk. If it happens to be greater than expected, reassessment of risk is
necessary. Usually, an increase in such should be made.
 The stronger the internal control, the lower the control risk, the lower the tolerable deviation rate.

Principal sample selection methods: Appropriate sample selection methods could reduce
sampling risk.

a. Random-number sampling – use of a computerized random number generator or random

number tables.
b. Systematic selection – the number of sampling units in the population is divided by the
sample size to give a sampling interval regardless of the amount involved (for example 50,
and having determined a starting point within the first 50, each 50th sampling unit
thereafter is selected).
c. Haphazard selection – the auditor selects the sample without following a structured
technique, but the method is intended to avoid or predictability (for example avoiding
difficult to locate items, or always choosing or avoiding the first or last entries on a page)
and thus attempt to ensure that all items in the population have a chance of selection.
Haphazard selection is not appropriate when using statistical sampling.

Other sample selection methods:

1. Value-weighted selection – sets the high-value items as priority to be included in the
sample
2. Block selection – involves selecting a block(s) of contiguous items from within the
population. Block selection cannot ordinarily be used in audit sampling because most
populations are structured such that items in a sequence can be expected to have similar
characteristics to each other, but different characteristics from items elsewhere in the
population.
3. Stratification – grouping of items of similar size and each group is treated as a separate
population. For example, assume 1,000 items are stratified into two groups: the 100 largest
items will all be examined individually, but sampling techniques will be applied to the
remaining 900 items. In this case, the population size for the sampling application would be
900, not 1,000. Stratification is used when there is a wide range (variability) in the
monetary size of items in the population.

Steps when applying a variables sampling

1. Define the objective of the test

 For example, the auditor wishes to estimate the value of an account balance (e.g., the
client's accounts receivable balance).
 51

2. Define the population

 For example, the population might consist of 5,000 accounts with a recorded book value of
P4,500,000. The auditor would examine 100% of accounts for which potential errors could
equal or exceed the tolerable error and would exclude those accounts from the population to
be sampled.

3. Define the sampling unit

 The auditor should consider the completeness of the population in defining the sampling unit
(for example, each of the 5,000 accounts is a sampling unit)

4. Determine the sample size

 The auditor uses the following parameters, in conjunction with tables or formulas to
determine sample size.
1) Tolerable misstatement
2) Expected misstatement (size, frequency, etc.)
3) Acceptable level of risk: audit risk, risk of incorrect acceptance, and risk of incorrect
rejection
4) Characteristics of the population (e.g., an estimate of the standard deviation, or
variability, of the population)
5) Assessed risk: asses
5. Select the sample
 Sample items should be selected in such a way that the sample can be expected to be
representative of the population (e.g., random sampling).
 In this example, an appropriate sample would consist of individual account balances.
Confirmations could then be used to determine the audited values for sample items.
6. Evaluate the sample results
 The auditor projects the misstatements found in the sample to the population using one of
several methods (e.g., MPU, ratio, difference, etc.). The projected misstatement is applied to
the recorded balance to obtain a "point estimate" of the true balance.
 The auditor must then add an allowance for sampling risk (sometimes called a "precision
interval") to this estimate.
7. Form conclusions about the balances (or transactions) tested
 In deciding whether to accept the client's book value, the auditor determines whether the recorded
book value falls within the acceptable range (i.e., the point estimate +/- the allowance for sampling
risk). If so, the book value is fairly stated.
 The auditor's treatment of items selected for sampling that cannot be located (e.g., are "lost") will
depend on their effect on the auditor's evaluation of the sample.
 If the sample is representative of the population, the auditor generally will make a correct decision
regarding whether the account balance is fairly stated.
 If the sample is not representative of the population, the auditor will make an incorrect decision, either
accepting a materially misstated balance, or rejecting a fairly stated balance.

8. Document the sampling procedure

 The auditor must document each step in audit sampling, starting with planning and including the
rationale for the auditor's parameters, the performance of procedures, the observed results, and the
evaluation and interpretation of those results.

AUDIT DOCUMENTATION / WORKING PAPERS

AUDIT DOCUMENTATION
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.

Audit documentation:
It refers to the documentation of audit evidences collected and evaluated by the auditor to
support the audit opinion.
The records kept by the auditor that documents:
a. The procedures applied
b. The tests performed
c. The information or evidenced obtained, and
d. The conclusions the auditor reached in the engagement
Also called ―working papers‖ or ―work papers‖ or audit file

Purposes / functions of audit documentation:

File documentation plays a critical role in the planning and performance of the audit. During an
audit engagement, data are compiled and included in the audit working papers. It provides the
record that work was in fact performed and it forms the basis for the auditor ‘s report. It will also be
 52

used for quality control reviews, monitoring of adherence to the accounting firm ‘s standards, and
possibly inspections by third parties.

1. Primary
 To support the auditor's conclusions/opinion/report on the financial statements (and not
to support the FS).
 To provides a basis for determining the appropriate audit report.
 To support the auditor's representation that an adequate audit was conducted in
accordance with PSA/GAAS
 To provide evidence of the audit work performed
 To assist the auditor in the planning, performance, review, supervision and coordination
of the engagement and in preparation of the audit report
 To show that the accounting records agree or reconcile with the financial statements
 Provide supervisory personnel the opportunity to assess the sufficiency of evidence
obtained during the audit

2. Other objectives:
 To assist the auditor in planning future audits
 To enable the audit team to be accountable for its work
 To provide information useful in rendering other services (MAS or tax consulting)
 To provide adequate defense in case of litigation
 To enable an experienced auditor to conduct quality control reviews and inspections in
accordance with quality control standards
 To enable an experienced auditor to conduct external inspections in accordance with
applicable legislation, regulations or other requirements
Design of audit documentation:
When preparing working papers, the auditor should remember that working papers should
be designed to meet the circumstances and the auditor's needs on each engagement.

Form, content and extent of audit documentation:

Form, content and extent of audit documentation depend on auditor ‘s judgment – since it is
neither necessary nor practical to document every matter.
Audit documentation should be complete in itself and should not require subsequent or
additional oral explanation.
Audit documentation should be concise and limited only to essentials.
Audit documentation should be appropriately organized to provide a clear link to the
significant matters
Experienced auditor: The audit documentation should be in such form, content and extent
of audit documentation that would 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 PSAs
and applicable legal and regulatory requirements
b. The results of the audit procedures and the audit evidence obtained, and
c. Significant matters arising during the audit and the conclusions reached thereon.

Factors to consider by the auditor in deciding the form, content and extent of audit
documentation:
a. Nature of the audit procedures to be performed;
b. Risks of material misstatement;
c. Extent of judgment required in performing the work and evaluating the results;
d. The significance of the audit evidence obtained;
e. Nature and extent of exceptions identified;
f. 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; and
g. Audit methodology and tools used

Classification and composition of auditor’s working papers:

A. Continuing engagement (recurring audit):
1. Permanent file – contains information of continuing or long-term significance/interest
to the auditor in performing recurring audits, such as:
a. Information
 Organizational chart
 Analysis of business and industry
 Analyses of long-term accounts (such as PPE, long-term liabilities and of
stockholders' equity accounts)
 Analyses of internal control (flowchart, narrative descriptions, etc.)
b. Copies or extracts of entity ‘s important legal documents and agreements:
 Corporate charter or articles of Incorporation (or articles of co-partnership) and
by-laws
 Major contracts (such as bond and note indentures)
 53

 Pension plans, stock option plans, profit-sharing plans and employee bonus
 Terms of share capital and bond issues
 Engagement letter

2. Current audit file – contains evidence gathered and conclusions reached relevant to
the audit of a particular year. It is designed to support management assertions. Includes
all papers accumulated during the current year ‘s audit:
 Copy of the financial statements
 Audit plan and audit programs
 Working (top) trial balance – listing of unadjusted ending balances of accounts
(contains columns for adjusting and reclassifying entries)
 Adjusting and reclassifying entries – adjustments are made to correct material
errors while reclassifications are made to properly present information in the
financial statements
 Lead or top schedule (assembly sheet) – shows the major components of an
amount reported in the financial statements; this working paper show the
grouping of related accounts; it eliminates voluminous details from the auditor ‘s
working trial balance by classifying and summarizing similar or related items
 Supporting schedules – schedules that support specific amounts on the financial
statements; usually the largest portion of the audit file
 Audit memoranda – includes documentation on discussions of certain items such
as internal control, inventory observation, errors identified, and problems
encountered
 Account analysis – shows the activity during the period in a particular short-term
account
 Correspondence with other parties such as lawyers, customers, banks, and
management
 Audit notes – used to record items of work to be done and questions concerning
the audit investigation
 Abstract or copies of minutes of board of directors ‘meeting

B. One-time engagement – no distinction as to permanent or current file

Other types of files:

1. Tax files – contain file of information on client ‘s current and income taxes and other
business taxes that may be used as bases for:
a. Preparing current year ‘s tax returns
b. Preparing other tax-related services
c. Representing the client in tax assessment case
2. Correspondence file – contains all correspondence/letters to or from (or in behalf of) a
client
3. Completion memorandum – a summary that describes the significant matters identified
during the audit and how they are addressed

Ownership of working papers or audit documentation:

Legal provision on ownership of working papers (Sec. 29 of RA 9298 – Ownership of
Working Papers): All working papers, schedules and memoranda made by a CPA 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 CPA, except reports submitted by a CPA to a client shall be
treated confidential and privileged and remain the property of such CPA in the absence of a written
agreement between the CPA 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.
 Audit documentation or working papers are the property of the auditor/audit firm and the client has no right
to the working papers prepared by the auditor.
 Confidentiality of working papers: Although working papers are the personal property of the auditor,
they cannot be shown to third parties under the rule on confidentiality unless it falls under the certain
exceptions such as production of documents through subpoena issued by any court, tribunal, or
government regulatory or administrative body.
 Although certain working papers may sometimes serve as a useful reference source for his client, auditor ‘s
working papers should not be regarded as part or substitute for the client's accounting records.
 The audit documentation for a specific audit engagement is assembled in an audit file.

Auditor/CPA firm’s responsibility on audit documentation:

1. Policies and procedures: Establishment of policies and procedures on audit documentation
2. Confidentiality and safe custody: Adopt appropriate procedures for maintaining
confidentiality and safe custody of working papers and
3. Retention of audit documentation: Working papers should be retained by the auditor for
a period of time sufficient to meet the needs of his practice and to satisfy any pertinent legal
requirements of record retention. Retention period should be no shorter than 5 years from
 54

the date of the auditor ‘s report, or, if later, the date of the group auditor ‘s report. The
auditor should not delete or discard audit documentation before the end of its retention
period.
4. Completion of final audit file: within 60 days after the date of the auditor ‘s report

Deletion from/changes to audit documentation:

After completion date: Not allowed
During assembly process: Allowed but limited to changes that are administrative in
nature, such as:
1. Deleting or discarding superseded documentation
2. Sorting, collating and cross-referencing working papers
3. Signing off on completion checklists relating to the file assembly process
4. Documenting audit evidence that the auditor has obtained, discussed and agreed with
the relevant members of the audit team before the date of the auditor ‘s report.

Elements of working papers:

Working papers should be properly organized to facilitate their review. Working papers should
have the following elements:
1. Heading – used to properly identify each working paper; it includes the name of the client,
type/title of working paper, description of its content, and the date or period covered by the
examination.
2. Dates and initial of staff and reviewers
3. Indexing – use of lettering or numbering system to aid in cross-referencing to other
working papers
4. Cross-indexing / cross referencing – Audit working papers are indexed by means of
reference numbers. The primary purpose of cross-indexing audit working papers is to permit
cross-referencing and simplify supervisory review by providing a trail useful to the auditor
and supervisors in reviewing the working papers. (For example, reported findings should be
adequately cross-referenced to supporting documentation.)
Audit working papers should have an indexing system that shows the relationship
between findings, conclusions, and the related facts. The main advantage of properly
indexed working papers is to better organize the working papers.
5. Tick marks – symbols that describe the audit procedures performed. Tick marks are
explained in working papers.

Using electronic tools in working papers:

There are three important principles to note when using electronic tools in working paper
preparation:
All the requirements of the PSAs still apply;
Electronic files require electronic document management. This addresses matters such as
accessibility (such as password access), data security, application management (including
training), back-up routines, edit rights, storage locations, review procedures, and decisions
on what changes to files will be tracked to provide the necessary audit trail; and
Final documents (all documents that are required to be maintained to support the audit
opinion) must be retained and be accessible in accordance with the firm ‘s file retention
policies.

COMPLETING THE AUDIT

The procedures being performed in completing the audit are necessary. These procedures are
usually performed by audit managers or other senior members of the audit team who have
extensive audit experience with the client because the procedures involve many subjective
judgments by the auditor. These procedures do not pertain to specific transaction cycles or
accounts.

REVIEWING RELATED PARTY TRANSACTIONS

Management’s responsibility: Identification and disclosure of:

a. Related parties; and
b. Related party transactions

Auditor’s responsibility

1. Review related party transactions to ensure that they have been properly identified,
recorded and disclosed in the financial statements
2. Obtain a written representation from management concerning:
a. Completeness of information on identification of related parties; and
b. Adequacy of disclosure in the FS
Reasons for the review: The auditor should modify the auditor ‘s report in case of:
Inability to obtain sufficient appropriate audit evidence concerning related parties and
 55

transactions with such parties

Inadequate disclosure in the FS

PERFORM SUBSEQUENT EVENTS REVIEW

Subsequent events refer to events occurring between period end (the date of the financial
statements or the balance sheet date) and the date of the auditor ‘s report that may affect
the financial statements and the auditor ‘s report.
These events are also called post-balance sheet events/transactions since they occur
after or subsequent to the balance sheet date.
Subsequent events may also refer to facts discovered after the date of the auditor ‘s report.
The period between the date of the financial statements and the date of the auditor's report
is called the subsequent period. During this period, the auditor has an active responsibility
to investigate certain subsequent events.

Types of subsequent events:

1. Those requiring adjustment – those that provide evidence of conditions that existed at
the date of the financial statements.
Examples:
 Settlement of litigation in excess of amount recorded
 Loss on uncollectible accounts resulting from of customer ‘s continued deteriorating
financial condition leading to bankruptcy

2. Those requiring disclosure – events that are indicative of conditions that arose after the
date of the financial statements.
Examples:
 Issuance of bonds/stocks after the BS date
 Major purchase of a business
 Loss on inventory due to fire that occurred in the subsequent period
 Loss of plant due to flood
 Loss on uncollectible receivable because of a major catastrophe suffered by the
customer after the BS date

Subsequent events relevant to the auditor: limited to those subsequent events (both
requiring adjustment or disclosure) that occur subsequent to date of the FS and the date of the
auditor ‘s report

Auditor’s responsibility for subsequent events:

1. Perform audit procedures designed to identify subsequent events

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 would include:

a. Reviewing procedures management has established to ensure that subsequent
events are identified.
b. Inquiry:
 Inquiring of management as to whether any subsequent events have
occurred which might affect the financial statements.
 Inquiring of the entity ‘s legal counsel concerning litigation claims, and
assessments
c. Reading minutes of the meetings (of shareholders, those charged with governance,
audit and executive committees) including those held after period end and inquiring
about matters discussed at meetings for which minutes are not yet available.
d. Reading the entity ‘s latest available interim financial statements as well as budgets
and cash flow forecasts and other related management reports; compare them with
the financial statements under audit.
e. Obtaining representation letter from management regarding whether any events
occurred during the subsequent period that require adjustments to or disclosure in
the financial statements.
2. To consider/evaluate the effect of subsequent events (whether such events are
properly accounted for and adequately disclosed) on the financial statements and
on the auditor’s report
When subsequent events that materially affect the financial statements are identified,
the auditor should consider whether such events are properly accounted for and adequately
disclosed in the financial statements.
 56

LITIGATIONS AND CLAIMS

Litigation and claims involving an entity may have a material effect on the financial statements
and thus may be required to be disclosed and/or provided for in the financial statements.

Audit procedures regarding litigation and claims:

1. Identify existence of any litigation and claims

The auditor should carry out procedures to identify existence of any litigations and claims
involving the entity which may result in a material misstatement of the financial statements.
Such procedures would include the following:
 Make appropriate inquiries of management including obtaining representations
 Review minutes of those charged with governance and correspondence with the entity
‘s legal counsel
 Examine legal expense accounts, and
 Use any information obtained regarding the entity ‘s business including information
obtained from discussions with any in-house legal department.

2. Communicate directly with the entity’s lawyers.

The auditor should seek direct communication with the entity ‘s lawyers when litigation or
claims have been identified or when the auditor believes they may exist. The letter would
ordinarily specify the following:
 A list of litigation and claims;
 Management ‘s assessment of the outcome of the litigation or claim and its estimate
of the financial implications, including costs involved; and
 A request that the entity ‘s legal counsel confirm the reasonableness of management
‘s assessments and provide the auditor with further information if the list is
considered by the entity ‘s legal counsel to be incomplete or incorrect.

The letter, which should be prepared by management and sent by the auditor, should
request the lawyer to communicate directly with the auditor.

If management refuses to give the auditor permission to communicate with the entity ‘s
legal counsel, this would be a scope limitation and should ordinarily lead to a qualified
opinion or a disclaimer of opinion. Where the entity ‘s legal counsel refuses to respond in an
appropriate manner and the auditor is unable to obtain sufficient appropriate audit evidence
by applying alternative audit procedures, the auditor would consider whether there is a
scope limitation which may lead to a qualified opinion or a disclaimer of opinion.

PERFORMING WRAP-UP PROCEDURES

Performing analytical procedures in the overall review at/near the end of the audit
Analytical procedures involve analysis of significant ratios and trends including the resultant investigation
of fluctuations and relationships that are inconsistent with other relevant information or expectation:

Analytical procedures are required to be performed during the planning and overall review stages.
 Purpose of performing analytical procedures in the overall review stage of the
audit: to ensure that the auditor ‘s overall conclusion as to whether the financial
statements as a whole are consistent with the auditor ‘s understanding of the entity.

 Auditor’s focus when performing analytical procedures in the overall review stage:
a. Identifying unusual fluctuations or transactions or unexpected account balances that
were not previously identified
 Requires investigation, adequate explanation and appropriate corroborative
evidence by performing additional tests of details
b. Assessing the validity of the conclusions reached and evaluating the overall financial
statements presentation
Assessing going concern assumption
Financial statements are ordinarily prepared based on going concern basis, contrary to the
quitting concern basis, in the absence of information to the contrary. This means that the
assets and liabilities are recorded on the basis that the entity will be able to realize its assets
and discharge its liabilities in the normal course of business.
Going concern assumption – an entity is ordinarily viewed as continuing in business for
the foreseeable future with neither the intention nor the necessity of liquidation, ceasing
trading or seeking protection from creditors pursuant to laws and regulations.

Management’s responsibility:
 57

a. Management should assess the entity ‘s ability to continue as a going concern – making a
judgment about the future outcome of uncertain events or conditions (for a period of one
year from balance sheet date)
b. To disclosure (based on the result of assessment)

Disclosure requirements if FS are not prepared on a going concern basis:

a. The fact that FS are not prepared on a going concern basis
b. The basis on which the FS are prepared, and
c. The reasons why the entity is not regarded as a going concern

Auditor’s responsibility:
a. Overall evaluation of the appropriateness of management ‘s use of the going concern
assumption in the preparation of the financial statements
b. Identifying material uncertainties about the entity ‘s ability to continue as a going
concern that need to be disclosed in the financial statements
c. Whether such events or conditions are adequately disclosed in the financial statements
d. Consider report modification because of these events or conditions
e. If conditions or events such as those identified previously create substantial doubt as to
the ability of the entity to continue as a going concern, the auditor should consider
whether management has feasible plans (plans for and the ability to implement
alternative means of maintaining adequate cash flows)

The auditor has no responsibility to predict future events or conditions that may cause an entity to cease to
continue as a going concern. Thus, auditors are not required to design audit procedures solely to detect
going concern problems.
Factors that can mitigate the adverse effects of identified material going concern
uncertainty: The auditor should consider whether management has plans for and the ability to
implement alternative means of maintaining adequate cash flows to mitigate events and
conditions that may cast doubt about the entity ‘s ability to continue as a going concern.

Examples of mitigating factors:

 When there is a history of profitable operations and a ready access to financial
resources
 Management has plans and ability to maintain adequate cash flows by alternative
means, such as:
 Disposal of assets (including disposal of operations producing negative cash flows)
 Borrowing money or restructuring debt
 Leasing (instead of purchasing) of PPE items
 Renewal or, extension or rescheduling of loan repayments
 Reducing or delaying or postponing expenditures
 Obtaining additional capital
 Reducing or postponing dividend payments
 Availability of alternative source of supply in case of loss of a principal supplier

Audit procedures to identify conditions and events that may cast doubt about an
entity’s ability to continue as a going concern:
 Analytical procedures
 Subsequent events review
 Review of compliance with debt and loan agreements
 Reading minutes of meetings
 Inquiry of legal counsel
 Confirmation with related and third parties of arrangements for financial support

MANAGEMENT REPRESENTATION LETTER:

Auditor’s responsibility: The auditor should obtain appropriate written representations

from management.
Management’s responsibility: Management has responsibility to provide written
representations (this responsibility is included in the engagement letter that sets out the
terms of engagement).
 Management letter vs. management representation letter:
 Management letter is a letter to management regarding internal control deficiencies/weaknesses.
On the other hand, management representation letter is a letter from the management
confirming its responsibility and its oral representations.

Purposes of a management representation letter:

a. Main: To emphasize or impress upon management its ultimate responsibility for the
financial statements

b. Other purposes:
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 It confirms oral representations made by management during the audit

 It reduces the possibility of misunderstanding between the auditor and the client
concerning the matters that are the subject of the representations
 It documents management ‘s acceptance acknowledgment of its responsibility for
fair presentation of the financial statements
 It may provide corroborative evidence when audit evidence may not be reasonably
expected to be available
For example: Audit evidence to corroborate management ‘s intention to hold a
specific investment for long-term appreciation or to discontinue a line of business
 It complements, but do not replace or substitute, other audit procedures or other
audit evidence that the auditor could reasonably expect to be available

Forms of management representations: Management representations may be verbal,

whether solicited or unsolicited, or written, whether explicitly such as contained in a
management
representation letter or implicitly such as contained in financial information provided. The
forms of representations include:
a. A representation letter from management – known as the management
representation letter or client’s representation letter
b. A letter from the auditor (confirmatory letter) – outlining the auditor ‘s
understanding of management ‘s representations, duly acknowledged and confirmed
by management
c. Relevant minutes of meetings (of the board of directors or similar body)
d. Signed copy of the financial statements
e. Matters communicated in discussions or electronically such as e-mails or telephone
messages.
f. Schedules, analyses, and reports prepared by the entity, and management ‘s
notations and comments therein.

Basic elements of a management representation letter:

a. Addressee: Should be addressed to the auditor
b. Contents: Should contain the specified information
c. Date: Should be appropriately dated (ordinarily coincides with date of the auditor ‘s
report)
d. Signatory: Should be appropriately signed by the members of management who
have primary or overall responsibility for financial and operating aspects of the entity
Appropriate signatory of a management representation letter:
 Owner-manager
 Chief/senior executive officer
 Chief/senior financial officer
 Other members of management
Basic contents of management representation letter:
 That management acknowledges its responsibility for the fair presentation of the
financial statements in accordance with the applicable financial reporting framework
 That management has approved the financial statements
 That management acknowledges its responsibility for the design and implementation of
internal control to prevent and detect error
 That management believes the effects of those uncorrected financial statement
misstatements aggregated by the auditor during the audit are immaterial, both
individually and in the aggregate, to the financial statements taken as a whole

Classification of matters to be included in a management representation letter:

Written confirmation or representations should be obtained for all significant representations
provided to the auditor for all financial statements on which the auditor reports. These
representations are grouped below:
a. Representations that directly relate to items that are material, either individually or in
aggregate, to the financial statements.
b. Representations not directly related to items that are material to the financial
statements but are significant, either individually or in aggregate, to the engagement.
c. Representations that are relevant to management ‘s judgments or estimates that are
material, either individually or in aggregate, to the financial statements.
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Specific matters included in a management representation letter:

 Management ‘s acknowledgement of its responsibility for the fair presentation of the FS
 Management ‘s acknowledgement of its responsibility for the design and implementation of
internal control to prevent and detect error
 Availability of all financial records and related data and minutes of meetings (of shareholders,
board of directors, and committee of directors)
 Irregularities involving management or employees
 Confirmation on the completeness of the information provided regarding the identification of
related parties
 That the FS are free of material misstatements, including omissions
 Compliance or noncompliance with aspects of contractual agreements or requirements of
regulatory that could have a material effect on the FS in the event of noncompliance.
 Plans or intentions that may materially alter the carrying value or classification of assets and
liabilities
 Plans to abandon lines of product or other plans or intentions that will result in any excess or
obsolete inventory, and no inventory is stated at an amount in excess of net realizable value
 Satisfactory title on assets and liens or encumbrances on the company ‘s assets
 Communications from regulatory agencies concerning noncompliance with/or deficiencies in
financial reporting practices
 Information or recording and/or disclosure of:
 The identity of, and balances and transactions with, related parties
 Losses arising from sale and purchase commitments
 Agreements and options to buy back assets previously sold
 Assets pledged as collateral
 All liabilities, both actual and contingent
 Formal or informal compensating balance arrangements or other arrangements involving
restrictions on cash balances and credit line or similar arrangements
 Subsequent events requiring adjustment of or disclosure in the FS
 Claims and assessments in connection with litigation
 Capital stock repurchase options and agreements, and capital stock reserved for options,
warrants, conversions and other requirements
Limitations of ma nage ment representations: although management
representations are considered part of evidential matter, they (are):
 Not a substitute for performing other audit procedures or a means to reduce the auditor
‘s responsibility
 Not as the sole source of evidence on significant audit matters
 Cannot be substitute for other audit evidence that the auditor could reasonably expect to
be available

Auditor’s responsibility on representations relating to matters that are material to

the financial statements:
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; and
c. Consider whether the individuals making the representations can be expected to be well
informed on the particular matters.

Legal representation letter – client ‘s letter of inquiry to lawyer who have been consulted
by the client concerning litigation, claims, or assessments to provide corroborative evidential
matter; such letter of inquiry should be mailed only by the auditor after preparation by the
client and review by the auditor

Application of materiality:
1. Representations may be limited to matters that are considered either individually or
collectively material to the financial statements
2. Materiality limits would not apply when obtaining written client representation on:
a. Fraud or irregularities involving management
b. Availability of minutes of meetings

Effect if management refuses to provide the necessary written representations:

Refusal by management to provide a written representation requested by the auditor that
the auditor deems necessary constitutes a scope limitation and would result in a qualified
opinion or a disclaimer of opinion. In such circumstances, also consider:
a. Any reliance placed on other representations made by management during the audit;
and
b. Any additional implications of the refusal on the auditor ‘s report.
When management representation is contradicted by other audit evidence: The
auditor should investigate the circumstances and, when necessary, reconsider the reliability
of other representations made by management
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SUBSEQUENT DISCOVERY OF OMITTED PROCEDURES AFTER SUBMISSION OF THE AUDIT

REPORT

Omitted audit procedures may be discovered (after the audit report has been submitted)
during a firm's internal inspection program or during peer review.
Auditor’s action:
a. The auditor should assess the importance of the omitted procedures to his ability to
support the audit opinion.
b. The auditor should determine whether other audit procedures that were applied tend
to compensate for the omitted audit procedures. If so, no further action is necessary.
c. If, on the other hand, the omitted audit procedures impair the auditor's ability to
support the previously issued opinion, and there are people relying (or likely to rely)
on the report, then the auditor should promptly undertake to apply the omitted
procedures or the corresponding alternative procedures.
d. If, after applying the omitted procedures, the auditor determines that the financial
statements are materially misstated and that the auditor's report is inappropriate,
the auditor should discuss the matter with the management and take steps to
prevent future reliance on the report.

THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS

(Based on PSA 700 revised – The Independent Auditor ‘s Report On a Complete
Set of General Purpose Financial Statements)

Introduction

At the end of the audit, the auditor shall:

a) Form an opinion on the financial statements (FSs) based on an evaluation of the conclusions
drawn from the audit evidence obtained; and
b) Express clearly that opinion through a written report that also describes the basis for the
opinion.

Auditor’s Opinions

Types of Auditor ‘s Opinions

a) Unmodified (unqualified) opinion—The opinion expressed when the FSs are prepared, in all
material respects, in accordance with the applicable FRF.
b) Modified opinion—The three types of are:
i. Qualified opinion – the auditor is satisfied that the FSs are presented fairly, except for a
specific aspect of them.
ii. Adverse opinion – the auditor does not believe the FSs are fairly presented.
iii. Disclaimer of opinion – the auditor does not know if the FSs are presented fairly.

The table below illustrates how the auditor ‘s judgment about the affects the type of opinion to be
expressed.

Nature of Matter Giving Rise to Material but Not Material and Pervasive
the Modification Pervasive
FSs are materially misstated Qualified opinion Adverse opinion
Inability to obtain SAAE (Scope limitation):
Due to management imposed Qualified opinion Resign, if appropriate; or
limitation Disclaimer of opinion
Other limitations Qualified opinion Disclaimer of opinion

Pervasive effects or possible effects on the FSs are those that, in the auditor ‘s judgment:
a) Are not confined to specific elements, accounts or items of the FSs;
b) If so confined, represent or could represent a substantial proportion of the FSs; or
c) In relation to disclosures, are fundamental to users ‘understanding of the FSs.
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Auditor’s Reports

The auditor ‘s report shall be in writing (hard copy format or an electronic medium).

Standard Auditor ‘s Report

The following are the parts of a standard auditor ‘s report with unqualified opinion without
emphasis of matter paragraph and other matter paragraph:
a) Title
b) Addressee
c) Sub-title (if the report includes ―Other Reporting Responsibilities‖ paragraph in (h))
d) Introductory Paragraph
e) Management ‘s Responsibility for the financial statements
f) Auditor ‘s Responsibility
g) Auditor ‘s Opinion
h) Other Reporting Responsibilities, if applicable
i) Signature of the Auditor
j) Date of the Auditor ‘s Report
k) Auditor ‘s Address Title
The auditor ‘s report shall have a title that clearly indicates that it is the report of an independent
auditor. For example, ―Independent Auditor ‘s Report, ‖ affirms that the auditor has met all of the
relevant ethical requirements regarding independence and distinguishes the independent auditor
‘s report from reports issued by others.

Addressee

The auditor ‘s report is normally addressed to those for whom the report is prepared, often either
to the shareholders and/or to TCWG of the entity.

Introductory Paragraph

The introductory paragraph in the auditor ‘s report shall:

a) Identify the entity whose FSs have been audited;
b) State that the FSs have been audited;
c) Identify the title of each statement comprising the FSs;
d) Refer to the summary of significant accounting policies and other explanatory information;
and
e) Specify the date or period covered by each FS comprising the FSs.

Management ‘s Responsibility for the Financial Statements

This section describes the responsibilities of those in the organization responsible for the FSs and
internal control relevant to the preparation of FSs that are free from material misstatement,
whether due to fraud or error.

Auditor ‘s Responsibility

This section states that the responsibility of the auditor is to express an opinion on the FSs based
on the audit.

Auditor ‘s Opinion

This includes a section with the heading ―Opinion. ‖ Use the phrase: The financial statements
present fairly, in all material respects, in accordance with [the applicable financial reporting
framework].

Other Reporting Responsibilities

If the auditor addresses other reporting responsibilities (e.g., reportorial requirement of

regulatory authorities) in the auditor ‘s report on the FSs that are in addition to to report on the
FSs, these shall be addressed in a separate section in the auditor ‘s report that shall be sub-titled
―Report on Other Legal and Regulatory Requirements‖.
Signature of the Auditor

The auditor ‘s report shall be signed. The auditor ‘s signature is either in the name of the audit
firm, the personal name of the auditor or both, as appropriate.
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In the Philippines, Securities Regulation Code (SRC) Rule 68 requires that the auditor ‘s report on
FSs filed with the Securities and Exchange Commission (SEC), which will likewise be filed with the
Bureau of Internal Revenue (BIR), be manually signed. In case of an auditing firm, the certifying
partner shall sign his/her own signature and shall indicate that he/she is signing for the firm, the
name of which is also indicated in the report. The auditor is also required to state the signing
accountant ‘s license number, Tax Identification No. (TIN), Privilege Tax Receipt (PTR) No.,
registration number with the PRC/BOA, and accreditation issued by the SEC.

Date of the Auditor ‘s Report

The auditor ‘s report shall be dated no earlier than the date on which the auditor has obtained
SAAE on which to base the auditor ‘s opinion on the FSs, including evidence that:
a. All the statements that comprise the FSs, including the related notes, have been prepared;
and
b. Those with the recognized authority have asserted that they have taken responsibility for
those FSs.

The date of the auditor ‘s report informs the user of the auditor ‘s report that the auditor has
considered the effect of events and transactions of which the auditor became aware and that
occurred up to that date.

In the Philippines, under SRC Rule 68, management is required to submit to the SEC, together
with the FSs, a
‗Statement of Management Responsibility ‘that indicates, that the company’s Board of Directors
reviewed and approved the FSs before such statements are submitted to the stockholders of the
company.

Modifications to Auditor ‘s Report

The instances of modifications include when the auditor:

adds ―Emphasis of Matter Paragraph‖
includes ―Other of Matter Paragraph‖
provides modified auditor ‘s opinion Emphasis of Matter Paragraph
A paragraph included in the auditor ‘s report that refers to a matter appropriately presented or
disclosed in the FSs, in the auditor ‘s judgment, is of such importance that it is fundamental to
users ‘understanding of the FSs. The auditor can include emphasis of matter paragraph provided
the auditor has obtained SAAE that the matter is not materially misstated in the FSs. The
inclusion of this paragraph in the auditor ‘s report does not affect the auditor ‘s opinion.

When the auditor includes an Emphasis of Matter paragraph in the auditor ‘s report, the auditor
shall:
Include it immediately after the Opinion paragraph;
Use the heading ―Emphasis of Matter, ‖ or other appropriate heading;
Include in the paragraph a clear reference to the matter being emphasized and to where
relevant disclosures that fully describe the matter can be found in the FSs; and
Indicate that the auditor ‘s opinion is not modified in respect of the matter emphasized Other
Matter Paragraph
A paragraph included in the auditor ‘s report that refers to a matter other than those presented
or disclosed in the FSs that, in the auditor ‘s judgment, is relevant to users ‘understanding of the
audit, the auditor ‘s responsibilities or the auditor ‘s report.

The auditor shall include this paragraph immediately after the Opinion paragraph and any
Emphasis of Matter paragraph, or elsewhere in the auditor ‘s report if the content of the Other
Matter paragraph is relevant to the Other Reporting Responsibilities section.

Modified Auditor ‘s Opinions

Description of Introductory Paragraph

Qualified or Adverse Opinion – No modification made.
Disclaimer of Opinion – Amend this paragraph of the auditor ‘s report to state that the auditor
was only engaged (not audited) to audit the FSs.

Description of Auditor ‘s Responsibility Paragraph

Qualified or Adverse Opinion – Amend this section to state that the auditor believes that the
audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the
auditor ‘s modified audit opinion.
Disclaimer of Opinion – Amend this section to state only the following: ―Our responsibility is to
express an opinion on the financial statements based on conducting the audit in accordance
with Philippine Standards on Auditing. Because of the matter(s) described in the Basis for
 63

Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient appropriate
audit evidence to provide a basis for an audit opinion. ‖

Basis for Modification Paragraph

The auditor shall include additional paragraph on the standard auditor ‘s report immediately
before the opinion paragraph, and use the heading ―Basis for Qualified Opinion, ‖ ―Basis for
Adverse Opinion, ‖ or
―Basis for Disclaimer of Opinion, ‖ as appropriate.

Opinion Paragraph
The auditor shall use the heading ―Qualified Opinion, ‖ ―Adverse Opinion, ‖ or ―Disclaimer of
Opinion, ‖ as appropriate, for the opinion paragraph.

Sample of Auditor’s Reports

INDEPENDENT AUDITOR’S REPORT

The Board of Directors and Shareholders Report on the Financial Statements

We have audited [if disclaimer of opinion, We were engaged to audit] the accompanying financial
statements of [Name of Client], which comprise the statements of financial position as at
[Reporting Date], 2012 and 2011, and the statements of [comprehensive income, income,
operations, or other appropriate title used in the financial statements], statements of changes in
equity and statements of cash flows for the years then ended, and a summary of significant
accounting policies and other explanatory information.

Management ‘s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements
in accordance with [Applicable Financial Reporting Framework], and for such internal control as
management determines is necessary to enable the preparation of financial statements that are
free from material misstatement, whether due to fraud or error.

Auditors ‘Responsibility

[If qualified opinion or adverse]

Our responsibility is to express an opinion on these financial statements based on our audits. We
conducted our audits in accordance with Philippine Standards on Auditing. Those standards
require that we comply with ethical requirements and plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from material
misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditors
‘judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditors
consider internal control relevant to the entity ‘s preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the entity ‘s internal control. An
audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating the overall
presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our [qualified or adverse, as appropriate] audit opinion.

[If disclaimer of opinion]

Our responsibility is to express an opinion on these financial statements based on conducting the
audit in accordance with Philippine Standards on Auditing. Because of the matter described in the
Basis for Disclaimer
of Opinion paragraph, however, we were not able to obtain sufficient appropriate audit evidence
to provide a basis for an audit opinion.

Opinion [If unqualified/unmodified opinion]

In our opinion, the financial statements present fairly, in all material respects, the financial
position of [Name of Client] as at [Reporting Date], 2012 and 2011, and its financial performance
and its cash flows for the years then ended in accordance with [Applicable financial reporting
framework].
 64

[If qualified opinion]

Basis for Qualified Opinion

The Company’s inventories are recognized in the statement of financial position at P16 million
Based on the audit evidence obtained, we believe that an adjustment to inventories of P5 million
is required to recognize slow moving items at their net realized value. The tax effect of this
adjustment is P1.5 million. Accordingly, we believe that shareholders ‘equity and profit for the
year are overstated by P3.5 million respectively.]

Qualified Opinion

In our opinion, except for the effects of the matters descried in the basis for qualified opinion
paragraph, the financial statements present fairly, in all material respects, the financial position of
[Name of Client] as of [Reporting Date], 2012 and 2011, and its financial performance and its
cash flows for the years ended in accordance with Philippine Financial Reporting Standards.

[If adverse opinion]

Basis for Adverse Opinion

As discussed in Note X to the financial statements, the Company’s financing arrangements

expired and the amount outstanding was payable on December 31, 20XI. The company has been
unable to re-negotiate or obtain replacement financing and is considering filing for bankruptcy.
Based on the audit evidence obtained, we believe that the company will not be able to meet its
obligations in the ordinary course of business. Accordingly, we do not agree with management ‘s
preparation and presentation of financial statements on a going concern basis. Had the financial
statements been prepared on a liquidation basis of accounting, we believe that it would have had
a significant negative effect on the company’s financial position and financial performance.
Adverse Opinion

Adverse Opinion

In our opinion, because of the significance of the matter discussed in the basis for adverse
opinion paragraph, the financial statements do not present fairly, in all material respects the
financial position [Name of Client] as of [Reporting Date], 2012 and 2011, and of its financial
performance and its cash flows for the years then ended in accordance with Philippine Financial
Reporting Standards.

[If disclaimer of opinion]

Basis for Disclaimer of Opinion

The company’s investment in its joint venture XYZ (Country X) Company is carried at xxx on the
company’s statement of financial position, which represents over 90% of the company’s net
assets as at December 31, 2012. We were not allowed access to the management and the
auditors of XYZ, including XYZ ‘s auditors ‘audit documentation. As a result, we were unable to
determine whether any adjustments were necessary in respect of the company’s proportional
share of XYZ ‘s assets that it controls jointly, its proportional share of XYZ ‘s liabilities for which it
is jointly responsible, its proportional share of XYZ ‘s income and expenses for the year, and the
elements making up the statement of changes in equity and statement of cash flow.

Disclaimer of Opinion

Because of the significance of the matter described in the Basis for Disclaimer of Opinion
paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion.
Accordingly, we do not express an opinion on the financial statements.
[If with emphasis of a matter] Emphasis of Matter
We draw attention to Note X to the financial statements, which appropriately describe the
significant uncertainty related to the outcome of a lawsuit in which the company is the defendant.
The lawsuit alleges infringement of certain patent right and claims royalties and punitive damages
in the amount of P10 million to the outcome of the lawsuit, the company believes that it will be
able to successfully defend its case and, accordingly, no provision for any liability that may result
has been recognized in the financial statements. Our opinion is not qualified in respect of this
matter.
Report on Other Legal and Regulatory Requirements [NAME OF AUDITING FIRM]
BOA Registration No.
SEC Accreditation No. TIN
 65

By:

[NAME OF PARTNER]
Partner
CPA License No. SEC A.N.
TIN BIR AN.
PTR No., Issued on [Date, Place of Issue]
Makati City, Philippines [Date of Auditors ‘Report]

Supplementary Information Presented with the Financial Statements

Supplementary information – information that is presented together with the FSs that is not
required by the applicable FRF used to prepare the FSs, normally presented in either
supplementary schedules or as additional notes.

The auditor shall evaluate whether such supplementary information is clearly differentiated from
the audited FSs. If such supplementary information is not clearly differentiated, the auditor shall
ask management to change how the unaudited supplementary information is presented. If
management refuses to do so, the auditor shall explain in the auditor ‘s report that such
supplementary information has not been audited. The fact that supplementary information is
unaudited does not relieve the auditor of the responsibility to read that information to identify
material inconsistencies with the audited financial statements.

Comparative Information

The two broad approaches to the auditor ‘s reporting responsibilities in respect of comparative
information are:
a) Corresponding figures –comparative information where amounts and other disclosures for the
prior period are included as an integral part of the current period FSs, and are intended to be
read only in relation to the amounts and other disclosures relating to the current period
(referred to as ―current period figures‖). The level of detail presented in the corresponding
amounts and disclosures is dictated primarily by its relevance to the current period figures;
and
b) Comparative FSs –comparative information where amounts and other disclosures for the prior
period are included for comparison with the FSs of the current period but, if audited, are
referred to in the auditor ‘s opinion. The level of information included in those comparative
FSs is comparable with that of the FSs of the current period.

Audit Procedures

The auditor shall evaluate whether:

a) The comparative information agrees with the amounts and other disclosures presented in the
prior period or, when appropriate, have been restated; and
b) The accounting policies reflected in the comparative information are consistent with those
applied in the current period or, if there have been changes in accounting policies, whether
those changes have been properly accounted, presented and disclosed.
If the auditor becomes aware of a possible material misstatement in the comparative information
while performing the current period audit, the auditor shall perform such additional audit
procedures necessary to obtain SAAE, including requesting written representations for all periods
referred to in the auditor ‘s opinion.

Audit Reporting

The essential audit reporting differences between the approaches are:

a) For corresponding figures, the auditor ‘s opinion on the FSs refers to the current period only;
whereas
b) For comparative FSs, the auditor ‘s opinion refers to each period for which FSs are presented.

Corresponding figures

The auditor ‘s opinion shall not refer to the corresponding figures because the auditor ‘s opinion is
on the current period FSs includes corresponding figures, except:
a) Modification in auditor ‘s report on the prior period remain unresolved
b) Misstatement in prior period FSs
c) Prior period FSs not audited
d) Prior period FSs audited by a predecessor auditor

Modification in auditor ‘s report on the prior period remain unresolved

 66

The auditor shall modify the auditor ‘s opinion on the current period ‘s FSs. Misstatement in prior
period FSs
If the auditor obtains audit evidence that a material misstatement exists in the prior period FSs
on which an unmodified opinion has been previously issued, and the corresponding figures have
not been properly restated, the auditor shall express a qualified opinion or an adverse opinion in
the auditor ‘s report on the current period FSs.

When the prior period FSs that are misstated have not been amended and an auditor ‘s report
has not been reissued, but the corresponding figures have been properly restated or appropriate
disclosures have been made in the current period FSs, the auditor ‘s report may include an
Emphasis of Matter paragraph.

Prior period FSs not audited

The auditor shall state in an Other Matter paragraph in the auditor ‘s report that the
corresponding figures are unaudited.

Prior period FSs audited by a predecessor auditor

The auditor shall state (if nor prohibited by law to do so) in an Other Matter paragraph in the
auditor ‘s report:
a) That the FSs of the prior period were audited by the predecessor auditor;
b) The type of opinion expressed and, if the opinion was modified, the reasons therefore; and
c) The date of that report.

Comparative financial statements

The auditor ‘s opinion shall refer to each period for which FSs are presented on which an audit
opinion is expressed.

Opinion on Prior Period FSs Different from Previous Opinion

The opinion expressed on the prior period FSs may be different from the opinion previously
expressed if the auditor becomes aware of circumstances or events that materially affect the FSs
of a prior period during the course of the audit of the current period. The auditor shall disclose the
substantive reasons for the different opinion in an Other Matter paragraph.

Prior Period FSs Audited by a Predecessor Auditor

In addition to expressing an opinion on the current period ‘s FSs, the auditor shall state in an
Other Matter paragraph:
a) that the FSs of the prior period were audited by a predecessor auditor;
b) the type of opinion expressed and, if the opinion was modified, the reasons therefore; and
c) the date of that report,
unless the predecessor auditor ‘s report on the prior period ‘s FSs is reissued with the FSs.

Prior Period Financial Statements Not Audited

If the prior period FSs were not audited, the auditor shall state in an Other Matter paragraph that
the comparative FSs are unaudited.

Other Information in Documents Containing Audited Financial Statements

Other information refers to financial and non-financial information (other than the FSs and the
auditor ‘s report thereon) which is included, either by law, regulation or custom, in a document
containing audited FSs and the auditor ‘s report thereon. Other information may comprise, for
example:
A report by management or TCWG on operations.
Financial summaries or highlights.
Employment data.
Planned capital expenditures.
Financial ratios.
Names of officers and directors.
Selected quarterly data.

―Documents containing audited FSs‖ refers to annual reports (or similar documents), that are
issued to owners (or similar stakeholders), containing audited FSs and the auditor ‘s report, as
well as other documents containing audited FSs, such as those used in securities offerings.
 67

The auditor ‘s opinion does not cover other information and the auditor has no specific
responsibility for determining whether or not other information is properly stated. However, the
auditor reads the other information because the credibility of the audited FSs and the auditor ‘s
report may be undermined by material inconsistencies between the audited FSs and other
information.

Material Inconsistencies

If, on reading the other information, the auditor identifies a material inconsistency, the auditor
shall determine whether the audited FSs or the other information needs to be revised.

Material Inconsistencies Identified in Other Information Obtained Prior to the Date of the Auditor
‘s Report

If revision of the audited FSs is necessary and management refuses to make the revision, the
auditor shall modify the opinion in the auditor ‘s report.

If revision of the other information is necessary and management refuses to make the revision,
the auditor shall communicate this matter to TCWG; and
a) Include in the auditor ‘s reports and Other Matter paragraph describing the material
inconsistency.
b) Withhold the auditor ‘s report.
c) Withdraw from the engagement, if possible.
d) Seek advice from the auditor ‘s legal counsel.

Material Inconsistencies Identified in Other Information Obtained Subsequent to the Date of the
Auditor ‘s Report

If revision of the audited FSs is necessary, the auditor shall follow the relevant requirements in
―Subsequent Events‖.

If revision of the other information is necessary and management agrees to make the revision,
the auditor shall carry out the procedures necessary under the circumstances, which may include
reviewing the steps taken by management to ensure that individuals in receipt of the previously
issued FSs, the auditor ‘s report thereon, and the other information are informed of the revision.

If revision of the other information is necessary, but management refuses to make the revision,
the auditor shall notify TCWG of the auditor ‘s concern regarding the other information and take
any further appropriate action, which may include obtaining advice from the auditor ‘s legal
counsel.

Material Misstatements of Fact

If, on reading the other information for the purpose of identifying material inconsistencies, the
auditor becomes aware of an apparent material misstatement of fact, the auditor shall discuss the
matter with management. Misstatement of fact occurs when other information that is unrelated to
matters appearing in
the audited FSs that is incorrectly stated or presented. A material misstatement of fact may
undermine the credibility of the document containing audited FSs.

If the auditor concludes that there is a material misstatement of fact in the other information
which management refuses to correct, the auditor shall notify TCWG of the auditor ‘s concern and
take any further appropriate action, which may include obtaining advice from the auditor ‘s legal
counsel.

Audit of Financial Statements Prepared in Accordance with Special Purpose Framework

Introduction

Special purpose FSs are FSs prepared in accordance with a special purpose framework designed
to meet the financial information needs of specific users.

Examples of special purpose frameworks are:

A tax basis of accounting for a set of FSs that accompany an entity ‘s tax return;
The cash receipts and disbursements basis of accounting for cash flow information that an
entity may be requested to prepare for creditors;
The financial reporting provisions established by a regulator to meet the requirements of that
regulator such as SEC, BSP or IC; or
The financial reporting provisions of a contract, such as a bond indenture, or a project grant.
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The financial reporting framework (FRF) must be acceptable. The financial information needs of
the intended users are a key factor in determining the acceptability of the FRF and is a matter of
professional judgment.

The auditor shall comply with (a) relevant ethical requirements, including independence and (b)
all PSAs relevant to the audit.

Forming an Opinion and Reporting Considerations

Description of the applicable financial reporting framework:

a) The auditor ‘s report shall also describe the purpose for which the FSs are prepared and, if
necessary, the intended users, or refer to a note in the special purpose FSs that contains that
information; and
b) If management has a choice of financial reporting frameworks in the preparation of such FSs,
the explanation of management ‘s responsibility for the FSs shall also make reference to its
responsibility for determining that the applicable financial reporting framework is acceptable
in the circumstances.

The auditor ‘s report shall include an Emphasis of Matter paragraph alerting users of the auditor
‘s report that the FSs are prepared in accordance with a special purpose framework and that, as a
result, the FSs may not be suitable for another purpose. In addition to the above, the auditor may
consider it appropriate to indicate that the auditor ‘s report is intended solely for the specific
users.

INDEPENDENT AUDITOR’S REPORT

[Appropriate Addressee]

We have audited the accompanying financial statements of ABC Company, which comprise the
balance sheet as at December 31, 20X1, and the income statement, statement of changes in
equity and cash flow statement for the year then ended, and a summary of significant accounting
policies and other explanatory information. The financial statements have been prepared by
management of ABC Company based on the financial reporting provisions of Section Z of the
contract dated January 1, 20X1 between ABC Company and DEF Company (―the contract‖).

Management ‘s Responsibility for the Financial Statements

Management is responsible for the preparation of these financial statements in accordance with
the financial reporting provisions of Section Z of the contract; this includes the design,
implementation and maintenance of internal control relevant to the preparation of financial
statements that are free from material misstatement, whether due to fraud or error.

Auditor ‘s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We
conducted our audit in accordance with Philippine Standards on Auditing. Those standards require
that we comply with ethical requirements and plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditor ‘s
judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity ‘s preparation of the financial statements in order
to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the entity ‘s internal control. An audit also includes
evaluating the appropriateness of accounting policies used and the reasonableness of accounting
estimates made by management, as well as evaluating the overall presentation of the financial
statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.

Opinion

In our opinion, the financial statements of ABC Company for the year ended December 31, 20X1
are prepared, in all material respects, in accordance with the financial reporting provisions of
Section Z of the contract.

Basis of Accounting and Restriction on Distribution and Use

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Without modifying our opinion, we draw attention to Note X to the financial statements, which
describes the basis of accounting. The financial statements are prepared to assist ABC Company
to comply with the financial reporting provisions of the contract referred to above. As a result, the
financial statements may not be suitable for another purpose. Our report is intended solely for
ABC Company and DEF Company and should not be distributed to or used by parties other than
ABC Company or DEF Company.

[Auditor ‘s signature]

[Date of the auditor ‘s report] [Auditor ‘s address]

Audits of Single Financial Statements and Specific Elements, Accounts or Items of a
Financial Statement

Introduction

―Element of a financial statement‖ or ―element‖ means an ―element, account or item of a financial

statement. ‖ Examples of Specific Elements, Accounts or Items of a Financial Statement
Accounts receivable, allowance for doubtful accounts receivable, inventory, including related
notes.
A schedule of externally managed assets and income of a private pension plan, including
related notes.
A schedule of disbursements in relation to a lease property, including explanatory notes.
A schedule of profit participation or employee bonuses, including explanatory notes.

Considerations When Accepting the Engagement

The auditor shall comply with relevant ethical requirements, including independence and all PSAs
relevant to the audit.

If the auditor is not also engaged to audit the entity ‘s complete set of financial statements, the
auditor shall determine whether the audit of a single financial statement or of a specific element
of those financial statements in accordance with PSAs is practicable.

Form of opinion

The auditor ‘s decision as to the expected form of opinion is a matter of professional judgment. It
may be affected by whether use of the phrase ―presents fairly, in all material respects‖ in the
auditor ‘s opinion on a single financial statement or on a specific element of a financial statement
prepared in accordance with a fair presentation framework is generally accepted in the particular
jurisdiction.

Forming an Opinion and Reporting Considerations

If the auditor undertakes an engagement to report on a single financial statement or on a specific

element of a financial statement in conjunction with an engagement to audit the entity ‘s
complete set of financial statements, the auditor shall express a separate opinion for each
engagement.
If the auditor concludes that it is necessary to express an adverse opinion or disclaim an
opinion on the entity ‘s complete set of financial statements as a whole, PSA 705 does not
permit the auditor to include in the same auditor ‘s report an unmodified opinion on a single
financial statement that forms part of those financial statements or on a specific element that
forms part of those financial statements. This is because such an unmodified opinion would
contradict the adverse opinion or disclaimer of opinion on the entity ‘s complete set of financial
statements as a whole.

If the auditor concludes that it is necessary to express an adverse opinion or disclaim an

opinion on the entity ‘s complete set of financial statements as a whole but, in the context of a
separate audit of a specific element that is included in those financial statements, the auditor
nevertheless considers it appropriate to express an unmodified opinion on that element, the
auditor shall only do so if:
a) The auditor is not prohibited by law or regulation from doing so;
b) That opinion is expressed in an auditor ‘s report that is not published together with the
auditor ‘s report containing the adverse opinion or disclaimer of opinion; and
c) The specific element does not constitute a major portion of the entity ‘s complete set of
financial statements.

INDEPENDENT AUDITOR’S REPORT

[Appropriate Addressee]
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We have audited the accompanying balance sheet of ABC Company as at December 31, 20X1 and
a summary of significant accounting policies and other explanatory information (together ―the
financial statement‖).

Management ‘s Responsibility for the Financial Statement

Management is responsible for the preparation and fair presentation of this financial statement in
accordance with those requirements of the Financial Reporting Framework in Jurisdiction X
relevant to preparing such a financial statement, and for such internal control as management
determines is necessary to enable the preparation of the financial statement that is free from
material misstatement, whether due to fraud or error.

Auditor ‘s Responsibility

Our responsibility is to express an opinion on the financial statement based on our audit. We
conducted our audit in accordance with Philippine Standards on Auditing. Those standards require
that we comply with ethical requirements and plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statement. The procedures selected depend on the auditor ‘s
judgment, including the assessment of the risks of material misstatement of the financial
statement, whether due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity ‘s preparation and fair presentation of the
financial statement in order to design audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the entity ‘s internal
control. An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates, if any, made by management, as well as evaluating the
overall presentation of the financial statement.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
Opinion

In our opinion, the financial statement presents fairly, in all material respects, the financial
position of ABC Company as at December 31, 20X1 in accordance with those requirements of the
Financial Reporting Framework in Jurisdiction X relevant to preparing such a financial statement.

[Auditor ‘s signature]

[Date of the auditor ‘s report] [Auditor ‘s address]

Engagements to Report on Summary Financial Statements

Introduction

Summary FSs refer to historical financial information that is derived from FSs but that contains
less detail than the FSs, while still providing a structured representation consistent with that
provided by the FSs of the entity ‘s economic resources or obligations at a point in time or the
changes therein for a period of time.

Engagement Acceptance

The auditor shall accept an engagement to report on summary FSs only when the auditor has been
engaged to conduct an audit of the FSs from which the summary FSs are derived.

Form of Opinion

When the auditor has concluded that an unmodified opinion on the summary FSs is appropriate,
the auditor ‘s opinion shall use one of the following phrases:
a) The summary FSs are consistent, in all material respects, with the audited FSs, in accordance
with [the applied criteria]; or
b) The summary FSs are a fair summary of the audited FSs, in accordance with [the applied
criteria].

When the auditor ‘s report on the audited FSs contains a qualified opinion, an Emphasis of Matter
paragraph, or an Other Matter paragraph, but the auditor is satisfied that the summary FSs are
consistent, in all material respects, with or are a fair summary of the audited FSs, in accordance
with the applied criteria, the auditor ‘s report on the summary FSs shall:
a) State that the auditor ‘s report on the audited FSs contains a qualified opinion, an Emphasis
of Matter paragraph, or an Other Matter paragraph; and
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b) Describe:
i. The basis for the qualified opinion on the audited FSs, and that qualified opinion; or the
Emphasis of Matter or the Other Matter paragraph in the auditor ‘s report on the audited
FSs; and
ii. The effect thereof on the summary FSs, if any.

When the auditor ‘s report on the audited FSs contains an adverse opinion or a disclaimer of
opinion, the auditor ‘s report on the summary FSs shall
a) State that the auditor ‘s report on the audited FSs contains an adverse opinion or disclaimer
of opinion;
b) Describe the basis for that adverse opinion or disclaimer of opinion; and
c) State that, as a result of the adverse opinion or disclaimer of opinion, it is inappropriate to
express an opinion on the summary FSs.

If the summary FSs are not consistent, in all material respects, with or are not a fair summary of
the audited FSs, the auditor shall express an adverse opinion on the summary FSs.

The Date of the Auditor ‘s Report

The auditor shall date the auditor ‘s reports no earlier than:

a) The date on which the auditor has obtained sufficient appropriate evidence on which to base
the opinion, including evidence that the summary FSs have been prepared and those with the
recognized authority have asserted that they have taken responsibility for them; and
b) The date of the auditor ‘s report on the audited FSs.
Restriction on Distribution or Use or Alerting Readers to the Basis of Accounting

When distribution or use of the auditor ‘s report on the audited FSs is restricted, or the auditor ‘s
report on the audited FSs alerts readers that the audited financial statements are prepared in
accordance with a special purpose framework, the auditor shall include a similar restriction or
alert in the auditor ‘s report on the summary FSs.

REPORT OF THE INDEPENDENT AUDITOR ON THE SUMMARY FINANCIAL

STATEMENTS

[Appropriate Addressee]

The accompanying summary financial statements, which comprise the summary balance sheet as
at December 31, 20X1, the summary income statement, summary statement of changes in equity
and summary cash flow statement for the year then ended, and related notes, are derived from
the audited financial statements of ABC Company for the year ended December 31, 20X1. We
expressed an unmodified audit opinion on those financial statements in our report dated February
15, 20X2. Those financial statements, and
the summary financial statements, do not reflect the effects of events that occurred subsequent
to the date of our report on those financial statements.

The summary financial statements do not contain all the disclosures required by [describe
financial reporting framework applied in the preparation of the audited financial statements of
ABC Company]. Reading the summary financial statements, therefore, is not a substitute for
reading the audited financial statements of ABC Company.

Management ‘s Responsibility for the Summary Financial Statements

Management is responsible for the preparation of a summary of the audited financial statements
in accordance with [describe established criteria].

Auditor ‘s Responsibility

Our responsibility is to express an opinion on the summary financial statements based on our
procedures, which were conducted in accordance with Philippine Standard on Auditing (PSA) 810,
―Engagements to Report on Summary Financial Statements. ‖

Opinion

In our opinion, the summary financial statements derived from the audited financial statements of
ABC Company for the year ended December 31, 20X1 are consistent, in all material respects,
with (or a fair summary of) those financial statements, in accordance with [describe established
criteria].

[Auditor ‘s signature]
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[Date of the auditor ‘s report] [Auditor ‘s address]

REVIEW, OTHER ASSURANCE SERVICES, AND RELATED SERVICES

Review Engagements

The objective of a review of FSs is to enable a practitioner to state whether, on the basis of
procedures which do not provide all the evidence that would be required in an audit, anything has
come to the practitioner ‘s attention that causes the practitioner to believe that the FSs are not
prepared, in all material respects, in accordance with the applicable financial reporting framework
(negative assurance).

A review engagement provides a moderate level of assurance.

The practitioner should comply with the Code of Ethics general principles, such as:
a) Independence;
b) Integrity;
c) Objectivity;
d) Professional competence and due care;
e) Confidentiality;
f) Professional behavior; and
g) Technical standards.

The practitioner should conduct a review in accordance with PSRE 2400.

The practitioner should plan and perform the review with an attitude of professional skepticism.

Terms of engagement

The practitioner and the client should agree on the terms of the engagement.

Planning

The practitioner should plan the work so that an effective engagement will be performed. In
planning a review of financial statements, the practitioner should obtain or update the knowledge
of the business.

Documentation
The practitioner should document matters which are important in providing evidence to support
the review report, and evidence.

Procedures and Evidence

The practitioner should apply judgment in determining the specific nature, timing and extent of
review procedures, which are primarily through inquiry and analytical procedures to obtain
sufficient appropriate evidence and to be able to draw conclusions.

The practitioner should apply the same materiality considerations as would be applied if an audit
opinion on the FSs were being given.

The practitioner should inquire about events subsequent to the date of the FSs that may require
adjustment of or disclosure in the FSs. The practitioner does not have any responsibility to
perform procedures to identify events occurring after the date of the review report.

If the practitioner has reason to believe that the information subject to review may be materially
misstated, the practitioner should carry out additional or more extensive procedures as are
necessary to be able to express negative assurance or to confirm that a modified report is
required.

Conclusions and Reporting

The review report should contain a clear written expression of negative assurance.

The report on a review of FSs should contain the following basic elements, ordinarily in the
following layout:
a) Title;
b) Addressee;
c) Opening or introductory paragraph I
d) Scope paragraph
e) Statement of negative assurance;
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f) Date of the report;

g) Practitioner ‘s address; and
h) Practitioner ‘s signature.

The review report should:

a) State that nothing has come to the practitioner ‘s attention based on the review that causes
the practitioner to believe the FSs are not presented fairly, in all material respects, in
accordance with the applicable financial reporting framework; or
b) If matters have come to the practitioner ‘s attention, describe those matters that impair a fair
presentation, in all material respects, in accordance with the applicable financial reporting
framework, including, unless impracticable, a quantification of the possible effect(s) on the
FSs, and either:
i. Express a qualification of the negative assurance provided; or
ii. When the effect of the matter is so material and pervasive, give an adverse opinion;
or
c) If there has been a material scope limitation, describe the limitation and either:
i. Express a qualification of the negative assurance; or
ii. When the possible effect of the limitation is so significant and pervasive that the
practitioner concludes that no level of assurance can be provided, not provide any
assurance.

The practitioner should date the review report as of the date the review is completed.

SAMPLE UNQUALIFIED REVIEW REPORT

REVIEW REPORT TO ....

We have reviewed the accompanying financial statements of ABC Company, which comprise the
statement of financial position as at December 31, 19XX, and the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then ended.
These financial statements are the responsibility of the Company’s management. Our
responsibility is to issue a report on these financial statements based on our review.

We conducted our review in accordance with the Philippine Standard on Review Engagements
2400. This Standard requires that we plan and perform the review to obtain moderate assurance
as to whether the financial statements are free of material misstatement. A review is limited
primarily to inquiries of company personnel and analytical procedures applied to financial data
and thus provides less assurance than an audit. We have not performed an audit and,
accordingly, we do not express an audit opinion.
Based on our review, nothing has come to our attention that causes us to believe that the
accompanying financial statements are not presented fairly, in all material respects, in
accordance with Philippine Financial Reporting Standards (or Philippine Financial Reporting
Standard for Small and Medium-sized Entities).

PRACTITIONER

Date Address
Examination of Prospective Financial Information

Introduction

―Prospective financial information‖ means financial information based on assumptions about events
that may occur in the future and possible actions by an entity. It is highly subjective in nature
and its preparation requires the exercise of considerable judgment. Prospective financial
information can be in the form of:
a forecast,
a projection or
a combination of both, for example, a one year forecast plus a five-year projection.

A ―forecast‖ means prospective financial information prepared on the basis of assumptions as to future events
which management expects to take place and the actions management expects to take as of the
date the information is prepared (best-estimate assumptions).

A ―projection‖ means prospective financial information prepared on the basis of:

a) Hypothetical assumptions about future events and management actions which are not
necessarily expected to take place, such as when some entities are in a start-up phase or are
considering a major change in the nature of operations; or
b) A mixture of best-estimate and hypothetical assumptions.
Such information illustrates the possible consequences as of the date the information is prepared
if the events and actions were to occur (a ―what-if‖ scenario).
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Management is responsible for the preparation and presentation of the prospective financial
information, including the identification and disclosure of the assumptions on which it is based.
The auditor may be asked to examine and report on the prospective financial information to
enhance its credibility whether it is intended for use by third parties or for internal purposes.

The Auditor ‘s Assurance

When reporting on the reasonableness of management ‘s assumptions the auditor provides only a
moderate level of assurance. However, when in the auditor ‘s judgment an appropriate level of
satisfaction has been obtained, the auditor is not precluded from expressing positive assurance
regarding the assumptions.

Acceptance of Engagement

Before accepting an engagement to examine prospective financial information, the auditor would
consider, amongst other things:
The intended use of the information;
Whether the information will be for general or limited distribution;
The nature of the assumptions, that is, whether they are best-estimate or hypothetical
assumptions;
The elements to be included in the information; and
The period covered by the information.

The auditor should not accept, or should withdraw from, an engagement when the assumptions
are clearly unrealistic or when the auditor believes that the prospective financial information will
be inappropriate for its intended use.

The auditor and the client should agree on the terms of the engagement.

Knowledge of the Business

The auditor should obtain a sufficient level of knowledge of the business to be able to evaluate
whether all significant assumptions required for the preparation of the prospective financial
information have been identified.

Period Covered

The auditor should consider the period of time covered by the prospective financial information.
Since assumptions become more speculative as the length of the period covered increases, as
that period lengthens, the ability of management to make best-estimate assumptions decreases.

Examination Procedures

When determining the nature, timing and extent of examination procedures, the auditor ‘s
considerations should include:
a) The likelihood of material misstatement;
b) The knowledge obtained during any previous engagements;
c) Management ‘s competence regarding the preparation of prospective financial information;
d) The extent to which the prospective financial information is affected by the management ‘s
judgment; and
e) The adequacy and reliability of the underlying data.

Report on Examination of Prospective Financial Information

When the auditor believes that the presentation and disclosure of the prospective financial
information is not adequate, the auditor should express a qualified or adverse opinion in the
report on the prospective financial information, or withdraw from the engagement as appropriate.
An example would be where financial information fails to disclose adequately the consequences of
any assumptions which are highly sensitive.

When the examination is affected by conditions that preclude application of one or more
procedures considered necessary in the circumstances, the auditor should either withdraw from
the engagement or disclaim the opinion and describe the scope limitation in the report on the
prospective financial information.

The following is an example of an extract from an unmodified report on a forecast:

We have examined the forecast in accordance with Philippine Standard on Assurance

Engagements. Management is responsible for the forecast including the assumptions set out in
Note X on which it is based.
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Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis for
the forecast. Further, in our opinion the forecast is properly prepared on the basis of the
assumptions and is presented in accordance with Philippine Financial Reporting Standards.

Actual results are likely to be different from the forecast since anticipated events frequently do
not occur as expected and the variation may be material.

The following is an example of an extract from an unmodified report on a projection:

We have examined the projection in accordance Philippine Standard on Assurance Engagements.

Management is responsible for the projection including the assumptions set out in Note X on
which it is based.

This projection has been prepared for (describe purpose). As the entity is in a start-up phase the
projection has been prepared using a set of assumptions that include hypothetical assumptions
about future events and management ‘s actions that are not necessarily expected to occur.
Consequently, readers are cautioned that this projection may not be appropriate for purposes
other than that described above.

Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis for
the projection, assuming that (state or refer to the hypothetical assumptions). Further, in our
opinion the projection is properly prepared on the basis of the assumptions and is presented in
accordance with Philippine Financial Reporting Standards.

Even if the events anticipated under the hypothetical assumptions described above occur, actual
results are still likely to be different from the projection since other anticipated events frequently
do not occur as expected and the variation may be material.
Agreed-upon Procedures Engagements

Introduction

The objective of an agreed-upon procedures engagement is for the auditor to carry out
procedures of an audit nature to which the auditor and the entity and any appropriate third
parties have agreed and to report on factual findings.

An engagement to perform agreed-upon procedures may involve the auditor in performing certain
procedures concerning individual items of financial data (for example, accounts payable, accounts
receivable, purchases from related parties and sales and profits of a segment of an entity), a
financial statement (for example, a balance sheet) or even a complete set of financial statements.

As the auditor simply provides a report of the factual findings of agreed-upon procedures, no
assurance is expressed. Instead, users of the report assess for themselves the procedures and
findings reported by the auditor and draw their own conclusions from the auditor ‘s work.

The report is restricted to those parties that have agreed to the procedures to be performed since
others, unaware of the reasons for the procedures, may misinterpret the results.

General Principles of an Agreed-Upon Procedures Engagement

The auditor should comply with the Code of Ethics general principles, such as:
a. Integrity;
b. Objectivity;
c. Professional competence and due care;
d. Confidentiality;
e. Professional behavior; and
f. Technical standards.

The auditor should conduct an agreed-upon procedures engagement in accordance with this PSRS
and the terms of the engagement.

Defining the Terms of the Engagement

Matters that would be included in the engagement letter include the following:
A listing of the procedures to be performed as agreed upon between the parties.
A statement that the distribution of the report of factual findings would be restricted to the
specified parties who have agreed to the procedures to be performed.

Planning
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The auditor should plan the work so that an effective engagement will be performed.

Documentation

The auditor should document matters which are important in providing evidence to support the
report of factual findings, and evidence that the engagement was carried out in accordance with
this PSRS and the terms of the engagement.

Procedures and Evidence

The auditor should carry out the procedures agreed upon and use the evidence obtained as the
basis for the report of factual findings.

The procedures applied in an engagement to perform agreed-upon procedures may include the
following:
Inquiry and analysis.
Recomputation, comparison and other clerical accuracy checks.
Observation.
Inspection.
Obtaining confirmations.

Reporting

The report on an agreed-upon procedures engagement needs to describe the purpose and the
agreed-upon procedures of the engagement in sufficient detail to enable the reader to understand
the nature and the extent of the work performed.

Illustration of a Report of Factual Findings in Connection with Accounts Payable

REPORT OF FACTUAL FINDINGS

To (those who engaged the auditor)

We have performed the procedures agreed with you and enumerated below with respect to the
accounts payable of ABC Company as at (date), set forth in the accompanying schedules (not
shown in this example). Our engagement was undertaken in accordance with the Philippine
Standard on Related Services. The procedures were performed solely to assist you in evaluating
the validity of the accounts payable and are summarized as follows:
1. We obtained and checked the addition of the trial balance of accounts payable as at (date)
prepared by ABC Company, and we compared the total to the balance in the related general
ledger account.
2. We compared the attached list (not shown in this example) of major suppliers and the
amounts owing at (date) to the related names and amounts in the trial balance.
3. We obtained suppliers ‘statements or requested suppliers to confirm balances owing at (date).
4. We compared such statements or confirmations to the amounts referred to in 2. For amounts
which did not agree, we obtained reconciliations from ABC Company. For reconciliations
obtained, we identified and listed outstanding invoices, credit notes and outstanding checks,
each of which was greater than Pox. We located and examined such invoices and credit notes
subsequently received and checks subsequently paid and we ascertained that they should in
fact have been listed as outstanding on the reconciliations.

We report our findings below:

a) With respect to item 1 we found the addition to be correct and the total amount to be in
agreement.
b) With respect to item 2 we found the amounts compared to be in agreement.
c) With respect to item 3 we found there were suppliers ‘statements for all such suppliers.
d) With respect to item 4 we found the amounts agreed, or with respect to amounts which did
not agree, we found ABC Company had prepared reconciliations and that the credit notes,
invoices and outstanding checks over Pxxx were appropriately listed as reconciling items with
the following exceptions:

(Detail the exceptions)

Because the above procedures do not constitute either an audit or a review made in accordance
with Philippine Standards on Auditing, we do not express any assurance on the accounts payable
as of (date).

Had we performed additional procedures or had we performed an audit or review of the financial
statements in accordance with Philippine Standards on Auditing, other matters might have come
to our attention that would have been reported to you.
 77

Our report is solely for the purpose set forth in the first paragraph of this report and for your
information and is not to be used for any other purpose or to be distributed to any other parties.
This report relates only to the accounts and items specified above and does not extend to any
financial statements of ABC Company, taken as a whole.

AUDITOR

Date Address
Compilation Engagements

Introduction

A compilation engagement would ordinarily include the preparation of financial statements (which
may or may not be a complete set of financial statements) but may also include the collection,
classification and summarization of other financial information.

The objective of a compilation engagement is for the accountant to use accounting expertise, as
opposed to auditing expertise, to collect, classify and summarize financial information. This
ordinarily entails reducing detailed data to a manageable and understandable form without a
requirement to test the assertions underlying that information. The procedures employed are not
designed and do not enable the accountant to express any assurance on the financial information.
However, users of the compiled financial information derive some benefit as a result of the
accountant's involvement because the service has been performed with professional competence
and due care.

General Principles of a Compilation Engagement

The accountant should comply with the Code of Professional Ethics general principles, such as:
a) integrity;
b) objectivity;
c) professional competence and due care;
d) confidentiality;
e) professional behavior; and
f) technical standards.

Defining the Terms of the Engagement

An engagement letter confirms the accountant's acceptance of the appointment and helps avoid
misunderstanding regarding such matters as the objectives and scope of the engagement, the
extent of the accountant's responsibilities and the form of reports to be issued.

Planning

The accountant should plan the work so that an effective engagement will be performed.

Documentation

The accountant should document matters which are important in providing evidence that the
engagement was carried out in accordance with this PSA and the terms of the engagement.

Procedures

The accountant requires a general understanding of the nature of the entity's business
transactions, the form of its accounting records and the accounting basis on which the financial
information is to be presented through experience with the entity or inquiry of the entity's
personnel.

If the accountant becomes aware that information supplied by management is incorrect,

incomplete, or otherwise unsatisfactory, the accountant should consider performing the above
procedures and request management to provide additional information or if the accountant
becomes aware of material misstatements, the accountant should try to agree appropriate
amendments with the entity. If such additional information or amendments are not made and the
financial information is considered to be misleading, the accountant should withdraw from the
engagement.

Responsibility of Management

The accountant should obtain an acknowledgment from management of its responsibility for the
appropriate presentation of the financial information and of its approval of the financial
information.
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Reporting on a Compilation Engagement

The financial information compiled by the accountant should contain a reference such as
"Unaudited," "Compiled without Audit or Review" or "Refer to Compilation Report" on each page
of the financial information or on the front of the complete set of financial statements.

EXAMPLE OF A REPORT ON AN ENGAGEMENT TO COMPILE FINANCIAL STATEMENTS

COMPILATION REPORT TO ....

On the basis of information provided by management we have compiled, in accordance with the
Philippine Standard on Related Services, the balance sheet of ABC Company as of December 31,
19XX and statements of income, changes in equity and cash flows for the year then ended.
Management is responsible for these financial statements. We have not audited or reviewed these
financial statements and accordingly express no assurance thereon.

Accountant

Date
Address