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AUDIT-An Overview: Auditing Defined

1. An audit is defined as an independent examination of financial statements to enable the auditor to express an opinion on whether the statements are prepared in accordance with the applicable financial reporting framework. 2. There are three main types of audits - financial statement audit, compliance audit, and operational audit. Financial statement audits are usually conducted by external auditors to determine if financial statements are fairly presented. Compliance audits review adherence to regulations, while operational audits assess performance and efficiency. 3. The roles of management and independent auditors are distinct but related - management prepares the financial statements and the auditor evaluates them and issues an audit report. The auditor must comply with ethical standards and conduct the audit in accordance with

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0% found this document useful (0 votes)
244 views16 pages

AUDIT-An Overview: Auditing Defined

1. An audit is defined as an independent examination of financial statements to enable the auditor to express an opinion on whether the statements are prepared in accordance with the applicable financial reporting framework. 2. There are three main types of audits - financial statement audit, compliance audit, and operational audit. Financial statement audits are usually conducted by external auditors to determine if financial statements are fairly presented. Compliance audits review adherence to regulations, while operational audits assess performance and efficiency. 3. The roles of management and independent auditors are distinct but related - management prepares the financial statements and the auditor evaluates them and issues an audit report. The auditor must comply with ethical standards and conduct the audit in accordance with

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Adan Eve
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CHAPTER 1

AUDIT- An Overview
Auditing Defined

 Philippine Standards on Auditing


- To enable auditor to express an opinion on whether the financial statements are prepared in
all material respects, in accordance with the applicable financial reporting framework
- Examination of financial statements
 American Accounting Association
- An audit is a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence
between these assertions and established criteria and communicating the results to interested
users.
Auditing is a systematic process

- Auditing proceeds by means of an ordered and structured series of steps

An audit involves obtaining and evaluating evidence about assertions regarding economic actions
and events
Assertions- representations made by an entity about economic actions and events. Auditor’s
overall objective is to determine whether these assertions are valid by obtaining and evaluating evidences.
An audit is conducted objectively

- Audit should be conducted without bias of conflict of interest to override professional


judgement.
- Objectivity is essential because auditor’s conclusion can influence the decisions of parties
relying on the report
Auditors ascertain the degree of correspondence between assertions and established criteria

- Established criteria- needed to judge the validity of the assertions. It is the basis against
which the assertions have been evaluated or measured
Auditors communicate the audit results to various interested parties

- Communication of the audit finding is the ultimate objective of any audit

SUMMARY OF THE DEFINITION OF AUDIT

Independent Auditor Establishes the degree of


correspondence between

3 Major Types of Audit


Following systematic
1. Financial Statement Audit Assertions Communicate the
process results to interested
parties
Objectively obtains
Established
and evaluates
criteria
evidence
- Fair representation of financial statements in accordance with applicable financial reporting
framework (Usually conducted by External Auditors)
2. Compliance Audit
- Review of organization’s procedures to determine whether the organization has adhered to
specific procedures, rules, or regulations (Usually conducted by Government Auditors)
- Dependent upon the existence of verifiable data and recognized criteria established by an
authoritative body
3. Operational Audit
- Study of a specific unit of an organization for the purpose of measuring its performance
- Operation’s effectiveness and efficiency
- To assess entity’s performance, identify areas for improvements and make recommendations
to improve performance (Usually conducted by Internal Auditors)
- Also known as Performance Audit or Management Audit
4. Integrated Audit
- Fair representation of financial statements and effectiveness of internal control over financial
reporting
- Required to those publicly-listed companies and entities
5. Forensic Audit
- Deter (prevent) and/or detect fraud

General Characteristics of Audits


1. Systematic examination and evaluation
- Compliance of assertion with established criteria
2. Communication of results of the examination
- Usually written

Comparison of 3 Types of Audit

Financial Audit Compliance Audit Operational Audit


Assertions made by Financial statements Organization has That the organization’s
the auditee are fairly presented complied with laws, activities are conducted
regulations or contracts effectively and
efficiently
Established criteria Financial reporting Laws, regulations or Objectives set by the
Framework- Philippine contracts board of directors
Financial Reporting
Standards
Content of the An opinion about Reports on the degree Recommendations or
auditor’s report whether the financial of compliance with the suggestions on how to
statements are fairly applicable laws, improve operations
presented in conformity regulations and
of the applicable contracts
framework

Types of Auditors
1. External Auditors or Independent Auditors
- Independent CPAs who offer services on contractual basis
- Who generally perform financial statement audits
- CPA in public practice
2. Internal Auditors
- Entity’s own employees who investigate and appraise the effectiveness and efficiency of
operations and internal controls
- Usually perform operational audit
- To help the company in achieving its goals
3. Government Auditors/Internal Revenue Agents
- Government employees whose main concern is to determine whether the persons or entities
comply with government rules or regulations
- Conduct compliance audit
4. Government Accountability Office Auditors
- Evaluate effectiveness and efficiency of government programs
- Refer to Commission on Audit

The Independent Financial Statement Audit


1. Responsibility for the financial statements
- Auditor’s responsibility is to form and express an opinion on these financial statements based
on the audit results
- Management’s responsibility is to adopt and implement adequate accounting and internal
control systems that will help ensure the preparation of reliable financial statements
2. Assurance provided by the auditor
- An audit conducted in accordance with the PSAs is designed to provide only reasonable
assurance not absolute assurance.
- There are inherent limitations pf an audit that affects the auditor’s ability to detect material
misstatement

Inherent Limitations
1. Nature of the procedures performed
1. The use of testing or sampling risk
- Auditors do not examine all evidence available.
- Many audit conclusions are made by examining only sample evidence

2. Error in the application of judgement or non-sampling risk


- There is no absolute assurance that material misstatement in the financial statements will be
detected
- Errors in application of judgment may cause auditors to commit mistakes in the application of
audit procedures or evaluation of evidence obtained
2. Nature of the financial reporting framework used
- Many financial items involve subjective decisions that are subject to an inherent variability
which cannot be eliminated by performing audit procedures
3. Nature of evidence obtained by the auditor
- Audit evidence does not consist “hard facts” which prove or disprove the accuracy of the
financial statements
- Audit evidence is generally persuasive rather than conclusive in nature

Note: Opinion of an auditor is not an assurance as to the future viability of the entity nor the efficiency or
effectiveness with which management has conducted the affairs of the entity

ROLE OF MANAGEMENT AND INDEPENDENT AUDITOR


Management Independent Auditor

Prepares Financial
Statements
General Requirements when Auditing Financial Statements
Unaudited
1. Auditor comply with the relevant Ethical Requirements Evaluates Financial
should Financial
adhere to standards of ethical conduct that embody andStatements
- MustStatements demonstrate integrity,
objectivity and concern for public rather than self-interest
Audited Financial Statements Audit Report on Financial
Statements

2. Auditor should conduct an audit in accordance with the Philippine Standards on Auditing
(PSAs) Users of Financial Statements
- Standards contain the basic principles and essential procedures which the auditor should
follow.
- Includes explanatory and other materials that are designed to assist auditors in interpreting
and applying the auditing standards
3. Auditor should apply professional judgment in planning and performing the audit
- Essential to the proper conduct of the audit
4. Auditor should obtain sufficient appropriate audit evidence to reduce risk to an acceptably
low level
- Audit evidence is needed to support the opinion expressed in the auditor’s report.
- Should be sufficient and appropriate
5. The auditor should plan and performs the audit with an attitude of professional skepticism
recognizing that circumstances may exist which may cause the financial statements to be
materially misstated
- Means the auditor makes a critical assessment, with a questioning mind, of the validity of
audit evidence obtained and alert to audit evidence that contradicts or bring into questions the
reliability of documents or management representations
- The auditor neither assumes that management is honest nor assumes unquestioned honesty

Need for an Independent Financial Statement Audit


1. Conflict of interest between management and users of financial statements
- May result managers providing the outside users with overly optimistic or even false
financial information
- Users of financial statements have become skeptical of unaudited financial statements
2. Expertise
- A qualified person is hired by users to verify the reliability of the financial statements on their
behalf
3. Remoteness
- Most of users do not have access to entity’s records to personally verify the quality of the
financial information.
- An independent auditor is needed to assist them in verifying the reliability of the financial
information
4. Financial Consequences
- Misleading financial information could have substantial economic consequences for a
decision maker thus auditing financial statements is needed.

Theoretical Framework of Auditing


Selected postulates, assumptions or ideas that support many auditing concepts and standards
1. Audit function operates on the assumption that all financial data are verifiable
- No evidence=no audit to perform
2. Auditor should always maintain independence with respect to the financial statements
under audit
- Independence is essential for ensuring the credibility of the auditor’s report
3. There should be no long-term conflict between the auditor and the client management
- Both the auditor and the management must be interested in the fair representation of the
financial statements
4. Effective internal control system reduces the possibility of material misstatement of the
financial statement
- The stronger the internal control is, the more assurance it provides about the reliability of the
accounting data and financial statements
5. Consistent application of the applicable financial reporting framework such as the PFRS
results in fair representation of financial statement
6. What was held true in the past will continue to hold true in the future in the absence of
known conditions to the country
7. An audit benefits the public
- Financial statements are ordinarily prepared and presented in order to meet the common
information need of a wide range of users.
Industry Specialization

- Public accounting firms have long recognized the value of industry specialization
- Firms believe that such organizational structure leads to higher-quality integrated services

Career Levels
1. Staff Auditors- entry level, performs tasks assigned by senior auditor
2. Senior Auditors- supervises some aspect of the audit
3. Managers- supervises the audit management
4. Partners- responsible for performance of audit in accordance with standards
5. Senior/Managing Partners- responsible for developing firm’s policies, planning activities, and
day to day management

Audit Season
- Busy season from December through April
- Followed by a period of slack demand

Philippine Framework for Assurance Engagements

Assurance Engagements
- Designed to enhance the degree of confidence of the intended users about subject matter

2 Types of Assurance Engagement


1. Reasonable Assurance
- Positive form of assurance- AUDIT/EXAMINATION
2. Limited Assurance
- Negative form of assurance- REVIEW, lesser scope of procedures

Assurance as to Availability of Subject Matter Information


- Walang kinalaman sa level ng assurance
1. Assertion-Based Engagement
- Assertion by responsible party is made available to intended users
- Example: assertion of client management about fair presentation of its financial statements
2. Direct Reporting Engagements
- Subject matter information is provided to the intended users in the assurance report
- Example: operating effectiveness of internal control where management did not provide an
assertion

Steps in Providing Assurance Services


1. Acceptance
- Relevant Ethical Requirement will be satisfied (Code of Ethics for Professional Accountants
by International Federation of Accountants IFAC)
- Engagement exhibits the following
 Subject matter is appropriate
 Criteria are suitable and available
 Has access to sufficient appropriate evidence
 Conclusion is to be contained in a written report
 There is a rational purpose for the engagement
- Client’s management does not lack integrity
- Client agrees to the terms of the engagement
 Engagement letter
 Management representation letter
- Rejected?- engaging party may request a non-assurance engagement

Changes in the Engagements


- No change from assurance to non-assurance or reasonable to limited assurance without
reasonable justification
Example of Reasonable Justification
 Change in requirements
 Client misunderstanding
- Obtained evidence will not be disregarded

Elements of Assurance Engagements (PERCS)


A. 3 party relationship
B. Appropriate subject matter
C. Suitable criteria
D. Sufficient appropriate evidence
E. Written assurance report

Three-Party Relationship
1. Practitioner
- Requested to perform engagement
- May use any expert/professionals
2. Responsible Party
- Responsible for subject matter and subject matter info
3. Intended Users
- Whom practitioner prepares the assurance report

Appropriate Subject Matter


- Identifiable and capable of measurement against criteria
1. Financial or non-financial performance
2. Physical characteristics
3. Systems and processes
4. Behavior

Subject Matter Information


- Evaluation or measurement of subject matter
- Can be subjected to procedures to form a conclusion
- Another term is “assertion”

Criteria
- Benchmarks used to evaluate the subject matter and are available to intended users
- May be formal such as PFRS, COSO’s Internal Control, Integrated Framework, or Laws and
Regulations (Established Criteria)
- Or less formal such as internally developed code, rules and regulations, and policies
(Specifically Developed Criteria)

Suitable Criteria: (RUN-CR)


1. Relevance- contribute to decision making
2. Completeness- relevant factors are not omitted
3. Reliability- consistent evaluation/measurement
4. Neutrality- free from bias
5. Understandability- clear, comprehensive, and are not subject to significantly different
interpretations

Sufficient Appropriate Evidence


 Professional Skepticism
- Questioning mind and critical assessment
- Alert from red flags
- Assurance of free or material misstatement
- Attitude
 Professional Judgment
- Application of relevant training
- Professional knowledge, skills
- experience in decision making
- Competence
 Sufficiency of evidence
- “quantity” of evidence
- Need of corroborating (verifying, supporting) evidence
 Appropriateness
- “quality” of evidence
- Relevance and reliability
NOTE: Practitioner or expected to be an expert in authentication

Reliability of Evidence
1. From independent or outside source
2. Controls are effective
3. Directly obtained
4. In documentary form
5. Original documents

Other consideration in gathering evidence


1. Different sources or nature (corroborating evidence)
2. More difficult when it covers a period of time
3. Cost-benefit is considered
4. Materiality
5. Engagement Risk- risk na baka mali ung opinion na ibigay ng auditor
 Inherent Risk- risk of material misstatement
 Control Risk
 Detection Risk- beyond the control of auditor
6. Nature, Timing and Extent

Why not Absolute Assurance?


1. Based on judgment
2. Selective Testing/Sampling
3. Inherent limitations
4. Most evidence are persuasive, rather than conclusive

Assurance Report
1. Audit- positive form of assurance
 Unqualified- presented fairly in all material aspects
 Qualified- presented fairly in all material aspects
(Material misstatement or scope limitation or uncertainty)
 Adverse- “Do not present fairly”
(Material and pervasive/widespread misstatements)
 Disclaimer- do not express and opinion
(high degree of scope limitation and uncertainty)
2. Review- negative/indirect form of assurance

Auditor Association with Financial Information


- Auditor attaches a report or consents to the use of the auditor’s name
 If Auditor is not associated in this manner- third parties can assume no responsibility of
the auditor
- Unauthorized use of auditor’s name
 Require management to cease doing so and consider further steps, such as
Informing any known third-party users
Seek legal advice
CHAPTER 2
The Professional Standards
Standards
- Are established to measure the quality of performance of individuals and organizations
Accounting Professions Standards
- CPAs’ professional qualities
- CPA’s professional engagements/judgement exercised
- CPA firm’s quality control policies and procedures
Board of Accountancy
- Promulgated 10 Generally Accepted Auditing Standards (GAAS)
- Establish required level of quality for performing financial statement audits
Philippine Standards on Auditing
- Issued to clarify the meaning of the 10 GAAS
Generally Accepted Auditing Standards
- Represent measures of the quality of the auditor’s performance
- a minimum standard of performance that auditors should follow

Generally Accepted Auditing Standards (GAAS)

General Standards of Standards of


Standards Fieldwork Reporting

1. Technical 1. Planning 1. Generally


Training and 2. Internal Control Accepted
Proficiency Consideration Accounting
2. Independence 3. Evidential Principles
3. Professional Matter 2. Inconsistency
Care 3. Disclosure
4. Opinion

General Standards
1. Examination is to be performed by person/s having adequate technical training and proficiency as
an auditor
2. In all matters relating to an engagement, an independent in mental attitude is to be maintained by
the auditor
3. Due professional care is to be exercised in the performance of the audit and in the preparation of
the report
Standards of Fieldwork
1. The work is to be adequately planned
2. There is to be a proper study and evaluation of existing internal control
3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries
and confirmations to afford a reasonable basis for an opinion regarding the financial statements
under examination

Standards of Reporting
1. The report shall state whether the financial statements are presented in accordance with GAAP
2. Which principles have not been consistently observed in the current period in relation to the
preceding period
3. Informative disclosures are to be regarded as reasonably adequate unless otherwise stated in the
report
4. The report should contain a clear-cut indication of the character of the auditor’s examination if
any and the degree of responsibility he is taking

Philippine Standards on Auditing


Auditing and Assurance Standards Council (AASC) has been given the task to promulgate
auditing standards, practices and procedures which shall be generally accepted in the Philippines

AASC PRONOUNCEMENTS
Adoption of International Standards
To facilitate the preparation by the AASC of its pronouncements and to attain uniformity of those
Framework for Assurance and Engagements Related Services
with the international auditing standards, AASC adopts the ff issued by the International Auditing and
Assurance Board (IAASB) created by the International Federation of Accountant (IFAC)
1.Audit
International Standards
Review on Auditing (ISAs)
Others Agreed-upon Compilation
2. International Standards on Assurance Engagements (ISAEs)
Procedures Engagement
Engagement
Philippine Philippine Philippine Philippine Philippine
Standards Standards Standards Standards on Standards on
on Auditing on Review on Related Services Related Services
Engagement Assurance
3. International Standards on Review Engagements (ISREs)
4. International Standards on Related Services (ISRSs)

System of Quality Control


Quality Controls- are policies and procedures adopted by CPAs to provide reasonable assurance
of conforming with professional standards in performing audit and related services

Philippine Standards on Quality Control (PSQC) 1


- A firm has an obligation to establish a system of quality control to provide reasonable
assurance that the firm and its personnel
 Comply with professional standards and regulatory and legal requirements
 That the report issued by the firm are appropriate in the circumstances

Elements of Quality Control Policies and Procedures (PSA 220)


- Adoption by audit firms vary depending on the
 Firm’s size and nature of its practice
 Cost benefit considerations and others

1. Leadership Responsibilities
- To promote an internal culture based on recognition that quality is essential in the
performance of the engagements
- The engagement partner should:
 Take responsibility for the overall quality on each audit engagement
 Set example regarding the quality of audit by emphasizing through actions and
messages
 Performing work that complies with professional standards
 Complying with the firm’s quality control policies and procedures
 Issuing appropriate audit reports
 Engagement’s team ability to raise concerns without fear of reprisals

2. Ethical Requirements
- To provide reasonable assurance that firm and its personnel comply with ethical requirements
 Integrity
 Objectivity
 Professional competence and due care
 Confidentiality
 Professional behavior
- The engagement partner should consider whether the members of the engagement team have
complied with these ethical principles
- Issues involving engagement team member’s non-compliance with ethical requirements must
be properly resolved and documented

3. Independence
- That the members of the engagement team, the firm, and, where applicable, the network firms
maintain independence when providing audit services
- Engagement partner
 Should form a conclusion on compliance with independence requirements that apply
to audit engagement
- Engagement partner should:
 Obtain relevant information that identifies threats to independence
 Evaluate information on identified breaches of the firm’s independence
 Take appropriate safeguards to eliminate or reduce such threats
 Document conclusions on independence

4. Acceptance and Continuance of Client Relationship


- To provide reasonable assurance that it will only undertake or continue relationships and
engagement where it:
 Considered the integrity of the client
 Is competent to perform the engagement and has the capabilities, time, and resources
to do co
 Can comply with ethical requirements
- Engagement partner should be satisfied that appropriate procedures have been followed and
that conclusions reached are appropriate and have been documented

5. Human Resources and Assignment


- To provide reasonable assurance that it has sufficient personnel with capabilities,
competence, and commitment to ethical principles necessary to perform the engagement
- Should address personnel
 Recruitment
 Performance evaluation, compensation and promotion
 Capabilities and competence
 Career development
 Assignment of engagement teams
- Engagement partner should be satisfied that the team collectively has the appropriate
capabilities, competence and time to perform the audit engagement in accordance with
standards, and regulatory and legal requirements.

6. Engagement Performance
- That engagements are performed in accordance with professional standards and other
regulatory and legal requirements; and that the audit report issued is appropriate in the
circumstances
- Engagement partner should take responsibility for the direction, supervision, review and
overall performance of the audit engagement
a) Direction- informing
b) Supervision- monitoring
c) Review
d) Consultation
e) Engagement Quality Review
f) Differences in Opinion

7. Monitoring
- Continued adequacy and operational effectiveness of quality control policies and procedures
is to be monitored
- Assurance that the systems of quality control are relevant, adequate and operating effectively

Quality Assurance Review


- Thru BOA, government has required all CPA firms and individual CPAs in public practice to
obtain a certificate of accreditation to practice public accountancy valid for 3 years and can
be renewed after complying with the requirements of the BOA

Renewal of the Certificate


- Individual CPAs and firms should undergo a quality assurance review that these CPAs
comply with accounting and auditing standards and practices

CHAPTER 3
Auditor’s Responsibility
Responsibility of Client’s Management
- Fair representation of the financial statements
Auditor’s Responsibility
- To design the audit to provide reasonable assurance of detecting material misstatements in
financial statements
Misstatements emanate from:
 Error
 Fraud
 Noncompliance with Laws and Regulations

Error
- Unintentional misstatements
- Omission of an amount or a disclosure
 Mathematical or clerical mistakes in underlying records and accounting data
 Incorrect accounting estimates arising from oversight or misinterpretation of facts
 Mistakes in the application of accounting policies
Fraud
- Intentional act involving use of deception to obtain an unjust or illegal advantage
- Fraudulent acts that cause material misstatements in financial statements
- Involves motivation to commit the act and a perceived opportunity to do so

Types of Fraud
1. Fraudulent Financial Reporting
- Also known as “management fraud”
- Intentional misstatements or omissions of amounts or disclosures in financial statements
- Usually involves members of management or those charged with governance
 Manipulation, falsification or alteration of records or documents
 Misrepresentation in or intentional omission of the effects of transactions from records or
documents
 Recording of transactions without substance
 Intentional misapplication of accounting policies
2. Misappropriation of Assets
- Also called “employee fraud”
- Theft of an entity’s assets committed by employees
- Accompanied by false misleading records or documents in order to conceal the fact that
assets are missing
 Embezzling receipts
 Stealing entity’s assets as cash, marketable securities and inventory
 Lapping of accounts receivable

Responsibility of Management and Those Charged with Governance (PSA 240)


1. Management
- To establish a control environment and to implement internal control policies and procedures
2. Individuals charged with governance
- To ensure the integrity of an entity’s accounting and financial reporting systems

Auditor’s Responsibility
- Cannot be held responsible for the prevention of fraud and error
- Responsibility is to design the audit to provide reasonable assurance that the financial
statements are free from material misstatements, whether caused by error or fraud

Noncompliance with Laws and Regulations


Noncompliance refers to acts of omission or commission by the entity being audited, either
intentional or unintentional, which are in contrary to prevailing laws or regulations
- May result in fines, litigations or other consequences that may have material effect on
financial statements
 Tax evasion
 Violation of environmental protection laws
 Inside trading of securities

Fraud Risk Factors Relating to Misstatements Resulting from Fraudulent Financial Reporting
1. Management’s Characteristics and Influence over the Control Environment
- Pertains to management’s abilities, pressures, style, and attitude relating to internal control
and the financial reporting process
2. Industry Conditions
- Involve the economic and regulatory environment in which the entity operates
3. Operating Characteristics and Financial Stability
- Pertain to the nature and complexity of the entity and its transactions, the entity’s financial
condition, and its profitability
Fraud Risk Factors Relating to Misstatements Resulting from Misappropriation of Assets
1. Susceptibility of Assets to Misappropriation
- Pertain to the nature of an entity’s assets and the degree to which they are subject to theft
2. Controls
- Involve the lack of controls designed to prevent or detect misappropriation of assets

CHAPTER 4
The Audit Process- Accepting an Engagement

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