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Auditing and assurance principle
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98 views13 pagesAuditing Theory Chapter 1
Auditing and assurance principle
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Sheila Mae PlanciaCopyright
© © All Rights Reserved
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/ 13
Chapter 1
AUDIT- An Overview
Dependable financial intormation is essential wo our sociery. We often rely
‘pon information provided by others in making economic decisions. ‘The
reed of various users for more reliable financial information has created a
Gemand for an independent audit of financial statements.
The primary function of an independent audit isto lend credibility to the
finareial statements of an entity. The auditor’s opinion enhances the value
wnt usefulness of these financial statements, By attaching a report to the
financial statements, the auditor provides increased assurance to users that
the financial statements are reliable.
Auditing Defined
PSA 200 defines auditing by stating the objective of a financial
statement audit, that is, to enable the auditor to express an opinion
Sthether the financial statements are prepared, in all materia respects, in
Secordance with the applicable financial reporting framework.
“This definition confines the audit to examination of the financial
statements. Although the great majority of audit. work today deals with
Sadit of financial statements, operational and anpliane auditing are
becoming more and more important.
‘A more comprehensive definition of auditing is giver. by the American
‘Accounting Association:
An audit isa steric prcss of gaily cbtanirg and exiuating
cider regrdingessetiors abut exec airs and ext to ascertain
the dag of corespordone been tse assertions and eta erteria
‘ard commacriatig the rss to irersted ses.”
1 ‘This definition conveys the following thoughts.
hk
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
Asseriors are representations made by an auditee about economic
actions and events. The auditor's objective is to determine whether
these assertions are valid. To satisfy this objective, the auditor
performs audit procedures and gathers evidence that corroborates
or refutes the assertions.
|. An audit is conducted objectively
‘The auditor should conduct the audit without bias. Impartial
attitude must be maintained by the auditor when evaluating
evidence and formulating his conclusion.
|. Auditors ascertain the degree of correspondence between
assertions and established criteria
Establhed criteria are needed to judge the validity of the assertions.
‘These criteria are important because they establish and inform the
users of the basis against which the assertions have been evaluated
or measured. In an audit, the auditor determines the degree by
which the assertions conform to the established criteria. “For
example, when auditing financial statements, the auditor judges the
fair presentation of the financial statements (ascarirs) by comparing
the starements with the applicable financial reporting framework
(citeri).
».. Auditors communicate the audit results to various interested
users
mAMUNC: findis i »bjective of
ion of audit findings is the ultimate ol
The communication of sult Gig Tal che els mast Be
Be riscated to intefested users on a timely basis.
Figure 1.1 Mlustrative Definition of Auditing
Following a systematic process
Objectively obtains and evaluates evidence
Establishes the degree of correspondence
Established *,
Criteria
‘Communicates the results to interested.
ee
3 \ > Types of Audits
2. Communication of the results of the examination, usually in a
‘written report, to the party by whom, or on whose behalf, the
auditor was appointed.
‘Unlike compliance and financial statement audits, where the criteria are
usually defined, criteria used in operational audit to evaluate the
effectiveness and efficiency of operations are not clearly established.
Based on primary audit objecti ?
financial, compliance and. ee three major types of audit-
3 Financial statement audit
‘This is an audit conducted to determi :
ste af ty a ly pened nase: wh he
sep
Bethe focus of the ducuadn grteee eee mat wal E a
‘Types of auditors
‘Auditors can be classified according to their affiliation with the entity
being examined.
© Exteralauditos & Andre.
"These are independent CPAs who offer their professional services
to different clients on a contractual basis. External auditors are
= Compliance audit
Compliance audit involves i aniza
procedures to determine whether he sguseatin Mees
“i 8
also known as performance audit or management avcit,
Ie should be nored tha, although ;
audi possess the same gates arcu, te ta al
1, Systematic examination and evaluat :
ah tion of evidence whic!
Seca oe asserions comply. wid
criteria; and
4
the ones who generally conduct financial statement audits.
Internal auditors OPE ATOWAL AUTOR
Internal auditors are entity's own employees who investigate and
appraise the effectiveness and efficiency of operations and
intemal controls. The main function of intemal auditors is to
assist the members of the organization in the effective discharge
of their responsibilities. Internal auditors usually perform
operational audits.
Government auditors (°A/B1R CommymlCE AMD IDR
These are govemment employees whose main concern is to
determine whether persons or entities comply with government
Jaws and regulations. Govemment auditors usually conduct
compliance audits.
* The Independent Financial Statement Audit
Higure 12 Comparison among the different types of audit ‘The purpose of an independent financial statement audit is to enhance
the degree of confidence of intended users in the financial statements
‘This is achieved by the expression of an opinion by the auditor on the
fair presentation of the financial statements. An audit conducted in
accordance with PSAs and relevant ethical requirements enables the
auditor to form that opinion.
Financial audit Compliance audit Operational a
Assertions That the financial ‘That the organizati
made bythe statements are has complied with on tate
auditee faitly presented. Jaws, regulations or atvitce sn
contracts. conducted a
effect
previ ‘An audit in accordance with PSAs is conducted on the premise
; ; f that management, and where appropriate, those charged with
Established Financial Laws, regulations and Objectives seb governance have the responsibility for the preparation and
ore reporting, contracts, the board of presentation of financial statements in accordance with the
Standards or eae reporting framework. ‘This responsibility
other financial implementation and maintenance of
pane eal control relevant to the preparation and presentation of
Peo ial starements that are free from material misstatement,
oe c whether due to fraud or error and to provide the auditor with
pena: aot opinion |Report onthe Recommendat unrestricted. access to all information, records and documents
degree of compliance orsuggestions relevant to the financial statements.
report the financial with applicable laws, how to improve
{temenss are regulstons and operations, |
a pA ‘contracts. © Assurance provided by the auditor
with the ‘The auditor’s opinion on the financial statements is not a
applicable guarantee that the fina atementts are dependable. An audit
financial conducted in accordance with Philippine Standards on Auditing
reporting (PSAs) is designed to provide only reasonable assurance (not
framework, absolute assurance) that the financial statements taken, as a whole
‘Naa io are free from material misstatement. The auditor 's not and
genta cannot obtain absolute assurance because there are inherent
a4 limitations of audit that affect the auditor's ability to detect
perform Extemal auditors Government auditors Internal auditors
material misstatements. These limitations result from such factors
as: -.
ee
|. The use of testing / Sampling risk
For practical reasons, auditors do not examine all evidence
available. Many audit conclusions are made by examining only
sample of evidence. Whenever'a sample is taken, there is
always a possibility that the auditor's conclusion, based on the
sample, may be different from the conclusion that would have
been reached if the auditor examines the entire population.
Error in application of judgment /Non-sampling risk
‘The work undertaken by the auditor to form an opinion is
permeated by judgment. Human weaknesses can cause
auditors to commit mistakes in the application of audit |
procedures and evaluation of evidence.
Reliance on management's representation
Some evidence supporting the financial statements must be
obtained by obtaining oral or written representations from
‘management. For example, it is difficult for the auditor to
determine the proper valuation of accounts receivable without
management's honest assessment. If the management lacks
integnity, management may provide the auditor with false
representations causing the auditor to rely on unreliable
evidence.
Inherent limitations of the client's accounting and
internal control systems.
Although the auditor performs procedures to detect material
misstatements, when auditing financial statements, such
procedures may not be effective in detecting misstatements
resulting from collusion among employees or management's
circumvention of internal control.
5. Nature of evidence
wvidence obtained by the auditor does not consist of “bard
fas” which prove or disprove the accuracy of the financial
statements. Instead, it comprises pieces of information and
impressions which are gradually accumulated during the
course of an audit and which, when taken together, persuade
the auditor about the faimess of the financial statements.
Thus, audit evidence is generally persuasive rather than
conclusive in nature.
Figure 13- Role of Management and Independent Auditor
ety: :
~~ Prepares
Financial
Statements
Evaluates
Financial
Statements
J tes
‘Audited Audit Report
Financial ‘on Financial
Statements ‘Statements
Users of Financial Staterets Because of the inherent limitations of an audit, there
avoidable stat tome material misatements ofthe rel
statements may not be detected, even though the audit is
planned and performed in accordance with PSAs. pei ae
subsequent discovery of a material misstatement of the financial
statements does notin itself indicate a failure to conduct an audit in
accordance with PSAs.
General principles governing the audit of financial
statements
‘The procedures required to conduct an audit in accordance with
PSAs should be determined by the auditor having regard to the
requirements of PSAs, relevant professional bodies, legislations,
regulations, and where appropriate, the terms of the engagement
and the reporting requirements. PSA 200 provides the following
guidelines when auditing financial statements:
1. ‘The auditor should comply with relevant ethical
requirements, including those relating to independence,
relating to financial statement audit engagements.
In order to retain public confidence in the credibility of the
audom work auditors must adhere to standards ot ol
conduct that embody and demonstrate integrity, objectivity,
fend couse or he paler peat ee 2
2, The auditor should conduct an audit in accordance wit
Philippine Standards on Auditing. a
Tete standuats leponin(che Dac principles and (Coe
procedures which the auditor should tee the pre)
also include explanatory and other materalé which, rather
than being prescriptive (that is mandatory), is designed 10:
perdi Layeagriteniiator pra:
ee Eee ee oe
10
3, The auditor should exercise professional judgment in
planning and performing an audit of financial statements.
Professional judgment is the hallmark of auditing, The
distinguishing feature of the professional judgment expected
of an auditor is that it is exercised by an auditor whose
training, knowledge and experience have assisted in making
competent and reasonable judgment. Professional judgment
is essential because informed decisions required throughout
the audit cannot be made without the application of auditor's
knowledge and experience to the facts and circumstances.
4. ‘The auditor should obtain sufficient appropriate audit
evidence to reduce audit risk to an acceptably low level to
tenable the auditor to express an opinion on the financial’
statements.
‘Audit evidence is necessary to support the auditor's opinion
and report. It is cumulative in nature and is primarily obtained
from audit procedures performed during the audit. Audit
evidence must be both sufficient and appropriate to afford a
reasonable basis for an opinion on the financial statements.
5, The auditor should plan and perform the audit with an
attitude of professional skepticism recognizing that
circumstances may exist which may cause the financial
statements to be materially misstated.
‘An attitude of professional skepticism means the auditor
males a critical assessment, with a questioning mind, of the
validity of audit evidence obtained and is alert to audit
evidence that contradicts or bring into questions the reliability
of documents or management representations.
In planning and performing an audit, the auditor neither
assumes that the management is honest nor assumes
tunguestioned honesty. Thus, representations from
iu management are not a substitute for obtaining sufficient
appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.
© Need for an independent financial statement audit
‘The need for an independent audit of financial statements stems
from the following interrelated sources:
As
Conflict of interest between management and users of
financial statements.
Ina sense, financial statements may be viewed as the report
by management as to how the entity performed under their
direction and supervision. Managers are frequently placed in
positions where they can benefit by providing outside parties
with overly optimistic or even false financial information.
Outside parties, however, want unbiased, realistic financial
statements. Recognizing this inherent conflict of interest,
users of financial statements have become skeptical of
unaudited financial statements.
. Expertise
‘The complexity of accounting and auditing requires expertise
Gueetrie Ue anes ie altos cast
most of the users of financial information are not equipped
with the necessary skills and competence to determine
whether the financial statements are reliable, a qualified
person is hired by users to verify the reliability of the financial
statements on their behalf.
Remoteness
Users of financial information are usually precluded from
directly assessing the reliability of the information. Most of
the users do not have access to the entity's records: to
personally verify the reliability of the financial statements. As
12
independent auditor is needed to assist them in
Serres te wichaiey of the fatal foreaton
4, Financial consequences Ba
Gsleading financial information could have substantial
ease consequences for 2 decision male. Iti therefore
important that financial statements be audited before these
statements are used for making important decisions.
{8 Theoretical framework of Auditing
it function’ operates within a theoretical framework.
ee selected postulates, assumptions or ideas that support
many auditing concepts and standards.
1. Audit fretion cpenates on the asiarption that all fiveeial data are
verifiable , it
balances reported in the financial statements must have
aproning Jocaments or evidence to prove their vali. I
no evidence exits in relation to the financial statements on
‘which an auditor is to express an opinion, then there can
no audit to perform.
2. The edi shad cs marin inckperene «th respect to the
Tadependence is essential for ensuring the credibility of the
auditor's report. The report of the auditor will be of linle or
no value to the readers of the financial statements if the
readers are aware that the auditor is not independent with
respect to the client.
3, There should be ro longterm crf between the aucitr ard the dire
Short term conflicts may exist regatding the spplaon of
auditing procedures and accounting polices, but in the e
13~ N
both the auditor and the management must be interested in
the fair presentation of the financial statements.
Effective irternal creel syste recs the pssibility of ers ard feed
