LS 1.

10
OVERVIEW
Fundamentals of Auditing and Assurance Services

 Auditing
Audit – derived from Latin word “Audire” which means to hear
- Auditing: is a systematic process by which a competent, In olden days, some experienced
independent person objectively obtains and evaluates people ordinarily judges the
evidence regarding assertions about economic actions accounts of business people for
and events to ascertain the degree of correspondence the purpose of the correctness
of accounts
between those assertions and established criteria and
communicating the results to interested users (American
Accounting Association, AAA)

Systematic Process
This implies a structured, logical, and organized series of steps and procedures.

Competent, Independent Person

The auditor must be qualified to understand the criteria used and the competence to
know how and what evidence to accumulate to reach a proper conclusion. The auditor
must also have an independent mental attitude which involves impartial and objective
thinking

Objectively Obtains and Evaluates Evidence

This means examining the bases for the assertions and judiciously evaluating the results
without bias or prejudice either for or against the individual (or entity) making the
representations

Assertions about Economic Actions and Events

These are the representations made by the individual or entity. They comprise the
subject matter of auditing

Degree of Correspondence
Refers to the closeness with which the assertions can be identified with established
criteria

Established Criteria
These are the standards against which the assertions or representations are judged

Communicating the Results

Referred to attestation. By attesting to the degree of correspondence with established
criteria through a written report: Audited Financial Statements

Interested Users
Individuals who use (rely on) the auditor’s findings.
 Overall Objectives of Auditing
In conducting an audit of financial statements, the overall objectives of the auditor are
(PSA 200, 11):
a. To obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error, thereby
enabling the auditor to express an opinion on whether the financial statements are
prepared, in all material aspects, in accordance with an applicable financial
reporting framework; and
b. To report on the financial statements, and communicate as required by the PSAs,
in accordance with the auditor’s findings

 Auditing as a Structured Process

Auditing is a structured process that…
a. Involves the application of analytical skills, professional judgment & professional
skepticism
b. Is usually performed by a team or professionals, directed with managerial skills;
c. Uses appropriate form of technology and
d. Complies with relevant technical standards: ISAs, ISQCs, IFRS, IPSASs, & any
applicable international, national, or local equivalents as appropriate
e. Complies with required standards or professional ethics

 Major Types of Audits

Audit Procedures Financial Audit Compliance Audit Operational Audit
Is conducted to It involves a review of It’s a study of a
determine whether an organization’s specific unit of an
the financial procedures to organization for the
statements of an determine whether purpose of measuring
Primary Audit entity are fairly the organization has its performance,
Objectives presented in adhered to specific identify areas for
accordance with the procedures, rules, or improvements &
applicable financial regulations make
reporting framework recommendations to
improve performance
That the F/S are fairly That the organization That the
presented has complied with organization’s
Assertions made by
laws, regulations, or activities are
the Auditee
contracts conducted effectively
& efficiently
Financial reporting Laws, regulations, Objectives set by the
Established Criteria framework such as and contracts board of directors
PFRS
An opinion about Reports on the Recommendations or
whether the F/s are degree of compliance suggestions on how to
Content of the fairly presented in with the applicable improve operations
Auditor’s Report conformity with the laws, regulations &
applicable reporting contracts
framework
 Types of Auditors
 Independent Auditors/External Auditors – CPAs who offer their professional services to
different clients on a contractual basis
 Internal Auditor – entity’s own employees who investigate & appraise the effectiveness &
efficiency of operations & internal controls
 Government Auditors – government employees whose main concern is to determine
whether persons or entities comply with government laws and regulations

 Role of Management & Independent Auditor

Management Independent Auditor

- Prepares unaudited financial - Evaluates F/S to determine whether the

statements F/s prepared by the management
- Provides all the financial data conforms to the established criteria

- Assits the auditors

Audited F/S adds credibility to the report
- Receives the audit
and reduces information risk
- Report on F/Ss

Users of Financial Statements

 General Requirements When Auditing Financial Statements

- Comply with the relevant ethical requirements including independence
- Conduct an audit in accordance with the Philippine Standards of Auditing (PSAs)
- Apply professional judgment in planning and performing the audit
- Obtain sufficient appropriate audit evidence to reduce the risk to an acceptably low
level
- Perform the audit with an attitude of professional skepticism

 Users Audited Financial Statements

Users Types of Decisions

Management Review performance, make operational
decisions, report results to capital markets
Stockholders Buy or sell stock
Bondholders Buy or sell bonds
Financial Institutions Evaluate loan decisions, considering
interest rates, terms, and risk
Taxing Authorities Determine taxable income and tax due
Regulatory Agencies Develop regulations and monitor
 compliance
Labor Unions Make collective bargaining decisions
Court System Assess the financial position of a company
in litigation
Vendors Assess credit risk
Retired Employees Protect employees from surprises
concerning pensions and other post-
retirement benefits

 Why is Independent Necessary?

 Information risk – the possibility that information on which a business decision was made
was inaccurate

Factors that contribute to information risk:

 Remoteness of information users from information providers
 Potential bias and motives of information provider
 Voluminous data
 Complex exchange transactions
 Consequences : when financial information is not reliable, investors and other
users lose a significant source of information that they need to make decisions that
have important consequences

Auditing can have a significant effect on reducing information risk as…

- User can verify the information
- User shares information risk with management
- Audited financial statements are provided

Why Independent is Necessary? (PSA 120)

3. Financial statements are ordinarily prepared and presented annually and are directed
toward the common information needs of a wide range of users. Many of those users
rely on the financial statements as their major source of information because they do
not have the power to obtain additional information to meet their specific information
needs. Thus, financial statements need to be prepared in accordance with one, or a
combination of:

a. Accounting standards generally accepted in the Philippines

b. International Accounting Standards; and
c. Another authoritative and comprehensive financial reporting framework which
has been designed for use in financial reporting and is identified in the financial
statements

 Theoretical Framework of Auditing

 Audit function operates on the assumption that all financial data are verifiable
 The auditor should always maintain independence with respect to the financial
statements under audit
 There should be no long-term conflict between the auditor and the management
 Effective internal control system reduces the possibility of material misstatements of
the financial statements
  Consistent application of the applicable financial reporting framework such as the
PFRS results in fair presentation of financial statements
 What was held true in the past will continue to hold true in the future in the absence
of known conditions to the contrary
 An audit benefits the public

 General Approach to Auditing Financial Statements

 Audit Process
- Is the sequence of different activities involved in an audit. The emphasis & order of
certain activities may vary depending upon a particular audit, but this process would
basically include the ff:
-

Auditing Process

Financial Statement Auditing Process

3 Fundamental Concepts: Materiality, Audit Risk, Evidence

 Materiality
 Material Misstatements – occurred when it could reasonably be expected to
influence the economic decisions of users made on the basis of the financial
statements
Risk Nature Source
Inherent and Control The financial statements Entity
Risks may contain a material objectives/operations and
 misstatement management’s
design/implement of
internal control
Detection risk The auditor may fail to Nature and extent of the
detect a material procedures performed by
misstatement in the the auditor
financial statements

 Materiality – refers to the amount by which a set of FS could be misstated w/o

affecting the judgment of a reasonable person
- Magnitude of an omission or misstatement

Scope of PSA 320

This Philippine Standard on Auditing (PSA) deals with the auditor’s responsibility to
apply the concept of materiality in planning and performing an audit of financial
statements. PSA 450 (revised and redrafted) explains how materiality is applied in
evaluating the effect of identified misstatements on the audit and of uncorrected
misstatements, if any, on the financial statements.

 Audit Risk
- The risk that the auditor mistakenly give a “clean”
or unqualified opinion on financial statements that
are materially misstated

 Audit Evidence (PSA 230-Objective)

5. The objective of the auditor is to prepare
documentation that provides
a. A sufficient (quantity) and appropriate (quality)
record of the basis for the auditor’s report; and
b. Evidence that the audit was planned and performed in accordance with PSAs and
applicable legal and regulatory requirements
 Management Assertions
Assertions – are representations by management, explicit or otherwise, that are
embodied in the financial statements.
- Relate to the recognition, measurement and presentation of classes
of transactions and events, account balances and disclosures in the
financial statements

Classes of Transactions & Events

 Occurrence – transactions and events that have been recorded or disclosed have
occurred, and such transactions and events pertain to the entity
 Completeness – all transaction and events that should have been recorded, and all
related disclosures that should have been included in the financial statements have
been included
 Authorization – all transactions and events have been properly authorized
 Accuracy – amount and other data relating to the recorded transactions and events
have been recorded appropriately, and related disclosures have been appropriately
measured and described
 Cutoff – transactions and events have been recorded in the correct accounting
period
 Classification – transaction and events have been recorded in the proper accounts
 Preparation – transaction and events are appropriately aggregated or disaggregated
and clearly described and related disclosures are relevant and understandable in the
context of the requirements of the applicable reporting framework

Account Balances (Related Disclosures)

 Existence - assets, liabilities, and equity interests exists
 Rights & Obligations – the entity holds or controls the rights to assets, and liabilities
are obligations of the entity
 Completeness – all assets, liabilities, equity interest that should have been recorded
have been recorded, and all related disclosures that should have been included in
the financial statements have been included
 Classification – assets, liabilities, and equity interests have been recorded in the
proper accounts
 Accuracy, Valuation, & Allocation – assets, liabilities, and equity interests have been
included in the financial statements at appropriate amounts, and any resulting
valuation or allocation adjustments have been appropriately measured and
described
 Presentation – assets, liabilities, and equity interest are appropriately aggregated or
disaggregated and clearly described, and related disclosures are relevant and
understandable in the context of the requirements of the applicable financial
reporting framework
 Code of Professional Ethics
Ethical principles governing the auditor’s professional responsibilities are:
a. Independence
b. Integrity
c. Objectivity
d. Professional competence and due care
e. Confidentiality
f. Professional behavior; and
g. Technical standards

Code of Professional Ethics 2018

- Includes safeguards which are “actions, either individually or in combination,
that a Public Accountant takes that effectively reduce threats to compliance
with the fundamental principles to an acceptable level.”
- It is no longer a valid notion that all threats can be addressed by the application
of safeguards. The enhanced conceptual framework clarifies that in certain
circumstances, the public accountant may not have any other option but to
decline, or end the specific professional activity, or service
- It emphasizes that threats are addressed either by eliminating the
circumstances creating the threats; applying safeguards where they are
available or capable of reducing the identified threats to an acceptable level; or
by declining or ending the specific professional activity or services