Chapter 2
INTRODUCTION TO AUDITING AND FINANCIAL
STATEMENT AUDIT
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Upon completion of this chapter you will
1, Understand the basic concept and objective of auditing.
2. Understand why there is a demand for auditing.
3. Understand the meaning of information risk and how it will be reduced.
4. Understand the philosophy of an audit.
5. Understand the economic benefits of a financial statement audit.
és Understand the limitations of a financial statement audit.
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9.
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. Know the different types of auditors.
. Know the different types of audits.
. Be familiar with the history of auditing.
0. Recognize the relationship and differences of accounting and auditing.
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DEFINITION OF AUDITING
In today’s environment, the type of assurance engagement that is most common is an audit of
historical financial information. Part of the reason for this is that the requirement for an audit is
contained in many pieces of legislation, including the Corporation Code of the Philippines, which
‘governs the audit of annual financial reports for reporting entities.
Interestingly, auditing, or the audit of financial reports, is no longer defined in the Auditing and
Assurance Standards Council (AASC) Glossary. In Philippine Standards on Auditing (PSA)
200.11, the objectives of the auditor in undertaking an audit of a financial report are stated as
follows:
a. To obtain reasonable assurance about whether the financial report as a whole is free
‘from material misstatement, whether due to fraud or error, thereby enabling the auditor
to express an opinion on whether the financial report is prepared, in all material
respects, in accordance with an applicable financial reporting framework; and
b. To report on the financial report, and communicate as required by the Philippine
‘Auditing Standards, in accordance with the auditor's findings.
While these objectives describe the expected outcomes, they do not describe the process. A useful
definition is that developed by the American Accounting Association (AAA) in A Statement of
Basic Auditing Concepts (ASOBAC). It defines auditing as:
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 10
interested users.This definition contains several ideas important in a wide variety of aut practices The attributes
. a lows:
of auditing contained in this definition that merit special comment are as follows
process - connotes a purposeful and logical steps and is based on the
discipline of a structured and organized series of procedures to decision making. It is oy
haphazard, unplanned, or unstructured
1, A_systemat
2. Objectively obtaining and evaluating evidence ~ means examining the underlying suppor
for assertions or representations and judiciously evaluating the results without bias or
prejudice cither for or against the individual or entity making the assertions,
3. Assertions about economic actions and events — are the information or representations
made by the individual or entity. They comprise the subject matter of auditing. Assertion
include information contained in the financial statements, management internal operating
reports, and tax returns.
4, Degree of correspondence ~ refers to the closeness with which the assertions can be
identified with the established criteria, The expression of correspondence may be
quantified, such as the amount of a shortage in a petty cash fund, or it may be qualitative,
such as the fairness of financial statements.
5. Established criteria — are the standards against which the assertions or representations are
judged. Established criteria may be specific rules prescribed by a legislative or regulatory
body, budgets and other measures of performance set by management, or the Philippine
Financial Reporting Standards (PFRS).
6. Communicating the results ~ is the communication of the auditor’s findings to users and
is achieved through a writen repor, called audit report, that inform readers ofthe degree
of correspondence between the assertions and established criteria. The communication of
results either enhances or weakens the credibility of the representations made by another
Party. The goal of the audit process is to add credibility to management's representations
So that interested users can use the information with reasonable assurance that itis free of
material misstatement.
7. Interested users ~ are individuals or entities who rely on the auditor’s findings. In a
business environment, they include stockholders, management, employees, ereditors,
governmental agencies and the general public.
Exhibit 2.1 depicts an overview of financial statement auditing,
This broad definition reflects the essenti
Processes sufficient to encom,
‘might be conducted.
al nature of all assurance engagements as investigative
ipass the many different purposes for which an assurance service
OBJECTIVE OF A FINANCIAL STATEMENT AUDIT
The objective of an audi
whether the financizChapter 2 ~ Introduction to Audit
a5
Although the auditor's opinion enhances the credibility of the financial statements, the user
cannot assume that the opinion is 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.
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GENERAL PRINCIPLES OF A FINANCIAL STATEMENT AUDIT
The auditor should comply with the “Code of Professional Ethics for Certified Public
Accountants” promulgated by the Board of Accountancy and approved by the Philippine
Professional Regulation Commission. Ethical principles governing the auditor's professional
responsibilities are:
Independence.
Integrity.
Objectivity.
Professional competence and due care.
Confidentiality.
Professional behavior.
Technical standards.
‘The auditor should conduct an audit in accordance with Philippine Standards on Auditing (PSA),
These contain basic principles and essential procedures together with related guidance in the form
of explanatory and other material.
‘The auditor should plan and perform the audit with an attitude of professional skept
recognizing that circumstances may exist which cause the financial statements to be materially
misstated. For example, the auditor would ordinarily expect to find evidence to support
management representations and not assume they are necessarily correct.Auditing and Assuraey
*Steveny
SCOPE OF A FINANCIAL STATEMENT AUDIT
The term “scope of an audit” refers to the audit procedures deemed necessary in y
circumstances to achieve the objective of the audit. The procedures required to conduct an co
in accordance with Philippine Standards on Auditing should be determined by the auditor ya?
regard to the requirements of Philippine Standards on Auditing, relevant professional paye®
legislation, regulations and, where appropriate, the terms of the audit engagement and penne
requirements
DEMAND FOR FINANCIAL STATEMENT AUDIT
Users of financial statements look to the independent auditor's report for assurance abou
reliability of information and its conformance to the applicable financial reporting famenoa,
(€.g., Philippine Financial Reporting Standards). The need for independent audits of Financia}
statements can further be attributed to four conditions as follows: (1) complexity Of transactions
(2) remoteness of information, (3) biases and motives of the provider. and (4) consequence."
|. Complexity of Transactions - Both the transactions between organizations and the
Process of preparing financial statements have become numerous and increasingh
complex and therefore more difficult to record properly. As the level of comple
increases, the risk of misinterpretations and of intentional or unintentional misstatemeny,
also increases. Finding it impossible to evaluate the quality of the financial statement
themselves, users rely on the independent auditors to assess the reliability of the
information contained in the statements.
The volume and complexity of economic activities in business and related authortane
pronouncements often require the assistance and objective evaluation of professional
accountants to properly record the transactions related to those economic activities.
2. Remoteness of Information ~ In today’s global economy, it is virtually impossible users
of financial information to have much firsthand knowledge about the organization with
which they do business. Distance, time, cost, as well as lack of expertise, make it
practical for decision makers to seek direct access to the underlying accounting records
to perform their own verifications of the financial statement. Rather than accept the
quality of the financial data provided by others, users rely on the independent auditor's
report to meet their needs.
The separation between the transactions details (e.g., supporting documents of the joumal
entries) that produce financial statements and the users who need to make decisions based
on those financial statememis creates a demand for an independent party to examine the
information for multiple users.
3. Biases and Motives of the Provider ~ If the information is provided by someone whost
goals are inconsistent with those of the user of the financial statements, the information
may be biased in favor of the provider. Many users of financial statements are concerned
about conflict of interest between themselves and the management of the reporting enti
The apprehension extends to a fear that the financial statements prepared by anagem
may be significantly biased in favor of the management and do not represent the act!
results of operations of the reporting entity. Users seek assurance from independett
auditors that financial statements are free of management biases.Chapter 2 Introduction to Auditing and Financial Statemont Audit at)
Biases and potential conflicts of interests of persons who provide information about the
economic activities ereate a demand for an independent party to lend credibility to the
provider’s information.
Consequences ~ Financial statements represent an important and, in some cases, the only
source of information used in making significant business decisions. Thus, users want the
financial statement to contain as much relevant and reliable information as possible. This
need is recognized by the extensive disclosure requirements imposed by the Securities
and Exchange Commission and other regulatory agencies such as Insurance Commission
and Bangko Sentral ng Pilipinas. It is also recognized by the relevance of the financial
statements disclosures to many lenders. Financial statement users look to the independent
auditor for assurance that the financial statements have been prepared in conformity with
the applicable financial reporting framework, including all the appropriate disclosures.
Economic activities involve many different types of users who create a demand for an
independent party to increase the relevance and reliability of the information they use to
make a wide variety of decisions which significantly affect many people.
These four conditions collectively contribute to information risk, which is the risk that the
information used to assess business risk is not accurate or misleading, Information risk includes
the possibility that the financial statements may be incorrect, incomplete, or biased. Thus, it can
be said that financial statement audits enhance the credibility of financial statement by reducing
information risk.
REDUCING INFORMATION RISK
After comparing costs and benefits, managers and financial statement users may conclude that the
best way to deal with information risk is simply to have it remain reasonably high. A small
company may find it less expensive to pay higher interest costs than to increase costs of reducing,
information risk. For larger businesses, it is usually practical to incur costs to reduce information
risk. Three main ways to do so are as follows: (1) user verifies information, (2) user shares
information risk with management, and (3) user are provided with audited financial statements.
1. User Verifies Information — The user may go to business premises to examine books of
accounts and other accounting records in order to obtain information about the reliability
of the financial statements. Normally, this is impractical because of costs of doing so. In
addition, it would be economically inefficient for all users to verify the information
individually.
2, User Shares Information Risk with Management — Management is responsible for
providing reliable information to users. If users rely on inaccurate financial statements
End asa result incur financial loss, they may have a basis for a lawsuit against
management. A difficulty with sharing information risk with management is that users
may not be able to collect on losses. If a company is unable to repay a loan because of
bankruptcy, itis unlikely that management will have sufficient funds to repay users.
3. User Are Provided With Audited Financial Statements ~ The most reasonable and
common way for users to obtain reliable information is to have it audited. Decision
makers can then use the audited information on the assumption that it is reasonably
complete, accurate, and unbiased.Typically, the mana
engages an independen
are free from material misstatements,
determined to be misleading, the auditor can be s
ment or audit committee of the board of directors of a compan,
itor (o provide assurance to users that the financial Statements
If the financial statements are ultima,
red by both the management and use
ely
,
THE PHILOSOPHY OF AN AUDIT AND NOTION OF ACCOUNTABILITY,
STEWARDSHIP AND AGENCY
Principals (i.e., business owners) appoint agents (
taking authority to them. In doing so, principals place trust in their agents to act the
brincipals’ best interest. However, as a result of information asymmetries between Principals ang
agents and differing motives, principals may lack trust in their agents and may therefore need to
Put in place mechanism, such as the audit to reinforce this trust. The philosophical theories that
explain the demand for auditing and support the performance of an independent audit are as
follows: (a) stewardship or agency theory, (2) motivational theory, (3) information theory, and (4)
insurance theory. °
managers) and delegate some decison
1. Stewardship or Agency Theory ~ Stewai
(as well as the owners or investors) wan
Statement assertions, The manager is the azent or steward ofthe owners or mesa but
cach party acts in his or her own self-interest and the goals or objectives of each party are
different. This situation inevitably creates conflict between the owner and manager. The
owner perceives that the manager's goals or objectives may be detrimental to the owner's
own goals. Thus, the manager wants financial statement representations audited by an
independent party to enhance his or her stewardship of these financial statements and to
lessen the owner's mistrust of the manager.
P OF agency theory implies that the manager
ity an audit adds to the financial
investors.
Investors
Managers
Required periodic reporting ees
as Use of resources
CO
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Verinestion
by independent expert
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2. Motivational Theory — Preparers of financial statements know that their assertions willbe
Subjected to an audit; thus, financial statements will be brought more eee
Sccounting standards. The motivational benefits of an audit are difficult to prChapter 2- Introduction fo Auditing and Financial Statement Audit 29
conclusively, but some believe that management's knowledge that an audit will be
performed mitigates against improper financial statement preparation.
3. Information Theory — An assurance service is a means of improving the quality of
information. For example, investors require information to make an assessment of
expected returns and risks associated with their investment. An assurance service is also
valued as a means of improving financial and non-financial data for internal decision
making detecting errors and motivating employees to exercise more care in preparing
records.
The information theory also states that investors benefit through the increased confidence
of external users of the information. For example, for private companies seeking funds
from lending institutions, the costs incurred in audit fees were more than recompensed by
the increased savings associated with lower interest rates when compared with the
interest rates charged to similar companies that weren’t audited.
4. Insurance Theory ~ The insurance theory states that demand for assurance occurs from
those who may suffer loss when things go wrong. For example, if an organization goes
into liquidation and has no resources to pay its debts, it may be possible to recover some
of the losses from the auditor. As auditors are required to have insurance against such
potential losses, this has given rise to a ‘deep-pockets’ effect in that the auditor is seen to
have a greater ability to pay. As audit firms will be very concerned with maintaining their
reputation, any legal action undertaken against them may damage this reputation will be
ECONOMIC BENEFITS OF A FINANCIAL STATEMENT AUDIT
Among the economic benefits of financial statement audits are the following: (1) access to capital
markets, (2) lower cost of capital, (3) deterrent to inefficiency and fraud, and (4) control and
operational improvements.
1. Access to Capital Markets — public companies must satisfy statutory audit requirements
under the securities acts in order to register securities and have them traded on securities
markets. In addition, stock markets may impose their own requirements for listing
securities. Without audits, companies would be denied access to these capital markets and
many private companies would be denied access to loans.
2. Lower Cost _of Capital - companies often engages auditor to have their financial
statement audited in order to obtain bank loans with more favorable terms. Because of the
reduced information risk associated with audited financial statements, creditors may offer
loans with lower interest rates.
3. Deterrent to Inefficiency and Fraud — research has demonstrated that when employees
know that an independent audit is to be made, they take care to make fewer errors in
performing accounting functions and are less likely to misappropriate company assets.
Thus, the data in company records will be more reliable, and losses from embezzlements
nd the like will be reduced. In addition, the fact that financial statement assertions are to
be verified reduces the likelihood that management will engage in fraudulent financial
reporting.Auditing and Assurance Servic
the independent auditor often makes
to evaluate management's: assessments. of
measures and to make
onal_ Improvements
rol_and_Oper
suggestions t improve intemal control, i
business risks, to recommend improved performance | mes
revommendations to achieve greater operational efficiencies
organization
within the client's
LIMITATIONS OF A FINANCIAL STATEMENT AUDIT
a number of inherent limitations. One constraint is that
f Following are {wo important economic
A financial statement audit is subject t0
the auditor works within fairly restrictive economic limits
limitati:
> OF
1. Reasonable Cost — A limitation on the cost of an audit resull
sampling. of the accounting records and supporting data. In addition, the auditor may
choose to test intemal controls and may obtain assurance from a well-functioning system
of internal controls.
Reasonable Length of Time ~ time constraint may affect the amount of evidence that can
be obtained concerning events and transactions after the balance sheet date that may have
an effect on the financial statements, Moreover, there is a relatively short time period
available for resolving uncertainties existing at the statement date.
Another significant limitation is the established accounting framework for preparing financial
Statements. Following are two important limitations associated with the established accounting
framework.
Alternative Accounting Principles - Alternative accounting principles are permitted
under GAAP. Financial statement users must be knowledgeable about a company’s
accounting choices and their effect on financial statements.
4. Accounting Estimates ~ Estimates are an inherent part of the accounting process, and no
one, including auditors, can foresee the outcome of uncertainties. Estimates range from
the allowance for doubtful accounts and an inventory obsolescence reserve to impairment
tests for fixed assets and goodwill. An audit cannot add exactness and certainty to
financial statements even if these factors do not exist.
Despite these limitations, a financial statement audit adds credibility to the financial statements.
RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
While the auditor is responsible for forming and expressing an opinion on the financial
statements, the responsibility for preparing and presenting the financial statements (i.e., assertions
embodied within the financial statements) is that of the management of the entity, For example,
management, not the auditor, is responsible that all recorded assets and liabilities exist, that all
recorded transactions occurred, that no transactions are omitted, that assets are the rights and
liabilities are the obligations of the entity, that all disclosed amounts are appropriate, and that the
financial statements are properly classified and disclosed. Moreover, the audit of the finan
statements does not relieve management of its responsibilities.Chapter 2 Introduction to Auditing and Financial Statemant Audit un
TYPES OF AUDITORS
Individuals who are engaged to audit economic actions and events can be classified into three
groups as follows: (1) external or independent auditors, (2) internal auditors, and (3) government
auditors.
lL
emal or independent auditors ~ are certified public accountants (CPA) who have their
own independent accounting practices that provide independent auditing services of
client financial statements. Independent auditors mostly perform financial statement
audits, but they may also perform compliance and operational audits. They are also
referred to as external auditors.
Internal auditors — are employees of the entities they audit and are primarily concerned in
determining whether organizational policies and procedures have been followed in
safeguarding the entity’s assets. They are involved in an independent appraisal activity
called internal auditing, which is designed to assist the management of the organization in
the effective discharge of its responsibilities. Internal auditors generally perform
compliance and operational audits.
The internal auditing staff often reports to the president and also to the audit committee
of the board of directors, This is to ensure that the internal auditors will have ready access
to all units of the organization, and their recommendations will be given prompt attention
by department heads. It is also necessary that the internal auditors be independent of the
department heads and other line executives whose work they review.
Government auditors — are engaged to provide assurance that all local and national
governmental agencies, including government owned and controlled corporations, have
complied with laws, rules, regulations, policies, and procedures. Government auditors
generally conduct comprehensive audits which combine elements of financial,
compliance and operational auditing,
Government auditors perform audits to determine that spending programs follow the
intent of Congress and operational audits to evaluate the effectiveness and efficiency of
selected government programs Government auditors also conduct examinations of
government owned and controlled corporations” financial statements.
TYPES OF AUDITS
Audits are generally classified into different types of activities as follows: (1) financial or
independent audits, (2) compliance audits, and (3) operational audits.
1.
Financial or independent audits - is an audit of the financial statements of an entity. It
involves obtaining and evaluating evidence about an entity’s presentation of its financial
position, results of operations, and cash flows for the purpose of expressing an opinion as
to whether they are presented fairly in accordance with a specified financial reporting
framework or criteria most often the Philippine Financial Reporting Standards
(PERS),
Compliance audits — involves obtaining and evaluating evidence to determine whether
certain financial or operating activities of an entity conform to established policies andating ond Assurance Services
set by some higher authority thay
Procedures, conditions, laws, rules, or regulations
May have a material effect on the financial statements:
fe assurance that the client is in
sg lender (¢. banks and other
ether the client maintained or
For ext
mple, auditors may perform an audit to provid
compliance with loan covenants established by the eli
financial institutions) in financing agreements such as WI
exceeded the specified minimum debt to equity ratio level.
« unit of an organization for the purpose of
vt evaluating evidence about the
Operational audits ~ is a study of a spe
uring its performance. It involves obtaining am u eve a
easuring : activities, policies a
efficiency, economy and effectiveness of an entity's operating aries Tet aaa
procedures in relation to specified objectives. At the completion o rations. This type of
management normally expects recommendations for improving operons, iS OP
audit is sometimes referred to as a performance audit or a managem'
For example, auditors may perform an audit of a client’s employee cash ee
liquidation policy to determine that approved business expenses are iqui . Bi the
employees (effectiveness), the expenses incurred are ordinary and reasonable, and the
process of liquidating the expenses is fair and timely (efficient).
Table 2.1 summarizes the basic differences between the financial statement audit, compliance
audit and operational audit as to purpose, users of report, report and criteria.
~ | Differences Between Financial Statement Aust, Compliance Audit and Operational
TaaLe 24 | Audit —— _
- |
Financia statement Aust | Complanee Aust | Opmrationa Aus,
Purpose | Express an opinion on the | To determine whether cient | To determine the efficiency,
| faimess of financial | is folowing specified economy and effectiveness of
information (i.e. | procedures set by higher | an entity's operating activities
| presentation of fnanci | Suthonty Ge, polises, |
| statements | laws, reguiatons ete) |
se an anes a
Users of | Shareholders, creditors, | Board of rectors, Board of directors,
Report | regulatory agencies and | management of the entity or | management ofthe entty or
general public third parties seting down | thid parties
procedures
| Summary of findings or
assurance degree of
| compliance
|
Summary of findings |
regarding efficiency and |
effectiveness observed
Criteria | Identified fnancial reporting | Management policies, rules | Performance measures,
framework (e.9.,PFRS) | or regulations indicators or objectives as
| determined by the |
| ‘management |
a
ORIGIN AND HISTORY OF AUDITING
The Concise Oxford Dictionary defines ‘account’ variously, including ‘to answer for’, and the
‘reckoning of money held in trust’. In these senses of the word, traces of accounting can be foundChapter 2 Introduction to Auditing and Financial Statement Audit 2
in the histories of the earliest civ
little known.
ation, even those in which the art of the recorded word was
The following discussion relates to the history of auditing from the primitive until the emergence
of auditing firms and popularization of auditing in the United States of America.
Primitive Auditing
Accounting in those far-off days could only have taken place orally. The steward in charge of the
cattle, goods and other forms of wealth would, from time to time, produce to his master the
wealth with which he was entrusted and give an account of his stewardship, reciting from
memory the goods and chattels acquired, those disposed of and those still in his possession. The
master would listen to this recital of the steward’s transaction and question him thereon. The
master was the listener, the auditor. So the word “auditor” (derived from the Latin word audire,
which means to hear) acquired a secondary meaning: “one who satisfies himself as to the truth of
the accounting of another”.
Auditing in Ancient Egypt and Babylonia
With the advent of writing and the acquisition of the art by the most literate of the population,
some form of written record was kept by the steward and the master (or his delegate) examined
the record. So there evolved, side by side, the art of bookkeeping and the practice of auditing, the
latter no longer being confined to a mere listening to an account of stewardship.
A method of auditing that seemed to be prevalent in ancient Egypt and Babylonia consisted of, in
part, two or more officials keeping separate records and checking the accuracy of these records by
comparing them with each other. This concept of checks and balances is an acceptable business
practice even today. Auditor’s look it in evaluating their client's control.
Auditing in Ancient Greece and Rome
Many social and political traditions in Western society have their origins in ancient Greece. One
of these traditions was the audit of public accounts. All public officials apparently had to submit
their accounts to designated auditors. This requirement probably extended to the highest ranking
members of the Greek society.
To many, Roman civilization was the epitome of structure and organization. We should not b
surprised to learn, then, that audits of some type were performed in that era, Roman officials, like
their Greeks counterparts, were required to submit their accounts to a designated person or body
when they left office.
Auditing in Medieval Period
‘Audits became more sophisticated during the medieval period of British history. High officials
accountable to heads of state compared independent tallies of monies collected by sheriffs for the
crown, Today, we refer to independent tallies as controls and the verification of these tallies by a
high official as auditing.Auditing During the Industrial Revolution
Jish corporations registered with the
tatements by boards of directors ang
hareholders of the company. These
‘oder definition, The only vestige
The Industrial Revolution produced carly examples of En
state. This practice led to laws mandating the preparation OF <
provisions for “shareholder audits” of these statements by s
auditors possessed little or no independence, atleast By OU" HPCE. in the audited company
of independence was the requirement that auditors not old ,
; were required to do
Auditors were not only allowed to own stock in the audited company uu faa se i
In later years, this requirement was lifted, and external professionals
audits.
Early Auditing in the United States of America
The American audits in the late nineteenth and early twentieth centuries were patterned aftr the
British model, that is, examinations were made to report on the stewardship of management and
to detect fraud. In many cases, all transactions of an entity were audited. Later, cost consideration
forced auditors to shift their techniques from detailed examinations to sampling and testing, In
addition, early American audits emphasized the balance sheet because the purpose of many of
these audits was to secure financing from a bank.
The fair presentation of financial statements became the dominant standard when companies were
subjected to more government regulation. In the United States, income taxes were established in
the early 1900s. The passage of federal securities act in 1933 and 1934 mandated audits for
companies with publicly traded securities, and the creation of the Securities and Exchange
Commission in 1934 provided for a federal government oversight of the audits of most large
corporations in the country.
1960s to 1990s
The world economy continued to grow in the 1960s to 1990s. This period marked an important
development in the technological advancement and the operating size and complexity of the
companies. In the 1970s, auditors performed an important role in enhancing the credibility of the
financial information and advancing the operations of an effective capital market. Thus, the role
of auditors among others, were to affirm the truthfulness and ensure the fair presentation of the
financial statements.
In the earlier part of this period, auditors changed its audit approach from “verifying transaction
in the books” to “relying on system”. Such a change resulted due to the increase in the number of
transactions from the continued growth in the size of companies, where it is unlikely for auditors
to verify all the transactions. Thus, the auditors had placed higher reliance on companies’ internal
control system in their audit procedures. Furthermore, auditors were required to ascertain and
document the accounting system with particular consideration to the flow information and
identification of internal controls in place. When internal control of the company was effective,
auditors reduced the level of detailed substance testing.
In the early 1980s, there was a readjustment in auditors’ approaches where the assessment of
internal control systems was found to be an expensive process and so auditors began to cut back
their systems work and make greater use of analytical procedures. An extension of readjustment
was the development of risk-based auditing. Risk-based auditing is an audit approach where an
auditor will focus on those areas which are more likely to contain errors. To adopt its use, theChapter 2~ Introduction to Auditing and Financial Statement Audit 35
auditors are required to gain a thorough understanding of clients’ organization, its key personnel,
policies and procedures, and the market that they operate.
Moreover, most of the companies in this period had introduced the used computer systems to
Process their financial and other data, and to perform, monitor and control many of their
operational and administrative processes. Similarly, auditors placed heavy reliance on the
advanced computer assisted auditing tools to facilitate their audit procedures. In addition to the
auditing of the financial statements, the auditors at the same time were providing advisory
services to the audit clients.
Moreover, accounting and auditing during this period has become an industry with strong
competition among auditing firms. Thus, the role of auditors in the provision of advisory services
‘emerged as a secondary audit objective. Since then, the role of the auditor has always been highly
associated with such advisory services instead of audit of financial statements.
1990s to present
The auditing profession witnessed substantial and rapid change since 1990s as a result of the
accelerating growth at the world economies. Auditing in the present day has expanded beyond the
basic financial statement attest function and has developed into new processes that build on a
business risk perspective of their clients. The business risk approach rests on the notion that a
broad range of the client’s business risks are relevant to the audit. Advocates of the business risk
approach opined that many business risks, if not controlled, will eventually affect the financial
statements, Moreover, by understanding the full range of risks in businesses, the auditor will be in
a better position to identify matters of significance and relevance to the audit profession on a
timely basis.
Since the early 1990s, the audit profession began to take increased responsibility to detect and
report fraud and to assess, and report more explicitly, doubts about an auditee’s ability to
continue in conformance with society’s and regulators’ increasing concern about corporate
governance matters. Adoption of the business risk approach in turn enhances auditor’s ability to
fulfill these responsibilities.
Presently, the objective of auditing is to lend credibility to financial and non-financial information
provided by management in its financial statements. By 2000, consulting revenues exceeded
auditing revenues at all the major audit firms in the United States. Regulators of the auditing
profession and the investing public began to doubt whether audit firms could remain independent
on audit issues when the firms were so dependent on consulting revenues. The quality of audits is
being placed under scrutiny after a series of financial scandals of public companies such as
Sunbeam, Waste Management, Xerox, Adelphia, Enron and WorldCom. The collapses of these
giant corporations had brought about a crisis of confidence in the work of auditors.
‘As a consequence of the high level of litigation and criticism against the auditors, nearly all large
accounting firms split their consulting practice into separate companies and made announcements
on their more stringent rules and measures to ensure better independence and audit quality. In
addition, a spate of radical reforms was undertaken in various countries, by the accounting
bodies, governments and stock exchange commissions to strengthen the audit practice.‘Auditing and Assurance Services
DISTINCTION BETWEEN ACCOUNTING AND AUDITING
; «the nublic cor
Many financial statement users and members of the general e cern
jccounting, The confusion results because most auditing is aie matters.
information, and may auditors have considerable expertise in accot
nfuse auditing with
ed with accounting
; \ics events for the
Accounting is the process of recording, classifying, and summarizing i Sa Toler de relevant
Purpose of providing financial information used in decision mal Le ac vale ta
information, accountants must have a thorough understanding of the Jecountants must develop
Provide the basis for preparing the accounting information. In addition, a Seales ime
& system to make sure that the entity’s economic events are properly rec
and at a reasonable cost,
On the other hand, auditing is determining whether recorded information Ce fe
economic events that occurred during the accounting period. When aucing accounting dats, te
auditor must possess expertise in the accumulation and interpretation of audi 1 audit procedures
expertise that distinguishes auditors from accountants. Determining the prope ,
¢ lems unique to
deciding the number and types of items to test, and evaluating the results are prob! iq
the auditor.
Accounting and auditing are separate disciplines within dissimilar bodies a Knowledge,
However, a familiarity with the audit process is not wholly sufficient to render a al it
Competent. Because an auditor audits financial statements, he or she must also be familiar with
the Philippine Financial Reporting Standards.