University of Luzon - Refresher Course in Accountancy

Auditing – Module 1.1

1.1 Fundamentals of Auditing and Assurance Services

1.1.1 Introduction to assurance engagements
1.1.1.1 Nature, objective and elements
1.1.1.2 Types of assurance engagements (audits, reviews, other assurance engagements
1.1.2 Introduction to auditing
1.1.2.1 Nature, philosophy, and objectives
1.1.2.2 Types of audit
1.1.2.2.1 According to nature of assertion/data (financial statements audit, operational audit,
and compliance audit)
1.1.2.2.2 According to types of auditor (external independent financial statements audit,
internal audit, and government audit)

INTRODUCTION TO ASSURANCE ENGAGEMENTS

FOCUS NOTES:
 Ethical Principles and Quality Control Standards
 Practitioners who perform assurance engagements are governed by:
a. The Framework, PSAs, PSREs, and PSAEs
b. The Code of Ethics for Professional Accountants
c. Standards on Quality Control

 Fundamental ethical principles (applicable to all professional accountants):

a. Integrity;
b. Objectivity;
c. Professional competence and due care;
d. Confidentiality; and
e. Professional behavior.

 Definition and Objective of an Assurance Engagement

Assurance engagement is an engagement in which a practitioner aims to obtain sufficient appropriate

evidence in order to express a conclusion designed to enhance the degree of confidence by the intended
users other than the responsible party about the outcome of the measurement or evaluation of an
underlying subject matter against criteria.

 Types of assurance engagement

As to who measures or evaluates the underlying subject matter

1. Attestation engagements (assertion-based)
2. Direct engagements (direct reporting)

As to the level of assurance provided to users

1. Limited assurance engagements
2. Reasonable assurance engagements

Specific Assurance Engagements Covered by AASC Pronouncements/Standards

Engagement Engagement Standards

Applicable
1. Audits of Historical Financial Information PSA and Related Practice Notes
2. Reviews of Historical Financial Information PSRE and the Related Practice
Notes
3. Assurance Engagements Other than Audits and Reviews of PSAE and the Related Practice
Historical Financial Information Notes

PSA – Philippine Standards on Auditing

PSRE – Philippine Standards on Review Engagement
PSAE – Philippine Standards on Assurance Engagements

1
University of Luzon - Refresher Course in Accountancy
Auditing – Module 1.1

2
University of Luzon - Refresher Course in Accountancy
Auditing – Module 1.1

 Elements of an Assurance Engagement

1. Three-party relationship;

 Practitioner
 Responsible party
 Intended users

2. An appropriate underlying subject matter;

Examples of subject matter:

 Historical financial performance or condition
 Future financial performance or condition
 Nonfinancial performance or conditions
 Physical characteristics
 Systems and processes
 Behavior

To be appropriate underlying subject matter:

 Identifiable and capable of consistent measurement or evaluation against the identified
criteria.
 Can be subjected to procedures for obtaining sufficient appropriate evidence.

3. Suitable Criteria;

 The benchmarks used to measure or evaluate the underlying subject matter.

 Attributes of suitable criteria:
1. relevance
2. completeness
3. reliability
4. neutrality
5. understandability

4. Sufficient appropriate evidence; and

 Sufficiency – quantity/adequacy
 Appropriateness – quality; relevance and reliability
 Relevant – when evidence satisfies/pertains to objectives.
 Reliable evidence are a function of the ff.:
1. Source of evidence (internal vs external)
2. Condition of internal control ( effective vs ineffective)
3. Manner/way of obtaining evidence (direct vs indirect)
4. Documentary vs oral evidence
5. Original vs photocopy/facsimile

 In obtaining sufficient appropriate evidence, the practitioner:

 Applies professional skepticism in planning and performing the engagement.
 Uses professional judgment in considering materiality, assurance engagement risk and
quantity and quality of available evidence when planning and performing the engagement.

5. A written assurance report in a form appropriate to reasonable assurance or limited assurance

engagement.

 Written report containing a clear expression of the assurance conclusion about the subject
matter information.
 In reasonable assurance engagements – it is expressed in positive form.
 In limited assurance engagements- report is expressed in a form that conveys whether, based on
the engagement performed, a matter has come to the practitioner’s attention to cause the
practitioner to believe the subject matter information is materially misstated.

 Factors that contribute to rarity of absolute assurance (reason why absolute assurance impossible)

3
University of Luzon - Refresher Course in Accountancy
Auditing – Module 1.1
 Use of selective testing.
 Limitations of internal control.
 Evidence available is persuasive rather than conclusive
 Use of judgment.
 Nature of subject matter.

 Example of Assurance Engagement

a. audit
b. review

 Not Assurance Engagement

a. agreed-upon procedures engagement
b. compilation of financial or nonfinancial information
c. preparation of tax returns
d. consulting engagement

Multiple Choice:
1. Which of the following is not one of the fundamental ethical principles applicable to all professional
accountants?
a. integrity and objectivity
b. independence
c. professional competence and due care
d. confidentiality
e. professional behavior

2. Which type of assurance engagement provides the highest degree of confidence to the intended users?
a. reasonable assurance engagement
b. limited assurance engagement
c. attestation engagement
d. direct engagement

3. Which is not a party to an assurance engagement?

a. Practitioner
b. Intended users
c. Consultant
d. Responsible party

4. The person or persons or class of persons for whom the practitioner prepares the assurance report is:
a. Practitioner
b. Intended users
c. Consultant
d. Responsible party

5. A subject matter in an assurance engagement can take many forms such as:
a. Financial performance or conditions
b. Nonfinancial performance or conditions
c. Physical characteristics
d. Systems and processes
e. Behavior
f. All of the above

6. A practitioner should accept an engagement if the subject matter in an engagement is appropriate. Which is
not a characteristic of an appropriate subject matter?
a. identifiable and capable of consistent evaluation or measurement against the identified criteria.
b. can be subjected to procedures for gathering sufficient appropriate evidence.
c. reliable and free from bias.
d. All of the above are characteristics of an appropriate subject matter.

7. In these engagements, the evaluation or measurement of the subject matter is performed by the responsible
party, and the subject matter information is in the form of an assertion by the responsible party that is made
available to the intended users.
a. limited assurance engagements

4
University of Luzon - Refresher Course in Accountancy
Auditing – Module 1.1
b. reasonable assurance engagements
c. attestation engagements
d. direct engagements

8. In these engagements, the practitioner either directly performs the evaluation or measurement of the subject
matter, or obtains a representation from the responsible party that has performed the evaluation or
measurement that is not available to the intended users. The subject matter information is provided to the
intended users in the assurance report.
a. limited assurance engagements
b. reasonable assurance engagements
c. attestation engagements
d. direct engagements

9. The benchmarks used to evaluate or measure the subject matter:

a. Appropriate subject matter
b. Suitable criteria
c. Sufficient appropriate evidence
d. A written assurance report

10. A suitable criteria exhibits the following characteristics, EXCEPT:

a. relevance
b. completeness
c. independence
d. reliability
e. neutrality
f. understandability

11. The measure of the quantity of evidence.

a. sufficiency c. relevance
b. appropriateness d. reliability

12. The measure of the quality of the evidence.

a. sufficiency c. relevance
b. appropriateness d. reliability

13. Appropriateness of evidence is a function of the reliability and:

a. relevance. c. adequacy
b. sufficiency d. consistency

14. The risk that the practitioner expresses an inappropriate conclusion when the subject matter information is
materially misstated.
a. audit risk
b. assurance engagement risk
c. inherent risk
d. control risk

15. The practitioner expresses a conclusion in the positive form in:

a. limited assurance engagements
b. reasonable assurance engagements
c. attestation engagements
d. direct engagements

16. The practitioner expresses a conclusion in the negative form in:

a. limited assurance engagements
b. reasonable assurance engagements
c. attestation engagements
d. direct engagements

17. The level of assurance engagement risk is higher in a reasonable assurance engagement than in a limited
assurance engagement.
a. True
b. False

5
UL Refresher Course in Accountancy
Auditing – Module 1.1
18. Which of the following is the least persuasive type of evidence?
a. Computations made by the auditor.
b. Time cards of factory workers.
c. Canceled checks.
d. Vendor's invoice.

19. The following statements are correct, EXCEPT:

a. The greater the risk of misstatement, the more evidence is likely to be required.
b. The higher the quality of audit evidence, the less may be required.
c. The sufficiency and appropriateness of audit evidence are interrelated.
d. Obtaining more evidence will compensate for its poor quality.

20. Which of the following statements regarding reliability of evidence is NOT correct?
a. Evidence is more reliable when it is obtained from independent sources outside the entity.
b. Evidence that is generated internally is more reliable when the related controls are effective.
c. Evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly.
d. The condition of internal controls of the entity does not contribute to the reliability of audit evidence.

6
UL Refresher Course in Accountancy
Auditing – Module 1.1

INTRODUCTION TO AUDITING

Nature, philosophy & objectives of auditing:

Definition: Auditing is a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence between those
assertions and established criteria and communicating the results to interested users.

Components of the Audit Definition:

1. Systematic process – audit follows a structured, documented plan.
2. Conducted objectively – an audit is an independent, objective and expert examination and evaluation of
evidence. Auditors are fair. They maintain impartial attitude
3. Auditor obtains and evaluates evidence – auditor gathers and evaluates the appropriateness and
sufficiency of evidence.
4. Evidence obtained concerns assertions about economic actions and events – Assertions are representations
by management, explicit or otherwise, that are embodied in the financial statements.
5. Auditor ascertains the degree of correspondence between assertions and established criteria.
6. Communicating the results to interested users - reporting the results to the users

Conditions that create a demand for Auditing:

1. There is a potential conflict of interest between those who prepare information (management) and those
who use information (owners, investors creditors, and regulators). This potential conflict can result in
biased information.
2. Information can have substantial economic consequences for a decision maker.
3. Expertise is often required for preparing and verifying information.
4. Users of information frequently are prevented from directly assessing the quality of information.

Types of Audits (accdg. to nature of assertion and objectives):

1. Financial Statements Audit – examination of financial statements of an entity to determine whether the
financial statements are presented fairly in conformity with the generally accepted accounting principles;
the objective is to enable the auditor to express an opinion whether the financial statements are prepared,
in all material respects, in accordance with an identified financial reporting framework.
2. Operational Audit – a systematic review of an organization’s activities in relation to specified objectives
for purposes of assessing performance, identifying opportunities for improvement and developing
recommendations for improvement or further action. The purpose of operational audit is to measure
performance of specific unit of an organization, that is, the effectiveness and efficiency of operation.
3. Compliance Audit – an audit to measure compliance with standards, laws and regulations, specific
procedures, policies or specified criteria. Its purpose is to determine whether an entity has adhered to and
followed the recognized criteria.

Types of Audit According to Type of Auditor:

1. External Audit – an audit performed by an auditor independent of the entity. The auditor who conducts the
external audit is called external or independent auditor. The external auditor performs the independent
financial statements audit. He may also conduct a compliance audit.
2. Internal Auditing – an independent appraisal function established within an organization to examine and
evaluate its activities as a service to the organization. The internal auditor (employee of the company)
performs the internal auditing which encompassed operational auditing. Internal auditor may also perform
compliance audit for their companies.
3. Government Auditing – involves the determination of whether government funds are being handled
properly and in compliance with existing laws and whether the programs are being conducted efficiently
and economically. Government auditors perform financial statements audit, compliance audit and
operational audit.

7
UL Refresher Course in Accountancy
Auditing – Module 1.1
Comparing & Relating the Types of Audit:
AUDITING

EXTERNAL AUDITING INTERNAL AUDITING GOVERNMENT

AUDITING

Performed by independent Performed by internal Performed by government

auditors auditors auditors

Usually includes financial Usually includes Includes financial,

statement audit and operational audit and compliance, and operational
compliance audit compliance audit audits

Financial Statements Audit (a closer look):

1. An audit provides written assurance (reasonable assurance) from an independent party that assertions embodied in
a set of financial statements are reliable.
 External parties who need financial statement audits include
 Investors
 Employees and labor unions
 Regulatory and taxing authorities
 Internal parties include
 Management
 Financial officers
 Sales executives
2. None of the parties who demand an audit are in a position to obtain information about a company except from
company management
 Management often has an incentive to misstate the financial statements for its own interest
8
UL Refresher Course in Accountancy
Auditing – Module 1.1
3. Financial statements are audited by auditors
 Financial statements are the representations of and responsibility of management
 Auditors express an opinion regarding fair presentation
4. The client in the audit of a public company is not management
 The client is the Board of Directors, as representative of the shareholders (owners)
5. An audit is a systematic process
 Involves both an investigation and a report
 Investigation is the gathering and evaluation of evidence
 Reporting is the conveyance of the auditor’s opinion regarding fair presentation

Inherent Limitations of Audit:

1. Use of testing
2. Inherent limitations of accounting and internal control system
3. Use of judgment
4. Most audit evidence is persuasive rather than conclusive.

The AUDIT PROCESS :

PHASE I: Client Acceptance (pre – engagement)

PHASE II: Planning
PHASE III: Testing for Evidence (Test of controls and substantive testing)
PHASE IV: Evaluation and Reporting

MULTIPLE CHOICE:
1. Independent auditing can best be described as:
a. A branch of accounting.
b. A discipline that attests to the results of accounting and other functional operations and data.
c. A professional activity that measures and communicates financial and business data.
d. A regulatory function that prevents the issuance of improper financial information.

2. Which of the following best describes why an independent auditor reports on financial statements:
a. to give stockholders some assurance that any fraudulent activities will be detected
b. a poorly designed internal control structure may exist which produces unreliable financial statements
c. the client may not be totally knowledgeable of prevailing GAAP
d. to lend credibility since the client may not be objective with respect to its own financial statements

3. The demand for assurance for financial statement users is similar to that of a potential home buyer that hires a
home inspector in that:
a. The buyer [or user] pays directly for this assurance in both situations.
b. There is often information asymmetry and conflicts of interest present.
c. The cost of obtaining information is not relevant.
d. Independence is not necessary in either situation.

4. Which of the following best represents the term "assurance domain"?

a. Internal and external auditors. c. Areas where auditors can provide services.
b. Financial statement audits. d. Professional auditing standards.

5. Which of the following best describes the relationship between attestation services and audit services?
a. Attestation is a subset of auditing that improves the quality of information for decision makers.
b. Auditing is a subset of attestation that focuses on providing clients with advisory services and decision
support.
c. Auditing is a subset of attestation that focuses on the issuance of an opinion on the fairness of financial
statements.
d. Attestation is a subset of auditing that provides a higher level of assurance than does an audit engagement.

6. Which of the following audit phases would generally be conducted before all of the others?
a. Auditing business processes and related accounts.
b. Preliminary assessment of materiality and audit risk.
c. Gaining an understanding of the client's industry
d. Consideration of internal control systems.

7. A service provided by practitioners that always involves a report that goes to a third party is
a. assurance b. attestation c. audit d. Both B and C.

9
UL Refresher Course in Accountancy
Auditing – Module 1.1
8. Which one of the following is not part of the attest process?
a. gathering evidence about assertions
b. proving the accuracy of the books and records
c. evaluating evidence against objective criteria
d. communicating the conclusions reached

9. Which one of the following is not a management expectation for independent auditors?
a. an outside source of expertise on accounting matters
b. individuals who perform tests and draw conclusions on assertions
c. a participant in management decision making
d. a provider of a written communication

10. Internal auditors may perform all of the following types of audits except
a. operational audits.
b. compliance audits.
c. computer system audits.
d. all of the above may be performed by internal auditors.

11. An “integrated audit” includes an audit of

a. the company’s internal controls.
b. the company’s financial statements.
c. the company’s compliance with its rules and policies.
d. Both A and B.

12. Which of the following services is the broadest and most inclusive?
a. Audit b. Attestation c. Assurance d. Compliance

13. An expectation of the public is that the auditor will recognize that the primary users of audit assurance are
a. the clients.
b. the Public Company Accounting Oversight Board.
c. members of management.
d. third-party users.

14. Auditing is important in a free market society because

a. the public requires CPAs functioning as divisions of regulatory bodies.
b. auditors detect all errors and fraud made by company employees.
c. it provides reliable information based upon which to judge economic performance.
d. the auditor is an amiable insurance policy for investors.
e. all of the above are true.

15. Third-party users of the audit report expect the auditor to do all of the following except:
a. to evaluate measurements and disclosures made by management
b. to provide a biased evaluation of the financial statements
c. to determine whether financial statements are presented in accordance with GAAP
d. to gather sufficient evidence to support their opinion

16. Results of the financial statement audit are communicated to users through a(n)
a. financial statement. c. audit report.
b. written management assertion. d. none of the above.

17. Assurance services may include which of the following?

a. attesting to financial statements
b. examination of the economy and efficiency of governmental operations
c. evaluation of a division's performance for management
d. tax preparation services
e. A, B, and C only

18. The criteria against which the auditor measures the fairness of financial statement presentation are known as
a. generally accepted auditing standards.
b. generally accepted accounting principles.
c. generally accepted accounting standards.
d. generally accepted governmental accounting principles.

19. Which one of the following statements is not true about internal auditing?
a. Internal auditing is an objective evaluation function.
10
UL Refresher Course in Accountancy
Auditing – Module 1.1
b. Internal auditing is established within an organization.
c. Internal auditing's purpose is to provide assurance regarding the company's compliance with stated policies and
procedures.
d. Internal auditing is established as an independent service to regulatory bodies and creditors.

20. An audit which has as its purpose the evaluation of the economy and efficiency with which resources are employed
is known as a(n)
a. financial audit. c. operational audit.
b. compliance audit. d. governmental audit.

21. An audit which determines whether organizational policies are being followed and whether external mandates are
being met is known as
a. a financial audit. c. an operational audit.
b. a compliance audit. d. none of the above

22. The objective of an operational audit is to

a. evaluate whether laws have been broken by management.
b. evaluate fairness of presentation of financial statements.
c. evaluate compliances with company rules and regulations.
d. evaluate the effectiveness and efficiency with which resources are employed.

23. Which type of auditor may perform an operational audit?

a. external auditor.
b. internal auditor.
c. governmental auditor.
d. Both B and C.
e. All of the above.

24. What is the criteria used in an operational audit?

a. GAAP. c. rules and regulations.
b. effectiveness and d. company policies.
efficiency. e. Both B and C.

25. What is the criteria used in a compliance audit?

a. GAAP.
b. effectiveness and efficiency.
c. rules and regulations.
d. company policies.
e. Both C and D.

End of Module 1.1.

The Test Items in this Module will serve as formative assessment. Use the
google form answer sheet for Module 1.1 to be uploaded in our google
classroom. Thank you.

11