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Since 1977

AT.3403
Risk-based Financial Statements Audit SOLIMAN/UY/AGUILA
Process, Responsibilities and Objectives MAY 2023

LECTURE NOTES

The Risk-Based Audit Process Phase 2—Risk Response

• In accordance with professional and ethical standards, • Once the risks of material misstatement of financial
the auditor shall perform a quality audit. In achieving a statements have been identified and assessed, the
quality audit, the auditor shall conduct the audit with auditor then designs and implements appropriate
the exercise professional judgment and maintain responses to those risks in order to obtain sufficient
professional skepticism throughout the planning and appropriate audit evidence about the assessed risks of
performance of the audit and, among other things: material misstatement to reduce audit risk to an
acceptably low level.
§ Identify and assess risks of material misstatement,
whether due to fraud or error, based on an • The auditor’s responses include overall responses and
understanding of the entity and its environment, further audit procedures to address risks at the financial
including the entity’s internal control. statement level and assertion level, respectively. This
§ Obtain sufficient appropriate audit evidence about phase is the main audit evidence gathering and
whether material misstatements exist, through evaluation.
designing and implementing appropriate responses
to the assessed risks. Phase 3—Conclusion and Reporting
§ Form an opinion on the financial statements based
on conclusions drawn from the audit evidence • This phase of the audit demands careful and thorough
obtained. review of the auditor. The judgments made during this
phase of the audit are often crucial to the ultimate
• The audit process, described above, is presented in the outcome of the engagement. The procedures covered in
following three audit phases: this stage of audit often bring to light matters that are
1. Risk Assessment of major concern in forming an opinion on the financial
2. Risk Response statements.
3. Conclusion and Reporting
• After the planned audit procedures have been
Phase 1—Risk Assessment performed, an evaluation of the results will take place.
The auditor shall:
Client Acceptance and Continuance 1. Form an opinion on the financial statements based
on an evaluation of the conclusions drawn from the
• In this phase, the auditor makes a critical decision about audit evidence obtained; and
whether to accept an audit engagement of a new client 2. Express clearly that opinion through a written report
or to continue an audit of an existing client. that also describes the basis for the opinion.

• In the case of initial audit, the auditor communicates • The auditor’s report shall be in writing (hard copy
with the previous auditor to aid in making the said format or an electronic medium). That report contains
decision. If the auditor determines that the client is the following opinions depending on the outcome of
acceptable, the auditor agrees the terms of engagement engagement:
and documents the same in an Engagement Letter.
a. Unmodified (Unqualified or Clean) opinion—The
Planning and Assessing Risks opinion expressed when the financial statements
are prepared, in all material respects, in
• To effectively (and efficiently) perform an audit, the accordance with the applicable financial reporting
auditor should plan the audit. As part of this planning framework.
process, the auditor obtains understanding of the entity
(client), its environment and its internal control. This b. Modified opinion—The three types of are:
understanding serves as the very frame of reference
how the audit is conducted and upon which the auditor 1. Qualified opinion—The auditor is satisfied that
exercises professional judgment and maintains the financial statements are presented fairly,
professional skepticism. except for a specific aspect of them.
2. Adverse opinion—The auditor does not
• The auditor also, in this phase, determines materiality believe the financial statements are fairly
applicable to the financial statements, identifies presented.
material accounts and disclosures in the financial 3. Disclaimer of opinion—The auditor does not
statements, and assesses the risks of material know if the financial statements are
misstatement at both the overall financial statements presented fairly.
level and assertion level.

• The auditor then uses the results of this phase as a basis

when designing and performing responses in the next
phase to obtain sufficient appropriate audit evidence.

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Responsibilities of Management and Auditor

• In addition to fundamental principles, the code also
Responsibilities of Management requires professional accountants to be independent
when performing audits, both of mind and in
The management and those charge with governance of appearance.
entity of the company have the following responsibilities:
Audit in Accordance with PSAs
a. Preparation and presentation of financial statements in
accordance with the applicable financial reporting • The auditor shall comply with all PSAs relevant to the
framework. audit. A PSA is relevant to the audit when the PSA is in
b. Design, establishment and maintenance of internal effect and the circumstances addressed by the PSA
control relevant to the preparation of reliable financial exist. The auditor shall not represent compliance with
reports that are free from material misstatements PSAs in the auditor’s report unless the auditor has
whether due to fraud or error. complied with the requirements of this PSA and all other
PSAs relevant to the audit.
In addition, the management of an entity is also responsible
to provide the auditor all information relevant to the conduct • If an objective in a relevant PSA cannot be achieved,
of an audit of financial statements, as well as to provide the auditor shall evaluate whether this prevents the
unrestricted access to persons within the entity from whom auditor from achieving the overall objectives of the
the auditor intends to obtain sufficient and appropriate auditor and thereby requires the auditor, in accordance
evidence. with the PSAs, to modify the auditor’s opinion or
withdraw from the engagement. Failure to achieve an
Responsibilities of the Auditor objective represents a significant matter requiring
documentation.
The overall objectives of an auditor in an audit of financial
statements are Professional Judgment

a. To obtain a reasonable assurance whether the financial • The ability of the auditor to exercise judgment that is
statements are free from material misstatements professionally made is often described as the hallmark
whether due to fraud or error as a basis to express an or trademark of auditing. Professional accountants are
opinion as to fairness of the financial statements, in all engaged to audit of financial statements because of
material respects, in accordance with the applicable their ability to exercise professional judgment.
financial reporting framework; and
• Professional judgment is the application of relevant
training, knowledge, and experience, within the context
b. To report on the financial statements.
provided by auditing, accounting and ethical standards,
in making informed decisions about the courses of
Objectives of an Audit of Financial Statements
action that are appropriate in the circumstances of the
audit engagement.
The objectives of an auditor in an audit of financial
statements are reflected in the auditor’s responsibilities
above, that is, to obtain a reasonable assurance whether
• The auditor shall exercise professional judgment in
planning and performing an audit of financial
the financial statements are free from material
statements. It is essential to the proper conduct of an
misstatements whether due to fraud or error, and to report
audit because it enables the proper interpretation of:
on the financial statements.
§ Relevant ethical requirements
The following basic concepts underlying an audit of financial
§ PSAs
statements are important related to achieving these
§ Informed decisions
objectives.
• Professional judgment is necessary in particular
Gathering Audit Evidence and Documentation regarding decisions about:
§ Materiality and audit risk
• From the start to end of the audit, the auditor gathers
§ Nature, timing, and extent of audit procedures
and accumulates audit evidence and documentation
§ Evaluating whether sufficient appropriate audit
evidence has been obtained
that supports the opinion to be expressed.
§ Evaluating management’s judgments in applying
the applicable financial reporting framework
Maintaining Audit Quality
§ Drawing of conclusions, for example, assessing the
reasonableness of the management’s estimates
• Quality audit means that the audit is performed in
accordance with relevant ethical, professional, legal,
Professional Skepticism
and regulatory requirements.

Relevant Ethical Requirements

• It is believed that professional skepticism is the
auditor’s best method to detect fraud in the financial
statements.
• Relevant ethical requirements ordinarily comprise Parts
A and B of the Code of Professional Ethics. The
• Professional skepticism is an attitude that includes a
questioning mind, being alert to conditions which may
fundamental principles, in accordance with the code of
indicate possible misstatement due to error or fraud,
ethics, applicable to audit of financial statements are:
and a critical assessment of audit evidence. The auditor
1. Integrity
shall plan and perform an audit with professional
2. Objectivity
skepticism recognizing that circumstances may exist
3. Professional competence and due care
that cause the financial statements to be materially
4. Confidentiality
misstated.
5. Professional behavior

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• Professional skepticism includes being alert to, for 6. Presentation – Transactions and events are
example: appropriately aggregated or disaggregated and
§ Audit evidence that contradicts other audit clearly described, and related disclosures are
evidence obtained relevant and understandable in the context of the
§ Information that brings into question the requirements of the applicable financial reporting
reliability of documents and responses to framework.
inquiries to be used as audit evidence
§ Conditions that may indicate possible fraud b. Account balances and related disclosures.
§ Circumstances that suggest the need for audit 1. Existence – Assets, liabilities, and equity interests
procedures in addition to requirements of PSAs exist.
2. Completeness – All assets, liabilities, and equity
• Maintaining professional skepticism throughout the interests that should have been recorded have been
audit is necessary if the auditor is, for example, to recorded, and all related disclosures that should
reduce the risks of: have been included in the financial statements have
§ Overlooking unusual circumstances. been included.
§ Over generalizing when drawing conclusions 3. Accuracy, valuation, and allocation – Assets,
from audit observations. liabilities, and equity interests have been included
§ Using inappropriate assumptions in determining in the financial statements at appropriate amounts,
the nature, timing, and extent of the audit and any resulting valuation adjustments have been
procedures and evaluating the results thereof. appropriately recorded, and related disclosures
have been appropriately measured and described.
Management Assertions and Development of Audit 4. Classification – Assets, liabilities, and equity
Objectives interests have been recorded in the proper
accounts.
Management assertions are representations by 5. Rights and obligations – The entity holds or controls
management, whether express or implied, about classes of the rights to assets, and the liabilities are the
transactions, account balances, and the related disclosures obligation of the entity.
contained in the financial statements. Management 6. Presentation – Assets, liabilities, and equity
assertions are grouped according to the following categories interests are appropriately aggregated or
(Based on PSA 315, Revised 2019): disaggregated and clearly described, and related
disclosures are relevant and understandable in the
a. Classes of transactions and events and related context of the requirements of the applicable
disclosures financial reporting framework.
1. Occurrence – Transactions and events that have
been recorded or disclosed have occurred and Auditors may use different terms to describe the
pertain to the entity. management assertions so long as the aspects included
2. Completeness – All transactions and events that above are addressed. The auditor considers the relevance
should have been recorded have been recorded, of each assertion for each significant class of transactions
and all disclosures that should have been included and account balance. Once relevant assertions are
in the financial statements have been included. identified, the auditor then develops audit objectives for
3. Accuracy – Amounts and other data relating to each category of assertions. From the audit objectives set,
recorded transactions and events have been the auditor decides on the nature, type and quantity of
recorded appropriately, and related disclosures evidence to satisfy such audit objectives. The objectives
have been appropriately measured and described. remain the same from audit to audit, but the evidence could
4. Classification – Transactions and events have been vary depending on the circumstances of the engagement.
recorded in the proper accounts.
5. Cutoff – Transactions and events have been
recorded in the correct accounting period.

DISCUSSION QUESTIONS

1. The purpose of an audit is to enhance the degree of designing and implementing appropriate responses
confidence of intended users in the financial statements. to the assessed risks.
c. Form an opinion on the financial statements based
The financial statements subject to audit are those of on conclusions drawn from the audit evidence
the entity, prepared and presented by management of obtained.
the entity with oversight from those charged with d. Subject all available evidence related to entity’s
governance. financial statements to testing to get reasonable
a. True, False assurance that the financial statements are free
b. False, True from material misstatements.
c. True, True
d. False, False 3. Which of the following is not a distinguishing feature of
risk-based auditing?
2. Which of the following procedures is not one of the a. Identifying areas posing the highest risk of financial
features of a risk-based audit process in accordance statement errors.
with PSAs? b. Analysis of internal control.
a. Identify and assess risks of material misstatement, c. Collecting and evaluating evidence.
whether due to fraud or error, based on an d. Concentrating audit resources in those areas
understanding of the entity and its environment, presenting the highest risk of financial statement
including the entity’s internal control. errors.
b. Obtain sufficient appropriate audit evidence about
whether material misstatements exist, through

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4. An audit is conducted on the premise that management d. Is satisfied that the financial statements are
and, where appropriate, those charged with presented fairly.
governance, have acknowledged and understand that
they have responsibilities that are fundamental to the 9. When an auditor issues an adverse opinion, the
conduct of an audit in accordance with PSAs. Which of implication is that the auditor
the following is not one of those responsibilities? a. Does not know if the financial statements are
a. To provide the auditor unrestricted access to presented fairly.
persons within the entity from which the auditor b. Does not believe the financial statements are fairly
determines it necessary to obtain audit evidence. presented.
b. The preparation and presentation of financial c. Is satisfied that the financial statements are
statements in accordance with the pronouncements presented fairly except for a specific aspect of them.
issued by AASC. d. Is satisfied that the financial statements are
c. The establishment and maintenance of internal presented fairly.
control relevant to the preparation and presentation
of financial statements that are free from material 10. Which of the following is incorrect regarding the general
misstatement, whether due to fraud or error. principles of an audit?
d. To provide complete information to the auditor. a. The auditor should comply with the “Code of Ethics
for Professional Accountants in the Philippines.”
5. Which of the following statements is false? b. The auditor should conduct an audit in accordance
a. In an audit of financial statements, being an with PSAs.
assurance engagement, the auditor is engaged for c. The auditor shall not represent compliance with
purposes of expressing an opinion designed to PSAs unless the auditor has complied with all of the
enhance the degree of confidence of intended users PSAs relevant to the audit.
in the financial statements. d. The auditor would ordinarily expect to find evidence
b. The overall objective of the independent auditor is to support management representations and
to obtain reasonable assurance about whether the assume they are necessarily correct.
financial statements as a whole are free from
material misstatement, whether due to fraud or 11. The following are the general principles governing an
error, and to report on the financial statements in audit of financial statements audit, except
accordance with the auditor’s findings. a. Independence c. Confidentiality
c. In order to obtain reasonable assurance, the auditor b. Professionalism d. Professional behavior
shall obtain sufficient appropriate audit evidence to
be able to draw reasonable conclusions on which to 12. The auditor shall plan and perform an audit with an
base the audit opinion. Reasonable assurance is attitude of professional skepticism recognizing that
obtained when the auditor has thereby reduced circumstances may exist that cause the financial
audit risk to an acceptably high level. statements to be materially misstated.
d. The objective of an audit cannot be fulfilled unless
the auditor achieves the overall objective of the The auditor shall exercise professional judgment in
auditor. In all cases when the overall objective of planning and performing the audit in accordance with
the auditor cannot be achieved, the PSAs require PSAs.
that the auditor modifies the auditor’s opinion a. True, True c. False, True
accordingly or withdraws from the engagement. b. False, False d. True, False

6. The concept of reasonable assurance indicates that the 13. Which of the following is least likely an application of
auditor is: maintaining an attitude of professional skepticism?
a. not an insurer of the correctness of the financial a. The auditor does not consider representations from
statements. management as substitute for obtaining sufficient
b. not responsible for the fairness of the financial and appropriate audit evidence to be able to draw
statements. reasonable conclusions on which to base the audit
c. responsible only for issuing an opinion on the opinion.
financial statements. b. The auditor is alert to audit evidence that
d. responsible for finding all misstatements. contradicts or brings into question the reliability of
documents or management representations.
7. The auditor’s opinion c. The auditor makes a critical assessment, with a
a. Guarantees the credibility of the financial questioning mind, of the validity of audit evidence
statements. d. In planning and performing an audit, the auditor
b. Is an assurance as to the future viability of the assumes that management is dishonest.
entity.
14. Financial reporting frameworks often discuss the
c. Is not an assurance as to the efficiency with which concept of materiality in the context of the preparation
management has conducted the affairs of the and presentation of financial statements. Although
entity. financial reporting frameworks may discuss materiality
d. Certifies the correctness of the financial statements. in different terms, they generally explain that
a. Misstatements, including omissions, are considered
8. When an auditor issues a qualified opinion, the to be material if they, individually or in the
implication is that the auditor aggregate, could reasonably be expected to
a. Does not know if the financial statements are influence the economic decisions of users taken on
presented fairly. the basis of the financial statements.
b. Does not believe the financial statements are fairly b. Judgments about materiality are made in the light
presented. of surrounding circumstances and are affected by
c. Is satisfied that the financial statements are the size or nature of a misstatement, or a
presented fairly except for a specific aspect of them. combination of both.

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c. Judgments about matters that are material to users be material, individually or when aggregated with
of the financial statements are based on a misstatements in other balances or classes.
consideration of the common financial information d. The susceptibility of an account balance or class of
needs of users as a group. The possible effect of transactions to misstatement that could be
misstatements on specific individual users, whose material, individually or when aggregated with
needs may vary widely, is not considered. misstatements in other balances of classes,
d. All of the above assuming that there were no related internal
controls.
15. Materiality is:
a. Expressed only in terms of pesos 21. Inherent risk and control risk differ from detection risk
b. Measured using guidelines established by PICPA in that inherent risk and control risk
c. Not applicable to assurance engagements a. arise from the misapplication of auditing procedures
d. Addressed within a practitioner’s audit and other b. may be assessed in either quantitative or
assurance reports nonquantitative terms
c. exist independently of the financial statement audit
16. Two overriding considerations affect the many ways an d. can be changed at the auditor’s discretion
auditor can accumulate evidence:
I. Sufficient appropriate evidence must be 22. Which of the following is an incorrect statement?
accumulated to meet the auditor’s professional a. Detection risk cannot be changed at the auditor’s
responsibility. discretion
II. Cost of accumulating evidence should be minimized. b. Detection risk bears an inverse relationship to
inherent and control risks
In evaluating these considerations: c. The greater the inherent and control risks the
a. the first is more important than the second. auditor believes exists, the less detection risk that
b. the second is more important than the first. can be accepted
c. they are equally important. d. The auditor might make separate or combined
d. it is impossible to prioritize them. assessments of inherent risk and control risk

17. The existence of audit risk is recognized by the 23. In implementing the audit risk model, which of the
statement in the standard auditor’s report that the following is not a limitation of the model that makes its
a. The auditor is responsible for expressing an opinion implementation difficult?
on the financial statements, which are the a. Inherent risk is difficult to formally assess.
responsibility of management. b. Audit risk is objectively determined.
b. Financial statements are presented fairly, in all c. The model treats each risk component as separate
material respects, in conformity with GAAP. and independent.
c. Audit includes examining, on a test basis, evidence d. Audit technology is not precisely developed in
supporting the amounts and disclosures in the assessing each component.
financial statements.
d. Auditor obtains reasonable assurance about 24. Assertions about classes of transactions and events for
whether the financial statements are free of the period under audit least likely include
material misstatement. a. Transactions and events that have been recorded
have occurred and pertain to the entity.
18. Risk of material misstatement is b. All transactions and events that should have been
a. The risk that the auditor might express an opinion recorded have been recorded.
that the financial statements are materially c. Transactions and events have been recorded in the
misstated when they are not. correct accounting period.
b. The likelihood that the financial statements are d. All assets, liabilities and equity interests that should
materiality misstated prior to the audit. have been recorded have been recorded.
c. Both a and b.
d. Neither a nor b. 25. Relevant assertions have a meaningful bearing on
whether the account is fairly stated and are used to
19. What are the two elements of the risk of material assess the risk of material misstatement and design and
misstatement at the assertion level? performance of audit procedures.
a. Inherent risk and detection risk
b. Audit risk and detection risk The auditor’s audit objectives follow and are closely
c. Inherent risk and control risk related to management assertions.
d. Detection risk and control risk a. True, False
b. False, True
20. Detection risk is c. True, True
a. The risk that the auditor gives an inappropriate d. False, False
audit opinion when the financial statements are
materially misstated. End of AT.3403
b. The risk that a misstatement, that could occur in an
account balance or class of transactions and that
could be material individually or when aggregated
with misstatements in other balances or classes, will
not be prevented or detected and corrected on a
timely basis by the accounting and internal control
systems.
c. The risk that an auditor's substantive procedures
will not detect a misstatement that exists in an
account balance or class of transactions that could

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