Introduction to Auditing objectives for the purpose of assessing

Auditing is a systematic process of objectively obtaining performance.

and evaluating evidence regarding assertions about - Focus: efficiency and effectiveness of
economic actions and events to ascertain the degree of operations
correspondence between these assertions and - Efficiency – management audit
established criteria and communicating the results to Effectiveness – program results audit
the intended users. - Example: audit of a company’s IT System,
objective – evaluate effectiveness and
Key phrases of Auditing efficiency of IT system, criteria –
• A systematic process management’s standards on effectiveness
• Objectively obtaining and evaluating evidence and efficiency
• Assertions about economic actions and events
• Degree of correspondence between these • Compliance Audits
assertions and established criteria - Involves determination of whether a person
• Communicating the results to interested users or entity has adhered to laws, regulations,
or contracts.
Accounting Auditing - Example: BIR audit of company’s tax
- Provide accounting - Accumulating evidence returns, objective – determine company’s
information about to determine if the compliance with existing tax rules and
economic entities that is recorded accounting regulations, criteria – tax laws/regulations.
useful in making information properly
economic decisions reflects the economic As to Auditors
- Broader than auditing events that occurred • External Audits
- Assurance encompass during the period - Performed by auditors who are
assertion-based - Narrower than
independent of the organizations whose
engagements and assurance
assertions (representations) are being
assertion-based - Auditing is a under the
audited.
engagements encompass umbrella of assurance
audits. services rendered by - Auditors involved are called independent or
CPAs. external auditors
- Example: independent audits of financial
Types of Audit statements
As to Objectives
• Financial Statements Audits • Internal Audits
- Expression of an opinion on the financial - An objective and independent assurance
statements of an entity after the CPA is and consulting activity designed to add
satisfied as to the fairness of such financial value to the organization
statements, in all material respects, in - Goes beyond the financial aspect of an
accordance with applicable financial entity and include areas in: government
reporting framework. process, risk management, control
- Example: statutory audit of an entity’s - Cannot reach the same level of
annual financial statements, objective – independence of external auditors
determine the fairness of the FS, criteria – - Independence can be maximized if internal
applicable financial reporting framework auditors report to senior personnel not
(e.g. PFRS) directly involved in managing the
organization – e.g. Audit Committee of the
• Operations Audits Board of Directors (BOD).
- Involve systematic review of an
organization’s activity in relation to specified
 • Government Audits Scope
- Involves determination of whether • The auditor determines the scope of the audit in
government funds are being handled accordance with the requirements of legislation,
properly and in compliance with existing regulations and relevant professional bodies.
laws; and • An auditor uses his professional judgment to
- Whether the government programs of a determining audit procedures to be performed
particular agency are being conducted in accordance with PSA.
efficiently and economically
- Commission on Audit – recognized as Information Risk
Supreme Audit institution in the Philippines Information Risk – the risk that the information is
misstated or misleading.
Commission of Audit (COA) • Remoteness of users from providers of
• Authority of COA is embodied in the information.
Constitution • Inherent bias of information providers.
• Composed of (1) Chairman & (2) • Voluminous and complex transaction data.
Commissioners collectively called the
Commission Proper Reducing information risk
• Members must be CPAs or Lawyers provided at 1. Allow users to verify information
any time the members must not be from one 2. Users shares information risk with management
profession only. 3. Have the financial statements audited.
• Appointed by the President of the Philippines
with consent of Commission on Appointments The Auditor’s Report
for a term of 7 years. • Communicates the opinion of the auditor to
users.
Relationship Among Types of Audits • Unqualified Auditor’s Report
Objectives of the Entity
Reliability Effective Compliance Limitations of an Audit
of Financial and Efficient with Laws • Nature of financial reporting
Reports Operations and • Nature of audit procedures
Regulations
• The need for the audit to be conducted within a
Audit Financial Operations Compliance
reasonable period of time and at a reasonable
Statements Audit Audit
cost.
of Audit
Auditor - External - -
auditor Government Government An audit is also limited by its scope and objective. The
- auditor auditor auditor does NOT express an opinion on such matters
Government - Internal - Internal such as:
auditor auditor auditor • Future viability of the entity
- Internal - External - External • effectiveness or efficiency of management
auditor auditor auditor • compliance with ALL laws and regulations.
(internal (outsourced) (outsourced)
use) History of Auditing

Audits of Historical Financial Statements

Financial Statements Audit – Objective and Scope
Objective
• To express an opinion as to the fairness of the
financial statements.
Early Mesopotamia – earliest documents shows signs of Audit Responsibilities and Objectives
auditing or indications such as checkmarks, dots and Overall Objective of the Independent Auditor
other symbols being performed. The objective of an audit of financial statements is to
Audere – to hear or to listen. Ear as auditory system. enable the auditor to express an opinion whether the
Ancient Greece and Rome (Plato) – stated that people in financial statements are prepared, in all material
the government shall be held accountable to the respects, in accordance with an applicable financial
resources entrusted to them. reporting framework.
Queen Elizabeth 1st (1559) – formal responsibility in • To obtain reasonable assurance about whether
auditing the financial statements as a whole are free
17th – 19th century – more positions related to audit from material misstatement whether due to
function were formalized later on in England. fraud or error; and
• To report on the financial statements.

Theoretical Framework of Financial Statements Audit

• Verifiable data
Industrial Revolution – big break of auditing. • Independence
Management is separated from the owners. • No long-term conflict of interest
Early 20th century – audit objectives. American auditors • Effective internal control
focuses on actual financial condition of an entity, audit • Consistent compliance w/ GAAP = fair
sampling, while British focus on detection of fraud and presentation
error, detailed testing. • Validity of prior information
1933 – 1940 – americans started reporting statements • An Audit benefits the public
present fairly; British are true and fair view.
1940 = 1980 – world war II. Audit sampling was widely Financial Statements and the Management’s
accepted. Studying evaluation of internal controls Responsibilities
became a standard part of audit process. Audit risk Complete set of financial statements
appears. Risk based approach. • Statements of financial position;
• Statement of profit or loss and other
comprehensive income;
• Statement of changes in equity;
• Statement of cash flows; and
• Notes, comprising a summary of significant
accounting policies and other explanatory notes
1987 – sponsored study. Coso framework or internal
control integrated framework. Committee of Sponsoring
Responsibilities of the Management and These
Organizations – responsible for the studies and making
Charged with Governance
recommendations.
2001 – Enron manipulated financial reports to defraud • Preparation and presentation of the financial
the shareholders and creditors. Arthur Andersen most statements in accordance with the applicable
known accounting firm globally but then their financial reporting framework;
professional license was revoked because of Enron and • Design, implementation and maintenance of
are not allowed to do audit anymore after the incident. internal control;
2002 – Sarbanes-oxley also known as the public • Identification of applicable financial reporting
accounting reform and investment act of 2002. framework;
• Exercise of judgment in making accounting
estimates and applications of appropriate
accounting policies.
 • To provide the auditor with • Independence – independence of mind +
- All information that are relevant to the independence in appearance
preparation and presentation of financial • Quality control standards (PSQC 1 and PSA 220)
statements; – Compliance + appropriate report
- additional information that the auditor may
request from management/TCWG; Conduct of an Audit in Accordance with PSAs
- unrestricted access to those within the • The auditor shall comply with all PSAs relevant
entity from whom the auditor determines it to the audit
necessary to obtain audit evidence. • A PSA is relevant to the audit when the PSA is in
effect and circumstances addressed by such PSA
The Auditor’s Opinion exists.
• Unmodified (unqualified) Opinion • In exceptional circumstances, the auditor may
- Financial statements are fairly presented judge it necessary to depart from a requirement
(clean) in PSA which does not meet the objective of the
• Modified Opinion audit and perform alternative procedures.
- Material misstatement • If compliance with PSA cannot be achieved, the
- Unable to obtain sufficient appropriate auditor shall modify his opinion or withdraw
Pervasiveness of the from the engagement.
Matter
Reasons for Material Material Professional Skepticism
Modification: But Not and • Recognize the circumstances may exist that
Pervasive Pervasive
cause the financial statements to be materially
Misstatement Qualified Adverse
misstated.
Inability to Qualified Disclaimer*
• The auditor neither assumes that the client is
obtain
evidence dishonest nor of unquestioned honesty.
*if the inability to obtain sufficient appropriate evidence • Auditors may use their past experience to assess
is due to scope of limitation imposed by management, honesty and integrity of client management
the auditor should try to resign or withdraw from the • However, a belief that management is honest
engagement first, if such is not prohibited by does NOT relieve the auditor the need to
law/regulation. maintain professional skepticism

Conduct of an Audit of Financial Statements Professional skepticism requires the auditor to be alert
Basic Concepts Underlying an Audit of Financial about:
Statements • Evidence that contradicts other evidence
obtained
• Info that brings into question the reliability of
documents and responses to be used as
evidence
Ethical Requirements • Conditions that may indicate possible fraud
• Code of Ethics for Professional Accountants in (fraud risks factors).
the Philippines (Parts A and B)
- Integrity Maintaining professional skepticism reduces the risk of:
- Objectivity • Overlooking unusual circumstances
- Professional competence and due care • Over-generalizing when drawing conclusions
- Confidentiality • Using inappropriate assumptions in designing
- Professional behavior nature, timing & extent of audit procedures and
• Part B – application of framework in specific evaluating the results
situations
Professional Judgment Management Assertions
Classes of Account Presentation &
Transactions Balances Disclosures
- Occurrence - Existence - Occurrence &
• Hallmark of auditing - Completeness - Rights & Rights &
• Establishment of materiality and assessment of - Accuracy Obligation Obligation
risks - Classification - Completeness - Completeness
• Nature, timing and extent of procedures - Cutoff - Valuation and - Accuracy and
allocation Valuation
• Sufficiency and appropriateness of evidence
- Classification
gathered and
• Evaluation of management judgment and Understandability
estimates
Audit Risk (Risk-based audit)
Materiality • The likelihood or possibility that the auditor
• Materiality is a relative concept expresses
• Information is material if it affects the decisions 1. An inappropriate audit opinion
of the users taken on the basis of the financial 2. When the financial statements are
statements materially misstated.
• The assessment of what is material is a matter
of professional judgment of the auditor.

Audit Evidence
• Audit evidence is all the information used by
auditor in arriving at the conclusions on which
Inherent Risk
audit opinion is based.
• the susceptibility of an assertion to a
- Includes (1) accounting records (2) other
misstatement that could be material in absence
information
of the related internal controls
- Auditors are not expected to address all
- nature of the item
information that may exist
- complex calculation
- Cumulative in nature
- amounts derived from accounting estimates
- business risk affecting inherent risks
Management Assertions
• Management assertions are
Control Risk
- Representations of management, explicit or
• the likelihood that a misstatement that could
implicit, about the recognition,
occur in an assertion and that could be material
measurement, presentation, classification
and will not be prevented, detected, or
and disclosure of various elements of
corrected on a timely basis by the entity’s
financial statements & related disclosures.
internal control
- Auditors assess the risks of material
- human errors and mistakes
misstatement and design and perform tests
- collusion/circumvention of controls
of controls and substantive tests based on
- override of controls
these assertions.

Detection Risk
Financial Statements Assertions
• the likelihood that the auditor will not detect a
misstatement that exists in the financial
statements
 • while inherent and control risks are function of
client’s accounts and systems, detection risk is a
function of the auditor’s procedures.
• Among the components of the audit risk,
detection risk is the only component that the
auditor can control.
• Thus, the auditor plans the nature, timing and
extent of audit procedures to reduce the audit
risk to an acceptably low level.

Audit Risk Model

Limitations of an Audit
• Nature of financial reporting
• Nature of audit procedures
• The need for the audit to be conducted within a
reasonable period of time and at a reasonable
cost.
An audit is also limited by its scope and objective. The
auditor does NOT express an opinion on such matters
such as:
• Future viability of the entity
• Effectiveness of efficiency of management
• Compliance with ALL laws and regulations

Overview of Risk-based Audit Process