AUDITING MIDTERM Compressed

Modules in Auditing (A Risk Based Approach)
Prepared by: ROLANDO E. ROBLEDO DBA, CPA, FBE
Module 1n Principles of Auditing
OVERVIEW
“Where Financial Accounting ends, Auditing begins”
This is a common statement usually presented to start an audit engagement. The final output in the
financial accounting transactions are the financial statements. These documents shows a clear
picture on the status of the enterprise with regard to its stability, liquidity, profitability and viability.
However, there should be an assurance that these documents are free of material misstatements.
They must be examined and verified by an independent and objective individual or entity which can
provide an opinion on the fairness and truthfulness of these documents. This is the main purpose of
conducting an audit on the financial statements which will be subjected to different tests and
validation to ensure that no material misstatements exist.
Learning Objectives
Discuss the history and evolution of auditing.
Describe the nature of an audit
Discuss the different types of audit
Identify the parties involved in preparing and auditing financial statements and briefly described
their roles.
List the types of audit service providers and the skills and knowledge needed by professionals in
entering the audit profession
Identify the requirements needed to help achieve audit quality and client performance satisfaction
ENTRY TEST/ PRE TEST
How do financial accounting differ from auditing?
What is the importance of auditing the financial statements of an enterprise?
What are the requirements needed to help achieve audit quality and client performance
satisfaction?
What are the differences between internal and external auditors?

Brief history of auditing
The attitude of profit maximization from end middle ages - merchant houses in Italy.
Double-entry bookkeeping was first described in Italy (Pacioli 1494).
Industrial Revolution Great-Britain in 1780 leading to the emergence of large industrial companies.
1853 the Society of Accountants in Edinburgh was founded.
By the audit process, the auditor enhances the usefulness and value of the financial statements, and
also increases the credibility of other non-audited information released by management.
The function of auditing is to lend credibility to the financial statements. Additional task is to
promote operational and cost efficiency.
Investors want more information than just financial statements such as:
Is the company a going concern?
Is it free of fraud?
Is it managed properly?
Is there integrity in its database?
Do directors have proper and adequate information to make decisions?
Are there adequate controls?
What effect do the company's products and by-products have on the environment?
Can an ‘unfortunate mistake’ bring this company to its knees?
Audit Definition
“An audit is 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 to interested users.”
American Accounting Association
There are two kinds of audit namely internal audit and external audit.
External Auditing Profession
Financial statement audit
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
Objectives of external auditing is to provide opinions on:
Reliability of financial statements
Internal control effectiveness
Integrated audit: Provided when an external auditor is engaged to perform an audit of the
effectiveness of internal control over financial reporting that is integrated with an audit of financial
statements
External audit is intended to enhance confidence that users can place on management-prepared
financial statements
Unqualified audit report: When the auditor issues this type of report, it implies that the auditor has
no reservations about management’s financial statements or internal controls
When the auditor has reservations about the fair presentation of the financial statements
Audit report is modified to explain the nature of the reservations
Adverse opinion is expressed when auditors believe that:
Financial statements taken as a whole are not presented fairly in conformity with GAAP and/or
Client’s internal controls not effective
External Auditing: A Special Function
Described by US Chief Justice Warren Burger - Captures the essence of the external auditing
profession
Most important party served by the auditors is the public
Auditing requires:
Technical competence
Freedom from bias
Concern for the integrity of the financial reporting process
Auditors - Guardians of the capital markets

Public expects auditors to:
Find fraud
Require that management use accounting principles that best portray the spirit of the concepts
adopted by accounting standard setters
Be independent of management
Auditing profession faces many pressures
Keeping fees down
Making careful decisions regarding independence
Conducting a quality audit
Can an auditor owns its clients shares of stock?
When auditors own stock in their audit clients
They are not independent of their clients because they are part owners
Auditors may make judgments that favor the client company rather than external users of the
financial statements
External users may perceive an independence conflict
Users of Audited Financial Statements and decisions they make based on the reports
Why is there a risk that information provided by management may not always be reliable?
There is a need for unbiased reporting and independent assurance because of the following:
Potential bias
Management has incentives to bias financial information to convey a better impression of financial
data than real circumstances might merit
Remoteness
Organization and users of its financial information are distant from each other in terms of either
geographic distance or the extent of information available to the both parties
Complexity- Difficulty in determining a proper presentation of complex transactions, information,
and processing systems
Consequences- With unreliable information, investors lose a significant source of information

needed to make important decisions
Overall Objectives in Conducting an Audit
Obtaining assurance about financial statements being free from material misstatement
Reporting on financial statements based on auditor’s findings
In completing these objectives, the auditor:
Complies with relevant ethical requirements
Plans and performs an audit with professional skepticism
Exercises professional judgment
Obtains sufficient appropriate evidence on which to base the auditor’s opinion
Conducts audit in accordance with professional auditing standards
General Principles Governing an Audit of Financial Statements
An auditor should comply with the Code of Ethics for Professional Accountants
An auditor should conduct an audit in accordance with Phil. Standards on Auditing.
Scope of an audit - the audit procedures deemed necessary to achieve the objective of the audit.
Certain inherent limitations in an audit affect the auditor’s ability to detect material
misstatements.
Test and sampling
Internal control
Audit evidence
Audit process permeated by judgment

Management is responsible for the financial statements, accounting, and internal control.
Parties Involved in Preparing and Auditing Financial Statements
Providers of External Auditing Services
External auditing profession includes:
Sole-practitioner firms
Local and regional firms
Large multinational professional services firms
Organizational hierarchy of audit firms
Partners/Owners
Responsible for overall conduct of each audit
Responsible for many audit engagements being conducted simultaneously
Managers
Review audit work of seniors and staff
Responsible for fewer audit engagements being conducted simultaneously
Seniors
Responsible for overseeing day-to-day activities on a specific audit
Oversee performance of auditing procedures
Skills and Knowledge Needed for External Auditing Profession
Technical knowledge and expertise
Auditors must:
Understand accounting and auditing authoritative literature
Develop industry and client-specific knowledge
Develop and apply computer skills

Evaluate internal controls
Assess and respond to fraud risk
Leadership, teamwork, and professional skills
Auditors:must
Make presentations to management and audit committee members
Exercise logical reasoning
Communicate decisions to users
Manage and supervise by providing meaningful feedback
Act with integrity and ethics and Interact in a team environment
Collaborate and maintain a professional personal presence
Audit Quality
Performing an audit in accordance with accepted auditing standards (GAAS)
Providing assurance that audited financial statements and disclosures are presented in accordance
with GAAP
Providing assurance that those financial statements are not materially misstated whether due to
errors or fraud
Drivers of Audit Quality
Audit firm culture contributes to audit quality when leadership:
Creates work culture where audit quality is valued and rewarded
Emphasizes that ‘doing the right thing’ is appropriate from a public interest perspective
Ensures that employees have time and resources to address difficult issues
Ensures that monetary considerations do not adversely affect audit quality
Promotes benefits of audit partners seeking guidance on difficult issues
Ensures that audit firm has quality systems in place
Fosters evaluation and compensation practices

Ensures that audit quality is monitored within audit firm with appropriate consequences in case of
loopholes
Skills and qualities required of engagement team
Understanding clients’ business and adhering to auditing and ethical standards
Exhibiting professional skepticism and addressing issues identified during audit
Ensuring that staff has appropriate experience and is properly supervised
Ensuring that lower level staff is provided with mentoring and on the job training opportunities
Attending to and learning during training
There is effectiveness of the audit process when:
Audit methodology is well structured and:
Encourages partners and managers to work diligently in planning the audit
Provides a framework and procedures to obtain sufficient appropriate audit evidence in an effective
and efficient manner
Requires appropriate audit documentation
Provides for complying with auditing standards, but does not inhibit professional judgment
Ensuring that audit work is effectively reviewed
Audit quality control procedures are effective, understood, and applied
Quality technical support is available when auditors encounter unfamiliar situations
Ethical standards are communicated and achieved
Auditors’ evidence collection not constrained by financial pressures

Reliability and usefulness of audit reporting include:
Auditors appropriately concluding as to the truth and fairness of financial statements
Auditors communicating with audit committee about the following:
Audit scope
Threats to auditor objectivity
Important risks identified and judgments made in reaching audit opinion
Qualitative aspects of client’s accounting and possible ways of improving financial reporting
Factors Outside the Control of Auditors
Client corporate governance
Regulatory environment
Professional requirements that help to achieve audit quality
Maintaining auditor independence
Participating in review programs
Issuing engagement letters
Making appropriate client acceptance
Evaluating the audit firm’s limitations
Maintaining quality audit documentation
Threats to independence
Self-review threat
Advocacy threat
Adverse interest threat
Familiarity threat
Undue influence threat
Financial self-interest threat
Management participation threat
Safeguards to avoid independence problems include:
Safeguards created by profession or regulation
Safeguards created by audit client
Safeguards created by audit firm
Review Programs
Internal inspections/ peer reviews
Engagement quality review
Interoffice review
Engagement Letters
States scope of work to be done on audit
There should be no doubt in the mind of client, external auditor, or court system - regarding
expectations agreed to by external auditor and client
Includes:
Audit fee
Timing description of external auditor’s work
Documentation that client is expected to provide to external auditor
Client Acceptance/Continuance Decisions
Guidelines established to screen out:
Clients in financial and/or organizational difficulty
Clients constituting a disproportionate percentage of firm’s total practice
Disreputable clients
Clients offering an unreasonably low fee for auditor’s services

Audit firm limitations
An external audit firm should not undertake engagement that it is not qualified to handle
Audit documentation
Document everything done on audit
Documentation should clearly show evidence of supervisory review
Documentation should indicate:
What tests were performed
Who performed them
Any significant judgments made
Business Risk and Audit Risk
Companies, depending on the nature of their operations and industry, the regulatory environment in
which they operate, and their size and complexity, they face a variety of business risks.
The risk that causes the greatest concern by the auditor is the risk that the auditor expresses an
inappropriate audit opinion when the financial statements are materially misstated (known as audit
risk). “The auditor should plan and perform the audit to reduce audit risk to an acceptably low level
that is consistent with the objective of an audit.”
TYPES OF AUDIT
Financial Statement Audit
Examine financial statements, determine if they give a true and fair view or fairly present the
financial statement
Integrated audit: Provided when an external auditor is engaged to perform an audit of the
effectiveness of internal control over financial reporting that is integrated with an audit of financial
statements
Operational Audit
A study of a specific unit of an organization for the purpose of measuring its performance.
Compliance Audit
A review of an organization’s procedures and financial records performed to determine whether the
organization is following specific procedures, rules, or regulations set out by some higher authority.
Types of Auditors
Internal auditors are employed by individual companies to investigate and appraise the effectiveness
of company operations for management.
Independent auditors are typically certified either by a professional organization or government

agency.
Management Assertions and Audit Objectives
The audit starts with the financial statements prepared by the client and the claims or “assertions”.
that the client makes about these numbers.
It is the auditor's job to validate management's assertions. In order to do so, the auditor will identify
audit objectives, which can be regarded as the auditor's counterpart of management assertions.
Management assertions
Management assertions are implied or expressed representations by management about classes of

transactions and related accounts in the financial statements. An example of a management
assertion is that “the company’s financial statements are prepared based on international financial
reporting standards.”
Assertions about classes of transactions and events for the period under audit
Occurrence. Transaction and events that have been recorded have occurred and pertain to the
entity.
Completeness – All transactions and events that should have been recorded have been recorded..
Accuracy - Amounts and other data relating to recorded transactions and events have been recorded
appropriately.
Cutoff - Transactions and events have been recorded in the correct accounting period.
Classification - Transactions and events have been recorded in the proper accounts.
Assertions about account balances at the period end.
Existence:- Assets, liabilities and equity interests exist.
Rights and obligations:- An entity holds or controls the rights to assets, and liabilities are the
obligations of the entity.
Completeness—All assets, liabilities and equity interests that should have been recorded have been
recorded
Valuation and allocation —Assets, liabilities, and equity interests are included in the financial
statements at appropriate amounts and any resulting valuation or allocation adjustments are
appropriately recorded.
Assertions about presentation and disclosure
Occurrence and rights and obligations—Disclosed events, transactions, and other matters have
occurred and pertain to the entity.
Completeness—All disclosures that should have been included in the financial statements have been
included..
Classification and understandability—Financial information is appropriately presented and

described, and disclosures are clearly expressed.
Accuracy and valuation—Financial and other information are disclosed fairly and at appropriate
amounts.
Audit Process Model
Phase I - Client Acceptance
Phase II - Planning
Phase III - Testing and Evidence
Phase IV - Evaluation and Judgment
Phase I Client Acceptance
Objective: The client acceptance phase of the audit plan, Phase I, involves deciding whether to
accept a new client or continue with an existing one.
Procedures:
Evaluate the client's background and reasons for the audit.

(2) Determine whether the auditor is able to meet the
ethical requirements regarding the client.
(3) Determine need for other professionals.
(4) Communicate with predecessor auditor;
(5) Prepare client proposal.
(6) Select staff to perform the audit, and
(7) Obtain an engagement letter.
Phase 2 Planning the audit
Objective: Determine the amount and type of evidence and review required to give the auditor
assurance that there is no material misstatement of the financial statements.
Procedures
Perform audit procedures to understand the entity and its environment, including the entity’s
internal control;
Assess the risks of material misstatements of the financial statements.
Determine materiality; and
(4) Prepare the planning memorandum and audit program, containing the auditor’s response to the
identified risks.
Phase 3 Testing and Evidence
Objective Test for evidence supporting internal controls and the fairness of the financial
statements.
Procedures:
Tests of controls;
Substantive tests of transactions;
Analytical procedures;
Tests of details of balances.
Search for unrecorded liabilities

Phase 4 Evaluation and Reporting
Objective: Complete the audit procedures and issue an opinion.
Procedures:
Evaluate governance evidence;
Perform procedures to identify subsequent events;
Review financial statements and other report material;
Perform wrap-up procedures;
Prepare Matters of Attention for Partners;
Report to the board of directors; and
Prepare Audit report.
References
Johnstone, K. M., Gramling, A. A., Rittenberg, L.E., Auditing- A Risk based Approach 9th Edition.
South Western/ Cennage Learning 2014
Cabrera, E.B. Auditing Assurance, 2018 Edition. GIC Enterprises Co., Inc. Manila 2018
Philippine Standards on Auditing (PSAs). Auditing and Assurance Standards Council 2010
Cabrera, E. B., Comprehensive Reviewer in Auditing Theory, 2011 Edition GIC Enterprises Co., Inc.
2011
REVIEW QUESTIONS
What is the objective of external auditing? Describe the role of external auditing in meeting society’s
demands for unbiased financial and internal control information.
What is the “special function” that auditors perform? Whom does the external auditing profession
serve in performing this special function?
Why is it important that users perceive auditors are independent? What is the difference between
being independent in fact and being independent in appearance?
It has been stated that auditors must be independent because audited financial statements must
serve the needs of wide variety of users. If the auditor were to favor one group, such as existing
shareholders, there might be a bias against another group, such as prospective investors. What steps
has the external auditing taken to minimize potential bias toward important users and thereby
encourage auditor independence?
Modules in
Auditing
(A Risk Based Approach)
Prepared by:
ROLANDO E. ROBLEDO DBA, CPA, FBE

Module 1
Principles of Auditing
OVERVIEW
“Where Financial Accounting ends, Auditing begins”
This is a common statement usually presented to start an audit
engagement. The final output in the financial accounting
transactions are the financial statements. These documents
shows a clear picture on the status of the enterprise with
regard to its stability, liquidity, profitability and viability.
However, there should be an assurance that these
documents are free of material misstatements. They must be
examined and verified by an independent and objective
individual or entity which can provide an opinion on the
fairness and truthfulness of these documents. This is the
main purpose of conducting an audit on the financial
statements which will be subjected to different tests and
validation to ensure that no material misstatements exist.
Learning Objectives
1. Discuss the history and evolution of auditing.
2. Describe the nature of an audit
3. Discuss the different types of audit
4. Identify the parties involved in preparing and
auditing financial statements and briefly described
their roles.
5. List the types of audit service providers and the
skills and knowledge needed by professionals in
entering the audit profession
6. Identify the requirements needed to help achieve
audit quality and client performance satisfaction
ENTRY TEST/ PRE TEST
1. How do financial accounting differ from
auditing?
2. What is the importance of auditing the
financial statements of an enterprise?
3. What are the requirements needed to help
achieve audit quality and client performance
satisfaction?
4. What are the differences between internal
and external auditors?
TOPIC PRESENTATION/
DISCUSSION
• The attitude of profit maximization from end
middle ages - merchant houses in Italy.
• Double-entry bookkeeping was first
described in Italy (Pacioli 1494).
• Industrial Revolution Great-Britain in 1780
leading to the emergence of large industrial
companies.
• 1853 the Society of Accountants in Edinburgh
was founded.
• By the audit process, the auditor enhances
the usefulness and value of the financial
statements, and also increases the credibility
of other non-audited information released by
management.
The function of auditing is to lend credibility to the
financial statements. Additional task is to promote
operational and cost efficiency.
Investors want more information than just financial
statements such as:
 Is the company a going concern?

 Is it free of fraud?
 Is it managed properly?
 Is there integrity in its database?
 Do directors have proper and adequate information to make
decisions?
 Are there adequate controls?
 What effect do the company's products and by-products
have on the environment?
 Can an ‘unfortunate mistake’ bring this company to its
knees?
Audit Definition
“An audit is 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 to interested users.”
American Accounting Association
There are two kinds of audit namely internal
audit and external audit.
• Financial statement audit
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
• Objectives of external auditing is to provide
opinions on:
– Reliability of financial statements
– Internal control effectiveness
• Integrated audit: Provided when an external
auditor is engaged to perform an audit of the
effectiveness of internal control over
financial reporting that is integrated with an
audit of financial statements
• External audit is intended to enhance
confidence that users can place on
management-prepared financial statements
• Unqualified audit report: When the auditor
issues this type of report, it implies that the
auditor has no reservations about
management’s financial statements or
internal controls
• When the auditor has reservations about the
fair presentation of the financial statements
– Audit report is modified to explain the nature of
the reservations
• Adverse opinion is expressed when auditors
believe that:
– Financial statements taken as a whole are not
presented fairly in conformity with GAAP and/or
– Client’s internal controls not effective
• Described by US Chief Justice Warren Burger -
Captures the essence of the external auditing
profession
– Most important party served by the auditors is
the public
– Auditing requires:
• Technical competence
• Freedom from bias
• Concern for the integrity of the financial reporting
process
– Auditors - Guardians of the capital markets
• Public expects auditors to:
– Find fraud
– Require that management use accounting
principles that best portray the spirit of the
concepts adopted by accounting standard setters
– Be independent of management
• Auditing profession faces many pressures
– Keeping fees down
– Making careful decisions regarding independence
– Conducting a quality audit
Can an auditor owns its clients shares of
stock?
• When auditors own stock in their audit
clients
– They are not independent of their clients
because they are part owners
• Auditors may make judgments that favor the
client company rather than external users of
the financial statements
• External users may perceive an independence
conflict
Users of Audited Financial Statements and
decisions they make based on the reports
Why is there a risk that information provided
by management may not always be reliable?
• There is a need for unbiased reporting and independent
assurance because of the following:
• Potential bias
• Management has incentives to bias financial
information to convey a better impression of
financial data than real circumstances might merit
• Remoteness
• Organization and users of its financial information
are distant from each other in terms of either
geographic distance or the extent of information
available to the both parties
Complexity- Difficulty in determining a
proper presentation of complex transactions,
information, and processing systems
Consequences- With unreliable information,

investors lose a significant source of
information needed to make important
decisions
Overall Objectives in Conducting an Audit
• Obtaining assurance about financial statements being free
from material misstatement
• Reporting on financial statements based on auditor’s
findings
• In completing these objectives, the auditor:
– Complies with relevant ethical requirements
– Plans and performs an audit with professional skepticism
– Exercises professional judgment
– Obtains sufficient appropriate evidence on which to base
the auditor’s opinion
– Conducts audit in accordance with professional auditing
standards
General Principles Governing an Audit
of Financial Statements
➢An auditor should comply with the Code of
Ethics for Professional Accountants
➢An auditor should conduct an audit in
accordance with Phil. Standards on Auditing.
General Principles Governing an Audit
of Financial Statements
➢ Scope of an audit - the audit procedures deemed
necessary to achieve the objective of the audit.
➢ Certain inherent limitations in an audit affect the
auditor’s ability to detect material misstatements.
➢ Test and sampling
➢ Internal control
➢ Audit evidence
➢ Audit process permeated by judgment
➢ Management is responsible for the financial
statements, accounting, and internal control.
Parties Involved in Preparing and Auditing
Financial Statements
Providers of External Auditing Services
• External auditing profession includes:

– Sole-practitioner firms
– Local and regional firms
– Large multinational professional services firms
Organizational hierarchy of audit firms
• Partners/Owners
Responsible for overall conduct of each audit
Responsible for many audit engagements being conducted
simultaneously
• Managers
Review audit work of seniors and staff
Responsible for fewer audit engagements being conducted
simultaneously
• Seniors
Responsible for overseeing day-to-day activities on a specific
audit
Oversee performance of auditing procedures
Skills and Knowledge Needed for External
Auditing Profession
• Technical knowledge and expertise
– Auditors must:
• Understand accounting and auditing authoritative literature
• Develop industry and client-specific knowledge
• Develop and apply computer skills
• Evaluate internal controls
• Assess and respond to fraud risk
• Leadership, teamwork, and professional skills
– Auditors:
• Make presentations to management and audit committee
members
• Exercise logical reasoning
• Communicate decisions to users
• Manage and supervise by providing meaningful feedback
• Act with integrity and ethics and Interact in a team environment
• Collaborate and maintain a professional personal presence
Difference between large and small audit firms
Audit Quality
• Performing an audit in accordance with

accepted auditing standards (GAAS)
– Providing assurance that audited financial
statements and disclosures are presented in
accordance with GAAP
– Providing assurance that those financial
statements are not materially misstated whether
due to errors or fraud
• Audit firm culture contributes to audit quality when leadership:
– Creates work culture where audit quality is valued and rewarded
– Emphasizes that ‘doing the right thing’ is appropriate from a public
interest perspective
– Ensures that employees have time and resources to address difficult
issues
– Ensures that monetary considerations do not adversely affect audit
quality
• Promotes benefits of audit partners seeking guidance on difficult
issues
• Ensures that audit firm has quality systems in place
• Fosters evaluation and compensation practices
• Ensures that audit quality is monitored within audit firm with
appropriate consequences in case of loopholes
• Skills and qualities required of engagement
team
– Understanding clients’ business and adhering to
auditing and ethical standards
– Exhibiting professional skepticism and addressing
issues identified during audit
– Ensuring that staff has appropriate experience
and is properly supervised
– Ensuring that lower level staff is provided with
mentoring and on the job training opportunities
– Attending to and learning during training
• There is effectiveness of the audit process
when:
– Audit methodology is well structured and:
• Encourages partners and managers to work diligently
in planning the audit
• Provides a framework and procedures to obtain
sufficient appropriate audit evidence in an effective
and efficient manner
• Requires appropriate audit documentation
• Provides for complying with auditing standards, but
does not inhibit professional judgment
• Ensuring that audit work is effectively reviewed
• Audit quality control procedures are effective,
understood, and applied
– Quality technical support is available when auditors
encounter unfamiliar situations
– Ethical standards are communicated and achieved
– Auditors’ evidence collection not constrained by
financial pressures
• Reliability and usefulness of audit reporting include:
– Audit reports
– Auditors appropriately concluding as to the truth and
fairness of financial statements
– Auditors communicating with audit committee about the following:
• Audit scope
• Threats to auditor objectivity
• Important risks identified and judgments made in reaching audit
opinion
• Qualitative aspects of client’s accounting and possible ways of
improving financial reporting
• Factors Outside the Control of Auditors

Client corporate governance
Regulatory environment
• Professional requirements that help to
achieve audit quality
– Maintaining auditor independence
– Participating in review programs
– Issuing engagement letters
– Making appropriate client acceptance
– Evaluating the audit firm’s limitations
– Maintaining quality audit documentation
• Threats to independence
– Self-review threat
– Advocacy threat
– Adverse interest threat
– Familiarity threat
– Undue influence threat
– Financial self-interest threat
– Management participation threat
• Safeguards to avoid independence problems include:
– Safeguards created by profession or regulation
– Safeguards created by audit client
– Safeguards created by audit firm
Review Programs
• Internal inspections/ peer reviews
• Engagement quality review
• Interoffice review
Engagement Letters
• States scope of work to be done on audit
• There should be no doubt in the mind of client, external
auditor, or court system - regarding expectations agreed to
by external auditor and client
• Includes:
– Audit fee
– Timing description of external auditor’s work
– Documentation that client is expected to provide to
external auditor
Client Acceptance/Continuance Decisions
• Guidelines established to screen out:
– Clients in financial and/or organizational difficulty
– Clients constituting a disproportionate percentage of
firm’s total practice
– Disreputable clients
– Clients offering an unreasonably low fee for auditor’s
services
Audit firm limitations

An external audit firm should not undertake engagement that
it is not qualified to handle
Audit documentation
• Document everything done on audit
• Documentation should clearly show evidence
of supervisory review
• Documentation should indicate:
– What tests were performed
– Who performed them
– Any significant judgments made
• Companies, depending on the nature of their
operations and industry, the regulatory
environment in which they operate, and their
size and complexity, they face a variety of
business risks.
• The risk that causes the greatest concern by the
auditor is the risk that the auditor expresses an
inappropriate audit opinion when the financial
statements are materially misstated (known as
audit risk). “The auditor should plan and
perform the audit to reduce audit risk to an
acceptably low level that is consistent with the
objective of an audit.”
TYPES OF AUDIT
Financial Statement Audit
Examine financial statements, determine if
they give a true and fair view or fairly
present the financial statement
Integrated audit: Provided when an external
auditor is engaged to perform an audit of the
effectiveness of internal control over
financial reporting that is integrated with an
audit of financial statements
TYPES OF AUDIT
Operational Audit
A study of a specific unit of an organization for the purpose
of measuring its performance.
Compliance Audit
A review of an organization’s procedures and financial
records performed to determine whether the
organization is following specific procedures, rules, or
regulations set out by some higher authority.
Types of Auditors
• Internal auditors are employed by individual
companies to investigate and appraise the
effectiveness of company operations for
management.
• Independent auditors are typically certified
either by a professional organization or
government agency.
Management Assertions and Audit
Objectives
• The audit starts with the financial statements
prepared by the client and the claims or
“assertions”. that the client makes about
these numbers.
• It is the auditor's job to validate
management's assertions. In order to do so,
the auditor will identify audit objectives,
which can be regarded as the auditor's
counterpart of management assertions.
• Management assertions are
implied or expressed
representations by management
about classes of transactions
and related accounts in the
financial statements. An
example of a management
assertion is that “the company’s
financial statements are
prepared based on international
financial reporting standards.”
Assertions about classes of transactions
and events for the period under audit
➢ Occurrence. Transaction and events that have
been recorded have occurred and pertain to
the entity.
➢ Completeness – All transactions and events
that should have been recorded have been
recorded..
➢ Accuracy - Amounts and other data relating to
recorded transactions and events have been
recorded appropriately.
➢ Cutoff - Transactions and events have been
recorded in the correct accounting period.
➢ Classification - Transactions and events have
been recorded in the proper accounts.
Assertions about account balances at
the period end.
▪ Existence:- Assets, liabilities and equity
interests exist.
▪ Rights and obligations:- An entity holds or
controls the rights to assets, and liabilities are
the obligations of the entity.
▪ Completeness—All assets, liabilities and
equity interests that should have been
recorded have been recorded
▪ Valuation and allocation —Assets, liabilities,
and equity interests are included in the
financial statements at appropriate amounts
and any resulting valuation or allocation
adjustments are appropriately recorded.
Assertions about presentation and
disclosure
❖ Occurrence and rights and obligations—
Disclosed events, transactions, and other
matters have occurred and pertain to the
entity.
❖ Completeness—All disclosures that should
have been included in the financial statements
have been included..
❖ Classification and understandability—
Financial information is appropriately
presented and described, and disclosures are
clearly expressed.
❖ Accuracy and valuation—Financial and other
information are disclosed fairly and at
appropriate amounts.
Audit Process Model
• Phase I - Client Acceptance
• Phase II - Planning
• Phase III - Testing and Evidence
• Phase IV - Evaluation and Judgment
Phase I Client Acceptance
Objective: The client acceptance phase of the audit plan,
Phase I, involves deciding whether to accept a new client
or continue with an existing one.
Procedures:
(1) Evaluate the client's background and reasons for
the audit.
(2) Determine whether the auditor is able to meet the
ethical requirements regarding the client.
(3) Determine need for other professionals.
(4) Communicate with predecessor auditor;
(5) Prepare client proposal.
(6) Select staff to perform the audit, and
(7) Obtain an engagement letter.
Phase 2 Planning the audit
Objective: Determine the amount and type of evidence
and review required to give the auditor assurance
that there is no material misstatement of the financial
statements.
Procedures
(1) Perform audit procedures to understand the
entity and its environment, including the
entity’s internal control;
(2) Assess the risks of material misstatements of
the financial statements.
(3) Determine materiality; and
(4) (4) Prepare the planning memorandum and
audit program, containing the auditor’s
response to the identified risks.
Phase 3 Testing and Evidence
• Objective Test for evidence supporting internal
controls and the fairness of the financial
statements.
• Procedures:
(1) Tests of controls;
(2) Substantive tests of transactions;
(3) Analytical procedures;
(4) Tests of details of balances.
(5) Search for unrecorded liabilities
Phase 4 Evaluation and Reporting
Objective: Complete the audit procedures and
issue an opinion.
Procedures:
(1) Evaluate governance evidence;
(2) Perform procedures to identify
subsequent events;
(3) Review financial statements and other
report material;
(4) Perform wrap-up procedures;
(5) Prepare Matters of Attention for Partners;
(6) Report to the board of directors; and
(7) Prepare Audit report.
POST TEST
• Pls see copy of exam AT post test 1
References
• Johnstone, K. M., Gramling, A. A., Rittenberg, L.E., Auditing- A Risk based
Approach 9th Edition. South Western/ Cennage Learning 2014
• Cabrera, E.B. Auditing Assurance, 2018 Edition. GIC Enterprises Co., Inc.
Manila 2018
• Philippine Standards on Auditing (PSAs). Auditing and Assurance
Standards Council 2010Finance, Accounting, Budget
• Cabrera, E. B., Comprehensive Reviewer in Auditing Theory, 2011 Edition
GIC Enterprises Co., Inc. 2011
REVIEW QUESTIONS
1. What is the objective of external auditing? Describe the role of
external auditing in meeting society’s demands for unbiased
financial and internal control information.
2. What is the “special function” that auditors perform? Whom
does the external auditing profession serve in performing this
special function?
3. Why is it important that users perceive auditors are
independent? What is the difference between being
independent in fact and being independent in appearance?
4. It has been stated that auditors must be independent because
audited financial statements must serve the needs of wide
variety of users. If the auditor were to favor one group, such as
existing shareholders, there might be a bias against another
group, such as prospective investors. What steps has the
external auditing taken to minimize potential bias toward
important users and thereby encourage auditor independence?
AUDITING INTRODUCTION
Historical background
• Records of auditing activity in early Babylonian times (around 3,000 BC).
• Ancient China, Greece and Rome.
– The Latin meaning of the word 'auditor' was a 'hearer or listener' because
in Rome auditors heard taxpayers.
– Modern auditing dates to beginning of the modern corporation

• The attitude of profit maximization from end middle ages - merchant houses in
Italy.
• Double-entry bookkeeping was first described in Italy (Pacioli 1494).
• Industrial Revolution Great-Britain in 1780 lead to the emergence of large
industrial companies.
• 1853 the Society of Accountants in Edinburgh was founded.
• Auditing Standards and Regulation are Rapidly Changing
By the audit process, the auditor enhances the usefulness and value of the financial
statements, and also increases the credibility of other non-audited information released
by management.
• The function of auditing is to lend credibility to the financial statements
 Is the company a going concern?
 Is it free of fraud?
 Is it managed properly?
 Is there integrity in its database?
 Do directors have proper and adequate information to make decisions?
 Are there adequate controls?
 What effect do the company's products and by-products have on the
environment?
 Can an ‘unfortunate mistake’ bring this company to its knees?
International Financial Reporting Standards

• International Financial Reporting Standards (IFRS) are the standards that are
applied for financial accounting.
• IFRS were formerly called International Accounting Standards (IAS)
• The International Accounting Standards Board (IASB) has accounting standard
setting responsibilities for IFRS.
• The EU has agreed to apply most of the IFRS from 2005 onwards.
Advantages of International Auditing Standards

• worldwide
– increases confidence in non-domestic investment
• consistent
– international investors comprehend financial statements from different
countries
• high quality
– Non-national standards encourage better quality, less political influence
1
International Auditing and Assurance Standards Board (IAASB) Issues:
• International Standards on Auditing (ISAs) as the standards to be applied by
auditors in reporting on historical financial information.
• International Standards on Assurance Engagements (ISAEs) as the standards to
be applied by practitioners in assurance engagements dealing with information
other than historical financial information
• International Standards on Quality Control (ISQCs) as the standards to be
applied for all services falling under the Standards of the IAASB, and
• International Standards on Related Services (ISRSs) as the standards to be
applied on related services, as it considers appropriate
• International Standards on Review Engagements (ISREs) as the standards to be
applied to the review of historical financial information.
ISA 200 states the objective of an audit of financial statements 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.
Terms used 'give a true and fair view' or ‘present fairly, in all material respects’
equivalent terms?
Audit- Definition
“An audit is 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 to interested users.” American Accounting Association

➢ An auditor should comply with the Code of Ethics for Professional Accountants
issued by IFAC.
➢ An auditor should conduct an audit in accordance with International Standards on
Auditing.

➢ Scope of an audit - the audit procedures deemed necessary to achieve the
objective of the audit.
➢ Certain inherent limitations in an audit affect the auditor’s ability to detect material
misstatements.
➢ Test and sampling
➢ Internal control
➢ Audit evidence
➢ Audit process permeated by judgment
➢ Management is responsible for the financial statements, accounting, and internal
control.
• Companies, depending on the nature of their operations and industry, the

regulatory environment in which they operate, and their size and complexity, they
face a variety of business risks.
2
• The risk that causes the greatest concern by the auditor is the risk that the
auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated (known as audit risk). “The auditor should plan and
perform the audit to reduce audit risk to an acceptably low level that is consistent
with the objective of an audit.” (ISA 200)
TYPES OF AUDIT
Audit of financial statements - Examine financial statements, determine if they give a
true and fair view or fairly present the financial statements.
Operational Audit A study of a specific unit of an organization for the purpose of
measuring its performance.
Compliance Audit A review of an organization’s procedures and financial records
performed to determine whether the organization is following specific procedures,
rules, or regulations set out by some higher authority.
Types of Auditors
• Internal auditors are employed by individual companies to investigate and
appraise the effectiveness of company operations for management.
• Independent auditors are typically certified either by a professional organization
or government agency.
Certification of the Auditor

• Certified Public Accountant (CPA)
• Chartered Accountant (CA)
• Contador Público (CP)
• Other
Management Assertions and Audit Objectives

• The audit starts with the financial statements prepared by the client and the
claims or “assertions”. that the client makes about these numbers.
• It is the auditor's job to validate management's assertions. In order to do so, the
auditor will identify audit objectives, which can be regarded as the auditor's
counterpart of management assertions.
Management assertions are implied or expressed representations by management
about classes of transactions and related accounts in the financial statements. An
example of a management assertion is that “the company’s financial statements are
prepared based on international financial reporting standards.”
Assertions about classes of transactions and events for the period under audit
➢ Occurrence. Transaction and events that have been recorded have occurred and
pertain to the entity.
➢ Completeness – All transactions and events that should have been recorded
have been recorded..
➢ Accuracy - Amounts and other data relating to recorded transactions and events
have been recorded appropriately.
➢ Cutoff - Transactions and events have been recorded in the correct accounting
period.
➢ Classification - Transactions and events have been recorded in the proper
accounts.
3
Assertions about account balances at the period end.
▪ Existence:- Assets, liabilities and equity interests exist.
▪ Rights and obligations:- An entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
▪ Completeness—All assets, liabilities and equity interests that should have been
recorded have been recorded
▪ Valuation and allocation —Assets, liabilities, and equity interests are included in
the financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
Assertions about presentation and disclosure

❖ Occurrence and rights and obligations—Disclosed events, transactions, and
other matters have occurred and pertain to the entity.
❖ Completeness—All disclosures that should have been included in the financial
statements have been included..
❖ Classification and understandability—Financial information is appropriately
presented and described, and disclosures are clearly expressed.
❖ Accuracy and valuation—Financial and other information are disclosed fairly and
at appropriate amounts.
Audit Process Model

• Phase I - Client Acceptance
• Phase II - Planning
• Phase III - Testing and Evidence
• Phase IV - Evaluation and Judgment
• Phase I Client Acceptance
Objective: The client acceptance phase of the audit plan, Phase I, involves deciding
whether to accept a new client or continue with an existing one.
Procedures: (1) Evaluate the client's background and reasons for the audit. (2)
Determine whether the auditor is able to meet the ethical requirements regarding the
client. (3) Determine need for other professionals. (4) Communicate with predecessor
auditor; (5) Prepare client proposal. (6) Select staff to perform the audit, and (7) Obtain
an engagement letter.
Phase II Planning the audit
Objective: Determine the amount and type of evidence and review required to give the
auditor assurance that there is no material misstatement of the financial statements.
Procedures (1) Perform audit procedures to understand the entity and its environment,
including the entity’s internal control; (2) Assess the risks of material misstatements of
the financial statements. (3) Determine materiality; and (4) Prepare the planning
memorandum and audit program, containing the auditor’s response to the identified
risks.
4
Phase III Testing and Evidence
Objective Test for evidence supporting internal controls and the fairness of the
financial statements.
Procedures: (1) Tests of controls; (2) Substantive tests of transactions; (3) Analytical
procedures; (4) Tests of details of balances. (5) Search for unrecorded liabilities.
Phase IV, Evaluation and Reporting
Objective: Complete the audit procedures and issue an opinion.
Procedures: (1) Evaluate governance evidence; (2) Perform procedures to identify

subsequent events; (3) Review financial statements and other report material; (4)
Perform wrap-up procedures; (5) Prepare Matters of Attention for Partners; (6) Report to
the board of directors; and (7) Prepare Audit report.
International Public Accounting Firms

“The Big Four”: - Deloitte & Touche; PricewaterhouseCoopers; Ernst & Young; KPMG
Audit Staff
Staff Accountants (or Junior Assistants then Senior)
Senior Accountants (or Supervisor)
Managers
Partners/Directors
VALUE OF AUDIT
Reduces information risk to interested parties
◼ Investors, creditors, employees, suppliers, regulatory agencies, tax
agencies, etc.
Reduces cost of capital to company
FINANCIAL STATEMENTS
Representations of management
◼ Responsible for assertions embodied in financial statements
Examined by auditor
WHO IS AUDIT CLIENT?

Board of directors
◼ Auditor is engaged by board of directors
Board of directors
◼ Elected by shareholders
◼ Represents shareholder interests
5
OTHER AUDIT & ATTEST SERVICES
Operational audits
◼ Assess effectiveness & efficiency of operations
Compliance audits
◼ Assess whether entity has complied with applicable laws & regulations
◼ Mostly for Not-for-Profit organizations
Agreed-upon procedures
◼ Attest service with contractual procedures
CONSULTING & OTHER ASSURANCE SERVICES

Business valuation
Financial planning
Litigation support
Information system design & processing
Forecasts & projections
Sarbanes-Oxley prohibits many services to public companies
6
Purpose of an Audit and Premise upon Which an Audit Is Conducted
1. The purpose of an audit is to enhance the degree of confidence that users can place in the
financial statement. This purpose is achieved when an auditor expresses an opinion on the
financial statements.
2. An audit is based on the premise that management has responsibility to prepare the financial
statements, maintain internal control over financial reporting, and provide the auditor with
relevant information and access to personnel.
Responsibilities
3. Auditors are responsible for having the appropriate competence and capabilities to perform the
audit, should comply with ethical requirements, and maintain professional skepticism throughout
the audit.
Performance
4. The auditor needs to obtain reasonable assurance as to whether the financial statements are
free from material misstatement.
5. Obtaining reasonable assurance requires the auditor to plan and supervise the work, determine
materiality levels, identify risks of material misstatement, and design and implement appropriate
audit responses to the assessed risks.
6. An audit has inherent limitations such that the auditor is not able to obtain absolute assurance
about whether the financial statements are free from misstatement.
Reporting
7. The auditor expresses an opinion as to whether the financial statements are free of material
misstatement or states that an opinion cannot be
expressed.
Audit phases
Five steps involved in an audit.
Phase I Making Client Acceptance and Continuance Decisions

Phase II Performing Risk Assessment
Phase III Obtaining Evidence about Internal Control Operating Effectiveness
Phase IV Obtaining Substantive Evidence about Accounts, Disclosures, and
Assertions
Phase V Completing the Audit and Making Reporting Decisions
Five management financial statement assertions
Existence or Occurrence: Assertions about existence address whether assets and liabilities
exist and assertions about occurrence address whether recorded transactions, such as sales
transactions, have occurred.
Example: Management asserts that sales recorded in the income statement represent
transactions in which the exchange of goods or services with customers for cash or other
consideration had occurred.
Completeness: Assertions about completeness address whether all transactions and accounts
that should be included in the financial statements are included.
Example: Management asserts that notes payable in the balance sheet include all such
obligations of the organization.
Valuation or Allocation: Assertions about valuation or allocation address whether accounts

have been included in the financial statements at appropriate amounts.
Example: Management asserts that trade accounts receivable included in the balance sheet are
stated at net realizable value.
Rights and Obligations: Assertions about rights address whether assets are the rights of the
organization, while assertions about obligations address whether liabilities are the obligations of
the organization.
Example: Management asserts that amounts capitalized for leases in the balance sheet represent
the cost of the entity’s rights to leased property and that the corresponding lease liability
represents an obligation of the entity.
Presentation and Disclosure: Assertions about presentation and disclosure address whether
components of the financial statements are properly classified, described, and disclosed.
Example: Management asserts that obligations classified as long-term liabilities in the balance
sheet will not mature within one year
Three broad types of audit procedures and the purpose of each test
Risk assessment procedures. Procedures performed by the auditor to obtain information for
identifying and assessing the risks of material misstatement in the financial statements whether
due to error or fraud. Risk assessment procedures by themselves do not provide sufficient
appropriate evidence on which to base an audit opinion, but are used for purposes of planning the
audit.
Tests of controls. Audit procedures designed to evaluate the operating effectiveness of

controls in preventing, or detecting and correcting, material misstatements, typically at the
assertion level.
Substantive procedures. Audit procedures designed to detect material misstatements in

accounts which include tests of details and substantive analytical procedures
Nine specific actions an auditor can undertake to collect evidence.
Inspection of documentation Examining a client document for evidence of authorization

Inspection of assets Physically examining a client’s equipment
Observation Looking at a process or procedure, such as observing the client
use of a restricted access area
External confirmation Obtaining a direct written response to the auditor from a third
party, such the client’s customers, confirming the amount owed
to the client
Recalculation Checking the mathematical accuracy of a document or record,
such as an inventory count sheet
Reperformance Independently performing procedures or controls that were
originally performed by the client, such as reperforming a bank
reconciliation
Analytical procedures Analyzing plausible relationships among both financial and non-
financial data
Scanning Performing a type of analytical procedure which involves reviewing
accounting data to identify significant or unusual items, such as
examining a credit balance in an account that typically has a debit
balance
Inquiry Seeking information of persons within or outside of the client
organization, such as communicating with the CFO or general
counsel about changes in accounting policy
Generally Accepted Auditing Standards
Generally Accepted Auditing Standards, or GAAS, are ten auditing standards,
developed by the AICPA, consisting of general standards, standards of field work, and
standards of reporting, along with interpretations. They were developed by the AICPA in
1947 and have undergone minor changes since then.
General Standards
1. The auditor must have adequate technical training and proficiency to perform the
audit
2. The auditor must maintain independence in mental attitude in all matters related to
the audit.
3. The auditor must use due professional care during the performance of the audit and
the preparation of the report.
Standards of Field Work
1. The auditor must adequately plan the work and must properly supervise any
assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment,
including its internal control, to assess the risk of material misstatement of the financial
statements whether due to error or fraud, and to design the nature, timing, and extent of
further audit procedures.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit
procedures to afford a reasonable basis for an opinion regarding the financial
statements under audit.
The new standards are in effect for audits of financial statements for periods beginning
on or after December 15, 2006.
Standards of Reporting
1. The auditor must state in the auditor's report whether the financial statements are in
accordance with generally accepted accounting principles (GAAP).
2. The auditor must identify in the auditor's report those circumstances in which such
principles have not been consistently observed in the current period in relation to the
preceding period.
3. When the auditor determines that informative disclosures are not reasonably
adequate, the auditor must so state in the auditor's report.
4. The auditor must either express an opinion regarding the financial statements, taken
as a whole, or state that such an opinion cannot be expressed in the auditors report.
When the auditor cannot express an overall opinion, the auditor should state the
reasons therefore in the auditor's report. In all cases where the auditor's name is
associated with the financial statements, the auditor should clearly indicate the
character of the auditor's work, if any, and the degree of responsibility the auditor is
taking, in the auditor's report.
Professional Standards
Generally Accepted Auditing Standards General Standards
Adequate technical training and proficiency
Independence in mental attitude is to be maintained
Due professional care is to be exercised
Generally Accepted Auditing Standards Standards of Field Work
Work is to be adequately planned and properly supervised
Sufficient understanding of the entity and its environment, including internal

control, is to be obtained
Sufficient appropriate evidential matter is to be obtained to afford a

reasonable basis for the opinion
Generally Accepted Auditing Standards Standards of Reporting
State whether the financial statements are presented in accordance with

GAAP
Identify circumstances in which such principles have not been consistently

applied
Informative disclosures are adequate unless otherwise stated in the report
Report should clearly state the degree of responsibility being assumed by the
auditors by expressing an opinion or stating that one cannot be expressed,
and the reason therefore.
Auditor Responsibility for the Detection of Errors and Fraud
Assess the risk of errors and fraud that may cause the financial statements to contain a material
misstatement.
Based on that assessment, plan and perform the audit to obtain reasonable assurance that material
misstatements, whether caused by errors or fraud, will be detected.
Exercise due care in planning, performing and evaluating the results of audit procedures, and the
proper degree of professional skepticism to achieve reasonable assurance that material
misstatements due to error or fraud will be detected.
Auditor Responsibility for the Detection of Illegal Acts
Those that could have a direct and material effect on financial statement amounts--same as for
errors and fraud. An audit obtains reasonable assurance of detecting these types of illegal acts.
Those with an indirect effect on financial statement amounts:
Be aware of possible occurrence.
If information comes to the auditor’s attention, apply audit procedures directed at determining
whether an illegal act has occurred. An audit does not provide assurance that indirect-effect illegal
acts will be detected.
The GAAP Hierarchy
Authoritative Body Pronouncements
Pronouncements of Bodies Composed of Expert Accountants, That Are Exposed for Public Comment
Pronouncements of Bodies of Expert Accountants That Are Not Exposed for Public Comment
Widely Recognized Practices and Pronouncements
Other Accounting Literature
The Attestation Standards 11 Standards
5 General Standards
2 Field Work Standards
4 Reporting Standards
Generalized form of the auditing standards

The Attestation Standards
General Standards
Adequate technical training and proficiency
Independence in mental attitude
Due professional care
Adequate knowledge in the subject matter
Subject matter should be capable of evaluation or measurement against criteria
The Attestation Standards Standards of Field Work
Work is to be adequately planned and properly supervised
Sufficient evidence shall be obtained to support conclusion
*No requirement for a sufficient understanding of internal controls.
The Attestation Standards Standards of Reporting
Identify the subject matter and state the character of the engagement
State the practitioner’s conclusion
State all of the practitioner’s significant reservations
The report should contain a statement restricting its use to parties who have agreed upon the
criteria or procedures
Elements of Quality Control
Independence, Integrity, and Objectivity
Personnel Management
Acceptance and Continuance of Clients and Engagements
Engagement Performance
Monitoring
The Standard Auditors’ Report
Title
Addressee
Content
Introductory Paragraph
Scope Paragraph
Opinion Paragraph
Signature
Date
International Auditing Standards
International Federation of Accountants( IFAC)
Worldwide organization of national accounting bodies (i.e., the AICPA) of over 100 countries.
International Auditing and Assurance Standards Board (IAASB)
Committee of the IFAC that issues International Standards on Auditing (ISAs)
International Audit Report

International vs. U.S. Standard Report
Scope paragraph
Audit in accordance with International Standards on Auditing instead of U.S. GAAS
Opinion paragraph
May substitute phrase “give a true and fair view” for “present fairly, in all material respects.”
May indicate that financial statements comply with either International Accounting Standards or
relevant country’s standards.
Signature
Signed by individual auditor, firm or both.

Republic of the Philippines
Congress of the Philippines
Metro Manila
Twelfth Congress
Third Regular Session
Begun and held in Metro Manila, on Monday, the twenty-eight day of July, two thousand three.
Republic Act No. 9298 May 13, 2004
AN ACT REGULATING THE PRACTICE OF ACCOUNTANCY IN THE PHILIPPINES, REPEALING

FOR THE PURPOSE PRESIDENTIAL DECREE NO. 692, OTHERWISE KNOWN AS THE
REVISED ACCOUNTANCY LAW, APPROPRIATING FUNDS THEREFOR AND FOR OTHER
PURPOSES
Be it enacted by the Senate and House of Representatives of the Philippines in Congress

assembled:
Section 1. Shorts Title. - This act shall be known as the "Philippine Accountancy Act of 2004"
Section 2. Declaration of Policy. - The State recognizes the importance of accountants in nation
building and development. Hence, it shall develop and nurture competent, virtuous, productive and
well rounded professional accountants whose standard of practice and service shall be excellent,
qualitative, world class and globally competitive though inviolable, honest, effective, and credible
licensure examinations and though regulatory measures, programs and activities that foster their
professional growth and development.
Section 3. Objectives. - This Act shall provide and govern:
The standardization and regulation of accounting education;
The examination of registration of certified public accountants; and
The supervision, control, and regulation of the practice of accountancy in the Philippines.
Section 4. Scope of Practice. - The practice of accountancy shall include, but not limited to, the
following:
(a) Practice of Public Accountancy - shall constitute a person, be it his/her individual

capacity, or as a staff member in an accounting or auditing firm, holding out himself/herself
as one skilled in the knowledge, science and practice of accounting, and as a qualified
person to render professional services as a certified public accountant; or offering or
rendering, or both or more than one client on a fee basis or otherwise, services as such as
the audit or verification of financial transaction and accounting records; or the preparation,
signing, or certification for clients of reports of audit, balance sheet, and other financial,
accounting and related schedules, exhibits, statement of reports which are to be used for
publication or for credit purposes, or to be filed with a court or government agency, or to be
used for any other purposes; or to design, installation, and revision of accounting system; or
the preparation of income tax returns when related to accounting procedures; or when
he/she represent clients before government agencies on tax and other matters relating to
accounting or render professional assistance in matters relating to accounting procedures
and the recording and presentation of financial facts or data.
(b) Practice in Commerce and Industry - shall constitute in a person involved in decision
making requiring professional knowledge in the science of accounting, or when such
employment or position requires that the holder thereof must be a certified public accountant.
(c) Practice in Education/Academe - shall constitute in a person in an educational institution

which involve teaching of accounting, auditing, management advisory services, fiancé,
business law, taxation and other technically related subject: Provided, That members of the
Integrated Bar of the Philippines may be allowed to teach business law and taxation
subjects.
(d) Practice in Government - shall constitute in a person who holds, or is appointed to, a
position in an accounting professional group in government or in an government-owned
and/or controlled corporation, including those performing proprietary functions, where
decision making requires professional knowledge in the science of accounting, or where a
civil service eligibility as a certified public accountant is a prerequisite.
ARTICLE II
PROFESSIONAL REGULATORY BOARD OF ACCOUNTANCY
Section 5. The Professional Regulatory Board of Accountancy and its Composition. - The
Professional Regulatory Board of Accountancy, hereinafter referred to as Board, under the
supervision and administrative control of the Professional Regulation Commission, hereinafter
referred to as the Commission, shall be composed of a Chairman and six (6) members to be
appointed by the President of the Philippines from a list of three (3) recommendees for each position
and ranked by the Commission from a list of five (5) nominees for each position submitted by the
accredited national professional organization of certified public accountant. The Board shall elect a
vice-chairman from among each members for a term of one (1) year. The chairman shall preside in
all meetings of the Boards and in the event of a vacancy in the office of the chairman, the vice-
chairman shall assume such duties and responsibilities until such time as a chairman is appointed.
Section 6. Qualifications of a members of the Professional Regulatory Board. - A member of

the Board shall, at the time of his/her appointment, posses the following qualifications:
Must be a natural-born citizen and a resident of the Philippines;
Must be a duly registered Certified Public Accountant with at least ten (10) years of work
experience in any scope of practice of accountancy;
Must be a good moral character and must not have been convicted of crimes involving moral
turpitude; and
Must not have any pecuniary interest, directly or indirectly, in any school, college, university
or institution conferring an academic degree necessary for admission to the practice of
accountancy or where review classes in preparation for the licensure examination are being
offered or conducted, nor shall he/she be a member of the faculty or administration thereof at
a time of his/her appointment to the Board.
Section 7. Term of Office. - The Chairman and Members of the Board shall hold office for a term of
three (3) years. Any vacancy occurring within the term of a member shall be filled up for the
unexpired portion of the term only. No person who has served two (2) successive complete terms
shall be eligible for reappointment until the lapse of one (1) year. Appointment to fill up an expired
term is not to be considered as a complete term.
Section 8. Compensation and Allowances of the Board. - The chairman and the members of the
Board shall receive compensation and allowances comparable to that being received by the
chairman and members of existing regulatory boards under the Commission as provided for in the
General Appropriate Act.
Section 9. Powers and Functions of the Board. - The Board shall exercise the following specific
powers, functions and responsibilities:
To prescribed and adopt the rules and regulations necessary for carrying out the provisions
of this Act;
To supervise the registration, licensure and practice of accountancy in the Philippines;
To administer oaths in connection with the administration of this Act;
To issue, suspend, revoke, reinstate the Certificate of Registration for the practice of the
accountancy profession;
To adopt an official seal of the Board;

To prescribe and/or adopt a Code of Ethics for the practice of accountancy;
To monitor the conditions affecting the practice of accountancy and adopt such measures,
including promulgation of accounting and auditing standards, rules and regulations and best
practices as may be deemed proper for the enhancement and maintenance of high
professional, ethical, accounting and auditing standards: That domestic accounting and
auditing standards rules and regulations shall include the international accounting and
auditing standards, and generally accepted best practices;
To conduct an oversight into the quality of audits of financial statements though a review of
the quality control measures instituted by auditors in order to ensure compliance with the
accounting and auditing standards and practices,
To investigate violations of this act and the rules and regulations promulgated hereunder and
for the purpose, to issue summons, subpoena and subpoena ad testificandum and subpoena
duces tecum to violator or witness thereof and compel their documents in connection
therewith: Provided, That the Board upon approval of the Commission may, subject to such
rules and regulations that may be promulgated to implement this section, delegate the fact-
finding aspect of such investigations to the accredited national professional organization of
certified public accountant: Provided, further, That the Board and/or the Commission may
adopt their findings of fact as may be seems fit;\
The Board may, muto propio in its discretion, may such investigations as it deem necessary
to determine whether any person has violated any provisions of this law, any accounting or
auditing standard or rules duly promulgated by the Board as part of the rules governing the
practice of accountancy;
To issue a cease or desist order to any person, associations, partnership or corporation

engaged in violation of any provision of this Act, any accounting or auditing standards or
rules of duly promulgated by the Board as part of the rules governing the practice of
accountancy in the Philippines;
To punish for contempt of the Board, both direct and indirect, in accordance with the
pertinent provision of and penalties prescribed by the Rules of Court;
To prepare, adopt, issue or amend the syllabi of the subjects for examinations in consultation
with the academe, determine and prepare questions for the licensure examination which
shall strictly be within the scope of the syllabi of the subjects for examinations as well as
administer, correct and release the result of the licensure examinations;
To ensure the coordination with the Commission of the Higher Education (CHED) or other
authorized government offices that all higher educational instruction and offering of
accountancy comply with the policies, standards and requirements of the course prescribed
by the CHED or other authorized government offices in the areas of curriculum, faculty,
library and facilities; and
To exercise such other powers as may be provided by law as well as those which may be
implied from, or which are necessary or incidental to the carrying out of, the express powers
granted to the Board to achieve the objectives and purposes of this Act.
The policies resolution, rules and regulations issued or promulgated by the Board shall be subject to
review and approval of the Commission. However, the Board's decisions, resolutions or orders
rendered in the administrative cases shall be subject to review only if on appeal.
Section 10. Administrative Supervisions of the Board, Custodian of its Records, Secretariat
and Support Services. - The Board shall be under the administrative supervision of the
Commission. All records of the Board, including applications for examination and administrative and
other investigative cases conduced by the Board shall be under the custody of the Commission. The
Commission shall designate the secretary of the Board and shall provide the secretariat and other
support services to implement the provisions of this Act.
Section 11. Grounds for Supervision or Removal of Members of the Board. - The President of
the Philippines, upon the recommendation of the Commission, after the giving the concerned
member an opportunity to defend himself in proper administrative investigation to be conducted by
he Commission, may suspend or remove any member of the following grounds:
Neglect of Duty or incompetence;
Violation or tolerance of any violation of this Act and it's implementation rules and regulations
or the Certified Public Accountant's Code of Ethics and the technical and professional
standards of practice for certified public accountant;
Final judgment of crimes involving moral turpitude; and
Manipulation or rigging of the certified public accountant's licensure examination results,

disclosure of secret and confidential information in the examination questions prior to the
conduct of the said examination or tampering of grades.
Section 12. Annual Report. - The Board shall, at the close of each calendar year, submit an annual
report to the President of the Philippines though the Commission giving the detailed account of its
proceedings and accomplishment during the year and making recommendations for the adoption of
measures that will upgrade and improve the conditions affecting the practice of accountancy in the
Philippines.
ARTICLE III
EXAMINATION, REGISTRATION AND LICENSURE
Section 13. The Certified Public Accountant Examinations. - All applicants for registration for the
practice of accountancy shall be required to undergo a licensure examination to be given by the
Board in such places and dates as the Commission may be designate subject to compliance with the
requirements prescribed by the Commission in accordance with Republic Act No. 8981.
Section 14. Qualifications of Applicant for Examinations. - Any person applying for examination
shall establish the following requisites to the satisfaction of the Board that he/she:
is a Filipino citizen;
is of good moral character;
is a holder of the degree of Bachelor of Science in Accountancy conferred by the school,

college, academy or institute duly recognized and/or accredited by the CHED or other
authorized government offices; and
has not been convicted of any criminal offence involving moral turpitude.
Section 15. Scope of Examination. - The licensure examination for certified public accountants
shall cover, but are not limited to, the following subjects:
Theory of Accounts
Business Law and Taxation
Management Services
Auditing Theory
Auditing Problems
Practical Accounting Problem I
Practical Accounting Problem II
The Board, subject to the approval of the Commission, may revise or exclude any of the subjects
and their syllabi, and add new ones as the need arises.
Section 16. Rating in the Licensure Examination. - To be qualified as having passed the
licensure examination for accountants, a candidate must obtain a general average of seventy five
percent (75%), with no grade lower than sixty-five percent (65%) in any given subject. In the event a
candidate obtains the rating of seventy-five percent (75%) and above in at least a majority of
subjects as provided for in this Act, he/she shall receive a conditional credit for the subjects passed:
Provided, That a candidate shall take an examination in the remaining subjects within two (2) years
from preceding examination: Provided, further, That if the candidate fails to obtain at least a general
average of seventy-five percent (75%) and a rating of at least sixty-five percent (65%) in each of the
subjects reexamined, he/she shall be considered as failed in the entire examination.
Section 17. Report of Rating. - The Board shall submit to the Commission the rating obtained by
each candidate within ten (10) calendar days after the examination, unless extended for just cause.
Upon the release of the results of the examination, the Commission shall send by mailing the rating
received by each examinee at his/her given address using the mailing envelop submitted during the
examination.
Section 18. Failing Candidates to Take Refresher Course. - Any candidate who fails in two (2)
complete Certified Public Accountant Board Examinations shall be disqualified from taking another
set of examinations unless he/she submit evidence to the satisfaction of the Board that he/she
enrolled in and completed at least twenty-four (24) units of subject given in the licensure
examination.
For purposes of this Act, the examination in which the candidate was conditioned together with the
removal examination on the subject in which he/she failed shall be counted as one compete
examination.
Section 19. Oath. - All successful candidates in the examination shall required to take an oath of
professional before any member of the Board or before any government official authorized of the
Commission or any person authorized by law to administer oaths upon presentation of proof of
his/her qualification, prior to entering upon the practice of the profession.
Section 20. Issuance of Certificate of Registration and Professional Identification Card. - A

certificate of registration shall be issued to examinees who pass the licensure examination subject to
payment of fees prescribed by the Commission. The Certificate of Registration shall bear the
signature of the chairperson of the Commission and the chairman and members of the Board,
stamped with the official seal of the Commission and of the Board, indicating that the person named
therein is entitled to the practice of the profession with all the privileges appurtenant thereto. The
said certificate shall remain in full force and effect until withdrawn, suspended or revoked in
accordance with this Act.
A Professional Identification Card bearing the registration number date of issuance, expiry date, duly
signed by the chairperson of the Commission, shall likewise be issued to every registrant renewable
every three (3) years.
Section 21. Roster of Certified Public Accountant. - A roster showing the names and place of
business of all registered certified public accountants shall be prepared and updated by the Board,
and copies thereof shall be made available to any party as may deemed necessary.
Section 22. Indication of Certificate of Registration, Identification Card and Professional Tax
Receipt. - The certified public Accountant shall be required to indicate his/her certificate of
registration number and date of issuance, the duration of validity, including the Professional Tax
Receipt number on the documents he/she signs, uses or issues in connection with the practice of
his/her profession.
Section 23. Refusal to Issue Certificate of Registration and Professional Identification Card. -
The Board shall not register and issue a certificate of registration and professional identification Card
to any successful examinee convicted by the court of competent jurisdiction of a criminal offence
involving moral turpitude or guilty of immoral and dishonorable conduct to any person or unsound
mind. In the event of refusal to issue certificate for any reason, the Board shall give the applicant a
written statement setting forth the reasons for such action, which statement shall be incorporated in
the record of the Board.
Section 24. Suspension and Revocation of Certificate of Registration and Professional

Identification Card and Cancellation of Special Permit. - The Board shall have the power, upon
the notice and hearing, to suspend or revoke the practitioner's certificate of registration and
professional identification card or suspend his/her from the practice of his/her profession or cancel
his/her special permit for any of the causes or ground mentioned under Section 23 of this Act or any
of the provisions of this Act, and its implementing rules and regulations, the certified Public
Accountant's Code of Ethics and the technical and professional standards of practice for certified
public accountants.
Section 25. Reinstatement, Reissuance and Replacement of Revoked or Lost Certificates. -

The Board may, after the expiration of two (2) years from the date of revocation of a certificate of
registration and upon application and for reasons deemed proper and sufficient, reinstate the validity
of a revoked certificate of registration and in so doing, may, in its discretion, exempt the applicant
from taking another examination.
A new certificate of registration to replace lost, destroyed, or mutilated certificate/license may be

issued, subject to the rules and promulgated by the Board and the Commission, upon the payment
of the required fees.
ARTICLE IV
PRACTICE OF ACCOUTANCY
Section 26. Prohibition in the Practice of Accountancy. - No person shall practice accountancy in
this country, or use the title "Certified Public Accountant", or use the abbreviated title "CPA" or
display or use any title, sign, card, advertisement or other device to indicate such person practices or
offers to practice accountancy, or is a certified public accountant, unless such person shall have
received from the Board a certificate of registration/Professional license and be issued a
professional identification card or a valid temporary/special permit duly issued to him/her by the
Board and the Commission.
Section 27. Vested Rights. - Certified Public Accountants Registered When This Law is Passed. -
All certified public accountants registered at the time this law takes effect shall automatically be
registered under the provisions hereof, subject, however, to the provisions herein set forth as to
future requirements. Certificate of Registration/Professional license held by such persons in good
standing shall have the same license force and effect as though issued after the passage of this Act.
Section 28. Limitation of the Practice of Public Accountancy. - Single practitioners and
partnerships for the practice of public accountancy shall be registered certified public accountants in
the Philippines: Provided, That from the effectivity of this Act, a certificate of accreditation shall be
issued to certified public accountant in public practice only upon showing, in accordance with rules
and regulations promulgated by the Board and approved by the Commission, that such registrant
has acquired a minimum of three (3) years meaningful experience in any of the areas of public
practice including taxation: Provide, further, that this requirement shall not apply to those already
granted a certificate of accreditation prior to the effectivity of this Act. The Security and Exchange
Commission shall not register any corporation organized for the practice of public accountancy.
Section 29. Ownership of Working Papers. - All working papers, schedules and memoranda
made by a certified public accountant and his staff in the course of an examination, including those
prepared and submitted by the client, incident to or in the course of an examination, by such certified
public accountant, except reports submitted by a certified public accountant to a client shall be
treated confidential and privileged and remain the property of such certified public accountant in the
absence of a written agreement between the certified public accountant and the client, to the
contrary, unless such documents are required to be produced though subpoena issued by any court,
tribunal, or government regulatory or administrative body.
Section 30. Accredited Professional Organization. - All registered certified public accountants
whose appear in the roster of certified public accountants shall be united and integrated though their
membership in a one and only registered and accredited national professional organization of
registered and licensed certified public accountants, which shall be registered with the Securities
and Exchange Commission as a nonprofit corporation and recognized by the Board subject to the
approval by the Commission. The members of the said integrated and accredited national
professional organization shall receives benefits and privileges appurtenant thereto upon payment of
required fees and dues. Membership in the integrated organization shall not be a bar to membership
in any other association of certified public accountants.
Section 31. Accreditation to Practice Public Accountancy. - Certified public accountants, firms
and partnerships of certified public accountants, engaged in the practice of public accountancy,
including partners and staff members thereof, shall registered with the Commission and the Board,
such registration to be renewed every three (3) years: Provided, That subject to the approval of the
Commission, the Board shall promulgate rules and regulations for the implementation of registration
requirements including the fees and penalties for violation thereof.
Section 32. Continuing Professional Education (CPE) Program. - All certified public accountants
shall abide by the requirements, rules and regulations on continuing professional education to be
promulgated by the Board, subject to the approval of the Commission, in coordination with the
accredited national professional organization of certified public accountants or any duly accredited
educational institutional. For this purpose, a CPE Council is hereby created to implement the CPE
program.
Section 33. Seal and Use of Seal. - All license certified public accountants shall obtain and use a
seal of a design prescribed by the Board bearing the registrant's name, registration number and title.
The auditors reports shall be stamped with the said seal, indicating therein his/her current
Professional Tax Receipt (PTR) number, date/place of payment when filed with government
authorities or when used professionally.
Section 34. Foreign Reciprocity. - Subject or citizen of foreign countries may be allowed to
practice accountancy in the Philippines in accordance with the provisions of existing laws,
international treaty obligations including mutual recognition agreement entered into by the
Philippines government with other countries. A person who is not a citizen of the Philippines shall not
be allowed to practice accountancy in the Philippines unless he/she can prove, in the manner
provided by the Rules of Court that, specific provision of law country of which he/she is a citizen,
subject or national admits citizens of the Philippines to the practice of the same profession without
restriction.
Section 35. Coverage of Temporary/Special Permits. - Special/temporary permit may be issued

by the Board subject to the approval of the Commission and payment of the fees the latter has
prescribed and charged thereof to the following persons:
A foreign certified public accountant called for consultation or for specific purpose which, in
the judgment of the Board, is essential for the development of the country: Provided, That
his/her practice shall be limited only for the particular work that he/she is being engaged:
Provided, further, That there is no Filipino certified public accountant qualified for such
consultation or specific purposes;
A foreign certified public accountant engaged as professor, lecturer or critic in fields essential
to accountancy education in the Philippines and his/her engagement is confined to teaching
only; and
A foreign certified public accountant who is an internationally recognized expect or with

specialization in any branch of accountancy and his/her service is essential for the
advancement of accountancy in the Philippines.
ARTICLE V
PENAL AND FIINAL PROVISIONS
Section 36. Penal Provision. - Any person who shall violate any of the provisions of this Act or any
of its implementing rules and regulations as promulgated by the Board subject to the approval of the
Commission, shall upon conviction, be punished by a fine of not less than Fifty Thousand Pesos
(50,000.00) or by imprisonment for a period not exceeding two (2) years or both.
Section 37. Implementing Rules and Regulations. - Within Ninety (90) days after the effectivity of
this Act, the Board, subject to the approval of the Commission and in coordination with the
accredited national professional organization of certified public accountants, shall adopt and
promulgate such rules and regulations to carry out the provisions of this Act and which shall be
effective Fifteen (15) days following their publication in the Official Gazette or in any of the major
daily newspaper of general circulation.
Section 38. Interpretation of this Act. - Nothing in this Act shall be construed to effect or prevent
the practice or any other legally recognized profession.
Section 39. Enforcement of this Act. - It shall be primary duty of the Commission and the Board to
effectivity enforce the provisions of this Act. All duly constituted law enforcement agencies and
officers of national, provincial, city or municipal government or of any political subdivision thereof,
shall upon the call or request of the Commission or the Board, render assistance in enforcing the
provisions of this Act and to prosecute any person violating the provisions of the same. The
Secretary of Justice or his duly designated representative shall act as legal adviser to the
Commission and the Board and shall render legal assistance as may be necessary in carrying out
the provisions of this Act.
Any person may bring before the Commission, Board of the aforementioned officers of the law,
cases of illegal practice or violations of this Act committed by any person or party.
The Board shall assist the Commission in filing the appropriate charges though the concerned
prosecution office in accordance with law and Rules of Court.
Section 40. Funding Provision. - The chairperson of the Professional Regulation Commission shall
immediately include the Commission's programs the implementation of this Act, the funding of which
shall be included in the annual General Appropriations Act.
Section 41. Transitory Provision. - The incumbent chairman and members of the Board shall
continue to serve in their respective positions under the terms for they have been appointed under
Presidential Decree No. 692, without the need of new appointments.
All graduates with Bachelors Degree, Major in Accounting shall be allowed to take the CPA
Licensure Examination within two (2) years from the effectivity of this Act under the rules and
regulations to be promulgated by the Board subject to the approval by the Commission.
Section 42. Separability Clause. - If any clause, provisions, paragraph or parts thereof shall be
declared unconstitutional or invalid, such judgment shall not affect, invalidate or impair any other part
hereof, but shall be merely confined to the clause, provisions, paragraph or part directly involved in
the controversy in which such judgment has been rendered.
Section 43. Repealing Clause. - Presidential Decree No. 692 is hereby repealed and all other laws,
orders, rules and regulations or resolutions or part/s thereof inconsistent with the provisions of this
Act are hereby repealed or modified accordingly.
Section 44. Effectivity. - This Act shall take effect after Fifteen (15) days following its publication in
the Official Gazette or in any major daily newspaper of general circulation.
Approved,
FRANKLIN DRILON JOSE DE VENECIA JR.
President of the Senate Speaker of the House of
Representatives
This Act which is consolidation of Senate Bill No. 2748 and House Bill No. 6678 was finally passed
by the Senate and the House of the Representatives on February 6, 2004 and February 7, 2004,
respectively.
OSCAR G. YABES ROBERTO P. NAZARENO

Secretary of Senate Secretary General
House of Represenatives
Approved: May 13, 2004
GLORIA MACAPAGAL-ARROYO
President of the Philippines
Revisions to the Philippine Accountancy Act
• Mar Lorenz Jamero
• July 5, 2021
Somewhere out there, is one hopeful accounting student who dreams to graduate,
pass the board exam, and practice being a Certified Public Accountant (CPA). Did
you know that there is such a thing as the Philippine Accountancy Law of 2004? This
is the law that regulates the practice of the accounting profession in the Philippines.
Subsequently, after many years, there have been movements to revise this law to
better adjust to more modern times. However, the law met much contention from the
relevant stakeholders affected by such revisions.
What is RA 9298
Republic Act No 9298 is the Philippine Accountancy Act of 2004. Congress enacted
this law on May 13, 2004. In a nutshell, the law recognizes the importance of
accountants in nation building and development. Hence, the government aims to
develop and nurture world-class accountants who are competent, excellent, and
productive. Thus, the law provides and governs the standardization and regulation of
accounting education. Aside from that, the law also controls regulation of the practice
of accountancy in the Philippines. Additionally, the Philippine Regulation
Commission created the Professional Regulatory Board of Accounting (BOA)
through this law.
5 Reasons for Revision
1. Redefine the practice of accountancy in accordance with current trends in the

practice of the profession.
2. Expressly provide that the BOA has the exclusive oversight over the
registration and the practice of accountancy in the Philippines.
3. Legitimize the creation of Standard Setting Bodies and to justify the
appropriation of 35 funds to carry out its functions.
4. Give emphasis to the relationship of the Professional Regulation Commission
– Board of Accountancy (PRC-PBOA) with the Commission on Higher
Education (CHED) and other government agencies in regulating educational
institutions which are offering Accountancy program and for this purpose the
creation of the Education Technical Council (ETC)
5. Amend the requirements for admission to the licensure examinations for
Certified Public Accountants to give Filipino citizens who are graduates of
foreign schools the chance to take the examination. Further, congress
envisions that requiring an examinee to undergo professional experience
before taking the licensure examination would give him/her a greater chance
of passing the licensure examination. Also, this would be a major step of
improving the national passing percentage of the licensure examination.
5 More reasons for Revision
1. Modify the manner of determining whether an examinee passed or failed the

examination. Eliminate the provision granting conditional status to some
examinees. Discontinue the publication of top performing examinees.
Moreover, congress also seeks to discontinue the conduct of refresher
courses due to the removal of the granting of conditional status to the
examinees.
2. Strengthen the practice of the profession through accreditation and
compliance with continuing professional development requirements.
3. Provide a provision that will specify the integration of the accountancy
profession into 60 one accredited professional organizations.
4. Congress also proposed a provision on Rules of Professional Conduct that
strengthens the enforcement of the Code of Ethics of CPAs in the
Philippines.
5. Provide appropriations for budgetary requirements necessary for the conduct
of the activities of the standard setting bodies of the Accountancy profession
and the Education Technical Council.
The Philippine Accountancy Act has about 17 proposed revisions. These changes
vary from changing the definition of the practice of Accountancy, regulatory reform,
and the powers and authority of the BOA. Additionally, congress is also discussing
revisions to the scope of the CPA Licensure Exams, reporting and disclosure of the
results.
In a Facebook post, the AccountingBytes compiled a list of the most controversial

proposed changes. Consequently, Some of these were met with much resistance
from current accounting students.
Proposed Changes
1. Allowing accountancy graduates of foreign schools to become CPAs;

2. Requiring a candidate for the board exam to have a prior two years of work
experience;
3. Requiring the exam takers to obtain a numerical rating of at least 75% in each
subject in order to pass the licensure exam;
4. Removing “conditional status”. Instead, it only becomes “passed” or “failed”;
5. Reporting of the results of the exam shall not contain any numerical rating;
6. Prohibiting the publication of the top performing examinees;
7. Automatic registration to the integrated professional organization of CPAS
upon passing; and
8. Implementing a strict no mandatory CPD no license renewal policy.
It is not difficult to see where the resistance of the accounting students comes from.
Indeed, becoming a CPA is already a difficult task to begin with yet some of these
policies make the process much harder to traverse.
Importance of getting the voice of stakeholders
As with all law, congress must get the voice of those who will be affected by the
revisions. This is because lawmakers are not the ones affected by the changing of
the laws, their constituents are. Hence, CPAs, accounting students, accounting
organizations, and the academe need to voice out their concerns and opinions so as
to be better served by our lawmakers. On the other hand, lawmakers need to listen
to the voices of their constituents as they are the ones primarily affected. Moreover,
they also have the experience on the ground and know the current situation.
References
AN ACT STRENGHTENING THE PRACTICE OF ACCOUNTANCY IN THE

PHILIPPINES, AMENDING FOR THE PURPOSE REPUBLIC ACT NO. 9298, 2021
(Philippines).
Philippine Accountancy Act, 2004 (Philippines)
Tan-Torres, J. L. (2021, May 23). Musings on the amendments of the accountancy

law | Joel L. Tan-Torres. BusinessMirror.
https://businessmirror.com.ph/2021/05/24/musings-on-the-amendments-of-the-
accountancy-law/
Professional Standards
Generally Accepted Auditing Standards
General Standards
1) Adequate technical training and proficiency
2) Independence in mental attitude is to be maintained
3) Due professional care is to be exercised

1) Work is to be adequately planned and properly supervised
2) Sufficient understanding of the entity and its environment, including internal
control, is to be obtained
3) Sufficient appropriate evidential matter is to be obtained to afford a reasonable
basis for the opinion
1) State whether the financial statements are presented in accordance with GAAP
2) Identify circumstances in which such principles have not been consistently
applied
3) Informative disclosures are adequate unless otherwise stated in the report
4) Report should clearly state the degree of responsibility being assumed by the
auditors by expressing an opinion or stating that one cannot be expressed, and
the reason therefore.
Statements On Auditing Standards (SASs)

SASs are issued by the Auditing Standards Board and are considered
interpretations of GAAS.
SASs receive their authority from Rule 202 of the Code of Professional Conduct.
GAAS and the SASs are considered to be minimum standards of performance
for auditors.
SASs are organized under two numbering systems
» Original SAS number (chronologically organized)
» AU number (organized by topic)
Statements On Auditing Standards (SASs)

The AU classification system
» Introduction (100)
» General Standards (200)
» Standards of Field Work (300)
» Standards of Reporting 1-3 (400)
» Standards of Reporting 4 (500)
» Other Types of Reports (600)
» Special Topics (700)
» Compliance Auditing (800)
» Special Reports of the Committee on Auditing Procedures (900)
1
Auditor Responsibility for the Detection of Errors and Fraud
Assess the risk of errors and fraud that may cause the financial statements to
contain a material misstatement.
Based on that assessment, plan and perform the audit to obtain reasonable
assurance that material misstatements, whether caused by errors or fraud, will
be detected.
Exercise due care in planning, performing and evaluating the results of audit
procedures, and the proper degree of professional skepticism to achieve
reasonable assurance that material misstatements due to error or fraud will be
detected.
Auditor Responsibility for the Detection of Illegal Acts

Those that could have a direct and material effect on financial statement
amounts--same as for errors and fraud. An audit obtains reasonable assurance
of detecting these types of illegal acts.
Those with an indirect effect on financial statement amounts:
» Be aware of possible occurrence.
» If information comes to the auditor’s attention, apply audit procedures
directed at determining whether an illegal act has occurred. An audit does
not provide assurance that indirect-effect illegal acts will be detected.
The GAAP Hierarchy

Authoritative Body Pronouncements
Pronouncements of Bodies Composed of Expert Accountants, That Are Exposed
for Public Comment
Pronouncements of Bodies of Expert Accountants That Are Not Exposed for
Public Comment
Widely Recognized Practices and Pronouncements
Other Accounting Literature

11 Standards
» 5 General Standards
» 2 Field Work Standards
» 4 Reporting Standards
» Generalized form of the auditing standards
General Standards
1) Adequate technical training and proficiency
2) Independence in mental attitude
3) Due professional care
4) Adequate knowledge in the subject matter
5) Subject matter should be capable of evaluation or measurement against
criteria

1) Work is to be adequately planned and properly supervised
2) Sufficient evidence shall be obtained to support conclusion
*No requirement for a sufficient understanding of internal controls.
2
1) Identify the subject matter and state the character of the engagement
2) State the practitioner’s conclusion
3) State all of the practitioner’s significant reservations
4) The report should contain a statement restricting its use to parties who have
agreed upon the criteria or procedures
Financial Forecasts and Projections

Pro Forma Financial Information
Internal Control
Compliance With Laws, Regulations, and Contracts
Management’s Discussion and Analysis
Applying Agreed-Upon Procedures
Elements of Quality Control

Independence, Integrity, and Objectivity
Personnel Management
Acceptance and Continuance of Clients and Engagements
Engagement Performance
Monitoring
Regulation of the Public Accounting Profession—Public Companies
Public Company Accounting Oversight Board (PCAOB)
» Created as a result of SARBOX and overseen by the SEC
» Registration of public accounting firms that audit public companies
» Establish or adopt auditing, quality control, ethics, independence and
other standards for auditors of public companies
» Conduct periodic inspections of registered public accounting firms
Securities and Exchange Commission (SEC)
» Administers legislation related to securities and other financial matters.
Regulation of the Public Accounting Profession—Nonpublic Companies
American Institute of Certified Public Accountants
» Peer review/inspection program
» Ethics investigations
State Boards of Accountancy
» Registration of all CPAs and CPA firms
» Ethics investigations
The Standard Auditors’ Report

l Title
l Addressee
l Content
» Introductory Paragraph
» Scope Paragraph
» Opinion Paragraph
l Signature
l Date
3
The Standard Auditors’ Report Introductory Paragraph
We have audited the accompanying balance sheet of XYZ Company as of

December 31, 20XX, and the related statements of income, retained earnings,
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
The Standard Auditors’ Report Scope Paragraph
We conducted our audit in accordance with generally accepted auditing

standards [auditing standards generally accepted in the United States of
America]. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
The Standard Auditors’ Report Opinion Paragraph
In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of XYZ Company as of December 31,
20XX, and the results of its operations and its cash flows for the year then ended
in conformity with generally accepted accounting principles [accounting principles
generally accepted in the United States of America].
• Note: As a result of the Sarbanes-Oxley Act of 2002, auditors are required to
also provide assurance on internal control for public companies.
International Auditing Standards

International Federation of Accountants( IFAC)
» Worldwide organization of national accounting bodies (i.e., the AICPA) of
over 100 countries.
» International Auditing and Assurance Standards Board (IAASB)
» Committee of the IFAC that issues International Standards on Auditing
(ISAs)
International Audit Report
International vs. U.S. Standard Report
Scope paragraph
» Audit in accordance with International Standards on Auditing instead of
U.S. GAAS
Opinion paragraph
» May substitute phrase “give a true and fair view” for “present fairly, in all
material respects.”
» May indicate that financial statements comply with either International
Accounting Standards or relevant country’s standards.
Signature
» Signed by individual auditor, firm or both.
4
5
Financial Control
Basic Auditing Concepts
The sections of an audit

1. The audit is planned
2. The internal control is studied and tested
3. Substantive tests are performed
4. The audit report is issued
What’s materiality?
Materiality: the magnitude of an omission or misstatement of accounting information
that, in the light of surrounding circumstances, makes it probable that the judgment of a
reasonable person relying on the information would have been changed or influenced
by the omission or misstatement
Materiality considerations
Quantitative factors
 Net income
 Net income before taxes
 Revenue
 Total assets
 Current assets
 Stockholders’ equity
Qualitative factor
 The probability that illegal payments might occur
 The probability that fraud might occur
 Provisions in a client’s loan agreement with a bank requiring that certain
financial statement ratios be maintained at minimum levels
 An interruption in a trend in earnings
Materiality, audit effort and audit risk

 Larger materiality borders (Materiality), associated with less audit effort and
higher audit risk.
 By selecting narrower materiality borders, the more audit effort will be extended,
and less exposure to audit risk.
What’s Audit risk?

 Audit Risk: The risk that the auditor may unknowingly fail to appropriately modify
an opinion on financial statements that are materially misstated
1
Types of risk
 Inherent Risk: The susceptibility of an account or transaction to error.
 Control Risk: The risk that the control system will fail to prevent or detect a
material error.
 Control system designed by management based on cost/benefit
considerations.
 All systems have an inherent level of error occurrence.
 Auditor attempts to estimate inherent error level so appropriate audit
procedures can be performed.
 Detection Risk: The risk that substantive procedures will fail to detect a material
misstatement. It contains two types of risks (sampling risk and non sampling risk)
Acceptable audit risk
 The level of audit risk the auditor is willing to accept. It is usually set at minimum
level.
 When AAR increases, audit effort decreases and audit risk increases.
Audit risk model

DR= AAR/ (IR x CR)
-ve relation between (IR and CR) and DR
-ve relation between (IR and CR) and AAR
+ve relation between AAR and DR
Relationships
Type of risk Change Evidence
Inherent risk ↑ ↑
Control risk ↑ ↑
As evidence increases, detection risk decreases
Sampling
 What is sampling?
 It is testing less than 100% of the population
Types of sampling:
 Statistical
 Non-statitical
2
FRAUD
The Risk of Fraud and Mechanisms to Address Fraud: Regulation, Corporate Governance, and Audit
Quality
• THE AUDIT OPINION FORMULATION PROCESS
• Professional Judgment in Context - Examples of Fraud in Organizations
• Fraudulent financial reporting can involve:
• Embezzlement of funds by higher-level management
• Diversion of funds by creating a separate account
• Inaccurate financial reporting
• Presentation of financial related reports that are not a formal part of financial
statements
• Professional Judgment in Context - Examples of Fraud in Organizations
Fraud
• An intentional act involving use of deception that results in a material misstatement of financial
statements
• Two types of misstatements
• Misappropriation of assets
• Fraudulent financial reporting
• Different from errors
• Errors occur unintentionally
Asset Misappropriation
• Involves theft or misuse of organization’s assets
• Examples
• Skimming cash
• Stealing inventory
• Payroll fraud
• A dominant fraud scheme perpetrated against small businesses
• Perpetrators commonly being employees
Asset Misappropriation
• Fraudulent Financial Reporting
• The intentional manipulation of reported financial results to misstate the economic condition of
the organization
• Common ways
• Manipulation, falsification, or alteration of accounting records or supporting documents
• Misrepresentation or omission of events or transactions
• Misapplication of accounting principles
• Define the Fraud Triangle and Describe the Three Elements of the Fraud Triangle
The Fraud Triangle

• Incentives or Pressures to Commit Fraud
• Management compensation schemes
• Financial pressures for improved earnings or an improved balance sheet
• Debt covenants
• Pending retirement or stock option expirations
• Personal wealth tied to either financial results or survival of company
• Greed
Incentives or Pressures to Commit Fraud

• Personal factors
• Pressure from family, friends, or culture
• Addictions to gambling or drugs
• Opportunities to Commit Fraud
• Significant related-party transactions
• Company’s industry position
• Management’s inconsistency involving subjective judgments
• Complex transactions
• Complex or difficult to understand transactions
• Ineffective monitoring of management by the board
• Complex or unstable organizational structure
• Weak or nonexistent internal controls
Rationalizing the Fraud

• Rationalization involves reconciling unlawful or unethical behavior
• Rationalization for fraudulent financial reporting
• “Saving” a company
• Rationalization for asset misappropriation
• Mistreatment by the company
• Sense of entitlement by the individual perpetrating the fraud
• Describe Implications for Auditors of Recent Fraudulent Financial Reporting Cases and
the Third COSO Report on Fraud
• Implications to Keep in Mind when Conducting an Audit

• Pressure created for top management by the analyst following and earnings expectations
• Before completing an audit, sufficient time should be allowed to examine major year-end
transactions:
• Especially if there are potential problems with revenue
• Understanding complex transaction to determine:
• Their economic substance
• The parties that have economic obligations
• Implications to Keep in Mind when Conducting an Audit
• Understanding and analyzing weaknesses in an organization’s internal controls
• To determine where and how a fraud may take place
• Developing audit procedures to address specific opportunities for fraud to take place
Professional Skepticism
• Center for Audit Quality (CAQ) describes professional skepticism as follows in its 2010 report on
fraud
• Skepticism involves the validation of information through probing questions, critical
assessment of evidence, and attention to inconsistencies
• Skepticism is meant to create a hostile atmosphere or to imply micromanagement
• Skepticism increases not only the likelihood that fraud will be detected, but also the
perception that fraud will be detected, which reduces the risk that fraud will be
attempted
Professional Skepticism
• Defined by international auditing standards
• An attitude that includes a questioning mind and a critical assessment of audit evidence
• Requires an ongoing questioning of whether the information and audit evidence
obtained suggests that a material misstatement due to fraud may exist
• Auditing in Practice - Professional Skepticism
• The Standard states:
• Auditor’s previous experience with an entity contributes to a better understanding of
the entity
• However, maintenance of professional skepticism is important because there may have
been changes in circumstances
• Auditors should not be satisfied with less-than-persuasive audit evidence based on a
belief that management and those charged with governance are honest and have
integrity
The Third COSO Report - An Analysis

• Identified the major characteristics of companies that had perpetrated fraud
• Compared fraud and nonfraud companies
• The Third COSO Report - An Analysis
• Major findings
• The amount and incidence of fraud remains high
• The median size of company perpetrating the fraud rose tenfold
• Heavy involvement in fraud by the CEO and/or CFO
• Most common fraud involved revenue recognition
• One-third of the companies changed auditors during the latter part of the fraud
• Majority of the frauds took place at companies that were listed on the Over-The-
Counter (OTC) market
• The Third COSO Report - An Analysis
• Common motivations for fraud among companies
• Need to meet internal or external earnings expectations
• Attempt to conceal deteriorating financial conditions
• Need to increase stock price
• Need to bolster performance for pending equity or debt financing
• Desire to increase management compensation based on financial results
The Enron Fraud: What went Wrong?

• Management accountability
• Corporate governance
• Accounting rules
• Financial analyst community
• Banking and investment banking
• External auditing profession and Arthur Andersen
•
Mitigating the Risk of Fraudulent Financial Reporting
• Center for Audit Quality recommends three ways in which individuals involved in the financial
reporting process can mitigate risk of fraudulent reporting
• Need to acknowledge the existence of a strong, highly ethical tone at the top of an
organization
• Need to consistently exercise professional skepticism in evaluating and/or preparing
financial reports
• Need to understand the role of strong communication in the financial reporting process
• Message to Auditors
• Assume greater responsibility for detecting fraud
• Provide assurance that financial statements are free of material fraud
Sarbanes-Oxley Act of 2002
• Broad legislation mandating new standard setting for audits of public companies and new
standards for corporate governance
• Applies to publicly traded companies
• Not privately held organizations
•
Corporate Governance
• A process by which owners and creditors exert control and require accountability for resources
entrusted to organizations
• Owners elect board of directors to provide:
• Oversight of organizations’ activities
• Accountability to stakeholders
Parties Involved in Corporate Governance

• Board of directors: The major representative of stockholders, who ensure that the organization
is run according to the organization’s charter and that there is proper accountability
• Audit committee: A subcommittee of the board of directors responsible for monitoring audit
activities and serving as a surrogate for the interests of shareholders
Parties Involved in Corporate Governance

• Board of directors and its audit committee oversee management
• Expected to protect stockholders’ rights
• Ensure that controls exist to prevent and detect fraud
• Stakeholders: Anyone who is influenced, either directly or indirectly, by actions of a company
Principles Related to Boards and Management

• Objective is to build long-term sustainable growth in shareholder value
• Responsible for creating a culture of performance with integrity and ethical behavior
• Effective corporate governance should be integrated with company’s business strategy
• Principles Related to Boards and Management
• Make efforts to ensure that companies have sound disclosure policies and practices –
transparency is very critical
• Independence and objectivity are necessary attributes of board members
• Responsibilities of Audit Committees
• Appointment, compensation, and oversight of work of registered accounting firms
• Must be independent
• Establish whistleblowing mechanisms within companies
• Authority to engage their own independent counsel
• Companies must provide adequate funding for audit committees
Auditing principles
1. Attributes of Auditors
Discuss the three or more attributes that an auditors possess in order to maintain credibility.
Explain the importance of these attributes to the audit.
ANS:
1) Subject Matter Knowledge - The assurance provider must be an expert in the
area of service provided. Expertise in a complex body of knowledge sets the
assurance professional apart from others.
2) Independence - The assurance provider must be unbiased, free from conflict of
interest, objective and independent of the company receiving assurance services.
This allows the professional to remain neutral and free from influence by parties
with a vested interest in the outcome of assurance services.
3) Agreed Upon Criteria - Clear criteria must be available for the assurance
provider to measure objectives and results against. In a financial statement
assurance engagement, the criteria are represented by Generally Accepted
Accounting Principles.
4) Process Expertise - Evidence is obtained and evaluated during the course of an
assurance engagement. Professionals providing these services must be able to
draw accurate conclusions based upon the results of testing competent, sufficient
evidence obtained.
2. Users of financial statements
Identify at least three types of users of financial statements. Describe their primary use of the
financial statements and how the misstatement of those statements might injure the user.
ANS:
Users of audited financial statements may include:
• Management may utilize the audit report to determine whether the financial
statements are presented in accordance with GAAP, whether the firm is availing
itself of appropriate internal controls, and as a means of evaluating employee
performance. Misstatement of the financial statements would cause the client to
make erroneous decisions about financial position, internal controls and
employee rewards and punishments.
• A financial institution that is asked to make a loan uses the financial statement to
judge the credit worthiness of the borrower. Misstatements in the financial
statements lead to errors in lending that jeopardize the assets of the bank and
depositors.
• A vendor who is asked to grant credit uses the statements and faces injury in a
manner similar to the financial institution.
• A third-party stockholder uses the financial statements to determine if the
investment will provide the returns consistent with the needs of the investor.
Misstatements of the financial statements will lead to different results or possible
loss of the investment.
• Others: Potential stockholders, taxing authorities, regulatory agencies, labor
unions, employees, bondholders, court system, retirement plans, or retired
employees
3. Overview of Financial Statement Audit
Define auditing and discuss how its components fit into an overview of a financial statement
audit.
ANS:
Financial statement auditing has been defined as a “systematic process of actively 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.”
4. Audit Quality
What is audit quality?
ANS:
A definition published by the GAO (2003) states that a quality audit is one performed “in
accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance
that the audited financial statements and related disclosures are presented in accordance with
generally accepted accounting principles GAAP and (2) are not materially misstated whether due
to errors or fraud. ”
What are three drivers of audit quality according to the Financial Reporting Council (FRC)’s
“The Audit Quality Framework”?
ANS:
There are five primary drivers of audit quality, including (1) audit firm culture, (2) the skills and
personal qualities of audit partners and staff, (3) the effectiveness of the audit process, (4) the
reliability and usefulness of audit reporting, and (5) factors outside the control of auditors that
affect audit quality.
5. The Need for Audited Financial Statements
Why do financial statement users need independent assurance about information provided by
management?
ANS:
The need for independent assurance arises from several factors:
* Potential bias —Management has incentives to bias financial information in order to convey a
better impression of the financial data than real circumstances might merit. For example,
management? ’s compensation may be tied to profitability or stock price, so managers may be
tempted to “bend” GAAP to make the organization ’s performance look better.
* Remoteness —An organization and the users of its financial information are often remote from
each other, both in terms of geographic distance and the extent of information available to the
both parties. Most users cannot interview management, tour a company ’s plant, or review its
financial records firsthand; instead, they must rely on financial statements to communicate the
results of management’s performance. This can tempt management to keep information from
users or bend GAAP so the organization looks better.
*Complexity —Transactions, information, and processing systems are often very complex, so it
can be difficult to determine their proper presentation. This provides an opportunity for
management to deceive users.
* Consequences —During the past decade, many financial statement users —pension funds,
private investors, venture capitalists, and banks —lost billions of dollars because financial
information had become unreliable. As an example, the factors leading up to, and the
consequences of, unreliable
information can be seen in the sub-prime mortgage crisis in the United States. Many borrowers
did not provide correct information on their loan applications and lenders sometimes did not
perform adequate due diligence in making lending decisions. Consequently, various financial
statement users and others suffered significant losses. When financial information is not reliable,
investors and other users lose a significant source of information that they need to make
decisions that have important consequences.
6. Requirements of auditors in public accounting
Recent landscape changes in accounting and auditing developed from corporate fraud and,
arguably, auditor failure. In order to continually lead and adapt to the dynamics of regulation,
principles based accounting practices and auditing standards, what types of skills and traits are
auditors required to possess?
ANS:
In addition to integrity, ethics and independence, auditors must possess an inherent ability to
understand the client. This pertains not only to the manner in which the company operates, but
the industry in which the client participates. The auditor must be able to use sound professional
judgment and skepticism to perceive issues and propose solutions. An auditor must understand
the environment in which a client does business. The surrounding economic, cultural and
political aspects of a company are all vital to the auditor's understanding of risks.
An auditor must be able to interpret a complex body of knowledge, apply audit procedures and
measure assertions against the criteria of generally accepted accounting principles. Risks must be
adequately considered for the audit and the client so that the audit firm may reduce exposure in
the marketplace.
Information technology used by clients must also be understood by the auditor so that internal
control, prevention and detection of misstatements and the audit trail might be assessed.
Similarly, the auditor must use software to perform an audit efficiently and adequately.
INTERNAL CONTROL OVER FINANCIAL REPORTING:
MANAGEMENT’S RESPONSIBILITIES AND IMPORTANCE TO THE
EXTERNAL AUDITORS
Learning Objectives
1. Articulate the importance of internal control over financial reporting for organizations
and their external auditors
2. Define internal control as presented in COSO’s updated Internal Control, Integrated
Framework and identify the components of internal control
3. Describe the control environment component of internal control, list its principles,
and provide examples of each principle
4. Describe the risk assessment component of internal control, list its principles, and
provide examples of each principle
5. Describe the control activities component of internal control, list its principles, and
provide examples of each principle
6. Describe the information and communication component of internal control, list its
principles, and provide examples of each principle
7. Describe the monitoring component of internal control, list its principles, and provide
examples of each principle
8. Identify management’s responsibilities related to internal control over financial
reporting, including the factors management considers when assessing control
deficiencies
Importance of Internal Control for Safeguarding Assets

• To achieve the objective of reliable financial reporting, organizations need to have
effective controls in place
Important concerns:
• Why is internal control over financial reporting important to an organization?
• How does internal control help an organization achieve reliable financial reporting?
• Why does an external auditor need to know about a client’s internal control?
• What is internal control over financial reporting, and what are its components?
• What type of control is segregation of duties, and what risks is that control intended to
mitigate?
• Articulate the Importance of Internal Control Over Financial Reporting for
Organizations and Their External Auditors
Importance of Internal Control Over Financial Reporting
• Internal control helps:

• Mitigate risks of not achieving organizational objectives
• Provide confidence regarding reliability of financial information
• Reduce occurrence of unforeseen circumstances
• Improve quality of information
Control Deficiencies and Poor Decisions at Reliable Insurance Co.
• Reliable Insurance Co. introduced an insurance policy to provide supplemental

coverage to Medicare benefits for the elderly
• The company’s internal control system failed to record claims on a timely basis
• It underpriced the policies and misrepresented its financial condition to
shareholders and lenders
• It led to:
• Unreliable financial statements
• Failure of the business
Importance of Internal Control to the External Audit

• Auditors are required to identify and assess risks of material misstatement due to
fraud or error
• For this, the auditor needs to understand the company’s internal controls to
determine appropriate audit procedures
• Integrated audit: Occurs when an auditor provides an opinion on:
• The effectiveness of the client’s internal control over financial reporting and
• The financial statements
THE COMPONENTS OF INTERNAL CONTROL
• Internal Control, Integrated Framework

• Most widely used internal control framework
• Published by COSO (Committee of Sponsoring Organizations)
• COSO’s updated Internal Control, Integrated Framework
• Comprehensive framework of internal control
• Used to assess effectiveness of:
• Internal control over financial reporting
• Controls over operational and compliance objectives
• Internal Control - Integrated Framework
• COSO defines internal control as a process:

• Effected by an entity’s board of directors, management, and other personnel
• Designed to provide reasonable assurance regarding achievement of objectives
relating to operations, reporting, and compliance
COSO Framework for Internal Control
Components of internal control
• Risk assessment: Process for identifying and assessing risks that may affect
organizations from achieving objectives
• Control environment
• Set of standards, processes, and structures that provides the basis for carrying
out internal control across the organization
• Includes the tone at the top regarding importance of:
• Internal control
• Expected standards of conduct
• Control activities: Actions established by policies and procedures
• Help ensure that management’s directives regarding internal control are
carried out
• Information and communication
• Information can come from internal and external sources
• Communication is the process of providing, sharing, and obtaining necessary
information
• Monitoring: Helps determine whether the controls are present and continuing to
function effectively
Effective internal controls need to:
• Be effectively designed and implemented

• Operate effectively
• Entity-Wide Controls
• Operate across an entity and affect multiple processes, transactions, accounts, and
assertions
• Controls related to control environment
• Controls over management override
• Organizations’ risk assessment process
• Centralized processing and controls
• Controls to monitor results of operations
• Controls over period-end financial reporting process
• Policies that address business control and risk management practices
• Transaction Controls
• Control activities implemented to mitigate transaction processing risk
• Affect certain processes, transactions, accounts, and assertions
• Do not have an entity-wide effect
A strong control environment protects against risks related to reliability of financial

statements
• Examples of control environment deficiencies

• Low level of control consciousness within an organization
• Audit committee not having independent members
• Absence of an ethics policy within an organization
Ethical Values and the Control Environment at HealthSouth

• In the case of HealthSouth, it did not matter that the organization had a code of ethics
for its employees
• The company and its board were dominated by the management
• The unwritten message was stronger than any written message: “Do what we want
you to do or lose your job”
• This illustrates that a weak control environment enables fraud to occur
Commitment to Integrity and Ethical Values - COSO Principle 1

• Demonstrated through the tone set by the board and management
• Organizations should have:
• Standards of conduct regarding expectations for integrity and ethical values
• Processes in place to determine if individuals are performing in accordance
with expected standards of conduct
• Processes for identifying and addressing any deviations in expected conduct
Inappropriate Tone Regarding Internal Controls Leads to Other Deficiencies at

NutraCea
• The weak control environment at NutraCea led to other material weaknesses in
internal control
• Management failed to properly analyze, account for, and record significant sales
contracts for proper revenue recognition
• Management failed to retain the resources to:
• Analyze significant transactions
• Prepare financial statements
• Respond to regulatory comments in a timely manner
Board of Directors Exercises Oversight Responsibility - COSO Principle 2

• Board of directors includes various committees
• Audit committee oversees management
• Compensation committee
• Reviews and approves compensation of top officers
• Oversees organization’s benefit plans
• Makes recommendations regarding board compensation
• Board of directors is required to exercise objective oversight for the development and
performance of internal control
• The board should have:
• Sufficient knowledge and skills to fulfill its oversight responsibilities
• Sufficient number of independent members to ensure the board’s objectivity
Managements Establish Structure, Authority, and Responsibility - COSO

Principle 3
Organization Demonstrates Commitment to Competence - COSO Principle 4

• Commitment towards competence is demonstrated through policies and procedures
to:
• Attract
• Train
• Mentor
• Evaluate
• Retain employees
Organization Enforces Accountability - COSO Principle 5

• Individuals held accountable for internal control responsibilities
• Accountability mechanisms
• Establishing and evaluating performance measures
• Providing appropriate incentives and rewards
• Describe the Risk Assessment Component of Internal Control, List Its
Principles, and Provide Examples of Each Principle
•
COSO Component - Risk Assessment
• Internal sources of risk
• Changes in management responsibilities
• Changes in internal information technology
• Poorly conceived business model
• External sources of risks
• Economic recessions decrease product or service demand
• Increase in competition
• Changes in regulation that make the business model unsustainable
• Changes in the reliability of source goods that reduce profitability
Specifies Relevant Objectives -COSO Principle 6

• When specifying the objectives of reliable financial reporting, management should
take steps for financial reporting to reflect underlying transactions and events
• Financial reporting objectives should be consistent with accounting principles
• Management should consider level of materiality when specifying objectives
Identifies and Analyzes Risk - COSO Principle 7

• Appropriate levels of management need to be involved in the identification and
analysis of risk
• Risk identification should include both internal and external factors
• External - Economic changes that may impact barriers to competitive entry
• Internal - Change in management responsibilities that could affect the way
certain controls operate
Assesses fraud risk - COSO Principle 8

• Risks related to misappropriation of assets and fraudulent financial reporting
• Assessment of fraud risk considers:
• Ways in which the fraud could occur
• Fraud risk factors that impact financial reporting
• Incentives and pressures that might lead to fraud
• Opportunities for fraud
• Personnel who might engage in or rationalize fraud activities
• Auditing in Practice - Ineffective Internal Control Over Financial
Reporting Leads to Embezzlement at Citigroup
• A mid-level accountant in Citigroup’s office embezzled about $19 million from the
company
• He transferred money from various Citigroup accounts to his personal bank
account by making adjusting journal entries from interest expense accounts
and debt adjustment accounts to Citigroup’s main cash accounts
• To conceal the transactions, he used a false contract number in the reference
line of the wire transfer
Identifies and analyzes significant change - COSO Principle 9

• As internal and external conditions change, an organization’s internal controls need to
change
• Example - The introduction of new information system technologies
• An organization needs a process for identifying and assessing changes in internal and
external factors that can affect its ability to produce reliable financial reports
• Describe the Control Activities Component of Internal Control, List Its Principles, and
Provide Examples of Each Principle
COSO Component: Control Activities

• Ensure that management’s directives regarding controls are accomplished
• Performed within processes
• Performed at all levels of an organization
Selects and Develops Control Activities - COSO Principle 10

• No universal set of control activities applicable to all organizations
• Organizations select and develop control activities that are specific to the risks
they identify during risk assessment
• Application controls (also referred to as transaction controls): Activities implemented
to mitigate transaction processing risk that affect only certain processes, transactions,
accounts, and assertions
• Transaction Processing under Control Activities
• Control objectives desired by an organization
• Recorded transactions exist and have occurred
• All transactions are recorded
• Transactions are properly valued
• Transactions are properly presented and disclosed
• Transactions relate to rights or obligations of the organization
Transaction Processing under Control Activities

• Accounting estimates should be based on underlying processes and data that have
been successful in providing accurate estimates in the past
• Controls should be built around the processes to provide reasonable assurance that:
• The data are accurate
• The estimates are faithful to the data
• The underlying estimation model reflects current economic conditions and has
proven to provide reasonable estimates in the past
• Controls over adjusting, closing, and other unusual entries
• Documented support for all entries
• Reference to underlying supporting data with a well-developed transaction
trail
• Transaction trail: Records that allow auditors to trace transactions from
origination through final disposition, or vice versa
• Review by CFO or controller
• Automated and Manual Transaction Controls
Application controls mitigate risks, whether automated or manual

• Input controls
• Designed to ensure that:
• Authorized transactions are correct and complete
• Only authorized transactions can be input
• Types of inputs controls
• Input validation tests (also referred to as edit tests): Built into an
application to examine input data for obvious errors
• Self-checking digits: Developed to test for transposition errors
associated with identification numbers
• Operate by computing an extra digit, or several digits, that are
added into a numeric identifier
• Processing controls
• Correct program used for processing
• All transactions are processed
• Transactions update appropriate files
• Output controls
• All data are completely processed
• Output is distributed only to authorized recipients
• Other Important Control Activities
• Segregation of duties: Protect against risk that individuals may collude to conceal a
fraud
• Requires that a minimum of two employees be involved such that one does not
have:
• Authority and ability to process transactions
• Custodial responsibilities
• Physical controls over assets: Protect and safeguard assets from accidental or
intentional destruction and theft
• Other Important Control Activities
• Preventive controls: Designed to prevent occurrence of a misstatement
• Most cost efficient
• Detective controls: Designed to discover errors that occur during processing
Selects and Develops General Controls over Technology - COSO Principle 11
• General computer controls (also referred to as technology general controls or

information technology controls ): Pervasive control activities that affect multiple
types of information technology systems
• Include manual or automated control activities over:
• Technology infrastructure
• Security management
• Technology acquisition, development, and maintenance
• Technology Infrastructure
• Provides the support for information technology to function effectively
• Control activities are necessary to check the technology for any problems and take
corrective action
• Other control activities related to infrastructure
• Backup procedures
• Disaster recovery plans
Security Management
• Control activities that limit access to technologies
• Security control activities protect from inappropriate and unauthorized access
• Considerations in security management related to user access:
• Data item access limited to those who are directly involved
• Ability to change, modify, or delete a data item restricted to those with
authorization
• Security Management
• Ability to identify and verify any potential users as authorized or
unauthorized for the data item and function requested
• A security department should actively monitor attempts to compromise
the system and prepare periodic reports to those responsible for the
integrity and access of data
• Methods used by organizations to develop technologies
• In-house - An organization should have:
• Polices on documentation and approval requirements
• Authorization of change requests
• Appropriate protocols and testing of changes made
• Packaged software - An organization should have policies regarding selecting and
implementing these packages
• Outsource arrangements
Deploys through Policies and Procedures - COSO Principle 12
• Policies should:
• Outline what is expected
• Establish clear responsibility and accountability
• Procedures should:
• Put policies into action
• Be performed diligently, consistently, and by appropriate and competent
personnel in a timely manner
COSO Component - Information and Communication

• Information - Required by an organization from internal and external sources to carry
out its internal control responsibilities
• Communication
• Process of providing, sharing, and obtaining information internally
• Requires two-way communication with external parties
Uses Relevant Information - COSO Principle 13
• Identify and obtain internal and external information to:

• Support internal control
• Achieve objective of reliable financial reporting
Communicates Internally - COSO Principle 14
• Internal communication of information occurs throughout organizations through:

• Periodic newsletters
• Posters in the break rooms
• Formal communications from senior management
• Whistleblower function - Special line of communication needed for anonymous or
confidential communications
Communicates Externally - COSO Principle 15
• Two-way communication with external parties

• Shareholders
• Business partners
• Customers
• Regulators
• External communication should include messages regarding:
• Importance of internal control
• Organization’s values and culture
COSO Component - Monitoring
• Process that provides feedback on effectiveness of each of the five components of

internal control
• For its accomplishment, managers select either of the following or a combination of
both
• Mix of ongoing evaluations
• Separate evaluations
• Requires that identified deficiencies in internal control be communicated to the
personnel concerned with follow-up action taken
Conducts Ongoing and/or Separate Evaluations - COSO Principle 16
• Ongoing evaluations: Procedures built into the normal recurring activities of an entity
• Computerized monitoring undertaken by organizations to review large volume
of transactions
• Separate evaluations: Conducted periodically by:
• Objective management personnel
• Internal auditors
• External consultants
Evaluates and Communicates Deficiencies - COSO Principle 17
• Control deficiencies identified need to be communicated to appropriate personnel to

take appropriate corrective actions on a timely basis
Documentation of Internal Control
• Provide clarity and communication of standards and expectations

• Can be either paper or electronic
• Advantages
• Help train new personnel
• Serve as a reference tool for all employees
• Provide evidence that the controls are operating
• Enable proper monitoring activities
• Support reporting on internal control effectiveness
• Used by external auditors to understand client’s internal control system
• Documents supporting management’s assessment as an audit evidence
required
• Documents required for supporting financial transactions
• Authorization of transactions
• Existence of transactions
• Support for journal entries
• Financial commitments made
• Guidelines for Developing Reliable Documentation
• Prenumbered paper or computer-generated documents facilitate control of, and
accountability for, transactions
• Timely preparation
• Improves credibility and accountability of documents
• Decreases rate of errors on all documents
• Authorization of a transaction
Transaction trail
• Tracing a transaction from its origination through to its final disposition, or

vice versa
• important aspects of Electronic Transaction Trail
• Unique identification of transaction
• Date and time of transaction
• Individual responsible for the transaction
• Location from which the transaction originated
• Details of the transaction
• Cross-reference to other transactions
• Authorization or approval of the transaction
• Reporting on Internal Control Over Financial Reporting
• Sarbanes-Oxley Act of 2002 requires public company management to annually report
on the design and operating effectiveness of controls
• Guidelines provided by U.S. Securities and Exchange Commission (SEC) require:
• Suitable criteria be used as the benchmark in assessing internal control
effectiveness
• The five internal control components be viewed as part of an integrated system
in making the assessment
Evaluating Internal Control Over Financial Reporting
• Management identifies significant risks to reliable financial reporting

• Significant account: Possibility of material misstatement without considering
effect of internal controls
• Relevant assertion: Judgment in valuing an account without considering effect
of internal controls
• Management conducts a walkthrough to focus on design and operating effectiveness
of controls
• Walkthrough: Process whereby management follows a transaction from
origination through organization’s processes until it is reflected in
organization’s financial records
• Includes a combination of:
• Inquiry
• Observation
• Inspection of documentation making up transaction trail
• Reperformance of controls
Assessing Internal Control Deficiencies
• Control deficiency: Shortcoming in internal controls such that objective of reliable

financial reporting may not be achieved
• Design deficiency - Control necessary to meet control objective missing
• Operation deficiency - Properly designed control does not operate as designed
Categories of control deficiencies:

• Material weakness
• A deficiency, or a combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a material
misstatement of the company’s annual or interim financial statements will not
be prevented or detected on a timely basis
• Significant deficiency
• A deficiency, or a combination of deficiencies, in internal control over
financial reporting that is less severe than a material weakness, yet
important enough to merit attention by those responsible for oversight
of the company’s financial reporting
• Not needed to be reported to external users
• Not included in management’s report on internal control
effectiveness
• Severity of a deficiency depends on:

• Magnitude of the potential misstatement resulting from the deficiency
• Whether there is a reasonable possibility that the organization’s controls will
fail to prevent, or detect and correct a misstatement
• Consideration of specific facts and circumstances surrounding the identified
deficiency

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Modules in Auditing (A Risk Based Approach)

Prepared by: ROLANDO E. ROBLEDO DBA, CPA, FBE

Module 1n Principles of Auditing

“Where Financial Accounting ends, Auditing begins”

Discuss the history and evolution of auditing.

Describe the nature of an audit

Discuss the different types of audit

ENTRY TEST/ PRE TEST

How do financial accounting differ from auditing?

What is the importance of auditing the financial statements of an enterprise?

What are the differences between internal and external auditors?

Double-entry bookkeeping was first described in Italy (Pacioli 1494).

1853 the Society of Accountants in Edinburgh was founded.

Is the company a going concern?

Is there integrity in its database?

Do directors have proper and adequate information to make decisions?

Are there adequate controls?

Can an ‘unfortunate mistake’ bring this company to its knees?

American Accounting Association

External Auditing Profession

Financial statement audit

Reliability of financial statements

Internal control effectiveness

Audit report is modified to explain the nature of the reservations

Adverse opinion is expressed when auditors believe that:

Client’s internal controls not effective

External Auditing: A Special Function

Most important party served by the auditors is the public

Freedom from bias

Concern for the integrity of the financial reporting process

Auditors - Guardians of the capital markets

Public expects auditors to:

Auditing profession faces many pressures

Keeping fees down

Making careful decisions regarding independence

Conducting a quality audit

Can an auditor owns its clients shares of stock?

When auditors own stock in their audit clients

External users may perceive an independence conflict

Consequences- With unreliable information, investors lose a significant source of information

Overall Objectives in Conducting an Audit

Reporting on financial statements based on auditor’s findings

In completing these objectives, the auditor:

Complies with relevant ethical requirements

Plans and performs an audit with professional skepticism

Exercises professional judgment

Obtains sufficient appropriate evidence on which to base the auditor’s opinion

Conducts audit in accordance with professional auditing standards

General Principles Governing an Audit of Financial Statements

An auditor should conduct an audit in accordance with Phil. Standards on Auditing.

Test and sampling

Audit process permeated by judgment

Parties Involved in Preparing and Auditing Financial Statements

Providers of External Auditing Services

External auditing profession includes:

Local and regional firms

Large multinational professional services firms

Organizational hierarchy of audit firms

Responsible for overall conduct of each audit