2.

0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
Overview of the audit process likelihood of misstatements in account balance
and then adjusts the amount and type of audit
(1) Pre-engagement Activities work to the likelihood of material misstatements
a. Investigate new clients and existing clients occurring in account balances
b. Obtain an engagement letter - Auditors must focus on the risks to the entity’s
(2) Planning activities operations and ensure controls are in place to
a. Obtain knowledge of the client’s business eliminate, mitigate or compensate for those risks
b. Obtain preliminary understanding of - Audit teams now devote a significant amount
internal controls of their engagement planning to their client’s
c. Design a preliminary account balance business risks. Business risk is the risk that the
audit program (based on knowledge of client will fail to achieve its objectives.
internal controls)
d. Assign partner, manager and staff to Under this approach, the auditor performs the
engagement ff:
(3) Internal Control Risk Assessment 1. Identification of the client’s strategy and the
Activities processes for developing that strategy
a. Gathers evidence and evaluates the 2. Examination of the core business process and
client’s internal control structure. resource management
(4) Document the assessed level of control 3. Identification for each of the key processes
risk (and sub-processes) the inputs, activities,
a. Modify the audit program to final form if outputs, systems and transactions.
necessary 4. Assessment of the risks that the processes will
(5) Account Balance Audit Activities not meet the goals and controls related to
a. Gather evidence about the account those risks
balance peso amounts and related
footnote disclosures. Prepare audit Risk – is a concept used to express
working papers uncertainty about events and/or their outcomes
b. Decide whether or not evidence is that could have a material effect on the
sufficient. If not obtain more, unless cost is organization Four components of risk relevant
prohibitive to conducting the audit:
c. Evaluate the evidence and make audit
decision. Document the decision in
working papers
(6) Reporting Activities - Decide on appropriate
audit report opinion

Steps/Stages in Risk-Based Audit

1) Risk Assessment
2) Risk Response
3) Reporting

Auditor’s standard report:

We conducted our audits in accordance with Phil.
Standards on Auditing. Those standards require
that we comply with ethical standards and plan
and perform the audit to obtain reasonable
assurance about whether the financial statements
are free of material misstatements.
 The phrase “reasonable assurance” is intended
to inform the users that auditors do not
guarantee or insure the fair
 presentation.
 This phrase communicates that there is some
risk that the financial statements are not fairly
stated even when the opinion of the auditor is
unqualified.
 The phrase “free of material misstatement” is
intended to inform the users that the auditor’s
responsibility is limited to material financial 1) Audit risk
information. 2) Engagement risk
3) Financial reporting risk
Materiality is important because it is 4) Business risk
impractical for auditors to provide assurance
on immaterial amounts.
Audit risk: The risk that an auditor may give an
Thus, materiality and risk are fundamental
unqualified opinion on financial statements that
concepts that are important to planning the
are materially misstated. Risk that the auditor
audit and designing the audit approach.
fails to find material misstatements in the
client’s FS and thereby inappropriately
Risk-based approach is an audit approach that
issues an unqualified opinion of the FS. The
begins with an assessment of the types and
auditor can control the risk in two ways:
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
 Avoid audit risk by not accepting certain required
companies as client. B. Forming an opinion based on audit findings and
 Set audit risk at a level that the auditor preparing the auditor’s report
believes will mitigate the likelihood that the
auditor will fail to identify material
misstatements. Phase I-A Performance of Preliminary
It is not possible to completely eliminate Engagement Activities (Pre-Engagement
audit risk, but it can be reduced by doing Activities)
more work. However, doing more work increases At the beginning, the auditor should perform:
audit fees, which may create issues with the client.  Perform procedures required by PSA 220
“Quality Management of an Audit of Financial
Engagement risk: Economic risk that a CPA firm Statements” regarding the continuance of the
is exposed to, due to association with a client relationship and the specific audit
particular client, including loss of reputation, engagement
inability of client to pay the auditor, or  Evaluate compliance with ethical
financial loss because management is not honest requirements, including independence as
and inhibits the audit process. This risk is required by PSA 220
controlled by careful selection and retention  Establish an understanding of the terms of
of client engagement as required by PSA 210 “Agreeing
the Terms of Audit Engagements”
Financial reporting risk: Those risk that relate
directly to the recording of transactions and Pre-engagement
presentation of financial data in an organization’s (1) Acceptance and Continuance of Client
financial statements. Would arise from issues such Relationships and Audit Engagements (PSA 220) -
as assets impairments, mark-to-market In making a decision whether to accept or
accounting, warranties, pensions, estimates as well reject an engagement, an auditor should
as competence and integrity of management and consider the following:
incentives to misstate the FS a) Integrity of the Client (PSQC 1 A19) -
It is essential for a CPA firm to maintain its
Business risk: Those risk that affect the integrity, objectivity and reputation for
operations and potential outcomes of providing high quality services. Auditors
organizational activities. Business risk and financial cannot afford to be regularly associated
reporting risk, generally originates from the with clients who are engaging in
client and its environment, and these risks management fraud or other unlawful
then affect the auditor’s engagement risk activities. (this is related to engagement
and audit risk. The effectiveness of risk risk).
management processes will determine whether a Before accepting any engagement, the CPA
company or audit firm will continue to exist. should investigate the history of the
Business risk and financial reporting risk may prospective client, including such matters as
affect each other. Ex. Management facing strong the:
competition and weak financial results may be - Identities and reputation of the directors, officers
motivated to circumvent a weak internal control and major stockholders.
system or take advantage of complex financial - The nature of the client’s operations, including its
instruments to achieve desired financial results. business practices
Audit firms discovered that being associated - Indications that the client might be involved in
with companies with poor integrity creates money laundering or other criminal activities
risk that can destroy the audit firm or
significantly increase the cost of conducting the b) Competence of the auditor and team
audit. Engagement Team (PSA 220 A11) -
When considering the appropriate
Risk-Based Audit Process competence and capabilities expected of
Phase I – Risk Assessment the engagement team as a whole, the
A. Performance of preliminary engagement following are considered:
activities to decide whether to accept/continue an i. Understanding of, and practical
audit engagement experience with, audit engagements
B. Planning the audit to develop an overall audit of a similar nature and complexity
strategy and plan through appropriate training and
C. Performance of risk assessment procedures to participation.
identify the risk of material misstatement through ii. Understanding of professional
understanding the entity standards and regulatory and legal
Phase II – Risk Response requirements.
A. Designing overall responses and further audit iii. Technical expertise, including
procedures to develop appropriate responses to expertise with relevant information
the assessed risk of material misstatement technology and specialized areas of
B. Implementing responses to assessed risk of accounting or auditing.
material misstatement to reduce audit risk to an iv. Knowledge of relevant industries in
acceptably low level which the client operates.
Phase III – Reporting v. Ability to apply professional judgment.
A. Evaluating the audit evidence obtained to vi. Understanding of the firm’s quality
determine what additional audit work (if any( is control policies and procedures
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
limitation will result in the auditor disclaiming an
Other things to consider: opinion on the financial statements, the auditor
1. Engagement Performance shall not accept such a limited engagement
 Direction, Supervision and Performance as an audit engagement, unless required by
 Reviews law or regulation to do so.
 Consultation
 Engagement Quality Control Review Performing the preliminary engagement activities
enables the auditor to plan an audit engagement:
c) Compliance with independence and a. The auditor maintains the necessary
relevant ethical requirements of the independence and ability to perform the
auditor and team - engagement
d) Significant matters that have arisen b. There are no issues with management
during the current or previous audit integrity that may affect the auditor’s
engagement - For example, a client may willingness to continue the engagement
have started to expand its business c. There is no misunderstanding with the
operations into an area where the firm client as to the terms of engagement
does not possess the necessary expertise. Consideration for client continuance and ethical
requirements, including independence occurs
(2) Compliance with Relevant Ethical requirements throughout the audit engagement as conditions
(PSA 220) - Throughout the audit engagement, the and changes in circumstances occur
engagement partner shall remain alert, through
observation and making inquiries as necessary, for Client Selection And Retention
evidence of noncompliance with relevant ethical It is essential for a CPA firm to maintain its
requirements by members of the engagement integrity, objectivity and reputation for providing
team. high quality services. Auditors cannot afford to be
If matters come to the engagement partner’s regularly associated with clients who are engaging
attention through the firm’s system of quality in management fraud or other unlawful activities.
control or otherwise that indicate that members of Before accepting any engagement, the CPA should
the engagement team have not complied with investigate the history of the prospective client,
relevant ethical requirements, the engagement including such matters as the identities and
partner, in consultation with others in the firm, reputation of the directors, officers and major
shall determine the appropriate action which may stockholders. To help assess engagement risk,
include eliminating the activity or interest that auditors:
creates the threat, or withdrawing from the audit  generally obtain management’s permission to
engagement, where withdrawal is legally make inquiries of other 3rd parties
permitted.  CPAs choose to avoid engagements entailing a
high engagement risk
(3) Establish an understanding of the terms of  assess whether they can complete the audit in
engagement: Preconditions For An Audit (PSA accordance with PSAs
210) Others may accept such engagements, but
Before accepting an engagement with a new client, are aware that it is a must to expand audit
the CPA firm shall establish conditions: (PSA 210) procedures to offset unusually high levels of
1) Whether the financial reporting framework to risk.
be applied in the FS is acceptable To reduce their business risk, public
2) The agreement of management that it accounting firms:
acknowledges and understands its  try to carefully manage their audit
responsibility for: engagements
i. Preparation of FS in accordance with  are not obligated to accept undesirable clients
applicable financial reporting framework  are not obligated to continue to serve clients
ii. Internal control to enable the preparation when relationships deteriorate or when
of FS that are free from material management behavior becomes suspicious
misstatement, whether due to fraud or
error Final step - The CPA firm will confer and agree
iii. Providing the auditor with management the terms of the audit
Access to all information of engagement.
which management is aware is The agreed terms shall be recorded in an
relevant to the preparation of FS such as audit engagement letter or in other written
records, documentation and other matters form of agreement and shall include:
Additional information that the i. The objective and scope of audit of the FS
auditor may request from management ii. The responsibilities of the auditor
for the purpose of the audit iii. The responsibilities of management
Unrestricted access to persons iv. Identification of the applicable financial
within the entity from whom the auditor reporting framework for the preparation of FS
determines it is necessary to obtain audit v. Reference to the expected form and content of
evidence any reports to be issued by the auditor and a
statement that there may be circumstances in
If management or those charged with governance which a report may differ from its expected
impose a limitation on the scope of the form and content
auditor’s work in the terms of a proposed audit
engagement such that the auditor believes the Engagement letter - General contents of the
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
letter: the terms of the audit engagement and is not
(a) The objective and scope of the audit of the permitted by management to continue the
financial statements; original audit engagement, the auditor shall:
(b) The responsibilities of the auditor; a) Withdraw from the audit engagement where
(c) The responsibilities of management; possible under applicable law or regulation;
(d) Identification of the applicable financial and
reporting framework for the preparation of the b) Determine whether there is any obligation,
financial statements; and either contractual or otherwise, to report the
(e) Reference to the expected form and content of circumstances to other parties, such as those
any reports to be issued by the auditor and a charged with governance, owners or
statement that there may be circumstances in regulators.
which a report may differ from its expected form
and content. Knowledge of the business
Risk assessment procedures and sources of
Acceptance of a Change in the Terms of the information about the entity and its environment,
Audit Engagement (PSA 210) including its internal control. Purpose of risk
 The auditor shall not agree to a change in the assessment procedures:
terms of the audit engagement where there is no  To obtain an understanding of the client.
reasonable justification for doing so.  Information obtained may be used as audit
 A change in circumstances that affects the evidence to support assessments of the risks
entity’s requirements or a misunderstanding of material misstatements.
concerning the nature of the service originally  The auditor may choose to perform
requested may be considered a reasonable basis substantive procedures or tests of control
for requesting a change in the audit engagement. concurrently with risk assessment procedures
 In contrast, a change may not be considered to be efficient.
reasonable if it appears that the change relates to Risk assessment procedures
information that is incorrect, incomplete or 1) Inquiries of management and others within the
otherwise unsatisfactory. An example might be entity
where the auditor is unable to obtain sufficient  From which people will the auditor make
appropriate audit evidence regarding receivables inquiries?
and the entity asks for the audit engagement to  From management
be changed to a review engagement to avoid a  From those responsible for financial
qualified opinion or a disclaimer of opinion. If, reporting
prior to completing the audit engagement, the  From others within the firm (internal audit
auditor is requested to change the audit personnel, or production)
engagement to an engagement that conveys a  From other employees with different levels
lower level of assurance, the auditor shall of authority
determine whether there is reasonable  The auditor should inquire about the
justification for doing so. entity’s external legal counsel or valuation
 Before agreeing to change an audit experts that the entity has used and
engagement to a review or a related service, an reviewing information obtained from
auditor who was engaged to perform an audit in external sources such as reports by
accordance with PSAs may need to assess, in analysts, banks, or rating agencies, trade
addition to the matters referred to in previous and economic journals, or regulatory or
slide, any legal or contractual implications of the financial publications, etc.
change.
 If the auditor concludes that there is 2) Analytical procedures - helpful in identifying
reasonable justification to change the audit the existence of unusual transactions, events,
engagement to a review or a related service, the amounts, ratios and trends that might indicate
audit work performed to the date of change may matters which have FS and audit implications.
be relevant to the changed engagement; The auditor develops expectations about
however, the work required to be performed and plausible relationships that are reasonably
the report to be issued would be those expected to exist. When comparison of those
appropriate to the revised engagement. In order expectations with recorded amounts or ratios
to avoid confusing the reader, the report on the yields unusual or unexpected relationships, the
related service would not include reference to: auditor considers those results in identifying
a) The original audit engagement; or risks of material misstatements. Often, such
b) Any procedures that may have been analytical procedures use data aggregated at
performed in the original audit a high level. In such case, the auditor should
engagement, except where the audit consider the results of analytical procedures
engagement is changed to an engagement along with other information gathered in
to undertake agreed-upon procedures and identifying the risks of material misstatement
thus reference to the procedures
performed is a normal part of the report 3) Observation and inspection - Specific audit
 If the terms of the audit engagement are procedures:
changed, the auditor and management shall  Observation of entity’s operations
agree on and record the new terms of the  Inspection of documents, records and
engagement in an engagement letter or other internal control manuals
suitable form of written agreement.  Reading reports prepared by management
 If the auditor is unable to agree to a change of (quarterly management reports and
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
interim financial statements) and those the aggregate, could reasonably be expected to
charged with governance (minutes) influence the economic decisions of users taken on
 Visits to entity’s premises and plant the basis of the financial statements
facilities -Judgments about materiality are made in light of
 Tracing transactions through the surrounding circumstances, and are affected by
information system relevant to financial the size or nature of a misstatement, or a
reporting (walk-throughs) combination of both; and
-Judgments about matters that are material to
Understanding the Entity and Its users of the financial statements are based on a
Environment Including Its Internal Control. consideration of the common financial information
Auditor’s understanding consists of the following: needs of users as a group.
 Relevant industry, regulatory, and other -In designing the audit plan, the auditor establishes
external factors including applicable financial an acceptable materiality level so as to detect
reporting framework quantitatively material misstatements.
 Nature of the entity -The auditor also needs to consider the possibility
 The entity’s selection and application of of relatively small misstatements that
accounting policies, including the reasons for cumulatively, could have a material effect on the
any changes. FS.
 The entity’s objectives and strategies, and -Ex. An error in month-end procedure could be an
those related business risks that may result in indication of a potential misstatement if that error
risks of material misstatements is repeated every month
 The measurement and review of the entity’s
financial performance In planning the audit, materiality should be
 Internal control considered by the auditor when:
Determining the nature, timing and extent of audit
Materiality procedures
Application of the Concept of Materiality to Audit Identifying and assessing the risks of material
PSA 320 “Materiality in Planning and Performing an misstatements
Audit” Determining the nature, timing and extent of
-establishes standards and deals with auditor’s further audit
responsibility to apply the concept of materiality in The auditor’s determination of materiality is a
planning and performing an audit of financial matter of professional judgement and is affected
statements. by the auditor’s perception of the financial
information needs of users of FS. It is reasonable to
Materiality (FRSC) assume that the users:
Information is material if its omission or Have a reasonable knowledge of business and
misstatement could influence the economic economic activities and accounting and a
decisions of users taken on the basis of the willingness to study the information in the FS with
financial statements. reasonable diligence
Materiality depends on the size of the item or error Understand that FS are prepared, presented and
judged in the particular circumstances of its audit to levels of materiality
omission or misstatement Recognize uncertainties inherent in the
Thus materiality provides a threshold or cut-off measurement of amounts, based on the use of
point rather than being a primary qualitative estimates, judgement and consideration of future
characteristics which information must have if it is events
to be useful. Make reasonable economic decisions on the basis
Auditor’s must therefore have knowledge of the of the information in the FS
likely uses of their client’s statements and the
decisions that are being made. Levels of Materiality
Materiality involves both quantitative and 1st level – overall materiality (or materiality for the
qualitative considerations. In assessing the FS as a whole)
quantitative importance of a misstatement, it is 2nd level – specific materiality (or materiality level
necessary to relate the peso amount of the error to for particular classes of transactions, account
the FS being examined balances or disclosure)
Qualitative considerations, relate to the causes of
misstatement. An error that may not be material Overall Materiality
quantitatively, may be material qualitatively. – is based on the auditor’s professional judgement
Ex. as to the highest amount of misstatements that
Misstatement is due to irregularity or illegal act of could be included in the FS, without affecting the
the client. economic decisions taken by an FS user.
Inadequate or improper description of an If the amount of uncorrected misstatements, either
accounting policy and it is likely that a user of the individually or in aggregate is higher than the
FS would be misled by the description overall materiality established for the engagement,
Failure to disclose the breach of regulatory it would mean that the FS are materially misstated.
requirement and it is likely that consequent -Overall materiality is based on the common
imposition of regulatory restrictions will financial information needs of various users as a
significantly impair operating capability group. So, the possible effect of misstatements on
Materiality in Planning and Performing Audit specific users whose needs may vary, is not
-Misstatements, including omissions, are considered
considered to be material if they, individually or in Specific Materiality
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
In some cases, there may be a need to identify during the engagement if circumstances change.
misstatements of lesser amounts than overall -If the auditor sets a low planning materiality
materiality that would affect the decision of users amount, then more evidence is required than for a
of FS. high amount
This could relate to sensitive areas such as: -In establishing planning materiality, an auditor
-Particular note disclosures must also consider any potential effect a
-Compliance with legislation or certain terms in a misstatement may have which may be greater
contract than the peso amount involved. A misstatement
-Transactions upon which bonuses are based. which may not be material based on quantitative
factors, but that does not allow a client to meet a
Performance Materiality condition in a contractual obligation or
-Is used by the auditor to reduce the risk to an expectations of an FS user may be considered
appropriate low level that the accumulation of material.
uncorrected and unidentified misstatements OTHER CONSIDERATIONS
exceed materiality for the FS as a whole (Overall When accepting new audit engagement, inquire
materiality) or materiality levels established for about the overall materiality used by the previous
particular classes of transactions, account balances auditor. This would help determine whether further
or disclosures (specific materiality) audit procedures may be required on the opening
-Is set at a lower amount(s) than overall or specific asset and liability balances.
materiality. The objective is to perform more audit Ensure that any experts employed by the entity (to
work than would be required by overall or specific assist the entity in preparing the FS) or used by the
materiality to: audit team are instructed to use appropriate
Ensure that misstatements less than overall or materiality level in relation to the work they
specific materiality are detected, so as to perform
appropriately reduce the possibility that aggregate Relationship between materiality and audit risk
of uncorrected errors are undetected -when planning the audit, the auditor considers
Provide a margin or buffer for possible undetected what would make the FS materially misstated. The
misstatements. This buffer is between detected but auditor’s assessment of specific materiality helps
uncorrected misstatements in the FS in the the auditor decide which items to examine and
aggregate or overall or specific materiality whether to use sampling and analytical
This margin provides some assurance for the procedures. This enables the auditor to select audit
auditor that undetected misstatements, along with procedures that can be expected to reduce audit
all uncorrected misstatements, will not likely to risk to an acceptably low level.
accumulate to reach an amount that would cause There is an inverse relationship between
the FS to be materially misstated. materiality and the level of audit risk. The lower
Performance materiality is set in relation to overall the audit risk the higher the materiality level. the
materiality or specific materiality. higher the audit risk . The lower the materiality
Ex. A specific performance materiality can be set level
at a lower amount that overall materiality for The auditor would compensate by:
testing repairs and maintenance expenses, if there Reducing the assessed level of control risk, where
is a higher risk of assets not being capitalized. this is possible and supporting the reduced level by
Ex. Specific performance materiality may also be carrying out extended or additional tests of control
used to perform additional work in areas that may Reducing detection risk by modifying the nature,
be sensitive due to the nature of potential timing and extent of planned substantive
misstatements and their occurrence, rather than procedures
their monetary size.
Ex. Overall Materiality was set at P200,000. Audit 2.3.4.4
procedures were planned to detect all errors in Components of Audit risk:
excess of P200,000. An error of P80,000 might go Risk that the subject matter information is
undetected. If three such errors existed totalling materially misstated
P240,000 and are undetected, the FS would be Inherent Risk – the susceptibility or tendency of a
materially misstated. subject matter information to a material
Ex. Overall Materiality was set at P200,000. misstatement, assuming there are no related
If performance materiality was set at P120,000, it controls
would be more likely that at least one or all of the Control Risk – the risk that a material misstatement
P80,000 errors would be detected. Even if only one that could occur will not be prevented, or detected
of the errors is identified and corrected, the and corrected, on a timely basis by related internal
remaining P160,000 misstatement would still be controls.
less than P200,000 and the FS as a whole would Detection Risk – the risk that the practitioner will
not be materially misstated. not detect material misstatements that exists.
This is affected by the effectiveness of the
How To Determine Materiality procedures conducted by the auditor to gather
-Auditors make a preliminary assessment of evidence. This risk must be kept low, if the
materiality of the FS as a whole by determining the combined level of inherent risk and control risk are
amount by which they believe the FS high. To keep this risk at a low level, the audit
could be misstated without affecting users’ must be more effective and efficient in gathering
decisions. audit evidences. This means more quality
-This amount is called “preliminary judgement evidence, more audit procedures. Keeping this risk
about materiality” or “planning materiality”. low means lower risk that the practitioner will not
- It is a professional judgement that may change detect misstatements.
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
However, a higher detection risk maybe involves the establishment of the overall strategy
acceptable, when the combined level of inherent for the engagement and developing an audit plan,
and control risk are low. When inherent risk and in order to reduce the audit risk to an acceptably
control risk are low, it means that there is lower low level.
risk of material misstatement. Involves the engagement partner and other key
Below is a table showing the interrelationship of members of the engagement team continuous and
the components of audit risk: iterative process
Important Note: The italized items refers to the -begins shortly after or in connection with the
level of detection risk that must be set in order to completion of the previous audit and continues
reduce overall audit risk. until the completion of the current audit

engagement.
-includes consideration of timing of certain
Ex. If combined level of inherent and control risk activities and audit procedures that need to be
are very low, (their intersection would be the box completed prior to the performance of further audit
highlighted in yellow) the level of detection risk procedures
can be set at highest, and this would still result to The nature, extent and timing will vary, depending
an acceptably low audit risk. on:
Based on the table above, for example, if the -The size and complexity of the entity
client’s combined level of inherent risk and control -The auditor’s previous experience with the entity
risk are high, audit risk is potentially high, unless -Changes in circumstances that might occur during
the detection risk is reduced. Therefore the the audit engagement
detection risk must reduced to low so that audit Considerations:
risk will be at an acceptable level. If detection risk -analytical procedures to be applied as risk
is to be reduced, it means that the auditor must assessment procedures
reduce the risk that he will fail to detect material -obtain general understanding of legal and
misstatements. In order to reduce detection risk to regulatory framework applicable to the entity and
a low level, the auditor must set lower materiality how the entity complies
levels in order to have higher chances of detecting -determination of materiality
material misstatements. This also means -the involvement of experts
increasing the extent of substantive testing. -performance of other risk assessment procedures
If audit risk is potentially high due to higher risk of The auditor may discuss elements of planning with
misstatements (IR and CR), then materiality level the client’s management to facilitate the conduct
should be lower. If audit risk is potentially low due and management of the audit
to lower risk of misstatements (IR and CR), then engagement. Overall audit strategy and audit plan
materiality level can be higher. remain the auditor’s responsibility.
2.3.4.1.5 Ex. Coordinating some of the planned audit
PHASE I-B PLANNING THE AUDIT TO DEVELOP AND procedures with the work of the client’s personnel.
OVERALL AUDIT STRATEGY AND AUDIT PLAN However, nature and timing of detailed audit
Once the client has been obtained and the procedures should not be discussed with
engagement letter signed by both parties (auditor management in order to maintain the effectiveness
and client), the planning process intensifies as the through element of unpredictability.
auditors concentrate their efforts in obtaining a Benefits Of Audit Planning
detailed understanding of the client’s business in -Helps ensure that appropriate attention is devoted
developing an overall audit strategy and assess to important areas of the audit
the risks of material misstatement of the financial -Aids in identifying potential problems and
statement. resolving them on a timely basis
-Helps ensure that the audit is properly organized,
PSA 300 “Planning an Audit of Financial managed and performed in an effective and
Statements efficient manner
-establishes standards and provides guidance on -Assists in the proper assignment and review of the
the considerations and activities applicable to work of the engagement team members
planning an audit of financial statements. It states -Helps coordinate the work to be done by auditors
that the auditor should plan the audit so that the of components and other parties involved such as
engagement will be performed in an effective experts, specialists, etc
manner.
The auditor-in-charge must develop a plan of Overall Audit Strategy
action to organize, coordinate and schedule PSA 300 requires that the auditor establishes the
activities of the audit staff. The audit plan is overall strategy for the audit. This overall strategy
normally drafted before starting the work at the sets the scope, timing and direction of the audit
client’s offices. and guides the development of more detailed audit
Nature and Scope of Audit Planning plan.
Audit Planning Process of establishing audit strategy:
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
Identifying the characteristics of the engagement Understanding the Entity and Its Environment.”
that define its scope Example 1. Financial reporting The nature, timing and extent of planned further
framework audit procedures at the assertion level, as
Industry-specific reporting requirements determined under PSA 330, “The Auditor’s
Locations of the components of the entity Responses to Assessed Risks.”
Other planned audit procedures that are required
Ascertaining the reporting objectives of the to be carried out so that the engagement complies
engagement to plan the timing of the audit and the with PSAs
nature of the communication required such as:
Deadlines for interim and final reporting. -The auditor shall
Key dates and organization of meetings with Update and change the overall audit strategy and
management and those charged with governance the audit plan as necessary during the audit
to discuss the nature and extent of audit work. Plan the nature, timing and extent of direction and
Discussion with management regarding the supervision of engagement team members and the
expected communication on the status of audit review of their work
work throughout the engagement. Document the overall audit strategy, audit plan
and any significant changes made to both and the
Considering the important factors that will reasons for the changes
determine the focus and direction of the Undertake the ff. activities prior to starting an
engagement team efforts, such as: initial audit.
Determination of appropriate materiality levels Perform procedures required by PSA 220 regarding
Preliminary identification of areas where there acceptance of the client relationship and the
maybe higher risk of material misstatement specific audit engagement
preliminary identification of material components Communicate with previous auditor, where there
and account balances has been change of auditors, in compliance with
Evaluation of whether the auditor may plan to relevant ethical requirements
obtain evidence regarding the effectiveness of AUDIT PROGRAM
internal control A set of audit procedures specifically designed for
Identification of recent significant entity-specific, each audit.
industry, financial reporting or other relevant Includes both substantive and tests of controls
developments The audit program serves as a set of instructions to
Considering the results of preliminary engagement assistants involved in the audit and as a means to
activities and where applicable, whether control and record the proper execution of the
knowledge gained on other engagements work
performed by the engagement partner is relevant May also contain the audit objectives for each area
and and a time budget in which hours are budgeted for
Ascertaining the nature, timing and extent of the various audit areas or procedures
resources necessary to perform the engagement Additional considerations in Initial Audit
Benefits Of Developing Overall Audit Strategy Engagements
-Assists the auditor to determine the ff, subject to The Auditor should consider the ff. in developing
completion of the auditor’s risk assessment the overall audit strategy and audit plan:
procedures: Arrangements made with the previous auditor
The resources to deploy for specific audit areas , (unless prohibited by law or regulation) Ex. Review
such as the use of appropriately experienced team of previous auditor’s working papers.
members for high risk areas or the involvement of Any major issues (including application of
experts on complex matters accounting principles or auditing and reporting
-The amount of resources to allocate to specific standards) discussed with management in
audit areas such as the number of team members connection with initial selection as auditors, the
assigned to observe the inventory count at communication of such matters to those charged
material locations, the extent of review of other with governance and how these matters affect the
auditor’s work in the case of group audits, or the overall audit strategy and audit plan
audit budget in hours to allocate to high risk areas. The planned audit procedures to obtain sufficient
-When these resources are to be deployed, such as appropriate audit evidence regarding opening
whether at an interim audit stage or at key cut-off balances (PSA 510 “Initial
dates Engagements-Opening Balances)
-How such resources are managed, directed, and Other procedures required by the firm’s system of
supervised, such as when team briefing and quality control for initial audit engagements
debriefing meetings are expected to be held, how
engagement partner and manager reviews are Changes to Planning Decisions During the Course
expected to take place (onsite or offsite), and of the Audit
whether to complete engagement quality control - The auditor may need to modify the overall audit
reviews strategy and audit plan, due to unexpected events,
changes in conditions or audit evidence obtained.
AUDIT PLAN This would result to changes in the planned nature,
The auditor shall develop an audit plan that shall timing and extent of further audit procedures.
include a description of: Ex. The auditor may obtain audit evidence through
The nature, timing and extent of planned risk substantive procedures that contradicts the audit
assessment procedures, as determined under PSA evidence obtained with respect to testing of the
315, “Identifying and Assessing the operating effectiveness of controls.
Risks of Material Misstatement Through The auditor then re-evaluates the planned audit
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
procedures, based on the revised consideration of Application of Analytical Procedures in Planning
assessed risks at the assertion level for all or some the Audit
classes of transactions, account balances or When used for planning, analytical procedures
disclosures assist the auditors in planning the nature, timing
and extent of audit procedures that will be used for
For smaller entities: specific accounts or transactions.
-If the engagement partner is a sole practitioner, This approach used is obtaining an understanding
there is no question as to direction, supervision, of the client’s business and transactions and
and review identifying areas that may represent higher risks
When using professional judgement or when By identifying existence of unusual transactions
complex or unusual problems arise, and the audit and events, amount ratios and trends, matters that
is performed by the sole practitioner, it might affect the FS and audit planning, can be
is desirable to plan to consult with other suitably brought to light.
experienced auditor’s or the auditor’s professional Relevant non-financial information (number of
body. employees, area of selling space, volume of
production) may also contribute to the
Documentation accomplishment of the purpose of analytical
The auditor should document the overall audit procedures
strategy and the audit plan, including any changes The auditors may then plan a more thorough
and the reasons for the changes investigation of the potential problem areas and
Documentation records the key decisions perform a more effective audit.
considered necessary to properly plan the audit PSA 520 requires that auditors perform analytical
and to communicate significant matters to the procedures for every audit
engagement team.
The auditor may summarize the overall audit Establishment of an Engagement or Audit Team
strategy in the form of a memorandum that The team usually consists of engagement partner,
contains the key decisions regarding overall scope, a manager, at least one senior, and one or more
timing and conduct of the audit staff auditors. The number of people assigned will
Is sufficient to demonstrate the planned nature, depend on:
timing and extent of risk assessment procedures, Size and complexity of the audit
and further audit procedures at the assertion level Availability and experience of personnel
for each material class of transactions, account Need for special expertise
balances and disclosure in response to the Opportunity to train people
assessed risks. Continuity and rotation of personnel
-The auditor may use standard audit programs or An engagement involving an entity in a regulated
audit completion checklists, that should be tailored industry such as banking, also requires that the
fit to reflect the particular engagement major members of the audit team have necessary
Additional considerations in Initial Audit knowledge and experience in that industry.
Engagements
The Auditor should: Considerations of Work Performed by Other
Perform procedures regarding the acceptance of Auditors/Parties
the client relationship and the specific audit In deciding to become the principal auditor, the
engagement (PSA 220) auditor must consider the ff:
Communicate with the previous auditor, where Materiality of the portion of the FS which the
there has been a change of auditors, in compliance principal auditor audits
with relevant ethical requirements Principal auditor’s degree of knowledge regarding
The Auditor should consider the ff. in developing the business of the components
the overall audit strategy and audit plan: Risk of material misstatement in the FS of the
Arrangements made with the previous auditor components audited by the other auditor
(unless prohibited by law or regulation) Ex. Review Performance of additional procedures regarding
of previous auditor’s working papers. the components audited by the other auditor,
Any major issues (including application of resulting in the principal auditor having significant
accounting principles or auditing and reporting participation in such audit
standards) discussed with management in Predecessor Auditor
connection with initial selection as auditors, the Communication with the previous auditors can
communication of such matters to those charged provide the successor auditor with background
with governance and how these matters affect the information about the client, details
overall audit strategy and audit plan about the client’s system of internal control, and
The planned audit procedures to obtain sufficient evidence as to account balances at the beginning
appropriate audit evidence regarding opening of the year under audit
balances (PSA 510 “Initial -The successor auditor should first obtain client’s
Engagements-Opening Balances) consent or permission before making inquiries with
The assignment of firm personnel with appropriate predecessor auditors
levels of capabilities and competence to respond to
anticipated significant risks Other CPA
Other procedures required by the firm’s system of -Subsidiaries or divisions of large companies
quality control for initial audit engagements located in different parts of the country or the
world, may have different auditors. Principal
Discussion of Other Critical Matters in Engagement auditor is the one with responsibility for reporting
Planning on the FS of an entity when those FS include
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
financial information of one or more components Assessment of Going Concern Assumption
audited by another auditor. PSA 570 requires auditors to evaluate whether
-Other auditor means an auditor, other than the substantial doubt exists about an entity’s ability to
principal, with responsibility for reporting on the continue as a going concern, based on procedures
financial information of a component which is planned and performed to obtain evidence about
included in the FS audited by the principal auditor. the management assertions in the FS.
Other auditors include affiliated firms, whether When information obtained raises substantial
using the same name or not, correspondents as doubt about the entity’s ability to continue in
well as unrelated auditors. operation for a year following the date of the FS
Component means a division, branch, subsidiary, being audited, the auditor should add a paragraph
joint venture, associated company or other entity calling attention to the fact that the statements
whose financial information is included in the FS have been prepared assuming the entity will
audited by the principal auditor continue as a going concern. If disclosures are
PSA 600 “Using the Work of Another Auditor” adequate, the auditor may issue unqualified
establishes standards and provides guidance when opinion.
an auditor uses the work of another auditor on the
financial information of one or more components Examples of events or conditions that may raise
included in the FS of the entity. significant doubt as to the going concern of an
Specialists – bring unique knowledge and entity:
judgement in a field other than accounting and Financial
auditing. Effective planning involves arranging for Net liability or Net current liability position (A<L)
appropriate use of specialists inside and outside Fixed-term borrowings approaching maturity
the client organization without realistic prospects of renewal or repayment
Ex. An auditor might need to have: Excessive reliance on short-term borrowings to
An art appraiser to put values on works of art. finance long-term assets
A mineralogist to determine the physical Indications of withdrawal of financial support by
characteristics of mineral reserves debtors and other creditors Negative operating
An actuary to provide data on a group’s life cash flows indicated by historical or prospective FS
expectancy Adverse key financial ratios (Current ratio, Debt
and Equity Ratio, etc)
Use of Client’s Staff Substantial operating losses or significant
Client’s staff, including internal auditors can help deterioration in the value of assets used to
prepare for the audit generate cash flows Arrears or discontinuance of
Client’s staff should have the accounting records dividends
up-to-date when the auditors arrive. Inability to pay creditors on due dates
-Client’s staff may also prepare some of the Inability to comply with the terms of loan
working papers for the auditors. This would help agreement
reduce audit cost and freeing auditors from routine Change from credit to cash-on-delivery
work. Working papers prepared by client staff transactions with suppliers
should be labelled as such, subject also to review Inability to obtain financing for essential new
and testing by the auditors. product developments or other essential
Tasks that may be prepared by client’s staff: investments
Preparation of trial balance based on the general Operating
ledger Loss of key management without replacement
Preparation of Aging of Accounts Receivable Loss of a major market, franchise, license, or
Analyses of Accounts Receivable Written-off principal supplier Labor difficulties or shortages of
Lists of Property Additions and retirements during important supplies
the year (PPE lapsing schedule) Other
Analyses of revenue and expense accounts. Non-compliance with capital or other statutory
Internal Auditors – affects the audit in two ways. requirements
First, to enhance internal control. Pending legal or regulatory proceedings against
Second, by assisting independent auditors in the entity that may result in claims that are
performing specific audit procedures such as unlikely to be satisfied Changes in legislation or
observing client personnel during inventory count government policy expected to adversely affect
Ex. If the internal auditors determined that bank the entity
reconciliations were properly prepared and all cash Identification of Related Parties
receipts were deposited, the entity’s -Transactions with related parties are to be
controls would enhance the reliability of the disclosed in the FS if material.
accounting records. This would reduce the extent -GAAP requires disclosure of the nature of related
of substantive testing by the auditor. Before party relationship, description of the transaction,
reducing the extent of testing for specific peso amounts and amounts due from and to
assertions because of work performed by the related parties.
internal auditors , the ff. should be considered: -Most auditors assess inherent risk as high for
Materiality of the amount related parties and transactions, because of
Risk of misstatement accounting disclosure requirement and lack of
Degree of subjectivity involved in evaluating audit independence between the parties involved
evidence Related Party-an affiliated company, a principal
As the above factors increase, the lesser is the owner of the client company, or any other party
reliance on the internal auditor’s work. with which the client deals where one of the
parties can influence management or operating
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
policies of the other. accounting procedures has begun and
Related party transaction-any transaction between Procedures on specific phases of the audit can be
the client and a related party Example. 1. Sales or further challenged and revised as the work
purchase transactions between a parent company progresses.
and its subsidiary On recurring engagements, the program for the
Exchange of equipment between two companies preceding audit should be studied before preparing
owned by the same person the program for the current audit. Current program
Loans to officers should reflect modifications required by experience
Exercise of significant management influence on gained in the business, internal control or
an audit client by its most important customer accounting methods of the client
It is important that all related parties be identified Preparation of a Time Budget
and included in the permanent files early in the Time budget
engagement. – is an estimate of the total hours an audit is
Common ways of identifying related parties include expected to take.
inquiry of management, review of SEC filings, and Based on the information obtained in
examination of stockholder listings to identify understanding the client
principal stockholders Also serves as the basis for estimating fees.
An important tool to communicate to the audit staff
Client’s Legal Obligations those areas that are critical and requires more
Current information that the auditor’s should time.
review: Used to measure the efficiency of staff
Minutes of directors’ and stockholders’ meetings Determine each stage of the engagement, whether
Changes to articles of incorporation or by-laws the work is progressing at a satisfactory rate
Significant contracts executed during the year Considers the ff. factors:
Auditor should be alert to: The client’s size as dictated by gross assets, sales,
Major contracts or agreements, including merger number of employees
and acquisition agreements, debt agreements, Location of client facilities
compensation agreements and asset purchase Anticipated accounting and auditing problems
agreements Competence and experience of staff available
Information about current situations and future The total time must be allocated by the
business plans preparation of work schedules, indicating who is to
Authorization of dividends do what and how long it should take. Total hours
For new clients, the auditors should read the are budgeted by major categories and may be
articles of incorporation and by-laws since the scheduled on a weekly basis
inception of the entity, as well as changes to them
and make summaries for the permanent file. For repeat engagements, development of time
The auditor should also read all contracts having budgets is facilitated by referring to the preceding
an impact on the current year. year’s detailed time records
Managing time is an important consideration
Completion of the Initial Audit Program because billing is often based on the amount of
Audit Program time charged to the engagement. The most costly
– a set of audit procedures specifically designed for element is the auditor’s time. Time budgets can
each audit. motivate staff to perform efficiently, and personnel
- Includes both substantive and tests of controls are evaluated on their ability to complete
-The audit program serves as a set of instructions assignments within the allotted time.
to assistants involved in the audit and as a means Special Considerations:
to control and record the proper execution of the Too much emphasis on time management may
work lower the quality of the audit.
-May also contain the audit objectives for each Staff may underreport time spent on the audit
area and a time budget in which hours are procedure in order to make an impression that
budgeted for the various audit areas or procedures they finished the work on time or even ahead of
The auditor should develop and document an audit time.
program setting out the nature, timing and extent Underreporting may:
of planned audit procedures required to implement Cause the firm to lose revenue it is entitled to.
the overall audit plan Creates unrealistic basis for the following year’s
The auditor determines the procedures to test the time budget
assertions embodied in the FS. Ex. To test the May cause staff burnout, if they work additional
existence of sales: hours, without being compensated
The auditor takes samples of entries in the sales Assignment of Personnel to the Engagement
journal, compare data against approved customer On larger engagements, there are likely to be one
order, sales order and shipping document and or more partners and staff at several experience
sales invoice. levels doing the audit. Specialists in technical
Confirm a sample of accounts receivable year-end areas such as statistical sampling and computer
auditing may be assigned.
On initial engagements, the audit program On smaller audits, there may be only one or two
develops in three stages: staff members
The broad phase of the program can be outlined at
the time of engagement Major considerations:
Other details of the program can be identified after Need for continuity from year to year. Continuity
the review of internal control structure and helps the CPA firm maintain familiarity with the
2.0 The Risk-based Financial Statements Audit -Client Acceptance, Audit Planning, Supervision and Monitoring
technical requirements and closer interpersonal Conditions that may require changes in audit tests.
relations with client personnel.
Persons assigned must be familiar with the client’s 2.4 Direction, Supervision and Review
industry The nature, timing and extent, depends on many
Professional competence of assistants performing factors:
work delegated to them, when deciding the extent Size and complexity of the entity
of direction, supervision and review appropriate for Area of the audit
each assistant The assessed risks of material misstatements and
any changes
Scheduling of Work The capabilities and competence of the individual
Audit work that can be performed during the team members performing the audit work.
interim period includes:
Consideration of internal control
Issuance of management letter
Substantive tests of transactions that have
occurred to the interim date.
Interim tests of certain FS balances, such as
Equity. However the auditor must perform
additional tests of the accounts during the
remaining period between the time that the
interim test was performed and the date of the
statement of financial position Advantages of
performing audit during interim period:
Auditors may assess internal control more
effectively by observing and testing controls at
various times throughout the year
Auditors can give early consideration for
accounting problems
Creates a more uniform workload for CPA firms
For large clients, the auditors may have office
space within the client’s building and perform
auditing procedures throughout the entire
year.
Considerations for performing substantive tests
scheduled near and after the year-end date:
Deadline for submitting final audit report and filing
of income tax returns
Ability of the client’s staff to submit required
schedules
Other audit clients

DOCUMENTATION OF AUDIT PLAN AND AUDIT

PROGRAM
The auditor should develop and document an audit
program setting out the nature, timing and extent
of planned audit procedures required to implement
the overall audit plan.
Documentation of the planning process is done
through the preparation of working papers
showing:
Audit plans
Audit programs
Time budget
Documentation required for audit plans:
Description of the client company – its structure,
nature of business and organization
Audit objectives (if it is for stockholders, creditors
or a special purpose audit)
Description of the nature and extent of other
services such as preparation of tax returns, etc
Timetable of the audit work
Work to be done by the client’s employer
Assignment of audit staff
Target completion dates of the major segments of
the engagement
Preliminary evaluation and judgement about
materiality level for the engagement
Any special problems to be resolved during
engagement particularly those revealed by
analytical procedures