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Module 2 - The Risk-Based Financial Statement Audit - Client Acceptance, Audit Planning, Supervision and Monitoring

The document outlines the standards and principles that govern independent financial statement audits. It discusses the responsibilities of management and auditors, and the nature of audit evidence and assurance. The key standards are the Generally Accepted Auditing Standards (GAAS), which establish requirements for audit quality. GAAS includes general standards on auditor qualifications, independence, and care. It also includes standards of fieldwork on planning, internal controls, and evidence. Standards of reporting cover opinion statements and consistency in applying accounting principles. The overall goal is for auditors to provide reasonable but not absolute assurance about the reliability of financial statements.

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100% found this document useful (1 vote)
2K views19 pages

Module 2 - The Risk-Based Financial Statement Audit - Client Acceptance, Audit Planning, Supervision and Monitoring

The document outlines the standards and principles that govern independent financial statement audits. It discusses the responsibilities of management and auditors, and the nature of audit evidence and assurance. The key standards are the Generally Accepted Auditing Standards (GAAS), which establish requirements for audit quality. GAAS includes general standards on auditor qualifications, independence, and care. It also includes standards of fieldwork on planning, internal controls, and evidence. Standards of reporting cover opinion statements and consistency in applying accounting principles. The overall goal is for auditors to provide reasonable but not absolute assurance about the reliability of financial statements.

Uploaded by

Evie Marionette
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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2.

0 Intended
Learning
Outcomes
Module 2: The Risk-based Financial Statement Audit –
Client Acceptance, Audit Planning, Supervision and
Monitoring
At the end of the module, the students should be able to:
2.1 Explain the overview of the risk-based audit process
2.2 Illustrate and explain the pre-engagement procedures
2.3 Explain the scope and purposes of audit planning
2.3.1 Identify and discuss the essential planning procedures
2.3.1.1 Knowledge of the business
2.3.1.2 Preliminary analytical procedures
2.3.1.3 Materiality
2.3.1.4 Assessing and managing audit risks
2.3.1.5 Overall audit plan and audit program (experts, internal auditor, other
independent auditors)
2.4 Perform the direction, supervision, and review
2.5. discuss the:
● general principles governing the audit of financial statements
● the major classification of generally accepted auditing standards (GAAS)
● auditor’s responsibilities in an audit
● salient features of the SEC Code of Corporate Governance
2.6. explain the importance of adhering to the GAAS.

2.1 The
Independent
Financial
Statement Audit
General Requirements when Auditing Financial Statements
The auditor should:
● comply with relevant ethical requirements incorporated in the Code of
Ethics, Board of Accountancy-CE.pdf
● Download Board of Accountancy-CE.pdf
● , for PAs.
● conduct an audit based on the PSAs.Auditing and Assurance Standards
Council - Downloads - Philippine Standards on Auditing (PSAs).mhtml
● Download Auditing and Assurance Standards Council - Downloads -
Philippine Standards on Auditing (PSAs).mhtml

● apply professional judgment in planning and performing the audit.
● should obtain sufficient and appropriate audit evidence to reduce the audit
risk to an acceptable low level.
● should have an attitude of professional skepticism (questioning mind,
critical assessment on the sufficiency, appropriateness of audit evidence)

Need for an Independent Financial Statement Audit Financial Statement Audit


(Definition, Objectives, Principles).mhtml
Download Financial Statement Audit (Definition, Objectives, Principles).mhtml

● conflict of interest - exists between the managers and the users of the
financial statements which is why the users demand audited financial
statements that are realistic and free from bias.
● the expertise of an auditor - is needed to verify the reliability of the financial
statements being presented to users.
● the remoteness of the financial records- users do not have access to the
financial records and the auditor can assist them to verify the reliability of the
financial records.
● financial consequences - misleading financial information may result in
wrong economic decisions by management.

Theoretical Framework of Auditing:


● all financial data are verifiable - based on supporting documents or
evidence to prove their validity.
● independence of the auditor in an audit - no influence coming from the
management to ensure credibility of the auditor's report.
● no long-term conflict between the auditor and the client - no conflict in
the application of auditing procedures and accounting principles that might
affect the fair presentation of the financial statements.
● effective control system - reduces the possibility of material misstatements
● Consistent application of the financial reporting framework (PFRS)-
results in a fair presentation of the financial statements and any deviation will
render the financial statements materially misstated.
● Past experience and knowledge in auditing a client- can be used to
determine the audit procedure to be performed in the future (if without
conditions to the contrary).
● an audit benefits the public -financial statements are the major source of
information of a wide range of users.

Responsibility for the Financial Statements


● Management Responsibility
○ preparing and presenting the financial statements in accordance
with the applicable financial reporting framework ( SMR is signed
by the CFO, CEO, and the BOD)
○ ensure to adopt and implement adequate accounting and internal
control systems to ensure the preparation of reliable financial
statements.
● Auditors' Responsibility
○ to form and express an opinion on the financial statements based
on the audit results.

Assurance provided by the auditor


● auditors opinion on the financial statements
○ does not guarantee that the financial statements are dependable.
○ An audit only provides reasonable assurance* that the financial
statements taken as a whole are free from material misstatements.
*(Conduct of the audit is based on Generally Accepted Auditing Standards
(GAAS)
○ It is not an absolute assurance (100% error-free) due to inherent
limitations such as:
a. testing or sampling risk
■ due to cost constraints, conclusions based on the
sample may be different if the entire population is
examined.
b. judgment or non-sampling risk
■ examination of all evidence available is not an absolute
assurance that material misstatements or "errors" will
be detected due to professional judgment that may
cause the auditor to commit mistakes.

Nature of Financial Reporting


● the application of the applicable financial reporting framework (PFRS) may
involve significant judgment and estimates on the part of the management
which may be subjective and may provide a false misrepresentation which
can be unreliable audit evidence.

Nature of Evidence
● Audit evidence are pieces of information that are gathered during the audit
and can persuade the auditor about the fairness of the financial statements.
○ Audit evidence is persuasive rather than conclusive.
○ Due to inherent limitations, even if the audit is conducted based on
the PSAs, material misstatements in the Financial Statements may
not be detected.
○ The auditor's opinion on the Financial statement attests that the FS
was prepared in accordance with the Financial Reporting
Framework.
○ It is not an assurance of the future viability of the entity, nor to the
efficiency and effectiveness of its operations conducted by the
management.
Let us watch the video below to understand the Independent Financial Statement Audit
https://youtu.be/VoSUpe6FU0k
Links to an external site.
https://youtu.be/WzlBl9Q6rM0
Links to an external site.
https://youtu.be/p7_6FutPolo

2.2 Professional
Standards
(including Quality
Control)
Standards
● established to measure the quality of performance of individuals and
organizations.
● relating to the accounting profession concerns the CPAs :
○ Professional qualities
○ judgment exercised in the performance of an engagement.
○ quality control policies and procedures.

Generally Accepted Auditing Standards (GAAS)


● promulgated by the BOA
● establish the required level of quality for performing financial statements
audits.
● must be followed by CPAs when auditing financial statements.
● represents the measure of the quality of the auditors' performance
● minimum standard of performance of the auditor
● classified as:
○ General Standards,
○ Standards of fieldwork, and
○ Standards of Reporting.

General Standards
1. Technical Training and Proficiency of the auditor
2. Independence in the mental attitude of the auditor
3. Due Professional Care is exercised by the auditor in the performance of the audit and
preparation of the audit report.

Standards of Fieldwork
4. Planning - the work should be properly planned and assistants are properly
supervised
5. Internal Control Considerations-a proper study and evaluation of the existing
internal control and a test for any restrictions on the auditing procedures.
6. Evidential Matter- competent and sufficient evidence gathered through inspection,
observation, inquiries, and confirmation as a reasonable basis for an opinion.

Standards of Reporting
7. The report shall state whether the financial statements are in accordance with the
GAAP.
8. The Inconsistencies in the application of the principle from the prior period to the
present shall be identified ( circumstances).
9. Informative disclosures shall be regarded as reasonably adequate unless otherwise
stated in the report.
10. Opinion -
● in the audit report, an opinion shall be expressed regarding the financial
statements, taken as a whole, or an assertion to the effect that an opinion can
not be expressed.
○ When the overall opinion can not be expressed, the reasons for it
should be stated.
● An auditor's name associated with the report gives a clear-cut indication of
the character of the auditor's examination and the degree of responsibility
that the auditor is taking.

The Auditing and Assurance Standards Council (AASC)


Links to an external site.
● has been given the task to promulgate auditing standards, practices, and
procedures which shall be generally accepted in the Philippines.
● Structure of the AASC pronouncements:
○ Framework for Assurance Engagements
■ Audit
■ Review
■ Other Assurance Engagements
○ Related Services
■ Agreed-upon Procedures Engagement
■ Compilation Engagement
● AASC pronouncements -adopted from the pronouncements of the IAASB
created by the International Federation of Accountants (IFAC) if applicable
with or without changes (considering any local requirements imposed by law
or practice)
○ Standards (PSAs, PSAREs, PSAEs, PSRs, PSQCs)
○ Links to an external site.

○ Philippine Auditing Practice Statements (PAPSs)
○ Links to an external site.
■ provide interpretative guidance and practical assistance
to professional accountants in implementing the
Standards and to promote good practice.
Systems of Quality Control
-ensure that CPA members of audit teams perform the same level of quality of work.
● Quality controls
○ are policies and procedures adopted by the CPA to provide
reasonable assurance of conforming with professional standards
on performing audits and related services.
● Philippines Standards on Quality Management (PSQM) formerly the
Philippines Standards of Quality Control (PSQCs)
- A firm and its personnel should :
○ comply with professional standards, regulatory and legal
requirements and
○ issue reports that are appropriate to the circumstances.
● Quality Control Policies (PSA 220)
● Links to an external site.

- a guide to audit firms in establishing their own system of quality control
○ Leadership responsibilities for the quality of audit -
engagement partner should set an example
○ Ethical requirements- integrity, objectivity, professional
competence, and due care, confidentiality, and professional
behavior
○ Independence - maintain the quality of independence

■ identify and evaluate threats to independence


■ take appropriate safeguards to eliminate or reduce such
threats
■ document conclusions on independence and the basis
for such conclusions
○ Acceptance and continuance of client relationships- establish
policies and procedures when or when not to accept specific
engagements considering the :
■ the integrity of the client
■ competency of the firm to perform the engagement
■ compliance with ethical requirements
○ Human resources assignment - the audit team has sufficient
personnel with the capabilities, competence, and commitment to
ethical principles necessary to perform the engagement.
○ Engagement performance - there is reasonable assurance that
the engagements are performed in accordance with professional
standards and regulatory requirements (responsibility of the
engagement partner).
■ direction - inform assistants of their responsibilities
■ supervision - monitor the progress of the audit/resolve
issues/consider the level of consultation
■ review - assistants' work should be reviewed as to
appropriateness to the conclusions reached.
■ consultation - encourage firm personnel to seek
authoritative sources (within or outside the firm)
■ engagement quality control review - provides an
objective evaluation of the significant judgments made
and the conclusions reached in formulating the auditor's
report (Quality Control Reviewer)
■ differences in opinion - team members should bring
differences in opinion to the attention of the engagement
partner or others within the firm without fear of reprisal. It
should be resolved before the audit report can be issued.
○ Monitoring -
■ continued adequacy and operational efficiency of quality
control policies and procedures
■ systems of quality control are relevant, adequate, and
operating effectively
■ quality control and procedures are communicated
( understood and implemented) to its personnel.

Quality Assurance Review


● government's assurance that the CPAS' work is to the highest standards.
● CPAs in public practice should acquire a Certificate of Accreditation to
Practice Public Accountancy which is valid for three(3) years and can be
renewed after complying with the requirements of BOA.
● The PRC-Quality Review Committee shall conduct a quality review of all the
audits conducted by CPAs that may cause the renewal or revocation of their
CPA license.

https://youtu.be/Z4ND0Hgi4GQ
Links to an external site.
2.3 The Auditor's
Responsibilities
Responsibility to Prevent and Detect Fraud (PSA 240)
Links to an external site.
is the main responsibility of :
1. Management
● Must establish a strong control environment and maintain policies and
procedures to assist in achieving the objective of ensuring the orderly and
efficient conduct of the entity’s business.
● An appropriate control environment as a deterrent to fraud includes
establishing:
○ Code of conduct
○ Ethics/Fraud Policy
○ Ethics and whistleblower program
○ Hiring and promotion guidelines, exit interview
○ Oversight by the Audit Committee, Board, or other oversight body
○ Investigation of reported issues and remediation of confirmed
violations.
2. Individuals charged with governance
● ensure the integrity of the entity's accounting and financial reporting systems
and that appropriate controls are in place.

Related Topic:

The SEC Code of Corporate Governance


Auditor's Responsibilities
● is not and can not be held responsible for the prevention of fraud and error.
● to design an audit to provide reasonable assurance that the financial
statements are free from material misstatement whether caused by an error
or fraud.
○ Planning phase
■ Inquiries of management about the possibility of
misstatements
■ assess the risk of fraud or error ( motive or opportunity to
commit fraud referred to as "fraud risk factors")
○ Testing Phase
■ perform procedures necessary to determine whether
material misstatements exist
■ identify material misstatements as caused by error or
fraud
■ if material fraud is detected but it can't be evaluated as
to its effect on the FS is immaterial or material
○ Completion Phase
The auditor should obtain a written representation from the client's management
as to :
■ management's responsibility for the implementation and
operations of accounting and internal control systems as
to the detection of fraud or error
■ that the effects of the uncorrected financial statements
misstatements aggregated by the auditor during the
audit are immaterial, both individually and in aggregate.
■ management has disclosed to the auditor all significant
facts relating to any fraud or suspected fraud known to
management.
■ management has disclosed to the auditor the results of
its assessment of the risk that the financial statements
may be materially misstated as a result of fraud.
Reporting Phase
■ If the auditor believes that a material error or fraud
exists, He will:
■ request the management to revise the
financial statements ;
■ if not, the auditor will express a qualified
opinion or adverse opinion.
■ if the auditor is unable to evaluate the effect of the fraud
due to limitations on the scope of the auditor's
examination,
■ the auditor should issue a qualified opinion or
disclaimer of an opinion on the financial
statements

● to design the audit to provide reasonable assurance of detecting material


misstatements in the financial statements which can emanate from Error,
Fraud, and Non-Compliance with Laws and Regulations

Auditors Legal Liability


● arise from the auditor's failure to exercise due professional care in the
performance of an audit and in the preparation of the audit report.
● depends upon the degree of omission or commission.
○ deliberate fraud- worst fault with the maximum penalty
● The auditor shall not disclose any confidential information without the consent
of the client except when called upon in court.
● The partners in a public accounting firm are jointly liable:
○ for civil actions against a partner
○ for the work of their employees
○ for outsourced audit work/technical information

https://youtu.be/nr8a453-1yo
Links to an external site.
https://youtu.be/oPvXVFsCvbs
2.4 SEC Code of
Corporate
Governance

SMC 24-2019 Salient Features

Code of Corporate Governance for Public Companies and Registered Issuers SMC
24-2019
Download SMC 24-2019
was issued by SEC as part of its efforts to promote good corporate governance in the
country.

● applies to Public Companies


○ those with assets of at least P50 million and having 200 or more
shareholders holding at least 100 shares each of equity securities.
● covers Registered Issuers or companies that issue:

○ Proprietary and Non-Proprietary Shares/Certificates


○ equity securities offered to the public but are not listed in an
Exchange; or
○ debt securities offered to the public and required to be registered
with the SEC, whether or not listed in an Exchange.

● rooted in the same corporate governance principles provided in the Code of


Corporate Governance for Publicly-Listed Companies SMC 19-2016
● Download SMC 19-2016
● with the same intention of raising the corporate governance standards of
Philippine corporations consistent with the G20/OECD Principles of Corporate
Governance and other internationally recognized corporate governance
principles.

● adopts a comply-or-explain approach to allow companies some flexibility in


establishing their corporate governance practices (taking into consideration
the principle of proportionality).
○ Companies do not have to comply with the Code, but in their
Annual Corporate Governance Reports:
■ they must state whether they comply with the Code’s
provisions,
■ if not -identify any areas of non-compliance, and explain
the reasons for non-compliance.

● Compliance with the higher standards of corporate governance should


translate to better value propositions for shareholders and customers,
minimized risks, growth, and sustainability,

● promotes 16 principles across different corporate governance subjects,


namely:
○ board’s governance responsibilities,
○ disclosure and transparency,
○ internal control and risk management frameworks,
○ cultivating a synergic relationship with shareholders/members, and
○ duties to stakeholders.

● recommends that the Board of Directors should have a policy on diversity to


avoid groupthink and ensure that optimal decision-making is achieved. To
reinforce its independence:
○ the board should also be composed of a majority of non-executive
directors (NEDs) and have at least two (2) independent directors,
or such number as to constitute at least one-third of the members
of the board, whichever is higher.

● encourages the establishment of Board Committees to support the effective


performance of the board’s functions. such as:
○ the Audit Committee,
○ Corporate Governance Committee and
○ Board Risk Oversight Committee

● The Board should also ensure a policy and system governing:


○ related party transactions and
○ other unusual or infrequently occurring transactions, particularly
those which pass certain thresholds of materiality.
● The policy should include the appropriate review and approval of material-
related party transactions, which guarantee fairness and transparency of the
said transactions.

● To promote disclosure and transparency, the code outlines recommendations


aimed at :
○ enhancing company disclosure policies and procedures,
○ strengthening external auditor’s independence and
○ improving audit quality, increasing focus on non-financial
sustainability reporting, and
○ promoting comprehensive and cost-efficient access to relevant
information.

● encourages covered companies to have a strong and effective :


○ internal control system and
○ enterprise risk management system and
○ an independent internal audit function.

● Covered companies should likewise establish an Investor Relations Office or


Customer Relations Office or its equivalent to ensure constant engagement
and communication with its shareholders/members.

● recommends that Covered Companies should:


○ fully disclose basic shareholder/ member rights in its Manual on
Corporate Governance, and
○ make available, at the option of a shareholder/member, an
alternative dispute mechanism to resolve intra-corporate disputes
in an amicable and effective manner.
○ respect the rights of stakeholders and allow for effective redress for
violation of their rights.

Other Related Memo Circulars by the SEC for Financial Reporting:


Revised SRC Rule 68

Categories of
Fraud
(AICPA/ACFE)

Broad Categories of Fraud (AICPA)


1. Misappropriations of Assets or Defalcation (Theft)
Employees take assets from the organization for personal gains such as theft,
embezzlement, or misuse of assets.
● Cash misappropriation schemes
○ Larceny -stealing cash after it has been recorded in the books
○ Skimming – stealing cash before it is recorded in the books
○ Fraudulent Disbursements
■ Billing – payment for fictitious vendors
■ Payroll – ghost employees
■ Expense reimbursement – overstate reimbursement
request
■ Check tampering - change the payee or amount
● Corruption
○ Fraud for the detriment of an organization is conducted generally
indirectly or directly for the benefit of an employee, outside
individual, or another organization
■ Bribes and kickbacks
■ diversion to an outsider of a profitable transaction for the
organization
■ Embezzlement or misappropriation of money and
property and falsification of financial records.
2. Fraudulent Financial Reporting (Distortion of Financial Statements)
● Intentional Manipulations of financial statements
○ Manipulation, falsification, or alteration of accounting records or
supporting documents
○ Misrepresentation or omission of events
○ Intentional misapplication of accounting principles

Main Categories of Fraud (ACFE)


Please click this link: Fraud Tree
Links to an external site.

Red Flags
● Key warning signs of Improper or Aggressive Accounting
○ incorrect billings,
○ holding the books open,
○ capitalizing expenses,
○ complex revenue recognition
● Conditions that are normally present whenever fraud is committed.
○ Living beyond their means
○ Experiencing financial difficulties
○ Excessive organizational pressure
Internal Auditors should be alert in determining red flags or possible indicators of fraud.
Financial Shenanigans
● actions that intentionally distort reported financial performance and
financial condition
○ recording revenue too soon or of questionable quality,
○ recording non-existing revenues,
○ boosting income with one-time gains,
○ recording current expenses/ revenue to a later or earlier period,
○ failing to record or reduce liabilities
○ shifting current revenue to a later period
○ shifting future expenses to the current as a special charge

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