Chapter 1 – An Overview

Auditing Defined
“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

This definition conveys the following thoughts:

1. Auditing is a systematic process;
2. An audit involves obtaining and evaluating evidence about assertions regarding economic
actions and events;
3. An audit is conducted objectively; and
4. Auditors ascertain the degree of correspondence between assertions and established
criteria.

Three Phases of Auditing

- Steps done in order to obtain and evaluate evidence:
1. Planning
2. Fieldwork
3. Reporting

Types of Audits
Financial Statement Audit / External Audit / Independent Audit
- A financial statement audit is conducted to determine whether the financial statements of
an entity are fairly presented in accordance with the applicable financial reporting
framework.
- The only one that has a standard format.
- Intended users: external
Compliance Audit
- A compliance audit involves a review of an organization’s procedures to determine whether
the organization has adhered to specific procedures, rules, or regulations.
- Intended users: external, internal

Operational Audit / Performance

Audit / Management Audit
- An operational audit is a study of a
specific unit of an organization for
the purpose of
measuring its performance.
- Intended users: interna
 Operational Audit / Performance Audit / Management Audit
- An operational audit is a study of a specific unit of an organization for the purpose of
measuring its performance.
- Intended users: internal

Types of Auditors
External Auditors / Independent Auditors
- These are independent CPAs who offer their professional services to different clients on a
contractual basis.
- Outsiders or auditors who are not employed by the organization.
Internal Auditors
- Internal auditors are the entity’s own employees who investigate and appraise the
effectiveness and efficiency of operations and internal controls.
- May also be an outsider or auditor who is not employed by the organization.
Government Auditors
- These are government employees whose main concern is to determine whether persons or
entities comply with government laws and regulations.

The Independent Financial Statement Audit

- 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 aspects, in accordance
with the applicable financial reporting framework.
- its objective is to express an opinion on the fairness of the financial statement.
Applicable Financial Reporting Frameworks:
 Full PFRS
 PFRS for SMEs
 PFRS for microbusinesses

Responsibility for the financial statements

a. The management is responsible for preparing and presenting the financial statements in
accordance with the applicable financial reporting framework.
b. The auditor’s responsibility is to form and express an opinion on these financial
statements based on the audit results.
 Assurance provided by the auditor
- The auditor’s opinion on the financial statements is not an absolute assurance that the
financial statements are dependable. An audit conducted in accordance with the PSAs is
designed to provide only reasonable assurance that the financial statements taken as a whole
are free from material misstatements. This is because there are inherent limitations of an
audit that affect the auditor’s ability to detect material misstatements.

-Inherent Limitations-
 Matters of facts and estimates
 Nature of examination
 Human error

General Requirements when Auditing Financial Statements

The auditor should comply with the relevant ethical requirements, including those
pertaining to independence, relating to financial statements audit engagements.
The auditor should conduct an audit in accordance with the Philippine Standards on
Auditing (PSAs).
The auditor should apply professional judgement in planning and performing the
audit.
The auditor should obtain sufficient appropriate audit evidence to reduce the audit
risk to an acceptably low level.
The auditor should plan and preform the audit with an attitude of professional
skepticism recognizing that circumstances may exist which may cause the financial
statements to be materially misstated.

Need for an Independent Financial Statement Audit

1. Conflict of interest between management and users of financial statements
2. Expertise
3. Remoteness
4. Financial consequences

Theoretical Framework of Auditing

Audit function operates on the assumption that all financial data are verifiable.
The auditor should always maintain independence with respect to the financial
statements under audit.
There should be no long-term conflict between the auditor and the client
management.
Effective internal control system reduces the possibility of material misstatements of
the financial statements.
Consistent application of the applicable financial reporting framework such as the
PFRS results in fair presentation of financial statements.
What was held true in the past will continue to hold true in the future in the absence
of known conditions to the contrary.
An audit benefits the public.
 Chapter 2 – The Professional Standards

Auditor's opinion must be based on an examination conducted in accordance

with professional standards. Failure to comply with these standards exposes the auditor risks
such as loss of public respects or even assessment of legal damages.
Standards - are established to measure the quality of performance of
individuals and
organizations.
Board of Accountancy (BOA) - promulgated ten Generally Accepted Auditing Standards
(GAAS) that establish required level of quality for performing financial statement audits.
Philippine Standards on Auditing (PSA) - are issued to clarify the meaning of these ten
GAAS.
Auditing procedures - are the means used by the auditors in attaining the quality
required by the standards.
GAAS - represent measures of the quality of the auditor’s performance. These standards
should be looked as a minimum standard of performance that auditors should follow.

PHILIPPINE STANDARDS ON AUDITING (PSAs)

The Auditing and Assurance Standards Council (AASC) has been given the task to
promulgate auditing standards, practices and procedures which shall be generally accepted
in the Philippines.
Practice Statements - are issued to provide practical assistance to auditors in implementing
the standards and to promote good practice in the accountancy profession.

SYSTEM OF QUALITY CONTROL

Quality controls are policies and procedures adopted by CPAs to provide reasonable
assurance of conforming with professional standards in performing audit and related service.
Under Philippine Standards on Quality Control (PSQC) 1, a firm has an obligation to
establish a system of quality control designed to provide reasonable assurance that the firm
and its personnel comply with professional standards and regulatory and legal requirements
and that the report issued by the firm are appropriate in the circumstances.
ELEMENTS OF QUALITY CONTROL POLICIES AND PROCEDURES
1. Leadership Responsibilities
2. Ethical Requirements
- Integrity
- Objectivity
- Professional Competence & Due Care
- Confidentiality; and
- Professional Behavior
3. Independence
4. Acceptance and Continuance of Client Relationships
5. Human Resources and Assignment
6. Engagement Performance
- Direction
- Supervision
- Review
- Consultation
- Engagement Quality Control Review
- Differences of Opinion
7. Monitoring
 Chapter 3 – Auditor’s Responsibility

The fair presentation of the financial statements in accordance with the applicable financial
reporting framework is the responsibility of the client’s management. The auditor’s
responsibility is to design the audit to provide reasonable assurance of detecting material
misstatements in the financial statements.
The Misstatement may emanate from
1. Error (unintentional)
2. Fraud (intentional)
3. Noncompliance with laws and regulations

Types of Fraud
Fraudulent financial reporting - involves intentional misstatements including
omissions of amounts or disclosures in financial statements to deceive financial
statement users. This type of fraud is also known as Management fraud because it
usually involves members of management or those who charged with governance.
This may involve:
 Manipulation, falsification (including forgery), or alteration of accounting records
or supporting documentation from which the financial statements are prepared.
 Misrepresentation in, or intentional omission from, he financial statements of
events, transactions or other significant information.
 Intentional misapplication of accounting principles relating to amounts,
classification, manner of presentation, or disclosure.
 Recording of transactions without substance

2. Misappropriation of assets - involves the theft of an entity’s assets and is often

perpetrated by employees in relatively small and immaterial amounts. However, it
can also involve management who are usually more able to disguise or conceal
misappropriations in ways that are difficult to detect.
This may include:
 Embezzling receipts
 Stealing physical assets or intellectual property
 Causing an entity to pay for goods and services not received
 Using an entity’s assets for personal use

Responsibility of management and those charge with governance

The primary responsibility for the prevention and detection of fraud rests with both
those charged with governance of the entity and management.
PSA 240 requires,
1. Management to establish a control environment and to implement internal control
policies and procedures designed to ensure the detection and prevention of fraud and error.
2. Individuals charged with governance of an entity’s accounting and financial reporting
systems and that appropriate controls are in place.

The auditor cannot be held responsible for the prevention and detection of fraud and error.

Planning Phase

1. When planning an audit, the auditor should make inquiries of management

about the possibilities of misstatements due to fraud and error
2. In accordance with PSA 315, the auditor shall identify and assess the risks of
material misstatement due to fraud at the financial statement level and at the
assertion level for classes of transaction, account balances and disclosures.

Testing Phase

3. During the course of the audit, the auditor may encounter circumstances that
may indicate the possibility of fraud or error.
4. When material misstatements in the financial statements are identified, the
auditor should consider whether such a misstatement resulted from fraud or an
error. This is essential because errors may result to adjustments to the
financial statements, but fraud may have other implications on the audit.

Completion Phase

5. The auditor should obtain written representation from management that:

 The management acknowledges its responsibilities for the
implementation and operations of accounting and internal control
systems that are designed to prevent and detect fraud and error.
 It believes the effect of those uncorrected misstatements aggregated by
the auditor during the audit are immaterial, both individually and in
aggregate, to the financial statements taken as a whole. The summary
of the items should be included in the written representations.
 It has disclosed to the auditor all significant facts relating to any fraud or
suspected frauds known to the managements that may have affected the
entity.
 It has disclosed to the auditor the results of its assessment of risk that the
financial statements may be materially misstated as a result of fraud.

Reporting Phase
 6. When the auditor believes that material error or fraud exists, the auditor
should request the management to revise the financial statements.
Otherwise, the auditor shall issue a qualified or adverse opinion.
7. If the auditor is unable to evaluate the effect of the fraud on the financial
statements because of scope limitation to the examination, the auditor should
either qualify or disclaim an opinion to the financial statements

Noncompliance with laws and regulations

Tax evasion
Violation of environmental protection laws; and
Inside trading of securities
Non-compliance with laws and regulations may result in fines, litigation or other
consequences for the entity that may have a material effect on the financial statements

Responsibility of Management
It is the responsibility of management, with the oversight of those charged with governance,
to ensure that the entity’s operations are conducted in accordance with the provisions of laws
and regulations, including compliance with the provisions of laws and regulations that
determine the reported amounts and disclosures in an entity’s financial statements.

o Effective internal control system

reduces the possibility of material
misstatements of the
financial statements.
o Consistent application of the
applicable financial reporting
framework such as the PFRS
results in fair presentation of
financial statements.
o What was held true in the past
will continue to hold true in the
future in the absence of
known conditions to the contrary.
o An audit benefits the public.