CHAPTER 1 1) Systematic examination and evaluation of

(audit – an overview) evidence which are undertaken to

ascertain whether assertions comply with
established criteria.
2) Communication of the results of the
1.1 AUDITING DEFINE
examination, usually in a written report,
AUDITING to the party by whom, or on whose
 Defines by the Philippine Standards in behalf, the auditor was appointed.
Auditing (PSA) through stating the objective
of a financial statement audit; that is, to 1.3 TYPES OF AUDITORS
enable the auditor to express an opinion on  Auditors can be classified according to their
whether the financial statements are affiliation with the entity being examined.
prepared, in all material respects, in (1) EXTERNAL AUDITORS or INDEPENDENT
accordance with the applicable financial
AUDITORS
reporting framework. - There are independent Certified
AUDIT Public Accountants (CPAs) who offer
their professional services to different
 a systematic process of objectively
clients on a contractual basis.
obtaining and evaluating evidence
- There are the one who generally
regarding assertions about economic actions
perform financial statement audits.
and events to ascertain the degree of
(2) INTERNAL AUDITORS
correspondence between these assertions
- They are entity’s own employees who
and established criteria and communicating
investigate and appraise the
the results to interested users.
effectiveness and efficiency of
THIS DEFINITION CONVEYS THE FOLLOWING operations and internal controls.
THOUGHTS: - They usually perform operational
(1) Auditing is a systematic process audits.
(2) An audit involves obtaining and (3) GOVERNMENT AUDITORS
evaluating evidence about assertions - There are government employees
regarding economic actions and events whose main concern is to determine
(3) An audit is conducted objectively whether persons or entities comply
(4) Auditors ascertain the degree of with government laws and regulations.
correspondence between assertions and - They usually conduct compliance
established criteria audits.
(5) Auditors communicate the audit results to
various interested users 1.4 THE INDEPENDENT FINANCIAL
STATEMENT AUDIT
1.2 TYPES OF AUDITS  The objective of an audit of financial
 Based on primary audit objectives, there are statements is to enable the auditor to express
three major types of audit. an opinion whether the financial statements are
(1) FINANCIAL STATEMENT AUDIT prepared, in all material aspects, in
- It is conducted to determine whether accordance with the applicable financial
the financial statements of an entity reporting framework.
are fairly presented in accordance o Responsibility for the financial statements
with the applicable financial reporting  Management – responsible for
framework. preparing and presenting the
(2) COMPLIANCE AUDIT financial statements
- It involves a review of an  Auditor – to form and express an
organization’s procedures to opinion on these financial statements
determine whether the organization based on the audit results.
has adhered to specific procedures, o Assurance provided by the auditor
rules, or regulations. - The auditor’s opinion on the financial
(3) OPERATIONAL AUDIT statements is not a guarantee that the
- It is a study of a specific unit of an financial statements are dependable.
organization for the purpose of  Nature of the procedures
measuring its performance. - There are practical and inherent
- Also known as performance audit or limitations on the auditor’s ability to
management audit. obtain evidence. For example:
 All types of audit possess the same general
characteristics. They all involve:
 The use of testing or sampling risk – 1.7 THEORETICAL FRAMEWOK OF AUDITING
due to cost constraints, auditors do SELECTED POSTULATES, ASSUMPTIONS OR
not examine all evidence available. IDEAS THAT SUPPORT MANY AUDITING
 Error in the application of judgement CONCEPTS AND STANDARDS
or non-sampling risk – even if the
(1) Audit function operates on the
auditor examines all evidence
assumption that all financial data are
available, there is no absolute
verifiable.
assurance that material
(2) The auditor should always maintain
misstatement in the financial
independence with respect to the
statements will be detected.
financial statements under audit.
 Nature of financial reporting (3) There should be no long-term conflict
- Many financial statement items involve
between the auditor and the client
subjective decisions that are subject to
management.
an inherent variability which cannot be
(4) Effective internal control system reduces
eliminated by performing audit the possibility of material misstatements
procedures.
of the financial statements.
 Nature of evidence (5) Consistent application of the applicable
- Audit evidence obtained by the financial reporting framework such as
auditor does not consist of “hard facts” the PFRS results in fair presentation of
which prove or disprove the accuracy financial statements.
of the financial statements. Thus, audit (6) What was held true in the past will
evidence is generally persuasive rather continue to hold true in the future in the
than conclusive in nature. absence of known conditions to the
contrary.
1.5 GENERAL REQUIREMENTS WHEN (7) An audit benefits the public.
AUDITING FINANCIAL STATEMENTS
 PSA provides the following guidance when
auditing financial statements:
(1) The auditor should comply with the
relevant ethical requirements, including
those pertaining to independence,
relating to financial statements audit
engagements.
(2) The auditor should conduct an audit in
accordance with the Philippine
Standards on Auditing (PSAs).
(3) The auditor should apply professional
judgement in planning and performing
the audit.
(4) The auditor should obtain sufficient
appropriate audit evidence to reduce
the audit risk to an acceptably low level.
(5) The auditor should plan and perform the
audit with an attitude of professional
skepticism recognizing the circumstances
may exist which may cause the financial
statements to be materially misstated.

1.6 NEED FOR AN INDEPENDENT FINANCIAL

STATEMENT AUDIT
 The need for an independent audit of
financial statements stems from the following
interrelated sources:
(1) Conflict of interest between management
and users of financial statements
(2) Expertise
(3) Remoteness
(4) Financial consequences
 CHAPTER 2 control to provide reasonable assurance
(the professional standards) that the firm and its personnel
 comply with professional standards and
regulatory and legal requirements, and
2.1 GENERALLY ACCEPTED AUDITING  that the report issued by the firm are
STANDARDS (GAAS) appropriate in the circumstances.
 GAAS represent measures of the quality of
2.4 ELEMENTS OF QUALITY CONTROL
the auditor’s performance.
POLICIES AND PROCEDURES
TEN GAAS
 LEADERSHIP RESPONSIBILITIES
 GENERAL STANDARDS  The engagement partner should set
(1) Technical training and proficiency example regarding the quality of audit by
(2) Independence emphasizing through actions and messages
(3) Professional care (a) the importance of performing work
 STANDARDS OF FIELDWORK that complies with professional
(4) Planning standards,
(5) Internal control consideration (b) complying with the firm’s quality
(6) Evidential matter control policies and procedures,
 STANDARDS OF REPORTING (c) issuing appropriate audit reports, and
(7) Generally accepted accounting (d) the engagement’s team ability to
principles raise concerns without fear of
(8) Inconsistency reprisals.
(9) Disclosure
(10) Opinion  ETHICAL REQUIREMENTS
(a) Integrity
2.2 PHILIPPINE STANDARDS ON AUDITING (b) Objectivity
(PSAs) (c) Professional competence and due care
AASC (d) Confidentiality
(e) Professional behavior
 The Auditing and Assurance Standards
Council (AASC) has been given the task to  INDEPENDENCE
promulgate auditing standards, practices and  The engagement partner should:
procedures which shall be generally accepted (a) Obtain relevant information to
in the Philippines. identify circumstances and
AASC PRONOUNCEMENTS relationships that create threats to
o Framework for Assurance Engagements independence;
 Audit – Philippines Standards on (b) Evaluate information on identified
Auditing breaches of the firm’s independence
 Review – Philippine Standards on policies and procedures to determine
Review Engagements whether they create a threat to
 Other Assurance Engagements – independence;
Philippine Standards on Assurance (c) Take appropriate safeguards to
Engagements eliminate such threats or reduce them
o Related Services to an acceptable level;
 Agreed-upon Procedures Engagement (d) Document conclusions on
– Philippine Standards on Related independence and the basis for such
Services conclusion.
 Compilation Engagement – Philippine  ACCEPTANCE AND CONTINUANCE OF
Standards on Related Services CLIENT RELATIONSHIPS
 The firm should establish policies and
2.3 SYSTEM OF QUALITY CONTROL procedures for the acceptance and
QUALITY CONTROLS continuance of client relationships and
 are policies and procedures adopted by specific engagement, designed to provide
CPAs to provide reasonable assurance of reasonable assurance that it will only
conforming with professional standards in undertake or continue relationships and
performing audit and related services. engagement where it:
 Under Philippine Standards on Quality (a) Has considered the integrity of the
Control (PSQC) 1, a firm has an client;
obligation to establish a system of quality
 (b) Is competent to perform the (c) Not to issue the auditor’s report
engagement and has the capabilities, until the completion of the
time and resources to do so; engagement quality control
(c) Can comply with ethical requirements. review.
6) Differences of Opinion
 HUMAN RESOURCES AND ASSIGNMENT
 Such policies and procedures should  MONITORING
address issues concerning personnel  The continued adequacy and operational
(a) Recruitment; effectiveness of quality control policies and
(b) Performance evaluation, compensation procedures is to be monitored.
and promotion;
(c) Capabilities and competence;
(d) Career development;
(e) Assignment of engagement teams. [ACRONYMS]
 ENGAGEMENT PERFORMANCE o AASC – Auditing and Assurance Standards
 The firm should establish policies and Council
procedures designed to provide o GAAS – Generally Accepted Auditing
reasonable assurance that engagements Standards
are performed in accordance with o I/PSA – International/Philippine Standards on
professional standards and other Auditing
regulatory and legal requirements; and o I/PSAE – International/Philippine Standards
that the audit report issued is appropriate on Assurance Engagements
in the circumstances. o I/PSRE – International/Philippine Standards
1) Direction on Review Engagements
2) Supervision o I/PSRS – International/Philippine Standards
3) Review on Related Services
4) Consultation o IAASB – International Auditing and Assurance
The engagement partner should: Board
(a) Be responsible for the o IFAC – International Federation of
engagement team undertaking Accountants
appropriate consultation on o PSQC – Philippine Standards on Quality
difficult and contentious matters; Control
(b) Be satisfied that members of the o QRC – Quality Review Committee
engagement team have o SEC – Securities and Exchange Commission
undertaken appropriate
consultation during the course of
the engagement, both within the
engagement team and others at
the appropriate level within or
outside the firm;
(c) Be satisfied that the nature and
scope of, and conclusions resulting
from such consultations, are
documented and agreed with the
party consulted;
(d) Determine that conclusions resulting
from consultations have been
implemented.
5) Engagement Quality Control Review
This requires the engagement partner:
(a) To determine that an engagement
quality control reviewer has been
appointed;
(b) To discuss significant matters
arising during the audit
engagement, including those
identified during the quality
control review, with the
engagement quality control
reviewer;
 CHAPTER 3 auditor should perform procedures
(auditor’s responsibility) necessary to determine whether material
misstatements exist.
4) When material misstatement in the financial
statements are identified, the auditor should
3.1 ERROR
consider whether such a misstatement
ERROR resulted from a fraud or error.
 refers to unintentional misstatements in Completion Phase
the financial statements, including the 5) The auditor should obtain a written
omission of an amount or a disclosure. presentation from the client’s management
that:
3.2 FRAUD  the management acknowledges its
FRAUD responsibility for the implementation
and operations of accounting and
 refers to intentional act by one or more internal control systems that are
individuals among management involving designed to prevent and detect fraud
the use of deception to obtain an unjust or and error;
illegal advantage.  it believes the effects of those
 fraudulent acts that cause material uncorrected financial statement
misstatements in the financial statements. misstatements aggregated by the
TYPES OF FRAUD auditor during the audit are immaterial,
both individually and in the aggregate,
(1) Fraudulent financial reporting or to the financial statements taken as a
management fraud whole. A summary of such items should
- involves intentional misstatements or be included in or attached to the
omissions of amounts or disclosures in written representation;
the financial statements.  it has disclosed to the auditor all
(2) Misappropriation of assets or employee significant facts relating to any frauds
fraud or suspected frauds known to
- involves theft of an entity’s assets management that may have affected
committed by the entity’s employees in the entity; and
relatively small and immaterial  it has disclosed to the auditor the results
amounts. of its assessment of the risk that the
AUDITOR’S RESPONSIBILITY financial statements may be materially
misstated as a result of fraud.
 The auditor is not and cannot be held
responsible for the prevention of fraud and Reporting Phase
error. 6) When the auditor believes that material
Planning Phase error or fraud exists, the auditor should
request the management to revise the
1) When planning an audit, the auditor should
financial statements. Otherwise, the auditor
make inquiries of management about the
will express a qualified or adverse
possibility of misstatements due to fraud
opinion.
and error.
7) If the auditor is unable to evaluate the
2) The auditor should assess the risk that
effect of fraud on the financial statements
fraud or error may cause the financial
because of a limitation on the scope of the
statements to contain material
auditor’s examination, the auditor should
misstatements. In this regard, PSA 240
either qualify or disclaim opinion on the
requires the auditor to specifically assess
financial statements.
the risk of material misstatements due to
fraud both at the financial statement level
and assertions level. 3.3 NONCOMPLIANCE WITH LAWS AND
REGULATIONS
Testing Phase
NONCOMPLIANCE
3) During the course of the audit, the auditor
may encounter circumstances that may  refers to acts of omission or
indicate the possibility of fraud or error. For commission by the entity being audited,
example, there are discrepancies found in either intentional or unintentional, which
the accounting records, conflicting or missing are contrary to the prevailing laws or
documents, or lack of cooperation from regulations.
management. In these circumstances, the
  Common examples include: tax evasion, evaluate the possible effect on the financial
violation of environmental protection statements. When evaluating the possible
laws, and inside trading of securities. effect on the financial statements, the
auditor considers:
AUDITOR’S RESPONSIBILITY
 The potential financial consequences,
Planning Phase such as fines, penalties, damages,
1) In order to plan the audit, the auditor threat of expropriation of assets,
should obtain a general understanding of enforced discontinuation of operations
the legal and regulatory framework and litigation.
applicable to the entity and the industry  Whether the potential financial
and how the entity is complying with that consequences require disclosure.
framework.  Whether the potential financial
To obtain the general understanding of consequences are so serious as to call
laws and regulations, the auditor would into question the fair presentation given
ordinarily: by the financial statements.
 Use the existing knowledge of the 5) When the auditor believes there may be
entity’s industry and business. noncompliance, the auditor should document
 Inquire of management concerning the the findings, discuss them with management,
entity’s policies and procedures and consider the implication on other
regarding compliance with laws and aspects of the audit.
regulations.
 Inquire of management as to the laws 3.4 FRAUD RISK FACTORS RELATING TO
or regulations that may be expected to MISSTATEMENTS RESULTING FROM
have a fundamental effect on the FRAUDULENT FINANCIAL REPORTING
operations of the entity.
THREE CATEGORIES
 Discuss with management the policies or
procedures adopted for identifying, 1) Management’s characteristics and
evaluating and accounting for litigation influence over the control environment
claims and assessments. 2) Industry conditions
 Discuss the legal and regulatory 3) Operating characteristics and financial
framework with auditors of subsidiaries stability
in other countries (for example, if the Fraud Risk Factors Relating to Management’s
subsidiary is required to adhere to the Characteristics and Influence Over the Control
securities regulations of the parent Environment
company). o There is motivation for management to
2) After obtaining a general understanding, engage in fraudulent financial reporting.
the auditor should design procedures to o There is a failure by management to display
help identify instances of noncompliance and communicate an appropriate attitude
with laws and regulations such as: regarding internal control and the financial
 Reading minutes of meetings. reporting process.
 Inquiring management as to whether o Non-financial management participates
the entity is in compliance with such excessively in, or is preoccupied with, the
laws and regulation. selection of accounting principles or the
 Inspecting correspondence with the determination of significant estimates.
relevant licensing or regulatory o There is a high turnover of management,
authorities. counsel, or board members.
3) The auditor should also design audit o There is a strained relationship between
procedures to obtain sufficient appropriate management and the current or predecessor
audit evidence about compliance with those auditor.
laws and regulations generally recognized o There is a history of securities law violations,
by the auditor to have an effect on the or claims against the entity or its
determination of material amounts and management alleging fraud or violations of
disclosures in financial statements. securities laws.
Testing Phase o The corporate governance structure is weak
4) When the auditor becomes aware of or ineffective, which may be evidenced by.
information concerning a possible instance Fraud Risk Factors Relating to Industry
of noncompliance, the auditor should obtain Conditions
an understanding of the nature of the act
o New accounting, statutory or regulatory
and the circumstances in which it has
requirements that could impair the financial
occurred, and sufficient other information to
stability or profitability of the entity.
o A high degree of competition or market
saturation, accompanied by declining
margins.
o A declining industry with increasing business
failures and significant declines in customer
demand.
o Rapid changes in the industry, such as high
vulnerability to rapidly changing technology
or rapid product obsolescence.

3.5 FRAUD RISK FACTORS RELATING TO

MISSTATEMENTS RESULTING FROM
MISAPPROPRIATION OF ASSETS
TWO CATEGORIES
1) Susceptibility of assets to
misappropriation
2) Controls
Fraud Risk Factors Relating to Susceptibility of
Assets to Misappropriation
o Large amounts of cash on hand or processed.
o Inventory characteristics, such as small size
combined with high value and high demand.
o Easily convertible assets, such as bearer
bonds, diamonds or computer chips.
o Fixed assets characteristics, such as small size
combined with marketability and lack of
ownership identification.
Fraud Risk Factors Relating to Controls
o Lack of appropriate management oversight
(for example, inadequate supervision or
inadequate monitoring of remote locations).
o Lack of procedures to screen job applicants
for positions where employees have access
to assets susceptible to misappropriation.
o Inadequate record keeping for assets
susceptible to misappropriation.
o Lack of an appropriate segregation of
duties or independent checks.
o Lack of an appropriate system of
authorization and approval of transactions
(for example, in purchasing).
o Poor physical safeguards over cash,
investments, inventory or fixed assets.
o Lack of timely and appropriate
documentation for transactions (for example,
credits for merchandise returns).
o Lack of mandatory vacations for employees
performing key control functions.