OVERVIEW OF THE AUDIT PROCESS AND PRELIMINARY ACTIVITIES

ESCALA - CHAPTER 4

Definition of Financial Statement Audit

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 communicate the results thereof.

Premise of an Audit in Accordance with PSAs

An audit is conducted on the premise that management and, where appropriate, those charged with governance, have fundamental responsibilities for the financial statements.

Overall Objectives of the Auditor (PSA 200)

1. Obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, to express an opinion on whether they are prepared in accordance with an applicable financial reporting framework.

2. Report on the financial statements and communicate as required by PSAs.

Categories of Management Assertions (Traditional/TAP per PSA 500)

1. Classes of transactions and events for the period under audit (TOCCAC).

2. Account balances at the period end (ACERV).

3. Presentation and disclosure (POCAC).

Occurrence Assertion - Transactions (Traditional PSA 500)

Transactions and events that have been recorded have occurred and pertain to the entity.

Completeness Assertion - Transactions (Traditional PSA 500)

All transactions and events that should have been recorded have been recorded.

Cutoff Assertion - Transactions (Traditional PSA 500)

Transactions and events have been recorded in the correct accounting period.

Accuracy Assertion - Transactions (Traditional PSA 500)

Amounts and other data relating to recorded transactions and events have been recorded appropriately.

Classification Assertion - Transactions (Traditional PSA 500)

Transactions and events have been recorded in the proper accounts.

Completeness Assertion - Balances (Traditional PSA 500)

All assets, liabilities, and equity interests that should have been recorded have been recorded.

Existence Assertion - Balances (Traditional PSA 500)

Assets, liabilities, and equity interests exist.

Rights and Obligations Assertion - Balances (Traditional PSA 500)

The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.

Valuation and Allocation Assertion - Balances (Traditional PSA 500)

Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

Occurrence and Rights and Obligations Assertion - Presentation & Disclosure (Traditional PSA 500)

Disclosed events, transactions, and other matters have occurred and pertain to the entity.

Completeness Assertion - Presentation & Disclosure (Traditional PSA 500)

All disclosures that should have been included in the financial statements have been included.

Accuracy and Valuation Assertion - Presentation & Disclosure (Traditional PSA 500)

Financial and other information are disclosed fairly and at appropriate amounts.

Classification and Understandability Assertion - Presentation & Disclosure (Traditional PSA 500)

Financial information is appropriately presented and described, and disclosures are clearly expressed.

Categories of Management Assertions (New per PSA 315)

1. Classes of transactions and events and related disclosures for the period under audit (POCCAC).

2. Account balances and related disclosures at period end (PACER C).

Presentation Assertion - Transactions & Disclosures (PSA 315)

Transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the applicable financial reporting framework.

Occurrence Assertion - Transactions & Disclosures (PSA 315)

Transactions and events that have been recorded or disclosed have occurred, and such transactions and events pertain to the entity.

Completeness Assertion - Transactions & Disclosures (PSA 315)

All transactions and events that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.

Cutoff Assertion - Transactions & Disclosures (PSA 315)

Transactions and events have been recorded in the correct accounting period.

Accuracy Assertion - Transactions & Disclosures (PSA 315)

Amounts and other data relating to recorded transactions and events have been recorded appropriately, and related disclosures have been appropriately measured and described.

Classification Assertion - Transactions & Disclosures (PSA 315)

Transactions and events have been recorded in the proper accounts.

Presentation Assertion - Balances & Disclosures (PSA 315)

Assets, liabilities, and equity interests are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the applicable financial reporting framework.

Accuracy, Valuation, and Allocation Assertion - Balances & Disclosures (PSA 315)

Assets, liabilities, and equity interests have been included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments have been appropriately recorded, and related disclosures have been appropriately measured and described.

Completeness Assertion - Balances & Disclosures (PSA 315)

All assets, liabilities, and equity interests that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.

Existence Assertion - Balances & Disclosures (PSA 315)

Assets, liabilities, and equity interests exist.

Rights and Obligations Assertion - Balances & Disclosures (PSA 315)

The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.

Classification Assertion - Balances & Disclosures (PSA 315)

Assets, liabilities, and equity interests have been recorded in the proper accounts.

Responsibilities of Management and Governance (PSA 200)

1. Preparation and presentation of financial statements in accordance with the applicable financial reporting framework, including internal control.

2. Providing the auditor access to all information, additional requested information, and unrestricted access to persons within the entity.

Specific Responsibilities of Management for Financial Statements

1. Identification of the applicable financial reporting framework.

2. Preparation and presentation of financial statements by that framework.

3. Adequate description of that framework in the financial statements.

Major Audit Procedures

1. Risk assessment procedures.

2. Test of controls.

3. Substantive procedures.

Risk Assessment Procedures

Audit procedures performed to obtain an understanding of the entity and its environment, including its internal control, to identify and assess risks of material misstatement at the financial statement and assertion levels.

Test of Controls

An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.

Substantive Procedures

An audit procedure designed to detect material misstatements at the assertion level. Comprises:

1. Tests of details (classes of transactions, account balances, and disclosures).

2. Substantive analytical procedures.

Specific Audit Procedures

1. Inquiry

2. Inspection

3. Observation

4. Analytical Procedures

5. Reperformance

6. Recalculation

7. Confirmation

Inquiry (Specific Audit Procedure)

Seeking information from knowledgeable persons, both financial and non-financial, throughout or outside the entity.

Inspection (Specific Audit Procedure)

Examination of physical documents, records, or assets to assess accuracy, completeness, and compliance. Divided into:

a. Inspection of Records or Documents

b. Inspection of Tangible Assets

Observation (Specific Audit Procedure)

Looking at a process or procedure being performed by others.

Analytical Procedures (Specific Audit Procedure)

Evaluations of financial information made by a study of plausible relationships among both financial and non-financial data, including investigation of inconsistent fluctuations.

Reperformance (Specific Audit Procedure)

The auditor's independent execution of procedures or controls that were originally performed as part of the entity's internal control.

Recalculation (Specific Audit Procedure)

Checking the mathematical accuracy of documents or records manually or electronically.

Confirmation (Specific Audit Procedure)

A specific type of inquiry obtaining representation of information or an existing condition directly from a third party.

Audit Evidence

Information used by the auditor in arriving at conclusions on which the auditor's opinion is based, including accounting records and other information.

Unmodified Opinion (Unqualified Opinion)

Expressed when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

Modified Opinion Types

1. Qualified Opinion

2. Adverse Opinion

3. Disclaimer of Opinion

Basis for Modified Opinion: Choice between Qualified and Adverse

The auditor concludes, based on obtained audit evidence, that the financial statements as a whole are not free from material misstatement.

Basis for Modified Opinion: Choice between Qualified and Disclaimer

The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

Two Sub-Phases of the Audit Process

1. Investigative Phase (performing procedures and gathering evidence).

2. Reporting Phase (expressing opinion, preparing report, and communicating results).

Detailed Steps of the Audit Process

1. Preliminary engagement activities

2. Planning an audit of financial statements

3. Study and evaluation of internal control

4. Evidence-gathering (Substantive testing)

5. Completing the audit

7. Post-audit responsibilities

Primary Objective: Preliminary Engagement Activities

To minimize the likelihood of being associated with a client whose management lacks integrity.

Primary Objective: Planning an Audit of Financial Statements

To assess the different risks associated with the audit to determine the nature, timing, and extent of further audit procedures necessary to be performed.

Primary Objective: Study and Evaluation of Internal Control

To establish a basis for reliance on internal controls, in determining the nature, timing, and extent of audit procedures to be performed.

Primary Objective: Evidence-Gathering (Substantive Testing)

To ascertain the degree of correspondence between the financial statements prepared by client management and the financial reporting framework.

Primary Objective: Completing the Audit

To assist the auditor in assessing whether the conclusion reached is consistent with the evidence gathered.

Primary Objective: Issuance of the Audit Report

To communicate the conclusions reached by the auditor to various intended users.

Primary Objective: Post-Audit Responsibilities

To assess and evaluate the quality of services delivered by the engagement team.

5 Major Considerations in Accepting/Rejecting an Engagement

1. Firm competence

2. Firm independence

3. Ability to serve the client properly

4. Auditability of the prospective client

5. Integrity of prospective client's management

Competence Requirement (Code of Ethics)

A professional accountant in public practice should agree to provide only those services that they are competent to perform (within capacity and capability).

Independence Components

1. Independence of Mind: State of mind permitting expression of a conclusion without influences compromising professional judgment.

2. Independence in Appearance: Avoidance of facts/circumstances significant enough that a reasonable third party would conclude integrity/objectivity was compromised.

Members Required to be Independent on an Audit Engagement

All members of the audit team, which includes members of the engagement team, the firm, and its network firm/s.

Evaluating Firm's Ability to Serve Client

Considering available resources (such as personnel) to ensure the firm can serve the prospective client properly.

Evaluating Auditability

Determining whether accounting records, documents, and supporting information are available. Their absence raises significant doubt about auditability.

Methods to Investigate Management Integrity

Reading published articles, inquiring of appropriate parties, or communicating with the previous (predecessor) auditor.

Prerequisite for Communicating with Parties Other Than Client

The auditor shall seek explicit permission from the client and document all items discussed.

Matters to Discuss with the Previous (Predecessor) Auditor (RID)

1. Reasons for change in auditors

2. Information that might bear on Integrity of management

3. Disagreements between previous auditor and management as to accounting principles, auditing procedures, etc.

Objective of Accepting an Engagement

To accept or continue an audit engagement only when the basis has been agreed, by establishing presence of preconditions and confirming a common understanding of terms.

Preconditions for an Audit

1. Management's use of an acceptable financial reporting framework in preparing financial statements.

2. Agreement of management (and governance) to the premise on which an audit is conducted.

Auditor Action when Preconditions are Absent

Discuss the matter with management; do not accept the proposed engagement unless required by law or regulation.

Limitation on Scope Prior to Engagement Acceptance

If management imposes a scope limitation that would result in disclaiming an opinion, the auditor shall not accept the engagement (unless required by law/regulation).

Recording Terms of Engagement

Agreed terms shall be recorded in an audit engagement letter or other suitable written agreement.

Timing of Sending Engagement Letter

Preferably before the commencement of the audit to help avoid misunderstandings.

General Contents of an Audit Engagement Letter

1. Objective and scope of the audit

2. Responsibilities of the auditor

3. Responsibilities of management

4. Identification of the applicable financial reporting framework

5. Reference to expected form/content of reports to be issued

Additional Matters Referenced in Engagement Letter (RA FORMS)

1. Risk of audit (inherent limitations)

2. Unrestricted Access to records

3. Framework used

4. Objective of the audit

5. Reports form/content

6. Management's responsibility

7. Scope elaboration

Other Optional Items in Engagement Letter (FRAP Reports)

1. Fees basis and billing arrangements

2. Representation letter expectation

3. Acknowledgment of terms by management

4. Planning arrangements

5. Description of other letters or Reports

Factors Influencing Separate Engagement Letter for Components (CLOSI)

1. Component auditor appointment authority

2. Legal requirements regarding audit appointments

3. Ownership degree by parent

4. Separate auditor's report requirement

5. Independence degree of component management from parent

Factors Prompting Revised Terms or New Letter in Recurring Audits

1. Misunderstanding of objective/scope

2. Revised or special terms

3. Recent change in senior management/board/ownership

4. Significant change in client size/nature

5. Change in legal, regulatory, or reporting requirements/framework

Requirement for Changing Engagement to Lower Assurance Level

The auditor must determine whether there is reasonable justification for the requested change.

Reasonably Justifiable Reasons for Change in Engagement

1. Change in circumstances affecting the need for the service.

2. A misunderstanding as to the nature of an audit or related service originally requested.

Non-Justifiable Reasons for Change in Engagement

1. Restriction on scope imposed by management or circumstances.

2. Change relates to information that is incorrect, incomplete, or unsatisfactory.

3. Auditor unable to obtain sufficient appropriate audit evidence.

Auditor Action when Change in Engagement is Justified

1. Stop performing old engagement.

2. Stop referring to old engagement (except if new engagement is agreed-upon procedures).

3. Perform new engagement and record new terms in a new engagement letter.

Auditor Action when Change in Engagement is NOT Justified

1. Continue original audit engagement.

2. If prohibited by management to continue, withdraw from audit engagement and consider obligations to report reasons to appropriate parties.