AUDITING

• a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

Objective and General Principles Governing an Audit of Financial Statements (PSA 200) (Amended as a Result of Revision of PSA 700)

PHILIPPINE STANDARD ON AUDITING (PSA)

• Its purpose is to establish standards and provide guidance on the objective and general principles governing an audit of financial statements.

• It also describes management’s responsibility for the preparation and presentation of the financial statements and for identifying the financial reporting framework to be used in preparing the financial statements, referred to in the PSAs as the “applicable financial reporting framework.”\

AUDIT OF FINANCIAL STATEMENTS, AS DEFINED IN THE PHILIPPINE FRAMEWORK FOR ASSURANCE ENGAGEMENTS

• is an assurance engagement

• The Framework defines and describes the elements and objectives of an assurance engagement

• The PSAs apply the Framework in the context of an audit of financial statements and contain the basic principles and essential procedures, together with related guidance, to be applied in such an audit, Paragraphs 34-35 in this PSA discuss the meaning of the term “financial statements” and management's responsibility for such statements

• a condition for acceptance of an assurance engagement is that the criteria referred to in the definition are “suitable criteria” and available to intended users. Paragraphs 37-48 in this PSA discuss suitable criteria and their availability to intended users for an audit of financial statements through the auditor’s consideration of the acceptability of the financial reporting framework.

OBJECTIVE OF AN AUDIT OF FINANCIAL STATEMENTS

• to enable the auditor to express an opinion whether the financial statements are prepared, in all maternal respects, m accordance with an identified financial reporting framework.

Ethical Requirements Relating to an Audit of Financial Statements

• The auditor should comply with relevant ethical requirements relating to audit engagements.

• PSA 220 (Revised) identifies the fundamental principles of professional ethics established by Parts A and B of the Ethics Code and sets out the engagement partner’s responsibilities with respect to ethical requirements.

• PSA 220 (Revised) recognizes that the engagement team is entitled to rely on a firm’s systems in meeting its responsibilities with respect to quality control procedures applicable to the individual audit engagement (for example, in relation to capabilities and competence of personnel through their recruitment and formal training; independence through the accumulation and communication of relevant independence information; maintenance of client relationships through acceptance and continuance systems; and adherence to regulatory and legal requirements through the monitoring process), unless information provided by the firm or other parties suggests otherwise.

• Accordingly, Philippine Standard on Quality Control-(PSQC) 1, “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements,” requires the firm to establish policies and procedures designed to provide it with reasonable assurance that the firm and its personnel comply with relevant ethical requirements.

Ethical Requirements Relating to an Audit of Financial Statements

• The auditor should conduct an audit in accordance with Philippine Standards on Auditing.

• PSAs contain basic principles and essential procedures together with related guidance in the form of explanatory and other material, including appendices.

• The basic principles and essential procedures are to be understood and applied in the context of explanatory and other material that provide guidance for their application.

• The text of a whole Standard is considered in order to understand and apply the basic principles and essential procedures.

• In conducting an audit in accordance with PSAs, the auditor is also aware of and considers Philippine Auditing Practice Statements (PAPSs) applicable to the audit engagement.

• PAPSs provide interpretative guidance and practical assistance to auditors in implementing PSAs

• An auditor who does not apply the guidance included in a relevant PAPS needs to be prepared to explain how the basic principles and essential procedures in the Standard addressed by the PAPS have been complied with.

• The auditor may also conduct the audit in accordance with both ISAs and PSAs.

• However, there are currently no fundamental differences between the IAASB pronouncements and corresponding requirements issued by the AASC and no such differences are expected in the future.

Scope of an Audit of Financial Statements

• Refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the audit.

• The auditor should not represent compliance with Philippine Standards on Auditing unless the auditor has complied fully with all of the Philippine Standards on Auditing relevant to the audit.

• The auditor may, in exceptional circumstances, judge it necessary to depart from a basic principle or an essential procedure that is relevant in the circumstances of the audit, in order to achieve the objective of the audit.

• In such a case, the auditor is not precluded from representing compliance with PSAs, provided the departure is appropriately documented as required by PSA 230, “Audit Documentation.”

Professional Skepticism

• The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated.

• means the auditor makes a critical assessment, with a questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that contradicts or brings into question the reliability of documents and responses to inquiries and other information obtained from management and those charged with governance.

• Accordingly, representations from management are not a substitute for obtaining sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion.

Reasonable Assurance

• is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole.

• that the financial statements taken as a whole are free from material misstatement, whether due to fraud or error.

• An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the auditor’s ability to detect material misstatements.

• These limitations result from factors such as the following:

  • The use of testing.

  • The inherent limitations of internal control (for example, the possibility of management override or collusion).

  • The fact that most audit evidence is persuasive rather than conclusive

• Also, the work undertaken by the auditor to form an opinion is permeated by judgment, in particular regarding:

  • The gathering of audit evidence, for example, in deciding the nature, timing and extent of audit procedures; and

  • The drawing of conclusions based on the audit evidence gathered, for example, assessing the reasonableness of the estimates made by management in preparing the financial statements.

• Other limitations may affect the persuasiveness of evidence available to draw conclusions on particular assertions (for example, transactions between related parties).

• In these cases, certain PSAs identify specified audit procedures which will, because of the nature of the particular assertions, provide sufficient appropriate audit evidence in the absence of:

  • Unusual circumstances which increase the risk of material misstatement beyond that which would ordinarily be expected; or

  • Any indication that a material misstatement has occurred.

• An audit opinion does not assure the future viability of the entity nor the efficiency or effectiveness with which management as conducted the affairs of the entity.

Audit Risk and Materiality

• The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

• The concept of reasonable assurance acknowledges that there is a risk the audit opinion is inappropriate.

• The auditor should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the objective of an audit.

• The auditor reduces audit risk by designing and performing audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base an audit opinion.

• Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level.

Responsibility for the Financial Statements

• Responsibility for the preparation and presentation of the financial statements in accordance with the applicable financial reporting framework is that of the management of the entity.

• The audit of the financial statements does not relieve management or those charged with governance of their responsibilities.

Determining the Acceptability of the Financial Reporting Framework

• The auditor should determine whether the financial reporting framework adopted by management in preparing the financial statements is acceptable.

• auditor ordinarily makes this determination when considering whether to accept the audit engagement.

• An acceptable financial reporting framework is referred to in the PSAs as the “applicable financial reporting framework.”

• The auditor determines whether the financial reporting framework adopted by management is acceptable in view of the nature of the entity (for example, whether it is a business enterprise, a public sector entity or a not-for-profit organization) and the objective of the financial statements.

Expressing an Opinion on the Financial Statements

• PSA 700, “The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements,” for standards and guidance on the matters the auditor considers in forming an opinion on such financial statements and on the form and content of the auditor’s report.

• The auditor also refers to PSA 701 when expressing a modified audit opinion including an emphasis of matter, a qualified Opinion, a disclaimer of opinion or an adverse opinion.

The auditor refers to PSA 800 when expressing an opinion on:

• A complete set of financial statements prepared in accordance with another comprehensive basis of accounting;

• A component of a complete set of general purpose or special purpose financial statements, such as a single financial statement, specified accounts, elements of accounts, or items in a financial statement;

• Compliance with contractual agreements; and

• Summarized financial statements.

Major Steps in the Systematic Process of Financial Statements Audit

Phase I Pre-engagement and Audit Planning Activities

• Begins with the preliminary arrangements with the client. Once the client has signed the engagement letter, the planning process starts as the auditor concentrates his efforts in obtaining a detailed understanding of the client’s business and an overall audit strategy.

• The auditor should observe PSA 300 (Revised) on “Planning an Audit of Financial Statements.”

• Audit planning includes understanding the client’s:

  • (1) industry environment,

  • (2) business and management,

  • (3) accounting and reporting systems, and

  • (4) internal control.

• He then assesses the “audit risk” relative to the engagement.

• auditor may decide to assess control risk at the maximum level for some assertions and below maximum for others.

  • Maximum control risk is defined at the greatest probability that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the entity’s internal control structure.

• Assessments of materiality, acceptable audit risk, inherent risk and control risk are used to develop an overall audit plan and audit program.

Phase II Gathering and Evaluating Audit Evidence

• auditors perform two basic types of audit tests: test of controls and substantive tests.

INTERIM AUDIT PHASE

• auditor focuses his attention on both the design and operation of aspects of the internal control structure to determine whether the necessary controls were functioning as intended.

• preliminary assessment of control risk is below the maximum level = may decide to perform tests of controls

• control risk at the maximum level = not required to perform any tests of controls

• Tests of controls are performed to determine whether a control is working.

• Tests of controls may require inquiry, observation, or inspection of documents.

The tests of controls involve the following types of procedures:

1. Inquiries of client personnel

2. Inspection of documents and records

3. Observation of the application of specific policies and

4. Reperformance of the application of specific policies and procedures

The compliance tests of controls over the basic transaction cycles:

1. revenue and collection cycle,

2. expenditure cycle, and

3. financing and investing cycle may be done in this stage.

• Tests of controls precede substantive testing and performed to reduce the assessed level of control risk below the maximum level.

• Substantive tests of transactions may also be conducted at this stage

• When controls are not considered effective, or when control deviations are discovered, substantive tests can be expanded in this phase or in the final audit phase.

• Results of the auditor's tests of controls whether obtained through reprocessing of transactions, observation or document testing and examination must be fully documented.

• Documentation is a necessary part of the overall evidence describing the thought processes leading to the design of substantive tests and this is especially critical when the auditor assesses control risk to be below the maximum level.

FINAL AUDIT EVIDENCE

• This phase involves substantive tests of details of balances and analytical procedures.

• Substantive audit testing is the process of obtaining evidence in support of transactions and balance.

• The nature, timing and extent of substantive testing is a function of the auditor’s judgment concerning audit risk and materiality.

Nature of Substantive Tests

• Test of balances refer to

  • Substantive tests of transactions and balances, and

  • analytical review procedures performed at or near the balance sheet date that are directed at the verification of an account balance.

• In designing audit programs for tests of balances in a typical audit engagement, the following approaches are often used:

  • When internal control over a specific class of transactions are effective = tests of balances are applied to resulting balance sheet account balances and reliance is placed primarily on internal controls and on analytical review procedures for related income statement account balances

  • When internal control over a specific class of transactions are not tested or cannot be relied upon = tests of balances are applied both to resulting balance sheet and income statement account balances.

Substantive tests may be performed before the balance sheet date when the auditor can

1. Control the added audit risk that errors existing in the account at the balance sheet date will not be detected and

2. reduce the cost of substantive tests at the statement date.

Audit Objectives for Substantive Tests - the auditor aims to substantiate management's assertions relative to:

• (1) existence or occurrence,

  • This relates to whether specific assets and liabilities exist at a given point in time and whether recorded transactions represent economic events that occurred during the year.

• (2) completeness,

  • This involves determining whether all transactions that should have been recorded by the client are accurately included in the accounts.

• (3) rights and obligation,

  • This requires the auditor to obtain evidence that the client has rights to existing assets and that existing liabilities and owners’ equity claims against the entity are valid.

• (4) valuation or allocation, and

  • This involves determining whether financial statement elements are stated at the proper amount in accordance with GAAP.

• (5) presentation and disclosure of the items in the financial statements

  • This involves determining whether statement items are properly identified, classified and arranged in the statements and whether accompanying disclosures are adequate.

The nature, timing, and extent of the procedures performed in the substantive tests

• depend upon the auditor’s assessed level of control risk and the resulting detection risks he or she accepts for each assertion.

• For example, a minimum level of control risk would result in a higher acceptable detection risk and therefore, in less extensive substantive test.

Phase III Issuing the Audit Report

• Expressing an audit opinion is the auditor’s overriding goal

• The audit report concisely describes the auditor’s responsibility, the nature of the examination, the audit finding and his opinion on the financial statements

• If upon completion of the audit field work, the auditor decides that an opinion cannot be rendered, he must clearly disclaim an opinion and give reasons for the disclaimer.

• If an opinion can be rendered, the auditor must decide whether to issue an unqualified, qualified or adverse opinion.