Independent Financial
Audit Engagement
by: Mr. Kart Victor A. Lagustan, CPA
Auditing & Assurance Services Instructor
Southwestern University – PHINMA
House Rules
Come to Class on Time
Be ready to learn
Listen and follow directions
Be respectful
Believe in yourself
Do your best and have fun
Vegas Rule
Risk-Based Audit Approach
Is an audit approach that begins with
an assessment of the types and
likelihood of misstatements in account
balance and then adjust the amount
and type of audit work, to the
likelihood of material misstatements
occurring in account balances
Risk-Based Audit Approach
Under this approach, the auditor performs the following:
1. Identification of the client’s strategy and the
processes for developing that strategy
2. Examination of the core business process and
resource management
3. Identification for each of the key processes (as well as
subprocesses) the objectives, inputs, activities,
outputs, systems and transactions
4. Assessment of the risks that the processes will not
meet the goals and controls related to those risks
Risk-based vs. Account-based
Account-Based – first obtain an
understanding of control and assess control
risk for particular types of errors and frauds
in specific accounts and cycle
Overview of Risk Elements
Affecting an Audit
The risk than an
Audit Risk
Economic risk that a CPA firm is
exposed to.
auditor may give an
unqualified opinion
on financial
statements that are
materially misstated
Engagement
Risk
Those
riskrecording
that affect
Relate directly
to the
of
thethe
operations
and of
transactions and
presentation
Business Risk financial data
potential
outcomes of
in an organization’s
organizational
activities
financial
statement
Financial
Reporting Risk
PHASE
PHASE
PHASE
I.II.
RISK
III.
RISK
REPORTING
ASSESSMENT
RESPONSE
PreEngagement
Planning
Obtain an
engagement
letter
Obtain
preliminary
understanding of
the entity &
internal control
Assign partner,
manager and
staff to
engagement
Design a
preliminary
account
balance audit
program
Internal Control
Risk
Assessment
Account
Balance Audit
Activities
Reporting
Sufficient &
appropriate
audit evidence
Modify the audit
program form if
necessary
Evaluation of
evidence, make
audit decisions.
Working papers
Decide on the
appropriate
audit report
PHASE I. RISK ASSESSMENT
Performance of Preliminary Engagement
CHAPTER 10: Understanding the Entity and Its
Environment
CHAPTER 11: Internal Control in an FS Audit
CHAPTER 12: Fraud and Error
CHAPTER 13: Corporate Governance & Audits
BACK
PHASE II. RISK RESPONSE
CHAPTER 14: Response to Assessed Risks
CHAPTER 15: Audit Evidence
CHAPTER 16-18: Audit Sampling
CHAPTER 19: Internal Controls for Account balances
(Auditing Problems topic)
CHAPTER 20: Substantive Tests of Transactions and
Balances (Auditing Problems topic)
CHAPTER 21: Audit Documentation
BACK
PHASE III. REPORTING
CHAPTER 22: Audit Evaluation Evidence
CHAPTER 23: Completing the Audit and PostAudit Responsibilities
CHAPTER 24: Modifications to the Independent
Auditor’s Report
BACK
Preliminary Engagement
Activities
Pre-Test
Client Acceptance and Continuance
As discussed in “Quality Control”, the auditor
shall only undertake or continue audit
engagement where the auditor:
1. is competent to perform the engagement
and has the capabilities, time and resources
to do so;
2. complies with relevant ethical requirements;
and
3. considers the integrity of the client.
Communication with Predecessor
Auditor
▪ The successor auditor normally inquires the
following from the predecessor auditor
about the prospective client:
– Integrity of management
– Disagreements with management about audit
procedures or accounting principles
– Communication with Audit Committee about
fraud, illegal acts, or internal control
– Reason for change in auditor
Basis of Audit Engagement
▪ In addition, the auditor shall accept or
continue an audit engagement only when
the basis of audit engagement has been
agreed, through:
– Establishing preconditions for an audit; and
– Confirming common understanding between
the auditor and management and, where
appropriate, those charged with governance
(TCWG) on the terms of the audit engagement.
Preconditions for an Audit
▪ In addition, the auditor shall accept or
continue an audit engagement only when
the basis of audit engagement has been
agreed, through:
– Establishing preconditions for an audit(p376);
– Confirming common understanding between
the auditor and management and, where
appropriate, those charged with governance
(TCWG) on the terms of the audit engagement.
Management’s Responsibilities
The following are the management’s responsibilities, which
constitute the premise on which the audit is conducted:
Preparation and presentation of the financial statements
Design, implementation and monitoring of internal control
to financial statements
To provide the auditor with:
Access to all information relevant to audit
Additional information the auditor may request
Unrestricted access to persons within the entity
BACK
Audit Engagement Letter
Engagement letter primarily includes:
▪ The objective and scope of the audit;
▪ The responsibilities of the auditor;
▪ The responsibilities of management;
▪ Identification of the applicable FRF; and
▪ Reference to form and content of audit reports
and statement regarding deviation from form
and content, in certain circumstances.
Additional Contents of the Audit
Engagement Letter
▪ Elaboration of the scope of the audit
▪ The form of any other communication of results of
the audit
▪ Audit and internal control inherent limitations
▪ Planning and performance of the audit, including the
composition of the audit team
▪ Written representations from management
▪ Draft financial statements from management
▪ Audit fees, including computation and billing
Additional Contents of the Audit
Engagement Letter
▪
▪
▪
▪
▪
▪
Acknowledgement from management
Involvement of other auditors and experts
Involvement of internal auditors and other staff
Arrangements with the predecessor auditor
Any restriction of the auditor’s liability
Further agreements between the auditor and the
entity
▪ Any obligations to provide audit working papers to
other parties
Audits of Components
When the auditor of a parent entity is also the auditor of a
component, the following factors are considered whether
to send a separate engagement letter to the component:
▪ Who appoints the component auditor;
▪ Whether a separate auditor’s report is to be issued on the
component;
▪ Legal requirements in relation to audit appointments;
▪ Degree of ownership by parent; and
▪ Degree of independence of the component management
from the parent entity.
Recurring Audits
The auditor should consider the following factors
when sending new engagement letter:
▪ Misunderstanding of the objective and scope
▪ Any revised or special terms
▪ A recent change of senior management
▪ A significant change in ownership
Acceptance of a Change in the
Terms of the Audit Engagement
▪ Request to Change the Terms of the Audit
Engagement
▪ Request to Change to a Review or a Related Service
Decline the Engagement
BACK
TRUE OR FALSE
1.
2.
3.
4.
5.
6.
7.
All attestations are assurance services
All assurance services are attestation
All independent audit are assurance services
All independent audit are attestation services
All review of FS are attestation services
All Non assurance services are engagement
One should be a certified public accountant to become
an auditor.
Identification & Enumeration
8. To whom are you going to ask permission before inquiring the
predecessor auditor?
9-11. The three phase of Risk Based Approach
12-14. The three major management responsibilities
15-18. Different types of audit opinion
19. Audit Risk Formula
20. A letter sent by the auditor to the client that contains the
objective, scope and responsibilities of both party in an audit.
AUDIT PLANNING
▪ establishing the overall audit strategy (a
general strategy) for the engagement; and
▪ developing an audit plan (a detailed approach
for the expected nature, timing and extent of
the audit),
▪ in order to reduce audit risk (i.e., the chance
that audit opinion is inappropriate) to an
acceptably low level.
The main outputs after planning
the audit are:
▪ The overall audit strategy (a.k.a., audit
planning memorandum)
▪ The audit plan (a.k.a., audit programs or audit
completion checklists)
Benefits of Audit Planning
▪ Appropriate attention to important areas of the audit.
▪ Identify and resolve potential problems on a timely basis.
▪ Organize and manage the audit engagement so that it is
performed in an effective and efficient manner.
▪ Assist in the proper selection of engagement team
members and the assignment of work to them.
▪ Facilitate the direction and supervision of engagement
team members and the review of their work.
▪ Assist, where applicable, in coordination of work done by
auditors of components and experts.
Overall Audit Strategy
Overall audit strategy sets the scope, timing, and direction of
the audit, and guides the development of the audit plan.
In establishing the overall audit strategy, the auditor is
required to:
▪ Identify the characteristics of the engagement that define
its scope
1. The Financial Reporting Framework
2. Industry specific reporting requirements, and
3. The locations of the components of the entity
Overall Audit Strategy
In establishing the overall audit strategy, the auditor is required
to:
▪ Ascertain the reporting objectives of the engagement to plan
the timing of the audit and the nature of the communications
required
1. Deadlines for interim and final reporting
2. Key dates and organization of meetings with management
and TCWG to discuss the nature and extent of audit work
3. Discussion with management regarding the expected
communication on the status of audit work throughout the
engagement
Overall Audit Strategy
▪ Consider the factors that, in our professional judgment, are
significant in directing the engagement team’s efforts
1. Determination of appropriate materiality levels
2. Preliminary identification of areas where there may be higher
risks of material misstatements
3. Preliminary identification of material components and account
balances
4. Evaluation of whether the auditor may plan to obtain evidence
regarding the effectiveness of internal control, and
5. Identification of recent significant entity-specific, industry,
financial reporting or other relevant developments
Overall Audit Strategy
▪ Consider the results of preliminary engagement activities
and, where applicable, whether knowledge gained on other
engagements performed by the engagement partner for
the entity is relevant
▪ Ascertain the nature, timing and extent of resources
necessary to perform the engagement.
Nature, Timing and Extent of
Necessary Resources
▪ The selection of the engagement team (including, where
necessary, the engagement quality control reviewer) and
the assignment of audit.
▪ Engagement budgeting and timetable.
– The auditor shall document the overall audit strategy commonly in
the form of a memorandum.
AUDIT PLAN
▪ more detailed than the overall audit strategy in
that it includes the nature, timing and extent of
audit procedures to be performed by
engagement team members required to
implement the overall audit strategy into a
comprehensive description of the work to be
performed.
AUDIT PLAN
▪ The auditor shall develop an audit plan that shall include a description of:
1.
The nature, timing, and extent of planned risk assessment procedures (RAP)
2.
The nature, timing, and extent of planned further audit procedures (FAP),
which include tests of controls and substantive procedures, at the assertion
level
3.
Other planned audit procedures that are required to be carried out
▪ The auditor shall document audit plan recording the planned nature, timing and
extent of risk assessment procedures and further audit procedures (tests of
controls and substantive procedures) at the assertion level in response to the
assessed risks. The auditor may use standard (pre-printed) audit programs,
tailored as needed.
BACK
Materiality
▪ For any given client, materiality is not simply a
function of specific amounts in the financial
statements. An auditor must understand who
the potential users are and the type of
judgments made by those users when relying
on financial statements.
Application of Materiality
Materiality is applied both in planning, performing and concluding on
the audit. In particular, when:
▪ Identifying material classes of transactions, account balances and
disclosures
▪ Determining the nature, timing and extent of risk assessment
procedures
▪ Identifying and assessing the risks of material misstatement
▪ Determining the nature, timing and extent of further audit
procedures (testing of controls and performing substantive
procedures)
▪ Evaluating the effect of uncorrected misstatements, if any, on the
financial statements and in forming the opinion in our audit report.
Materiality Levels
The auditor establishes the following levels of materiality in
an audit of financial statements:
▪ Materiality for the financial statements as a whole
▪ Materiality for particular classes of transactions, account
balances, or disclosures, if necessary
▪ Performance materiality for (a) and (b) above
▪ Clearly trivial materiality
Materiality for the Financial
Statements as a whole (a.k.a.
Preliminary/Planning Materiality)
▪ The auditor’s determination of materiality is a matter of
professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of the
financial statements. The determination of materiality is not
a mechanical exercise, if fact, there is no specific
methodologies prescribed in the standard. However, a
percentage is often applied to a chosen benchmark as a
starting point to determine materiality. Qualitative
conditions should also be considered in determining
materiality.
Materiality for Particular Classes
of Transactions, Account Balances,
or Disclosures
▪ For certain entities, there may be one or more particular
classes of transactions, account balances, or disclosures for
which misstatements of lesser amounts than materiality for
the financial statements as a whole could reasonably be
expected to influence the economic decisions of users taken on
the basis of the financial statements.
Performance Materiality (a.k.a.
Tolerable Misstatement)
▪ Performance materiality is the amount or amounts set by the
auditor at less than materiality for the FSs as a whole to reduce
to an appropriately low level the probability that the aggregate
of uncorrected and undetected misstatements exceeds
materiality for the FSs as a whole, i.e., to provide a cushion, so
that if misstatements are detected, the auditor may
nevertheless be able to conclude with reasonable assurance
that the total misstatement in the FSs does not exceed
materiality.
Performance Materiality (a.k.a.
Tolerable Misstatement)
The auditor is required to determine performance materiality for
purposes of:
▪ assessing the risks of material misstatement; and
▪ determining the nature, timing, and extent of further audit
procedures.
If materiality level(s) have been set for particular classes of
transactions, account balances, or disclosures, performance
materiality also refers to amount(s) set at less than these levels
Clearly trivial materiality
▪ Clearly trivial materiality is the amount below which
misstatements would be clearly trivial and would not need to
be accumulated because such amounts clearly would not have
a material effect on the financial statements.
▪ When there is any uncertainty about whether one or more
items are clearly trivial, the matter is considered not to be
clearly trivial.
Revision of Materiality
Materiality levels are not cast in stone once determined. These
may be adjusted, upward or downward, as necessary as the
audit progresses for example due to the following reasons:
▪ Changes in entity’s circumstances
▪ New information
▪ Change in understanding of entity and its operations
BACK
Evaluation of Misstatements
Identified During the Audit
▪ Closely related to the concept of materiality is misstatement.
Misstatement is a difference between the amount,
classification, presentation, or disclosure of a reported
financial statement item and the amount, classification,
presentation, or disclosure that is required for the item to be in
accordance with the applicable financial reporting framework.
Misstatements can arise from error or fraud.
Misstatements may be identified at
any stage of the audit.
Misstatements may result from:
▪ • An inaccuracy in gathering or processing data from which the
FSs are prepared
▪ • An omission of an amount or disclosure
▪ • An incorrect accounting estimate arising from overlooking or
clear misinterpretation of facts
▪ • Judgments of management concerning accounting estimates
that the auditor considers unreasonable or the selection and
application of accounting policies that the auditor considers
inappropriate.
Types of Misstatements
Factual misstatements are misstatements about which there is no
doubt.
Judgmental misstatements are differences arising from the
judgments of management concerning accounting estimates that
the auditor considers unreasonable, or the selection or application
of accounting policies that the auditor considers inappropriate.
Projected misstatements are the auditor’s best estimate of
misstatements in populations, involving the projection of
misstatements identified in audit samples to the entire population
from which the samples were drawn.
Uncorrected misstatements
Audit Risk and The Audit Risk
Model
Audit risk is the risk (likelihood) that the auditor
gives an inappropriate audit opinion when the
FSs are materially misstated. Audit risk is a
function of the risks of material misstatement
and detection risk [AR = f(ROMM x DR)].
Risks of Material Misstatement
(ROMM)
The ROMM refers to the likelihood that the financial
statements are materiality misstated prior to the audit.
The ROMM may exist at two levels:
• The overall financial statement level; and
• The assertion level for classes of transactions, account
balances, and disclosures.
ROMM at the overall FSs level refer to risks of material
misstatement that relate pervasively to the FSs as a
whole and potentially affect many assertions.
Inherent risk
Inherent risk is the susceptibility of an assertion about a class of
transaction, account balance or disclosure to a misstatement that
could be material, either individually or when aggregated with other
misstatements, before consideration of any related controls.
Inherent risk is higher for some assertions and related classes of
transactions, account balances, and disclosures than for others. For
example, it may be higher for complex calculations or for accounts
consisting of amounts derived from accounting estimates that are
subject to significant estimation uncertainty. External circumstances
giving rise to business risks may also influence inherent risk. For
example, technological developments might make a particular
product obsolete, thereby causing inventory to be more susceptible
to overstatement.
Control Risk
Control risk is the risk that a misstatement that could occur in an
assertion about a class of transaction, account balance or disclosure
and that could be material, either individually or when aggregated
with other misstatements, will not be prevented, or detected and
corrected, on a timely basis by the entity’s internal control.
Control risk is a function of the effectiveness of the design,
implementation and maintenance of internal control. However,
internal control, no matter how well designed and operated, can
only reduce, but not eliminate, risks of material misstatement in the
financial statements, because of the inherent limitations of internal
control. Accordingly, some control risk will always exist.
Detection Risk
Detection risk is the risk that the procedures performed
by the auditor to reduce audit risk to an acceptably low
level will not detect a misstatement that exists and that
could be material, either individually or when
aggregated with other misstatements.
For a given level of audit risk, the acceptable level of
detection risk bears an inverse relationship to the
assessed risks of material misstatement at the assertion
level. The higher the assessed level of risk of material
misstatement, the lower the detection risk the auditor
sets, and vice versa.
Detection Risk
Detection risk relates to the nature, timing, and extent of the
auditor’s procedures that are determined by the auditor to
reduce audit risk to an acceptably low level. It is therefore a
function of the effectiveness of an audit procedure and of its
application by the auditor.
Therefore, from the given relationship above, detection risk
cannot be set to zero given that there is always risk of
material misstatement of the financial statements. This is also
because of many factors in audit such as sampling risk
(remember, the auditor does not examine the entire
transactions and account balances) and human error.
Limitations of Audit Risk Model
The audit risk model has the following limitations:
• Inherent risk is difficult to formally assess.
• Audit risk is judgmentally determined.
• The model treats each risk component as separate and independent
when in fact the components are not independent.
• Audit technology is not so precisely developed that each component
of the model can be accurately assessed.
Because of these limitations, many auditors use the audit risk model
as a functional one, rather than mathematical model
Materiality and Audit Procedures
The level of materiality has an inverse
relationship on audit procedures. The lower the
materiality (performance materiality), the more
extensive the required audit procedures to be
able to gain reasonable assurance that the class
of transactions, account balance, or disclosure
is not materiality misstated.
Risks of Material Misstatements,
Detection Risk and Audit Procedures
The higher the assessed level of risk of material
misstatement, the lower the detection risk the
auditor sets, and vice versa. The lower the
detection risk, the more rigorous (nature, timing
and extent) the substantive audit procedures
should be performed, and vice versa.
Substantive Audit
procedures
Assessed level of
ROMM is high
Assessed level of
ROMM is low
Nature
More effective
Less effective
Timing
At year end
At interim dates
Extent
More extensive
Less extensive
Audit Risk and Materiality
There is an inverse relationship between
materiality and the level of audit risk, i.e., the
higher the materiality, the lower the audit risk,
and vice versa. The auditor takes the inverse
relationship between materiality and audit risk
into account when determining the nature,
timing and extent of audit procedures.
Materiality and Audit Evidence
Materiality and audit evidence are inversely
related. The lower the level of materiality the
auditor determines, the more audit evidence
must be obtained (and vice versa) in order to
gain more confidence (assurance) that the item
is not materiality misstated
BACK
Quiz 3
▪ At interim dates
▪ At year end
▪ Less extensive
Substantive
Audit
procedures
Nature
▪ More Effective
▪ More extensive
▪ Less effective
Assessed level of Assessed level of
ROMM is high
ROMM is low
51
52
Timing
53
54
Extent
55
56
Quiz 3
7. If Audit Risk increases, materiality (increases/decreases)
8. If Audit risk decreases, materiality (increases/decreases)
9. If Materiality increases, audit evidence
(increases/decreases)
10. If materiality decreases, audit evidence
(increases/decreases)
BACK
Bonus:
3 points
Risk of Material Mistatement Formula
BACK
Understanding the Entity
and Its Environment
Importance
The auditor’s understanding of the entity and its
environment, including internal control is the
foundation of the conduct of an effective audit.
It establishes a frame of reference within which
the auditor plans the audit and exercises
professional judgment throughout the audit
Importance
• Assessing ROMM of the financial statements;
• Establishing materiality;
• Considering the appropriateness of the selection and application of
accounting policies, and the adequacy of financial statement disclosures;
• Identifying areas where special audit consideration
• Developing expectations for use when performing analytical procedures;
• Responding to the assessed ROMM and
• Evaluating the sufficiency and appropriateness of audit evidence obtained.
Procedures to Obtain an
Understanding
The procedures that the auditor should follow in order to
obtain an understanding sufficient to assess the risks
and consider these risks in designing the audit plans
include the following:
a. performing risk assessment procedures;
b. considering the use of information obtain in prior
period audits; and
c. having discussion among audit engagement team.
Risk Assessment Procedures (RAP)
Risk assessment procedures are the audit procedures performed to
obtain an understanding of the entity and its environment, including
the entity’s internal control, to identify and assess the risks of
material misstatement, whether due to fraud or error, at the
financial statement and assertion levels, thereby providing a basis
for designing and implementing responses to the assessed risks of
material misstatement.
The risk assessment procedures shall include the following:
a.
Inquiries of management, and of others within the entity.
b.
Analytical procedures.
C. Observation and inspection.
However, it does not provide SAAE
Inquiries of Management, and of
Others within the Entity
Entity Personnel
Those charged with
governance
Internal audit personnel
Employees involved in
initiating, processing or
recording complex or
unusual transactions
In-house legal counsel
Marketing or sales
personnel
Information to be Obtained
May help the auditor understand the environment in which the financial statements are
prepared.
May provide information about internal audit procedures performed during the year
relating to the design and effectiveness of the entity’s internal control and whether
management has satisfactorily responded to findings from those procedures.
May help the auditor to evaluate the appropriateness of the selection and application of
certain accounting policies.
May provide information about such matters as litigation, compliance with laws and
regulations, knowledge of fraud or suspected fraud affecting the entity, warranties, postsales obligations, arrangements (such as joint ventures) with business partners and the
meaning of contract terms.
May provide information about changes in the entity’s marketing strategies, sales trends,
or contractual arrangements with its customers.
Analytical Procedures
Analytical procedures mean evaluations of financial
information through analysis of plausible relationships
among both financial and non-financial data. Analytical
procedures also encompass such investigation as is
necessary of identified fluctuations or relationships that
are inconsistent with other relevant information or that
differ from expected values by a significant amount.
At this stage of audit, the auditor normally performs
many ratio and financial statements analysis with the
objective of obtaining understanding of the entity and
its environment or changes thereon.
Observation and Inspection
Observation and inspection may support inquiries of management and others, and may
also provide information about the entity and its environment. Examples of such audit
procedures include observation or inspection of the following:
• The entity’s operations.
• Documents (such as business plans and strategies), records, and internal control
manuals.
• Reports prepared by management (such as quarterly management reports and interim
financial statements) and those charged with governance (such as minutes of board of
directors’ meetings).
• The entity’s premises and plant facilities (tour).
• Books, periodicals and other publications related to the entity and its environment.
Understanding The Entity and Its
Environment
The auditor shall obtain an understanding of the
following:
• Relevant industry, regulatory, and other external factors
including the applicable financial reporting framework
• Nature of the entity
o Its operations;
o Its ownership and governance structures;
o The types of investments that the entity is making and plans
to make; and
o The way that the entity is structured and how it is financed.
Understanding The Entity and Its
Environment
• The entity’s selection and application of accounting policies,
including the reasons for changes thereto. The auditor shall
evaluate whether the entity’s accounting policies are
appropriate for its business and consistent with the applicable
financial reporting framework and accounting policies used in
the relevant industry.
• The entity’s objectives and strategies, and those related
business risks that may result in risks of material
misstatement.
• The measurement and review of the entity’s financial
performance
Documentation
The auditor shall document:
• The risk assessment procedures performed, as part of detailed audit plan.
• The discussion among the engagement team, and the significant decisions
reached (normally in a memorandum or minutes of meeting)
• Key elements of the understanding obtained regarding each of the aspects
of the entity and its environment including the sources of information from
which the understanding was obtained (normally in a ‘understanding the
business template’)
For recurring audits, certain documentation may be carried forward, updated
as necessary to reflect changes in the entity’s business or processes.
BACK
Industry, Regulatory and Other
External Factors
Industry Factors
Relevant industry factors include industry conditions such as the competitive
environment, supplier and customer relationships, and technological developments.
Examples of matters the auditor may consider include:
• The market and competition, including demand, capacity, and price competition.
• Cyclical or seasonal activity.
• Product technology relating to the entity’s products.
• Energy supply and cost.
The industry in which the entity operates may give rise to specific risks of material
misstatement. Hence, it is important that the engagement team include members with
sufficient relevant knowledge and experience.
Industry, Regulatory and Other
External Factors
Industry Factors
Relevant industry factors include industry conditions such as the competitive
environment, supplier and customer relationships, and technological developments.
Examples of matters the auditor may consider include:
• The market and competition, including demand, capacity, and price competition.
• Cyclical or seasonal activity.
• Product technology relating to the entity’s products.
• Energy supply and cost.
The industry in which the entity operates may give rise to specific risks of material
misstatement. Hence, it is important that the engagement team include members with
sufficient relevant knowledge and experience.
Industry, Regulatory and Other
External Factors
Regulatory Factors
Relevant regulatory factors include the regulatory environment. The regulatory
environment encompasses, among other matters, the applicable financial reporting
framework and the legal and political environment. Examples of matters the auditor
may consider include:
• Accounting principles and industry specific practices.
• Regulatory framework for a regulated industry.
• Legislation and regulation.
• Taxation (corporate and other).
• Government policies currently affecting the conduct of the entity’s business.
• Environmental requirements affecting the industry and the entity’s business.
Industry, Regulatory and Other
External Factors
Other External Factors
Examples of other external factors affecting the
entity that the auditor may consider include the
general economic conditions, interest rates and
availability of financing, and inflation or
currency revaluation.
BACK
Nature of the Entity
An understanding of the nature of an entity enables
the auditor to understand such matters as:
• Whether the entity has a complex structure.
• The ownership, and relations between owners and
other people or entities. This understanding assists
in determining whether related party transactions
have been identified and accounted for
appropriately.
Nature of the Entity
Examples of matters that the auditor may consider when
obtaining an understanding of the nature of the entity
include:
• Business operations
• Investments and investment activities
• Financing and financing activities
• Financial reporting
Significant changes in the entity from prior periods may give
rise to, or change, risks of material misstatement.
BACK
The Entity’s Selection and
Application of Accounting Policies
An understanding of the nature of an entity enables the auditor to understand such
matters as:
• Whether the entity has a complex structure.
• The ownership, and relations between owners and otheAn understanding of the
entity’s selection and application of accounting policies may encompass such matters
as:
• The methods the entity uses to account for significant and unusual transactions.
• The effect of significant accounting policies in controversial or emerging areas for which
there is a lack of authoritative guidance or consensus.
• Changes in the entity’s accounting policies.
• Financial reporting standards and laws and regulations that are new to the entity and
when and how the entity will adopt such requirements.
BACK
Objectives and Strategies and
Related Business Risks
The entity conducts its business in the context of
industry, regulatory and other internal and external
factors. To respond to these factors, the entity’s
management or those charged with governance
define objectives, which are the overall plans for the
entity. Strategies are the approaches by which
management intends to achieve its objectives. The
entity’s objectives and strategies may change over
time.
BACK
Measurement and Review of the
Entity’s Financial Performance
▪ Management and others will measure and review those
things they regard as important. Performance measures,
whether external or internal, create pressures on the entity.
These pressures, in turn, may motivate management to
take action to improve the business performance or to
misstate the financial statements. Accordingly, an
understanding of the entity’s performance measures
assists the auditor in considering whether pressures to
achieve performance targets may result in management
actions that increase the risks of material misstatement,
including those due to fraud.
BACK
Understanding the Entity’s
Internal Control
. Its purpose is to address identified business risks that
threaten the achievement of the entity’s objectives
about:
• the reliability of the entity’s financial reporting
(auditor’s primary concern);
• the effectiveness and efficiency of its operations; and
• its compliance with applicable laws and regulations.
Components of Internal Control
The following are the five components of an effective
internal control:
a. Control environment
b. Risk assessment process
c. Information system and communication
d. Control activities
e. Monitoring
Control Environment
▪ Control environment is the governance and
management functions and the attitudes,
awareness, and actions of TCWG and
management concerning the entity’s internal
control and its importance in the entity. It is the
foundation of internal control as it sets the tone of
an organization that influences the control
consciousness of its people.
Control Environment
▪
▪
▪
▪
▪
▪
▪
▪
The seven elements of the control environment are:
a. Communication and enforcement of integrity and ethical values
b. Commitment to competence
c. Human resource policies and practices
d. Assignment of authority and responsibility
e. Management's philosophy and operating style
f. Participation of those charged with governance
g. Organizational structure
Risk Assessment Process
▪ The entity’s risk assessment process refers to the
entity’s process for identifying business risks relevant
to financial reporting objectives and deciding about
actions to address those risks, and the results thereof.
If that process is appropriate to the circumstances,
including the nature, size and complexity of the entity,
it assists the auditor in identifying ROMM. Whether
the entity’s risk assessment process is appropriate is a
matter of judgment.
Risk Assessment Process
▪ The auditor shall obtain an understanding of whether
the entity has a process for:
▪ a. Identifying business risks relevant to financial
reporting objectives;
▪ b. Estimating the significance of the risks;
▪ c. Assessing the likelihood of their occurrence; and
▪ d. Deciding about actions to address those risks.
Information System and
Communication
▪ Information and communication relates to the identification,
capture, and exchange of information that enables individuals to
carry out their responsibilities. It includes information system
and communication relevant to financial reporting system which
consists of the procedures and records established to initiate,
record, process and report entity transactions (as well as events
and conditions) and to maintain accountability for the related
assets, liabilities and equity.
▪ Information system and communication consists of
infrastructure (physical and hardware components), software,
people, procedures, and data.
Information System and
Communication
▪ The auditor shall obtain an understanding of the
information system, including the related business
processes, relevant to financial reporting, including how
the entity communicates financial reporting roles and
responsibilities and significant matters relating to financial
reporting, including:
▪ a. Communications between management and TCWG;
and
▪ b. External communications, such as those with
regulatory authorities.
Control Activities
▪ Control activities are policies and procedures of the entity that
help ensure that management directives are carried out.
▪ Examples of control activities include policies and procedures on:
▪ Authorization
▪ Performance reviews
▪ Information processing
▪ Physical controls
▪ Segregation of duties
Monitoring
▪ Monitoring is a process that assesses the effectiveness of
internal control performance over time. It includes assessing
the design and operation of controls on a timely basis and
taking necessary corrective actions modified for changes in
conditions.
Monitoring
The types of monitoring activities are:
▪ ongoing monitoring activities - often built into the normal
recurring activities of an entity and include regular
management and supervisory activities.
▪ separate evaluations - often performed by internal auditors or
company employees and provide feedback on the
effectiveness of other internal control processes.
▪ a combination of the two above.
Inherent Limitations of Internal
Control
▪ Internal control can only provide reasonable assurance that the entity’s
objectives are met because of the following inherent limitations:
▪ Cost-benefit considerations
▪ Human errors or mistakes
▪ Management override or circumvention
▪ Collusion among employees or outside parties
▪ Usually directed only at routine transactions, rather than non-routine
transactions
▪ May become inadequate due to changes in entity’s circumstances
Understanding Entity’s Internal
Controls Through Transaction
Cycles
▪ Transaction cycles refer to certain business processes, or segments into
which related transactions can be conveniently grouped and for which
specific accounting procedures and control activities are established by an
entity's management.
▪ The common divisions of transaction cycles are:
▪ Revenue and receipt cycle
▪ Purchasing and disbursement cycle
▪ Payroll and personnel cycle
▪ Production or conversion (Inventory and warehousing) cycle
▪ Investing and financing cycle
Design and Implementation of
Relevant Controls
▪ Risk assessment procedures to obtain audit evidence about the design
and implementation of relevant controls may include:
Inquiring of entity personnel
Observing the application of specific controls.
Inspecting documents and reports.
Tracing transactions through the information system relevant to
financial reporting.
Documentation
▪ The auditor may document its understanding through any or
combination of the following techniques:
▪ a. Narratives – A narrative is a written description of a client’s internal
controls.
▪ b. Flowcharts – An internal control flowchart is a diagram of the
client’s documents and their sequential flow in the organization.
Flowcharts have two advantages over narratives: typically they are
easier to read and easier to update. It is unusual to use both a narrative
and a flowchart to describe the same system because both present the
same information.
Documentation
▪ c. Internal Control Questionnaires (ICQ) – An ICQ asks a series of
questions about the controls in each audit area as a means of
identifying internal control deficiencies. Most questionnaires require a
“yes” or a “no” response, with “no” responses indicating potential
internal control deficiencies. The two main disadvantages of
questionnaires are their inability to provide an overview of the system
and their inapplicability for some audits, especially smaller ones.
Performing a Transaction
Walkthrough Test
▪ Walkthrough test involves tracing a few transactions through the
financial reporting system. This test is normally done after the auditor
has initially documented its understanding of the transaction cycles and
significant business processes. It should be done every year.
What is a Material Weakness in
Internal Control?
▪ Material weakness in internal control is deficiency, or a combination of
deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the company’s annual
or interim financial statements will not be prevented or detected on a timely
basis.
Deficiency in internal control exists when:
A control is designed, implemented or operated in such a way that it is unable
to prevent, or detect and correct, misstatements in the financial statements
on a timely basis; or
A control necessary to prevent, or detect and correct, misstatements in the
financial statements on a timely basis is missing.
BACK
FRAUD, ERROR &
Noncompliance
Pre-Test
▪ “Magbasa ng magbasa… wag kang umasa sa
stock knowledge…… WALA KA NUN…. “
FRAUD & ERROR
Fraud refers to an intentional act by one or more
individuals among management, TCWG,
employees, or third parties, involving the use of
deception to obtain an unjust or illegal advantage.
While, error pertains to unintentional
misstatements or omissions in FSs, including the
omission of an amount or disclosure. Differentiating
fraud from error requires professional judgment.
The risk of not detecting fraud is higher than that of
error because fraud may be concealed, especially if
through collusion.
Types of Fraud
In relation to audit of financial statements:
Fraudulent financial
reporting
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 of amounts or
Involves
intentional
misstatements,
including
omissions
management
and TCWG.
Examples
of thisFS
type
of fraud
are theinvolves
following:
disclosures
in FSs,
to deceive
users,
normally
management.
•
Embezzling
Examplesreceipts
are the following:
•
Lapping of accounts receivable
Manipulation or falsification of financial records
•
Entity funds sent to a personal bank account
Misrepresentation or intentional omission of information in the FSs
•
Inventory items sold personally by entity employees
misapplication
of accounting
policies
•
GoodsIntentional
or services paid
for by the entity
but not received
•
Use of entity assets for personal use
Types of Fraud
As to perpetrator:
Management fraud
Employee fraud
refers to fraud involving one or more members of management or
Employee
fraud – refers to fraud involving only employees of the entity.
TCWG.
Responsibility of Management and
Those Charged with Governance
(TCWG) vs. that of the Auditor
The primary responsibility for the prevention and
detection of fraud rests with both TCWG of the
entity and management. Management shall
establish a control environment and implement
internal control policies and procedures to prevent
and detect fraud. On the other hand, TCWG,
through its oversight function, shall ensure the
integrity of accounting and financial reporting
systems and that appropriate controls are in place.
Responsibility of Management and
Those Charged with Governance
(TCWG) vs. that of the Auditor
On the other hand, the auditor’s responsibility is to
reasonable assurance about whether the FSs taken
as a whole are free from material misstatement,
whether caused by fraud or error. The auditor is not
responsible for discovering fraud, and is not and
cannot be held responsible for the prevention of
fraud. Unless the auditor has reason to believe the
contrary, the auditor may accept records and
documents as genuine. An audit rarely involves the
authentication of documents.
Risk Assessment
Auditor should assess the risk that fraud and
error may cause the financial statements to
contain material misstatements and should
inquire of management as to any fraud or
significant error which has been discovered
Risk Assessment
Increase the risk of fraud and error include:
Questions w/ respect to the integrity or
competence of management
Unusual pressures within or on an entity
Unusual transactions
Problems obtaining sufficient appropriate
audit evidence
Detection
The auditor should design audit procedures
to obtain reasonable assurance that
misstatements arising from fraud and error
that are material to the financial
statements taken as a whole are detected
Inherent Limitations of an Audit
The risk of not detecting a material
misstatement resulting from fraud is higher
than the risk of not detecting a material
misstatement resulting from error, because
fraud ordinarily involves acts designed to
conceal it, such as collusion, forgery,
deliberate failure to record transactions, or
intentional misrepresentations being made
to the auditor
Fraud Risk Factor
1. Incentives/ Pressures
2. Opportunities
3. Attitudes/rationalizations
-refer to your book page 532 to 538
Types of Errors/Irregularities in
the Transaction Cycle (pg. 538)
1. Sales and Collection Cycle
Errors in sales and collection
Frauds in sales and collection
–
–
▪
▪
Fraudulent financial reporting
Misappropriation of asset
–
–
–
Skimming
Lapping
Kiting
Types of Errors/Irregularities in
the Transaction Cycle (pg. 538)
2. Acquisitions and Payment Cycle
– Errors in the acquisitions and payment cycle
– Frauds in the Acquisitions and payment
cycle
▪
▪
▪
Paying for fictitious purchases
Receiving kickbacks
Purchasing goods for personal use
Types of Errors/Irregularities in
the Transaction Cycle (pg. 538)
3. Payroll and Personnel Cycle
– Errors
– Fraud involving payroll
▪
▪
▪
▪
Fictitious employees
Excess payments to employees
Failure to Record payroll
Inappropriate assignment of Labor costs to Inventory
Types of Errors/Irregularities in
the Transaction Cycle (pg. 538)
4. Inventory Warehousing
– Errors
– Irregularities affecting inventory
▪
▪
Inventory theft
Overstatement of inventory
Types of Errors/Irregularities in
the Transaction Cycle (pg. 538)
5. Investing Activities
– Errors
– Major Frauds involving Investing Activities
6. Financing Activities
– Errors
– Irregularities
Procedures when Errors or
Irregularities are Suspected
Altering the following:
1. Engagement staffing
2. Extent of staff supervision
3. Degree of professional skepticism applied
4. Overall strategy for the expected conduct
and scope of the engagment
Procedures when Errors or
Irregularities are Suspected
The extent of such modified or additional
procedures depends on the auditor’s
judgment as to:
a. The types of fraud and error indicated
b. The likelihood of their occurrence
c. The likelihood that a particular type of fraud
or error could have a material effect on the
financial statement
Reporting of Fraud and Error
1.


To Management
Auditor suspects fraud may exist
Fraud or significant errors is actually found to
exist
2. To users of the auditor’s report on the financial
statement
3. To regulatory and Enforcement Authorities
Withdrawal from the Engagement
1. Determine the professional and legal responsibilities
2. Consider whether it is appropriate to withdraw from
engagement
3. If the auditor withdraws:
▪
▪
Discuss with the appropriate level of management and
TCWG
Determine whether there is a professional or legal
requirement
Management Representations
1. Responsibility over the internal control to prevent fraud
2. Disclosure to the auditor the results of its assessment
3. Disclosure to the auditor its knowledge of fraud or
suspected fraud
– Management
– Employees
– Others
4. Disclosed to the auditor its knowledge of any allegations
of fraud or suspected fraud
BACK
Pre-Test: Chapter 12 & 13
 Identify if the ff is a Fraudulent financial
reporting or Misappropriation of Assets
1. Recording of Fictitious journal entries
2. Intentional misapplication of accounting
principles
3. Alteration of accounting records
4. Stealing physical assets
5. Embezzling receipts
Pre-Test: Chapter 12 & 13
 Identify the Fraud Risk Factor relating to
Fraudulent financial reporting
6. Excessive pressure from management to meet
the requirements
7. Ineffective monitoring of management
8. Management failing to correct known material
weaknesses in internal control on a timely
basis
Pre-Test: Chapter 12 & 13
9. Threatened personal financial situation of
management or those charge with
governance
10. Significant related-party transactions not in
the ordinary course of business
11. Low morale among senior management
Pre-Test: Chapter 12 & 13
 Identify the Fraud Risk Factor relating to
Misappropriation of Asset
12. Personal financial obligations may create
pressure on management or employees with
access to cash.
13. Inadequate internal control over assets may
increase the susceptibility of
misappropriation of those assets
14. Tolerance of petty theft
Pre-Test: Chapter 12 & 13
 Identify the transaction cycle affected by the
following errors/fraudulent act
15. Skimming
16. Lapping
17. Paying for fictitious purchases
18. Receiving kickbacks
19. Excess payments to employees
20. Paying dividends to inappropriate parties
Pre-Test: Chapter 12 & 13
 Enumeration
21-22) Types of Fraud as to perpetrator
23-28)Types of Transaction Cycle
29-30)Give at least 2 out of 3 most common
misappropriation of Asset under Revenue and
Collection Cycle under Fraud
BACK
Short Quiz
Purpose
Types
RAP
FAP
ToC
SP
Inspection
57
58
59
Observation
External confirmation
60
62
62
63
64
65
Recalculation
Reperformance
Analytical procedures
66
67
68
69
70
71
72
73
74
Inquiry
75
76
77
Audit Evidence &
Designing an Effective
Response to Assessed Risk
Pre-Test
Audit Evidence
The auditor obtains two types of audit evidence such as:
I.
a. Underlying accounting records - The records of
initial accounting entries and supporting records, such as
checks and records of electronic fund transfers; invoices;
contracts; the general and subsidiary ledgers, journal
entries and other adjustments to the financial
statements that are not reflected in journal entries; and
records such as work sheets and spreadsheets
supporting cost allocations, computations,
reconciliations and disclosures.
II. b. Other information – All other evidence obtained by
the auditor such as minutes of meetings, confirmation
from third parties and information obtained from such
audit procedures as inquiry, observation, and inspection.
Sources of Audit Evidence
The following are the list of sources of audit
evidence:
• Performance of audit procedures. (Primary
source)
• Previous audits.
• Firm’s quality control procedures for client
acceptance and continuance
• Work of a management’s expert.
• Management representations.
• Other sources inside and outside the entity.
Risk Response Phase
>see Figure 14.1 Page 601
 Designing the overall audit responses and
further audit procedures. This will require:
i. Updating overall audit strategy
ii. Developing response to assessed risks
iii. Briefing team on audit plans as required
 Performance of further audit procedures
i. Performing planned procedures
ii. Assessing results and evidence obtained
iii. Documenting findings and conclusion
Audit procedures as to purpose:
a.
Risk assessment procedures (RAP) – are the
audit procedures performed to obtain an
understanding of the entity and its environment,
including the entity’s internal control, to identify
and assess the risks of material misstatement,
whether due to fraud or error, at the financial
statement and assertion levels, thereby
providing a basis for designing and
implementing responses to the assessed risks of
material misstatement; and
Audit procedures as to purpose:
b.
•
•
Further audit procedures (FAP) which comprise:
Tests of controls (ToC) – an audit procedure
designed to evaluate the operating effectiveness
of controls in preventing, or detecting and
correcting, material misstatements at the
assertion level; and
Substantive procedures (SP), including tests of
details and substantive analytical procedures –
an audit procedure designed to detect material
misstatements at the assertion level.
Audit procedures as to type:
a.
b.
c.
Inspection - involves examining records or
documents, whether internal or external, in paper
form, electronic form, or other media, or a physical
examination of an asset.
Observation - consists of looking at a process or
procedure being performed by others, for example,
the auditor’s observation of inventory counting by
the entity’s personnel, or of the performance of
control activities.
Inquiry - consists of seeking information of
knowledgeable persons, both financial and
nonfinancial, within the entity or outside the entity.
Audit procedures as to type:
d.
e.
f.
g.
External Confirmation - a direct written response to the
auditor from a third party (the confirming party), in paper
form, or by electronic or other medium.
Recalculation - consists of checking the mathematical accuracy
of documents or records.
Reperformance - involves the auditor’s independent execution
of procedures or controls that were originally performed as
part of the entity’s internal control.
Analytical Procedures - consist of evaluations of financial
information made by a study of plausible relationships among
both financial and non-financial data. Analytical procedures
also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant
information or deviate significantly from predicted amounts.
Audit procedures as to type:
d.
e.
f.
g.
External Confirmation - a direct written response to the
auditor from a third party (the confirming party), in paper
form, or by electronic or other medium.
Recalculation - consists of checking the mathematical accuracy
of documents or records.
Reperformance - involves the auditor’s independent execution
of procedures or controls that were originally performed as
part of the entity’s internal control.
Analytical Procedures - consist of evaluations of financial
information made by a study of plausible relationships among
both financial and non-financial data. Analytical procedures
also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant
information or deviate significantly from predicted amounts.
Types of Analytical Procedures
The following are the types of typical analytical procedures applied
in an audit:
a.
Trend analysis – this type is based on the assumption that
performance will continue in line with previous performance or
industry trends unless something unusual is happening in the
company.
b.
Ratio analysis – this type similar to financial statement
analysis, and is highly effective technique to highlight account
balances that are out of line and may signal the potential for
fraud.
c.
Test of reasonableness – this type tests whether a recorded
amount is reasonable with regards to the auditor’s
expectation.
d.
Regression analysis – this type involves time-series analysis
by examining trends in relationship with previous results.
Summary of analytical procedures
Procedure
Objective
Attention
directing?
Required?
Results
Planning and Risk
Assessment
Preliminary analytical
procedures (As part of RAP)
To obtain understanding
the entity and its
environment in order to
identify and assess ROMMs
Yes
Yes
Identification and
assessment of ROMMs
Stages
Testing (Fieldwork)
Substantive analytical
procedures
To detect material
misstatements, about
an assertion, as part of
responses to ROMMs
No
No
Obtain reasonable
assurance about the
fairness of an assertion
Completion
Concluding (Final or overall)
analytical procedures
To form an overall conclusion
that the financial statements
are consistent with the
auditor’s understanding of
the entity
Yes
Yes
Conclusion that FSs are
consistent with the auditor’s
understanding or the auditor
may identify previously
unrecognized ROMM
Summary of audit procedures
Purpose
Types
Inspection
Observation
External confirmation
RAP
✓
✓
FAP
ToC
✓
✓
SP
✓
✓
✓
✓
Recalculation
Reperformance
Analytical procedures
✓
Inquiry
✓
✓
✓
✓
✓
Common Analytical procedures
Analytical Procedures
1. Compare current financial
information for prior periods.
Example
Compare inventory levels for the current
year to that of prior years
2. Compare current financial
information with anticipated data
3. Compare current financial
information with known or predictable
relationships
4. Compare current financial
information with industry information
Compare research and development
expense to the budgeted amount.
Compare interest expense to the
average outstanding balance of
interest-bearing debt
Compare client’s gross profit
percentage to published industry
average
Compare production records in units to
sales
5. Compare current financial
information with current nonfinancial
information
Objective of the auditor in
obtaining audit evidence
The auditor shall design and perform audit
procedures to enable the auditor to obtain
sufficient appropriate audit evidence (SAAE) to
be able to draw reasonable conclusions on which
to base the auditor’s opinion.
Sufficiency is the measure of the quantity of
evidence. Appropriateness is the measure of the
quality of evidence; that is, its relevance and its
reliability.
Information to Be Used as Audit
Evidence\
When designing and performing audit procedures, the
auditor shall consider the relevance and reliability of
the information to be used as audit evidence. The
quality of all audit evidence is affected by the
relevance and reliability of the information upon
which it is based.
Relevance
Relevance deals with the logical connection with, or
bearing upon, the purpose of the audit procedure
and, where appropriate, the assertion under
consideration.
Assertion
Assertions are representations by management,
explicit or otherwise, that are embodied in the
financial statements. The auditor uses these
assertions in considering different types of
potential misstatements that may occur in the
financial statements. Auditor’s audit objectives
follow and are closely related to management
assertions. Hence, assertions guide the auditor
in the performance of auditor procedures.
Three categories of assertions are
as follows:
1.
a.
b.
c.
d.
e.
Classes of transactions and events (COCAC)
Occurrence—transactions and events that have been
recorded have occurred and pertain to the entity.
Completeness—all transactions and events that should
have been recorded have been recorded.
Accuracy—amounts and other data relating to
recorded transactions and events have been recorded
appropriately.
Cutoff—transactions and events have been recorded in
the correct accounting period.
Classification—transactions and events have been
recorded in the proper accounts.
Three categories of assertions are
as follows:
2.
a.
b.
c.
d.
Account balances (RCEV)
Existence—assets, liabilities, and equity interests exist.
Rights and obligations—the entity holds or controls the
rights to assets, and liabilities are the obligations of the
entity.
Completeness—all assets, liabilities and equity
interests that should have been recorded have been
recorded.
Valuation and allocation—assets, liabilities, and equity
interests are included in the financial statements at
appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
Three categories of assertions are
as follows:
3.
a.
b.
c.
d.
Presentation and disclosure (COCA)
Occurrence and rights and obligations—disclosed
events, transactions, and other matters have occurred
and pertain to the entity.
Completeness—all disclosures that should have been
included in the financial statements have been
included.
Classification and understandability—financial
information is appropriately presented and described,
and disclosures are clearly expressed.
Accuracy and valuation—financial and other
information are disclosed fairly and at appropriate
amounts.
Reliability
The reliability of information to be used as audit evidence,
and therefore of the audit evidence itself, is
influenced by its source and its nature, and the
circumstances under which it is obtained, including
the controls over its preparation and maintenance
where relevant.
Evidence is general more reliable when:
a.
b.
c.
d.
e.
Obtained from independent sources;
The related controls are effective;
Obtained directly than indirectly or by inference;
In documentary form than oral; and
In original state than by photocopies or facsimiles.
BACK
PSA 530: Audit Sampling
(Ch16,17&18)
Pre-Test
Means of Selecting Items for
Testing
When designing tests of controls and tests of details,
the auditor’s means of selecting items for testing
are:
• Selecting all items (100% examination),
• Selecting specific items, and
• Audit sampling.
Selecting All Items
100% examination is unlikely in the case of tests of
controls; however, it is more common for tests
of details. 100% examination may be
appropriate when, for example:



• The population constitutes a small number of
large value items;
• There is a significant risk and other means do
not provide sufficient appropriate audit evidence;
or
• Cost effective by using CAATs.
Selecting Specific Items
Specific items selected may include:
• High value or key items.
• All items over a certain amount.
• Items to obtain information about matters such
as the nature of the entity or the nature of
transactions.
Audit Sampling: Definition of
Terms
(a) Audit sampling (sampling) – The application of
audit procedures to less than 100% of items
within a population of audit relevance such that
all sampling units have a chance of selection.
(b) Population – The entire set of data from which a
sample is selected and about which the auditor
wishes to draw conclusions. For example, all of
the items in a class of transactions or account
balance constitute a population. A population
may be divided into strata, or sub-populations,
with each stratum being examined separately.
Audit Sampling: Definition of
Terms
(c)
(i)
(ii)
Sampling risk – The risk that the auditor’s conclusion based on
a sample may be different from the conclusion if the entire
population were subjected to the same audit procedure.
Sampling risk can lead to two types of erroneous conclusions:
In the case of a test of controls, that controls are more effective
than they actually are, or in the case of a test of details, that a
material misstatement does not exist when in fact it does.
Because it affects audit effectiveness and is more likely to lead to
an inappropriate audit opinion, the auditor is primarily concerned
with this type of erroneous conclusion.
In the case of a test of controls, that controls are less effective
than they actually are, or in the case of a test of details, that a
material misstatement exists when in fact it does not. This type of
erroneous conclusion affects audit efficiency as it would usually
lead to additional work to establish that initial conclusions were
incorrect.
Audit Sampling: Definition of
Terms
(d) Non-sampling risk – The risk that the auditor does
not recognize misstatements or deviations included
in the sample for what they are.
(e) Sampling unit – The individual items constituting a
population.
(f)
(i)
(ii)
Statistical sampling – An approach to sampling that
has the following characteristics:
Random selection of the sample items; and
The use of probability theory to evaluate sample
results, including measurement of sampling risk.
Audit Sampling: Definition of
Terms
A sampling approach that does not have
characteristics (i) and (ii) is considered nonstatistical sampling.
(g) Stratification – The process of dividing a population
into sub-populations, each of which is a group of
sampling units which have similar characteristics
(often monetary value).
(h) Tolerable misstatement – A monetary amount set
by the auditor in respect of which the auditor seeks
to obtain an appropriate level of assurance that it is
not exceeded by
Audit Sampling: Definition of
Terms
A sampling approach that does not have characteristics (i)
and (ii) is considered non-statistical sampling.
(g)
(h)
Stratification – The process of dividing a population into
sub-populations, each of which is a group of sampling
units which have similar characteristics (often monetary
value).
Tolerable misstatement – A monetary amount set by the
auditor in respect of which the auditor seeks to obtain an
appropriate level of assurance that it is not exceeded by
the actual misstatement in the population.
Audit Sampling: Definition of
Terms
(i)
Tolerable rate of deviation – A rate of deviation
from prescribed internal control procedures set
by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance
that it is not exceeded by the actual rate of
deviation in the population.
(j) Estimated maximum misstatement – The upper
limit of the range of possible misstatement
consistent with the auditor’s risk assessment and
results of other audit procedures.
Audit Sampling: Definition of
Terms
(k) Estimated maximum rate of deviation – The upper
limit of the range of possible rates of deviation
consistent with the auditor’s planned reliance on
internal controls.
(l) Projected misstatements – The auditor’s best
estimate of misstatements in populations involving
the projection of misstatements identified in audit
samples to the entire populations from which the
samples were drawn.
(m) Anomaly – A misstatement or deviation that is
demonstrably not representative of misstatements
or deviations in a population.
Testing Procedures which do not
involve Sampling
1.
Tests performed on 100% of the items within a
population.
Inquiry and Observation
2.


3.
Procedures that depend on segregation of duties or
that otherwise provide no documentary evidence
Tracing one or a few transactions to obtain an
understanding of an accounting system and its
internal contro.
Analytical Procedures
Types of Statistical Sampling
1.
Non statistical sampling




Haphazard Sampling
Block Selection
Judgmental sampling
Use of a computerized random number generator or
random number tables.
Nonstatistical and Statistical
sampling
2. Statistical Sampling
The two commonly used statistical sampling used in auditing are:
1.Attributes sampling–generally used for tests of controls
Tests rate of deviation from a prescribed control procedure
Estimate frequency of errors in population based on frequency
in sample
Determine whether or not estimated error rate indicates
control is working effectively
2.
Variables Sampling–generally used for tests of details
Tests whether recorded account balances are fairly stated
Estimate value of population based on value of items in sample
Attributes Sampling
a.
Traditional (Classical) attributes sampling
•
This has been already discussed above under the
steps of audit sampling.
Under traditional attribute sampling, sample size
is determined and
•
Attributes Sampling
b.
•
•
•
•
•
•
Stop-or-go (Sequential) sampling
Performed in stages
Auditor decides to stop or continue sampling
after each stage
Appropriate when expected deviation rate is low
Sample selected in steps
Each step is based on results of previous step
No fixed sample size and may result in lower
sample if few or no errors detected
Attributes Sampling
c.
•
•
•
•
Discovery sampling
Sample size is very small
Appropriate when expected deviation rate is
extremely low or zero
Sample large enough to detect at least one error
if it exists
Any errors in sample results in rejection
Examples of Factors Influencing
Sample Size for Tests of Control
FACTOR
EFFECT ON
SAMPLE SIZE
An increase in the extent to which the risk of material misstatement is
reduced by the operating effectiveness of controls
INCREASE
An increase in the rate of deviation from the prescribed control activity DECREASE
that the auditor is willing to accept
An increase in the rate of deviation from the prescribed control activity INCREASE
that the auditor expects to find in the population
A decrease in the risk that the auditor will conclude that the risk of
material misstatement is lower than the actual risk of material
misstatement in the population
INCREASE
An increase in the number of sampling units in the population
Depends on the type of sample
Examples of Factors Influencing Sample
Size for Substantive Procedures
FACTOR
EFFECT ON
SAMPLE SIZE
An increase in the auditor’s assessment of the risk of material
misstatement
INCREASE
An increase in the use of other substantive procedures directed at the
same assertion
DECREASE
A decrease in the risk that the auditor will conclude that a material
misstatement does not exist, when in fact it does exist
INCREASE
An increase in the total misstatement that the auditor is willing to
accept
DECREASE
An increase in the amount of misstatement the auditor expects to find
in the population
INCREASE
Stratification of the population when appropriate
DECREASE
The number of sampling units in the population
Negligible Effect
QUIZ: AUDIT SAMPLING
1-3 Means of Selecting Items for Testing
4. The application of audit procedures to less than
100% of items within a population of audit
relevance such that all sampling units have a
chance of selection.
5. The entire set of data from which a sample is
selected and about which the auditor wishes to
draw conclusions
QUIZ: AUDIT SAMPLING
6-8. Testing Procedures which do not involve Sampling
9. The risk that the auditor’s conclusion based on a
sample may be different from the conclusion if the
entire population were subjected to the same audit
procedure.
10. The risk that the auditor does not recognize
misstatements or deviations included in the sample
for what they are.
11. The individual items constituting a population.
Substantive Procedures
FACTOR
An increase in the auditor’s assessment of the risk of material
misstatement
An increase in the use of other substantive procedures directed
at the same assertion
A decrease in the risk that the auditor will conclude that a
material misstatement does not exist, when in fact it does exist
An increase in the total misstatement that the auditor is willing
to accept
An increase in the amount of misstatement the auditor expects
to find in the population
Stratification of the population when appropriate
12
13
14
15
16
17
Tests of Control
FACTOR
An increase in the extent to which the risk of material misstatement
is reduced by the operating effectiveness of controls
An increase in the rate of deviation from the prescribed control
activity that the auditor is willing to accept
An increase in the rate of deviation from the prescribed control
activity that the auditor expects to find in the population
A decrease in the risk that the auditor will conclude that the risk of
material misstatement is lower than the actual risk of material
misstatement in the population
An increase in the number of sampling units in the population
18
19
20
21
Depe
nds
on the
QUIZ: AUDIT SAMPLING
22-25. Give the 4 common types of Non Statistical
sampling
Audit Sampling for
Substantive Test
Substantive Procedures
Are concerned with amounts and are of two types
 Analytical Procedures
 Test of Details of transactions and balances
Purpose: to obtain audit evidence to detect material
misstatements in the financial statements
Risks in Substantive TEsts
Auditor enounters:
 Nonsampling risk; and
 Sampling risk


Risk of incorrect rejection (Alpha) – efficiency
Risk of incorrect acceptance (beta)effectiveness
Variable Sampling plan techniques
1.
-
2.
Probability-Proportional-to size sampling
technique
Estimate the maximum amount of overstatement
of a recorded amount with measureable level of
risk of making a decision error
Advantage/disadvantages can be read in the book
Classical variables sampling technique
- use normal distribution theory to evaluate
selected characteristics of a population on the
basis of a sample items constituting the
population
Variations of Classical Variable
sampling
1.
2.
Mean-per-unit estimation – projects the sample
average to the total population by multiplying
the sample average by the number of items in
the population
Difference estimation – uses the average
differences between audited amounts and
individual recorded amounts to estimate the
total audited amount of a population and
allowance for sampling
Variations of Classical Variable
sampling
3. Ratio Estimation – uses the ratio of audited
amounts to recorded amounts in the sample to
estimate the total peso amount of the
population and an allowance for sampling
4. Regression Approach – similar to difference and
ratio approaches. Using both the average ration
and the average difference in calculating an
estimate of the total amount for the population
SEAT WORK
Identify the Assertion being referred
Assertion specification
Accounting
Cycle
1. Over applied or under applied Production
overhead is reviewed
periodically, and rates are
adjusted as necessary
2. A copy of a receiving report
Inventory
signed by a receiving clerk is
used by inventory accounting to
record receipt of goods
Assertion
Valuation/
measuremen
t
Existence/
Occurrence
Assertion specification
Accounting
Cycle
Sale
transaction
3. Recording of sales is
supported by customer orders,
sales orders approved by the
credit department, and
approved and executed shipping
documents
4. A trustworthy employee
Cash
prepares a prelisting of cash
Receipts
receipts before further
processing
Assertion
Existence/
Occurrence
Existence/
Occurrence
Assertion specification
Accounting
Cycle
5. Cash receipts are recorded at Cash
the amount received
Receipts
Assetion
6. Approval of Acquisitions is
evidenced by signature on the
purchase order
7. Vouchers are prenumbered
and accounted for
Purchases
transaction
Valuation/
Measuremen
t
Existence/
occurrence
Purchase
transaction
Completenes
s
8. Examine voucher for
signature indicating
performance
Purchase
transaction
Valuation/
Measuremen
t
Assertion specification
Accounting
Cycle
9. Employees record their time
Payroll
using a time clock but record no cycle
other employee’s time
10. Payroll calculations are
Payroll
verified
cycle
11. Account codes assigned are
reviewed by appropriate levels
of management
12. Labor tickets are used by
production employees for
recording labor
Payroll
cycle
Production
Assertion
Rights and
obligation
Valuation/
measuremen
t
Presentation
and
disclosures
Existence/
occurrence
Assertion specification
13. Checks are prenumbered
and accounted for
14. Independent bank
reconciliation is performed
monthly
15. Chart of accounts
adequately describes accounts
to be used, and account coding
is assigned by one person and
checked by another
Accounting
Cycle
Cash
payments
Assertion
Cash
payments
Completenes
s
Cash
payment
Presentation
and
disclosure
Completenes
s
Assertion specification/ audit
procedure
16. prenumbered shipping
documents are accounted for to
determine that a sales invoice is
prepared for all shipments
17. For a sample of entries in
the cash receipts journal,
reconcile the total to validated
deposit tickets
18. Independent bank
reconciliation performed
monthly
Accounting
Cycle
Sales
transaction
Assertion
Cash
receipts
Existence/
occurrence
Cash
payment
completenes
s
Completenes
s
Assertion specification
Accounting
Cycle
19. Cash payments are recorded Cash
to result in presentation and
payment
disclosure in accordance with
PFRS
20. All payroll earned by
Payroll
employees is recorded
Assertion
21. Recorded payroll
Payroll
transactions are for services
received
22. Production transactions are Production
recorded by the proper amounts
Rights and
obligations
Presentation
and
disclosures
Completenes
s
Valuation
and
measuremen
Assertion specification/ audit
procedure
23. A materials requisition is
prepared and signed by
appropriate operating personnel
24. All inventory warehousing
transactions that occurred are
recorded
25. Acquisitions that occurred
are recorded
Accounting
Cycle
Inventory
Assertion
Inventory
Completenes
s
Purchasing
completenes
s
Existence/
occurrence
AUDIT DOCUMENTATION
AUDIT DOCUMENTATION
-
Establishes standards
Provides guidance
PSA230 requires that auditor should prepare on a
timely basis, audit documentation that provides:
a. Sufficient and appropriate record of the basis for
the auditor’s report
b. Evidence that the audit was performed in
accordance with PSAs and applicable legal and
regulatory requirements
AUDIT DOCUMENTATION
Audit Documentation - “working paper” record of
audit procedures performed, relevant audit
evidence obtained, and conclusions the auditor
reached
Audit File – one or more folders or other storage
media, in physical or electronic form, containing
records that comprise the audit documentation
for a specific engagement
Experienced Auditor
Means an individual (internal/external) who has
practical audit experience, and a reasonable
understanding of
a. Audit processes
b. PSAs and applicable legal and regulatory
requirements
c. The business environment in which the entity
operates
d. Auditing and financial reporting issues relevant
to the entity’s industry
Experienced Auditor
Means an individual (internal/external) who has
practical audit experience, and a reasonable
understanding of
a. Audit processes
b. PSAs and applicable legal and regulatory
requirements
c. The business environment in which the entity
operates
d. Auditing and financial reporting issues relevant
to the entity’s industry
Objective of Audit Documentation
PRIMARY: preparing sufficient and appropriate
audit documentation on a timely basis to help
enhance the quality of the audit and to
facilitate the effective review and evaluation of
the audit evidence obtained and conclusions
reached before the auditor’s report is finalized
TYPES OF WORKING PAPERS
1.
Audit Administrative Working Papers – aid the
auditors in planning and administration of
engagements. (Audit Program)
 Standard all-purpose
 Tailor-made
 Modified standard form
2. Working Trial Balance - list of the accounts in the
client’s general ledger with columns that, as a
minimum include unadjusted amounts directly
from the clients accounting records, proposed
adjusting entries, and adjusted amounts.
(backbone of working papers
TYPES OF WORKING PAPERS
3. Lead or Top Schedule – grouping of related
account balances.
4. Supporting Schedules and Analyses
5. Summary of Adjusting and Reclassifying Entries
6. Audit Notes or Memoranda and Documentation
of Corroborating Evidence
Current Audit File
-designed to support the assertion embodied in the
financial statements
1. Original draft of the report
2. Audit plan and programs
3. Working trial balance
4. Adjusting and reclassifying journal entries
5. Lead and supporting schedules
6. General informations
Permanent file
1.
2.
3.
4.
5.
6.
These are intended to contain data of a historical
or continuing in nature pertinent to the current
examination
Excerpts of the corporate charter or Articles
Analysis of business and industry
Copies of contracts
Chart of accounts and manuals
Flowcharts and notes of prior years
Continuing analyses of fixed asset
Permanent file
7. Organizational charts
8. Terms of capital stock and bond issues
9. Previous audit analytical procedures
10. Minutes of the meeting
11. Labor-management agreement
12. Related parties
13. Complex business transactions
14. Copies of pension plans, stock option plans
15. Tax Files
16. Correspondence file
AUDIT EVIDENCE
AUDIT EVIDENCE
-
Sufficient and appropriate
Evaluation:
1. Materiality
2. Risks
3. Misstatements
4. Fraud
5. Evidence
6. Analytical procedures
FACTORS
1.
2.
3.
4.
5.
6.
7.
Materiality of misstatements
Management response
Quality of information
Persuasiveness
Previous experience
Results of audit procedures performed
Understanding the entity
FINAL ANALYTICAL PROCEDURE
-
Assess the overall presentations of the FS
Identify previously unrecognized risk of material
misstatement
Ensure that the conclusions formed during the
audit on individual components or elements of
the FS can be corroborated
Assist in arriving at the overall conclusions as to
the reasonableness of the FS
COMPLETING THE AUDIT
COMPLETING THE AUDIT
-
This phase of the audit demands careful and
thorough review of the audit by an experienced
and knowledgeable person as this stage often
brings to light matters that are of major concern
in forming an opinion on the FSs. This is also
known as wrapping up the audit
Various Issues
1.
2.
3.
4.
5.
6.
7.
Related party transactions
Subsequent events review
Letter of inquiry
Evaluating going concern status
Management representation
Analytical procedures
Evaluating findings
COMPLETING THE AUDIT
a)
b)
c)
d)
e)
The matters covered, among other things, in this
phase of audit are:
Performing review for litigation, claims, other
contingencies and commitments
Performing review for subsequent events (events
after the end of reporting period), including the
consideration of subsequent discovery of facts
Considering appropriateness of going concern
assumptions
Performing concluding (overall or final) analytical
procedures
Obtaining written representations from
management
Litigation, Claims, Other
Contingencies and Commitments
-
Management is responsible for identifying,
evaluating, and ensuring proper accounting,
including disclosures, for litigation, claims, other
contingencies and commitments involving the
entity.
Litigation, Claims, Other
Contingencies and Commitments
-
-
The auditor obtains evidence relating to
• The existence of conditions indicating an
uncertainty
• The period in which the cause of uncertainty
occurred
• The probability of an unfavorable outcome
• The amount or range of potential loss
Litigation, Claims, Other
Contingencies and Commitments
The auditor's procedures will include:
•
Inquiring of management policies and procedures for
identifying, evaluating, and accounting for litigation,
claims, other contingencies and commitments
•
Obtaining from management a description and
evaluation of litigation, claims, other contingencies and
commitments a existing at the end of reporting date
•
Examining documents, including correspondence and
invoices from lawyers, including letter from client's
attorney regarding litigation, claims, other
contingencies and commitments
•
Requesting management and TCWG written
representations about proper accounting and disclosure
of litigation and claims.
Subsequent Events (including subsequent
discovery of facts and omitted procedures)
These are:
• events occurring between the date of the FSs
and the date of the auditor’s report, and
• facts that become known to the auditor after the
date of the auditor’s report.
Subsequent Events (including subsequent
discovery of facts and omitted procedures)
The date of the FSs pertains to the date of the end of
the latest period covered by the FSs. On the
other hand, the date of the auditor’s report is the
date the auditor dates the report on the FSs,
which:
• cannot be dated earlier than the date on which
the auditor has obtained sufficient appropriate
audit evidence (completion of fieldwork/audit)
on which to base the opinion on the FSs, and
• cannot be earlier than the date of approval of
the FSs.
Subsequent Events (including subsequent
discovery of facts and omitted procedures)
Date of approval of the FSs is the date on which all the statements
that comprise the FSs have been prepared and those with the
recognized authority have asserted that they have taken
responsibility for those FSs. Another important date to take
note is the date the FSs are issued, which is the date that the
auditor’s report and audited FSs are made available to third
parties.
Types of Subsequent Events
The two types of subsequent events are:
a)
Type 1 – Adjusting events are those that provide evidence of
conditions that existed at the date of the FSs.
b)
Type 2 – Non-adjusting events are those that provide evidence
of conditions that arose after the date of the FSs.
Auditor’s Responsibility in Reviewing
Subsequent Events
Events Occurring Between the Date of the FSs and the Date of the Auditor’s Report
The auditor shall obtain sufficient appropriate audit evidence about whether events
occurring between the date of the FSs and the date of the auditor’s report
that require adjustment of, or disclosure in, the FSs are appropriately
reflected in those FSs.
The auditor shall perform the following procedures, taking into account the
auditor’s risk assessment:
a)
Obtaining an understanding of any procedures management has established
to ensure that subsequent events are identified.
b)
Inquiring of management and TCWG as to whether any subsequent events
have occurred.
c)
Reading minutes, if any, of the meetings, of the entity’s owners,
management and TCWG, that have been held after the date of the FSs and
inquiring about matters discussed at any such meetings for which minutes
are not yet available.
d)
Reading the entity’s latest subsequent interim FSs.
e)
Requesting management and TCWG to provide a written representation
letter.
Auditor’s Responsibility in Reviewing
Subsequent Events
Facts that become Known to the Auditor after the
Date of the Auditor’s Report
The auditor has no obligation to perform any audit
procedures regarding the FSs after the date of
the auditor’s report, except, when, after the date
of the auditor’s report a fact becomes known to
the auditor that, had it been known to the
auditor at the date of the auditor’s report, may
have caused the auditor to amend the auditor’s
report.
Auditor’s Responsibility in Reviewing
Subsequent Events
The auditor’s actions on that fact depends on whether it was discovered or
became known:
•
before the date the FSs are issued; or
•
after the FSs have been issued.
Facts: After Auditor’s Report Date but Before the FSs Date
The auditor shall perform the following:
•
Discuss the matter with management and TCWG.
•
Determine whether the FSs need amendment &, if so,
•
Inquire how management intends to address the matter in the FSs.
If management amends the FSs, the auditor shall:
•
Carry out necessary audit procedures
•
Provide a new auditor’s report with Emphasis of Matter paragraph or
Other Matter paragraph.
Auditor’s Responsibility in Reviewing
Subsequent Events
When management does not amend the FSs where the
auditor believes they need to be amended, then:
a) If the auditor’s report has not yet been provided to
the entity, the auditor shall modify the opinion; or
b) If the auditor’s report has already been provided to
the entity, the auditor shall notify management and,
TCWG, not to issue the FSs to third parties before the
amendments. If the FSs are nevertheless
subsequently issued without the amendments, the
auditor shall take appropriate action to seek to
prevent reliance on the auditor’s report and consider
seeking legal advice
Auditor’s Responsibility in Reviewing
Subsequent Events
Facts: After the FSs have been Issued
The auditor’s actions and procedures are essentially the same as
when the facts have been discovered after the auditor’s report
but before the issuance of FSs. In addition, the auditor shall
review the steps taken by management to ensure that anyone
in receipt of the previously issued FSs with the auditor’s report
is informed of the situation.
If management does not or fails to take the necessary steps, the
auditor shall notify management and TCWG that the auditor
will seek to prevent future reliance on the auditor’s report. If
management or TWCG do not take these necessary steps, the
auditor shall take appropriate action to seek to prevent
reliance on the auditor’s report.
Dating of Auditor’s Report
The amended auditor’s report may be dated either of the
following techniques:
a. Single-dated – use the date of the subsequent event
as the date of the new auditor’s report.
b. Dual-dated – Use the dates of the original auditor’s
report and the date of the event, to disclose the work
done only on that event after the original audit report
date. For example, “(Date of auditor’s report),
except as to Note Y, which is as of (date of
completion of audit procedures restricted to
amendment described in Note Y).”
Going Concern Considerations
The going concern assumption is a fundamental principle
in the preparation of FSs. The auditor’s going concern
considerations normally include the following areas:
•
Accounting framework
•
Auditing management’s assessment of going
concern
•
Events or conditions that may cast significant doubts
about the entity’s ability to continue as a going
concern
•
Determining the implications for the auditor’s report
Concluding Analytical Procedures
An auditor often uses the same measures and ratios during
preliminary analytical procedures and concluding
analytical procedures, and ordinarily the same measures
and ratios will be appropriate for both. This may involve:
•
Reading FSs and notes
•
Considering adequacy of evidence gathered
•
Considering unusual or unexpected items not previously
identified
In addition, if after completing the above procedures, the
auditor may discover previously unrecognized audit
issues or risks. In this case, the auditor shall obtain
additional evidence.
Written Representations
An auditor often uses the same measures and ratios during
preliminary analytical procedures and concluding
analytical procedures, and ordinarily the same measures
and ratios will be appropriate for both. This may involve:
•
Reading FSs and notes
•
Considering adequacy of evidence gathered
•
Considering unusual or unexpected items not previously
identified
In addition, if after completing the above procedures, the
auditor may discover previously unrecognized audit
issues or risks. In this case, the auditor shall obtain
additional evidence.
Written Representations
Written Representations
A written statement by management provided to the
auditor to confirm certain matters or to support
other audit evidence. Written representations in this
context do not include FSs, the assertions therein, or
supporting books and records.
The two common types written representations are:
a) General
b) Specific
Other Audit Special
Considerations and
Reports
Audit of Financial Statements Prepared in
Accordance with Special Purpose Framework
-
Special purpose FSs are FSs prepared in accordance with a
special purpose framework designed to meet the financial
information needs of specific users.
-
Examples of special purpose frameworks are:
•
A tax basis of accounting for a set of FSs that accompany
an entity’s tax return;
•
The cash receipts and disbursements basis of accounting
for cash flow information that an entity may be requested to
prepare for creditors;
•
The financial reporting provisions established by a
regulator to meet the requirements of that regulator such as
SEC, BSP or IC; or
•
The financial reporting provisions of a contract, such as a
bond indenture, or a project grant.
-
Forming an Opinion and Reporting
Considerations
-
-
Description of the applicable financial reporting
framework:
a) The auditor’s report shall also describe the purpose
for which the FSs are prepared and, if necessary, the
intended users, or refer to a note in the special purpose
FSs that contains that information; and
b) If management has a choice of financial reporting
frameworks in the preparation of such FSs, the
explanation of management’s responsibility for the FSs
shall also make reference to its responsibility for
determining that the applicable financial reporting
framework is acceptable in the circumstances.
Forming an Opinion and Reporting
Considerations
-
The auditor’s report shall include an Emphasis of
Matter paragraph alerting users of the auditor’s
report that the FSs are prepared in accordance
with a special purpose framework and that, as a
result, the FSs may not be suitable for another
purpose. In addition to the above, the auditor
may consider it appropriate to indicate that the
auditor’s report is intended solely for the specific
users.
Other Audit Special
Considerations and
Reports
Unqualified Opinion
▪ Often called a clean opinion, an unqualified opinion is an audit report
that is issued when an auditor determines that each of the financial
records provided by the small business is free of any misrepresentations.
In addition, an unqualified opinion indicates that the financial records
have been maintained in accordance with the standards known as
Generally Accepted Accounting Principles (GAAP). This is the best type
of report a business can receive. Typically, an unqualified report consists
of a title that includes the word “independent.” This is done to illustrate
that it was prepared by an unbiased third party. The title is followed by
the main body. Made up of three paragraphs, the main body highlights
the responsibilities of the auditor, the purpose of the audit and the
auditor’s findings. The auditor signs and dates the document, including
his address.
Qualified Opinion
▪ In situations when a company’s financial records have
not been maintained in accordance with GAAP but no
misrepresentations are identified, an auditor will issue
a qualified opinion. The writing of a qualified opinion
is extremely similar to that of an unqualified opinion.
A qualified opinion, however, will include an
additional paragraph that highlights the reason why
the audit report is not unqualified.
Disclaimer of Opinion
▪ On some occasions, an auditor is unable to complete
an accurate audit report. This may occur for a variety
of reasons, such as an absence of appropriate financial
records. When this happens, the auditor issues a
disclaimer of opinion, stating that an opinion of the
firm’s financial status could not be determined.
Adverse Opinion
▪ The worst type of financial report that can be issued
to a business is an adverse opinion. This indicates that
the firm’s financial records do not conform to GAAP. In
addition, the financial records provided by the
business have been grossly misrepresented. Although
this may occur by error, it is often an indication of
fraud. When this type of report is issued, a company
must correct its financial statement and have it reaudited, as investors, lenders and other requesting
parties will generally not accept it.
AUDITOR’S REPORT
Modifications to the standard audit report
1. Scope Limitation
2. Departure from FRF/Standards
3. Emphasizing a matter
4. Inconsistency
5. Going-concern Uncertainties
6. Lack of Independence
1. Scope Limitation
The auditor is prevented from doing an important
procedure
A. Limitation imposed by circumstances
OPINION
1. UNQUALIFIED w/o
explanatory paragraph
REASON
2. QUALIFIED
If the auditor failed to perform
alternative procedure or was not
satisfied with it and the effects is
material but not pervasise.
If the auditor has performed an
alternative procedure and was satisfied
with it
Mod. Par – 5th paragraph before
opinion
1. Scope Limitation
The auditor is prevented from doing an important
procedure
A. Limitation imposed by circumstances
OPINION
3. DISCLAIMER
REASON
If the auditor failed to perform
alternative procedure or was not
satisfied with it and the effects is
material and pervasive.
1. Scope Limitation
The auditor is prevented from doing an important
procedure
B. Limitation imposed by the client
OPINION
1. QUALIFIED
REASON
2. DISCLAIMER
3. Withdraw from the
engagement
If material and pervasive
If material but not pervasive
1. Departure from FRF
1.
2.
3.
4.
5.
Improper measurement
Inappropriate accounting policies
Unreasonable accounting estimates
Inadequate disclosures
Experts findings are unreasonable
OPINION
REASON
1. QUALIFIED
If effect is material but not pervasive
2. ADVERSE
If effect is material and pervasive
3. Emphasizing a matter
1.
To highlight in the audit report certain matters
including in the notes to FS
a)
b)
c)
d)
e)
f)
Significant related party transactions
Selected catastrophe such as fire or flood
Ongoing litigations
Incorporation or re-organization
Inconsistency
Substantial doubt about going concern
OPINION
REASON
1. Unqualified opinion with The fair presentation of FS is not
affected
explanatory paragraph
4. Inconsistency (change in
accounting policy or correction of
prior period)
OPINION
REASON
1. Unqualified opinion with If client has justified the change or the
corrections
explanatory paragraph
2. Qualified opinion
If the client failed to justify the change
or the correction and the effect is
material but not pervasive
3. Adverse opinion
If the client failed to justify the change
or the correction and the effect is
material and pervasive
5. GOING CONCERN UNCERTAINTIES
OPINION
REASON
1. Unqualified opinion with If client has disclosed the uncertainties
explanatory paragraph
2. Qualified opinion
If the client failed to disclose and the
effect is material but not pervasive
3. Adverse opinion
If the client failed to disclose and the
effect is material and pervasive
If the FS are prepared on a goingconcern basis but the entity is not on a
going concern
4. Disclaimer of opinion
Multiple uncertainties
6. Lack of Independence
OPINION
Disclaimer of opinion
REASON
Omit all paragraph and create a
disclaimer statement
Review and Other
Assurance Services
REVIEW
▪ The objective of a review of FSs is to enable a
practitioner to state whether, on the basis of
procedures which do not provide all the
evidence that would be required in an audit,
anything has come to the practitioner’s
attention that causes the practitioner to believe
that the FSs are not prepared, in all material
respects, in accordance with the applicable
financial reporting framework (negative
assurance).
REVIEW
▪ A review engagement provides a moderate level of assurance.
▪ The practitioner should comply with the Code of Ethics general
principles, such as:
▪ a)
Independence;
▪ b)
Integrity;
▪ c)
Objectivity;
▪ d)
Professional competence and due care;
▪ e)
Confidentiality;
▪ f)
Professional behavior; and
▪ g)
Technical standards.
REVIEW
▪ The Auditor’s Assurance
▪ When reporting on the reasonableness of
management’s assumptions the auditor
provides only a moderate level of assurance.
However, when in the auditor’s judgment an
appropriate level of satisfaction has been
obtained, the auditor is not precluded from
expressing positive assurance regarding the
assumptions.
Related Services
RELATED SERVICES
▪ General Principles of Related services (Compilation and Agreed-Upon
Procedures Engagement)
▪ The auditor should comply with the Code of Ethics general principles,
such as:
▪ a.
Integrity;
▪ b.
Objectivity;
▪ c.
Professional competence and due care;
▪ d.
Confidentiality;
▪ e.
Professional behavior; and
▪ f.
Technical standards.
Agreed-upon Procedures Engagements
▪ The objective of an agreed-upon procedures
engagement is for the auditor to carry out
procedures of an audit nature to which the
auditor and the entity and any appropriate third
parties have agreed and to report on factual
findings.
Compilation Engagements
▪ A compilation engagement would ordinarily
include the preparation of financial statements
(which may or may not be a complete set of
financial statements) but may also include the
collection, classification and summarization of
other financial information.
Compilation Engagements
▪ The objective of a compilation engagement is for the
accountant to use accounting expertise, as opposed to
auditing expertise, to collect, classify and summarize financial
information. This ordinarily entails reducing detailed data to a
manageable and understandable form without a requirement
to test the assertions underlying that information. The
procedures employed are not designed and do not enable the
accountant to express any assurance on the financial
information. However, users of the compiled financial
information derive some benefit as a result of the
accountant's involvement because the service has been
performed with professional competence and due care.
END OF ACTG 109 Lectures