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