Review Notes Assurance Services – a professional engagement wherein a CPA provides assurance regarding the reliability of a subject matter with the aim of increasing the confidence of intended users regarding the subject matter (which is not the responsibility of the CPA). Five Elements of Assurance Engagements All five must be present for an engagement to be classified as an assurance engagement. Code 5 Elements: TSECR Element 1 - three-party relationship a. Professional accountant / practitioner - CPA, the one who provides a report expressing assurance. b. Responsible party - person or class of persons responsible for the subject matter. c. Intended users - person or class of persons for whom the CPA prepares the report. They will benefit from the report of the CPA. Responsible party could also be one of the intended users. procedures are performed? procedures (see next table) How much evidence is gathered? Consider internal controls of the client? Wording of the report Key words Much evidence Systems and processes Behavior Example Financial statements Ranking of TV stations in the Philippines Capacity of a bridge, body characteristics (archaeology) enrollment system, manufacturing system corporate governance Element 3 - sufficient appropriate evidence — no evidence, no opinion a. Accounting records and documents b. Source documents c. Other information - interviews, minutes of meetings Element 4 - suitable criteria - standards/ benchmarks used to evaluate evidence and the subject matter a. Audit of FS — criteria is PFRS (GAAP) b. Operational audit — criteria is management objectives and goals c. Compliance audit — criteria is law or regulation Inquiry Absolute assurance Reasonable assurance Limited assurance impossible to achieve high level of assurance/comfort that the subject matter is reliable. moderate level of assurance Examples of Assurance Engagements Level of assurance provided Auditor independence from client required? How many audit Inspection Observation Analytical procedures Confirmation Reperformance Recomputation / Recalculation Audits Reasonable level (High) Reviews Limited level (Moderate) Yes Yes 2. 3. Two procedures This procedure consists of seeking information of knowledgeable persons, both financial and nonfinancial, throughout the entity or outside the entity. Looking at records, documents to gather evidence regarding an assertion. Looking at tangible assets. Looking at a process or procedure being performed by others. The evaluation of financial information through a study of plausible relationships among both financial and non-financial data. Verify an assertion with a third party (ex. Cash in bank — bank, AR — customer, invty with 3rd parties — consignee, AP — supplier) An independent execution of procedures or controls that were originally performed as part of the entity’s internal control. The auditor verifies the accuracy of a mathematical computation performed by the client. Risk assessment procedures – used to obtain understanding of the entity and its environment Tests of controls – used to check the operating effectiveness of controls Substantive tests – used to detect material misstatements in the FS Other assurance services (examples) 1. ISO certifications - assurance that products or services provided are world-class in quality based on an audit to check the process for creating the product or providing the service. Non-assurance services - services or engagements where one or more of the elements (TSECR) is/are missing. MAS Seven Negative assurance “Nothing has come to my attention…” Audit procedures can be classified according to purpose, such as: 1. Element 5 - written assurance report. Positive assurance “…presented fairly, in all material respects…” Audit Procedures - steps taken to gather evidence from a client. Element 2 - subject matter — the item being given assurance. Anything can be the subject matter of an assurance engagement. Subject matter Financial performance or condition Non-financial performance or condition Physical characteristics Yes (inquiry, analytical procedures) Lesser evidence as compared to an audit No 2 parties instead of 3 — client and the advisor (CPA). Provide advice Review Notes Compilation Agreed-upon procedures Tax compliance Tax planning and technical assistance to clients. CPA prepared the FS based on client records — CPA cannot give an opinion on the FS — written assurance report is not given. Only accounting expertise is used. CPA just performs procedures agreed in advance with the client — CPA presents the findings/results of the procedures, but does not give an opinion — written assurance report is not given assist the client to comply with tax regulations (ex. Fill-up returns), written assurance report is not given before a transaction is entered into, the auditor is consulted by the client regarding possible tax consequences of their planned transaction — auditor provides advice on how to legally minimize the tax due — 2 parties instead of 3 — client and the advisor (CPA) Basic Concepts of Audits An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. An audit requires the attitude of professional skepticism, which means that the auditor applies a questioning mind and a critical approach to the gathering and evaluation of evidence. Due audit care is also expected of the auditor (being conscientious and careful in performing the engagement) Systematic process Objectively Obtaining and evaluating evidence Evidence Assertions Degree of correspondence Established criteria Communicating the results involves a series of sequential steps neutral, impartial, without bias evidence is gathered by performing audit procedures any information obtained and used as a basis for the conclusions in an audit, which ultimately influences the opinion to be expressed. representations of management, explicit or otherwise, that are embodied in the financial statements. the auditor compares what the client has recorded vs what is required by the standards (PFRS). PFRS (in other countries, GAAP) Completeness Valuation and allocation Rights and obligations Occurrence Accuracy Cut-off Classification All transactions and events that should have been recorded have been recorded. Assets, liabilities and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. transactions and events that have been recorded have occurred, and pertain to the entity. Amounts and other data relating to recorded transactions and events have been recorded appropriately. Transactions and events have been recorded in the correct accounting period. Transactions and events have been recorded in the proper accounts. Four Types of Audit Reports - QUAD Report No. 1 - Unqualified Opinion - the most common opinion, the best opinion Unqualified means there are no exceptions. The entire FS is fairly stated. The auditor was able to gather sufficient, appropriate audit evidence, and the auditor did not note any remaining uncorrected material misstatements. Report No. 2 - Adverse Opinion - the worst opinion The auditor noted that the FS contains material and pervasive misstatements. Almost, if not all, of the entire FS is materially misstated. FS is misleading. Report No. 3 - Disclaimer of Opinion - no opinion given The auditor noted that an opinion cannot be expressed due to a material and pervasive inability of the auditor to obtain sufficient appropriate audit evidence. Report No. 4 - Qualified Opinion - best among the modified opinions (Q, A, D) The auditor believes that the FS contains material but not pervasive misstatements. OR The auditor encountered material but not pervasive inability to obtain sufficient appropriate audit evidence during the engagement. thru issuance of audit report Different Types of Audits Examples of financial statement assertions Existence interests exist. All assets, liabilities and equity interests that should have been recorded have been recorded. Assets, liabilities and equity A. Audits according to subject matter (SM) Review Notes 1. 2. 3. B. FS audits - expression of an opinion on the fair presentation of FS. SM - financial statements. Criteria – GAAP clients that lack integrity. 1. Operational audit - determine the efficiency, effectiveness and areas for improvement of a company, or a part of the company. SM operations/performance. Criteria - management goals or targets for the year Compliance audit - express an opinion on the compliance (or non-compliance) of a subject matter. SM - act of a person/company, status of company, documentation, operations. Form: Client evaluation form (checklist) 2. External audit - audit was performed by an independent CPA. The CPA/auditor was paid a professional fee (not a salary). External audits can be FS audits, Operational audits, or compliance audits. 2. Internal audit - audits performed by an employee of the company (internal auditor). The main objective of this audit is to assist management in the effective discharge of their responsibilities. Internal auditors are paid a salary. Internal audits can be Operational audits or compliance audits. 3. Government audit - audits performed by government auditors (from BIR, SEC, BSP, COA, etc.). This type of audit goes beyond the usual financial statement audit, to include audits of compliance with laws and regulations, operations of governmental entities, and the proper disbursement and management of public funds. The FS Audit Process Audit firm checks - determine if our firm has the necessary knowledge, time, resources and manpower to conduct the audit successfully. Considerations: client industry, applicable accounting and auditing standards, taxation requirements, size of the entity (branches, etc.), volume of transactions, manpower requirements vs. actual manpower present in the firm, accounting system of client (Quickbooks, Xero, Sage, SAP, Oracle) - do we have experts that can help us, tentative timetable (proposed by the prospective client) Audits according to the type of person performing the audit 1. Client background checks - external sources of information, as well as internal sources. Interviews, online research - management, those charged with governance, media comment, current events and developments 3. Ethical considerations a. b. c. Integrity - do we have reason to believe that the prospective client lacks integrity? Competence - are we competent enough to do the engagement? Do we have experts available? Independence - is our firm independent from the prospective client? yes - we can accept no - we cannot accept 4. Auditability - the financial statements must be properly supported by accounting records and source documents, as well as tangible assets. 5. Going concern problems or issues if present - GC issue (ex. Continuous net losses over several years, lack of liquidity over an extended period) Capacity to pay the audit fee. 6. 1. Pre-engagement — screening of clients to determine acceptability 2. Audit planning — effectiveness The ability to achieve an unqualified opinion is not considered, since at this point, no evidence has been gathered about the client yet. 3. Internal control consideration — efficient audits (focus on high-risk accounts in the FS) What if the company has been audited previously by another CPA? 4. Substantive testing - actually perform the procedures that you listed in Steps 2 and 3. 5. Audit completion - evaluate the evidence gathered, perform wrap-up procedures and determine your audit opinion. 6. Audit reports - prepare, sign and issue the audit report and give the report to the client, together with the audited FS. Terms a. Successor auditor (SA) - incoming auditor / the CPA that will perform the next audit. This CPA received the client from a previous auditor. b. Predecessor auditor (PA) - outgoing auditor / the CPA that performed the most recent audit before the current period. This CPA shall “pass” the client to the successor auditor. 7. Post-audit responsibilities - quality management (debriefing), maintain proper client relations. Pre-engagement Major concern: Accept only the engagements that we are competent to perform, and avoid being associated with Philippine Standards on Auditing (PSAs) require that the successor auditor should initiate communication with the predecessor auditor. The predecessor auditor cannot initiate communication with the successor auditor because of the rule of confidentiality (ex. An auditor cannot volunteer to others, information about a client, without the client’s permission.) Review Notes Process: 1. SA shall determine if the prospective client has a PA. 2. If there is a PA, the SA shall request permission from the prospective client, to communicate with the PA. ( 3. If permission is granted, the SA can now talk with the PA. If permission is denied, such denial should be investigated by the SA —this could be grounds for lack of trust between SA and prospective client — leading to rejection of the engagement. 4. Once SA makes an inquiry with the PA, the following items shall be discussed: a. b. c. 5. Disagreements between PA and prospective client management - pinag-awayan sa mag dating audit • disagreements about accounting principles • disagreements about audit procedures Reason for change in auditors Instances or matters that bring the client’s integrity into question Before the PA can reply to the inquiries of the SA (in number 4 above), the PA shall request permission from his/her former client - permission to answer the SA’s questions. If the client says “yes, you may answer” - no problem, PA shall discuss with SA without restrictions. If the client says “no, you cannot answer” —this could be grounds for lack of trust between SA and prospective client — leading to rejection of the engagement. Engagement Letter - letter documenting the understanding of duties and responsibilities of client and auditor, including the terms of engagement (stipulations). The letter is signed by both the partner(s) and the client’s management/directors and provides a written record of the agreement between the parties. Contents: DISUROT 1. Division of responsibilities - management responsibilities vs auditor’s responsibilities 2. Inherent limitations of audits - we remind the client that in an audit, there could be remaining undetected material misstatements, even if a proper audit has been conducted. 3. Scope of the audit - coverage (HO only, branches only, both HO and branches, etc.) 4. Unrestricted access - documents, records, assets and personnel. Should be audit-related. 5. Report formats - short-form vs. long-form 6. Objective of the audit - clarify to the client that the objective of the audit is to determine if the FS is fairly stated. Clarify that a standard audit is not a guarantee that fraud will be discovered. 7. Timetable and fees In audits of components / group audits - shall we send a letter to the component as well as the parent/head office? Group audit - the audit of a parent company and one or more subsidiaries; the audit of a home office and one or more branches. Factors to consider: 1. Who appointed the auditor 2. Legal requirements 3. Whether separate reports will be given for the parent and the subsidiaries In the case of recurring engagements - audits that repeat (suki clients). Should we send a separate EL every period? General rule: No need to send a new EL every period. Exceptions to the rule: 4Rs 1. Revised terms of engagement - ex. Change in scope, change in timetable or fees, etc. 2. Change in senior management or those charged with governance - nag-iba yung tao na kausap natin - send a new EL addressed to the new contact person to remind the client about the arrangement with the auditor. 3. Legal requirements 4. Client misunderstood the technical aspects of the original EL - we send a re-worded version of the letter to facilitate understanding. Note!!!! The auditor is required to document the terms of understanding with the client, but the engagement letter by itself is not required. This is because there are many ways to document the terms of engagement: Examples 1. Most common - engagement letter 2. Minutes of meetings with the client 3. Recorded meeting with client consent - audio, video Request for changes in engagement Sample changes: 1. Change from lower level of assurance to higher level of assurance - expected. Nothing unusual — does not require additional investigation. The change can be accommodated outright. 2. Change from higher level of assurance to lower level of assurance — not expected. Unusual — requires additional investigation before it can be accommodated. Procedures to apply when there is a request to change the engagement (higher to lower) 1. Inquire with the client on the reason for change in engagement. 2. Determine if the reason for change is justifiable or valid. a. The client misunderstood the objective of the original engagement - ex. Client thought that an audit is about a CPA preparing the FS of the client. - valid b. There was a change in circumstances of the client - ex. Client originally requested for an audit because the client plans to apply for a bank loan (audited FS are required to be submitted when applying for a loan). Two weeks later, the client approached the auditor, and informed the auditor that the audit is no longer required because the planned loan application has been canceled. The client requested if the auditor can do a review engagement instead of the audit. – valid c. The client wants a change in engagement in order to reduce the scope of the engagement. Client is becoming increasingly uncomfortable because of the detailed nature of audit procedures. Client is requesting to change the Review Notes engagement into a review (requires significantly less audit procedures) - client is hiding something from the auditor — invalid 3. If the reason for change is unjustifiable or invalid — you cannot accommodate the requested change. a. Refuse the client’s request to change the engagement b. Ask the client if you can still continue the original engagement • If allowed to continue - do so, and issue the report for the original engagement. • If not allowed to continue - withdraw from the engagement, and inform the client and other relevant parties about the withdrawal. Audit Planning 1. 2. 3. 4. 2. If the reason for change is justifiable or valid — you may accommodate the requested change. a. Stop the original ongoing engagement. b. Agree on new terms of engagement (DISUROT) c. Perform the new/revised engagement. d. Issue the report for the new/revised engagement. In the new report, do not mention the story about the change in engagement, to avoid being misunderstood by the readers of the new report. 4. after BS date onwards). Audit planning involves developing a general audit strategy and a detailed approach for the expected conduct of the audit. Effectiveness - achieve our goal (express an opinion on FS) Constraints - budget (audit fee), timeframe (1-2 weeks usual) Work-back: Opinion —> sufficient, appropriate audit evidence —> audit procedures a. b. What procedures should be performed? (Inquiry, Inspection, Observation, Analytical procedures, Confirmation, Re-performance, Re-calculation) When should the procedures be performed? (On BS date, earlier than BS date, later than BS date) c. Who should perform the procedures? (Associate, Senior Associate, Audit Manager, Audit Partner) d. How much evidence should be gathered? Outputs of audit planning Audit strategy - approach to be taken in performing the audit 1. With reliance on controls approach – We believe, based on risk assessment procedures, that the client’s internal control system is working effectively. This means that the client’s unaudited financial statements might contain less misstatements. Accordingly, the auditor shall plan to perform less substantive testing, gather less samples, and schedule the tests earlier than the BS date, if possible (usually September 30 onwards). Audit plan - document containing all the procedures needed to be performed from the start until the end of the engagement. Usually presented as a generic template, to be customized on a per client basis. Audit programs - contain the list of test of controls and substantive tests. It also includes the assigned team member for each procedure, a space for writing comments and findings, and a column for the time budget. Procedure Obtain the bank reconciliation prepared by the client for Dec. 31 and test each reconciling item and the mathematical accuracy of the prepared reconciliation. Done by ERG Findings Time budget 15 minutes. Reasons for planning an audit: 1. 2. 3. 4. 5. Helps ensure that appropriate attention is devoted to important areas of the audit. Helps to identify potential problems in advance. Allows the work to be completed expeditiously. Assists in the proper assignment and coordination of work. Helps ensure that the audit is conducted effectively and efficiently. Error – refers to unintentional misstatements in the FS, including the omission of an amount or disclosure, such as: a. b. c. Mathematical or clerical mistakes in the underlying records and accounting data. An incorrect accounting estimate arising from oversight or misinterpretation of facts. Mistake in the application of accounting policies Fraud – Fraud refer to intentional act by one or more individuals among management, those charged with governance, employees or third parties, involving the use of deception to obtain an unjust or illegal advantage. An auditor is primarily concerned with fraudulent acts that cause a material misstatement in the FS. No reliance on controls approach We believe, based on risk assessment procedures (“research procedures”), that the client’s internal control system is missing or ineffective. This means that the client’s unaudited financial statements might contain a lot of misstatements. Accordingly, the auditor shall plan to perform more substantive testing, gather more samples, and schedule the tests on or near the BS date (one week before BS date, one week Types of Fraud 1. Fraudulent financial reporting - involves intentional misstatements or omissions of amounts or disclosures in the FS to deceive FS users. Usually known as management fraud. Examples: Review Notes - Manipulation, falsification or alteration of records or documents Misrepresentation in, or intentional omission of, the effects of transactions rom records or documents Recording of transactions without substance Intentional misapplication of accounting policies 2. Misappropriation of assets - involves theft of an entity’s assets committed by company employees. Usually known as employee fraud. Embezzling receipts Stealing entity assets such as cash, FVPL, and inventory Lapping of AR 2. Fraud Triangle 1) Pressure to commit fraud financial pressure due to great economic need (debts) Pressure to keep up an unsustainable lifestyle Unrealistic promises made by management regarding company performance 2) Opportunity to commit fraud - Usually comes in the form of weaknesses in internal control Not depositing cash on hand in a timely manner Lack of segregation of duties 3) Rationale / justification in committing fraud Everybody is doing it, so why not I? Corruption cop-out The end justifies the means Responsibilities for Fraud and Error Preventing fraud - stop fraud from happening A. Management - responsible to establish a control environment and to implement internal control policies and procedures designed to ensure, among others, the prevention and detection of fraud and error. B. Those charged with governance (owners) responsible to ensure the integrity of an entity’s accounting and financial reporting systems and that appropriate controls are in place. The auditor is never responsible for the prevention of fraud. Detecting fraud – checking if fraud already happened A. Management - responsible to detect fraud B. Those charged with governance (owners) responsible to detect fraud C. Auditor - responsible to detect fraud that has a material or direct effect on financial statements.
