Chapter 1 - An Overview of Audit
Thursday, 12 May 2022
1:39 PM
An Overview
- The primary function of an independent audit is to lend credibility to the financial
statements prepared by an entity.
Auditing Defined
- The Philippine Standards on Auditing (PSA) defines auditing by stating the
objective of a financial statement audit; that is, to enable the auditor to express an
opinion on whether the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework.
- According to the American Accounting Association, 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
these assertions and established criteria and communicating the results to interested
users.
- The definition conveys the following thoughts:
a. Auditing is a systematic process
▪ Auditing proceeds by means of an ordered and structured series of steps.
b. An audit involves obtaining and evaluating evidence about assertions
regarding economic actions and events
▪ Assertions are representations made by an entity about economic actions
and events. The auditor's overall objective is to determine whether these
assertions are valid.
c. An audit is conducted objectively
▪ Objectivity requires the auditor to make an impartial assessment of all the
relevant circumstances in forming a conclusion. Auditors should not allow
bias or conflict of interest to override professional judgement.
d. Auditors ascertain the degree of correspondence between assertions and
established criteria
▪ Established criteria are needed to judge the validity of the assertions.
These criteria are important because they establish and inform the users of
the basis against which the assertions have been evaluated or measured.
e. Auditors communicate the audit results to various interested users
▪ The communication of audit findings is the ultimate objective of any audit.
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Types of Audits
1. Financial statement audit
○ It is conducted to determine whether the financial statements of an entity are
fairly presented in accordance with the applicable financial reporting framework.
2. Compliance audit
○ Involves a review of an organization's procedures to determine whether the
organization has adhered to specific procedures, rules, or regulations.
○ The performance of a compliance audit is dependent upon the existence of
verifiable data and recognized criteria established by an authoritative body.
3. Operational audit
○ It is a study of a specific unit of an organization for the purpose of measuring its
performance. The main objective of this type of audit is to assess entity's
performance, identify areas for improvements and make recommendations to
improve performance.
○ It is also known as performance audit or management audit.
○ The criteria used for evaluating the effectiveness and efficiency of operations are
not clearly established. The criteria used for operating audits would typically vary
depending on the organization's standards and objectives.
- Regardless of the different types of audit, all audits possess the same general
characteristics. They all involve:
○ Systematic examination and evaluation of evidence which are undertaken to
ascertain whether assertions comply with established criteria
○ Communication of the results of the examination, usually in a written report,
to the party by whom, or on whose behalf, the auditor was appointed.
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Types of Auditors
1. External Auditors or Independent Auditors
- These are independent Certified Public Accountants (CPAs) who offer their
professional services to different clients on a contractual basis.
- They are the ones who generally perform financial statement audits.
2. Internal Auditors
- Are entity's own employees who investigate and appraise the effectiveness and
efficiency of operations and internal controls.
- Its main function is assist the members of the organization in the effective discharge of
their responsibilities.
- They usually perform operational audits.
3. Government Auditors
- These are government employees whose main concern is to determine whether
persons or entities comply with government laws and regulations.
- They usually conduct compliance audits.
The Independent Financial Statement Audit
- The objective of an audit of financial statements is to enable the auditor to express an
opinion whether the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework.
○ Responsibility for the financial statements
▪ The management is responsible for preparing and presenting the financial
statements in accordance with the applicable financial reporting framework.
▪ The auditor's responsibility is to form and express an opinion on these
financial statements based on the audit results.
○ Assurance provided by the auditor
▪ The auditor's opinion on the financial statements is not a guarantee that
the financial statements are dependable.
▪ An audit conducted in accordance with the PSAs is designed to provide
only reasonable assurance (not absolute assurance) that the financial
statements are taken as a whole are free from material misstatements.
○ Nature of the procedures
▪ There are practical and inherent limitations on the auditor's ability to obtain
evidence:
□ The use of testing or sampling risk
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□ The use of testing or sampling risk
 Whenever a sample is taken, there is always a possibility that
the auditor's conclusion, based on the sample, may be different
from the conclusions that would have been reached if the auditor
examines the entire population.
□ Error in the application of judgement or non-sampling risk
 There is no absolute assurance that material misstatement in the
financial statements will be detected. This is because the work
undertaken by the auditor to form an opinion is permeated by
judgement.
○ Nature of financial reporting
▪ The application of the applicable financial reporting framework such as the
PFRS involves application of significant judgement and estimates on the
part of the management.
○ Nature of evidence
▪ Audit evidence comprises pieces of information and impressions which are
gradually accumulated during the course of an audit, an which, when taken
together, persuade the auditor about the fairness of financial statements.
▪ Audit evidence is generally persuasive rather than conclusive in nature.
▪ Owing to the inherent limitations of an audit, there is unavoidable risk that
even an audit conducted in accordance with the PSAs may not be able to
detect material misstatement in the financial statements.
General Requirements when Auditing Financial Statements
1. The auditor should comply with the relevant ethical requirements, including those
pertaining to independence, relating to financial statements audit engagements.
2. The auditor should conduct an audit in accordance with the Philippine Standards on
Auditing (PSAs)
3. The auditor should apply professional judgement in planning and performing the
audit.
4. The auditor should obtain sufficient appropriate audit evidence to reduce the audit risk
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4. The auditor should obtain sufficient appropriate audit evidence to reduce the audit risk
to an acceptably low level.
5. The auditor should plan and perform the audit with an attitude of professional
skepticism recognizing that circumstances may exist which may cause the financial
statements to be materially misstated.
Professional Skepticism
- Means that the auditor makes a critical assessment, with a questioning mind, of the
validity of audit evidence obtained and is alert to audit evidence that contradicts or
bring into questions the reliability of documents or management representations.
Need for an independent financial statement audit
1. Conflict of interest between management and users of financial statements
2. Expertise
3. Remoteness
4. Financial consequences
Theoretical Framework of Auditing
1. Audit function operates on the assumption that all financial data are verifiable.
2. The auditor should always maintain independence with respect to the financial
statements under audit
3. There should be no long-term conflict between the auditor and the client management.
4. Effective internal control system reduces the possibility of material misstatements of
the financial statements.
5. Consistent application of the applicable financial reporting framework such as the
PFRS results in fair presentation of financial statements.
6. What was held trye in the past will continue to hold true in the future in the absence of
known conditions to the contrary.
7. An audit benefits the public
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