INSTRUCTIONAL MATERIAL
FOR
ACCO 30043
AUDITING AND ASSURANCE
PRINCIPLES
COMPILED BY:
PROF. GLENN A. MAGADIA
PROF. MARK ANECITO R. PERLAS
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TABLE OF CONTENTS
Cover Page …………………………………………………………………………………..1
Table of Contents …………………………………………………………………………..2
Course Outline …………………………………………………………………..………….3
Lesson 1 – Overview of Assurance, Auditing and Non-Assurance ……………...17
Lesson 2 – Major Phases in an Audit – Part I ………………………………………..46
Lesson 3 – Major Phases in an Audit – Part II ……………………………………….86
Lesson 4 – Major Phases in an Audit – Part III ……………………………………..107
Lesson 5 – Practice of Accountancy Profession …………………………………..140
Suggested Answer for Multiple Choice Questions ………………………………...166
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AUDITING THEORY
(Auditing and Assurance Principles)
Simplified Module for the New Normal
First Semester of AY – 2020-2021
Prof. Glenn A. Magadia
Prof. Mark Anecito R. Perlas
All rights reserved. July 30, 2020
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AUDITING THEORY
(Auditing and Assurance Principles)
Course Description:
This course is designed to expose students both the demand for and the supply of the
profession’s flagship service, which is FINANCIAL STATEMENT AUDITS, and to the nature of
the value-added assurance services which information demand in the information age. The
purpose of this subject is to integrate the objectives, classifications, techniques, and procedures
in auditing which are specified in Philippine Standards on Auditing (PSA) and other regulatory law
and standards, in a logical manner to assist students in understanding audit decision making,
evidence accumulation and audit reporting in today’s complex and changing business
environment with emphasis on external auditing/public accounting practice as performed by
Independent Certified Public Accountants. The course covers also the Philippine Accountancy
Act of 2004, the Code of Ethics for Professional Accountants, internal controls, and other services
and reports.
Course Prerequisites: ACCO 20103 – Intermediate Accounting Part 3
Course Code: ACCO 30043
Course Credit Units: 3 Units
Course Duration: 18 Weeks - Weekly Online Lecture Material (Modular Format and
Synchronous/Asynchronous Learning Style)
Course Materials:
Course and reading materials will include books, e-books available online or in the
library (ils.pup@edu.ph), excerpts from textbooks and other books, webinars, articles from
journals, news and business/social media and consensus standards if applicable. Readings
materials related to each week’s topics will be assigned/send on-line and, at times, may be
announced to support the direction of topic in the class.
For this module, we will use as our reference the book, Auditing and Other Assurance
Services 2018 Edition by Baldres, R.N., De Leon, E.M., and Magadia, G.A.
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Course Assessments:
Every end of the weekly topic, every student has to answer True or False Questions,
Multiple Choice Questions, Task-Based Activity and Cognitive/Comprehensive Case Study (if
necessary/as the case maybe), all of these are provided at the end of the instructional material.
Course Outcomes:
Upon completion of this module, the students will be able to:
1. Have the full sound knowledge and understanding of auditing theory, & other assurance
services, particularly audits of independent CPA’s, the nature of auditing and its environment,
and the professional responsibilities of CPAs, the audit planning, audit program, its process
and procedures, audit objectives, evidence, auditing standards, and the elements of the
independent auditor’s report.
2. Be aware of the laws, standards and regulations related to the practice of accounting
profession.
3. Integrate and apply the skills in the preparation of audit reports and apply acquired
knowledge to realistic case problem situations.
4. Develop skills in applying the theories learned in conducting an independent audit,
studying and evaluating internal control, audit evidence and its procedures, and preparing
the independent auditor’s report.
5. Enhance skills in the use of computer, calculator and other office equipment required in
the conduct of an audit.
6. Develop the value of competence, integrity, honesty, objectivity, timeliness and
perseverance as required of a professional accountant.
7. Realize the contribution of PSAs, PFRS (Full, Small and Medium-sized Enterprises and
Small Entities), International Standards, Code of Professional Ethics for CPAs; Accountancy
Law of 2004 (R.A. 9298) and the overall auditing theory to the development of a more socially
and morally oriented professional accountant.
8. Appreciate and preserve the professional accountant’s high standards of competence,
integrity and objectivity.
9. Comprehend the immediate transition of the traditional audit to new normal audit practice.
Week 1: Class and Subject Orientation
Introduce yourself as Faculty Member/Professor/Instructor, discuss the House Rules –
Class Management, things they need to comply with, grading system etc. and other
announcements. Don’t forget to ask them about their questions, queries and clarifications. This
will be the time for expectations-setting for both the instructor and the students.
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Introduction of the subject, review of financial accounting and reporting concepts such as
accounting cycle and the users of financial statements, and relating these previous concepts
learned from those subjects. Here we will differentiate accounting versus auditing. Lastly, discuss
the rationale behind and importance of auditing in the business environment.
Lesson 1 – Overview of Assurance, Auditing and Non-Assurance Services
Week 2: Introduction about Assurance, Other Assurance Services and Non-Assurance
Services
Fundamentals of assurance and auditing services
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Definition, nature and elements
Difference between assurance, attestation, audit
Broad sense of CPA services
➢ Assurance engagements
➢ Non-assurance engagements
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Nature and Elements of an assurance engagements
➢ High-level of assurance engagements
➢ Moderate-level of assurance engagements
Week 3: Overview of Auditing – Financial Statement Audit and Other topics
Introduction to Auditing and Financial Statement (FS) Audit
•
Definition, objective, nature, types, purpose and scope of an audit
➢ The historical development of auditing
➢ The social concept of an audit and its changing role
➢ Responsibility of the financial statements
➢ Limitations of FS audit
•
Types of auditors
•
General types of auditing
➢ External Auditing or Independent Financial Statement Auditing
➢ Internal Auditing
➢ Government Auditing
•
Concepts of Professional Judgement and Professional Skepticism
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Read Topics on:
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•
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Philippine Framework for Assurance Engagements (PFAE)
PSAE 3000 (Revised) – Assurance Engagements Other Than Audits or Reviews of
Historical Financial Statements
PSA 200 (Revised and Redrafted) – Overall Objectives of the Independent Auditor
and the Conduct of an Audit in Accordance with PSA
Chapters 1, 2, & 16, Auditing and Other Assurance Services, Magadia, et. al
Lesson 2 – Major Phases of an Audit - Part I
1. Client acceptance and continuance and establishing an understanding of the terms of
the engagement.
2. Preplanning activities such as establishing materiality.
3. Planning the audit.
4. Considering the entity’s internal control.
5. Perform audit procedures (test of control and substantive procedures).
Week 4:
Accepting the engagement and planning the audit
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Client acceptance and continuance
Establishing an understanding of the terms of the engagement
Assessing risks and making preliminary judgments about materiality levels
Planning the audit
➢ Audit team composition and roles, with evaluation of compliance with ethical and
technical requirements including Independence
➢ Establishing budget
➢ Planning meeting with client and with audit team
➢ Other critical matters in engagement planning
Obtaining an understanding of the client’s business and industry
Performing preliminary analytical procedures
Developing preliminary audit strategies for significant assertions
Auditor’s responsibilities relating to fraud in FS audit
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Considerations of laws and regulation in FS audit
Assessing the risk of material misstatement Due to Error or Fraud
Communication with those charged with governance
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Week 5:
Risk assessment, materiality and audit strategies
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Audit risk model and its usage and limitations
The auditor’s risk assessment process
➢ Business Risk and the Risk of Material Misstatement
➢ Understanding the Entity and Its Environment
➢ Auditor’s Risk Assessment Procedures
Conditions and Events that may Indicate Risks of Material Misstatement
Materiality and steps in applying materiality
Relationship between materiality and audit risk
Concept of audit strategy, audit plan, and audit program
Read Topics on:
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PSA 200 (Revised and Redrafted) - Over-all Objectives of the Independent Auditor
and the Conduct of an Audit in accordance with PSA
PSA 210 (Revised and Redrafted) – Terms of Engagement
PSA 230 (Redrafted) – Audit Documentation
PSA 240 (Redrafted) – The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements
PSA 300 (Redrafted) – Planning an Audit of Financial Statements
PSA 315 (Redrafted) – Identifying and Assessing the Risks of Material Misstatement
Through Understanding the Entity and its Environment
PSA 320 (Revised and Redrafted) – Audit Materiality
PSA 330 (Redrafted) – The Auditor’s Responses to Assessed Risks
Chapters 5, 6, and 7, Auditing and Other Assurance Services, Magadia, et. al.
Week 6:
Internal control in a financial statement audit
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Basic concepts and elements of internal control and its limitation
Illustration of typical internal control
Evaluation of internal control in a financial statements audit
How adequacy of inadequacy of internal control affects audit procedures
Communication of material weaknesses in internal control
Read Topics on:
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PSA 265 – Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management
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PSA 315 (Redrafted) – Identifying and Assessing the Risks of Material Misstatement
Through Understanding the Entity and Its Environment
PSA 330 (Redrafted) – The Auditor’s Responses to Assessed Risks
Committee of Sponsoring Organizations of the Treadway Commission (COSO)
Internal Control Framework/Over Financial Reporting
Chapter 8, Auditing and Other Assurance Services, Magadia, et. al.
Week 7:
Audit Evidence
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Concept of evidence
Gathering and evaluating audit evidence
Concept of sufficient appropriate audit evidence
Audit Procedures
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Inspection
Observation
Inquiry
Confirmation
Recalculation/recomputation
Reperformance
Substantive analytical procedures
Additional: Journal-entry testing
The use of assertions in obtaining audit evidence and performing audit procedures
➢
➢
➢
➢
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Existence/Occurrence
Completeness
Valuation/Measurement/Allocation
Rights and Obligation
Presentation, Notes and Disclosure
Audit Documentation
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Purposes, forms, format and content of working papers
Types of files
Ownership, confidentiality, and retention of working papers
Read Topics on:
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PSA 230 – Audit Documentation
PSA 240 (Redrafted) – The Auditor’s Responsibilities to Fraud in an Audit of Financial
Statements
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•
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PSA 260 (Revised) – Communication with Those Charged with Governance
PSA 320 (Revised and Redrafted) – Materiality in Planning and Performing an Audit
PSA 330 (Redrafted) – The Auditor’s Responses to Assessed Risks
PSA 500 (Redrafted) – Audit Evidence
PSA 505 (Revised and Redrafted) – External Confirmations
PSA 520 (Redrafted) – Analytical Procedures
Chapters 7, 12 and 13, Auditing and Other Assurance Services, Magadia, et. al
Week 8: Online Mid-Term Departmental Examination
The committee should adhere to the guidelines issued by the Dean regarding the
giving of the Departmental Examination.
Lesson 3 – Major Phases of an Audit - Part II
Week 9:
Audit of business transaction cycles:
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Revenue and Collection cycle
Expenditure and Disbursement cycle
Personnel and Payroll cycle
Conversion/Production cycle
Financing and Investing cycle
➢ Nature of the transaction cycles
➢ Types of transactions and financial statement accounts affected
➢ Types of documents and accounting records involved
➢ The business functions of the transaction cycles
➢ Control objectives and fraud of the transaction cycles
➢ Control risk assessment on the transaction cycles
Read Topics on:
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Chapters 7 and 8, Auditing and Other Assurance Services, Magadia, et. al
Week 10:
I. Audit sampling in test of control
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Basic concepts
➢ Nature and purposes
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•
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➢ Why auditors sample
➢ Testing procedures without sample
➢ Sampling and non-sampling
➢ Statistical and non-statistical sampling
➢ Attributes and variable sampling
➢ Sample size and sample selection methods
Steps in the application of audit sampling
Non-statistical attribute sampling
II. Audit sampling for substantive tests
• Basic concepts
➢ Risk in substantive testing
➢ Probability-proportional to size sampling
➢ Classical variables sampling
1. Mean-per-unit estimation
2. Ratio estimation
3. Difference estimation
4. Regression analysis
• Steps in the application of classical variable sampling
➢ Non-statistical sampling for substantive testing
Read Topics on:
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PSA 315 (Redrafted) – Identifying and Assessing the Risk of Material Misstatement
Through Understanding the Entity and Its Environment
PSA 320 – Audit Materiality
PSA 500 (Revised) – Audit Evidence
PSA 530 – Audit Sampling
Chapters 9 and 10, Auditing and Other Assurance Services, Magadia, et. al.
Lesson 4 – Major Phases of an Audit - Part III
6. Complete the audit.
7. Issuance of the auditor’s report.
Week 11:
Completing the audit and other post-audit responsibilities
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Review of working papers
Using the works of others
➢ Audits of group financial statements (including the work of other component auditors)
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➢ Using the work of an auditor’s expert
➢ Considering the work of internal auditors
•
Other audit considerations
➢ Auditing accounting estimates and related disclosures
➢ Auditing fair value measurements and related disclosures
➢ Review of related party transactions
➢ Initial audit engagement – Opening Balances
➢ Different prior-year auditors
Week 12:
Completing the audit and other post-audit responsibilities – continuation
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Procedures regarding litigation, commitments, contingent liability and other potential
unrecorded liabilities
Going concern consideration
Analytical procedures in the overall or final review stage
Evaluating the financial statement presentation and disclosures
Review of subsequent events for audit of financial statements
➢ Importance of review of minutes of the meetings
Final assessment of audit results
➢ Revisit the audit strategy and audit plan
Communications of audit matters with those charged with governance and management
letter preparation
Obtain representation letter from the management
Evaluating findings, formulating an opinion and drafting the audit report
Documenting facts discovered after the financial statement has been issued
Read Topics on:
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PSA 500 – Audit Evidence
PSA 520 – Analytical Procedures
PSA 550 (Revised and Redrafted) – Related Parties
PSA 560 – Subsequent Events
PSA 570 – Going Concern
PSA 580 – Written Representations
PSA 600 – Using Work of Another Auditor
Chapters 12, 13 and 14, Auditing and Other Assurance Services, Magadia, et. al.
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Week 13:
Reports on audited financial statements
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Standard audit report with an unmodified opinion
Basic elements of a standard audit report with an unmodified opinion
Communicating Key Audit Matters in the Independent Auditor’s Report
Emphasis of matter paragraphs and other matters paragraphs
Audit reports with modifications to the auditor’s opinion
Reports on comparatives
Reports on group financial statements audit
Other information in documents containing audited financial statements and annual report
Other reporting considerations
Read Topics on:
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PSA 200 (Revised and Redrafted) – Overall Objective of the Independent Auditor and
the Conduct of an Audit in accordance with PSA
PSA 220 (Revised) – Quality Control for Audit Work
PSA 700 (Revised) – The Independent Auditor’s Report on a Complete Set of
Financial Statements
PSA 701 – Communicating Key Audit in the Independent Auditor’s Report
PSA 705 (Revised) – Modification to the Opinion on the Independent Auditor’s Report
PSA 706 (Revised) – Emphasis of Matter Paragraphs and Other Matter Paragraphs
on the Independent Auditor’s Report
PSA 710 (Redrafted) – Comparatives
PSA 720 (Revised) – Other Information in Documents Containing Audited Financial
Statements
Chapter 15, Auditing and Other Assurance Services, Magadia, et. al.
Week 14:
Nature and Reports on other services
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Independent auditor’s report on special purpose audit engagements
Procedures and reports for Non-audit engagements
➢ Examination of prospective financial information
➢ Engagements to review financial statements
➢ Engagements to perform agreed-upon procedures regarding financial information
➢ Engagements to compile financial information
Read Topics on:
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PSA 800 (Revised and Redrafted) – Special Considerations: Audits of Financial
Statements (FS) Prepared in Accordance with Special-Purpose Frameworks
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•
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PSA 805 (Revised and Redrafted) – Special Considerations: Audits of Single Financial
Statements (FS) and Specific Elements, Accounts or Items of a Financial Statements
(FS)
PSA 810 (Revised and Redrafted) – Engagements to Report on Summary Financial
Statements (FS)
PSRE 2400 – Engagements to Review Financial Statements (FS), including
amendments
PSAE 2410 – Review of Interim Financial Information, including amendments
PSAE 3400 – Examination of Prospective Financial Information
PSRS 4400 – Engagement to Perform Agreed-Upon Procedures Regarding Financial
Information
PSRS 4410 – Engagement to Compile Financial Information
Chapter 16, Auditing and Other Assurance Services, Magadia, et. al.
Lesson 5 – Practice of Accountancy Profession
Week 15: Philippine Accountancy Act of 2004 and its IRR, Quality Control Standards, and
Other Pronouncements
Professional Regulations and Quality Control
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Philippine Accountancy Act of 2004
Accounting and Auditing Standard Setting Council
Quality Control standards
Advertising for the Philippine Accountancy Profession
Continuing Professional Education/Continuing Professional Development
Practice of Accountancy Profession
Regulatory bodies affecting public accounting profession
Accreditation of Accounting Teacher/BOA Accreditation and BIR Accreditation
Read Topics on:
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R.A. No. 9298 – The Philippine Accountancy Act of 2004, including its Implementing
Rules and Regulations
Issuances, Resolutions and Circulars from PRC, BOA and SEC
Philippine Standard on Quality Control No. 1 (Redrafted) – Quality Control for Firms
that Perform Audits and Reviews of Historical Financial Information, and Other
Assurance and Related Service Engagements
PSA 220 (Redrafted) – Quality Control for Audits of Financial Statements
Chapter 3, Auditing and Other Assurance Services, Magadia, et. al.
Week 16: Code of Professional Ethics for Accountant and Other Topics
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Code of Professional Ethics
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Fundamental principles and its conceptual framework
Conduct of Professional Accountants in Public Practice
Conduct of Professional Accountants in Business
Amendment to Code of Ethics, Disclosure of Entity’s Non-Compliance in Laws and
Regulations (NOCLAR)
Other Topics
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BOA Memo for the coverage of actual board examinations
Pronouncements and updates in the world of accounting and auditing especially in
conducting audit in the time of pandemic (Covid-19)
Awareness to the new policies and procedures in the profession to be used in the
future.
Read Topics on:
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Code of Ethics for Professional Accountants in the Philippines (2018 Edition)
Philippine Auditing Practice Notes 1 of 2020
Chapter 4, Auditing and Other Assurance Services, Magadia, et. al.
Week 17: Preparing the New Normal Students for the Final Exams Physically, Mentally,
Emotionally, Socially and Spiritually.
Week 18: Online Final Departmental Examination
Submission of all requirements online, if and only if applicable.
The committee should adhere to the guidelines issued by the Dean regarding the
giving of the Departmental Examination. Computation of grade, encoding of grades to
SIS Faculty Module and Submission of Grade Sheets to the Office.
Grading System (Pending for Approval.)
Quizzes
Assignments, Homeworks, Etc
Departmental examination
(Mid term + Final Exam/2)
Total
50%
10%
30%
100%
Final Grade = (1st Grading Period + 2nd Grading Period)
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END OF THE FIRST SEMESTER
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Prepared by:
Prof. Glenn A. Magadia
Prof. Mark Anecito R. Perlas
Reviewed by:
Prof. Marietta M. Doquenia
Chairperson – Basic Accounting
Noted by:
Prof. Lilian DM. Litonjua
Dean
Approved by:
Dr. Emanuel C. De Guzman
Vice-President for Academic Affairs
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Lesson 1 – Overview of Assurance, Auditing and Non-Assurance Services
Overview:
The name assurance services is used to describe the broad range of information
enhancement services performed by certified public accountant (CPA) that are designed to
enhance the degree of confidence in the information. The accountant must be “independent” to
perform these services. In general, assurance services consist of two types: those that increase
the reliability of information and those that involve putting information in a form or context that
facilitates decision making.
Learning Objective:
After studying this lesson, the student should:
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•
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Understand the fundamentals of assurance and auditing services, its nature, elements
and objectives.
Understand the difference between assurance, attestation and audit.
Able to absorb the financial statement audit as a whole and distinguish external auditor,
government auditor and internal auditor as types of auditors.
Course Materials:
Definition of Assurance Services
Assurance services may be defined with broad scope. The influential American Institute
of Certified Public Accountants (AICPA) Special Committee on Assurance Services, the “Elliot
Committee”, has defined assurance services as follows:
Assurance services are independent professional services that improve the quality of the
information, or its context, for decision makers.
The said definition focuses on the decision making aspect where the actions of
responsible officer will depend on the qualitative and quantitative information. Let us elaborate
further the important concepts mentioned in the above definition.
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The first important concept in the definition is independence which is the hallmark of the
profession. The Code of Ethics for Professional Accountants in the Philippines requires that the
practitioner should be independent in mind and in appearance. Independence in mind is the state
of the mind that permits the expressions of a conclusion without being affected by influences that
compromise professional judgment, allowing an individual to act with integrity, and exercise
objectivity, and professional skepticism. Independence in appearance, on the other hand, refers
to the avoidance of the facts and circumstances that are so significant that a reasonable and
informed third party, having knowledge of all relevant information, including safeguards applied,
would reasonably conclude a firm’s or a member of the assurance team’s, integrity, objectivity, or
professional skepticism had been compromised.
The second concept is the professional services that encompassed the application of
professional judgment based on education and experience. Third is the improvement in the quality
of the information or its context. An assurance service engagement can improve quality by
increasing confidence in the information’s reliability and relevance. Context can be improve
though the format in which information is presented. The last concept is the decision makers.
They are the “consumers” of assurance services, and they personify the consumer focus of new
and different professional work. They may or may not be the “client” that pays the fee, and they
may or may not be one of the parties to an assertion or other information. The decision makers
are the beneficiaries of the assurance services.
The Philippine Framework for Assurance Engagements, with more narrow scope than the
previously discussed definition by the Elliot Committee, defined an assurance engagement as
follows:
Assurance engagement means an engagement in which a practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended users, other than the responsible
party, about the outcome of the evaluation or measurement of a subject matter against criteria.
A number of terms used in this definition are defined below:
Practitioners – those parties who are providing the assurance service.
Intended users – those parties for whom the assurance report is prepared. This can
include the responsible party although the responsible party cannot be the sole user of the report.
Responsible party – the party that is responsible for preparing and providing the
information or the assertion, for example, the management of a company.
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Subject matter (and subject matter information) – what practitioners are reporting on.
Subject matter refers to underlying matter of interest to intended users and subject matter
information is information that results from evaluating or measuring the subject matter.
Criteria – the benchmarks against which to measure the subject matter.
REASONABLE AND LIMITED ASSURANCE ENGAGEMENTS
The Philippine Framework for Assurance Engagements directs that a practitioner can
enter into two types of assurance engagements or, effectively, provide two levels of assurance
on any particular type of an assurance engagement. These two types of assurance engagements
are reasonable assurance engagement and limited assurance engagement. The difference
between these types of assurance is reflected in the nature of the work performed, the level of
engagement risk and the type of conclusion provided.
For a reasonable assurance engagement, the practitioner needs to reduce the assurance
engagement risk (i.e., the risk that an inappropriate conclusion is expressed when the information
on the subject matter is materially misstated) to an acceptably low level in the circumstances of
the engagement as the basis for a positive form of expression of the practitioner’s conclusion.
Such risk is never reduced to nil and therefore, there can never be absolute assurance.
Practitioners aiming to obtain reasonable assurance must obtain sufficient evidence in order that
they may give a positive conclusion. The audit opinion as currently expressed in audit report
reflects a reasonable assurance conclusion.
On the other hand, for a limited assurance engagement the practitioner needs to reduce
the assurance engagement risk to a level that is acceptable in the circumstances of the
engagement, but where that risk is greater than for a reasonable assurance engagement, as the
basis for a negative form of expression of the practitioner’s conclusion. An interim review of the
financial statements of listed companies is an example of a limited assurance engagement.
The practitioner uses the same risk basis for planning their work and the same levels of
materiality in evaluating the outcome of tests for reasonable and limited assurance engagements.
Since the extent of evidence collected for a limited assurance engagement may be limited due to
the reduced sample sizes and test coverage adopted, the level of risk of material misstatement
remaining is potentially higher than in a reasonable assurance engagement. Hence, the
practitioner is not in a position to express the same degree of confidence as in a reasonable
assurance engagement. The conclusion in a limited assurance engagement is accordingly framed
in a negative sense, “based on the procedures performed, nothing came to our attention that the
management assertion on XYZ is materially misstated…” in contrast with a reasonable assurance
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conclusion which would be formed in a positive sense, i.e., “based on the procedures performed,
the management assertion on XYZ is reasonably stated…”
Expression of Conclusion in Reasonable Assurance Engagements and Limited Assurance
Engagements
Reasonable Assurance Engagements
“In our opinion internal control is effective, in all material respects, based on XYZ criteria.”
Limited Assurance Engagements
“Based on our work described in this report, nothing has come to our attention that causes
us to believe that internal control is not effective, in all material respects, based on XYZ
criteria.”
ASSERTION-BASED AND DIRECT REPORTING ENGAGEMENTS
The Philippine Framework for Assurance Engagements further differentiates assurance
engagements into two types. The differentiation is based on who initially measures or evaluates
the subject of interest (subject matter) and provides information about it.
In an assertion-based engagement (also known as attestation engagement), the
responsible party, (the preparer of the information; usually management), carries out the
measurement or evaluation of the subject matter and reports the information (the subject matter
information) which contains the responsible party’s assertion (e.g., “the subject matter information
is fairly stated as of date/month/year…”). The work the practitioner performs is to give an
assurance conclusion on this assertion.
Both the subject matter information including the responsible party’s assertion and the
practitioner’s assurance report are made available together to the intended users. Attestation
engagements are a familiar form of assurance engagement, as audits and reviews of financial
statements have been structured as attestation engagements: management reports the financial
performance and position in the annual accounts, asserts the information as being true and fair,
and the practitioner gives a conclusion on the assertion.
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The second type of engagement is a direct reporting engagement. The responsible party
does not present the subject matter information in a report in a direct engagement. Instead, the
practitioner performs the evaluation or measurement of the subject matter information without any
assertion by the responsible party, or obtains representation from the responsible party that it has
performed the valuation or measurement but the information is not available to the intended users.
The practitioners reports directly on the subject matter and provides the intended users with an
assurance report containing the subject matter information.
An example of a direct engagement would be a Sarbanes-Oxley engagement to report on
the effective control over the financial reporting process. A direct assurance conclusion would be
constructed as “… In our opinion the company maintained, in all material respects, effective
internal control over financial reporting as of date/month/year, based on the criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO)…”
It is necessary to distinguish between an assertion-based assurance engagement and a
direct reporting assurance engagement. An assertion-based assurance engagement requires the
auditor to issue an opinion on written assertions made by others. On the other hand, directreporting assurance engagement requires the auditor to provide assurance on an accountability
matter on which the responsible party has not made a written assertion.
For example, an audit report could be issue on the adequacy of internal control. Where
management does not issue a report on the adequacy of internal control, and therefore the auditor
is required to report directly on its adequacy, the engagement is classed as a direct reporting
assurance engagement. If, however, management has stated an opinion on the adequacy of
internal control and the auditor is required to attest to this statement, it is an assertion-based
assurance engagement.
Practitioners more commonly perform assertion-based engagements. This is because,
ultimately, management (as the responsible party) is responsible for their business and, therefore,
should be in a position to present relevant assertions in the subject matter information. They are
also in a better position to understand who would use the information, what users want to see, in
what format, and for what purpose.
ELEMENTS OF AN ASSURANCE ENGAGEMENT
All assurance engagements possess certain basis elements that must be present for the
engagement to meet professional standards. The five elements of an assurance engagement are
the following: (1) a three party relationship involving a practitioner, a responsible party, and
intended users; (2) an appropriate subject matter; (3) suitable criteria, (4) sufficient appropriate
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evidence; and (5) a written assurance report in the form appropriate to a reasonable assurance
engagement or a limited assurance engagement.
Three-Party Relationships
An assurance engagement involves three separate parties: an intended user or users; a
party who is responsible for the subject matter or subject matter information, such as
management; and the practitioner.
The responsible party is the person (or persons) responsible for the subject matter or
subject matter information (the assertion) to the user and acknowledges the responsibility to the
practitioner.
In a direct-reporting engagement the responsible party is responsible to the subject matter.
In an assertion-based engagement, the responsible party is responsible for the subject matter
information (the assertion), and maybe responsible for the subject matter. The responsible party
may or may not be the engaging party (the party who engages the practitioner). The intended
users are the person, persons or class of persons for whom the practitioner prepares the
assurance report. The responsible party can be one of the intended users, but not the only one.
Subject Matter and Subject Matter Information
Subject matter, and subject matter information, is the financial and non-financial
information for which the practitioner gathers sufficient appropriate evidence to be evaluated or
measured against suitable criteria as a reasonable basis for expressing a conclusion or reporting
findings in the assurance engagement report.
The subject matter, and subject matter information, of an assurance engagement may
take many forms such as:
❖ Financial performance or conditions (for example, historical or prospective financial
position, financial performance and cash flows) for which the subject matter information
may be the recognition, measurement, presentation and disclosure represented in
financial statements.
❖ Non-financial performance or conditions (for example, performance of an entity) for which
the subject matter information may be key indicators of efficiency and effectiveness.
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❖ Physical characteristics (for example, capacity of a facility) for which the subject matter
information may be a specifications document.
❖ Systems and processes (for example, an entity’s internal control or IT system) for which
the subject matter information may be an assertion about effectiveness.
❖ Behavior (for example, corporate governance, compliance with regulation, human
resource practices) for which the subject matter information maybe a statement of
compliance or a statement of effectiveness.
To be capable of evaluation or measurement in an assurance engagement, subject
matter, and subject matter information, should be both:
❖ Identifiable and capable of consistent evaluation or measurement against the identified
criteria.
❖ Be reasonably subjected to procedures for gathering sufficient appropriate evidence to
support the desired level of assurance i.e., reasonable assurance or limited assurance
conclusion.
Suitable Criteria
Assurance engagements require the practitioner to express an overall conclusion
on the subject matter assessed in reference to specified criteria. Criteria are the benchmarks
used to evaluate or measure the subject matter including, where relevant, benchmarks for
presentation and disclosure. Criteria also assist the parties to the engagement and agreed
recipients of the assurance report to understand how the practitioner has evaluated the
subject matter to reach a conclusion. Criteria are dependent on the subject matter and may
be already established or developed for a specific engagement.
Suitable criteria must be:
❖ Relevant to the purpose of the assurance engagement (relevant criteria contribute to
conclusion that assist decision-making by the intended users of the assurance report).
❖ Complete including, where relevant, benchmarks for presentation and disclosure.
Criteria are sufficiently complete when relevant factors that could affect the
conclusions in the context of the engagement circumstances are not omitted.
❖ Reliable to allow a reasonably consistent evaluation or measurement of the subject
matter including, where relevant, presentation and disclosure, when used in similar
circumstances by similarly qualified practitioners.
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❖ Neutral (i.e., neutral criteria contribute to conclusions that are free from bias).
❖ Understandable to contribute to conclusions that are clear, comprehensive and not
subject to significantly different interpretations.
Sufficient Appropriate Evidence
In an assurance engagement, the practitioner plans and performs an assurance
engagement with an attitude of professional skepticism to obtain sufficient appropriate evidence
about whether the subject matter information satisfies the criteria or is free of material
misstatement. In doing so, the practitioner should consider issues of materiality, assurance
engagement risk, and the sufficiency and appropriateness of evidence when planning and
performing the engagement, in particular when determining the nature, timing and extent of
evidence-gathering procedures. Sufficiency involves considerations of the quantity of evidence,
while appropriateness considers the quality of the evidence in terms of relevance and reliability.
The quantity and quality of evidence is dependent upon the level of assurance required
and the risk of the subject matter information being materially misstated or misrepresented. For
example, the higher the level of assurance required and the higher the risk of misstatement or
misrepresentation, the higher the quantity and/or quality of evidence is required.
Written Assurance Report
In an assurance engagement, the practitioner provides a written report containing a
conclusion that conveys the assurance obtained about the subject matter information or related
assertion to the suitable criteria. Philippine Standards on Auditing, Philippine Standards on
Review Engagements and Philippine Standards on Assurance Engagements establish basic
elements for assurance reports. In addition, the practitioner considers other reporting
responsibilities, including communicating with those charged with governance when it is
appropriate to do so.
Reporting on assurance engagement varies depending on whether the engagement is an
assertion-based or direct-reporting engagement and on the level of assurance provided as
defined above.
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FACTORS AFFECTING THE PRACTITIONER’S PERFORMANCE OF AN ASSURANCE
ENGAGEMENT
The factors affecting the practitioner’s performance of an assurance engagement are the
following: (1) extent of work performed, (2) professional skepticism, (3) sufficiency and
appropriateness of audit evidence, (4) materiality, and (5) assurance engagement risk.
Extent of Work Performed
The two types of assurance engagements are separated by the extent of worked
performed. In reasonable assurance engagements, practitioners would do all that they need to
do to support a positive opinion. However, this does not mean that absolutely all evidence is
gathered or examined because there are time and cost factors to consider relative to the specific
engagement. The gathering of evidence in limited assurance engagements is deliberately limited
in comparison to a reasonable assurance engagement. Practitioners need to use their
professional judgment in determining how much evidence is needed for limited assurance
engagements. The sufficiency of evidence is affected by the risk of the specific engagement and
the quality of evidence.
Professional Skepticism
The practitioner plans and performs an assurance engagement with an attitude of
professional skepticism recognizing that circumstances may exist that cause the subject matter
information to be materially misstated. An attitude of professional skepticism means the
practitioner makes a critical assessment, with a questioning mind, of the validity of evidence
obtained and is alert to evidence that contradicts or brings into question the reliability of
documents or representations by the responsible party.
Sufficiency and Appropriateness of Audit Evidence
To express a conclusion on subject matter, practitioners need sufficient appropriate
evidence to obtain assurance that the information is free of material misstatement. In planning
the work, practitioners will exercise professional judgment and consider what constitutes sufficient
evidence and will use professional skepticism to question the validity of the evidence obtained.
When determining the extent and nature of procedures needed, practitioners consider materiality,
assurance engagement risk and the quantity and quality of available evidence.
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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. The quantity of evidence needed is
affected by the risk of the subject matter information being materially misstated (the greater the
risk, the more evidence is likely to be required) and also by the quality of such evidence (the
higher the quality, the less may be required). Accordingly, the sufficiency and appropriateness of
evidence are interrelated. However, merely obtaining more evidence may not compensate for its
poor quality.
Materiality
Materiality helps the practitioners determine the nature, timing and extent of evidencegathering procedures, and when assessing whether the subject matter information is free of
misstatement. When considering materiality, the practitioner understands and assesses what
factors might influence the decisions of the intended users. For example, when the identified
criteria allow for variations in the presentation of the subject matter information, the practitioner
considers how the adopted presentation might influence the decisions of the intended users.
Materiality is considered in the context of quantitative and qualitative factors, such as relative
magnitude, the nature and extent of the effect of these factors on the evaluation or measurement
of the subject matter, and the interests of the intended users. The assessment of materiality and
the relative importance of quantitative and qualitative factors in a particular engagement are
matters for the practitioner’s judgment.
Assurance Engagement Risk
Assurance engagement risk represents the risk that practitioners provide an inappropriate
conclusion when the subject matter information is materially misstated. There are ordinarily three
components of assurance engagement risk for practitioners to think about when planning and
performing an assurance engagement:
Inherent risk – the susceptibility of the information to a material misstatement (e.g., where
there have been complex transactions).
Control risk – the risk a material misstatement will not be prevented or detected on a timely
basis by internal controls.
Detection risk – the risk that the practitioners will not detect a material misstatement that
exists.
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When assessing these risks, practitioners will need to understand the type of engagement
and nature of information being reported on. In a reasonable assurance engagement, the
practitioner reduces assurance engagement risk to an acceptably low level in the circumstances
of the engagement to obtain reasonable assurance as the basis for a positive form of expression
of the practitioner’s conclusion. The level of assurance engagement risk is higher in a limited
assurance engagement than in a reasonable assurance engagement because of the different
nature, timing or extent of evidence gathering procedures. However in a limited assurance
engagement, the combination of the nature, timing and extent of evidence gathering procedures
is at least sufficient for the practitioner to obtain a meaningful level of assurance as the basis for
a negative form of expression.
Conclusion Provided
The types of assurance are distinctly expressed in the report wording. Practitioners
provide a positive form of conclusion for a reasonable assurance engagement, for example, ‘In
our opinion, the internal controls are effective, in all material respects, based on XYZ criteria’. In
a limited assurance engagement, practitioners express a conclusion in a negative form, such as,
‘Based on our work described in this report, nothing has come to our attention that causes us to
believe that the internal control are not effective, in all material respects, based on XYZ criteria’.
TYPES OF ASSURANCE ENGAGEMENTS
The following are the typical types of assurance engagements:
1. Audit/Examination of Historical Financial Information. An audit of historical information i.e.,
such as financial statements or some component of financial statements, is a form of assurance
engagements in which the auditor issues a written report expressing an opinion about whether
the financial statements are fairly stated in accordance with the Philippine Financial Reporting
Standards. Audits represent the predominant form of assurance performed by CPA firms.
2. Review of Historical Financial Information. A review of historical financial information i.e., such
as financial statements or some component of financial statements, provides a moderate amount
of assurance on the financial statements, and less evidence necessary to support this level of
assurance. A review is often adequate to meet financial statement users’ needs, and it can be
provided by the CPA firm at a much lower fee than an audit.
3. Other Assurance Engagements. The demand for new types of assurance services was
developed as a natural extension of the audit function. Management realized that contracting
costs could be reduced in many situations by providing investors, creditors, customers, and others
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transacting with the company access to information that is certified as to its reliability. As with an
audit, these new assurance services reduce information risk for the outside parties and thus
enable the company to contract at more favorable terms. These emerging assurance
engagements are in the following areas:
a. Corporate Sustainability Reporting. Corporate sustainability reporting (CSR), also known
as triple-bottom-line reporting, involves reporting non-financial and financial information to a
broader set of stakeholders than just shareholders. The reports inform stakeholder groups of
the reporting organization’s ability to manage key risks. Because these interests vary, the
type of information various; however, much of it has to do with the company’s economic,
operational, social, philanthropic and environmental objectives.
Corporate sustainability reporting is still at a relatively early stage of development.
Currently, there are no authoritative generally accepted criteria for reporting on sustainability or
standards for performing assurance. A number of initiatives have, however, been taken.
b. Trust Services. Trust Services – jointly developed by the American Institute of Certified
Public Accountants (AICPA) and Canadian Institute of Chartered Accountants (CICA) – are
set of services designed to provide information system business assurance and advisory
services that instill confidence in an organization, system, or other entity by improving the
quality or context of information for decision makers. They were developed by the AICPA’s
Assurance Services Executive Committee.
In a Trust Services engagement, management prepares and communicates a system
description that can be included on the company’s Web site, attached to the practitioners’ report,
or communicated to users in some other manner. It must clearly articulate the boundaries of the
system so as to allow individuals to understand both the scope of management’s assertions
related to it and the practitioners’ report. At present CPAs offers two types of trust services –
WebTrust and SysTrust.
i. WebTrust provides assurance on electronic commerce (including Web sites). The
CPA is engaged to examine both that a client complied with the Trust Services
criteria (e.g., the company uses procedures in accordance with its defined policies)
and that it maintained effective controls over the system based on Trust Services
criteria (e.g., the company’s procedures are effective).
ii. SysTrust provides assurance on any defined electronic system. The system
components include its infrastructure, software, personnel, procedures and data. In
a SysTrust engagement the CPA is engaged to examine only that a client maintained
effective controls over the system based on the Trust Services Principles and
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Criteria. The practitioner then performs tests to determine whether those controls
were operating as effectively during the specified period.
Both WebTrust and SysTrust are designed to incorporate a seal management process by
which a seal (logo) may be included on a client’s Web site as an electronic representation
of the practitioner’s unqualified WebTrust report. If the client wishes to use the seal
(logo), the
engagement must be updated at least annually. Also, the initial reporting
period must include at least two months.
c. CPA Performance View. This service is intended to demonstrate that the public
accountants can aide client firms in developing an integrated set of financial and non-financial
performance and measures to employ in managing the client’s business.
CPA Performance View identifies and measures key activities that are critical to the entity.
Rather than relying strictly on historical financial information, CPA Performance View uses nonfinancial information such as customer satisfaction, employee training and satisfaction, and
product quality to identify critical success factors that can lead to organizational change, better
performance, and increased revenue for an organization.
d. CPA Risk Advisory Services. This service is intended to help organizations manage risk.
The overall approach may be viewed as one of (1) identifying and analyzing risks, (2)
designing and implementing strategies related to risks, and (3) measuring, monitoring, and
reporting on solutions.
e. CPA ElderCare/Prime Plus. CPA ElderCare/Prime Plus services is designed to provide
assurance to individuals that their elderly family members’ needs are being met by various
institutions and professionals by comparing its specific objectives in providing care with
actual services rendered. These services may include financial services such as goal setting,
funding analysis, cost management, and needs assessment or non-financial services such
as interpersonal and relationship management. Exhibit 1.4 provides more detailed examples
of these services.
f. Health Care Performance Measurement. Health care recipients and their employers are
increasingly concerned about the quality and availability of health care services. This service
provides assurance about the effectiveness of health services provides by health
maintenance organizations, hospitals, doctors and other health care providers.
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NON-ASSURANCE ENGAGEMENTS
Not all engagements performed by practitioner are assurance engagements. Other
frequently performed engagements that are not assurance engagements (and therefore expressly
excluded from the Philippine Framework on Assurance Engagements) include:
➢ Non-assurance engagements such as agreed-upon procedures engagements and
compilations of financial or other information.
➢ The preparation of tax returns where no conclusion conveying assurance is expressed.
➢ Consulting (or advisory) engagements such as management and tax consulting, where no
opinion on the subject matter is expressed.
REPORTS ON NON-ASSURANCE ENGAGEMENTS
A practitioner reporting on a non-assurance engagement within the scope of the
Framework clearly distinguishes that report from an assurance report. So as not to confuse users,
a report that is not an assurance report avoids, for example:
➢ Implying compliance with this Framework, PSAs, PSREs or PSAEs;
➢ Inappropriately using the words “assurance,” “audit” or “review”; and
➢ Including a statement that could reasonably be mistaken for a conclusion designed to
enhance the degree of confidence of intended users about the outcome of the evaluation
or measurement of a subject matter against criteria.
DEFINITION OF AUDITING
In today’s environment, the type of assurance engagement that is most common is an
audit of historical financial information. Part of the reason for this is that the requirement for an
audit is contained in many pieces of legislation, including the Corporation Code of the Philippines,
which governs the audit of annual financial reports for reporting entities.
Interestingly, auditing, or the audit of financial reports, is no longer defined in the Auditing
and Assurance Standards Council (AASC) Glossary. In Philippine Standards on Auditing (PSA)
200.11, the objectives of the auditor in undertaking an audit of a financial report are stated as
follows:
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a. To obtain reasonable assurance about whether the financial report as a whole is
free from material misstatement, whether due to fraud or error, thereby enabling the auditor
to express an opinion on whether the financial report is prepared, in all material respects, in
accordance with an applicable financial reporting framework; and
b. To report on the financial report, and communicate as required by the Philippine
Auditing Standards, in accordance with the auditor’s findings.
While these objectives describe the expected outcomes, they do not describe the process.
A useful definition is that developed by the American Accounting Association (AAA) in A
Statement of Basic Auditing Concepts (ASOBAC). It defines auditing as:
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.
This definition contains several ideas important in a wide variety of audit practices. The
attributes of auditing contained in this definition that merit special comment are as follows:
1. A systematic process – connotes a purposeful and logical step and is based on the
discipline of a structured and organized series of procedures to decision making. It is not
haphazard, unplanned, or unstructured.
2. Objectively obtaining and evaluating evidence – means examining the underlying support
for assertions or representations and judiciously evaluating the results without bias or
prejudice either for or against the individual or entity making the assertions.
3. Assertions about economic actions and events – are the information or representations
made by the individual or entity. They comprise the subject matter of auditing. Assertions
include information contained in the financial statements, management internal operating
reports, and tax returns.
4. Degree of correspondence – refers to the closeness with which the assertions can be
identified with the established criteria. The expression of correspondence may be quantified,
such as the amount of a shortage in a petty cash fund, or it may be qualitative, such as the
fairness of financial statements.
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5. Established criteria – are the standards against which the assertions or representations
are judged. Established criteria may be specific rules prescribed by a legislative or regulatory
body, budgets and other measures of performance set by management, or the Philippine
Financial Reporting Standards (PFRS).
6. Communicating the results – is the communication of the auditor’s findings to users and
is achieved through a written report, called audit report, that inform readers of the degree of
correspondence between the assertions and established criteria. The communication of
results either enhances or weakens the credibility of the representations made by another
party. The goal of the audit process is to add credibility to management’s representations so
that interested users can use the information with reasonable assurance that it is free of
material misstatement.
7. Interested users – are individuals or entities who rely on the auditor’s findings. In a
business environment, they include stockholders, management, employees, creditors,
governmental agencies and the general public.
This broad definition reflects the essential nature of all assurance engagements as
investigative processes sufficient to encompass the many different purposes for which an
assurance service might be conducted.
OBJECTIVE OF A 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
an identified financial reporting framework. The phrase used to express the auditor’s opinion is
“present fairly, in all material respects”.
Although the auditor’s opinion enhances the credibility of the financial statements, the user
cannot assume that the opinion is an assurance as to the future viability of the entity nor the
efficiency or effectiveness with which management has conducted the affairs of the entity.
GENERAL PRINCIPLES OF A FINANCIAL STATEMENT AUDIT
The auditor should comply with the “Code of Professional Ethics for Certified Public
Accountants” promulgated by the Board of Accountancy and approved by the Philippine
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Professional Regulation Commission. Ethical principles governing the auditor’s professional
responsibilities are:
•
•
•
•
•
•
•
Independence.
Integrity.
Objectivity.
Professional competence and due care.
Confidentiality.
Professional behavior.
Technical standards.
The auditor should conduct an audit in accordance with Philippine Standards on Auditing
(PSA). These contain basic principles and essential procedures together with related guidance
in the form of explanatory and other material.
The auditor should plan and perform the audit with an attitude of professional skepticism
recognizing that circumstances may exist which cause the financial statements to be materially
misstated. For example, the auditor would ordinarily expect to find evidence to support
management representations and not assume they are necessarily correct.
SCOPE OF A FINANCIAL STATEMENT AUDIT
The term “scope of an audit” refers to the audit procedures deemed necessary in the
circumstances to achieve the objective of the audit. The procedures required to conduct an audit
in accordance with Philippine Standards on Auditing should be determined by the auditor having
regard to the requirements of Philippine Standards on Auditing, relevant professional bodies,
legislation, regulations and, where appropriate, the terms of the audit engagement and reporting
requirements.
DEMAND FOR FINANCIAL STATEMENT AUDIT
Users of financial statements look to the independent auditor’s report for assurance about
reliability of information and its conformance to the applicable financial reporting framework (e.g.,
Philippine Financial Reporting Standards). The need for independent audits of financial
statements can further be attributed to four conditions as follows: (1) complexity of transactions,
(2) remoteness of information, (3) biases and motives of the provider, and (4) consequence.
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1. Complexity of Transactions – Both the transactions between organizations and the
process of preparing financial statements have become numerous and increasingly complex
and therefore more difficult to record properly. As the level of complexity increases, the risk
of misinterpretations and of intentional or unintentional misstatements also increases.
Finding it impossible to evaluate the quality of the financial statements themselves, users
rely on the independent auditors to assess the reliability of the information contained in the
statements.
The volume and complexity of economic activities in business and related authoritative
pronouncements often require the assistance and objective evaluation of professional
accountants to properly record the transactions related to those economic activities.
2. Remoteness of Information – In today’s global economy, it is virtually impossible users of
financial information to have much firsthand knowledge about the organization with which
they do business. Distance, time, cost, as well as lack of expertise, make it impractical for
decision makers to seek direct access to the underlying accounting records to perform their
own verifications of the financial statement. Rather than accept the quality of the financial
data provided by others, users rely on the independent auditor’s report to meet their needs.
The separation between the transactions details (e.g., supporting documents of the journal
entries) that produce financial statements and the users who need to make decisions based
on those financial statements creates a demand for an independent party to examine the
information for multiple users.
3. Biases and Motives of the Provider – If the information is provided by someone whose
goals are inconsistent with those of the user of the financial statements, the information may
be biased in favor of the provider. Many users of financial statements are concerned about
conflict of interest between themselves and the management of the reporting entity. The
apprehension extends to a fear that the financial statements prepared by management may
be significantly biased in favor of the management and do not represent the actual results of
operations of the reporting entity. Users seek assurance from independent auditors that
financial statements are free of management biases.
Biases and potential conflicts of interests of persons who provide information about the
economic activities create a demand for an independent party to lend credibility to the
provider’s information.
4. Consequences – Financial statements represent an important and, in some cases, the
only source of information used in making significant business decisions. Thus, users want
the financial statement to contain as much relevant and reliable information as possible. This
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need is recognized by the extensive disclosure requirements imposed by the Securities and
Exchange Commission and other regulatory agencies such as Insurance Commission and
Bangko Sentral ng Pilipinas. It is also recognized by the relevance of the financial statements
disclosures to many lenders. Financial statement users look to the independent auditor for
assurance that the financial statements have been prepared in conformity with the applicable
financial reporting framework, including all the appropriate disclosures.
Economic activities involve many different types of users who create a demand for an
independent party to increase the relevance and reliability of the information they use to make a
wide variety of decisions which significantly affect many people.
These four conditions collectively contribute to information risk, which is the risk that the
information used to assess business risk is not accurate or misleading. Information risk includes
the possibility that the financial statements may be incorrect, incomplete, or biased. Thus, it can
be said that financial statement audits enhance the credibility of financial statement by reducing
information risk.
REDUCING INFORMATION RISK
After comparing costs and benefits, managers and financial statement users may
conclude that the best way to deal with information risk is simply to have it remain reasonably
high. A small company may find it less expensive to pay higher interest costs than to increase
costs of reducing information risk. For larger businesses, it is usually practical to incur costs to
reduce information risk. Three main ways to do so are as follows: (1) user verifies information, (2)
user shares information risk with management, and (3) user are provided with audited financial
statements.
1. User Verifies Information – The user may go to business premises to examine books of
accounts and other accounting records in order to obtain information about the reliability of
the financial statements. Normally, this is impractical because of costs of doing so. In
addition, it would be economically inefficient for all users to verify the information individually.
2. User Shares Information Risk with Management – Management is responsible for
providing reliable information to users. If users rely on inaccurate financial statements and
as a result incur financial loss, they may have a basis for a lawsuit against management. A
difficulty with sharing information risk with management is that users may not be able to
collect on losses. If a company is unable to repay a loan because of bankruptcy, it is unlikely
that management will have sufficient funds to repay users.
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3. User Are Provided with Audited Financial Statements – The most reasonable and common
way for users to obtain reliable information is to have it audited. Decision makers can then
use the audited information on the assumption that it is reasonably complete, accurate, and
unbiased.
Typically, the management or audit committee of the board of directors of a company
engages an independent auditor to provide assurance to users that the financial statements are
free from material misstatements. If the financial statements are ultimately determined to be
misleading, the auditor can be sued by both the management and users.
THE PHILOSOPHY OF AN AUDIT AND NOTION OF ACCOUNTABILITY, STEWARDSHIP
AND AGENCY
Principals (i.e., business owners) appoint agents (i.e., managers) and delegate some
decision-making authority to them. In doing so, principals place trust in their agents to act in the
principals’ best interest. However, as a result of information asymmetries between principals and
agents and differing motives, principals may lack trust in their agents and may therefore need to
put in place mechanism, such as the audit, to reinforce this trust. The philosophical theories that
explain the demand for auditing and support the performance of an independent audit are as
follows: (a) stewardship or agency theory, (2) motivational theory, (3) information theory, and (4)
insurance theory.
1. Stewardship or Agency Theory – Stewardship or agency theory implies that the
manager (as well as the owners or investors) wants the credibility an audit adds to
the financial statement assertions. The manager is the agent or steward of the owners
or investors, but each party acts in his or her own self-interest and the goals or
objectives of each party are different. This situation inevitably creates conflict
between the owner and manager. The owner perceives that the manager’s goals or
objectives may be detrimental to the owner’s own goals. Thus, the manager wants
financial statement representations audited by an independent party to enhance his
or her stewardship of these financial statements and to lessen the owner’s mistrust
of the manager.
2. Motivational Theory – Preparers of financial statements know that their assertions
will be subjected to an audit; thus, financial statements will be brought more in line
with accounting standards. The motivational benefits of an audit are difficult to prove
conclusively, but some believe that management’s knowledge that an audit will be
performed mitigates against improper financial statement preparation.
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3. Information Theory – An assurance service is a means of improving the quality of
information. For example, investors require information to make an assessment of
expected returns and risks associated with their investment. An assurance service is
also valued as a means of improving financial and non-financial data for internal
decision making, detecting errors and motivating employees to exercise more care in
preparing records.
The information theory also states that investors benefit through the increased
confidence of external users of the information. For example, for private companies
seeking funds from lending institutions, the costs incurred in audit fees were more
than recompensed by the increased savings associated with lower interest rates
when compared with the interest rates charged to similar companies that weren’t
audited.
4. Insurance Theory – The insurance theory states that demand for assurance occurs
from those who may suffer loss when things go wrong. For example, if an organization
goes into liquidation and has no resources to pay its debts, it may be possible to
recover some of the losses from the auditor. As auditors are required to have
insurance against such potential losses, this has given rise to a ‘deep-pockets’ effect
in that the auditor is seen to have a greater ability to pay. As audit firms will be very
concerned with maintaining their reputation, any legal action undertaken against them
may damage this reputation will be treated very seriously.
ECONOMIC BENEFITS OF A FINANCIAL STATEMENT AUDIT
Among the economic benefits of financial statement audits are the following: (1) access
to capital markets, (2) lower cost of capital, (3) deterrent to inefficiency and fraud, and (4) control
and operational improvements.
1. Access to Capital Markets – public companies must satisfy statutory audit
requirements under the securities acts in order to register securities and have them
traded on securities markets. In addition, stock markets may impose their own
requirements for listing securities. Without audits, companies would be denied access
to these capital markets and many private companies would be denied access to
loans.
2. Lower Cost of Capital – companies often engage auditor to have their financial
statement audited in order to obtain bank loans with more favorable terms. Because
of the reduced information risk associated with audited financial statements, creditors
may offer loans with lower interest rates.
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3. Deterrent to Inefficiency and Fraud – research has demonstrated that when
employees know that an independent audit is to be made, they take care to make
fewer errors in performing accounting functions and are less likely to misappropriate
company assets. Thus, the data in company records will be more reliable, and losses
from embezzlements and the like will be reduced. In addition, the fact that financial
statement assertions are to be verified reduces the likelihood that management will
engage in fraudulent financial reporting.
4. Control and Operational Improvements – the independent auditor often makes
suggestions to improve internal control, to evaluate management’s assessments of
business risks, to recommend improved performance measures and to make
recommendations to achieve greater operational efficiencies within the client’s
organization.
LIMITATIONS OF A FINANCIAL STATEMENT AUDIT
A financial statement audit is subject to a number of inherent limitations. One constraint is
that the auditor works within fairly restrictive economic limits. Following are two important
economic limitations.
1. Reasonable Cost – A limitation on the cost of an audit results in selective testing,
or sampling, of the accounting records and supporting data. In addition, the auditor
may choose to test internal controls and may obtain assurance from a well-functioning
system of internal controls.
2. Reasonable Length of Time – time constraint may affect the amount of evidence
that can be obtained concerning events and transactions after the balance sheet date
that may have an effect on the financial statements. Moreover, there is a relatively
short time period available for resolving uncertainties existing at the statement date.
Another significant limitation is the established accounting framework for preparing
financial statements. Following are two important limitations associated with the
established accounting framework.
3. Alternative Accounting Principles – Alternative accounting principles are permitted
under GAAP. Financial statement users must be knowledgeable about a company’s
accounting choices and their effect on financial statements.
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4. Accounting Estimates – Estimates are an inherent part of the accounting process,
and no one, including auditors, can foresee the outcome of uncertainties. Estimates
range from the allowance for doubtful accounts and an inventory obsolescence
reserve to impairment tests for fixed assets and goodwill. An audit cannot add
exactness and certainty to financial statements even if these factors do not exist.
Despite these limitations, a financial statement audit adds credibility to the financial
statements.
TYPES OF AUDITORS
Individuals who are engaged to audit economic actions and events can be classified into
three groups as follows: (1) external or independent auditors, (2) internal auditors, and (3)
government auditors.
1. External or independent auditors – are certified public accountants (CPA) who
have their own independent accounting practices that provide independent auditing
services of client financial statements. Independent auditors mostly perform financial
statement audits, but they may also perform compliance and operational audits. They
are also referred to as external auditors.
2. Internal auditors – are employees of the entities they audit and are primarily
concerned in determining whether organizational policies and procedures have been
followed in safeguarding the entity’s assets. They are involved in an independent
appraisal activity called internal auditing, which is designed to assist the management
of the organization in the effective discharge of its responsibilities. Internal auditors
generally perform compliance and operational audits.
The internal auditing staff often reports to the president and also to the audit
committee of the board of directors. This is to ensure that the internal auditors will
have ready access to all units of the organization, and their recommendations will be
given prompt attention by department heads. It is also necessary that the internal
auditors be independent of the department heads and other line executives whose
work they review.
3. Government auditors – are engaged to provide assurance that all local and
national governmental agencies, including government owned and controlled
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corporations, have complied with laws, rules, regulations, policies, and procedures.
Government auditors generally conduct comprehensive audits which combine
elements of financial, compliance and operational auditing.
Government auditors perform audits to determine that spending programs follow the intent
of Congress and operational audits to evaluate the effectiveness and efficiency of selected
government programs Government auditors also conduct examinations of government owned
and controlled corporations’ financial statements.
TYPES OF AUDITS
Audits are generally classified into different types of activities as follows: (1) financial or
independent audits, (2) compliance audits, and (3) operational audits.
1. Financial or independent audits – is an audit of the financial statements of an entity.
It involves obtaining and evaluating evidence about an entity’s presentation of its
financial position, results of operations, and cash flows for the purpose of expressing
an opinion as to whether they are presented fairly in accordance with a specified
financial reporting framework or criteria most often the Philippine Financial Reporting
Standards (PFRS).
2. Compliance audits – involves obtaining and evaluating evidence to determine
whether certain financial or operating activities of an entity conform to established
policies and procedures, conditions, laws, rules, or regulations set by some higher
authority that may have a material effect on the financial statements.
For example, auditors may perform an audit to provide assurance that the client is in
compliance with loan covenants established by the client’s lender (e.g., banks and
other financial institutions) in financing agreements such as whether the client
maintained or exceeded the specified minimum debt to equity ratio level.
3. Operational audits – is a study of a specific unit of an organization for the purpose
of measuring its performance. It involves obtaining and evaluating evidence about the
efficiency, economy and effectiveness of an entity’s operating activities, policies and
procedures in relation to specified objectives. At the completion of an operational
audit, management normally expects recommendations for improving operations.
This type of audit is sometimes referred to as a performance audit or a management
audit.
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For example, auditors may perform an audit of a client’s employee cash advance
liquidation policy to determine that approved business expenses are liquidated by the employees
(effectiveness), the expenses incurred are ordinary and reasonable, and the process of liquidating
the expenses is fair and timely (efficient).
DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Accounting in those far-off days could only have taken place orally. The steward in charge
of the cattle, goods and other forms of wealth would, from time to time, produce to his master the
wealth with which he was entrusted and give an account of his stewardship, reciting from memory
the goods and chattels acquired, those disposed of and those still in his possession. The master
would listen to this recital of the steward’s transaction and question him thereon. The master was
the listener, the auditor. The word “auditor” (derived from the Latin word audire, which means to
hear) acquired a secondary meaning: “one who satisfies himself as to the truth of the accounting
of another”.
Many financial statement users and members of the general public confuse auditing with
accounting. The confusion results because most auditing is usually concerned with accounting
information, and may auditors have considerable expertise in accounting matters.
Accounting is the process of recording, classifying, and summarizing of economics events
for the purpose of providing financial information used in decision making. To provide relevant
information, accountants must have a thorough understanding of the principles and rules that
provide the basis for preparing the accounting information. In addition, accountants must develop
a system to make sure that the entity’s economic events are properly recorded on a timely basis
and at a reasonable cost.
On the other hand, auditing is determining whether recorded information properly reflects
the economic events that occurred during the accounting period. When auditing accounting data,
the auditor must possess expertise in the accumulation and interpretation of audit evidence. It is
this expertise that distinguishes auditors from accountants. Determining the proper audit
procedures, deciding the number and types of items to test, and evaluating the results are
problems unique to the auditor.
Accounting and auditing are separate disciplines within dissimilar bodies of knowledge.
However, a familiarity with the audit process is not wholly sufficient to render an auditor
competent. Because an auditor audits financial statements, he or she must also be familiar with
the Philippine Financial Reporting Standards.
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Multiple Choice Questions
1. Any services in which the CPA firm issues a written communication that express a conclusion
with respect to the reliability of a written assertion that is the responsibility of another party is
a (n)
a. Accounting and bookkeeping service
c. Attestation service
b. Management advisory service
d. Tax service
2. The three types of attestation services are:
a. Audits, review, and compilations
b. Audits, compilations, and other attestation services
c. Reviews, compilations, and other attestation services
d. Audits, reviews, and other attestation services
3. Which of the following is not primary category of attestation report?
a. Compilation report
b. Review report
c. Audit report
d. Special audit report based on a basis of accounting other than generally accepted
accounting principles.
4. The primary goal of the CPA in performing the attest function is to
a. Detect fraud.
b. Examine individual transactions so that the auditor may certify as to their validity.
c. Determine whether the client's assertions are fairly stated.
d. Assure the consistent application of correct accounting procedures.
5. Which of the following criteria is unique to the independent auditor’s attest function?
a. General competence
b. Familiarity with the particular industry of each client
c. Due professional care
d. Independence
6. Assurance engagement
a. Is an engagement in which a practitioner is engaged to issue, or does issue, a written
communication that expresses a conclusion about the reliability of a written assertion that
is the responsibility of another party.
b. 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.
c. Is an engagement in which the auditor provides a moderate level of assurance that the
information subject to the engagement is free of material misstatement.
d. Is an engagement intended to enhance the credibility of information about a subject
matter by evaluating whether the subject matter conforms in all material respects with
suitable criteria, thereby improving the likelihood that the information will meet the needs
of an intended user.
7. The single feature that most clearly distinguishes auditing, attestation, and assurance is
42
a. Type of service.
b. Training required to perform the service
c. Scope of services.
d. CPA’s approach to the service
8. Identify the following as financial audit (FA), compliance audit (CA), and operational audit
(OA).
• A supervisor is not carrying out his assigned responsibilities.
• A company’s tax return does not conform to income tax laws and regulations.
• A municipality’s financial statements correctly show actual cash receipts and
disbursements.
• A company’s receiving department is inefficient.
a. CA, CA, FA, OA
c. OA, CA, FA, OA
b. OA, CA, CA, OA
d. CA, CA, FA, CA
9. The criteria for evaluating quantitative information vary. For example, in the audit of historical
financial statements by CPA firms, the criteria are usually
a. Philippine Auditing Standards
b. Philippine Financial Reporting Standards/Philippine Accounting Standards
c. Regulations of the Bureau of Internal Revenue
d. Regulations of the Securities and Exchange Commission
10. Which of the following types of audit uses as its criteria, laws and regulations?
a. Operational audit
c. Financial statement audit
b. Compliance audit
d. Financial audit
11. An operational audit is designed to
a. Assess the efficiency and effectiveness of management’s operating procedures.
b. Assess the presentation of management’s financial statements in accordance with
Philippine
Accounting Standards.
c. Determine whether management has complied with applicable laws and regulations.
d. Determine whether the audit committee of the board of directors is effectively
discharging its responsibility to oversee management’s operations.
12. A review of any part of an organization’s procedures and methods for the purpose of
evaluating efficiency and effectiveness is classified as a (n)
a. Audit of financial statements
c. Operational audit
b. Compliance audit
d. Production audit
13. Which one of the following is more difficult to evaluate objectively?
a. Efficiency and effectiveness of operations.
b. Compliance with government regulations.
c. Presentation of financial statements in accordance with generally accepted accounting
principles.
d. All three of the above are equally difficult.
14.
Independent auditing can best be described as a
a. Branch of accounting.
b. Discipline that attests to the results of accounting and other operations and data.
c. Professional activity that measures and communicates financial and business data.
d. Regulatory function that prevents the issuance of improper financial information.
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15. A financial statement audit:
a. Confirms that financial statement assertion are accurate.
b. Lends credibility to the financial statements.
c. Guarantees that financial statements are presented fairly.
d. Assures that fraud had been detected.
16. Which of the following best describes the objective of an audit of financial statements?
a. To express an opinion whether the financial statements are prepared in accordance
with prescribed criteria.
b. To express an assurance as to the future viability of the entity whose financial
statements are being audited.
c. To express an assurance about the management’s efficiency or effectiveness in
conducting the operations of entity.
d. To express an opinion whether the financial statements are prepared, in all material
respect, in accordance with an identified financial reporting framework.
17. Because an external auditor is paid a fee by a client company, he or she
a. Is absolutely independent and may conduct an audit.
b. May be sufficiently independent to conduct an audit
c. Is never considered to be independent
d. Must receive approval of the Securities and Exchange Commission before conducting
an audit.
18. Which of the following is responsible for an entity’s financial statements?
a. The entity’s management
c. The entity’s audit committee
b. The entity’s internal auditors
d. The entity’s board of directors
19. The best statement of the responsibility of the auditor with respect to audited financial
statement is:
a. The audit of the financial statements relieves management of its responsibilities
b. The auditor’s responsibility is confined to his expression of opinion about the audited
financial statements.
c. The responsibility over the financial statements rests with the management and the
auditor assumes responsibility with respect to the notes of financial statements.
d. The auditor is responsible only to his unqualified opinion but not for any other type of
opinion.
20. Because an examination in accordance with generally accepted auditing standards is
influenced by the possibility of material errors, the auditor should conduct the examination with
an attitude of
a. Professional responsiveness
c. Objective judgment
b. Conservative advocacy
d. Professional skepticism
21. Indicate the level of assurance provided by audit and related services.
a
b
c
d
• Audit
High
High
Negative
Absolute
• Review
Moderate
None
Moderate
High
• Agreed-upon procedures None
None
None
Limited
• Compilation
None
None
None
None
22. It refers to the level of auditor’s satisfaction as to the reliability of an assertion being made by
one party for use by another party.
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a. Confidence level
b. Reasonableness level
c. Assurance level
d. Tolerable level
23. Which of the following best describes why an independent auditor reports on financial
statements?
a. Independent auditors are likely to detect fraud.
b. Competing interests may exist between management and the users of the statements.
c. Misstated account balances are generally corrected by an independent audit.
d. Ineffective internal controls may exist.
24. An audit can have a significant effect on
a. Information Risk
b. The risk-free interest rate
c. Business Risk
d. All of these
25. The main way(s) to reduce information risk is to have
a. The user verifies the information.
b. The user shares the information risk with management.
c. Audited financial statements provided.
d. All of the above.
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Lesson 2 – Major Phases of an Audit - Part I
Overview:
There are seven major phases in Auditing Financial Statements enumerated below, and
this lesson will cover the first five.
1. Client acceptance and continuance and establishing an understanding of the terms
of the engagement.
2. Preplanning activities such as establishing materiality.
3. Planning the audit.
4. Considering the entity’s internal control.
5. Perform audit procedures (test of control and substantive procedures).
6. Complete the audit.
7. Issuance of the auditor’s report.
The auditor and the client should agree on the terms of the engagement. The agreed
terms would need to be recorded in an audit engagement letter or other suitable form of contract.
It is in the interest of both client and auditor that the auditor sends an engagement letter, preferably
before the commencement of the engagement, to help in avoiding misunderstandings with
respect to the engagement.
The engagement letter documents and confirms:
1. the auditor’s acceptance of the appointment;
2. the objective and scope of the audit;
3. the extent of the auditor’s responsibilities to the client; and
4. the form of any reports.
The auditor should obtain understanding of its internal control and document the same.
Learning Objective:
After studying this lesson, the student should:
• Comprehend and fully understand the first five major phases of an audit.
• Understand the concepts of internal control in an auditor’s perspective.
• Understand the concepts of audit evidence/documentation, audit planning, audit
program and audit procedures.
• Know the relationship between audit evidence and the auditor’s report.
• Understand the basic concepts of audit evidence.
• Understand the use of assertions in obtaining audit evidence.
• Define audit procedures and understand their relationship to assertions.
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• Identify and define the audit procedures used for obtaining audit evidence.
• Learn the objectives of audit documentation.
• Develop an understanding of the content, types, organization and ownership of
audit documentation.
Course Materials:
Contents of Audit Engagements
The form and content of audit engagement letters may vary for each client, but they would
generally include reference to:
•
•
•
•
•
•
The objective of the audit of financial statements.
Management’s responsibility for the financial statements.
The scope of the audit, including reference to applicable legislation, regulations,
or pronouncements of professional bodies to which the auditor adheres.
The form of any reports or other communication of results of the engagement.
The fact that because of the test nature and other inherent limitations of an audit,
together with the inherent limitations of any accounting and internal control
system, there is an unavoidable risk that even some material misstatement may
remain undiscovered.
Unrestricted access to whatever records, documentation and other information
requested in connection with the audit.
The auditor may also wish to include in the letter:
➢ Arrangements regarding the planning of the audit.
➢ Expectation of receiving from management written confirmation concerning
representations made in connection with the audit.
➢ Request for the client to confirm the terms of the engagement by acknowledging
receipt of the engagement letter.
➢ Description of any other letters or reports the auditor expects to issue to the client.
➢ Basis on which fees are computed and any billing arrangements.
When relevant, the following points could also be made:
➢ Arrangements concerning the involvement of other auditors and experts in some
aspects of the audit.
➢ Arrangements concerning the involvement of internal auditors and other client staff.
➢ Arrangements to be made with the predecessor auditor, if any, in the case of an initial
➢ audit.
➢ Any restriction of the auditor’s liability when such possibility exists.
➢ A reference to any further agreements between the auditor and the client.
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Audits of Components
When the auditor of a parent entity is also the auditor of its subsidiary, branch or division
(component), the factors that influence the decision whether to send a separate engagement letter
to the component include:
➢
➢
➢
➢
➢
➢
Who appoints the auditor of the component?
Whether a separate audit report is to be issued on the component.
Legal requirements.
The extent of any work performed by other auditors.
Degree of ownership by parent.
Degree of independence of the component’s management.
Recurring Audits
On recurring audits, the auditor should consider whether circumstances require the terms
of the engagement to be revised and whether there is a need to remind the client of the existing
terms of the engagement. The auditor may decide not to send a new engagement letter each
period. However, the following factors may make it appropriate to send a new letter:
➢
➢
➢
➢
➢
Any indication that the client misunderstands the objective and scope of the audit.
Any revised or special terms of the engagement.
A recent change of senior management, board of directors or ownership.
A significant change in nature or size of the client’s business.
Legal requirements.
Acceptance of a Change in Engagement
A request from the client for the auditor to change the engagement may result from:
1. a change in circumstances affecting the need for the service;
2. a misunderstanding as to the nature of an audit or related service originally requested; or
3. a restriction on the scope of the engagement, whether imposed by management or caused
by circumstances.
Items 1 and 2 would ordinarily be considered a reasonable basis for requesting a change
in the engagement. In contrast, a change would not be considered reasonable if it appeared that
the change relates to information that is incorrect, incomplete or otherwise unsatisfactory.
If the auditor agreed to a change of the engagement:
➢ the auditor and the client should agree on the new terms;
➢ the report issued would be that appropriate for the revised terms of engagement; and
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➢ in order to avoid confusing the reader, the report would not include reference to:
(a) The original engagement; or
(b) Any procedures that may have been performed in the original engagement, except
where the engagement is changed to an engagement to undertake agreed-upon
procedures and thus reference to the procedures performed is a normal part of the report.
If the auditor is unable to agree to a change of engagement and is not permitted to
continue the original agreement:
➢ the auditor should withdraw; and
➢ consider whether there is any obligation, either contractual or otherwise, to report to
other parties, such as the board of directors or shareholders, the circumstances
necessitating the withdrawal.
Appointment of the Independent Auditor
Early appointment of the independent auditor has many advantages to both the auditor
and his client. Early appointment enables the auditor to plan his work so that it may be done
expeditiously and to determine the extent to which it can be done before the balance sheet date.
Although early appointment is preferable, an independent auditor may accept an engagement
near or after the close of the fiscal year. In such instances, before accepting the engagement, he
should ascertain whether circumstances are likely to permit an adequate audit and expression of
an unqualified opinion and, if they will not, he should discuss with the client the possible necessity
for a qualified opinion or disclaimer of opinion.
Planning
The auditor should plan the audit work so that the audit will be performed in an effective manner.
“Planning” means developing a general strategy and a detailed approach for the expected
nature, timing and extent of the audit. The auditor plans to perform the audit in an efficient and
timely manner.
Importance of Adequate Planning
Adequate planning of the audit work helps to ensure that:
1) Appropriate attention is devoted to important areas of the audit;
2) Potential problems are identified; and
3) The work is completed expeditiously.
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Planning also assists in proper:
1) Assignment of work to assistants; and
2) Coordination of work done by other auditors and experts.
Extent of Planning
The extent of planning will vary according to the following:
1) Size of the entity;
2) Complexity of the audit; and
3) Auditor’s experience with the entity and knowledge of the business.
Composition of the Audit Team
Human resources—the competence, judgment, and integrity of personnel—represent the
greatest asset of any public accounting firm. The professional staff of a typical public accounting
firm includes partners, managers, senior auditors, and staff auditors.
Partners
The lead partner on an engagement is responsible for assuring that the audit is performed
in accordance with applicable professional standards. Accordingly, this individual is ultimately
responsible for adequate planning, supervision, and execution of the audit. Partners are also
responsible for maintaining primary contacts with clients. These contacts include discussing with
clients the objectives and scope of the audit work, resolving controversies that may arise as to
how items are to be presented in the financial statements, and attending the client’s stockholders’
meetings to answer any questions regarding the financial statements or the auditors’ report. Other
responsibilities of the partner include recruiting new staff members, supervising the professional
staff, reviewing audit working papers, and signing the audit reports.
The partnership level in a public accounting firm is comparable to that of top management
in an industrial organization. Executives at this level are concerned with the long-run well-being
of the organization and of the community it serves. They should and do contribute important
amounts of time to civic, professional, and educational activities in the community.
Managers
In large public accounting firms, managers or supervisors perform many of the duties that
would be discharged by partners in smaller firms. A manager may be responsible for supervising
two or more concurrent audit engagements. This supervisory work includes reviewing the audit
working papers and discussing with the audit staff and with the client any accounting or auditing
50
problems that may arise during the engagement. The manager is responsible for determining the
audit procedures applicable to specific audits and for maintaining uniform standards of fieldwork.
Often, managers have the administrative duties of compiling and collecting the firm’s billings to
clients.
Familiarity with tax laws, as well as a broad and current knowledge of accounting theory
and practice, is an essential qualification for a successful manager. Like the partner, the audit
manager may specialize in specific industries or other areas of the firm’s practice.
Senior Auditors
The responsibility assumed by the senior “in-charge” auditor varies based on the size of
the engagement. On a smaller engagement, the senior auditor may assume responsibility for
planning and conducting the audit and drafting the audit report, subject to review and approval by
the manager and partner. On larger engagements a senior auditor may assume responsibility for
supervising some aspect of the audit. In conducting the audit, the senior will delegate most audit
tasks to assistants based on an appraisal of each assistant’s ability to perform particular phases
of the work. One of the major responsibilities of the senior is on-the-job staff training. In assigning
work to staff accountants, the senior should make clear the end objectives of the particular audit
operation. By assigning assistants a wide variety of audit tasks and by providing constructive
criticism of the assistants’ work, the senior should try to make each audit a significant learning
experience for the staff accountants.
The senior will also maintain a continuous record of the hours devoted by all members of
the staff to the various phases of the audit. In addition to maintaining uniform professional
standards of fieldwork, the senior is responsible for preventing the accumulation of excessive staff
hours on inconsequential matters and for completing the entire engagement within the budgeted
time, if possible.
Staff Accountants
The first position of a college graduate entering the public accounting profession is that of
staff assistant (staff assistant). Staff accountants usually encounter a variety of assignments that
fully utilize their capacity for analysis and growth. Of course, some routine work must be done in
every audit engagement, but college graduates with thorough training in accounting need have
little fear of being assigned for long to extensive routine procedures when they enter the field of
public accounting. Ordinarily, the demand for accounting services is so high as to create a
situation in which every incentive exists for the rapid development of promising assistants. The
audit staff members of all public accounting firms attend training programs that are either
developed “in house” or sponsored by professional organizations. One of the most attractive
51
features of the public accounting profession is the richness and variety of experience acquired
even by the beginning staff member.
The Overall Audit Plan
The auditor should develop and document an overall audit plan describing the expected
scope and conduct of the audit. While the record of the overall audit plan will need to be sufficiently
detailed to guide the development of the audit program, its precise form and content will vary
depending on the following:
1) Size of the entity;
2) Complexity of the audit; and
3) Specific methodology and technology used by the auditor.
Matters to be considered by the auditor in developing the overall audit plan include:
➢ Knowledge of the business.
➢ General economic factors and industry conditions affecting the entity’s business.
➢ Important characteristics of the entity, its business, its financial performance and its
reporting requirements including changes since the date of the prior audit.
➢ The general level of competence of management.
Understanding the Accounting and Internal Control Systems
➢ The accounting policies adopted by the entity and changes in those policies.
➢ The effect of new accounting or auditing pronouncements.
➢ The auditor’s cumulative knowledge of the accounting and internal control systems and
the relative emphasis expected to be placed on tests of control and substantive
procedures.
Risk and Materiality
➢ The expected assessments of inherent and control risks and the identification of significant
audit areas.
➢ The setting of materiality levels for audit purposes.
➢ The possibility of material misstatement, including the experience of past periods, or fraud.
➢ The identification of complex accounting areas including those involving accounting
estimates.
Nature, Timing and Extent of Procedures
➢ Possible change of emphasis on specific audit areas.
➢ The effect of information technology on the audit.
➢ The work of internal auditing and its expected effect on external audit procedures.
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Coordination, Direction, Supervision and Review
➢ The involvement of other auditors in the audit of components, for example, subsidiaries,
branches and divisions.
➢ The involvement of experts.
➢ The number of locations.
➢ Staffing requirements.
Other Matters
➢
➢
➢
➢
The possibility that the going concern assumption may be subject to question.
Conditions requiring special attention, such as the existence of related parties.
The terms of the engagement and any statutory responsibilities.
The nature and timing of reports or other communication with the entity that are expected
under the engagement.
The Audit Program
The auditor should develop and document an audit program setting out the nature, timing
and extent of planned audit procedures required to implement the overall audit plan.
The audit program serves as a:
1) Set of instructions to assistants involved in the audit; and
2) Means to control and record the proper execution of the work.
The audit program also contains:
1) The audit objectives for each area; and
2) A time budget in which hours are budgeted for the various audit areas or procedures.
In preparing the audit program, the auditor would consider the following:
1) Specific assessments of inherent and control risks and the required level of assurance to
be provided by substantive procedures;
2) Timing of tests of controls and substantive procedures;
3) Coordination of any assistance expected from the entity, the availability of assistants and
the involvement of other auditors or experts; and
4) Other matters considered by the auditor in developing the overall audit plan need to be
considered in more detail during the development of the audit program.
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Changes to the Overall Audit Plan and Audit Program
The overall audit plan and the audit program should be revised as necessary during the
course of the audit. Planning is continuous throughout the engagement because of changes in
conditions or unexpected results of audit procedures. The reasons for significant changes would
be recorded.
Knowledge of Business
In performing an audit of financial statements, the auditor should have or obtain a
knowledge of the business sufficient to enable the auditor to identify and understand the events,
transactions and practices that, in the auditor’s judgment, may have a significant effect on the
financial statements or on the examination or audit report.
The auditor’s level of knowledge for an engagement would include:
➢ a general knowledge of the economy and the industry within which the entity operates,
and
➢ a more particular knowledge of how the entity operates.
The level of knowledge required by the auditor would, however, ordinarily be less than
that possessed by management.
Prior to accepting an engagement, the auditor would obtain:
➢ a preliminary knowledge of the industry and of the ownership,
➢ management and operations of the entity to be audited, and
➢ would consider whether a level of knowledge of the business adequate to perform the
audit can be obtained.
Following acceptance of the engagement, further and more detailed information would be
obtained. To the extent practicable, the auditor would obtain the required knowledge at the start
of the engagement. As the audit progresses, that information would be assessed and updated
and more information would be obtained.
For continuing engagements, the auditor would:
➢ update and reevaluate information gathered previously, including information in the prior
year’s working papers.
54
➢ also perform procedures designed to identify significant changes that have taken place
since the last audit.
➢ The auditor can obtain knowledge of the industry and the entity from a number of sources.
For example:
1. Previous experience with the entity and its industry.
2. Discussion with people with the entity (for example, directors and senior operating
personnel).
3. Discussion with internal audit personnel and review of internal audit reports.
4. Discussion with other auditors and with legal and other advisors who have provided
services to the entity or within the industry.
5. Discussion with knowledgeable people outside the entity (for example, industry
economists, industry regulators, customers, suppliers, competitors).
6. Publications related to the industry (for example, government statistics, surveys, texts,
trade journals, reports prepared by banks and securities dealers, financial
newspapers).
7. Legislation and regulations that significantly affect the entity.
8. Visits to the entity’s premises and plant facilities.
9. Documents produced by the entity (for example, minutes of meetings, material sent to
shareholders or filed with regulatory authorities, promotional literature, prior years’
annual and financial reports, budgets, internal management reports, interim financial
reports, management policy manual, manuals of accounting and internal control
systems, chart of accounts, job descriptions, marketing and sales plans).
Using the Knowledge
A knowledge of the business is a frame of reference within which the auditor exercises
professional judgment. Understanding the business and using this information appropriately
assists the auditor in:
➢
➢
➢
➢
Assessing risks and identifying problems.
Planning and performing the audit effectively and efficiently.
Evaluating audit evidence.
Providing better service to the client.
Audit Materiality
The auditor should consider materiality and its relationship with audit risk when conducting
an audit.
“Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends on the size
of the item or error judged in the particular circumstances of its omission or misstatement. Thus,
55
materiality provides a threshold or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.”
The auditor considers materiality at both the overall financial statement level and in
relation to individual account balances, classes of transactions and disclosures. Materiality should
be considered by the auditor when:
(a) determining the nature, timing and extent of audit procedures; and
(b) evaluating the effect of misstatements.
The Relationship between Materiality and Audit Risk
There is an inverse relationship between materiality and the level of audit risk, that is, the
higher the materiality level, the lower the audit risk and vice versa. The auditor's assessment of
materiality and audit risk may be different at the time of initially planning the engagement from at
the time of evaluating the results of audit procedures. This could be because of:
➢ a change in circumstances; or
➢ because of a change in the auditor's knowledge as a result of the audit.
Evaluating the Effect of Misstatements
In evaluating the fair presentation of the financial statements the auditor should assess
whether the aggregate of uncorrected misstatements that have been identified during the audit is
material. The aggregate of uncorrected misstatements comprises:
(a) specific misstatements identified by the auditor including the net effect of uncorrected
misstatements identified during the audit of previous periods; and
(b) the auditor's best estimate of other misstatements which cannot be specifically
identified (i.e., projected errors).
If the auditor concludes that the misstatements may be material the auditor needs to:
➢ consider reducing audit risk by extending audit procedures; or
➢ requesting management to adjust the financial statements.
If management refuses to adjust the financial statements and the results of extended audit
procedures do not enable the auditor to conclude that the aggregate of uncorrected
misstatements is not material, the auditor should consider the appropriate modification to the
auditor’s report in accordance with PSA 700 “The Auditor’s Report on Financial Statements.”
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The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements
A major part of risk assessment is assessing the risk of fraud. In considering the risk of
fraud, the auditor should refer to the work done as part of the audit of financial statements to
comply with PSA 240 Revised. The auditor should evaluate the risk of material misstatement due
to fraud and the risk of management override of controls. The following controls might address
the risk of fraud and management override:
➢ Controls over significant, unusual transactions, particularly those that result in late or
unusual journal entries.
➢ Controls over journal entries and adjustments made in the period-end financial
reporting process.
➢ Controls over related-party transactions.
➢ Controls related to significant management estimates.
➢ Controls that mitigate incentives for, and pressures on, management to falsify or
inappropriately manage financial results.
The auditors’ fraud risk assessment involves identifying risks of material misstatement of
the financial statements due to fraud and determining the appropriate audit response. To
identify fraud risks, the auditors perform a number of procedures, including having discussions
with engagement personnel, making inquiries of management and others within the
organization, performing analytical procedures, and considering fraud risk factors.
How do the auditors respond to fraud risks? They respond in the following three ways: (1)
a modification in approach having an overall effect on how the audit is conducted; (2) an
alteration in the nature, timing, and extent of the procedures performed; and (3) performance of
procedures to further address the risk of management override of internal control.
What do the auditors do if they obtain evidence of fraud? They should evaluate the
implications for the audit and communicate their suspicions to an appropriate level of
management, at least one level above the level involved. If the fraud involves senior
management or material misstatement of the financial statements, the matter should be
reported to the audit committee of the board of directors. In very serious situations, the auditors
may decide to withdraw from the engagement.
Internal Control
The auditor should obtain an understanding of the accounting and internal control systems
sufficient to plan the audit and develop an effective audit approach. Accounting system means
the series of tasks and records of an entity by which transactions are processed as a means of
maintaining financial records. Such systems identify, assemble, analyze, calculate, classify,
57
record, summarize and report transactions and other events. Internal Control System means all
the policies and procedures (internal controls) adopted by the management of an entity to assist
in achieving management’s objective of ensuring, as far as practicable,:
➢
➢
➢
➢
➢
orderly and efficient conduct of its business, including adherence to management policies;
safeguarding of assets;
prevention and detection of fraud and error;
accuracy and completeness of the accounting records; and
timely preparation of reliable financial information.
The internal control system extends beyond those matters which relate directly to the
functions of the accounting system. Internal Control Components
(a) The control environment;
(b) The entity’s risk assessment process;
(c) The information system, including the related business processes, relevant to financial
reporting, and communication;
(d) Control activities; and
(e) Monitoring of controls.
Control environment
The control environment includes the attitudes, awareness, and actions of management
and those charged with governance concerning the entity’s internal control and its importance in
the entity. The control environment also includes the governance and management functions and
sets the tone of an organization, influencing the control consciousness of its people. It is the
foundation for effective internal control, providing discipline and structure.
The control environment encompasses the following elements:
• Communication and enforcement of integrity and ethical values.
• Commitment to competence.
• Participation by those charged with governance.
• Management’s philosophy and operating style.
• Organizational structure.
• Assignment of authority and responsibility.
• Human resource policies and practices.
Entity’s risk assessment process
An entity’s risk assessment process is its process for identifying and responding to
business risks and the results thereof. For financial reporting purposes, the entity’s risk
assessment process includes how management identifies risks relevant to the preparation of
financial statements that are presented fairly, in all material respects in accordance with the
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entity’s applicable financial reporting framework, estimates their significance, assesses the
likelihood of their occurrence, and decides upon actions to manage them.
Risks can arise or change due to circumstances such as the following:
• Changes in operating environment. Changes in the regulatory or operating environment
can result in changes in competitive pressures and significantly different risks.
• New personnel. New personnel may have a different focus on or understanding of
internal control.
• New or revamped information systems. Significant and rapid changes in information
systems can change the risk relating to internal control.
• Rapid growth. Significant and rapid expansion of operations can strain controls and
increase the risk of a breakdown in controls.
• New technology. Incorporating new technologies into production processes or
information systems may change the risk associated with internal control.
• New business models, products, or activities. Entering into business areas or
transactions with which an entity has little experience may introduce new risks associated
with internal control.
• Corporate restructurings. Restructurings may be accompanied by staff reductions and
changes in supervision and segregation of duties that may change the risk associated with
internal control.
• Expanded foreign operations. The expansion or acquisition of foreign operations carries
new and often unique risks that may affect internal control, for example, additional or
changed risks from foreign currency transactions.
• New accounting pronouncements. Adoption of new accounting principles or changing
accounting principles may affect risks in preparing financial statements.
Information system, including the related business processes, relevant to financial
reporting, and communication
An information system consists of infrastructure (physical and hardware components),
software, people, procedures, and data. Infrastructure and software will be absent, or have less
significance, in systems that are exclusively or primarily manual. The information system relevant
to financial reporting objectives, which includes the financial reporting system, 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.
Accordingly, an information system encompasses methods and records that:
➢ Identify and record all valid transactions.
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➢ Describe on a timely basis the transactions in sufficient detail to permit proper
classification of transactions for financial reporting.
➢ Measure the value of transactions in a manner that permits recording their proper
monetary value in the financial statements.
➢ Determine the time period in which transactions occurred to permit recording of
transactions in the proper accounting period.
➢ Present properly the transactions and related disclosures in the financial statements.
Communication involves providing an understanding of individual roles and
responsibilities pertaining to internal control over financial reporting. It includes the extent to which
personnel understand how their activities in the financial reporting information system relate to
the work of others and the means of reporting exceptions to an appropriate higher level within the
entity. Open communication channels help ensure that exceptions are reported and acted on.
Control Activities
Control activities are the policies and procedures that help ensure that management
directives are carried out, for example, that necessary actions are taken to address risks that
threaten the achievement of the entity’s objectives. Generally, control activities that may be
relevant to an audit may be categorized as policies and procedures that pertain to the following:
➢
➢
➢
➢
Performance reviews
Information processing
Physical controls
Segregation of duties
Monitoring of controls
Management’s monitoring of controls includes considering whether they are operating as
intended and that they are modified as appropriate for changes in conditions. Monitoring of
controls may include activities such as management’s review of whether bank reconciliations are
being prepared on a timely basis, internal auditors’ evaluation of sales personnel’s compliance
with the entity’s policies on terms of sales contracts, and a legal department’s oversight of
compliance with the entity’s ethical or business practice policies.
Inherent Limitations of Internal Controls
1. Management’s usual requirement that the cost of an internal control does not exceed the
expected benefits to be derived.
2. Most internal controls tend to be directed at routine transactions rather than non-routine
transactions.
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3. The potential for human error due to carelessness, distraction, mistakes of judgment and
the misunderstanding of instructions.
4. The possibility of circumvention of internal controls through the collusion of a member of
management or an employee with parties outside or inside the entity.
5. The possibility that a person responsible for exercising an internal control could abuse that
responsibility, for example, a member of management overriding an internal control.
6. The possibility that procedures may become inadequate due to changes in conditions, and
compliance with procedures may deteriorate.
Accounting and Internal Control Assessment
I.
II.
III.
IV.
V.
Understanding of accounting and internal control system
Plan the assessed level of control risk
Performance of tests of controls (if appropriate)
Reassessment of control risk
Final assessment of control risk
Understanding of Accounting and Internal Control Systems
In the audit of financial statements, the auditor is only concerned with those policies and
procedures within the accounting and internal control systems that are relevant to the financial
statement assertions. The understanding of relevant aspects of the accounting and internal
control systems, together with the inherent and control risk assessments and other
considerations, will enable the auditor to:
(a) identify the types of potential material misstatements that could occur in the financial
statements;
(b) consider factors that affect the risk of material misstatements; and
(c) design appropriate audit procedures.
The nature, timing and extent of the procedures performed by the auditor to obtain an
understanding of the accounting and internal control systems will vary with, among other things:
➢
➢
➢
➢
➢
➢
The size and complexity of the entity and of its computer system.
Materiality considerations.
The type of internal controls involved.
The nature of the entity’s documentation of specific internal controls.
The auditor’s assessment of inherent risk.
Experience gained from prior audits.
Procedures in Obtaining Understanding
1. Make inquiries of appropriate company personnel
2. Inspect documents and records
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3. Observe the company’s activities and operations
4. Walk-through
Documentation of Understanding
The auditor should document his understanding of internal control. The extent of
documentation is a matter of the CPA’s judgment and the form of documentation depends upon
his preference and skills.
1. Narrative descriptions
2. Internal control questionnaires (ICQ)
3. Flowcharts
4. Checklists
Preliminary Assessment of Control Risk
The preliminary assessment of control risk is the process of evaluating the effectiveness
of an entity’s accounting and internal control systems in preventing or detecting and correcting
material misstatements. There will always be some control risk because of the inherent limitations
of any accounting and internal control system. After obtaining an understanding of the accounting
and internal control systems, the auditor should make a preliminary assessment of control risk, at
the assertion level, for each material account balance or class of transactions. The auditor
ordinarily assesses control risk at a high level for some or all assertions when:
(a) the entity’s accounting and internal control systems are not effective; or
(b) evaluating the effectiveness of the entity’s accounting and internal control systems would
not be efficient.
7The preliminary assessment of control risk for a financial statement assertion should be
high unless the auditor:
(a) is able to identify internal controls relevant to the assertion which are likely to prevent or
detect and correct a material misstatement; and
(b) plans to perform tests of control to support the assessment.
Test of Controls
If appropriate, tests of control are performed to obtain audit evidence about the
effectiveness of the:
(a) design of the accounting and internal control systems, that is, whether they are suitably
designed to prevent or detect and correct material misstatements; and
(b) operation of the internal controls throughout the period.
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Procedures for Performing Tests of Controls
1. Inspection
3. Observation
2. Inquiry
4. Reperformance
5. Walk-through
Required Documentation
Assessed Control Risk
High (Maximum)
Less than high (Below Maximum)
Understanding of ICS
Required
Required
Tests of Controls
Required
Required
Assessment of Control Risk
Required
Not Required
Reason for assessment
Not Required
Required
Reassessment of control risk
Based on the results of the tests of control, the auditor should evaluate whether the internal
controls are designed and operating as contemplated in the preliminary assessment of control
risk. The evaluation of deviations may result in the auditor concluding that the assessed level of
control risk needs to be revised. In such cases, the auditor would modify the nature, timing and
extent of planned substantive procedures.
Final Assessment of Control Risk
Before the conclusion of the audit, based on the results of the substantive procedures and
other audit evidence obtained by the auditor, the auditor should consider whether the assessment
of control risk is confirmed.
As a result of obtaining an understanding of the accounting and internal control systems
and tests of control, the auditor may become aware of weaknesses in the systems. The auditor
should make management aware, as soon as practical and at an appropriate level of
responsibility, of material weaknesses in the design or operation of the accounting and internal
control systems, which have come to the auditor’s attention. The communication to management
of material weaknesses would ordinarily be in writing. However, if the auditor judges that oral
communication is appropriate, such communication would be documented in the audit working
papers. It is important to indicate in the communication that only weaknesses which have come
to the auditor’s attention as a result of the audit have been reported and that the examination has
not been designed to determine the adequacy of internal control for management purposes.
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Audit Evidence
Most of the auditor’s work involves obtaining and evaluating evidences using procedures
such as inspection of records and confirmations to test the fair presentation of the financial
statements. To perform this task effectively and efficiently, an auditor must understand thoroughly
the important aspects of audit evidence. This includes understanding how audit evidence relates
to financial statement assertions and the auditor’s report, the sufficiency and appropriateness of
evidence, types of audit procedures and the documentation of evidence in the working papers.
PSA 500 as revised provides the basic framework for the auditor’s understanding of
evidence and its use to support the auditor’s opinion on the financial statements. The auditor
gathers evidence by conducting audit procedures to test management assertions in expressing
an opinion on the financial statements. The evidence gathered from the audit procedures is used
to determine the fairness of the financial statements and the type of audit report to be issued. The
financial statements reflect management’s assertions about the various financial statement
components. The auditor conducts audit procedures to gather evidence regarding whether each
relevant management assertion is being supported. The application of audit procedures provides
the evidence that supports the auditor’s report.
The concept of audit evidence is that, all information used by the auditor in arriving at the
conclusions on which the audit opinion is based, and includes the information contained in the
accounting records underlying the financial statements and other information. Auditors are not
expected to examine all information that may exist. Audit evidence, which is cumulative in nature,
includes audit evidence obtained from audit procedures performed during the course of the audit
and may include audit evidence obtained from other sources such as previous audits and a firm's
quality control procedures for client acceptance and continuance.
Its Nature
Accounting records generally include the records of initial 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 formal journal entries; and records such as worksheets and spreadsheets supporting
cost allocations, computations, reconciliations, and disclosures. The entries in the accounting
records are often initiated, authorized, recorded, processed, and reported in electronic form. In
addition, the accounting records may be part of integrated systems that share data and support
all aspects of the entity's financial reporting, operations, and compliance objectives.
Management is responsible for the preparation of the financial statements based on the
accounting records of the entity. The auditor should obtain audit evidence by testing the
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accounting records, for example, through analysis and review, reperforming procedures followed
in the financial reporting process, and reconciling related types and applications of the same
information. Through the performance of such audit procedures, the auditor may determine that
the accounting records are internally consistent and agree to the financial statements. However,
because accounting records alone do not provide sufficient appropriate audit evidence on which
to base an audit opinion on the financial statements, the auditor should obtain other audit
evidence. Table 7.1 shows other information that the auditor may use as audit evidence.
Other Information that the Auditor may Use as Audit Evidence
•
•
•
•
•
•
•
minutes of meetings
confirmations from third parties
industry analysts' reports
comparable data about competitors (benchmarking)
controls manuals
information obtained by the auditor from such audit procedures as inquiry, observation,
and inspection
other information developed by or available to the auditor that permits the auditor to reach
conclusions through valid reasoning.
The Appropriateness of Audit Evidence
Appropriateness is the measure of the quality of audit evidence, that is, its relevance and
its reliability in providing support for, or detecting misstatements in, the classes of transactions,
account balances, and disclosures and related assertions.
Relevance
The definition of relevance emphasizes the need for engagement work to be restricted to
achieving the engagement objectives. However, evidence also should be gathered on “all
matters” within the engagement scope. Relevant information has a logical relationship to what it
purports to prove.
A given set of audit procedures may provide audit evidence that is relevant to certain
assertions but not to others. For example, inspection of records and documents related to the
collection of receivables after the period end may provide audit evidence regarding both existence
and valuation, although not necessarily the appropriateness of period-end cutoffs. On the other
hand, the auditor often obtains audit evidence from different sources or of a different nature that
is relevant to the same assertion. For example, the auditor may analyze the aging of accounts
receivable and the subsequent collection of receivables to obtain audit evidence relating to the
65
valuation of the allowance for doubtful accounts. Furthermore, obtaining audit evidence relating
to a particular assertion, for example, the physical existence of inventory, is not a substitute for
obtaining audit evidence regarding another assertion, for example, rights and obligations.
Reliability
The reliability of audit evidence is influenced by its source and by its nature which is
dependent on the individual circumstances under which it is obtained. Generalizations about the
reliability of various kinds of audit evidence can be made; however, such generalizations are
subject to important exceptions. Even when audit evidence is obtained from sources external to
the entity, circumstances may exist that could affect the reliability of the information obtained. For
example, audit evidence obtained from an independent external source may not be reliable if the
source is not knowledgeable. While recognizing that exceptions may exist, the following
generalizations about the reliability of audit evidence are useful:
➢ Audit evidence is more reliable when it is obtained from knowledgeable independent
sources outside the entity.
➢ Audit evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective.
➢ Audit evidence obtained directly by the auditor (for example, observation of the application
of a control) is more reliable than audit evidence obtained indirectly or by inference (for
example, inquiry about the application of a control).
➢ Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium (for example, a contemporaneously written record of a
meeting is more reliable than a subsequent oral representation of the matters discussed).
➢ Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
The auditor should consider the reliability of the information to be used as audit evidence,
for example, photocopies; facsimiles; or filmed, digitized, or other electronic documents, including
consideration of controls over their preparation and maintenance where relevant. However, an
audit rarely involves the authentication of documentation, nor is the auditor trained as or expected
to be an expert in such authentication.
When information produced by the entity is used by the auditor to perform further audit
procedures, the auditor should obtain audit evidence about the accuracy and completeness of
the information. In order for the auditor to obtain reliable audit evidence, the information upon
which the audit procedures are based needs to be sufficiently complete and accurate. For
example, in auditing revenue by applying standard prices to the records of sales volume, the
auditor should consider the accuracy of the price information and the completeness and accuracy
of the sales volume data. Obtaining audit evidence about the completeness and accuracy of the
information produced by the entity's information system may be performed concurrently with the
66
actual audit procedure applied to the information when obtaining such audit evidence. In other
situations, the auditor may have obtained audit evidence of the accuracy and completeness of
such information by testing controls over the production and maintenance of the information.
However, in some situations the auditor may determine that additional audit procedures are
needed. For example, these additional procedures may include the use of computer-assisted
audit techniques (CAATs) to recalculate the information.
The auditor ordinarily obtains more assurance from consistent audit evidence obtained
from different sources or of a different nature than from items of audit evidence considered
individually. In addition, obtaining audit evidence from different sources or of a different nature
may indicate that an individual item of audit evidence is not reliable. For example, corroborating
information obtained from a source independent of the entity may increase the assurance the
auditor obtains from a management representation. Conversely, when audit evidence obtained
from one source is inconsistent with that obtained from another, the auditor should determine
what additional audit procedures are necessary to resolve the inconsistency.
The Sufficiency of Audit Evidence
Sufficiency is the measure of the quantity of audit evidence. The auditor should consider
the sufficiency and appropriateness of audit evidence to be obtained when assessing risks and
designing further audit procedures. The quantity of audit evidence needed is affected by the risk
of misstatement (the greater the risk, the more audit evidence is likely to be required) and also by
the quality of such audit evidence (the higher the quality, the less the audit evidence that may be
required). Accordingly, there is an inverse relationship between the sufficiency and
appropriateness of audit evidence.
The auditor may consider the relationship between the cost of obtaining audit evidence
and the usefulness of the information obtained. However, the matter of difficulty or expense
involved is not in itself a valid basis for omitting an audit procedure for which there is no
appropriate alternative.
In forming the audit opinion, the auditor does not examine all the information available
(evidence) because conclusions ordinarily can be reached by using sampling approaches and
other means of selecting items for testing. Also, the auditor may find it necessary to rely on audit
evidence that is persuasive rather than conclusive; however, to obtain reasonable assurance, the
auditor must not be satisfied with audit evidence that is less than persuasive. The auditor should
use professional judgment and should exercise professional skepticism in evaluating the quantity
and quality of audit evidence, and thus its sufficiency and appropriateness, to support the audit
opinion. Determining the sufficiency of evidence is one of the more critical decisions the auditor
faces on an engagement.
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The Evaluation of Audit Evidence
The auditor should be thorough in searching for evidence and unbiased in its evaluation.
The auditor must be capable of assessing when a sufficient amount of appropriate evidence has
been obtained in order to determine whether the fairness of management’s assertions can be
supported.
It is stated in PSA 500 that the auditor should use assertions for classes of transactions,
account balances, and presentation and disclosures in sufficient detail to form a basis for the
assessment of risks of material misstatement and the design and performance of further audit
procedures. The auditor uses assertions in assessing risks by considering potential
misstatements that may occur, and thereby designing audit procedures that are responsive to the
particular risks.
Assertions used by the auditor fall into the following categories:
A.
Assertions about classes of transactions and events for the period under audit.
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.
B.
Assertions about account balances at the period end.
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.
C.
Assertions about presentation and disclosure.
Occurrence and rights and obligations. Disclosed events and transactions 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.
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Accuracy and valuation. Financial and other information are disclosed fairly and at
appropriate amounts.
Relevant assertions are assertions that have a meaningful bearing on whether the account
is fairly stated. For example, valuation may not be relevant to the cash account unless currency
translation is involved; however, existence and completeness are always relevant. Similarly,
valuation may not be relevant to the gross amount of the accounts receivable balance but is
relevant to the related allowance accounts. Additionally, the auditor might, in some circumstances,
focus on the presentation and disclosure assertion separately in connection with the period-end
financial reporting process.
The assertions are not individually assessed but quite often at the same time. For
example, to ensure completeness of electricity expense, the auditor ensures that the 12 months
of payments were booked. Since the client may record the bills paid on a cash basis, electricity
expense of a month of previous basis period might be entered in the current year. Electricity
expense of last month of current year might be recorded next year. If the monthly fluctuation is
immaterial, the auditor always ignores the cut-off issue. In case where electricity is a material
expense, the auditor considers preparing adjustments for year ended cut-off purpose so that the
profit or loss would not be materially misstated.
AUDIT PROCEDURES
Audit procedures are specific acts or methods performed by the auditor to gather evidence
to determine if specific assertions are being met. The auditor should obtain audit evidence to draw
reasonable conclusions on which to base the audit opinion by performing audit procedures to:
a) Obtain an understanding of the entity and its environment, including its internal control, to
assess the risks of material misstatement at the financial statement and relevant assertion
levels (audit procedures performed for this purpose are referred to as risk assessment
procedures)
b) When necessary, or when the auditor has determined the need to do so, test the operating
effectiveness of controls in preventing or detecting material misstatements at the relevant
assertion level (audit procedures performed for this purpose are referred to as tests of
controls)
c) Detect material misstatements at the relevant assertion level (audit procedures performed
for this purpose are referred to as substantive procedures and include tests of details of
69
classes of transactions, account balances, and disclosures, and substantive analytical
procedures).
The auditor must perform risk assessment procedures to provide a satisfactory basis for
the assessment of risks at the financial statement and relevant assertion levels. Risk assessment
procedures by themselves do not provide sufficient appropriate audit evidence on which to base
the audit opinion and must be supplemented by further audit procedures in the form of tests of
controls, when relevant and substantive procedures.
The auditor obtains audit evidence by one or more of the following procedures:
a)
b)
c)
d)
e)
f)
g)
h)
Inspection of records or documents
Inspection of tangible assets
Observation
Inquiry
Confirmation
Recalculation
Reperformance
Analytical procedures
Vouching refers to first selecting an item for testing from the underlying accounting data
and then examining the source document (corroborating information). This procedure is used to
establish the existence or occurrence of the selected item. For example, to verify the occurrence
of sales transactions, recorded sales transactions in the sales journal maybe compared to
supporting documents such as invoices and shipping documents.
Tracing refers to selecting an accounting transaction (corroborating information) and
tracing it into the journal or ledger (underlying accounting data). This procedure establishes the
completeness of transactions. For example, to ensure that the selected shipping documents
occurred are recorded, the auditor compares/traces shipping documents to sales invoice then to
sales journal.
Inspection of Tangible Assets
Inspection of tangible assets consists of physical examination of the assets. Inspection of
tangible assets may provide appropriate audit evidence with respect to their existence, but not
necessarily about the entity's rights and obligations or the valuation of the assets. Inspection of
individual inventory items ordinarily accompanies the observation of inventory counting. For
example, when observing an inventory count, the auditor may inspect individual inventory items
(such as opening containers included in the inventory count to ensure that they are not empty) to
verify their existence.
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•
Underlying accounting data consist of the book of original entry (e.g., journals and
registers), the general and subsidiary ledgers, related accounting manuals, and
records such as worksheets supporting cost allocations, computations and
reconciliations.
•
Corroborating evidence includes both written and electronic information (e.g.,
checks, invoices, contracts, and minutes of meetings); confirmations and other
written representations by knowledgeable people; information obtained by the
auditor from inquiry, observation, inspection, and physical examination; and other
information developed by, or available to, the auditor that permits conclusions
through valid reasoning.
Observation
Observation consists of looking at a process or procedure being performed by others.
Examples include observation of the counting of inventories by the entity's personnel and
observation of the performance of control activities. Observation provides audit evidence about
the performance of a process or procedure but is limited to the point in time at which the
observation takes place and by the fact that the act of being observed may affect how the process
or procedure is performed.
Inquiry
Inquiry consists of seeking information of knowledgeable persons, both financial and
nonfinancial, inside or outside the entity. Inquiry is an audit procedure that is used extensively
throughout the audit and often is complementary to performing other audit procedures. Inquiries
may range from formal written inquiries to informal oral inquiries. Evaluating responses to inquiries
is an integral part of the inquiry process.
Confirmation
Confirmation, which is a specific type of inquiry, is the process of obtaining a
representation of information or of an existing condition directly from a third party. For example,
the auditor may seek direct confirmation of receivables by communication with debtors.
Confirmations are frequently used in relation to account balances and their components but need
not be restricted to these items. A confirmation request can be designed to ask if any modifications
have been made to the agreement, and if so, what the relevant details are. For example, the
auditor may request confirmation of the terms of agreements or transactions an entity has with
third parties. Confirmations also are used to obtain audit evidence about the absence of certain
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conditions, for example, the absence of a ‘side agreement’ that may influence revenue
recognition.
PSA 505, External Confirmations, requires that the auditor should determine whether the
use of external confirmation is necessary to obtain sufficient appropriate audit evidence to support
specific assertions.
The major types of information that are normally confirmed, along with the source of the
confirmation, are indicated in Exhibit 7.1.
There are two common types of confirmation requests:
1. Positive confirmations
2. Negative confirmations
A positive confirmation asks the recipient to respond in all circumstances. It may request
the recipient to provide the information (called a blank form), or the confirmation may include the
information and request the respondent to indicate whether he agrees with the information. The
latter type of positive confirmation is often used because the response rate is higher than the
blank form. However, because recipients may sign the request without verifying the information,
there is a risk that the information is incorrect and tends to be less reliable.
In negative confirmation, the recipient is asked to respond only when the information is
incorrect. Because confirmations are considered significant evidence only when returned, this
type of confirmation is less competent than positive confirmation. To be considered reliable,
confirmations must be controlled by the auditor from the time they are prepared until they are
returned.
Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records.
Recalculation can be performed through the use of information technology, for example, by
obtaining an electronic file from the entity and using CAATs to check the accuracy of the
summarization of the file.
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Reperformance
Reperformance is the auditor's independent execution of procedures or controls that were
originally performed as part of the entity's internal control, either manually or through the use of
CAATs, for example, reperforming the aging of accounts receivable.
Analytical Procedures
Analytical procedures consist of evaluations of financial information made by a study of
plausible relationships among both financial and nonfinancial 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. PSA 520, Analytical
Procedures, provides further guidance on analytical procedures.
Journal-entry testing
Examining journal entries and other adjustments for evidence of material misstatement
due to fraud. Material misstatements of financial statements due to fraud often involve the
manipulation of the financial reporting process by recording inappropriate journal entries or
adjustments. Therefore, the auditors should review such entries and adjustments for suspicious
characteristics, such as entries made to unrelated, unusual, or seldom-used accounts; entries
recorded at the end of the period or as post-closing entries that have little or no explanation or
description; or entries made either before or during the preparation of the financial statements
that do not have account numbers.
Audit Documentation/Working Papers
Audit documentation is the principal record of auditing procedures applied, relevant audit
evidence obtained, and conclusions reached by the auditor in the engagement. PSA 230 (revised)
Audit Documentation, requires the auditor to document matters that are important to support an
opinion and evidence that the audit was conducted in accordance with Philippine Standards on
Auditing and applicable legal and regulatory requirements..
Audit documentation is also referred to as working papers or the audit file. Some working
papers are prepared in hard-copy format, but, nowadays, audit software is normally used to
prepare and store them.
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Working papers are prepared mainly to
a. Assist the auditor in planning, performance, review and supervision of the engagement.
b. Support the auditor’ representation as to compliance with Philippine Standards on
Auditing.
c. Support the auditor’s opinion on financial statements.
Working papers also assist the auditor in
a. Planning future audits.
b. Providing information useful in rendering other services.
c. Providing adequate defense in case of litigation.
The auditor should prepare the audit documentation so as to enable an experienced
auditor, having no previous connection with the audit, to understand:
a. The nature, timing, and extent of audit procedures performed to comply with PSAs and
applicable legal and regulatory requirements;
b. The results of the audit procedures and the audit evidence obtained;
c. Significant matters arising during the audit and the conclusions reached thereon.
The auditor must document significant findings or issues, actions taken to address them
(including additional evidence obtained), and the basis for the conclusions reached in connection
with each engagement. Judging the significance of a matter requires an objective analysis of the
facts and circumstances. Significant findings or issues are substantive matters that are important
to the procedures performed, evidence obtained, or conclusions reached, and include, but are
not limited to, the following:
a. Significant matters involving the selection, application, and consistency of accounting
principles, including related disclosures. Significant matters include, but are not limited to,
accounting for complex or unusual transactions, accounting estimates, and uncertainties as
well as related management assumptions.
b. Results of auditing procedures that indicate a need for significant modification of planned
auditing procedures, the existence of material misstatements, omissions in the financial
statements, the existence of significant deficiencies, or material weaknesses in internal
control over financial reporting.
c. Audit adjustments. An audit adjustment is a correction of a misstatement of the financial
statements that was or should have been proposed by the auditor, whether or not recorded
by management that could, either individually or when aggregated with other misstatements,
have a material effect on the company's financial statements.
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d. Disagreements among members of the engagement team or with others consulted on the
engagement about final conclusions reached on significant accounting or auditing matters.
e. Circumstances that cause significant difficulty in applying auditing procedures.
f. Significant changes in the assessed level of audit risk for particular audit areas and the
auditor's response to those changes.
g. Any matters that could result in modification of the auditor's report.
It is not practical to document every matter the auditor considers. In deciding the extent of
working papers is a matter of professional judgment by the auditor.
The form and content of working papers depend on factors such as:
➢
➢
➢
➢
➢
Nature of the engagement.
Form of the auditor’s report.
Nature and complexity of the business.
Nature and condition of the entity’s accounting and internal control systems.
Needs in the particular circumstances for direction, supervision, and review of work
performed by assistants.
➢ Specific audit methodology and technology used in the course of the audit.
TYPES OF FILES
1. Permanent files
2. Current files
Permanent files contain information about the client that are of continuing relevance to the
audit. These files provide a convenient source of information about the audit that is of continuing
significance from year to year. Current files include all the information applicable to the year under
audit.
Examples of Information Included in Permanent and Current Files
Permanent File
➢
➢
➢
➢
➢
➢
Copies of the corporate charter/ bylaws
Copies of contracts
Chart of accounts
Organizational chart
Accounting manuals
Information relating to the understanding the internal control
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➢ Terms of stock and bond issues
➢ The results of analytical procedures from prior year’s audit.
Current File
➢
➢
➢
➢
➢
➢
Audit program
Working trial balance
Copies of minutes of meetings
Copy of financial statement
Copy of auditor’s report
Working papers supporting financial statement accounts (lead and detailed
schedules)
AUDIT PROGRAM
An audit program contains the detailed audit procedures that will be conducted by the
auditor. It is normally maintained in a separate file to improve the coordination and integration of
all parts of the audit. As the audit progresses, each auditor initials the program for the audit
procedures conducted and indicates the date of completion.
WORKING TRIAL BALANCE/LEAD SCHEDULE
The working trial balance is a listing of the general accounts with its year-end balances as
unadjusted amount directly obtained from client, proposed audit adjustment, and the audited
balance amount. Each line item on the trial balance is supported by a lead schedule. Lead (Top)
schedule contains the detailed accounts from the general ledger making up the line item total.
Each detailed account on the lead schedule is supported by appropriate schedules supporting
the audit work performed and the conclusion reached. For example, the trial balance would
contain only one line for cash and the lead schedule would list all general ledger cash accounts
(e.g., Petty Cash, Cash in Bank A, Cash in Bank B) and each detailed account on the lead
schedule for cash is supported by appropriate schedules (Cash count for Petty Cash, Bank
Reconciliation for Cash in Bank). Figure 7.3 shows the relationships of working papers to financial
statements.
Supporting Schedules
These are the largest portion of audit documentation prepared by auditors in support of
specific amounts on the financial statements. For example, aging of receivables, bank
reconciliations, and lapsing schedule/listing for property and equipment.
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Adjusting and Reclassification Entries
Adjusting entries are made to correct the discovered misstatement in the client’s records.
Reclassification entries are made in the financial statements to present the accounting information
properly. It should be noted that only those adjusting and reclassification entries that significantly
affect the fair presentation of financial statements must be made. The determination of when
misstatement should be adjusted is based on materiality.
Its Format
Working papers may be prepared in both manually and electronically. Whether these were
prepared manually or electronically, the manner in which it is formatted usually contains the
following characteristics:
Heading
All working papers should have a proper heading such as the name of the client, the title
of the working paper and the date covered by the examination.
Indexing and Cross-Referencing
Indexing is the use of lettering or numbering system in the working paper. For example
cash may be labeled as A for its lead schedule. When auditor conducts audit work on one working
paper and the supporting information is obtained from another working paper, the auditor crossreferences the information on each working paper. This is important to provide a trail useful in
reviewing the working papers.
Tick Marks
The auditors use tick marks to document work performed. These are the symbols that
describe the audit procedures performed by the auditor.
Ownership of Working Papers
According to PAS 230, working papers are the property of the auditor. Portions of working
papers may be made available to the client at the discretion of the auditor, but they should not be
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considered as part or as substitute for the client’s records. The Philippine Accountancy Act of
2004, Section 29 specifies the legal provision on ownership of audit working papers.
Confidentiality of Working Papers
Although the auditor owns the working papers, they cannot be shown, except under
certain circumstances, to anyone without the client’s consent. Section 4 of the Code of Ethics for
Professional Accountants in the Philippines provides guidance for the confidentiality of information
obtained during the course of audit. One of the guidance is that the auditor can disclose
confidential information even without the client’s consent when:
1. Disclosure is required by law.
a. To produce documents or to give evidence in the course of legal proceedings.
b. To disclose to the appropriate public authorities infringements of law which come to light.
2. There is a professional duty or right to disclose.
a. To comply with technical standards and ethics requirements.
b. To protect professional interest of a professional accountant in legal proceedings.
c. To comply with the quality review of a member body or professional body. To respond to
an inquiry or investigation by a member body or regulatory body.
Multiple Choice Questions
1. Prior to the acceptance of an audit engagement with a client who has terminated the services
of the predecessor auditor, the CPA should
a. Contact the predecessor auditor without advising the prospective client and request a
complete report of the circumstance leading to the termination with the understanding that
all information disclosed will be kept confidential.
b. Accept the engagement without contacting the predecessor auditor since the CPA can
include audit procedures to verify the reason given by the client for the termination.
c. Not communicate with the predecessor auditor because this would in effect be asking
the
auditor to violate the confidential relationship between auditor and client.
d. Advise the client of the intention to contact the predecessor auditor and request
permission for the contact.
2. Before accepting an audit engagement, a successor auditor should make specific inquiries of
the predecessor auditor regarding the predecessor’s
a. Opinion of any subsequent events occurring since the predecessor’s audit report was
issued.
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b. Understanding as to the reasons for the change of auditors.
c. Awareness of the consistency in the application of accounting standards between
periods.
d. Evaluation of all matters of continuing accounting significance.
3. A successor auditor most likely would make specific inquiries of the predecessor auditor
regarding
a. Specialized accounting principles of the client’s industry.
b. The competency of the client’s internal audit staff.
c. The uncertainty inherent in applying sampling procedures.
d. Disagreements with management as to auditing procedures.
4. Which of the following should an auditor obtain from the predecessor auditor prior to
accepting an audit engagement?
a. Analysis of balance sheet accounts
b. Analysis of income statement accounts
c. All matters of continuing accounting significance
d. Facts that might bear on the integrity of management
5. When an independent auditor is approached to perform an audit for the first time, he or she
should make inquiries of the predecessor auditor. Inquiries are necessary because the
predecessor may be able to provide the successor with information that will assist the successor
in determining whether
a. The predecessor’s work should be used.
b. The company rotates auditors.
c. In the predecessor’s opinion, control risk is low.
d. The engagement should be accepted.
6. The development of a general strategy and a detailed approach for the expected nature, timing,
and extent of audit refers to :
a. Supervision
b. Audit procedures
c. Directing
d. Planning
7. The auditor should consider the nature, extent, and timing of the work to be performed and
should prepare a written audit program for every audit. Which audit standard is most closely
related to this requirement?
a. The audit is to be performed by a person or persons having adequate technical training
and proficiency as an auditor.
b. In all matters relating to the assignment, an independent mental attitude is to be
maintained by the auditor(s).
c. Due professional care is to be exercised in the planning and performance of the audit
and preparation of the report.
d. The work is to be adequately planned and assistants, if any, are to be properly
supervised.
8. Which of the following would a successor auditor normally perform after acceptance of an audit
client?
a. Inquiry of predecessor auditor regarding the client.
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b. Review the SEC filings of the client.
c. Inquiry of bankers regarding the client.
d. Review of predecessor auditor working papers.
9. To obtain an understanding of a continuing client’s business in planning an audit, an auditor
most likely would
a. Perform tests of details of transactions and balances.
b. Review prior-year working papers and the permanent file for the client.
c. Read specialized industry journals.
d. Reevaluate client’s internal control environment.
10. Which of the following is required documentation in an audit in accordance with Philippine
Auditing Standards?
a. A flowchart or narrative of the information system describing the recording and
classification of transactions for financial reporting.
b. An audit program setting forth in detail the procedures necessary to accomplish the
engagement’s objectives.
c. A planning memorandum establishing the timing of the audit procedures and
coordinating the assistance of entity personnel.
d. An internal control questionnaire identifying policies and procedures that assure specific
objectives will be achieved.
11. Which of the following procedures would an auditor most likely perform in planning a financial
statement audit?
a. Inquiring of the client’s legal counsel concerning pending litigation.
b. Comparing the financial statements to anticipated results.
c. Examining computer generated exception reports to verify the effectiveness of internal
controls.
d. Searching for unauthorized transactions that may aid in detecting unrecorded liabilities.
12. Analytical procedures used in planning an audit should focus on
a. Reducing the scope of tests of controls and substantive tests.
b. Providing assurance that potential material misstatements will be identified.
c. Enhancing the auditor’s understanding of the client’s business.
d. Assessing the adequacy of the available evidential matter.
13. According to PSA 400, which of the following is correct regarding internal control system?
a. Internal control system refers to all the policies and procedures adopted by the auditor
to assist in achieving management’s objective.
b. A strong environment, by itself, ensure the effectiveness of the internal control system.
c. In the audit of financial statements, the auditor is only concerned with those policies and
procedures within the accounting and internal control systems that are relevant to the
financial statements.
d. The internal control system is confined to those matters which relate directly to the
functions of the accounting system.
14. Which of the following is correct about internal control?
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a. Accounting and internal control systems provide management with conclusive evidence
that
objectives are reached.
b. One of the inherent limitations of accounting and internal control systems is the
possibility that the procedures may become inadequate due to changes in conditions, and
compliance with
procedures may deteriorate.
c. Most internal controls tend to be directed at non-routine transactions.
d. Management does not consider costs of the accounting and internal control systems.
15. Corporate directors, management, external auditors, and internal auditors all play important
roles in creating a proper control environment. Top management is primarily responsible for
a. Establishing a proper environment and specifying overall internal control.
b. Reviewing the reliability and integrity of financial information and the means used to
collect
and report such information.
c. Ensuring that external and internal auditors adequately monitor the control environment.
d. Implementing and monitoring controls designed by the board of directors.
16. Which of the following best describe the interrelated components of internal control?
a. Organizational structure, management philosophy, and planning.
b. Control environment, risk assessment, control activities, information and
communication
systems, and monitoring.
c. Risk assessment, backup facilities, responsibility accounting and natural laws.
d. Legal environment of the firm, management philosophy, and organizational structure.
17. In an audit of financial statements, an auditor’s primary consideration regarding a control is
whether it
a. Reflects management’s philosophy and operating style.
b. Affects management’s financial statement assertions.
c. Provides adequate safeguards over access to assets.
d. Enhances management’s decision-making processes.
18. Effective internal control
a. Eliminates risk and potential loss to the organization.
b. Cannot be circumvented by management.
c. Is unaffected by changing circumstances and conditions encountered by the
organization.
d. Reduces the need for management to review exception reports on a day-to-day basis.
19. Which of the following statements about internal control is correct?
a. Properly maintained internal controls reasonably assure that collusion among
employees cannot occur.
b. Establishing and maintaining internal control is the internal auditor’s responsibility.
c. Exceptionally strong control allows the auditor to eliminate substantive tests.
d. The cost-benefit relationship should be considered in designing internal control.
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20. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of
the risk that
a. Tests of controls may fail to identify controls relevant to assertions.
b. Material misstatements may exist in the financial statements.
c. Specified controls requiring segregation of duties may be circumvented by collusion.
d. Entity policies may be overridden by senior management.
21. A proper understanding of the client’s internal control is an integral part of the audit planning
process. The results of the understanding
a. Must be reported to the shareholders and the SEC.
b. Bear no relationship to the extent of substantive testing to be performed.
c. Are not reported to client management.
d. May be used as the basis for withdrawing from an audit engagement.
22. An entity should consider the cost of a control in relationship to the risk. Which of the following
controls best reflects this philosophy for a large peso investment in heavy machine tools?
a. Conducting a weekly physical inventory.
b. Placing security guards at every entrance 24 hours a day.
c. Imprinting a controlled identification number on each tool.
d. Having all dispositions approved by the vice president of sales.
23. Audit evidence concerning segregation of duties ordinarily is best obtained by
a. Performing tests of transactions that corroborate management’s financial statement
assertions
b. Observing the employees as they apply specific controls.
c. Obtaining a flowchart of activities performed by available personnel.
d. Developing audit objectives that reduce control risk.
24. Which of the following statements about preliminary assessment of control risks is correct?
a. After obtaining an understanding of the accounting and internal control systems, the
auditor should make a preliminary assessment of control risks, at the assertion level, for
all accounts or transaction classes.
b. The preliminary assessment of control risk can be done only after completing tests of
controls.
c. The preliminary assessment of control risk for a financial assertion is normally low,
unless the auditor is able to identify weaknesses that may indicate ineffectiveness of
accounting and internal control system.
d. The auditor ordinarily assesses control risk at high level for some or all assertions when
it is not cost efficient to do tests of controls.
25. An auditor wishes to perform tests of controls on a client’s cash disbursements procedures. If
the controls leave no audit trail of documentary evidence, the auditor most likely will test the
procedures by
a. Confirmation and observation.
c. Analytical procedures and confirmation.
b. Observation and inquiry.
d. Inquiry and analytical procedures
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26. Which of the following would not be a method used to conduct tests of controls?
a. Inquiry
b. Walkthrough
c. Confirmation
d. Observation
27. The auditor is examining copies of sales invoices only for the initials of the person responsible
for checking the extensions. This is an example of a
a. Test of controls
c. Dual purpose test
b. Substantive test
d. Test of balances
28. Which of the following is correct statement?
a. The auditor should use professional judgment to assess audit risk and to design audit
procedures to ensure it is eliminated.
b. The auditor is an insurer, and his or her report constitutes a guarantee.
c. The subsequent discovery that a material misstatement exists in the financial
statements is evidence of inadequate planning, performance, or judgment on the part of
the auditor.
d. The auditor should obtain an understanding of the accounting and internal control
systems sufficient to plan the audit and develop an effective audit approach.
29. According to PSA 400 – Risk Assessments and Internal Control, audit risk means
a. The susceptibility of an account balance or class of transactions to misstatement that
could be material, individually or when aggregated with misstatements in other balances
or classes, assuming that there were no related internal controls.
b. The risk that a misstatement, that could occur in an account balance or class of
transactions and that could be material, individually or when aggregated with
misstatements in other balances or classes, will not be prevented or detected and
corrected on a timely basis by the accounting and internal control systems.
c. The risk that an auditor’s substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material, individually or
when aggregated with misstatements in other balances or classes.
d. The risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated.
30. Inherent risk and control risk differ from detection risk in that they
a. Arise from the misapplication of auditing procedures.
b. May be assessed in either quantitative or nonquantitative terms.
c. Exist independently of the financial statement audit.
d. Can be changed at the auditor’s discretion.
31. Inherent risk and control risk differ from detection risk in that inherent risk and control risk are
a. Elements of audit risk while detection risk is not.
b. Changed at the auditor’s discretion while detection risk is not.
c. Considered at the individual account-balance level while detection risk is not.
d. Functions of the client and its environment while detection risk is not.
32. Which of the following is an incorrect statement?
a. Detection risk is a function of the effectiveness of an auditing procedure and its
application.
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b. Detection risk arises partly from uncertainties that exists when the auditor does not
examine 100 percent of the population.
c. Detection risk arises partly because of other uncertainties that exist even if the auditor
were to examine 100 percent of the population.
d. Detection risk exists independently of the audit of the financial statements.
33. PSA 315 requires
a. The auditor to obtain an understanding of the entity and its environment, including its
internal
control.
b. Discussion among the engagement team about the susceptibility of the entity’s financial
statements to material misstatement.
c. The auditor to identify and assess the risks of material misstatement at the financial
statement and assertion levels.
d. All of the above.
33. Which of the following is incorrect regarding PSA 315?
a. The purpose of this PSA is to establish standards and to provide guidance on obtaining
an understanding of the entity and its environment, including its internal control, and on
assessing the risks of material misstatement in a financial statement audit.
b. This PSA requires the auditor to make risk assessments at the financial statement and
assertion levels based on an appropriate understanding of the entity and its environment,
including its internal control.
c. The requirements and guidance of this PSA are to be applied in conjunction with the
requirements and guidance provided in other PSAs.
d. This PSA discusses the auditor’s responsibility to determine overall responses and to
design and perform further audit procedures whose nature, timing, and extent are
responsive to the risk assessments.
34. Which statement is incorrect regarding audit evidence?
a. Audit evidence is all the information used by the auditor in arriving at the conclusions
on which the audit opinion is based.
b. Audit evidence includes the information contained in the accounting records underlying
the financial statements and other information.
c. Audit evidence is cumulative in nature.
d. Auditors are expected to address all information that may exist.
35. Accounting records least likely include
a. The records of initial entries and supporting records.
b. The general and subsidiary ledgers.
c. Work sheets and spreadsheets supporting cost allocations.
d. Comparable data about competitors (benchmarking).
36. Other information that the auditor may use as audit evidence least likely includes
a. Minutes of meetings.
b. Confirmations from third parties.
c. Information obtained by the auditor from such audit procedures as inquiry, observation,
and inspection.
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d. Adjustments to the financial statements that are not reflected in formal journal entries.
37. Which statement is correct regarding the sufficiency and appropriateness of audit evidence?
a. Sufficiency is the measure of the quality of audit evidence.
b. Appropriateness is the measure of the quantity of audit evidence; that is, its relevance
and its reliability in providing support for, or detecting misstatements in, the classes of
transactions, account balances, and disclosures and related assertions.
c. The quantity of audit evidence needed is affected by the risk of misstatement (the
greater the risk, the more audit evidence is likely to be required) and also by the quality of
such audit evidence (the higher the quality, the less may be required).
d. Merely obtaining more audit evidence may compensate for its poor quality.
38. Which of the following statements is incorrect regarding relevance of audit evidence?
a. A given set of audit procedures may provide audit evidence that is relevant to certain
assertions, but not others.
b. The auditor often obtains audit evidence from different sources or of a different nature
that is relevant to the same assertion.
c. Obtaining audit evidence relating to a particular assertion is a substitute for obtaining
audit evidence regarding another assertion.
d. None of the above.
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Lesson 3 – Major Phases of an Audit - Part II
Audit of Business Transaction Cycles and Audit Sampling
Overview:
Auditors generally divide an entity’s information system into business processes or
transaction cycles. Using this approach, the auditor is able to gather evidence by examining the
processing of related transactions from their origin to their ultimate disposition in accounting
journals and ledgers. The five basic processes are (1) the revenue process, (2) the purchasing
process, (3) the human resource management process, (4) the inventory management process,
and (5) the financing process. Auditors divide the financial statement components into business
processes or cycles in order to manage the audit better.
In the early days of auditing, it was not unusual for the independent auditor to examine all
of the records of the company being audited. However, as companies grew in size and complexity,
it became uneconomical to examine all the accounting records and supporting documents.
Auditors found it necessary to draw conclusions about the fairness of a company’s financial
statements based on an examination of a subset of the records and transactions. As a result, the
auditor provides reasonable, not absolute, assurance that the financial statements are fairly
presented. The justification for accepting some uncertainty is the trade-off between the cost of
examining all the data and the cost of making an incorrect decision based on a sample of the
data.
Learning Objectives:
After studying this lesson, the student should:
•
•
•
•
•
•
Identify the fundamental tasks performed in the transaction cycles.
Describe the functional departments involved in transaction cycles activities and
trace the flow of these transactions through the organization.
Understand the documents, journals, and accounts that provide audit trails,
promote the maintenance of historical records, support internal decision making,
and sustain financial reporting.
Identify the risks associated with various transaction cycles and recognize the
controls that reduce those risks.
Identify the nature and purposes of audit sampling.
Describe differences between statistical and non-statistical sampling; attribute and
variable sampling, including the risks associated.
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•
•
Identify the nature of various sample selection methods under attribute and
variable sampling
Understand the steps in performing audit sampling and how to document the
samples selection
Course Materials:
A. Revenue Cycle
The revenue cycle is a recurring set of business activities and related information
processing operations associated with providing goods and services to customers and collecting
cash in payment for those sales. The basic activities in the revenue cycle are: order entry soliciting and processing customer activities- filling customer orders and shipping merchandiseinvoicing customers and maintaining customer accounts collections - the cashier handles
remittances and deposits them in the bank; accounts receivable personnel credits customer
accounts for the payments received.
The sales department receives the order information from the customer, either by mail,
phone, or in person. Information is captured on a sales order form which includes customer name,
account number, name, number and description of items ordered, quantities and unit prices plus
taxes, shipping info, discounts, freight terms. This form is usually prepared in multiple copies that
are used for credit approval, packing, stock release, shipping, and billing. The credit department
provides transaction authorization by approving the customer for a credit sale and returns and
allowances. The shipping department receives information from the sales department in the form
of packing slip and shipping notice. When the goods arrive from the warehouse, the documents
are reconciled with the stock release papers. The goods are packed and labeled. The packing
slip is included. The shipping notice is sent to billing. A bill of lading is prepared to accompany the
shipment.
The common documents in revenue cycle are as follows:
• Sales invoice notifies customer of amount to be paid.
• Monthly statement summarizes all transactions that occurred during month.
• Credit memo authorizes the billing department to credit the customer's account,
should be issued by credit manager.
The following are the threats and related controls for Revenue Cycle:
Threat 1: Sales to customers with poor credit.
Controls: Having an independent credit approval function and maintaining good customer
accounting can help to prevent problems.
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Threat 2: Shipping errors
Controls: Reconciling shipping notices with picking tickets; bar-code scanners; and data
entry application controls will help to catch these errors.
Threat 3: Theft of inventory
Controls: Secure the location of inventory and document transfers; release only with valid
shipping orders; have good accountability for picking and shipping; and finally, periodically
reconcile records with a physical count.
Threat 4: Failure to bill customers
Controls: Separating shipping and billing and pre-numbering of shipping documents helps
along with reconciliation of all sales documents.
Threat 5: Billing errors
Controls: Reconciliation of picking tickets and bills of lading with sales orders; data entry
edit controls; and price lists may prevent billing errors.
Threat 6: Theft of cash
Controls: Segregation of duties is essential to prevent this serious problem (the following
duties should be separate: handling cash and posting to customer accounts; handling
cash and authorizing credit memos and adjustments; issuing credit memos and
maintaining customer accounts); use of lockboxes for receipts and electronic fund transfer
(EFT) for disbursements; mailing customer statements monthly; use cash registers in retail
operations where cash payments are received; deposit cash daily in the bank; and have
the bank reconciliation function performed by independent third parties.
Threat 7: Posting errors in updating accounts receivable.
Controls: Use of editing and batch totals is essential here.
Threat 8: Loss of data.
Controls: Regular backups are essential with one copy stored off-site; and logical and
physical access controls to prevent leakage to competitors and irregularities.
Threat 9: Poor performance
Controls: Use sales and profitability analyses; accounts receivable aging; and cash
budgets to track operations.
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*Each of these substantive tests of transactions could be conducted as a test of controls or a dual-purpose
test. Of these six assertions, the cutoff assertion is the one that is most often conducted as a substantive
procedure.
B. Expenditure Cycle
The expenditure cycle is a recurring set of business activities and related data processing
operations associated with the purchase of and payment for goods and services. The basic
activities in the expenditure cycle are: Requesting the purchase of needed goods. Ordering goods
to be purchased. Receiving ordered goods. Approving vendor invoices for payment. Paying for
goods purchased.
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Inventory control monitors inventory and authorizes restocking with a purchase requisition.
A copy is retained and one is sent to accounts payable. Purchasing acts on the purchase
requisition and prepares a purchase order. The original is sent to a vendor. Copies go to inventory
control and accounts payable. A blind copy is sent to receiving and another is filed in purchasing.
When the goods are received, the receiving staff count and inspect the goods. The blind
PO tells what goods were ordered. The count is a significant control check. Receiving prepares a
receiving report. One copy accompanies the goods to the storeroom. Other copies go to
purchasing, inventory control, and accounts payable.
Accounts payable reconciles the purchase requisition, purchase order and receiving
report. When the vendor invoice arrives, it is examined thoroughly and reconciled and if all
documents agree, the transaction is recorded in the purchases journal and the accounts payable
subsidiary ledger. The information is filed until the time arises to make payment. The general
ledger department receives a journal voucher from AP and a summary from inventory control.
The inventory and accounts payable control accounts are updated.
For the disbursements, accounts payable reviews the documents related to a liability:
purchase requisition, purchase order, receiving report, and vendor invoice. If proper, cash
disbursements department is authorized to make payment.
Cash disbursements prepares the check, a separate person signs it, sends it to the
vendor, and notifies accounts payable. At the end of the period, cash disbursements and accounts
payable send summary information to general ledger.
The following are the threats and related controls for Expenditure Cycle:
Threat 1: Stock-outs
Controls: Inventory control system; accurate perpetual inventory; and vendor performance
analysis is needed to prevent this problem.
Threat 2: Requesting goods not needed.
Controls: Review and approval by supervisors; use of pre-numbered requisition forms;
and restricted access to blank purchase orders.
Threat 3: Purchasing goods at inflated prices.
Controls: Competitive bidding and proper supervision; approved purchase orders; and
price list consultations are needed to prevent this problem.
Threat 4: Purchasing goods of inferior quality.
Controls: Use experienced buyers who know good vendors; review purchase orders; and
incorporate approved vendor list into formal procedures.
Threat 5: Purchasing from unauthorized vendors.
Control: Pre-numbered purchase orders should be approved; restrict access to approved
vendor list and have procedures in place for any change to the list.
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Threat 6: Kickbacks paid to buyers to influence their decisions.
Controls: Clear conflict of interest policy prohibiting the acceptance of any gift from
vendors; disclosure of financial interest policy for purchasing agents; and vendor audits.
Threat 7: Receiving unordered goods.
Controls: Receiving department must reject any goods for which there is no approved
purchase order.
Threat 8: Errors in counting goods received.
Controls: Use "blind" P.O. copies to force receiving personnel to actually count goods;
provide incentives for counting goods.
Threat 9: Theft of inventory.
Controls: Secure inventory storage locations; make transfers of inventory with proper
approval and documentation; do periodic physical count and reconciliation with recorded
amounts.
Threat 10: Errors in vendor invoices.
Controls: Invoice accuracy should be verified and compared to P.O.s and receiving report
data.
Threat 11: Paying for goods not received.
Controls: Voucher package and original invoice should be necessary for payments.
Threat 12: Failure to take available purchase discounts.
Controls: File approved invoices by due date; track invoices by due date; use a cash
budget to plan for cash needs.
Threat 13: Paying same invoice twice.
Controls: Invoices should be approved only with a full voucher package and paid ones
should be canceled so they cannot be used again; do not pay invoices marked "Duplicate"
or "Copy".
Threat 14: Recording and posting errors for purchases and payments.
Controls: Data entry controls, and periodic reconciliation of subsidiary ledger with general
ledger control account.
Threat 15: Misappropriation of cash by paying fictitious vendors and alteration of checks.
Controls: Restrict access to cash, blank checks, and check signing machine; use check
protection, pre-numbered checks, and imprinted amounts on checks to cut down on
forgery and fraud; use petty cash fund for small expenditures only; have proper
segregation of duties and independent bank reconciliation function.
Threat 16: Theft associated with Electronic Fund Transfer (EFT) use.
Controls: Access controls to the system; encryption of transmissions; timestamp and
number transmissions; control group should monitor all EFT activity.
Threat 17: Loss of data.
Controls: Use file labels, back up of all data files regularly; and, use access controls.
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The Fixed Asset System processes nonroutine transactions which are recorded as capital
assets. The receiving department delivers fixed assets to the user/manager. The fixed asset
department performs the record keeping function. Asset acquisition handles the steps leading to
the acquisition of new fixed assets: recognition of need, authorization and approval, possible
capital investment analysis, and selection of supplier. Because of the value of fixed assets, special
approvals are needed.
INDEPENDENT VERIFICATION CONTROLS.
1. Periodically, the internal auditor should review the asset acquisition and approval
procedures to determine the reasonableness of key factors including: the useful life of the asset,
the original financial cost, proposed cost savings as a result of acquiring the asset, the discount
rate used, and the capital budgeting method used in justifying decisions to buy or dispose of
assets.
2. The internal auditor should verify the location, condition, and fair value of the
organization’s fixed assets against the fixed asset records in the subsidiary ledger.
3. The automatic depreciation charges calculated by the fixed asset system should be
reviewed and verified for accuracy and completeness. System errors that miscalculate
depreciation can result in the material misstatement of operating expenses, reported earnings,
and asset values.
AUTHORIZATION CONTROLS. Because fixed assets are requested and employed by endusers asset acquisitions should be formal and explicitly authorized. Each material transaction
should be initiated by a written request from the user or department. In the case of high-value
items, there should be an independent approval process that evaluates the merits of the request
on a cost-benefit basis.
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*These tests of details of transactions are commonly conducted as a dual-purpose test (i.e., in
conjunction with tests of controls).
†These tests can be conducted manually or using CAATs.
C. Payroll Cycle
Payroll lends itself to batch computerization because it is processed at fixed time intervals
which permits some time lag. Processing the payroll file usually involves most employees each
time it is processed, which is an efficient use of computer resources and can be accomplished
with a single pass through the file.
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Three types of controls can be used to circumvent payroll errors in a Human Resource
Management (HRM)/payroll system. Batch totals are used to verify totals entered into the system
both at the time of data entry and at each stage in the processing. Hash totals are particularly
useful in this regard, since hash totals calculated at the time of original data entry and again at
each stage in the process can be compared. When the comparisons match throughout the
process, three conclusions can be made:
1) all payroll records have been processed;
2) the data input was accurate; and
3) no bogus timecards were entered at any point after initial input.
Upon completion of a payroll, the payroll register should be cross-footed to verify that the
totals of the net pay column and other deduction columns equal the total of the gross pay column.
A third control is the use of a payroll clearing account. This is a general ledger account that can
be used as part of a two-step accuracy and completeness process. First, the payroll control
account will be debited for the amount of the gross pay for the pay period; cash and other various
withholding liability accounts are credited. Second, the cost accounting process distributes labor
costs to various expense categories and credits the payroll control account for the total amount
of the debits made to the other accounts. The result is that the payroll control account will have a
zero balance. This becomes an internal check known as a zero-balance check, indicating that
the proper postings have been made to all of the accounts associated with payroll for a given pay
period.
Many problems may result when there are unauthorized changes to the payroll master
file. Unauthorized changes may be made to employee pay rates, resulting in the company paying
too much in wages. "Ghost" or "phantom" employees may be added to the payroll master to
divert funds to dishonest employees through the issuance of paychecks to such "employees."
Likewise, terminated employees may still be paid, resulting in the fraudulent diversion of payroll
funds. Two controls that should be implemented and maintained to provide overall control of the
payroll master file: proper segregation of duties and controlling access to the file. Good internal
control dictates that only authorized HRM personnel be allowed to update the payroll master file
for any hiring, termination, pay raise, and promotion. HRM personnel, who have such access to
the payroll master file, should never be allowed to directly participate in actual payroll processing
or paycheck distribution. This way an adequate control is created to match actual paychecks (or
earnings statements when direct deposit is in place) with employees when a manager, supervisor,
or other third-party hand out the checks (or earnings statements). Also, a different individual
should approve all changes to the payroll master file in writing other than the individual who
recommends or initiates the changes. User IDs and passwords should always be used to control
access to the payroll master file, and an access control matrix should be established to define
what actions each authorized employee is allowed to make and confirms the files the employee
may access.
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* These tests of details of transactions are commonly conducted as dual-purpose tests (i.e., in conjunction
with tests of controls).
D. Inventory Management Process
The production cycle is a recurring set of business activities and related data processing
operations associated with the manufacture of products. There are four basic activities in the
production cycle: product design, planning and scheduling, production operations, and cost
accounting.
The threats to the production cycle and the applicable control procedures used to mitigate
each threat are as follows:
Threat 1: Unauthorized transactions
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Controls: Accurate sales forecasts, maintaining accurate inventory records; authorizing
production; restricting access to the production planning program; and review and
approval of capital expenditures
Threat 2: Theft or destruction of inventories and fixed assets
Controls: Restrict physical access to inventories; document internal physical flow of
assets; proper segregation of duties; periodic physical count and reconciliation of
inventory; document and authorize materials requests and disposal of fixed assets; and
have adequate insurance
Threat 3: Recording and posting errors
Controls: Automate data collection procedures; online data entry edit controls; and
conduct periodic physical inventory and fixed asset counts
Threat 4: Loss of data
Controls: Regularly back up files; keep additional master files; use internal and
external file labels; restrict access; and keep logs of all activities
Threat 5: Inefficiencies and quality control problems
Controls: Prepare regular performance reports; highlight exception reports and variances;
compare actual performance to budgeted performance; measure throughput; and
measure the cost of quality control.
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*Many of these tests of details of transactions are commonly conducted as dual-purpose tests (i.e., in
conjunction with tests of controls).
E. Financing Process
For many entities, accounts receivable and inventory represent the major current assets
included in the financial statements. Also included in most financial statements are accounts that
are referred to as other assets. A common type of other asset is a prepaid expense. Examples of
prepaid expenses include
• Prepaid insurance.
• Prepaid rent.
• Prepaid interest.
One major difference between asset accounts such as accounts receivable or inventory
and prepaid expenses is the materiality of the account balances. On many engagements, prepaid
expenses, deferred charges, and intangible assets are not highly material. As a result, substantive
analytical procedures may be used extensively to verify these account balances.
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The auditor’s approach to the audit of investments varies depending on the size of the
investment and the amount of investment activity. For an entity that has a large investment
portfolio, the auditor is likely to follow a reliance strategy in which internal control is formally
evaluated and tests of controls are performed in order to set control risk below the maximum.
However, for the vast majority of entities that do not require an audit of internal controls over
financial reporting, it is more efficient for the auditor to follow a substantive strategy and perform
a detailed audit of the investment securities at year-end.
*These tests of details of transactions are commonly conducted as dual-purpose tests (i.e., in conjunction
with tests of controls).
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Audit Sampling
Audit sampling is the process of selecting and evaluating a sample of items from a
population of audit relevance such that the auditors expect the sample to be representative of
some characteristic of the population. With this definition, representative means that the sample
will result in conclusions that are similar to those that would be drawn if the same procedures
were applied to the entire population.
Statistical sampling applies the laws of probability to selecting sample items for
examination and evaluating sample results. Specifically, statistical sampling methods enable the
audit team to make quantitative statements about the results and to measure the sufficiency of
evidence gathered (i.e., determine a sufficient sample size) and evaluate the results in such a
way to control sampling risk. Nonstatistical sampling plans do not meet either of these criteria.
Thus, these two types of plans differ in terms of how sample size is determined and how the
results are evaluated.
Sampling risk is the risk that the auditors’ conclusion based on a sample might be
different from the conclusion they would reach if they examined every item in the entire population.
Sampling risk is reduced by increasing the size of the sample. At the extreme, when an entire
population is examined there is no sampling risk. But auditing large samples or the entire
population is costly. Auditors may also draw erroneous conclusions because of nonsampling
errors, these are due to factors not directly caused by sampling. For example, the auditors may
fail to apply appropriate audit procedures, or they may fail to recognize errors in the documents
or transactions that are examined. The risk pertaining to nonsampling errors is referred to as
nonsampling risk.
Due to sampling risk, the auditor faces the chance that sampling may lead to one of two
possible types of decision errors: (1) deciding that the population tested is not acceptable when
in reality it is and (2) deciding that the population tested is acceptable when in reality it is not. In
statistical terms, these errors are known as Type I and Type II errors, respectively. More formally,
Type I and Type II errors are defined as follows:
•
Risk of incorrect rejection (Type I). In testing an internal control, this is the risk that
the sample supports a conclusion that the control is not operating effectively when, in
truth, it is operating effectively. When an auditor is evaluating the level of reliance that
can be placed on a control in the context of a financial statement audit, this risk is also
commonly referred to as the risk of underreliance or the risk of assessing control
risk too high. In substantive testing, this is the risk that the sample supports the
conclusion that the recorded account balance is materially misstated when it is actually
not materially misstated.
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•
Risk of incorrect acceptance (Type II). In testing a control, this is the risk that the
sample supports a conclusion that the control is operating effectively when, in truth, it
is not operating effectively. When an auditor is evaluating the level of reliance that can
be placed on a control in the context of a financial statement audit, this risk is also
commonly referred to as the risk of overreliance or the risk of assessing control risk
too low. In substantive testing, this is the risk that the sample supports the conclusion
that the recorded account balance is not materially misstated when it is actually
materially misstated.
In general, sampling can be viewed as including the following major steps:
The major types of statistical sampling plans used for audit sampling include the following:
1. Attributes sampling. This sampling plan enables the auditors to estimate the rate of
occurrence of certain characteristics in the population (e.g., deviations from performance
of a prescribed control). Attributes sampling frequently is used in performing tests of
controls.
2. Discovery sampling. This form of attributes sampling is designed to locate at least one
deviation (exception) in the population. Discovery sampling often is used in situations in
which the auditors expect a very low rate of occurrence of some critical deviation. As an
example, the auditors might use discovery sampling to attempt to locate a fraudulent cash
disbursement.
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3. Classical variables sampling. These sampling applications provide the auditors with an
estimate of a numerical quantity, such as the dollar balance of an account. As would be
expected, this technique is primarily used by auditors to perform substantive procedures.
For example, variables sampling might be used to plan, perform, and evaluate a sample
of accounts receivable selected for confirmation. Frequently used variables sampling
plans include mean-per-unit estimation, ratio estimation, and difference estimation.
4. Probability-proportional-to-size (PPS) sampling. This technique applies attributes
sampling theory to develop an estimate of the total dollar amount of misstatement in a
population. Probability-proportional-to-size sampling is used as an alternative to classical
variables sampling methods for performing substantive tests of transactions or balances.
Unlike classical variables sampling techniques that define the sampling unit as each
transaction or account balance in the population, PPS sampling defines the sampling unit
as each individual peso making up the book value of the population.
Sample selection methods are the following:
1. Unrestricted Random Selection (Random Selection). When using unrestricted random
selection (random selection), the audit team identifies a series of random numbers from
either a random number of table or computer program and selects the numbered item in
the corresponding population.
2. Systematic Random Selection (Systematic Selection). When using systematic random
selection (systematic selection), the audit team randomly selects a starting point from
within the population and includes every nth item thereafter, where n is determined based
on the number of items in the population and the necessary sample size.
3. Haphazard Selection. When using haphazard selection, items are selected in an
unstructured manner but without any intentional bias. One significant limitation of
haphazard selection is that, unlike either random selection or systematic selection, the
sampling method cannot be described in sufficient detail to permit another individual to
replicate it.
4. Block Selection. The use of block selection involves selecting a series of contiguous (or
adjacent) items from the population. Block selection is less desirable because it is difficult
to efficiently obtain a representative sample; ordinarily, a relatively large number of blocks
need to be selected to be representative.
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Proper documentation for audit samples could be a focal point of supervisory or quality
reviews. Some important information that may be documented are as follows:
•
•
•
•
•
The objective of the sampling application, characteristic of interest, and definition of
the population
The factors affecting sample size (along with the method or rationale for the selected
level of those factors) and determination of sample size.
The method of selecting the sample and description of items selected for examination.
The method of measuring sample items and summary of measurements
The evaluation of sample results and overall conclusion with respect to the sample.
Some important concepts to sampling are as follows:
➢ Allowance for sampling risk (ASR). Also referred to as precision, an interval around the
sample results in which the true population characteristic is expected to lie.
➢ Confidence level. In attributes sampling, the complement of the risk of assessing control
risk too low. In variables sampling, the complement of the risk of incorrect acceptance.
Thus, if the risk of assessing control risk too low (or of incorrect acceptance) is .05, the
confidence level is .95.
➢ Deviation rate. A defined rate of departure from prescribed controls. Also referred to as
occurrence rate or exception rate.
➢ Difference estimation. A sampling plan that uses the difference between the audited
(correct) values and book values of items in a sample to calculate the estimated total
audited value of the population.
➢ Expected population deviation rate. An advance estimate of a deviation rate. This
estimate is necessary for determining the required sample size in an attributes sampling
plan.
➢ Mean. The average item value, computed by dividing total value by the number of items
composing total value.
➢ Mean-per-unit estimation. A classical variables sampling plan enabling the auditors to
estimate the average dollar value (or other variable) of items in a population by
determining the average value of items in a sample.
➢ Projected misstatement. An estimate of the most likely amount of monetary
misstatement in a population.
➢ Ratio estimation. A sampling plan that uses the ratio of audited (correct) values to book
values of items in the sample to calculate the estimated total audited value of the
population.
➢ Reliability. The complement of the risk of incorrect acceptance.
➢ Representative sample. A sample possessing essentially the same characteristics as
the population from which it was drawn.
➢ Sequential (stop-or-go) sampling. A sampling plan in which the sample is selected in
stages, with the need for each subsequent stage being conditional on the results of the
previous stage.
➢ Standard deviation. A measure of the variability or dispersion of item values within a
population; in a normal distribution, 68.3 percent of all item values fall within ±1 standard
deviation of the mean, 95.4 percent fall within ±2 standard deviations, and 99.7 percent
fall within ±3 standard deviations.
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➢ Stratification. Dividing a population into two or more relatively homogeneous subgroups
(strata). Stratification increases the efficiency of most sampling plans by reducing the
variability of items in each stratum.
➢ Tolerable deviation rate. The maximum population rate of deviations from a prescribed
control that the auditor will tolerate without modifying the planned assessment of control
risk.
Multiple Choice Questions
1. An entity's financial statements were misstated over a period of years due to large amounts of
revenue being recorded in journal entries that involved debits and credits to an illogical
combination of accounts. The auditor could most likely have been alerted to this fraud by
a. Scanning the general journal for unusual entries.
b. Performing a revenue cut-off test at year-end.
c. Tracing a sample of journal entries to the general ledger.
d. Examining documentary evidence of sales returns and allowances recorded after
year-end.
2. An auditor reconciles the total of the accounts receivable subsidiary ledger to the general
ledger control account, as of August 31, 2019. By this procedure, the auditor would be most likely
to learn of which of the following?
a. An August invoice was improperly computed.
b. An August check from a customer was posted in error to the account of another
customer with a similar name.
c. An opening balance in a subsidiary ledger account was improperly carried forward
from the previous accounting period.
d. An account balance is past due and should be written off.
3. On receiving the bank cutoff statement, the auditor should trace
a. Deposits in transit on the year-end bank reconciliation to deposits in the cash receipts
journal.
b. Checks dated prior to year-end to the outstanding checks listed on the year-end bank
reconciliation.
c. Deposits listed on the cutoff statement to deposits in the cash receipts journal.
d. Checks dated subsequent to year-end to the outstanding checks listed on the yearend bank reconciliation.
4. In conducting a search for unrecorded liabilities, the auditor should do all EXCEPT:
a. Examine paid invoices for a short period following the balance sheet date and trace to
client's year-end adjustment for unrecorded liabilities.
b. Examine unpaid invoices for a short period following the balance sheet date and trace
to client's year-end adjustment for unrecorded liabilities.
c. Examine prior year's audit workpapers to ascertain that adjustments for unrecorded
liabilities have not been overlooked.
d. Examine invoices paid a few days prior to the balance sheet date.
5. In performing an audit on the existence of inventory contained in a warehouse, an auditor is
primarily concerned with
a. Observing and testing the number of units on hand.
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b. Determining if the value of the inventory is reasonable.
c. Identifying the ownership of the inventory.
d. Locating slow moving items contained in inventory.
6. Which of the following accounts would contain the best data for an auditor performing an
analytical review to evaluate the reasonableness of the annual payroll?
a. Payroll taxes expense.
c. Payroll taxes withheld.
b. Sales and cost of goods sold.
d. Credit union payable.
7. The most significant audit step in substantiating additions to the office equipment account
balance is
a. Examination of vendors' invoices and receiving reports for current year's acquisitions.
b. Review of transactions near the balance sheet date for proper period cutoff.
c. Calculation of ratio of depreciation expense to gross office equipment cost.
d. Comparison to prior year's acquisitions.
8. In testing the reasonableness of interest income, an auditor could most effectively use
analytical tests involving
a. The beginning balance in the investments account for fixed income securities.
b. The average monthly balance in the investments account for fixed income securities.
c. The ending balance in the investment accounts for fixed income securities.
d. Documentary support of specific entries in the account.
9. All corporate capital stock transactions should ultimately be traced to the _____________.
a. Minutes of the Board of Directors.
c. Cash receipts journal.
b. Cash disbursements journal.
d. Numbered stock certificates.
10. Confirmation is most likely to be a relevant form of evidence with regard to assertions about
accounts receivable when the auditor has concerns about the receivables' ______________.
a. Valuation
c. Classification
b. Existence
d. Completeness
11. If all other factors in a sampling plan are held constant, changing the measure of tolerable
error to a smaller value would cause the sample size to be:
a. Smaller
c. Larger
b. Unchanged
d. Indeterminate
12. In order to quantify the risk that sample evidence leads to erroneous conclusions about the
sampled population:
a. Each item in the sampled population must have an equal chance of being selected.
b. Each item in the sampled population must have a chance of being selected proportional
to its book value.
c. Each item in the sampled population must have an equal or known probability of being
selected.
d. The precise number of items in the population must be known.
13. The tolerable occurrence rate for a control test is generally, what?
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a. Lower than the expected occurrence rate in the related accounting records.
b. Higher than the expected occurrence rate in the related accounting records.
c. Identical to the expected occurrence rate in the related accounting records.
d. Unrelated to the expected occurrence rate in the related accounting records.
14. In examining cash disbursements, an auditor plans to choose a sample using systematic
selection with a random start. The primary advantage of such a systematic selection is that
population items
a. Which include errors will not be overlooked when the auditor exercises compatible
reciprocal options.
b. May occur in a systematic pattern, thus making the sample more representative.
c. May occur more than once in a sample.
d. Do not have to be prenumbered in order for the auditor to use the technique.
15. Attribute sampling, as applied to control testing, can assist the auditor in several ways. Which
of the following tasks is not enhanced by sampling?
a. Determining the number of documents to examine in testing for a specific attribute.
b. Selecting the documents to be tested.
c. Examining the documents.
d. Evaluating the sample results.
16. Several risks are inherent in the evaluation of audit evidence which has been obtained through
the use of statistical sampling. Which of the following risks is an example of the risk of
underassessment of control risk?
a. Failure to properly define the population to be sampled.
b. Failure to draw a random sample from the population.
c. Failure to accept the statistical hypothesis that internal control is unreliable when, in
fact, it is.
d. Failure to accept the statistical hypothesis that a book value is not materially misstated
when the true book value is not materially misstated.
17. A bank auditor is interested in estimating the average account balance of its depositors
based on a sample. This substantive test is an example of
a. Attribute sampling.
c. Discovery sampling.
b. Acceptance sampling.
d. Variables sampling.
18. In conducting a substantive test of an account balance, an auditor hypothesizes that no
material error exists. The risk that sample results will support the hypothesis when a material
error actually does exist is the risk of
a. Incorrect rejection.
c. Alpha error.
b. Incorrect acceptance.
d. Type I error.
19. What effect does an increase in the standard deviation have on the required sample size of
mean-per-unit estimation and probability proportional to size sampling? Assume no change
in any of the other characteristics of the population and no change in desired precision and
confidence.
Mean-per-unit Estimation
PPS
a.
Decrease in sample size
No change in sample size
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b.
c.
d.
No change in sample size
Increase in sample size
No change in sample size
Decrease in sample size
No change in sample size
Increase in sample size
20. An advantage of statistical over non-statistical sampling is that statistical sampling:
a. Enables auditors to objectively measure the reliability of their sample results.
b. Permits use of a smaller sample size than would be necessary with non-statistical
sampling.
c. Is compatible with a wider variety of sample selection methods than is non-statistical
sampling.
d. Allows auditors to inject their subjective judgment in determining sample size and
selection process in order to audit items of greatest value and highest risk.
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Lesson 4 – Major Phases of an Audit - Part III
Completing the Audit and Auditor’s Report
Overview:
Once the various business processes, controls, and related financial statement accounts
have been audited, the evidence is summarized and evaluated. Before determining the
appropriate audit report, the auditor considers a number of additional issues that may impact the
client’s system of internal control over financial reporting and financial statements. The auditors’
report should not be dated prior to the date they have gathered sufficient, appropriate evidence.
This date is often the last day of fieldwork but it may be a later date. Therefore, the auditors’
opinion on the financial statements is based on all evidence gathered by the auditors up to the
date of the audit report and any other information that comes to their attention between that date
and the issuance of the financial statements.
Reports are essential to audit and assurance engagements because they communicate
the auditor’s findings. Users of financial statements rely on the auditor’s report to provide
assurance on the company’s financial statements. The audit report is the final step in the entire
audit process. The reason for studying it now is to permit reference to different audit reports as
we study the accumulation of audit evidence. These evidence concepts are more meaningful after
you understand the form and content of the final product of the audit.
Learning Objectives:
After studying this lesson, the student should:
•
•
•
•
•
•
Identify the nature and purposes of the procedures and tasks performed as part of
completing the audit especially procedures needed in evaluating findings, formulating an
opinion and drafting the audit report, including the tools for documentation and key
persons in-charge of the tasks both in preparation and review of the procedures.
Understand the work being done by other teams needed for the audit.
Describe the other audit considerations as part of completing the audit.
Understand how to document the audit findings subsequent to audit and other post-audit
responsibilities.
Understand what does it means to issue standard audit report with an
unmodified/unqualified opinion.
Identify the elements of standard audit report with an unmodified/unqualified opinion.
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•
•
•
•
•
Describe how to communicate Key Audit Matters, emphasis of a matter and other
paragraphs in auditor’s report.
Know the types of modifications of opinions in auditor’s report.
Familiarize with the other information related to issuance of auditor’s report and other
reporting considerations.
Identify nature and purpose of auditor’s report on special-purpose audit engagements.
Describe the nature and purposes of reports to non-audit engagements.
Course Materials:
Audit Documentation Review
The work of the audit staff is primarily accomplished through a review of the audit working
papers. The seniors on audit engagements typically perform their review of the audit working
papers as the papers are completed. While audit partners and managers will generally
communicate with seniors and other staff members throughout the audit, their review of the
working papers generally is not completed until near (or after) completion of fieldwork. The audit
partner and manager will devote special attention to those accounts that have a higher risk of
material misstatement. Also, a final consideration will be made of whether the results of
procedures performed throughout the audit, including while completing the audit, identify
conditions and events that indicate there could be substantial doubt about the company’s ability
to continue as a going concern.
There are three reasons why an experienced member of the audit firm must thoroughly
review audit documentation at the completion of the audit:
1. To evaluate the performance of inexperienced personnel. A considerable portion of most
audits is performed by audit personnel with fewer than four or five years of experience. These
people may have sufficient technical training to conduct an adequate audit, but their lack of
experience affects their ability to make sound professional judgments in complex situations.
2. To make sure that the audit meets the CPA firm’s standard of performance. Within any
CPA firm, the quality of staff performance varies considerably, but careful review by top-level
personnel in the firm helps to maintain a uniform quality of auditing.
3. To counteract the bias that often enters into the auditor’s judgment. Auditors must attempt
to remain objective throughout the audit, but they may lose proper perspective on a long
audit when complex problems need to be solved.
Most firms have a policy requiring an engagement quality review for publicly traded
companies and for privately held companies whose financial statements are expected to be widely
distributed. The engagement quality reviewer should be independent and should understand the
audit approach, findings, and conclusions for critical audit areas and should review the audit
report, financial statements, and footnotes for consistency.
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Using the Work of Others
Work of Internal Auditor
Favorable conclusions about competence and objectivity enable external auditors to rely
on the work completed by the internal audit department related to gaining an understanding of
and testing of a company’s internal control system. By relying in part on the work of the internal
audit department, external auditors may be able to reduce the nature, timing, or extent of their
own procedures for these accounts. Take note, however, that this utilization of internal auditors’
work cannot be a complete substitute for the external auditors’ own procedures.
Work of Audit Specialists/Auditor’s Expert
Audit specialists are persons skilled in fields other than accounting and auditing—
actuaries, appraisers, attorneys, and geologists—who are not members of the audit team.
Auditors are not expected to be experts in all fields of knowledge that can contribute information
to the financial statements. When an audit specialist is engaged, auditors must know about his or
her professional qualifications, experience, reputation, and much as possible its independence to
the company subjected to audit. Provided that some additional auditing work is done on the data
that the audit specialist uses in reaching its conclusions, auditors may rely on the work of an audit
specialist in connection with audit decisions. Normally, audit specialists are not referred to in the
auditor’s report unless the audit specialist’s findings cause the auditors’ report to be modified
(e.g., because of a GAAP departure).
Other Audit Considerations
Auditing accounting estimates and related disclosures
Determining whether all necessary estimates have been developed and accounted for
properly requires knowledge of the client’s business and the applicable generally accepted
accounting principles. When evaluating the reasonableness of accounting estimates, the auditors
obtain an understanding of how management developed the estimates and then use one or more
of these three basic approaches:
1. Review and test management’s process of developing the estimates, which often involves
evaluating the reasonableness of the steps performed by management.
2. Independently develop an estimate of the amount to compare to management’s estimate.
3. Review subsequent events or transactions bearing on the estimate.
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Auditing fair value measurements and related disclosures
In planning and performing audit procedures related to fair value measurements, the
auditors should obtain an understanding of the company’s process for determining fair value
measurements and disclosures, including relevant controls. In addition, the auditors should:
•
•
•
Evaluate whether management’s assumptions related to inputs are reasonable and
reflect, or are not inconsistent with, market information.
If management relies on historical financial information in the development of an input
consider the extent to which such reliance is justified.
Evaluate whether the company’s method for determining fair value measurements is
applied consistently and, if so, whether the consistent application is appropriate given the
current situation.
Review of related party transactions
Related party transactions have often been used to facilitate fraudulent financial reporting.
Accordingly, auditors should determine the business purpose of any significant and unusual
related party transactions that they encounter. Even if the transactions are recorded appropriately,
the auditors also must be concerned that material related party transactions are adequately
disclosed in the client’s financial statements or the related notes. The primary challenge for the
auditors is identifying any related party transactions that management has not disclosed, because
they may be recorded in the accounting records with all other transactions. Common methods of
determining related parties include making inquiries of management and reviewing SEC filings to
check stockholders’ listings, and minutes of the meeting obtained from the client.
Initial audit engagements – Opening Balances/Different prior-year auditors
In the first audit of the client, the auditors should obtain sufficient appropriate evidence
about whether the opening balances for the various accounts contain misstatements that
materially affect the current period’s financial statements. The auditors need to determine whether
the prior period’s closing balances were properly brought forward to the current period, and
whether those balances reflect the application of appropriate accounting policies. When
satisfactory prior year audits of the business have been performed by a predecessor auditor, the
successor auditors will ordinarily have communicated with the predecessor about matters such
as management integrity, disagreements that the predecessor may have had with management,
communications with the audit committee, and the predecessor’s understanding of the reason for
the change of auditors. Current auditors also discuss as agreed with the predecessor auditors,
the contents of the predecessor auditors’ working papers. Based on this evaluation, the successor
auditors will decide whether it is necessary to perform additional procedures specifically designed
to obtain evidence regarding the opening balances.
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Take note that the successor auditors must ask management of the prospective client to
authorize the predecessor auditors to respond fully to the successor’s inquiries. If a prospective
client is reluctant to authorize communications with the predecessor auditors, the successor
auditors should seriously consider the implications in deciding whether to accept the engagement.
Completing the Engagement
Procedures regarding litigation, claims, contingent liability and other potential unrecorded
liabilities
•
A letter of audit inquiry (referred to as a legal letter) sent to the client’s attorneys is the primary
means of obtaining or corroborating information about litigation, claims, and assessments.
The auditor should ask management to send a legal letter to the attorneys, requesting that
they provide the following but not limited to this information:
➢ A list and evaluation of any pending or threatened litigation to which the attorney has
devoted substantial attention. The list may be provided by the client.
➢ A list of unasserted claims and assessments considered by management to be probable
of assertion and reasonably possible of unfavorable outcome.
➢ A request that the attorney describe and evaluate the outcome of each pending or
threatened litigation. This should include the progress of the case, the action the entity
plans to take, the likelihood of unfavorable outcome, and the amount or range of
potential loss.
Refusal by a client’s attorney to furnish information in a legal letter is a limitation on the
scope of the audit sufficient to preclude an unqualified opinion.
•
In general, loss contingencies that are judged to be remote are neither accrued in the financial
statements nor disclosed in the footnotes. The auditor may identify contingent liabilities while
conducting various audit procedures. Examples of procedures that may help the auditor
identify contingent liabilities include
➢ Reading the minutes of meetings of the board of directors and stockholders.
➢ Reviewing contracts, loan agreements, leases, and letters from government agencies.
➢ Reviewing income tax liability, tax returns, and BIR audit reports.
➢ Confirming or otherwise documenting guarantees and letters of credit obtained from
financial institutions or other lending agencies.
➢ Inspecting other documents such legal letter reply.
•
Long-term commitments are usually identified through inquiry of client personnel during the
audit of the revenue and purchasing processes and through review of the minutes of board
meetings. In most cases, such commitments are disclosed in a footnote to the financial
statements.
•
The search for unrecorded liabilities includes procedures performed near the date of the
auditors’ report, such as examining subsequent cash disbursements. These procedures are
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designed to detect liabilities that existed at year-end but were omitted from the liabilities
recorded in the client’s financial statements.
Going Concern Consideration
As auditors gather evidence throughout the engagement, they may encounter information
that raises questions as to the client’s ability to continue as a going concern, such as negative
trends, including recurring operating losses, working capital deficiencies, negative cash flow from
operations, indications of financial difficulties, and other internal and external events which have
negative impact to the company’s operations and stability. Going-concern status is a significant
issue for users of financial statements, because assets and liabilities are normally recorded and
classified on the assumption that the company will continue to operate. If the auditors’ evaluation
suggests substantial doubt on the company’s going concern, auditors should obtain information
about management’s plans to mitigate the effect of these factors and assess the likelihood that
these plans can be effectively implemented. If after evaluating the information and management’s
plans, the auditors conclude that the substantial doubt is resolved, they may issue a standard
report. If on the other hand, substantial doubt still exists about the company’s ability to continue
as a going concern for a period of one year from the balance sheet date, the auditors should add
an emphasis-of-matter paragraph to their unmodified opinion or issue a disclaimer of opinion.
Final Analytical Procedures
The objective of conducting analytical procedures near the end of the engagement is to
help the auditor assess the conclusions reached on the financial statement components and
evaluate the overall financial statement presentation. This involve reviewing the adequacy of the
evidence gathered in response to unexpected fluctuations in the account balances identified
during the planning of the audit and identifying any unusual or unexpected balances not previously
considered. These final analytical procedures may indicate that more evidence is needed for
certain account balances. The auditor performs final analytical procedures to consider the overall
reasonableness of the financial statement amounts.
Evaluating financial statement presentation and disclosures
The client prepares a draft of the financial statements, including footnotes. The auditor
reviews the financial statements to ensure compliance with accounting standards, proper
presentation of accounts, and inclusion of all necessary disclosures. Most public accounting firms
use some type of financial statement disclosure checklist to assist the auditor in this process.
Report of Subsequent Events for audit
Evidence not available at the close of the period under audit often becomes available
before the auditors finish their fieldwork and issue their audit report. The CPA’s opinion on the
fairness of the financial statements may be changed considerably by these subsequent events.
The term subsequent event refers to an event occurring after the date of the balance sheet but
prior to the date of the auditors’ report (the date on which the auditors have obtained sufficient
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appropriate audit evidence to support their opinion). Subsequent events are divided into two broad
categories: (1) those providing additional evidence about facts existing on or before the balance
sheet date (“recognized subsequent events”/Type I), and (2) those involving facts coming into
existence subsequent to the balance sheet date (“nonrecognized subsequent events”/Type II).
For the period after year-end through the date of the auditors’ report, the auditors should
perform audit procedures to obtain sufficient appropriate audit evidence that all subsequent
events that require adjustment or disclosures in the financial statements have been identified.
During this period, the auditors should determine that proper cutoffs of cash receipts and
disbursements and sales and purchases have been made, and they should examine data to aid
in the evaluation of assets and liabilities as of the balance sheet date. In addition, the auditors
should:
1. Obtain an understanding of management’s procedures to ensure that subsequent events are
identified.
2. Inquire of management (and those charged with governance) about whether subsequent
events have occurred.
3. Read available minutes of directors, stockholders, and appropriate committee meetings that
have been held after the date of the financial statements and inquire about matters discussed
at any such meeting for which minutes are not yet available. In completing the audit, the
auditors should determine that they have considered all minutes, including those for meetings
subsequent to year-end.
4. Read the company’s latest subsequent interim financial statements, if any.
Generally, the auditors’ responsibility for performing procedures to gather evidence as to
subsequent events extends only through the date of the audit report. However, even after
completing normal audit procedures, the auditors are responsible for evaluating subsequent
events that come to their attention prior to the report release date. When material subsequent
events are identified, auditors are required to ensure that the financial statement disclosure of
these events reflects all current information and is according to relevant accounting standards.
When a subsequent event is recorded or disclosed in the financial statements after the
date on which the auditor has obtained sufficient appropriate audit evidence but before the
issuance of the financial statements, the auditor must consider the dating of the auditor’s report.
This is the concept of dual-dating.
Final assessment of audit results
The auditors will request that management record any adjustments required to correct
misstatements. When management refuses to correct these misstatements, the auditors should
evaluate their importance. Any known material misstatements must be corrected, or the auditors
cannot issue an unqualified opinion on the financial statements. In evaluating whether an
individual misstatement is material, the auditors consider both quantitative and qualitative factors.
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Prior to evaluating the effect of uncorrected misstatements, the auditors should reassess
materiality to confirm whether it remains appropriate in the context of the client’s actual financial
results. They will consider the quantitative and qualitative effects of uncorrected misstatements
on relevant classes of transactions, accounts, and disclosures. If the auditors estimate that the
total of known and likely misstatements is material to the financial statements, they will conclude
that the risk of material misstatement is too high to issue an unqualified opinion on the financial
statements. The auditors should also evaluate whether the accumulated results of their
procedures and observations affect the assessments of the risks of material misstatement made
earlier in the engagement.
Client Approval of Adjusting Entries and Disclosures
During the course of the audit, the auditors may suggest various adjustments and
disclosures concerning the financial statements. However, because they are the representations
of management, the financial statements are not modified to reflect these items until management
approves them. Since the auditors’ responsibility is to express an opinion on the financial
statements, unresolved differences between auditor and client with respect to such differences
may result in modification of the auditors’ report. If any adjusting entries are not recorded;
management must represent to the auditors (in the representation letter) that management
believes the adjustments are not material. These adjustments are called uncorrected
misstatements/passed adjustments.
Communication of Audit Matters with those Charged with Governance
The auditors communicate certain matters related to the conduct of the audit to those
individuals responsible for oversight of the entity’s strategic direction and its financial reporting
process, referred to as those charged with governance” such as the board of directors, and the
audit committee in particular. The intent of this communication is to ensure that the audit
committee or other responsible body receives additional information on the scope and results of
the audit. The communication should address the following matters but not limited to:
•
•
•
•
•
•
•
•
•
•
The auditor’s responsibility under PSAs.
Significant accounting policies.
Management judgments and accounting estimates.
Significant audit adjustments.
The auditor’s judgments about the quality of the entity’s accounting principles.
Disagreements with management.
Consultation with other accountants.
Major issues discussed with management before the auditor was retained.
Difficulties encountered during the audit.
Fraud involving senior management and fraud that causes material misstatement of the
financial statements.
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This communication should be in writing, and the report should indicate that it is intended
solely for the use of those charged with governance and, if applicable, management. The auditor
must also communicate in writing to management and the audit committee all significant
deficiencies and material weaknesses identified during the audit. The written communication
should be made prior to the issuance of the auditor’s report on internal control over financial
reporting. In addition, the auditor normally prepares a management letter. The general intent of
a management letter is to make recommendations to the client based on observations during the
audit; the letter may include suggested improvements in various areas, such as organizational
structure, efficiency issues, internal controls, and financial reporting practices.
Obtain Management Representation Letter
The auditors obtain written representations (or management representations) to confirm
certain matters and corroborate other evidence obtained during the audit. The representations
take the form of a letter on the client’s letterhead addressed to auditors and signed by principal
officers of the client (normally the chief executive officer [CEO] and chief financial officer [CFO]).
The primary purpose of the representation letter is to have the client’s principal officers
acknowledge that they are primarily responsible for the fairness of the financial statements. Since
the financial statements must reflect all material subsequent events, the representation letter
should be dated as of the date of the audit report.
Although representations should be limited to matters that are material, professional
standards note that materiality guidelines do not apply for representations not related to amounts
included in the financial statements or for management’s acknowledgement regarding its
responsibility for designing, implementing, and maintaining internal control to prevent and detect
fraud.
Clearly, written representations provide an important part of auditors’ overall ability to
support the opinion on the financial statements. As a result, management’s refusal to furnish
representations constitutes a scope limitation, which requires a qualification in the auditor’s report
on the entity’s financial statements or a disclaimer of opinion. Auditors should be very skeptical
of any situation in which the client’s management refuses to furnish representations.
Drafting the audit report
After the preceding procedures have been performed, the auditors will ordinarily be in a
position to issue their audit report. When the auditors have obtained reasonable assurance that
the financial statements follow generally accepted accounting principles and the audit has been
performed in conformity with auditing standards, including no significant scope limitations, an
unqualified opinion will ordinarily be issued.
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Post-audit Responsibilities
Subsequent discovery of facts existing at audit report date
When facts are encountered that may affect the auditor’s previously issued report, the
auditor should consult with his or her attorney because legal implications may be involved and
actions taken by the auditor may involve confidential client–auditor communications. The auditor
should determine whether the facts are reliable and whether they existed at the date of the audit
report. The auditor should discuss the matter with an appropriate level of management and
request cooperation in investigating the potential misstatement.
If the client refuses to cooperate and make the necessary disclosures, the auditor should
notify the board of directors and take the following steps, if possible:
1. Notify the client that the auditor’s report must no longer be associated with the financial
statements.
2. Notify any regulatory agencies having jurisdiction over the client that the auditor’s report can
no longer be relied upon.
3. Notify each person known to the auditor to be relying on the financial statements. Notifying a
regulatory agency such as the SEC is often the only practical way of providing appropriate
disclosure.
Subsequent discovery of omitted audit procedures
The omission of appropriate audit procedures in a particular engagement might be
discovered during a peer review or other subsequent review of the auditors’ working papers. In
addressing this problem, the auditors should assess the importance of the omitted procedures to
their previously issued opinion. If they believe that the omitted procedures impair their ability to
support their previously issued opinion, and their report is still being relied upon by third parties,
they should attempt to perform the omitted procedures or appropriate alternative procedures.
Because of the legal implications of these situations, the auditors should consider consulting their
legal counsel.
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Reports on Audited Financial Statements
The auditors’ report on the financial statements expresses an opinion on whether the
financial statements present the entity’s financial position, results of operations, and cash flows
in accordance with GAAP (or other applicable financial reporting framework). The report should
be titled independent auditor’s report (or other suitable title stressing the independence of the
auditors). It is addressed to the client, who is the person or group that engaged the auditors. The
report is typically addressed to the board of directors and shareholders but may also be addressed
to an individual lender, creditor, or investor who requested the audit.
Applicable Financial Reporting Framework
The auditor’s judgment regarding whether the financial statements are presented fairly, in
all material respects, is made in the context of the applicable financial reporting framework. As
discussed in PSA 210, “Terms of Audit Engagements,” without an acceptable financial reporting
framework, the auditor does not have suitable criteria for evaluating the entity’s financial
statements. PSA 200 describes the auditor’s responsibility to determine whether the financial
reporting framework adopted by management in preparing the financial statements is acceptable.
Forming an Opinion on the Financial Statements
The auditor should evaluate the conclusions drawn from the audit evidence obtained as
the basis for forming an opinion on the financial statements. The auditor evaluates whether, based
on the audit evidence obtained, there is reasonable assurance about whether the financial
statements taken as a whole are free from material misstatement. This involves concluding
whether sufficient appropriate audit evidence has been obtained to reduce to an acceptably low
level the risks of material misstatement of the financial statements and evaluating the effects of
uncorrected misstatements identified. This evaluation includes considering whether, in the context
of the applicable financial reporting framework:
a) The financial statements adequately disclose the significant accounting policies
selected and applied;
b) The accounting policies selected and applied are consistent with the applicable
financial reporting framework and are appropriate;
c) The accounting estimates made by management are reasonable;
d) The information presented in the financial statements is relevant, reliable, comparable,
and understandable;
e) The financial statements provide adequate disclosures to enable the intended users
to understand the effect of material transactions and events on the information
conveyed in the financial statements; and
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f)
The terminology used in the financial statements, including the title of each financial
statement, is appropriate.
Elements of the Auditor’s Report in an Audit Conducted in Accordance with PSA
PSA 700 (Revised) set out the requirements relating to the following elements of the
auditor’s report with an unmodified opinion:
1. Title
The auditor’s report should have a title that clearly indicates that it is the report of an independent
auditor. A title indicating the report is the report of an independent auditor, for example,
“Independent Auditor’s Report,” affirms that the auditor has met all of the relevant ethical
requirements regarding independence and, therefore, distinguishes the independent auditor’s
report from reports issued by others.
2. Addressee
The auditor’s report should be addressed as required by the circumstances of the engagement.
Ordinarily, the auditor’s report on general purpose financial statements is addressed to those for
whom the report is prepared, often either to the shareholders or to those charged with governance
of the entity whose financial statements are being audited.
3. Auditor’s Opinion
The first section of the auditor’s report shall include the auditor’s opinion, and shall have the
heading “Opinion.” The Opinion section of the auditor’s report shall also disclose the identity of
the entity whose financial statements have been audited; that the financial statements have been
audited; the title of each statement comprising the financial statements; reference to the notes,
including the summary of significant accounting policies; and the date of, or period covered by,
each financial statement comprising the financial statements.
When expressing an unmodified opinion on financial statements prepared in accordance with a
fair presentation framework, the auditor’s opinion shall, unless otherwise required by law or
regulation, use the following phrase:
In our opinion, the accompanying financial statements present fairly, in all material
respects, […] in accordance with [the applicable financial reporting framework].
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If the reference to the applicable financial reporting framework in the auditor’s opinion is
not to PFRSs issued by the Financial Reporting Standards Council, the auditor’s opinion
shall identify the jurisdiction of origin of the framework.
4. Basis for Opinion
The auditor’s report shall include a section, directly following the Opinion section, with the heading
“Basis for Opinion”, that:
a) States that the audit was conducted in accordance with Philippine Standards on Auditing;
b) Refers to the section of the auditor’s report that describes the auditor’s responsibilities
under the PSAs;
c) Includes a statement that the auditor is independent of the entity in accordance with the
relevant ethical requirements relating to the audit, and has fulfilled the auditor’s other ethical
responsibilities in accordance with these requirements. The statement shall identify the
jurisdiction of origin of the relevant ethical requirements [Code of Ethics for Professional
Accountants in the Philippines (Philippine Code of Ethics)] or refer to the International Ethics
Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA
Code); and
d) States whether the auditor believes that the audit evidence the auditor has obtained is
sufficient and appropriate to provide a basis for the auditor’s opinion.
5. Key Audit Matters
For audits of complete sets of general purpose financial statements of listed entities, the auditor
shall communicate key audit matters in the auditor’s report in accordance with PSA 701. When
the auditor is otherwise required by law or regulation or decides to communicate key audit matters
in the auditor’s report, the auditor shall do so in accordance with PSA 701. This is further
discussed below.
6. Responsibilities of Management for the Financial Statements
This section of the auditor’s report shall describe management’s responsibility for:
a) Preparing the financial statements in accordance with the applicable financial reporting
framework, and for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether due to fraud
or error; and
b) Assessing the entity’s ability to continue as a going concern and whether the use of the going
concern basis of accounting is appropriate as well as disclosing, if applicable, matters relating to
going concern. The explanation of management’s responsibility for this assessment shall include
a description of when the use of the going concern basis of accounting is appropriate.
This section of the auditor’s report shall also identify those responsible for the oversight of
the financial reporting process, when those responsible for such oversight are different
from those who fulfill the responsibilities. In this case, the heading of this section shall also
refer to “Those Charged with Governance” or such term that is appropriate in the context
of the legal framework in the particular jurisdiction.
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7. Auditor’s Responsibilities for the Audit of the Financial Statements
This section of the auditor’s report shall:
a. State that the objectives of the auditor are to:
i. Obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error; and
ii. Issue an auditor’s report that includes the auditor’s opinion.
b. State that reasonable assurance is a high level of assurance, but is not a guarantee that
an audit conducted in accordance with PSAs will always detect a material misstatement when
it exists; and
c. State that misstatements can arise from fraud or error, and either:
i. Describe that they are considered material if, individually or in the aggregate, they could
reasonably be expected to influence the economic decisions of users taken on the basis
of these financial statements; or
ii. Provide a definition or description of materiality in accordance with the applicable
financial reporting framework.
The Auditor’s Responsibilities for the Audit of the Financial Statements section of the
auditor’s report shall further:
a) State that, as part of an audit in accordance with PSAs, the auditor exercises
professional judgment and maintains professional skepticism throughout the audit;
and
b) Describe an audit by stating that the auditor’s responsibilities are:
i.
To identify and assess the risks of material misstatement of the financial
statements, whether due to fraud or error; to design and perform audit
procedures responsive to those risks; and to obtain audit evidence that is
sufficient and appropriate to provide a basis for the auditor’s opinion. The risk
of not detecting a material misstatement resulting from fraud is higher than for
one resulting from error, as fraud may involve collusion, forgery, intentional
omissions, misrepresentations, or the override of internal control.
ii.
To obtain an understanding of internal control relevant to the audit in order to
design audit procedures that are appropriate in the circumstances, but not for
the purpose of expressing an opinion on the effectiveness of the entity’s
internal control. In circumstances when the auditor also has a responsibility to
express an opinion on the effectiveness of internal control in conjunction with
the audit of the financial statements, the auditor shall omit the phrase that the
auditor’s consideration of internal control is not for the purpose of expressing
an opinion on the effectiveness of the entity’s internal control.
iii.
To evaluate the appropriateness of accounting policies used and the
reasonableness of accounting estimates and related disclosures made by
management.
iv.
To conclude on the appropriateness of management’s use of the going
concern basis of accounting and, based on the audit evidence obtained,
whether a material uncertainty exists related to events or conditions that may
cast significant doubt on the entity’s ability to continue as a going concern. If
the auditor concludes that a material uncertainty exists, the auditor is required
to draw attention in the auditor’s report to the related disclosures in the financial
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v.
statements or, if such disclosures are inadequate, to modify the opinion. The
auditor’s conclusions are based on the audit evidence obtained up to the date
of the auditor’s report. However, future events or conditions may cause an
entity to cease to continue as a going concern.
When the financial statements are prepared in accordance with a fair
presentation framework, to evaluate the overall presentation, structure and
content of the financial statements, including the disclosures, and whether the
financial statements represent the underlying transactions and events in a
manner that achieves fair presentation.
8. Other Reporting Responsibilities
If the auditor addresses other reporting responsibilities in the auditor’s report on the financial
statements that are in addition to the auditor’s responsibilities under the PSAs, these other
reporting responsibilities shall be addressed in a separate section in the auditor’s report with a
heading titled “Report on Other Legal and Regulatory Requirements” or otherwise as appropriate
to the content of the section.
9. Name of the Engagement Partner
The name of the engagement partner shall be included in the auditor’s report for audits of
complete sets of general purpose financial statements of listed entities unless, in rare
circumstances, such disclosure is reasonably expected to lead to a significant personal security
threat. In the rare circumstances that the auditor intends not to include the name of the
engagement partner in the auditor’s report, the auditor shall discuss this intention with those
charged with governance to inform the auditor’s assessment of the likelihood and severity of a
significant personal security threat.
10. Signature of the Auditor
The auditor’s signature is either in the name of the audit firm, the personal name of the auditor or
both, as appropriate for the particular jurisdiction. In addition to the auditor’s signature, in certain
jurisdictions, the auditor may be required to declare in the auditor’s report the auditor’s
professional accountancy designation or the fact that the auditor or firm, as appropriate, has been
recognized by the appropriate licensing authority. In some cases, law or regulation may allow for
the use of electronic signatures in the auditor’s report.
11. Auditor’s Address
The auditor’s report shall name the location in the jurisdiction where the auditor practices.
12. Date of the Auditor’s Report
The auditor’s report shall be dated no earlier than the date on which the auditor has obtained
sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial
statements, including evidence that: all the statements that comprise the financial statements,
including the related notes, have been prepared; and those with the recognized authority have
asserted that they have taken responsibility for those financial statements.
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COMMUNICATING KEY AUDIT MATTERS IN THE INDEPENDENT AUDITOR’S REPORT
The purpose of communicating key audit matters (KAM) is to enhance the communicative
value of the auditor’s report by providing greater transparency about the audit that was performed.
Communicating KAM provides additional information to intended users of the financial statement
to assist them in understanding those matters that, in the auditor’s professional judgment, were
of most significance in the audit of the financial statements of the current period. However, KAM
is not:
a. A substitute for disclosures in the financial statements that the applicable financial
reporting framework requires management to make, or that are otherwise
necessary to achieve fair presentation;
b. A substitute for the auditor expressing a modified opinion when required by the
circumstances of a specific audit engagement in accordance with PSA 705
(Revised)
c. A substitute for reporting in accordance with PSA 570 when a material uncertainty
exists relating to events or conditions that may cast significant doubt on an entity’s
ability to continue as a going concern; or
d. A separate opinion on individual matters.
In determining KAM, the auditor shall take into account the following:
a. Areas of higher assessed risk of material misstatement, or significant risks
identified in accordance with PSA 315 (Revised)
b. Significant auditor judgments relating to areas in the financial statements that
involved significant management judgment, including accounting estimates that
have been identified as having high estimation uncertainty.
c. The effect on the audit of significant events or transactions that occurred during
the period.
The auditor shall determine which of the matters determined were of most significance in the
audit of the financial statements of the current period that should form part of KAM. In
documenting the KAM in auditor’s report, it shall disclose why the matter was considered to
be one of most significance in the audit and therefore determined to be a key audit matter,
how the matter was addressed in the audit, and include a reference to the related
disclosure(s) if any, in the financial statements.
EMPHASIS OF MATTER PARAGRAPHS AND OTHER MATTER PARAGRAPHS
a) Emphasis of Matter paragraph – A paragraph included in the auditor’s report that refers
to a matter appropriately presented or disclosed in the financial statements that, in the
auditor’s judgment, is of such importance that it is fundamental to users’ understanding
of the financial statements. Circumstances that needs for this type of paragraph are
as follows:
• When a financial reporting framework prescribed by law or regulation would be
unacceptable but for the fact that it is prescribed by law or regulation.
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•
•
•
•
•
•
To alert users that the financial statements are prepared in accordance with a
special purpose framework.
When facts become known to the auditor after the date of the auditor’s report and
the auditor provides a new or amended auditor’s report (i.e., subsequent events).
An uncertainty relating to the future outcome of exceptional litigation or regulatory
action.
A significant subsequent event that occurs between the date of the financial
statements and the date of the auditor’s report.
Early application (where permitted) of a new accounting standard that has a
material effect on the financial statements.
A major catastrophe that has had, or continues to have, a significant effect on the
entity’s financial position.
The auditor shall include an Emphasis of Matter paragraph in the auditor’s report
provided:
•
•
The auditor would not be required to modify the opinion in accordance with
PSA 705 (Revised) as a result of the matter; and
When PSA 701 applies, the matter has not been determined to be a key audit
matter to be communicated in the auditor’s report.
b) Other Matter paragraph – A paragraph included in the auditor’s report that refers to a
matter other than those presented or disclosed in the financial statements that, in the
auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report. The auditor shall include an Other Matter
paragraph in the auditor’s report, provided:
• This is not prohibited by law or regulation; and
• When PSA 701 applies, the matter has not been determined to be a key audit
matter to be communicated in the auditor’s report.
MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT
The auditor shall modify the opinion in the auditor’s report when:
a) The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement; or
b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that
the financial statements as a whole are free from material misstatement.
Types of Modification to the Auditor’s Opinion
1. Qualified Opinion
“When reporting in accordance with a fair presentation framework, the accompanying
financial statements present fairly, in all material respects [...] in accordance with [the
applicable financial reporting framework] except for the possible effects of the matter(s)…”
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The auditor shall express a qualified opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate,
are material, but not pervasive, to the financial statements; or the auditor is unable to
obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor
concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive.
Pervasive, in the context of misstatements, means to describe the effects on the financial
statements of misstatements or the possible effects on the financial statements of
misstatements, if any, that are undetected due to an inability to obtain sufficient
appropriate audit evidence.
2. Adverse Opinion
“When reporting in accordance with a fair presentation framework, the accompanying
financial statements do not present fairly [...] in accordance with [the applicable financial
reporting framework]”
The auditor shall express an adverse opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate,
are both material and pervasive to the financial statements.
3. Disclaimer of Opinion
(the auditor does not express an opinion on the accompanying financial statements; and
because of the significance of the matter(s) such are described in the Basis for Disclaimer
of Opinion section)
The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes that
the possible effects on the financial statements of undetected misstatements, if any, could
be both material and pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances involving
multiple uncertainties, the auditor concludes that, notwithstanding having obtained
sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not
possible to form an opinion on the financial statements due to the potential interaction of
the uncertainties and their possible cumulative effect on the financial statements.
The table below illustrates how the auditor’s judgment about the nature of the matter giving
rise to the modification.
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PSA 450 defines a misstatement as a difference between the amounts, 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. Accordingly, a material misstatement of the
financial statements may arise in relation to:
a) The appropriateness of the selected accounting policies;
b) The application of the selected accounting policies; or
c) The appropriateness or adequacy of disclosures in the financial statements.
The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a
limitation on the scope of the audit) may arise from:
a) Circumstances beyond the control of the entity;
b) Circumstances relating to the nature or timing of the auditor’s work; or
c) Limitations imposed by management.
Report on Comparatives
For purposes of the PSAs, the following terms have the meanings attributed below:
a. Comparative information – The amounts and disclosures included in the financial
statements in respect of one or more prior periods in accordance with the applicable
financial reporting framework.
b. Corresponding figures – Comparative information where amounts and other disclosures
for the prior period are included as an integral part of the current period financial
statements, and are intended to be read only in relation to the amounts and other
disclosures relating to the current period (referred to as “current period figures”).
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c. Comparative financial statements – Comparative information where amounts and other
disclosures for the prior period are included for comparison with the financial statements
of the current period but, if audited, are referred to in the auditor’s opinion.
The auditor shall determine whether the financial statements include the comparative
information required by the applicable financial reporting framework and whether such information
is appropriately classified. For this purpose, the auditor shall evaluate whether: the comparative
information agrees with the amounts and other disclosures presented in the prior period or, when
appropriate, have been restated; and the accounting policies reflected in the comparative
information are consistent with those applied in the current period or, if there have been changes
in accounting policies, whether those changes have been properly accounted for and adequately
presented and disclosed. If the auditor becomes aware of a possible material misstatement in
the comparative information while performing the current period audit, the auditor shall perform
such additional audit procedures as are necessary in the circumstances to obtain sufficient
appropriate audit evidence to determine whether
a material misstatement exists.
Prior Period Financial Statements Audited by a Predecessor Auditor
If the financial statements of the prior period were audited by a predecessor auditor and
the auditor is permitted by law or regulation to refer to the predecessor auditor’s report on the
corresponding figures and decides to do so, the auditor shall state in an Other Matter paragraph
in the auditor’s report: that the financial statements of the prior period were audited by the
predecessor auditor; the type of opinion expressed by the predecessor auditor and, if the opinion
was modified, the reasons therefore; and the date of that report.
Prior Period Financial Statements Not Audited
If the prior period financial statements were not audited, the auditor shall state in an Other
Matter paragraph in the auditor’s report that the corresponding figures are unaudited. Such a
statement does not, however, relieve the auditor of the requirement to obtain sufficient appropriate
audit evidence that the opening balances do not contain misstatements that materially affect the
current period’s financial statements.
Audit of Group Financial Statements
The auditor should consider whether the auditor’s own participation is sufficient to be able
to act as the principal auditor. When planning to use the work of another auditor, the principal
auditor should consider the professional competence of the other auditor in the context of the
specific assignment. The principal auditor should perform procedures to obtain sufficient
appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor’s
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purposes, in the context of the specific assignment. The principal auditor should consider the
significant findings of the other auditor.
When the principal auditor concludes that the work of the other auditor cannot be used
and the principal auditor has not been able to perform sufficient additional procedures regarding
the financial information of the component audited by the other auditor, the principal auditor
should express a qualified opinion or disclaimer of opinion because there is a limitation in the
scope of the audit. When the principal auditor bases the audit opinion on the financial statements
taken as a whole solely upon the report of another auditor regarding the audit of one or more
components, the principal auditor’s report should state this fact clearly and should indicate the
magnitude of the portion of the financial statements audited by the other auditor.
Auditor’s Responsibilities related to Other Information
The auditor shall determine, through discussion with management, which document(s)
comprises the annual report, and the entity’s planned manner and timing of the issuance of such
document(s).
The auditor shall read the other information and, in doing so shall consider whether there
is a material inconsistency between the other information and the financial statements. If the
auditor concludes that a material misstatement of the other information exists, the auditor shall
request management to correct the other information. If management: agrees to make the
correction, the auditor shall determine that the correction has been made; or refuses to make the
correction, the auditor shall communicate the matter with those charged with governance and
request that the correction be made.
If the auditor concludes that a material misstatement exists in other information obtained
prior to the date of the auditor’s report, and the other information is not corrected after
communicating with those charged with governance, the auditor shall take appropriate action,
including:
a) Considering the implications for the auditor’s report and communicating with those charged
with governance about how the auditor plans to address the material misstatement in the
auditor’s report.
b) Withdrawing from the engagement where withdrawal is possible under applicable law or
regulation.
If the date the auditor concludes that a material misstatement exists in other information
obtained after the of the auditor’s report, the auditor shall:
a) If the other information is corrected, perform the procedures necessary in the circumstances;
or
b) If the other information is not corrected after communicating with those charged with
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governance, take appropriate action considering the auditor’s legal rights and obligations, to
seek to have the uncorrected material misstatement appropriately brought to the attention of
users for whom the auditor’s report is prepared.
OTHER SERVICES AND REPORTS
Auditor’s report on Special Purpose Audit Engagements
Special reports are reports resulting from the audit of, or application of agreed-upon
procedures to historical financial data other than financial statements prepared in conformity with
PFRS.
These reports apply on the following:
•
•
•
•
Financial statements prepared in accordance with a comprehensive basis of
accounting other than generally accepted accounting principles in the Philippines;
Specified accounts, elements of accounts, or items in a financial statement (hereafter
referred to as reports on a component of financial statements);
Compliance with contractual agreements; and
Summarized financial statements.
The auditor should review and assess the conclusions drawn from the audit evidence
obtained during the special purpose audit engagement as the basis for an expression of opinion.
The report should contain a clear written expression of opinion.
Before undertaking a special purpose audit engagement, the auditor should ensure there
is agreement with the client as to the exact nature of the engagement and the form and content
of the report to be issued. The auditor’s report on a special purpose audit engagement, except for
a report on summarized financial statements*, should include the following basic elements,
ordinarily in the following layout:
a) title;
b) addressee;
c) opening or introductory paragraph
• identification of the financial information audited; and
• a statement of the responsibility of the entity’s management and the responsibility
of the auditor;
d) a scope paragraph (describing the nature of an audit)
• the reference to the PSAs applicable to special purpose audit engagements; and
• a description of the work the auditor performed;
e) opinion paragraph containing an expression of opinion on the financial information;
f) date of the report;
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g) auditor’s address; and
h) auditor’s signature.
*The auditor’s report on summarized financial statements should include the following basic
elements ordinarily in the following layout:
a) title;
b) addressee;
c) an identification of the audited financial statements from which the summarized
financial statements were derived;
d) a reference to the date of the audit report on the unabridged financial statements and
the type of opinion given in that report;
e) an opinion as to whether the information in the summarized financial statements is
consistent with the audited financial statements from which it was derived. When the
auditor has issued a modified opinion on the unabridged financial statements yet is
satisfied with the presentation of the summarized financial statements, the audit
report should state that, although consistent with the unabridged financial statements,
the summarized financial statements were derived from financial statements on which
a modified audit report was issued;
f) a statement, or reference to the note within the summarized financial statements,
which indicates that for a better understanding of an entity’s financial performance
and position and of the scope of the audit performed, the summarized financial
statements should be read in conjunction with the unabridged financial statements
and the audit report thereon;
g) date of the report;
h) auditor’s address; and
i) auditor’s signature.
The auditor should consider whether any significant interpretations of an agreement on
which the financial information is based are clearly disclosed in the financial information.
Examination of Prospective Financial Information
Prospective financial information means financial information based on assumptions
about events that may occur in the future and possible actions by an entity. It is highly subjective
in nature and its preparation requires the exercise of considerable judgment. Prospective financial
information can be in the form of a forecast, a projection or a combination of both, for example, a
one year forecast plus a five-year projection.
A “forecast” means prospective financial information prepared on the basis of assumptions
as to future events which management expects to take place and the actions management
expects to take as of the date the information is prepared (best-estimate assumptions). A
“projection” means prospective financial information prepared on the basis of: (a) hypothetical
assumptions about future events and management actions which are not necessarily expected to
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take place, such as when some entities are in a start-up phase or are considering a major change
in the nature of operations; or (b) a mixture of best-estimate and hypothetical assumptions.
Management is responsible for the preparation and presentation of the prospective
financial information, including the identification and disclosure of the assumptions on which it is
based. The auditor may be asked to examine and report on the prospective financial information
to enhance its credibility whether it is intended for use by third parties or for internal purposes.
The auditor should not accept, or should withdraw from, an engagement when the
assumptions are clearly unrealistic or when the auditor believes that the prospective financial
information will be inappropriate for its intended use. The auditor should consider the extent to
which reliance on the entity’s historical financial information is justified.
When the auditor believes that the presentation and disclosure of the prospective financial
information is not adequate, the auditor should express a qualified or adverse opinion in the report
on the prospective financial information, or withdraw from the engagement as appropriate.
When the auditor believes that one or more significant assumptions do not provide a
reasonable basis for the prospective financial information prepared on the basis of best-estimate
assumptions or that one or more significant assumptions do not provide a reasonable basis for
the prospective financial information given the hypothetical assumptions, the auditor should either
express an adverse opinion in the report on the prospective financial information, or withdraw
from the engagement.
When the examination is affected by conditions that preclude application of one or more
procedures considered necessary in the circumstances, the auditor should either withdraw from
the engagement or disclaim the opinion and describe the scope limitation in the report on the
prospective financial information.
Engagements to Review Financial Statements
The objective of a review of financial statements is to enable an auditor 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 auditor's attention that causes the auditor to believe that the
financial statements are not prepared, in all material respects, in accordance with generally
accepted accounting principles in the Philippines (negative assurance).
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The auditor should plan and perform the review with an attitude of professional skepticism
recognizing that circumstances may exist which cause the financial statements to be materially
misstated. For the purpose of expressing negative assurance in the review report, the auditor
should obtain sufficient appropriate evidence primarily through inquiry and analytical procedures
to be able to draw conclusions.
The review report should contain a clear written expression of negative assurance. The
auditor should review and assess the conclusions drawn from the evidence obtained as the basis
for the expression of negative assurance. Based on the work performed, the auditor should
assess whether any information obtained during the review indicates that the financial statements
are not presented fairly, in all material respects, in accordance with generally accepted accounting
principles in the Philippines.
The review report should:
a) state that nothing has come to the auditor's attention based on the review that causes the
auditor to believe the financial statements are not presented fairly, in all material respects
in accordance with generally accepted accounting principles in the Philippines (negative
assurance); or
b) if matters have come to the auditor's attention, describe those matters that impair a fair
presentation, in all material respects in accordance with generally accepted accounting
principles in the Philippines, including, unless impracticable, a quantification of the
possible effect(s) on the financial statements, and either:
i. express a qualification of the negative assurance provided; or
ii. when the effect of the matter is so material and pervasive to the financial statements
that the auditor concludes that a qualification is not adequate to disclose the misleading
or incomplete nature of the financial statements, give an adverse statement that the
financial statements are not presented fairly, in all material respects in accordance with
generally accepted accounting principles in the Philippines; or
c) if there has been a material scope limitation, describe the limitation and either:
i. express a qualification of the negative assurance provided regarding the possible
adjustments to the financial statements that might have been determined to be necessary
had the limitation not existed; or
ii. when the possible effect of the limitation is so significant and pervasive that the auditor
concludes that no level of assurance can be provided, not provide any assurance.
Engagements to Perform Agreed-Upon Procedures regarding Financial Information
An engagement to perform agreed-upon procedures may involve the auditor in performing
certain procedures concerning individual items of financial data (for example, accounts payable,
accounts receivable, purchases from related parties and sales and profits of a segment of an
entity), a financial statement (for example, a balance sheet) or even a complete set of financial
statements.
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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. As the auditor simply provides a report of the factual
findings of agreed-upon procedures, no assurance is expressed. Instead, users of the report
assess for themselves the procedures and findings reported by the auditor and draw their own
conclusions from the auditor’s work.
Independence is not a requirement for agreed-upon procedures engagements. Where the
auditor is not independent, a statement to that effect would be made in the report of factual
findings.
The report is restricted to those parties that have agreed to the procedures to be performed
since others, unaware of the reasons for the procedures, may misinterpret the results. The report
on an agreed-upon procedures engagement needs to describe the purpose and the agreed-upon
procedures of the engagement in sufficient detail to enable the reader to understand the nature
and the extent of the work performed.
Engagements to Compile Financial Information
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.
Independence is not a requirement for a compilation engagement. However, where the
accountant is not independent, a statement to that effect would be made in the accountant's
report.
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. In all circumstances
when an accountant's name is associated with financial information compiled by the accountant,
the accountant should issue a report.
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In all circumstances when an accountant's name is associated with financial information
compiled by the accountant, the accountant should issue a report. The generally accepted
accounting principles in the Philippines and any known departures therefrom should be
disclosed within the financial information, though their effects need not be quantified. If the
accountant becomes aware of material misstatements, the accountant should try to agree
appropriate amendments with the entity. If such amendments are not made and the financial
information is considered to be misleading, the accountant should withdraw from the
engagement.
The financial information compiled by the accountant should contain a reference such as
"Unaudited," "Compiled without Audit or Review" or "Refer to Compilation Report" on each page
of the financial information or on the front of the complete set of financial statements.
Multiple Choice Questions
1. Which of the following is not a procedure normally performed while completing the audit?
a. Obtain a lawyer's letter.
b. Obtain a representations letter.
c. Perform an overall review using analytical procedures.
d. Obtain confirmation of capital stockholdings from shareholders.
2. Which of the following types of matters do not generally require disclosure in the financial
statements?
a. General risk contingencies.
b. Commitments.
c. Loss contingencies.
d. Liabilities to related parties.
3. Which of the following is not correct relating to representation letters?
a. They are ordinarily dated as of the date of the audit report.
b. They are signed by members of top management.
c. They must be obtained for audits.
d. They often serve as a substitute for the application of other procedures.
4. One reason why the independent auditors perform analytical procedures on the client's
operations is to identify:
a. Weaknesses of a material nature in internal control.
b. Non-compliance with prescribed control procedures.
c. Improper separation of accounting and other financial duties.
d. Unusual transactions.
5. The auditors' primary means of obtaining corroboration of management's information
concerning litigation is a:
a. Letter of audit inquiry to the client's lawyer.
b. Letter of corroboration from the auditor's lawyer upon review of the legal
documentation.
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c. Confirmation of claims and assessments from the other parties to the litigation.
d. Confirmation of claims and assessments from an officer of the court presiding over
the litigation.
6. A successor auditor has accepted an engagement that was previously performed by a
predecessor auditor and, prior to accepting the engagement, has communicated with the
predecessor. When the successor believes that the predecessor has performed satisfactory
previous audits, which of the following is correct?
a. A second communication is required and must include details of previous audits.
b. Ordinarily the successor auditors may be able to accept the opening balances of the
current year with a minimum of verification work.
c. Absent ongoing litigation, a predecessor must provide all working papers requested
by the predecessor.
d. The client should be informed of the need to perform a detailed audit of all opening
balances.
7. Which of the following audit procedures would most likely assist an auditor in identifying
conditions and events that may indicate there could be substantial doubt about an entity’s
ability to continue as a going concern?
a. Review compliance with the terms of debt agreements.
b. Confirmation of accounts receivable from principal customers.
c. Reconciliation of interest expense with debt outstanding.
d. Confirmation of bank balances.
8. Which of the following material events occurring subsequent to the balance sheet date
would require an adjustment to the financial statements before they could be issued?
a. Loss of a plant as a result of a flood.
b. Sale of long-term debt or capital stock.
c. Settlement of litigation in excess of the recorded liability.
d. Major purchase of a business that is expected to double the sales volume.
9. In evaluating an entity's accounting estimates, one of the auditor's objectives is to determine
whether the estimates are
a. Prepared in a satisfactory control environment.
b. Consistent with industry guidelines.
c. Based on verifiable objective assumptions.
d. Reasonable in the circumstances.
10. In auditing an asset valued at fair value, which of the following potentially provides the
auditor with the strongest evidence?
a. A price for a similar asset obtained from an active market.
b. An appraisal obtained discounting future cash flows.
c. Management's judgment of the cost to purchase an equivalent asset.
d. The historical cost of the asset.
11. Which of the following least likely indicates the existence of previously unidentified related
parties?
a. Transactions which have abnormal terms of trade, such as unusual prices, interest
rates, guarantees, and repayment terms.
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b. Transactions which lack an apparent logical business reason for their occurrence.
c. Transactions in which substance does not differ from form.
d. Unrecorded transactions such as the receipt or provision of management services at
no charge.
12. An expert may be:
Engaged by the entity
Engaged by the auditor
Employed by the entity
Employed by the auditor
a
Yes
No
Yes
No
b
No
Yes
No
Yes
c
Yes
Yes
No
No
d
Yes
Yes
Yes
Yes
13. The primary source of information to be reported about litigation, claims, and assessments is
the
a. Client’s lawyer
c. Client’s management
b. Court records
d. Independent auditor
14. The primary reason an auditor requests that letters of inquiry be sent to a client’s attorneys is
to provide the auditor with
a. The probable outcome of asserted claims and pending or threatened litigation.
b. Corroboration of the information furnished by management about litigation, claims, and
assessments.
c. The attorneys’ opinions of the client’s historical experiences in recent similar litigation.
d. A description and evaluation of litigation, claims, and assessments that existed at the
balance
sheet date.
15. It exists when other information contradicts information contained in the audited financial
statements.
a. Material misstatement of fact
c. Material inconsistency
b. Material error
d. Material deviation
16. In evaluating the assumptions on which the estimate is based, the auditor would need to pay
particular attention to assumptions which are
a. Reasonable in light of actual results in prior periods.
b. Consistent with those used for other accounting estimates.
c. Consistent with management’s plans which appear appropriate.
d. Subjective or susceptible to material misstatement.
17. Which statement is incorrect regarding auditing fair value measurements and disclosures?
a. The auditor should obtain sufficient appropriate audit evidence that fair value
measurements and disclosures are in accordance with GAAP in the Philippines.
b. Many measurements based on estimates, including fair value measurements, are
inherently imprecise.
c. The auditor's consideration of such assumptions is based on information available to
the auditor at the time of the audit.
d. The auditor is responsible for predicting future conditions, transactions or events which,
had they been known at the time of the audit, may have had a significant effect on
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management's actions or management's assumptions underlying the fair value
measurements and disclosures.
18. Which of the following events occurring after the issuance of an auditor’s report most likely
would cause the auditor to make further inquiries about the previously issued financial
statements?
a. A technological development that could affect the entity’s future ability to continue as
a going concern.
b. The entity’s sale of a subsidiary that accounts for 30 percent of the entity’s
consolidated sales.
c. The discovery of information regarding a contingency that existed before the financial
statements were issued.
d. The final resolution of a lawsuit explained in a separate paragraph of the auditor’s
report
19. If an accounting change has no material effect on the financial statements in the current year
but the change is reasonably certain to have a material effect in later years, the change should
be
a. Treated as a consistency modification in the auditor’s report for the current year.
b. Disclosed in the notes to the financial statements of the current year.
c. Disclosed in the notes to the financial statements and referred to in the auditor’s report
for the current year.
d. Treated as a subsequent event.
20. Which statement is incorrect regarding corresponding figures?
a. The corresponding figures are not presented as complete financial statements
capable of standing alone.
b. The level of detail presented in the corresponding amounts and disclosures is dictated
primarily by its relevance to the current period figures.
c. The auditor’s report refers only to the financial statements of the current period.
d. The auditor’s report refers to each period that financial statements are presented.
21. Examples of unqualified opinions which contain modified wording (without adding an
emphasis of matter paragraph) include:
a. the use of other auditors.
b. material uncertainties.
c. substantial doubt about the audited company continuing as a going concern.
d. lack of consistent application of GAAP.
22. Browny Co.’s financial statements adequately disclose uncertainties that concern future
events, the outcome of which are not reasonably estimable. The auditor’s report should
include a(n):
a. unqualified opinion.
b. disclaimer of opinion.
c. qualified opinion.
d. adverse opinion.
23. In which situation would the auditor be choosing between “except for” qualified opinion and
an adverse opinion?
a. The auditor lacks independence.
b. A client-imposed scope restriction.
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c. A circumstance-imposed scope restriction.
d. Lack of full disclosure required by footnotes.
24. Statement 1: KAM may be significant events that have transpired during the year.
Statement 2: KAM should not consider the related disclosure in the financial statements.
a. Both statements are true.
b. Both statements are false.
c. First statement is true and second statement is false.
d. First statement is false and second statement is true.
25. The auditors' primary means of obtaining corroboration of management's information
concerning litigation is a:
a. Letter of audit inquiry to the client's lawyer.
b. Letter of corroboration from the auditor's lawyer upon review of the legal
documentation.
c. Confirmation of claims and assessments from the other parties to the litigation.
d. Confirmation of claims and assessments from an officer of the court presiding over
the litigation.
26. Which of the following best describes the auditor's responsibility for "other information"
included in the annual report to stockholders which contains financial statements and the
auditor's report?
a. The auditor has no obligation to read the "other information."
b. The auditor has no obligation to corroborate the "other information," but should read
the "other information" to determine whether it is materially inconsistent with the financial
statements.
c. The auditor should extend the examination to the extent necessary to verify the "other
information."
d. The auditor must modify the auditor's report to state that the "other information is
unaudited" or "not covered by the auditor's report."
27. Comparative financial statements include the financial statements of a prior period which were
examined by a predecessor auditor whose report is not presented. If the predecessor auditor's
report was qualified, the successor auditor must
a. Obtain written approval from the predecessor auditor to include the prior year's financial
statements.
b. Issue a standard comparative audit report indicating the division of responsibility.
c. Express an opinion on the current year statements alone and make no reference to the
prior year statements.
d. Disclose the reasons for any qualification in the predecessor auditor's opinion.
28. In which of the following circumstances may the auditor issue the standard audit report?
a. The financial statements are affected by a departure from a generally accepted
accounting principle.
b. Substantial doubt exists concerning the ability of the entity to continue as a going
concern.
c. The principal auditor assumes responsibility for the work of another auditor.
d. Unable to obtain sufficient appropriate audit evidence during the course of audit.
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29. Which of the following best describes the reference to the expression "taken as a whole" in
the audit report?
a. It applies equally to a complete set of financial statements and to each individual
financial statement.
b. It applies only to a complete set of financial statements.
c. It applies equally to each item in each financial statement.
d. It applies equally to each material item in each financial statement.
30. Reports on debt compliance and similar engagements may be issued as a separate report or
as part of a report that expresses the auditor’s opinion on the financial statements. When they
are issued as a part of the report on the financial statements, it is done by:
a. adding a middle paragraph before the opinion paragraph.
b. adding a paragraph after the opinion paragraph.
c. adding an additional phrase or sentence within the opinion paragraph.
d. adding a paragraph between the introductory and scope paragraphs.
31. Which of the following is not an element of examining a forecast?
a. Evaluating the preparation of the prospective financial statements.
b. Understanding internal controls.
c. Evaluating the support underlying the assumptions.
d. Issuing an examination report.
32. An accountant’s standard report on a compilation of a projection should not include a:
a. statement that a compilation of a projection is limited in scope.
b. separate paragraph that describes the limitations on the presentation’s usefulness.
c. disclaimer of responsibility to update the report for events occurring after the report’s
date.
d. statement that the accountant expresses only limited assurance that the results may
be achieved.
33. Which of the following is not a distinction between a compilation and a review?
a. The CPA must be independent as a prerequisite to performing a review engagement,
but need not be independent to perform a compilation.
b. In conducting a review, the CPA must obtain an understanding of the client's internal
control system; but this is not necessary for a compilation engagement.
c. Analytical procedures are applied in a review engagement, but are not required in a
compilation.
d. A compilation offers no assurance, whereas a review provides limited assurance.
34. Accepting an engagement to compile a financial projection
for a publicly held company
most likely would be inappropriate if the projection were to be distributed to
a. A bank with which the entity is negotiating for a loan.
b. A labor union with which the entity is negotiating a contract.
c. The principal stockholder, to the exclusion of the other stockholders.
d. All stockholders of record as of the report date.
35. Which of the following is correct relating to an engagement to apply agreed-upon
procedures to prospective financial statements?
a. Use of the report is restricted to the specified users.
b. Such engagements are permissible for forecasts but not for projections.
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c. Responsibility for the adequacy of the procedures performed is taken by the
practitioner.
d. Such engagements are not permissible under the professional standards.
36. The party responsible for assumptions identified in the preparation of prospective financial
statements is usually:
a. A third-party lending institution.
b. The client's management.
c. The reporting accountant.
d. The client's independent auditor.
37. Which of the following procedures is usually the first step in reviewing the financial
statements of a nonpublic entity?
a. Make preliminary judgments about risk and materiality to determine the scope and
nature of the procedures to be performed.
b. Obtain a general understanding of the entity's organization, its operating
characteristics, and its products or services.
c. Assess the risk of material misstatement arising from fraudulent financial reporting
and the misappropriation of assets.
d. Perform a preliminary assessment of the operating efficiency of the entity's internal
control activities.
38. An audit report should be dated as of
a. the date the report is delivered to the entity audited.
b. the balance sheet date of the latest period reported on.
c. the date a letter of audit inquiry is received from the entity's attorney of record.
d. the date of the last day of fieldwork.
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Lesson 5 – Practice of Accountancy Profession
Overview:
A Certified Public Accountant (CPA) shall be considered in the practice of his profession,
if the nature and character of his employment whether as an officer or employee in a private
enterprise or educational institution involves decision-making requiring professional knowledge in
the science of accounting or when he represents his private employer before any government
agency on tax matters related to accounting, and such employment or position requires that the
holder thereof must be a CPA; or if he holds or is appointed to a position in the accounting
occupational group in the government or in government-owned or controlled corporations,
including those performing proprietary functions, where a civil service eligibility as a CPA is a
prerequisite.
Learning Objectives:
After studying this lesson, the student should:
•
•
•
•
Understand the relevant laws and regulations in the practice of accountancy profession
including its Code of Professional Ethics.
Know the different sectors in the practice of accountancy profession.
Familiarize with the regulatory bodies in the practice of accountancy profession.
Be updated with the latest trends and pronouncements affecting the practice of
accountancy profession.
Course Materials:
Philippine Accountancy Act of 2004 and its IRR, Quality Control Standards,
And Other Pronouncements
Practice of accountancy shall constitute in a person, be it in his individual capacity, or
as a partner or staff member in an accounting or auditing firm, holding out himself as one skilled
in the knowledge, science, and practice of accounting, and as qualified to render professional
services as a certified public accountant; or offering or rendering, or both, to more than one client
on a fee basis or otherwise, services such as the audit or verification of financial transactions and
accounting records; the preparation, signing, or certification for clients of reports of audit, balance
sheets, and other financial accounting and related schedules, exhibits, statements, or reports
which are to be used for publication or for credit purposes, or to be filed with a court or government
agency, or to be used for any other purpose; the installation and revision of accounting system,
the preparation of income tax returns when related to accounting procedures; or when he
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represents clients before government agencies on tax matters related to accounting or renders
professional assistance in matters relating to accounting procedures and the recording and
presentation of financial facts or data.
The Republic Act (RA) 9298, Philippine Accountancy Act, as revised and enacted in
2004, stipulates that the Professional Regulatory Board of Accountancy (BOA), which operates
under the supervision of the Professional Regulation Commission (PRC), is responsible for the
regulation of professional accountants in the Philippines. In accordance with the act, the practice
of accountancy encompasses work in public accountancy, commerce and industry,
education/academe, and government.
The Republic Act (RA) 9298, Philippine Accountancy Act outlines the procedures for
individuals who wish to practice accountancy. Candidates must first pass a licensure examination
administered by the BOA. In order to be eligible to sit for the examination, applicants must meet
the following criteria: (i) be a Filipino citizen; (ii) be of good moral character; (iii) be a holder of the
degree of Bachelor of Science in Accountancy conferred by a school, college, academy or
institute duly recognized and/or accredited by the Commission on Higher Education (CHED) or
other authorized government offices; and (iv) not been convicted of any criminal offense.
Upon successfully completing the exam, individuals may be registered with the BOA and
receive a Certificate of Registration from the BOA and a professional identification card issued by
the BOA and the PRC. Once registered with the BOA as Certified Public Accountants (CPAs),
individuals must join an accredited, national professional accountancy organization of which there
is only one in the Philippines—the Philippine Institute of Certified Public Accountants (PICPA).
Finally, candidates must then complete three years of meaningful practical experience in order to
receive a Certificate of Accreditation from the BOA permitting them to publicly practice. CPAs in
Public Practice (auditors) must renew their Certificate of Accreditation and professional
identification card every three years with the BOA and the PRC and comply with continuing
professional development (CPD) requirements.
There are three entities involved in the regulation of professional accountants: the PRC,
the BOA, and PICPA. Their respective responsibilities are as follows.
The PRC operates under the offices of the President of the Philippines and its mandate is
to regulate and supervise the practice of all professionals. The PRC administers the examination,
accreditation, inspection and monitoring, and CPD procedures of all 43 professional bodies that
encompass the fields of health, business, education, social sciences, engineering and technology
and operate under the PRC’s supervision. In turn, the professional bodies are responsible for
governing their respective professions’ practice and ethical standards. The professional body for
accountancy is the BOA.
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The BOA, under the Republic Act (RA) 9298, Philippine Accountancy Act, is responsible
for: (i) supervising the registration, licensing, and practice of accountancy in the Philippines; (ii)
maintaining a registry of registered and accredited CPAs; (iii) issuing and renewing Certificates
of Registration and Accreditation; (iv) adopting ethical, accounting and auditing standards, taking
into consideration international standards and generally accepted best practices; (v) conducting
quality assurance (QA) reviews; (vi) investigating violations of rules and regulations and issuing
sanctions; (vi) preparing and issuing the syllabi of the subjects for examinations in consultation
with the academe, preparing questions for the licensing examination; and administering and
releasing the results of the examinations; (vii) ensuring all tertiary educational providers comply
with policies and standards prescribed by the CHED.
No person shall be appointed a member of the Board of Accountancy unless he:
1. Is a citizen of the Philippines;
2. Is of good moral character;
3. Is a duly registered Certified Public Accountant in the Philippines;
4. Has been in the practice of accountancy for at least ten years; and
5. Is not directly or indirectly connected with any school, college, or university
granting degrees that may qualify graduates with such degrees for admission to
the Certified Public Accountant examinations, or with Certified Public Accountant’s
Review School or Institute, nor shall have any pecuniary interest in such school,
college, university or Certified Public Accountant’s Review School or Institute.
In 1975, with the accreditation by the PRC of the PICPA as the bona fide professional
organization representing CPAs in the country, the Board has coordinated with PICPA to further
strengthen the profession. With PICPA, it has worked for the passage of The Accountancy Act of
1967; the issuance of the Code of Professional Ethics in 1978; the issuance of guidelines in 1987
for the mandatory continuing professional education (CPE) program for CPAs; the integration of
the accounting profession completed in 1987; the biennial oath taking of new CPAs; standards
setting for the profession through membership in the Accounting Standards Council and the
Auditing Standards Practices Council; and the declaration of the Accountancy Week.
Thirdly, the PICPA is responsible for: (i) promoting and maintaining high professional and
ethical standards among accountants by adopting a Code of Ethics for its members as a task
delegated by the BOA; (ii) developing and improving the accountancy education; (iii) protecting
the CPA designation; and (iv) carrying out the fact-finding component of investigations upon the
delegation and approval of the BOA and the PRC. Under PICPA, there are four sub-organizations
for the different sectors of accountancy profession. These are:
1. Association of CPAs in Public Practice (ACPAPP)
2. Association of CPAs in Commerce and Industry (ACPACI)
3. Government Association of CPAs (GACPA)
4. National Association of CPAs in Education (nACPAE)
Finally, auditors of public interest entities are subject to additional requirements. Only
individual external auditors and auditing firms that are accredited by the Securities and Exchange
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Commission (SEC) can perform statutory audits of financial statements of publicly listed SECregistered entities. They are subject to the QA review system operated by the SEC and any
penalties imposed by the SEC for lack of compliance with professional standards. Auditors
providing services to banks or insurance or cooperatives are required to be accredited with the
Bangko Sentral ng Pilipinas, the Insurance Commission and the Cooperative Development
Authority of the Philippines, respectively.
There is no independent audit oversight authority in the Philippines. As such, auditors are
regulated at the state level by the Professional Regulation Commission (PRC) and the
Professional Regulatory Board of Accountancy (BOA), and at the professional level by the
Philippine Institute of Certified Public Accountants (PICPA). In order to offer auditing services in
the Philippines, individuals must be registered and accredited by the BOA and PRC and be a
member of PICPA.
Quality Assurance
The Professional Regulatory Board of Accountancy (BOA), under the Republic Act 9298,
Philippine Accountancy Act 2004, is responsible for setting quality control standards and
establishing a quality assurance (QA) review system for all auditors while the Securities and
Exchange Commission (SEC) is solely authorized to carry out QA reviews for auditors of listed
companies as per the Securities Regulation Code Rule 68.
The BOA created the Auditing and Assurance Standards Council (AASC) in 2006 in order
to adopt and disseminate applicable quality control standards in the Philippines. The AASC has
adopted the Philippine Standards on Quality Control, which is based on ISQC 1.
In 2010, the BOA established a Quality Assurance Review Office (QARO) and its Quality
Assurance Review Program (QARP), which were approved by the Professional Regulation
Commission. The implementation of the QARP has been planned; however, key personnel that
would carry out the functions of the QARO and the QARP are still being recruited and therefore
no QA reviews have been carried out as of February 2018. Once the QARO is staffed for
operations, it appears that the BOA will utilize a risk-based approach to conduct the reviews and
its overall process will align with SMO 1 requirements.
Due to the delay of the BOA’s QARP, the Philippine Institute of Certified Public
Accountants (PICPA) established a voluntary QARP (VQARP) for its members—which includes
all auditors—with the assistance of the World Bank and the Association of Certified Public
Accountants in Public Practice. Guidelines for the voluntary QARP were approved in January
2016 and PICPA began carrying out reviews in April 2016 although it has only been able to carry
out a limited number of inspections due to the voluntary nature of the program. Its VQARP follows
the same methodology as the BOA’s QA system.
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Lastly, the SEC operates the SEC Oversight Assurance Review (SOAR) Inspection
program. A SEC Memorandum Circular No. 9 Series of 2017 issued in August 2017 will now
permit the SEC to carry out onsite inspections of audit firms handling audits of listed companies.
Prior to this, the SEC would do a desktop review of listed companies’ audited financial statements
every three years and could impose penalties for material deficiencies. According to PICPA, the
SOAR Inspection Program fulfills the SMO 1 best practices.
Investigation and Discipline
The Professional Regulatory Board of Accountancy (BOA), under the Republic Act 9298,
Philippine Accountancy Act 2004, is responsible for the investigation and discipline (I&D) of any
violations of the accountancy law by any professional accountant. The Professional Regulation
Commission (PRC) is ultimately responsible for approving any sanction recommended by the
BOA.
The BOA and the PRC may delegate the fact-finding component of investigations to the
nationally accredited professional accountancy organization which is the Philippine Institute of
Certified Public Accountants (PICPA). The BOA and PRC may then proceed with adopting
PICPA’s findings and issuing sanctions as it sees fit.
PICPA’s by-laws provide for the establishment of an Ethics Board which may hear and
decide cases on: (i) violations of the PICPA Constitution and By-laws; (ii) a breach of the Code of
Ethics; (iii) infringements of any provisions of the Rules of Professional Conduct of the BOA; and
(iv) a violation of any of the rules provided by the Rules and Regulations of the BOA. The Ethics
Board will forward its decision onto the PICPA Board and the BOA, unless the decision of the
Ethics Board has been appealed to the PICPA Board in which case it is the duty of the PICPA
Board to forward its final decision to the BOA. The BOA may then recommend a sanction which
is approved by the PRC before becoming final.
Lastly, the Securities and Exchange Commission (SEC) is authorized to carry out
investigations and issue penalties for auditors of listed companies as per the Securities
Regulation Code Rule 68. Through a Memorandum of Understanding between the SEC and the
BOA, the SEC’s findings are also forwarded to the BOA as appropriate given that the BOA issues
and grants licenses to practice auditing.
In 2018, the PICPA carried out an extensive assessment of all three I&D systems against
the SMO 6 components. The information can be found in its 2018 SMO Action Plan and indicates
that a gap remains between linking results of quality assurance (QA) reviews with the BOA’s and
PICPA’s I&D system as only the SEC has an operational QA review system.
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Continuing Professional Development
The Republic Act 9298, Philippine Accountancy Act stipulates the initial professional
development requirements for Certified Public Accountants (CPA) in the Philippines. These
include specific education, examination, and practical experience requirements.
The accountancy education programs and CPA examination are regulated by the
Professional Regulation Commission (PRC), the Professional Regulatory Board of Accountancy
(BOA), and the Commission on Higher Education (CHED). Tertiary education providers may offer
accountancy programming that is in line with the requirements prescribed by the CHED while the
examination is offered by the BOA.
The Philippine Institute of Certified Public Accountants (PICPA) reports that the
requirements outlined in the law are in line with the IES requirements. Further, it notes that the
CHED issued several memorandums in 2017 that revise policies for university accountancy
curricula to comply with the competency framework issued by the IAESB.
The law also mandates that CPAs comply with continuing professional development
(CPD) requirements issued by the BOA and approved by the PRC. CPD is required to be offered
in coordination with the accredited national PAO—PICPA—and CPD providers must be
accredited. For these purposes, the PRC has established a CPD Council.
In November 2016, the BOA issued Board Resolution No. 358 Series of 2016, “Increasing
the Required Continuing Professional Development (CPD) Units from Sixty (60) to One Hundred
twenty (120) Credit Units within a Compliance Period of Three (3) Years for all CPAs and
Changing the Thematic Areas to Competence Areas” to align with latest IES requirements. In July
2017, the BOA issued operational guidelines that made these requirements effective and by 2019,
all CPAs will be required to comply with 120 hours of CPD.
Auditing and Assurance Standards Council
The Auditing and Assurance Standards Council (AASC) was created in December 2005,
under the Philippine Accountancy Act of 2004, by the Professional Regulation Commission upon
the recommendation of the Board of Accountancy (BOA). The AASC is tasked to assist the BOA
to establish and promulgate auditing standards in the Philippines. The AASC shall have 18 regular
members with a term of three years, renewable for another term, coming from the following:
Chairman
Board of Accountancy
Securities and Exchange Commission
1
1
1
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Bangko Sentral ng Pilipinas
Commission on Audit
Association of CPAs in Public Practice
Philippine Institute of CPAs:
Public Practice
Commerce and Industry
Academe/Education
Government
1
1
1
9
1
1
1
The AASC has adopted the Philippine Standards on Auditing (PSA) which incorporate the
ISA and pronouncements issued by the IAASB and include additional country-specific standards
to address issues not covered by IAASB pronouncements. In order for the new and revised PSA
to become effective, the standards must be approved by AASC, the BOA, Professional Regulation
Commission, and be published in the official gazette. At the time of the assessment, the Philippine
Institute of Certified Public Accountants reports that the 2016 ISA have been adopted as PSAs
and are applicable in the jurisdiction.
Finally, the AASC has also adopted Philippine Standards on Review Engagements,
Philippine Standards on Assurance Engagements, Philippine Standards on Related Services, and
Philippine Standards on Quality Control which are all based on the IAASB standards.
Financial Reporting Standards Council
The Financial Reporting Standards Council (FRSC) was established by the Professional
Regulatory Commission under the Implementing Rules and Regulations of the Philippine
Accountancy of Act of 2004 to assist the Board of Accountancy in carrying out its power and
function to promulgate accounting standards in the Philippines. The FRSC’s main function is to
establish generally accepted accounting principles in the Philippines.
The FRSC is the successor of the Accounting Standards Council (ASC). The ASC was
created in November 1981 by the Philippine Institute of Certified Public Accountants (PICPA) to
establish generally accepted accounting principles in the Philippines. The FRSC carries on the
decision made by the ASC to converge Philippine accounting standards with international
accounting standards issued by the International Accounting Standards Board (IASB).
The FRSC consists of who a Chairman and members are appointed by the BOA and
include representatives from the Board of Accountancy (BOA), Securities and Exchange
Commission (SEC), Bangko Sentral ng Pilipinas (BSP), Financial Executives Institute of the
Philippines (FINEX), Commission on Audit (COA) and Philippine Institute of Certified Public
Accountants (PICPA). The FRSC has full discretion in developing and pursuing the technical
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agenda for setting accounting standards in the Philippines. Financial support is received
principally from the PICPA Foundation.
The FRSC monitors the technical activities of the IASB and invites comments on exposure
drafts of proposed IFRSs as these are issued by the IASB. When finalized, these are adopted as
Philippine Financial Reporting Standards (PFRSs). The FRSC similarly monitors issuances of the
International Financial Reporting Interpretations Committee (IFRIC) of the IASB, which it adopts
as Philippine Interpretations–IFRIC. PFRSs and Philippine Interpretations–IFRIC approved for
adoption are submitted to the BOA and PRC for approval.
The FRSC formed the Philippine Interpretations Committee (PIC) in August 2006 to assist
the FRSC in establishing and improving financial reporting standards in the Philippines. The role
of the PIC is principally to issue implementation guidance on PFRSs. The PIC members are
appointed by the FRSC and include accountants in public practice, the academe and regulatory
bodies and users of financial statements. The PIC replaced the Interpretations Committee created
by the ASC in 2000.
The FRSC has adopted the IFRS as the Philippine Financial Reporting Standards (PFRS)
with several limited modifications and the PFRS for Small-and Medium-sized Entities (PFRS for
SMEs) which are the IFRS for SMEs without modifications. Recently effective January 1, 2019,
PFRS for Small Entities was implemented.
The PFRS are subject to the approval and pronouncement process of the BOA, PRC, and
the Philippine Securities and Exchange Commission (SEC), which includes issuing invitations for
comments on exposure drafts, adoption of the standard, BOA and PRC approval, publication in
an official gazette, and SEC adoption of the new pronouncement. As of December 2017, the
Philippine Institute of Certified Public Accountants reports that the FRSC has adopted all
standards as issued by the IASB such that the PFRS are fully converged with the IFRS.
The SEC has established a three-tier financial reporting framework. Public interest entities
must apply the full PFRS if they meet certain thresholds. SMEs are permitted to use PFRS for
SMEs provided that they do not fall into one of the categories of entities required to use full PFRS.
Finally, micro-sized entities have option to use either income tax basis accounting standards
effective 31 December 2004 (standards before entities transitioned to PFRS), or the PFRS for
SMEs. In addition, the Bangko Sentral ng Pilipinas (BSP; the Philippines Central Bank) has
required all banks to follow PFRS since 2005.
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Future of Accountancy Profession in the Philippines
As the global professional environment unfolds, with the onset of the 21st century,
accountancy continues its trailblazing efforts. It is the first among the Philippine professions to be
included under the World Trade Organization’s (WTO) policy of liberalization of services. This
means that Philippine accountants will be freely competing with in the global playing field against
accountants from other parts of the world and will be able to hold their own. This is due, in no
small measure, to the long and distinguished careers of the country’s accountants, to the linkages
that local firms have forged with the world’s biggest accounting firms, and to the integrity with
which the Board of Accountancy and the Professional Regulation Commission are now
administering a profession that has acquired a global perspective.
CODE OF PROFESSIONAL ETHICS FOR ACCOUNTANTS
While the Professional Regulatory Board of Accountancy (BOA), in accordance with the
Republic Act 9298, Philippine Accountancy Act 2004, is tasked with setting ethical requirements
for the profession, this responsibility has been delegated to the Philippine Institute of Certified
Public Accountants (PICPA) as the national professional accountancy organization accredited by
the Professional Regulation Commission (PRC).
Ethical requirements for professional accountants are approved by PICPA’s Board of
Directors and then submitted to the BOA for adoption and the PRC for approval prior to
application.
In December 2015, the PRC issued Resolution No. 263, which adopted the 2013 IESBA
Code of Ethics without modifications as approved by PICPA.
Subsequently, PICPA indicates that its Board of Directors submitted BOD Resolution No.
2017-07-08 to the BOA recommending the adoption of the 2016 IESBA Code of Ethics. The BOA
has approved the recommendation with the stipulation that the PRC shall put in place the
appropriate mechanism to implement the Non-compliance with Laws and Regulation (NOCLAR)
standard. Currently as per PICPA website, we are adopting the 2018 edition of Code of Ethics.
The Code of Ethics for Professional Accountants were decided to be revised, updated,
and issued by the International Ethics Standards Board for Accountants (IESBA) so that it could
serve as the basis for developing ethics and independent standards for professional accountants
considering the advancing of technologies and new business models in the industry.
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International Ethics Standards Board for Accountants (IESBA) is an independent standard
body that is working for the public interest by setting robust and appropriate accounting standards
including the requirements for professional accountants all over the world, making as an output
the Code of Ethics for Professional Accountants as well as the International Independent
Standard. It has 172 volunteer members from around the world of which members are appointed
by the International Federation of Accountants (IFAC) Board and is subject to approval of Public
Interest Oversight Board (PIOB).
The Newly Revised Code was released in April 2018. The process took a massive
consultation to the stakeholders including the IFAC and SMP Committee. The new design was
easier to navigate, use and enforce. It was also completely rewritten and the requirements are
clearly distinguished from application material making it to promote more the general ethical
behaviors. This Code contains three parts:
A. Part A establishes the fundamental principles of professional ethics for professional
accountants and provides a conceptual framework that professional accountants shall apply
to:
(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the significance of the threats identified; and
(c) Apply safeguards, when necessary, to eliminate the threats or reduce them to an
acceptable level.
B. Parts B and C describe how the conceptual framework applies in certain situations. They
provide examples of safeguards that may be appropriate to address threats to compliance
with the fundamental principles. They also describe situations where safeguards are not
available to address the threats, and consequently, the circumstance or relationship creating
the threats shall be avoided. Part B applies to professional accountants in public practice.
C. Part C applies to professional accountants in business.
FUNDAMENTAL PRINCIPLES
1. Integrity
The principle of integrity imposes an obligation on all professional accountants to
be straightforward and honest in all professional and business relationships. Integrity also
implies fair dealing and truthfulness.
A professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the professional accountant believes that the
information:
• Contains a materially false or misleading statement
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•
•
Contains statements or information furnished recklessly
Omits or obscures information required to be included where such
omission or obscurity would be misleading.
When a professional accountant becomes aware that the accountant has been
associated with such information, the accountant shall take steps to be disassociated from
that information. A professional accountant will be deemed not to be in breach of the
previous paragraph if the professional accountant provides a modified report in respect of
a matter contained in the previous paragraph.
2. Objectivity
The principle of objectivity imposes an obligation on all professional accountants
not to compromise their professional or business judgment because of bias, conflict of
interest or the undue influence of others.
A professional accountant shall not perform a professional service if a
circumstance or relationship biases or unduly influences the accountant’s professional
judgment with respect to that service.
3. Professional Competence and Due Care
The principle of professional competence and due care imposes the following
obligations on all professional accountants:
•
•
To maintain professional knowledge and skill at the level required to ensure that
clients or employers receive competent professional service
To act diligently in accordance with applicable technical and professional
standards when providing professional services.
Competent professional service requires the exercise of sound judgment in
applying professional knowledge and skill in the performance of such service. Professional
competence may be divided into two separate phases:
• Attainment of professional competence
• Maintenance of professional competence
The maintenance of professional competence requires a continuing awareness
and an understanding of relevant technical, professional, and business developments.
Continuing professional development enables a professional accountant to develop and
maintain the capabilities to perform competently within the professional environment.
Where appropriate, a professional accountant shall make clients, employers, or other
users of the accountant’s professional services aware of the limitations inherent in the
services.
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4. Confidentiality
The principle of confidentiality imposes an obligation on all professional
accountants to refrain from:
• Disclosing outside the firm or employing organization confidential information
acquired as a result of professional and business relationships without proper
and specific authority or unless there is a legal or professional right or duty to
disclose
• Using confidential information acquired as a result of professional and
business relationships to their personal advantage or the advantage of third
parties.
A professional accountant:
• shall maintain confidentiality, including in a social environment, being alert to the
possibility of inadvertent disclosure, particularly to a close business associate or a
close or immediate family member.
• shall maintain confidentiality of information disclosed by a prospective client or
employer.
• shall maintain confidentiality of information within the firm or employing
organization.
• shall take reasonable steps to ensure that staff under the professional accountant’s
control and persons from whom advice and assistance is obtained respect the
professional accountant’s duty of confidentiality.
The need to comply with the principle of confidentiality continues even after the
end of relationships between a professional accountant and a client or employer.
The following are circumstances where professional accountants are or may be
required to disclose confidential information or when such disclosure may be appropriate:
• Disclosure is permitted by law and is authorized by the client or the employer
• Disclosure is required by law
• There is a professional duty or right to disclose, when not prohibited by law:
➢ To comply with the quality review of a member body or professional body.
➢ To respond to an inquiry or investigation by a member body or regulatory body.
➢ To protect the professional interests of a professional accountant in legal
proceeding.
➢ To comply with technical standards and ethics requirements.
In deciding whether to disclose confidential information, relevant factors to
consider include:
• Whether the interests of all parties, including third parties whose interests may be
affected, could be harmed if the client or employer consents to the disclosure of
information by the professional accountant.
• Whether all the relevant information is known and substantiated, to the extent it
is practicable; when the situation involves unsubstantiated facts, incomplete
information or unsubstantiated conclusions, professional judgment shall be used
in determining the type of disclosure to be made, if any.
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•
•
The type of communication that is expected and to whom it is addressed.
Whether the parties to whom the communication is addressed are appropriate
recipients.
5. Professional Behavior
The principle of professional behavior imposes an obligation on all professional
accountants to comply with relevant laws and regulations and avoid any action that the
professional accountant knows or should know may discredit the profession.
In marketing and promoting themselves and their work, professional accountants shall not
bring the profession into disrepute. Professional accountants shall be honest and truthful
and not:
• Make exaggerated claims for the services they are able to offer, the qualifications
they possess, or experience they have gained
• Make disparaging references or unsubstantiated comparisons to the work of
others.
CONCEPTUAL FRAMEWORK APPROACH
When a professional accountant identifies threats to compliance with the fundamental
principles and, based on an evaluation of those threats, determines that they are not at an
acceptable level, the professional accountant shall determine whether appropriate safeguards are
available and can be applied to eliminate the threats or reduce them to an acceptable level.
A professional accountant shall evaluate any threats to compliance with the fundamental
principles when the professional accountant knows, or could reasonably be expected to know, of
circumstances or relationships that may compromise compliance with the fundamental principles.
A professional accountant shall take qualitative as well as quantitative factors into account
when evaluating the significance of a threat. When applying the conceptual framework, a
professional accountant may encounter situations in which threats cannot be eliminated or
reduced to an acceptable level, either because the threat is too significant or because appropriate
safeguards are not available or cannot be applied. In such situations, the professional accountant
shall decline or discontinue the specific professional service involved or, when necessary, resign
from the engagement (in the case of a professional accountant in public practice) or the employing
organization (in the case of a professional accountant in business).Depending on the nature and
significance of the matter, such an inadvertent violation may be deemed not to compromise
compliance with the fundamental principles provided, once the violation is discovered, the
violation is corrected promptly and any necessary safeguards are applied.
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When a professional accountant encounters unusual circumstances in which the
application of a specific requirement of the Code would result in a disproportionate outcome or an
outcome that may not be in the public interest, it is recommended that the professional accountant
consult with a member body or the relevant regulator.
THREATS AND SAFEGUARDS
I.
Self-interest threat – the threat that a financial or other interest will inappropriately
influence the professional accountant’s judgment or behavior.
II.
Self-review threat – the threat that a professional accountant will not appropriately
evaluate the results of a previous judgment made or service performed by the professional
accountant, or by another individual within the professional accountant’s firm or employing
organization, on which the accountant will rely when forming a judgment as part of
providing a current service.
Advocacy threat – the threat that a professional accountant will promote a client’s or
employer’s position to the point that the professional accountant’s objectivity is
compromised.
III.
IV.
Familiarity threat ─ the threat that due to a long or close relationship with a client or
employer, a professional accountant will be too sympathetic to their interests or too
accepting of their work.
V.
Intimidation threat – the threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to exercise
undue influence over the professional accountant.
Safeguards created by the profession, legislation or regulation include:
a. Educational, training and experience requirements for entry into the profession.
b. Continuing professional development requirements.
c. Corporate governance regulations.
d. Professional standards.
e. Professional or regulatory monitoring and disciplinary procedures.
f. External review by a legally empowered third party of the reports, returns,
communications or information produced by a professional accountant.
Safeguards in the work environment:
a. Effective, well-publicized complaint systems operated by the employing
organization, the profession, or a regulator, which enable colleagues, employers,
and members of the public to draw attention to unprofessional or unethical
behavior.
b. An explicitly stated duty to report breaches of ethical requirements.
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PROFESSIONAL ACCOUNTANTS IN PUBLIC PRACTICE
Professional Appointment
Before accepting a new client relationship, a professional accountant in public practice
shall determine whether acceptance would create any threats to compliance with the fundamental
principles. Where it is not possible to reduce the threats to an acceptable level, the professional
accountant in public practice shall decline to enter into the client relationship.
Conflicts of Interest
A professional accountant in public practice shall take reasonable steps to identify
circumstances that could pose a conflict of interest. Such circumstances may create threats to
compliance with the fundamental principles.
Fees and Other Types of Remuneration
When entering into negotiations regarding professional services, a professional
accountant in public practice may quote whatever fee is deemed appropriate. The fact that one
professional accountant in public practice may quote a fee lower than another is not in itself
unethical.
Independence
Independence comprises:
•
Independence of Mind - The state of mind that permits the expression of a conclusion
without being affected by influences that compromise professional judgment, thereby allowing an
individual to act with integrity and exercise objectivity and professional skepticism.
•
Independence in Appearance - The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party would be likely to conclude, weighing all the
specific facts and circumstances, that a firm’s, or a member of the audit team’s, integrity,
objectivity or professional skepticism has been compromised.
Documentation
Documentation provides evidence of the professional accountant’s judgments in forming
conclusions regarding compliance with independence requirements. The absence of
documentation is not a determinant of whether a firm considered a particular matter nor whether
it is independent.
Engagement Period
Independence from the audit client is required both during the engagement period and the
period covered by the financial statements. The engagement period starts when the audit team
begins to perform audit services. The engagement period ends when the audit report is issued.
When the engagement is of a recurring nature, it ends at the later of the notification by either party
that the professional relationship has terminated or the issuance of the final audit report.
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Financial Interests
Holding a financial interest in an audit client may create a self-interest threat. The
existence and significance of any threat created depends on:
• The role of the person holding the financial interest
• Whether the financial interest is direct or indirect
• The materiality of the financial interest.
Taxation Services
Tax return preparation services involve assisting clients with their tax reporting obligations
by drafting and completing information, including the amount of tax due (usually on standardized
forms) required to be submitted to the applicable tax authorities. Accordingly, providing such
services does not generally create a threat to independence if management takes responsibility
for the returns including any significant judgments made. Preparing calculations of current and
deferred tax liabilities (or assets) for an audit client for the purpose of preparing accounting entries
that will be subsequently audited by the firm creates a self-review threat. For public entities, unless
in emergency situations, the firm shall not prepare tax calculations of current and deferred tax
liabilities (or assets) for the purpose of preparing accounting entries that are material to the
financial statements on which the firm will express an opinion.
A self-review threat may be created where the advice will affect matters to be reflected in
the financial statements. The significance of any threat shall be evaluated, and safeguards applied
when necessary to eliminate the threat or reduce it to an acceptable level.
An advocacy or self-review threat may be created when the firm represents an audit client
in the resolution of a tax dispute once the tax authorities have notified the client that they have
rejected the client’s arguments on a particular issue and either the tax authority or the client is
referring the matter for determination in a formal proceeding.
PROFESSIONAL ACCOUNTANTS IN BUSINESS
Potential Conflicts
As a consequence of responsibilities to an employing organization, a professional
accountant in business may be under pressure to act or behave in ways that could create threats
to compliance with the fundamental principles. Such pressure may be explicit or implicit; it may
come from a supervisor, manager, director, or another individual within the employing
organization. The significance of any threats arising from such pressures, such as intimidation
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threats, shall be evaluated and safeguards applied when necessary to eliminate them or reduce
them to an acceptable level.
Preparation and Reporting of Information
Professional accountants in business are often involved in the preparation and reporting
of information that may either be made public or used by others inside or outside the employing
organization. A professional accountant in business shall prepare or present such information
fairly, honestly and in accordance with relevant professional standards so that the information will
be understood in its context.
Acting with Sufficient Expertise
A professional accountant in business shall not intentionally mislead an employer as to
the level of expertise or experience possessed, nor shall a professional accountant in business
fail to seek appropriate expert advice and assistance when required.
Financial Interests
Professional accountants in business may have financial interests or may know of financial
interests of immediate or close family members that, in certain circumstances, may create threats
to compliance with the fundamental principles. The significance of any threat shall be evaluated,
and safeguards applied when necessary to eliminate the threat or reduce it to an acceptable level.
Inducements
Offers of inducements may create threats to compliance with the fundamental principles.
When a professional accountant in business or an immediate or close family member is offered
an inducement, the situation shall be evaluated. The existence and significance of any threats will
depend on the nature, value and intent behind the offer. A professional accountant in business
shall not offer an inducement to improperly influence professional judgment of a third party.
Amendment to Code: Disclosure of Entity’s Non-Compliance in Laws and Regulations
(NOCLAR)
NOCLAR is defined by the new standard as comprising acts of omission or commission,
intentional or unintentional, committed by a client, or by those charged with governance, by
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management or by other individuals working for or under the direction of a client which are
contrary to the prevailing laws and regulations.
The non-compliance which the standard addresses is concerned with laws and regulations
which are generally recognized to have a direct effect on the determination of material amounts
and disclosures in the client’s financial statements. It also addresses other laws and regulations
which may be fundamental to the operating aspects of the client’s business, to its ability to
continue its business or to avoid material penalties. It is worth noting that the standard does not
include within its scope any matters that are clearly inconsequential or any personal misconduct
which is unrelated to the business activities of the client or employer.
The NOCLAR guidance therefore aims to ensure that Professional Accountants (PA)
respond to identified or suspected NOCLAR on a timely basis in order to rectify, remediate or
mitigate its potentially adverse impact on stakeholders and the general public. The increased
emphasis on PAs’ duties and responsibilities in this area should also serve to stimulate increased
reporting of NOCLAR and even to act as a deterrent to non-compliance by audited entities.
Latest News in Accountancy Profession: Impact of COVID-19 Pandemic to Audit
With the occurrence of an extraordinary event, such as a pandemic or disease outbreak
or a natural disaster, which causes restriction to travel and suspension of business operations,
audit engagement teams may face challenges in conducting the audit of the annual financial
statements (AFS) of Philippine companies with domestic and/or foreign business operations
affected by such extraordinary event, thus AASC issued Philippine Auditing Practice Notes 1 last
April 2020 for the relative guidance.
Audit teams could face significant challenges completing their audits due to the following
circumstances, including but not limited to the following:
a. Barriers to obtaining the information needed to perform procedures and reach
conclusions;
b. Challenges in obtaining access to the management of components and others, including
legal counsel, management’s or auditor’s experts;
c. Difficulties accessing client premises to perform procedures (e.g., not being able to
observe management’s inventory counts or to physically verify fixed assets after year-end);
d. Audit procedures not providing the anticipated audit evidence, requiring modifications to
the audit approach (e.g. a significant decline in response rates for bank and/or debtor
confirmations);
e. A need to respond to risks of material misstatement arising from limitations on information
and/or management having less time than usual to prepare the financial information;
f. A need to perform additional audit work to respond to risks of material misstatement
arising from the potential financial effects of the outbreak (e.g. additional procedures to
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evaluate the appropriateness of management’s assessment of the entity’s ability to continue
as a going concern); and
g. Impediments to completing the audit as a result of the engagement team having to work
remotely.
The financial reporting impact of an extraordinary event, will depend on facts and
circumstances, including the degree to which an entity’s operations is exposed to the impact of
such event. It is important for audit teams to understand the nature and extent of an entity’s
potential operating or financial exposure to the impact of the event and to consider the potential
impact on financial reporting, in particular, on management’s assessment of the entity’s ability to
continue as a going concern and the potential need for additional disclosures to reflect
uncertainties and potential volatility triggered by the event. Audit teams are required to maintain
professional skepticism and objectively challenge management’s plans and significant
assumptions on events or conditions affecting the entity and its environment, including the
uncertainties associated with the extraordinary event.
Multiple Choice Questions
1. A basic objective of a CPA firm is to provide professional services that conform to professional
standards. Reasonable assurance of achieving this basic objective is provided through
a. A system of peer review.
b. Continuing professional education.
c. A system of quality controls.
d. Compliance with generally accepted reporting standards.
2. The examination by CPAs of a CPA firm’s auditing practices to ascertain compliance with its
quality control system
a. Compliance audit
c. Peer review
b. Examination
d. Quality control audit
3. Quality control policies and procedures are required to be implemented at
a
b
c
Audit firm level
Yes
Yes
No
Individual audit level
Yes
No
Yes
d
No
No
4. The following factors affect the nature, timing and extent of an audit firm’s quality control
policies and procedures, except
a
b
c
d
Size and nature of practice
Yes
Yes
No
No
Geographic dispersion
Yes
Yes
Yes
No
Organization
Yes
No
Yes
No
Appropriate cost/benefit considerations
Yes
Yes
No
No
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5. The firm is to be staffed by personnel who have attained and maintained the technical standards
and professional competence required to enable them to fulfill their responsibilities
with due care is the objective of what quality control policy?
a. Professional Requirements
c. Assignment
b. Skills and Competence
d. Delegation
6. Which of the following objectives are generally a component of a firm’s quality control?
A. Professional requirements
E. Consultation
B. Skills and competence
F. Due professional care
C. Assignment
G. Monitoring
D. Inspection
H. Delegation
a. A, B, C, D, E, F
b. A, B, C, F, E, G
c. A, B, C, E, G, H
d. B, C, G, F, H
7. Which of the following is not an element of professional requirements as prescribed by
Quality Control Policies for an audit firm?
a. Independence
c. Confidentiality
b. Integrity
d. Prudence
8. Which of the following is an element of “directing an audit assistant” objective?
a. Identifying in advance the staffing requirements of a particular audit engagement.
b. Informing assistants of their responsibilities and the objectives of the procedures they
are to perform.
c. Resolving any differences in professional judgment between audit personnel.
d. Resolution of differences in audit findings.
9. It involves informing assistants of their responsibilities and the objectives of the procedures
they have to perform:
a. Supervision
c. Monitoring
b. Directing
d. Consultation
10. Which statement is incorrect regarding the Code of Ethics for Professional Accountants in the
Philippines?
a. Professional accountants refer to persons who are Certified Public Accountants (CPA)
and who hold a valid certificate issued by the Board of Accountancy.
b. Where a national statutory requirement is in conflict with a provision of the IFAC
Code, the IFAC Code requirement prevails.
c. The Code of Ethics for Professional Accountants in the Philippines is mandatory for all
CPAs and is applicable to professional services performed in the Philippines on or after
January 1, 2004.
d. Professional accountants should consider the ethical requirements as the basic
principles which they should follow in performing their work.
11. Which statement is correct regarding the Code of Ethics for Professional Accountants in the
Philippines?
a. Professional accountants refer to persons who are Certified Public Accountants (CPA)
in public practice and who hold a valid certificate issued by the Board of Accountancy.
b. It is practical to establish ethical requirements which apply to all situations and
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circumstances that professional accountants may encounter.
c. Professional accountants should consider the ethical requirements as the ideal
principles which they should follow in performing their work.
d. All CPAs are expected to comply with the ethical requirements of the Code and other
ethical requirements that may be adopted and approved by IFAC. Apparent failure to do
so may result in an investigation into the CPA’s conduct.
12. The following definitions from the IFAC Code were modified to consider Philippine regulatory
requirements and circumstances, except
a. Firm
c. Professional accountants
b. Accountants in public practice
d. Lead engagement partner
13. The following are modifications to the IFAC Code to consider Philippine regulatory
requirements and circumstances, except
a. The period for rotation of the lead engagement partner was changed from five to
seven
years.
b. Advertising and solicitation by individual professional accountants in public practice
were
not permitted in the Philippines.
c. Additional examples relating to anniversaries and websites wherein publicity is
acceptable, as provided in BOA Resolution 19, Series of 2000, were included.
d. Payment and receipt of commissions were not permitted in the Philippines.
14. If the firm is involved in the preparation of accounting records or financial statements and
those financial statements are subsequently the subject matter of an audit engagement of the
firm, this will most likely create
a. Self-interest threat
c. Intimidation threat
b. Self-review threat
d. Familiarity threat
15. Assurance team include
a
• All professionals participating in the
assurance engagement
Yes
• All others within a firm who can directly
influence the outcome of the assurance
engagement
Yes
• For the purposes of an audit client, all those
within a network firm who can directly influence
the outcome of the audit engagement
Yes
b
c
d
Yes
Yes
Yes
Yes
No
No
No
No
Yes
16. Financial interest means
a. Any bank account which is used solely for the banking of clients’ monies.
b. Any monies received by a professional accountant in public practice to be held or paid
out on the instruction of the person from whom or on whose behalf they are received.
c. A financial interest beneficially owned through a collective investment vehicle, estate,
trust or other intermediary over which the individual or entity has no control.
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d. An interest in an equity or other security, debenture, loan or other debt instrument of
an entity, including rights and obligations to acquire such an interest and derivatives
directly related to such interest.
17. Intimidation threat
a. Is not a threat to independence.
b. Occurs when a member of the assurance team may be deterred from acting
objectively and exercising professional skepticism by threats, actual or perceived, from
the directors, officers or employees of an assurance client.
c. Occurs when, by virtue of a close relationship with an assurance client, its directors,
officers or employees, a firm or a member of the assurance team becomes too
sympathetic to the client’s interests.
d. Occurs when a firm, or a member of the assurance team, promotes, or may be
perceived to promote, an assurance client’s position or opinion to the point that
objectivity may, or may be perceived to be, compromised.
18. Practice in Public Accountancy shall constitute in a person
a. Involved in decision making requiring professional knowledge in the science of
accounting, or when such employment or position requires that the holder thereof must be
a certified public accountant.
b. In an educational institution which involve teaching of accounting, auditing,
management advisory services, finance, business law, taxation, and other technically
related subjects.
c. Who holds, or is appointed to, a position in an accounting professional group in
government or in a government owned and/or controlled corporation, including those
performing proprietary functions, where decision making requires professional knowledge
in the science of accounting.
d. Holding out himself/herself as one skilled in the knowledge, science and practice of
accounting, and as a qualified person to render professional services as a certified public
accountant; or offering or rendering, or both, to more than one client on a fee basis or
otherwise.
19. Any position in any business or company in the private sector which requires supervising the
recording of financial transactions, preparation of financial statements, coordinating with the
external auditors for the audit of such financial statements and other related functions shall be
occupied only by a duly registered CPA. Provided (choose the incorrect one)
a. That the business or company where the above position exists has a paid-up capital
of at
least P5,000,000 and/or an annual revenue of at least P10,000,000.
b. The above provision shall apply only to persons to be employed after the effectivity of
the
Implementing Rules and Regulations of RA 9298.
c. The above provision shall not result to deprivation of the employment of incumbents to
the position.
d. None of the above.
20. The integrated national professional organization of Certified Public Accountants accredited
by the BOA and the PRC per PRC accreditation No. 15 dated October 2, 1975.
a. Auditing and Assurance Standards Council (AASC)
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b. Financial Reporting Standards Council (FRSC)
c. Education Technical Council (ETC)
d. Philippine Institute of Certified Public Accountants (PICPA)
21. As defined in the IRR of RA 9298, it is an organization engaged in the practice of public
accountancy, consisting of sole proprietor, either alone or with one or more staff members.
a. Firm
b. Individual CPA
c. Partnership
d. Sector
22. The following statements relate to the Board of Accountancy. Which statement is correct?
a. The Board consists of a Chairman and six members.
b. The chairman and members are appointed by the President of the Philippines upon
recommendation of PICPA.
c. The Professional Regulation Commission may remove from the Board any member
whose certificate to practice has been removed or suspended.
d. Majority of the board members shall as much as possible be in public practice.
23. The APO shall submit its nominations with complete documentation to the Commission not
later than _____ prior to the expiry of the term of an incumbent chairman or member.
a. 30 days
b. 60 days
c. 90 days
d. 120 days
24. A member of the BOA shall, at the time of his/her appointment, possess the following
qualifications, except
a. Must be a natural-born citizen and resident of the Philippines.
b. Must be a duly registered CPA with more than ten (10) years of work experience in
any scope of practice of accountancy.
c. Must be of good moral character and must not have been convicted of crimes
involving moral turpitude.
d. Must not be a director or officer of the APO at the time of his/her appointment.
25. Which statement is incorrect regarding the term of office of the chairman and the members of
the Board of Accountancy (BOA)?
a. The Chairman and members of the Board shall hold office for a term of three years.
b. No person who has served two (2) successive complete terms shall be eligible for
reappointment until the lapse of one (1) year.
c. A person may serve the BOA for not more than twelve years.
d. A member of the BOA may continuously serve office for more than nine years.
26. The Board shall exercise the following specific powers, functions and responsibilities:
a
b
c
d
• To supervise the registration, licensure and
practice of accountancy
Yes
Yes
Yes
Yes
• To issue, suspend, revoke, or reinstate the
Certificate of Registration for the practice of
the accountancy profession
Yes
No
Yes
Yes
• To monitor the conditions affecting the practice
of accountancy
Yes
Yes
No
Yes
• To conduct an oversight into the quality of
audits of financial statements
Yes
No
Yes
No
• To issue a cease or desist order to any
person, association, partnership or corporation
engaged in violation of any provision of the Act
Yes
Yes
No
Yes
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27. Which of the following is not one of the penalties that can be imposed by the Board of
Accountancy?
a. Fine or imprisonment
c. Reprimand
b. Revocation of CPA certificate
d. Suspension of CPA certificate
28. The creation of FRSC and AASC is intended to assist the BOA in carrying out its function to
a. To monitor the conditions affecting the practice of accountancy and adopt such
measures, rules and regulations and best practices as may be deemed proper for the
enhancement and maintenance of high professional, ethical, accounting and auditing
standards.
b. To supervise the registration, licensure and practice of accountancy in the Philippines.
c. To prescribe and adopt the rules and regulations necessary for carrying out the
provisions of RA 9298.
d. To prepare, adopt, issue or amend the syllabi of the subjects for examinations.
29. A body that is created to assist the BOA in the attainment of the objective of continuously
upgrading the accountancy education in the Philippines to make the Filipino CPAs globally
competitive.
a. Philippine Institute of Certified Public Accountants (PICPA)
b. Education Technical Council (ETC)
c. Financial Reporting Standards Council (FRSC)
d. Associations of CPAs in Education (ACPAE)
30. The primary responsibility for the prevention and detection of fraud and error rests with
a. The auditor.
c. The management of an entity.
b. Those charged with governance.
d. Both b and c.
31. When planning and performing audit procedures and evaluating and reporting the results
thereof, the auditor should
a. Search for errors that would have a material effect and for fraud that would have either
material or immaterial effect on the financial statements.
b. Consider the risk of misstatements in the financial statements resulting from fraud or
error.
c. Search for fraud that would have a material effect and for errors that would have either
material or immaterial effect on the financial statements.
d. Consider the risk of material misstatements in the financial statements resulting from
fraud or error.
32. The following are examples of error, except
a. A mistake in gathering or processing data from which financial statements are prepared.
b. An incorrect accounting estimate arising from oversight or misinterpretation of facts.
c. A mistake in the application of accounting principles relating to measurement,
recognition,
classification, presentation, or disclosure.
d. Misrepresentation in the financial statements of events, transactions or other significant
information.
33. The term “fraud” refers to an intentional act by one or more individuals among management,
those charged with governance, employees, or third parties, involving the use of deception to
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obtain an unjust or illegal advantage. Which statement is correct regarding fraud?
a. Auditors make legal determinations of whether fraud has actually occurred.
b. Misstatement of the financial statements may not be the objective of some frauds.
c. Fraud involving one or more members of management or those charged with
governance is
referred to as “employee fraud”.
d. Fraud involving only employees of the entity is referred to as “management fraud”.
34. The types of intentional misstatements that are relevant to the auditor’s consideration of fraud
include
I. Misstatements resulting from fraudulent financial reporting
II. Misstatements resulting from misappropriation of assets
a. I and II
b. I only
c. II only
d. Neither I nor II
35. Fraudulent financial reporting involves intentional misstatements or omissions of amounts or
disclosures in financial statements to deceive financial statement users. Fraudulent financial
reporting least likely involve
a. Deception such as manipulation, falsification, or alteration of accounting records or
supporting documents from which the financial statements are prepared.
b. Misrepresentation in, or intentional omission from, the financial statements of events,
transactions or other significant information.
c. Intentional misapplication of accounting principles relating to measurement, recognition,
classification, presentation, or disclosure.
d. Embezzling receipts, stealing physical or intangible assets, or causing an entity to pay
for goods and services not received.
36. The primary duty to enforce the provisions of RA 9298 and its IRR rests with
a. The PRC
c. The PRC and BOA
b. The BOA
d. The AASC
37. A meaningful experience shall be considered as satisfactory compliance with the
requirements of Section 28 of RA 9298 if it is earned in (Choose the incorrect one)
a. Commerce and industry and shall include significant involvement in general
accounting, budgeting, tax administration, internal auditing, liaison with external auditors,
representing his/her employer before government agencies on tax and matters related to
accounting or any other related functions.
b. Academe/education and shall include teaching for at least three (3) trimesters or two
(2) semesters subjects in either financial accounting, business law and tax, auditing
problems, auditing theory, financial management and management services.
c. Government and shall include significant involvement in general accounting,
budgeting, tax administration, internal auditing, liaison with the Commission on Audit or
any other related functions.
d. Public practice and shall include at least two years as audit assistant and at least one
year as auditor in charge of audit engagement covering full audit functions of significant
clients.
38. The certified public accountant shall be required to indicate which of the following numbers
on the documents he/she signs, uses or issues in connection with the practice of his/her
profession?
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• His/her Certificate of Registration
• Professional Identification Card
• Professional Tax Receipt
• Telephone
a
Yes
Yes
Yes
Yes
b
Yes
Yes
Yes
No
c
Yes
Yes
No
No
d
No
Yes
Yes
No
39. The BOA shall not refuse the registration of any person who successfully passed the CPA
examinations if
a. Convicted by a court of competent jurisdiction of a criminal offense involving moral
turpitude
b. Convicted for a political offense.
c. Guilty of immoral and dishonorable conduct
d. None of the above.
40. Which of the following is not one of the grounds for proceedings against a CPA?
a. Gross negligence or incompetence in the practice of his profession.
b. Engaging in public practice while being employed in a private enterprise.
c. Insanity.
d. Immoral or dishonorable conduct.
41. Which of the following is are grounds for suspension or removal of members of BOA?
I. Neglect of duty or incompetence.
II. Violation or tolerance of any violation of the CPA’s Code of Ethics.
III. Final judgment of crimes involving moral turpitude.
IV. Rigging of the certified public accountant’s licensure examination results.
a. I, II, III and IV
b. I, II and III
c. III and IV
d. I, III and IV
42. The following statements relate to CPA examination ratings. Which of the following is
incorrect?
a. To pass the examination, candidates should obtain a general weighted average of
75% and above, with no rating in any subject less than 65%.
b. Candidates who obtain a rating of 75% and above in at least four subjects shall
receive a conditional credit for the subjects passed.
c. Candidates who failed in four complete examinations shall no longer be allowed to
take the examinations the fifth time.
d. Conditioned candidates shall take an examination in the remaining subjects within two
years from the preceding examination.
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SUGGESTED ANSWER FOR MCQs
Lesson I
1. c
2. d
3. a
4. c
5. d
6. d
7. c
8. c
9. b
10. b
11. a
12. c
13. a
14. b
15. b
16. d
17. b
18. a
19. b
20. d
1. d
2. b
3. d
4. d
5. d
6. d
7. d
8. d
9. b
10. b
11. b
12. c
13. c
14. b
15. a
16. b
17. b
18. d
19. d
20. b
21. d
22. c
23. b
24. d
25. b
26. c
27. a
28. d
29. d
30. c
31. d
32. d
33. d
34. d
35. d
36. d
37. c
38. c
6. a
7. a
8. b
9. a
10. b
11. c
12. c
13. b
14. d
15. c
16. c
17. d
18. b
19. c
20. a
6. b
7. a
8. c
9. d
10. a
11. c
12. d
13. c
14. b
15. c
16. d
17. d
18. c
19. b
20. d
Lesson II
Lesson III
1. a
2. c
3. b
4. d
5. a
Lesson IV
1. d
2. a
3. d
4. d
5. a
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21. a
22. c
23. b
24. a
25. d
21. a
22. a
23. d
24. c
25. a
26. b
27. d
28. c
29. a
30. a
31. b
32. d
33. b
34. d
35. a
36. b
37. b
38. d
1. c
2. c
3. a
4. d
5. b
6. c
7. d
8. b
9. b
10. b
11. d
12. d
13. a
14. b
15. a
16. d
17. b
18. d
19. d
20. d
21. a
22. a
23. b
24. b
25. d
26. a
27. a
28. a
29. b
30. d
31. d
32. d
33. b
34. a
35. d
36. c
37. d
38. b
39. b
40. b 41. a 42. c
Lesson V
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