Auditing

LECTURE 2: Introduction: Meaning and Objective of Auditing.

Auditing is a systematic process by which a competent, independent person

objectively obtains and evaluate 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. (Cabrera, 2017)
Auditing is the accumulation and evaluation of evidence about information to determine
and report on the degree of correspondence between the information and established
criteria by a competent, independent person (Arens, Elder & Beasley, 2015).
The objective of an audit of financial statements is to enable the auditor to express an
opinion whether the financial statement are prepared, in all material respects in
accordance with an identified financial reporting framework. (Arens, Elder & Beasley,
2015)

See separate sheet for Figure 1- Relationship of meaning & objective of auditing
to audit process.
The highlighted words under the meaning and objective of auditing and figure 1
are explained below (A visit to the meaning and objective of auditing), for your
reading reference).

A VISIT TO THE DEFINITION OF AUDITING

I. Under the meaning of competent, independent person

Certified Public Accountant (CPA)

A certified public accountant (CPA) is a designation given to individuals that pass

the Licensure CPA Examination and meet the education and experience
requirements. The CPA designation helps enforce professional standards in the
accounting industry.
 II. Under the meanings of obtain, accumulates and evaluate
evidence

A. Audit Evidence Decisions

A major decision facing every auditor is determining the appropriate types and
components of evidence needed to be satisfied that the client’s financial statements are
fairly stated are following four decisions about what evidence to gather and how much
of it to accumulate:
1. Audit Procedures – is the detailed instruction that explain the audit evidence to
be obtained during the audit. It is common to spell out these procedure in
sufficiently specific terms so an auditor may follow these instruction during the
audit.

Once an audit procedure is selected,

2. Auditor can vary the sample size from one to all the items in the population
being tested

After determining the sample,

3. Items to select – the auditor must decide which items in the population to test.

4. Timing – An audit of financial statements usually covers a period such as a year.

Normally, an audit is not completed until several weeks or months after the end
of the period. The timing of the audit procedures can therefore vary from early is
affected by when the client’s needs the audit to be completed.

Terms, Audit Procedures, and Types of Evidence

Term and Definition Illustrative Audit Procedure Types of Evidence

Examine – A reasonably detail study of a Examine a sample Inspection

document or record to determined specific
facts about it.
of vendor’s
invoices to determine whether the
goods or services received are
reasonable and of the type normally
used by the client’s business.
 Scan – A less detailed examination
document or record to determine whether
there is something unusual warranting
further investigation.
Read – An examination of written
information to determine facts pertinent
to the audit.
Compute – A calculation done by the
auditor independent of the client.
Recomputed – A calculation done to
determine whether a client’s calculation is
correct.
Foot- Addition of a column of a numbers to
determine the whether total is the same as
the client’s.
Trace – An instruction normally associated
with inspection and Reperformance. The
instruction should state what the auditor is
tracing and where it is being traced from
and to. Often, an audit procedure that
includes the term trace will also include a
second instruction, such as compare or
recalculate.
Scan the sales journal, looking for Analytical Procedure
large and unusual transaction.
Inspection
Read the minutes of the Board of
Directors meeting and summarize all
information that is pertinent to the
financial statement in an audit file.
Compute inventory turnover ratios Analytical Procedures
and compare with those of previous
years as a test of inventory
obsolescence
Recomputed the unit sales price Recalculation
times the number of units for a
sample of duplicate sales invoices .
and compare the totals with the
calculation.
Recalculation
Foot the sales journal for a 1-month
period and compare totals with the
general ledger.
Inspection
Trace a sample of sales transactions
from sales invoices to the sales
journal, and the total dollar value of
the sale.
Trace posting from the sales journal Reperformance
to the general ledger accounts.

Compare – A comparison of information in
two different locations. The instruction
should state which information is being
compared in as much detail as practical.
Select a sample of sales invoices and Inspection
compare the unit selling price as
stated on the invoice to the list of
unit selling prices authorized by
management.

Count – A determination of assets on hand
at a given time. This term should be
associated only with the type of evidence
defined as physical examination.
Observe – The act of observation should
associated with the type of evidence
defined as observation.
Physical Examination
Count a sample of 100 inventory
items and compare quantity and
description to client’s counts.
Observe whether the two inventory Observation
count teams independently count
and record inventory counts.

Inquire
Inquire – The act ofofinquiry
management whether
should be Inquiries of Client
associated there is any
with the obsolete
type inventory on
of evidence
defined as hand at the balance sheet dated.
inquiry.

Vouch sample of recorded Inspection

Vouch – The use of documents to verify
acquisition transactions vendor’s
recorded transaction or amounts.
invoices and receiving reports.

(Arens, Elder,Beasly, Auditing & Assurances Services, 2015-15e)

B. Audit Program – The list of audit procedures for an audit area or an entire
audit. The audit program always includes a list of the audit procedures, and it
usually includes sample sizes, items to select, and the timing of the tests.
Normally there is an audit program, including several audit procedures, for each
 component of the audit. Therefore, there will be an audit program for each
accounts in the financial statements.

C. Audit Documentation – an essential part of every audit for effectively

planning the audit, providing a record of the evidence accumulated and the results of
the tests.
It is the record of the audit procedures performed, relevant audit evidence, and
conclusions the auditor considers the necessary to adequately conduct the audit and to
provide support to the audit report. Audit Documentation may also be referred to as
WORKING PAPERS although documentation is item maintained computerized files.
Auditing standards state that audit documentation is the record of the audit procedures
performed, relevant audit evidence, and conclusions the auditor reach. Audit
documentation should include all the information the auditor considers necessary to
adequately conduct the audit and to provide support for the audit report. Audit
documentation may also referred to as working papers, although audit documentation is
often maintained computerized files.
Purpose of Audit Documentation. The overall objectives of audit documentation is to
aid the auditor in providing reasonable assurance that an adequate audit was
conducted in accordance with auditing standards. More specifically, audit
documentation, as it pertains to the current year’s audit provides:

a. Basis for Planning the Audit. If the auditor is to plan an audit adequately, the
necessary reference information must be available in the audit files. The files
may include such diverse planning information as descriptive information about
internal control, a time budget for individual audit areas, the audit program, and
the results of the preceding year’s audit.

b. A Record of the Evidence Accumulated and the Result of the Tests. Audit
documentation is the primary means of documenting that an adequate audit was
conducted in accordance with auditing standards. If the need arises, the auditing
must be able to demonstrate to regulatory agencies and courts that the audit was
well planned and adequately supervised; the evidence accumulated was
appropriate and sufficient; and the audit report was proper, considering the
results of the audit.

c. Data for Determining the Proper Type of Audit Report. Audit documentation
provides an important source of information to assist the auditor in deciding
whether sufficient appropriate evidence was accumulated to justify the audit
report in a given set of circumstances. The data in the files are equally useful for
 evaluating whether the financial statements are fairly stated, given the audit
evidence.

d. A Basis for Review by Supervisor and Partners. The audit files are the
primary frame of reference used by supervisory personnel to review the work of
assistant. The careful review by supervisors also provides evidence that the audit
was properly supervised. Audit documentation should indicate who performed
the audit work, the date of the work was performed, who reviewed the work, and
the date of that review.

D. Internal Control – consist of policies and procedures designed to provide

management with reasonable assurance that the company achieve its objective and
goals. These processes and procedures are often called controls and collectively they
make up the entity’s internal control.

E. Substantive Test of Transactions – are used to verify transaction recorded

in the journals and posted in the general ledger.

Test of details of balances – emphasize the ending balances in the general ledger of
both Balance Sheet and Income Statement.
Substantive test - are procedure designed to test the peso misstatements often called
monetary misstatements that directly affect the correctness of financial statements
balances. Auditors rely on three types of substantive tests.
● Substantive Test of Transactions
● Substantive Analytical procedures
● Test of details of balances.
Substantive Test are used to determine whether all transaction objectives have been
satisfied for each class of transaction.

Interim Audit: Tests of Controls

Substantive tests of transactions
Final Audit : Substantive tests of balances
Analytical procedures

F. Analytical Procedures are one of the types of evidence being gathered in

deciding what audit procedure to emphasize the overall reasonableness of transactions
and general ledger balances It is defined by auditing standard as evaluation of financial
information through analysis of relationship among financial and non-financial data.
Analytical procedure use comparison & relationship to assets whether account balances
or other data appear reasonable relative to the auditor’s expectations.

III. Under the meaning of Information

A. Financial Statements and Financial Statements Assertions.

Management Assertions – are implied as expressed representation by
management about classes of transaction and the related accounts and disclosure in
the financial statements. Management assertion are directly related to the financial
accounting framework used by the company as they are part of the criteria that
management uses to record and disclose accounting information in financial
statements.

1. Assertion about classes of transactions and events.

Occurrence – transactions and events that have been recorded have occurred and
portion to the entity.
Completeness – All transaction and events that should have been recorded.
Accuracy – Amounts and other data relating to recorded transaction and events have
been recorded appropriately.
Classification – Transactions and events have been recorded in the proper accounts.
Cut-off – Transactions and events have been recorded in the correct accounting period.

2. Assertion about Account Balances

Existences – Assets, Liabilities, and Equity interests exist.
Completeness - All transaction and events that should have been recorded
Valuation and Allocation – Assets, Liabilities, and Equity interest that should have
been recorded have been recorded.
Rights & Obligations – the entity holds on controls the rights to asset, and liabilities
are the obligation of the entity.

3. Assertions about Presentation and Disclosure

Occurrence - transactions and events that have been recorded have occurred and
portion to the entity.
Rights and Obligation - the entity holds on controls the rights to asset, and liabilities
are the obligation of the entity.

Completeness - All transaction and events that should have been recorded
Accuracy and Valuation - Amounts and other data relating to recorded transaction and
events have been recorded appropriately.
Classification and Understandability - Transactions and events have been recorded in
the proper accounts.
Management Assertions (Under Sarbanes-Oxley Act and Public Company
Accounting Oversight Board):
Existence or Occurrence
Completeness
Rights and Obligations
Valuation and Allocation
Presentation and Disclosure

B. Established Criteria (Standards - IFRS/PFRS, IAS/PAS)

IV. Under the meaning of Communicating

A. Financial Statements
 Statement of financial position
Statement of comprehensive income
Statement of changes in equity
Statement of cash flow
Notes to the financial statements (Disclosures)

B. Auditor’s opinion
a. Unqualified opinion
b. Modified opinions
Qualified opinion
Adverse opinion
Disclaimer of opinion