CHAPTER 1

AUDIT- An Overview
Auditing Defined

 Philippine Standards on Auditing

- To enable auditor to express an opinion on whether the financial statements are
prepared in all material respects, in accordance with the applicable financial reporting
framework
- Examination of financial statements

 American Accounting Association

- An audit is a systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of
correspondence between these assertions and established criteria and communicating
the results to interested users.
Auditing is a systematic process

- Auditing proceeds by means of an ordered and structured series of steps

An audit involves obtaining and evaluating evidence about assertions regarding economic actions
and events
Assertions- representations made by an entity about economic actions and events. Auditor’s
overall objective is to determine whether these assertions are valid by obtaining and evaluating
evidences.
An audit is conducted objectively

- Audit should be conducted without bias of conflict of interest to override professional

judgement.
- Objectivity is essential because auditor’s conclusion can influence the decisions of
parties relying on the report
Auditors ascertain the degree of correspondence between assertions and established criteria

- Established criteria- needed to judge the validity of the assertions. It is the basis against
which the assertions have been evaluated or measured
Auditors communicate the audit results to various interested parties

- Communication of the audit finding is the ultimate objective of any audit

SUMMARY OF THE DEFINITION OF AUDIT

Independent Auditor Establishes the degree of

correspondence between
3 Major Types of Audit
Following systematic
Types of Audit Assertions Communicate the
process results to interested
1. Financial Statement Audit
parties
- Fair representation
Objectively obtains of financial statements in accordance with applicable financial
Established
reporting framework (Usually conducted by External Auditors)
and evaluates
criteria
evidence
2. Compliance Audit
- Review of organization’s procedures to determine whether the organization has
adhered to specific procedures, rules, or regulations (Usually conducted by Government
Auditors)
- Dependent upon the existence of verifiable data and recognized criteria established by
an authoritative body

3. Operational Audit
- Study of a specific unit of an organization for the purpose of measuring its performance
- Operation’s effectiveness and efficiency
- To assess entity’s performance, identify areas for improvements and make
recommendations to improve performance (Usually conducted by Internal Auditors)
- Also known as Performance Audit or Management Audit

4. Integrated Audit
- Fair representation of financial statements and effectiveness of internal control over
financial reporting
- Required to those publicly-listed companies and entities

5. Forensic Audit
- Deter (prevent) and/or detect fraud

The Independent Financial Statement

 MANAGEMENT is responsible for preparing and presenting the FSs in accordance with
financial reporting framework
 AUDITOR’S responsibility is to form and express an opinion on the FSs based on his audit
 An audit conducted with PSA is designed to provide only REASONABLE ASSURANCE that
the FSs taken as a whole are free from material misstatement
Limitations of an Audit
1. Sampling Risk/Use of Testing
2. Error in Application of Judgment/Non-sampling risk
3. Reliance on Management’s Representation
4. Inherent Limitation of the Client’s Accounting and Internal Control Systems
5. Nature of Evidence

General Principles Governing the Audit of Financial Statements

1. Code of Professional Ethics
2. Philippine Standards on Auditing
3. Attitude of Professional Skepticism

General Characteristics of Audits

1. Systematic examination and evaluation
- Compliance of assertion with established criteria
2. Communication of results of the examination
- Usually written

Comparison of 3 Types of Audit

Financial Audit Compliance Audit Operational Audit

Assertions made by Financial statements Organization has That the
the auditee are fairly presented complied with laws, organization’s
regulations or activities are
contracts conducted effectively
and efficiently
Established criteria Financial reporting Laws, regulations or Objectives set by the
Framework- contracts board of directors
Philippine Financial
Reporting Standards
Content of the An opinion about Reports on the degree Recommendations or
auditor’s report whether the financial of compliance with suggestions on how to
statements are fairly the applicable laws, improve operations
presented in regulations and
conformity of the contracts
applicable framework

Types of Auditors
1. External Auditors or Independent Auditors
- Independent CPAs who offer services on contractual basis
- Who generally perform financial statement audits
- CPA in public practice

2. Internal Auditors
 - Entity’s own employees who investigate and appraise the effectiveness and efficiency of
operations and internal controls
- Usually perform operational audit
- To help the company in achieving its goals

3. Government Auditors/Internal Revenue Agents

- Government employees whose main concern is to determine whether the persons or
entities comply with government rules or regulations
- Conduct compliance audit

4. Government Accountability Office Auditors

- Evaluate effectiveness and efficiency of government programs
- Refer to Commission on Audit

The Independent Financial Statement Audit

1. Responsibility for the financial statements
- Auditor’s responsibility is to form and express an opinion on these financial statements
based on the audit results
- Management’s responsibility is to adopt and implement adequate accounting and
internal control systems that will help ensure the preparation of reliable financial
statements

2. Assurance provided by the auditor

- An audit conducted in accordance with the PSAs is designed to provide only reasonable
assurance not absolute assurance.
- There are inherent limitations pf an audit that affects the auditor’s ability to detect
material misstatement

Inherent Limitations
1. Nature of the procedures performed
1. The use of testing or sampling risk
- Auditors do not examine all evidence available.
- Many audit conclusions are made by examining only sample evidence

2. Error in the application of judgement or non-sampling risk

- There is no absolute assurance that material misstatement in the financial statements
will be detected
- Errors in application of judgment may cause auditors to commit mistakes in the
application of audit procedures or evaluation of evidence obtained

2. Nature of the financial reporting framework used

 - Many financial items involve subjective decisions that are subject to an inherent
variability which cannot be eliminated by performing audit procedures

3. Nature of evidence obtained by the auditor

- Audit evidence does not consist “hard facts” which prove or disprove the accuracy of the
financial statements
- Audit evidence is generally persuasive rather than conclusive in nature

Note: Opinion of an auditor is not 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

ROLE OF MANAGEMENT AND INDEPENDENT AUDITOR

Management Independent Auditor

Prepares Financial
Statements
General Requirements when Auditing Financial Statements
Unaudited Evaluates Financial
1. Auditor should Financial
comply with the relevant Ethical Requirements
adhere to standards of ethical conduct that embody and Statements
- MustStatements demonstrate integrity,
objectivity and concern for public rather than self-interest
Audited Financial Statements Audit Report on Financial
2. Auditor should conduct an audit in accordance with the Philippine Statements
Standards on Auditing
(PSAs)
- Standards contain the basic principles and essential procedures which the auditor
should follow. Users of Financial Statements
- Includes explanatory and other materials that are designed to assist auditors in
interpreting and applying the auditing standards

3. Auditor should apply professional judgment in planning and performing the audit
- Essential to the proper conduct of the audit
 4. Auditor should obtain sufficient appropriate audit evidence to reduce risk to an acceptably
low level
- Audit evidence is needed to support the opinion expressed in the auditor’s report.
- Should be sufficient and appropriate

5. The auditor should plan and performs the audit with an attitude of professional skepticism
recognizing that circumstances may exist which may cause the financial statements to be
materially misstated
- Means the auditor makes a critical assessment, with a questioning mind, of the validity
of audit evidence obtained and alert to audit evidence that contradicts or bring into
questions the reliability of documents or management representations
- The auditor neither assumes that management is honest nor assumes unquestioned
honesty

Need for an Independent Financial Statement Audit

1. Conflict of interest between management and users of financial statements
- May result managers providing the outside users with overly optimistic or even false
financial information
- Users of financial statements have become skeptical of unaudited financial statements

2. Expertise
- A qualified person is hired by users to verify the reliability of the financial statements on
their behalf

3. Remoteness
- Most of users do not have access to entity’s records to personally verify the quality of
the financial information.
- An independent auditor is needed to assist them in verifying the reliability of the
financial information

4. Financial Consequences
- Misleading financial information could have substantial economic consequences for a
decision maker thus auditing financial statements is needed.

Theoretical Framework of Auditing

Selected postulates, assumptions or ideas that support many auditing concepts and
standards
1. Audit function operates on the assumption that all financial data are verifiable
- No evidence=no audit to perform

2. Auditor should always maintain independence with respect to the financial statements
under audit
 - Independence is essential for ensuring the credibility of the auditor’s report

3. There should be no long-term conflict between the auditor and the client management
- Both the auditor and the management must be interested in the fair representation of
the financial statements

4. Effective internal control system reduces the possibility of material misstatement of the
financial statement
- The stronger the internal control is, the more assurance it provides about the reliability
of the accounting data and financial statements

5. Consistent application of the applicable financial reporting framework such as the PFRS
results in fair representation of financial statement
6. What was held true in the past will continue to hold true in the future in the absence of
known conditions to the country
7. An audit benefits the public
- Financial statements are ordinarily prepared and presented in order to meet the
common information need of a wide range of users.
Industry Specialization

- Public accounting firms have long recognized the value of industry specialization
- Firms believe that such organizational structure leads to higher-quality integrated
services
Career Levels
1. Staff Auditors- entry level, performs tasks assigned by senior auditor
2. Senior Auditors- supervises some aspect of the audit
3. Managers- supervises the audit management
4. Partners- responsible for performance of audit in accordance with standards
5. Senior/Managing Partners- responsible for developing firm’s policies, planning activities,
and day to day management

Audit Season
- Busy season from December through April
- Followed by a period of slack demand