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OVERVIEW OF AUDITING AND AUDIT PROCESS

DEFINITION AND OBJECTIVE OF AUDIT
The audit is one of the most dynamic areas of the accounting sciences. The word “audit” originated from
the Latin word audire, which means to listen. In general definition and classification, it is synonymous with
words like control, check, inspect, and revise (iEduNote, n.d.).
The Report of the Committee on Basic Auditing Concepts by the American Accounting Association (AAA)
defines an audit 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 thereof” (American Accounting
Association, n.d.).
This definition conveys the following (Baldres, De Leon, & Magadia, 2017):
1. A systematic process – It connotes purposeful and logical steps and is based on a discipline of a
structured and organized series of procedures to decision making.
2. Objectively obtaining and evaluating evidence – It involves 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 – These are the information or representations
made by the individual or entity. They comprise the subject matter of auditing and include
information contained in the financial statements, management internal operating reports, and tax
returns.
4. Degree of correspondence – It 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 shortage in a petty cash fund, or it may be qualitative, such as the fairness of the financial
statements.
5. Established criteria – These are the standards against which the assertions or representations
are judged. Established criteria may be specific rules prescribed by a legislative or a regulatory
body, budgets, and other measures of performance set by management, or the Philippine Financial
Reporting Standards (PFRS).
6. Communicating the results – This is often referred to as attestation. The final stage in the audit
process is the audit report – the communication of the findings to users. By attesting to the degree
of correspondence to established criteria, the investigator enhances or weakens the credibility of
the representations or claims that have been made by another party. The communication of findings
is achieved through a written report (Cabrera, 2015).
7. Interested users – These are individuals or entities who rely on the practitioner’s findings.
Philippine Standards on Auditing (PSA) 120 Framework of Philippine Standards on Auditing stated that 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, following an identified financial reporting
framework. The phrase used to express the auditor's opinion is ‘present fairly, in all material respects.’ A
similar objective applies to the audit of financial or other information prepared following appropriate criteria.”
(Auditing Standards and Practices Council, 2001)

OVERVIEW OF AUDIT PROCESS

An audit involves a sequence of different activities to obtain its objective. This process normally includes
the following steps (Asuncion et al., 2018):
Audit Step Primary Objective Description
Pre- To minimize the likelihood of This phase will require a decision from the auditor
Engagement being associated with a client whether or not to accept a new client or continue a
whose management lacks relationship with an existing one. This process
integrity. would require evaluation not only of the auditor's

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Audit Step Primary Objective Description

Audit Planning To assess the different risks
associated with the audit to
determine the nature, timing,
and extent of further audit
procedures necessary to be
performed
Consideration To establish a basis for
of Internal reliance on internal controls
Control in determining the nature,
timing, and extent of audit
procedures to be performed.
Substantive To ascertain the degree of
Testing correspondence between the
(Evidence financial statements
Gathering) prepared by the client's
management and the
financial reporting
framework. With this, the
auditor will be able to
conclude whether or not the
financial statements are
presented fairly per financial
reporting standards.
Completing the To assist the auditor in
Audit assessing the conclusion
reached is consistent with
evidence gathered.
Issuance of the To communicate the
Audit Report conclusions reached by the
auditor to various intended
users.
Post-Audit To assess and evaluate the
Responsibilities quality of services delivered
by the engagement team.
qualification, but also the integrity and auditability
of the client's financial statements.
Audit planning involves the development of an
overall audit strategy, audit plan, and audit
program. The auditor usually obtains more detailed
knowledge about the client's business and industry
in this phase to understand the transactions and
events affecting the financial statements.
Preliminary assessment of risk and materiality is
also made during this phase.
Since the entity's internal control directly affects the
reliability of the financial statements, it is
appropriate to study and evaluate these controls.
Using the information obtained in audit planning
and consideration of internal controls, the auditor
performs a substantive test to determine whether
the entity's financial statements are presented fairly
per financial reporting standards. Substantive
procedures could either be analytical procedures or
test of details of transactions and balances.
The auditor will always perform this phase.
Wrapping-up procedures are performed;
conclusions reached are reviewed, and an overall
opinion is formed during this phase.
In this stage, the auditor prepares and issues audit
report which describes the scope of the audit and
states the auditor's conclusion regarding the
fairness of the financial statements.
After completion of the audit engagement, it is the
auditor’s responsibility to perform procedures that
will enable him/her to identify areas for
improvement in the current and future
engagements.

AUDIT PRE-ENGAGEMENT
Acceptance of an engagement (Asuncion et al., 2018)
In deciding whether to accept or reject an engagement, an auditor should consider the following:
1. Its competence;
2. Its independence;
3. Its ability to serve the client properly; and
4. The integrity of the prospective client's management.
Furthermore, the auditor is expected to perform the following:
1. Obtain a preliminary knowledge of the client's business and industry to determine whether the
auditor has the degree of competence required by the engagement.
2. Consider whether there are any threats to the firm's independence and objectivity, and if so,
whether adequate safeguards can be established.

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3. Evaluate the firm's ability to serve the prospective client.

4. Evaluate auditability.
5. Investigate the integrity of the client's management through inquiry to appropriate parties or
communication with the predecessor auditor.
Matters to be discussed with predecessor auditor include the following:
a. The predecessor's understanding as to the reasons for the change in auditors;
b. Information that might bear on the integrity of the management; and
c. Disagreements between the predecessor auditor and management as to accounting
principles, auditing procedures, etc.
Note: Every time communication is made to parties other than the client, the auditor shall seek
permission from the client and document the items discussed.
6. Agree on the terms of the engagement and prepare an engagement letter
Agreeing the Terms of Audit Engagements
Terms shall be agreed upon between the auditor and the client. Preferably, this is done before the
commencement of the engagement to help avoid misunderstandings concerning the engagement. It is in
the interest of both client and the auditor that the auditor sends an engagement letter.
The agreed terms would need to be recorded in an audit engagement letter or other suitable forms of
contract. The engagement letter documents and confirms:
1. The objective and scope of the audit of the financial statements;
2. The responsibilities of the auditor;
3. The responsibilities of management;
4. Identification of the applicable financial reporting framework for the preparation of the financial
statements; and
5. Reference to the expected form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its expected form and
content
Audit of Components (Auditing Standards and Practices Council, 2009)
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
the following:
1. Who appoints the component auditor;
2. Legal requirements in relation to audit appointments;
3. Degree of ownership by the parent;
4. Whether a separate auditor's report is to be issued on the component; and
5. Degree of independence of the component's management from the parent entity.
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:
1. Any indication that the entity misunderstands the objective and scope of the audit.
2. Any revised or special terms of the audit engagement.
3. A recent change of senior management.
4. A significant change in ownership.
5. A significant change in the nature or size of the entity’s business.
6. A change in legal or regulatory requirements.
7. A change in the financial reporting framework adopted in the preparation of the financial
statements.
8. A change in other reporting requirements.

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Acceptance of a Change in Engagement

a. Stop performing the old engagement

b. Stop referring to the old engagement, except when the new
Yes engagement involves agreed-upon procedures
c. Start performing the new engagement

Is there a reasonable
justification?
a. Continue the original audit engagement
b. When prohibited to continue, withdraw from the audit
engagement
No
Note: Every time withdrawal is made, the auditor should
consider the necessity of communicating the reasons to
appropriate level of management.

Figure 1. Acceptance of a change in engagement

Source: Applied Auditing Book 1 of 2, 2018, p.5
Circumstances Justifiable
1. Change in circumstances affecting the need for the service
2. A misunderstanding as to the nature of an audit or related services originally requested
3. A restriction on the scope of the engagement, whether imposed by management or
caused by circumstances
4. If the change relates to information that is incorrect, incomplete or otherwise
unsatisfactory
5. The auditor is unable to obtain sufficient appropriate audit evidence regarding
assertions
AUDIT PLANNING
Planning an Audit of Financial Statements (Asuncion et al., 2018)
The nature and extent of planning activities will vary according to the:
1. Size and complexity of the entity
2. Previous experience with the entity of key engagement team members (partner, manager, and
staff-in-charge)
3. Changes in circumstances that occur during the audit engagement
4. Timing of the appointment of the independent auditor

Planning as a phase of the audit process

Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins
shortly after (or in connection with) the completion of the previous audit and continues until the completion
of the current audit engagement.
Major Audit Planning Activities
The auditor shall establish an overall audit strategy that sets the scope, timing, and direction of the audit,
and that guides the development of the audit plan after performing the following procedures:
1. Obtaining an understanding of the client and its environment
2. Determining the need for experts
3. Establishing materiality and assessing risks
4. Assessing the possibility of non-compliance
5. Identifying related parties
6. Performing preliminary analytical procedures
7. Development of the overall audit strategy and detailed audit plan
8. Preparation of preliminary audit programs.
Overall Audit Strategy
In establishing the overall audit strategy, the auditor shall:
1. Identify the characteristics of the engagement that define its scope;

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2. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature
of the communications required;
3. Consider the factors that, in the auditor's professional judgment, are significant in directing the
engagement team's efforts
4. Consider the results of preliminary engagement activities and, where practicable, whether
knowledge gained on other engagements performed by the engagement partner for the entity is
relevant
5. Ascertain the nature, timing, and extent of resources necessary to perform the engagement
Audit Plan
After the overall audit strategy has been established, an audit plan can be developed to address the various
matters identified in the overall audit strategy, taking into account the need to achieve the audit objectives
through the efficient use of the auditor's resources.
The audit plan is more detailed than the overall audit strategy in that it includes the nature, timing, and
extent of audit procedures to be performed by engagement team members. These procedures may be
documented in an audit program. It shall serve 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.
Completion of Overall Strategy and Audit Plan
The establishment of the overall audit strategy and the detailed audit plan are not necessarily discrete or
sequential processes, but are closely inter-related since changes in one may result in significant changes
to the other. Also, preferably, a plan shall be initially completed before consideration of internal controls or
performance of specific procedures.
Planning Documentation
The auditor shall document:
1. the overall audit strategy,
2. the audit plan, and
3. any significant changes made during the audit engagement to the overall strategy or audit plan,
and the reasons for such changes.

Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity
and Its Environment (Asuncion et al., 2018)
It is the objective of the auditor to identify and assess risks of material misstatements, whether due to fraud
or error, at the financial statement and assertion levels, through understanding the entity and its
environment, including the entity's internal control, thereby providing a basis for designing and
implementing responses to the assessed risks of material misstatements.
Risk Assessment Procedures
Risk assessment procedures are audit procedures performed to obtain an understanding of the entity and
its environment, including the entity's internal control, to identify and assess the risks of material
misstatement, whether due to fraud or error, at the financial statement and assertion levels.
Risk Assessment Procedures and Related Activities (Asuncion et al., 2018)
The auditor shall:
1. Identify risks throughout the process of obtaining an understanding of the entity and its
environment, including relevant controls that relate to the risks, and consider the classes of
transactions, account balances, and disclosures in the financial statements;
2. Relate the identified risks to what can go wrong at the assertion level;

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3. Consider whether the risks are of a magnitude that could result in a material misstatement of the
financial statements; and
4. Consider the likelihood that the risks could result in a material misstatement of the financial
statements.
The risk assessment procedures shall include the following:
1. Inquiries of management, and others within the entity who in the auditor's judgment may have
information that is likely to assist in identifying risks of material misstatement due to fraud or error;
2. Analytical procedures; and
3. Observation and inspection.
Note: Risk assessment procedures by themselves; however, do not provide sufficient appropriate
audit evidence on which to base the audit opinion.
Analytical Procedures during the Planning Stage
Analytical procedures consist of evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass the
investigation of identified fluctuations and relationships that are consistent with other relevant information
or that differ from expected values by a significant amount.
An analytical procedure is required to be performed during the planning stage. It is designed to assist the
auditor in planning the nature, timing, and extent of other auditing procedures.
The Required Understanding of the Entity and its Environment
The auditor shall obtain an understanding of the following:
1. Relevant industry, regulatory, and other external factors including the applicable financial reporting
framework;
2. The nature of the entity, including its operations; ownership and governance structure; types of
investments that the entity is making and plans to make; and the way the entity is structured and
how it is financed;
3. Entity's selection and application of accounting policies, including reasons for changes thereto;
4. Entity's objectives and strategies, and those related business risks that may result in the risk of
material misstatement;
5. The measurement and review of the entity's financial performance; and
6. Internal control
Assessment of Audit Risk and Materiality (Asuncion et al., 2018)
Materiality and audit risk affect the application of PSA and are reflected in the auditor's report. The auditor
must make judgments about materiality and audit risk in determining the nature, timing, and extent of
procedures to apply and in evaluating the results.
Materiality
Information is material if its omission or misstatement could influence the economic decisions of users taken
based on the financial statements. Materiality depends on the size of the item or error judged in the
particular circumstances of its omission or misstatement. The concept of materiality recognizes that some
matters, but not all, are important for the fair presentation of the financial statements in conformity with
PFRS.
The auditor should consider materiality and its relationship with audit risk when conducting an audit. The
auditor's purpose in considering materiality at the planning stage of the audit is to determine the appropriate
scope of their audit procedures.
Using professional judgment, the auditor shall determine materiality at
1. Financial statement level the smallest aggregate amount of misstatement applicable to all financial
statements.
2. Assertion level for classes of transaction, account balances, and disclosures – the largest tolerable
misstatement.

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Audit Risk
Audit Risk is the risk that the auditor gives an inappropriate audit opinion when the financial statements are
materially misstated. The formula for audit risk is:

Audit risk = Inherent risk x Control risk x Detection risk

Components of Audit Risk
1. Risk of Material Misstatement
a. Inherent Risk is 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 controls.
b. Control Risk is the risk that a misstatement will not be prevented or detected and corrected on
a timely basis by the accounting and internal control systems. It could occur in an account
balance or class of transactions that could be material, individually or when aggregated with
misstatements in other balances or classes
2. Risk of not Detecting the Misstatement
Detection Risk is the risk that the 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.
Summary of Procedures in Planning an Audit

Identify Detection Risk

Consider Materiality
Obtain understanding Determine the to Determine the
and Assess Risk of
of the entity's Acceptable Level of Nature, Timing and
Material
environment Audit Risk Extent of Further Audit
Misstatements
Procedures

Figure 2. Summary of Procedures in Planning an Audit

Source: Applied Auditing Book 1 of 2, 2018, p. 21

References
American Accounting Association. (n.d.). Auditing: A Journal of Practice & Theory. Retrieved from American Accounting
Association: https://aaahq.org/AUD/Publications/Auditing-Journal
Asuncion, D. J., Ngina, M. A., & Escala, R. F. (2018). Applied Auditing Book 1 of 2. Baguio: Real Excellence Publishing.
Auditing Standards and Practices Council. (2001). Philippine Standard on Auditing 120: Framework of Philippine
Standards on Auditing. Retrieved from https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-120.pdf
Auditing Standards and Practices Council. (2007). Philippine Standard on Auditing 300 (Redrafted): Planning an Audit
of Financial Statements. Retrieved from https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-300-
Redrafted.pdf
Auditing Standards and Practices Council. (2007). Philippine Standard on Auditing 315 (Redrafted). Retrieved from
https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-315-Redrafted.pdf
Auditing Standards and Practices Council. (2009). Philippine Standard on Auditing 210 (Redrafted): Agreeing the
Terms of Audit Engagements. Retrieved from https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-
210-Redrafted.pdf
Baldres, R. N., De Leon, E. M., & Magadia, G. A. (2017). Auditing and Other Assurance Services. Manila: Polytechnic
University of the Philippines.
Cabrera, M. E. (2015). Auditing Theory. Manila: GIC Enterprises & Co., Inc.
iEduNote. (n.d.). Audit: Definition, Objectives, Features, Origin, Limitations. Retrieved from iEduNote Web Site:
https://www.iedunote.com/audit

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