Chapter 1- The

demand for
Auditing and
Assurance
Services.
Expected Learning Outcomes:

● Describe the role of ● Understand why

auditing in meeting individual external
society’s demands for auditors are expected
reliable financial to make professional
information. and ethical judgements
about the information
provided by business
organizations.

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Expected Learning Outcomes:

● Explain the nature of ● Understand the need

assurance services. for increased
● Enumerate the various globalization of
parties who are accounting and
interested in audited Auditing standards.
financial statements.

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Economic Demand for
Auditing
The Demand for auditing can be understood as the need
for accountability when business owners hire others to
manage their businesses, as is typical in modern
corporations.

18th century and early 19th centuries- most organizations

were relatively small and were owned and operated as
sole proprietorships or partnerships.

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Economic Demand for
Auditing
The birth of modern accounting and auditing occurred
during the industrial revolution, when companies
became larger and needed to raise capital to finance
expansion.

Overtime, capital markets developed, enabling

companies to raise the investment capital necessary to
expand new markets, finance expensive research and
development, and fund, the buildings, technology, and
equipment needed to deliver products to market.
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Economic Demand for
Auditing
Capital market- allows public company to sell small
pieces of ownership (stocks) or to borrow money in the
form of thousands of small loans (bonds) so that vast
amounts of capital can be raised from a wide variety of
investors and creditors.

Public company- a company that sells its stocks or bonds

to the public, giving the public a valid interest in the
proper use of the company’s resources.

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Economic Demand for
Auditing
THE GROWTH OF MODERN CORPORATION
-Led to diverse groups of owners who are not directly
involved in running the business(shareholders) and the
use of professional managers hired by the owners to run
the corporation on a day-to-day basis.
-The managers serves as agents for the owners
(principals) and fulfill a stewardship function by
managing the corporation’s assets.

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Economic Demand for
Auditing
IT IS IMPORTANT TO UNDERSTAND THAT THE
RELATIONSHIP BETWEEN AN OWNER AND MANAGER
OFTEN RESULTS IN INFORMATION ASYMMETRY
BETWEEN THE TWO PARTIES.

INFORMATION ASYMMETRY- means that the manager

generally has more information about the “true”
financial position and the results of operations of the
entity than does the absence owner.

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Describe the role of auditing in meeting
society’s demands for reliable financial
information.
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.

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Practice Question:
True or false: Information asymmetry means that owners
generally have more information about the financial
position and results of entity operations than the
managers.

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Why do we
need
Assurance
Services?
What are
Assurance
Services?
 ASSURANCE SERVICES
“ Used to describe the broad
range of information
enhancement services
performed by CPA that are
designed to enhance the
degree of confidence in the
information.
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 ASSURANCE SERVICES
“ 2 types of ASSURANCE SERVICES
○ Those that increase the
reliability of information
○ Those that involve putting
information in a form or
context that facilitates
decision making.
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 ASSURANCE SERVICES
“ Attestation services- significant
portion of the assurance
services provided by CPAs.
-to attest, means to provide as
to its reliability.

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 ASSURANCE SERVICES
“ One of the most sought-after
attestation services is the
examination or audit of
historical financial statements.

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“

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Practice Question:

True or false: Attest services are a subset of

assurance services, and auditing is a type of
attest service

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Philosophy of an Audit

● The auditor’s role is to determine

whether the reports prepared by the
manager conform to the contract’s
provisions.
● Auditor’s verification of the financial
information adds credibility to the
report and reduces information risk.
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Philosophy of an Audit

● In terms of ECONOMIC DECISIONS

● There is always a risk, that incur
a significant loss.

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 Philosophy of an Audit
● RECORD OF FINANCIAL CONDITION AND PROGRESS:
(Businesses, institutions and individuals)
● They must maintain records of their financial
condition and progress.

● These records are necessary to evaluate and

guide business operations, to determine financial
status, to meet legal requirements and to serve as
a basis for credit.
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Philosophy of an Audit

● CREDITORS AND INVESTORS- present

and prospective, may wish to study
the financial statements of many
enterprises for credit extension and
investment purposes.

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Philosophy of an Audit

● GOVERNMENT AGENCIES- will need

financial reports to help them carry
out the duties imposed upon them
by law internal management needs
financial reports for planning,
directing and controlling business
operations.

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Philosophy of an Audit

● Audit examination- the process

employed to establish the reliability
or unreliability of the financial
statements and supporting records.

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Philosophy of an Audit

● Auditing of financial records has

become an important factor in the
dissemination of financial
information and the services of the
independent CPA are considered
indispensable.

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Philosophy of an Audit
● FREE MARKET ECONOMY
● Exist only if there is sharing of
reliable information among
parties that have an interest in
the financial performance of an
organization.
● Strengthened if the information
is transparent and unbiased.
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Philosophy of an Audit
FINANCIAL STATEMENT AUDIT
● Auditors undertake to gather
evidence to obtain high level of
assurance that financial statements
are free of material misstatements
due fraud or errors and that they
are presented in accordance with
appropriate accounting framework.

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Philosophy of an Audit
EXTERNAL AUDIT
● Intended to enhance confidence
that users can place on
management-prepared financial
statements.
● When auditor has no reservation
about management’s financial
statements or internal controls, the
report is referred to as an
unqualified audit report.
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Philosophy of an Audit
○ Auditors serve a number of parties
but the most important is the
PUBLIC:
■ As represented by investors
■ Lenders
■ Workers
■ Other who make decision based
on financial information.

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Philosophy of an Audit
○ In the essence, auditors should view
themselves as guardians of the
capital markets.

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Philosophy of an Audit
○ THE PUBLIC EXPECTS AUDITORS TO:
a. Find fraud
b. Require accounting principles
the best portray the spirit of
the concepts adopted by
accounting standard setters
c. Be independent in fact, but
they must act in a manner that
ensures that they are
independent in appearance. 32
Philosophy of an Audit
○ An independent auditor’s opinion
contained in the audit report
provides both internal and external
users with input to making logical
and informed decisions about the
financial position, managerial
performance and economic
vulnerability.

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Causes of information
Risk
○ Remoteness of information
○ Biases and motives of the
provider
○ Voluminous data
○ Complex exchange
transactions
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Reducing Information
Risk
○ User verifies information
○ User shares information risk
with management.
○ Audited financial statements
are provided.
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Importance of Audited
Financial Statements

Audited Financial Statements- the

accepted meant by which
business corporations report their
operating results and financial
position.
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Importance of Audited
Financial Statements
Reporting in accordance with an agreed-upon set of
accounting principles does not solve the problem by
itself. Why?
Because manager is the responsible for reporting on
the results of his or her own actions, which the
absentee owner cannot directly observe, the
manager is in a position to manipulate reports

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Importance of Audited
Financial Statements
Financial statements prepared by management and
transmitted to outsiders without first being audited
by independent accountants leave a credibility gap.

Independent auditors have no material personal or

financial interest

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Importance of Audited
Financial Statements
UNAUDITED FINANCIAL STATEMENTS -may have been
honestly, but carelessly prepared.

ASSETS May have been overstated as a result of arithmetical errors or due to

a lack of knowledge of financial accounting and reporting standards.
LIABILITIES May have been overlooked and omitted from the balance sheet.

NET INCOME May have been exaggerated because expenses were capitalized or
because sales transactions were recorded in advance of delivery
dates.

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Importance of Audited
Financial Statements
The possibility that unadited financial statements have
been deliberately falsfied in order to conceal theft and
fraud or as means of inducing the reader to invest in
the business or to extend credit.
Deliberate falsification- not common
-cause devastating losses to person
who make decisions.

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USER TYPES OF DECISIONS

Management Review performance, make operational decisions. Report

results to capital market.
Stockholders Buy or sell stock.

Bondholders Buy or sell bonds.

Financial institutions Evaluate loan decisions, considering interest rates, terms

and risk.
Taxing authorities Determine taxable income and tax due.

Regulatory Agencies Develop regulations and monitor compliance.

Labor Unions Make collective bargaining decisions.

Court System Assess the financial position of a company in litigation

Vendors Assess credit risk

Retired Employees Protect employees from surprise concerning pensions and

other post-retirement benefits.
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The Assurance Analogy and the
Philippine Standards on Auditing (PSAs)
● An audit provides reasonable assurance of
detecting material misstatements of
financial statements (both errors and fraud)
and noncompliance with laws that have
direct and material effect on the
determination of financial statements
amount.

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The Assurance Analogy and the
Philippine Standards on Auditing (PSAs)
Currently the International Auditing and Assurance
Standards Board (IAASB)
-Issues pronouncements designed to foster the
development of consistent worldwide auditing
standards while the

Auditing and Standards Practice Council of the

Philippines (AASC)
-Reviews and recommends for approval to the
PRCBOA their adoption as the Philippine Standards on
Auditing (PSAs). 43
The Assurance Analogy and the
Philippine Standards on Auditing (PSAs)
RA 9298
● Philippine law that regulates Practice of Accountancy.
● Provides that the Professional Regulatory Board of
Accountancy shall monitor the conditions affecting the
practice of accountancy and adopt such measures to
enhance and maintain the high professional, ethical and
auditing standards including promulgation of accounting
standards, domestic and international.
International financial markets would be facilitated if auditing
and accounting standards were more uniform.
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Additional Information:
Types of Audits
➢ Operational Audit- operations effectiveness and
efficiency
➢ Compliance Audit- established laws and regulations or
organization’s policies and procedures
➢ Financial Statement- fair presentation in accordance
with GAAP

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Practice Question:

True or false: The auditor's report, also known as

the audit opinion, is the main product or output
of the audit.

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Practice Question:

True or False:

To ensure the audit runs smoothly, it is

preferable to have members of the audit
team that have personal relationships
with the client.

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