AUDITING ASSURANCE AND PRINCIPLE

AUDIT

An Overview The primary function of an independent audit is to lend credibility to the financial
statement of an attaching a report to the financial statement, the auditor provides increased assurance to
users that the financial statement are reliable.

♦ Auditing

To enable the auditor to express an opinion whether the financial statements are prepared, in all
materials respects, in accordance with the applicable financial reporting framework. Operational and
compliance auditing are becoming more and more important. A more comprehensive definition of auditing
is given by the 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 interest users.” This definition conveys the following thoughts.

1. Auditing is a systematic process Auditing proceeds by means of an ordered and structure

series of steps.

2. An audit involves obtaining and evaluating evidence about assertions regarding economic
actions and events Assertions are represented made by an auditee about economic actions and
events. The auditor’s objective is to determine whether these assertions are valid. To satisfy this
objective, the auditor performs audit procedures and gathers evidence that corroborates or
refutes the assertions.

3. An audit is conducted objectively The auditor should conduct the audit without bias. Impartial
attitude must be maintained by the auditor when evaluating evidence and formulating his
conclusion.

4. Auditors ascertains the degree of correspondence between assertions and established criteria
Established criteria are needed to judge the validity of the assertions. These criteria are important
because they establish and inform the users of the basis against which the assertion have been
evaluated or measured.

5. Auditors communicate the audit results to various interested user For the audit to be useful, the
result must be communicated to interest users on a timely basis.

♦ Types of Audits Based on primary audit objectives, there are three major types of audit financial,
compliance and operational audits.

▪ Financial statement audit

An audit conducted to determine whether the financial statement of an entity are fairly presented
in accordance with the applicable financial reporting framework.

▪ Compliance audit

This involves a review of an organization’s procedure to determine whether the organization has
adhered to specific procedures, rules or regulations. A common example of this type of audit is
the examination conducted by BIR examiners to determine whether entities comply with tax rules
and regulation.

▪ Operational audit
 Operational audit is a study of a specific unit of an organization for the purpose of measuring its
performance. The objective of this audit is to assess entity’s performance, identify areas for
improvements and make recommendations to improve performance. Also known as performance
audit or management audit.

It should be noted that, although there are different types of audit, all audits possess the same
general characteristics. They all involve:

1. Systematic examination and evaluation of evidence which are undertaken to ascertain

whether assertion comply with established criteria; and

2. Communication of the result of the examination, usually in a written report to the party by
whom, or on whose behalf, the auditor was appointed. Unlike compliance and financial statement
audits, where the criteria are usually defined, criteria used in operational audit to evaluate the
effectiveness and efficiency of operation are not clearly established.

♦ Types of Auditors

▪ External auditors - Independent CPAs who offer professional services to different clients on a
contractual basis. The ones who generally conduct financial statement audit.

▪ Internal auditor - The main function of internal auditor is to assist the members of the
organization in the effective discharge of their responsibilities. These are entity’s own employee.
They usually perform operational audits.

▪ Government auditors - These are government employees whose main concern is to determine
whether person or entities comply with government rules and regulations. They usually perform
compliance audits.

♦ The Independent Financial Statement Audit

To enhance the degree of confidence of intended users in the financial statement. This is
achieved by the expression of an opinion by the auditor on the fair presentation of the financial
statement,

▪ Responsibility for the financial statement

This responsibility includes the design, implementation and maintenance of internal control
relevant to the preparation and presentation of financial statement that are free from material
misstatement, whether due to fraud or error and to provide the auditor with unrestricted access to
all information, records and documents relevant to the financial statements.

▪ Assurance provided by the auditor

To provide only reasonable assurance (not absolute assurance) that the financial statements
taken as a whole are free from material misstatement. The auditor is not and cannot obtain
absolute assurance because there are inherent limitations of audit that affect the auditor’s ability
to detect material misstatement.
 1. The use of testing / Sampling risk

-Auditors do not examine all evidence available. Only sample of evidence.

2. Error in application of judgement / Non-sampling risk

-Human weaknesses can cause auditors to commit mistakes in the application of audit
procedures and evaluation of evidence.

3. Reliance on management’s representation

- Some evidence supporting the financial statements must be obtained by oral or written
representations from management. If the management lacks integrity, management may
provide the auditor with false representation causing the auditor to rely on unreliable
evidence.

4. Inherent limitations of the client’s accounting and internal control system.

Although the auditor performs procedures to detect material misstatement when auditing
the financial statements, such as procedure may not be effective in detecting
misstatement resulting from collusion among employees or management’s circumvention
of internal control.

5. Nature of evidence

It compromises pieces of information and impressions which are gradually accumulated

during the course of an audit and which, when taken together, persuade the auditor about
the fairness of the financial statements.

♦ General principles governing the audit of financial statements

1. The auditor should comply with relevant ethical requirements, including those relating to
independence, relating to financial statements audit engagements. Auditors must adhere to
standard of ethical conduct that embody and demonstrate integrity, objectivity, and concern for
the public rather than self-interest.

2. The auditor should conduct an audit in accordance with Philippine Standard in auditing. This
standard is designed to assist auditors in interpreting and applying the auditing standard.

3. The auditor should exercise professional judgment in planning and performing an audit of
financial statements. Professional judgment is the hallmark of an auditing. The distinguishing
feature of the professional judgment expected of an auditor is that it is exercised by an auditor
whose training, knowledge and experience have assisted in making competent and reasonable
judgment.

4. The auditor should obtain sufficient appropriate audit evidence to reduce audit risk to an
acceptable low key to enable the auditor to express an opinion on the financial statements. It is
cumulative in nature and is primarily obtained from audit procedures performed during the audit.
Evidence must be both sufficient and appropriate to afford a reasonable basis for an opinion on
the financial statements.

5. The auditor should plan and perform the audit with an attitude of professional skepticism
recognizing that circumstances may exist which may cause the financial statement to be
materially misstated. An attitude of professional skepticism means the auditor makes a critical
assessment, with a questioning mind, of the validity of audit evidence obtained and is alert to
 audit evidence that contradicts or bring into question the reliability of documents to be materially
misstated, In planning and performing an audit the auditor neither assumes that the management
is honest nor dishonest. In planning and performing an audit, the auditor neither assumes that the
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.

-Managers are frequently placed in position where they can benefit by providing outside
parties with overly optimistic or even false financial information.

2. Expertise

-The complexity of accounting and auditing requires expertise in verifying the quality of the
financial information.

3. Remoteness

-Most of the users do not have the access to the entity’s records to personally verify the
reliability of the financial statements. As a result, 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. It is therefore important that financial statement be audited before these
statements are used for making important decision.

♦ Theoretical framework of Auditing

The audit function operates within a theoretical framework.

1. Audit function operates on the assumption that all financial data are verifiable. All balances
reported in the financial statement must have supporting documents or evidence to prove their
validity.

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

3. There should be no long-term between the auditor and the client management. Short-term
conflicts may exist regarding the application of auditing procedures and accounting policies, but in
the auditor and the management must be interested in the fair presentation of the financial
statements.

4. Effective internal control system reduces the possibility of errors and fraud affecting the
financial statements. The stronger the internal control is, the more assurance it provides about
reliability of the accounting data and financial statements.

5. Consistent compliance with applicable financial reporting framework results in fair presentation
of financial statements. In the case of the independent audit of financial statements, the criteria
are usually the PFRSS or PFRS for SMEs.
6. What was held true in the past will continue to hold true in the future in the absence of known
condition to the contrary. Experience and knowledge accumulated from auditing a client in prior
years can be used to determine the appropriate audit procedures that need to be performed.

7. An audit benefits the public. These users who rely on the financial statements as their major
source of information are the primary beneficiary of the financial statement audit