SELF-PACED LEARNING MODULE

COLLEGE DEPARTMENT

MODULE 1
Subject:
AUDITING AND ASSURANCE: CONCEPTS AND APPLICATION 1

AISAT COLLEGE – DASMARIÑAS, INC.

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 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |2
CONCEPTS AND APPLICATION 1

INFORMATION SHEET PR-1.1.1

OVERVIEW OF THE AUDIT PROCESS

Auditing Defined.

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

and evaluates 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.

Overall objectives of the Auditor.

Philippine Standard on Auditing (PSA)

• Establishes the independent auditor’s overall responsibilities when conducting an audit of

financial statements.
• Sets out the overall objectives of the independent auditor.
• Explains the nature and scope of an audit.

In conducting an audit of financial statements, the overall objectives of the auditor are:

a.) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement.

b.) To report on the financial statements, and communicate as required by the PSAs, in accordance with
the auditor’s findings.

Ethical Requirements Relating to an Audit of Financial Statements.

PSA 220 “Quality Control for an Audit of Financial Statements”

 Identifies the fundamental principles of professional ethics.

Honesty, Trustworthiness, Loyalty, Respect for others, Adherence to the law, Accountability.
 Sets out the engagement partner’s responsibilities with respect to ethical requirements.
 Recognizes that the engagement team is entitled to rely on a firm’s systems in meeting its
responsibilities with respect to ethical requirements.

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:

MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director
 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |3
CONCEPTS AND APPLICATION 1

Conduct of an Audit of Financial Statements

The auditor should conduct an audit in accordance with Philippine Standards on Auditing.

Professional Skepticism
Means the auditor makes a critical assessment, with a questioning mind, of the validity of
audit evidence obtained.

Reasonable Assurance
Is a concept relating to the accumulation of the audit evidence necessary for auditor to
Conclude that there are no material misstatements in the financial statements taken as a whole.

Limitations of An Audit

 Higher cost burden. Due to Higher Cost Burden, the auditor limits his scope
of work to selective testing or sampling thus in depth checking of books
of accounts is not possible.

 Base on test checks. Generally, an auditing exercise is based on test checking.

Inferring a result based on test check always need not to be true.

 Insufficient time. Generally, an auditor needs to release the report up to

a specified timeline. Sometime this timeline become a constraint for an auditor
in carrying out the auditing exercise effectively.

 Based on estimates. Estimate range from the allowance for doubtful accounts
and an inventory obsolescence reserve to impairment tests
of fixed assets and goodwill.

 Based on the Information provided by the Management. The audit opinion is based
on the information provided by the management. Hence, outsiders cannot
fully rely on the auditors.

Audit Risk and Materiality

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:
MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director
 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |4
CONCEPTS AND APPLICATION 1

Audit Risk is the risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated.

• May carry legal liability for a CPA.

• Auditing firms carry malpractice insurance to manage audit risk
and the potential legal liability.
• The two components of audit risk are risk of material misstatement
and detection risk.

Material Misstatement

A material misstatement is information in the financial statements that is sufficiently

incorrect that it may impact the economic decisions of someone relying on those statements.

Detection Risk

Detection risk is the chance that an auditor will fail to find material misstatements that
exist in an entity's financial statements.

Major Steps in the Systematic Process of Financial Statements Audit

Phase I: Pre-engagement and Audit Planning Activities

Audit process begins with the preliminary arrangements with the client.

The agreed terms of the audit engagement shall be recorded in an audit engagement letter or
other suitable form of written agreement and shall include: (Ref: PSA 210 (Redrafted), par A22-
25)

a) The objective and scope of the audit of the financial statements.

b) The responsibilities of the auditor.
c) The responsibilities of management.
d) Identification of the applicable financial reporting framework for the preparation of the
financial statements; and
e) 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.

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:

MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director
 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |5
CONCEPTS AND APPLICATION 1

Audit Engagement Letters. It is in the interest of both client and auditor that the auditor sends an
engagement letter, preferably before the commencement of the engagement, to help in avoiding
misunderstandings with respect to the engagement. The engagement letter documents and confirms
the auditor’s acceptance of the appointment, the objective and scope of the audit, the extent of the
auditor’s responsibilities to the client and the form of any reports.

The form and content of audit engagement letters may vary for each client, but they would
generally include reference to:

• The objective of the audit of financial statements.

• Management’s responsibility for the financial statements.
•The scope of the audit, including reference to applicable legislation, regulations, or
pronouncements of professional bodies to which the auditor adheres.
• The form of any reports or other communication of results of the engagement
• The fact that because of the test nature and other inherent limitations of an audit, together with
the inherent limitations of internal control, there is a TERMS OF AUDIT ENGAGEMENTS 231 ISA
210 AUDITING unavoidable risk that even some material misstatement may remain
undiscovered.
• Unrestricted access to whatever records, documentation and other information requested in
connection with the audit, and
• Management’s responsibility for establishing and maintaining effective internal control.

The auditor may also wish to include the following in the letter:

• Arrangements regarding the planning and performance of the audit.

• Expectation of receiving from management written confirmation concerning representations
made in connection with the audit.
• Request for the client to confirm the terms of the engagement by acknowledging receipt of the
engagement letter.
• Description of any other letters or reports the auditor expects to issue to the client.
• Basis on which fees are computed and any billing arrangements.

When relevant, the following points could also be made:

• Arrangements concerning the involvement of other auditors and experts in some aspects of the
audit.
• Arrangements concerning the involvement of internal auditors and other client staff.
• Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
• Any restriction of the auditor’s liability when such possibility exists.
• A reference to any further agreements between the auditor and the client.
• An example of an audit engagement letter is set out in the Appendix.

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:

MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director
 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |6
CONCEPTS AND APPLICATION 1

Audits of Components

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:

• Who appoints the auditor of the component.

• Whether a separate auditor’s report is to be issued on the component.
• Legal requirements.
• The extent of any work performed by other auditors. TERMS OF AUDIT ENGAGEMENTS ISA 210
232
• Degree of ownership by parent.
• Degree of independence of the component’s management. Recurring Audits

Recurring Audits

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:

• Any indication that the client misunderstands the objective and scope of the audit.
• Any revised or special terms of the engagement.
• A recent change of senior management or those charged with governance.
• A significant change in ownership.
• A significant change in nature or size of the client’s business.
• Legal or regulatory requirements.

Phase II: perform test of controls and substantive test of transactions

 Test of Control: if the auditor plans to reduce the determined control risk, then the auditor
should perform the test of control, to assess the operating effectiveness of internal controls (e.g.
authorization of transactions, account reconciliations, segregation of duties) including IT General
Controls. If internal controls are assessed as effective, this will reduce (but not entirely eliminate)
the amount of 'substantive' work the auditor needs to do (see below).

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:

MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director
 Unit AUDITING AND ASSURANCE:
CONCEPTS AND APPLICATION 1
Module OVERVIEW OF THE AUDIT PROCESS
PRE2-AACA
AUDITING AND ASSURANCE:
Units: 3 Page |7
CONCEPTS AND APPLICATION 1

 Substantive test of transactions: evaluate the client's recording of transactions by verifying the
monetary amounts of transactions, a process called substantive tests of transactions. For
example, the auditor might use computer software to compare the unit selling price on duplicate
sales invoices with an electronic file of approved prices as a test of the accuracy objective for
sales transactions. Like the test of control in the preceding paragraph, this test satisfies the
accuracy transaction-related audit objective for sales. For the sake of efficiency, auditors often
perform tests of controls and substantive tests of transactions at the same time.
 Assess Likelihood of Misstatement in Financial Statement.

Phase III: perform analytical procedures and tests of details of balances

 Where internal controls are strong, auditors typically rely more on Substantive Analytical
Procedures (the comparison of sets of financial information, and financial with non-financial
information, to see if the numbers 'make sense' and that unexpected movements can be
explained)
 Where internal controls are weak, auditors typically rely more on Substantive Tests of Detail of
Balance (selecting a sample of items from the major account balances, and finding hard evidence
(e.g., invoices, bank statements) for those items)

Phase IV: complete the audit and issue an audit report

After the auditor has completed all procedures for each audit objective and for each financial
statement account and related disclosures, it is necessary to combine the information obtained to reach
an overall conclusion as to whether the financial statements are fairly presented. This highly subjective
process relies heavily on the auditor's professional judgment. When the audit is completed, the CPA
must issue an audit report to accompany the client's published financial statements.

References:

Applied Auditing 2011 Edition

Ma. Elenita Balatbat Cabrera

https://toaz.info/doc-viewer

https://corporatefinanceinstitute.com/resources/knowledge/accounting/audit/

https://www.ifac.org/system/files/downloads/2008_Auditing_Handbook_A065_ISA_210.pdf

https://en.wikipedia.org/wiki/Financial_audit

SUBJECT TEACHER: APPROVED FOR IMPLEMENTATION:

MODULE 1st – 2nd
PRELIM
1 Meeting MS. JULIETA S. ECHEGOYEN MR. WILBERT A. MAÑUSCA
Subject Teacher School Director