Gaus '2020 - 2021) j Edition | Principles | of | AUDITING AND ASSURANCE | Sewices r- Based on ISAs, PSAs, Framework, PSQC, | PAPSs, PSREs, PSAEs, PSRSs, Revised Code of Ethics (2018) } GILBERT ANTHONY B. CABRERAii Preface UNITI Chapter UNIT IL Chapter UNIT tit Chapter _ 10 2 Contents in Brief INTRODUCTION TO ASSURANCE AND AUDITING SERVICES THE DEMAND FOR AUDITING AND ASSURANCE SERVICES PROFESSIONAL PRACTICE OF ACCOUNTANCY: AN OVERVIEW THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT MANAGEMENT OF A PUBLIC ACCOUNTING PRACTICE PROFESSIONAL ETHICS FUNDAMENTALS OF ASSURANCE AND FINANCIAL ‘STATEMENT AUDIT FUNDAMENTALS OF ASSURANCE SERVICES INTRODUCTION TO FINANCIAL STATEMENT AUDIT Risk-BASeD AUDIT OF FINANCIAL STATEMENTS OVERVIEW OF RISK-BASED AUDIT RISK ASSESSMENT — PART] PHASE I-A, PERFORMANCE OF PRELIMINARY ENGAGEMENT ACTIVITIES PHASE I-B. PLANNING THE AUDIT TO DEVELOP AN OVERALL AUDIT STRATEGY AND AUDIT PLAN RISK ASSESSMENT — Part II PHASE I-C.1. PERFORMANCE OF RISK ASSESSMENT PROCEDURES TO IDENTIFY / ASSESSED RISKS OF MATERIAL MISSTATEMENT THROUGH UNDERSTANDING THE ENTITY RISK ASSESSMENT — PART III PHASE I-C.2, CONSIDERATION OF INTERNAL CONTROL IN A FINANCIAL STATEMENT AUDIT FRAUD AND ERROR iW 33 65 14 152 174 199 216 224 255 151 198UNIT IV Chapter 13 14 15 16 7 18 UNITY Chapter 19 20 21 22 UNIT VI Chapter 23 24 UNIT VII Chapter 25 26 Risk RESPONSE RISK RESPONSE — PARTI DESIGNING AND EFFECTIVE RESPONSE TO ASSESSED RISK RISK RESPONSE — PART IL IMPLEMENTING THE DESIGNED RISK RESPONSE AND OBTAINING AUDIT EVIDENCE Basic AUDIT SAMPLING CONCEPTS AUDIT SAMPLING FOR TEST OF CONTROLS AUDIT SAMPLING FOR SUBSTANTIVE TESTS AUDIT DOCUMENTATION REPORTING AupIT EVIDENCE EVALUATION COMPLETING THE AUDIT AND POST-AUDIT RESPONSIBILITIES FORMING AN OPINION AND REPORTING ON FINANCIAL STATEMENTS MODIFICATIONS TO THE INDEPENDENT AUDITOR'S * REPORT AUDITING IN AN INFORMATION TECHNOLOGY (IT) ‘SYSTEM ENVIRONMENT AUDITING IN AN INFORMATION TECHNOLOGY (IT) ‘SYSTEM ENVIRONMENT — PARTI [AUDITING IN AN INFORMATION TECHNOLOGY (iy) ‘SYSTEM ENVIRONMENT ~ PART IL OTHER SERVICES AND REPORTS PROCEDURES AND REPORTS ON SPECIAL PURPOSE AUDIT ENGAGEMENTS NON-AUDIT ENGAGEMENTS: PROCEDURES AND REPORTS List of References 334 348 378 413 435 475 506 x 516 S71 598 636 668 694 731 iit 333 505 635 693 782Preface UNITI Chapter Chapter Contents INTRODUCTION TO ASSURANCE AND AUDITING-SERVICES 1 THEDEMAND FOR ASSURANCE AND AUDITING SERVICES Expected Learning Outcomes Economic Demand for Auditing What are Assurance Services? Philosophy of an Audit Importance of Audited Financial Statements Users of Audited Financial Statements The Assurance Analogy and the Philippine Standards on Auditing (PSAs) Review Questions 2 INTRODUCTION TO PROFESSIONAL PRACTICE OF ACCOUNTANCY Expected Learning Outcomes Accountancy as a Profession Who is a Professional Accountant? Scope of Practice Assurance, Autest, and Auditing Services Defined Assurance Services Attest Services Audit Services Relationship Among Assurance, Attest, and Auditing Services Types of Auditors External Auditors Internal Auditors Government Auditors Forensic Auditors Types of Other Audit Services Internal Audit Compliance Audit Operational Audit PARR cy 1 12 13 14 15 15 16 16 17 18 18 19 19 20 ai 21 22 22Forensic Audit Types of Other Attest Services Other Non-Assurance Services Agreed-Upon Procedures Tax Preparation and Planning Services Management Advisory Services Compilation, Accounting and Data Processing System Services Review Questions 3 THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT .- Expected Learning Outcomes Practice of Public Accountancy Defined Certified Public Accountant Requirements to Enter the Accountancy Profession A. Pre-Qualification Education Requirements B. CPA Licensure Examination C. Other Legal Regulatory Requirements Developing Capabilities and Competence after Admission to the Profession Core Values and Competency Requirements for CPAs in Public Practice Regulatory and Professional Organizations that Influence the Profession ‘A. Regulatory Government Agencies B. Professional Organizations C. Standard-Setting Bodies CPA's Legal Liability. Logal Concepts Related to Auditor's Liability Legal Liability of the Independent Auditor Limitation on Auditor's Responsibility Auditor's Defenses Against Client Suits ‘Auditor's Defenses Against Third-Party Lawsuits Minimizing Exposure to Legal Liability Society's Expectations and Auditor's Responsibilities Challenges Faced by the Public Accounting Profession The Accounting Profession’s Credibility Crisis Review Questions ~ 23 23 23 23 23 24 24 25 533 54 56 33Ww Chapter Chapter 4 MANAGEMENT OF A PUBLIC 5 ACCOUNTING PRACTICE Expected Learning Outcomes Establishment and Organization of Public Accountancy Practice Marketing Professional Services Sources of Clients Professional Fees Methods of Billing Clients Auditing in a Globalized Environment Regulation within the Firm System of Quality Control owe: of a System of Quality Control (. Leadership Responsibilities of Quality Within the Firm Ethical Requirements Acceptance and Continuance of Client Relationships and Specific Engagements )._ Human Resources . Engagement Performance Monitoring /-™amDS Ab Review Questions PROFESSIONAL ETHICS Expected Learning Outcomes Introduction Why do People Act Unethically The Need for Professional Ethics Characteristics and Values Associated with Ethical Behavior The Code of Ethics for Professional Accountants in the Philippines Threats to Compliance with Rules Safeguards to Mitigate or Eliminate Threats Code of Ethics, Applicability to CPAs in Public Practice Resolving Ethical Conflict Review Questions 65 70 70 1 2 B 73 4. 75 76 80 83 85 93 114 1S 116 118 19 121 123 125 127 139 140 65 4UNIT I FUNDAMENTALS OF ASSURANCE SERVICES AND FINANCIAL STATEMENT AUDIT Chapter 6 FUNDAMENTALS OF ASSURANCE SERVICES Expected Learning Outcomes Assurance Engagements Nature of Assurance Engagements Objective of An Assurance Engagement Types of Asstirance Engagements Reasonable Assurance Engagement Limited Assurance Engagement © * Other Assurance Services Assertion-Based Engagements Vs. Direct Reporting Engagements Elements of An Assurance Engagement Brief Description of Assurance Services Independent Financial Statements Audit Review of Financial Statements Other Review Engagements Other Assurance Services “Assurance Services and Information Technology CPA Web Trust Service Information System Reliability Service “Assurance Services on Other Types of Information Business Performance Measurement Health Care Performance Measurement Risk Assessment, Eldercare Plus Brief Description of Non-Assurance Services ‘Agreed-Upon Procedure Services Compilation of Financial and Other Information Tax Services Management Consulting / Advisory Services ‘Accounting and Data Processing or Information Technology System Services Review Questions 152 153 153 154 154 167 1 167 167 167 168 168 168 169 169 169 181 is2vill Chapter 7 INTRODUCTION TO FINANCIAL STATEMENT AUDIT Expected Learning Outcomes 174 Independent Auditing Defined 175 Objectives of Auditing 17 Scope of independent Audit 178 Why Independent Auditing Is Necessary 178 How Information Risk may be Reduced 180 Advantages and Practical Beriefts of An Independent Audit 181 Overview of the Audit Opinion Formulation Process 182 Activities of each Phase of the Audit Opinion Formulation Process 184 Management Assertions and Financial Statements 185 Core Concepts of Financial Statement Audit 187 Materiality’ 188 Audit Risk 188 Audit Evidence Regarding Management _ Assertions 189 General Principles of an Audit 190 Compliance of Ethical Requirements 190 Reasonable Assurance 190 Responsibility for the Financial Statements 191 Skills and Knowledge Needed in Financial Statement Audit 191 Parties Involved in Preparing and Auditing Financial Statements 192 The Context of Financial Statement Ai uditing 192 The Business Entity as the Primary Context of Auditing 193 Relating the Audit Process Components to the Business Model 193 Review Questions 194‘UNIT III Chapter Chapter RISK-BASED AUDIT OF FINANCIAL STATEMENTS 8 OVERVIEW OF RISK-BASED AUDIT PROCESS Expected Learning Outcomes 199 Introduction Risk-Based Audit Process Defined 200 Factors to Consider in Implementing the Audit Risk Model Limitation of the Audit Risk Model Risk-Based Audit vs. Account-Based Audit The Risk-Based Audit Process Phase I. Risk Assessment Phase Il, Risk Response Phase III. Reporting Relevant Philippine Standards on Auditing (PSAs) to be used in the Risk-Based Audit Process 206 Understanding the Audit Risk Model 209 Review Questions 212 9 RISK ASSESSMENT - PART I + Expected Learning Outcomes 216 PHASE I-A. PERFORMANCE OF PRELIMINARY ENGAGEMENT ACTIVITIES 216 Introduction 217 Client Selection and Retention 217 Client Acceptance / Retention Decisions 218 Audit Firm Limitations 219 Engagement Letters 220 Recurring Audits 221 PHASE I-B, PLANNING THE AUDIT TO DEVELOP ‘AN OVERALL AUDIT STRATEGY AND AUDIT PLAN 224 Nature and Scope of Audit Planning 25 Benefits of Audit Planning 226 The Overall Audit Strategy 226 Benefits of Developing the Audit Strategy 27 ‘A. Materiality 28 B. Audit Plan 234 Review Questions and Exercises 249 le 198 199 216Chapter Chapter 10 RISK ASSESSM =NT-PART II PHASE I-C.1_ P! dee ASSESSMENT PROCEDURES TO IDENTIFY / ASSESS RISK OF MATERIAL MISSTATEMENT ‘THROUGH UNDERSTANDING THE ENTITY Expected Learning Outcomes Introduction 1. Risk Assessment Procedures and Sources of Information About the Entity and Its Environment, Including lis Internal Control Risk Assessment Procedures I. Understanding the Entity and lis Environment Including Its Internal Control IIL Identifying and Assessing the Risk of Material Misstatement IV. Material Weakness an Internal Control V. Documentation Assessing Inherent Risk and Control Risk at the Assertion Level Using the Audit Risk Model to Determine the Nature, Timing, and Extent of Audit Procedures Audit Risk in the Smal! Business Review Questions and Exercises 11 RISK ASSESSMENT - PART IL PHASE I-C.2. CONSIDERATION OF INTERNAL CONTROL IN A FINANCIAL STATEMENT AUDIT Expected Learning Outcomes Nature and Purpose of Internal Control Internal control System Defined Components and Principles of Internal Control A, Control Environment B. Entity’s Risk Assessmem Process C. Information System, including the Business RFORMANCE OF RISK 255 256 257 257 259 260 260 261 261 267 272 273 279 280 281 281 284 285 Processes, Relevant to Financial Reporting and Communication D. Control Activities E. Monitoring of Controls 286 286 287 255 279Chapter Objectives of the Study of internal Control Documentation of Understanding How adequacy of adequacy of Internal Control Affects Audit Procedures Communication of Performance, Improvements and Observations in Internal Control to Management Reportable Conditions Reporting - Form and Content Review Questions and Exercises 12 FRAUD AND ERROR Expected Learning Outcomes Introduction Characteristics of Fraud Fraudulent Financial Reporting Misappropriation of Assets Responsibility for the Prevention and Detection of Fraud Responsibilities of the Auditor Risk Assessment Detection Inherent Limitations of an Audit Examples of Fraud Risk Factors Procedures when Errors or Irregularities are Suspected Reporting of Fraud and Error Documentation Withdrawal from the Engagement Review Questions UNITIV RISK RESPONSE” Chapter. 13 RISK RESPONSE - PARTI DESIGNING AN EFFECTIVE RESPONSE, TO ASSESSED RISK Expected Learning Outcomes Introduction Types of Response Nature of Audit Procedures Tests of Controls or Compliance Tests Types of Compliance Tests Substantive Procedures 287 289 299 301 302 303 305 3s 316 316 316 317 318 318 318 39 319 320 324 324 325 325 326 334 315 333 334xi Chapter 14 substantive Tests 338 The mena of Audit Techniques, Audit Procedures and Assertions 5 340 Deciding the Number of tems to Audit 341 Timing of Testing 341 Timing of Tests of Controls aM 2 Timing of Substantive Procedures pee in ‘Audit Procedures that will be Applied 344 Review Questions 345 RISK RESPONSE - PART Il IMPLEMENTING THE DESIGNED RISK RESPONSE AND OBTAINING AUDIT EVIDENCE Expected Learning Outcomes 348 Introduction 349 Nature and Significance of Audit Evidence 349 What Constitutes Audit Evidence 350 Sufficient Appropriate Audit Evidence 351 Interrelationship Between Risk, Appropriateness and Sufficiency of Audit Evidence 351 Competence or Appropriateness of Evidence 353 Sufficiency of Evidence 355 Procedures for Obtaining Audit Evidence 355 Inspection of Records or Documents 355 Inspection of Tangible Assets 356 Confirmation 356 Inquiry 357 Written Representation 358 Observation 359 Recalculation 359 Reperformance : 359 Analytical Procedures 359 Relationship of Types of Evidence to Audit Objectives 360 Evidence About Accounting Estimates 369 Nature of Accounting Estimates 369 Audit Procedures 370 Reviewing and Testing the Process Used by Management 370 Evaluation of Results of Audit Procedures 371 Evidence for Related Party Transactions 371 Review Questions and Exercises 372 348Chapter Chapter 15 BASIC AUDIT SAMPLING CONCEPTS Expected Learning Outcomes Introduction Nature and Purpose of Audit Sampling Why Auditors Sample Testing Procedures which do not Involve Sampling Sampling vs. Non-Sampling Risk Sampling Risk Non-Sampling Risk Nonstatistical and Statistical Sampling Nonstatistical Sampling Statistical Sampling Attribute and Variables Sampling Techniques Autribute Sampling Technique Design of the Sample Audit Objectives Population Risk and Assurance Tolerable Error Expected Error in the Population Stratification Performing the Audit Procedure Evaluation of Sample Results Analysis of Errors in the Sample Projection of Errors Assessing Sampling Risk Conclusion Detailed Audit Sampling Plan Definition / Description of Audit Sampling Plans Review Questions 16 AUDIT SAMPLING FOR TEST OF CONTROLS Expected Learning Outcomes Test of Controls Steps in the Application of Sampling in Test of Controls Mustration of Attributes Sampling Nonstatistical Attributes Sampling Review Questions 378 379 379 379 380 381 381 381 382 382 383 387 387 388 389 389 390 392 392 393 400 400 400 402 403 404 405 405 408 413 414 414 41S 427 428 alld 378 413xlv Chapter Chapter 17 AUDIT SAMPLING FOR SUBSTANTIVE TESTS Expected Learning Outcomes 435 Substantive Procedures ‘4 Risks in Substantive Tests rababl To-Size Sampling (PPS) 437 Probability-Proportional-| “Advantages and Disadvantages of PPS Sampling 438 Classical Variables Sampling an Variations of Classical Variables Sampling ‘Steps in Variables Sampling for Substantive Tests 441 “Application of the Steps in Variables Sampling Plan Using PPS Technique for Substantive Tests 441 Reaching a Conclusion in PPS Sampling 454 Application of Classical Variables Sampling Plan Using Classical Techniques 455 Review Questions 428 18 AUDIT DOCUMENTATION Expected Learning Outcomes 475 Introduction 475 Nature of Audit Documentation 475 Objectives of Audit Documentation 477 Form, Content and Extent of Audit Documentation 477 Characteristics of Quality Audit Documentation —_ 479 Documenting Planning and Risk Assessment Procedures 479 Documenting Audit Work Performed 480 Documenting Significant Issues and Their Resolution 480 Copies of Documentation 481 Types of Working Papers 481 Relationship of Working Papers to Financial ‘Statements 484 Content of a Year-End Audit File Index 488 Mechanics of Working Paper Preparation 491 Computer-Generated Working Papers 491 Ownership and Custody of Working Paper 492 Confidentiality of Working Papers 492 Review Questions 428 435 475UNIT V REPORTING Chapter 19 AUDIT EVIDENCE EVALUATION Expected Learning Outcomes Introduction Evaluating the Sufficiency and Appropriateness of Audit Evidence Factors to Consider Final Analytical Procedures Documentation Review Questions Chapter 20 COMPLETING THE AUDIT AND POST — AUDIT RESPONSIBILITIES Expected Learning Outcomes Introduction Completing the Audit Related arty Transactions Subsequent Events Review Letters of Inquiry / Review for Contingent Liabilities Evaluation of Going Concern Assumption Management Representation Analytical Procedures Evaluating Findings, Formulating an Opinion and Drafting the Audit Report Post-Audit Responsibilities Review Questions and Exercises Chapter 21 FORMING AN OPINION AND REPORTING ON FINANCIAL STATEN ENTS Expected Learning Outcomes Introduction Forming an Opinion on the Financial Statements Forms of Opinion Preparation of the Auditor's Report for Audits Conducted in accordance with International Standards on Auditing 506 507 508 510 Su 512 51S 516 516 517 $23 528 333 Sal 547 550 $383 556 S71 572 $73 574 583 505 506 516 S71Responsibilities for the Financial Statement Auditor's Responsibilities for the Audit of the Financial Statements Other Reporting Responsibilities Name of the Engagement Partner Signature of the Auditor * Auditor's Address Date of the Auditor's Report Supplementary Information Presented with Financial Statements Review Questions and Exercises 22 MODIFICATIONS TO THE INDEPENDENT AUDITOR’S REPORT Expected Learning Outcomes Introduction Types of Modified Opinions Objective Determining the Type of Modification to the Auditor's Opinion Form and Content of the Auditor's Report when the Opinion is Modified Description of Auditor's Responsibility When the Auditor Expresses a Qualified or Adverse Opinion Description of Auditor's Responsibility When the Auditor Disclaims an Opinion Communication with Those Charged with Governance Mlustrative Audit Reports with Modified Opinion Review Questions and Exercises 586 587 590 591 591 591 592 592 593 598 599 599 600 601 603 604 605 605 605 619 598UNIT VI AUDITING IN AN INFORMATION TECHNOLOGY (IT) SYSTEM ENVIRONMENT 635 Chapter 23 AUDITING IN AN INFORMATION TECHNOLOGY (IT) SYSTEM ENVIRONMENT - PART I 636 Expected Learning Outcomes 636 Introduction 637 Nature of IT and Its Capabilities 637 Major Componenis of an Information System 638 Functions of an Information System 639 Characteristics of Various Types of IT-Based Systems 640 Auditor's Responsibilities 642 Internal Control in an IT Environment 642 General Controls 642 Application Controls 650 Review Questions 654 Chapter 24 AUDITING IN AN INFORMATION TECHNOLOGY (IT) SYSTEM ENVIRONMENT - PART II 668 Expected Learning Outcomes 668 Introduction 669 Impact of Computers on Accounting System 669 Major Types of Computer Fraud 671 ‘Effects of Computers on the Audit Process 672 Auditing Clients Using Information technology (IT): Systems 676 Audit Techniques Using Computers 678 Specialized Audit Programs and Additional. « Techniques ; 682 Internal Contrel Considerations 682 The Effect of Electronic Records on Audit Evidence 685 Review Questions and Exercises 686axvill UNIT VII_ OTHER SERVICES AND REPORTS Chapter 25 PROCEDURES AND REPORTS ON SPECIAL PURPOSE AUDIT ENGAGEMENTS Expected Learning Outcomes Introduction A. Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks B. Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statements C. Summarized Financial Statements Review Questions and Exercises Chapter 26 NON-AUDIT ENGAGEMENTS; PROCEDURES AND REPORTS Expected Learning Outcomes Examination of Prospective Financial Information Engagements to Review Financial Statements 694 695 697 104 7113 T22 731 732 741 Engagements to Perform Agreed ~ Upon Procedures Financial Information Review Questions and Exercises List of References 752 773 693 694 Tl 782UNIT I INTRODUCTION TO ASSURANCE AND AUDITING SERVICES Chapter 1 The Demand for Auditing and Assurance Services 2 _ -Professional Practice of Accountancy: An Overview 3 The Public Accounting Prefession Environment 4 Management of a Public Accounting Practice 5 Professional EthicsChapter THE DEMAND FOR AUDITING AND ASSURANCE SERVICES Expected Learning Outcomes After studying this chapter, you should be able to: Describe the role of auditing in meeting society's demands for reliable financial information 2. Understand why individual external auditors are expected to make professional and ethical judgments about the information provided by business organizations. a. 3. Explain the nature of assurance services. Explain the importance of audited financial statements. Enumerate the various parties who are interested in audited financial statements. Understand the need for increased globalization of accounting and auditing standards. USSCHAPTER 1 THE DEMAND FOR AUDITING AND : ASSURANCE SERVICES ECONOMIC DEMAND FOR AUDITING Why do many of the largest companies spend millions of pesos each year for their annual audit? Is it worth asking why an entity would decide to spend so much money on an audit? Is it because these audits are required by law? While true in certain circumstances, this answer is far too simplistic. Although audits are often utilized in situation where they are not required by law, audits were in demand long before Securities Laws and the Bureau of Internal Revenue required them. i: ’ 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. Until the late 18" and early 19" centuries, most organizations were relatively small and were owned and operated as sole proprietorships or partnerships. Because businesses were generally run by théit’ owners and borrowing was limited, accountability to outside parties often was minimal. The birth of modern accounting and auditing occurred during the industrial revolution, when companies became larger and needed to raise capital to finance expansion. Over time, 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. « A capital market allows a public company to sell small pieces of ownership (i.., 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. A public company is 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. Thus, the growth of the 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4 Chapter 1 basis. In this setting, the managers serve as agents for the owners (Who a : z he Ifill a stewardship functio, sometimes referred to as principals) and fulfill a HP function by managing the corporation’s assets. It is important to understand that the relationship betiveen an owner and mang er 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 results of operations of the entity than does the absentee owner. What are Assurance Services? The name assurance services:is used to describe the broad range of information enhancement services performed by a certified public accountant (CPA) that arg designed to enhance the degree of confidence in the-information: In general, assurance services consists of two (2)utypes: @ those that increase the reliability of information and @ those that involve putting information in a form or context that facilitates decision making. A significant portion of the assurance services provided by CPAs is referred to as aitestation:services. To attest to information means to provide assurance as to its reliability. In an attestation engagement, CPAs provide a report on subject matter or an assertion about that subject matter. One of the most sought-after attestation services is the examination or audit of historical financial statements. In this book, we will focus on the Audit and Assurance Services that involve reliability enhancement. ‘ Philosophy of an Audit As the amount of capital involved and the number of potential owners increase, the potential impact of accountability also increases. The auditor's role is t determine whether the reports prepared by the manager conform to the contract's provisions. Thus, the auditor’s verification of the financial information adds credibility to the report and reduces information-risk, ot the risk that information circulated by a company’s management will be false misleading. Reducing information risk potentially benefits both the owner and the manager. Economie decisions are made under conditions of uncertainty; there is always ® risk that the decision maker will select the wrong alternative and incur significant loss. The credibility added to the information by auditors actually 4Demand for Auditing and Assurance Services § reduces the decisi See ision maker’s risk. To be more precise, the auditors reduce information risk, which is the risk that the fi formation used to make a Hee isk that the financial informati n Businesses, instituti a condificn Sad ae individuals must maintain records of their financial concen, ae cress These records are necessary to evaluate and guide eiserie ana Gate he ee financial Status, to meet legal requirements and nay wreh ie lets the ae Creditors and investors, present and prospective, rea ee sate financial statements of many enterprises for credit a nt. purposes. Government agencies will need financial sontee mentees Mande cues imposed upon them by law internal tisk eauints ports for planning, directing and controlling, These parties therefore, need reliable and credible financial information. The process employed to establish the reliability or unreliability of the finan statements and supporting records is referred to as an audit examination Auditing of financial records has become an important factor in the dissemination of financial information and the services of the independent certified public accountant are considered indispensable. Increasingly, his written report is required to add credibility to the financial statements. A free-market economy can exist only if there is sharing of reliable information among parties that have an interest in the financial performance of an organization. The market is further strengthened if the information is transparent and unbiased — that is, the data is not presented in such a way that it favors one party over another. An organization’s reported information must reflect the economics of its transactions and the current economic condition of both its assets and any obligations owed. auditors undertake to gather evidence to obtain financial statements are. free. of - material t they are presented in accordance Ina financial statement audit, the high level of assurance that misstatements due to fraud or errors and thal with appropriate. accounting framework. The external audit is intended to enhance the confidence that users can place on management-prepared financial statements. When the auditor has no reservations about management's financial statements or internal controls, the report is referred to as an unqualified audit report.6 Chapter I the most important is the public, as and others who make decisions baseq Auditing requires the highest and concern for integrity of s should view themselves as Auditors serve a number of parties, but represented by investors, lenders, workers, and ‘on financial information about an organization. level of technical competence, freedom from bias, the financial reporting process. In essence, auditor: guardians of the capital markets. ‘The,publicexpects.auditars to @) find fraud, (5) require accounting principles the st portray the spirit of the concepts adopted by accounting, standard setters, and be independent of management. When it comes to being independent, auditors must not only be independent infact, but they must act in 4 manner that ensures that they are independent in appearance. 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 financial position, managerial performance and economic vulnerability Without auditors, decisions such as these are more likely to be made from biased financial information resulting from a business entity’s undisclosed errors, irregularities or illegal acts, IMPORTANCE OF AUDITED FINANCIAL STATEMENTS Audited financial statements are the accepted means by which business corporations report their operating results and financial position. The word audited, when applied to financial statements, means that the balance sheet and the statements of income, retained earnings, and.cash flows are accompanied by an audit report. prepared by. independent public. accountants. expressing. their professional opinion as to the fairness of the company’s financial statements. Of course, reporting in accordance with an agreed-upon set of accounting principles does not solve the problem by itself. Because the manager is 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 the reports. Again, the owner adjusts for this possibility by assuming that the manager wif/ manipulate the reports to his or her benefit and by reducing the manager’s compensation accordingly. It is at this point that the demand for auditing arises. If the manager is honest, it may very well be in the manager's self-interest to hire an auditor to monitor and independently report to the owner on his or her activities. The owner likely will be willing to invest more in the business and to pay the manager more if the manager can be held accountable for how he or she uses the owner’s invested resources,Demand for Auditing and Assurance Services 7 Financial statements prepared by management and transmitted to outsiders without first being audited by independent accountants leave a credibility gap. In reporting on its own administration of the business, management can hardly expected to be entirely impartial and unbiased. Independent auditors have no material personal or financial interest in the business; their reports can be expected to be impartial and free from bias. Unaudited financial statements may have been honestly, but carelessly, prepared. Liabilities may have been overlooked and omitted from the balance sheet. Assets may have been overstated as a result of arithmetical errors or due to a lack of knowledge of financial accounting and reporting standards. Net income may have been exaggerated because expenses were capitalized or because sales transactions were recorded in advance of delivery dates. Finally, there is the possibility that unaudited financial ‘statements have been deliberately falsified in order to conceal theft and fraud or as a means of inducing the reader to invest in the business or to extend credit. Although deliberate falsification of financial statements is not common, it does occur and can cause devastating losses to persons who make decisions based upon such misleading statements. For all these reasons (accidental errors, lack of knowledge of accounting * principles, unintentional bias, and deliberate falsification), financial statements may depart from financial accounting and reporting standards principles. Audits provide users with assurance that the financial statements are presented in accordance with the financial accounting principles and reporting standards. Figure 1-1 presents an overview of the potential financial statement users and the decisions they make based on the financial reports.8 Chapter I Figure 1-1: Users of Audited Financial Statements Types of Decisions User Management Review performance, make operational decisions. Report Tesults | to capital markets ‘Stockholders Buy or sell stock Bondholders Buy or sell bonds Financial Institutions | Evaluate loan decisions, considering interest rates, terms, and tisk Taxing Authorities Determine taxable income and tax due Regulatory Agencies | Develop regulations and monitor compliance Labor Unions Make collective bargaining decisions a Court System Assess the financial position of a company in litigation Vendors, Assess credit risk Retired Employees | Protect employees from surprises concerning pensions and other post-retirement benefits THE ASSURANCE ANALOGY AND THE PHILIPPINE STANDARDS ON AUDITING (PSAs) An audit provides reasonable assurance of detecting material misstatements of the financial statements (both errors and fraud) and noncompliance with laws that have a direct and material’effect on the determination of financial statement amounts. Although an audit does not obtain reasonable assurance of detecting noncompliance with laws that have only an indirect effect on the financial statements, the auditors remain alert for such situations. If instances of noncompliance are discovered, regardless of type, the auditors should ‘caréfully evaluate their effects on the financial statements. 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 PRC- BOA their adoption as the Philippine Standards on Auditing (PSAs). In the Philippines, the law that regulates the Practice of Accountancy (RA 9298) 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 and auditing standards, domestic andDemand for Auditing and Assurance Services _9 international. International financial markets would be facilitated if auditing and accounting standards were more uniform. In summary, auditing is in demand because it plays a valuable role in monitoring the contractual relationships between the entity and its stockholders, managers, employees, and debt holders. Certified public accountants have been charged with providing audit services because of their traditional reputation of competence, independence, objectivity, and concern for the public interest. As a result, they are able to add credibility to information produced and reported by management to outside parties. REVIEW QUESTIONS Questions 1. What is the objective of financial statement audit? Describe the role of external auditing in meeting society’s demands for unbiased financial and internal control information. 2. What is the “special function” that auditors perform? Whom does the external auditing profession serve in performing this special function? 3. What factors create a demand for an independent external audit? 4. How does an audit enhance the quality of financial statements and management's reports on internal control? Does an audit guarantee a fair presentation of a company’s financial statements? What is the principal tise and significance of an audit report to a large 5. corporation with securities listed on a stock exchange? To a small family-owned enterprise? 6. Describe the several business situations that would create a need for a report by an independent public accountant concerning the fairness of a company’s financial statements. 7. Explain the following statement: One contribution of the independent auditor is to lend credibility to financial statements.10 Chapter 1 8. A corporation is contemplating issuing debenture bonds to a group of investors. a. Explain how independent audits of the corporation's financial statements facilitate this transaction. b. Describe the likely effects on the transaction if the corporation decides not to obtain independent audits of its financial statements. 9. Discuss the major factors in today’s society that have made the need for independent audits much greater that it was 50 years ago. 10. It has been stated that auditors must be independent because audited financial statements must serve the needs of a wide variety of users. If the auditor were to favor one group, such as existing shareholders, there might be a bias against another group, such as prospective investors. Do you agree? 11. Evaluate the following quotation: “Every business, large or small, should have an annual audit by a CPA firm. To forgo an audit because of its cost is false economy”. 12. The self-interest of the provider of financial information (whether an individual or a business entity) often runs directly counter to the interest of the user of the information.Chapter PROFESSIONAL PRACTICE OF ACCOUNTANCY: AN OVERVIEW Expected Learning Outcomes After studying the chapter, you should be able to: 4. 2. 3. Explain the attributes of a profession. Describe who a professional accountant is, Enumerate and explain the scope of the practice of professional accountants in the Philippines. |. Describe the nature of assurance, attest, and auditing services of accounting professionals. Describe the relationship among assurance, attest and auditing services. Distinguish between external auditors, internal auditors, government auditors and forensic auditors. Explain the nature of other audit services such as internal ‘ audit, compliance audits, operational audits and forensic audits. Describe the most sought-after non-assurance services such as * Agreed upon procedures » Tax preparation and planning services * Management advisory services * Compilation, accounting and processing system services QAggsCHAPTER 2 PROFESSIONAL PRACTICE OF ACCOUNTANCY: AN OVERVIEW ACCOUNTANCY AS A PROFESSION In our society, professions are generally recognized as elite occupational classifications. Ernest Greenwood in his article Attributes of a Profession. (1957) sets forth five major characteristics of an ideal profession. These are (1) systematic body of theory, (2) professional authority, (3) community sanction, (4) regulative code and (5)-a culture. Professional accountants satisfy these said attributes of a profession ® = Systemitic Theory The underlying theory of the public accounting profession consists of accounting theory — financial accounting and reporting standards and practices and auditing standards - a science of validation, Knowledge in systematic theory can be achieved best through formal college-level education in an academic environment. & Professional Authority Clients who use the service of a professional often do not really understand their own needs. The professional thus determines what is good or bad for the client and the client accedes to this professional judgment. The basis for the professional accountant's (CPA's) authority is his expertise in the systematic theory of accounting and auditing. @ Community Sanction Admission to the public accounting profession is controlled. To become a professional accountant (CPA), a candidate must satisfy government educational and experience requirements and pass the CPA Licensure Board Examinations. This licensing system is controlled by the Professional Regulation Commission through the Board of Accountancy. Also, although professional accountants (CPAs) are responsible to the community for their actions, it is generally accepted that a professional's performance should be judged by standards established by a profession itself.Professional Practice of Accountancy: An Overview 13 @ Regulations Code The powers and privileges granted to the public accounting profession by the community effectively constitute a monopoly. To prevent abuse of this monopoly and to discipline its members, the Rules of Professional Conduct or Code of Ethics have been promulgated and made legally binding through the Accountancy Law. @ A Culture The CPA is a member of a time-honored profession and the status of the profession and the responsibilities that accompany this status affect his/her behavior in society. Accounting ‘has developed a professional culture as evidenced by such factors as the formal norms of the code of ethics, the informal rules that guide relationships among practitioners and the traditions and myths that have arisen concerning the CPA examinations. The most recent revision in the Code of Ethics for Professional Accountants in the Philippines made effective on April 6, 2016 states "A profession is distinguished by certain characteristics including: © Mastery of a particular intellectual skill, acquired by training and education; ¢ Adherence by its members to a common code of values and conduct established by its administering body, including maintaining an outlook which is essentially objective; and © Acceptance of a’duty to society as a whole (usually in return for restrictions in use of a title or in the granting of a qualification)." WHO IS A PROFESSIONAL ACCOUNTANT? A professional-accountant is an individual who holds a valid certificate issued by the Board.of Accountancy (i.¢., Certified Public Accountant), whether he/she be in public practice, industry, commerce, the public sector or education. This professional accountant may belong to any of the following sectors: Professional Accountant in Public. Practice.,A professional accountant, irrespective of functional accountant in classification (for example, audit, tax or consulting) in a firm that provides professional services. This term is also used to refer to a firm of professional accountants in public practice.14 Chapter? ccountant in Business. A professional accountant employed for engaged in an executive or non-executive capacity in such areas as commerce, industry, service, the public sector, education, the not-for-profit sector, regulatory bodies or professional bodies, or a professional accountant contracted by such entities. The professional accountant in this group may be in any of the following sub-sectors: Professional A (a) commerce and industry; “a (b) education; and (c) government. Scope of Practice, The Philippine Accountancy Act of 2004 (RA. 9298) Article 1, Section 4, paragraphs (a) to (d) spell out the scope of the practice of accountancy as follows: @ Practice of Public Accountancy, This shall constitute in a person, be it in his/her individual capacity, or as a partner or as a staff member in an accounting or auditing firm, holding out himself/herself as one skilled in the knowledge, science and practice of accounting, and as a qualified person to render professional services as a certified public accountant; or offering or rendering, or both, to more than one client on a fee basis or otherwise, services such as the audit or verification of financial transaction and accounting records; or the preparation, signing, or certification for clients of reports of audit, statement of financial position, and other financial, accounting and related schedules, exhibits, statements or reports which are to be used for publication or for credit purposes, or to be filed with a court or government agency, or to be used for any other purpose; or the design, installation, and revision of accounting system; or the preparation of income'tax returns when related to accounting procedures; or when he/she represents clients before government agencies on tax and other matters related to accounting or renders professional assistance in matters relating to accounting procedures and the recording and presentation of financial facts or data. ® Practice in Commerce and Industry. This shall constitute in a person involved in decision making requiring professional knowledge in the science of accounting, or when such employment or position requires that the holder thereof must be a certified public accountant.‘Professional Practice of Accountancy: An Overview _15 (©) Practice in Education/Academe. This shall constitute in a person in an educational institution which involves teaching of accounting, auditing, management advisory services, finance, business law, taxation, and other technically related subjects. @ Practice in the Government, This shall constitute in a person who holds, or is appointed to, a position in the accounting professional group in government or in a government-owned and/or controlled corporation, including those performing proprietary functions, where decision making requires professional knowledge in the science of accounting, or where a civil service eligibility as a certified public accountant is a prerequisite. ASSURANCE, ATTEST, AND AUDITING SERVICES DEFINED Accounting professionals can perform various services that provide assurance about the reliability and relevance of information given by one party to another. The broadest category of such services is simply called assurance services. Attest services are a subset of assurance services, and auditing is a type of attest service. Many times these ternis are used interchangeably because they are related, and at a general level, they encompass the same process: the evaluation of evidence to determine whether information has been recorded and presented in accordance with a predetermined set of criteria, together with the issuance of a report that indicates the degree of correspondence, Assurance Services In the late 1990s, the accounting profession expanded the potential breadth of auditors’ activities beyond auditing and attest services to include a broader set of assurance services. Extending auditors’ activities to assurance services allows reporting not only on the reliability and credibility of information but also on the relevance and timeliness of that information. Assurance services are defined as follows: ‘Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. ‘The definition captures some important concepts. First, the definition focuses on ‘Making good decisions requires quality information, which, in the context of the broad set of assurances services, can be financial or nonfinancial. Second, it relates to improving the qualityeof-information or its context, An assurance service engagement can improve quality through increasing confidence in the information’s reliability and relevance. Context can be improved by clarifying the format and background with which the information16 Chapter 2 is presented. Third, the definition includes “independence”, which relates to the objectivity of the application of professional judgment and due care by the provider. To summarize, assurance services can include almost any service provided by accounting professionals that involves capturing information, improving its quality, or enhancing its usefulness for decision makers. Attest Services Auditors have a reputation for independence and objectivity. As a result, various parties frequently request that auditors attest to information beyond- historical financial information. However, professional standards did not allow for such services until the profession established a separate set of attestation standards in 1986, These standards provide the following definition for attest services: Altest-services occur when-a practitioner is engaged to issue ... a@ report on subject matter, or-an assertion about subject matter, that is the responsibility of another party. Notice that this definition is broader than the one previously discussed for auditing because it is not limited to economic events or actions. The subject matter of attest services can take many forms, including prospective information, analyses, systems and processes, and even the specific actions of specified parties. Note that financial statement auditing is a particular, specialized form of an attest service. Audit Services Auditing is a systematic process of objectivity obtainingand evaluating 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 interest-users, The phrase “systematic process” implies that there should be a well-planned and thorough approach for conducting an audit. This approach involves “objectivity in obtaining and evaluating evidence”. In other words, the auditor must search for audit evidence and objectively evaluate the relevance and validity of the evidence he or she finds. The type, quantity, and reliability of evidence will vary between audits, but the process of obtaining and evaluating evidence makes up most of the auditor’s activities on any audit.Professional Practice of Accountancy: An Overview 17 As our analogy of auditing illustrates, the evidence gathered by the auditor must relate to relevant assertions, which in auditing pertain to economic actions and events. The auditor compares the evidence gathered to management's financial statement assertions in order to asses “the degree of correspondence between those assertions and established criteria.” While different types of “criteria” might be available in various settings, financial accounting and reporting standards Principles usually serve as the basis for evaluating management’s assertions in the context of a financial statement audit. RELATIONSHIP AMONG ASSURANCE, ATTEST, AND AUDITING SERVICES It is important to understand the relationship among the range of services that are offered by CPAs, because different professional standards apply to each type of service. Figure 2-1 illustrates the universe of services that may be offered by CPAs and the relationships among these services. As shown, CPAs provide both assurance and non assurance services but a few, specially of the management consulting type, overlap. Certain management consulting services have assurance aspects. It also illustrates that attestation services are only a portion of the assurance services that are offered by CPAs. This textbook focuses primarily on financial statements auditing because it represents the major type of assurance service offered by most public accounting firms. In addition, in. many instances, the approach, concepts, methods, and techniques used for financial statement audit also apply to other attest and assurance service engagements.18 Chapter 2 Figure 2-1: The Relationship among Assurance, Auditing, Attest, and Services ASSURANCE SERVICES NONASSURANCE SERVICES Attestation Services Audits of Financial Statements » Examination of intemal Control «Trust Services, eg., WebTust and SysTrust Reviews of Financial Statements f Other Information ‘© Agreed-Upon Procedures Engagements Management Consulting Services ¢ Fraud Investigations «Information Technology Consultina Other Assurance Services 3 Other Nonassurance Services CPA ElderCarePrime Plus Services © — Compilation, Accounting and Data CPA Performance View Services Processing System Services © CPA Risk Advisory Services © Others © Others (TYPES OFAUDITORS, (2 ExternalAuditors» CPA firms have as their primary responsibility the performance of audits of the published historical financial statements of all publicly traded- companies, most other reasonably large companies and many smaller companies and noncommercial organizations. Because of the widespread use of audited financial statements, it is common to use the terms CPA firms, independent auditor, or auditor, synonymously. CPA firms cah perform operational auditing as well as compliance auditing as part of their management consultancy services.Professional Practice of Accountancy: An Overview 19 Internal Auditors Internal auditors could be CPA firms hired by the entity as consultants or employees of individual companies who perform independent appraisal activity within the organization such as review of accounting, financial and other operations as a basis for service to management. They provide management with valuable information for making decisions concerning effective operation of its business. The internal auditor is therefore concerned with all kinds of financial and other data generated for both internal and external users. Likewise, the ~ internal auditor is also engaged in cvaluating the efficiency of resource utilization (operational auditing), the effectiveness with which entity objectives are attained (management or performance auditing and routine compliance auditing). To be able to operate effectively, an internal auditor must be independent of the line functions in an organization and may report directly to the audit committee or board of directors. Government Auditors a ‘ Several government agencies perform a significant number of audits. These include the Commission on Audit (COA) and the Bureau of Internal Revenue. COA Auditors Government auditors from COA determine whether the government agencies and other entities that use public funds: (1) present their financial statements fairly in accordance with Financial Reporting Standards and applicable laws and regulations, (2) conduct the programs with economy and efficiency, (3) desired results are achieved. Many of the COA's audit responsibilities are the same as those of a CPA. firm. But since the authority for expenditures and receipts of govemmental agencies is defined by law, there is considerable emphasis ‘on compliance in these audits. Also, an increasing effort of the COA's audit efforts has been devoted to evaluating, the’ operational efficiency and effectiveness of various government programs. AS a result of their great responsibility for auditing government expenditures, their eligibility to be CPAs, their opportunities for performing operational20 Chapter 2 ‘audit, their use of advanced auditing concepts, COA auditors are highly regarded in the auditing profession. BIR Examiners BIR audits affect individuals as well as businesses. A form of compliance auditing, BIR audits or examinations are designed to determine whether the taxpayers have complied with the tax laws. These audits can be regarded solely as compliance audits. An auditor involved in these areas must have considerable tax knowledge and auditing skills to conduct an effective audit. Regulatory Auditors Other auditors include SEC, Bangko Sentral ng Pilipinas, Cooperative Commission, Office of Insurance Commission and other government agency examiners who check on the solvency and compliance of the various institutions and business firms with appropriate laws and regulations. @ k lit we Forensic auditors,are employed by corporations, government agencies, public accounting firms, and specialized consulting and investigative services firms. They are specially trained in detecting, investigating, and deterring fraud and white-collar crime (see the discussion of forensic auditing later in this chapter). Some examples of situations where forensic auditors are often involved include. x * Reconstructing incomplete or damaged accounting records to settle an insurance claim over inventory valuation. Probing money-laundering activities by tracking and reconstructing cash transactions, . Identify and investigating transactions and assets in business or marital disputes. Investigating and documenting embezzlement allegations and negotiating insurance settlements,Professional Practice of Accountancy: An Overview 24 (D¥PES OF OTHER AUDIT SERVICES In addition to the fii audits: a) b) °) 4) @ inancial statement audit, there are four (4) major types of Internal audits Compliance audits Operational audits Forensic audits Internal Audit Nature Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's opersitfons It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness f risk management, control, and government processes. Objective and Scope The objective of internal auditing is to assist all members of management in the effective discharge of their responsibilities, by furnishing them analyses, appraisals, recommendations, and pertinent comments concerning the activities reviewed. The internal auditor is concerned with any phase of business activity where he or she can be of service to management. This involves going beyond the accounting and financial records to obtain a full understanding of the operations under review. The attainment of this overall objective involves such activities as: © Reviewing and appraising the soundness, adequacy, and application of accounting, financial, and other operational controls, and promoting effective control at reasonable cost. © Ascertaining the extent of compliance with established policies, plans, and procedures. ‘© Ascertaining the extent to which company assets are accounted for and safeguarded from losses of all kinds. © Ascertaining the reliability of mariagement data developed within the organization. © Appraising the quality of performance in carrying out assigned responsibilities © Recommending operating improvements. Ba eh ag eg ea Se On eRe NAS22 Chapter 2 1) Compliance-Auditing ~ which is the examination, audit and settlement, in accordance with law and regulation. A compliance audit determines the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity being audited, For example, a university may be required to obtain an audit to ensure that applicable rules and policies are being followed with respect to the granting of student loans. Another example of compliance auditing is the examination of tax returns of individuals and companies by the Internal Revenue Service for compliance with the tax laws. ©) Operationalaudit This is a future-oriented, independent and systematic evaluation performed by the internal auditor for management of the operational activities controlled by top-, middle-, and lower-level management for the purpose of improving organizational profitability and increasing the attainment of the other organizational objectives. An operational audit involves a systematic review of part or all of an organization’s activities to evaluate whether resources are being used effectively and efficiently. The purpose of an operational audit is to provide assurance, assess performance, identify areas for improvement, and develop recommendations with respect to operational effectiveness and efficiency. Sometimes this type of audit is referred to as a performance audit or management audit. Operational audits present different challenges than financial statement audit or compliance audits because operational audits often require the auditor to identify or create objective, measurable criteria against which to assess effectiveness and efficiency. Some operational audits, such as information technology (IT) or cybersecurity audits, require specialized skills and expertise. Operational auditing has increased in importance in recent years, and this trend will likely continue. An example of an operational audit is when an entity auditors to assess the efficiency and effectiveness of its use of information technology resourcesProfessional Practice of Accountancy: An Overview 23 d) Forensic-Audits . The purpose of a forensic audit is to detect a deter fraudulent activities, Forensic auditing has increased significantly in recent years. As we mentioned above in discussing forensic auditors, some examples of where a forensic audit might be conducted include business or employee fraud, various other types of criminal investigations where money or other assets are involved, and matrimonial disputes involving division of assets. TYPES OF OTHER ATTEST SERVICES Auditors can provide numerous types of attest services regarding almost any subject matter. For example, an auditor might be asked to attest to the nature and quantity of inventory stored in an entity’s warehouse so that the entity can obtain a bank loan with the inventory as collateral. A promising new area of attestation services relates to assertions companies make about sustainability-claimed reductions in carbon emissions or appropriate handling of hazardous waste. OTHER NON-ASSURANCE SERVICES In addition to audit, attest, and assurance services, many public accounting firms perform other broad categories of non-assurance services. Agreed-Upon Procedures ‘An agreed-upon procedures engagement, in which the party engaging the professional accountant or the intended user determines the procedures and the professional accountant provides a report of factual findings as a result of undertaking those procedures. This is not an assurance engagement. eTax Preparation and Planning Services Many public accounting firms have tax professionals that assist clients in preparing and filing tax retumns, providing advice on tax and estate planning, and representing clients on tax issues before the Internal Revenue Service or tax courts.24 _Chopjer2 © Management Advisory Services Management advisory services (MAS) involve providing advice any assistance concerning an entity's organization, human Tesources, finances, operations, IT systems, or other activities. Another Significan, MAS service area is helping public companies implement effective internal control over financial reporting in preparation for an integrated audit to be performed by a different public accounting firm. Due to independence requirements, CPA firms perform MAS primarily fo; private entities or for public companies for whom they do not provide a financial statement audit. The large public accounting firms all have very robust MAS consulting practices for nonaudit clients. Compilation, Accounting and Data Processing System Services Public accounting firms perform a number of accounting-related services for their nonpublic or nonaudit clients. These services include bookkeeping, payroll processing, and preparing financial statements. When a public accounting firm prepares the financial statements of companies, the services are known as compilations. These forms of services provide less assurance than a financial statement audit. °Professional Practice of Accountancy: An Overview 28 REVIEW QUESTIONS Questions 2. Why is the practice of accountancy considered practice of a profession? Describe briefly the scope of practice of a professional accountant in the Philippines. State the major types of services CPAs perform, and explain each. Explain the relationships among audit services, attestation services, and assurance services, and give examples of each. Define assurance services, Describe what attest services are. What is the most common type of Attest engagement? What does an operational audit attempt to measure? Does an operational audit involve more or fewer subjective judgments than a compliance audit or an audit of financial statements? Explain. To whom is the report usually directed after.completion of an operational audit? Distinguish between a compliance audit and an operational audit. Is an independent status possible or desirable for intemal auditors as compared with the independence of a public accounting firm? Explain. Apart from auditing, what other professional services are offered by public accounting firms? . What are the differences and similarities in audits of financial statements, compliance audits, and operational audits? List five examples of specific operational audits that could be conducted by an internal auditor in a manufacturing company.26 Chapter? it i it we be a seriou: 13. In the conduct of audits of financial statements, it would S breach of responsibility if the auditor did not thoroughly understand accounting However, many competent accountants do not have an understanding of the auditing process. What causes this difference? re of the evidence the Bureau of Intemal Revenue 14, Describe the natu! zi I use in the audit of Mabuhay ‘Company's tax return. (BIR) examiner will 15. What are the major differences in the scope of the audit responsibilities for CPAs, COA auditors, BIR agents, and Internal Auditors? Multiple Choice Questions accounting includes the following expect ‘a. Practice in public accountancy. Practic education / academe. Practice in the government. Practice in commerce and industry, when the CPA is appointed as marketing manager of the enterprise. 1. The practice o! b. c. d. CPAs are considered professional persons because they: 2 a. holda license from a government agency. b. pass the CPA examination and have qualifying practical experience. c. serve the interests of the public im general and clients in particular. d. are members of the PICPA. 3. Society has attached a special meaning to the term “professional”. professional is a. someone who has passed a qualifying exam to enter the job market. b. a person who is expected to conduct himself or herself at a higher Jevel than the requirements of society’s laws or regulations. c. Any person who receives pay for the services performed. d. Someone who has both an education in the trade and on-the-job experience received under an experienced supervisor. 4. Which of the following is not an assurance engagement? a. Compilation b. Financial statements audit c. Information reliability services d. Reviews of prospective financial statementsProfessional Practice of Accountancy: An Overview _ 27 Non-assurance engagements include all of the following except a, agreed-upon procedures. b. management consulting ©. preparing of tax returns where no conclusion is expressed. d. compliance audit. Independent auditing can best be described as a. A branch of accounting bBoA discipline that attests to the results of accounting and other functional operations and data. ¢. A professional activity that measures and communicates financial and business data. d. A regulatory function that prevents that issuance of improper financial information. Which of the following professional services would be considered an attestation engagement? a. A consulting service engagement to provide computer processing advice to a client. b. An engagement to report on statutory requirements. c. An income tax engagement to prepare federal and state tax returns. d. The compilation of financial statements from a client’s financial records. In performing an attestation engagement, a CPA typically a. Supplies litigation support services b. Assesses control risk at a low level c. Expresses a conclusion about an assertion d. Provides management consulting advice Operational audits generally have been conducted by internal auditors and government audit agencies but may be performed by certified public accountants. A primary purpose of an operational audit is to provide A means of assurance that internal accounting controls are functioning as planned. ; : F b. A measure of management performance in meeting organizational a goals. a ; : The results of internal examinations of financial and accounting matters to a company’s top-level management. d. Aid to the independent auditor, who is conducting the audit of the financial statements.28 Chapter? 10. In comparison to the external auditor, an internal auditor is more likely to be concerned with a. Internal administrative control b. Cost accounting procedures c. Operational auditing d. Internal control 11. Which of the following best describes the operational audit? a. It requires the constant review by internal auditors of the administrative controls as they relate to the operations of the company. i b. It concentrates on implementing financial and accounting control in a newly organized company. ‘ It attempts and is designed to verify the fair presentation of a company’s results of operations. d. It concentrates on seeking aspects of operations in which waste could be reduced by the introduction of controls. 12. Compliance auditing often extends beyond audits leading to the expression of opinion on the fairness of financial presentation and includes audits of efficiency, economy effectiveness, as well as a. Accuracy b. Evaluation c. Adherence to specific niles of procedures d, Internal control 13. A summary of findings rather than assurance is most likely to be included in a(n): a. Agreed-upon procedures report. b. Compilation report. c. Examination report. d. Review report. 14. The attest function: a. Is an essential part of every engagement by the CPA, whether performing auditing, tax work, or other services. b. Includes the preparation of a report of the CPA's findings. c Requires a consideration of internal control, 4. Requires a complete review of all transactions during the period under examination.Professional Practice of Accountancy: An Overview _ 29 15, Attestation risk: is limited to a flow level in which of the following engagement(s)? a, Both examinations and reviews. b, Examinations, but not reviews. ¢. Reviews, but not examinations. d. Neither examinations nor reviews. 16. An operational audit differs in many ways from an audit of financial statements. Which of the following is the best example of one of these differences? a. The usual audit of financial statements covers the four basic statements, whereas the operational audit is usually limited to cither the balance sheet or the income statement. b. Operational audits are more subjective and often involve evaluating efficiency and effectiveness of operations. ©. Operational audits do not ordinarily result in the preparation of a report. d. The operational audit deals with pre-tax income, 17. Which of the following terms best describes the audit of a taxpayer's tax return by an BIR auditor? a. Operational audit. b, Internal audit. c. Compliance audit, d. Government audit. 18. Inquiries and analytical procedures ordinarily form the basis for which type of engagement? a, Agreed-upon procedures. 19. Operational auditing is primarily oriented toward: a. Future improvements to accomplish the goals of management. b. The accuracy of data reflected in management's financial records. c. The verification that a company's financial statements are fairly presented. d. Past protection provided by existing internal control.30 Chapter 2 20. A typical objective of an operational audit is for the auditor to: a. operations. Determine whether the financial statements fairly present the entity's b. Evaluate the feasibility of attaining the entity's operational objectives. c. Make recommendations for improving performance. d. Report on the entity's relative success in attaining profit maximization. Exercises Exercise 1 Match the following definitions (or partial definitions) of the various types of services to the appropriate service. Each service may be used once or not at all. Definition (or Partial Definition) Service a. An attest engagement in which the | 1. Agreed-upon procedures CPAs agree to perform procedures engagement for a specified party and issue a| 2. Assurance services report that is restricted to use by that | 3. Attest engagement party 4. Audit of financial statements b. An engagement designed to express | 5. Compliance audit limited assurance relating to subject | 6. Examination matter or an assertion. 7. Integrated audit c. An engagement in which the CPAs | 8. Operational audit issue an examination, a review, oran| 9. Review agreed-upon procedures report on ‘subject matter or an assertion about subject matter that is the responsibility of another party (e.g., management). d. An examination designed to provide an opinion that is the CPA's highest level of assurance that the financial statements follow Philippine Financial Reporting Standards, or another acceptable basis of accounting.Professional Practice of Accountancy: An Overview 34 . An audit that includes providing assurance on both the financial Statements and intemal control over financial reporting f, Professional services that enhance the — quality of information, or its context, for decision makers, 9. An attest engagement designed to provide the highest level of assurance that CPAs provide on an assertion, Exercise 2 For the purpose of this problem, assume the existence of five types of auditors: CPA, COA, BIR, bank examiner, and internal auditor. Also assume that the work of these various auditors can be grouped into five classifications: audits of financial statements, compliance audits, operational audits, accounting services, and consulting services, For each of the following topics, you are to state the type of auditor most probably involved, Also identify the topic with one of the above classes of work. You should organize your answer in a three-column format as follow: Column 1, the number of the topic; Column 2, the type of auditor involve and Column 3, the class of work. 1. Financial statements of a small business to be submitted to a bank in support of a loan application. 2. Financial statements of a large bank listed on the Philippine Stock Exchange to be distributed to stockholders. 3. Review of the management directive stating the goals and responsibilities of corporation’s mail-handling department. 4, Review of costs and accomplishments of a military research program carried on within the air foree to determine whether the program was cost-effective.32_Chapter 2 _ Review of transactions of a government agency to determin ion on a surprise basis of General Union Bank. Emphasis fication of cash, marketable securities, and loans consistent observation of the banking code. stem of a small business with the objective concerning installation of a computer-based Exam placed on veri receivable and on Analysis of the accounting sy: of making recommendations ¢: system. Determination of fairness of financii by a corporation that has professiona es of the receiving department of a large with special attention to efficiency of materials al statements for public distribution |-level internal auditing staff. Review of the activiti manufacturing company, inspection and promptness of reports issued. Review of the tax return of the corporate president to determine whether charitable contributions are adequately substantiated. Review of daily attendance during the first semester at Blue Ridge Public School to ascertain whether payments received from the government were substantiated by pupil-day data and whether disbursements by the school were within authorized limits. e whether disbursements under the Cash Transfer program of the Department of Social Welfare followed the intent of Congress. Compilation of quarterly financial statements for a small business that does not have any accounting personnel capable of preparing financial statements.Chapter THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT Expected Learning Outcomes After studying this chapter, you should be able to: Ae 10. pene the practice of public accountancy as provided for in RA Know who is a Certified Public Accountant (CPA). Enumerate the requirements to enter the accountancy profession in the Philippines. Describe the characteristics, capabilities and competencies that a BSA degree holder must possess as required by CHED. Understand the CPA Licensure Examination requirements. Know the need for the professional accountant to continuously develop capabilities and competence after admission to the profession. - Describe the core values and competency requirements for CPAs in public practice. Know the regulatory agencies, professional organizations and standard-setting bodies that influence the accounting profession. Understand the nature of legal concepts related to auditor's liability that a CPA may be confronted with. Know the auditor's defenses against client and third-party lawsuits and how to minimize exposures to legal liability. Understand the challenge and credibility crisis faced by the public accounting profession and how to address them. BugsCHAPTER 3 THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT PRACTICE OF PUBLIC ACCOUNTANCY DEFINED ArticleJ,Section4.of the Philippine"Accountancy/Act (RA'9298) describes the scope of the practice of public accountancy as follows: E "Practice of Public Accountancy shall constitute in a person, be it in his/her individual capacity, or as a partner or as a staff member in an accounting or auditing firm, holding out himself/herself as one skilled in the knowledge, science and practice of accounting, and as a qualified person to render professional services as a certified public accountant; or offering or rendering, or both, to more than one client on a fee basis or otherwise, services such as the audit or verification of financial transaction and accounting records; or the preparation, signing, or certification for clients of reports of audit, balance sheet, and other financial, accounting and related schedules, exhibits, statements or reports NOM] are to be used for publication or for credit purposes, or to be filed with a court or government agency, or to be used for any other purpose; or the design, installation, and revision of accounting system; or the preparation of income tax returns when related to! accounting procedures; or when he/she represents clients before government agencies on tax and other matters related to accounting or renders professional assistance in matters relating to accounting procedures and the recording and presentation of financial facts or data." Article IV; Sectiom26 of the same law provides: "No person shall practice accountancy in this country, or use the title "Certified Public Accountant", or use the abbreviated title "CPA" or display or use any title, sign, card, advertisement, or other device to indicate that such person practices or offers to practice accountancy, or is a certified public accountant, unless such person shall have received from the Board a certificate of registration/professional license and be issued a professionat identification card or a valid temporary/special permit duly issued to him/her'by the Board and the Commission."The Public Accounting Profession Environment _ 35 FIED PUBLIC ACCOUNTANT ertified public accountant (CPA) is a person who, after obtaining the required ation passes an extensive examination and is licensed by the country to practice as a professional accountant. Most young professionals aspiring to become CPAs usually would like start their careers working for a CPA firm. After they become CPAs, many leave the firm to work in industry, government or education. These people may continue to be CPAs but often give up their-right to practice as independent auditors. CPAs who practice as independent auditors must meet registration requirements to exercise their right to practice. It'is common therefore, for accountants to be CPAs who do not practice as independent auditors. REQUIREMENTS TO ENTER THE ACCOUNTANCY PROFESSION Meeting the expectations of diverse groups requires considerable expertise. Because of the increasing complexity of the business environment, the demands made on the professional accountants have certainly increased. To be able to enter the professional accountancy profession in the Philippines, an individual should be able to satisfy all of the following requisites: (a) Be a holder of a degree of Bachelor of Science in Accountancy (BSA) conferred by a school, college or institute duly recognized and/or accredited by the Commission on Higher. Education (CHED) or other authorized government office; (b) Qualify as a professional accountant by passing the CPA Licensure Board Examination administered by the Professional Regulatory Board of Accountancy; and (c) Satisfy all other legal and regulatory requirements before the individual takes on the role of a professional accountant. A. Pre-Qualification Education Requirements An individual aspiring to be a professional accountant should meet the pre-qualification education requirement that requires possession of a Bachelor of Science in Accountancy (BSA) degree.