Auditing Theory

AUDITING THEORY 2011
2011
AUDITING THEORY
Maybelle A. Posidio
BS Accountancy 3 2/7/2011
BS Accountancy 3 | Isabela State University
AUDITING THEORY
February 7, 2011
AUDIT An Overview
The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. The phrase used to express the auditors opinion is present fairly, in all material respects. A similar objective applies to the audit of financial or other information prepared in accordance with appropriate criteria. The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results to interested users. (American Accounting Association)
Illustrative Definition of Auditing Independent Auditor
Following a systematic process
Objectively obtains and evaluates evidence
Establish the degree of correspondence between Assertions Established Criteria
Communicates the results to interested users
Bachelor of Science in Accountancy
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Assertions Assertions are representations by management, explicit or otherwise, that are embodied in the financial statements. Established criteria establish and inform the users of the basis against which the assertions have been evaluated or measured. Types of Audit
Financial statement audit This is an audit conducted to determine whether the financial statements of an entity are fairly presented in accordance with an identified financial reporting framework. Compliance audit Compliance audit involves a review of an organizations procedures to determine whether the organization has adhered to specific procedures, rules or regulations. Operational audit An operational audit is a study of a specific unit of an organization for the purpose of measuring its performance. It is also known as performance audit or management audit.
Types of auditor
External auditor These are independent CPAs who offer their professional services to different clients on a contractual basis. External auditors are the one who generally perform financial statement audits. Internal auditors Internal auditors are entitys own employees who investigate and appraise the effectiveness and efficiency of operations and internal controls. Internal auditors usually perform operational audit. Government auditors These are government employees whose main concern as to determine whether persons or entities comply with government laws and regulations. Government auditors usually conduct compliance audits.
AUDITING THEORY Comparison among different types of audit
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Financial audit
Compliance audit That the organization has complied with laws, regulations or contracts.
Operational audit
Assertions made by the auditee
That the financial statements are fairly presented
That the organizations activities are conducted effectively and efficiently
Established criteria
Financial reporting standards or other financial reporting framework
Laws, regulations and contracts
Objective set by the board of directors
Content of auditors report
An opinion about whether the financial statements are fairly presented in conformity with an identified financial reporting framework
Reports on the degree of compliance with applicable laws, regulations and contracts
Recommendati ons or suggestions on how to improve operations
Auditor who generally perform
External auditors
Government auditors
Internal auditors
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The Independent Financial Statement Audit
Financial statement audits objective is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework or acceptable financial reporting standards. The presentation of the financial statements in accordance with a financial reporting framework is the responsibility of the management. The responsibility of the auditor is to form and express an opinion on these financial statements based on his audit. An audit of financial statement does not relieve management of its responsibilities. Hence, it is a managements responsibility to adopt and implement adequate accounting and internal control systems that will help ensure, among others, the preparation of reliable financial statements. The opinion of the auditor is not a full guarantee that the financial statements are dependable. An audit conducted in accordance with the Philippine Standards on Auditing (PSAs) is designed to provide only reasonable assurance (not absolute) that the financial statements are taken as a whole are free from material misstatements.
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Role of management and independent auditor
MANAGEMENT
INDPENDENT AUDITOR
Prepares Financial Statements
Unaudited Financial Statements
Evaluates Financial Statements
Audited Financial Statements
Audit Report On Financial Statements
Users of Financial Statements
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PSA 200 Overall Objective of the Independent Auditor and the Conduct of an Audit in Accordance with Philippine Standards on Auditing- This Philippine Standard on Auditing (PSA) establishes the independent auditors overall responsibilities when conducting an audit of financial statements in accordance with PSAs. Overall Objectives of the Auditor
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, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and b) To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditors findings. In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditors report is insufficient in the circumstances for purposes of reporting to the intended users of the financial statements, the PSAs require that the auditor disclaim an opinion or withdraw from the engagement, where withdrawal is legally permitted. (PSA 200)
Inherent Limitations of an Audit
The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. The use of testing/Sampling risk For practical reasons, auditors do not examine all evidence available. Many audit conclusions are made by examining only sample of evidence. Error in application of judgment/Non-sampling risk The work undertaken by the auditor to form an opinion is permeated by judgment. Human weaknesses can cause auditors to commit mistakes in the application of audit procedures and evaluation of evidence.
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Reliance on managements representation If the management lacks integrity, management may provide false representations causing the auditor to rely on unreliable evidence. Inherent limitations of the clients internal control system Procedures may not be effective in detecting misstatements resulting from collusion among employees or managements circumvention of internal control. Nature of evidences Evidence obtained by the auditor does not consist of hard facts which prove or disprove the accuracy of the financial statements.
General principles governing the audit of financial statements
The auditor should comply with the Code of Professional ethics promulgated by the Board of Accountancy (BOA) The auditor should conduct an audit in accordance with Philippine Standards on Auditing The auditor should plan and perform the audit with an attitude of professional skepticism
Need for an independent financial statement audit
Conflict of interest between management and users of financial statements Expertise Remoteness Financial consequences
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Theoretical framework of Auditing Selected postulates, assumptions or ideas that support many auditing concepts and standards Audit function operates on the assumption that all financial data are verifiable The auditor should always maintain independence with respect to the financial statements under audit There should be no long-term conflict between the auditor and the client management Effective internal control system reduces the possibility of errors and fraud affecting the financial statements Consistent application of generally accepted accounting principles (GAAP) or Philippine Financial Reporting Framework (PFRS) results in fair presentation of financial statements. What was held true in the past will continue to hold true in the future in the absence of known conditions to the contrary An audit benefits the public
Assurance Engagement
Assurance Engagement an engagement in which a practitioner expresses a conclusion designed to enhance the degree of confidence of intended users other than the responsible party about the outcome of evaluation of subject matter against criteria. Intended users are person, persons or class f persons for whom the practitioner prepares the assurance report. Criteria are benchmarks used to evaluate or measure the subject matter including, where relevant, benchmarks for presentation and disclosure. It has the following characteristics:
(1) Relevance (2) Completeness (3) Reliability (4) Neutrality (5) Understandability
AUDITING THEORY Subject matter can take in many forms such as:
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(1) Financial performance or conditions for which the subject matter information may be recognition, measurement, presentation and disclosure represented in financial statements. (2) Non-financial performance or conditions for which the subject matter information may be key indicators of efficiency and effectiveness. (3) Physical characteristics for which the subject matter of information may be specifications documents. (4) Systems and processes for which the subject matter information may be assertions about effectiveness. (5) Behavior for which the subject matter information may be statement of compliance or statement of effectiveness. Audit vs. Related Services Related compilations. services comprise reviews, agreed-upon procedures and
Reviews -- the objective of a review of financial statements is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would be required in an audit, anything has come to the auditor's attention that causes the auditor to believe that the financial statements are not prepared, in all material respects, in accordance with an identified financial reporting framework. Agreed-upon Procedures -- in an engagement to perform agreed-upon procedures, an auditor is engaged to carry out those procedures of an audit nature to which the auditor and the entity and any appropriate third parties have agreed and to report on factual findings. Compilation -- in a compilation engagement, the accountant is engaged to use accounting expertise as opposed to auditing expertise to collect, classify and summarize financial information. The procedures employed are not designed and do not enable the accountant to express any assurance on the financial information.
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PSA 120 Framework of Philippine Standards on Auditing - The purpose of this PSA is to describe the framework within which PSAs are issued in relation to the services which may be performed by auditors. Financial Reporting Framework
Financial statements are ordinarily prepared and presented annually and are directed toward the common information needs of a wide range of users. Many of those users rely on the financial statements as their major source of information because they do not have the power to obtain additional information to meet their specific information needs. Thus, financial statements need to be prepared in accordance with one, or a combination of: (a) accounting standards generally accepted in the Philippines; (b) International Accounting Standards; and (c) Another authoritative and comprehensive financial reporting framework which has been designed for use in financial reporting and is identified in the financial statements.
Framework for Auditing and Related Services
This Framework distinguishes audits from related services. Auditing -----------------------Related Services------------------Audit Review Agreed-upon Procedures Compilation
Nature of service
Comparative
level of assurance provided by the auditor
High, but not absolute assurance
Moderate assurance
No assurance
No assurance
Report provided
Positive assurance on assertions
Negative assurance on assertions
Factual findings of procedures
Identification of information compiled
The Framework does not apply to other services provided by auditors such as taxation, consultancy, and financial and accounting advice.
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The Professional Standards

Auditors opinion must be based on an examination conducted in accordance with professional standards. Standards are established to measure the quality of performance of individuals and organization. Generally Accepted Auditing Standards (GAAS) The Board of Accountancy promulgated 10 GAAS that establish required level of quality for performing financial audits. It represent measures of the quality of the auditors performance, it should be looked at as a minimum standard of performance that auditors should follow.
Generally Accepted Auditing Standards
General Standards
Standards of Fieldwork
Standards of Reporting
Technical Training and Proficiency Independence Professional care
Planning Internal Control Consideration Evidential Matter
Generally Accepted Accounting Principles Inconsistency Disclosure Opinion
1. General Standards
1. The examination is to be performed by person or persons having adequate technical training and proficiency as an auditor. 2. In all matters relating to an engagement, independence in mental attitude is to be maintained by the auditor. 3. Due professional care is to be exercised in the performance of the audit in the preparation of the report.
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2. Standards of fieldwork
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4. The work is to be adequately planned and assistants are to be properly supervised. 5. There is to be a proper study and evaluation of existing internal control. 6. Sufficient competent evidential matter is to be obtained to afford a reasonable basis for an opinion regarding the financial statement under examination.
3. Standards of Reporting
7. The report shall state whether the financial statement are presented in accordance with GAAP. 8. The report shall identify those circumstances in which principles have not been consistently observed in the current period in relation to the preceding period. 9. Informative disclosures are to be regarded as reasonably adequate unless otherwise stated in the report. 10. The report shall either contain an expression of opinion regarding the financial statement, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. Philippine Standards on Auditing (PSAs) PSA are issued to clarify the meaning of the 10 GAAS. Auditing procedures are the means used by the auditors in attaining the quality required by the standards. The Auditing and Assurance Standards Council (AASC) has been the task to promulgate auditing standards, practices and procedures which shall be generally accepted by the accounting profession in the Philippines. Adoption of International Standards To facilitate the preparation and to attain uniformity of the AASC pronouncements with international auditing standards, the AASC has approved the adoption of the: (ISAs) International Standards on Auditing (ISAEs) International Standards on Review Engagement (ISREs) International Standards on Related Services Issued by the International Auditing and Assurance Board (IAASB) created by the International Federation of Accountants (IFAC).
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Practical statements are also issued to provide practical assistance to auditors in implementing the standards and to promote good practice in the accountancy profession. System of Quality Control
Quality Controls are policies and procedures adopted by CPAs to provide reasonable assurance of conforming to professional standards in performing audit and related service. The Philippine Standard on Quality Control (PSQC) 1 has the purpose to establish basic principles and essential procedures and to provide guidance regarding a firms responsibilities for its system of quality control for audits and reviews of historical financial information, and for other assurance and related services engagements.
The firm should establish a system of quality control design to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements, and that reports issued by the firm or engagement partners are appropriate in the circumstances.
Elements of a System of Quality Control
Leadership Responsibilities for Quality within the Firm The firm shall establish policies and procedures designed to promote an internal culture recognizing that quality is essential in performing engagements. Such policies and procedures shall require the firms chief executive officer (or equivalent) or, if appropriate, the firms managing board of partners (or equivalent) to assume ultimate responsibility for the firms system of quality control. Relevant Ethical Requirements The firm shall establish policies and procedures designed to provide it with reasonable assurance that the firm and its personnel comply with relevant ethical requirements. Independence The firm shall establish policies and procedures designed to provide it with reasonable assurance that the firm, its personnel and, where applicable, others subject to independence requirements (including network firm
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personnel) maintain independence where required by relevant requirements. Such policies and procedures shall enable the firm to:
ethical
a) Communicate its independence requirements to its personnel and, where applicable, others subject to them; and b) Identify and evaluate circumstances and relationships that create threats to independence, and to take appropriate action to eliminate those threats or reduce them to an acceptable level by applying safeguards, or, if considered appropriate, to withdraw from the engagement, where withdrawal is permitted by law or regulation. Acceptance and Engagements Continuance of Client Relationships and Specific
The firm shall establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide the firm with reasonable assurance that it will only undertake or continue relationships and engagements where the firm: a) Has considered the integrity of the client, and does not have information that would lead it to conclude that the client lacks integrity; b) Is competent to perform the engagement and has the capabilities, including time and resources, to do so; c) Can comply with relevant ethical requirements. Human Resources The firm shall establish policies and procedures designed to provide it with reasonable assurance that it has sufficient personnel with the competence, capabilities, and commitment to ethical principles necessary to: a) Perform engagements in accordance with professional standards and regulatory and legal requirements; and b) Enable the firm or engagement partners to issue reports that are appropriate in the circumstances. Such policies and procedures address the following personal issues: Recruitment Performance Evaluation Capabilities Competence Career development Promotion Compensation
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Engagement Performance The firm shall establish policies and procedures designed to provide it with reasonable assurance that engagements are performed in accordance with professional standards and regulatory and legal requirements, and that the firm or the engagement partner issue reports that are appropriate in the circumstances. Such policies and procedures shall include: a) Matters relevant to promoting consistency in the quality of engagement performance; b) Supervision responsibilities; and c) Review responsibilities. The firms review responsibility policies and procedures shall be determined on the basis that work of less experienced team members is reviewed by more experienced engagement team members. Consultation The firm shall establish policies and procedures designed to provide it with reasonable assurance that: a) Appropriate consultation takes place on difficult or contentious matters; b) Sufficient resources are available to enable appropriate consultation to take place; c) The nature and scope of, and conclusions resulting from, such consultations are documented and are agreed by both the individual seeking consultation and the individual consulted; and d) Conclusions resulting from consultations are implemented. Engagement Quality Control Review The firm shall establish policies and procedures requiring, for appropriate engagements, an engagement quality control review that provides an objective evaluation of the significant judgments made by the engagement team and the conclusions reached in formulating the report. Such policies and procedures shall: a) Require an engagement quality control review for all audits of financial statements of listed entities;
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b) Set out criteria against which all other audits and reviews of historical financial information and other assurance and related services engagements shall be evaluated to determine whether an engagement quality control review should be performed; and c) Require an engagement quality control review for all engagements, if any, meeting the criteria established in compliance with subparagraph (b). Differences of Opinion The firm shall establish policies and procedures for dealing with and resolving differences of opinion within the engagement team, with those consulted and, where applicable, between the engagement partner and the engagement quality control reviewer. Such policies and procedures shall require that: a) Conclusions reached be documented and implemented; and b) The report not be dated until the matter is resolved.
Monitoring The firm shall establish a monitoring process designed to provide it with reasonable assurance that the policies and procedures relating to the system of quality control are relevant, adequate, and operating effectively. The firm shall document its policies and procedures and communicate them to the firms personnel.
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Auditors Responsibility
The auditors responsibility is to design the audit to provide reasonable assurance of detecting material misstatements in the financial statements. These misstatements may emanate from: 1. Error 2. Fraud, and 3. Noncompliance with Laws and Regulations
ERROR refers to unintentional misstatements in the financial statements, including the omission of an amount or a disclosure, such as: Mathematical or clerical mistakes in the underlying records and accounting data An incorrect accounting estimate arising from oversight or misinterpretation of facts Mistakes in the application of accounting policies FRAUD An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. The auditor is primarily concerned with fraudulent acts that cause a material misstatement in the financial statements Types of fraud
Fraudulent financial reporting also known as management fraud. It involves misstatements or omission of amounts or disclosures in the financial statements to deceive financial statement users. Misappropriation of assets or employee fraud involves theft of an entitys assets by the entitys employees. This type of fraud is often accompanied by false or misleading records or documents in order to conceal the fact that the assets are missing.
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PSA 240 The Auditors Responsibility Relating to Fraud in an Audit of Financial Statements -This Philippine Standard on Auditing (PSA) deals with the auditors responsibilities relating to fraud in an audit of financial statements.
Responsibility for the Prevention and Detection of Fraud The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. It is important that management, with the oversight of those charged with governance, place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to commit fraud because of the likelihood of detection and punishment. This involves a commitment to creating a culture of honesty and ethical behavior which can be reinforced by an active oversight by those charged with governance. Responsibilities of the Auditor An auditor conducting an audit in accordance with PSAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.
Objectives
The objectives of the auditor are: (a) To identify and assess the risks of material misstatement of the financial statements due to fraud; (b) To obtain sufficient appropriate audit evidence about the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses; and (c) To respond appropriately to identified or suspected fraud. Planning Phase 1. When planning an audit, the auditor should make inquiries of management about the possibility of misstatements due to fraud and error. Such inquiries may include Managements assessment of risk due to fraud Controls established to address the risk
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Any material error or fraud that has affected the entity or suspected that the entity is investigating Planning Phase is done trough discussion among the engagement team 2. The auditor should assess the risk that fraud or error may cause the financial statements to contain material misstatements. In this regard, PSA 240 requires the auditor to specifically assess the risk of material misstatements due to fraud and consider that assessment in designing the procedures to be performed". Fraud risk factors Events or conditions that indicate an incentive or pressure to commit fraud or provide an opportunity to commit fraud.
Risk Assessment Procedures and Related Activities
Management and Others within the Entity The auditor shall make inquiries of management regarding: (a) Managements assessment of the risk that the financial statements may be materially misstated due to fraud, including the nature, extent and frequency of such assessments; (b) Managements process for identifying and responding to the risks of fraud in the entity, including any specific risks of fraud that management has identified or that have been brought to its attention, or classes of transactions, account balances, or disclosures for which a risk of fraud is likely to exist; (c) Managements communication, if any, to those charged with governance regarding its processes for identifying and responding to the risks of fraud in the entity; and (d) Managements communication, if any, to employees regarding its views on business practices and ethical behavior. The auditor shall make inquiries of management, and others within the entity as appropriate, to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity. For those entities that have an internal audit function, the auditor shall make inquiries of internal audit to determine whether it has knowledge of
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any actual, suspected or alleged fraud affecting the entity, and to obtain its views about the risks of fraud. Those Charged with Governance Unless all of those charged with governance are involved in managing the entity, the auditor shall obtain an understanding of how those charged with governance exercise oversight of managements processes for identifying and responding to the risks of fraud in the entity and the internal control that management has established to mitigate these risks. The auditor shall make inquiries of those charged with governance to determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity. These inquiries are made in part to corroborate the responses to the inquiries of management. Unusual or Unexpected Relationships Identified The auditor shall evaluate whether unusual or unexpected relationships that have been identified in performing analytical procedures, including those related to revenue accounts, may indicate risks of material misstatement due to fraud. Other Information The auditor shall consider whether other information obtained by the auditor indicates risks of material misstatement due to fraud. Evaluation of Fraud Risk Factors The auditor shall evaluate whether the information obtained from the other risk assessment procedures and related activities performed indicates that one or more fraud risk factors are present. While fraud risk factors may not necessarily indicate the existence of fraud, they have often been present in circumstance where frauds have occurred and therefore may indicate risks of material misstatement due to fraud. (PSA 240)
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Testing Phase 3. Identification and Assessment of the Risks of Material Misstatement Due to Fraud When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or assertions give rise to such risks. 4. Evaluation of Audit Evidence After identifying the material misstatement in the financial statements, the auditor should consider whether such a misstatement resulted from a fraud or an error. If the auditor believes that the misstatements is, or may be the result of fraud, but the effect on the financial statements is not material, the auditor should Refer the matter to the appropriate level of management at least one level above those involved, and Be satisfied that, given the position of the likely perpetrator, the fraud has no other implications for other aspects of the audit or that those implications have been adequately considered. If the auditor detects a material fraud or suspected fraud, the auditor should Consider implication for other aspects of the audit particularly the reliability of management representations. Discuss the matter and the approach to further investigation with an appropriate level of that is at least one level above these involve Attempt to obtain evidence to determine whether a material fraud in facts and, if so, their effect, and Suggest that the client consult with legal counsel about questions of law.
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Completion Phase 5. Management Representations The auditor shall obtain written representations from management that: (a) It acknowledges its responsibility for the design, implementation and maintenance of internal control to prevent and detect fraud; (b) It has disclosed to the auditor the results of its assessment of the risk that the financial statements may be materially misstated as a result of fraud; (c) It has disclosed to the auditor its knowledge of fraud or suspected fraud affecting the entity involving: Management; Employees who have significant roles in internal control; or (iii) Others where the fraud could have a material effect on the financial statements; and (d) It has disclosed to the auditor its knowledge of any allegations of fraud, or suspected fraud, affecting the entitys financial statements communicated by employees, former employees, analysts, regulators or others.(PSA 240) Consider the Effect on the Auditors Report 6. When the auditor believes that the material error or fraud exists, he should request the management to revise the financial statements. Otherwise, the auditor will express a qualified or adverse opinion. 7. If the auditor is unable to evaluate the effect of fraud on the financial statements because of a limitation on the scope of the auditors examination, the auditor should either qualify or disclaim his opinion on the financial statements. (i) (ii)
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AUDITING THEORY NONCOMPLIANCE WITH LAWS AND REGULATIONS
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PSA 250 Consideration of Laws and Regulations in an Audit of Financial Statements - This Philippine Standard on Auditing PSA deals with the auditors responsibility to consider laws and regulations when performing an audit of financial statements.
Effect of Laws and Regulations The effect on financial statements of laws and regulations varies considerably. Those laws and regulations to which an entity is subject constitute the legal and regulatory framework. The provisions of some laws or regulations have a direct effect on the financial statements in that they determine the reported amounts and disclosures in an entitys financial statements. Other laws or regulations are to be complied with by management or set the provisions under which the entity is allowed to conduct its business but do not have a direct effect on an entitys financial statements. Non-compliance with laws and regulations may result in fines, litigation or other consequences for the entity that may have a material effect on the financial statements. Non-compliance Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations. Such acts include transactions entered into by, or in the name of, the entity, or on its behalf, by those charged with governance, management or employees. Non-compliance does not include personal misconduct (unrelated to the business activities of the entity) by those charged with governance, management or employees of the entity.
Responsibility of Management for Compliance with Laws and Regulations It is the responsibility of management, with the oversight of those charged with governance, to ensure that the entitys operations are conducted in accordance with the provisions of laws and regulations, including compliance with the provisions of laws and regulations that determine the reported amounts and disclosures in an entitys financial statements.
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Responsibility of the Auditor The auditor is responsible in identifying material misstatement of the financial statements due to non-compliance with laws and regulations. However, the auditor is not responsible for preventing noncompliance and cannot be expected to detect non-compliance with all laws and regulations.
Objectives
The objectives of the auditor are: (a) To obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements; (b) To perform specified audit procedures to help identify instances of noncompliance with other laws and regulations that may have a material effect on the financial statements; and (c) To respond appropriately to non-compliance or suspected non-compliance with laws and regulations identified during the audit. (PSA 250) Planning Phase 1. In order to plan the audit, the auditor should obtain a general understanding of the legal and regulatory framework applicable to the entity and the industry and how the entity is complying with that framework. To obtain the general understanding of laws and regulations, the auditor would ordinarily: Use the existing knowledge of the entitys industry and business. Inquire of management concerning the entitys policies and procedures regarding compliance with laws and regulations. Inquire of management as to the laws or regulations that may be expected to have a fundamental effect on the operations of the entity. Discuss with management the policies and procedures adopted for identifying, evaluating and accounting for litigation claims and assessments. Discuss the legal and regulatory framework with auditors of subsidiaries in other countries.
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2. The auditor should design procedures to help identify instances of noncompliance , such as; Inquiring of management as to whether the entity is in compliance with such laws and regulations. Inspecting correspondence with the relevant licensing or regulatory authorities. 3. The auditor should also design audit procedures to obtain sufficient appropriate audit evidence about compliance. Testing Phase 4. When the auditor becomes aware of information concerning a possible instances of noncompliance, the auditor should obtain an understanding of the nature of the act and the circumstances in which it has occurred, and sufficient other information to evaluate the possible effect on the financial statements. When evaluating the possible effect on the financial statements, the auditor considers: The potential financial consequences Whether the potential financial consequences require disclosure Whether the potential financial consequences are so serious as to call into question the fair presentation given by the financial statements. 5. When the auditor believes that there may be noncompliance, the auditor should document the findings, discuss them with management, and consider the implication on other aspects of the audit. Completion Phase 6. The auditor should obtain written representations that management has disclosed to the auditor all known actual or possible noncompliance that could materially affect the financial statements. Consider the effect on the Auditors Report 7. The auditor should request the management to revise the financial statement if there is none compliance that materially affect the financial statement. Otherwise, a qualified or adverse opinion will be issued. 8. If the scope limitation has precluded the auditor from obtaining sufficient appropriate evidence to evaluate the effect of noncompliance with laws and regulations, the auditor should express a qualified opinion or a disclaimer of opinion.
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PSA 260 COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE - This Philippine Standard on Auditing (PSA) deals with the auditors responsibility to communicate with those charged with governance in relation to an audit of financial statements.
Those charged with governance The person(s) or organization(s) (e.g., a corporate trustee) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. Management The person(s) with executive responsibility for the conduct of the entitys operations. The objectives of the auditor are to: a. Communicate clearly with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit; b. Obtain from those charged with governance information relevant to the audit; c. Provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process; and d. Promote effective two-way communication between the auditor and those charged with governance. The auditor shall determine the appropriate person(s) within the entitys governance structure with whom to communicate. The Auditors Responsibilities in Relation to the Financial Statement Audit The auditor shall communicate with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, including that: a. The auditor is responsible for forming and expressing an opinion on the financial statements that have been prepared by management with the oversight of those charged with governance; and b. The audit of the financial statements does not relieve management or those charged with governance of their responsibilities.
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Significant Findings from the Audit The auditor shall communicate with those charged with governance: (a) The auditors views about significant qualitative aspects of the entitys accounting practices, including accounting policies, accounting estimates and financial statement disclosures. When applicable, the auditor shall explain to those charged with governance why the auditor considers a significant accounting practice that is acceptable under the applicable financial reporting framework, not to be most appropriate to the particular circumstances of the entity; (b) Significant difficulties, if any, encountered during the audit; (c) Unless all of those charged with governance are involved in managing the entity: (i) Material weaknesses, if any, in the design, implementation or operating effectiveness of internal control those has come to the auditors attention and have been communicated to management (ii) Significant matters, if any, arising from the audit that were discussed, or subject to correspondence with management; and (iii) Written representations the auditor is requesting; and (d) Other matters, if any, arising from the audit that, in the auditors professional judgment, is significant to the oversight of the financial reporting process.
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THE AUDIT PROCESS Accepting an Engagement
General Approach When Auditing Financial Statements
Financial Statements Assertions Existence or Occurrence Rights and Obligations Financial Statements Completeness Valuation and Allocation Presentation and Disclosure
Audit Procedures
Audit Evidence
Audit Opinion
Financial statement assertionsfinancial statement assertions are assertions by management, explicit or otherwise, that are embodied in the financial statements and can be categorized as follows:
(a) Existence: an asset or a liability exists at a given date; (b) Rights and obligations: an asset or a liability pertains to the entity at a given date; (c) Occurrence: a transaction or event took place which pertains to the entity during the period;
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(d) Completeness: there are no unrecorded assets, liabilities, transactions or events, or undisclosed items; (e) Valuation: an asset or liability is recorded at an appropriate carrying value; (f) Measurement: a transaction or event is recorded at the proper amount and revenue or expense is allocated to the proper period; and (g) Presentation and disclosure: an item is disclosed, classified, and described in accordance with the applicable financial reporting framework. These assertions may also fall into following categories: Assertions about classes of transactions and events for the period under audit: Occurrence transaction and events that have been recorded have occurred and pertain to the entity Completeness all transactions and events that should have recorded have been recorded Accuracy amounts and other data relating to recorded transactions and events have been recorded appropriately Cutoff transactions and events have been recorded in the correct accounting period Classification transaction and events have been recorded in the proper accounts Assertions about account balances at the period end: Existence Rights and Obligations Completeness Valuation and allocation Assertions about presentation and disclosure: Occurrence and rights and obligations Completeness Classification and understandability Accuracy and valuation Audit Procedures The auditor should use the financial statement assertions to form the basis for the assessment of risks of material misstatement and the design and performance of further audit procedures. The audit procedures should enable the auditor to gather sufficient appropriate evidence about a particular assertion.
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AUDITING THEORY
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Some of the audit procedures used by the auditor includes: Inspection Observation Inquiry Confirmation Computation Analytical Procedures Evidence - Audit evidence refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based.
Overview of the audit process The audit process is the sequence of different activities involved in an audit.
Issuing a Report Completing the Audit Performing Substantive Tests Considering Internal Control Audit Planning Accepting an Engagement
Accepting an Engagement The first step in the audit process is to make a decision of whether to accept or reject the audit engagement. The procedures performed at this stage of the audit are referred to in PSA 300 as preliminary planning activities.
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AUDITING THEORY
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These procedures involve: (a) Performing procedures required by PSA 220, Quality Control for Audits of Historical Financial Information regarding the continuance of the client relationship and the specific audit engagement; (b) Evaluating compliance with ethical requirements, including independence, as required by PSA 220; and (c) Establishing an understanding of the terms of the engagement, as required by PSA 210, Terms of Audit Engagements. Performing these preliminary engagement activities enables the auditor to plan an audit engagement for which, for example: The auditor maintains the necessary independence and ability to perform the engagement. There are no issues with management integrity that may affect the auditors willingness to continue the engagement. There is no misunderstanding with the client as to the terms of the engagement.
An important element of a firms quality control policies and procedures is a system for deciding whether to accept or reject an audit engagement. In making this, decision, the firm should consider: 1. Its competence 2. Its independence 3. Its ability to serve the client properly and 4. The integrity of the prospective clients management
Competence
Before accepting the engagement, the auditor should obtain a preliminary knowledge of the clients business and industry to determine whether the auditor has the degree of competence required by the engagement or whether such competence can be obtained before the completion of the audit.
Independence
Before accepting an audit engagement, the auditor should consider whether there are any threats to the audit teams independence and objectivity and, if so, whether adequate safeguards can be establish.
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AUDITING THEORY Ability to serve the client properly
February 7, 2011
An engagement should not be accepted if there are no enough qualified personnel to perform the audit. In addition, there should be sufficient direction, supervision and review of work at all levels in order to provide reasonable assurance that the firms standard of quality is maintained in the performance of the engagement.
Integrity of the Management PSA 220 states that the auditors should conduct a background investigation of the prospective client in order to minimize the likelihood of association with clients whose management lacks integrity. This task would involve:
Making inquiries of appropriate parties in the business community Communicating with the predecessor auditor Before the incoming auditor contacts the predecessor auditor, the incoming auditor should obtain clients permission to communicate with the predecessor auditor. Once permission of the client is obtained, the incoming auditor should inquire into matters that may affect the decision to accept the engagement.
Establishing an understanding of the terms of the engagement:

PSA 210 Agreeing the Terms of Audit Engagement - This Philippine Standard on Auditing (PSA) deals with the auditors responsibilities in agreeing the terms of the audit engagement with management and, where appropriate, those charged with governance. This includes establishing that certain preconditions for an audit, responsibility for which rests with management and, where appropriate, those charged with governance, are present. Objective
The objective of the auditor is to accept or continue an audit engagement only when the basis upon which it is to be performed has been agreed, through: (a) Establishing whether the preconditions for an audit are present; and (b) Confirming that there is a common understanding between the auditor and management and, where appropriate, those charged with governance of the terms of the audit engagement.
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Preconditions for an audit The use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management and, where appropriate, those charged with governance to the premise on which an audit is conducted. Preconditions for an Audit
In order to establish whether the preconditions for an audit are present, the auditor shall: (a) Determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable; (b) Obtain the agreement of management that it acknowledges and understands its responsibility: (i) For the preparation of the financial statements in accordance with the applicable financial reporting framework, including where relevant their fair presentation; For such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; and To provide the auditor with: a. Access to all information of which management is aware that is relevant to the preparation of the financial statements such as records, documentation and other matters; b. Additional information that the auditor may request from management for the purpose of the audit; and c. Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence. Engagement Letter The auditor and the client should agree on the terms of the engagement. The agreed terms would need to be recorded in an audit engagement letter or other suitable form of contract. 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: 1. the auditors acceptance of the appointment; 2. the objective and scope of the audit; 3. the extent of the auditors responsibilities to the client; and 4. The form of any reports.
(ii)
(iii)
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AUDITING THEORY
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Principal Contents
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. Managements 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 any accounting and internal control system, there is an 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. The auditor may also wish to include in the letter: Arrangements regarding the planning 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 auditors liability when such possibility exists. A reference to any further agreements between the auditor and the client.
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AUDITING THEORY Recurring Audits
February 7, 2011
The auditor may decide not to send a new audit engagement letter or other written agreement each period. However, the following factors may make it appropriate to revise the terms of the audit engagement or to remind the entity of existing terms: Any indication that the entity misunderstands the objective and scope of the audit. Any revised or special terms of the audit engagement. A recent change of senior management. A significant change in ownership. A significant change in nature or size of the entitys business. A change in legal or regulatory requirements. A change in the financial reporting framework adopted in the preparation of the financial statements. A change in other reporting requirements.
Audits of Components
When the auditor of a parent entity is also the auditor of a component, the factors that may influence the decision whether to send a separate audit engagement letter to the component include the following: Who appoints the component auditor; Whether a separate auditors report is to be issued on the component; Legal requirements in relation to audit appointments; Degree of ownership by parent; and Degree of independence of the component management from the parent entity.
Acceptance of a Change in Engagement A request from the client for the auditor to change the engagement may result from: 1. A change in circumstances affecting the need for the service; 2. A misunderstanding as to the nature of an audit or related service originally requested; or 3. A restriction on the scope of the engagement, whether imposed by management or caused by circumstances.
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AUDITING THEORY
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If the auditor agreed to a change of the engagement: the auditor and the client should agree on the new terms; the report issued would be that appropriate for the revised terms of engagement; and in order to avoid confusing the reader, the report would not include reference to: (a) The original engagement; or (b) Any procedures that may have been performed in the original engagement, except where the engagement is changed to an engagement to undertake agreed-upon procedures and thus reference to the procedures performed is a normal part of the report. If the auditor is unable to agree to a change of engagement and is not permitted to continue the original agreement: the auditor should withdraw; and Consider whether there is any obligation, either contractual or otherwise, to report to other parties, such as the board of directors or shareholders, the circumstances necessitating the withdrawal.
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AUDIT PLANNING
Audit planning involves developing a general audit strategy and a detailed approach for the expected conduct of the audit. Planning involves developing a general strategy and a detailed approach for the expected nature, timing and extent of the audit.
PSA 300 Planning an Audit of Financial Statement this Philippine Standard on Auditing (PSA) deals with the auditors responsibility to plan an audit of financial statements. Objective
The objective of the auditor is to plan the audit so that it will be performed in an effective manner. Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate planning benefits the audit of financial statements in several ways, including the following: Helping the auditor to devote appropriate attention to important areas of the audit. Helping the auditor identify and resolve potential problems on a timely basis. Helping the auditor properly organize and manage the audit engagement so that it is performed in an effective and efficient manner. Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to respond to anticipated risks, and the proper assignment of work to them. Facilitating the direction and supervision of engagement team members and the review of their work. Assisting, where applicable, in coordination of work done by auditors of components and experts.
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AUDITING THEORY Planning Activities
February 7, 2011
The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan. In establishing the overall audit strategy, the auditor shall: (a) Identify the characteristics of the engagement that define its scope; (b) Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications required; (c) Consider the factors that, in the auditors professional judgment, are significant in directing the engagement teams efforts; (d) Consider the results of preliminary engagement activities and, where applicable, whether knowledge gained on other engagements performed by the engagement partner for the entity is relevant; and (e) Ascertain the nature, timing and extent of resources necessary to perform the engagement. The auditor shall develop an audit plan that shall include a description of: (a) The nature, timing and extent of planned risk assessment procedures, as determined under PSA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment. (b) The nature, timing and extent of planned further audit procedures at the assertion level, as determined under PSA 330, The Auditors Responses to Assessed Risks. (c) Other planned audit procedures that are required to be carried out so that the engagement complies with PSAs.
The Overall Audit Plan
The auditor should develop and document an overall audit plan describing the expected scope and conduct of the audit. While the record of the overall audit plan will need to be sufficiently detailed to guide the development of the audit program, its precise form and content will vary depending on the following: 1) Size of the entity; 2) Complexity of the audit; and 3) Specific methodology and technology used by the auditor.
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AUDITING THEORY
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Matters to be considered by the auditor in developing the overall audit plan include:
Knowledge of the Business General economic factors and industry conditions affecting the entitys business. Important characteristics of the entity, its business, its financial performance and its reporting requirements including changes since the date of the prior audit. The general level of competence of management.
Understanding the Accounting and Internal Control Systems The accounting policies adopted by the entity and changes in those policies. The effect of new accounting or auditing pronouncements. The auditors cumulative knowledge of the accounting and internal control systems and the relative emphasis expected to be placed on tests of control and substantive procedures.
Risk and Materiality The expected assessments of inherent and control risks and the identification of significant audit areas. The setting of materiality levels for audit purposes. The possibility of material misstatement, including the experience of past periods, or fraud. The identification of complex accounting areas including those involving accounting estimates. The auditor should make a preliminary estimate of materiality to determine the amount of the evidence to accumulate. There is an inverse relationship between materiality and evidence. This means, more evidence will be required for a low peso amount of materiality than for a high peso amount.
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AUDITING THEORY
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PSA 320 Materiality in Planning and Performing an Audit- This Philippine Standard on Auditing (PSA) deals with the auditors responsibility to apply the concept of materiality in planning and performing an audit of financial statements.
For purposes of the PSAs, performance materiality means the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions, account balances or disclosures.
Materiality should be considered by the auditor:
In the planning stage, to determine the scope of the audit procedures; and In the completion phase of the audit, to evaluate the effect of misstatements on the financial statements.
Using Materiality in an Audit
Determine the Overall Materiality (Financial Statement Level) Planning Stage
Determine the tolerable misstatement (Account Balance Level)
Performing audit procedures
Completion Stage
Compare the aggregate amount of misstatements with the overall materiality
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AUDITING THEORY
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Bases that can be used to determine the materiality level
Since audit planning is often performed before year-end, annual financial statements are usually not available. As a result, the auditor uses alternative bases to compute for the materiality levels, such as:
y y y
Annualized interim financial statements Prior years financial statements Budgeted financial statements of the current year
Audit Risk Audit risk refers to that the auditor gives an in appropriate audit opinion on the financial statements.
Audit risk is the complement of audit assurance. If the auditor is willing to accept a 5% audit risk, he must design the audit to have 95% assurance or confidence level that his opinion is correct.
Audit Risk Model
Audit Risk = Inherent Risk * Control Risk * Detection Risk

Inherent risk is the susceptibility of an account balance or class of transactions to misstatement that could be material, individually or when aggregated with misstatements in other balances of classes, assuming that there were no related internal controls.
As the assessed level of inherent risk increases, the auditor should design more effective substantive procedures.
Control risk is the risk that a misstatement that could occur in an account balance or class of transactions and that could be material, individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected and corrected on a timely basis by the accounting and internal control systems.
As the assessed level of control risk increases, the auditor should design more effective substantive procedures.
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AUDITING THEORY
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Detection risk is the risk that an auditors substantive procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material, individually or when aggregated with misstatements in other balances or classes.
As the assessed level of inherent risk increases, the auditor should design more effective substantive procedures.
Steps in using the audit risk model
Set Desired Level of Audit Risk
Assess Inherent Risk
Assess Control Risk
Determine Acceptable Level of Determination Risk
Audit Planning
Consideration of Control
Performing Substantive Test
1. Set the desired level of Audit Risk The auditor uses his judgment in determining the risk that he is willing to take of accepting an assertion as fairly stated when in fact it is materially misstated. 2. Assess the Level of Inherent Risk In making this assessment, the auditor will rely primarily on his knowledge of the clients business and industry, and the results of his preliminary analytical procedures. 3. Asses the Level of Control Risk Assessment of control risk would involve studying and evaluating the effectiveness of the clients accounting and internal control systems.
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AUDITING THEORY
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4. Determine the Acceptable Level of Detection Risk The acceptable level of detection risk can be determined as follows:
Detection Risk = Audit Risk Inherent Risk * Control Risk

5. Design Substantive Test To obtain greater assurance, the auditor will have to modify the scope of his substantive tests such as: Performing more effective substantive procedures (nature) Performing year-end procedures (timing) Using larger sample size (extent)
Effect of materiality on audit risk and planned audit procedures MATERIALITY Planning materiality and/ or tolerable error AUDIT RISK Risk of material error occurring and/or not being determined
PLANNED AUDIT PROCEDURES
LOW
HIGH
More extensive
HIGH
LOW
Less extensive
Risk Assessment Procedures
The procedures performed by auditors to obtain an understanding of the entity and its environment including its internal control and to assess the risk of material misstatements in the financial statements are called risk assessment procedures. These include a. Inquiries of management and others within the entity b. Analytical procedures; and c. Observation and inspection
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AUDITING THEORY
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PSA 520 Analytical Procedures This Philippine Standard on Auditing (PSA) deals with the auditors use of analytical procedures as substantive procedures (substantive analytical procedures), and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.
For the purposes of the PSAs, the term analytical procedures means evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.
The objectives of the auditor are:
(a) To obtain relevant and reliable audit evidence when using substantive analytical procedures; and (b) To design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor understanding of the entity.
Steps in Applying Analytical Procedures
1. Develop expectation regarding financial statements using Prior years financial statements Anticipated results such as budgets or forecast Industry averages Non-financial information Typical relationships among financial statement account balances 2. Compare the expectation with the financial statements under audit. 3. Investigate significant unexpected differences (unusual fluctuations) to determine whether financial statements contain material misstatements.
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AUDITING THEORY Use of Analytical Procedures in an Audit
February 7, 2011
Stages Audit
of
the
Objective
Planning Audit
the
To understand the clients business To identify areas that may represent specific risks To obtain evidence to confirm (or refute) individual account balances To identify unusual fluctuations that was not identified in the planning and testing phases of the audit. To confirm conclusion reached with respect to the fairness of the financial statements
Substantive Tests Overall Review
Analytical procedures in planning an audit
Analytical procedures in planning an audit should focus on Enhancing the auditors understanding of the clients business Identifying areas that may represent specific risks. Nature, Timing and Extent of Procedures Possible change of emphasis on specific audit areas. The effect of information technology on the audit. The work of internal auditing and its expected effect on external audit procedures. Coordination, Direction, Supervision and Review The involvement of other auditors in the audit of components, for example, subsidiaries, branches and divisions. The involvement of experts. The number of locations. Staffing requirements. Other Matters The possibility that the going concern assumption may be subject to question. Conditions requiring special attention, such as the existence of related parties. The terms of the engagement and any statutory responsibilities.
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The nature and timing of reports or other communication with the entity that are expected under the engagement.
The Audit Program
The auditor should develop and document an audit program setting out the nature, timing and extent of planned audit procedures required to implement the overall audit plan. The audit program serves as a: 1) Set of instructions to assistants involved in the audit; and 2) Means to control and record the proper execution of the work. The audit program also contains: 1) The audit objectives for each area; and 2) A time budget in which hours are budgeted for the various audit areas or procedures. In preparing the audit program, the auditor would consider the following: 1) Specific assessments of inherent and control risks and the required level of assurance to be provided by substantive procedures; 2) Timing of tests of controls and substantive procedures; 3) Coordination of any assistance expected from the entity, the availability of assistants and the involvement of other auditors or experts; and 4) Other matters considered by the auditor in developing the overall audit plan need to be considered in more detail during the development of the audit program.
Changes to the Overall Audit Plan and Audit Program The overall audit plan and the audit program should be revised as necessary during the course of the audit. Planning is continuous throughout the engagement because of changes in conditions or unexpected results of audit procedures. The reasons for significant changes would be recorded.
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AUDITING THEORY
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CONSIDERATION OF INTERNAL CONTROL
Assess Control Risk
Audit Planning
PSA 315 defines internal control as the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entitys objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. The term controls refers to any aspects of one or more of the components of internal control.
Components of Internal Control Control Environment
The control environment comprises the overall attitude, awareness and actions of directors and management regarding the internal control system and its importance in the entity. Factors reflected in the control environment include: Integrity and Ethical Values Management should establish ethical standards that discourage employees from engaging in dishonesty, unethical or illegal acts that could materially affect the financial statements.
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AUDITING THEORY
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Management philosophy and operation style The auditor should assess the management attitudes towards financial reporting and their emphasis on meeting projected profit goals because these will significantly influence the risk of material misstatements in the financial statements. Active participation of those charged with governance The entity must have an audit committee which will be responsible for overseeing the financial reporting policies and practices of the entity. Commitment to competence The entity should consider the level of competence required for each task and translate it to requisite knowledge and skills. Personnel policies and procedures The entity must implement appropriate policies for hiring, training, evaluating, promoting and compensating entitys personnel because the competence of the entitys employees will bear directly on the effectiveness of the entitys internal control. Assignment of responsibility and authority/ Organizational structure Organizational structure provides a framework for planning, directing and controlling the entitys operations. Appropriate methods of assigning responsibility must be implemented to avoid incompatible functions and to minimize the possibility of errors because of too much work load assigned to an employee.
Risk Assessment
The auditor shall obtain an understanding of whether the entity has a process for: Identifying business risks relevant to financial reporting objectives; Estimating the significance of the risks; Assessing the likelihood of their occurrence; and Deciding about actions to address those risks.
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AUDITING THEORY Information and communication system
February 7, 2011
The auditor shall obtain an understanding of the information system, including the related business processes, relevant to financial reporting, including the following areas: (a) The classes of transactions in the entitys operations that are significant to the financial statements; (b) The procedures, within both information technology (IT) and manual systems, by which those transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger and reported in the financial statements; (c) The related accounting records, supporting information and specific accounts in the financial statements that are used to initiate, record, process and report transactions; this includes the correction of incorrect information and how information is transferred to the general ledger. The records may be in either manual or electronic form; (d) How the information system captures events and conditions, other than transactions, that are significant to the financial statements; (e) The financial reporting process used to prepare the entitys financial statements, including significant accounting estimates and disclosures; and (f) Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments. The auditor shall obtain an understanding of how the entity communicates financial reporting roles and responsibilities and significant matters relating to financial reporting, including: (a) Communications between management and those charged with governance; and (b) External communications, such as those with regulatory authorities. (PSA 315)
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AUDITING THEORY Control Activities
February 7, 2011
Control activities are the policies and procedures that help ensure that management directives are carried out. Specific control procedures that are relevant to financial statement audit would include: 1. 2. 3. 4. Performance reviews Information processing Physical controls Segregation of duties
Monitoring
The auditor shall obtain an understanding of the major activities that the entity uses to monitor internal control over financial reporting, including those related to those control activities relevant to the audit, and how the entity initiates corrective actions to its controls. The auditor shall obtain an understanding of the sources of the information used in the entitys monitoring activities, and the basis upon which management considers the information to be sufficiently reliable for the purpose. (PSA 315)
Consideration of Internal Control The auditor should give adequate consideration to the internal control system of the entity because the quality of this internal control can have a significant impact on the audit. These include the following steps:
1. 2. 3. 4. 5.
Obtain understanding of the internal control Document the understanding of accounting and internal control system Assess the level of control risk Perform tests of controls Document the assessed level of control risks
The auditor should obtain sufficient understanding of the components of the entitys internal control relevant to the audit. This task involves: Evaluating the design of a control; and Determining whether it has been implemented
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AUDITING THEORY
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The auditor uses the understanding of internal control to; Identify types of potential misstatements that can occur Consider factors that affect the risk of material misstatement Design the nature, timing, and extent audit procedures to be performed After obtaining the sufficient knowledge about the design of internal control, the auditor should document his understanding of the accounting and internal control systems. This document need not be in any particular form. Some commonly used forms of documentation include: Narrative description of the entitys internal control Flowchart that diagrams the flow of transactions and documents; and Internal control questionnaire providing managements responses to questions about internal control.
Tests of control are performed to obtain audit evidence about the effectiveness of the:
(a) Design of the accounting and internal control systems, that is, whether they are suitably designed to prevent or detect and correct material misstatements; and (b) Operation of the internal controls throughout the period.
Nature of tests of control
Test of controls generally consists of one (or a combination) of the following evidence gathering techniques:
1. Inquiry consists of seeking information of knowledgeable persons inside or outside the entity. 2. Observation consists of looking at a process or procedure being performed by others, for example, the observation by the auditor of the counting of inventories by the entitys personnel or the performance of internal control procedures that leave no audit trail. 3. Inspection consists of examining records, documents, or tangible assets. 4. Reperformance involves repeating the activity performed by the client to determine whether proper results were obtained. Timing of tests of controls
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AUDITING THEORY
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Auditor usually perform test of controls during an interim visit in advance of period end. However, auditors cannot rely on the results of such test without considering the need to obtain further evidence relating to the remainder of the period. In determining whether or not to test the remaining period, the following factors must be considered: The results of the interim tests The length of the remaining period Whether changes have occurred in the accounting and internal control system during the remaining period.
Extent of test of control
The auditor should determine the size of a sample sufficient to support the assessed level of control risk.
Documenting the assessed level of control risk
After evaluating the results of tests of control and assessing the control risk, the auditor should document his assessment of control risk.
Material Weakness in Internal Control
The types of material weaknesses in internal control that the auditor may identify when obtaining an understanding of the entity and its internal controls may include: Risks of material misstatement that the auditor identifies and which the entity has not controlled, or for which the relevant control is inadequate. A weakness in the entitys risk assessment process that the auditor identifies as material or the absence of a risk assessment process in those cases where it would be appropriate for one to have been established. Material weaknesses may also be identified in controls that prevent, or detect and correct, error, or those to prevent and detect fraud. (PSA 315) These internal control weaknesses together with other matters of concern are documented in a formal management letter.
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AUDITING THEORY
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PERFORMING SUBSTANTIVE TESTS
Assess Control Risk
Audit Planning
Substantive tests are audit procedures design to substantiate the account balances or to detect material misstatements in the financial statements. Two types of substantive tests Analytical Procedures Test of details
Analytical Procedures
Analytical procedures consist of the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predictable amounts.
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AUDITING THEORY
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Using Analytical Procedures as Substantive Tests Develop Expectation about Financial Statements
Compare the Financial Statements with the Expectation Developed
Is the difference significant?
YES
Conduct further investigation
NO Accept the account as reasonable
The auditor should focus on those accounts that are predictable, when intending to perform analytical procedures as substantive tests. Generalizations that may be helpful in assessing the predictability of the accounts: Income statement accounts are more predictable compared to balance sheet accounts. Accounts that are not subject to management discretion are generally predictable. Relationships in a stable environment are more predictable than those in a dynamic or unstable environment.
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AUDITING THEORY Test of details
February 7, 2011
Test of details involves examining the actual details making up the various account balances. This approach may take the form of: Test of details of balances involves direct testing of the ending balance of an account. Test of details of transactions involves testing the transactions which give rise to the ending balance of an account.
Effectiveness of Substantive Tests -- The potential effectiveness of the auditors substantive tests is affected by its nature, timing, and extent. Nature of substantive test
The nature of substantive test relates to the quality of evidence. The auditor should determine the appropriate quality of evidence needed to support the desired level of detection risk.
Timing of substantive test
Substantive tests may be performed at interim date or at year end. Interim procedures are generally considered less effective due to incremental audit risk involved when auditing interim balances.
Extent of substantive test
The extent of substantive relates to the amount of evidence needed to satisfy a particular objective. The extent of substantive tests is based on auditors judgment after considering the materiality, the assessed risk, and the degree of assurance the auditors plans to obtain.
Relationship between Substantive Test and Test of Control -- Test of controls provides evidence that indicates a misstatement is likely to occur. Substantive tests, on the other hand, provide evidence about the existence of misstatement in an account balance.
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AUDITING THEORY AUDIT EVIDENCE
February 7, 2011
Audit evidence is the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence will comprise source documents and accounting records underlying the financial statements and corroborating information from other sources. y Underlying accounting data refers underlying the financial statements.
to
the
accounting
records
Corroborating information supporting the underlying accounting data obtained from the client and other sources.
When obtaining audit evidence from either tests of control or substantive tests, the auditor should consider the sufficiency and appropriateness of audit evidence obtained.
Sufficiency refers to the amount of evidence that the auditor should accumulate. The following factors may be considered in evaluating the sufficiency of evidence:
The competence of evidence The materiality of the item being examined The risk involved in a particular account Experience gained during previous audit may indicate the amount of evidence taken before and whether such evidence was enough.
Appropriateness is the measure of the quality of audit evidence and its relevance to a particular assertion and its reliability. Relevance relates the timeliness of evidence and its ability to satisfy the audit objective. Reliability relates to the objectivity of evidence and is influenced by its source and by its nature.
Generalizations that could help the auditor in assessing the reliability of audit evidence: Audit evidence obtained from independent outside sources is more reliable than that generated internally.
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AUDITING THEORY
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Audit evidence generated internally is more reliable when the related accounting and internal control system are effective. Audit evidence obtained directly by the auditor is more reliable than that obtained from the entity. Audit evidence in the form of documents and written representations is more reliable than oral representation.
Cost/benefit consideration when obtaining evidence The usefulness of the information obtained should exceed the cost of obtaining evidence. AUDIT DOCUMENTATION/ WORKING PAPERS Working papers are a record of the auditors planning; nature, timing and extent of the auditing procedures performed; and results of such procedures and the conclusions drawn from the evidence obtained. Working papers may be in the form of data stored on paper, film, electronic media or other media. Functions of the working papers
Working papers are prepared primarily to Support the auditors opinion on financial statements. Support the auditors representation as to compliance with PSA. Assist the auditor in the planning, performance, review and supervision of the engagement.
Secondarily, working papers also assist the auditor in
planning future audits providing information useful in rendering other services providing adequate defense in case of litigation
PSA 230 Audit Documentation - This Philippine Standard on Auditing (PSA) deals with the auditors responsibility to prepare audit documentation for an audit of financial statements. It is to be adapted as necessary in the circumstances when applied to audits of other historical financial information. Nature and Purposes of Audit Documentation
Audit documentation that meets the requirements of this PSA and the specific documentation requirements of other relevant PSAs provides:
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(a) Evidence of the auditors basis for a conclusion about the achievement of the overall objective of the auditor; and (b) Evidence that the audit was planned and performed in accordance with PSAs and applicable legal and regulatory requirements.
Form, Content and Extent of Audit Documentation
The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand: (a) The nature, timing, and extent of the audit procedures performed to comply with the PSAs and applicable legal and regulatory requirements; (b) The results of the audit procedures performed, and the audit evidence obtained; and (c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions. In documenting the nature, timing and extent of audit procedures performed, the auditor shall record: (a) The identifying characteristics of the specific items or matters tested; (b) Who performed the audit work and the date such work was completed; and (c) Who reviewed the audit work performed and the date and extent of such review. The auditor shall document discussions of significant matters with management, those charged with governance, and others, including the nature of the significant matters discussed and when and with whom the discussions took place. If the auditor identified information that is inconsistent with the auditors final conclusion regarding a significant matter, the auditor shall document how the auditor addressed the inconsistency.
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The form, content and extent of audit documentation depend on factors such as: y The size and complexity of the entity. y The nature of the audit procedures to be performed. y The identified risks of material misstatement. y The significance of the audit evidence obtained. y The nature and extent of exceptions identified. y The need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or audit evidence obtained. y The audit methodology and tools used.
Classification of working papers Permanent file contains information of continuing significance to the auditor in performing recurring audits. Current file contains evidence gathered and conclusions reached relevant to the audit of a particular year.
Working papers are property of the auditor and the client has no right to the working papers prepared by the auditor. Although the working papers are personal property of the auditor, these working papers cannot be shown to the third parties without the clients permission.
Guidelines for the preparation of working papers
Heading each working paper must be properly identified with such information as the name of the client, type of working paper, a description of its content, and the date or period covered by the examination, Indexing Indexing refers to the use of lettering or numbering system. each working paper must be indexed to aid in cross-referencing essential information. Cross-indexing/ cross referencing Cross-referencing is important to provide a trial useful to supervision in reviewing the working papers.
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Tick marks Working papers must include symbols that describe the audit procedures performed.
AUDITING ACCOUNTING ESTIMATES PSA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosure This PSA deals with the auditors responsibilities regarding accounting estimates, including fair value accounting estimates, and related disclosures in an audit of financial statements. Accounting estimate is an approximation of a monetary amount in the absence of a precise means of measurement. This term is used for an amount measured at fair value where there is estimation uncertainty, as well as for other amounts that require estimation.
Accounting estimates in historical financial statements measure the effects of past business transactions or events, or the present status of an asset or liability. The auditor must be specifically careful in considering accounts that are affected by accounting estimates because the risk of material misstatement is greater when accounting estimates are involved.
Management is responsible for making the accounting estimates included in the financial statements.
The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the financial statements taken as a whole. The auditor's objective when evaluating accounting estimates is to obtain sufficient appropriate evidential matter to provide reasonable assurance that: All accounting estimates that could be material to the financial statements have been developed. Those accounting estimates are reasonable in the circumstances. The accounting estimates are presented in conformity with applicable accounting principles and are properly disclosed.
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In evaluating the reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are: Significant to the accounting estimate. Sensitive to variations. Deviations from historical patterns. Subjective and susceptible to misstatement and bias. In evaluating reasonableness, the auditor should obtain an understanding of how management developed the estimate. Based on that understanding, the auditor should use one or a combination of the following approaches: Review and test the process used by management to develop the estimate. Develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate. Review subsequent events or transactions occurring prior to the date of the auditor's report.
Evaluating the Reasonableness Determining Misstatements of the Accounting Estimates, and
The auditor shall evaluate, based on the audit evidence, whether the accounting estimates in the financial statements are either reasonable in the context of the applicable financial reporting framework, or are misstated.
Disclosures Related to Accounting Estimates
The auditor shall obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates are in accordance with the requirements of the applicable financial reporting framework.
RELATED PARTIES
Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party in making financial and operating decisions.
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PSA 550 RELATED PARTIES This PSA deals with the auditors responsibilities regarding related party relationships and transactions when performing an audit of financial statements.
This PSA defines related party as:

Related party A party that is either:
a. A person or other entity that has control or significant influence, directly or indirectly through one or more intermediaries, over the reporting entity; b. Another entity over which the reporting entity has control or significant influence, directly or indirectly through one or more intermediaries; or c. Another entity that is under common control with the reporting entity through having; i. Common controlling ownership; ii. Owners who are close family members; or iii. Common key management. However, entities that are under common control by a state are not considered related unless they engage in significant transactions or share resources to a significant extent with one another. The auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks of material misstatement arising from the entitys failure to appropriately account for or disclose related party relationships, transactions or balances in accordance with the requirements of the framework. An audit performed in accordance with generally accepted auditing standards cannot be expected to provide assurance that all related party transactions will be discovered. Nevertheless, during the course of his audit, the auditor should be aware of the possible existence of material related party transactions that could affect the financial statements and of common ownership or management control relationships for which GAAP in the Philippines requires disclosure even though there are no transactions.
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AUDITING THEORY Determining the Existence of Related Parties
February 7, 2011
The auditor should place emphasis on testing material transactions with parties he knows are related to the reporting entity. Certain relationships, such as parent-subsidiary or investor-investee, may be clearly evident. Determining the existence of others requires the application of specific audit procedures, which may include the following: a. Evaluate the company's procedures for identifying and properly accounting for related party transactions. b. Request from appropriate management personnel the names of all related parties and inquire whether there were any transactions with these parties during the period. c. Review filings by the reporting entity with the Securities and Exchange Commission and other regulatory agencies for the names of related parties and for other businesses in which officers and directors occupy directorship or management positions. d. Determine the names of all pension and other trusts established for the benefit of employees and the names of their officers and trustees. e. Review stockholder listings of closely held companies to identify principal stockholders. f. Review prior years' working papers for the names of known related parties. g. Inquire of predecessor, principal, or other auditors of related entities concerning their knowledge of existing relationships and the extent of management involvement in material transactions. h. Review material investment transactions during the period under audit to determine whether the nature and extent of investments during the period create related parties.
Identifying Transactions with Related Parties
The following procedures are intended to provide guidance for identifying material transactions with parties known to be related and for identifying material transactions that may be indicative of the existence of previously undetermined relationships: a. Provide audit personnel performing segments of the audit or auditing and reporting separately on the accounts of related components of the reporting
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entity with the names of known related parties so that they may become aware of transactions with such parties during their audits. b. Review the minutes of meetings of the board of directors and executive or operating committees for information about material transactions authorized or discussed at their meetings. c. Review proxy and other material filed with the Securities and Exchange Commission and comparable data filed with other regulatory agencies for information about material transactions with related parties. d. Review conflict-of-interests statements obtained by the company from its management. e. Review the extent and nature of business transacted with major customers, suppliers, borrowers, and lenders for indications of previously undisclosed relationships. f. Consider whether transactions are occurring, but are not being given accounting recognition, such as receiving or providing accounting, management or other services at no charge or a major stockholder absorbing corporate expenses. g. Review accounting records for large, unusual, or nonrecurring transactions or balances, paying particular attention to transactions recognized at or near the end of the reporting period. h. Review confirmations of compensating balance arrangements for indications that balances are or were maintained for or by related parties. i. Review invoices from law firms that have performed regular or special services for the company for indications of the existence of related parties or related party transactions. j. Review confirmations of loans receivable and payable for indications of guarantees. When guarantees are indicated, determine their nature and the relationships, if any, of the guarantors to the reporting entity.
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When related party transactions are identified, the auditor should obtain sufficient appropriate evidence that these are properly accounted for and disclosed in the financial statements. The auditor should obtain written representation from management concerning the completeness of information provided regarding the identification of related parties and the adequacy of related party disclosures in the financial statements.
Evaluation of the Accounting for and Disclosure of Identified Related Party Relationship and Transaction
In forming an opinion on the financial statements the auditor shall evaluate: (a) Whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and (b) Whether the effects of the related party relationships and transactions: (i) Prevent the financial statements from achieving fair presentation; or (ii) Cause the financial statements to be misleading.
Written Representation
Where the applicable financial reporting establishes related party requirements, the auditor shall obtain written representations from management and, where appropriate, those charged with governance that; (a) They have disclosed to the auditor the identity of the entitys related parties and all the related party relationships and transactions of which they are aware; and (b) They have appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements of the framework.
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February 7, 2011
When using the work performed by an expert, the auditors should obtain sufficient appropriate audit evidence that such work is adequate for the purposes of the audit. An expert is a person or firm possessing special skill, knowledge and experience in a particular field other than accounting and auditing. Auditors have sole responsibility for their opinion, but may use the work of an expert. An expert may be:
Auditors expert An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence.(PSA 620) Engaged by the auditor Employed by the auditor Managements expert An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements. (PSA 620) Engaged by the entity Employed by the entity PSA 620 USING THE WORK OF AN AUDITORS EXPERT - deals with the auditors responsibilities regarding the use of an individual or organizations work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence.
But it doesnt deal with the auditors use of the work of an individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements (a managements expert)
The objectives of the auditor are:
(a) To determine whether to use the work of an auditors expert; and (b) If using the work of an auditors expert, to determine whether that work is adequate for the auditors purposes
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AUDITING THEORY Determining the need to use the work of an expert
February 7, 2011
During the audit the auditors may need to obtain, in conjunction with the entity or independently, audit evidence in the form of reports, opinions, valuations and statements of an expert. Examples are set out below. a. Valuations of certain types of assets, for example, land and buildings, plant and machinery, works of art, and precious stones. b. Determination of quantities or physical condition of assets, for example, minerals stored in stockpiles, underground mineral and petroleum reserves, and the remaining useful life of plant and machinery. c. Determination of amounts using specialized techniques or methods, for example, an actuarial valuation. d. The measurement of work completed and to be completed on contracts in progress. e. Legal opinions concerning interpretations of agreements, statutes and regulations.
When determining the need to use the work of an expert, the auditors would consider: a. The materiality of the financial statement item being considered; b. The risk of misstatement based on the nature and complexity of the matter being considered; and c. The quantity and quality of other audit evidence available. d. \
Competence and objectivity of the expert
When planning to use the work of an expert, the auditors should assess the professional competence of the expert. This may involve considering the expert's: a. Professional certification or licensing by, or membership in, an appropriate professional body; and b. Experience and reputation in the field in which the auditors are seeking audit evidence. The auditors should assess the objectivity of the expert.
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The risk that an expert's objectivity would be impaired increases when the expert is: a. Employed by the entity; or b. Related in some other manner to the entity, for example, by being financially dependent upon or c. Having an investment in the entity. If the auditors are concerned regarding the competence or objectivity of the expert the auditors would discuss any reservations with management and consider whether sufficient appropriate audit evidence can be obtained concerning the work of an expert. The auditors may seek to undertake additional audit procedures or seek audit evidence from another expert.
Scope of the expert's work
The auditors should obtain sufficient appropriate audit evidence that the scope of the expert's work is adequate for the purposes of the audit. Audit evidence may be obtained through a review of the terms of reference which are often set out in written instructions from the entity to the expert. Such instructions to the expert may cover matters such as: a. the objectives and scope of the expert's work; b. a general outline as to the specific matters the auditors expect the expert's report to cover; c. the intended use by the auditors of the expert's work, including the possible communication to third parties of the expert's identity and extent of involvement; d. the extent of the expert's access to appropriate records and files; e. clarification of the expert's relationship with the entity, if any; f. confidentiality of the entity's information; and g. Information regarding the assumptions and methods intended to be used by the expert and their consistency with those used in prior periods. In the event that these matters are not clearly set out in written instructions to the expert, the auditors may seek to communicate with the expert directly to obtain audit evidence in this regard.
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AUDITING THEORY Assessing the work of the expert
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The auditors should assess the appropriateness of the expert's work as audit evidence regarding the financial statement assertion being considered. This may involve assessment of whether the substance of the expert's findings is properly reflected in the financial statements or supports the financial statement assertions, and consideration of: a. source data used; b. assumptions and methods used and their consistency with prior periods; and c. Results of the expert's work in the light of the auditors' overall knowledge of the business and of the results of other audit procedures. When considering whether the expert has used source data which is appropriate in the circumstances, the auditors would consider the following procedures: a. making enquiries regarding any procedures undertaken by the expert to establish whether the source data is sufficient, relevant and reliable; and b. Reviewing or testing the data used by the expert. The appropriateness and reasonableness of assumptions and methods used and their application are the responsibility of the expert. The auditors do not have the same expertise and, therefore, cannot always challenge the expert's assumptions and methods. However, the auditors seek to obtain an understanding of the assumptions and methods used and to consider whether they are appropriate and reasonable, based on the auditors' knowledge of the business and the results of other audit procedures.
CONSIDERING THE WORK OF INTERNAL AUDITING
Internal auditing is an appraisal activity established within an entity as a service to the entity. Its functions include, amongst other things, examining, evaluating and monitoring the adequacy and effectiveness of the accounting and internal control systems. Considering the work of internal auditor involves two important phases: 1. Making a preliminary assessment of internal auditing; and 2. Evaluating and testing the work of internal auditing
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AUDITING THEORY Preliminary assessment of internal auditing
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The external auditor should obtain a sufficient understanding of internal audit activities to assist in planning the audit and developing an efficient audit approach. The external auditor should consider the internal auditors: Competence Objectivity Due professional care Scope of function The external auditor will have to evaluate and test the internal auditors work to confirm its adequacy for the external auditors purposes. The external auditor may also request the assistance of the internal auditor in performing routine or mechanical audit procedures.
PSA 610 USING THE WORK OF INTERNAL AUDITORS deals with the external auditors responsibilities regarding the work of internal auditors when the external auditor has determined, in accordance with PSA 315 that the internal audit function is likely to be relevant to the audit.
According to this PSA the objectives of the external auditor, where the entity has an internal audit function that the external auditor has determined is likely to be relevant to the audit, are to determine: (a) Whether, and to what extent, to use specific work of the internal auditors; and (b) If so, whether such work is adequate for the purposes of the audit.
Determining Whether and to What Extent to Use the Work of the Internal Auditors
The external auditor shall determine: a. Whether the work of the internal auditors is likely to be adequate for purposes of the audit; and b. If so, the planned effect of the work of the internal auditors on the nature, timing or extent of the external auditors procedures.
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In determining whether the work of the internal auditors is likely to be adequate for purposes of the audit, the external auditor shall evaluate: a. The objectivity of the internal audit function; b. The technical competence of the internal auditors; c. Whether the work of the internal auditors is likely to be carried out with due professional care; and d. Whether there is likely to be effective communication between the internal auditors and the external auditor. In determining the planned effect of the work of the internal auditors on the nature, timing or extent of the external auditors procedures, the external auditor shall consider: a. The nature and scope of specific work performed, or to be performed, by the internal auditors; b. The assessed risks of material misstatement at the assertion level for particular classes of transactions, account balances, and disclosures; and c. The degree of subjectivity involved in the evaluation of the audit evidence gathered by the internal auditors in support of the relevant assertions.
Using Specific Work of the Internal Auditors
In order for the external auditor to use specific work of the internal auditors, the external auditor shall evaluate and perform audit procedures on that work to determine its adequacy for the external auditors purposes. (Ref: Para. A6) To determine the adequacy of specific work performed by the internal auditors for the external auditors purposes, the external auditor shall evaluate whether: a. The work was performed by internal auditors having adequate technical training and proficiency; b. The work was properly supervised, reviewed and documented; c. Adequate audit evidence has been obtained to enable the internal auditors to draw reasonable conclusions; d. Conclusions reached are appropriate in the circumstances and any reports prepared by the internal auditors are consistent with the results of the work performed; and e. Any exceptions or unusual matters disclosed by the internal auditors are properly resolved.
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AUDITING THEORY Evaluating and testing the work of internal auditors
February 7, 2011
The external auditor will have to evaluate and test the internal auditors work to confirm its adequacy for the external auditors purposes. This evaluation may include considering whether the work is performed by competent persons; sufficient appropriate evidence is obtained; appropriate conclusions are reached; and exceptions are properly resolved.
Documentation
When the external auditor uses specific work of the internal auditors, the external auditor shall document conclusions regarding the evaluation of the adequacy of the work of the internal auditors, and the audit procedures performed by the external auditor on that work
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AUDITING THEORY 2011

Following a systematic process

Objectively obtains and evaluates evidence

Establish the degree of correspondence between Assertions Established Criteria

Communicates the results to interested users

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

AUDITING THEORY Comparison among different types of audit

Assertions made by the auditee

That the financial statements are fairly presented

That the organizations activities are conducted effectively and efficiently

Financial reporting standards or other financial reporting framework

Laws, regulations and contracts

Objective set by the board of directors

Content of auditors report

Recommendati ons or suggestions on how to improve operations

Auditor who generally perform

Bachelor of Science in Accountancy

The Independent Financial Statement Audit

Bachelor of Science in Accountancy

Role of management and independent auditor

Prepares Financial Statements

Unaudited Financial Statements

Evaluates Financial Statements

Audited Financial Statements

Audit Report On Financial Statements

Users of Financial Statements

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

General principles governing the audit of financial statements

Need for an independent financial statement audit

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

level of assurance provided by the auditor

High, but not absolute assurance

Positive assurance on assertions

Negative assurance on assertions

Factual findings of procedures

Identification of information compiled

Bachelor of Science in Accountancy

The Professional Standards

Generally Accepted Auditing Standards

Technical Training and Proficiency Independence Professional care

Planning Internal Control Consideration Evidential Matter

Generally Accepted Accounting Principles Inconsistency Disclosure Opinion

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

AUDITING THEORY NONCOMPLIANCE WITH LAWS AND REGULATIONS

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy

Bachelor of Science in Accountancy