Chap 6: Fundamentals of Assurance Services

ASSURANCE ENGAGEMENTS
NATURE

Assurance

- auditor's satisfaction as to the reliability of an assertion being made by 1 party for the use of
another party

Assurance Engagement

- a practitioner expresses a conclusion designed to enhance the degree of confidence that

intended users can have about the evaluation or measurements of a subject matter that is the
responsibility of a party against a criteria.

OBJECTIVE:

-For a professional accountant to evaluate or measure a subj matter that is the responsibility of
a party against a suitable criteria go express a conclusion which provides the intended user with
a level of assurance abt that subj matter.

TYPES:

REASONABLE ASSURANCE (RAE) LIMITED ASSURANCE ENGAGEMENT

ENGAGEMENT
- reduce the risk to an acceptably low level as
the basis of positive form of expression
-Ex - FS audit at review of prospective FS.
(LAE)
- reduce the risk to a level that is acceptable
but higher than a reasonable assurance as a
basis for a negative form of expression
- Ex. Review of non-financial indicators and
review of human resource practices, IC, IT
systems, Corp. governance and compliance sa
regulations

OTHER ASSURANCE SERVICES

CPA web trust

✓seal assures the user that the web site owner has met the established criteria related to
business practices, transaction integrity, and info processes

✓attestation service performed to give assurance to third-party users

Eldercare Plus

✓focuses on the needs of the elderly and whether caregivers are providing services that meet
specified objectives or at an acceptable level.

Business Performance Measurements Services

 ✓provide assurance about whether financial and non-financial info being reported from the
entity's performance measurement system is reliable and accurately leading the entity toward
meeting its strategic goals and objectives

Info System Reliability Services

✓CPAs provide assurance that an info system has been designed and operated to produce
reliable data including tests of the system to determine whether it protects against potential
causes pf data defects

✓performed to give assurance to management

Health Care Performance Measurement

✓evaluation of the quality of health care, medical services and outcome

Risk Assessment

✓identifies a set of risks that affect the org.

✓study of the link between risks and org's mission, vision, objectives, strategies and
development of new and relevant measures

ASSERTION-BASED ENGAGEMENT DIRECT REPORTING ENGAGEMENT

- evaluation or measurements of the subj - practitioner either directly performs the

matter and the subj matter info (assertion) by evaluation or measurement of the subj matter
the responsible party made available to not available to the intended users.
intended users. Ex. FS Audit

How can the users trust the FS? Auditors build up trust between the responsible party and
intended users.

ELEMENTS:

- 3 party relationship

a. practitioner - mediator para magtiwala pa lalo si user sa mngt; independent and competent

b. firm being audited/responsible party - responsible for the subj matter (ex. FS for the users)

c. intended users - creditors, investors, gov’t regulatory agencies,employeees, etc

- an appropriate subj matter

1. Data - financial and nonfinancial info (good gov, number of employees)

2. Systems and process - ex. Internal control

3. Behavior - how the org acts; if compliant ang company with laws and regulation

4. Physical characteristics - we check if the accuracy of the physical characteristics of a product,

facility, etc when subjected to an assurance engagement. Ex. Lightbulb life, printer capacity
- suitable criteria

-standard or benchmark where the subject matter will be evaluated or judged from. Ex. FS -
PAS or PFRS,
-characterized by relevance, completeness, reliability, neutrality, and understandability

- sufficient appropriate evidence

✓practitioner has a professional skepticism and considers sufficiency (quantity, greater the risk,
more evidence needed) and appropriateness (quality, higher quality, less evidence needed) of
evidence, materiality, and assurance engagement risk (risk that practitioner expresses an
inappropriate conclusion when subj matter info is materially misstated)

- written assurance report in the form appropriate for RAE or LAE.

✓Unmodified opinion - FS are fairly presented in all material respects

✓Qualified opinion - FS are fairly presented in all material respects “except for”… (Invty)

✓Adverse opinion - FS are not fairly presented in all material respects

✓Disclaimer of opinion - if the auditor can’t decide the evidence is misstated or not

Ex. Subj matter - FS

Sample evidence - inventory

Evidence - physical invty counting

Criteria - PAS 2 Inventories

ASSURANCE SERVICES (Brief description)

1. INDEPENDENT FS AUDIT (External Audit)

✓most predominant type of Assurance Engagement

✓to provide a high level of assurance thay the FS are free of material misstatement

OBJECTIVE: enable the auditor to express an Opinion whether the FS are prepared, in all
material aspect, in accordance with an identified financial reporting framework; "give a true and
fair view" or "present fairly, in all material respects"

AUDIT OPINION: the auditor obtains sufficient appropriate audit evidence as a basis in drawing
conclusion. It enhances the credibility of FS by providing a high (but not absolute) level of
assurance.

2. REVIEW OF FS - PSREs 2400 to 2410

✓involves limited investigation of much narrower scope than an audit

✓undertaken for the purpose of providing limited (negative) assurance that the statements are
presented in accordance with identified FRStandards
 ✓evidence supports a moderate level of assurance that info subj to review is free of material
misstatement

✓FS may be historical or prospective

OBJECTIVE: enable an auditor to state whether on the basis of procedures which do not
provide all the evidence required in an audit, nothing has come to the auditor's attention that
causes the auditor to believe that the FS are not prepared, in all material respects, in
accordance with an identified financial reporting framework (NEGATIVE ASSURANCE)

3. OTHER REVIEW ENGAGEMENTS

✓review of investment performance statistics for org (mutual funds, computer software and
clients internal controls over financial reporting reviews)

NON-ASSURANCE SERVICES (Brief Description)

1. Agreed-upon Procedures Services

✓party engaging the accountant or the intended user determines the procedures to be
performed and the accountant provides a report of factual findings as a result of undertaking
those procedures.l

✓intended user assesses the procedures and findings and draws his own conclusions. Ex.
Forecast or prospective FS

2. Compilation of Financial or Other Info

✓presenting in the form of FS that is the representation of mngt without understanding to

express any assurance on the statements

✓OBJECTIVE: for the CPA to uss acctg expertise to collect, clasify and summarize financial
info

✓improves the quality of info by displaying in FARStandards format and the practitioner's
identification of obvious errors.

3. Tax Services

✓preparing corporate and individual tax returns for both audit and non-audit clients

✓tax compliance (prep of tax returns) and tax planning (determines the tax consequences of
planned or potential transactions and suggests the desirable course of action to minimize the
tax liability while achieving the client's objectives

4. Management Consulting/Advisory Services

✓employ the practitioner's technical skills, education, observations, experiences and

knowledge of the analytical approach and procedures used in a consulting engagement

5. Accounting and Data Processing or IT Systems Services

 ✓manual or automated bookkeeping, journalizing, and posting adjusting entries or preparing
FS.

CHAP 7: INTRO TO FS AUDIT

INDEPENDENT AUDITING

✓SYSTEMATIC PROCESS by which a COMPETENT, INDEPENDENT PERSON

OBJECTIVELY OBTAINS AND EVALUATES EVIDENCE regarding ASSERTIONS ABOUT
Economic Actions And Events to ascertain the DEGREE OF CORRESPONDENCE between
those assertions and ESTABLISHED CRITERIA and COMMUNICATING THE RESULTS to
INTERESTED USERS

OBJECTIVES:

✓enable the auditor to express an opinion whether the FS are prepared, in all material respects,
in accordance with an identified financial reporting framework; "give a true and fair view" or
"present fairly, in all material respects"

✓enhances the credibility of FS by providing a high (but not absolute) level of assurance.

OVERALL RESPONSIBILITIES OF THE AUDITOR IN CONDUCTING AN AUDIT OF FS

(a) obtain a reasonable assurance abt whether the FS as a whole are free from material
misstatement, be it due to fraud or error, enabling him to express an opinion on whether the FS
are prepared, in all material respects, in accordance with an identified financial reporting
framework; and

(b) to report on the FS and communicate as required by the Phil Standards on Auditing (PSAs)
in accordance with the auditor's findings.

Note: in all cases when reasonable assurance can't be obtained and qualified opinion of the
auditor would not suffice in reporting to intended users, PSAs require the auditor to disclaim an
opinion or withdraw from the engagement, if withdrawal is legally permitted.

SCOPE:

✓procedures deemed necessary in the circumstances to achieve the objective of the audit:

-auditor will conduct a critical and systematic examination of the statements and of the related
documents, records, procedures, and control.

-when sufficient and competent audit evidences have been gathered, the auditor can then
formulate his opinion on the fairness of the FS.

-he then prepares the audit report containing the scope of his examination and the opinion he
has expressed on the financial statements for submission to the client, who in turn furnishes
copies to various interested parties

IMPORTANCE:
✓As the society becomes more complex, there is an increase likelihood that unreliable info will
be decision makers (info risk) as a result of the separation pf the ownership and management
that's why the need for audits arise

FACTORS CONTRIBUTING TO INFO RISK:

1. Remoteness of info users from info providers (mngt)

2. Potential bias and motives of info providers

3. Voluminous data

4. Complex exchange transactions

5. Consequences

HOW INFO RISK MAY BE REDUCED

1. Allow users to verify info

-user may go to the business establishment to examine records as to its reliability

-adopted by BIR examiners or business intending to purchase another business whereas it

use a special audit team to independently verify and evaluate key info of the prospective
business (Due Diligence Audit)

2. User shares info risk with mngt

-lawsuit may be brought against mngt when users incur financial losses to recover part of
such

3. Have the FS audited

ADVANTAGES OF INDEPENDENT AUDIT

To the Client/Auditee

1. FS become more credible and reliable

2. Mngt receives constructive suggestions in improving business operations

3. Fraud by mngt and employee is minimized

4. Audited FS provide a more credible basis for prep of tax returns

5. Better and sound mngt decisions can be made out of the accurately maintained financial
records and provided reports

To the Creditors, Prospective Investors and Employees

1. More credible basis will be available to financial institutions in deciding whether financial
assistance should be extended to the auditee.

2. There will be a reliable basis in decision-making related to extension of credit by suppliers

and other creditors

3. Potential and current investors will have more credible basis in evaluating managerial
efficiency.

4. Employees will have a better and credible basis in requesting for fringe benefits and wage
adjustments.

5. Both buyer and seller will have more confident basis for aiming at a decision as to the terms
and conditions of the arrangement in the event of sale, purchase, or merger of a business.

To Government Agencies and Legal Community

1. BIR has more assurance concerning accuracy and dependability of tax return

2. Gov't institutions will have better basis in extending financial assistance to business
enterprises.

3. Legal Community is provided an independent basis for administering estates and trust,
setting action in bankruptcy and insolvency, etc.

THE AUDIT OPINION FORMULATION PROCESS (Overview)

Phase I

RISK ASSESSMENT

✓client acceptance & continuance decision

-once client is accepted, auditor needs to perform this to understand the client's business
thoroughly to determine the likelihood that financial accounts might be in error

✓ACTIVITIES:

•assess preconditions for an audit

•develop common understanding of the audit engagement with the client

•identify and assess risks of material misstatement

•respond to identify risks of material misstatement

Phase II
RISK RESPONSE

✓obtaining evidence abt Internal Control Operating Effectiveness

✓obtaining substantive evidence abt accounts, disclosures and assertions

✓ACTIVITIES:

•select controls to test, if applicable

•perform test of controls, if applicable

•consider the results of test controls, if applicable

•perform substantive tests

Phase III

REPORTING

✓completing the audit

✓making reporting decisions

-AUDITOR'S REPORT/AUDIT OPINION: main product or output of the audit

-If uncorrected misstatements are judged to be material, the auditor will request that the client
correct misstatements but if they are insignificant enough or if the client is willing to correct
them, the auditor issues an UNQUALIFIED (clean) REPORT.

-If clients refuses, auditor issues an opinion that clearly indicates that the FS are materially
misstated and explains the nature of the misstatement.

✓ACTIVITIES:

•complete review and communication activities

•determine the type(s) of opinion(s) to issue

MANAGEMENT ASSERTIONS AND FS

FS Assertions

-mngt's expressed or implied claims abt info reflected in the FS

-focus of the auditor's evidence collection effort

Collection of Evidence Process:

1. Carefully consider the most important assertions the company is making abt the account
2. Decide what evidence you would need to substantiate the truthfulness of each important
assertions

2 aspects of info in the FS:

1. TRANSACTIONS AND RELATED DISCLOSURE ASSERTIONS

(a) Occurrence

(b) Completeness

(c) Authorization

(d) Accuracy

(e) Cutoff

(f) Classification

(g) Preparation

2. ACCOUNT BALANCES AND RELATED DISCLOSURE ASSERTIONS

(a) Existence

(b) Rights and Obligations

(c) Completeness

(d) Accuracy, valuation and allocation

(e) Classification

(f) Presentations

CORE CONCEPTS IN FS AUDIT

1. MATERIALITY

- magnitude of an omission or misstatement of acctg info that makes it probable that the
judgment of a reasonable person relying on that info be changed or influenced by the omission
ot misstatement.

- assessment of this helps the auditor determine the nature, timing, and extent of audit
procedures used to collect audit evidence

2. AUDIT RISK

- risk that auditor may mistakenly give a "clean" opinion ob FS that are materially misstated

- REASONABLE ASSURANCE: failure of detecting a material misstatement can still occur

even if the auditor does a good job

- the more effective and extensive the audit work, the lower the audit risk
3. AUDIT EVIDENCE

- consists of underlying accounting data and any additional information available to the auditor,
either from the client or external sources

- SUFFICIENT APPROPRIATE EVIDENCE = REASONABLE ASSURANCE

- Sufficiency - quantity

- Appropriateness:

•Relevance - whether it relates to the specific mngt assertion being tested

•Reliability - diagnosticity of the evidence

Upon these 3 Core Concepts, the process was built:

Overview of FS Audit Process

1. Auditor gathers evidence abt the business transactions that have been recorded and
accumulated.

2. He uses this evidence to compare the assertions contained in the FS to the criteria used by
the mngt in preparing them.

3. Audit report is created to communicate the degree of correspondence between assertions

and the criteria to the users of FS.

GENERAL PRINCIPLES OF AN AUDIT

1. COMPLIANCE WITH ETHICAL REQUIREMENTS

✓ Auditor should comply with the "Revised Code of Ethics for Professional Accountants in the
Philippines" promulgated by the BOA and approved hy the Phil PRC.

✓Ethical Principles

- independence

- integrity

- objectivity

- professional competence and due care

- confidentiality

- professional behavior

- technical standards

✓Auditor should conduct an audit in accordance with the Phil. Standards on Auditing and with
an attitude of professional skepticism
2. REASONABLE ASSURANCE

Note: Auditors do not guarantee the fair presentation of FS.

✓Inherent Limitations in an Audit

•use of testing

•any acctg and IC system inherent limitations

•fact that most audit evidence is persuasive rather than conclusive

✓Work permeated by judgment

•gathering of audit evidence

•drawing of conclusions based on the evidence

3. RESPONSIBILITY FOR FS

✓preparing and presenting the FS is mngt's responsibility

4. SKILLS AND KNOWLEDGE NEEDED IN FS AUDIT

✓technical knowledge and expertise

-understand acctg & auditing authoritative literature

-develop industry and client-specific knowledge

-develop and apply computer skills

-evaluate internal controls

-assess and respond to fraud risk

✓leadership, teamwork and proferssional skills

5. PARTIES INVOLVED IN PREPARING AND AUDITING FS

✓Management

-responsible for:

(a) preparing and presenting the FS in accordance with financial reporting framework

(b) designing, implementing, and maintaining internal control over financial reporting; and

(c) providing the auditors with info relevant to the financial statements and internal controls
✓Internal Audit function

-provides mngt and the audit committee with assurance on internal controls and reports

✓Audit Committee

-oversees both mngt and internal auditors and hire the external auditor

✓External Auditor

-to obtain reasonable assurance as to the fairness of mngt's statements

-provide a publicly available report

6. CONTEXT OF FS AUDITING

✓Business or Entity being Audited

-primary context of Auditing and primary aspect of the environment in which FS Auditing is
conducted

-impacts Auditor and the nature of the audit

7. RELATING THE AUDIT PROCESS COMPONENTS TO THE BUSINESS MODEL

✓Business Cycles

(a) revenue and collection cycle

(b) purchases and disbursement cycle

(c) payroll

(d) invty warehousing transaction

(e) financing process

*Each involves a variety of important transactions

*Auditors often rely on this process model to divide the audit of a business' financial
statements into manageable pieces.

✓Accounting Info Systems

-capture the details of those transactions

-must be capable of producing reliable financial reports

✓Internal Control (IC) System

-ensures that the transactions are handled and recorded appropriately and that resources are
protected