THE PHILOSOPHY OF AN AUDIT

·        Auditing lends credibility to the financial statements.

·        When financial statements are audited, they more believable, credible, or reliable because of
the assurance given by auditing.

·        Auditing instills public confidence on the financial Information.

DEFINITION OF AUDITING

The American Accounting Association defines auditing as a “systematic process of objectively

obtaining and evaluating evidence regarding assertions about economic actions and events to
ascertain the degree of correspondence between assertions and established criteria and
communicating the results to interested users".

Systematic process

·        auditing consists of a structured, logical, and organized series of steps and procedures.

·        the audit process is made up of a sequential series of steps that independent auditors follow to
ensure that the audit is conducted in an organized, effective, and efficient manner

Objectively obtaining and evaluating evidence

·        the bulk of the work of the auditor in the conduct of the audit

·        the auditor has to obtain or gather sufficient appropriate audit evidence and evaluate them
through audit tests and procedures to warrant the expression of an opinion

·        the auditor has to examine the bases for the assertions or representations made by
management and judiciously evaluate the results without bias or prejudice either in favor of or against
the individual or entity making the representations

Assertions about economic actions and events

·        assertions are the representations made by the individual or entity under audit and comprise the
subject matter (information) of auditing

·        these include information contained in the financial statements, internal operating reports, and
tax returns and are representations made by management as to the fairness of the financial
statements

Degree of correspondence

·        the closeness or proximity with which the assertions made by management can be identified
with established criteria

Established criteria

·        criteria are “the benchmarks used to evaluate or measure the subject matter including, where
relevant, benchmarks for presentation and disclosure”

·        in a financial statement audit criteria are the standards against which the assertions or
representations are judged to warrant degree of correspondence
Communicating the results

·        the manifestation of an auditor's attest function in an audit.

·        stage in the audit process is the issuance of the audit report or the communication of the audit
findings to the users

·        the auditor attesst as to the degree of correspondence between the assertions of management
with the established criteria and thereby enhances and lends (or weakens) credibility of the
representations or claims made by management in the financial statements

Interested users

·        these are the individuals or entities which use or rely on the auditor's findings.

·        in the business environment, these users may include the stockholders, management, creditors,
Investors, government agencies, and the public in general

FINANCIAL STATEMENT ASSERTIONS

·        To assert means "to tell the whole world"

·        In a financial statement audit, the auditor establishes the degree of correspondence between
assertions and established criteria.

·        These assertions are in the form of representations made by management and are contained in
the financial statements. The responsibility for the preparation and presentation of the financial
statements ultimately rests with management.

·        Management either expressly or impliedly makes representations in the financial statements in

the form of assertions.

·        The task of the auditor is to test the fairness or reasonableness of these assertions and
determine whether they comply with the provisions of the Philippine Financial Reporting Standards
(PFRS).

CLASSIFICATIONS OF FINANCIAL STATEMENT ASSERTIONS

·        Existence. Assets, liabilities, and equity interests exist.

·        Occurrence. Transactions and events that have been recorded have occurred and pertain to
the entity.

·        Completeness. All transactions and events that should have been recorded have been
recorded.

·        Rights and obligations. Assets are the rights, and Liabilities are the obligations, of the entity.

·        Valuation or allocation. Assets, liabilities, equities, revenues, and expenses are included in the
financial statements at appropriate amounts; revenues, costs, and expenses are allocated to the
proper accounting periods; and any resulting valuation or allocation adjustments are appropriately
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. Transactions and events have been recorded in the proper accounts.

·        Presentation and disclosure. Financial statement components are properly classified,

described, and disclosed

TRANSACTION CYCLES

·        Various accounts may exist in the financial statements of a company and it would be unrealistic
for an auditor to examine these accounts and perform a 100% examination on them.

·        This is the reason why auditors usually narrow down the activities of the business under audit
into homogeneous classes called as transaction cycles.

·        A transaction cycle is all of the classes of transactions for group of related business activities.

·        A class of transactions is a group of transactions of similar activities that are processed by the
accounting system in similar manner and subject to similar control to ensure proper processing.

·        The division of the audit into transaction cycles makes the audit more manageable and aids in
the assignment of tasks to different members of the audit team.

CLASSIFICATIONS OF TRANSACTION CYCLES

Revenue/ Receipt Cycle

Includes procedures and policies for obtaining orders from customers, approving credit, shipping
merchandise, preparing sales invoices, recording revenue and accounts receivable, and handling and
recording cash receipts

Expenditure/ Disbursement Cycle

Includes procedures for initiating purchases of raw materials, other assets or services; placing
purchase orders; inspecting goods upon receipt and preparing receiving reports; recording liabilities to
suppliers; authorizing payment; and making and recording cash disbursements

Conversion Cycle

Includes procedures for storing materials, placing materials into production, assigning production
costs to inventories, and accounting for the cost of goods sold

Personnel/ Payroll Cycle

Includes procedures for hiring, terminating, and determining pay rates; timekeeping; computing gross
payroll, payroll taxes and amounts withheld from gross pay; maintaining payroll records and preparing
and distributing paychecks

Financing Cycle

Includes procedures for authorizing, executing, and recording transactions involving purchase and
sale of marketable equity securities, temporary as well as long-term; fixed tangible assets (excluding
inventory); bank loans: leases: bonds payable; and capital stock.

OBJECTIVE AND SCOPE OF A FINANCIAL STATEMENT AUDIT (PSA 120, par. 11)
(PSA 120, par 1)

“The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in ail material respects, in accordance with an
applicable financial reporting framework.”

Expression of an opinion

·        This is the primary responsibility of the auditor in an audit

·        The auditor expresses an opinion as to the fairness and reasonableness of the financial
statements and issues a written audit report as the output of the audit.

·        Note that the words fair and reasonable are used instead of correct. This is due to the fact that
an audit has certain limitations which preclude the practitioner from giving an absolute guarantee that
the financial statements are free from material misstatement.

·        Rather, the auditor only provides reasonable assurance, which is a high but not absolute level of
assurance, and vouches as to the accuracy instead of correctness of the preparation and presentation
of the financial statements.

In all material respects

·        This phrase emphasizes that the concept of materiality is recognized in the conduct of an audit.

·        Materiality is viewed as a threshold or cutoff point Instead of a mere quantitative figure which
makes information useful for decision making.

Applicable financial reporting framework

·        This is the framework through which the financial statements are prepared.

·        In the case of an audit, the applicable financial reporting framework is specifically the Philippine
Financial Reporting Standards (PFRS).

Taken as a whole

·        Although this phrase is not included in the objective of an audit, it should be emphasized that
the opinion expressed by the auditor is based on the financial statements taken as a whole, which
means the entirety of all the information contained in a complete set of financial statements.

·        It should be noted with emphasis that the primary responsibility of the auditor lies in the
expression of an opinion on the financial statements taken as a whole.

·        All other objectives of the auditor other than this is merely secondary.

·        This means that an auditor cannot be sued for the identification of all fraud, errors, or
noncompliance in the conduct of an audit because this responsibility is only secondary, unless the
auditor is asked to conduct a fraud audit.

·        Furthermore, the primary responsibility for the preparation and presentation of financial
statements rests with management.

SCOPE OF A FINANCIAL STATEMENT AUDIT

·        refers to the audit procedures or tests the auditor decides to perform

·        In the observance of Generally Accepted Auditing Standards or GAAS, the auditor must
exercise his judgment in determining which auditing procedures are necessary in the circumstances
to afford a reasonable basis for his opinion.

INFORMATION RISK

·        that information is misstated or misleading

·        brought about by factors such as:

o   remoteness of information users from information provider

o   potential bias and motives of information provider

o   voluminous data

o   complex exchange transaction

REDUCING INFORMATION RISK

·        Allow users to verify information

·        User shares information risk with management

·        Have the financial statements audited

CONCEPT OF THE AUDIT REPORT

·        the end product or output of the financial statement audit is the independent auditor's report

·        the means through which the auditor provides reasonable assurance that the financial
statements are fairly stated

·        the manifestation of the practitioner's attest function of communicating the results of the audit to
interested users

·        this report is uniform in format and suitably titled to avoid confusion regarding the level of
assurance being provided and to differentiate it from other reports which client management might
include with the financial statements

addressed to intended users, usually to the Board of Directors and/ or stockholders of the company
under audit