Module 4

Introduction to Audit Process

and Preliminary Engagement
Activities

Reference: Chapter Seven and Chapter Five of Audit & Assurance Principle
 Learning Outcomes

After studying this module, the students are expected to:

▪ Explain the overall objectives of an independent

auditor in financial statement audit engagement.
▪ Discuss the basic concepts that underlie a financial
statement audit.
▪ Identify the major phases of the financial statement
audit process.
▪ Describe the procedures involved during pre-
engagement activities.
Objectives of Independent Auditor
in the audit of Financial Statements

• To obtain reasonable assurance about whether the

financial statements as a whole are free from
material misstatement, whether due to fraud or
error, and

• to express an opinion on whether the financial

statements are prepared, in all material respects, in
accordance with an applicable financial reporting
framework
Responsibilities of Management and
Those Charged With Governance

• Preparation and presentation of the financial

statements in accordance with the applicable financial
reporting framework.

• Design, implementation and maintenance of internal

control relevant to the preparation and presentation
of financial statements
Basic Concepts Underlying
a Financial Statement Audit
Auditor Independence

Professional skepticism

Conduct and Scope of an Audit

Audit Evidence and FS Assertions

Audit Materiality

Audit Risk

Professional Judgment

Inherent Limitation of an Audit

 Professional Skepticism
« We trust but we need to verify »

An auditor should be alert about. . .

• audit evidence that contradicts other audit evidence
obtained

• information that brings into question the reliability of

documents and responses to inquiries to be used as
audit evidence

• conditions that may indicate possible fraud

 Conduct and Scope of an Audit in
Accordance with PSAs
• The auditor shall comply with all PSAs relevant to the audit.

• If compliance with PSA cannot be achieved, the auditor shall

modify his opinion or withdraw from the engagement

• Scope of an audit refers to the audit procedures that, in the

auditor’s judgment and based on the PSAs, are deemed
appropriate to achieve the objectives of the audit
 Audit Evidence

• Audit evidence is all the information obtained and used

by the auditor in arriving at the conclusions on which
the audit opinion is based.

• The auditor should obtain sufficient appropriate audit

evidence
 Management Assertions

• Auditor shall gather audit evidence regarding the

assertions (i.e., representations) of management in their
financial statements.

• Broadly speaking, assertions include: presentation and

disclosure, existence and occurrence, rights and
obligations, completeness and valuation and allocation
Management Assertions for Each Category
of Assertions
Management Assertions
 Materiality

• Materiality is a relative concept.

• Information is material if its omission or misstatement

could influence the economic decisions of users taken
on the basis of the financial statements.

• The assessment of what is material is a matter of

professional judgment of the auditor.
Materiality
 Audit Risk

• The likelihood or possibility that the auditor expresses an

inappropriate audit opinion when the financial statements
are materially misstated.

• Audit risk may be assessed either in quantitative (e.g., ten

percent of total assets) or non-quantitative terms (e.g., high,
moderate, or low)

• Audit risk is a function of the possibility of material

misstatement and the possibility that the auditor will not
detect such misstatement
 Components of Audit Risk

• Inherent risk - - the susceptibility of an assertion to a

misstatement that could be material assuming that there
were no related internal controls

• Control risk - - the likelihood that a misstatement that could

occur in an assertion and that could be material and will not
be prevented, detected or corrected on a timely basis by the
entity’s internal control

• Detection risk - - the likelihood that the auditor will not

detect a misstatement that exists in the financial statements
Audit Risk
Audit Risk
Audit Risk
 Professional Judgment

• In auditing, professional judgment. . . is the application of

relevant knowledge and experience, within the context
provided by auditing, accounting and ethical standards, in
reaching decisions about the courses of action that are
appropriate in the circumstances of the audit engagement

• Professional judgment needs to be exercised throughout the

audit.

• Application and exercise of professional judgment shall be

appropriately documented
Poll Question #1
 Phases of the Audit Process

• Pre-audit responsibilities

• Audit Planning

• Study and Evaluation of Internal Control

• Substantive Testing

• Completing the Audit

• Issuance of the Audit Report

• Post-audit responsibilities
 Accepting the Engagement

✓ Requirements of PSQC 1 Accepting the Engagement

If the engagement partner obtains information that would have
caused the firm to decline the audit engagement had that
information been available earlier, the engagement partner shall
communicate that information promptly to the firm, so that the
firm and the engagement partner can take the necessary action.
(PSA 220)

✓ Pre-conditions for an Audit

Pre-audit Responsbilities
 Principal Contents of an Engagement Letter

• Reports and other communication of results of the audit

• Auditor’s responsibilities
• Access to records and other information needed by
auditor in connection with the audit
• Management’s responsibilities
• Basis of fees and and billing arrangement
• Objective of the engagement
• Scope of the audit
Engagement Letter
 Engagement Letter

Other Concerns
• Audit of Components
• Recurring Audits
• Accepting a Change in the Engagement
• Rejecting a Change in the Engagement
 Audit Planning

• Involves establishing the overall audit strategy for the

engagement and developing an audit plan.

• Involves:
– obtaining an understanding of the client and its environment,
– establishing materiality and audit risk,
– assessing the possibility of non-compliance,
– identifying related parties,
– performing preliminary analytical, and
– developing preliminary audit program
Audit Planning
 Study and Evaluation of Internal Control

• Obtain an understanding of the client’s internal control

structure.

• The study and evaluation of client’s internal control will

serve as the basis of the auditor in assessing control risk
and in ultimately determining the nature, timing and
extent of substantive test procedures
 Substantive Testing

• Procedures used to detect material misstatements in

account balances, classes of transaction and disclosures.

• Substantive test procedures are classified as tests of

details and analytical procedures

• Evidences obtained thru substantive tests procedures

serve as basis in forming audit report
 Completing the Audit

• At this stage, the auditor communicates the updated list

of findings to management and to those charged with
governance

• Involves:
– Performing final analytical analytical procedures
– Obtaining management representation letters
– Summarizing and evaluating audit findings
– Reviewing the audit staff working papers
 Issuance of the Auditor’s Report

• Finally, the auditor issues an opinion regarding the

fairness of the financial statements.
• Types of audit opinion are:
– Unqualifed opinion
– Qualified opinion
– Adverse Opinion
– Disclaimer of opinion
 Post-Audit Responsibilities

• Debriefing - - - this phase of the audit process involves

assessing and evaluating the quality of delivery of the audit
service team

• Usually involves:
– Considering events during the audit

– Analyzing the activities within the audit

– Producing recommendations
Poll Question #2
Overview of Financial Statement Audit
Public Accounting Firm Organization
Members of the External Audit Team
 Learning Outcomes

After studying this module, the students are expected to:

▪ Explain the overall objectives of an independent

auditor in financial statement audit engagement.
▪ Discuss the basic concepts that underlie a financial
statement audit.
▪ Identify the major phases of the financial statement
audit process.
▪ Describe the procedures involved during pre-
engagement activities.