1.

Discuss the following concepts in the conduct of audit:

a. Materiality
b. Reasonable Assurance
c. Professional skepticism
d. Professional judgment

The purpose of an audit is to increase the degree of confidence of the intended users in the
financial statements prepared by the management. This can be attained through rendering of opinion or
conclusion by an auditor, whether the financial statements are prepared in all material respects,
compliant to an applicable financial reporting framework. Due to the importance of the conduct of
audit, certain concepts must be clearly understood.

Even in the conduct of audit, the concept of materiality is applied. Materiality is when an
omission or misstatement of financial information will affect the financial statements and could further
influence the user’s economic decision. Hence, materiality expresses the limit or the cutoff point after
which accounting information becomes relevant to the users of information. Also, materiality relies to
the professional judgment of the accountant. Judgments around materiality are made within the light
of encompassing circumstances, and are influenced by the auditor’s discernment of the financial
information needs of users, and by the size or nature of a misstatement, or a combination of both.

The Concept of reasonable assurance on the other side serves as the basis of auditor’s opinion
as to whether a client’s financial statements are free from material misstatement, thus allowing the
auditor to give a conclusion on whether the financial statements are presented fairly, in all material
respects, in accord with the applicable financial reporting framework. Reasonable assurance does not
equate to an absolute assurance, but it is a high level of assurance concerning material misstatements.
Reasonable assurance embraces the understanding that there is a remote likelihood that material
misstatements cannot be prevented or detected on a timely basis. So as to attain reasonable assurance,
the auditor needs to obtain appropriate and sufficient audit evidence to lessen the audit risk to an
acceptably low level.

Professional skepticism on the other hand, is an attitude that a professional accountant should
possess, having a questioning mind, being alert to conditions that may indicate possible misstatement
due to fraud or error, and a critical assessment of audit evidence. Professional skepticism is a skill that
developed over time and professional accountant must constantly build and refine. Meanwhile, the
concept of professional judgment pertains to the application of the accumulated or gathered knowledge
and experience acquired from an essential accounting or auditing training. Professional judgment
observes and exercises ethical standards that results in making informed decisions about the courses of
action that are suitable in specific circumstances, such as an audit mission or the accounting of
economic transactions considering accounting principles. With the exercise of professional skepticism
and professional judgment, an auditor could be expected to determine and assess risks of material
misstatements, gather appropriate and sufficient audit evidence, and render an opinion on the financial
statements.
 In conclusion, it is significant to understand the different concepts in conducting an audit so as
to maintain a quality work. It is as well important to have financial statements be audited as this would
help increase the credibility of the financial statements and builds or enhances the confidence of the
intended users whether the accounts are fairly presented and true. This would also help in improving a
company’s internal controls and systems.

2. Discuss the pre-conditions to audit.

Under the PSA 210, it defines the preconditions to audit which includes determining whether
the financial reporting framework to be applied in the preparation of the financial statements is
acceptable; and obtain the agreement of management, where appropriate, those charged with
governance that it acknowledges and understands its responsibility.

There are only two things that the auditor must remember and do in compliance with the
preconditions for an audit. To begin with, the auditor must identify the appropriateness and
acceptability of the financial reporting framework to be applied in the preparation of the financial
statements. This involves assessing whether the law or regulation prescribes the applicable financial
reporting framework, considering the purpose of the financial statements, and the nature of the
reporting entity. In most cases this will essentially be a matter of affirming with the client that the
financial statements will be prepared under a financial reporting framework. Next thing that the auditor
must do is to obtain agreement that the management or those charged with governance acknowledges
and understands their responsibilities that includes the following: (1) Preparation of the financial
statements in compliance with that financial reporting framework; (2) Creating and upholding internal
control systems that are adequate to ensure that the preparation of financial statements are free from
material misstatement, whether due to fraud or error; and (3) Providing the auditor with access to
information significant to the preparation of the financial statements, allowing additional information
requested by the auditor from the management for the purpose of the audit, and enabling the auditor
to access individuals within the entity from whom the auditor may wish to collect audit evidence as it
deems necessary. In connection to this, if the management or those charged with governance inflict a
limitation on the scope of the auditor’s work, the auditor should decline such a limited engagement as
an audit engagement if that limitation would render the auditor to disclaiming an opinion on the
financial statements, unless required by law or regulation to do so. Furthermore, in case of the absence
of the preconditions for an audit, the auditor must discuss the matter with the management or those
charged with governance. Unless required by the law or regulation to do so, the engagement shall be
declined in instances that the financial reporting framework is neither appropriate nor acceptable, or if
the management has failed to provide the agreement needed by the auditor.

In conclusion, preconditions to audit is very important because it serves as the basis whether
the auditor would accept or continue the audit engagement. This is essential to ensure that the
reporting framework applied is suitable.

3. Explain the importance of the following:

a. Review
b. Consultation
c. Engagement quality control review

Under the PSA 220, quality control for an audit of financial statements provides guidance on the
regulation of persons who function as members of the engagement team and extend assistance to the
auditor in planning and performing auditing processes. With this, important terms must be clearly
understood to better implement quality control procedures at the engagement level that provide the
auditor with reasonable assurance.

Under engagement performance, review, consultation, and engagement quality control review
plays important role. Review is important because it ensures that the work performed is in accordance
with professional standards and regulatory requirements, as well as with the firm’s review policies and
procedures. Review is significant as it is a way of determining whether appropriate consultations have
taken place. Also, review helps to determine if the work performed supports the conclusions reached,
that the evidence collected is sufficient and appropriate to support the audit observations and
conclusions, and that the resulting conclusions is appropriately documented and implemented. Through
this, we will be able to know if the objectives of the engagement have been attained.

Consultation on the other hand is equally important because it helps reducing the risk of error and
develops the application and exercise of professional judgment. Engagement team members shall apply
their cumulative knowledge, abilities, and experience in solving difficult or contentious matters and in
completing the audit. Consultation within team members is beneficial to reach sound conclusions and
for staff development and training. Also, consultation between teams is encouraged as team members
can benefit from the experience of others with similar audit entities or having the same accounting or
audit issues. The engagement partner is also expected to be satisfied with the nature and scope of such
consultations is in agreement with the party consulted, and the reached conclusions are documented
and implemented.

Meanwhile, engagement quality control review is essential as this provide an objective evaluation of the
relevant judgments the engagement team made and the conclusions it reached in formulating the
report. This objective evaluation includes discussion of significant matters with the engagement partner,
review of the financial statements or other subject matter information and the proposed auditor’s
report, review of selected engagement documentation relating to the significant judgments the
engagement team made and the conclusions it reached, and evaluation of the conclusions reached in
formulating the auditor’s report and consideration of whether the proposed auditor’s report is
appropriate.

In conclusion, review, consultation, and engagement quality control review are all important
because all of them uphold and encourage consistency in the quality of engagement performance
through its policies and procedures.
1. Discuss the benefits and advantages of planning an audit engagement.

Audit planning is a means of determining ahead of time what is to be accomplished,

how it will be conducted and when it will be done by the auditor in order to have efficient,
timely and effective completion of work. Before actually conducting an audit, it is important
to first plan an audit engagement to have a specific guideline to follow which would help
the auditor to gather sufficient and appropriate evidence, maintain audit costs at a
reasonable level, and helps in preventing misunderstandings with the audit client. Generally,
audit planning ensures that the audit will be rendered in an effective manner.

Due to the significance of planning an audit engagement, it delivers benefits and

advantages which include enabling the auditor to give proper attention to major areas of
the audit, assisting the auditor in prompt detection and correction of possible problems,
ensuring timely completion of audit work, facilitating coordination of the audit work done
by auditors and other experts, 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, and facilitating the direction and supervision of
engagement team members and the review of their work.

Proper planning of an audit engagement is considered as an important prerequisite.

It is investment that is expected to pay returns in the later phase of the audit engagement.
Identifying a potential issue or complex audit area at the start of the planning process could
save time later in the audit. Although it may seem difficult, this additional effort may save
time as deadlines approach. Errors will likely happen if timing is shortened, forcing work to
be rushed. Thus, appropriate and effective audit plan is essential prior to the conduct of
audit to enhance the quality of audit work.

2. Discuss each element of a system of internal control.

Internal control systems are processes intended to safeguard an organization's assets,

avoid fraud and error, and achieve accurate and complete accounting records. Moreover,
controls serve as basis for accurate financial reporting, effective operations, and compliance
with laws and regulations. With this, the internal control system has certain elements to have a
satisfactory system of control.

One element of internal control system is the control environment. This element is crucial since
it’s the base for the other components of internal control. The control environment sets the tone on
how employees engage in their daily activities. The control environment includes the overall attitude,
awareness, and actions of the management and those charged with governance regarding entity’s
internal control and its importance in the entity. Control environment encompasses several factors
which include communication and enforcement of ethical values and integrity, commitment to
competence, participation by those charged with governance, philosophy of management and its
operating style, organizational structure, authority and responsibility assignment, and human resources
policies and procedures.

Second element is the entity’s risk assessment process.  Risk assessment is the determination, analysis,
and management of risks in preparation of financial statements. Appropriately recognizing risks permit
management to determine how to prevent and manage these risks. Risk factors relevant to financial
reporting include internal and external factors which could adversely affect the ability of an entity to
process and report financial data. Management should assess risk on a regular basis, as changes in an
organization could influence an organization’s risk assessment.

Third element is the information system, including the related business processes, relevant to financial
reporting, and communication. This is intended to initiate, record, process, and report entity
transactions and to maintain accountability for the related assets, liabilities, and equity; Resolve
incorrect processing of transactions; Process and account for system overrides or bypasses to controls;
Transfer information from transaction processing systems to the general ledger; Capture information
relevant to financial reporting for events and conditions other than transactions, such as amortization of
assets; and ensure information required to be disclosed by the applicable financial reporting framework
is accumulated, recorded, processed, summarized and appropriately reported in the financial
statements. To sum it up, this element relates to the identification and transfer of relevant information
on a timely basis that allows personnel to execute its responsibilities. For example, having timely
financial reporting allows management to detect irregularities in its operations.

Fourth element is the control activities. Control activities are policies and procedures that help
guarantee that management directives are carried out. One of the common and imperative control
activities is the segregation of duties. The goal of this control activity is obviously to prevent an
individual to be assigned on a specific responsibility that would make him vulnerable to commit fraud or
any unethical conduct. Therefore, different individuals must be tasked for authorizing transactions,
recording transactions, having custody of assets, and performing reconciliations so as to avoid any errors
or fraud.

Last element is the monitoring of controls. This is the process that an entity applies in evaluating the
quality of internal control over time. The management is responsible for monitoring all controls and to
identify if the controls are operating effectively as intended. If not, management then modifies these
controls as appropriate. Moreover, monitoring is often done through a company’s quality assurance or
internal control departments.

Therefore, each element of internal control system is significant because it aids in reducing the
risk of material misstatement, whether due to fraud or error, at financial statement level and assertion
levels which delivers an information that is complete, accurate, and is reliable.
3. Compare and contrast overall materiality, materiality for each account balances and disclosures,
and performance materiality.

Materiality is a concept or standard for auditing and accounting relating to the importance of the
amount, transaction or discrepancy. The materiality assessment of the auditor is a matter of
professional judgment and is influenced by the auditor's understanding of the financial information
needs of users of the financial statements. Information is material if its omission or misstatement may
have an effect on the economic decisions made by users on the basis of financial statements. Materiality
depends on the size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus, materiality establishes a threshold or a cut-off point rather than a primary
qualitative characteristic which information must have if it is to be useful.

Overall materiality, specific materiality and performance materiality have one thing in common – to set
a threshold base on auditor’s professional judgment to determine if the errors or misstatements
individually or aggregated could affect the financial statements as a whole. However, these three have
different functions. Overall materiality is the level that is judged by the auditor to represent what is
significant to the financial statements as a whole – the point at which the investment decisions of the
users would be influenced. It is used to assess whether the financial statements as a whole are free from
material misstatements. Its primary purpose is to identify performance materiality (which is needed, for
example, to help auditors design their audit procedures) and a clearly trivial threshold for accumulating
misstatements. Specific materiality could relate to sensitive areas such as particular note disclosures
(that is, management remuneration or industry-specific data), compliance with legislation or certain
terms in a contract, or transactions upon which bonuses are based. It could also relate to the nature of a
potential misstatement such as an illegal act, non-compliance with loan covenants and
statutory/regulatory reporting requirements. Sometimes an auditor may wish to use specific materiality
for particularly high-risk items such as cash, revenue or related party transactions. Performance
materiality is a smaller percentage of overall materiality that is determined by the level of audit risk.
Higher risk, lower percentage and vice versa. Performance materiality is used in gathering evidence to
help evaluate misstatements that have the potential to be quantitatively material in aggregate.

There are no rules that can be applied consistently to determine materiality. Materiality is a relative
term. What may be material in one circumstance may not be material in another. The concept of
materiality recognizes that some matters, either individually or in aggregate, are important if the
financial statements are to be presented fairly, in all material respects, in accordance with applicable
reporting framework. The auditor must therefore consider not only each misstatement separately, but
also the aggregate effect of all misstatements. In the end, the assessment of what is material is a matter
for the professional judgment and experience of the auditor.
Elements of quality control

The Elements of a System of Quality Control and procedures at audit firm level
includes leadership responsibilities for quality within the firm, relevant ethical
requirements, acceptance and continuance of client relationships and specific
engagements, human resources, engagement performance and monitoring.
 
Leadership responsibilities for quality within the firm is an essential element
since this pertains to the firm creating policies and procedures intended to
encourage an internal culture. This promotion of internal culture within the firm
equates to the quality provided in performing engagements. The firm shall
establish policies and procedures in which any person assigned with the
responsibility must be competent enough and has sufficient and appropriate
experience and capability, and the necessary authority, to undertake that
responsibility. In ethical requirements, the firm shall establish policies and
procedures designed to deliver it with reasonable assurance that the firm and
its personnel comply with relevant ethical requirements. This element is based
on the compliance with the code of ethics and its fundamental principles and is
very important to consider to avoid any threat or incase of any threats, it can
be mitigated or eliminated immediately or reduced to an acceptable level. The
element acceptance and continuance of client relationships and specific
engagements is also very essential. Procedures and policies must be
established with regards to this element because before accepting a client or
continuing to engage in providing audit service to a client, a firm must first
ensure that it is competent enough to perform the engagement and has the
competences and skills, including time and resources, to provide the service. It
must be that before accepting specific engagements, the firm or audit team is
able to comply with relevant ethical requirements, and has considered the
integrity of the client. The element human resources on the other hand must
provide also policies and procedures to ensure that the firm perform
engagements in a manner that complies with professional standards and
regulatory and legal requirements and enable the firm or engagement partners
to issue reports that are appropriate in the circumstances. In applying policies
and procedures in this element, one can establish, determine and control the
number and characteristics of the individuals that is required in the firm. The
element engagement performance is also vital for establishing and improving
system of quality control for public accountancy firms. Such policies and
procedures shall contain matters relevant to promoting consistency in the
quality of engagement performance, supervision responsibilities, and review
responsibilities. The firm’s 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. The last element
which is monitoring simply advocates the necessity to implement or consider
evaluation of firm’s system of quality control, including periodic inspection of a
selection of completed engagements.
 
In conclusion the elements of System of Quality Control and procedures at
audit firm level are all important and significant in attaining and ensuring that
the firm is able to provide or render service that is with quality provided by
competent professional accountants.