MODULE 2: AUDIT, AN OVERVIEW

I. Description
This module discusses on the basic principles of Audit and its primary functions and its
classification.

II. Objectives
After completing the module, the students are expected to:

 Define Audit
 Identify the different types of Audits and Auditors
 Understand the Independent Audit of Financial Statements
 State the general principles governing the audit of financial statements
 Identify the theoretical framework of Auditing

III. Duration
Start: Week 3
End: Week 3

IV. Learning Contents

A. Definition

Philippine Standards on Auditing

This definition describes financial statements audit only, a more comprehensive

definition is given by the American Accounting Association:

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 the assertions and established criteria
and communicating the results to interested users.

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Desiree D. Cemefrania, CPA
 Definition of Terms:

1. Assertions – representation made by the entity about economic actions and

events.

2. Objectivity – requires the auditor to make impartial assessment of all the

relevant circumstances in forming a conclusion.

3. Established Criteria – needed to judge the validity of the assertions.

B. TYPES OF AUDIT

1. Financial Statement Audits is conducted to determine whether the financial

statements of an entity are fairly presented in accordance with the applicable
financial reporting framework.

2. Compliance Audit involves the review of an organization’s procedures to determine

whether the organization has adhered to the specific procedures, rules or
regulations. The criteria are established by an authoritative body.

Example: BIR examination audit, BSP compliance audit

3. Operational Audit study of a specific unit of an organization for the purpose of

measuring its performance. The main purpose is to:
a. Assess the entity’s performance
b. Identify areas for improvement
c. Make recommendations to improve performance

Operational Audit is also known as Performance Audit or Management Audit. The

criteria for this type of audit are not clearly established. The criteria are based on the
organization’s standards and objectives.

Financial Statement Compliance Audit Operational Audit

Audit
Assertions The FS are fairly The organization has The organization’s
presented complied with the activities are
laws, regulations or conducted efficiently
contracts and effectively
Established Criteria Financial Reporting Laws, regulations Objectives set by the
Framework and contracts Board of Directors
Content of the report Opinion on the fair Reports on the Recommendations
presentation of the degree of on the improvements
FS in accordance compliance with the of the operations
with financial applicable laws,
reporting framework regulations and
contracts

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Desiree D. Cemefrania, CPA
 C. GENERAL CHARACTERISTICS OF AUDIT

There are different kinds of audit, but all of them possess the following:

1. Systematic examination and evaluation of evidence undertaken to ascertain

whether assertions comply with the established criteria.

2. Communication of the results of the examination, in a written report, to the party by

whom, or whose behalf, the auditor was appointed.

D. TYPES OF AUDITORS

1. External Auditors/ Independent Auditors

These are Certified Public Accountants who offer their professional services to clients
on a contractual basis. They generally perform the Financial Statements Audit.

2. Internal Auditors

Internal Auditors are the entity’s own employees who investigate and appraise the
effectiveness and efficiency of the operations and internal controls. They usually
perform Operational Audit.

3. Government Auditors

These are government employees whose main objective is to determine whether

persons or entities comply with government laws and regulations. They usually
perform Compliance Audit.

E. INDEPENDENT FINANCIAL STATEMENT AUDIT

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

 Responsibility of the Financial Statements

The management is responsible for preparing and presenting the financial

statements in accordance with the applicable financial reporting framework.

The auditor’s responsibility is to form and express an opinion on these

financial statements based on the audit result. An audit of financial statement
does not relieve the management of its responsibilities.

 Assurance Provided by the Auditor

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Desiree D. Cemefrania, CPA
 The assurance provided by the auditor is not a guarantee that the financial
statements are dependable. An audit conducted in accordance with PSAs
provides a reasonable assurance that the financial statements are free from
material misstatements. Inherent limitations are existent that could affect the
auditor’s ability to detect material misstatements.

 Nature of the Procedure

Practical and inherent limitations on the auditor’s ability to obtain evidence

1. The use of testing or sampling risk.

Due to cost constraint (and time constraint), auditors do not examine all
evidence available. Many audit conclusions are made by examining sample of
evidence only. When using a sample there is a possibility that the conclusions
drawn from the sample may be different from the conclusion that would have
been reached if the auditor examines the entire population.

2. Error in the application of judgement or non-sampling risk

Even if the auditor examines all evidences, there is no absolute assurance

that material misstatements will be detected, because the work undertaken by
the auditor to form an opinion is permeated by judgement. There is a
possibility of error in judgement that may cause mistakes in the application of
audit procedures.

 Nature of Financial Reporting

Application of PFRS involves estimation and judgement by the management.

Most financial statement items involve subjective decisions that are subject to
inherent variability that cannot be eliminated by performing audit procedures.

 Nature of Evidence

The audit is evidence is generally persuasive rather than conclusive in nature. This
is because audit evidence comprises pieces of information and impressions that are
gradually accumulated during the course of audit, and when taken together
persuade the auditor about the fairness of the financial statements.

There is what we call inherent limitation; an unavoidable risk that even an audit
conducted in accordance with PSAs may not be able to detect material
misstatements in the financial statements. Subsequent discovery of the material
misstatement in the financial statements does not itself indicate a failure to conduct
the audit in accordance with PSAs.

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Desiree D. Cemefrania, CPA
 The auditor’s opinion is not an assurance as to the future viability of the entity nor the
efficiency or effectiveness with which management has conducted the affairs of the
entity

F. GENERAL REQUIREMENTS WHEN AUDITING FINANCIAL STATEMENTS

PSA 200 – Overall objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with the Philippine Standards on Auditing

The objective of audit is to enhance the degree of confidence of the intended users in the
financial statements.

1. The auditor should comply with the ethical requirements relating to an audit of
financial statements, as stated in the code of ethics for CPAs (Part A and B) in order
to retain public confidence in the credibility of the auditors’ work.

a. Integrity
b. Objectivity
c. Professional Competence and Due Care
d. Confidentiality
e. Professional Behavior

2. The auditor shall plan and perform an audit with professional skepticism
recognizing that circumstances may exist that cause the financial statements to be
materially misstated.

Professional Skepticism is an attitude that includes a questioning mind, being alert to

conditions that may indicate possible misstatement due to error or fraud, and a
critical assessment of audit evidence.

3. The auditor shall exercise professional judgement in planning and performing an

audit of financial statements.

Professional Judgment – the application of relevant training, knowledge and

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

Informed decisions throughout the audit cannot be made without the application of
professional judgement to the facts and circumstances.

4. To obtain reasonable assurance, the auditor shall obtain sufficient appropriate

audit evidence to reduce the risk to an acceptably low level and thereby enable the
auditor to draw reasonable conclusions on which to base the auditor’s opinion.

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Desiree D. Cemefrania, CPA
 Audit evidence is needed to support the opinion expressed in the auditor’s report.
Sufficiency and appropriateness of the audit evidence is a matter of professional
judgement.

5. The auditor should conduct an audit with Philippine Standards on Auditing

(PSAs).

Philippine Standards in Auditing issued by the Auditing and Assurance Council (AASC),
and according to PSA 200, are to be applied in assurance engagements other than
audits or reviews of historical financial information. PSAs contain the basic principles and
essential procedures which the auditor should follow. It contains explanatory and other
materials that are designed to assist auditors in interpreting and applying auditing
standards.

In the auditor’s report, the auditor represent compliance with PSA.

Sample script from the auditor’s report:

G. WHY IS THERE A NEED FOR INDEPENDENT FINACIAL STATEMENTS AUDIT?

1. Conflict of Interest between management and the users of financial statement.

Management are often times placed in a position where they can benefit from overly
optimistic financial result, outside parties however want unbiased, realistic financial
statements. Because of this conflict, users have become skeptical of unaudited
financial statements.

2. Expertise

Most users of financial information are not equipped with the skills and competence
to determine whether the financial statements are reliable, a qualified person is hired
by users to verify the reliability of the financial statements on their behalf.

3. Remoteness

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Desiree D. Cemefrania, CPA
 Users of financial statements are usually prevented from directly assessing the
reliability of the information. They do not have direct access to the entity’s records to
personally verify the quality of the financial information. Therefore, an independent
auditor is needed to assist them in verifying the reliability of the financial information.

4. Financial consequences

Misleading financial information could have substantial economic consequences for a

decision maker. Therefore, it is important that financial statements must be audited
first before they are used for making important decisions.

H. THEORETICAL FRAMEWORK OF AUDIT

Theoretical framework of Auditing is a selected postulates, assumptions or ideas that

support many auditing concepts and standards.

1. Audit function operates on the assumption that all financial data are verifiable.

Verifiability of the balances is embodied in the supporting documents or evidence

to prove their validity. If no evidence exists, there can be no audit to perform.

2. The auditor should always maintain independence with respect to the financial
statements under audit

The report of the auditor will be of no or little value if the readers are aware that
the auditor is not independent with respect to the client.

3. There should be no long term conflict between the auditor and the client
management

Both parties must be interested in the fair presentation of the financial

statements.

4. Effective internal control system reduces the possibility of material misstatements

of the financial statements.

The condition of the entity’s internal control directly affects the reliability of the
financial statements. The stronger the internal control, the more assurance is
provided about the reliability of the data.

5. Consistent application of the applicable financial reporting framework such as the

PFRS results in fair presentation of financial statements

It is assumed that fair presentation is achieved when the applicable financial

reporting framework is applied. Any deviation from the specific requirements
would render the financial statements materially misstated.

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Desiree D. Cemefrania, CPA
 6. What was held true in the past will continue to hold true in the future in the
absence of known conditions to the contrary.

Knowledge accumulated in a client from prior audit years can be determine the
audit procedures to be performed.

7. An audit benefits the public.

V. References

 Auditing Theory by J. Salosagcol, Tiu and Hermosilla

 Philippine Standards on Auditing 200

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Desiree D. Cemefrania, CPA