AUDITING THEORY OCTOBER 7, 2021

INTRODUCTION
TO FINANCIAL
STATEMENT
AUDIT
CHAPTER 7
 INTRODUCTION TO FINANCIAL STATEMENT AUDIT

Auditing is a 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.

This definition includes several key words and phrases

briefly discussed in this section:
PAGE: 1
1 SYSTEMATIC PROCESS
This implies a structured, logical, and organized series of steps and procedures.
Auditing consists of a series of sequential steps that include information
testing system and testing of transactions and balances

2 COMPETENT, INDEPENDENT PERSON

The auditor must be qualified to understand the criteria used and the
competence to know how and what evidence to accumulate to reach the
proper conclusion. The auditor must also have an independent mental attitude
which involves impartial and objective thinking.

3 OBJETIVELY OBTAINS AND EVALUATE EVIDENCE

This means examining the bases for the assertions (representations) and
judiciously evaluating the results without bias or prejudice either for or against
the individual (or entity) making the representations.
4 ASSERTIONS ABOUT ECONOMIC ACTIONS AND EVENTS
These are the representations made by the individual or entity. They comprise the subject
matter of auditing. Assertions include information contained in financial statements,
internal operating reports, and tax returns. In the audit of financial statements, assertions
are the representations of management as to the fairness of the financial statements.

5 DEGREE OF CORRESPONDENCE
This refers to the closeness with which the assertions can be identified with established
criteria. The expression of correspondence may be quantified, such as the amount of a
shortage in a petty cash fund, or it may be qualitative, such as the fairness (or
reasonableness) of financial statements.

6 ESTABLISHED CRITERIA
These are the standards against which the assertions or representations are judged.
Criteria may be specific rules prescribed by a legislative body, budgets and other measures
of performance set by management, or financial reporting standards established by the
Financial Reporting Standards Council (FRSC) and other authoritative bodies.
 COMMUNICATING INTRESTED
5 6
THE RESULTS USERS

This is often referred to as These are individuals who use (rely on)
attestation. The final stage in the the auditor's findings. In a business
audit process is the audit report the environment, this includes
communication of the findings to stockholders, management,
users. By attesting to the degree of creditors, governmental agencies,
correspondence with established and the public.
criteria, the investigator enhances
(or weakens) the credibility of the
representations or claims that have
been made by another party. The
communication of findings is
achieved through a written report.
 INTRODUCTION TO FINANCIAL STATEMENT AUDIT

The IFAC Education Committee defines auditing as follows: "Auditing is a

structured process that:

Involves the application of analytical skills, professional judgment,

professional skepticism;
Is usually performed by a team of professionals, directed with managerial
skills
Uses appropriate forms of technology and adheres to a methodology;
Complies with all relevant technical standards, such as International
Standards on Auditing (ISAS), International Standards on Quality Control
(ISQCS), International Financial Reporting Standards (IFRS), International
Public Sector Accounting Standards (IPSAS), and any applicable
international, national or local equivalents as appropriate, and
Complies with required standards or professional ethics."
PAGE: 5
 The Philippine Standards on Auditing
OBJECTIVES OF (PSA) 120 "Framework of Philippine
AUDITING Standards on Auditing" states the
objective of an audit as follows:

INTRODUCTION TO 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. The phrase used to express the
auditor's opinion is present fairly, in all material respects. A similar
objective applies to the audit of financial or other information
prepared in accordance with appropriate criteria.
In conducting an audit of financial statements, the overall responsibilities of the
auditor are:

A B

To obtain reasonable assurance

about whether the financial
statements as a whole are free
To report on the financial
from material misstatement,
statements, and communicate as
whether due to fraud or error,
required by the Philippine Standards
thereby enabling the auditor to
on Auditing (PSAs), in accordance
express an opinion on whether the
with the auditor's findings
financial statements are prepared,
in all material respects, in
accordance with an applicable
financial reporting framework, and
AUDITNG THEORY

SCOPE OF
INDEPENDENT
AUDIT
SCOPE OF AN INDEPENDENT UNIT
The term "scope of an audit" refers to the audit procedures deemed
necessary in the circumstances to achieve the objective of the audit. The
procedures required to conduct an audit in accordance with PSAs,
relevant professional bodies, legislation, regulation and, where
appropriate, the terms of the audit engagement and reporting
requirements.

When sufficient and competent audit evidences have been gathered, the
auditor can then formulate his opinion n the fairness with which the
financial statements have been prepared. 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 of the report to various interested parties
AUDITNG THEORY

WHY
INDEPENDENT
FINANCIAL
AUDITING IS
NECESSARY?
Without wide public acceptance, This is referred to as "Information
professions cannot exist, and Risk". Some of the factors that
independent auditing is no
exception. Over the years, contribute to information risk are:
society has perceived a need for
audits of publicly held companies, Remoteness of information users
which has developed as a result
of the separation of ownership from information providers
and management.
Potential bias and motives of
Auditing services are used
extensively by business
information provider
government, and other not-for-
Voluminous data
profit organizations. As society
becomes more complex, there is Complex exchange transactions
an increased likelihood that
unreliable information will be Consequences
provided to decision makers.
AUDITNG THEORY

HOW
INFORMATION
RISK MAY BE
REDUCED?
To reduce information risk or the risk that information upon which a business
decision is made is inaccurate, managements of businesses and the users of their
financial statements may adopt any or all of the following approaches:

A B

1. Allow users to verify information. 2. User shares information risk

The user may go to the business
establishment to examine records and
obtain information about the reliability
of the statement. Although impractical
because of costs, this is usually adopted
by BIR examiners or a business intending
to purchase another business. It is
common for a purchaser to use a
special audit team to independently
verify and evaluate key information of
the prospective business. This is also
known as "due diligence audit"
with management.
It is important to emphasize the
fact that management has the
primary responsibility of providing
reliable information to users. If
users rely on inaccurate financial
statements and as a consequence
incurs a financial loss, a lawsuit may
be brought against management to
recover part of such.
AUDITNG THEORY

3. Have the financial statements audited.

To obtain reliable information, the user can

have an independent audit performed. The
audited information is then used in the decision
making process on the assumption that it is
reasonably complete, accurate, and unbiased.
 INTRODUCTION TO FINANCIAL STATEMENT AUDIT

ADVANTAGES AND PRACTICAL BENEFITS

OF INDEPENDENT AUDIT

TO THE AUDITEE OR TO CREDITORS,

PROSPECTIVE
CLIENT INVESTORS, EMPLOYEES

TO GOVERNMENT AGENCIES
AND LEGAL COMMUNITY

PAGE: 15
AUDITNG THEORY

OVERVIEW OF THE
AUDIT OPINION
FORMULATION
PROCESS
AUDITNG THEORY

ACTIVITIES OF
EACH PHASE OF
THE AUDIT
OPINION
FORMULATION
PROCESS
MANAGEMENT ASSERTIONS AND FINANCIAL STATEMENTS
Financial statement assertions are management's expressed or implied
claims about information reflected in the financial statements. Assertions
are central to auditing because they are the focus of the auditor's evidence
collection effort. In other words, much of what auditors do revolves around
collecting and evaluating evidence about management's financial statement
assertions.

One of the main tasks of the auditor is to collect sufficient appropriate

evidence that management's assertions regarding the financial statements
are correct. The process is really quite logical and intuitive. First, you would
carefully consider the most important assertions the company is making
about the account, and then you would decide what evidence you would
need to substantiate the truthfulness of each important assertion.
Assertions about classes of transactions and events
(and related disclosures) for the period:

Occurrence: Transactions and events Accuracy: Amount and other data

that have been recorded or disclosed
have occurred, and such transactions
and events pertain to the entity.
Completeness: All transactions and
events that should have been recorded
have been recorded, and all related
disclosures that should have been
included in the financial statements
been included.
Authorization: All transactions and
events have been properly authorized.
relating to recorded transactions and
events have been recorded
appropriately, and related disclosures
have been appropriately measured and
described.
Cutoff: Transactions and events have
been recorded in the correct
accounting period.
Classification: Transactions and
events have been recorded in the
proper accounts
AUDITNG THEORY

PREPARATION

Transactions and events are appropriately

aggregated or disaggregated and clearly
described and related disclosures are relevant
and understandable in the context of the
requirements of the applicable financial
reporting framework.
Assertions about account balances
(and related disclosures) at the period end:
Existence: Assets, liabilities, and equity
interests exist.
Rights and obligations: The entity holds
or controls the rights to assets, and
liabilities are the obligations of the entity.
Completeness: All assets, liabilities, and
equity interest that should have been
recorded have been recorded, and all
related disclosures that should have been
included in the financial statements have
been included.
Accuracy, valuation, and allocation:
Assets, liabilities, and equity interests
have been included in the financial
statements at appropriate amounts,
and any resulting valuation or allocation
adjustments have been appropriately
recorded, and related disclosures have
been appropriately measured and
described
Classification: Assets, liabilities, and
equity interests have been recorded in
the proper accounts
AUDITNG THEORY

PRESENTATIONS

Assets, liabilities, and equity interests are

appropriately aggregated or disaggregated
and clearly described, and related disclosures
are relevant and understandable in the context
of the requirements of the applicable financial
reporting framework.
AUDITNG THEORY

CORE CONCEPTS
IN FINANCIAL
STATEMENT AUDIT
THREE FUNDAMENTAL CONCEPT:
MATERIALITY
Materiality refers to the amount by which a set of
financial statements could be misstated without
affecting the judgment of reasonable person. It also
refers to the magnitude of an omission or misstatement
of accounting information that, in the light of
surrounding circumstances make is probable that the
judgment of a reasonable person relying on that
information would have been changed or influenced by
the omission or misstatement.
EVIDENCE
The third concept involved in auditing is evidence
regarding management's assertions, or, more simply, audit
evidence. Most of the auditor's work in arriving at an
opinion on the financial statements consists of obtaining
and evaluating audit evidence relating to management's
assertions. Audit evidence consists of the underlying
accounting data and any additional information available to
the auditor, whether originating from the client or
externally.
AUDIT RISK
Audit Risk the second major concept involved in
auditing is audit risk, which is the risk that the
auditor may mistakenly give a "clean" opinion on
financial statements that are materially misstated.
Audit risk is the risk that the auditor mistakenly
expresses a clean audit opinion when the financial
statements are materially misstated.
EVIDENCE
The assertions, in conjunction with assessment of
materiality and audit risk, are used by the auditor to
determine the nature, timing, and extent of evidence to be
gathered Once the auditor has obtained sufficient
appropriate evidence that the management assertions can
be relied upon for each significant account and disclosure,
the auditor has reasonable assurance that the financial
statements are fairly presented Note the two key
descriptors of audit evidence: sufficient and appropriate
AUDITNG THEORY

GENERAL
PRINCIPLES OF AN
AUDIT
(COMPLIANCE WITH
ETHICAL
REQUIREMENTS)
The auditor should
comply with the "Revised (a) independence;
Code of Ethics for
(b) integrity;
Professional
Accountants in the (c) objectivity;
Philippines" promulgated
by the Board of (d) professional competence and
Accountancy and
approved by the
due care,
Philippine Professional (e) confidentiality,
Regulation Commission
Ethical principles (f) professional behavior; and
governing the auditor's
professional (g) technical standards.
responsibilities are:
 Reasonable assurance is a concept relating to the

REASONABLE accumulation of the audit evidence necessary for

the auditor to conclude that there are no material

ASSURANCE misstatements in the financial statements taken

as a whole. Reasonable assurance relates to the
whole audit process.

INTRODUCTION TO FINANCIAL STATEMENT AUDIT

However, there are inherent limitations in an audit that affect the

auditor's ability to detect material misstatements. These limitations

result from factors such as - the use of testing, the inherent

limitations of any accounting and internal control system (for
example, the possibility of collusion) and the fact that most audit
evidence is persuasive rather than conclusive.
Responsibility for the Financial
Statements.
While the auditor is responsible
for forming and expressing an
opinion on the financial
statements, the responsibility for
preparing and presenting the
financial statements is that of
the management of the entity.
The audit of the financial
statements does not relieve
management of its
responsibilities.
Skills and Knowledge Needed in
Financial Statement Audit
Audits are performed in teams where
each auditor is expected to complete
tasks requiring considerable technical
knowledge and expertise, along with
leadership, teamwork, and professional
skills. In terms of technical knowledge
and expertise, auditors must
understand accounting and auditing
authoritative literature, develop
industry and client-specific knowledge,
develop and apply computer skills,
evaluate internal controls, and assess
and respond to fraud risk.
 PARTIES INVOLVED IN PREPARING
AND AUDITING FINANCIAL
STATEMENTS
INTRODUCTION TO FINANCIAL STATEMENT AUDIT

Various parties are involved in the preparation and audit of financial statements and
related disclosures Management has responsibilities for (a) presenting financial
statements in accordance with the applicable financial preparing and reporting
framework, (b) designing, implementing and maintaining internal control over
financial reporting, and (c) providing the auditors

with information relevant to the
financial statements and internal controls. The internal audit function provides
management and the audit committee with assurance on internal controls and
repots The audit committee, a subcommittee of the organization's board of
directors, oversees both management and the internal auditors, and they also hire
the external auditor
The Context of Financial
Statement Auditing
You have already learned about
different kinds of auditors and
audit services, public
accounting firms, and the
auditor's role in society. Now let
us turn our attention to the
primary context that shapes
the external auditor's
environment: the business or
entity being audited.
The Business Entity as the Primary
Context of Auditing
In studying the subsequent chapters,
you will be building your auditing tool kit.
How you apply auditing tools on any
particular engagement will depend
greatly in the nature of the entity's
business.
The point is that the context provided
by the entity's business greatly impacts
the auditor and the nature of the audit
and is thus a primary aspect of the
environment in which financial
statement auditing is conducted
 RELATING IN THE AUDIT PROCESS
COMPONENTS TO THE BUSINESS
MODEL
INTRODUCTION TO FINANCIAL STATEMENT AUDIT

Most businesses establish processes that fit in broad business process categories,
also known as business cycles. The five categories that characterize the processes
of most businesses are:

1 Revenue and collection cycle

2. Purchases and disbursement cycle

3. Payroll
4. Inventory Warehousing Transaction
5. Financing Process

Each business process involves a variety of important transactions.

AUDITNG THEORY

The enterprise designs and implements,

accounting information system to capture
the details of those transactions. It also
designs and implements a system of
internal control to ensure that the
transactions are handled and recorded
appropriately and that resources are
protected.
AUDITNG THEORY

The accounting information's system must

be capable of producing reliable financial
reports, which summarize the effects of the
organizations transactions on its account
balances and which are used to establish
management accountability to outside
owners.
AUDITNG THEORY

Auditors often rely on this process model

to divide the audit of a business's financial
statements into manageable pieces.
AUDITING THEORY OCTOBER 7, 2021

Thank you &

God bless!
Reported by:
Sushimita Jerielle
O. Cuevas, CPA.