Module 4

https://drive.google.com/file/d/1ZphB59EHnSDmm3Q0345yhhdLj0_hq0MI/view

FS Audit Process
● Definition of Auditing
● Complete Set of FS
● Objective of an audit and an auditor
● Responsibilities of Mgmt (5)
● Basic Concepts
● FS Audit Process

Notes (Video Lecture)

A. Definition — Auditing is the systematic process of objectively obtaining and evaluating evidence in order
to be able to establish a degree of correspondence between an assertion (financial statements) and
established criteria (PFRS) and evaluating the results to the intended users

B. Complete Set of FS
1. Statement of Financial Position
2. Statement of Comprehensive Income
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to the Financial Statement (within the scope of audit

C. Objective of an audit and an auditor

● Audit - ends with an expression of opinion (to be able to get the report)
● Auditor - to be able to obtain a reasonable assurance that the financial statements are free from
material misstatements (obtain reasonable assurance)

D. Responsibilities of Management
1. Identifying your financial reporting framework
2. Preparation and presentation of FS (responsibility of the management, not the auditor; the
responsibility of the auditor is the auditor report)
3. Implementing and effective internal control structure
4. Selecting accounting policies
5. Making accounting estimates

E. Basic Concepts
1. Auditor independence — the auditor must not be easily influenced; their decision must not be
easily subordinated to that of other
● Mind - only the auditor himself can determine if he is independent
● Appearance - whenever you look independent in the eyes of the public

2. Professional Skepticism — auditor must adapt an attitude of questioning mind

● Questioning mind — the auditor must not be gullible; not easily convinced with
whatever the client are presenting; that the management representation is not a
substitute for sufficient and appropriate evidence

3. Conduct of Audit — As a general rule, it must comply with the PSA and the practice statement
● Exceptions: If the auditor is belatedly appointed then chances are the client would
request that the confirmation letters to be no longer be sent because the client would
argue that by the time that the auditor would receive the confirmation reply, then the FS
has already been released. If that would be the case, sending of confirmation letters is
a required procedure under the PSA but the auditor would have no choice but to again
permit the client but what would be the remedy?
○ We have to perform alternative procedures and what could that be?
■ Tracing the collection in the subsequent cash receipts.

4. Scope of the Audit — laws, rules and regulations are superior to the PSAs

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 5. Audit Evidence
● Accounting records – General Journal, Special Journal, General Ledger
● Other Information
○ all evidence gathered by the auditor that has not formed part of the accounting
records
○ minutes, third party confirmation and the controls manual

6. Audit Materiality – material if it can affect one’s decision

● Threshold or cutoff point
● The lower the tolerable misstatement of the auditor, the higher the audit procedure that
must be performed

7. Audit Risk — the risk or likelihood that an auditor will issue an inappropriate opinion
- general type of information risk is audit risk
● Quantitative – usually at certain percentage (Ex: 8% of total assets)
● Non-quantitative – setting audit risk at either low, medium or high
● Formula: Inherent risk x Control risk x Detection risk
○ Inherent risk and control risk are components of risk of material misstatements

8. Risk of Material Misstatement — the risk that the Financial Statements are materially misstated
prior to the audit
i. Inherent Risk – risk that there is a misstatement even in the absence of internal control
structure (Ex: cash and inventory are highly liquid assets and are always susceptible to
theft. Without any consideration of internal control, it is prone to theft. We determine
inherent risk by professional judgment.
1. Financial Statement level (MIMO) – we assess this through interview with the
management
a. Management Characteristic
b. Industry Characteristic
c. Management
d. Integrity
e. Operating Characteristic
2. Account Balance Level
a. Susceptibility of an account to theft
b. Complexity of the account
c. Calculations
d. Underlying transactions
e. Degree off judgment
ii. Control Risk – risk that there is a misstatement that is not prevented/detected by the
internal control structure
1. Ex: No segregation of duties - Custody, authorization, recording and execution
must be, as a rule, assigned to different people but if it is assigned to one
person there is no segregation of duties. It will be considered to be a material
deficiency in the internal control structure.

● Inherent risk and control risk are independent components - we cannot alter and modify
them but we can only respond through by setting the detection risk
○ The relationship between the risk of material misstatement and detection risk
is inverse
■ Whenever you have high risk of material misstatement, the lower the
detection level you should set
■ Lower risk - higher level of detection risk
■ Reason: because we want to achieve efficiency and effectiveness of
our audit
○ Detection risk - risk that the misstatement that is not detected by the auditor

F. FS Audit Process
1. Pre-engagement
2. Audit planning

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 3. Consideration of internal controls
4. Evidence gathering or substantive testing
5. Completing the audit
6. Issuance of the audit report
7. Post-audit responsibilities

Pre Engagement
● Contents of Engagement Letter
● When to send a separate engagement letter (audit of a component)
● When to send a new engagement letter to a recurring client
● Change in terms of Engagement

Notes (Video Lecture)

1. Pre-engagement
- involves screening new and existing clients
- trying to determine “should I accept this new client, should I continue with a client that I already have?”
- prepare a checklist and do a research for a prospective or recurring client
- consider ethical requirements as early as the pre-engagement

Two Ethical Primary Requirements

1. Independence - annual independence confirmation every May 2 → the auditor
accomplishes a checklist to ensure that he has no conflict of interest in the engagement
- checklist: firm’s way to confirm that all assigned people in the team is
independent
2. Professional Competence
○ If you are not competent, do not accept the engagement except when you
have time to gain competence or money to hire experts to help/assist you in
the engagement.
○ If you don’t accept an engagement, refer another CPA

Things considered in the pre-engagement

● Communicate with the predecessor auditor
○ It is the successor auditor who initiates the communication
○ Always, client permission is required
○ Questions that you must ask the predecessor auditor
■ What are the disagreements between the predecessor auditor and
management about accounting principles and audit procedures?
■ What are the reasons for the change of auditor?
■ What are the matters that bear integrity on management?

- Predecessor auditor - the auditor for last year

- Successor auditor - current year auditor

A. Contents of Engagement Letter (MISUROT)

1. Managements’ responsibility for the FS
2. Inherent limitation of the audit
3. Scope of the engagement
4. Unrestricted access to the documents and records
5. Reports that to be issued
6. Objectives of the engagement
7. Timetable and fees

B. When to send a separate engagement letter (audit of a component) (IOSALE)

- You have an audit of component when there is a parent-subsidiary relationship
1. Independence of Component Management - if highly independent send a separate engagement
letter

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 2. Ownership by the parent
3. Separate, whenever a separate audit report is issued
4. who Appointed the component auditor
5. Legal requirements
6. Extent of any work performed by other auditor

C. When to send a new engagement letter to a recurring client

- generally, do not send an engagement letter
1. Misunderstanding
2. Legal requirement/new law
3. Change in reporting framework, ownership, nature or size of entity, term of engagement and
change in senior management

D. Change in terms of Engagement

- Initially you are contracted for an audit engagement and then a few days after it was changed and you will
be no longer performing audit instead you will perform a review
1. From review to audit – allowed; no restriction; level of assurance went higher from limited to
reasonable; can freely accept the engagement
2. From audit to review (the following reasons are justifiable)
● Change in circumstance - client hire you because he will obtain a loan from a bank but
the bank said that a review would already suffice
● Misunderstandings
● If no valid reason – not allowed

Audit Planning
1. Obtaining an understanding of the client and its environment
2. Determining the need for experts
3. Establishing materiality and assessing risk
4. Assessing the possibility of non compliance
5. Identifying related parties
6. Performing preliminary analytical procedure
7. Development of overall audit strategy and detailed audit plan; preparation of preliminary
audit program

Notes (Video Lecture)

2. Audit Planning
- You have to be able to determine the strategy/approach that will be adapted by the auditor.
- You have to be aware of the strengths and weaknesses of your client.

Two types of Strategy adapted by the auditor:

1. With reliance
● apply this approach when there is a less than high risk client
● client has strong internal control structure
2. No reliance approach
● when you a have high risk client
● client has weak controls

7. Development of overall audit strategy and detailed audit plan; preparation of preliminary audit
program
● Audit plan - summary of the procedures from the start to the end of the audit
○ Perform risk assessment procedures
■ Inquiry: weakest procedures, supported by another procedures (observation)
■ Inspection: supported by another procedures (observation)

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 ■ Observation
■ Analytics
● Audit program - procedure on an account or per transaction cycle (to do list)

Study and Evaluation of Internal Control

● Obtain and document understanding of internal control
● Make a preliminary assessment of control risk
● Determine the auditor’s response to risk assessment
● Reassess control risk
● Determine the nature, timing and extent of audit procedure

Notes (Video Lecture)

3. Study and Evaluation of Internal Control
- End product: you will be able to determine the nature, timing, and extent of audit procedures also known
as the scope of the audit.

Different Procedures in the Study and Development of Internal Control

1. Inquiry
2. Inspection
3. Observation
4. Re-performance
5. Walkthrough
● going through the transaction cycles of the clients and tracing through the system the
different source documents
● there is no need to gather samples because you’re just trying study the internal control
of the client

- Study of internal control is always required but evaluation of internal control is not always required.
- You only evaluate if the strategy that you’re going to adapt is the reliance approach.

Substantive Testing
● Description of Substantive Test
● Reporting of Audit Findings
● Resolution of Audit Differences

Notes (Video Lecture)

4. Substantive Testing
A. Procedures in Substantive Testing:
1. Inquiry – weakest procedure
2. Inspection
3. Observation – 2nd strongest
4. Analytics – 2nd weakest procedure
5. Recalculation
6. Confirmation – strongest procedure

B. Two types of Substantive Testing

1. Test of balance
● Trying to perform procedure in relation to the ending balance
● Example: In a general ledger, cash receipts = 10, disbursements = 8, ending balance of
cash = 2
2. Test of transaction
● Trying to perform procedures pertaining to the transaction
● Example: In a general ledger, cash receipts = 10, disbursements = 8, ending balance of
cash = 2

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 C. Reporting of Audit Findings & Resolution of Audit Differences
- report to client
- items require adjustments in the client’s books provided that the amount is considered to be material

1. Report to client
● Accepts the proposal – there is no problem (issue unqualified opinion)
● Does not accept the proposal – decided to stick to the original amounts in the financial
statements then the auditor has no choice but to modify the report
2. Added feature of services
● Recommendation letter
● Communicate to the client the different areas of internal control that need improvement

Completing the audit

● Final materiality judgments
● Summarizes and evaluates audit findings
● Reviews working papers
● Reviews financial statement presentation and disclosure
● Considers subsequent events

Notes (Video Lecture)

5. Completing the Audit
● Subsequent events review
○ Identify the events/transactions that happened after the reporting date (IAS 10, Events After the
Reporting Period) whether there is a need for an adjustment in Financial Statements or
additional disclosure

● Do your final review of the financial statements to ensure that all required disclosures are actually there in
the Financial Statements

Notes (Video Lecture)

6. Issuance of the Audit Report
The Different Auditors Report
1. Unqualified opinion - issued when the financial statements are fairly stated in all material respect (known
as the most common opinion)
2. Adverse opinion - when the financial statements are very materially misstated
3. Qualified opinion - known as “except for”
- when the financial statements are either materially misstated or there is a material scope
limitation
- the financial statements are fairly stated in all material respects except for the inventory account
which should be reported as..
4. Disclaimer - very material scope limitation
- when the auditor was not able to gather sufficient and appropriate evidence or
- there are impairment in independence that it is not appropriate for the auditor to issue an audit
report

Post Audit Responsibilities

● Considering events during the audit
● Analyzing the activities within the audit
● Producing recommendations

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