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    Escala Audit Assurance Ch1

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    Alexander Dimalipos

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    Chapter 1 - Fundamental Principles of Assurance Services CHAPTER 1 FUNDAMENTAL PRINCIPLES OF ASSURANCE SERVICES —_NDAMENTAL PRINCIPLES OF ASSURANCE SERVICES _ Chapter Overview and Objectives: This chapter discusses the fundamental principles of assurance services. At the end of this chapter, readers should be able to discuss 1. The fundamental principles of assurance services 2. The assurance services a. Definition b. Objective c. Elements d. Types (as to level of assurance and as to structure) e. Common examples The non-assurance services 4. The global organizations and standard-setting boards of the accountancy s profession 5. The professional standards governing assurance and non-assurance engagements [cer erannuE SInuDEEEsNESSIEEEEINSEEEEINNEESSSESNINNEEESITONSO ESSE” Relevant references: PFAE - Philippine Framework for Assurance Engagements PSA 120 - Framework of Philippine Standards on Auditing Preface - Preface to the Philippine Standards on Quality Control, Auditing, Review, Other Assurance and Related Services Aim... Believe... Claim... << Page 1 Chapter 1 - Fundamental Principles of Assurance Services INTRODUCTION TO ASSURANCE Decision-making has been a normal part of our lives. Countless number of decisions each and every day is made which can significantly affect a life of every person and of every organization. To have a favorable outcome, decision makers heavily rely on information available which, more often than not, is prepared or provided by other persons ‘or organizations. However, in most instances, the interests of the providers of information contradict with those of the users of the information. Thus, creating the need for an objective evaluation of the information in order to have a more reliable and dependable information. In business, reliable information becomes an essential aspect of decision-making. Decision makers gather relevant and reliable information prior to making any economic decisions that normally include the following: Users Economic decisions Potential and 7 to decide when to buy, hold or sell an equity existing investors | investment ¥ to assess the stewardship or accountability of management ¥ to determine distributable profits and dividends (for Board of Directors - BOD) Lenders and ¥ to assess the security for amounts lent to the entity other creditors Employees Y to assess the ability of the entity to pay and provide other benefits to its employees Government ¥ to determine taxation policies ¥ to prepare and use national income statistics ¥ to regulate the activities of entities “Lifted from Conceptual Framework for Financial Reporting Commonly, these users will rely on the financial information embodied in the financial statements presented and prepared by the entity where they plan to invest, grant a loan, request salary increases or additional benefits, or change taxation policies. This situation had created the need for independent Certified Public Accountant (CPA) who is equipped with appropriate skills and knowledge to objectively evaluate the information. The CPA is expected to provide reasonable assurance as to the fairness of preparation and presentation of the financial information. Such assurance will be expressed in the form of an opinion or conclusion which will later be communicated in an assurance report. ———— Aim... Believe... Claim... Page 2 Chapter 1— Fundamental Principles of Assurance Services What is assurance? Assurance refers to the practitioner’s satisfaction as to the reliability of an assertion being made by one party for use by another party. Simply stated, assurance means how sure or certain the practitioner is that the representation made by a particular party is reliable. ASSURANCE ENGAGEMENTS Definition Assurance engagement (or services) means an engagement in wl practitioner expresses a conclusion designed to enhance the degree of Confidence of the intended users other than the responsible party about the Outcome of the evaluation or measurement of a subject matter against criteria. hich a Assurance services are three-party contracts in which assurers report on (oF improve) the quality of information. It is used to describe the broad range of information enhancement services that are provided by CPAs. These services are performed by an independent professional designed to improve the quality or enhance the credibility of the subject matter of the engagement. Objective of assurance engagement The objective of an assurance engagement is for a practitioner to evaluate or measure a subject matter that is the responsibility of another party against identified suitable criteria and express a conclusion that provides the intended user with a level of assurance about that subject matter. Elements of assurance engagements Written Assurance Report Responsible Party Practitioner i Materiality iL aaa Sufficient Assurance E1 n lees Appropriate Risk ee pee Evidence Cost-Benefit Constraint Professional Skepticism Page 3 Chapter 1 - Fundamental Principles of Assurance Services ‘As depicted on the above diagram, the following are the elements of an assurance engagement (3SECC): ‘A. Athree-party relationship involving a practitioner, a responsible party, and intended users; ‘An appropriate Subject matter; Suitable Criteria; Sufficient appropriate Evidence; and ‘A written assurance report (Conclusion) in the form appropriate to a reasonable assurance engagement or a limited assurance engagement. moop ‘A. Three-Party Relationship: ‘An assurance engagement involves three se a. The practitioner is broader than the term auditor as used in Philippine Standards on Auditing (PSAs) and Philippine Standards on Review Engagements (PSREs), which relates only to practitioners performing audit and review engagements with respect to historical financial information must be independent to both the responsible party and the intended users «is governed by ethical requirements (i.e. professional competence) regarding the conduct of the engagements © may use the work of persons from other professional disciplines, referred to as experts for engagements requiring specialized skills and knowledge beyond those ordinarily possessed by an individual practitioner ‘responsible for determining the nature, timing or extent of procedures required by the engagement parate parties, namely So as not to be confused with the term professional accountant, practitioner and auditor, the following explains the uses of these terms. Professional | Certified Public Accountant engaged in any area of accountant _| accountancy Practitioner | CPA rendering professional services (assurance or non-assurance) Auditor A practitioner rendering audit and review services b. The responsible party © isthe person/s responsible to the subject matter, the subject matter information, or both may or may not be the engaging party to the practitioner . ae may not be from the same organization with the intended * maybe one of the intended users, but should not be the only one —_—_—_—_—_———————————— i Page 4 Chapter 1 — Fundamental Principles of Assurance Services c. The intended users * are the person/s for whom the practitioner prepares the assurance report. The assurance report shall be addressed to all users whenever practical. * in case of broad range of interests by the readers of assurance report, intended user may be limited to major stockholders with significant and common interests. «may be identified by agreement between the practitioner and the responsible party or engaging party, or by law. Once identified, the report to be issued must be restricted only to parties identified. B. Appropriate Subject Matter Subject matter is the nature of the assertion the practitioner gathers sufficient evidence. On the other hand, subject matter information pertains to the outcome of the evaluation or measurement of the subject matter. It is for which the practitioner gathers sufficient appropriate evidence to provide a reasonable basis for expressing a conclusion in an assurance report The subject matter, and subject matter information, of an assurance engagement can take many forms. Table below summarizes illustration given in the Philippine Framework for Assurance Engagements. Form Subject matter eee information Financial historical or recognition, performance or | prospective financial | measurement, conditions position, financial presentation and performance and cash | disclosure represented in flows financial statements Non-financial performance ofan _| key indicators of performance or | entity efficiency and conditions effectiveness Physical capacity ofa facility | Specifications document characteristics Systems and an entity's internal | assertion about processes control or IT system _| effectiveness Behavior corporate statement of compliance governance, ora statement of compliance with effectiveness regulation, human resource practices —————— Aim... Believe... Claim Pages Chapter 1— Fundamental Principles of Assurance Services Furthermore, subject matters have different characteristics, including | degree to which information about them is: ing Y qualitative versus quantitative; Y objective versus subjective; Y historical versus prospective; and ¥ relates to a point in time or covers a period. such characteristics affect the: a. Precision with which the subject matter can be evaluated or me, against criteria; and are b. The persuasiveness of available evidence. The assurance repo, characteristics of particular relevance to the intended users, Tt Notes Characteristics of a subject matter to be considered appropriate ‘An appropriate subject matter is: Identifiable, and capable of consistent evaluation or measuremen | against the identified criteria; and b. Such that the information about it can be subjected to procedures fy gathering sufficient appropriate evidence to support a easonable assurance or limited assurance conclusion, as appropriate. a. Cc. Criteria The benchmarks used to evaluate or measure the subject matter including where relevant, benchmarks for presentation and disclosure. Criteria may be a. Formal > PERS - preparation of financial statement Established internal control framework (e.g. COSO) or internal control objectives specifically designed for the engagement - reporting on internal controls Applicable laws, regulations or contracts - reporting for compliance > Vv b. Less formal > Internally developed code of conduct (e.g. entity's by-laws) > Agreed level of performance (e.g. the number of times 2 particulat committee is expected to meet in a year) c. Established > those embodied in laws or regulations, or issued by authorized . recognized bodies of experts that follow a transparent due process * associated to formal criteria d. Specifically developed » those designed for the purpose of the engagement ” associated to less formal criteria Chapter 1 - Fundamental Principles of Assurance Services Suitable criteria are required for reasonably consistent evaluation or measurement of a subject matter within the context of professional judgment. Without the frame of reference provided by suitable criteria, any conclusion is open to individual interpretation and misunderstanding. Suitable criteria are context-sensitive, that is, relevant to the engagement circumstances. Even for the same subject matter there can be different criteria. For example, one responsible party might select the number of customer complaints resolved to the acknowledged satisfaction of the customer for the subject matter of customer satisfaction; another responsible party might select the number of repeat purchases in the three months following the initial purchase. Characteristics of suitable criteria: (RUN CR) a. Reliability - reliable criteria allow reasonably consistent evaluation or measurement of the subject matter including, where relevant, presentation and disclosure, when used in similar circumstances by similarly qualified practitioners. b. Understandability - contribute to conclusions that are clear, comprehensive, and not subject to significantly different interpretations. c. Neutrality - contribute to conclusions that are free from bias. d. Completeness - criteria are sufficiently complete when relevant factors that could affect the conclusions in the context of the engagement circumstances are not omitted. Complete criteria include, where relevant, benchmarks for presentation and disclosure. e. Relevance - relevant criteria contribute to conclusions that assist decision-making by the intended users. Communication of criteria to intended users Criteria need to be available to the intended users to allow them to understand how the subject matter has been evaluated or measured. Criteria are made available to the intended users in one or more of the following ways: a. Publicly. b. Through inclusion in a clear manner in the presentation of the subject matter information. Through inclusion in a clear manner in the assurance report. d. By general understanding, for example the criterion for measuring time in hours and minutes. ee Aim... Believe... Claim... Page7 rinciples of Assurance Services ; idence iti Sufficient Appropriate Fi information gathered by the practit, D. ins to ; iteria, on which the co, Evidence Ee subject matter against criteri ni i e evaluating based. ' loner clusion ‘ it with an attitude of Profess; the engagement Wi" si The praction Pe ent appropriate evidence about wheth 0 obtai 5 er the skeptics information is free from material misstatement, subject matte idence, the practitioner will not be able to attain the objectig without the ev engagement which is formulating and expressing an Pinion of an assural or conclusion. i jing and performing the engagement Cn toner consideration when planning and performing ie onenent (determining the nature, timing and extent of evidence. gathering procedures). ; Quantity of evidence (Sufficiency) Quality of evidence (Appropriateness) Materiality Assurance engagement risk Cost-benefit consideration Professional skepticism mpeose Sufficiency vs. Appropriateness ‘Two characteristics must be possessed by the evidence to be gathered inan assurance engagement. These are sufficiency and appropriateness. Sufficiency is the measure of the quantity of evidence. The quantity of evidence needed is affected by the Y Risk of the subject matter information being materially misstated (the y_ "eater the risk, the more evidence is likely to be required); and Quality of such evidence (the higher the quality, the less may be required), Appropriateness revit te 1e quality of en ae ‘ously called competence) is the measure of th €; that is, its relevance and its reliability. Accordingly, the interrelated. How eutficiency and appropriateness of evidence #* T, compensate for its merely obtaining more evidence may "™ Poor quality, What is sufficie eet nt and appropri i carl Shae is oF her professional ny Shall be determined by the practiions ‘epticism, ‘al judge al ment and by exercising prof Te Chapter 1 — Fundamental Principles of Assurance Services In terms of obtaining sufficient appropriate evidence, it is generally more difficult to obtain assurance about subject matter information covering a period than about subject matter information at a point in time. In addition, conclusions provided on processes ordinarily are limited to the period covered by the engagement; the practitioner provides no conclusion about whether the process will continue to function in the specified manner in the future. Materiality Materiality is relevant when the practitioner determines the nature, timing and extent of evidence-gathering procedures, and when assessing whether the subject matter information is free of misstatement. When considering materiality, the practitioner understands and assesses what factors might influence the decisions of the intended users. For example, when the identified criteria allow for variations in the presentation of the subject matter information, the practitioner considers how the adopted presentation might influence the decisions of the intended users. The assessment of materiality and the relative importance of quantitative and qualitative factors in a particular engagement are matters for the practitioner’s judgment. Assurance engagement risk Definition Assurance engagement risk is the risk that the practitioner expresses an inappropriate conclusion when the subject matter information is materially misstated. Managing assurance engagement risk The practitioner may reduce assurance engagement risk to a lower level by increasing the assurance level provided by the procedures performed. To be meaningful, the level of assurance obtained by the practitioner is likely to enhance the intended users’ confidence about the subject matter information to a degree that is clearly more than inconsequential. —_——— — —_—_—_———— Aim... Believe... Claim. Page 9 ae Chapter 1 - Fundamental Principles of Assurance Services Components In general, assurance engagement risk can be represented by the following components, although not all of these components will necessarily be present or significant for all assurance engagements: Assurance Engagement Risk ] Risk of non-detection Risk of material Misstatement or detection risk The risk that the subject matter information is peas eae materially misstated. Its composed of the following: a oranet tatetas Control risk The risk that a material misstatement that could ‘occur will not be prevented, or detected and corrected, ona timely Inherent risk The susceptibility of the subject matter information to a material misstatement, assuming re fate ‘ oe as ‘6 || “basis by related internal or controls The degree to which the practitioner considers each of these components is affected by the engagement circumstances, in particular by the nature of the subject matter and whether a reasonable assurance or a limited assurance engagement is being performed. Materiality and assurance engagement risk (audit risk) will be discussed in detail in Chapter 5. Cost-benefit Consideration In performing evidence-gathering procedures, the practitioner is expected to observe cost-benefit consideration. This means that “the benefits that will be derived from obtaining the evidence should exceed the cost of obtaining it’. The practitioner considers the relationship between the cost of obtaining evidence and the usefulness of the information obtained. However, the matter of difficulty or expense involved is not a valid basis for omitting an evidence gathering procedures for which there is no alternative. To simplify, in case there is a significant evidence-gathering procedure that must be performed but it involves high cost or high level of difficulty, the practitioner may: 1. Identify and perform alternative procedures that can minimize the associated cost or level of difficulty. Aim... Believe... Claim. Page Chapter 1 - Fundamental Principles of Assurance Services 2. Inthe absence of alternative procedures, the practitioner is still required to perform the procedures as long as he/she believes that performance of it is necessary and beneficial to the entire engagement. Professional Skepticism The practitioner plans and performs an assurance engagement with an attitude of professional skepticism recognizing that circumstances may exist that cause the subject matter information to be materially misstated. This means the practitioner makes a critical assessment, with a questioning mind, of the validity of evidence obtained and is alert to evidence that contradicts or brings into question the reliability of documents or representations by the responsible party. simply stated, professional skepticism dictates that whenever the practitioner gathers information, he/she considers the possibility that the information received might contain misstatement. To exhibit professional skepticism, the practitioner will then validate the information received by performing additional procedures. Accordingly, the more the practitioner intends to exhibit the attitude of professional skepticism, the more procedures will be required. The following are examples of exhibiting professional skepticism 1, An attitude of professional skepticism is necessary throughout the engagement process for the practitioner to reduce the risk of overlooking suspicious circumstances, of over generalizing when drawing conclusions from observations, and of using faulty assumptions in determining the nature, timing and extent of evidence gathering procedures and evaluating the results thereof. 2. An assurance engagement rarely involves the authentication of documentation, nor is the practitioner trained as or expected to be an expert in such authentication. However, the practitioner considers the reliability of the information to be used as evidence, for example photocopies, facsimiles, filmed, digitized or other electronic documents, including consideration of controls over their preparation and maintenance where relevant. 3. When receiving contradicting information from different sources, the practitioner ordinarily performs procedures to identity the possible causes of the discrepancies (e.g. bank reconciliation, subsidiary and and inquiries with parties involved to general ledgers reconciliation, account for the differences). Chapter 1 — Fundamental Principles of Assurance Services However, in the event that the practitioner had already exhausted all possible means to identify for the differences but still there are items unaccounted, the following generalizations about reliability of evidence may be useful. a, External vs. internal source Evidence is more reliable when it is obtained from independent sources outside the entity. b. Effective internal control Evidence that is generated internally is more reliable when the related controls are effective. c. Directly vs. indirectly obtained by the practitioner Evidence obtained directly by the practitioner (for example, observation of the application of a control) is more reliable than evidence obtained indirectly or by inference (for example, inquiry about the application of a control). d. Written vs. oral representations Evidence is more reliable when it exists in documentary form, whether paper, electronic, or other media (for example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of what was discussed). e. Original vs. reproduced copies Evidence provided by original documents is more reliable than evidence provided by photocopies or facsimiles. E. Written Assurance Report The practitioner provides a written report containing a conclusion or an opinion that conveys the assurance obtained about the subject matter information. In addition, the practitioner considers other reporting responsibilities, including communicating with those charged with governance. The opinion to be expressed by the practitioner may include either of the following: Types of Opinion Type Common phrase used 1._Unmodified/Unqualified | Present fairly, in all material respect 2. Qualified Except for 3. Adverse Do not present fairly, in all material respect 4. Disclaimer of opinion _| We do not express a conclusion Levels and forms of assurance The levels (high or moderate) and forms (positive or negative) of assurance provided by the practitioner is dependent on the type of assurance engagement being rendered. Aim... Believe... Clair Page 12 Chapter 1 - Fundamental Principles of Assurance Services The following are types of assurance engagement as to level of assurance provided: 7 Reasonable assurance engagement - the objective is a reduction in assurance engagement risk to an acceptably low level in the circumstances of the engagement as the basis for a positive form of expression of the practitioner’s conclusion. Such form conveys “reasonable assurance”. Example of expressing an opinion in reasonable assurance engagement: “In our opinion internal control is effective, in all material respects, based on XYZ criteria.” Limited assurance engagement - the objective is a reduction in assurance engagement risk to a level that is acceptable in circumstances of the engagement, but where the risk is greater than for a reasonable assurance engagement, as a basis for a negative form of expression of the practitioner’s conclusion. This form conveys “limited assurance”. Example of expressing an opinion in limited assurance engagement: “Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.” Reasonable vs. Limited Assurance Engagement Reasonable Limited Level of Reasonable or High, but not Limited or assurance absolute Moderate provided Form Positive Negative Example Audit Review Procedures Y¥ Inquiry v Inquiry performed Y Observation Y Analytical Y Inspection procedures Y Analytical procedures ¥ Confirmation Y Reperformance ¥__Recalculation Moreover, the following are types of assurance engagement as to structure: Aim... Believe... Claim. Page 13 Chapter 4— Fundamental Principles of Assurance Services Assurance Engagements as to structure The A B. following are the assurance engagements according to structure, Attestation engagements Attestation engagement is an engagement in which a practitioner is engaged to issue, or does issue, a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party. Common types of attestation engagements are: a. Audit engagement is an engagement in which the auditor provides a reasonable (but not absolute) level of assurance that the subject matter is free from material misstatements. b. Review engagement is an engagement in which the auditor provides a moderate level of assurance that the information subject to the engagement is free of material misstatement. Direct engagements Direct engagement is a residual definition of assurance engagement as to structure. Furthermore, assurance engagements may be classified further depending on the availability or non-availability of the assertions to the intended users. This classification will include the following: 1 Assertion-based engagements are assurance engagements that the evaluation or measurement of the subject matter is performed by the responsible party, and the subject matter information is in the form of an assertion by the responsible party that is made available to the intended users. This is commonly used for attestation engagements. 2. Direct reporting engagements are assurance engagements that the practitioner either directly performs the evaluation or measurement of the subject matter, or obtains a representation from the responsible party that has performed the evaluation or measurement that is not available to the intended users in the assurance reports. This is commonly used for direct engagements. NON-ASSURANCE ENGAGEMENTS Non. assurance engagements lack one or more of the elements of assurance engagements. Common examples include: A Agreed-upon procedures v auditor is engaged to carry out those procedures of an audit nature to which the auditor and the entity and any appropriate third parties have agreed and to report the factual findings Chapter 1 - Fundamental Principles of Assurance Services Y recipients of the report must form their own conclusions from the report by the auditor. Y report is restricted to those parties who have agreed to the procedures to be performed B. Compilation of financial and other information ¥ accountant is engaged to use accounting expertise as opposed to auditing expertise to collect, classify and summarize financial information ¥ ordinarily entails detailed data to a manageable and understandable form ¥ accountant will not express any assurance on the financial information ¥ intended users derived some benefits as a result of the accountant’s involvement C. Some tax services where no conclusion is expressed, and tax consulting v Practitioner provides advice on income tax and business strategies v Develop tax strategies to minimize businesses’ tax liability and worries D. Management consulting and other advisory services Y Practitioner provides advice or recommendations for the improvement of client’s use of its capabilities and resources to achieve the objective the client’s organization Needless to say, non-assurance engagements provide no assurance to intended users. SUMMARY OF DIFFERENCES BETWEEN ASSURANCE AND NON-ASSURANCE ENGAGEMENT Assurance engagement Non-assurance engagement Y Designed to improve the quality or enhance credibility of the subject matter ¥ Designed to provide comments, suggestions or recommendations on how to use the information ¥ Should be provided by independent professional ¥ Independence is not required ¥ Common examples include a. Audit; b.review; and c. examination of prospective financial information ¥ Common examples include a.agreed-upon procedures; b.compilation; c. preparation of tax returns; and d.management advisory services ¥ Three-party contract Y Two-party contract Y Output: assurance in the form of an opinion ¥ Output: recommendation on how to use the information Chapter 1 - Fundamental Principles of Assurance Services Presented on the diagram below are the examples of common assurance and non-assurance engagements. Non-assurance Assurance Attestation Other services Compllation Agreed-upon * Audit « Performance Bookkeeping procedures : iew ¢ Review hes A Management Tax services where © Other Examination advisory ‘no conclusion is attestation _of forecasts expressed services GLOBAL ORGANIZATIONS AND STANDARD-SETTING BOARDS OF THE ACCOUNTANCY PROFESSION The International Federation of Accountants (IFAC) is the global organization for the accountancy profession. The organization was founded in 1977 and is comprised of more than 175 member and associate organizations in 130 countries and jurisdictions, representing nearly 3 million professional accountants. It supports the development, adoption, and implementation of high-quality international standards’. To pursue its purpose, it supports four independent standard setting boards namely: 1. International Auditing and Assurance Standards Board (IAASB)* 2. International Accounting Education Standards Board (IAESB)™? 3. International Ethics Standards Board for Accountants (IESBA) * 4. International Public Sector Accounting Standards Board (IPSASB) * Presented on the next page is a diagram of the structure of these organizations and their respective roles and pronouncements. 2 IAESB ceased operation in 2019. Accountar i il \cy education will be taken forward by IFAC as part of the new approach at the global level. Source: htps://wwwviaesborg/ : Aim... Believe... Claim... Page 16 Chapter 1 — Fundamental Principles of Assurance Services yooqpuny ay3 fo uoyssnasip payiorap ay) 4of pt sardoy9 22s, PBorqsesdyavam//:scuny qam squawaounouoig Sununosoy 012g 2ygng © jeuoeusaqu 0 yooqpueH = quaulasuncUOLg “pliom ay punoue saisnua sorsas| jgnd Jayio pue syuauuseno3| kg asn 40} spsepueys Ayyenb| -yaly quauidojanap ayy ysno.ya| apimpyuom —Zunoday _jersueuy| ind anosduy o1 :2}0y)

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