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Overview of the Risk-Based Audit Process

BS Accountancy

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 SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY
Accountancy Department

ACCT 1093 – Auditing and Assurance: Concepts and Applications, Part 1

Lesson 1: Overview of the Risk-Based Audit Process

Learning Outcomes: At the end of this module, you are expected to:
1. Describe the nature of auditing.
2. Describe the objectives of the Independent Auditor and conduct of an audit in
accordance with Philippine Standards on Auditing.
3. Distinguish between the risk-based audit process and the accounts-based
audit process.
4. Describe the activities in the risk-based audit process.
5. Explain the factors to consider in implementing the Audit Risk Model.
6. Explain the limitations of the Audit Risk Model.

LEARNING CONTENT

Introduction:
After learning the accounting issues (i.e., recognition, measurement, presentation and disclosures) on
accountable events and transactions affecting the elements of financial statements, namely assets, liabilities,
equity, income and expenses, we will now explore the road towards evaluation of whether the financial
statements of the entity are prepared in accordance with the generally accepted accounting standards. In other
words, a financial statement audit. We will be dealing various procedures in planning, executing and completing
the audit. But before we go into details, let’s have first an overview of the risk-based audit process.

Lesson Proper

First and foremost, let’s define AUDITING!

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.

Hence, what are the overall objectives of the auditor in a risk-based audit?

1. To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error, thereby enabling the auditor to express an
opinion on whether the financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework; and

2. To report on the financial statements, and communicate as required by the ISAs, in accordance
with the auditor’s findings.
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In the conduct of financial statement audit, certain Ethical Requirements are considered by the auditor.
These requirements will be discussed separately in your Auditing Theory course. The following are the
relevant sources of these requirements:

The auditor should comply with relevant ethical requirements relating to audit engagements.
As discussed in PSA 220, "Quality Control for an Audits of Financial Statements," ethical requirements relating to audits of
financial statements ordinarily comprise Parts A and B of the Code of Ethics for Professional Accountants in the Philippines
issued by the Philippine Institute of Certified Public Accountants and adopted and promulgated by the Board of Accountancy.
PSA 220 (Clarified) identifies the fundamental principles of professional ethics established by Parts A and B of the Code of
Ethics and sets out the engagement partner's responsibilities with respect to ethical requirements. PSA 220 recognizes that
the engagement team is entitled to rely on a firm's systems in meeting its responsibilities with respect to quality control
procedures applicable to the individual audit engagement (for example, in relation to capabilities and competence of
personnel through their recruitment and formal training; independence through the accumulation and communication of
relevant independence information; maintenance of client relationships through acceptance and continuance systems; and
adherence to regulatory and legal requirements through the monitoring process), unless information provided by the firm or
other parties suggests otherwise. Accordingly, Philippine Standard on Quality Control (PSQC) 1, "Quality Control for Firms
that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements," requires
the firm to establish policies and procedures designed to provide it with reasonable assurance that the firm and its personnel
comply with relevant ethical requirements.

A term highlighted in the auditor’s overall objectives is “REASONABLE ASSURANCE”. How do we

characterize this important term in Auditing?
Philippine Standard on Auditing (PSAs) require the auditor to obtain reasonable assurance about whether the
financial statements as a whole are free from material misstatement, whether due to fraud or error.

Reasonable assurance is a high but not absolute level of assurance. It is obtained when the auditor has
obtained sufficient appropriate audit evidence to reduce audit risk (that is, the risk that the auditor
expresses
an inappropriate opinion when the financial statements are materially misstated) to an acceptably low
level.

The auditor cannot provide absolute assurance due to the inherent limitations in the work carried out.
This
results from the majority of audit evidence (on which the auditor draws conclusions and bases the
auditor’s
opinion) being persuasive rather than conclusive.

So, what could be the limiting factors why an auditor cannot provide an ABSOLUTE ASSURANCE, but only
REASONABLE ASSURANCE. The following table summarizes the inherent limitations of an audit:

Limitations Reasons
The Nature The preparation of financial statements involves:
of Financial • Judgment by management in applying the applicable financial reporting
Reporting framework; and
• Subjective decisions or assessments (such as estimates) by management
involving a range of acceptable interpretations or judgments.

Nature of Most of the auditor’s work in forming the auditor’s opinion consists of obtaining and
Audit evaluating audit evidence. This evidence tends to be persuasive in character rather
Evidence than conclusive.
Available
Audit evidence is primarily obtained from audit procedures performed during the
course of the audit. It may also include information obtained from other sources such
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• Previous audits;
• A firm’s quality control procedures for client acceptance and continuance;
• The entity’s accounting records; and
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 • Audit evidence prepared by an expert employed or engaged by the entity.

The Nature Audit procedures, however well designed, will not detect every misstatement.
of
Audit Consider the following:
Procedures • Any sample of less than 100% of a population introduces some risk that a
misstatement will not be detected;
• Management or others may not provide, intentionally or unintentionally, the
complete information required. Fraud may involve sophisticated and carefully
organized schemes designed to conceal it; and
• Audit procedures used to gather audit evidence may not detect that some
information is missing.

Timeliness The relevance/value of financial information tends to diminish over time, so a balance
of Financial needs to be struck between the reliability of information and its cost.
Reporting
Users of financial statements expect that the auditor will form his or her opinion within
a reasonable period of time and at a reasonable cost. Consequently, it is impracticable
to address all information that may exist, or to pursue every matter exhaustively on
the assumption that information is in error or fraudulent until proved otherwise.

As an auditor, what is the scope of your FINANCIAL STATEMENT AUDIT?

The scope of the auditor’s work and the opinion provided are usually confined to whether the financial
statements are prepared, in all material respects, in accordance with the applicable financial reporting
framework.

As a result, an unmodified auditor’s report* does not provide any assurance about the future viability
of the entity, nor the efficiency or effectiveness with which management has conducted the affairs of
the entity.

Any extension of this basic audit responsibility, such as that required by local laws or securities
regulations, would require the auditor to undertake further work and to modify or expand the auditor’s
report
accordingly.
* Kapag sinabing auditor’s report, ito ‘yung iniissue ng auditor na opinion tungkol sa fairness ng financial
statements na in-audit niya. Actually, ito yung pinaka-goal mo kung bakit ka nag-o-audit – para maibigay mo yung
opinion tungkol sa FS nila. May iba’t ibang klase ng auditor’s report. Isa dito yung UNMODIFIED or UNQUALIFIED.

Mayroon kasi tayung tinatawag na STANDARD AUDIT REPORT. Itong Standard Audit Report na ito ay nagsasaad
ng opinyon na ang FS ng entity ay fairly presented. Bale ito yung TEMPLATE ng mga auditor’s report. Kapag itong
Standard Audit Report na ito ay HINDI MINODIFY o HINDI KWINALIFY ng auditor, ibig sabihin nun sinasabi ng
auditor na ang FS ng entity ay fairly presented in all material respects.

Pero ‘pag minodify ito ng auditor, may problema sa FS ng entity. Ang tawag sa ibang types ng auditors report
maliban sa UNMODIFIED/UNQUALIFIED ay:
1. Modified/Qualified (may portion sa FS na hindi sumasang-ayon and auditor, pero hiindi sa kabuuan ng FS.
Portion lang talaga kaya kwinaqualify niya ang opinion niya);

2. Adverse (Totally hindi sumasang-ayon sa presentation ng FS and auditor. Therefore, affected ang buong FS.);
and

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3. Disclaimers of Opinion (Ito naman yung iniissue na report ng auditor kung hindi niya na-audit yung FS dahil sa
maraming dahilan. Isang dahilan ay ang hindi pakikiisa ng auditee sa mga audit procedures na ginagawa ng
auditor. Ibig sabihin, hindi talaga nakapagimplement ng audit procedure si auditor kaya wala siyang maibigay na
opinion tungkol sa fairness ng FS presentation).
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