Auditi ‘| ting Theory | A Guide in Understanding | «he e | Philippine Standards on Auditing | : |. Jekell G. Salosagcol, CPA Michael F. Tiu, CPA | | Roel Hermosilla,.CPA; MBA, LLB CRC-ACE REVIEW SCHOOL 3 Fir. Villaroman Building : P. Campa St. cor. Espana, Manila { ‘ ‘B 735:8901/ 735-9031 K Scanned with CamScannerALL RIGHTS RESERVED 2021 No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means — electronic, or mechanical, including photocopying, — without the written permission of the publisher ‘Any copy of this book not beating the signature of one of the authors shall be considered as proceeding frpm an illegal source >) ISBN 976-621-416-007-6 Published & Printed By: “4, SIC ENTERPRISES & CO., INC. ational Book Development Board Registered (2017 C-M. Recto Avenue, Sampaloc «+ Manila, Philippines PREFACE To the 2021 Eéition We remain committed in helping accountancy students and CPA candidates in understanding the constantly evolving standards affecting the practice of accountancy. This 2021 edition is organized and presented to make it easy for the readers to grasp the estental concepts ‘embodied inthe Philippine Standards on Auditing Ia recognition of the limited number of units made available for the: study of aniting theory, every effort has béen made to keep this book ondise and to the point, while providing faithful representation of auditing standards and principles. We increased the number of multiple choice questions so that the readers will be able to assess theic comprehension and absorption of the topics discussed. Majority of the endofthe-chapter questions included in this edition were meticulously sdected from past CPA Licensure examinations, which were modified to align them with the “new standards, Ce Extensive references are made to the ASC pronouncements, the (Gade of Ethics for Profesional Accountants in the Philippines, the Philippine Accountancy Act of 00 and other ating books, These references have definitely brought an clement of authority inthis book not otherwise available. ; “TWi book cannot teach the principles of ang, However, we belive that it can help facitate leaming if the student accepts the responsibilty to lean and expends the necessary time and eff Scanned with CamScannerWe gratefully acknowledge the effort of our staff at CRC-ACE Review School who helped in typing and lay outing the contents of this book, Thank you for sharing our aspiration to complete this newest edition, Our sincere gratitude is given to the many faculty members and reviewers for their overwhelming support, as well as, to the countless CPA reviewees who have expressed their positive reception to the preceding editions. Your vahtable appreciation has dertainly enhanced cour inspiration and commitment to further advance the standard of accotintancy education. Special thanks. go to many people who have given their time, talent, inspiration, encouragement and assistance for the ion of this humble,piece of work. Without you, this work would not have been made possible. , Above all, to God Almighty, we thank You for guiding us“to this vocation and giving us fulfillment in this professional mission. «- Jekell G. Salosageol ~ 7 MichitelP, Tia Roel E.-Hermosilla enna neMnRrLE TEs sibia EEE no CONTENTS Chapter 1: AUDIT: An Overview 1 Auditing defined ‘Types of Audits Types of Auditors “The Independent Financial Stateinent Audit Chapter 2 ». The Professional Standards i 3 Generally Accepted Auciting Standards Philippine Standurds on Auditing Qalty Control Systems Chapter 3 _ Tha Auditor's Responsibility 6 “‘Karbe : . 2 Fraud ; ‘Noncomplance with Laws and Regulations Chapter 4. The Audit Process- Accepting an Engagement 11 General Audit Approach Overview of the Audit Process ‘Accepting an Engagement Engagement Letter Scanned with CamScannerChapter 5 Chapter 6 Chapter? Chapter 8 © Computer Assisted Audit Techniques (CAATs) Audit Planning Understanding the Client’s Business and In Matétiality ape na Audit Risk Analytical Procedures Planning Documentation Consideration of Internal Control Nature of Internal Control Components of Internal Control Consideration of Internal Control Communication of Internal Control Weaknesses ‘Auditing in a Compuiterized Environment ~ Charactristies of CIS " Intemal Contrkin a CIS envionment | Auditing Around the Computer Performing Substantive Tests Analytical Procedures __Test of details Audit Evidence Working Papers Attendance at Physi nventry Count Ly Related Parties‘ ~ «Using the Work of a Auaitot’s Expert Considering the Work of Internal Auiditors ‘Auditing Accounting Estimates Chapter 9 * Chapter 10 Chapter 11 Chapter 12 Chapter 13 ‘Audit Sampling Sampling Risks Statistical and Non-statstical Sampling Basic Steps. when Using Audit Sampling Sampling for Tests of Control ‘Sampling for Substantive Tests Completing the audit Subsequent Events Litigations, Claims and Assessment Management Representation Letter Going concern Wrap-up Procedures ‘Audit Reports on Financial Statements ‘The Unmiodified Report Modification of the Report Reports on Consolidated Financial Statements Reports on Comparatives Special Purpose Audit Engagements Assurance and Related Services Review of Financial Statements ‘Agreed-upon Procedures Engagement Compilation of Financial Statements Assurance Engagements The Code of Ethics and Republic Act 9298 “The Code of Ethics for Professional Accountants The Philippine Accountancy Act of 2004 433 475 @21 Scanned with CamScannerChapter 1 AUDIT- An Overview Dependable financial information is essential to cur society. We often iely upon information’ provided by others in making economic decisions. The’ need of various users for more reliable financial information has created a“ demand for'an independent audit of financial statements. ‘The primary function of an independent audit is to lend eredibility'to the financial statements prepared by an entity. The auditor’s opinion enkiances the value and usefulness of the financial statements, By attaching an auditor's report to the financial statements, the auditor provides increased assurance ~ to users that the financial statements are reliable. ~ © Auditing Defined ‘The Philippine Standards on Auditing (PSA) defines auditing by stating the objective ofa financial statement audit; that is, to enable the auditor to express an opinion on whether the financial statements are prepared, ft all’ material respects, in accordance with the applicable financial reporting framework. ‘This delinition confines the audit to examination of the financial Statements, Although the great majority of audit work today deals with audit of financial statements, operational and. aomphanct ardting ate becoming snore and mote important. ‘A mote comprehensive definition of auditing is given by the American Accounting Association: An adi is 0 ytematic proces of ebjetiey obtaining and evaluating cuidence regarding acertons abot economic actions and event to ascerin the degre of cormspondene betwen tes asertions and etablbed ria and concmnicaig th eset interested vr.” . 1 Scanned with CamScannertplies on ‘This defiztion coavess the following thoughts. 1. Auditing is a systematic process ‘Auditing proceeds by means of an ordered and structured series of steps. This enables the auditcr to conduct the audit ina more efficient manner by ensuring that all potential risks are properly addressed in every step of the audit process. 2 Am audit involves obtaining and evaluating evidence about assertions regarding economic actions and events Auertons are representations, made by an entity about economic actions and events. The auditor's overall objective is to determine _ whether these assertions are valid. In order to achieve this objective, the auditor obtains and evaluates relevant evidence that will either corroborate of fefute the assertions. 3. An audit is conducted objectively ‘The audit should be conducted without bias. Objectivity requires the auditor to make an ‘impartial assessment -of all the. relevant circumstances in forming 2 conclusion. Auditors should not allow bias or conflict of interest to Gverride professional. judgment, Objectivity is essential because the auditors conclusion can influence the decisions of partie relying on the report. boon 4 Auditors ascertain the degree of correspondence between and established criteria Extoblibed criteria ate needed to judge the validity of the assertions. “These critea are importint because they establish and inform the users ofthe basis against which the assertions haye been evaluated ot measured. For, example, when auditing financial statements, the auditor evaluates the fair presentation of the financial. statements (as (viteia). comparing these financial statements with . the y) by. sequirements of the applicable ‘financial’ reporting framework 5. Auditors communicate the audit results to vatious interested ‘users: . ~The communication of audit findings isthe ultimate objective of a andi For the aud tobe wef the results mist be communicated to interested users in a timely manner. - Definition of Auditing Independent Auditor a Following a systematic process * Objectively obtains and evaluates evidence ‘Communicates the results to interested users / Scanned with CamScanner© Types of Audits Based on primary audit object jectives, there are three majot types of audit, ‘namely, financial statement, compliance and operational audits Financial statement audit * ‘A financial statement audit is conducted to determine whether the financial statements of an entity ate fairly presented in accordance ‘with the applicable financial reporting framework. This type of audit will be the focus ofthe discussion in this book. Compliance audit : ‘A. compliance audit involves a review’ of an organization’s procedures to determine whether the organization has adhered to specific procedures, rules, or regulations. The performance of a compliance audit is dependent upon thé existence of verifiable data and recognized criteria established by an authoritative body. A common example of this type of audit is the eximination conducted by Bureaui of Internal Revenue (BIR) personnel to determine whether entities comply with tax rules and regulations. Operational audit ‘ ‘An operational audit is a'study ofa specific unit of an Grganization for the puspose of measuring its performance. The main objective ofthis type of audit isto assess entity’s performance, identify areas for. improvements and make recommendations ‘to improve performance. This type of audits also known as perfirmance audit ot ‘management audit. » Unlike compliance ‘and financial statement audits, where the criteria axe usually defined, the criteria for evaluating the effectiveness “and efficiency of operations are not clearly established. The citeria used for operating audits would typically vary depending on the organization's standards and objectives. . 4 . It should be noted that, although there are different types of audit ‘all audits possess the same general characteristics. ‘They all involve: : 1 Siematic examination and eraliation of evidence’ which ite , undertaken to ascertain whether assertions comply wit tablished citeda:and = 2. Communication ofthe results of the examination, usually in‘a written « feport, to the party by whom, or on whose behalf, the auditor was appointed. - ¥ The table below shows a comparison of the thre diferent ‘types of audits: Financial audit Compliance audit. Operational audit Assertion" Thatthefinacial That the organization That the ‘made by the statements are- has complied withlaws, ° organization's auditee fairly presented. regulations or ‘ontracts. Established Financial Reporting Laws, regulations and criteria Frameworksuch as “contracts. the Philippine Financial Reporting ‘Standards (PFRS) Content ofthe An opinion about Scanned with CamScannerTypes of auditors ‘Auditors can be clas being EE Extemal Auditors or Independent Auditors “These are independent Certified Public Accountants (CPAs) who offer their professional services to diferent cients on contractual basis. External auditors are the ones who generally perform financial statement audits. * | Internal-Auditors Bi at Internal auditors are entity's ovin employees who investigate and. appstie the effectiveness and efficiency of operations and internal ‘eontrols. The main function of intemal auditors is to asist the ‘members of the organization in the effective discharge of theit responsbbilitie. Internal auditors usualy perform operational | audits. | 2° Government Auditors . These’ are government employees; whose main concern is to determine whether persons or entities comply with government ‘laws vand_ regulations. recent macs ener ht yo compliance audits. 6° “+ ‘sied according to thee affiliation with the entity jib ena patti ‘* The Independent Financial Statement Audit The objective of an audit of financial statements isto enable the auditor {0 express an opinion whether the financial statements are prepared, i all material respects, in accordance with the ee ‘pplabl financial porting £2 Responsibility for 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 responsiblity is to form and express an opinion on these financial statements based on the audit results. An audit of financial statements does not, relieve, management of its responsibilities.’ Hence, itis management's responsbility to adopt and implement adequate accounting and internal control systems that wil help ensure the preparation of reliable financial statements {Assurance provided by the auditor The auditors opinion on the financial statements is not a “| guiarantee that the financial statements are dependable. An audit ‘conducted in accordance with the PSAs is designed to provide only reasonable gssyrance (not absolute assurance) that the financial statements taken as a whole are free from material misstatements, ‘This is because there are inhetent ‘limitations of an audit that affect the auditor’ ability to detect material mistatements. These limitations may arse from the nature ofthe procedures performed, nature ofthe financial reporting framework ued andthe mature of evidence: obey he sat @' Nature of the procedures Scanned with CamScanner‘There are practical and inherent limitat ons ability toobuin idence Fae sate on the auditor's ability > The use of testing or sampling risk Due to cost constrains, auditors do aot examine all evidence available. Many audit conclusions are made by examining only sample of evidence. Whenever a sample is taken, there i always, 4 possibility that the auditor’s conclusion, based on the sample, thay be different from the conclusion that would have been teached if the auditor examines the entire population. | > Brrr the application ofjadgnent or no-sampling risk Even if the auditor examines all evidence available, there is no absolute assurance that material misstatement inthe financial 4 statements will be detected. This is because ‘the work ‘undertaken by the auditor to form an opinion is permeated by judgment: Enrérs in the application of judgment may cause auditors to’ commit mistakes in’ the application -of audit procedures or evaluation of evidence obtained. Nature of financial reporting, "The application of the applicable financial reporting framework Such as the PFRS involves application of significant judgment and * estimates on the part ofthe management: Many fiiancial statement items involve subjective decisions that are subject to'an inherent variability which cannot be. eliminated by performing audit =procedures! * i : For example, its difficult forthe auditor to deterinne the proper valuation of accounts receivable without management's honest assessment. If the management lacks integrity, management may provide the auditor with false representitions causing the auditor to depend on unreliable evidence. 8g * Nature of evidence Ait evidence obtained by the auditor does not consist of “hard facts” which prove ot disprove the accuracy of the financial statements. Instead, it comprises pieces” of information. and ‘impressions which are gradually accumulated during the course of an audit and which, when taken together, persuade the auditor about the fairness of the financial statements. Thus, audit evidence is generally persuasive rather than conclusive in nature. (Owing to the inherent limitations of an audit, there is unavoidable risk that even an audit conducted in accordance with the PSAs may not-be able to detect material misstatement in the financial Statements. Accordingly, the subsequent discovery of 2 material misstatement of the financial statements does not in itself inicate a failure to conduct the suit in accordance with the PSAs, In addition, the auditor's opinion on the financial statements deals with whether the financial statements are prepared in accordance with the applicable financial reporting framework. The opinioa of the auditor 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 : Scanned with CamScannerRole of Management and independent Auditor ca Independent Auditor Unaudited Financial ‘Statements. Audited Financial Statements Evaluates, Financial Statements: ‘Audit Report on Financial Statements 10 ‘© General Requirements when Auditing Financial Statements The procedures required to conduct an audit in accordance with PSAs should be determined by the auditor having regard tothe requirements of PSAs, relevant professional bodies, legislations, regulations, and where appropriate, the terms of the engagement and the reporting requirements. PSA provides the following guidance when auditing financial statements: |. The auditor should comply with the relevant ethical requirements, including those. pertaining to independence, relating to financial Statements audit engagements, In order to retain public confidence in the credibility ofthe auditors’ work, auditors must adhere to standards of ethical conduct that ‘embody and demoristrate integrity, objectivity, and concern for the public rather than self-interest, 2 ‘The auditor should conduct an audit in accordance with the Philippine Standards on Auditing (PSAs). “These standards contain the basic principles and essential procedures which the auditor should follow, The standards also include ‘explanatory and other iaterials that are designed to assist auditors in interpreting and applying the auditing standards. ‘The auditor should not represent compliance to PSA in the auditor's report unless the auditor has complied. with all the PSAs relevant to the audit. 3.. The auditor should apply professional judgment in planning and performing the audit Professional judgment is essential to the proper conduct ofthe audit. ‘This is because compliance with the relevant ethical requirements and the PSAs and the informed decisions teqjuired throughout the audit cannot be made without the application of professional judgment to «+ the facts and circumstances. i Scanned with CamScanner4. The auditor should obtain sul rece the sl eet Slcient appropriate anit evidenée to ‘acceptably low level. Audit evidence is needed to support the opinion expressed in the auditor's report. This evidence should be both sufficient and appropriate. Whether the audit evidence obtained is sufficient and appropriate to reduce the audit risk to an acceptable level is a matter of professional judgment. 5. The auditor should plan and perform the audit with an attitude of professional skepticism recognizing that circumstances may exist ‘which may cause the financial statements to be materially misstated ‘An attitude of professional skepticism means the auditor makes 2 critical assessment, with a questioning mind, of the validity of audit ‘evidence obtained and is alert to iudit evidence that contradicts or bring into questions the reliability of documents or management representations. In planning and performing an audit, the auditor neither assumes that the management is honest nor assumes unquestioned honesty. Thus, repteseatations from management are not a substitute for obtaining sufficient appropriate audit evidence.to be able to draw reasonable conclusions oni which to base the audit opinjon. © Need for an independent financial statement audit “The need for an independent audit of financial stafements stems from the following interrelated sources: : 1. Conflict of interest between management and users of financial statements, a In a sense, financial statements may be viewed ‘as the report by ‘minagement as to how the entity performed under ther direction and supervision. Managers aze frequently placed in postions where they can benefit by providing outside parties with overly optimistic orev {alse financial information, Outside partes, however, want unbiased, 12 realistic financial statements. Recognizing this inherent conflict of interest, users of financial statements have become skeptical of ‘unaudited financial statements. Expertise : ‘The complexity of accounting and auditing requires expertise in ‘eriffing the quality of the financial information: Since most of the users of financial information are not equipped with the necessary skills and competence to determine whether the financial statements ace reliable, a qualified person is hired by users to verify the reliability of the financial statements on their behalf. > Remoteness Users of financial information are usualy prevented from directly assessing the relablty ofthe information. Most of the users do not hhave access to the enti’s records to personally verify the quality of the financial information. Consequently, an ind anditor is needed to assist them in verifting the seliabilty of the financial information. ’ te . Financial consequences * Misleading financial information, could have substantial economic consequences for a decision makes. Ic is therefore important that financial statements be audited first before they are used for making important decisions 13 Scanned with CamScanner¥ Theoret: . ical Framework of Auditing 7 ‘The audit function operates within a theoretical framework. Below are Postulates, assumptions or ideas that support many auditing, concepts and standards, sits 1 Andi funetion operates onthe assumption that al fancal dat are via All balances reported in the financial statements must have supporting, documents of evidence to prove theis validity. If no evidence exists in tclation to the financial statements on which an auditor is to express an opinion, then there can be no audit to perform. 2. The auditor showld aloays maintain independence with respec tote financial " dalementswnder anit ‘Independence is essential for ensuring the credibility of the auditor's “ccloreport. The report of the auditor will be of litle or no value to the readers of the financial statements if the readers are aware that the auditor is not independent with respect to the cient. J Thre shouldbe no longterm conflict between the auditor and. the cent management. __... Short-terin ‘conflicts may exist regarding the application of auditing =» Procedures and accounting principles, but in the end, both the auditor and the management imuist be interested in the fair presentation of the financial statements. 4, Effective internal contr system reduces the passility of material misstatements of ‘the financial statements, ‘The condition of the entity’ internal control system directly affects the reliability of the financial statements. The stronger the intetnal control is, the more assurance it provides about the reliability of the accounting dats and financial statements. 4 J. Consent application of the applicable ical porting framework suchas the PERS results in fir prsenttion of ane tatemets. Alors often use different eritesia to evaluate the validity of an aséertion. In the case of a financial statement audit the itera are usually the financial reporting frameworks which could be the PFRS, BPRS for Smal and Medium-ieed Enis, or PFRS for Small ANILICS. 7 ce {cis assumed that air presentation is achieved whén the applicable financial reporting framework is applied. Hence, any deviation from the specific requirements ofthe framework would render the financial statements materially misstated. 6 Wht re inte at il tine bald inthe in tv cence of evar conditions to he coat. nee Experience and knowledge accumulated from auditing aclentin peor years canbe used to determine the appropriate audit procedures that rcedto be performed. s Z Am andit bengits the publi: Financial statements aie Gtdinarily prepared and presented in order to ‘meet the common information needs ofa wide range of users. These users who rely on the financial statemeats a5 their major source of information are’ the primary beneficiary of the financial statement audit. = ‘ , 15 Scanned with CamScannerMultiple Choice Questions - Audit in General 1 2 Recording, classifying, and summarizing ‘When auditing financial statements, the primary concem is with a. Determining whether recorded information properly reflects the economic events that occurred during the accounting period. b. Determining if fraud has occurred. Determining if taxable income has been calculated correct. 4. Analyzing the financial information to be sare thatit complies with government requirements. t economic events in a logical manner for the purpose of providing financial information for decision ‘aking is commonly called ya. Finance be Auditing Accounting 4. Economics _ 3. The trait chat dtaguishes auditors from accountants is the 1... Auditor's ability to interpret accounting standards. b. “Auditors education beyond the Bachelor's degree. ‘Auditor's continuing professional development. d. Auditor's accumulation and interpretation of evidence related to ~ the company’s financial statements. 4. The subject mater of any audit consists of 4. Assettons about economic actions and events b. Economic data cc. Financial statements (d Operating data 5, * Am audit involves ascertaining the degree of correspondence between assertions and established criteria. In the case ofa financial statement ‘audit which ofthe following is nota valid criterion? 16 Philippine Standards on Auditing - Philippine Financial Reporting Standards PFRS for Small and Medium-sized Entities PERS for Small Entities te eee The criteria for evaluating quantitative information vary. For example, in the case ofan independent audit of financial statements by CPA fitms, the criteria are usually the 4. Philippine Standards on Auditing b. Philippine Financial Reporting Standards € National Internal Revenue Code 4. Regulations ofthe Securities and Exchange Comission Most ofthe independent auditor's work in formulating 2a opinion on the financial statements consists of a. “Obtaining and examining evidence b. Examining cash transactions Comparing recorded accountability with assets 4, Studying and evaluating internal control ‘An audit of financial statements is conducted to determine ifthe 2. Organization is operating efficiently and effectively *b, Client is following ‘specific procedures or rules set down by'some higher authority c. Overall financial ‘statements are stated in accordance with the applicable financial reporting framework. 4... Clien’s internal control is functioning as intended. ‘An audit involves ascertaining the degree of correspondence between assertions and established criteria. In the case of an audit of financial statements, which ofthe following would be a valid terion? 2. International Standards on Auditing, b. Philippine Standaéds on Auditing ‘c.’Philippine Financial Reporting Standards cd. - Quality Control Standards 7 Scanned with CamScanner: | 10. In financial statement audits, the audit process should be conducted in | 7 accordance with 15. Which of the following best describes an operational audit? a. The audit program’ a. ” Ttattempts of verifying the fair presentation of a company’s results b. The Philippine Standards on Auditing 1 of operations. c. The Philppine Accounting Standards b: Tteconcentetes on implementing financial and accounting control dete ot i * in a newly organized company. tilippine Financial Reporting Standards Ttconcentrates on secking out aspects of operations in which waste ‘would be reduced by the introduction of controls. z i regulations as its 11. Which of the following types of audit uses laws and regulations 25,1 dd. It requires ‘a constant review of the administrative controls by om ve internal auditors as they reate to operations of the company. Operational | a AS & aan entciest audit | 16. A typical objective of an operational audit isto determine whether an ‘Compl eatity’s . dd.” Performance audit X a. Internal control structure is adequately operating ai designed 12." An ‘audit’ designed to. provide reasonable. assurance of detecting , Oe ee = — of w pec peor F couiiacts oe pratt sarcomere Be ‘c Specific operating units are functioning efficiently and effectively ‘wo abe ~ ‘ | cd: ‘Finadcial statements present fairly the results of operations 2. Performance : ‘ b. Management audit, 17, One objective of an operational audit is to: 6.0) +" cment aud : operational aut isto: © Operational audit a. Determine whether the financial statements fairly present: the 4, Compliance audit. . { entity's operations. " b. Evahate the feqsiility of attining the entity's: operational 13, Am audit that involves biasing ‘and evaluating evidence about the efficiency and effectiveness of an entity's operating activities in teation Make commendations for improving performance © “to specified objectives is a(n): .- Report on the entity's ‘relative ssuccess in attaining profit a. Extemal audit att . ‘tine pmanimization? . {7 = b. Compliatice audit” ‘i rt . ¢ Operational audit 18) The auditor communicates the results of his or her work through the + d. Financial statement sudit medium of the “i ast iM i : a. Engagement letter. 14. ‘Which of the following is more difficult to evaluate objectively be Audit report. ‘ 2. Efficiency and effectiveness of operations 3 Management letter. 'b. Compliance with applicable government. d. Financial statements. regulations : c Preseattion of financial statements. accordance with the applicable financial reporting criteria d.__ All the given cxitera ae equally difficult to evaluate objectively 18, | * 19 a Scanned with CamScanner19. When pesformin ditnieaton toa: '8 20 operational audit, the intemal audit team must frst 2. A financial audit has been b. A financial audit has been S performed by an indepedident auditor a performed by an internal auditor. ri ‘was performed by either an independent or an internal itor. d. Specific criteria are developed to define effectiveness. 20. Which of the following types of auditing is performed most commonly by CPA’s on a contractual basis? : a.) Tnternal auditing 'b. Income tax auditing ¢.. Government auditing i. External auditing 21,! An examination of part of an organization's procedures and methods for the purpose of evaluating efficiency and effectiveness is what type of audit? - a. Operational audit. b. Compliance auc. ¢ Financial statement audit. d. Production audit. 22. Which of the following’is not one of the major differences between financial and operational auditing? 2. The financial audit is oriented to the past, but an operational audit concerns performance for the future. b. » The financial audit report has widespread distribution, but the. operational audit report has limited distribution. ¢ Financial audits deal with the information on -the financial ‘statements, but’ operational audits ate concemed with’ they ~ information in the ledgers and journals. d. Financial andits are limited to matters, that direcdy affect,the fairness of the financial statement presentation, but operational andits cover any aspect of efficiency and effectiveness. 20. 4, ‘The overall objective of intemal aditing is to 4 Attest to the efficiency with which resources are employed b.Ascertain that contol are costs justified - "Provide: assurance that financial data have been accurately recorded. ’ . 4. Assist members of the organization inthe effective discharge of, their responsibilities. = - Internal auditing is an independent appraisal function established within an otganization to examine and evaluat its activities. ‘To that end, internal auditing provides assistance to a. External auditors x "b, Stockholders 2, c. Management and the board of directors d. Goverriment “Internal auditors’ independence is enhanced when they.teport to 4. The audit committee of the board of directors. b. The head of the finance department: “e. The external auditors. 7 4. The president of the Company. ‘Which of the following groups could not be involved in an operational audit? a. External auditors 2 i ot b, Internal auditors i cc. Government auditors © d.Allof the above could be involved. Which of the following statements i not a distinction between external ‘auditors and internal suitors? 7 a.” Exiemnal auditors, represent third party users, whereas internal _* auditors repost directly to management. }. Although external auditors stive for both validity and relevance of evidence, internal auditors are conceened almost exclusively, with validity.” . 2 Scanned with CamScannerInternal auditors are adie i employees of the auditee, whereas independent auditors are independent contractors. ‘The intemal auditor's span of coverage goes beyond financial auditing to encompass operational and performance auditing, * Financial Statement Audit 28. The 1 objective of the ordinary examination by the independent auditor + is the expression of an opinion on a b. © a “The fairness of the financil statements - “The accuracy of the financial statements ‘The accuracy of the annual report “The balance sheet and income statement 29. Auditors accumulate evidence to a b. « a 30. ‘The sesponsbility for the preparation of the fina Defénd themselves in the event of a awsuit “Justify the conclusions they have otherwise reached Satisfy the requirements of the Securities’ and Exchange Commission. Enable them to reach conclusions about the faimess: of the financial statements and issue an appropriate audit report. jncial statements -and the accomipanying notes belongs to 2 be © d. ‘The auditor ‘The management Both management aad the auditor equally ‘The management fot the siterients and the auditor for the notes 31, Independent auditing can best be Wescibed as 2 a Profesional activity that tneasures and communicates financial accounting data. b Subset of accounting 2 35. © Professional activity that attests to the fair presentation of the financial statements. Regulatory activity that prevents the issuance of ‘misleading financial information. ‘ ‘An audit of the financial statements of JMV Corporation i: being conducted by an éxternal auditor. The external auditor is expected to 4. Express an opinion as tothe faitness of JMVs financial statements. b. Express an opinion as to the attractiveness of JMV for investment purposes. . Certify the.correctness of JMV’s financial statemnents. 4d. Examine all evidence supporting JMV’s financial statements. Which of the following statements about independent financial statement audit is correct? a. The audit of financial statements relieves management of its teiponsibilties forthe financial statements. b. An audits designed to provide limited assurance that the financial statements taken as a whole are free from material misstatement. The procedures required to conduct an audit.in accordance with PSAs should be determined by the client who engaged the services of the auditor. i 4. - The auditor’ opinion is not an assurance 2s to the future viability of the entity as well as the effectiveness and efficiency with which ‘management has conducted the affairs ofthe entity. ‘The primary purpose of an independent financial statement audit is to 2. Provide a basis for assessing management's performance. b. Comply with government regulatory requirements. cc. Assure management that the financial statements are unbiased and fee froin material error. 4. Provide users with an unbiased opinion about the fairness of information reported in the financial statements. ‘The level of assurance provided by an auditor when exptessing an opinion on the financial statements is 23. Scanned with CamScannera Low b. Reasonable Limited a. None 36. By providing high level of assurance on audit reports on financial statements, the auditor a b. c a. Guarantees the fai presentation of the financial statements Confirms the accuracy ofthe financial statements. Enhances the credibility ofthe financial statements. [Assures the readers that fraudulent activities of employees have been detected. 31. “The reason an independent auditor gathers evidence is to 2 b. «. « a 48. ‘Theoretically, it is possible to provide an infinite tange of assurance ‘Form an opinion on the financial statements. Detect fraud. ‘Evaluate management's performance. Evaluate the entty’s internal control. from a very low level of assurance to an absolute level of assurance, In practice, the professional accountants cannot provide absolute assurance because of the following except, a b © "There are inherent imitations of audit that cannot be eliminated. ‘The auditor employs testing process when performing audit procedures. : : ‘The auditor usually: lacks the expertise necessary to verify the financial statements. 4. The auditor uses professional judgment in gathering evidence and dsaving conclusions based on that evidence. "39, Which ofthe following is not one ofthe limitations of an audit? a. The use of testing . Limitations imposed by client c Humanertor d._ Nature of evidence obtained 4 4B. Which of the following statements does not properly -describe a limitation of asf audit? a b @ Which of the following is one of the lr a b b. a Many audit conclusions are made on the basis‘of examining a sample of evidence. . Some cridence supporting peso representation in the financial statements must be obtained by oral or writen representation of ‘management Fatigue can cause auditors to overlook pertinent evidence, Many financial statement assertions cannot be audited. tions of an audi? The possibilty that management may prevent the auditor from petforming the necessary audit procedures. ‘The likelihood thatthe auditor may not be able to detect material misstatements in the financial statements because the auditor is engaged only after year-end. The fact that most audit evidence is persuasive rather than conclusive in nature. ‘The risk that the auditor may not possess the taining and proficiency required by the engagement. 2.. The primary reason for an audit by an extemnal audit frm is To satisfy governmental regulatory requirements, ‘To guarantee that there are no misstatements in the financial statements. “Fo provide increased assurance to users as tothe fatness ofthe financial statements. “To ensure that any fraud willbe discovered. “The independent audit i important to readers of financial statement because it a b. Determines the future stewardship of the management of the © company whose financial statements ate audited. ‘Measures and communicates financial and business data involved ._ in financial statements. Scanned with CamScanner© Tnvolv i ‘ Invokes the objective examination of and reporting on inagement prepared statements. ts on the accuracy of all inf the financi i, formation in the financial dq, 44. The best statement of the responsibilty of the auitor with respect to audited financial statement is: 4 The auditor's responsibilty on fair ptesentation of financial statements is limited only up to the date ofthe audit report. b. The auditor's responsibilty is confined to the expression of opinion on the financial statements audited c. , The responsiblity over the financial statements rests with the ‘management and the auditor assumes responsibility with respect to the notes of financial statements. a. “The auditor is responsible only to his unmodified opinion but not for any other types of opinion. 45, Which of the following is incorrect about the responsibility for financial statements? a. Management is responsible for fair presentation of the financial statements. : b. Auditor is responsible for expressing an opinion on the financial statements 7 ; Audit of financial’ statements does not reduce managemént’s responsibility / : 4. The fair presentation of financial statements is an implicit part of the auditor’ responsibilty. 46.-Which. of the following, statements about independent financial statement audit is incomrect? a. - Scope ofthe audit refers to audit procedires deemed necessary in the circumstances to achieve the objective of the audit. ‘b.’ “The auditor's opinion enhances the. credibility of the financial sratements. ‘ | j 41. 48. 49. © Lateral auditors are not independent enough to express an opinion ‘on the financial statements of an entity where they ate employed. 4. The risk that the auditor wall ail to uncover material misstatement is chminated when the auditor conducts the audit in accordance with the PSAs. a Which of the following statements d \ a limitation of an audit? y aarcg ae 4% Many audit conclusions are made On the basis of examining a sample of evidence. ‘The work undertaken by the auditor is permeated by ju igment. The auditor might misinterpret the evidence obtained. = d Most of the items in the financial statements. do not have supporting evidence. i a Which of the following is one of the limitations of an sudit? a. Nature of evidence obtained ~~ by Inadequacy ofthe accounting records Confidentiality of information, 4+ Scope limitations imposed by the entity “The assumption underlying an audit of financial statements is that they will be used by a. Different groups for different purposes. b. The general public in making investment decisions . "The board of directors as basis of declaring cash dividends. d.The regulatory agencies to verify information’that is relevant to their supervisory functions. © ~ : “The procedures deemed necessary in the circumstances to achiewe the objective of a financial statement audit shall be determined by the 2. Client management ’ b. “Independent auditor cc. Internal Auditor d+ Those charged with governance a Scanned with CamScanner4. The remoteness ofthe wer to direct obtain financial information fiom the company: : 51. Which one of the following isan example of man cations from theindependent dion? 2 An active participant in management decision making. b. Am internal An intemal source of expertise of financial and other mates. 55. The need for independent audits of financial, statements can be ©, An expert providing a written communication s the product ofthe é engagement. 2 lasaat eee 4. Individuals who perform day-to-day accounting functions on b. Consequence behalf of the company. & Complexity of subject matter d._ Validity 52. Which of the following is not one of the general principles governing an audit of financial statements? 56, Which of the folowing best describes the reason why an independent 2. The auditor should plan and perform the audit with an attitude of saditr repors on Fae hi gacacen ety a professional skepticism. a. A management fraud may exist and its more likely to be detected bb. ‘Theauditor should obtain sufficient appropriate evidence primarily through inquity and analytical procedures t0 be able to draw by independent auditors. b. Different interests may exist between the company preparing the statements and the persons using the statements. Scanned with CamScanner reasonable conclusions ¢. The auditor should conduct the audit in accordance with PSA €. A misstatement of account balances may exist and is generally 4. The ‘auditor should comply with the Philippine Code of corrected as the result of the independent auditor's work. Professional Ethics. dA pootly designed internal control system may be in existence. 57. Which of the following statements does not describe a condition that creates a demand for auditing? 2. Conflict between information preparer and a user can result in 53. Which one of the following is aot among the conditions that giv rise to a demand-by external users for independent audits of financial ‘statements? a. Remoteness of users . biased information, b. Complexity. of making economic decisions ; J b... Information can have substantial economic consequences for a c. Potential conflict of interest between users and preparers of the decision-maker. statements ~ s Expertise is often required for information preparation and 5d. Consequgnce for making decisions 8 he verification ’ do Users can directly asiess the quality of information. + 54 Which-of the following ould not represent one of the primary s i" “i problems that would lead the users to demand for independent audits 58.."There are“four conditions that give rte 10 the need for independent of a company’s financial statements? audits of financial statements. One ofthese conditions is consequence. In this context, consequence means that the The downsizing of b beg istlem pene chloe Peete sabens nt fn he cong The complexity of transactions affecting financial statements. of theis actions. 8B ee/ Auditor must anticipate all possible consequences of the report issued. © Impact of using different accounting methods may not be filly understood by the users of the statements. 4. Financial statements are sed for making important decisions. 59. One of the conditions that give rise to a demand for an external audit Of financial statements is expertise. Which of the following best describes the meaning of expertise as used inthis context? a. Auditors usually rely on the work of an expert 25 a basis for ‘evaluating some assertions embodied in the financial statements. . The readers of the financial statements must possess the necessary expettie tobe able to understand the financial statements. c_ Users usually ack the necessary expertise.to verify the reliability of the financial information. d. As experts, auditors. are expected to detect ‘all material misstatements in the financial statements. 60. Upon completion of a financial statement audit, the auditor has a. No assurance that the financial statements are fairly presented b. Absolute assurance that. the financial statements are fairly presented cc. Reatonable assurance that all material errors and fraud affecting the financial statements have been detected. dA low level of assurance that all material errors and irregularities have been found: 61. An auditor should secognize thatthe application of auditing procédures may ‘evidential matter indicating the possibility of ertors or fraud and therefore should 2. Pln and perform the engagement with an attitude of profesional Not depend on ‘intemal accounting control features that are esigaed to prevent or detect eros ot fraud * Design audit tests to detect unrecorded transactions ‘b, 30 Nan 4. Extend the work to audit most recorded transactions and records of an enti 62. An attitade that includes a questioning mind and a critical assessment of ali evidence is referred t0 a8 a. , Due professional care. b.. Professional skepticism. c. Reasonable assurance. d. Supervision. 6B. Professional skepticism equites that an auditor assume that ‘management is a. Honest, in the absence of fraud risk factors. b. Dishonest until completion of audit tests. Neither honest nor dishonest. ° 4. ‘Offering reasonable assurance of honesty, 64, Which of thé following is not one of the reasons why auditors'cannot provide absolute assurance when atditing financial statements? 4. The auditor, commonly examines a sample, rather than the entire populition of transactions. + be The nature of the financial teporting frameworks usually requires the use of complex estimates which involve uncertainty, The fact, that most audit evidence. is only persuasive and not i) conclusive in nature cd. The auditors are usually prevented by the client from verifying cos ertain accounts in the fitancial statements 65., Which of the following is not-one of the majot assumptions ‘when auditing Girancial statements? " a: The datain the financial statements are verifiable. b. Compliance to PFRS® results in fair presentation of financial statements. c. Effective intemal control system contributes little to the reliability of financial statements. d. The auditor should be independent. 31 Scanned with CamScannerb. ‘The management of the mudit client because the auditor is hired and paid by management. © The Auditing sod Aarne Studs ‘Counc, becrse i termines auditing standards and auditoi’s responsibility. d. The snd conmits of tera chant beens tat eos i responsible for coordinating and reviewing all audit activites within the company. 66. Which of the following statements does not properly describe an clement of theoretical framework of auditing? a. The data to be audited can be verified b. Short-term conflicts may exist between managers who prepare the data and auditors who examine the data. Auditors act on behalf of the management d. An audit benefits the public 67. Auditing is based on the assumption that financial data are verifiable. Data ate verifiable when two or more qualified individuals, a. Working together, can prove, beyond doubt, the accuracy of the 70. Which ofthe following bas the primary responsibility forthe faimess of the representations made inthe financial statements? 2. Client’s management and those charged with governance b. Audit committee Independent auditor data b. Working independenty, each reach essentially similar conclusions. d. Board of Accountancy ‘Working independently, can prove, beyond reasonable doubt, the truthfulness of the data. 4, Working together, can agree upon the accuracy of the data + Which of the following statements is correct concerning an auditor's responsibilities regarding financial statements? 2. Making suggestions that are adopted about the form and content ‘of an entity's financial. statements impairs an auditor's independence. b. An auditor may draft an entity's financial statements based on information from managements accounting system. 7 © The fir presentation of audited financial statements in conformity with PFRS i an implicit part of the auditor's responsibilities. * An auditor’s responsibilities for audited financial statements are not confined to the expression ofthe auditor's opinion. ‘ 68." Which of the following statements is true when the CPA has’ been engaged to do an audit engagement? a. The CPA firmis engaged and paid by the cient; therefore, the firm 7 responsibilty to be an advocate for the client. b Tae CPA fms engaged and paid by the client, but the primary * beneficiaries of the audit are the statement users. ‘e-Should a sination arise where there is no convincing authostate standard available, and there is a choice of actions which coul ~ impact clients financial statements either positively or negatively, the CPA is free to endorse the choice which is in che clients interests. : “3 pede As lg ss CPA firs are competent is aot reqited that they semain unbiased. ‘ 4 ning the poi cenal autor for a0” In determining the primary responsibilty ofthe extec - audit of a company’s financial statement, the auditor owes Primal Naeatogitieeto! : : a Stockholders, creditors and the investing public: 3 32 Scanned with CamScannerChapter2 ; THE PROFESSIONAL STANDARDS ‘When auditing financial statements, an auditor assimes certain professional responsibilities. Auditor's opinion must be based on an examination conducted in accordance with professional standards, Failure to comply with these standards exposes the auditor to risks such as oss of public respect or even assessinent of legal damages. Standards are established to measure the quility of performance of individuals and organizations. Standards relating to the accounting profession concern themselves with CPAs’ professional qualities, the judgment exercised by the CPAs in the performance of their professional engagement, andthe CPA firm's quality control polices and procedures: ‘The Board of Accountancy promulgated ten generally accepted auditing standards (GAAS) that establish required level of quality for pecforthing financial statement asits These standards must be followed by CPAs when auditing financial statements. Philippine Standards on ‘Auditing (PSAs) are issued to clarify the meaning of these ten GAAS. Auditing procedures ate the means used by the auditors ia attaining the quality requited by the standatds. “+ Generally Accepted Auditing Standards (GAAS) GAAS represest measures of the quality ofthe auditor’ performance. These standards should be looked at as a minimum standard of performance that auditors should follow. These ten GAAS ate grouped into general, fieldwork and reporting standards. 38 Scanned with CamScannerGenerally Accepted Auditing Standards Generally Accepted Auditing Standards (GAAS) Standards of Standards of General a d Standards Fieldwork Reporting ee 2 ectical Geoeny Training and ‘Accepied Proficiency Tnternal Control | | Accounting Consideration Principles Sat cee || Tamesiae fae mater Disclosure Opini General Standards 1.- The examination is to be performed by person or persons having adequate technical taining and proficiency as an auditor. 2. In all matters reting to an engagement, an independence in meatal attitude is tobe maintained by the auditor. 3. Due professional cate is to be exercised in the performance of the audit and inthe preparation ofthe report 36 Standards of Fieldwork 4. The work is to be adequately planned and assistants, if any, are to be properly supervised. 5. There is to be a proper study and evaluation of existing internal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures ate to be restricted. Suficent competent cvidental materi tobe obtined throagh inspection, observation, inquites sid confirmations to afford x teasonable bass for an opinion regarding the financial statements under examination. Standards of Reporting - 7., The’ report shall, state whether the financial statements are presented in accordance with generally accepted accounting principles. 8. The report shall identify those circumstances in which principles have not been consistently obseived in the cusrent period in schtion to the preceding period. 9, Informative disclosures ae to be regarded as reasonably adequate unless otherwise stated inthe report. 10.The report shall either contain an expression of opiaion regarding the financial sitements, taken 2s a whol, ot an assertion tothe effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases, where an auditor's name is associated: with the financial statements, the report shoukl contain a cleat-cut indication of the character of the audtoi’s ‘examination if any and the degree of responsibilty be i taking ED Scanned with CamScanner‘© PHILIPPINE STANDARDS ON AUDITING (PSAs) - ~ ‘The Auditing and Assurance Standards Council (ASC) has been given the task to promulgate auditing standards, practices and procedures which shall be generally accepted in the Philippines, The structure of AASC pronouncements is shown below. AASC PRONOUNCEMENTS Framework for Assurance A Engagements scorn snues )( ace iconic Jf idea ‘mse vee 1 Adoption of Intemational Standards ‘To facilitate the preparation by the AASC of its pronouncements and to attain uniformity Jof those pronouncements with international auditing staridards, the’ ASC has approved the adoption of the International Standards on Auditing (ISAs), International Standards on Assurance Engigements (ISAEs), Intemational Standards on Review Engagement (ISREs) and International Standards on Related 38 Services (ISRSs) issued by the International Auditing and Assurance Board (IASB) created by. the International’ Federation of Accountants (IFAC). In addition to these standards, Practices Statements are also issued to provide practical assistance to auditors in implementing the standards and to promote good practice in the accountancy profesion, In this connection, the AASC undertakes a review of the standards and practices statements issued by IAASB to determine if these can be: adopted “in the Philippines with or ‘without changes, ‘after considering any local requirements imposed by law or practice. © SYSTEM OF QUALITY CONTROL If the public is to tely on the professional CP: tis es appropriate: controls ate put in place to ensure that their work is consistently of high quality. The need for practicing CPAs to implement ‘and maintain quality conteol measures is derived from the fact that audits are usualy conducted by audit teams. It is only by implementing quality control polices and procedures that CPAs can ensure that all merabers ‘of the audit teams perform the same level of quality of work. Qialty controls ate policies and procedures adopted by CPAs to provide reasonable, assurance of conforming with professional standards in performing audit and related services... Under Philippine Standards on Quality Control (PSQG)'1, firm has an * obligation to establish a systern of quality control to provide reasonable assurance thatthe firm and its personnel } comply with professional standards and regulatory and legal requitements, and ~} that the report issued by the firm are appropriate in the | circumstances. 9, Scanned with CamScannerELEMENTS OF QUALITY, CONTROL POLICIES AND PROCEDURES Audit firms are required to implement quality control policies and procedures in order to ensure that all audits are conducted in accordance with PSAs... ‘The quality control policies and procedures adopted by audit firms vary ~ depending on the firm's sie and nature ofits practice, cost benefit considerations ‘and other factors. PSA 220 has identified the following uality control policies that may serve as 2 guide to audit firms in, establishing their own’ system of quality contro 3] LEADERSHIP RESPONSIBILITIES ‘The firm should esublsh policies and procedures designed to “)<" “promote an interial culture based on recognition that quality is essential in the performance of the engagements, . ‘The engagement partner should take responsibility, for overall quality oneach aut engagement to which the partner is assigned. The engagement partner should set example regarding the «quay of audit by emphasizing through actions and messages > the importance of performing work that complies with > professional standards,» ! ’ > complying with the fiim’s quality control polices and procedures, > issuing appropriate audit reports, and" ">< >the engagemen’'sfeam ability to raise concerns without fear of 2 ETHICAL REQUIREMENTS The firm should éstablih policies and procedures designed to provide reasonable assurance thatthe frm and its personnel comply with ethical requirements, which include: “ > Integrity; é & ‘Objectivity: + Professional competence and due cate; » Confidentiality; and . + Professional behavior The engagement partner should consider whether members of the ‘engagement team have complied with these ethical principles. Any issues involving engagement team member's non-compliance with ethical requirements must be, properly resolved and documented. INDEPENDENCE “The firm, should establish polices and procedures designed to | provide reasonable assurance that the members of the engagement “team, the firm and, where applicable, the network firms maintain » | independence when providing audit services. ‘The engagement patinet should form a conclusion on compliance. with independence requirements that apply to the audit engagement. ‘The engagement pirtner should: > Obtain relevant informnatién’ to identify’ circumstances and relationships that create threats to independence; } Evaluate information on identified ‘breaches of thé firm's independence policies and procedures to determine whether they create a threat to independence; > "Take appropriate safeguards to eliminate such threats or reduce them to an acceptablé level and > "Document conchisions on independence and the basis for such conchsion. ” Al Scanned with CamScannerACCEPTANCE AND CONTINUANCE OF CLIENT RELATIONSHIPS “The fim should establish polices and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide reasonable assurance that it will only undertake of continue felationships and engagement where it > Has considered the integrity of the client; > Is competent to perform the engagement and. has the ities, time and resources to do so; and > Can comply with ethical requirements. ‘engagement ‘partner. should be: satisfied that appropriate oe the acceptance-and continuance .of client tclitonships and specific audit engagement have been followed, and that conclusions reached are appropriate and have been documented. HUMAN RESOURCES AND ASSIGNMENT ‘The fim should establish policies and procedures designed to provide reasonable assurance that it has sufficient personnel with the | ~ capabilities, competence, and commitment to ethical principles: necessary to perform the engigement. Such policies and procedures should address issues conceming personnel > Recruitment; . : > Performance evaluation, compensation and promotion; >, Capabilities and competence; > Career development; and >. Assignment of engagement teams The-engagement partes should be satisfied that the engagement team collectively has the appropriate capabilites, competence and: time to perform the audit engagement in accordance with professional standards, and regulatory ahd legal requirements, and to enable an auditor’s report that is appropriate inthe circumstances to be issued. ‘ 2 {2 ENGAGEMENT-PERFORMANCE, aa ‘The firm should establish polices and procedures designed to provide reasonable assurance that engagements are performed in accordance with professional standards and other regulatory and Jegal requirements; and that the audit eport issued is appropriate in the circumstances. i ‘The engagement partner should take responsibilty forthe direction, supervision, review and overall performance of the audit engagement. 1. Direction Assistants should be informed of thei esponsbiltes, the nature of the entity’ business, potential problems that may aise and the detailed approach o the performance ofthe engagement. 2. Supervision. 8. ov “The engagement partnet‘should monitor the progress of the andi, resolve accountng and audit isues, and consider the level of consultation appropriate forthe engagement. 3. Review Work performed by assistants should be reviewed to consider whether the audit procedures, evidence and documentation ate appropriate to support the conclusion reached. : 4, Consultation ~ “The firm should establish policies and procedures that encourage firm personnel to seek assistance from authoritative sources either within or outside the firm.’ 143 Scanned with CamScanner‘The engagement partner should: & Be responsible for the engagement team undertaking appropriate consultation on difficlt and contentious matters; Be satisfied that members of the engagement team have undertaken appropriate consultation during the course of the engagement, both within dhe engagement team and others at the appropriate level within or outside the firm; © Be satisfied that the nature and scope of, andl conclusions resulting from such consukations, are documented and agreed with the party consulted ob 4, Deteine that conchsions resuking ftom consttatons have been implemented. “_ 5, Engagement Quality Control Review ‘The firm should establish policies and procedures requiring an | engagement qualty control review that provides an. objective evaluation of the significant judgments made and conclusions » raced informing te ator sepo. ‘This requires the engagement partner a. To detemmine that an engagement culty control reviewer has been appointed; b. To discuss significant matters arising during the audit engagement, including those identified -dusing the qualty contol even, with the engagement duality. control ‘reviewer; and c._ Nott isue the adi’ iepot ut the completion ofthe engagement quality contol review...) The fem should establish policies and procedures sett * sscope of quality control review, criteria for the eligibility of the fxewe, and docmenaion ofthe quliy con review, 6. Differences of Opinion : ‘The engagement téam’should follow the firm's’ policies and procedures for dealing with and esolving differences of opinion 11> that aie Within the eogagement team, with those Contd and, ‘where applicable, between the engagement partner and the us, Qgagement quality control reviewer ‘The engagement parinér should inform the members of the engagement ‘eam to bring matters involving differeces of pinion to the attention ‘of the engagement partner o others goo, ithin th fir as appropriate without fear of reprisals. The audit "sport should not be issued uni the mate involving differences eke seen resolved. a MONITORING * control ee ‘and. procedure’ is to be monitored. Policies and procedures must besdoptlio provi msoaible smut tate 45 a i Scanned with CamScannerQUALITY ASSURANCE REVIEW Recognizing the importance of professional accountants’ services to the society, the govemrient has also taken steps to ensure that CPAs work to the highest standards which can reasonably be expected from them. “The government thru the BOA has required all CPA firms and individual CPAs in public practice to obtain a cetificate of accreditation to practice public accountancy. Such certificate is valid for three years and can be renewed after complying with the requirements of the BOA. ~ (As a condition to the renewal of the certificate of accreditation to practice . © public accountancy, the Bourd requires individual CPAs and CPA firms to undergo a quality assurance review to ensure that these CPAs comply ‘with accounting and auditing standards aad practices. “The PRC is supposed to create a-Quilty Review Committee (QRO) a ‘which shall conduct a quality review on the audits conducted by CPAs in fecommend the revocation of the certificate of registrations of CPAs ho have not observed the quality control measures of those who have ‘ot complied with the standards of quality prescribed for the practice of public accountancy. agencies like the Securities and Exchange Commission (SEC) have initiated programs’ to ensixe ‘that CPA firms \ are’ implementing appropriate quality control polices and procedures that would enable these firms to comply with the professional standards when providing professional services. ‘public practice. Based on the results of the quality review, the QRC nay i ‘As of today; the QRC has not yet been cteated. Nevertheless, regulatory Multiple Choice Questions ; vite Generly Anepted Andiing Standards (GAAS) w Which of the following best describes what is meant by’ generally accepted auditing standards? : 2. Audit objectives generally determined on audit engagements. b. . Acts.to be performed by the auditor. ae Measures of the quality of the auditor's performance... d. Procedures to be.used to gather evidence to support financial statements. | S In the auditing envionment, failure to meet auditing standards is often a. |. Amaccepted practice 4 . A suggestion of negligence ¢.'.- Conclusive evidence of negligence 4. Tantamount to criminal behavior “Audit standards requir the auditor to a. Perform procedures that are designed to detect all instances of fraud. i .b,- Provide. reasonable assurance that the financial statements are not materially misstated. «Issue an unmodified opinion only when the auditor is satisfied _ ; thae no instances of ffaud have oceusted. 4. "Design the audit program to meet financial statement users’ expectations conceming fraud. , + Which of te following underlies the application of generally accepted “,vauditing standards, pariclaty the. standards of field work and reporting? 5 “use Element of internal control, b. Elements of materiality and isk... , 5, c. Element of reasonable assurance, 4) «> Element of cosroborating evidence, “ar Scanned with CamScannerRequirements for training, indepesdence and due professicnal care ate oe ety sroup of the generally accepted auting standard? Bb. General < Reporting & Quality control The general standards of the generally accepted auditing standards. include a requirement that : F 2. The fieldwork to be adequately planned. b. ‘The auditor's report to state whether the financial statements are presented in conforinity with PFRS. : ce ” Duc professional care be exercised by the auditor. ‘ d. The auditor to obtain sufficient, competent evidential matter Which of the following reflects a cosicept from the geicral standards of GAAS? : a. The confirmation of accounts receivable. b. Completing an internal control questionnaire.“ * €.° The intial planning of the audit with the audit partner, manage, senior, staff and client personnel. i 4 ~The assignment of audit personnel to an engagement whete they have no financial interest. ; ; "What isthe general character of the three generlyaceptedsudting standards eral standards? 4 2 Ca Foon indepen and professional cae of individuals performing the audit. al bb Clea of evidence gathering: nail © Ceiteria' for the content’ of the auditors’ report on and related footnote disclosires. : d. Tp eniiio for the planning ‘of the audit and. supervision of assistants, if any. nd sie nen : rich of the flowing oso tothe sun fH 2 Adegae poo om : c Obtaining suficient competent evidential matter. ~ Proper study and cvaluation of internal control as a basis for reliance thereon Technical eaining and proficiency. “ While: performing ‘audit, ‘services for, their clients, professional accountants have a duty to provide alevel of care which is.” 2 Reasonable : * b. Greater than average Superior > sy 4. Guaranteed to be fre from error. at: ‘The standard of duc audit care requites the auditor to 2. Make perfec judgment decisions i all cases. wb. Ensure that the financial statements ate free from error.’ * - sPossess skills clealy above the average fr the profession. 4. Apply judgment in a conscientious manner, caefilly weighing the relevant factors before reaching a decision. Which of the following is most likely to be unique to the audit work of CPAs a8 compared to work performed by pracitioners of other professions? - 1 Due professional care: . » Competence, c. ‘Independence. 7 be ow 4. Comiples body of knowledge” 80 de db vniohes teow eee : ‘The third general standard states that due cates to be exercised inthe performance of an-audit:This,standardis ordinarily interpreted to rege 658 sy a . Thorough review of the existing safeguards over acess to assets sand records. 16 3 gas t \ b. Limited review of the indications of employee fratid and illegal 8 wets! Nolk tg moe e pay Scanned with CamScannerObjective review of the ad lequacy of the technical training and Proficiency of firm personnel: a Se reno he zat eed oy supervision. 4.“ What'is the general character of the three generally accepted auditing standards classified as standards of field work? The competence of lesons performing the audit. 2 ‘b. Criteria: for the content of the auditor's report on financial statements and related footnote disclosures c. The criteria of audit planning and evidence gathering, 4... The need to maintain an independence in menal aude in all sates eing tothe st 15. "the ‘third tanta of field. work States that sufficient competent evidential snatter may in part be obtained through the following srmmethods except a. Inspection b. Confirmation Observation di» Reconeliation «= Deh a ig following except tConsilenton of itera contol Consistent pplication of accounting principles, -) Informative disclosures Conformity of nancial stxtements with GAAP “The thd generally accepted standard of epsting in aig fers 0 a 2. Whether financial statements are presented in cnfoiy with 2 GAAP. bb. Whether accounting principles have bea consisenty observed. ‘Adequacy of disclosures an whole. 50 “An expression of opinion on the nancial statements taken 25 # “an expression of opi + The objertive of the consistency standard isto provide atuance that ‘There ate no varias inthe format and presentation of financial statements, for on an identical basis. © The autor is consulted before material changes are made inthe, application of accounting principles. 4. The comparability of financial statements between petiods in not materially affected by changes ia accountng princes without disclosure, 1. The fourth generally accepted auditing itandard of reporting requires an auditor to render a report whenever an auditor's name is associated with financial statements. The overall purpose of the fourth standard fi feporting is to require that reports: "* State that the examination of financial statements hasbeen conducted in accordance with generily, acepted auditing “standards.” Tndicate the character of the auditors examisatin and the degree ‘of responsibility asiumed by the auditor’ . "Imply thatthe auditor is ‘independent iad 2s well a in appearance with respect to the fnascalsatenebts unde. ‘examination. xm the he scp pen wi ging he been applied ‘anidird requires the auditor's report to contain ‘earding the financil statements taken a a ‘whole, or an assertion to the effect that an opinion innot be expressed. ‘The objective ofthe fourth standard isto prevent An auditor from reporting on ose basic financial sttemeat and ‘Substantially different transactions and events ate not accounted ”~ conden nthe pei’ « Scanned with CamScanner& . Management from teducing its final responsibility for the basic financial statements © Thesmountisinsgicant a Misinterpretations ing the de f responsibility the ‘The requitement of the PSA is impractical to perfoi ee aad gree of resp : The requirement ofthe PSA is impossible to perform.” ; ‘Any of the given three choices is correct. 21. The auditor is‘not liable to his client for 25," The Philippine Standards oa Auditing ‘canbe descubed as a. Negligence... 1 Providing very specific guidance about the specific stivties an b,- Fraud. - . auditor must perform on each engagement, Dishonesty ».” Similar to Philippine Financial Reporting Standards (PFRS). 4. Exrors in the application of judgment © Defining the minimum standards of performance for an auditor. Koen es bast Ms 4. Providing assurance that an auditor wll nc isse a inappropriate. audit opinion : a : Aung (5A) 5 7 26, Which of the folowing best desis the facon of Auditing and Te Papa 7 re Assurance Standards Council (ASC)? ee pete Mavegl To ‘establish “and promulgate generally. accepted accounting ir andar : issued by the Auditing - principles in the Philippines. 2 ‘The Pape Sencis oo Se eee ; b. "To investigate violations of the Accountancy Law. an Aaseunes tations of the generally accepted auditing standards. ¢- To promulgate audtng sandards,pcizs ind procedues that b At the eateda used in ealating the fair presentation of the : thal be generally accepted by the accounting profession in the Are ; . financial statements. =.) 5 4. To determine the minimom requirements for admission in the ra : :daecountn requirement c. Are’ interpretations of the generally accepted accounting entices rece ; ae optional gidelines which an auditor may choose to follow or 27. Pronouncements issued by AASC may be inthe form of ‘not follow-when conducting an audit. |, 1.4 : " ‘ i a Philippine ——-Phikppine 1 here arse : ; ing to Philippine Standards on, Auditing, ‘because there ats Philppine Standards on Standards on Philippine Beta Raton as sa fe the aural to det Stndarson Acar °° Resi” Stands on * ‘material misstatements, the auditor is: Jo-soh Auditing, -Exygements Engogements Related : *h gutantor but tan inser of the semen v9 ; Serias | ~ b. Aninsurer but nots guarantor ofthe statements, a. 2 Yes Ye Yes Ye -" Neither'a guarantor nor an insures of financial statements. “be. Yes No ‘Yes yNo a Bi Tor and an insurer of the financial statements. ee des Yous Yes No 3 guarantor and 3 $ No. Ye Noo Yes” ‘An auditor does not have to comply with a specific reqterent of the aie snes Wate Hed 2 PSA if the auditor believes that: ’ 52 mA. 53 Scanned with CamScanner29. 31. Based on the structure of AASC pronouncements, rated services f ae Audit Review “Agred-pon procedures. Conilton a Yes ” Yes No No be No No Yes Yes | cay kes Yes Ye) Be “ide No. .«., Yes Yebensths i? at “The risk that an auditor will fil to uncover a material misstatements Tf cient has good intemal control Which of the following is correct about the Philippine Auditing Practices Statements (PAPS)? These are issued to resolve issues relating to PSAS. b. These statements ate intended to have the authority of PSAs. These statements are issued to provide practical assistance to auditors in implementing PSAs or to promote good practice. d.__ These statements are forms of interpretations issued by AASC. Which of the following pronouncements issued by the AASC is designed to resolve issues relating to PSAs? 42. Philippine Auditing Practices Statements b. Interpretations Statements of Auditing Standards inthe Philippines ad. Generally Accepted Auditing Standards L. Ifauditor observes the Code of Péofesional Ethics ¢._.. When the auditor complies with PSA. + d. Under no circumstances. 3 ‘The udicr’s best defence when materi misstatements se, 101 uncovered is to have conducted the audit 2,” Inaccondance with PSA. b, As effectively as reasonably possible. timely manner. ., ¢ 4 d Onl after an adequate investigation of the management vom 54 is: 3. “The fe of he atior meet eg 4. Amaccepted practice. A suggestion of negligence. © Anevidence of negligence. 4. Tantamount to criminal behavior. Quality Conte Sytem 34. One of aCPA firm's basic objectives isto provide PPO fess sae of that conform with professional standards, Ressomsble 4 achieving this basic objective is provided through a A system of quality control. be, A quality assurance review. c _ Continuing professional education. cd. Compliance with generally accepted reporting standards. 35. A firm of independent auditors must esuiblsh and follow quality control policies and procedures because these standards 4° "Are necessary to meet increasing repiements of auditors' lb as insurers. Are required by the SEC for auditors ofall rms, ©, Incude formal ing of records of sch polices and procedur ATE pec. som Give reasonable assucince that the fim a5 a whole ‘with the professional standards. s will comply 36, ‘The main puipose of implementing «sof quay provide the firm with reasonable assurance that; 'Y ®O8tOl is. to a. The firm. and its personnel will ot requirements.” ry SFY and lepal The aut wil be performed in acondince with pg’ 55 Scanned with CamScannerWhich of the following is an element of a CPA. firm’s quality control, system that should be considered in establishing its quality control policies and procedures? 2 Complying with laws and regulations Using statistical sampling techniques Independence 4d. Consideration of audit risk and materiality ._Flaments of a CPA firm's quality control that should be considered in ‘estublishing its quality control policies and procedures must include: Monitoring Ethical Requirements Engagement Peformance Yes Yes a Yes b, Yes Yes No ci Yes No Yes d No Yes ‘Yes Which of the following is one of the elements of & CPA firm’s quality control system? i. Leadership responsibilities b, Computer assisted audit techniques & Control activites 4. Control environment Which of the following quality control objectives would be least important to the auditor? a. Engagement performance b. Human resources & Determination of audit fee 4. Independence A quality control policy that requites personae! in the fam to adhere to independence, integsty, objectivity, confidentiality and yaofessional bekavior, relates to : a. Ethical Requirements ‘b, Human resources 131 Scanned with CamScanner“Assignment d. Consultation . 46. Which of the following quality control polices and procedures does ‘not telate to human resources and assignment? 2 Emphasize independence of mental attitude in training programs - and in supervision and review of the audits. b. Monitor the effectiveness of recuiting programs. Identify criteria which will be considered in evaluating individual performance and expected proficiency, d. ~ Identify on a timely basis the staffing requirements of specific audits. 47.” Yn pursuing a CPA firm's quality control objectives, a CPA firm may maintain records indicating which partners or employees of the CPA firm were previously employed by the CPA firm's clients. Which quality: control element would this be most likely to satisfy? 2 Monitoring b. Assignment Independence d_ Skill and competence 48. A procedure in which a quility control partner periodically tests the. application of quality control procedures is most directly related 10 ‘which quality control element? 2. Engagement performance b. Independence, integrity, and objectivity, Monitoring d. Personnel management 49. In connection with the clement of engagement performance, a CPA firm’s system of quality control should ordinarily provide that all persorine! é 2 Have the knowledge required to enable-them to fulfil responsbilties assigned. : 58 33, b. Review and test compliance with the fimm’s quality control polices and procedures, © Seek assistance from persons having appropriate levels. of koowledge, judgment and authority, 4. Appropriately maintain independence when providing assurance services Maintaining or providing access to adequate reference libraries and other authoritative sources is a procedure that is most likely performed to comply with the policy of 2 Monitoring b. Skills and competence > Consultation d. > Assignment Which of the following quality control procedures relates: to engagement petformance? a. Hiring b. Direction: a= Professional development 4. Advancement. Within the context of quality control, the primary purpose of continuing professional education and traning activites isto enable a.* CPA firm to provide its personnel with: 2° Technical taining that assures proficiency asa valuation expert. __ b! Professional education that is required in order to perform with due professiosial care & Knowledge required to fulfil assigned responsibiles. 4. Knowledge required to perform a peer review. Tn compliance with the clement of human resources the firm should address issues relating to a: Engagement performance . Assignment of engagernent teams Consultation 4. Differences of opinion 9 Scanned with CamScanner54, prone one to engagement, the auditors may use poles ad 2 Designating senior qualified personnel to provide advice on accounting or auditing questions throughout the engagement. b. Requiring timely identification of the staffing requirements of specific engagements to that enough qualified personnel can be made available. : Establishing at entry levels a polcy for recruiting that iicludes | minimum standards of academic preparation and. - ~ accomplishments. d. Evaluate clients upon occurrence of. specified events. to 55. In connection with the element of assignment, a CPA fizm's system of = 2 b. c da 56. Which of the following is a policy that must be established to comply Tn pursuing the firm's quality control objectives with respect to determine whether the relationships ought to be continued. ty control should ordinzrily establish procedures that <, Provide adequate supervision at all levels, considering the | training, ability and experience of the personnel assigned. Encourage petsonne! to use authoritative sources on complex or ‘unusual matter. Require preparation of time budgets for audits to determine, 4 requitemen's and to schedule the audit work. Establish qualifications deemed necessary for vatious levels of responsibility within the firm. with the quality control engagement performance? a b. The firm is to be staffed by personnel who have attained and maintained the technica standards and professional competence , .. fequired to enable them to fulfill their responsibilities. “Thete is sufficient diection, supervision, and review of work performed at all levels to provide reasonable assurance that the work performed meets appropriate standards of quality. 60 ‘The fim should assign responsibility for each engagement to an ‘engagement partner. ‘The continued adequacy and operational effectiveness of quality control polices and procedures are to be observed. ‘The work performed by the assistants should be reviewed by personnel of at least equal competence to consider all ofthe following except: 4 Whether the conclusions expressed are consistent with the results of the work performed. b. Whether the-work was performed snd documented. Whether the objectives ofthe audit have been achieved. 4. Whether the engagement personnel maintained independence. ‘The primaty factor that should be considered in determining the extent of supervision needed by an assistant is the assstant’s a. Willingness to exercise de care b. Competence © Professional certification 4 Independence The auditor with final responsibilty for an engagement and one of the assistants havea difference of opinion about the resus of an inciting procedure. If the assistant believes itis necessary to be disassociated ~ from the mattet's resolution, the CPA firm's procedures should enable othe assistant to, 2. Refer the dishgreement to the Quality Review Committee. b. | Document the details of the disagreement with the condusion reached, " eDiseussthe'disagfeement withthe entiy’s management oF is audit comminee.” © * 4. - Report the disagreement to an impartial peer review monitoring . team. : 6 Scanned with CamScanner60. ‘The. primary purpose of establishing quality control policies and procedures for deciding whether to accept a new client is to a. “Enable the CPA firm to attest to the integrity of the client management. : b. Satisfy the CPA firm's duty to the public concerning the acceptance of new clients. f © Minimize the likelihood of association with clients whose management lacks integrity. a ‘tigate before performing any field work whether an ‘unmodified opinion can be expressed. 61, ° In, making’ ‘decision to ‘accept or retain a client, the firm should consider a. Itseompetence. + 1. Its ability to comply with ethical requirements c. The integrity of the client's management: 4. All three should be considered. 62. ACPA fiam’s quality control procedures pertaining to the acceptance of a prospective audit cient would most likely include - a: Inquiry of management as to whether disagreements between the vo. predecessor auditor and the prospective client were’ resolved | satisfactorily. be» Consideration of whether sufficient competent evidential matter ‘may be obtained to afford a reasonable basis for an opinion. Inquiry of third parties, such as the prospective clients bankers and attorneys, about information regarding the prospective client and its management. ; sufficiently effective to permit a reduction in the required substantive tests, : 63. Quality control policies arid procedites should provide the firm reasonable assurance that the policies and procedures relating to the other elements of quality contol are being effctively applid. This statement defines the qutity control element of 62 Consideration of whether. the internal control. striictute “is 66. a. 4 Planning b. Independence, integrity and objectivity © Assignment 4 Monitoring In connection with the clement of monitoring a CPA firm’s system of quality control should ordinarily provide for the maintenance of a A file of minutes of staff meetings b. Updated personnel fils. : © Documentation to demonstrate compliance with its policies and procedures. 4 Documentation to demonstrate compliance with peer review disectives. : ‘A deficiency inthe fir’ system of quality contol is an indication that 2.” The auditengagement was not performed in accordance with the professional standards, : b. The audit reports issued were not appropriate. Both aandb . 4. Neither a norb It involves a study of appraisal by the Board or its duly authorized sepresentatives, of the quality of audit of financial statements through an evaluation of the quality control measures instituted by the CPA firm to ascertain compliance with ethical and technical standards af public practice A” Quality review b.. Peer review © Compliance audit d. External audit Which of the following is responsible" for. establishing auidting standards that willbecome generally accepted inthe Philippines? a Securities and Exchange Commission b. Finaticial Reporting Standards Council "Commission on Audit d._.. Auditing and Assurance Standards Council 63 Scanned with CamScanneractic Tim Chapter3 AUDITOR'S RESPONSIBILITY ‘The fai presentation of the financial statements in accordance with the ‘ppliible financial reponing framewockis the responsiblity ofthe cen’ management. The auditor's responsibilty is to design the audit to provide easonable assurance of detecting material misstatements inthe ftancal statements, These misstatements may emanate from: 1. Error 2. Fraud; or 3. Noncompliance with Laws and Regulations ® ERROR : The term “error” refers to unintentional misstatements ia the financial statements, including the omission of an amount ora disclosure, such as: “> Mathematical ot cltical mistakes in the underlying records and * accounting data; } Incorrect accounting’ estimates arising from oversight ot misinterpretation of facts; or > Mistakes in the application of accountisig policies. @ FRAUD Pad bet ied eat: bia ng management, those churged with governance, employees ot thid partes, involving the use of deception to obtain an unjust or ilegal advantage. Although fraud is a broad legal concept, the auditor is ‘primarily concemed with fraudulent acts that cause matetial misstatements in the financial statements, 65 Scanned with CamScanner‘Types of Fraud ‘There ate two:types of fraud that are relevant to financial statement audit- misstatements resulting from fraudulent financial reporting ‘and misstatements resulting from misappropriation of assets Fraudulent financial reporting involves intentional misstatements ot omissions of amounts or disclosures in the financial statements to deceive financial statement users This type of fiaud is also known as management fraud because it usually involves members of ‘management or those charged with governance. This may involve: > Manipulation, falsification ot alteration of records or documents; > Misrepresentation in of intentional omission of the effects of” transactions from records or documents; > Recording of transactions without substance; of > Intentional misapplication of accounting policies Misappropsiation of assets involves theft of an entiy’s assets committed by the entity's employees. Ths is also called "employee ~- fraud " because itis often perpetrated by employees. in relatively small and immaterial amouats. This may include: > Embezzling receipts; : > Stealing entity's assets such as cash, marketable securities, and inventory; ot : ; > Lapping of accounts receivable. Employee fraud is often accompanied by false of misleading records , or documents in order to ‘conceal the fact that the assets are missing. ‘Fraud iavolves. motivation to commit. the. act ‘and a. perceived opportunity to do so, For example, an employee might be motivated t0 steal company’s assets because this employee lives beyond hhis means ‘Also, 2 member of management may be forced to manipulate the financial statements in order to meet an overly optimistic projection. ae Ptctved opportunity to omni fraud mi exist when an ndvidal believes that he can get away with it. Thisis usally the case when there 'S mo proper segregation of ‘duties -among employees “of when ‘management believes that internal contol egn be easily ceumvented. ‘The primary factor that distinguishes fraud from éitot is whether the underlying ‘cause of misstatement in the financial statements is intentional or unintentional. Alnough the auditor may be able to ‘identify opportunities for fraud to be perpetrated, it s often difficult, if ‘ot impossible, for the auditor to determine intent, particularly in matters involving Sanpete judgment, such as accounting éstimates and the appropriate application of accounting principles. Cons auditors responsibilty for the detseton of faud sd « ent essentially the sarne. S>Responsibility of Management and Those Charged with * Governance ' = 2 The responsibilty for the preveniin and detection of fraud and eror fests with both management and those charged with the governance ‘of the entity. In this regard, PSA 240 requires <> Management’-to establish’ + “control environment and to \-3) “imiplement internal control policies and procedures designed to ensure, among others, the detection and prevention of fraud and it tots? ‘etna? viet © 9D Individuals charged with governance of an entity ensure the integrity of an entity's accounting and financial reporting systems and that appropriate controls are in place. EE Auditor’s Responsibility Although anniial audits of financial statements may act as deterrent to fraud and ‘error, the “auditor is not and cannot be: held responsible for the prevention of fraud and error. ‘The auditor's 61 Scanned with CamScannerWac tol of! ort ‘ou responsibilty is to design the audit to provide reasonable assurance that the financial statements are free from material misstatements, whether caused by error or fraud. Planning Phase © 41. When planning an auclt, the auditor should make inquiries of management about the possibilty of misstatements duc to fraud and error. Such inquiries may include: > Management’ assessment of risks due to fraud; > Controls established to addtess the risks; or } Any material error ot fraud that has affected the entity or suspected fraud thatthe entity is investigating, ‘The auditor's inquiries of management may provide useful information concerming the tsk of material misstatements in the financial statements resulting from employee fraud. However, such inquiries are unlikely to provide useful ‘information regasding the isk of material misstatements in the financial statements resulting from management fraud. ‘Accordingly, the auditor should also inquire of those individuals in change of governance to seck their views on the adequacy of accounting and internal control systems in place, the risk of fraud and error, and the integrity of management. 2. The auditor should assess the risk that fraud or error may cause the financial statements to contain material misstatements. In this regard, PSA 240 requites.the auditor to specifically assess the rsk of material misstatements due to fraud both atthe financial statement level and assertions level. § The fact that fraud is usually concealed can make it very difficult to detect it. Nevertheless, using the auditor’s Knowledge of the business, the auditor may identify events oF ._ 68 conditions:that provide an opportunity, a motive or a means to commit au, or indicate hat fu may akeady have occurred. Such events of conditions ae refered to af “raud sik factor”. Fraud risk factors do not necessarily indicate the existence of feaud, ‘however, they often have been present in circumstances where frauds have occurred. Examples of ftaud tisk factors taken from PSA 240 ae set outa the end of this chapter. Jodgments about the increased tsk of material misstatements due to fraud may inflence the auditor's response aad professional judgment inthe following ways: > ‘The auditor may approach the audit with a height tened level of professional skepticism; > The audit team may be selected in ways that ensure that » Whe knowledge, sill, and ability of personnel assigned significant esponsbilties are commensurate with the auditor's assessment of risk; of > ‘The auditor may design mote effective “audit Procedures ot may increase the extent of the procedures tbe performed. Testing Phase 3. During the course of the audit, the auditor may encounter circumstances that may indicate the possibly of fraud ot error, For eximple, there are discrepancies found in the accounting records, conflicting or missing documents, or ack o Scanned with CamScannerSc etion from management. In these ciscumstinces, the auditor should perform procedures necessary to termine whether material misstatements exist. When material misstatement in the financial statements are identified, the auditor should consider whether such a misstatement resulted from a fraud or an error: This is important because errors will only result to an adjustment of financial statements but fraud may have ‘other implications on an audit. If the auditor believes that the misstatement is, or may be the result of fraud, but the effect on the financial statements is not material, the auditor should: > Report the matter to’ the appropriate level of management at least one level above those involved; and > Be sitsfied that, ‘given’ the’ position .of the. likely perpetrator, the fraud has-no other implications for . | other aspécts of the auditor that those implications have been adequately considered. “However, if the auditor detects:a material fraud or has been unable to evaluate whether the effect on financial statement is material or immaterial, the auditor should: > Consider implication for other aspects of the audit _particulaty the reliability of management repiesentations; > Discuss the matter-and the approach to further. investigation with an appropriate level that is atleast one level above those involved; and “> "Attempt to obtain evidence to determine whether 4 ‘matetial fraud in fact exists and, if so, their effect, and +} Suggest that the client consult with legal counsel about questions ‘of law. 0 Completion Phase 5., The stor should obtain a writen ia en Gutimcgaie % the management acknowledges its responsibility for the implementation and operations of Scouting ‘and intemal control systems that are designed 10 prevent and detect fraud and error; v it believes the effects of those uncorrected financial’ statement misstatements aggregated by the audit ‘during the audit are immaterial, ‘tit inceny and in the aggregate, to the financial sttements taken sa whole. A summary of such items should be included in or attached tothe written representation; > it has disclosed to the auditor all significant facta relating to any frauds ot suspected frauds known to management that-may have affected the entity; and > it has disclosed to the auditor the results of ite assessment ofthe risk thatthe financial statements may ‘be material misstated asa result of fraud: Reporting Phase 6. Whea the auditor belcves ‘that material error or fraud “exists, the auditor should request the management to revise the financial statements. Otherwise, the auditor will express 1 qualified or adverse opinion. 7. If the auditor is unable'to evaluate the effect of fraud on the financial statements because of limitation on the scope of n Scanned with CamScannerthe mors examination, the auditor should ether qualify sclaim opinion on the financial statements Because of the inherent limitations of an audit there is an unavoidable risk that material misstatements in the financial statements resulting from fraud and error may not be detected, ‘Therefore, the subsequent discovery of material misstatement in the financial statements resulting from fraud or error does not, in and of itself, indicate that the auditor has: failed to adhere to the basic, principles and essential procedures of an audit, ‘The tisk of not detecting a material misstatement resulting from * fraud is higher than the risk of not detecting misstatements resulting from error. This is because fraud may involve sophisticated and carefully organized schemes designed to cosieal it, such as forgery, deliberate failure to record transactions, or intentional | risrepresentation being made to. the auditor. Hence,” audit procedures that aie effective for detecting material errors may be ineffective for detecting material fraud, especially. those concealed through collusion. Furthermore, the risk of the auditor not detecting 2 materi misstatement resulting from management fraud is greater than for employee fraud, This is because members of management are often ina position that assumes their integrity and enables them to override the formally established control procedures. . Certain levels of management may be. in a position to override control procedures designed to prevent similar frauds, by other * employees," for example, by directing subordinates to record * transactions incorrectly or to conceal them, Given its position of authority within an entity, management has the ability to either direct some employees to do something of solicit their help to assist management i caring outa fu, with or without the employee 2 ‘© NONCOMPLIANCE WITH LAWS AND REGULATIONS ‘Noncompliance refers to acts of omission ot commission by the entity being audited, ether intentional or unintentional, which are contrary to the realign or regltions. Sich tinct uansictons entered into by, ot in the name of, the entity or on its behalf by its management ‘oremployces. Common examples include” Y > Tax evasion; Violation of environmental protection laws; Inside trading of securities. Noncompliance with laws and regulations may result in fines, litigations ‘or other consequences for the entity that may have a material effect on the financial statements 1. Responsibility of Management It's the responsibility of management, with the oversight of those charged with governance; to ensure that the entity’s operations are conducted in accordance with: laws and regulations. The ‘esponsibility for the prevention and detection of noncompliance * rests with the entity's management. £3. Auditor’s Responsibility ‘An audit cannot be expected to detect noncompliance with all hws and regulations. ‘Nevertheless, the auditor should recognize that noncompliance by the entity wth lws and regulations may materially affect the financial statements. Planning Phase Scanned with CamScanner» In order to plan the audit, the auditor should obtain g General understanding of the legal and regulatory framework applicable to the entity and the industry and how the entity is complying with that framework To obtain the general understanding of laws and regulations, the auditor would ordinal > Use the existing knowledge ofthe entty’s industry and business; +> Inquite of management concerning the entity's policies and procedures regarding compliance ‘with laws and regulations; > Inquire of management as to the laws.or regulations that 3. The auditor should also design audit procedures to obtain sufficient appropriate audit evidence about compliance with those laws and regulations generally recognized by the auditor to have an effect on the determination of material amounts and disclosures in financial statements. Testing Phase 4 When the auditor becomes aware of information concening 4 possible instance of soncompliance, the auditor should obtain an understanding of the nature of the act and the circumstances in which it has occurred, and sufficient other information to evaluate the possible effect on! the financial statements, When evahating the possible effect ‘on the financial statements, the auditor considers: Scanned with CamScanner may be expected to have a fundamental effect on the ‘operations of the entity; > The potential. financial consequences, such as fines, . Penalties, damages, threat of expropriation of assets, > Discuss with managenient tie policies’oe proctdwesil ee eee ef penal ‘adopted for identifying, evaluating and accounting for ite od Chis ind shectoeated > “Whether the potential financial consequences require disclosure; and > Discuss the legal “and regulatory framework with | ~ auditors of subsidiaries in other countries (for example, if the subsidiary is required to adhere to the securities regulations of the parent company). "2. After obtaining a general understanding, the auditor should - design procedures to help identify instances ‘of ‘noncompliance with lows and regulations such as: Whether the potential financial consequences-ate so serious a to call into question the fair presentation given by the financial statements, / 5. Wha the auditor believes there may be noncompliance, the ~ auditor should document the findings, discuss them with management, and consider the implication on other 7 aspects of the audit : > Reading mintites of meetings; } Inquiring of management as to whether the entity iis compliance with such laws and regulation; of > Inspecting correspondence with the relevant licensig of regulatory authoritics. oe S° f 4Completion Phase Bs 6 The auditor should obtain written representations “that ‘management has disclosed to the auditor all known actual of Possible noncompliance with laws and regulations that could ‘materially affect the financial statements. Reporting Phase 7, When the auditor believes that there is noncompliance with | laws and regulations that materly affects the financial statements, the auditor should request the management to revise the financial statements. Otherwise, the auditor will hhave to express either qualified o adverse opinion. express a qualified opinion or a disclaimer of opinion. -An audit is subject to the unavoidable risk that. some material ‘inisstatements in the financial statements will not be detected, even , though the audit is properly planned and performed in accordance with PSAs. This risk is higher with regard to material misstatements resulting from noncompliance with laws and regulations because: “> Noncompliince may involve conduct designed to conceal it, such as collusion, forgery, deliberate failure to record transactions, senior management override of controls of intentional misrepresentations being made to the auditor. 16 {fa scope limitaionrhas precluded the auditor from obtaining sufficient appropriate evidence to evaluate the effect of | ‘noncompliance with laws and regulations, the auditor should > ‘There are many laws and regulations relating pritcipally to the operating aspects of the entity that typically do not have 4 material effect on the financial statements and are not ‘captured by the accounting and internal control systems, Auditors are primarily concerned with noncompliance that may cause the financial’ statements to. contain material misstatements. Accordingly, the auditor should design the audit to provide reasonable assurance that noncompliance that has 2 ‘material and direct effect on the financial statements are detected. Auditors do not normally design audit procedures to detect ‘noncompliance that will not directly affect the far presentation of the financial statements unless the results of other procedures that were applied cause the auditor to suspect that amaterialindect effect noncompliance may have occured. Ordinarily, the futheesemoved ‘nos.-compliance is from the financial , statements, the less likely the auditor isto become aware of it of to recognize the non-compliance. : ‘The fraud risk factors identified below are examples of such factors typically faced by auditors in a broad range of situations. The fraud tsk factors listed below are only examples; not all ofthese factors are ely to be present in all audits, nor isthe list necessanly complete. ‘Ihe auditor exercises professional judgment when ‘considering fraud risk factors individually rin combination and whether thee are specific controls that mitigate the risk. “ Fraud Risk Factors Relating to: Misstatements Resulting from Fraudulent Financial Reporting Scanned with CamScannerFraud tisk factors that relate to misstatements resulting from fraudulent ffnancial reporting may be grouped in the following three categories: 1. Management's Characteristics and Influence over the Control Environment. : 2 Industry Conditions. 3. Operating Characteristics and Financial Stability. For each of these three categories, examples of fraud risk factors relating to misstatements arising from fraudulent financial reporting are set out below. Foi Rik Factors Relating to Managements Characteristics and Iflence over the Control Eminent ‘These fraud risk factors pertain to management's abilities, pressures, style, 4 snd attitude relating to intemal control and the financial reporting process. There is motivation for management to engage in fraudulent financial © reporting, Specific indicators might include the following: A significant portion of management’s compensation is represented | by bonuses, stock options or other incentives, the value of which is ‘contingent upon the entity achieving unduly aggressive targets for ‘operating results, financial position or cash flow. ¥ Thete ‘is excessive interest by management in maintaining of increasing the enttys stock price or eamings trend through the use of unusually aggressive accounting practices. Y Management commits to analysts, creditors and other third parties t0 4 scheving whet ape be endl agresive orcs unrealistic forecasts. : 3 Y Management has an interest in pursuing inappropriate means ‘0 minimize reported earings for tax-motivated reasons. B There is a failure by management to display and communicate an appropriate attitude regarding internal control and the financial reporting process. Specific indicators might include the following: Y Management does not effectively communicate and support the entiy’s values or ethics, or management communicates inappropriate values.or ethics. 2 Y Management is dominated by a single person or a small group ‘ without compensating controls such as effective ovérsight by those’ charged with governance Management does aot monitor significant controls adequately. Management fails to correct known material weaksicsses in internal control on a timely basis. . Y Managemeat sets unduly aggressive financial targets and expectations for operating personnel. Y Management disphys significant “disregard for regulatory authorities. Y Management ; continues to. employ ineffective accounting, information technology of internal auditing staf: = Non-financial management participates excessively in, ‘or is . preoccupied with, the selection of accounting principles or the determination of significant estimates. ~ ,Thereis a high turnover of management, counsel or board members. There sa strained tcltionship between inanagement and the current for predecessor auditor., Specific indicators might include the following: : Frequent disputes. with the current or a, predecessor auditor on accounting, auditing or reporting matters. ¥ Unreasonable demands on the auditor, including unreasonable time constraints segatding the completion of the audit or the issuance of the auditor's report; ” Scanned with CamScannerFotmal or informal restrictions on the auditor that inappropriately limit the auditor's ‘access to people or information, oF limit the auditor's ability to communicate effectively with those charged with governance ¥ Domineering management behavior in especially involving attempts.to influence 1 work. . = There is a history of securities law violations, or claims against the entity orits management alleging raud or violations of securities laws dealing with the auditor, the scope of the auditor's ‘which may “The corporate governance structure is weak or ineffective, bbe evidenced by, for example: Y- Alack of members who are independent of management. Lisle attention being paid to financial reporting matters and to the sccounting and internal control systems by those charged with | governance. Fraud Risk Fars Relating to Indust Conditions “These fraud tisk factors involve the economic and regulatory environment in which the entity operates. — ‘New accounting, stitutory or regulatory requirements that. could impair the financial stability or profitability ofthe entity. = A high degree of competition or market saturation, accompanied by declining thargins. = A declining industry with increasing business failures and significant declines in customer demand. ‘ = Rapid changes in the industry, such as high vulnerability to rapidly changing technology of rapid product obsolescence. 8 rand Risk Fastors Relating to Operating Characters and Financial Stability “These fraud risk factors pertain to the nature and complexity of the entity and its transactions, the entity’s financial condition, and its profitability. — Inability to generate cash flows from operations while reporting carnings and earnings growth, =. Significant pressure to obtain additional capital necessary t0 stay competitive, considering the financial position ofthe entity (iicluding __ need for funds to finance major research and development or capital” expenditures). ~ Assets, liabilities, revenues or expenses based'on significant estimates that involve unusually subjective judgments or uncertainties, or that are subject to potential significant change in the near term in a manner that may have a financially disruptive effect on the entity (for example, the ulimate collectabilty Of receivables, the timing of ‘evenue recognition, the realizability of financial instruments based on highly- subjective valuation of collateral or ‘difficult-to-assess' repayment sources, of a significant deferral of costs). —. Significant related party transactions which are not in the ordinary course of business. . = Significant related party transactions which aré not audited or are, audited by another firm. ~ Significant, unusual or highly complex transactions (especially those close to year-end) that pose difficult questions conceming substance * yet form. 81 Scanned with CamScannera. __ Significant bank accounts ot subsidiary ot branch operations in tax- haven jusdictions for which there appears to be no clear business justification. = An overly complex organizational structure involving sumerous or -unusual legal entities, managerial lines of authority or contractual arrangements without apparent business purpose. — Difficulty in ‘determining the organization or person (or persons) controling the enti. — Unusually pid growth or profitability, especially compared with that of other companies in the same industry. hn Especial high vlerblyto changes in intrest tes. — Unusually high dependence on debt, a masginal ability to meet debt sepayment requirements, or debt covenants that are difficult to smuintain. ‘= Unrealistically aggressive sales or profitability incentive programs. ' A threat of imminent bankruptcy, foreclosure or hostile takeover. ~ Adverse consequences on significant pending transactions (such as a’ ‘business combination ot contract award) if poor financial results are. * reported. é ~ A poor or deteiomtng financial position when management has ” Personally guaranteed significant debti ofthe entity Fraud Risk Factors Relati is ing to, Miss ulti eee tatements Resulting from 82 Fraud isk factors that rebte to misstatements resulting from ‘misappropriation of assets may be grouped in the following two categories: 1. Suscepiibilty of Assets to Misappropriation. 2 Controls. ; . For each of these two categories, examples of fraud tisk factors relating to misstatements resulting from misappropriation of assets are set out below. The extent of the auditor’s consideration ofthe fraud risk factors in category 2 is-influenced by the degree to which fraud risk factors in category 1 are present. : Fru Risk Factors Relating to Susaptiilty of Aus to Mitappropriation “These fraud risk factors pertain to the nature ofan entity's assets and the degree to which they ace subjectto theft. * ~ Large amounts of cash on hand or processed. = Inventory characteristics, such as small size combined with high value and high demand. + Easily convertible assets such as bearer bonds, diamonds or computer chips. = “Fixed, asset!“charactetistics; sich as: small size combined, with marketability and lick of ownership identification. Frad Risk Factors Relating to Castros “These fraud tisk factors involve the lack of controls designed to prevent oo detect misappropriation of assets. ; = Lack of appropriate management oversight (for example, inadequate supervision or inadequate monitoring of remote locations). B . Scanned with CamScanner