AUD 0 Compliance audit

Auditing and Assurance Principles

AUDIT - An Overview
An audit is a systematic process of objectively
obtaining and evaluating evidence regarding
assertions about economic actions and events to
ascertain the degree of correspondence between
these assertions and established criteria and
communicating the results to interested users.
1. Auditing is a systematic process
2. An audit involves obtaining and evaluating
evidence about assertions regarding
economic actions and events.
3. An audit is conducted objectively.
4. Auditors ascertain the degree of
correspondence between assertions and
established criteria.
Operational Audit

TYPES OF AUDITORS
 External Auditors or Independent Auditors
 Internal Auditors
 Government Auditors

The Independent Financial Statement Audit

➜ Responsibility for the Financial Statements
➜ Assurance provided by the Auditor
- Not a guarantee
- Reasonable assurance
- Inherent limitations
TYPES OF AUDITS
Nature of the Procedures
➜ The Use of Testing or Sampling Risk
Financial Statement Audit ➜ Errors in the Application of The Judgement
or Non-Sampling Risk
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 of the management. Many financial
statement items involve subjective decisions that
are subject to an inherent variability which cannot
be eliminated by performing audit procedures.

Nature of Evidence
 Persuasive rather than conclusive
 There is unavoidable risk that even an
audit conducted in accordance with PSA’s
may not be able to detect material
misstatement in the financial statements.
General Requirements When Auditing
 Financial Statements
1. The auditor should comply with the
relevant ethical requirements, including
those pertaining to independence, relating
to financial statements audit engagements.
2. The auditor should conduct an audit in
accordance with the Philippine Standards
on Auditing (PSAs).
3. The auditor should apply professional
judgment in planning and performing the
audit.
4. The auditor should obtain sufficient
appropriate audit evidence to reduce the
audit risk to an acceptably low level.
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.
Need for an Independent Financial
Statement Audit
➜ Conflict of interest between management and
users of financial statements.
➜ Expertise.
➜ Remoteness.
➜ Financial Consequences.
Professional Standards
Reasonable Assurance
Reasonable
 not absolute
 contains room for error
Assurance
 fairly presented
 based on auditor’s opinion
Generally Accepted Auditing Standards (GAAS)
 Minimum requirements in the performance
of the audit
 Enhances the quality of assurance
 Accuracy, consistency, and variability
 Basis in evaluating performance of the
audit
Three Categories of GAAS
A. General Standards
B. Standards of Field Work
C. Standards of Reporting
GENERAL STANDARDS
1. Adequate Technical Training and Proficiency
- Formal university education for entry into the
profession,
- Practical training and experience in auditing,
and
- Continuous professional education during the
auditor’s professional career.
2. Independence in Mental Attitude
- The auditor must be free of client influence in
performing the audit and reporting the
findings. The auditor must also meet the
independence requirements of the AICPA’s
professional conduct.
3. Due Professional Care
- The auditor must be diligent and careful in
performing an audit and issuing a report on
the findings. The standard of due care requires
the auditor to act in good faith and not to be
negligent in an audit.
4. Adequate Planning and Proper Supervision
- A sufficient understanding of internal control
is to be obtained to plan an effective and
efficient audit.
5. Understanding the Internal Control Structure
- A sufficient understanding of internal control
is to be obtained to plan an effective and
efficient audit.
6. Obtaining Sufficient Competent Evidential
Matter
- The sufficient competent evidential matter is
to be obtained through inspection,
observation, inquiries, and confirmations to
afford a reasonable basis for an opinion
regarding the financial statements under audit.
7. Financial Statements Presented in Accordance
with GAAP
- The first reporting standard requires the
auditor to identify GAAP as established criteria
for evaluating management’s financial
statement assertions.
8. Consistency in the Application of GAAP
- The report shall identify those circumstances
in which such principles have not been
consistently observed in the current period in
relation to the preceding period.
9. Adequacy of Informative Disclosure
- Informative disclosures in the financial
statements are regarded as reasonably
adequate unless otherwise stated in the report.
10. Expression of Opinion
- The final reporting standard requires the
auditor to either express an opinion on the
financial statements taken as a whole or state
that an opinion cannot be expressed.
Philippine Standards on Auditing (PSAs)
Auditing and Assurance Standards Council
The AASC is a ruling body ensuring the excellence
and uniformity of auditing and assurance-related
services in the country.
Philippine Standards On Auditing
- PSAs contain the basic principles and essential
procedures which the auditor should follow.
- They are to be applied in the audit of financial
statements.
 The PSAs issued by the Auditing Standards
Practices Council (Council) are based on
International Standards on Auditing (ISAs)
issued by the International Auditing Practices
Committee of the International Federation of
Accountants.
Quality Control System
Quality Controls are policies and procedures
adopted by CPAs to provide reasonable assurance
of conforming with professional standards in
performing audit and related services.
Under Philippine Standard on Quality Control
(PSQC) 1, a firm has an obligation to establish a
system of quality control to provide reasonable
assurance that the firm and its personnel:
 comply with professional standards and
regulatory and legal requirements
 that the report issued by the firm are
appropriate in the circumstances
In this regard, engagement teams:
 Implement quality control procedures that
are applicable to audit engagement;
 Provide the firm with relevant information
to enabling the functioning of that part of
the firm's system of quality control relating
to independence; and
 Are entitled to rely on the firm's systems
unless information provided by the firm or
other parties suggest otherwise
Elements of Quality Control System
PSA 220 states that audit firm should
implement policies and procedures designed to
ensure that all audits are conducted in accordance
with PSAs.
1. Leadership Responsibilities for Quality on Audits
- The firm should establish policies and
procedures designed to promote an internal
culture based on recognition that quality is
essential in the performance of the
engagements.
2. Ethical Requirements
- The firm should establish policies and
procedures designed to provide reasonable
assurance that the firm and its personnel
comply with ethical requirements, which
include:
 Integrity;
 Objectivity;
 Professional competence and due care;
 Confidentiality; and
 Professional behavior
3. Independence
- The firm should establish policies and
procedures designed to provide it with
reasonable assurance that the members of the
engagement team, the firm and, where
applicable, the network firms maintain
independence when providing assurance
services.
- The engagement partner should:

 Obtain relevant information to
identify circumstances and
relationships that create threats to
independence;
 Evaluate information on identified
breaches of the 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 acceptable level; and
 Document conclusions on
independence and the basis for such
conclusion.
4. Acceptance and Continuance of Client
Relationships
- The firm should establish policies and
procedures for the acceptance and continuance
of client relationships and specific
engagements, designed to provide reasonable
assurance that it will only undertake or
continue relationships and engagements.
 Has considered the integrity of the
client;
 Is competent to perform the
engagement and has the capabilities,
time, and resources to do so; and
 Can comply with ethical requirements.
5. Human Resources and Assignment
- The firm 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
engagement.
- Such policies and procedures should address
issues concerning personnel:
 Recruitment;
 Performance evaluation, compensation,
and promotion;
 Capabilities and competence;
 Career development; and
 Assignment of engagement teams
6. Engagement Performance
- The firm should establish policies and
procedures designed to provide reasonable
assurance that engagements are performed in
accordance with professional standards and
other regulatory and legal requirements; and
that the audit report issued is appropriate in
the circumstances.
- The engagement partner should take
responsibility for:
 Direction
 Supervision
 Review
 Consultation
 Engagement Quality Control Review
 Differences of Opinion
7. Monitoring
- The continued adequacy and operational
effectiveness of quality control policies and
procedures is to be monitored.
Quality Control Review
- The government thru the Professional
Regulatory Board of Accountancy (BOA) has
required all CPA firms and individual CPAs in
public practice to obtain a certificate of
accreditation to practice public accountancy
(valid for 3 years).
- As a condition to the renewal of the certificate,
the Board requires individual CPAs & CPA
firms to undergo quality control review to
ensure compliance with accounting and
auditing standards and practices.
- The PRC has created a Quality Review
Committee (QRC) which shall:
 conduct a quality review on
applicants for registration; and
 recommend revocation of certificate
to those who have not observed the
quality control measures.
The Auditor's Responsibility
Error and Fraud
Error
- the term " error " refers to unintentional
misstatements in the financial statements.
Errors such as:
 Mathematical or Clerical Mistakes
 Incorrect Accounting Estimates
 Mistakes in application of accounting
policies
Fraud
- The fraud refers to intentional act by one or
more individuals among management, those
 charged with governance, employees, or third
parties, involving the use of deception to
obtain an unjust or illegal advantage.
Types of Fraud
A. Fraudulent Financial Reporting
- This type of fraud is also known as
"Management Fraud" because it usually
involves members of management or those
charged with governance.
 Manipulation, falsification
 Recording w/o substance
 Intentional Omission
 Intentional Misapplication
B. Misappropriation of Assets
- This type of fraud is also known as "Employee
Fraud" because it is often perpetrated by
employees in relatively small and immaterial
amounts.
 Embezzling Receipt:; Stealing; Lapping
Accounts Receivable
Responsibility of Management
- to establish a control environment and to
implement internal control policies and
procedures.
Responsibility of Individuals Charged with
Governance
- to ensure the integrity of an entity's accounting
and financial reporting systems and that
appropriate controls are in place.
Auditor ' s Responsibility
- Although the annual audit 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 responsibility is to DESIGN THE
AUDIT to provide reasonable assurance of
detecting material misstatements in the
financial statements that may arise from:
(1) error, (2) fraud, and (3) non-compliance
with laws and regulations.
PLANNING PHASE
1. When planning an audit, the auditor should
make inquiries of management about the
possibility of misstatements due to fraud and
error. Management inquiry may include:
 Management' s assessment of risks due
to fraud;
 Controls established to address the
risks;
 Any material error or fraud that has
affected the entity or suspected fraud
that the entity is investigating.
2. The auditor should assess the risk that fraud or
error may cause the FS to contain material
misstatements.
TESTING PHASE
3. During the course of the audit, the auditor may
encounter circumstances that may indicate the
possibility of fraud or error. In these
circumstances, the auditor should perform
procedures necessary to determine whether
material misstatements exist.
4. After identifying material misstatement in the
FS, the auditor should consider whether such a
misstatement resulted from a fraud or an error
 If error, it needs adjustment of financial
statements.
 If fraud, it may have other audit
implications.
 If fraud, it may have other implications.
➜ If the misstatement may be a result of
fraud, but the effect is not material, the
auditor should: If fraud,
 Refer the matter to the appropriate
level of management at least one level
above those involved; and,
 Be satisfied, given the position of the
likely perpetrator, the fraud has no
other implications for other aspects of
the audit or that those implications
have been adequately considered.
➜ If the misstatement may be a result of
fraud, and the effect is material or has been
unable to evaluate whether the effect on
the FS is material or not, the auditor
should:
 Consider implication for other aspects
of the audit particularly the reliability of
management representations;
 Discuss the matter and the approach to
further investigation with an
appropriate level or that is at least one
level above those involved;
 Attempt to obtain evidence to
determine whether a material fraud in
fact exists and, if so, their effect; and,
 Suggest that the client consult with legal
counsel about questions of law.
COMPLETION PHASE
5. The auditor should obtain a written
representation from the client' s management
that:
 It acknowledges its responsibility for
the implementation and operations of
accounting and internal control systems
that are designed to prevent and detect
fraud and error.
 It believes that effects of those
uncorrected FS misstatements
aggregated to the FS taken as a whole. A
summary of such items should be
included in or attached to the written
representation.
 It has disclosed to the auditor all
significant facts relating to any frauds
or suspected frauds known to
management that may have affected the
entity;
 It believes that effects of those
uncorrected FS misstatements
aggregated by the auditor during the
audit are immaterial, both individually
and in the aggregate, to the FS taken as
a whole. A summary of such items
should be included in or attached to the
written representation.
CONSIDER THE EFFECT ON THE AUDITOR'S
REPORT
6. When the auditor believes that material error
or fraud exists, he should request the
management to revise the financial statements.
Otherwise, the auditor will express a qualified
or adverse opinion.
7. If the auditor is unable to evaluate the effect of
fraud on the FS because of a limitation on the
scope of the auditor's examination, the auditor
should either qualify or disclaim his opinion on
the FS.
REMINDERS:
 Because of inherent limitations, there is an
unavoidable risk that material
misstatements in the FS resulting from
fraud or error may not be detected.
Therefore, subsequent discovery of
material misstatement is not an indicative
of the auditor ' s failure to adhere to the
basic principles and essential procedures of
an audit.
 The risk of not detecting a material
misstatement resulting from fraud is higher
than the risk of not detecting
misstatements resulting from error.
 The risk of not detecting a material
misstatement resulting from management
fraud is greater than from employee fraud.
Noncompliance with Laws and Regulations
NONCOMPLIANCE
- refers to acts of omission or commission,
intentional or unintentional committed by the
entity, or by those charged with governance,
by management or by other individuals
working for or under the direction of the
entity, which are contrary to the prevailing
laws or regulations. [Section 225.2]
Common examples include:
 tax evasion
 violation of environmental protection
laws
 inside trading of securities
RESPONSIBILITIES
Management and those charged with
governance
- to ensure that the entity's operations are
conducted in accordance with the provisions of
laws and regulations, including compliance
with the provisions of laws and regulations
that determine the reported amounts and
disclosures in an entity's financial statements.
Management Responsibility (PSA 250)
 Monitoring legal requirements and
ensuring that operating procedures are
designed to meet these requirements.
 Instituting and operating appropriate
systems of internal control.
 Developing, publicizing, and following a
code of conduct.
 Ensuring employees are properly trained
and understand the code of conduct.
 Monitoring compliance with the code of
conduct and acting appropriately to
discipline employees who fail to comply
with it.
 Engaging legal advisors to assist in
monitoring legal requirements.
 Maintaining a register of significant laws
and regulations with which the entity has
to comply within its particular industry and
a record of complaints.
Auditor
- to obtain sufficient appropriate audit evidence
regarding material amounts and disclosures in
the financial statements that are determined
by the provisions of those laws and regulations
- performing specified audit procedures that
may identify noncompliance with those laws
and regulations that may have a material effect
on the financial statements.
PLANNING PHASE
1. Obtain a general understanding of the legal
and regulatory framework applicable to entity.
2. Design procedures to help identify instances of
noncompliance with laws and regulations
3. Design audit procedures to obtain sufficient
appropriate evidence about compliance with
laws and regulations.
The Auditor's Consideration of Compliance With
Laws and Regulations
- The auditor should obtain a general
understanding of:
 The legal and regulatory framework
applicable to the entity and the industry
or sector in which the entity operates
 How the entity is complying with that
framework.
- The auditor should obtain sufficient
appropriate audit evidence regarding material
amounts and disclosures in the financial
statements that are determined by the
provisions of those laws and regulations
generally recognized to have a direct effect on
their determination.
- The auditor should perform the following audit
procedures that may identify instances of
noncompliance with other laws and
regulations that may have a material effect on
the financial statements:
 Inquiring of management and, when
appropriate, those charged with
governance about whether the entity is
in compliance with such laws and
regulations; and
 Inspecting correspondence, if any, with
the relevant licensing or regulatory
authorities.
TESTING PHASE
4. When the auditor is aware concerning instance
of noncompliance, evaluate the possible effects
on the FS.
5. When the auditor believes there maybe
noncompliance, the auditor should document
the findings, discuss them with management
and consider the implication on other aspects
of the audit.
COMPLETION PHASE
6. The auditor should obtain a written
representation from the client's management.
7. When the auditor believes that there is
noncompliance, the auditor should request the
management to revise the financial statements.
Otherwise, a qualified or adverse opinion will
be issued.
8. If a scope limitation has precluded the auditor
from obtaining sufficient appropriate evidence,
the auditor should express a qualified opinion
or a disclaimer of opinion.
FRAUD RISK FACTORS RELATING TO
MISSTATEMENTS RESULTING FROM
FRAUDELENT FINANCIAL REPORTING
THREE CATEGORIES
1. Management’ s characteristics and
Influence over the Controlled Environment
2. Industry conditions
3. Operating Characteristics and Financial
Stability
Management's characteristics and influence
over the control environment.
 A motivation for management to engage in
fraudulent financial reporting.
 A failure by management to display and
communicate an appropriate attitude
regarding internal control and the financial
reporting process.
 Nonfinancial management’s excessive
participation in, or preoccupation with, the
selection of accounting principles or the
determination of significant estimates
 High turnover of senior management,
counsel, or board members.
 Strained relationship between
management and the current or
predecessor auditor.
 There is a history of securities law
violations, or claims against the entity of its
management alleging fraud or violations of
securities laws.
 The corporate governance structure is
weak or ineffective, which may be
evidenced.
Risk factors relating to industry conditions
 New accounting, statutory, or regulatory
requirements that could impair the
financial stability or profitability of the
entity.
  High degree of competition or market  Especially high vulnerability to changes in
saturation, accompanied by declining interest rates.
margins.  Unusually high dependence on debt or
 Declining industry with increasing business marginal ability to meet debt repayment
failures and significant declines in requirements; debt covenants that are
customer demand. difficult to maintain.
 Rapid changes in the industry, such as high  Unrealistically aggressive sales or
vulnerability to rapidly changing profitability incentive programs.
technology or rapid product obsolescence.  Threat of imminent bankruptcy or
foreclosure, or hostile takeover.
Risk factors relating to operating  Adverse consequences on significant
characteristics and financial stability pending transactions, such as a business
combination or contract award, if poor
 Inability to generate cash flows from
financial results are reported.
operations while reporting earnings and
 Poor or deteriorating financial position
earnings growth.
when management has personally
 Significant pressure to obtain additional
guaranteed significant debts of the entity.
capital necessary to stay competitive
considering the financial position of the
Risk factors relating to misstatements arising
entity—including need for funds to finance
from misappropriation of assets
major research and development or capital
expenditures.
TWO CATEGORIES
 Assets, liabilities, revenues, or expenses
based on significant estimates that involve 1. Susceptibility of assets to misappropriation.
unusually subjective judgments or These pertain to the nature of an entity ' s
uncertainties, or that are subject to assets and the degree to which they are subject
potential significant change in the near to theft.
term in a manner that may have a
financially disruptive effect on the entity— 2. Controls. These involve the lack of controls
such as ultimate collectability of designed to prevent or detect
receivables, timing of revenue recognition, misappropriations of assets.
realizability of financial instruments based
Risk factors relating to susceptibility of assets
on the highly subjective valuation of
to misappropriation
collateral or difficult-to-assess repayment
 Large amounts of cash on hand or
sources, or significant deferral of costs.
processed
 Significant related party transactions which
 Inventory characteristics, such as small
are not audited or are audited by another
size, high value, or high demand
firm.
 Easily convertible assets, such as bearer
 Significant, unusual, or highly complex
bonds, diamonds, or computer chips
transactions, especially those close to year
 Fixed asset characteristics, such as small
end, that pose difficult "substance over
size, marketability, or lack of ownership
form" questions.
identification.
 Significant bank accounts or subsidiary or
branch operations in tax-haven
Risk factors relating to controls
jurisdictions for which there appears to be
 Lack of appropriate management oversight
no clear business justification.
(for example, inadequate supervision or
 Overly complex organizational structure
monitoring of remote locations)
involving numerous or unusual legal
 Lack of job applicant screening procedures
entities, managerial lines of authority, or
relating to employees with access to assets
contractual arrangements without
susceptible to misappropriation
apparent business purpose.
 Inadequate record-keeping with respect to
 Difficulty in determining the organization
assets susceptible to misappropriation
or individual(s) that control(s) the entity.
 Lack of appropriate segregation of duties
 Unusually rapid growth or profitability,
or independent checks
especially compared with that of other
companies in the same industry.
  Lack of appropriate system of
authorization and approval of transactions
(for example, in purchasing)
 Poor physical safeguards over cash,
investments, inventory, or fixed assets
 Lack of timely and appropriate
documentation for transactions (for
example, credits for merchandise returns)
 Lack of mandatory vacations for employees
performing key control functions
The Audit Process – Accepting an Engagement
GENERAL AUDIT APPROACH
- A general approach to auditing financial
statements would require consideration of
financial statement assertions, audit
procedures and audit evidence.
Financial Statement Assertions
- Management makes assertions regarding the
recognition, measurement, presentation, and
disclosure of the various elements of financial
statements and related disclosures.
- These assertions may fall into the following
categories:
1. Assertions about Classes of Transactions
and Events
a) Occurrence
b) Completeness
c) Cut-off
d) Accuracy
e) Classification
2. Assertions about Account balances at the
period end
a) Completeness
b) Existence
c) Rights and Obligations
d) Valuation and Allocation
3. Assertions about Presentation and
Disclosure
a) Occurrence and rights and obligations
b) Completeness
c) Accuracy and valuation
d) Classification and understandability
Audit Procedures
- The auditor should use assertions in sufficient
detail to form a basis for the assessment of
risks of material misstatement and the design
and performance of further audit
procedures.
- The procedure selected should enable the
auditor to gather sufficient appropriate
evidence about a particular assertion.
- Some of the audit procedures used by the
auditor to gather sufficient appropriate
evidence include:
 Inspection
involves examining of records,
documents, or tangible assets.
 Observation
consists of looking at a process or
procedure being performed by others
 Inquiry
consists of seeking information from
knowledgeable persons inside or
outside the entity.
 Confirmation
consists of the response to an inquiry to
corroborate information contained in
the accounting records
 Computation
consists of checking the arithmetical
accuracy of source documents and
accounting records or performing
independent calculations.
 Analytical Procedures
consist of the analysis of significant
ratios and trends including the resulting
investigation of fluctuations and
relationships that are inconsistent with
other relevant information or deviate
from predicted amounts.
Audit Evidence
- Audit procedures are used to obtain sufficient
appropriate evidence
- Audit Evidence refers to info obtained by
auditor in arriving at the conclusions on which
audit opinion is based..
- It comprises source documents and accounting
records underlying FS and corroborating info
from other sources.
OVERVIEW OF THE AUDIT PROCESS
Audit Process
- The Audit process is the sequence of different
activities involved in an audit. The emphasis
 and order of certain activities may vary
depending upon a particular audit, but this
process would basically include the following
audit activities.
Steps in the Audit Process
1. Accepting an Engagement
2. Audit Planning
3. Considering Internal Control
4. Performing Substantive Tests
5. Completing the Audit
6. Issuing a Report
Accepting an Engagement
Definition
- The first step in the audit process is to make a
decision of whether to accept or reject an audit
engagement.
Preliminary Planning activities (PSA 300)
a) Performing procedures regarding the
continuance of the client relationship and
the specific audit engagement;
b) Evaluating compliance with ethical
requirements, including independence;
c) Establishing an understanding of the terms
of the engagement
Audit Planning
- In planning an audit, the auditor obtains more
detailed knowledge about the client's business
and industry. Knowledge of the client's
business and industry is important because it
helps in understanding the transactions and
events affecting the financial statements.
- Risk and Materiality
Considering the Internal Control
Definition
- The auditor is required to give adequate
consideration to the entity's internal control
because the condition of the entity's internal
control directly affects the reliability of the
financial statements.
Consideration of Internal Control involves:
- Obtaining understanding of the entity's
internal control.
- Assessing the level of Control Risk:
 The risk that the client's internal control
may not prevent or detect material
misstatements in the financial statements.
Performing Substantive Tests
- Substantive tests are audit procedures
designed to detect material misstatements in
financial statements.
- The nature, timing, and extent of the
substantive tests are highly dependent on the
results of the auditor's consideration of
internal control.
 Effective
 Weak
Completing the Audit
Definition
- After the auditor has completed testing the
account balances, the auditor perform
additional audit procedures to complete the
audit and become satisfied that the evidence
gathered is consistent with the opinion to be
expressed in auditor's report.
Common Procedures:
- Review of Subsequent events and
contingencies;
- Assessing the appropriateness of the use of the
going concern assumption;
- Performing overall analytical review
procedures;
- Obtaining written representations from the
client's management.
Issuing a Report
- On the basis of audit evidence gathered and
evaluated, the auditor forms a conclusion
about the financial statements.
 Conclusion (in the form of an opinion) - is
communicated to interested users through
an audit report.
ACCEPTING AN ENGAGEMENT
1. COMPETENCE
- One of the primary considerations before
accepting an audit engagement is to determine
whether the auditor has the necessary skills
and competence to handle the engagement.
2. INDEPENDENCE
- Essential to the credibility if the auditor’s
report is the concept of independence.
3. ABILITY TO SERVE THE CLIENT PROPERLY
a) An engagement should not be accepted if
there are no enough qualified personnel to
perform the audit.
b) There should be sufficient direction,
supervision, and review of work at all
levels.
4. INTEGRITY OF MANAGEMENT
- Requires the firm to conduct a background
investigation of the prospective client.
  Making inquiries of appropriate parties in
the business community
 Communicating with the predecessor
auditor.
Retention of Existing Clients
- Clients should be evaluated at least once a year
or upon occurrence of major events.
ENGAGEMENT LETTER
- The auditor and the client should agree on the
terms of the engagement and record it in an
engagement letter.
- The engagement letter serves as the written
contract between the auditor and the client.
The letter sets forth:
1. The objective of the audit;
2. Management’s responsibility;
3. Scope of the audit;
4. Forms or any reports that the auditor expects
to issue;
5. Facts that unavoidable risk of undiscovered
material misstatements due to audit
limitations; and
6. Client’s responsibility to give unrestricted
access to information in connection with the
audit.
The auditor may also include:
1. Billing arrangements
2. Expectations of receiving management
representation letter
3. Arrangements concerning others’ involvement
4. Confirmation request to client
Importance of the engagement letter
1. Avoid misunderstandings
2. Document and confirm auditor’s acceptance of
the appointment
Recurring Audits
- For recurring engagements, An auditor does
not normally send new engagement letter
every year. But there are factors that may
cause the auditor to send a new engagement
letter.
- In cases where the auditor does not send a new
engagement letter, the auditor should remind
the client:
1. Terms of the original arrangement;
2. Responsibilities of auditor and client.
Issue a new engagement letter if:
1. Client misunderstands the objective and scope
of the audit;
2. Any revised of special terms of the
engagement;
3. A recent change of senior management, board
of directors, or ownership;
4. A significant change in the nature or size of
client’s business; or
5. Legal requirements and other government
agencies’ pronouncements
Audits of Components
- When the auditor of a parent entity is also the
auditor of its component, the auditor should
consider the following factors in making a
decision of whether to send a separate letter to
component.
1. Who appoints the auditor of the
component;
2. Whether to issue a separate component
audit report;
3. Legal requirements;
4. Extent of other auditor’s work;
5. Degree of ownership by parent; or
6. Degree of independence (component).
Audit Planning
UNDERSTANDING THE CLIENT’S BUSINESS AND
INDUSTRY
Audit Planning
- Auditor's main objective is to determine the
scope of the audit procedures to be performed
Benefits of Planning
 Helps ensure that appropriate attention is
devoted to important areas of audit
 It helps identify potential problems
 It allows the work to be completed
expeditiously
 It allows work to be completed
expeditiously
 It assists in the proper assignment and
coordination of work
 Facilitating the direction and supervision
of engagement team members and review
their work
Nature and Extent of Planning Activities
 Size and complexity of the entity
 Key engagement team members' previous
experience with the entity
 Changes in circumstances
during the audit engagement
that occur Understanding the Client
- Knowledge of the client's business and
industry – how and why a client does what it
does - is essential if the audit is to be carried
out effectively and efficiently.
- The auditor should obtain a sufficient level of
knowledge of the entity's business to identify
and understand the events, transactions
and practices that may have a significant
effect on the financial statements.
Sources of Information
a) Review of prior years' working papers
b) Tour of the client's facilities
c) Reading relevant books, periodicals, and
other publications
d) Discussion with people within or outside
the entity
e) Reading corporate documents and
financial report
Uses of Information Obtained
- Understanding the business and using this
information appropriately assists the auditor
in:
 Assessing risks and identifying potential
problems
 Planning and performing the audit
effectively and efficiently
 Evaluating audit evidence as well as the
reasonableness of the client's
representation and estimates
 Providing better service to the client
Additional Consideration on New Engagement
PSA 510, requires the auditor obtain sufficient
appropriate evidence that:
 The opening balances do not contain
misstatements that materially affect the
current year's financial statements
 The prior period's closing balances have
been correctly brought forward to the
current period or when appropriate have
been restated
 Appropriate accounting policies are
consistently applied or changes in
accounting policies have been properly
accounted for and adequately disclosed
Understanding The Internal Control
- Another important step in assessing risk of
material misstatements in the financial
statements is for the auditor to obtain
sufficient understanding about the entity's
internal control system.
Developing An Overall Audit Strategy
- The best audit strategy is the approach that
results in the most efficient audit, which is an
effective audit performed at the least possible
cost.
An Audit Plan Should Be Made Regarding:
 How much evidence to accumulate
 What are the procedures to be performed
 When should the procedures be
performed
MATERIALITY
- is defined in the Financial Reporting Standard
Council’s “Framework for the Preparation and
Presentation of Financial Statements,” in the
following terms: "Information is material if its
omission or misstatement could influence the
economic decision of users taken on the basis of
the financial statements."
- In designing an audit plan, the auditor should
make a preliminary estimate of materiality for
use during the examination. The concept of
materiality recognizes that some matters are
important for fair presentation of financial
statements while other matters are not
important.
Materiality may be viewed as:
 The largest amount of misstatement that
the auditor could tolerate in the financial
statements
 The smallest aggregate amount that could
misstate the financial statements.
Materiality is a matter of professional
judgement and necessarily involves :
 Quantitative Factors
 amount of the item in relation to the
financial statements
 Qualitative Factors
 the nature of misstatement
Importance of Materiality in Planning an Audit
- The auditor should make a preliminary
estimate of materiality to determine the
amount of evidence to accumulate. There is an
inverse relationship between materiality and
evidence. This means, more evidence will be
required for a low peso amount of materiality
than for a high peso amount.
Uses of Materiality
- According to PSA 320, materiality should be
considered by the auditor:
 In the PLANNING STAGE, to determine the
scope of audit procedures; and
 In the COMPLETION PHASE of the audit, to
evaluate the effect of misstatements on the
financial statements.
Using Materiality Levels
The following steps may be used as a guide when
using materiality levels.
STEP 1 & 2 – performed in the planning phase
STEP 3 – performed in the completion phase if the
audit.
STEP 1: DETERMINE THE OVERALL
MATERIALITY – FINANCIAL STATEMENT LEVEL
- The auditor should determine the amount of
misstatement that could be material to the
financial statements taken as a whole.
 If the materiality level is set too low,
auditor will be wasting his time auditing
accounts that are not important.
 If materiality level is set too high, auditor
may not detect misstatements that could be
material to the readers of the financial
statements.
- When establishing materiality levels on a
financial statement level, the auditor should
consider that the financial statements are
interrelated- that is, a misstatement on one
financial statement usually affects the other
statement. For this reason, the auditor should
consider materiality in terms of the smallest
aggregate level of misstatement that could
distort any one of the financial statements.
- A common method of estimating materiality at
the financial statement level is to multiply a
statement base (total assets, sales, or net
income) by a certain percentage.
Example:
Assume that the auditor believes that
misstatements aggregating P40,000 would
have a material effect on the client's income
statement and that these misstatements would
have to aggregate P60,000 to materially affect
the balance sheet. When designing audit
procedures, it is wiser for the auditor to design
audit procedures that will be expected to
detect misstatements aggregating P40,000. By
using P40,000 as the materiality level, the
auditor will have a reasonable assurance that
 both financial statements are not materially
misstated.
Materiality Guidance:
- Most accounting firms provide guidance to
their staff auditors in order to promote
consistent materiality judgements. The
guidelines usually involve applying
percentages to some base, such as total assets,
total revenue, or pretax income. In choosing a
base, the auditor considers the stability of the
base from year to year so that materiality does
not fluctuate significantly between annual
audits. Income is often more volatile than total
assets or revenue.
- A simple guideline for small business audits
could be, for example, to set overall materiality
at 1% of total assets or revenue, whichever is
higher. A traditional starting point for many
companies is 5% of net income.
STEP 2:DETERMINE THE TOLERABLE
MISSTATEMENT – ACCOUNT BALANCE LEVEL
- Once the overall materiality is established, the
auditor determines materiality at the account
balance level. This is done by allocating the
overall materiality to the financial statement
account balances. This allows the auditor to
determine the audit procedures that will be
applied to specific accounts. The allocated
materiality to an account is called the
tolerable misstatement for that account. This
is also known as the performance
materiality.
- The professional standards do not provide
specific guidelines as to how the allocation
should be done. This process is highly
subjective and requires the exercise of great
deal of judgement by the auditor.
STEP 3: COMPARE THE AGGREGATE AMOUNT OF
UNCORRECTED MISSTATEMENTS WITH THE
OVERALL MATERIALITY
- After performing audit procedures, the auditor
will have to compare the aggregate
uncorrected misstatements with the overall
materiality (preliminary estimate of
materiality or revised materiality level) to
determine whether or not the financial
statements are materially misstated.
Bases that can be used to determine the
materiality level
- Since audit planning is often performed before
year-end, annual financial statements are
usually not available. As a result, the auditor
uses alternative bases to compute for the
materiality levels, such as:
 Annualized interim financial statements
 Prior years’ financial statements
 Budgeted financial statements of the
current year
AUDIT RISK
▰ Why design the audit?
To provide reasonable assurance Financial
statements taken as a whole are free from
material misstatements
▰ What to use as basis?
The auditor should use professional
judgment to assess audit risk and design audit
procedures to ensure it is reduced to an
acceptably low level
Three Main Issues To Consider When
Designing Substantive Auditing Procedures
1. What level of assurance does the auditor wish to
attain that the financial do not contain material
misstatements?
↑ Level of assurance
↑ Scope of Auditor’s substantive test
2. How susceptible is the account to material
misstatement?
↑ Susceptibility of account
↑ Scope of Auditor’s substantive test
3. How effective is the client’s internal control in
preventing or detecting misstatements?
↑ Effectiveness of client’s internal control
↓ Scope of Auditor’s substantive test
(3) Preliminary Basis For The Development Of
The Audit Risk Model
Audit Risk Model
Preliminary Basis:
Audit Risk = Inherent Risk x Control Risk x
Detection Risk
Audit Risk
▰ Refers to the risk that the auditor gives an
inappropriate audit opinion, this happens
when the auditor believes that the financial
statements are fairly stated when in fact it
is materially misstated
▰ Audit risk is the complement of audit
assurance. 10% Audit risk = the auditor
must design audit to have 90% assurance
level
↓ Desired level of Audit risk
↑ Effective substantive procedures
Inherent Risk
▰ Is the susceptibility of an account balance
or class of transactions to a material
misstatement assuming that there were no
related internal controls.
▰ PSA 315 requires the auditor to assess
inherent risk at the financial
statement/account balance or transaction
class levels
↑ Level of inherent risk
↑ Effective substantive procedures
Factors that affect the risk of misstatement at:
1. Financial Statement Level
a) Management Integrity
b) Management Characteristics
c) Operating Characteristics
d) Industry Characteristics
2. Account Balance Level
a) Susceptibility of the account to theft
b) Complexity of calculations related to
account
c) Complexity underlying transactions and
other events
d) Degree of judgment involved in
determining account balances
Control Risk
▰ Is a risk that a material misstatement could
occur in an account balance or class of
transactions that will not be prevented,
detected, or corrected on a timely basis by
accounting and internal control systems.
▰ It is related to the client’s internal control
▰ Assessed using the auditor’s judgement
▰ Is the probability that financial statements
are materially misstated, due to failures in
the controls used by a business.
↑ Level of control risk
↑ Effective substantive procedures
Detection Risk
▰ Is the risk that an auditor’s substantive
procedure will not detect a material
misstatement.
▰ Unlike inherent and control risks, the
auditor can control the level of detection
risks by performing more effective
substantive procedures.
▰ The acceptable level of detection risk is
inversely related to the assessed level of
both inherent and control risks.
↓ Acceptable level of detection risk
↑ Assurance directly provided from
substantive tests
Set the desired level of Audit Risk
- No specific guidelines as long as opinion can be
issued at a low-level risk
Assess the level of Inherent Risk
- Identify accounts that are more likely to be
misstated
-
R
ely on own knowledge of the client’s business
and industry and the results of the preliminary
analytical procedures
Assess the level of Control Risk
- Study and evaluate the effectiveness of the
accounting and internal control systems of the
client
Determine the acceptable level of Detection Risk
Detection Risk = Audit Risk
Inherent Risk x Control Risk
Design Substantive Tests
- A lower acceptable level of detection risk
increases the assurance to be provided by
substantive tests. Ex: 30% acceptable level of
detection risk = substantive tests should
provide 70% assurance
• To increase assurance the auditor can:
a) Perform more effective substantive
procedures (nature)
b) Perform year-end procedures (timing)
c) Using larger sample size (extent)
• To decrease:
a) Perform less effective substantive
procedures
b) Perform the tests at interim
c) Using smaller sample size
Relating Inherent, Control And Detection Risk
To The Overall Audit Risk
▰ The three risks are component of the
overall audit risk therefore an increase or
decrease on these components would also
increase or decrease the audit risk
▰ Among the three, only the detection risk
can be controlled by the auditor. The
auditor can only assess the level of the two
because both are functions of the
management and its environment
Relationship Between Materiality And Risk
▰ There is an inverse relationship between
materiality and the level of audit risk
Risk Assessment Procedures
▰ Performed by auditors to obtain an
understanding of the entity and its
environment including its internal control
and to assess the risks of material
misstatements in the financial statement
1. Inquiries of management and others
within the entity
2. Analytical procedures
3. Observation and Inspection
ANALYTICAL PROCEDURES AND PLANNING
DOCUMENTATION
Analytical Procedures
- Analytical procedures involve analysis of
significant ratios and trends, including the
resulting investigation of fluctuations and
relationships that are inconsistent with other
relevant information or deviate from predicted
amounts.
Steps in applying Analytical Procedures
1. Develop an expectation of recorded amounts:
 Prior years’ financial statements
 Anticipated results such as budgets and
forecasts
 Similar industry information
 Relationships among elements of financial
statements
 Relationships between financial and non-
financial data
2. Compare the expectations with the financial
statements under audit.
3. Investigate and evaluate significant differences
from the expectation
Uses of Analytical Procedures
- Analytical procedures may be used for the
following purposes:
 As a planning tool, to determine the
nature, timing, and extent of other
auditing procedures.
 As a substantive test to obtain
corroborative evidence about particular
assertions related to the account
balance or transaction class; or
 As an overall review of the financial
statements in the completion phase of
the audit.
The Use of Analytical Procedures in an Audit
Stage of the audit Objective
• To understand the client’s
Planning The Audit business
• To identify areas that may
represent specific risks
Substantive Tests • To obtain evidence to
confirm (or refute)
individual account
balances
• To identify unusual
fluctuations that were not
identified in the planning
and testing phases of the
Overall Review audit
• To confirm conclusions
reached with respect to
the fairness of the
financial statements
DOCUMENTING THE AUDIT PLAN 7. Dependent auditor is needed to assist them in
verifying the reliability of the financial
- The final step in the planning process is the
information
documentation of the audit planning process
➜ False
by preparing an overall audit plan, audit
program, and time budget.
8. The auditor should obtain sufficient
Audit Plan appropriate audit evidence to reduce the audit
An audit plan is an overview of the expected scope risk to an acceptably high level.
and conduct of the audit. The overall audit plan ➜ False
sets out in broad terms the nature, timing, and
extent of the audit procedures to be performed. 9. Objectivity deals with being biased and
listening to others opinions.
Audit Program
➜ False
- The auditor should develop and document an
audit program setting out the nature, timing 10.Internal Auditors work for the government not
and extent of planned audit procedures the company
required to implement the overall audit plan.
➜ False
Time Budget
- A time budget is an estimate of the time that 11.Operational audits are conducted to determine
will be spent in executing the audit procedures whether financial statements are correctly
listed in the audit program. This provides a presented.
basis for estimating audit fees and assists the ➜ False
auditor in assessing the efficiency of the
assistants. 12.Independent auditors usually perform
compliance audits
➜ False
QUIZ 1: OVERVIEW OF AUDITING
13.The established criteria for compliance audits
1. Misleading financial information could have are laws, regulations, and contracts
substantial economic consequences for a ➜ True
decision maker.
➜ Financial Consequences 14.The auditor checks if the assertions match the
established criteria
2. What are the 3 types of audits? ➜ True
➜ Compliance, financial statement, and
operational audit 15.Operational audits are conducted to determine
the efficiency and effectiveness of the company
3. The established criteria for compliance audits ➜ True
is
➜ The Law 16.The auditor should conduct an audit in
accordance with the Philippine Standards on
4. Internal Auditors usually perform Auditing (PSAs)
➜ Performance Audit ➜ True

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 stated.
➜ False
6. Audit evidence is generally persuasive rather
than inclusive in nature
➜ False
17.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
➜ True
18.Financial statements may be viewed as the
report by management as to how the entity
performed under their direction and
supervision
➜ True
19.Independent Professional judgment
essential to the proper conduct of the audit.
➜ True
20.Audit evidence is needed to support the
opinion expressed in the auditor's report.
➜ True
QUIZ 2: THE PROFESSIONAL STANDARDS
1. Which of the following professional services
would be considered an assurance
engagement?
➜ An engagement to report on compliance
with statutory requirements
2. Which of the following best describes the
objective of an assurance engagement?
➜ Enhance the credibility of information in
order to improve the likelihood that the
information will meet the needs of an
intended user
3. Standards that encompass the details,
complexities, and legalities of business and
corporate accounting.  ➜ Assignment of engagement teams
➜ Generally Accepted Accounting Principles
4. Sets of standards against which the quality of
audits are performed and may be judged
➜ Generally Accepted Auditing Standards
5. The Philippine Standards on Auditing can be
specified as
➜ Defining the minimum standards of
performance for an auditor
6. Which of the following best describes the
function of the Auditing and Assurance
Standards Council (AASC)?
➜ To establish auditing standards,
processes, and procedures that the
Philippine accounting community will
generally accept.
7. The failure of the auditor to meet the
requisites of PSA is
➜ Evidence of negligence
8. Which of the following AASC declarations is
intended to address PSA-related issues?
➜ Interpretations
9. The person in the firm who is responsible for
the audit engagement and its performance and
responsible for the auditor’s report that is
issued in behalf of the firm
➜ Engagement Partner
is 10.Elements of a CPA firm’s quality control that
should be considered in establishing its quality
control policies procedures
➜ Monitoring, Ethical Requirements,
Independence
11.In order to accept or retain a client
relationship, the firm must consider
➜ Its competence, Compliance with ethical
requirements, The integrity of the client
12.The firm should establish policies and
procedures designed to provide reasonable
assurance that it has sufficient personnel with
capabilities, competence, and commitment to
ethical principles necessary to perform the
engagement.
➜ Human Resources and Assignment
13.Which of the following quality control
procedures are with accordance to
engagement performance?
➜ Professional development
14.To comply with the element of human
resources, the firm should address issues that
are relating to
15. The standard of due care requires the auditor
to act in good faith and to be negligent in an
audit.
➜ False
16.The four procedure under obtaining sufficient
evidential matter are Inspection Observation,
Constriction, and Inquiry
➜ False
17.What makes the opinion a reliable one is
because of the absolute assurance that they
can give to their clients
➜ False
18.The report should identify those circumstances
in which principles have not been consistently
observed in the current period in relation to
preceding period.
➜ False
19.The standard of adequate planning and
supervision requires an auditor identify and
monitor audit procedures
➜ True
20.The report should identify those circumstances
in which principles have not been consistently
observed in the current period in relation to
preceding period.
➜ True
QUIZ 3: The Auditor's Responsibility
1. It is their responsibility to ensure that the
entity’s operation are conducted in accordance 13. A subsequent discovery of material
with laws and regulations. The responsibility misstatement resulting from fraud or error
indicates that the auditor fails to adhere to the
for the prevention and detection of
basic principles.
noncompliance rests with the entity’s
➜ False
management.
➜ Management 14. Auditor is not responsible but can be held
responsible for the prevention of error and
2. Refers to acts of omission or commission by fraud.
the entity being audited, either intentional or ➜ False
unintentional, which are contrary to the
prevailing laws or regulations. 15. There is a failure by management to display
➜ Noncompliance and communicate an appropriate attitude
regarding internal control and the financial
3. Obtaining a written representation from the reporting process:
client's management is in what phase?
➜ Completion S1. Management displays a significant regard
for regulatory authorities.
4. A factor that distinguishes error from fraud.
➜ Intention S2. Management does not effectively
communicate and do not support the entity's
5. If a scope of limitation precludes the auditor values or ethics.
from obtaining sufficient appropriate evidence ➜ False; False
to evaluate the noncompliance with laws and
regulations, the auditor should express: 16. S1: When the auditor believes that there is a
➜ Qualified or Disclaimer of opinion noncompliance with laws and regulations that
materially affects the financial statements, the
6. It is a type of auditor opinions the company auditor does not need to request the
limited the auditor’s ability to thoroughly management to revise the financial
conduct his audit, or the auditor couldn’t get statements;
satisfactory explanations for their questions.
➜ Disclaimer of opinion S2: The auditor will then express either
7. It is obtained by the auditor from the qualified or a disclaimer of opinion
management which indicates the disclosure ➜ False; False
that all known actual or possible 17. S1: The auditor must obtain specific
noncompliance with laws and regulation could understanding of the client’s legal and
materially affect the financial statements. regulatory framework applicable to the entity
➜ Written Representation and the industry;

8. There is no unavoidable risk that material S2: and how the entity is complying with that
misstatements may not be detected. framework
➜ False ➜ False; True
9. Auditor, from his knowledge, can easily detect 18. S1. Only employees can misappropriate assets.
frauds
➜ False S2. One example of misstatement resulting
from misappropriation of assets is
10. Error also involves deception manipulation of documents.
➜ False ➜ False; False
11. In noncompliance with laws and regulation 19. S1: Noncompliance with laws and regulations
(NOCLAR), the auditor is not permitted to may result in fines, litigation, or other
report to the authorities without reporting the consequences for the entity that may have a
matter to management but only in exceptional material effect on the financial statements
cases
➜ False S2: Auditor should recognize that
noncompliance by the entity with laws and
12. Error refers to unintentional misstatements regulations may immaterially affect the
that are sophisticated and carefully organized. financial statements
➜ False ➜ True; False

20. S1: When the auditor becomes aware of
information concerning a possible instance of
noncompliance, the auditor does not need to
obtain an understanding of the nature of the
act and the circumstances in which it has
occurred;
S2: and sufficient other information to not
evaluate the possible effect on the financial
statement.
➜ False; False
QUIZ 4:
The Audit Process – Accepting an Engagement
1. Harry, CPA, is succeeding William, CPA, on the
audit engagement of Big Ben Corporation.
Harry plans to consult William and to review
William’s prior year working papers. Harry
may do so if
➜ William and Big Ben consent
2. It should be given to the entity’s internal
control because the condition of the entity’s
internal control directly affects the reliability
of the financial statements.
➜ Adequate consideration
3. Which of the following factors most likely
would cause an auditor not to accept a new
audit engagement?
➜ Concluding that the entity’s management
probably lacks integrity
4. Which of the following would be least likely to
be included in the auditor’s engagement letter
➜ Type of opinion to be issued
5. Before accepting an engagement, the auditor
should obtain a preliminary knowledge of the
client’s business and industry to determine
whether the auditor has this characteristic.
➜ Degree of Competence
6. It should also be made to develop an overall
audit strategy and a detailed approach for the
expected conduct and scope of the
examination.
➜ Preliminary Assessment of Risk and
Materiality
7. Auditors accumulate evidence to:
➜ Enable them to reach conclusions about
the fairness of the financial statements
8. The auditor’s evaluation of clients is not a one-
time consideration. That’s why clients should
be evaluated for how many times per year
upon occurrence of major events?
➜ At least once a year
9. A procedure that involves the computation and
analysis of trends and investigation of
fluctuations and relationships that are
inconsistent with relevant information
➜ Analytical Procedure
10. Before accepting an engagement to audit a
new client, a CPA is required to obtain
➜ A preliminary understanding of the
prospective client’s industry and
business
11. Management assertions are:
➜ Explicitly expressed representations
about the company’s financial condition
12. This is the product after careful evaluation of
audit evidence
➜ Audit Opinion
13.Engagement letter that documents and
confirms the auditor’s acceptance of the
engagement would normally be sent to the
client
➜ Before the commencement of the
engagement
14. The evidence that can be obtained using this
test if the auditor wants to assess control risk
at less than a high level.
➜ Test of Controls
15. Preliminary knowledge about the client’s
business and industry must be obtained prior
to the acceptance of the engagement primarily
to
➜ Determine the degree of knowledge and
expertise required by the engagement
16. Statement 1: Audit Procedures allows
auditors to obtain evidence that supports or
opposes the FS assertions
Statement 2: Audit Objectives helps in
assessing the risk of misstatements
➜ Both statements are correct
17. The preliminary planning activities
procedures involve the following:
➜ Performing procedures regarding the
continuance of the client relationship
and the specific audit engagement
 ➜ Evaluating compliance with ethical
requirements, including independence
➜ Establishing an understanding of the
terms of the engagement
18. Statement 1: An audit opinion is first made
then procedures are done to gather audit
evidence to support the initial opinion
Statement 2: Vouching tests for
overstatements in the financial statements
➜ Only statement 2 is true
19. Statement 1: Completeness Assertion involves
tracing; tracing forward from source
documents to accounting records
Statement 2: Tracing tests for
understatements in the financial statements
➜ Both statements are correct
20. The following are the procedures when
completing the audit
➜ Review of subsequent events and
contingencies
➜ Assessing going concern assumption
➜ Performing overall analytical review
procedures
➜ Obtaining written representations from
the client management
QUIZ 5: AUDIT PLANNING
1. The probability that an auditor’s procedure
leading to the conclusion that a material error
does not exist in an account balance when, in
fact, such error does not exist is referred to as
➜ Detection Risk
2. The following are called risk assessment
procedures:
➜ Analytical Procedures
➜  Inquiries of Management
➜ Inspection and Observation
3. In planning the audit, the auditor should assess
materiality at two levels
➜ the financial statement level and the
account balance level
4. The concept of materiality
➜ Requires the auditor to make judgements
as to whether misstatements affect the
fairness of the financial statements.
5. Summer Corporation has a few large accounts
receivable that total one million pesos whereas
Mochy Corporation has many small accounts
receivable that total one million pesos.
Misstatement in any one account is more
significant for Summer Corporation because of
the concept of:
➜ Comparative analysis
6. The relationship between materiality and risk
is ordinarily
➜ Inverse
7. Which of the following is the most likely first
step an auditor would perform at the
beginning of an initial audit engagement?
➜ Tour the client’s facilities and review the
general records
8. Auditors frequently refer to the terms audit
assurance overall assurance and level of
assurance to refer to
➜ Detection Risk
9. As the risk of material misstatement increases,
detection risk should:
➜ Decrease
10.Each of the following may be relevant to an
auditor when obtaining knowledge about the
client’s business and industry
➜ Discussion with people within or outside
entity
➜ Reading publications related to the
industry
➜ Visits of the entity’s premises
11.How can an auditor decrease the coverage of
his substantive procedures?.
➜ Use smaller sample size
12.The risk that the auditor may express an
incorrect opinion on the financial statements is
called
➜ Audit Risk
13.A measure of the auditor’s assessment of the
likelihood that there are material
misstatements in an account before
considering the client’s internal control is
➜  Inherent Risk
14.In the planning stage of the audit, the
application of analytical procedures helps the
auditor in assessing the risk of material
misstatements in the financial statements.
➜ True
15.As an auditor, you can use information from
similar industries to develop an expectation
for performing analytical procedures.
➜ True

16. Requesting that bank balances be confirmed is

not normally performed in the planning stage
of the audit.
➜ True

17.When performing analytical procedures in

planning, when you find that there is a
significant difference between the expected
and recorded balances, you must design more
extensive substantive tests.
➜ True

18.Analytical procedures are the final step in the

planning process
➜ False

19.A time program is an estimate of the time that

will be spent in executing the audit procedures
listed in the audit program.
➜ False

20.The audit team gathers information about a

new client’s business and industry in order to
obtain information about engagement risk.
➜ False