BASIC CONCEPTS OF AUDITING

PILOSOPHY OF AN AUDIT

Businesses, institutions, and individuals must maintain records of their financial condition and
progress. These records are necessary to:
a. Evaluate and guide business operations,
b. Determine financial status,
c. Meet legal requirements, and
d. Serve as basis for a credit.

Creditors and investors (present and prospective) may wish to study the financial statements of
many enterprises for:
a. Credit extension, and
b. Investment purposes

Government agencies need financial reports to help them carry out the duties imposed upon
them by law.

Internal management needs financial reports for PLANNING, DIRECTING, and CONTROLLING
business operations.

Therefore: These parties need reliable financial information. The PROCESS employed to
establish the RELIABILTY or UNRELIABILITY of the financial statements and supporting records is
referred to as an AUDIT EXAMINATION.

Auditing of financial records has become an important factor in the dissemination of financial
information and the services of the INDEPENDENT Certified Public Accountant (CPA) are
considered INDESPENSABLE. Is written report or opinion is increasingly required to add
CREDIBILITY to the financial statements.
An independent auditor’s opinion provides both internal and external users with input to
making LOGICAL and INFORMED about (1) financial position, (2) managerial performance,
and (3) economic vulnerability. Without auditors, decisions are more likely to be made from
biased financial information resulting from a business entity’s undisclosed ERRORS,
IRREGULARITIES or ILLEGAL ACTS.

The opinion paragraph of the standard independent auditor’s report goes

“In our/my opinion, the financial statements present fairly, in all material respects, the
financial position of Remelicious Enterprises as of December 31, 2019, and its operating
performance and its cash flows for the year then ended in accordance with the Philippine
Financial Reporting Standards.”
AUDITING, defined

Auditing is a systematic process by which a competent, independent person OBJECTIVELY

obtains and evaluates evidence regarding assertions about economic actions and events to
ascertain the degree of correspondence between those assertions and established criteria, and
communicating the results to interested users.

*systematic process. This implies a structured, logical and organized series of steps and
procedures.

*competent, independent person. The auditor must be qualified to understand the criteria used
and the competence to know how and what evidence to accumulate to reach the proper
conclusion. The auditor must also have an independent mental attitude which involves impartial
and objective thinking.

*objectively obtains and evaluates evidence. This means examining the bases for the assertions
(representations) and judiciously evaluating the results without bias or prejudice either for or
against the individual (or entity) making the representations

*assertions about economic actions and events. These are the representations made by the
individual or entity. They comprise the subject matter of auditing. Assertions include (1)
information contained in the financial statements, (2) internal operating reports, and (3) tax
returns.

*degree of correspondence. This refers to the “closeness” with which the assertions can be
identified with established criteria. The expression of correspondence may be quantitative (such
as the amount of a shortage in a petty cash fund) or it may be qualitative (such as the fairness or
reasonableness of financial statements.

*established criteria. These are the standards against which the assertions or representations
are judged. Criteria may be (1) specific rules prescribed by a legislative body, (2) budgets and
other measures of performance set by management, or (3) Philippine Accounting standards
(PAS)/Philippine Financial and Reporting Standards (PFRS) established by the Accounting
Standards Council (ASC) and other authoritative bodies.

*communicating the results. This is often referred to as ATTESTATION. The final stage in the
audit process is the audit report - the communication of the audit findings to users. By attesting
to the degree of correspondence with established criteria, the investigator enhances (or weakens,
as the case may be) the credibility of the representations or claims that have been made by
another party. The communication of finds is achieved through a written report.

*interested users. These are individuals who use (rely on) the auditor’s findings. In a business
environment, they include (1) shareholders, (2) management, (3) creditors, (4) government
agencies, and (5) the public.
In practice, CPAs offer many services to their clients manly deal with financial, control, and tax
matters. These services include: (1) audit and review of financial statements, (2) tax
compliance, and (3) consulting or advisory services. These are broadly classified as
ASSURANCE and NON-ASSURANCE.

ASSURANCE ENGAGEMENT is an independent, professional service that aims to improve the

quality of information so that users of such information can make informed decision. Here, the
practitioner expresses a conclusion (in a written report) designed to enhance the degree of
confidence of the intended users other than the responsible party about the outcome of the
evaluation or measurement of a subject matter against criteria (accounting & reporting
standards).

AUDIT of FINANCIAL STATEMENTS is an example of assurance engagement. In this

engagement, a practitioner issues a written report containing an opinion about whether the F/S are
in accordance with the applicable financial reporting framework (AFRF) that enhances the user’s
confidence on F/S.

On the contrary TAX COMPLIANCE and MANAGEMENT SERVICES are example of non-
compliance engagement because they do not enhance client’s confidence on the subject matter.

The demand for ASSURANCE SERVICES arises from various reasons:

1. Potential bias of information provider. Such bias will be reduced because assurance
engagement involve independent, third-party evaluation.
2. Remoteness of information user from information provider. As users do not
generally have access to verify the information for themselves, assurance
engagements provide an opportunity for the information to be verified on their
behalf.
3. Complexity of subject matter information. Complex subject matter compels the
users, who may lack the capability to perform the evaluation themselves, to seek
practitioner’s assistance.
4. Expertise and independence of practitioner. Users benefit from the expertise and
independence of practitioners who are able to act with integrity, objectivity, and
“professional skepticism.”
5. Risk Management. As assurance engagements enhance the credibility of
information, this reduces information risk ( risk of unreliable information) that may
bring financial loss to users because of unwise decision.

The ASSURANCE LEVEL and ENGAGEMENT RISK

1. Absolute level 2.. Reasonable level

2. Limited level 4. None
In accordance with the Philippine Framework for Assurance of assurance profEngagement, the
levels of assurance provided by the practitioner are:

1. REASONABLE ASSURANCE engagement, and

2. LIMITED ASSURANCE engagement.

Reasonable Assurance is HIGH but less than ABSOLUTE assurance. Its objective is to reduce
assurance engagement risk to an acceptable low level. Various procedures are performed to
obtain sufficient appropriate evidence. It reports a POSITIVE form of conclusion.

Limited Assurance is Low (moderate) level of assurance. Its objective is to reduce assurance
engagement risk to a level that is acceptable but where the risk is greater than for a reasonable
assurance engagement. Procedures are deliberately limited relative to a reasonable assurance
engagement. It reports a NEGATIVE form of conclusion.

AUDIT of FINANCIAL STATEMENTS is an example of reasonable assurance engagement.

The auditor expresses an opinion, in a POSITIVE FORM, about whether the F/S are fairly stated,
in all material respects, in accordance with AFRF.

REVIEW of FINANCIAL STATEMENTS falls under limited assurance engagement. The

practitioner performs fewer procedures than that of audit. And to convey that only limited IS
“nothing has come to my/our attention that the financial statements are not prepared, in all
material respects, in accordance with the AFRF (applicable financial reporting framework)

LIMITATIONS OF ASSURANCE ENGAGEMENT

Practitioners cannot usually provide absolute assurance because reducing assurance engagement
risk to ZERO is unattainable (or cost beneficial) due to:

1. Use of selective testing

2. Use of judgment
3. Inherent limitations of internal control
4. Persuasive evidence rather than conclusive
5. Characteristics of the subject matter.