AASI302 FINALS

Lesson 2: COMPLETING THE AUDIT AND REPORT PREPARATION

COMPLETING THE AUDIT

Almost every audit engagement has a deadline for issuance of audit report and release of audited financial statements.
Thus, audit procedures need to be completed in time to allow for adequate review and evaluation of working papers
and the financial statements before the opinion is signed. The various issues that the auditor considers in completing
his audit examination include
1. Related party transactions
2. Subsequent events review
3. Letters of inquiry/review of contingent liabilities
4. Evaluating going concern status
5. Management representation
6. Analytical procedures
7. Evaluating findings, formulating an opinion and drafting the audit report

1. Related Party Transactions

Transactions with related parties are important to auditors because they will be disclosed in the financial statements if
they are material. PAS/PFRS require disclosure of the nature of the related-party relationship, a description of
transactions, including peso amounts; and amounts due to and from related parties. Management is responsible for
the identification and disclosure of related parties and transactions with such parties. This responsibility requires
management to implement adequate accounting and internal control systems to ensure that transactions with
related parties are appropriately identified in the accounting records and disclosed in the financial statements.
Once related parties are identified, examination of related party transactions is pursued during examination of relevant
account balances or classes of transactions. The auditor should apply procedures to give adequate consideration to the
possibility that the other party to material transactions is related. An example which might indicate the existence of a
related party transaction is borrowing or lending on an interest-free basis or at a rate significantly different than
prevailing market rates at the time of the transaction.

The auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence
regarding the identification and disclosure by management of related parties and the effect of related party
transactions that are material to the financial statements. However, an audit cannot be expected to detect all
related party transactions.

2. Subsequent Events Review

The auditor has a responsibility to review transactions and events occurring after the balance sheet date to determine
whether anything occurred that might affect the valuation or disclosure of the statements being audited.

Two types of subsequent events require consideration by management and evaluation by the auditor:
1. those that provide further evidence of conditions that existed at period end; and
2. those that are indicative of conditions that arose subsequent to period end.

When the auditor becomes aware of events which materially affect the financial statements, the auditor should
consider whether such events are properly accounted for and adequately disclosed in the financial statements.

3. Letters of Inquiry/Review for Contingent Liabilities

A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from
activities that have already taken place. For a contingent liability to exist, the following three (3) conditions must be
present:
1. There is a potential future payment to an outside party that resulted from an existing condition;
2. There is uncertainty about the amount of the future payment; and
3. The outcome will be resolved by some future event or events.

Certain contingent liabilities are of considerable concern to the auditor:

 Income tax disputes
 Product warranties
 Pending litigation for patent infringement, product liability or other actions
 Notes receivable discounted
 Guarantees of obligations or others
 Unused balances in outstanding letters of credit

An audit inquiry letter (also called a lawyer's letter) is sent by the auditor to the client's lawyer as a primary means of
corroborating the information management provides about litigation, claims, and assessments. The objective of the
letter is to obtain information to facilitate the auditor's understanding of a client's contingencies.

4. Evaluation of Going Concern Assumption

PSA 570 requires the auditor to evaluate whether there is a substantial doubt about a client's ability to continue as a
going concern for at least one year after balance sheet date. This assessment is initially made as a part of planning but
is revised whenever significant new information is obtained.

A final assessment is desirable after all evidence has been accumulated and proposed audit adjustments have been
incorporated into the financial statements.

Analytical procedures are one of the most important types of evidence to assess going concern. Discussions with
management and a review of future plans are important considerations in evaluating the analytical procedures. The
knowledge of the client's business gained throughout the audit is important information used to assess the likelihood
of financial failure within the next year.

5. Management Representations
Obtaining appropriate management representation is also a subsequent events procedure required in an audit
examination. The auditor should obtain evidence that management acknowledges its responsibility for the fair
presentation of the financial statements in accordance with the relevant financial reporting framework, and has
approved the financial statements. The auditor can obtain evidence of management's acknowledgment of such
responsibility and approval from relevant minutes of meetings of the board of directors or similar body or by obtaining
a written representation from management or a signed copy of the financial statements.

The auditor would ordinarily include in audit working papers evidence of management's representations in the form of
a summary of oral discussions with management or written representations from management.

A written representation is better audit evidence than an oral representation and can take the form of:
(a) a representation letter from management;
(b) a letter from the auditor outlining the auditor's understanding of management's representations, duly
acknowledged, and confirmed by management; or
(c) relevant minutes of meetings of the board of directors or similar body or a signed copy of the financial statements.

6. Analytical Procedures
Analytical procedures are normally used as a part of planning the audit, during the performance of detailed tests in
each cycle, and at the completion of the audit.
Analytical procedures performed as part of the overall review assist the auditors in assessing the validity of the
conclusions reached, including the opinion to be issued. They are useful as a final review for material misstatements
or financial problems and to keep the auditor take a final "objective look" at the financial statements. It is usual for a
partner to do the analytical procedures during the final review of working papers and financial statements. Knowledge
of the client's business combined with, effective analytical procedures help identify possible oversights in "an audit."

7. Evaluating Findings, Formulating an Opinion and Drafting the Audit Report

Making a Final Assessment of Materiality and Audit Risk

The auditor's assessment of materiality and audit risk may be different at the time of initially planning the engagement
from at the time of evaluating the results of audit procedures. This could be because of a change in circumstances or
because of a change in the auditor's knowledge as a result of the audit.

When completing the audit, the auditor must reconsider materiality and determine a material amount to be used in
evaluating the estimated misstatement in the financial statement. Audit risk should also be reconsidered.

In evaluating whether the statements are presented fairly, an auditor should aggregate any uncorrected
misstatement to be able to consider them in relation to the financial statement as a whole. The aggregation should
include not only the known but also the likely misstatement. Known misstatements are individual misstatements
specifically identified by an auditor. Likely misstatements are an auditor's best estimate of misstatement based on a
projection of the misstatements detected during sampling.

If audit risk increases due to numerous events and conditions while the audit is being undertaken, the auditor should
evaluate whether additional substantive procedures need to be performed. The auditor then determines whether the
accumulated evidence indicates that the level of audit risk is appropriately low such that the auditor can render an
opinion.

Evidence Supports Auditor's Opinion

To evaluate whether the financial statements are fairly stated, errors uncovered in the audit are summarized. Whenever
the auditor uncovers errors that are in themselves material, adjustments should be made on the trial balance to correct
the statement. There may also be a large number of immaterial errors discovered that are not adjusted at the time they
are found. It is necessary to combine individually immaterial errors to evaluate whether the combined amount is
material that may require adjustment.

If the auditor believes that he or she has sufficient evidence, but it does not warrant a conclusion of fairly presented
financial statements, the auditor may either
a. require the client to revise the statements to the auditor's satisfaction, or
b. issue either a qualified or an adverse opinion.

On the basis of these evaluations, the audit report is issued for the financial statements.

WRITING THE AUDIT REPORT

PSA 700 (Revised), "The Independent Auditor’s Report on a Complete Set of General-Purpose Financial Statements"
establishes the standards and provides guidance on the form and content of the auditor's report issued as a result of an
audit performed by an independent auditor of the financial statements of an entity. Much of the guidance provided can
be adapted to auditor reports on financial information other than financial statements.
Forming an Opinion on the Financial Statements
Thẹ auditor shall form an opinion on whether the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework.

In order to form that opinion, the auditor shall conclude as to whether the auditor has obtained reasonable assurance
about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error.

Form of Opinion
The auditor shall express an unmodified opinion when the auditor concludes that the financial statements are prepared,
in all material aspects, in accordance with the applicable financial reporting framework.

If the auditor:
a) concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from
material misstatement; or
b) is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are
free from material misstatement, the auditor shall modify the opinion in the auditor's report in accordance with PSA
705 (Revised).

MODIFICATIONS TO THE INDEPENDENT AUDITOR’S REPORT

PSA 705 (Revised), “Modifications to the Opinion in the Independent Auditor’s Report," deals with the auditor's
responsibility to issue an appropriate report in circumstances when in forming an opinion in accordance with PSA 700
(Revised), "Forming an Opinion and Reporting on Financial Statements," the auditor concludes that a modification to
the auditor's opinion on the financial statements is necessary.

Types of Modified Opinions

The three types of modified opinions are
a) A qualified opinion
b) An adverse opinion
c) A disclaimer of opinion

The decision regarding which type of modified opinion is appropriate depends upon:
a) The nature of the matter giving rise to the modification, that is, whether the financial statements are materially
misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated;
and
b) The auditor's judgment about the pervasiveness of the effects or possible effects of the matter on the financial
statements.

Circumstances When a Modification to the Auditor's Opinion is Required

The auditor shall express clearly an appropriately modified opinion on the financial statements that is necessary when:
a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free
from material misstatement; or
b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a
whole are free from material misstatement.

Determining the Type of Modification to the Auditor’s Opinion

Qualified Opinion
The auditor shall express a qualified opinion when:
a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements; individually
or in the aggregate, are material, but not pervasive, to the financial statements; or
b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the
auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be
material but not pervasive.

Adverse Opinion
The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the
financial statements.

Disclaimer of Opinion
The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on
which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be both material and pervasive.

The auditor shall disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the
auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of the
individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential
interaction of the uncertainties and their possible cumulative effect on the financial statements.

The table below illustrates how the auditor's judgment about the nature of the matter giving rise to the modification,
and the pervasiveness of its effects or possible effects on the financial statements, affects the type of opinion to be
expressed.

Nature of Matter Giving Rise to the (Auditor's Judgment)

Modification Material but Not Pervasive Material and Pervasive
Financial statements are materially misstated Qualified Adverse Opinion
Inability to obtain sufficient appropriate audit
Qualified Disclaimer of Opinion
evidence

Consequence of an Inability to Obtain Sufficient Appropriate Audit Evidence Due to a Management-Imposed

Limitation after the Auditor Has Accepted the Engagement
If, after accepting the engagement, the auditor becomes aware that management has imposed a limitation on the scope
of the audit that the auditor considers likely to result in the need to express a qualified opinion or to disclaim an
opinion on the financial statements, the auditor shall request that management remove the limitation.

If management refuses to remove the limitation, the auditor shall communicate the matter to those charged with
governance and determine whether it is possible to perform alternative procedures to obtain sufficient appropriate
audit evidence.

If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall determine the implications
as follows:
a) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any,
could be material but not pervasive, the auditor shall qualify the opinion; or
b) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any,
could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the
gravity of the situation, the auditor shall:
1. Resign from the audit, where practicable and not prohibited by law or regulation; or
2. If resignation from the audit before issuing the auditor's report is not practicable or possible, disclaim an opinion on
the financial statements.

If the auditor resigns, before resigning, the auditor shall communicate to those charged with governance any matters
regarding misstatements identified during the audit that would have given rise to a modification of the opinion.

Other Considerations Relating to an Adverse Opinion or Disclaimer of Opinion

When the auditor considers it necessary to express an adverse opinion or disclaim an opinion on the financial
statements as a whole, the auditor's report shall not also include an unmodified opinion with respect to the same
financial reporting framework on a single financial statement or one or more specific elements, accounts or items of a
financial statement. To include such an unmodified opinion in the same report in these circumstances would contradict
the auditor's adverse opinion or disclaimer of opinion on the financial statements as a whole.

Form and Content of the Auditor's Report When the Opinion Is Modified

Basis for Modification Paragraph

When the auditor modifies the opinion on the financial statements, the auditor shall, in addition to the specific
elements required by PSA 700 (Redrafted), include a paragraph in the auditor's report that provides a description of
the matter giving rise to the modification. The auditor shall place this paragraph immediately before the opinion
paragraph in the auditor's report and use the heading "Basis for Qualified Opinion," "Basis for Adverse Opinion," or
"Basis for Disclaimer of Opinion," as appropriate.

If there is a material misstatement of the financial statements that relates to specific amounts in the financial
statements (including quantitative disclosures), the auditor shall include in the basis for modification paragraph a
description and quantification of the financial effects of the misstatement, unless impracticable. If it is not
practicable to quantify the financial effects, the auditor shall so state in the basis for modification paragraph.

If there is a material misstatement of the financial statements that relates to narrative disclosures, the auditor shall
include in the basis for modification paragraph an explanation of how the disclosures are misstated.

If there is a material misstatement of the financial statements that relates to the non-disclosure of information required
to be disclosed, the auditor shall:
a) Discuss the non-disclosure with those charged with governance;
b) Describe in the basis for modification paragraph the nature of the omitted information; and
c) Unless prohibited by law or regulation, include the omitted disclosures, provided it is practicable to do so, and the
auditor has obtained sufficient appropriate audit evidence about the omitted information.

If the modification results from an inability to obtain sufficient appropriate audit evidence, the auditor shall include in
the basis for modification paragraph the reasons for that inability.

Even if the auditor has expressed an adverse opinion or disclaimed an opinion on the financial statements, the auditor
shall describe in the basis for modification paragraph the reasons for any other matters of which the auditor is aware
that would have required a modification to the opinion, and the effects thereof.

Opinion Paragraph
When the auditor modifies the audit opinion, the auditor shall use the heading "Qualified Opinion," "Adverse
Opinion," or "Disclaimer of Opinion," as appropriate, for the opinion paragraph.
When the auditor expresses a qualified opinion due to a material misstatement in the financial statements, the auditor
shall state in the opinion paragraph that, in the auditor's opinion, except for the effects of the matter(s) described in
the Basis for Qualified Opinion paragraph:
a) The financial statements present fairly, in all material respects in accordance with the applicable financial
reporting framework when reporting in accordance with a fair presentation framework; or
b) The financial statements have been prepared, in all material respects, in accordance with the applicable financial
framework when reporting in accordance with a compliance framework.

When the modification arises from an ability to obtain sufficient appropriate audit evidence, the auditor shall use the
corresponding phrase "except for the possible effects of the matter(s)..." for the modified opinion.

When the auditor expresses an adverse opinion, the auditor shall state in the opinion paragraph that, in the auditor's
opinion, because of the significance of the matter(s) described in the basis for Adverse Opinion paragraph:
a) The financial statements do not present fairly accordance with the applicable financial reporting framework when
reporting in accordance with a fair presentation framework; or
b) The financial statements have not been prepared, in all material respects, in accordance with the applicable financial
reporting framework when reporting in accordance with a compliance framework.

When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor
shall state in the opinion paragraph that:
a) because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, the
auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion; and
accordingly,
b) the auditor does not express an opinion on the financial statements.

Description of Auditor's Responsibility When the Auditor Expresses a Qualified or Adverse Opinion
When the auditor expresses a qualified or adverse opinion, the auditor shall amend the description of the auditor's
responsibility to state that the auditor believes that the audit evidence the auditor has obtained is sufficient and
appropriate to provide a basis for the auditor's modified audit opinion.

Description of Auditor's Responsibility When the Auditor Disclaims an Opinion

When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor
shall amend the introductory paragraph of the auditor's report to state that the auditor was engaged to audit the
financial statements. The auditor shall also amend the description of the auditor's responsibility and the description
of the scope of the audit to state only the following: "Our responsibility is to express an opinion on the financial
statements based on conducting the audit in accordance with International Standards on Auditing. Because of the
matter(s) described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion."

Communication with Those Charged with Governance

When the auditor expects to modify the opinion in the auditor's report, the auditor shall communicate with those
charged with governance the circumstances that led to the expected modification and the proposed wording of the
modification.

Reference:
Philippine Standards on Auditing [https://aasc.org.ph/downloads/psa/PSA.php]