AUDIT OF FINANCIAL STATMENTS

What is an auditing?

" A systematic process of objectively obtaining and evaluating evidence regarding assertions made
about economic actions and events to ascertain the degree of correspondence between those
assertions and established criteria and communicating the results to interested users"

-American Accounting Association (1973)

Assurance Services and Audit Services Distinguished

ASSURANCE ENGAGEMENTS

ATTESTATION ENGAGEMENTS
DIRECT ENGAGEMENTS
F.S. AUDITS

All three services follow the same process: the evaluation of evidence to determine the correspondence
of some information to a set of criteria, and the issuance of a report to indicate the degree of
correspondence. The difference between these three engagements lies in the scope of services.
Assurance service is the broadest concept, while audit is the narrowest.

Types of Audits

1. Financial statement audit

An audit conducted to determine whether the financial statements of an entity are fairly
presented in accordance with an identified financial reporting framework.
2. Compliance audit
An audit involves a review of an organization's procedures to determine whether the
organization has adhered to specific procedures, rules and regulations.
3. Operational audit
Also known as performance audit study of a specific unit of an organization for the purpose of
measuring its performance.

Type Assertions Criteria Report Intended

Users

Financial Financial Identified financial Audit report on the Interested

statements audit statements are reporting fairness of financial users include
fairly presented framework statements. investors,
creditors, etc.

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 Operational audit Operational or Management Report on Interested
performance data objectives efficiency and users include
effectiveness, management
including and the board
constructive of directors.
suggestions.

Compliance audit Compliance with Laws. Rules and Degree of Interested

applicable laws and regulations, or compliance report. users include
regulations or management management
management policy and the board
policy of directors.

Type of Auditors

1. External auditors
These are independent CPA's who offer their professional services to different clients on a
contractual basis. They are the ones who generally perform financial statement audits.
2. Internal auditors
These are entity's own employees who investigate and appraise the effectiveness and
efficiency of operations and internal controls. Internal auditors usually perform operational audits.
3. Government auditors
These are government employees whose main concern is to determine whether persons or
entities comply with government laws and regulations. Government auditors usually conduct
compliance audits.

Objective of Financial Statement Audit

To enable the auditor to express an opinion whether the financial statements are prepared, in all
material respects, in accordance with an identified financial reporting framework or acceptable
financial reporting standards.

Auditor’s Responsibility
The auditor's responsibility is to design the audit to provide reasonable assurance of detecting material
misstatements in the financial statements.
These misstatements may emanate from:
1. Error
2. Fraud, and
3. Noncompliance with Laws and Regulations
The auditor must exercise his judgment in determining which auditing procedures are necessary in the
circumstances to afford a reasonable basis for his opinion.

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Responsibility of Management and Those Charged with Governance

Management to establish a control environment and to implement internal control policies and
procedures designed to ensure, among others, the detection and prevention of fraud and error.
Individuals charged with governance of an entity to ensure the integrity of an entity's accounting and
financial reporting systems and that appropriate controls are in place.
The fair presentation of the financial statements in accordance with the applicable financial reporting
standards is the responsibility of the client's management.

Information Risk

The risk that information is misstated or misleading is known as information risk. This may result from
the following:

1. Remoteness of information users from information provider

2. Potential bias and motives of information provider
3. Voluminous data
4. Complex exchange transactions

Reducing Information Risk

To reduce information risk, management of businesses and the users of their financial statements may
adopt any or all of the following approaches:

1. Allow users to verify information

2. User shares information risk with management
3. Have the financial statements audited

Limitations of an Audit

The auditor's opinion on the financial statements is not a guarantee that the financial
statements are dependable. An audit conducted in accordance with Philippine Standards on
Auditing (PSAs) is designed to provide only reasonable assurance that the financial statements
taken as a whole are free from material misstatements.

In every audit, there are always inherent limitations that affect the auditor's ability to detect
material misstatements. These limitations result from such factors as:

1. The use of testing or Sampling risk

For practical reasons, auditors do not examine all evidence available. There is a possibility that
auditor's conclusion, based on the sample selected, may be different from the conclusion that
would have been reached if the auditor examines the entire population.

2. Error in application of judgment or Non-sampling risk

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 The preparation of financial statements involves judgment by management in applying
applicable financial reporting framework; and subjective decisions or assessments (estimates) by
management involving a range of acceptable interpretations or judgments.

3. Reliance on management's representation

Some evidence supporting the financial statements must be obtained by obtaining oral or
written representations from management. If the management lacks integrity, management may
provide the auditor with false representations causing the auditor to rely on unreliable evidence.

4. Inherent limitations of the clients accounting and internal control systems

Although the auditor performs procedures to detect material misstatements when auditing
financial statements, such procedures may not be effective in detecting misstatements resulting
from collusion among employees or management's circumvention of internal control.

5. Nature of evidence

Audit evidence is generally persuasive rather than conclusive in nature

Illustrative Independent Auditor’s Report

INDEPENDENT AUDITOR’S REPORT

To the Shareholders of ABC Company [or Other Appropriate Addressee]

Report on the Audit of the Consolidated Financial Statements

Opinion

We have audited the consolidated financial statements of ABC Company and its subsidiaries (the Group), which
comprise the consolidated statement of financial position as at December 31, 20X1, and the consolidated statement
of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows for
the year then ended, and notes to the consolidated financial statements, including a summary of significant
accounting policies.

In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, (or give a
true and fair view of) the consolidated financial position of the Group as at December 31, 20X1, and (of) its
consolidated financial performance and its consolidated cash flows for the year then ended in accordance with
Philippine Financial Reporting Standards (PFRSs).

Basis for Opinion

We conducted our audit in accordance with Philippine Standards on Auditing (PSAs). Our responsibilities under
those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial
Statements section of our report. We are independent of the Group in accordance with the International Ethics

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Standards Board for Accountants’ Code of Ethics for Professional Accountants (IESBA Code) together with the
ethical requirements that are relevant to our audit of the consolidated financial statements in [jurisdiction], and we
have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code. We
believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the
consolidated financial statements of the current period. These matters were addressed in the context of our audit of
the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a
separate opinion on these matters.

[Description of each key audit matter in accordance with PSA 701.]

Responsibilities of Management and Those Charged with Governance for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of the consolidated financial statements in
accordance with PFRSs, and for such internal control as management determines is necessary to enable the
preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or
error.

In preparing the consolidated financial statements, management is responsible for assessing the Group’s ability to
continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern
basis of accounting unless management either intends to liquidate the Group or to cease operations, or has no
realistic alternative but to do so.

Those charged with governance are responsible for overseeing the Group’s financial reporting process.

Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole
are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our
opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in
accordance with PSAs will always detect a material misstatement when it exists. Misstatements can arise from fraud
or error and are considered material if, individually or in the aggregate, they could reasonably be expected to
influence the economic decisions of users taken on the basis of these consolidated financial statements.

As part of an audit in accordance with PSAs, we exercise professional judgment and maintain professional
skepticism throughout the audit. We also:

Identify and assess the risks of material misstatement of the consolidated financial statements, whether due
to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is
sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement
resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional
omissions, misrepresentations, or the override of internal control.

Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Group’s internal control.
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 Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates
and related disclosures made by management.

Conclude on the appropriateness of management’s use of the going concern basis of accounting and based
on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast
significant doubt on the Group’s ability to continue as a going concern. If we conclude that a material uncertainty
exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial
statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit
evidence obtained up to the date of our auditor’s report.
However, future events or conditions may cause the Group to cease to continue as a going concern.
Evaluate the overall presentation, structure and content of the consolidated financial statements, including
the disclosures, and whether the consolidated financial statements represent the underlying transactions and events
in a manner that achieves fair presentation.
Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business
activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the
direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.
We communicate with those charged with governance regarding, among other matters, the planned scope and timing
of the audit and significant audit findings, including any significant deficiencies in internal control that we identify
during our audit.
We also provide those charged with governance with a statement that we have complied with relevant ethical
requirements regarding independence, and to communicate with them all relationships and other matters that may
reasonably be thought to bear on our independence, and where applicable, related safeguards.

From the matters communicated with those charged with governance, we determine those matters that were of most
significance in the audit of the consolidated financial statements of the current period and are therefore the key audit
matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about
the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our
report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest
benefits of such communication.

Report on Other Legal and Regulatory Requirements

[The form and content of this section of the auditor’s report would vary depending on the nature of the auditor’s other
reporting responsibilities prescribed by local law, regulation, or national auditing standards. The matters addressed
by other law, regulation or national auditing standards (referred to as “other reporting responsibilities”) shall be
addressed within this section unless the other reporting responsibilities address the same topics as those presented
under the reporting responsibilities required by the PSAs as part of the Report on the Audit of the Consolidated
Financial Statements section. The reporting of other reporting responsibilities that address the same topics as those
required by the PSAs may be combined (i.e., included in the Report on the Audit of the Consolidated Financial
Statements section under the appropriate subheadings) provided that the wording in the auditor’s report clearly
differentiates the other reporting responsibilities from the reporting that is required by the PSAs where such a
difference exists.]

The engagement partner on the audit resulting in this independent auditor’s report is [name].

[Signature in the name of the audit firm, the personal name of the auditor, or both, as appropriate for the particular
jurisdiction]
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 [Auditor Address]

[Date]

How auditing has evolved through human history

The word audit is a Latin term associated with hearing or listening (hence the “auditory nerve”, auditorium,
etc.) Centuries ago, most people lack reading/writing skills, so auditors familiar with the king’s (or lord’s)
possessions listen to servants as they describe the resources entrusted to them. Auditors note any error or
inconsistencies based on what they hear (or did not hear). Since, ancient times, audits have been the answer
to the call for transparency and accountability, to the need for reliable information.

Suggested Readings
Audit and Assurance Principle, 2018 Edition, by Jose M. Ireneo

Resource and Additional Resources

Audit and Assurance Principle, 2018 Edition, by Jose M. Ireneo
Auditing and Assurance Standards Council
https://aasc.org.ph/downloads/PSA/publications/PDFs/PSA-800-Revised-and-Redrafted.pdf
http://www.picpa.com.ph/attachment/6282016103649707.pdf

ASSESSMENT:

1. Assurance engagement risk is the risk

A. That the practitioner expresses an inappropriate conclusion when the subject matter
information is materially misstated.
B. Of expressing an inappropriate conclusion when the subject matter information is not
materially misstated.
C. Through loss from litigation, adverse publicity, or other events arising in connection with a
subject matter reported on.
D. Of expressing an inappropriate conclusion when the subject matter information is either
materially misstated or not materially misstated.
2. Reducing assurance engagement risk to zero is very rarely attainable or cost beneficial as a
result of the following factors, expect
A. The use of selective testing.
B. The fact that much of the evidence available to the practitioner is persuasive rather than
conclusive.
C. The practitioner may not have the required assurance knowledge and skills to gather and
evaluate evidence.
D. The use of judgement in gathering and evaluating evidence and forming conclusions based
on that evidence.
3. The overall objectives of the auditor in conducting an audit of financial statements are
I. To obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether caused by fraud or error.
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 II. To report on the financial statements.
III. To obtain conclusive rather than persuasive evidence.
IV. To detect all misstatements, whether due to fraud or error.
A. I and II only
B. II and IV only
C. I, II and III only
D. I, II, III, and IV only
4. The auditor is required to maintain professional skepticism throughout the audit. Which of the
following statements concerning professional skepticism is false?
A. A belief that management and those charged with governance are honest and have integrity
relieves the auditor of the need to maintain professional skepticism.
B. Maintaining professional skepticism throughout the audit reduces the risk of using
inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof
C. Professional skepticism is necessary to the critical assessment of audit evidence.
D. Professional skepticism is an attitude that includes questioning contradictory audit evidence
obtained
5. Which of the following best describes the reason why independent auditors report on financial
statements?
A. A management fraud may exist and it is more likely to be detected by independent auditors.
B. Different interest may exist between the company preparing the statements and the
persons using the statements.
C. A misstatement of account balances may exist and is generally corrected as the result of the
independent auditors’ work.
D. Poorly designed internal control may be in existence.
6. Which of the following professionals has primary responsibility for the performance of an audit?
A. The managing partner of the firm.
B. The senior assigned to the engagement.
C. The manager assigned to the engagement.
D. The partner in charge of the engagement.
7. What is the proper organizational role of internal auditing?
A. To serve as an independent, objective assurance and consulting activity that adds value to
operations.
B. To assist the external auditor in order to reduce external audit fees.
C. To perform studies to assist in the attainment of more efficient operations.
D. To serve as the investigative arm of the audit committee of the board of directors.
8. Operational audits generally have been conducted by internal and COA auditors, but may be
performed by certified public accountants. A primary purpose of an operational audit is to
provide
A. A measure of management performance in meeting organizational goals.
B. The results of internal examinations of financial and accounting matters to a company’s top-
level management.
C. Aid to the independent auditor, who is conducting the examination of the financial
statements.
D. A means of assurance that internal accounting controls are functioning as planned
9. Governmental auditing often extends beyond examinations leading to the expression of opinion
on the fairness of financial presentation and includes audits of efficiency, economy,
effectiveness, and also

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 A. Accuracy
B. Evaluation
C. Compliance
D. Internal control
10. Which of the following terms best describes the audit of a tax payer’s return by a BIR auditor?
A. Operational audit
B. Internal audit
C. Compliance audit
D. Government audit
11. Which of the following statements concerning consulting services is false?
A. The performance of consulting services for audit clients does not, in and of itself, impair the
auditor’s independence.
B. Consulting services differ fundamentally from the CPA’s function of attesting to the
assertions of other parties.
C. Consulting services ordinarily involve external reporting
D. Most CPA’s, including those who provide audit and tax services, also provide consulting
services to their clients.
12. Operational auditing is primarily oriented toward
A. Future improvements to accomplish the goals of management.
B. The accuracy of data reflected in management’s financial records.
C. The verification that a company’s financial statements are fairly presented.
D. Past protection provided by existing internal control.
13. Which of the following is the most appropriate action to be taken by a CPA who has been asked
to perform a consulting services engagement concerning the analysis of a potential merger if
he/she has little experience with the industry involved?
A. Accept the engagement but he/she should conduct research or consult with others to
obtain sufficient competence.
B. Decline the engagement because he/she lacks sufficient knowledge.
C. Accept the engagement and issue a report that contains his/her opinion on achievability of
the results of the merger.
D. Accept the engagement and perform it in accordance with Philippines standards on Auditing
(PSAs)
14. An objective of a performance audit is to determine whether an entity’s
A. Operational information is in accordance with government auditing standards.
B. Specific operating units are functioning economically and efficiently.
C. Financial statements present fairly the results of operations
D. Internal control is adequately operating as designed.
15. Internal auditors should review the means of physically safeguarding assets from losses arising
from
A. Exposure to the elements.
B. Under usage of physical facilities.
C. Misapplication of accounting principles.
D. Procedures that are not cost justified.
16. The internal auditing department’s responsibility for deterring fraud is to
A. Establish an effective internal control system
B. Maintain internal control
C. Examine and evaluate the system of internal control
D. Exercise operating authority over fraud prevention activities

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17. Internal auditors review the adequacy of the company’s internal control system primarily to
A. Help determine the nature, timing, and extent of tests necessary to achieve audit objectives.
B. Determine whether the internal control system provides reasonable assurance that the
company’s objectives and goals are met efficiently and economically.
C. Ensure that material weaknesses in the system of internal control are corrected.
D. Determine whether the internal control system ensures that financial statements are fairly
presented.
18. Which of the following services, if any, may a practitioner who is not independent provide?
A. Compilations but not reviews
B. Reviews but not compilations
C. Reviews but not financial statement audits
D. Agreed-upon procedures but not compilations

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