Unit 1 Fundamentals of Auditing and Assurance Services

Topic 1
Audit: An Overview
The primary function of an independent audit is to lend credibility to the financial statements prepared by
an entity. The auditor’s opinion enhances the value and usefulness of the financial statements. By giving a
report to the financial statements, the auditor provides increased assurance to the users that the financial
statements are reliable.
Preparer of the financial statements: Management
Auditor’s objective: form and express his opinion in the on the financial statements based on his audit
End users:
1. Government and other regulatory bodies
2. Investors
3. Creditors

Auditing Defined
PSA 120 defined auditing as to its objective. The objective of an audit of financial statements is 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.
The auditor’s opinion enhances the credibility of financial statements by providing a high, but not
absolute, level of assurance.
This definition confines audit as to the audit of financial statements. However, there are other types of
audit such as compliance and operation audit.
American Accounting Association defines audit as “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.”
Breakdown of definition
1. Systematic process- auditing follows an ordered and structured series of steps
2. Involves obtaining and evaluating evidence about assertions regarding economic actions and
events

Assertions- representations made by an auditee about economic actions or events

Auditors objective: to determine whether assertions are valid by performing audit procedures
gathering evidence that corroborates or refutes the assertions.

3. Conducted objectively- conduct audit without bias. Impartial attitude must be maintained when
evaluating evidence and formulating conclusion.
4. Ascertain the degree of correspondence between assertions and established criteria
 Established criteria- establish and inform users of the basis against which the assertions have been
evaluated or measured.

5. Communicate the audit results to various interested users- this is the ultimate objective of any
audit. For the results to be useful, it must be communicated on a timely basis.

Three major types of audits

1. Financial statement audit- 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- involves a review of an organization’s procedures to determine whether the
organization has adhered to specific procedures, rules or regulations.
3. Operational audit- study of a specific unit of an organization for the purpose of measuring its
performance. The main objective is to assess entity’s performance, identify areas for
improvements and make recommendations to improve performance. Also known as the
performance audit or management audit.
Unlike compliance and financial statement audits, where criteria are usually defined, criteria in
operational audit to evaluate effectiveness and efficiency of operations are not clearly established.
Types of auditors
1. External Auditors- independent CPAs who offer their professional services to different clients on
a contractual basis. They usually perform financial statement audit.
2. Internal Auditors- entity’s own employees who investigate and appraise the effectiveness and
efficiency of operations and internal controls. Their main function is to assist members of the
organization in effective discharge of their responsibilities. They usually perform operation audit.
3. Government Auditors- government employees whose main concern is to determine whether
persons or entities comply with government laws and regulations. They usually conduct
compliance audits.
Factors from which inherent limitations that affect the auditor’s ability to detect materials
misstatements arise
1. Sampling risk (Use of testing)- for practical reasons, auditors do not examine all evidence.
Sampling is made to limit the evidence to be examined, which may lead to a different opinion if
the entire population is tested.
2. Non-sampling risk (Error in Application of Judgement)- forming an audit opinion is heavily
influenced by judgment. Human weaknesses can lead an auditor to committing mistakes in the
application of audit procedures and evaluation of evidence.
3. Reliance on management representations- some evidence is obtained oral or written
representation from the management
4. Inherent limitations of the client’s accounting and internal control systems- collusions among
employees or management’s circumvention of internal control
5. Nature of evidence- evidence obtained by the auditor does not consist of “hard facts” but is
instead comprises pieced of information and impression which are gradually accumulated during
the course of an audit. Evidence is generally persuasive than conclusive in nature.
General Principles governing audit of Financial Statements
1. Code of Professional Ethics for CPAs promulgated by Board of Accountancy (BOA)
2. Philippine Standards on Auditing
3. Professional skepticism (refer to PSA 200)
Need for an independent financial statement audit
1. Conflict of interest between management and users of financial statements
2. Expertise
3. Remoteness
4. Financial consequences
Theoretical framework for Auditing
1. Audit function operates on the assumption that all financial data are verifiable
2. Auditor should always maintain independence with respect to the financial statements under audit
3. There should be no long-term conflict between the auditor and the client management
4. Effective internal control system reduces the possibility of errors and fraud affecting the financial
statements
5. Consistent application o of PFRS results in fair presentation of financial statements
6. What was held true in the past will continue to hold true in the future in the absence of known
conditions to the contrary
7. An audit benefits the public