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04 Introduction To Auditing
04 Introduction To Auditing
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INTRODUCTION TO AUDITING
RAYMUND FRANCIS A. ESCALA, CPA, MBA
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AUDITING
Definition
As defined by the American Accounting Association, 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
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between these assertions and established criteria and communicating the results thereof.
The following are key concepts obtained from the definition of an audit:
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a. A systematic process
b. It involves objectively obtaining and evaluating evidence about assertions.
c. It ascertains the degree of correspondence between assertions and established criteria
d. It includes communication of the results to interested users
Types of audit
audit.
1. Nature of assertion or data
a. Financial statement (FS) audit
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In compliance with the syllabus in Auditing of the Philippine CPA Licensure Examination, the following are the types of
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b. Operational audit
c. Compliance audit
2. Types of auditor
a. External audit
b. Internal audit
c. Government audit
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statements are fairly presented effectiveness. This will also applicable laws, rules,
in conformity with an identified include recommendations to regulations, or management
financial reporting framework improve operations. policy.
Generally External auditors Internal auditors Government auditors
performed by
(074) 665 6774 0916 840 0661 admin@reo.com.ph MAY 2023 CPA REVIEW SEASON
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framework; and
b. To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditor’s
findings.”
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From these statements, the following key phrases were emphasized:
➢ Expression of an opinion
➢ Financial statements are taken as a whole
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➢ Reasonable assurance
➢ In all material respects
➢ Presence of criteria
➢ Communication of the results
C. Suitable criteria
Criteria used in audit of financial statements generally include the PFRS, GAAP and other applicable financial
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reporting framework
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To warrant the issuance of an unmodified opinion, the auditor determines whether there is
a. a limitation on the scope of the auditor’s work (Qualified or Disclaimer of Opinion); or
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b. a disagreement with management regarding the acceptability of the accounting policies selected, the method of
their application or the adequacy of financial statement disclosures. (Qualified or Adverse Opinion)
Assurance provided by the auditor
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The auditor’s opinion is intended to enhance the credibility of financial statements by providing a high, but not
absolute, level of assurance.
Reasonable assurance and the inherent limitations of an audit
a. Use of selective testing
b. Inherent limitations of internal control
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c. Fact that most of audit evidence is persuasive rather than conclusive
d. Work undertaken by the auditor to form opinion is permeated by judgment
e. Nature/characteristics of assertions
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THE DEMAND FOR FS AUDIT
A. Management of the following
1. Business risk
Countless number of decisions is made each and every day by businesses in order to appropriately manage
business risk, which is any event or activity that will prevent the entity in meeting its business objectives such as
wealth and profit maximization. If an entity is exposed to a very significant business risk, such risk may ultimately
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lead the entity to fail. This is the primary reason why decisions to be made must be carefully evaluated and should
be founded on suitable basis.
Furthermore, investors, creditors, and other users of financial information demand high-quality, relevant, and
reliable information in order to come up with educated financial decisions.
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2. Information risk
Information risk the risk that the information prepared and presented by the entity contains misstatement.
Information risk is the mathematical complement of reliability level. This means that as information risk increases
(from 5% to 10%), reliability level decreases (from 95% to 90%).
Factors contributing to information risk
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➢ Voluminous data
➢ Complexity of transactions
➢ Remoteness of information
➢ Conflicts of interest between the provider and users of information
Ways of reducing information risk
➢ Verify the information
➢ Have the financial statements be audited
➢ Share information risk with the management
VALUE OF FS AUDIT
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Based from the discussions of the demand for FS audit, the following may be construed as the value of a FS audit
• Audit reduces information risk that may lead to lower cost of capital.
• Audit may be used to deter inefficiency and fraud.
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GENERAL PRINCIPLES OF AN FS AUDIT
Whenever FS audit are conducted, the following principles must be observed:
1. The auditor should comply with relevant ethical requirement (Code of Ethics).
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2. The auditor should conduct an audit in accordance with Philippine Standards on Auditing.
3. The auditor should plan and perform the audit with an attitude of professional skepticism.
4. The auditor should exercise professional judgment.
5. The auditor should obtain sufficient appropriate audit evidence.
The financial statements are considered as assertions or representation made by the entity, through its
management and those charged with governance, as appropriate. These assertions may be explicitly or implicitly
included in the financial statements and may fall into the following categories (TAP):
1. Assertions about classes of Transactions and events for the period under audit (TOCCAC):
✓ Occurrence - transactions and events that have been recorded have occurred and pertain to the entity.
✓ Completeness - all transactions and events that should have been recorded have been recorded.
✓ Cutoff - transactions and events have been recorded in the correct accounting period.
✓ Accuracy - amounts and other data relating to recorded transactions and events have been recorded
appropriately.
✓ Classification - transactions and events have been recorded in the proper accounts.
2. Assertions about Account balances at the period end (ACERV):
✓ Completeness - all assets, liabilities and equity interests that should have been recorded have been recorded.
✓ Existence - assets, liabilities, and equity interests exist.
✓ Rights and obligations - the entity holds or controls the rights to assets, and liabilities are the obligations of the
entity.
✓ Valuation and allocation - assets, liabilities, and equity interests are included in the financial statements at
appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.
3. Assertions about Presentation and disclosure (POCAC):
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✓ Occurrence and rights and obligations - disclosed events, transactions, and other matters have occurred and
pertain to the entity.
✓ Completeness - all disclosures that should have been included in the financial statements have been
included.
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✓ Accuracy and valuation - financial and other information are disclosed fairly and at appropriate amounts.
✓ Classification and understandability - financial information is appropriately presented and described, and
disclosures are clearly expressed.
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2. The auditor performs audit procedures
In conducting an audit of financial statements, the overall objectives of the auditor are:
a. To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the
framework; and
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financial statements are prepared, in all material respects, in accordance with an applicable financial reporting
b. To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditor’s
findings.
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To achieve the overall objectives of the audit, the auditor shall design and perform audit procedures which enable the
gathering of audit evidence. Procedures to be performed may be categorized into (1) major audit procedures and (2)
specific audit procedures.
environment, including the entity’s internal control, to identify and assess the risks of material misstatement,
whether due to fraud or error, at the financial statement and assertion levels.
2. Test of controls. An audit procedure designed to evaluate the operating effectiveness of controls in preventing,
or detecting and correcting, material misstatements at the assertion level.
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3. Substantive procedure. An audit procedure designed to detect material misstatements at the assertion level.
Substantive procedures comprise:
i. Tests of details (of classes of transactions, account balances, and disclosures), and
ii. Substantive analytical procedures.
6. Recalculation. It consists of checking the mathematical accuracy of documents or records. This procedure may
be performed manually or electronically.
7. Reperformance. It involves the auditor’s independent execution of procedures or controls that were originally
performed as part of the entity’s internal control.
8. Analytical Procedures. Procedures consist of evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass the
investigation of identified fluctuations and relationships that are inconsistent with other relevant information or
deviate significantly from predicted amounts.
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Through the procedures performed, the auditor obtains sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the audit opinion.
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The auditor provides a written audit report containing a conclusion or an opinion regarding the fairness of preparation
and presentation of financial statements in accordance with the applicable financial reporting framework.
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Opinion to be expressed by the auditor may include either of the following:
a. Unmodified opinion.
b. Modified opinion. The auditor modifies the opinion in the auditor’s report when:
1. A choice between Qualified and Adverse. The auditor concludes that, based on the audit evidence obtained,
the financial statements as a whole are not free from material misstatement; or
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2. A choice between Qualified and Disclaimer of opinion. The auditor is unable to obtain sufficient appropriate
audit evidence to conclude that the financial statements as a whole are free from material misstatement.
activities
2. Planning an audit Audit planning involves the development of an overall audit strategy, audit plan and audit program.
of financial The auditor usually obtained more detailed knowledge about the client’s business and industry in
statements order to understand the transactions and events affecting the financial statements.
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Preliminary assessment of risk and materiality is also made during this phase.
3. Study and Since entity’s internal control directly affects the reliability of the financial statements, it is
evaluation of appropriate to study and evaluate these controls.
internal control
4. Evidence- Using the information obtained in audit planning and consideration of internal controls, the auditor
gathering performs substantive test to determine whether entity’s financial statements are presented fairly in
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(Substantive accordance with financial reporting standards. Substantive procedures could either be analytical
testing) procedures or test of details of transactions and balances
This phase will always be performed by the auditor.
5. Completing the Wrapping-up procedures are performed; conclusions reached are reviewed; and an overall opinion
audit is formed during this phase.
6. Issuance of the In this stage, auditor prepares and issues audit report which describes the scope of the audit and
audit report states the auditor’s conclusion regarding the fairness of the financial statements.
7. Post-audit After completion of the audit engagement, auditor performs procedures that will enable him/her
responsibilities identify areas for improvement in the current and future engagements.
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1. Which of the following statements refers to the definition of auditing?
A. A service activity which function is to provide quantitative information primarily financial in nature about economic
entities that is intended to be useful in making economic decisions.
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B. The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and
events which are in part at least of a financial character and interpreting the results thereof.
C. The process of identifying, measuring and communicating economic information to permit informed judgment and
decisions by users of the information.
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D. 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 thereof.
2. Which of the following is not among the characteristics of auditing?
A. A systematic process
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B. It involves objectively obtaining and evaluating evidence about assertions.
C. It ascertains the degree of correspondence between assertions and established criteria
D. It includes communication of the results to the management
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3. The predominant type of attestation service performed by CPAs is
A. Audit C. Compilation
B. Review D. Management consulting
4. Which of the following types of auditing is performed most commonly by CPAs on a contractual basis?
A. Internal auditing C. BIR auditing
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9. The scope and objectives of internal auditing vary widely and depend on the size and structure of the entity and the
requirements of its management. Ordinarily, internal auditing activities include one or more of the following:
A. B. C. D.
Review of the accounting and internal control Yes Yes Yes Yes
systems
Examination of financial and operating Yes Yes Yes No
information
Review of the economy, efficiency and Yes Yes No No
effectiveness of operations
Review of compliance with laws, regulations and Yes No No No
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other external requirements
10. Which statement is correct regarding the relationship between internal auditing and the external auditor?
A. Some judgments relating to the audit of the financial statements are those of the internal auditor.
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B. The external audit function's objectives vary according to management's requirements.
C. Certain aspects of internal auditing may be useful in determining the nature, timing and extent of external audit
procedures.
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D. The external auditor is responsible for the audit opinion expressed, however that responsibility may be reduced by
any use made of internal auditing.
11. This type of audit involves a review of an organization’s procedures and methods for the purpose of evaluating
efficiency and effectiveness of operations, identifying areas for improvement, and making recommendations to
improve performance.
A. Financial statement audit
B. Operational audit
12. Operational auditing is primarily oriented toward
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C. Compliance audit
D. Internal audit
16. 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.
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 C. I, II and III only
B. II and IV only D. I, II, III and IV
17. Which of the following best describes the objective of an audit of financial statements?
A. To express an opinion whether the financial statements are prepared in accordance with prescribed criteria.
B. To express an assurance as to the future viability of the entity whose financial statements are being audited.
C. To express an assurance about the management's efficiency or effectiveness in conducting the operations of
entity.
D. To express an opinion whether the financial statements are prepared, in all material respect, in accordance with
an identified financial reporting framework.
18. The objective of the ordinary audit of financial statements is the expression of an opinion on:
A. the fairness of the financial statements. C. the accuracy of the annual report.
B. the accuracy of the financial statements. D. the balance sheet and income statement.
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19. In "auditing" accounting data, the concern is with
A. Determining whether recorded information properly reflects the economic events that occurred during the
accounting period.
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B. Determining if fraud has occurred.
C. Determining if taxable income has been calculated correctly.
D. Analyzing the financial information to be sure that it complies with government requirements.
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20. Third-party users of the audit report expect the auditor to do all of the following except:
A. To evaluate measurements and disclosures made by management
B. To provide a biased evaluation of the FSs
C. To determine whether financial statements are presented in accordance with GAAP
If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of
insufficient evidence, the auditor:
A. should withdraw from the engagement.
B. should request an increase in audit fees so that more resources can be used to conduct the audit.
C. has the responsibility of notifying financial statement users through the auditor’s report.
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7. The need for an independent audit arises due to the following reasons. (Choose the expectation)
A. Expertise of auditors C. Remoteness of users
B. Competing interests D. Complexity of decision-making
8. Which of the following statements does not describe a condition that creates a demand for auditing?
A. Conflict between an information preparer and a user can result in biased information.
B. Information can have substantial economic consequences for a decision maker.
C. Expertise is often required for information preparation and verification.
D. Users can directly assess the quality of information.
9. Which of the following is incorrect regarding the general principles of an audit?
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A. The auditor should comply with the "Code of Ethics for Professional Ethics for C ertified Public Accountants"
promulgated by the Philippine Professional Regulation Commission.
B. The auditor should conduct an audit in accordance with PSAs.
C. The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that
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circumstances may exist that cause the financial statements to be materially misstated.
D. The auditor would ordinarily expect to find evidence to support management representations and assume
they are necessarily correct.
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10. Which is not a theoretical postulate framing an audit?
A. Financial data can be subjected to verification.
B. Long-term conflict between the auditor and client may exist.
C. An audit benefits the public.
D. The auditor is independent of the client.
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11. Auditing is based on the assumption that the financial data are verifiable. Data are verifiable when two or more
qualified individuals,
A. Working together, can prove, beyond doubt, the accuracy of the data.
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B. Working independently, each reach essentially similar conclusions.
C. Working independently, can prove, beyond reasonable doubt, the truthfulness of the data.
D. Working together, can agree upon the accuracy of the data.
12. Which of the following is not one of the three categories of assertions?
A. Assertions about classes of transactions and events for the period under audit
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A. Risk assessment procedures C. Substantive procedures
B. Tests of control D. Analytical procedures
19. An auditor may achieve audit objectives related to particular assertions by:
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A. Performing analytical procedures. C. Adhering to a system of quality control.
B. Preparing audit documentation. D. Increasing the level of detection risk.
20. If a company’s external auditor expresses an unqualified opinion as a result of the audit of the company’s financial
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statements, readers of the audit report can assume that
A. The external auditor found no fraud
B. The company is financially sound and the financial statements are accurate
C. Internal control is effective
D. All material disagreements between the company and the auditor about the application of accounting principles
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were resolved in the satisfaction of the external auditor.
"You may only succeed if you desire succeeding; you may only fail if you do not mind failing."
Philippos
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