AUDIT AN OVERVIEW

Auditing defined:
The Philippine Standards on Auditing (PSA) defines auditing by
stating the objectives of a financial statement audit; that is to
enable the auditor to express an opinion on whether the financial
statements are prepared, in all material respects, in accordance
with the applicable financial reporting framework.

This definition confines the audit to examination of the financial

statements. Although the great majority of audit work today
deals with audit of financial statements, operational and
compliance auditing are becoming more and more important. A
more comprehensive definition auditing is given 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
between these assertions and established criteria and
communicating the results to interested users.”

This definition conveys the following thoughts:

1. Auditing is a systematic process
Auditing proceeds by means of an ordered and
structured series of steps. This enables the auditor to
conduct the audit in a more efficient manner by
ensuring that all potential risks are properly addressed
in every step of the audit process.

2. An audit involves obtaining and evaluating evidence

about assertions regarding economic actions and
events
Assertions are representations made by an entity about
economic actions and events. The auditor’s overall
objective is to determine whether these assertions are
valid. In order to achieve this objective, the auditor
obtains and evaluates relevant evidence that will either
corroborate or refute the assertions.

3. An audit is conducted objectively Types of Audits

The audit should be conducted without bias. Objectivity
requires the auditor to make an impartial assessment of
all the relevant circumstances in forming conclusion.
Auditors should not allow bias or conflict of interest to
override professional judgment. Objectivity is essential
because the auditor’s conclusion can influence the
decisions of parties relying on the report.
4. Auditors ascertain the degree of correspondence
between assertions and established criteria.
Established criteria are needed to judge the validity of
the assertions. These criteria are important because
they establish and inform the users of the basis against
which the assertions have been evaluated or measured.
For example, when auditing financial statements, the
auditor evaluates the fair presentation of the financial
statements, the auditor evaluates the fair presentation
of the financial statements (assertions) by comparing
these financial statements with the requirements of the
applicable financial reporting framework (criteria).
5. Auditors communicate the audit results to various
interested users
The communication of audit findings is the ultimate
objective of any audit. For audit to be useful, the results
must be communicated to interested users in a timely
manner.
Based on primary audit objectives, there are three major types of
audit, namely: financial statement, compliance and operational
audits.
❖ Financial statement audit
A financial statement audit is conducted to determine
whether the financial statements of an entity are fairly
presented in accordance with the applicable financial
reporting framework.
❖ Compliance audit
A compliance audit involves a review of an organization’s
procedures to determine whether the organization has
adhered to specific procedures, rules, or regulations. The
performance of a compliance audit is dependent upon the
existence of verifiable data and recognized criteria
established by an authoritative body. A common example of
this type of audit is the examination conducted by Bureau of
Internal Revenue (BIR) personnel to determine whether
entities comply with tax rules and regulations.
❖ Operational Audit
An operational audit is a study of a specific unit of an
organization for the purpose of measuring its performance.
The main objective of this type of audit is to assess entity’s
performance, identify areas for improvements and make
recommendations to improve performance. This type of
 audit is also known as performance audit or management
audit.
Unlike compliance and financial statement audits, where
the criteria are usually defined, the criteria for
evaluating the effectiveness and efficiency of operations
are not clearly established. The criteria used for
operating audits would typically vary depending on the
organization’s standards and objectives.
It should be noted that, although there are different
types of audit, all audit possess the same general
characteristics. They involve:
1. Systematic examination and evaluation of evidence
which are undertaken to ascertain whether assertions
comply with established criteria; and
2. Communication of the results of the examination,
usually in a written report, to the party by whom, or on
whose behalf, the auditor was appointed.
The table below shows a comparison of the three
different types of audits:
Types of Auditors
Auditors can be classified according to their affiliation with the
entity being examined.
❖ External Auditors or Independent Auditors
These are independent Certified Public Accountants (CPAs)
who offer their professional services to different clients on
a contractual basis. External auditors are the ones who
generally perform financial statement audits.
❖ Internal Auditors
Internal auditors are entity’s own employees who
investigate and appraise the effectiveness and efficiency of
operations and internal controls. The main function of
internal auditors is to assist the members of the
organization in the effective discharge of their
responsibilities. Internal auditors usually perform
operational audits.
❖ 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.
❖ The Independent Financial Statement Audit
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 the applicable financial reporting
framework.
Responsibility for the financial statements
The management is responsible for the preparing and presenting
the financial statements in accordance with the applicable
financial reporting framewok.
The auditor’s responsibility is to form and express an
opinion on these financial statements based on the audit results.
An audit of financial statements does not relieve management of
its responsibilities. Hence, it is management’s responsibility to
adopt and implement adequate accounting and internal control
systems that will help ensure the preparation of reliable financial
statement.
Assurance provided by auditor
The auditor’s opinion on the financial statements is not a
guarantee that the financial statements are dependable. An audit
conducted in accordance with the PSA is designed to provide only
reasonable assurance (not absolute assurance) that the financial
statements taken as a whole are free from material
misstatements. This is because there are inherent limitations of
an audit that affect the auditor’s ability to detect material
misstatements. These limitations may arise from the nature of
the procedures performed, nature of the financial reporting
framework used, and the nature of evidence obtained by the
auditor.
Nature of the procedures
There are practical and inherent limitations on the auditor’s ability
to obtain evidence. For example:
⮚ The use of testing or sampling risk
Due to cost constraints, auditors do not examine all evidence
available. Many audit conclusions are made by examining
only sample evidence. Whenever a sample is taken, there is
always a possibility that the auditor’s conclusion based on
the sample, may be different from the conclusion that would
have been reached if the auditor examines the entire
population.
⮚ Error in the application of judgment or non-sampling risk
Even if the auditor examines all evidence available, there is
no absolute assurance that material misstatement in the
financial statements will be detected. This is because the
work undertaken by the auditor to form an opinion is
permeated by judgment. Errors in the application of
judgment may cause auditors to commit mistakes in the
application of audit procedures or evaluation of evidence
obtained.
Nature of financial reporting
The application of the applicable financial reporting framework
such as the PFRS involves application of significant judgment and
estimates on the part of the management. Many financial
statement items involve subjective decisions that are subject to an
inherent variability which cannot be eliminated by performing
audit procedures.
For example, it is difficult for the auditor to determine the proper
valuation of accounts receivable without management’s honest
assessment. If the management lacks integrity, management may
provide the auditor with false representations causing the auditor
to depend on unreliable evidence.
Nature of evidence
Audit evidence obtained by the auditor does not consist of “hard
facts” which prove or disprove the accuracy of the financial
statements. Instead, it comprises pieces of information and
impressions which are gradually accumulated during the course of
an audit and which, when taken together, persuade the auditor
about the fairness of the financial statements. Thus, audit
evidence is generally persuasive rather than conclusive in nature.
Owing to the inherent limitations of an audit, there is
unavoidable risk that even an audit conducted in accordance
with the PSAs may not be able to detect material misstatement
in the financial statements. Accordingly, the subsequent
discovery of a material misstatement of the financial statements
does not in itself indicate failure to conduct the audit in
accordance with the PSAs.
In addition, the auditor’s opinion on the financial statements deals
with whether the financial statements are prepared in accordance
with the applicable financial reporting framework. The opinion of
the auditor is not an assurance as to the viability of the entity nor
the efficiency or effectiveness with which management has
conducted the affairs of the entity.
General Requirements when Auditing Financial Statements
The procedures required to conduct an audit in accordance with
PSAs should be determined by the auditor having regard to the
requirements of PSAs, relevant professional bodies, legislations,
regulations and where appropriate, the terms of the engagement
and the reporting requirements. PSA provides the following
guidance when auditing financial statements.
1. The auditor should comply with the relevant ethical
requirements, including those pertaining to independence,
relating to financial statements audit engagements.
In order to retain public confidence in the credibility of the
auditors’ work, auditors must adhere to standards of
ethical conduct that embody and demonstrate integrity,
objectivity, and concern for the public rather than self-
interest.
2. The auditor should conduct an audit in accordance with
the Philippine Standards on Auditing (PSAs).
The standards contain the basic principles and essential
procedures which the auditor should follow. The
standards also include explanatory and other materials
that are designated to assist auditors in interpreting and
applying the auditing standards.
The auditor should not represent compliance to PSA in the
auditor’s report unless the auditor has complied with all
PSAs relevant to the audit.
3. The auditor should apply professional judgment in
planning and performing the audit.
Professional judgment is essential to the proper conduct of
the audit. This is because compliance with the relevant
ethical requirements and the PSAs and the informed
decisions required throughout the audit cannot be made
without the application of professional judgment to the
facts and circumstances.
4. The auditor should obtain sufficient appropriate audit
evidence to reduce the audit risk to acceptably low level.
Audit evidence is needed to support the opinion expressed
in the auditor’s report. This evidence should be both
sufficient and appropriate. Whether the audit evidence
obtained is sufficient and appropriate to reduce the audit
risk to an acceptable level is a matter of professional
judgment.
5. The auditor should plan and perform the audit with an
attitude of professional skepticism recognizing that
circumstances may exist which may cause the financial
statements to be materially misstated.
An attitude of professional skepticism means the auditor
makes a critical assessment, with a questioning mind, of
the validity of audit evidence obtained and is alert to audit
evidence that contradicts or bring into questions the
reliability of documents or management representations.
Need for an independent financial statements audit
The need for an independent audit or financial statement stems
from the following interrelated sources:
1. Conflict of interest between management and users of
financial statements
2. Expertise
3. Remoteness
4. Financial consequences
Theoretical Financial Framework of Auditing
The audit function operates within a theoretical framework.
Below are selected postulates, assumptions or ideas that support
many auditing concepts and standards:
1. Audit function operates on the assumption that all
financial data are verifiable
2. The auditor should always maintain independent 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 material misstatements of financial statements
5. Consistent application of the applicable financial
reporting framework such as the PFRS results in fair
presentation of financial statements.
6. What was held in the past will continue to hold true in
the future in the absence of known conditions to the
country
7. An audit benefits the public