OVERVIEW OF FINANCIAL STATEMENTS AUDIT PROCESS

What is an Audit?
 Is a “systematic process” because an audit involves a logical series of steps that lead to
the rendering of an opinion on the fairness of financial statements.
 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 communicate the results thereof.
 Being systematic process, an audit engagement is performed using an ordered or
structured series of steps. This process is commonly called “AUDIT PROCESS”

Financial Statements
 Structured representation of the financial information derived from accounting records.
 Complete set FS under PFRSs:
 Statement of financial position
 Statement of comprehensive income
 Statement of changes in equity
 Cash flow statement
 Notes to financial statement

Overall objective of an Independent Auditor

The auditor should be able:
a) To obtain reasonable assurance about whether the FS 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 financial statements are prepared, in all material respect, in
accordance with an applicable financial reporting framework; and
b) To report on the financial statements, and communicate as required by the PSAs, in
accordance with the auditor’s findings.

Preparation of Financial Statement Audit

 The FS subject to audit are those of the entity, prepared and presented by the
management of the entity with oversight from those charged with governance.
Management assertions - are claims by members of management regarding certain aspects of
a business. Three (3) aspects of transactions:
1. Classes of Transactions
 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.
  Authorization – transactions should be properly authorized, and that the
authorization actually happened.
 Accuracy – amounts and other data relating to recorded transactions and events
have been recorded appropriately.
 Cutoff – transactions and events have been recorded in the correct accounting
period.
 Classification – transactions and events have been recorded in the proper
accounts.
2. Account Balances
 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.
 Completeness - assets, liabilities, and equity interests that should have been
recorded have been recorded.
 Allocation and Valuation – assets, liabilities, and equity interests are included in
the FS at appropriate amounts and any resulting valuation/allocation adjustments
are appropriately recorded.
3. Presentation & Disclosures
 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 FS have
been included.
 Accuracy and valuation – financial and other information are disclosed fairly at
appropriate amounts.
 Classification and understandability – financial information is appropriately
presented and described, and disclosures are clearly expressed.

Basic Concepts Underlying a Financial Statement Audit

1) Auditor Independence - the auditor shall comply with relevant ethical requirements,
including those pertaining to independence, relating to financial statement audit
engagements.
2) Professional Skepticism - the auditor shall plan and perform an audit with an attitude of
professional skepticism, recognizing that circumstances may exist that cause the FS to be
materially misstated.
3) Conduct of an Audit - the auditor shall comply with all PSAs relevant to the audit. The
auditor shall comply with each requirement of a PSA unless, in the circumstances of the
audit:
 the entire PSA is not relevant; or
 the requirement is not relevant because it is conditional, and the condition does
not exist.
4) Scope of an Audit - refers to the audit procedures that, in the auditor’s judgment and
based on the PSAs, are deemed appropriate in the circumstances to achieve the objective
of the audit.
 5) Audit Evidence - is all the information used by the auditor in arriving at the conclusions
on which the audit opinion is based, and includes the information contained in the
accounting records underlying the FS and other information.
6) Management Assertions - auditors gather evidence regarding the assertions of
management.
7) Audit Materiality – the assessment of what is material is a matter of professional
judgment of the auditor.
 According to 2008 IAAB Handbook, an information is material if its omission or
misstatements could influence the economic decisions of users taken on the basis of
the financial statements.
 Materiality provides a threshold or cutoff point rather than being a primary qualitative
characteristic which information must have if it is to be useful.
8) Audit Risk - the possibility or likelihood that the FS contain material misstatements that
the auditor may not be able to detect in the conduct of FS audit leading to expression of
an inappropriate audit opinion.
- May be assessed either in (1) quantitative terms (i.e., eight percent or ten
percent of the total assets); and (2) non-quantitative terms (i.e., high, or less
than high).
- Two components:
i. Inherent Risk (misstatement without control)
- the susceptibility of an assertion to a misstatement that could be material,
individually or when aggregated with other misstatements assuming that
there were no related internal controls.
- Example: complex calculations, and technological advancement that might
make a particular product obsolete, thereby causing inventory to be more
susceptible to overstatement.
ii. Control risk – (misstatement with control)
- the likelihood that a misstatement that could occur in an assertion and that
could be material, individually or when aggregated with other misstatements,
will not be prevented, or detected and corrected on a timely basis by the
entity’s internal control.
- Example: human errors or mistakes, by collusion or inappropriate
management override.
iii. Detection Risk (will not detect)
- the likelihood that the auditor will not be able detect a misstatement that
exists in an assertion that could be material, either individually or when
aggregated with other misstatements.

Professional Judgment
 may be described as the application of relevant knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in reaching decisions
about the courses of action that are appropriate in the circumstances of the audit
engagement.
  Interpretation of relevant ethical requirements and the PSAs and the informed decisions
required throughout the audit cannot be made without the application of knowledge and
experience to the facts and circumstances.

PHASES OF THE AUDIT PROCESS

1. Pre-engagement
2. Audit planning
3. Study and Evaluation of Internal control
4. Substantive testing
5. Completing the audit
6. Issuance of the Audit Report
7. Post-audit responsibilities

PRE-ENGAGEMENT PROCEDURES
Pre-conditions for an audit:
1. Determine whether financial reporting framework is acceptable.
2. Agreement of management that it acknowledges and understand its responsibility.
Possible encounters:
 If management or those charged with governance impose a limitation on the scope
of the auditor’s work in terms of proposed audit engagement.
 Pre-conditions for an audit are not present.
Terms of engagement:
After decision is made to accept or continue an engagement, an agreement should be
reached with client, preferably through audit committee, then an engagement letter is prepared.
Engagement letter content:
• Documentation and confirmation of acceptance to the appointment
• The objective and scope of the audit
• The extent of his responsibilities to the client and of any reports.
PRINCIPAL CONTENT OF AN ENGAGEMENT LETTER

1. Elaboration of the scope of the audit

2. Arrangement regarding the planning and performance of the audit.
3. Written representations
AUDITS OF COMPONENTS
 1. Who appoints the auditor of the component.
2. Whether a separate audit report is to be issued on the component.
3. Legal requirements
4. The extent of any work performed by other auditors.
5. Degree of ownership by parent
6. Degree of independence of the component’s management from the parent entity
AUDIT PLANNING
It involves obtaining an understanding of the client and its environment, determining the need for
experts, establishing materiality and audit risk, assessing the possibility of non-compliance,
identifying related parties, performing preliminary analytical procedures, an development of
overall audit strategy.
STUDY AND EVALUATION OF INTERNAL CONTROL
There are five steps in the study and evaluation of internal controls:
1. Obtain and document an understanding of internal control.
2. Make a preliminary assessment of control risk.
3. Determine the auditor’s response to the risk assessment.
4. Reassess control risk.
5. Determine the nature, extent and timing of substantive tests.
SUBSTANTIVE TESTING (EVIDENCE GATHERING)
Substantive tests are procedures used to detect material misstatements in account
balances, classes of transactions and disclosures. This may be classified as tests of details or
substantive analytical procedures.

COMPLETING THE AUDIT

After all the previous steps and the audit process have been accomplished, the auditor:
1. Performs final analytical procedures.
2. Reads minutes of recent board and committee meetings
3. Obtains management representation letters
4. Makes final materiality judgements
5. Summarizes and evaluates the audit finding
 6. Review the working papers
7. Reviews the financial statement presentation and disclosures for adequacy
8. Considers subsequent events
ISSUANCE OF AUDITOR’S REPORT
Types of audit reports
1. Unqualified opinion
2. Qualified opinion
3. Adverse opinion
4. Disclaimer of opinion
POST-AUDIT RESPONSIBILITIES
DEBRIEFING
This phase of the audit process involves assessing and evaluating the quality of
delivery of the audit service team.
• Considering events during the audit.
• Analyzing the activities within the audit
• Producing recommendations