AT -02

Fundamental Principles of Audit

Nature of Audit - 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.

Auditing vs Accounting
Accounting - is the process of recording, summarizing, analyzing, and reporting financial transactions of a
business.
Auditing - examines your business's financial records to verify they are accurate based on the established
criteria.
Note: Auditing will start once the accounting is done or when the financial statements are prepared.

Types of Audits
As to objective
Compliance - a formal review of an organization's procedures and operations mainly focusing on whether
an entity is complying with internal rules, regulations, policies, decisions, and procedures. Compliance
audit are usually performed by government auditors.
i. Review wage rates for compliance with minimum wage laws.
ii. BIR examiners to check compliance of the entity regarding tax laws

Operational - a method of examining how an organization conducts business. It requires analyzing the
processes, procedures and systems used within the company. This type of audit looks beyond the
organization's financial circumstances and examines its management practices.
i. Effectiveness (Program results) audit – The evaluation of programs, projects and activities to
determine the extent of achievement of previously set goals and objectives.

Financial – is type of audit that ensures that the financial information presented in the financial
statements are in accordance with a suitable criterion.

FS audit vs Operation audit

- FS audit is past oriented while Operational audit is concerned with future performance of the
entity
- FS audit is distributed to different readers while Operational audit is distributed internally within
the management
- FS audit focuses on matters that materially affects the FS while operational audit focuses on the
aspect of efficient and effectiveness.

As to auditor
External - Usually conducted by a certified public accountant (CPA) or a firm that specialises in external
audits. The purpose of an external audit is to provide assurance to stakeholders, such as shareholders and
creditors, that the company's financial statements are accurate and in compliance with relevant laws and
regulations.

Internal - The purpose of internal audit is to evaluate the effectiveness of internal controls and ensure that
the company's operations are in compliance with internal policies and procedures. Internal audit also
helps to identify potential risks and opportunities for improvement in the company's operations.
 Government - maintain and examine records of government agencies and of private businesses or
individuals performing activities subject to government regulations or taxation. Auditors employed
through the government ensure revenues are received and spent according to laws and regulations.

Types Objective Example

Operational Evaluates the efficiency and effectiveness of any Evaluate whether the computerized payroll
Performance part of an organization’s system is operating
Audit

Compliance Conducted to determine whether the client/entity is Determine whether the entity is complying
Audit following the rules set by the authority. with the regards to minimum wage laws

Financial Conducted to determine whether the Audit of San Miguel Corporation

Statements financial information presented in a financial
Audit statement is in accordance with suitable criteria.

Note: In terms of nature of audit, FS audit and Compliance audit is the same in nature. While for auditors,
External auditor is the same with Government Auditor.

Nature of FS Audit
- Type of audit conducted to determine whether the financial statements of an entity are fairly
presented in accordance with an identified financial reporting framework.
- Objective of the examination of financial statement is to enable the practitioner to express an
audit opinion on whether the financial statements are prepared, in all material respects, is
accordance with an applicable financial reporting framework.

Need for Independent FS Audit

- Primary economic reason is the demand by the intended user for the reliability and fairly
stated financial statements. This will help in enhancing the degree of confidence in the
financial statements.
- To help in decision making
- To reduce information risk
o As information risk increases, the reliability level decreases
- The following are some of the reasons that give rise to a demand for independent audit of FS:
o Conflict of interest between management and users of financial statement
o Remoteness of user
o Complexity of subject matter requires expertise.
o Consequence for decision making

Theoretical framework of FS Audit

- All data are verifiable through existence of supporting documents
- All auditor should maintain independence
- No long-term conflict between the auditor and the management
- Audit benefits the public
- Reduces the possibility of frauds/error.

Scope and conduct of an Audit of FS

The auditor normally exercises professional judgment in determining the scope of the audit and considers
the requirements of the relevant legislations, regulations and professional standards.
The auditor shall conduct the audit with the exercise professional judgment and maintain professional
skepticism throughout the planning and performance of the audit in:

• Identifying and assessing risks of material misstatement (ROMMs) – ROMMs refer to the risk
that the FSs are materially misstated prior to audit.
• Obtaining sufficient appropriate audit evidence (SAAE) through designing and implementing
appropriate responses to the assessed risks.
• Forming an opinion on the Financial statements
• Determining the nature, timing, and extent of audit procedures.

Throughout the performance of the audit, the auditor shall comply with the relevant ethical requirements
including those pertaining to independence, relating to FSs audit engagements.

Ethical Requirements
Fundamental principles of ethics for professional accountants (P2ICO)
- Integrity
- Objectivity
- Professional competence and Due care
- Confidentiality
- Professional Behavior

Professional Skepticism
an attitude that includes a questioning mind, being alert to conditions which may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence.

Professional skepticism includes being alert to, for example:

• Audit evidence that contradicts other audit evidence obtained
• Information that brings into question the reliability of documents and responses to inquiries
to be used as audit evidence.
• Conditions that may indicate possible fraud.
• Circumstances that suggest the need for audit procedures in addition to requirements of PSAs

Maintaining professional skepticism throughout the audit is necessary if the auditor is, for example, to
reduce the risks of:
• Overlooking unusual transactions
• Over generalizing when drawing conclusions from audit observations.
• Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.

Professional Judgment
Applying knowledge, skills and experience, in a way that is also informed by. professional standards /
knowledge, laws and ethical principles, to develop an opinion or decision about what should be done to
best serve clients.

Professional judgment is essential to the proper conduct of an audit because it enables the proper
interpretation of:
• Relevant ethical requirements
• PSAs
• Informed decisions

Professional judgment is necessary regarding decisions about:

• Nature, Timing, and extent of procedures
 • Sufficiency and appropriateness of audit evidence

General audit process

Entity prepares The auditor The auditor Auditor

and presents performs audit gathers audit expresses and
financial procedure evidence opinion
statement

1. Entity prepares and presents financial statements

- Financial statements are considered as assertions/representations made by the management.
o Assertions about classes of transactions (TAC3O)
 Occurrence
 Completeness
 Cutoff
 Accuracy
 Classifications
o Assertions about account balances at period end
 Completeness
 Existence
 Rights and Obligation
 Valuation and Allocation
o Assertions about presentation and disclosure
 Occurrence and rights and obligations
 Completeness
 Accuracy and valuation
 Classification and understandability

2. Auditor performs audit procedures

- The overall objective of the auditor are:
o 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 FS are prepared, in all material respects, in
accordance with an applicable reporting framework
o To report on the financial statements, and communicate in accordance with the
auditor’s findings.

- Major audit procedures

o Risk assessment procedures
 Obtain an understanding of the entity an its environment, including the
entity’s internal control, to identify and assess ROMM
o Test of Controls
 Evaluate the operating effectiveness of controls in preventing/detecting and
correcting, material misstatement
o Substantive procedure
 Audit procedure designed to detect material misstatement
 TOD
 Substantive Analytical procedure
 - Specific procedures
o Inspection of Documents
o Inspection of Tangible Assets
o Observation
o Inquiry
o Confirmation
o Recalculation
o Reperformance
o Analytical procedure

3. Auditor gathers audit evidence

- Auditor should obtain sufficient appropriate evidence to be able to draw reasonable
conclusions on which to base the audit opinion.

4. Auditor expresses an opinion

- The auditor provides a written audit report containing a conclusion regarding the fairness of
preparation and presentation of financial statements.

Opinions to be expressed by the auditor:

o Unqualified/Unmodified
o Qualified/Modified
 Qualified and Adverse
 Based on the audit evidence obtained the financial statements as a
whole are not free from material misstatement.
 Qualified and Disclaimer of opinion
 The auditor is not able to obtain sufficient appropriate evidence to
conclude that the financial statements as a whole are free from
material misstatement.