INTERNAL AUDIT FINANCIAL STATEMENT AUDIT

OVERVIEW OF THE FINANCIAL AUDIT PROCESS

3 CONCEPTS IN AUDIT
1. Audit Risk
2. Materiality
3. Evidence Regarding Management Assertions
AUDIT RISK
Audit risk is the risk that the auditor may unknowingly fail to appropriately
modify his or her opinion on financial statements that are materially misstated.
The auditor’s standard report states that the audit provides only reasonable
assurance that the financial statements do not contain material misstatements.
The term reasonable assurance implies some risk that a material misstatement
could be present in the financial statements and the auditor will fail to detect
it.
REASONABLE ASSURANCE
The auditor plans and conducts the audit to achieve
an acceptably low level of audit risk.

The auditor controls the level of audit risk by 2 E’s:

 Effectiveness and
 Extent of the Audit work Conducted
MATERIALITY
Materiality is the magnitude of an omission or misstatement of accounting
information that, in the light of surrounding circumstances, makes it probable
that the judgment of a reasonable person relying on the information would
have been changed or influenced by the omission or misstatement.

The focus of this definition is on the users of the financial statements. In

planning the engagement, the auditor assesses the magnitude of a
misstatement that may affect the users’ decisions.
EVIDENCE REGARDING MANAGEMENT ASSERTION
Audit evidence consists of the underlying accounting data and any
additional information available to the auditor, whether originating
from the client
or externally

The auditor is concerned with the relevance and reliability of the evidence.
Relevance refers to whether the evidence relates to the specific management assertion
being tested.
Reliability refers to the diagnosticity of the evidence. In other words, can
a particular type of evidence be relied upon to signal the true state of the account
balance or assertion being examined?
SAMPLING
In most situations, the auditor obtains only enough evidence to be persuaded
that the assertion is fairly stated. Additionally, for many parts of an audit, the
auditor examines only a sample of the transactions processed during the
period.
To deal with the problem of not being able to examine every transaction, the
auditor uses
(1) his or her knowledge about the transactions and/or
(2) a sampling approach to examine a subset of the transactions.
SAMPLE SIZE AND MATERIALITY

HIGH Sample size Level Assurance

This occurs because the auditor must gather more evidence (a

larger sample) to have a reasonable likelihood of detecting smaller
errors.

LOW Materiality
DIFFERENT STAGES OF CLIENT’S ACCOUNTING
SYSTEM
(1) the internal control put in place by the client to ensure proper handling of
transactions (e.g., evaluate and test the controls);
(2) the transactions that affect each account balance (e.g., examine a sample
of the transactions that happened during the period); and
(3) the ending account balances themselves (e.g., examine a sample of the
items that make up an ending account balance at year-end). Evidence that
relates directly to ending account balances is usually the highest quality, but
also the costliest, evidence.
 MAJOR PHASES OF AUDIT

Client
acceptance/ Audit business
continuance Establish processes Evaluate
and Preliminary materiality Consider and and related Complete the results and
establishing engagement and assess Plan the audit audit internal accounts audit issue
an activities risks control (e.g., revenue audit report
understanding generation)
with
the client
CLIENT ACCEPTANCE
Professional standards require that public accounting firms
establish policies and procedures for deciding whether to accept
new clients and to retain current clients.
(prevent lawsuits, associating with a client who lack integrity etc.)
PRELIMINARY ENGAGEMENT ACTIVITIES
(1) determining the audit engagement team requirements
and;
(2) ensuring the independence of the audit team and audit firm.
PRELIMINARY ENGAGEMENT ACTIVITIES
The auditor’s understanding of the entity and its environment should include
information about each of the following categories:
Industry, regulatory, and other external factors.
Nature of the entity, including the entity’s application of accounting
policies.
Objectives, strategies and related business risks, including the entity’s risk
assessment process.
Measurement and review of the entity’s financial performance.
Internal control
ESTABLISH MATERIALITY AND ASSESS RISKS
The audit team must make a preliminary assessment of the client’s
business risks and determine materiality. The audit team relies on
these judgments to then assess risk relating to the likelihood of
material misstatements in the financial statements.
PLAN THE AUDIT
Proper planning is important to ensure that the audit is conducted in an
effective and efficient manner. In developing the audit plan, the auditor should
be guided by
(1) the procedures performed to gain and document an
understanding of the entity and
(2) the results of the risk assessment process.
As part of the planning process, the auditor may conduct preliminary
analytical
procedures (such as ratio analysis) to identify specific transactions or account
balances that should receive special attention due to an increased risk of
material misstatement.
CONSIDER AND AUDIT INTERNAL CONTROL
Provide reasonable assurance regarding the achievement
of objectives in the following categories:

(1) reliability of financial reporting,

(2) effectiveness and efficiency of operations, and
(3) compliance with applicable laws and regulations
AUDIT BUSINESS PROCESSES AND RELATED
ACCOUNTS
The auditor typically assesses the risk of material misstatement by examining
the entity’s business processes or accounting cycles (e.g., purchasing process or
revenue process).
The auditor then determines the audit procedures that are necessary to
reduce the risk of material misstatement to a low level for the financial
statement accounts affected by a particular business process.
Individual audit procedures are directed toward specific assertions in the
account balances that are likely to be misstated.
COMPLETE THE AUDIT
After the auditor has finished testing the account balances, the
sufficiency of the evidence gathered is evaluated.

In this phase, the auditor also assesses the possibility of contingent

liabilities, such as lawsuits, and searches for any events subsequent
to the balance sheet date that may impact the financial statements.
EVALUATE RESULTS AND ISSUE AUDIT REPORT
The auditor’s report, also known as the audit opinion, is the main product or output of
the audit.
The audit report culminates the process of collecting and evaluating sufficient
appropriate evidence concerning the correspondence between management
assertions and the applicable reporting criteria (e.g. PFRS).
This correspondence is sometimes referred to as the “fairness” with which the
financial statements are presented
TYPES OF AUDIT REPORT/ AUDIT OPINION

Audit
Opinion

Unqualified Modified Disclaimer

Opinion Opinion

Qualified Adverse
MODIFIED OPINION
PIECEMEAL OPINION
A piecemeal opinion is a report issued by an outside auditor, in which the
auditor states an opinion regarding specific line items within a client's financial
statements.
This type of opinion is no longer allowed under generally accepted auditing
standards, but had been intended to offset an overall adverse opinion or
disclaimer of opinion.
A piecemeal opinion is now banned because it tended to contradict the effect
of the overall opinion.
FINANCIAL STATEMENT AUDITING Public Accounting Profession
ENVIRONMENT
THE ENRON
SCANDAL
GOVERNMENT REGULATION
Under pressure to restore public confidence, Congress passed the Sarbanes-
Oxley Public Company Accounting Reform and Investor Protection Act in July
2002.
It started a process of broad reform in corporate governance practices that
would affect the duties and practices of public companies, financial analysts,
external auditors, and securities exchange markets.
It effectively transferred authority to set and enforce auditing standards for
public company audits to the Public Company Accounting Oversight Board.
GENERALLY ACCEPTED AUDITING STANDARDS
General Standards:
1. The auditor must have adequate technical training and proficiency to perform the audit.
2. The auditor must maintain independence in mental attitude in all matters relating to the audit.
3. The auditor must exercise due professional care in the performance of the audit and the preparation
of the report.
Standards of Fieldwork:
1. The auditor must adequately plan the work and must properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment, including its
internal control, to assess the risk of material misstatement of the financial statements whether due to
error or fraud, and to design the nature, timing, and extent of further audit procedures.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to
afford a reasonable basis for an opinion regarding the financial statements under audit.
GENERALLY ACCEPTED AUDITING STANDARDS
Standards of Reporting:
1. The auditor must state in the auditor’s report whether the financial statements are presented
in accordance with generally accepted accounting principles (GAAP).
2. The auditor must identify in the auditor’s report those circumstances in which such principles
have not been consistently observed in the current period in relation to the preceding period.
3. When the auditor determines that informative disclosures are not reasonably adequate, the
auditor must so state in the auditor’s report.
4. The auditor must either express an opinion regarding the financial statements, taken as a
whole, or state that an opinion cannot be expressed, in the auditor’s report. When the auditor
cannot express an overall opinion, the auditor should state the reasons therefor in the auditor’s
report.
PUBLIC ACCOUNTING FIRMS
Public accounting firms range in size from a single proprietor to thousands of
owners (or “partners”) together with tens of thousands of professional and
administrative staff employees.
Public accounting firms typically offer a variety of professional services in
addition to financial statement audits
Public accounting firms are organized as proprietorships, general or limited
liability partnerships (in rare cases, as corporation).
Public accounting firms are often categorized by size. For example, the
largest firms are the “Big 4” public accounting firms: Deloitte, Ernst & Young,
KPMG, and PricewaterhouseCoopers.
AUDIT TEAM STRUCTURE
Audit
Partner

Audit
Manager

Audit Audit
Senior Senior

Audit Audit Audit Audit

Assistant Assistant Assistant Assistant
ORGANIZATION AND COMPOSITION
LEGAL AND REGULATORY ENVIRONMENT
AASC
The BOA created the Auditing and Assurance Standards Council (AASC) in
2006 in order to adopt and disseminate applicable auditing standards in the
Philippines. The AASC has adopted the Philippine Standards on Auditing
(PSA), which are adopted from the ISA and pronouncements issued by the
IAASB (International Auditing and Assurance Standards Board). The AASC will
develop country-specific standards and practice statements to address specific
auditing issues not covered by the IAASB pronouncements.
LEGAL AND REGULATORY ENVIRONMENT
PICPA
Responsible for:
(i) promoting and maintaining high professional and ethical standards among
accountants by adopting a Code of Ethics for its members as a task delegated by the
BOA;
(ii) developing and improving the accountancy education;
(iii) protecting the CPA designation; and
(iv) carrying out the fact-finding component of investigations upon the delegation and
approval of the BOA and the PRC.
LEGAL AND REGULATORY ENVIRONMENT
SEC
Finally, auditors of public interest entities are subject to additional requirements.
Only individual external auditors and auditing firms that are accredited by the
Securities and Exchange Commission (SEC) can perform statutory audits of financial
statements of publicly listed SEC-registered entities.
They are subject to the QA review system operated by the SEC and any penalties
imposed by the SEC for lack of compliance with professional standards.
For Financial Institutions –
Auditors providing services to banks or insurance or cooperatives are required to be
accredited with the BSP, the Insurance Commission and the Cooperative Development
Authority of the Philippines, respectively.
AUDIT OVERSIGHT ARRANGEMENTS
There is no independent audit oversight authority in the Philippines. As such, auditors
are regulated at the state level by the Professional Regulation Commission (PRC) and
the Professional Regulatory Board of Accountancy (BOA), and at the professional
level by the Philippine Institute of Certified Public Accountants (PICPA).

In order to offer auditing services in the Philippines, individuals must be registered

and accredited by the BOA and PRC and be a member of PICPA.
CONTINUING PROFESSIONAL DEVELOPMENT
The law also mandates that CPAs comply with continuing professional development
(CPD) requirements issued by the BOA and approved by the PRC. CPD is required to
be offered in coordination with the accredited national PAO—PICPA—and CPD
providers must be accredited. For these purposes, the PRC has established a CPD
Council.
In November 2016, the BOA issued Board Resolution No. 358 Series of 2016,
“Increasing the Required Continuing Professional Development (CPD) Units from Sixty
(60) to One Hundred twenty (120) Credit Units within a Compliance Period of Three
(3) Years for all CPAs and Changing the Thematic Areas to Competence Areas” to
align with latest IES requirements. In July 2017, the BOA issued operational
guidelines that made these requirements effective and by 2019, all CPAs will be
required to comply with 120 hours of CPD.