Financial Audit Components

Learning Objectives
• Know the financial audit components.
• Distinguish between the two auditing standards which are the
GAAS and SASs.
• Know the systematic process and logical process in conducting
an audit.
• Determine the audit objectives and audit procedures based on
management assertions.
• Differentiate tests of controls and substantive tests which are
the two methods of obtaining evidences.
• Know how to apply materiality concept.
• Know how to communicate audit results.
 Outline:
Financial Audit Components
• 1) Auditing standards
• 2) Systematic process and logical process
• 3) Management Assertions and Audit
Objectives
• 4) Obtaining Evidence
• 5) Ascertaining Materiality
• 6) Communicating Results
 FINANCIAL AUDIT COMPONENTS
• Auditor’s report: expresses an opinion as to whether the financial statements
are in conformity with generally accepted accounting principles (GAAP).

• External users of financial statements are presumed to rely on the auditor’s

opinion about the reliability of financial statements in making decisions.

• Thus, auditors are guided by these six (6) financial audit components:
• 1) Auditing standards
• 2) A systematic process
• 3) Management Assertions and Audit Objectives
• 4) Obtaining Evidence
• 5) Ascertaining Materiality
• 6) Communicating Results
 FINANCIAL AUDIT COMPONENTS:
1) Auditing standards
Generally Accepted Auditing Standards
(GAAS) Statements on Auditing Standards (SASs)
• establishes a framework for prescribing • Issued by AICPA to provide
auditor performance.
• External users of FSs place their trust in
specific guidance
the auditor’s competence, • authoritative interpretations
professionalism, integrity, and of GAAS.
independence.
– Every member of the profession
• Auditors are guided in their professional
must follow their
responsibility by the ten generally
accepted auditing standards (GAAS). recommendations or be able to
show why a SAS does not apply
• Disadvantage: It is not sufficiently
in a given situation.
detailed to provide meaningful – The burden of justifying
guidance in specific circumstances. departures from the SASs falls
upon the individual auditor.
 FINANCIAL AUDIT COMPONENTS:
1) Auditing standards
Generally Accepted Auditing Standards
(GAAS)
• divided into three classes:
• 1) general qualification standards
– adequate technical training and proficiency
– independence of mental attitude
– exercise due professional care
• 2) field work standards
– Adequately planned
– Sufficient understanding of control structure
– Obtain sufficient, competent evidence
• 3) reporting standards
– FSs in accordance with GAAP
– Identify circumstances not in GAAP
– Identify items with no adequate informative
disclosures
– Contains auditor’s opinion
Statements on Auditing Standards (SASs)
• often referred to as auditing
standards, or GAAS, although they
are not the ten GAAS.
• The first SAS (SAS 1) was issued by
the AICPA in 1972.
• Many SASs have been issued to
provide auditors with guidance:
– methods of investigating new clients
– procedures for collecting information
from attorneys regarding contingent
liability claims against clients
– techniques for obtaining background
information on the client’s industry.
 FINANCIAL AUDIT COMPONENTS:
2) Systematic Process & Logical Process
• Conducting an audit: a systematic and logical process that applies to
all forms of information systems.

• Systematic process: A systematic approach is particularly important

in the IT environment.
– objectively obtaining and evaluating evidence regarding assertions about
economic actions and events to ascertain the degree of correspondence
between those assertions and established criteria
– communicating the results to interested users.
• Logical process: creating a logical framework for conducting an IT
audit helps the auditor identify all-important processes and data files.
– Logical framework is a document that gives an overview of the objectives,
activities and resources of an audit.
 FINANCIAL AUDIT COMPONENTS:
3) Management Assertions and Audit Objectives

• Financial statements: reflect a set of

management assertions about the financial
health of the entity.

• Auditor’s Report: The product of the

attestation function which is a formal written
report that expresses an opinion about the
reliability of the assertions contained in the
financial statements.
 FINANCIAL AUDIT COMPONENTS:
3) Management Assertions and Audit Objectives
• The task of the auditor: To determine whether the FSs are fairly presented.

• To accomplish this goal, the auditor:

• 1) establishes audit objectives
– Audit objectives are developed based on managements assertions.
– Audit objectives may be classified into two general categories.
– 1) relate to transactions and account balances that directly impact financial reporting.
– 2) pertains to the information system itself.
• includes the audit objectives for assessing controls over manual operations and computer
technologies used in transaction processing.
• 2) designs audit procedures
– Audit procedures are developed based on management assertions.
• 3) gathers evidence that corroborate or refute management’s assertions
using: tests of controls and substantive tests
 FINANCIAL AUDIT COMPONENTS:
3) Management Assertions and Audit Objectives
• Six (6) general categories of management assertions:
• 1) accuracy assertion: accurately computed & based on current prices and
correct quantities
• 2) completeness assertion: declares that no material assets, equities, or
transactions have been omitted from the FSs.
• 3) existence or occurrence assertion: affirms that all assets and equities
contained in the BS exist and that all transactions in the IS actually occurred.
• 4) rights and obligations assertion: maintains that assets appearing on the BS
are owned by the entity and that the liabilities reported are obligations.
• 5) valuation or allocation assertion: states that assets and equities are valued
in accordance with GAAP and that allocated amounts such as depreciation
expense are calculated on a systematic and rational basis.
• 6) presentation and disclosure assertion: alleges that FS items are correctly
classified (e.g., long-term liabilities will not mature within one year) and that
footnote disclosures are adequate to avoid misleading the users of FSs.
 FINANCIAL AUDIT COMPONENTS:
3) Management Assertions and Audit Objectives

• Examples of audit objectives and audit procedures

that are developed based on management assertions.
 FINANCIAL AUDIT COMPONENTS:
4) Obtaining Evidence
• Evidence: Used by auditors to corroborate or refute
management’s assertions.

• Two (2) methods are performed to collect evidence:

• 1) tests of controls
– which establish whether internal controls are functioning properly.
– Ex. In IT environment, the reliability of the computer controls
• 2) substantive tests
– which determine whether accounting databases fairly reflect the
transactions and account balances.
– Ex. In IT environment, the reliability of the contents of databases that
have been processed by computer programs.
 FINANCIAL AUDIT COMPONENTS:
5) Ascertaining Materiality
• Materiality: degree of misstatement or omission that would affect
the decision-making process of the users of financial information.
• Two (2) factors as basis for determining the materiality:
– weaknesses in internal controls
– misstatements found in transactions and account balances

• Basis of assessing materiality: auditor’s judgment

• Two (2) factors that complicate auditor’s judgment of materiality
in an IT environment:
– Technology
– sophisticated internal control structure.
 FINANCIAL AUDIT COMPONENTS:
6) Communicating Results
• Audit report: used by auditors to communicate the results
of their tests to interested users.
– contains an audit opinion.
• This opinion is distributed along with the financial report to interested
parties both internal and external to the organization.
• Auditor’s opinion is the culmination of a systematic financial audit process.

• To whom should the results be communicated:

– In the case of an independent auditor: renders a report to the
audit committee of the BODs or stockholders of a company.
– In the case of the IT auditors: often communicate their findings to
internal and external auditors, who can then integrate these
findings with the non-IT aspects of the audit.
 Summary:
Financial Audit Components
• Auditing Standards: Auditors are guided in their professional responsibility by the two
auditing standards, GAAS and SASs. GAAS establishes a framework for prescribing auditor
performance while SASs are the authoritative interpretations of GAAS.
• Systematic Process & Logical Process: the processes used in conducting an IT audit.
• Management Assertions and Audit Objectives: The task of the auditor is to determine
whether the FSs are fairly presented by establishing audit objectives and designing audit
procedures based on management assertions, and gathering evidence that corroborate or
refute management’s assertions.
• Obtaining Evidence: is performed by using the 2 methods which are the tests of controls
and substantive tests.
• Ascertaining Materiality: depends on the auditor’s judgment which the basis for
determining the materiality are the weaknesses in internal controls and misstatements
found in transactions and account balances.
• Communicating Results: In the form of audit report, auditors communicate the results to
BODs or stockholders of a company in the case of an independent auditor or to internal
and external auditors in the case of an IT auditor.