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7/29/2019 Basic Principles of Audit Theory
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By: DAVE RITZ J. PERIA, CPA
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Auditing is a systematicprocess
by which a competent, independent
person objectively obtains and
evaluates evidence regardingassertions about economic actions
and events to ascertain the degree
of correspondence between the
assertions and established criteriaand communicating the results to
interested users.
Financial Statements
(including footnotes)
GAAP
Auditor's Report/
Other ReportsPersons who rely on
the financial reportsCreditors
Investors
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Financial Statement Audit
- conducted to determine whether the FS of anentity is presented in accordance with anidentified financial framework
Operational Audit
- is a study of an organizations unit to assessentitys performance, identify areas ofimprovement and make recommendations toimprove performance
Compliance Audit- involves a review of an organizationsprocedures to determine its compliance tospecific procedures, rules or regulations
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CPA Firms/External Auditors
-independent contractors
-are the ones who generally perform FS audit
Internal Auditors
- they usually perform operational audit
- Entitys own employees who investigate andappraise the effectiveness and efficiency ofoperations and internal controls
Government Auditors-conduct compliance audit like
COA Auditors
BIR Examiners
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to enable the auditor to express an opinion
whether the financial statements are prepared,
in all material respects, in accordance with anapplicable financial reporting framework.
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Financial Statement Assertions
Financial
Statements
EXISTENCE or
OCCURRENCE
RIGHTS andOBLIGATIONS
COMPLETENESS
VALAUATION and
ALLOCATION
PRESENTATION
and DISCLOSURE
AUDIT
EVIDENCE
AUDIT
PROCEDURE
S
AUDIT
OPINION
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Management is responsible in the fair
presentation of FS
In representing that the financial statements
are in accordance with applicable financialreporting framework, management
IMPLICITLY or EXPLICITLY makes assertions
regarding the recognition, measurement,
presentation and disclosure of the FSelements and related disclosures
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1. Assertions about CLASSES OF
TRANSACTIONS AND EVENTS for the period
under audit
2. Assertions about ACCOUNT BALANCES at theperiod end
3. Assertions about PRESENTATION AND
DISCLOSURE
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Completeness all transactions and events thatshould have been recorded have been recorded
Occurrence transactions and events that havebeen recorded have occurred ad pertain to the
entity Cut-off transactions and events have been
recorded in the correct accounting period
Accuracy amounts and other data relating to
recorded transactions and events have beenrecorded appropriately
Classification transactions and events have beenrecorded in the proper accounts
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Completeness all assets, liabilities and equityinterests that should have been recorded have beenrecorded
Existence assets, liabilities and equity interests
exist Rights and Obligations the entity holds or controls
the rights to assets, and liabilities are theobligations of the entity
Valuation and allocation assets, liabilities andequity interests are included in the financialstatements at appropriate amounts and anyresulting valuation or allocation adjustments areappropriately recorded
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Occurrence and rights and obligations disclosedevents, transactions, and other matters haveoccurred and pertain to the entity
Completeness all disclosures that should have
been included in the financial statements havebeen included
Classification and understandability financialinformation is appropriately presented and
described, and disclosures are clearly expressed Accuracy and Valuation financial and other
information are disclosed fairly and at appropriateamounts
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The auditor should select audit procedures
that enables the auditor to gather sufficient
appropriate evidence about a particular
assertion
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Inspection - involves examining records, documents ortangible assets
Observation consists of looking at a process orprocedure being performed by others
Inquiry consists of seeking information fromknowledgeable persons inside or outside the entity
Confirmation- consists of the response to an inquiry to
corroborate information contained in the accountingrecords
Computation consists of checking the arithmeticalaccuracy of source documents and accounting recordsor performing independent calculations
Analytical Procedures - consist of the analysis ofsignificant ratios and trends including the resultinginvestigation of fluctuations and relationships that areinconsistent with other relevant information or deviatefrom predicted amounts
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refers to the information obtained by the
auditor in arriving at the conclusions on
which the audit opinion is based.
comprises source documents andaccounting records underlying the FS andcorroborating information from othersources
it will either prove or disprove the validity ofmanagement assertions
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Management is responsible for preparation
and presentation of financial statements
With oversight from those charged with
governance. Audit does not relieve management or those
charged with governance of their
responsibilities
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The auditors responsibility is to form and
express an opinion on the financialstatements.
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The auditor should comply with the Code of
Professional Ethics
The auditor should conduct an audit in
accordance with Philippine Standards onAuditing
The auditor should adopt the attitude of
professional skepticism
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Professional skepticismis an auditors tendencynot to believe managements assertions without
sufficient corroboration.
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An audit conducted in accordance with PSA is
designed to provide only reasonable
assurance that the financial statement taken
as a whole are free from material
misstatements
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The use of testing.
The inherent limitations of internal control
(for example, the possibility of management
override or collusion). The fact that most audit evidence is
persuasive rather than conclusive.
Use of judgment
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ERROR refers to unintentional misstatement in financial
statements, including the omission of an amount or a
disclosure.
FRAUD refers an intentional act by one or more
individuals among management, those charged with
governance, employees, involving the use of deception to
obtain an unjust or illegal advantage.
NONCOMPLIANCE refers to acts of omission orcommission by the entity being audited, either intentional
or unintentional, which are contrary to the prevailing
laws or regulations.
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1. FRAUDULENT FINANCIAL REPORTING
or MANAGEMENT FRAUD
2. MISAPPROPRIATION OF ASSETS or
EMPLOYEE FRAUD
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FRAUDULENT FINANCIAL REPORTING or
MANAGEMENT FRAUD
- involves intentional misstatements oromissions of amounts or disclosures in thefinancial statements to deceive financialstatement users.
This may involve:
a. Manipulation, falsification or alteration ofrecords or documents
b. Misrepresentation in or intentional omissionof the effects of transactions from records ordocuments
c. Recording of transactions without substance
d. Intentional misapplication of accountingpolicies
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Involves MOTIVATION to commit it andPERCEIVED OPPORTUNITY to do so.
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When planning and performing audit procedures
and in evaluating and reporting the resultsthereof, the auditor should recognize that
fraud, error and noncompliance with laws andregulations may materially affect the financialstatements.
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MANAGEMENT- It is the responsibility of the
management to establish appropriate controls to
prevent and detect fraud, error and
noncompliance.
THOSE CHARGED WITH GOVERNANCE- It is the
responsibility of those charged with governance to
oversee management to ensure that appropriatecontrols are in place.
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The auditors responsibility is to designthe audit to obtain reasonable
assurance that the financial statementsare free from MATERIAL misstatements,whether caused by error, fraud or
noncompliance.
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Over reliance on client representations.
Lack of awareness or failure to recognize
that an observed condition may indicate a
material fraud. Lack of experience.
Personal relationships with clients.
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CONDUCTING
AN AUDIT OF
FINANCIALSTATEMENTS
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PRE-ENGAGEMENT
PROCEDURES
INTERNAL
CONTROL
CONSIDERATION
SUBSTANTIVE
PROCEDURES
COMPLETING
THE
AUDIT
AUDITPLANNING
ISSUE
REPORT
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1. Evaluate compliance with ethicalrequirements (PSA 220)
2. Evaluate continuance of relationship withexisting clients (PSA 220)
3. Establish the terms of the engagement (PSA210)
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Client selection and
retention
Communication
between predecessorand successor auditors
Engagement letters
Staff assignment
Time budget
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In making decisions whether to accept
or reject an audit engagement, thefirm should consider:
1. Its competence
2. Its independence3. Its ability to serve the client properly
4. The integrity of the prospective
clients management
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This serves as the written contractbetween the auditor and the client. Thissets forth:
a. Objective of the audit of FS
b. Management responsibility
c. Scope of the auditd. Forms or any reports or other
communication that the auditor expectsto issue
e. Limitations of the audit
f. Responsibility of the client to allow theauditor have unrestricted access towhatever information in connection withthe audit
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In addition, the auditor may alsoinclude the following items:
a. Billing arrangements
b. Expectations of receivingmanagement representation letter
c. Other arrangement like(involvement of an expert, internal
auditors and other client personnel?d. Request for the client to confirm
the terms of the engagment
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Helps ensure that appropriate attention is
devoted to important areas of the audit
Helps identify potential problems
Assists in proper assignment andcoordination of audit work
Helps ensure that the audit is conducted
effectively and efficiently
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Understand the entity and its environment
including the entitys internal control
Develop an overall audit strategy and
detailed approach (Risk, Materiality andAnalytical Procedures)
Audit Planning Documentation.
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1. Industry, regulatory and other external factors,including the applicable financial reportingframework
2. Nature of the entity, including the selection
and application of accounting policies3. Objectives and strategies and the related
business risks
4. Measurement and review of the entitysperformance
5. Internal control
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Phase 1: Understand and Document Understand the Clients Internal Control
Document the Internal Control understanding
Internal Control questionnaire
Narrative
Accounting and Control System Flowcharts
Phase 2: Assess Control Risk (Preliminary)
Phase 3: Testing and Reassessment Perform Test of Controls Audit Procedures
Re-Assess Control Risk
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Substantive Testing
Substantive Testing
Testing of Controls
More EffectiveMore Eff icient
Year-endInterim
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Audit risk (AR) is the risk (likelihood) that theauditor may unknowingly fail to modify the
opinion on financial statements that are
materially misstated (e.g., an unqualifiedopinion on misstated financial statements.)
The AUDIT RISK MODEL decomposes overall audit
risk into three components: inherent risk (IR),
control risk (CR), and detection risk (DR):AR = IR x CR x DR
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AUDIT RISK
The likelihood that
an error or fraud will occur,
and not get caught
by either the internal controls
or auditors procedures.
DETECTION RISK
The likelihood that
an error or fraud
will not be caught
by the auditors
procedures.
FinancialStatements
CONTROL RISK
The likelihood that an error
or fraud will not get caught by the
clients internal controls.
INHERENT RISK
The likelihood that,
in the absence of
internal controls,
an error or fraud
will enter the accounting
information system
AccountingInformationSystem
Internal Controls
Events,
TransactionsSubstantive
Procedures
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Using the information obtained in audit
planning and consideration of internal
control, the auditor performs test to
determine whether the entitys FS are fairly
presented in accordance with financial
reporting standards
These would involve EXAMINATION of
DOCUMENTS and EVIDENCE supporting the
amounts and disclosure in the FS
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Detection Risk and the Nature,
Timing, and Extent of AuditProcedures
Lower Detection Risk Higher Detection Risk
Nature More effective tests. Less effective tests.
Timing Testing performed at
year-end.
Testing can be performed at
Interim.
Extent More tests. Fewer tests.
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Auditevidence is all the information used by
the auditor in arriving at the conclusions on
which the audit opinion is based.
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1. Source documents and accounting records
underlying the financial statements.
2. Other corroborating information
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Sufficiency is the measure of the quantity ofaudit evidence.
Appropriateness is the measure of the
quality of audit evidence.
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The following factors should be considered
when evaluating the sufficiency of
evidence:
Competence of Audit Evidence Materiality of the amount involved
Risk of misstatement in the account
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Appropriate evidence
Must be relevant to a particularassertion; and
Must be reliable
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Relevance
Testing what you want to test (e.g., direction of
testing)
Reliability
Independence of source
Condition of internal control
How the evidence was obtained
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Review of subsequent events and
contingencies
Assessing going concern assumption
Performing overall analytical review
proceduresObtaining a written representations from the
management
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Forming a conclusions about the financial
statements.
This conclusion in the form of an opinion is
communicated to various interested users
through an AUDIT REPORT
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Auditors Report on Financial Statements
Unmodified ReportModifications to the
Opinion
Emphasis of Matter &Other MatterParagraphs
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The auditor must form judgment as to the ff.:
Consistency and appropriateness of selected and applied
accounting policies;
Reasonableness of accounting estimates;
Relevance, reliability, comparability and
understandability of information presented in the
financial statements including accounting policies; and
Provision of sufficient disclosures to enable users to
understand the effects of material transactions and
events conveyed in the financial statements.
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Materiality
Conclude whether:
Materiality remains appropriate
Uncorrected misstatements (individual or aggregate) could result
in a material misstatement
Audit Evidence Has sufficient appropriate audit evidence been obtained?
Are the accounting estimates reasonable
Did the analytical procedures performed corroborate
conclusions formed during the audit?
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4 Managements responsibility should describe the
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4. Management s responsibility should describe the
ff. managements responsibility: Preparation and fair presentation of the financial statements
in accordance with applicable financial reporting framework; Design, implementation and maintenance of internal control
5. Auditors responsibility should state the ff.: Responsibility of the auditor to express an opinion
The audit was conducted in accordance with PhilippineStandards on Auditing (PSAs)
General description of an audit
That the audit evidence obtained is sufficient and appropriate
6 Auditors opinion should state that the financial
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6. Auditor s opinion should state that the financial
statements are presented fairly in all material
respects in accordance with applicable financial
reporting framework7. Other reporting responsibilities
8. Auditors signature signed in the name of the
audit firm and/or the personal name of the auditor
9. Date of the report dated as of completion of all
essential audit procedures (last day of fieldwork)
10. Auditors address where the auditor maintains his
office
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Arises from either of the ff.:
Failure to conduct the audit in accordance
with PSA; and
Failure to prepare the financial statements inaccordance with the applicable financial
reporting framework
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S Li it ti
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Scope Limitation
May arise when:
The auditor is unable to perform necessary audit procedures; or
The auditor is unable to obtain sufficient appropriate evidenceabout an assertion
May be imposed by:
Client Circumstances beyond the control of the entity
Circumstances relating to the nature or timing of the auditors
work
Management
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CHAPTER CONTENT:
Guidance on how to express anappropriately modified opinion onfinancial statements when necessary.
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Pervasive effects on the financialstatements that in the auditors judgment:
i. Are not confined to specific
elements, accounts or items of the FSii. If so confined, represent or could
represent substantial proportion ofthe FS
iii. In relation to disclosures, arefundamental to users understanding
of the FS
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i. Misstatements that the auditor
has accumulated during the
audit and that have not been
corrected.
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i. A qualified opinion
ii. An adverse opinion
iii. A disclaimer of opinion
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FS are not free from material statement
The auditor is unable to obtain sufficient
appropriate evidence
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Obtained sufficient appropriate audit
evidence
Concludes that there is misstatements,individually or in aggregate
Misstatements are both material and
pervasive to FS
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unable to obtain sufficient appropriate
evidence on which to base the opinion
the possible effects on the FS of
undetected misstatements, if any, couldbe both material and pervasive
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MODIFICATION TO THE OPINION
Material Misstatements Scope Limitations
Materialbut not
Pervasive
Materialand
Pervasive
QualifiedOpinion
AdverseOpinion
Materialbut not
Pervasive
Materialand
Pervasive
QualifiedOpinion
DisclaimerOf Opinion
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In our opinion, because of thesignificance of the matter discussed
in the Basis for Adverse Opinion
Paragraph the FS do not presentfairly
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