Understanding Audits: Types and Financial Statements

Audit - An Overview

• An audit systematically obtains and evaluates evidence about economic actions and events.
• It assesses the degree of correspondence between assertions and established criteria.
• Communicates results to interested users.

Types of Audit

• Financial Statement Audit determines if an entity's financial statements are fairly presented within an identified financial reporting framework.
• Conducted by external auditors.
• Compliance Audit reviews an organization's procedures to determine adherence to specific rules, contracts, or regulations.
• Usually conducted by government auditors.
• Operational Audit studies a specific unit of an organization to measure its performance.
• Usually conducted by internal auditors.

Independent Financial Statement Audit

• Responsibility of management to prepare and present financial statements in accordance with the financial reporting framework.
• Auditor's responsibility is to form and express an opinion on the financial statements based on the audit.
• Audits conducted with PSA aim to provide only reasonable assurance that financial statements are free from material misstatements.

Limitations of an Audit

• Sampling risk/use of testing
• Error in application of judgement/non-sampling risk
• Reliance on management's representation
• Inherent limitations of the client's accounting and internal control systems
• Nature of evidence

General Principles Governing the Audit of Financial Statements

• Code of professional ethics
• Philippine Standards on Auditing (PSA)
• Attitude of professional skepticism

Need for an Independent Financial Statement Audit

• Conflict of interest
• Expertise
• Remoteness
• Financial consequences

Theoretical Framework of Auditing

• Financial data are verifiable.
• Independence is crucial.
• No long-term conflict of interest should exist.
• Effective internal control is necessary.
• Consistent application of GAAP/PFRS.
• Continuity assumption.
• Benefits the public

The Professional Standards

• Generally Accepted Auditing Standards (GAAS) represents the minimum standard of performance auditors should follow.
• General Standards include technical training and proficiency, independence, and professional care.
• Fieldwork Standards involve planning, internal control consideration, and evidential matter.
• Reporting Standards consist of GAAP, inconsistency, disclosure, and opinion.

Philippine Standards on Auditing (PSA)

• Establishes the independent auditor's overall responsibilities when conducting an audit of financial statements in accordance with PSAs.
• Issued by AASC as interpretations to GAAS.
• Practice statements provide practical assistance to auditors in implementing the standards and promoting good practice in the accountancy profession.

System of Quality Control

• Quality controls are policies and procedures adopted by CPAs.
• Provide reasonable assurance of conforming to professional standards.

Elements of Quality Control (PSA 220)

• Leadership responsibilities for quality on audits
• Ethical requirements, including integrity, objectivity, professional competence & due care, confidentiality, and professional behavior.
• Independence
• Acceptance and Continuance of Client Relationships
• Human Resources and Assignment
• Recruitment, performance evaluation, capabilities, career development, and engagement team assignment
• Engagement Performance
• Direction, supervision, review, consultation, engagement quality control review, and differences of opinion
• Monitoring

Quality Control Review

• All CPA firms and CPAs in public practice must obtain accreditation to practice public accountancy, as required by the Professional Regulatory Board of Accountancy (BOA).
• Quality Review Committee (QRC), created by PRC, conducts quality reviews on applicants for registration to practice public accountancy.

Auditor's Responsibility

• Design the audit to provide reasonable assurance of detecting material misstatements in the financial statements.

Sources of Misstatements

• Error
• Fraud
• Noncompliance with Laws and Regulations

Error

• Unintentional misstatements in financial statements.
• Mathematical or clerical mistakes, incorrect accounting estimates, or mistake in application of accounting policies.

Fraud

• Intentional act by individuals among management, employees, or third parties.
• Results in misrepresentation of financial statements.

Types of Fraud

• Management Fraud/Fraudulent Financial Reporting involves intentional misstatements or omissions of amounts or disclosures.
• Usually done by members of management.
• Employee Fraud/Misappropriation of Assets accompanied by false or misleading records to conceal missing assets.

Responsibility of Management and Those Charged with Governance (PSA 240)

• Management establishes a control environment and implements internal control policies.
• It is designed to ensure the detection and prevention of fraud and error.
• Individuals charged with governance ensure the integrity of the entity's accounting and financial reporting systems.

Auditor's Responsibility

• The auditor cannot be held responsible for the prevention of fraud and error.
• The auditor has the responsibility to design the audit to obtain reasonable assurance that the financial statements are free from material misstatements.

Audit: Planning Phase

• Make inquiries of management about the possibility of misstatement.
• Assess the risk that fraud/error may cause the financial statements to contain material misstatements.

Audit: Testing Phase

• Perform procedures necessary to determine whether material misstatements exist.
• Errors will only result in adjustment of FS but fraud may have other implications on an audit

Audit: Completion Phase

• Obtain a written representation from the client's management.
• When the auditor believes that material error/fraud exists, they should request management to revise the financial statements.
• If the auditor is unable to evaluate the effect of fraud on financial statements, they should either qualify or disclaim their opinion on the financial statements.

Fraud Risk Factors

• Fraudulent Financial Reporting (Management Fraud) is influenced by management's influence over the control environment, industry conditions, and financial stability.
• Misappropriation of Assets (Employee Fraud) is influenced by the susceptibility of assets to misappropriation and the lack of controls.

Noncompliance With Laws and Regulations

• Refers to acts or commission by the entity being audited, either intentional or unintentional, which are contrary to prevailing laws or regulations.
• Management is responsible for ensuring operations are conducted in accordance with laws and regulations.
• Auditors should recognize that noncompliance with laws and regulations may materially affect the financial statements.

Audit Planning

• Obtain a general understanding of the legal and regulatory framework applicable to the entity.
• Design procedures to help identify instances of noncompliance with laws and regulations.
• Design audit procedures to obtain sufficient appropriate audit evidence about compliance with laws and regulations.

Audit Testing

• When the auditor is aware of an instance concerning noncompliance, they evaluate the possible effect on the financial statements.
• The auditor should document the findings, discuss them with management, and consider the implications on other aspects of the audit.

Audit Completion

• Obtain a written representation from the client's management.
• When the auditor believes that there is noncompliance, they should request management to revise the financial statements.
• If a scope limitation has precluded the auditor from obtaining sufficient appropriate evidence, the auditor should express a qualified opinion or a disclaimer of opinion.

Financial Statement Assertions

• Assertions about classes of transactions and events for the period under audit: completeness, occurrence, cutoff, accuracy, and classification.
• Assertions about account balances at the period end: rights and obligations, existence, completeness, and valuation and allocation.
• Assertions about presentation and disclosure: completeness, occurrence and rights and obligations, classification and understandability, and accuracy and valuation.

Audit Procedures

• Procedures should enable the auditor to gather sufficient appropriate evidence about a particular assertion.
• Inspection involves examining records, documents, or tangible assets.
• Observation consists of looking at a process or procedure being performed by others.
• Inquiry consists of seeking information from knowledgeable persons inside or outside the entity.
• Confirmation consists of the response to an inquiry to corroborate information in the accounting records.
• Computation consists of checking the arithmetical accuracy of source documents and accounting records.
• Analytical Procedures consist of the analysis of significant ratios and trends.

Audit Evidence

• Information obtained by the auditor in arriving at the conclusions on which the audit opinion is based.
• Audit evidence comprises source documents and accounting records underlying the financial statements and corroborating information from other sources.

Accepting an Engagement

• When deciding whether to accept or reject an engagement, the firm should consider competence, independence, ability to serve the client properly, and integrity of management.

Retention of Existing Clients

• Evaluate clients at least once a year.
• Terminating an audit engagement if conditions arise that would cause the firm to reject a prospective client.

Engagement Letter

• Serves as the written contract between the auditor and the client.
• States the objective of the audit of financial statements, and management's responsibility.
• Indicates the scope of the audit and the forms of reports or other communication.
• Express the unavoidable risk that material misstatements may remain undiscovered.
• Client responsibility to grant unrestricted access to records, documentation and information requests.
• States billing arrangements and expectations.
• Request the client to confirm the terms of the engagement.
• To avoid misunderstanding with management and document and confirm the auditor's acceptance of the appointment.

Recurring Activities

• New engagement letter every year, unless there are misunderstandings, revisions, or changes in management, the size, or relevant pronouncements.

Audit Components

• Consider whether a separate letter is to be sent to the component - based on legal requirements, opinions and degree of ownership with the parent.

Audit Planning

• Involves developing a general audit strategy and a detailed approach.
• The auditor's main objective to determine the scope of the audit procedures to be performed.
• The auditor must obtain an understanding of the entity and its environment, including the internal control.

Additional Consideration on New Engagements

• Obtain sufficient appropriate audit evidence that the opening balances do not contain misstatements that materially affect the current year's financial statements.
• The prior period's closing balances have been correctly brought forward to the current period or have been restated.
• Appropriate accounting policies are consistently applied or properly disclosed.

Developing an Overall Audit Strategy

• The best strategy is the approach that results in the most efficient audit.
• An audit plan should be made regarding how much evidence to accumulate and when this should be done.
• The auditor must consider the appropriate levels of materiality and audit risk.

Materiality

• Information is material if its omission or misstatement could influence the economic decisions of users.
• The auditor should make a preliminary estimate of materiality when designing an audit plan.
• Materiality may be viewed as the largest amount of misstatement that the auditor could tolerate in the financial statements or the smallest aggregate amount that could misstate the financial statements.
• There is an inverse relationship between materiality and evidence.

Using Materiality

• (1) in the planning stage, to determine the scope of the audit and (2) in the completion stage, to evaluate the effect of misstatements in the FS

Audit Risk

• The risk that the auditor gives an inappropriate audit opinion on the financial statements.
• This occurs because the auditor believes that the financial statements are fairly stated when, in fact, they are materially misstated.
• The Audit Risk Model: Audit Risk = Inherent Risk x Control Risk x Detection Risk

Inherent Risk

• The susceptibility of an account balance or class of transactions to a material misstatement assuming that there are no related internal controls.
• Factors affect the risk of misstatement at FS level - management integrity, management characteristics.
• Risk is increased with more effective substantive procedures.

Control Risk

• The risk that the material misstatement that could occur in an account balance or class of transactions will not be prevented or detected on a timely basis by accounting and control systems.
• As the assessed level of Control Risk INCREASES, the auditor should design MORE EFFECTIVE SUBSTANTIVE PROCEDURES,

Detection Risk

• The risk that an auditor's substantive procedure will not detect a material misstatement.
• THE AUDITOR CAN CONTROL THE LEVEL OF DETECTION RISKS by performing more effective substantive procedures.

Steps in Using the Audit Risk Model

• Set the desired level of audit risk.
• Assess the level of inherent risk and control risk.
• Determine the acceptable level of detection risk.
• Design substantive tests.

Relationship Between Materiality and Risk

• There is an inverse relationship between materiality and the level of audit risk.
• Risk is increased with a lower acceptable materiality level.
• Risk can be adjusted by reducing the risk and providing more supervision.

Analytic Procedures

• Involves analysis of significant ratios and trends.

Steps in Applying Analytical Procedures

• Step 1. Develop expectations regarding financial statements using.
• Step 2. Compare expectations with the financial statements under audit.
• Step 3. Investigate significant unexpected differences.

Uses of Analytical Procedures

• As a planning tool to determine the nature, timing, and extent of auditing procedures.
• As a substantive test to obtain corroborative evidence.
• As an overall review of the financial statements.

Considerations of Internal Control

• Internal control is the process designed and affected by those charged with governance, management, and other personnel to provide reasonable assurance.
• Components of Internal Control: Control Environment, Risk Assessment, Information and Communication Systems, Control Activities, and Monitoring.

Steps in Consideration of Internal Control

• Obtain understanding of the internal control
• Document the understanding of accounting and internal control systems
• Assess the level of control risk
• Perform test of controls

Test of Controls

• Performed to obtain evidence about the effectiveness of the design and operation of the accounting and internal control systems.
• Auditor should obtain audit evidence through test of control to support any assessment of control risk.
• Types: Inquiry, Observation, Inspection, Reperformance

Auditing in a Computerized Environment

• Characteristics of Computerized Information Systems (CIS): Lack of Visible Transaction Trails, Consistency of Performance, Ease of Access to data and Computer Programs, Concentration of Duties, Systems Generated Transactions, and Vulnerability of Data and Program Storage Media.
• Internal Control in a CIS Environment General Controls. Organization controls, systems development and documentation controls, access controls, data recovery controls, monitoring controls.
• Application Controls- Controls over Input, Processing, Output

Test of Control in a CIS Environment

• The auditor's objectives and scope of the audit do not change in a CIS environment.
• In testing application controls, the auditor may either audit around the computer or use Computer-Assisted Audit Techniques (CAATs).

PERFORMING SUBSTANTIVE TESTS

• Substantive Tests-audit procedures designed to substantiate the account balances or to detect material misstatements in the financial statements.
• Two Types: Analytical Procedures, Test of Details

Effectiveness of Substantive Test

• Nature of substantive test relates to quality of evidence
• Effectiveness of Substantive test - increase with the extent of risk to material misstatement.
• Test of Control can provide evidence about misstatement occurrence.

Audit Evidence

• This data is the information the audior uses to support the report.
• Includes underlying accounting data and corroborating information.
• Sufficiency means the appropriateness of evidence.
• Cost consideration the auditor is finding persuasive evidence.

AUDIT DOCUMENTATION/WORKING PAPERS

• Should document matters that are important to support an opinion on FS, and evidence that the audit was conducted in accordance with PSA.

Functions of the Working Papers:

• Support the auditor's opinion on FS
• Form, Content, and Extent of Audit Documentation: Understand the procedures, audit results, and any significant audit decisions.

Classification of Working Papers

• There should be Permanent file and Current file.
• Permanent contains info of continuing significance to the auditor in performing recurring audits.
• Current Contains all the evidence of a working party.

Ownership of Working Papers

• The auditor should have ownership and papers may not serve as a reference for clients.
• All papers and materials are confidential unless shared with legal cause.

Auditing Accounting Estimates

• Accounting estimate' is an approximation of the amounts of an item in the absence of a precise means of measurement.
• Material misstatement is greater when accounting estimates are involved.
• Auditor responsibility - obtain sufficient appropriate evidence to see if statements are accounted for and disclosed.

Auditing Options

• Review and test process use by mgmt, make a independent estimate, or review if there are related events

Auditing Related Parties

• Relates to persons or entities that may have dealings w/ one another in which one party as the ability to exercise significant influence over the other party.
• Management responsibility - identification and disclosure.
• An audit cannot be expected to provide assurance that all related party transactions will be discovered

Using the Work of an Auditor's Expert

• An expert is a person or firm possessing special skill, knowledge and experience accounting and auditing.
• PSA 620 identifies two kinds of experts: Auditor or managers expert
• Not all engagements would require the help of an expert.
• The auditor has sole responsibility for the audit opinion expressed.

Considering the Work of Internal Auditors

• Internal auditing is an appraisal activity withi an entity
• The work of internal audit involves two important phases: prelim assessment and then evaluation.

Audit Sampling

• Involves the application of audit procedures to less than 100% of the items within an account, ensuring all sampling units have a chance of selection

Risk of Sampling

• Possibility that the auditor's conclusion, based on a sample, may differ from the conclusion reached if the entire population were subjected to the same audit procedures.
• To control increase sample size and follow a selection method.

Other Risk

• Non-sampling risk something that cannot be eliminated, to control follow proper directions.
• Following those risks are general apporaches of samplign
• General Approaches to Audit Sampling: Statistical and Non-Statistical Sampling.

Steps in Audit Sampling

• Determine the objective of the test, the sample size, audit procedures.
• Apply the procedures and decide whether to to account further and to the audit.

Determination of the Sample

• Should follow these attributes: Acceptable Sampling Rick, Tolerable and expected devotion rate and the steps.

Sample Selection Methods

• Common is to random select or use systematic selection.

Evaluation

• The sample should be compared and an overall conculsion to the population.

COMPLETING THE AUDIT AND POST AUDIT RESPONSIBILITIES

• The following is done to aid in the proceedings.
• Identifying subsequent events that may affect the FS under audit.
• PSA 560 states to follow events that need approval.

The Following will Cause an Auditor to Issue a Judgement of Adverse Opinion

• Events occurring after the report date but before the FS are issued.
• Identifying contingencies such as litigations, claims and assessment.
• Requires the auditor to carry out procedures in order to become aware of any litigation and claims involving the entity which may have a material effect on the FS.
• Obtaining written management representation - provide a fair report

Performing Wrap-Up Procedures

• Procedures done at the end of the audit that generally cannot be performed before the other audit work is complete.
• Final analytical procedures.
• Evaluating audit findings and preparing a list of potential adjusting entries.

The auditor did these Things

• Is there sufficient doubt for management on what is correct?
• Auditors will use all procedures
• After issuing do you need aid or not?

The Auditor's Report on Financial Statements

• PSA 700 requires an auditor's report to contain a clear expression of the auditor's opinion on the FS.
• Can only be an issue where there is evidence on facts.

Basic Elements of the Unmodified Report

• The report needs to explain responsibilities and limitations.
• Include name of the people singing and adresses in the report.
• Only give the report if correct evidence has been found

Modification to Opinion

• Modified opinion will indicate that there is a chance of limitaiton.
• Explain whether there is or is not adequte detail to look in the statements.
• May requalify depending on the information.

Other factors

• If not followed auditor may quit engagement.
• Piece mail opinions are unmodifed opinion.
• Omission for others
• Discovered facts
• Comparative data
• Inconsistencies

Other information Accompanied With FInancial Statements

• There is a change to ammend other info
• The qualifcation from psa 720 means other things dont need to be followed by them

Audit of Group Financial Statements

• A group auditor is the auditor following information on where it comes from.
• Its is important that auditors have a basis
• If SPFS auditor should be the same

Other facts to understand

• In all engagements auditor may request more
• Falsifying audits is not allowed on elements
• Summary should be followed by the report

Assurance Engagements

• Services that are normally performed in connection with the entity's FS.
• Should look at credibility of a subject to see if fits the requirment.
• Look for three key relationships to assess the nature.

Reports on Prospective Financial Information

• Financial data is dependent upon the entity.

THE CODE OF ETIHICS AND REPUBLIC ACT 9298

• Provides standards of conduct that embody and demonstrate integrity, objectivity, and concern for the public interest

The Code of Ethics states to

• Identify treaters to compliance
• Eval Signicane
• When necessary eliminate treats

Threats Inlcude

• Self interset, review advocacy, familiarity, and intimidation

There must be certain safegaurds

• Profession,work, safeguards in systems
• Follow general appliation of code for fairness.

Other codes

• Confidentiality should be followed unless authorized. The rest are codes of conduct for auditors in accoutning

Republic Act 9298

• Is what the act governs provides through regulation for examination and licensures

Board Info

• Naturaly born citizen who knows there rules.
• Terms are defined.
• Powers are stated like monitoring violations.

What a CPA license provides.

• Qualifications for CPA and more
• What support documents you need. A general score is what a CPA requires to be passed