MASTERS TECHNOLOGICAL INSTITUTE OF

MINDANAO

Lesson 2
Introduction to Auditing

OVERVIEW

Financial reports are important to stakeholders to assess the performance of a company. To add credibility to
these financial reports and enhance their usefulness, independent CPAs (as defined by the Board of
Accountancy, BOA, and approved by the Professional Regulation Commission, PRC) are engaged to examine
the management-prepared financial statements following generally accepted auditing standards. The CPA
practitioner is expected to express an opinion that the audited financial statements are fairly presented in
conformity to the applicable financial reporting framework (FRF).

However, the management of the business enterprise is primarily responsible about the preparation and
presentation of financial statements that conform to the applicable FRF. Any changes or adjustments to correct
material misstatements discovered in the audit need management approval. If not obtained, the CPA
practitioner is obliged to make the necessary modification in the “Independent Auditor’s Report”.

LEARNING COMPETENCIES

Explain why audits are demanded by society.

Contrast the various types of audits and types of auditors.
Explain the regulatory process for auditors of public companies and auditors of nonpublic companies.
Describe how the credibility of the accounting profession was affected by the large number of companies
reporting accounting irregularities in the beginning of this century.
Discuss the other types of reports that are issued by auditors.
Explain the key elements of the auditor’s standard report.

INTRODUCTION

PSA 200 (R&R) states that the objective of an audit of financial statements is to enable the auditor to express
an opinion whether the financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework.

KEY IDEAS

Although the auditor’s opinion enhances the credibility of the financial statements, the user cannot assume
that the opinion is an assurance as to the future viability of the entity nor the efficiency or effectiveness with
which management has conducted the affairs of the entity. Users of audited financial statements need to
recogize the delineation of responsibilities:

a. The auditor is responsible for forming and expressing an opinion on the financial statements while the
management of those charged with governance has the primary responsibility of preparing and presenting
these financial statements in accordance with the applicable financial reporting framework

b. Management is responsible for identifying the financial reporting framework to be used while the auditor
should determine whether such financial resportig framework adopted by management is acceptable.

Under PFRS, a complete set of financial statements includes a statement of financial position, a statement if
comprehensive income, a statement of changes in equity, a statement of cash flows, and notes comprising a
summary of significant accounting policies and other explanatory notes.

MODULE 1 – AUDITING AND ASSURANCE PRINCIPLES 1

 MASTERS TECHNOLOGICAL INSTITUTE OF
MINDANAO
EXCITE

GENERAL PRINCIPLES OF AN AUDIT

The general principles governing an audit of FS include:

1. The auditor should comply with relevant ethical requirements relating to an audit engagements
 PSA 22 (Red), “Quality Control for Audits of Historical Financial Statements”
2. The auditor should conduct an audit in accordance with Philippine Standards on Auditing (PSAs). PSAs
contain basic principles and essential procedures together with related guidance in the form of explanatory
and other material, including appendices. The auditor should also be aware of and consider Philippine Audting
Practice Statements (PAPs) applicable to the audit engagement because they provide interpretive guidance
and practical assistance in implementing PSAs.

The procedures required in the conduct of the audit should also give consideration to the requirements of
relevant professional bodies, legislation, and regulation and where appropriate, the terms of the engagement
and reporting requirements. In the event that local laws and regulations differ from the PSAs, an audit
conducted in accordance with the local laws and regulations will not automatically comply with PSAs.

3. The auditor should PLAN AND PERFORM the audit with the an ATTITUDE OF PROFESSIONAL
SKEPTICISM recognizing that circumstances may exist that cause the financial statements to be materially
misstated. It is expected that evidence should be obtained about management’s representations and should
not be assumed as necessarily correct.

4. The auditor should plan and perform the audit to REDUCE AUDIT RISK to an ACCEPTABLY LOW LEVEL
that is consistent with the objective of an audit. The auditor reduces audit risk by designing and performing
audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on
which to base an audit opinion.

ASSURANCES PROVIDED by AUDITOR

When the auditor renders an opinion on the audited FS, 3 important concepts underlie the assurances that the
auditor makes to users of the FS:

1. On the basis of evidence gathered (which includes sampling)

Sampling –test basis states explicitly that sampling is used to gather evidence on FS amounts and
disclosures.
2. The auditor provides REASONABLE ASSURANCE (an implicit risk that the overall audit conclusion is not
correct)
Reasonable assurance – the concept of reasonable assurance alludes to the concept of audit risk which is
implicit in the audit function and implied in the scope paragraph of the auditor’s report. It is a concept relating
to the accumulation of audit evidence necessary for the auditor to conclude that there are no material
misstatements in the FS taken as a whole.
3. That the FS are FREE from MATERIAL MISSTATEMENT (materiality)
Material misstatement – the auditor’s report contains no guarantee that the FS are accurate. Rather, the
auditor provides reasonable assurance concerning material misstatements and an opinion on fairness, in all
material respects.

INHERENT LIMITATIONS OF THE AUDIT

There are inherent limitations in an audit that affect the auditor’s ability to detect material misstatements as a
result of the use of testing, the inherent limitations of accounting and internal control systems such as
collusion, and the fact that most audit evidence is persuasive rather than conclusive.

Collusion arises when two or more individuals work together to effect misappropriation or concealment.

MODULE 1 – AUDITING AND ASSURANCE PRINCIPLES 2

 MASTERS TECHNOLOGICAL INSTITUTE OF
MINDANAO
EXPLORE: Types of Audits

Watch the video entitled “Overview of Financial Statement Auditing Process”

https://www.youtube.com/watch?v=c41bDuFJQEQ

AUDITING AND MANAGEMENT ASSERTIONS

PSA “Glossary of Terms” defines assertions as representations by management, explicit or otherwise, that are
embodied in the FS.

Two (2) categories of management assertions:

1. Internal control assertions
2. Financial statement assertions
Management is responsible for the preparation of the FS of an entity. The FS so prepared are a collection
of assertions as to both the state of affairs of the entity at financial reporting date and the results of its
operations for the period then ended. In broad terms, management asserts that the FS, and by implicationthe
FS items and underlying account balances and classes of transaction are free of material misstatement. That
is, management asserts that the FS items, and underlying account balances and classes of transactions are,
in all material respects, complete, valid and accurate.
This broad concept of FS assertions can be broken down by level of aggregation:
a. financial statement level
b. account balance level
c. class of transaction level

LEVEL OF ASSERTIONS
AGGREGATION COMPLETENESS VALIDITY ACCURACY
Financial statement level All valid account balances All account balances All valid account
are included in the FS item included in the FS item (i) balances included in
do exist and (ii) do pertain the FS item are
to the entity as at balance accurate as to (i)
date valuation and (ii)
presentation and
disclosure
Account balance level All valid assets, liabilities, Statement of financial All valid assets,
equities revenues and position account balances: liabilities, equities,
expenses are included in All assets, liabilities and revenues and
the account balance equities included in the expenses included in
account balance (i) do the account balance
exist and (ii) are are accurate as to(i)
owned/controlled by , or valuation and (ii)
owed by the entity as at classification
balance date.
Income statement account
balances: All income and
expenses included in the
account balance (i) do
pertain to the entity and (ii)
have occurred during the
relevant period
Class of transaction level All valid economic events All economic events All valid economic
are included in the class of included in the class (i) do events included in
transaction pertain to the entity and (ii) the class are
have occurred during the accurate as to (i)
relevant period value and (ii)
description

MODULE 1 – AUDITING AND ASSURANCE PRINCIPLES 3

 MASTERS TECHNOLOGICAL INSTITUTE OF
MINDANAO
Likewise, FS assertions per the AASC’s Glossary of Terms can be categorized as follows:

a. EXISTENCE: an asset or a liability exists at a given date

b. RIGHTS AND OBLIGATIONS: an asset or a liability pertains to the entity at a given date
c. OCCURRENCE: a transaction or an event took place which pertains to the entity during the period
d. COMPLETENESS: there are no unrecorded assets, liabilities, transactions or events, or undisclosed items
e. VALUATION: an asset or liability is recorded at an appropriate carrying value
f. MEASUREMENT: a transactions or event is recorded at the proper amount and revenue or expense is
allocated to the proper period
g. PRESENTATION and DISCLOSURE: an item is disclosed, classified and described in accordance with the
applicable financial reporting framework.

THREE (3) FUNDAMENTAL CONCEPTS IN CONDUCTING AND AUDIT

Materiality – recognizes that certain matters are clearly important to investors and other parties, while others
are less important. PSA 320 (RR), Materiality in Planning and Performing an Audit, requires the auditor to
assess materiality at both financial statement level and in relation to individual account balance, class of
transactions and disclosure.

Audit risk – is a function of the risk of material misstatement of the FS and the risk that the auditor will not
detect such misstatements. Thus to reduce audit risk, the auditor must assess the risk of material
misstatement and limit detection risk as well.
Detection risk – is the risk that an auditor’s substantive procedures will not detect a misstatement
that exists in an account balance or class of transactions that could be material, individually or when
aggregated with misstatements in other balances or classes.

Evidence - refers to the necessary information that an auditor gathers in order to form a credible opinion on
the assertions by the client’s management that are inherent in the FS.This evidence will therefore often
include information relating to the completeness, validity and accuracy of the recorded value of assets,
liabilities and equity if the client entity.

Misstatement represent the difference between what is reported and what is expected by the FRF or needed
for fair presentation of historical financial information.
This includes :
 Factual misstatements
 Judgmental misstatements
 Projected misstatements
The risk of material misstatement is an important concept for auditors as, for a given acceptable level of audit risk,
the greater the risk of material misstatement, the greater is both the quantity and quality of evidence that is
required to be gathered and evaluated by the auditor.

Misstatements in the FS can arise from either FRAUD or ERROR. What distinguishes them from each other is
whether the underlying action that results in the misstatement of the FS in intentional or unintentional.

The auditor response to the assessed risk of material misstatement at the overall FS level includes (a)
consideration of the knowledge, skill, and ability of personnel assigned significant engagement responsibilities,
including whether to involve experts, (b) the appropriate levels of supervision, and (c) whether there are events or
conditions that may cast significant doubt on the entity’s ability to continue as a going concern.

TYPES OF OPINIONS

1. Unqualified
2. Qualified
3. Adverse
4. Disclaimer

MODULE 1 – AUDITING AND ASSURANCE PRINCIPLES 4

 MASTERS TECHNOLOGICAL INSTITUTE OF
MINDANAO

EXCHANGE

1. What are the ethical principles governing the auditor’s professional responsibilities?

2. What are the inherent limitations in the conduct of audit?

3. What is audit risk and what should auditors do with these risks?

4. What are the different kind of misstatements?

5. Explain the key elements of the auditor’s standard report.

6. What are the types of opinions?And how do they differ?

EXAMINE

Self-check: To be announced.

MODULE 1 – AUDITING AND ASSURANCE PRINCIPLES 5