College of Accounting Education

3F Facundo Hall, Business and Engineering Building

Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

Introduction to Audit and Audit Standard Setting Process

References:
a. Preface to the International Standards and Philippine Standards
b. PSA 200 (Revised and Redrafted), Overall Objectives of the Independent Auditor and
the Conduct of an Audit in Accordance with Philippine Standards on Auditing

Auditing, defined
 An audit is a systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of
correspondence between these assertions and established criteria, and communicating
the results to interested users.
 Key Concepts from the Definition of Auditing
 An audit is a systematic process.
 An important element of auditing is objectivity (independence).
 An audit involves both an investigative and a reporting process.
 Investigative wherein an auditor evaluates evidence to ascertain the degree of
correspondence between economic assertions and established criteria.
 Reporting, because an audit involves communicating the results to interested
users through the audit report.

Distinctions
Audit vs. Assurance engagements
 Scope of service. Assurance engagements are broader than auditing. Assurance
engagements encompass assertion-based assurance engagements which encompass
audit engagements.

Audit vs. Accounting

 Accounting involves the process of recording financial transactions pertaining to an
entity and preparing the related financial statements while an audit involves examining
financial reports produced by an entity’s accounting system to ascertain those financial
statements conform with the established criteria.

Types of Audits
1. As to objective, criteria, and subject matter:
a. Financial statements audits.
b. Operational or performance audits. This type of audit can be divided into two
types:
i. Economy and efficiency (Management) audit – The appraisal of
management performance from the most efficient point of view, i.e.
cost-benefit analysis.
ii. Effectiveness (Program results) audit – The evaluation of programs,
projects, and activities to determine the extent of achievement of
previously set goals and objectives.
c. Compliance audits.
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

2. As to auditor:
a. External (Independent) audits – These are audits performed by CPAs who are
independent of the organizations whose assertions is the subject matter of the
audit. External auditors usually perform financial statement audits but may also
perform operational and compliance audits.
b. Internal audits – Internal auditing is an independent, objective assurance and
consulting activity designed to add value and improve an organization’s
operations. Internal auditors cannot achieve the same level of independence as
with external auditors because internal auditors are usually employed by the
entity they audit. However, organization independence by internal auditors can
be maximized when they have direct access to the audit committee or board of
directors of the entity. Internal audits mainly comprise operational and
compliance audits.
c. Governmental (State) audits – Government auditing involves the determination
of whether government funds are being handled properly and in compliance
with the applicable laws and regulations, and whether the government programs
of a particular agency are conducted effectively and efficiently. Governmental
auditors can perform financial statements audit, operational audit and
compliance audit.

Nature of Independent Financial Statements Audit

 Audit engagement of financial statements is a reasonable assurance engagement in
which a professional accountant in public practice expresses an opinion whether the
financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework, such as an engagement conducted in
accordance with PSAs.
 Financial statements audit is an assurance engagement as it enhances the degree of
confidence that intended users can place in the financial statements. Also, it is an
example of assertion-based assurance engagement since the financial statements are
assertions by management that these are fairly stated in all material respects.

Different types of audits as to their objective, subject matter and criteria:

Types Examples Objectives Subject Matter Criteria
Financial Annual audit of SMC Conducted to determine Financial Applicable financial
Statements financial statements whether the financial Statements reporting framework
Audit statements are stated in (GAAP)
accordance with specified
criteria.
Operation or Evaluate whether the Evaluates the efficiency and Operation of Company standards
Performance computerized payroll effectiveness of any part of an computerized for efficiency and
Audit system is operating organization’s operating payroll system effectiveness.
effectively and efficiently procedures and methods. At
the completion of an operation
audit, management normally
expects recommendations
from the auditor for improving
operations.
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

Compliance Determine whether bank Conducted to determine Bank loan Loan agreement
Audit requirements for loan whether the auditee is continuation provisions
continuation have been met following specific procedures, requirement
rules, or regulations set by
some higher authority.

Assertions in the Financial Statements

 Assertions are representation by management, explicit or otherwise, that are embodied
in the financial statements.
 The three categories of assertions are as follows:

a. Classes of transactions and events (COCAC)

1. Occurrence – transactions and events that have been recorded have occurred
and pertain to the entity.
2. Completeness – all transactions and events that should have been recorded have
been recorded.
3. Accuracy – amounts and other data relating to recorded transactions and events
have been recorded appropriately.
4. Cutoff – transactions and events have been recorded in the correct accounting
period.
5. Classification – transactions and events have been recorded in the proper
accounts.

b. Account balances (RCEV)

1. Existence – assets, liabilities, and equity interests exist.
2. Rights and obligations – the entity holds or controls the right to assets, and
liabilities are the obligations of the entity.
3. Completeness – all assets, liabilities and equity interests that should have been
recorded have been recorded.
4. Valuation and allocation – assets, liabilities, and equity interests are included in
the financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.

c. Presentation and disclosure (COCA)

1. Occurrence and rights and obligations – disclosed events, transactions, and
other matters have occurred and pertain to the entity.
2. Completeness – all disclosures that should have been included in the financial
statements have been included.
3. Classification and understandability – financial information is appropriately
presented and described, and disclosures are clearly expressed.
4. Accuracy and valuation – financial and other information are disclosed fairly
and at appropriate amounts.

Scope of Independent Financial Statements Audits

 The auditor shall exercise professional judgment in determining the scope of the audit
and consider the requirements of the relevant legislations, regulations, and professional
standards.
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

 Under PSA 200, the auditor’s opinion on the financial statements deals with whether
the financial statements are prepared, in all material respects, in accordance with the
applicable financial reporting framework. The auditor’s opinion therefore does not
assure, for example, the future viability of the entity nor the efficiency or effectiveness
with which management has conducted the affairs of the entity.

Demand for Independent Financial Statements Audit

 The need for independent financial statements audit arises from the importance of
reducing information risk. Users depend on reliable information in making important
decisions. Decisions made based on unreliable information could have adverse financial
consequences. Users, therefore, turn to the expertise of the auditor who provides an
unbiased opinion on the fair presentation of financial statements through the auditor’s
report.
 Causes of information risk are the following:
o Conflict of interest between management and users of financial statements
(potential bias)
o Remoteness between a user and the organization
o Voluminous data
o Complexity of the transactions, information, or processing systems

Theoretical Framework of Financial Statements Auditing

 Financial Statements audit, to be effective, should work based on the following basic
assumptions:
o Data to be audited can be verified
o Independence
o No long-term conflict between the auditor and the management
o Effective internal control system reduces risk of material misstatement of the
financial statements.
o Consistent application of GAAP results to fair presentation
o What was held true in the past will continue to hold true in the future in the
absence of known conditions to the contrary
o An audit benefits the public

The Auditor’s Overall Objectives – Obtaining Reasonable Assurance, Reducing Audit

Risk
 In the audit of financial statements, the overall objectives of the auditor are:
o To obtain reasonable assurance whether the financial statements are free from
material misstatements, whether due to fraud or error, to enable the auditor to
express an opinion on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting
framework (FRF); and
o To report on the financial statements and communicate as required by the
Philippine Standards on Auditing (PSAs), in accordance with the auditor’s
findings.
 Audit risk is the risk (or likelihood) that the auditor gives an inappropriate audit opinion
when the financial statements are materially misstated. It should be noted that audit risk
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

does not include risk that the auditor might express an opinion that the financial
statements are materially misstated when they are not. This risk is ordinarily
insignificant. Further, audit risk is a technical term related to the process of auditing; it
does not refer to the auditor’s business risks such as loss from litigation, adverse
publicity, or other events arising in connection with the audit of financial statements.
These other risks are called engagement risks.
 The audit is conducted to obtain reasonable assurance, which is a high, but not absolute,
level of assurance. The auditor cannot provide absolute assurance because of certain
inherent limitations of the audit. Therefore, there is always some audit risk in any audit
engagement.
 To achieve the above objectives, the auditor shall perform audit procedures to gather
sufficient appropriate audit evidence about assertions embodied in the financial
statements; and thereby, reduce audit risk to an acceptably low level that enables the
auditor to draw reasonable conclusions on which to base the auditor’s opinion.

Audit Risk Model

 Audit risk is a function of the risks of material misstatement and detection risk
(AR=ROMMxDR).
o Risk of material misstatement refers to the likelihood that the financial
statements are materially misstated prior to the audit. ROMM is the function of
Inherent Risk and Control Risk.
 Inherent Risk refers to the susceptibility of an assertion to a
misstatement, due to error or fraud, that could be material, individually
or in combination with other misstatements, before consideration of any
related controls.
 Control Risk is the risk that a misstatement due to error or fraud that
could occur in an assertion and that could be material, individually or
in combination with other misstatements, will not be prevented or
detected on a timely basis by the company’s internal control.
o Detection risk refers to the risk that the procedures being performed by the
auditor to reduce audit risk to an acceptably low level will not detect a
misstatement that exists and that could be material, either individually or when
aggregated with other misstatements.
 Therefore, risks of material misstatements are the function of the entity, its
environment, and its internal control, while detection risk is therefore the function of
the effectiveness of auditor’s audit procedures.
 In other words, audit risk may occur when the auditor expresses an inappropriate
opinion stating that the financial statements are fairly presented when in fact they are
not. This could occur when the financial statements are already materially misstated
even before the auditor begins the audit, and the auditor fails to detect these material
misstatements leading to the auditor to express inappropriate opinion. For this reason,
the auditor must focus on – as a risk-based audit approach – addressing these risks of
material misstatement of the financial statements to effectively conduct the audit and
avoid audit risk from occurrence.
 For a given level of audit risk, the acceptable level of detection risk bears an inverse
relationship to the assessed level of risk of material misstatement. The higher the
assessed level of risk of material misstatement, the lower the detection risk the auditor
sets, and vice versa.
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

 Therefore, from the given relationship above, detection risk cannot be set to zero (given
that there is always risk of material misstatement).

AASC Pronouncement
 The Auditing and Assurance Standards Council’s (AASC’s) mission is “the
promulgation of auditing standards, practices and procedures which shall be generally
accepted by the accounting profession in the Philippines”.
 The AASC replaced the Auditing Standards and Practices Council (ASPC), which was
established by the PICPA and ACPAPP.
 It has 15 regular members coming from the following in accordance with IRR of RA
9298 or the Philippine Accountancy Act of 2004:
No. of Members
Chairman 1
Board of Accountancy 1
Securities and Exchange Commission 1
Bangko Sentral ng Pilipinas 1
Commission on Audit 1
Association of CPAs in Public Practice 1
PICPA
Public Practice 6
Commerce and Industry 1
Academe/Education 1
Government 1
TOTAL 15

 However, per PRC BOA Resolution No. 22 Series of 2020, the BOA unanimously
agreed that the membership in the AASC be increased from fifteen (15) to eighteen (18)
to include two (2) representatives from the Small and Medium Sized Practitioners, a
representative from the Insurance Commission, and remove the representative from
government. The PRC BOA Resolution was dated July 1, 2020 and was published in
official gazette on July 9, 2020. Hence, the updated structure of the AASC is as follows:
No. of Members
Chairman 1
Board of Accountancy 1
Securities and Exchange Commission 1
Bangko Sentral ng Pilipinas 1
Insurance Commission 1
Commission on Audit 1
Association of CPAs in Public Practice 1
PICPA
Public Practice 9
Commerce and Industry 1
Academe/Education 1
TOTAL 18
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

 The AASC pronouncements are listed below together with the particular engagements
they are applicable to:
Philippine Standards Practice Statements Applicable to:
Engagement Standards:
Philippine Standards on Philippine Auditing Practice Audit of Historical Financial
Auditing (PSAs) Statements (PAPSs) Information
Philippine Standards on Philippine Review Review of Historical Financial
Review Engagements Engagement Practice Information
(PSREs) Statements (PREPSs)
Philippine Standards on Philippine Assurance Assurance Engagements
Assurance Engagements Engagement Practice dealing with subject matters
(PSAEs) Statements (PREPSs) other than Historical Financial
Information
Philippine Standards on Quality All services covered by
Controls (PSQCs) Engagement Standards above

AUDITS OF HISTORICAL FINANCIAL INFORMATION

200-299 General Principles and Responsibilities

 PSA 200 – Overall Objectives of the Independent Auditor and Conduct of an Audit in
Accordance with PSA
 PSA 210 – Agreeing the Terms of Audit Engagements
 PSA 220 – Quality Control for an Audit of Financial Statements
 PSA 230 – Audit Documentation
 PSA 240 – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements
 PSA 250 – Consideration of Laws and Regulations in an Audit of Financial Statements
 PSA 260 – Communication with Those Charged with Governance
 PSA 265 – Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management

300-499 Risk Assessment and Response to Assessed Risks

 PSA 300 – Planning an Audit of Financial Statements
 PSA 315 (Revised) – Identifying and Assessing the Risks of Material Misstatement
 PSA 320 – Materiality in Planning and Performing an Audit
 PSA 330 – The Auditor’s Responses to Assessed Risks
 PSA 402 – Audit Consideration Relating to an Entity using a Service Organization
 PSA 450 – Evaluation of Misstatements Identified during the Audit

500-599 Audit Evidence

 PSA 500 – Audit Evidence
 PSA 501 – Audit Evidence – Specific Consideration for Selected Items
 PSA 505 – External Confirmations
 PSA 510 – Initial Audit Engagement – Opening Balances
 PSA 520 – Analytical Procedures
 PSA 530 – Audit Sampling
 College of Accounting Education
3F Facundo Hall, Business and Engineering Building
Matina Campus, Davao City
Telefax: (082)305-5456
Phone No.: (082)300-5456 Local 137

 PSA 540 – Auditing Accounting Estimates, Including Fair Value Accounting

Estimates, and Related Disclosures
 PSA 550 – Related Parties
 PSA 560 – Subsequent Events
 PSA 570 – Going Concern
 PSA 580 – Written Representations

600-699 Using the Work of Others

 PSA 600 – Special Consideration – Audits of Group Financial Statements (Including
the Work of Component Auditors)
 PSA 610 – Using the Work of Internal Auditors
 PSA 620 – Using the Work of an Auditor’s Expert

700-799 Audit Conclusions and Reporting

 PSA 700 – Forming an Opinion and Reporting on Financial Statements
 PSA 701 – Communicating Key Audit Matters in the Independent Auditor’s Report
 PSA 705 – Modifications to the Opinion in the Independent Auditor’s Report
 PSA 706 – Emphasis of Matter Paragraphs and Other Matter Paragraphs in the
Independent Auditor’s Report
 PSA 710 – Comparative Information – Corresponding Figures and Comparative
Financial Statements
 PSA 720 – The Auditor’s Responsibilities Relating to Other Information in Documents
Containing Audited Financial Statements

800-899 Specialized Areas

 PSA 800 – Special Considerations – Audits of Financial Statements Prepared in
Accordance with Special Purpose Frameworks
 PSA 805 – Special Considerations – Audits of Single Financial Statements and Specific
Elements, Accounts or Items of a Financial Statement
 PSA 810 – Engagements to Report on Summary Financial Statements