By: DAVE RITZ J.

PERIA, CPA

Financial Statements (including footnotes)

Persons who rely on the financial reports

Creditors Investors

Auditing is a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria GAAP and communicating the results to Auditor's Report/ interested users.
Other Reports

 Financial

Statement Audit - conducted to determine whether the FS of an entity is presented in accordance with an identified financial framework Operational Audit - is a study of an organizations unit to assess entitys performance, identify areas of improvement and make recommendations to improve performance Compliance Audit - involves a review of an organizations procedures to determine its compliance to specific procedures, rules or regulations

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 and appraise the effectiveness and efficiency of operations and internal controls Government Auditors

-conduct compliance audit like COA Auditors BIR Examiners

 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.

Financial Statement Assertions

EXISTENCE or OCCURRENCE RIGHTS and OBLIGATIONS COMPLETENESS VALAUATION and ALLOCATION PRESENTATION and DISCLOSURE AUDIT PROCEDURE S

Financial Statements

AUDIT EVIDENCE

AUDIT OPINION

 Management

is responsible in the fair presentation of FS In representing that the financial statements are in accordance with applicable financial reporting framework, management IMPLICITLY or EXPLICITLY makes assertions regarding the recognition, measurement, presentation and disclosure of the FS elements and related disclosures

1.

2. 3.

Assertions about CLASSES OF TRANSACTIONS AND EVENTS for the period under audit Assertions about ACCOUNT BALANCES at the period end Assertions about PRESENTATION AND DISCLOSURE

Completeness all transactions and events that should have been recorded have been recorded Occurrence transactions and events that have been 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 been recorded appropriately Classification transactions and events have been recorded in the proper accounts

Completeness all assets, liabilities and equity interests that should have been recorded have been recorded Existence assets, liabilities and equity interests exist Rights and Obligations the entity holds or controls the rights to assets, and liabilities are the obligations of the entity 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

 Occurrence

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

 The

auditor should select audit procedures that enables 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 contained in the accounting records Computation consists of checking the arithmetical accuracy of source documents and accounting records or performing independent calculations Analytical Procedures - consist of the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predicted amounts

refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. comprises source documents and accounting records underlying the FS and corroborating information from other sources it will either prove or disprove the validity of management assertions

 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

 The

auditors responsibility is to form and express an opinion on the financial statements.

 The

auditor should comply with the Code of Professional Ethics The auditor should conduct an audit in accordance with Philippine Standards on Auditing The auditor should adopt the attitude of professional skepticism

Professional skepticism is an auditors tendency not to believe managements assertions without sufficient corroboration.

 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

 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

AUDITORS RESPONSIBILITY TO CONSIDER FRAUD, ERROR AND NONCOMPLIANCE

Philippine Standards on Auditing 240 and 250

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 or commission by the entity being audited, either intentional or unintentional, which are contrary to the prevailing laws or regulations.

1. FRAUDULENT FINANCIAL REPORTING or MANAGEMENT FRAUD 2. MISAPPROPRIATION OF ASSETS or EMPLOYEE FRAUD

FRAUDULENT FINANCIAL REPORTING or MANAGEMENT FRAUD

- involves intentional misstatements or omissions of amounts or disclosures in the financial statements to deceive financial statement users. This may involve: a. Manipulation, falsification or alteration of records or documents b. Misrepresentation in or intentional omission of the effects of transactions from records or documents c. Recording of transactions without substance d. Intentional misapplication of accounting policies

MISAPPROPRIATION OF ASSETS or EMPLOYEE FRAUD

Involves

theft of an entitys assets committed by the entitys employees. This may include: a. Embezzling of Receipts b. Stealing entitys assets cash, marketable securities and inventory c. Lapping of accounts receivable
-this type of fraud accompanied by false or misleading records or documents in order to conceal the fact that the assets are missing

 Involves

MOTIVATION to commit it and PERCEIVED OPPORTUNITY to do so.

When planning and performing audit procedures and in evaluating and reporting the results thereof, the auditor should recognize that fraud, error and noncompliance with laws and regulations may materially affect the financial statements.

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 appropriate controls are in place.

The auditors responsibility is to design the audit to obtain reasonable assurance that the financial statements are free from MATERIAL misstatements, whether caused by error, fraud or noncompliance.

 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.

CONDUCTING AN AUDIT OF FINANCIAL STATEMENTS

ISSUE REPORT COMPLETING THE AUDIT SUBSTANTIVE PROCEDURES INTERNAL CONTROL CONSIDERATION AUDIT PLANNING

PRE-ENGAGEMENT PROCEDURES

1.

Evaluate compliance with ethical requirements (PSA 220)

Evaluate continuance of relationship with existing clients (PSA 220) Establish the terms of the engagement (PSA 210)

2.

3.

Client selection and retention Communication between predecessor and successor auditors Engagement letters Staff assignment Time budget

 In

making decisions whether to accept or reject an audit engagement, the firm should consider: 1. Its competence 2. Its independence 3. Its ability to serve the client properly 4. The integrity of the prospective clients management

This serves as the written contract between the auditor and the client. This sets forth: a. Objective of the audit of FS b. Management responsibility c. Scope of the audit d. Forms or any reports or other communication that the auditor expects to issue e. Limitations of the audit f. Responsibility of the client to allow the auditor have unrestricted access to whatever information in connection with the audit

In addition, the auditor may also include the following items: a. Billing arrangements b. Expectations of receiving management 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

Helps ensure that appropriate attention is devoted to important areas of the audit Helps identify potential problems Assists in proper assignment and coordination of audit work Helps ensure that the audit is conducted effectively and efficiently

Understand the entity and its environment including the entitys internal control Develop an overall audit strategy and detailed approach (Risk, Materiality and Analytical Procedures) Audit Planning Documentation.

1.

2. 3. 4. 5.

Industry, regulatory and other external factors, including the applicable financial reporting framework Nature of the entity, including the selection and application of accounting policies Objectives and strategies and the related business risks Measurement and review of the entitys performance Internal control

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

More Efficient

More Effective Substantive Testing

Substantive Testing of Controls Testing

Interim

Year-end

Audit risk (AR) is the risk (likelihood) that the auditor may unknowingly fail to modify the opinion on financial statements that are materially misstated (e.g., an unqualified opinion 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

Internal Controls
Events,
Transactions

Accounting Information System

Substantive Procedures

Financial Statements

INHERENT RISK The likelihood that, in the absence of internal controls, an error or fraud will enter the accounting information system

CONTROL RISK The likelihood that an error or fraud will not get caught by the clients internal controls.

DETECTION RISK The likelihood that an error or fraud will not be caught by the auditors procedures.

AUDIT RISK The likelihood that an error or fraud will occur, and not get caught by either the internal controls or auditors procedures.

 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

AR = IR x CR x DR

Detection Risk and the Nature, Timing, and Extent of Audit Procedures
Lower Detection Risk Higher Detection Risk

Nature
Timing

More effective tests.

Testing performed at year-end. More tests.

Less effective tests.

Testing can be performed at Interim. Fewer tests.

Extent

Audit evidence is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based.

1.
2.

Source documents and accounting records underlying the financial statements. Other corroborating information

 Sufficiency

is the measure of the quantity of audit evidence. Appropriateness is the measure of the quality of audit evidence.

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

Appropriate evidence Must be relevant to a particular assertion; and Must be reliable

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

 Review

of subsequent events and contingencies Assessing going concern assumption Performing overall analytical review procedures Obtaining a written representations from the management

 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

Auditors Report on Financial Statements

Unmodified Report

Modifications to the Opinion

Emphasis of Matter & Other Matter Paragraphs

 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.

 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?

 Accounting

Policies

Are the policies adequately disclosed? Are the policies consistent with the financial reporting framework, and appropriate in the circumstances?

Financial

Statements Disclosure Fair Presentation Frameworks Compliance Frameworks

 Most

common type of audit report Issued when the auditor concludes, based on audit evidence obtained, that the financial statements are presented fairly, in all material respects in accordance with the applicable financial reporting framework Acceptable framework includes:

International Financial Reporting Standard for Small and Medium-sized entities International Financial Reporting Standards International Public Sector Accounting Standards

1. 2.

3.

Title should clearly indicate that it is the report of an independent auditor Addressee the parties for whom the report is prepared, i.e. shareholders, board of directors or a third party requesting the audit Introductory paragraph should contain the ff.: Name of the entity whose financial statements have been audited Statement that the financial statements have been audited Title of each financial statement audited including date and period covered Reference to the summary of significant accounting policies and explanatory notes

4.

Managements 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 Responsibility of the auditor to express an opinion The audit was conducted in accordance with Philippine Standards on Auditing (PSAs) General description of an audit That the audit evidence obtained is sufficient and appropriate

5.

Auditors responsibility should state the ff.:

6.

7. 8. 9. 10.

Auditors opinion should state that the financial statements are presented fairly in all material respects in accordance with applicable financial reporting framework Other reporting responsibilities Auditors signature signed in the name of the audit firm and/or the personal name of the auditor Date of the report dated as of completion of all essential audit procedures (last day of fieldwork) Auditors address where the auditor maintains his office

Arises from either of the ff.: Failure to conduct the audit in accordance with PSA; and Failure to prepare the financial statements in accordance with the applicable financial reporting framework

 Material

Misstatements

May arise from:

Inappropriate accounting policy selected; Misapplication of selected accounting policy; or Inappropriate or inadequate disclosure

If there is a material misstatement the auditor should:

Insist that the client revise the financial statements; or Issue either a qualified or adverse opinion should the management refuse to correct the misstatement

 Scope

Limitation

May arise when:

The auditor is unable to perform necessary audit procedures; or The auditor is unable to obtain sufficient appropriate evidence about 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

CHAPTER CONTENT:

Guidance on how to express an appropriately modified opinion on financial statements when necessary.

FS are not free from material statement The auditor is unable to obtain sufficient appropriate evidence

Pervasive effects on the financial statements that in the auditors judgment: i. Are not confined to specific elements, accounts or items of the FS ii. If so confined, represent or could represent substantial proportion of the FS iii. In relation to disclosures, are fundamental to users understanding of the FS

i.

ii.

A difference between the amount, classification, presentation, or disclosure of a reported FS item and the amount , classification, presentation or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Can arise from fraud or error

i.

Misstatements that the auditor has accumulated during the audit and that have not been corrected.

i.
ii. iii.

A qualified opinion An adverse opinion A disclaimer of opinion

FS are not free from material statement The auditor is unable to obtain sufficient appropriate evidence

1st
Obtained

sufficient appropriate audit evidence Misstatements, individually or in aggregate are material Misstatements are not pervasive to FS
2nd
Unable

to

obtain

sufficient

appropriate

evidence Possible effects on the FS of undetected misstatements, if any could be material but not pervasive

Obtained sufficient appropriate audit evidence Concludes that there is misstatements, individually or in aggregate Misstatements are both material and pervasive to FS

unable to obtain sufficient appropriate evidence on which to base the opinion the possible effects on the FS of undetected misstatements, if any, could be both material and pervasive

MODIFICATION TO THE OPINION

Material Misstatements

Scope Limitations

Material but not Pervasive

Material and Pervasive

Material but not Pervasive

Material and Pervasive

Qualified Opinion

Adverse Opinion

Qualified Opinion

Disclaimer Of Opinion

Except for the effects (or the possible effects) of the matter described in the basis for Qualified Opinion paragraph.

In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion Paragraph the FS do not present fairly

Because of the significance of the matter describes in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express and opinion on the FS.

Significant Uncertainties
Going Concern Early Application Of New Accounting Standards Major Catastrophe

Adequately disclosed in the notes to financial statements

Unmodified opinion with emphasis of matter paragraph

_END_