CHAPTER 4 |

THE AUDIT
PROCESS-
Accepting an
Engagement
An audit financial statement generally begins with
the Financial Statements prepared by the entity’s
management.

Figure 4.1 General Approach When Auditing FS

Financial Statement Assertions

Existence or Occurrence
Rights and obligations
Financial
Completeness Audit Procedure
statements
Valuation and allocation

Presentation and disclosure Audit Evidence

Audit Opinion
Financial Statement
assertions
Management is responsible for the fair presentation of the
financial statements that reflect the nature and operations of the
entity. In representing that the financial statements in accordance
with the applicable financial reporting framework, management
implicitly or explicitly makes assertions regarding the recognition,
measurement, presentation and disclosure of the various
elements of financial statements and related disclosure.

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Assertions about classes of
transactions and events for the
period under audit.
 Occurrence
 Completeness
 Accuracy
 Cutoff
 Classification

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Assertions about account balances at
the period.
 Existence
 Rights and obligations
 Completeness
 Valuation and allocation
 Occurrence and rights and obligations
 Accuracy and valuation

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Audit Procedures
The auditor should use assertions for classes of transactions, account
balances, and presentation disclosures in sufficient detail to form a
basic for the assessment of risks of material misstatement and the
design and performance of further audit procedures.

Selection of the appropriate procedures to satisfy a particular

assertion is affected by a number of factors including the auditor’s
assessment of materiality and risk. Regardless of the procedures
selected, there is only one basic criterion. The procedure selected
should enable the auditor to gather sufficient appropriate
evidence about a particular assertion.
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Some of the audit procedures used by the
auditor to gather sufficient appropriate
evidence include:
 Inspection
 Observation
 Inquiry
 Confirmation
 Computation
 Analytical procedures

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Evidence
-Audit procedure are the means used by the auditor to obtain sufficient
appropriate evidence.
-audit opinion is based Audit evidence, the information obtained by the
auditor.
-This evidence will either prove or disprove the validity of management
assertions.
-At the conclusion, the auditor should carefully evaluate the audit
evidence obtained in order to come up with an appropriate opinion.

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 Overview of the audit process
The audit process is the sequence of different activities

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involved in an audit. The emphasis and order of certain activities
may vary depending upon a particular audit, but basically this
process should include the following audit activities:

Figure 4.2- The Audit Process

Issuing a Report

Completing the Audit

Performing Substantive
Test

Considering Internal
Control

Audit Planning
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Accepting an
Engagement
Accepting an Engagement
In making this decision, the firm should consider…

1) Its competence,
2) Its independence,
3) Its ability to serve the client properly,
4) The integrity of the prospective client’s
management, and
5) Adequacy of accounting records.
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 Competence

▪ Necessary skills and competence to handle the

engagement
▪ Professional accountants should not portray
themselves as having expertise which they do
not possessed

Competence is acquired through a combination of

education, training and experience. 1
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 Independence

Essentially to the credibility of the auditor’s

report is the concept of independence.
Before accepting an audit engagement, the
auditor should consider whether there are
any threats to the audit team’s
independence and objectivity and, if so,
whether adequate safeguards can be
established. 1
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 Ability to serve the client
properly
• An engagement should not be accepted if there
are no enough qualified personnel to perform the
audit.
• PSA 220 suggests that audit work should be
assigned to personnel who have the appropriate
capabilities, competence and time to perform the
audit engagement in accordance with
professional standards.
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Integrity of management
The firm’s task as PSA 220 requires would involve:

•Making inquiries of appropriate parties in the business

community.
•Communication with the predecessor auditor

 It is not only a matter of courtesy to the predecessor

auditor, this communication allows the incoming auditor to
obtain information about the clients what will be useful in
determining whether the engagement will be accepted. 1
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Once permission of the client is obtained, the incoming
auditor include questions regarding:

 The predecessor auditor’s understanding as to the

reasons for the change of auditors.
 Any disagreement between the predecessor auditor and
the client’s management.
 Any facts that might have a bearing on the integrity of
prospective client’s management.
The Code of Ethics requires the predecessor auditor to
respond fully to the incoming auditor’s inquiry and advise the
incoming auditor’s if there are any professional reasons why 2
the engagement should not be accepted. 3
 Adequacy of Accounting
Records
▪ Since audit of FS is performed on the
assumption that the financial statements
are verifiable, the client’s accounting
records and documents supporting the
amounts and disclosures in the FS, must be
adequate enough to permit examination of
the accounts.
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Retention of Existing
Clients
Clients should be evaluated at least once a
year or upon occurrence of major events
such as changes in management, directors,
ownership, nature of client’s business, or
other changes that may affect the scope of
the examination.
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 Engagement letter
This serves as the written contract between the auditor and the client. This
letter sets forth:

 The objective of the audit of financial statements which is to express an

opinion on the financial statements.
 The management’s responsibility for the fair presentation of the financial
statements
 The scope of an audit
 The forms or any reports or other communication that the auditor expects
to issue.
 The fact that because of the limitations of the audit, there is an unavoidable
risk that material misstatement may remain undiscovered.
 Client’s responsibility to allow auditor to have unrestricted access to
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whatever records, documentations and other information requested in the 8
connection with the audit.
The auditor may also include
items such as…
 Billing arrangements
 Expectations of receiving
management representation
letter
 Arrangements concerning the
involvement of others (experts,
other auditors, internal auditors
and other client personnel)
 Request for the client to
confirm the terms of the
engagement 1
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 Importance of the
engagement letter

 Avoid misunderstandings with respect to the

engagement.
 Document and confirm the auditor's acceptance of
appointment.

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Audit Planning
Auditor obtains more detailed knowledge about the
client’s business and industry in order to;
• understand the transactions and events affecting the
financial statements, and
• to identify potential problem that might be encountered
during the audit.

A preliminary assessment of risk and

materiality should also be made to be able to:

• developed an overall audit strategy and a detailed 1

approach for the expected conduct and scope of the 1

examination.
Considering the
Internal Control
The auditor should give adequate consideration to
the entity’s internal control because the condition of
the entity’s internal control directly affects the
reliability of the financial statements.

The stronger the internal control, the more

assurance it provides about the reliability of
accounting data and financial statements.

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Considering the
Internal Control
Consideration of internal control involves;

• Obtaining understanding of the entity’s control

systems and,

• Assessing the level of control risk- that is, the

risk that the client’s internal control may not
prevent or detect material misstatements in the
financial statements.

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Performing
Substantive Test
• The auditor performs substantive tests to determine whether
the entity’s financial statements are presented fairly in
accordance with financial reporting standards.

• These procedures would involve examination of the

documents and evidence supporting the amounts and
disclosure in the financial statements.

• The extent of the substantive tests is highly dependent on the

results of the auditor’s consideration of internal control.

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Completing the Audit
After the auditor has completed testing the account balances, the
auditor performs additional audit procedures to complete the audit
and become satisfied that the evidence gathered is consistent with the
auditor’s report. These procedures include;

• review of subsequent events and contingencies,

• assessing the going concern assumption,
• performing overall analytical review procedures, and
• obtaining written representations from the client’s management

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Issuing a Report
On the basis of audit evidence gathered and evaluated, the
auditor forms a conclusion 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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