AUDIT THEORY (author)

CHAPTER 1 AUDIT – An Overview

 The need of various users for more reliable financial information has created a demand
for an independent audit of financial statements.
 The primary function of an independent audit is to lend credibility to financial
statements of an entity.
 “Auditing enables the auditor to express an opinion whether the financial statements
are prepared, in all material aspects, in accordance with the applicable financial
reporting framework.” PSA 200 on audit’s goal
 “An audit is a systematic process of objectivity obtaining and evaluating (suriin)
evidence regarding assertions (pahayag) about economic actions and events to
ascertain (alamin) the degree of correspondence (in accordance) between these
assertions and established criteria and communicating the results to interested users.”
American Accounting Association
 Assertions are representations made by an auditee about economic actions and events.
It is the auditor’s objective to determine whether these assertions are valid
 The timely communication of audit findings is the ultimate objective of any audit.

TYPES OF AUDIT
1. Financial Statement Audit
- To determine whether the financial statements of an entity are fairly presented
in accordance with applicable financial reporting framework.
2. Compliance Audit
- Involves a review of an organization’s procedures to determine whether the
organization has adhered (complied with) to specific procedures, rule or
regulations. A common example of this type of audit is the examination by BIR
examiners.
3. Operational Audit
- A study of a specific unit of an organization for the purpose of measuring its
performance; to assess entity’s performance, identify areas for improvements
and make recommendations to improve performance. Also known as
performance audit, management audit.

 All types of audit are systematic examinations and evaluation of evidence which are
undertaken to ascertain whether assertions comply with established criteria and
communication of the results of the audit is usually in written form or report.

TYPES OF AUDITORS
1. External Auditor
- Independent CPAs who offer their professional services to different clients on a
contractual basis. They generally conduct financial statement audits sino
nagbabayad sa mga external auditors?
2. Internal Auditor
- Entity’s own employees who investigate and appraise the effectiveness and
efficiency of operations and internal controls. They usually perform operational
audits. Are they also CPAs or pwedeng BSA graduate muna?
3. Government Auditor
- Government employees whose main concern is to determine whether persons
or entities comply with government laws and regulations. They usually conduct
compliance audits.

 The purpose of independent financial statement audit is to enhance the degree of

confidence of intended users in the financial statements. The auditor’s opinion is
formed in accordance with PSAs and relevant ethical requirements.
 Management have the responsibility for the preparation and presentation of financial
statements that includes the design, implementation, and maintenance of internal
control
 PSA. Philippine Standards on Auditing
 PSA is designed to provide only reasonable assurance (not absolute assurance) that
the financial statement taken as a whole are free from material misstatements.
 There are inherent limitations of audit that affect the auditor’s ability to detect material
misstatements. These limitations result from such factors as:
1. The use of testing/ Sampling risk

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AUDIT THEORY (author)

- Auditors do not examine all evidence available. Conclusions from taken sample
may be different from the conclusion that would have been made if the auditor
examines the entire population.
2. Error in application of judgment/ Non-sampling risk
- Human weaknesses can cause auditors to commit mistakes in the application of
audit procedures and evaluation of evidence.
3. Reliance on management’s representation
- For example, it is difficult for the auditor to determine the proper valuation of
accounts receivable without the management’s honest assessment. If the
management lacks integrity, management may provide the auditor with false
representations causing the auditor to rely on unreliable evidence.
4. Inherent limitations of the client’s accounting and internal control systems
- Such procedures perform by auditors may not be effective in detecting
misstatements resulting from the collusion (sabwatan) among employees or
management’s circumvention (pandaraya) of internal control.
5. Nature of evidence
- Audit evidence is generally persuasive (mapanghikayat) rather than conclusive
(kapani-paniwala) in nature. Evidence obtained by the auditor does not consist
of “hard facts” which prove or disprove the accuracy of the financial statements
 Because of these limitations, the subsequent discovery of a material misstatement of
the financial statements does not in itself indicate a failure to conduct an audit in
accordance with PSAs.
 PSA 200 provides the following guidelines when auditing financial statements:
1. The auditor should comply with relevant ethical requirements including auditor’s
independence.
2. The auditor should conduct an audit in accordance with PSA.
3. The auditor should exercise professional judgment in planning and performing an
audit of financial statements.
4. The auditor should obtain sufficient appropriate audit evidence
5. The auditor should plan and perform the audit with an attitude of professional
skepticism.
 Why is it necessary to conduct an independent financial statement audit?
1. Conflict of interest. Management could manipulate financial statements in which
may be viewed as the report by the management as to how the entity performed
under their direction and supervision.
2. Expertise. The complexity of accounting and auditing requires expertise in verifying
the quality of the financial information.
3. Remoteness. Most of the users do not have access to the entity’s records to
personally verify the reliability of the financial statements.
4. Financial consequences. Misleading financial information could have substantial
economic consequences for a decision maker
 Theoretical framework of Auditing
- Below are selected postulates, assumptions or ideas that support many auditing
concepts and standards.
1. All financial data are verifiable. No supporting document or evidence, no
audit to perform.
2. The auditor should always maintain independence. Credibility follows
independence.
3. No long-term conflict between the auditor and the client management. Both
must be interested in the fair presentation of the financial statements.
4. Effective internal control system reduces errors and fraud. The stronger the
internal control, the more reliable the financial data
5. Consistent compliance results in fair representation. The criteria are usually
PFRS or PFRS for SMEs
6. What was held true in the past will continue to hold true in the future.
Previous procedures can be used.
7. An audit benefits the public. Wide range of users are the primary beneficiary
of financial statement audit.