INITIATING ACTIVITY

Financial statements are the end product of the accounting process. It includes the statement of
financial position, statement of financial performance (or statement of comprehensive income),
statement of cash flows. Statement of changes in equity and accompanying notes.

Financial information provided by financial statements is a crucial factor in the decision making
process, especially by the external users of financial information. Since these users are external
to the entity preparing financial statements, they lack control on the reliability of the information
provided.

How would these external users reduce this unreliability or bias by the prepares of financial
information?

Discussion:

Auditing defined

Auditing is “a systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of correspondence
between those assertions and established criteria and communicating the results to the
interested users.”

Two processes of auditing:

a. Investigative process – involves the systematic gathering and evaluation of evidence

as a basis for determining whether assertions made by responsible person correspond
with the established criteria

b. Reporting process – involves communicating the audit opinion to interested users

Important Concepts:

1. Systematic process – auditing involves structured/logical series of sequential steps or

procedures known as the audit process

2. Objectively obtaining and evaluating evidence – auditing involves gathering and evaluating
sufficient appropriate audit evidence that will support the auditor’s opinion

• Objectivity refers to the combination of impartiality, intellectual honesty and freedom

from conflicts of interest.

• Audit evidence is the information obtained by the auditor in arriving at the conclusions
on which the audit opinion is based.
3. Assertions about economic actions and events – assertions are the subject matter of auditing

• In the context of audit of financial statements, assertions are representations of

management, explicit or otherwise, that are embodied in the financial statements.
Assertions include the accounts, balances/amounts and disclosures appearing on the
face of the financial statements (and in the notes to financial statements) and which
the management claims to be free of misstatements.

• Audit evidence gathered and evaluated by the auditor may support or contradict the
assertions of management.

4. Established criteria – the standards or benchmarks that are needed to judge the validity of the
assertions on the financial statements

• In the context of audit of financial statements, the established criteria are the applicable
financial reporting framework (for example, the PFRS).

5. Ascertain the degree of correspondence between assertions and established criteria – The
auditor’s objective is to determine whether the assertions conform with established criteria,
that is, whether the financial statements are prepared, in all material respects, in accordance
with the applicable financial reporting framework (such as the PFRS).

6. Communicating the results to the interested users – The ultimate objective of audit is the
communication of audit findings/opinion on the fairness of the financial statements to
interested users.

• Communicating results is achieved through issuance of a written audit report which

contains the audit opinion (or disclaimer of opinion).

Interested users are the wide variety of financial statements users who rely on the auditor’s
opinion such as the stockholders, creditors, potential investors and creditors, management,
government agencies, and the public (in general).

There are different types of audit. But the most common type of audit is a financial statement
audit. Financial statement audit is an audit conducted to determine whether the financial
statements of an entity are fairly presented in accordance with an identified financial reporting
framework (or PFRS)

Purpose of Financial Statement Audit

The primary economic reason for an audit of financial statements is the demand by external users
for reliable or fairly stated financial statements that they will use in making economic decisions.
Thus, the market for auditing services is driven by demand by external financial statements users.

An audit can help reduce information risk, that is, the risk that the financial statements that will be
used for decision-making are materially misleading, unreliable or inaccurate.
The purpose of an audit is to enhance the degree of confidence of intended users in the financial
statements. Such purpose is achieved by the expression of an opinion by the auditor on whether
the financial statements are prepared, in all material respects, in accordance with an applicable
financial reporting framework.

Management’s Assertions on the Financial Statements

Financial statements are a structured representation of historical financial information (including

related notes which comprise a summary of significant accounting policies and other explanatory
information), intended to communicate an entity’s economic resources or obligations at a point in
time or the changes therein for a period of time in accordance with a financial reporting framework.

Assertions are representations of management, explicit or otherwise, that are embodied in the
financial statements. Assertions include the accounts, balances/amounts and disclosures
appearing on the face of the financial statements (and in the notes to financial statements) and
which the management claims to be free of misstatements.

Financial statements are primarily the responsibility of the entity’s management who makes the
following assertions:

• existence or occurrence of transactions that result to reported assets, liabilities and

equity at the reporting date and income and expenses for the reporting period.
• completeness of information presented in the financial statements that are the results the
transactions and other events that actually occurred during the reporting period.
• rights or control over all reported assets, and obligations for reported liabilities at the
reporting period
• appropriate use of measurement bases for assets, liabilities, and equity and recognition
of income and expenses in accordance with the revenue and expense recognition
principles applicable; and
• appropriate presentation and disclosure of all financial statement components and
accompanying notes to the financial statements to the effect that the substance and not
merely the legal form of the recorded transactions is communicated to the users.

The Audit Process

The audit process starts when a reporting entity engages the services of an independent auditor
for an independent examination of its financial statements and concludes when an auditor issues
an audit opinion based on the assessment of the evidence gathered in the course of the conduct
of audit procedures and assessment of evidence gathered therefrom.

The following are the major phases in a financial statement audit:

a. pre-engagement activities
b. audit planning and evaluation of internal control
c. evidence gathering
d. reporting
Preliminary engagement activities assist the auditor in identifying and evaluating events or
circumstances that may adversely affect the auditor’s ability to plan and perform the audit
engagement. Such activities help ensure that:

a. There are no issues with client management’s integrity that may affect the willingness to
continue the engagement
b. The auditor maintains the necessary independence and ability to perform the engagement
c. There is no misunderstanding with the client as to the terms of the engagement

Audit planning involves establishing the overall audit strategy for the engagement and developing
an audit plan, in order to reduce audit risk to an acceptably low level so that the audit will be
performed in an effective manner. It includes the following tasks:

1. obtaining and understanding of the client, its business, industry and accounting policies;
2. obtaining an understanding of the client’s internal control system;
3. assessing materiality and audit risk;
4. identifying audit objectives;
5. determining whether reliance can be placed on certain controls in the system;
6. determining the nature, extent and timing of substantive tests to be performed; and
7. designing and finalizing the audit program

Most of the auditor's work in forming the auditor's opinion consists of obtaining and evaluating
audit evidence. The auditor shall conclude whether sufficient appropriate audit evidence has
been obtained based on his professional judgment.

• Audit evidence refers to all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based. Thus, audit evidence supports the
opinion and the auditor's report.

• Sometimes called as evidential matter, it is the main output/product of performing audit

procedures.

Audit Evidence Relationship with Assertions: Audit evidence comprises both:

a. Information that supports and corroborates management's assertions, and

b. Information that contradicts such assertions.

Audit Opinion and Audit Report:

Audit opinion:

• In a financial statement audit, the auditor obtains sufficient appropriate audit evidence to be
able to draw conclusions on which to base that opinion. The auditor’s opinion is on the fairness
of the audited financial statements.

• The auditor's opinion helps establish the credibility of the financial statements.
Auditor’s report:

• the primary product of an audit engagement

• the end product of the audit process

• a written report that contains auditor’s opinion about the fairness of the FS

• the medium through which the auditor communicates the results of his or her work

Audit documentation

The auditor should prepare, on a timely basis, audit documentation that provides:

a. A sufficient and appropriate record of the basis for the auditor’s report; and

b. Evidence that the audit was performed in accordance with PSAs and applicable legal and
regulatory requirements.

Audit documentation:

• It refers to the documentation of audit evidences collected and evaluated by the auditor to
support the audit opinion.

• The records kept by the auditor that documents:

a. The procedures applied

b. The tests performed

c. The information or evidenced obtained, and

d. The conclusions the auditor reached in the engagement

• Also called “working papers” or “workpapers” or audit file

Primary Purpose of Audit Procedures:

Audit procedures are performed to gather necessary (not all) corroborative evidence to
achieve audit objectives in order to result to sufficient appropriate audit evidence on the fairness
of the presentation of the entity’s financial statements.

Audit procedures are the means for obtaining sufficient appropriate audit evidence to satisfy
financial statement assertions and to support audit opinion on the fairness of the financial
statements. They are the detailed instructions for the collection of a particular type of evidence
that is to be obtained during the audit. Since audit procedures are performed to verify
management assertions, they would differ depending on the particular assertion or account
audited.
The following are the most common audit procedures applied by the auditor:

• Confirmation – obtaining written statements from a third party;

• Physical count and observation;
• Inquiry – obtaining written and oral information from management, employees and others;
• Documentation – obtaining internal evidence and external evidence (for example:
contracts, minutes of meetings, vouchers, bank statements, etc);
• Comparisons – establishing trends and valid relationships of information;
• Recalculations – establishing correctness of account balances; and
• Mechanical tests of data – verifying mathematical accuracy of accounting data (tracings,
footings, and cross-footings).

SUMMARY

• Auditing is a systematic process of objectively obtaining and evaluating evidence

regarding assertions about economic actions and events to ascertain the degree of
correspondence between those assertions and established criteria and communicating
the results to the interested users.
• Financial statement audit is an audit conducted to determine whether the financial
statements of an entity are fairly presented in accordance with an identified financial
reporting framework (or PFRS)
• The purpose of an audit is to enhance the degree of confidence of intended users in the
financial statements.
• Assertions are representations of management, explicit or otherwise, that are embodied
in the financial statements.
• Assertions of management may refer to:
o existence or occurrence
o completeness
o rights and obligations
o measurement and recognition; and
o presentation and disclosure
• Major phases in a financial statement audit:
o pre-engagement activities
o audit planning and evaluation of internal control
o evidence gathering
o reporting
• Audit documentation refers to the documentation of audit evidences collected and
evaluated by the auditor to support the audit opinion.