Auditi “| ting Theory | A Guide in Understanding | © he ee | Philippine Standards on Auditing | : |. Jekell G. Salosagcol, CPA Michael F. Tiu, CPA { | Roel Hermosilla,.CPA; MBA, LLB CRC-ACE REVIEW SCHOOL 3 Fir. Villaroman Building : P. Campa St. cor. Espana, Manila { ‘ ‘B 735:8901/ 735-9031 x Scanned with CamScannerALL RIGHTS RESERVED 2021 No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means — electronic, or mechanical, including photocopying, — without the written permission of the publisher ‘Any copy of this book not beating the signature of one of the authors shall be considered as proceeding frpm an illegal source ») | ISBN 976-621-416-0876 Published & Printed By: “4, SIC ENTERPRISES & CO, INC. ational Book Development Board Registered (2017 CM. Recto Avenue, Sampaloc \\* Manila, Philippines PREFACE To the 2021 Eéition We remain committed in helping accountancy students and CPA candidates in understanding the constantly evolving standards affecting the practice of accountancy. This 2021 edition is organized and presented to make it easy for the readers to grasp the essential concepts ‘embodied in the Philippine Standards on Auditing I recognition of the limited number of units made available for the: study of aniting theory, every effort has béen made to keep this book ondise and to the point, while providing faithful representation of auditing standards and principles. We increased the number of multiple choice-questions so that the readers will be able to assess thei comprehension and absorption of the topics discussed. Majority of the endofthe-chapter questions included in this edition were meticulously scected from past CPA Licensure examinations, which were modified to align them with the new standards, ae Extensive references are made to the ASC pronouncements, the (Code of Ethics for Profesional Accountants in the Philippines, the Philippine Accountancy Act of 00 and other auditing books, "These ‘references have definitely brought an clement of authority inthis book not otherwise avaiable. ; “Tis book cannot teach the principles of adiing, However, we belive that it can help facitate Teaming if the student accepts the responsibilty to lean and expends the necessary te and eff. Scanned with CamScannerWe gratefully acknowledge the effort of our staff at CRC-ACE Review School who helped in yping and lay outing the contents of this book, Thank you for sharing our aspiration to complete this newest edition, Our sincere gratitude is given to the many faculty members and reviewers for their overwhelming support, as well as, to the countless CPA reviewees who have expressed their positive reception to the preceding editions. Your valuable appreciation has dertainly enhanced cour inspiration and commitment to further advance the standard of accotintancy education. Special thanks. go to many people who have given their time, talent, inspiration, encouragement and assistance for the ion of this humble,piece of work. Without you, this work would not have been made possible. , Above all, to God Almighty, we thank You for guiding us“to this vocation and giving us fulfillment in this professional mission. «- Jekell G. Salosageol ~ 7 MichizelP, Ti Roel E.-Hermosilla ane RmnRrL ets astbia PEE a CONTENTS Chapter 1. : AUDIT: An Overview 1 Auditing defined ‘Types of Audits Types of Auditors ‘The Independent Financial Stateinent Audit Chapter 2 ». The Professional Standards i 3 Generally Accepted Auciting Standards Philippine Standurds on Auditing Qalty Control Stern Chapter 3 _ Thd Auditor's Responsibility 6 “Karbe : . 2 Fraud : ‘Noncomplance with Laws and Regulations Chapter 4. ‘The Audit Process- Accepting an Engagement 11 General Audit Approach (Overview of the Audit Process ‘Accepting an Engagement Engagement Letter Scanned with CamScannerChapter 5 Chapter 6 Chapter? Chapter 8 © Computer Assisted Audit Techniques (CAATs) Audit Planning Understanding the Clint’s Business and In Matétiality yee ray Audit Risk Analytical Procedures Planning Documentation Consideration of Internal Control Nature of Internal Control Components of Internal Control Consideration of Internal Control Communication of Internal Control Weaknesses ‘Auditing in a Compuiterized Environment Charactristis of CIS . IntemalControkin a CIS envionment ! ‘Auditing Around the Computer Performing Substantive Tests Analytical Procedures __Test of details Aut Evidence Working Papers Attendance at Physical Inventory Count tay Related Parties‘ ~ «Using the Work of an Auaitot’s Expert Considering the Work of Internal Auiditors ‘Auditing Accounting Estimates Chapter 9 * Chapter 10 Chapter 11 Chapter 12 Chapter 13 ‘Audit Sampling Sampling Risks Statistical and Non-statstical Sampling Basic Steps. when Using Audit Sampling Sampling for Tests of Control Sampling for Substantive Tests Completing the audit Subsequent Events Litigations, Claims and Assessment Management Representation Letter Going concer Wrap-up Procedures ‘Audit Reports on Financial Statements ‘The Unmiodified Report Modification of the Report Reports on Consolidated Financial Statements Reports on Comparatives Special Purpose Audit Engagements Assurance and Related Services Review of Financial Statements ‘Agreed-upon Procedures Engagement Compilation of Financial Statements Assurance Engagements The Code of Ethics and Republic Act 9298 “The Code of Ethics for Professional Accountants The Philippine Accountancy Act of 2004 433 475 @21 Scanned with CamScannerChapter 1 AUDIT- An Overview Dependable financial information is essential to cur society. We often iely upon information’ provided by others in making economic decisions. 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 the financial statements prepared by an entity. The auditor's opinion enkiances the value and usefulness of the financial statements, By attaching an auditor's report to the financial statements, the auditor provides increased assurance ~ to users that the financial statements are reliable. ~ © Auditing Defined ‘The Philippine Standards on Auditing (PSA) defines auditing by stating the objective ofa financial statement audit; that is, to enable the auditor to express an opinion on whether the financial statements are prepared, it all’ material respects, in accordance with the applicable financial reporting framework. ‘This delinition confines the audit to examination of the financial statements, Although the great majority of audit work today deals with audit of financial statements, operational and. omphanct ardting ate becoming snore and mote important. ‘A mote comprehensive definition of auditing is given by the American Accounting Association: | A adi is 0 tematic proces of ebetiey obtaining and exacting cvidence regarding acertonsabost ecoroic actions and event fo ascertn the dee of cormspondene betwen thes asertions and etablbd ria and comomnicaig th eset interested ver.” . 1 Scanned with CamScannertaile. ‘This definition coaveys the following thoughts. 1. Auditing is a systematic process “Auditing proceeds by means of an ordered and structured series of steps. This enables the auditcr to conduct the audit ina more efficient manner by ensuring that all potential risks are properly addressed in every step of the audit process. 2 Am audit involves obtaining and evaluating evidence about assertions regarding economic actions and events “Auertons ace representations, made by an entity about economic actions and events. The auditor's overall objective is to determine _ whether these assertions are valid. In order to achieve this objective, the auditor obtains and evaluates relevant evidence that will either corroborate of refute the assertions. 3. An audit is conducted objectively ‘The audit should be conducted without bias. Objectivity requires the auditor to make an ‘impartial assessment -of all the. relevant circumstances in forming 2 conclusion. Auditors should not allow bias or conflict of interest to Gverride professional. judgment, Objectivity is essential because the auditors conclusion can influence the decisions of partie relying on the report. boon 4 Auditors ascertain the degree of correspondence between and established criteria Extoblibed criteria ate needed to judge the validity of the assertions. “These criteria are importint because they establish and inform the users ofthe basis against which the assertions haye been evaluated ot measured. For, example, when auditing financial statements, the auditor evaluates the fait presentation of the financial. statements (as (viteia) comparing these financial statements with . the y) by. sequirements of the applicable ‘financial’ reporting framework 5. Auditors communicate the audit results to vasious interested ‘users: . ~The communication of audit findings isthe ultimate objective of a andit For the aud tobe wef dhe results mist be communicated to interested users in a timely manner. - Definition of Auditing Independent Auditor a Following a systematic process.» * Objectively obtains and evaluates evidence ‘Communicates the results to interested users / Scanned with CamScanner© Types of Audits Based on primary audit object jectives, there are three major types of audit, ‘namely, financial statement, compliance and opérational audits Financial statement audit * ‘A financial statement audit is conducted to determine whether the financial statements of an entity ate fairly presented in accordance ‘with the applicable financial reporting framework. This type of audit will be the focus ofthe discussion in this book. Compliance audit ; ‘A compliance audit involves a review’ of an organization’s procedures to determine whether the organization has adhered to specific procedures, rules, or regulations. The performance of a compliance audit is dependent upon the existence of verifiable data and recognized criteria established by an authoritative body. A common example of this type of audit is the eximination conducted by Bureaui of Internal Revenue (BIR) personnel to determine whether entities comply with tax rules and regulations. Operational audit ‘ ‘An operational audit is a'study ofa specific unit of an Grganization for the purpose of measuring its performance. The main objective of this type of audit isto assess entity’s performance, identify areas for improvements and make recommendations ‘to improve performance. This type of audits also known as perfrmance audit ot ‘management audit. » Unlike compliance ‘and financial statement audits, where the criteria axe usually defined, the criteria for evaluating the effectiveness “and efficiency of operations are not clearly established. The criteria used for operating audits would typically vary depending on the organization's standards and objectives. . 4 . It should be noted that, although there are different types of audit ‘all audits possess the same general characteristics. ‘They all involve: * 1 Siematic examination and eralation of evidence’ which ite , undertaken to ascertain whether assertions comply wit tablished citeda:and - 2. Communication ofthe results of the examination, usually in‘a written + feport, to the party by whom, or on whose behalf, the auditor was appointed. - ¥ The table below shows a comparison of the thre diferent ‘types of audits: Financial audit Compliance audit. Operational audit ‘Assertions " Thatthefinacial That the organization That the ‘made by the statements are- has compiedwithlaws, "organization's auditee feirly presented. regulations or ‘ontracts. Established Financial Reporting Laws, regulations and criteria Frameworksuch as “contracts. the Philippine * Financial Reporting ‘Standards (PFRS) Content ofthe An opinion about Scanned with CamScannerTypes of auditors ‘Auditors can be clas being EE Extemal Auditors or Independent Auditors “These are independent Certified Public Accountants (CPAs) who offer theix professional services to diferent cients on a contractual basis. External auditors are the ones who generally perform financial statement audits. * - Internal:Auditors Bi at Internal auditors are entity's ovin employees who investigate and. appstie the effectiveness anid efficiency of operations and internal ‘eontrols. The main function of intemal auditors is to astst the ‘members of the organization in the effective discharge of theit responsibilities. Internal auditors usually perform operational | audits. ! 2 Government Auditors . These’ are government employees; whose main concern is to determine whether persons or entities comply with government “laws vand regulations. recent mecseoeline eh yo compliance audits. °° “+ ‘ied according to thee affiliation with the entity jie ena patti ‘® The Independent Financial Statement Audit The objective of an audit of financial statements isto enable the auditor {0 express an opinion whether the financial statements are prepared, i all material respects, in accordance with the fe ‘pplabl financial porting £2 Responsibility for the financial statements ‘The management is responsible for preparing and presenting the financial statements in accordance: with the applicable financial reporting framework. . ‘The auditor's responsibility is to form and express an opinion on these financial statements based on the audit results. An audit of financial statements does not, relieve, management of its responsibilities.’ Hence, itis management's responsbility to adopt and implement adequate accounting and internal control systems that wil help ensure the preparation of reliable financial statements {3 Assurance provided by the auditor The auditors opinion on the financial statements is not a “| guiarantee that the financial statements are dependable. An audit ‘conducted in accordance with the PSAs is designed to provide only reasonable gssyrance (not absolute assurance) that the financial statements taken as a whole are free from material misstatements, ‘This is because there are inhetent ‘limitations of an audit that affect the auditor’ ability to detect material mistatements. These limitations may arise from the nature ofthe procedures performed, nature ofthe financial reporting framework ued andthe mature of evidence: bed ye sat @' Nature of the procedures Scanned with CamScanner‘There are practical and inherent limtat em toobuin idence ae a on the auditor's ability > The use of testing oF sampling risk Due to cost constrains, auditors do aot examine all evidence available. Many audit conclusions are made by examining only sample of evidence. Whenever a sample is taken, there i always, 4 possibilty that the auditor’s conclusion, based on the sample, thay be different from the conclusion that would have been teached if the auditor examines the entire population. | >" Bnvorin the application ofjadgnent or no-sampling risk Even if the auditor examines all evidence available, there is no absolute assurance that material misstatement inthe financial 4 statements will be detected. This is because ‘the work ‘undertaken by the auditor to form an opinion is permeated by judgment: Errérs in the application of judgment may cause auditors to commit mistakes in’ the application -of audit procedures or evaluation of evidence obtained. Nature of financial reporting, ~The application of the applicable financial reporting framework Such as the PFRS involves application of significant judgment and * estimates on the part ofthe management: May fiancial statement items involve subjective decisions that are subject to'an inherent variability which cannot be -climinated by perfotming audit -proceduses! * i : For example, its difficult for the auditor to deterinne the proper valuation of accounts receivable without management's honest assessment. If the management lacks integrity, management may provide the auditor with false representitions causing the auditor to depend on unreliable evidence. 8g Nature of evidence Ait evidence obtained by the auditor does not consist of “hard facts” which prove oc disprove the accuracy of the financial statements, Instead, it comprises pieces” of information. and ‘impressions which are gradually accumulated during the course of an audit and which, when taken together, persuade the auditor about the fairness of the financial statements. Thus, audit evidence is generally persuasive rather than conclusive in ature. Owing to the inherent limitations of an audit, there is unavoidable ‘isk that even an audit conducted in accordance with the PSAs may not-be able to detect material misstatement in the financial Statements. Accordingly, the subsequent discovery of 2 material misstatement of the financial statements does not in itself inicate a failure to conduct the suit in accordance with the PSAs. In addition, the auditor's opinion on the financial statements deals with whether the financial statements are prepared in accordance with the applicable financial reporting framework. The opinioa of the auditor is not an assurance as to the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity : Scanned with CamScannerRole of Management and independent Auditor a Independent Auditor Unaudited Financial ‘Statements. Audited Financial Statements Evaluates Financial Statements: ‘Audit Report on Financial Statements 10 ‘© General Requirements when Auditing Financial Statements The procedures required to conduct an audit in accordance with PSAs should be determined by the auditor having regard tothe requirements of PSAs, relevant professional bodies, legislations, regulations, and where appropriate, the terms of the engagement and the reporting requirements. PSA provides the following guidance when auditing financial statements: |. The auditor should comply with the relevant ethical requirements, including those. pertaining to independence, relating to financial Statements audit engagements, > In order to retin public confidence in the credibility ofthe auditors’ work, auditors must adhere to standards of ethical conduct that ‘embody and demoristrate integrity, objectivity, and concern for the public rather than self-interest, 2 ‘The auditor should conduct an audit in accordance with the Philippine Standards on Auditing (PSAs). “These standards contain the basic principles and essential procedures which the auditor should follow, The standards also include ‘explanatory and other iatrials that are designed to assist auditors in interpreting and applying the auditing standards. ‘The auditor should not represent compliance to PSA in the auditor's report unless the auditor has complied. with all the PSAs relevant to the audit. 3.. The auditor should apply professional judgment in planning and performing the audit. Professional judgment is essential tothe proper conduct ofthe audit. ‘This is because compliance with the relevant ethical requirements and the PSAs and the informed decisions tequired throughout the audit cannot be made without the application of professional judgment to + the facts and ciscumstances. ty Scanned with CamScanner4. The auditor should obtain sul rece the sd eet slice appropriate anit evidenée to ‘acceptably low level. Ait evidence is needed to support the opinion expressed in the auditor's report. This evidence should be both sufficient and appropriate. Whether the audit evidence obtained is sufficient and appropriate to reduce the audit risk to an acceptable level is a matter of professional judgment. 5. The auditor should plan and perform the audit with an attitude of professional skepticism recognizing that circumstances may exist ‘which may cause the financial statements to be materially misstated. ‘An attitude of professional skepticism means the auditor makes 2 critical assessment, with a questioning mind, of the validity of audit ‘evidence obtained and is alert to iudit evidence that contradicts or bring into questions the reliability of documents or management representations. In planning and performing an audit, the auditor neither assumes that the management is honest nor assumes unquestioned honesty. Thus, repteseatations from management are not 2 substitute for obtaining sufficient appropriate audit evidence.to be able to draw reasonable conclusions oni which to base the audit opinjon. © Need for an independent financial statement audit “The need for an independent audit of financial stafements stems from the following interrelated sources: : 1. Conflict of interest between management and users of financial statements, a In a sense, financial statements may be viewed ‘as the report by minagement as to how the entity performed under ther direction and supervision. Managers aze frequently placed in postions where they can benefit by providing outside parties with overly optimistic orev {alse financial information, Outside pats, however, want unbiased, 12 realistic financial statements. Recognizing this inherent conflict of interest, users of financial statements have become skeptical of ‘unaudited financial statements. Expertise : ‘The complexity of accounting and auditing requires expertise in veriffing the quality of the financial information. Since most of the users of financial information are not equipped with the necessary skills and competence to determine whether the financial statements are reliable, a qualified person is hired by users to verify the reliability of the financial statements on their behalf. > Remoteness Users of financial information are usualy prevented from directly assessing the relablty ofthe information. Most of the users do not Ihave access to the enti’s records to personally verify the quality of the financial information. Consequently, an ind auditor is needed to assist them in verifting the seliabilty of the financial information. ’ te . Financial consequences * Misleading financial information, could have substantial economic consequences for a decision makes. Ic is therefore important that financial statements be audited first before they are used for making important decisions 13 Scanned with CamScanner¥ Theoret: . ical Framework of Auditing 7 ‘The audit function operates within a theoretical framework. Below are Postulates, assumptions or ideas that support many auditing, concepts and standards, iets 1 Andit function operates onthe assumption that al faancal data are via All balances reported in the financial statements must have supporting, documents of evidence to prove theis validity. If no evidence exists in tclation to the financial statements on which an auditor is to express an opinion, then there can be no audit to perform. 2. The auditor sbowld aloays maintain independence with respect tte financial " dalementswnder anit ‘Independence is essential for ensuring the credibility of the auditor's “cctureport. The report of the auditor will be of litle or no value to the . readers of the financial statements if the readers are aware that the auditor is not independent with respect to the cient. 4 There shouldbe no longterm confit between the auditor and. the cent management. ._.. Short-terin ‘conflicts may exist'regarding the application of auditing = Procedures and accounting principles, but in the end, both the auditor and the management imist be interested in the fair presentation of the financial statements. 4, Effective internal contr system reduces the passiility of material misstatements of ‘the financial statements, ‘The condition of the entity’ internal control system directly affects the reliability of the financial statements. The stronger the intetnal control is, the more assurance it provides about the reliability of the accounting date and financial statements. 4 J. Conisen pplication of the applicable ica porting framework suchas the PERS results in fir prsenttion of fame tatemets. Altors often use different eritesa to evaluate the validity of an aséertion. In the case of a financial statement audit the itera are ‘usually the financial reporting frameworks which could be the PFRS, BPRS for Smal and Mediums Entities, or PFRS for Small AILS. 7 "i {is assumed that air presentation is achieved whén the applicable financial reporting framework is applied. Hence, any deviation from the specific requirements ofthe framework would render the financial statements materially misstated. 6 Wt re inte at il tino bade intbede in t aeee of evar conditions to he coat. ees Experience and knowledge accumulated from auditing aclentin peor years canbe used to determine the appropriate audit procedures that rcedto be performed. 3 Z Am andit bengits the pb: Financial statements aie Gtdinarily prepared and presented in order to ‘meet the common information needs ofa wide range of users. These users who rely on the financial statements a5 their major source of information are’ the primary beneficiary of the financial statement sud. = ‘ , 15 Scanned with CamScannerMultiple Choice Questions - Audit in General 1 2 Recording, classifying, and summarizing ‘When auditing financial statements, the primary concern is with a. Determining whether recorded information properly reflects the economic events that occurred during the accounting period. b. Determining if fraud has occurred. Determining if taxable income has been calculated correct. 4. Analyzing the financial information to be sare thatit complies with {government requirements. t economic events in a logical ‘manner for the purpose of providing financial information for decision ‘aking is commonly called ya. Finance by Auditing c. Accounting 4. Economics _ 3. The tit chat dtaguishes auditors from accountants is the 1... Auditor's ability to interpret accounting standards. b. “Auditors education beyond the Bachelor's degree. ‘& Auditor's continuing professional development. Auditor's accumulation and interpretation of evidence related to ~ the company’s financial statements. 4. The subject mater of any audit consists of 4. Assettons about economic actions and events b. Economic data c. Financial statements (d Operating data 5, * Am audit involves ascertaining the degree of correspondence between assertions and established criteria. In the case ofa financial statement ‘audit which ofthe following is nota valid criterion? 16 Philippine Standards on Auditing - Philippine Financial Reporting Standards PFRS for Small and Medium-sized Entities PERS for Small Entities t eee The criteria for evaluating quantitative information vary. For example, in the case ofan independent audit of financial statements by CPA fitms, the criteria are usually the Philippine Standards on Auditing . Philippine Financial Reporting Standards National Internal Revenue Code 4. Regulations ofthe Securities and Exchange Comission Most ofthe independent auditor's work in formulating 2a opinion on the financial statements consists of a. “Obtaining and examining evidence b. Examining cash transactions ¢. Comparing recorded accountability with assets 4, Studying and evaluating internal control ‘An audit of financial statements is conducted to determine ifthe 2. Organization is operating efficiently and effectively professional standards,» ! : > complying with the ftm’s quality control policies and procedures, > issuing appropriate audit reports, and" ">< > the engagements team ability to raise concerns without fear of 2 ETHICAL REQUIREMENTS The firm should éstablih policies and procedures designed to provide reasonable assurance thatthe frm and its personnel comply with ethical requirements, which include: > Integrity; é & ‘Objectivity: + Professional competence and due cate; > Confidentiality; and . + Professional behavior The engagement partner should consider whether members of the ‘engagement team have complied with these ethical principles. Any issues involving engagement team member's non-compliance with ethical requirements must be, properly resolved and documented. INDEPENDENCE “The firm, should establish polices and procedures designed to | provide reasonable assurance that the members of the engagement “team, the firm and, where applicable, the network firms maintain » independence when providing audit services. ‘The engagement patinet should form a conclusion on compliance. with independence requirements that apply to the adit engagement. The engagement partner should: > Obtain relevant informnatién’ to’ identify’ circumstances and relationships that create threats to independence; } Evaluate information on identified ‘breaches of thé firm’s independence policies and procedures to determine whether they create a threat to independence; > "Take appropriate safeguards to eliminate such threats of reduce them to an acceptablé level; and > "Document conchsions on independence and the basis for such conchsion. ” Al Scanned with CamScanner{2 ACCEPTANCE AND CONTINUANCE OF CLIENT RELATIONSHIPS “The firm should establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide reasonable assurance that it will only undertake of continue relationships and engagement where it : > Has considered the integrity of the client; > Is competent to perform the engagement and. has the ities, time and resources to do so; and _ > Can comply with ethical requirements. * The engagement ‘partner. should be: satisfied that appropriate procedures regarding. the acceptance: and continuance.of client felatonships and specific audit engagement have been followed, and that conclusions reached are appropriate and have been documented. HUMAN RESOURCES AND ASSIGNMENT ‘The firm should establish policies and procedures ‘designed to provide reasonable assurance that it has sufficient personnel withthe capabilites, competence, and commitment to ethical pi ciples = necessary to perform the engigement. Such polices and procedures should address issues concerning personnel > Recruitment; = > Performance evaluation, compensation and promotion; >, Capabiles and competence; : > Career development; and : >. Assignment of engagement tears The- engagement partner should be satisfied that the engagement team collectively has the appropriate capabilites, competence and: time to perform the audit engagement in accordance with professional standards, and regulatory and legal requirements, sad t0 enable an auditor’s report that is appropriate inthe circumstances to - be issued. = ‘ 42 {2 ENGAGEMENT-PERFORMANCE ie ‘The firm should establish polices and procedures designed to provide reasonable assurance that engagements are performed in Teg wih rotor! ai od tie gene ad kel I and hat taut epor sued pprope ‘The engagement partner should take respoasbilty forthe direction, supervision, review and overall performance of the audit engagement. 1. Direction Assistants should be informed of thet responsbilties, the nature 2. Supervision. os. Arner ‘3. Review 4, Consultation ~ that encourage = cither within or outside the firm. 143 Scanned with CamScannerThee: _ ; The engagement pares shoud: 6, Differences of Opinion E ement team have tos, fmgagement quality control reviewer, ; 4 ny, The engagement parinér should inform the members of the © Be satisfied that the nature and sco engagement team to bring matters. involving differences of ‘pinion to the attention of the engagement partner or others ° within the fir as approprate without fear of reprisals. The audit =a il eth let en i ea ae » 1; of opinion s resolved, vent, both wi “_ 5, Engagement Quality Control Review ‘The firm should estabich policies and procedures requting an engagement quality control review that provides an. objective evaluation of the significant judgments made and conclusions reached in formulating the auditor's report. a8 MoNrToRING ‘This requires the engagement parte 2 To determine that an engagement quality contol reviewer ‘has been dppointed; _ . To discuss significant. matters arising during the audit’) = _. engagement, including those identifieddusing the quality , control ‘feview, with the copigement quality. control feviewer; and * otto iste the audio’ report unt the completion of the engagement quality control review...) ‘The iam should eabsh policies and procedures setting outthe | : 7 i * s:scope of quality control review, criteria‘for the eligibility of the | : ‘ fee and doeunenason of he guy conta ee, : : 4s a . Scanned with CamScannerQUALITY ASSURANCE REVIEW Recognizing the importance of professional accountants’ services to the society, the government has also taken steps to ensure that CPAs work to the highest standards which can reasonably be expected from them. ‘The government thru the BOA has required all CPA firms and individual CPAS in public practice to obtain a certificate of accreditation to practice public accountancy. Such certificate is valid for three years and can be renewed after complying with the requirements of the BOA. “ ‘As acondition to the renewal of the certificate of accreditation to practice a public accountancy, the Bourd requires individual CPAs and CPA firms to undergo a quality assurance review to ensure that these CPAs comply ‘with accounting and auditing standards aad practices. “The PRC is supposed to create a Quality Review Committee (QRO) < ‘which shall conduct a quality review on the audits conducted by CPAs in < * public practice. Based on the results ofthe quality review, the QRC may" fecommend the revocation of the certificate of registrations of CPAs ho have not observed the quality control measures of those who have ‘not complied with the standards of quality prescribed for the practice of “ public accountancy: agencies like the Securities and Exchange Commission (SEC) have initiated programs to ensixe ‘that CPA firms are" implementing appropriate quality control poles and procedures that would enable these fiems t0 comply withthe professional standards when providing professional services. ‘As oftéday, the QRC kas not yet been created: Nevertheless, regulatory Multiple Choice Questions ; vite Generly Acepted Auditing Standards (GAAS) s 1. Which of the following best describes what is meant by' generally accepted auditing standards? : 2. Audit objectives generally determined on audit engagements. formed by the auditor. a. f the quality of the auditor's performance... |. Procedures to be.used.to gather evidence to support financial statements. | S 2. Inthe auditing environment, failure to mect auditing standards is often a. An accepted practice 3 b. A suggestion of negligence ior 3. Audit standards require the auditor to, a. Perfonm procedures that are designed to detect all instances of feud. ; 2 ince that the financial statements are mate L ¢. Issue an unmodified opinion only when the auditor is satisfied Jeudes Lo thaeno instances of fraud have occurted. & "Design the audit program to meet financial, statement users’ oojp9 vo espeetatons conceming fraud, , + 4. - Which of the following underlies the application of generally accepted “ee auditing. standards, particularly the standards of field work and reporting? 06 ‘ “ sore “suse Element of internal control... b. Elements of materiality and risk. f of corroborating ev S47 Scanned with CamScanner4.” Whatis the general character ofthe thre generally aceptd sting 9 Requirements for training, independence and due professional cate are a group ofthe gener accepted sng anand © orting a. Quality control ° 6. _ The general standards of the gencrally accepted auditing standards include a requirement that ; 2°’ The fieldwork to be adequately planned. 'b. ‘Theauditor’sreportto state whether the financial statements are presented in y with PRS. 5 «7 Due of d. The auditor to obtain sufficient, competent evidential mater. 7. Which of the following reflects a cosicept from the gesieral standards of GAAS? 2. The confirmation of accounts receivable. . b, Completing an internal control questionnaire. 4 Theasignment of audit personnel to an engagement where hey hhave no financial interest. : Standards classified as general standards? ements and related footnote disclosures. ‘ a. ee cats fre paning of he aut nd pe" of assistants, if any. °° renee rich of the flowing oso prin tothe un of .: Agate pg non ee ing ofthe audit with the audit partnet, manager, independence, ad professional cae of rl fag it fo og? © Criteria’ for the content’ of the auditors” report on nti b. Obtaining sufficient competent evidential matter.’ ~ Proper study and cezlution of internal control as a basis for reliance thereon \ “ds Technical ining nd proficiency. 110. While performing audit, 'services for, their clients, professional accountants have a duty to provide a level of care whichis.” b. Greater than average © Supetion ss os His A. Guaranteed to be free from error. it IL. The sand 4 Make perfec judgment decisions in alleen, yy Bnsue that he finance statements ate ee from ert: > Poses kl clealy above the average forthe profession. \pply judgment in a conscientious manner, carefully weighing se relevant factors before reaching a decision. 12. . Which of the following is most likely to be unique to the'audit work of CPAs a8 compared to work performed by pracitioners of other professions? 2» Due professional care...) b. » Competence, e es PSO Une b nana w whe : 13. ‘The third general standard states that due cae is to be exercised inthe vo) performance of an-audit. This, standard is, ordinarily interpreted to “ Setchoaay at eh r af ‘i SGD zope fh iting lege ort it 2 and records, uf i a via t , A quality assurance review. c Continuing professional education, d._ Compliance with generally accepted reporting standards. 35. A firm’ of independent auditors must estiblish and follow quality control policies and procedures because these standards ar" Ate necessary to meet increasing requirements of auditors* liability as insurers. 2, tea acacia. 4 J Wego gee poles and procedures + Sih pds * Ml cone pt mh ei a AY Sn it a regen ome SPY roy aad tg b. ‘The audit willbe petformed in accordance with pe 4° 55 Scanned with CamScanner41.” Which of the following is an element of a CPA firm’s quality control, system that should be considered in establishing its quality control policies and procedures? 2 Complying with laws and regulations b. Using statistical sampling techniques c. Independénce 4d. Consideration of audit risk and materiality 42, laments of a CPA firm's quality control that should be considered in ‘estublishing its quality control policies and procedures must include: Monering Ethical Requirements Engagement Yes a. Yes Yes b, Yes Yes No ci Yes No Yes d No Yes ‘Yes 43. Which ofthe following is one ofthe elements of CPA firm's quality control system? i. Leadership responsibilities b, Computer assisted audit techniques & Control activities 4. Control environment 44, - Which of the following quality contol objectives would be least important to the auditor? a. Engagement performance b. Human resources Determination of audit fee 4. Independence _ 45. A qulty control policy that requires personnel inthe fam to adhere to independence, integrity, objectivity, confidentiality aad ‘panfessional bekavior, relates to . a Ethical Requirements : b, Human resources 131 Scanned with CamScanner“Assignment - Consultation . 46. Which of the following quality control_policies and procedures docs fot relate to human resources and assignment? 2 Emphasize independence of mental attitude in training programs - and in supervision and review of the audits. b. Monitor the effectiveness of reciting programs. Identify criteria which will be considered in evaluating individual | performance and expected proficiency, d. ~ Identify on a timely basis the staffing requirements of specific audits. “47. Yn pursuing a CPA firm’s quality control objectives, a CPA firm may maintain records indicating which partners or employees of the CPA firm were previously employed by the CPA firm's clients. Which quality control element would this be most likely to satisfy? 2 Monitoring b. Assignment © Independence * 48. A procedure in which a quality control partner periodically tests the. ication of quality control procedures is most directly related to < ‘which quality control clement? 7 2. Engagement performance 1b. . Independence, integrity, and objectivity, Monitoring i d. Personnel management 49. 4a connection with the cement of engagement performance, 1 CPA firm's system of quality control should ordinarily provide that all. soninel ee Have the knowledge required. to enable them to fulfill responsbilties assigned. 58 si. 33, b. Review and test compliance with the fimm’s quality control policies and procedures. © Seek assistance from persons having appropriate levels of knowledge, judgment and authority. . 4. Appropriately maintain independence when providing assurance services Maintaining or providing access to adequate reference libraties and other authoritative sousces i a procedure that is mos ikely performed to comply with the policy of a Monitor b. Skills and competence So Which of the following quality control. procedures reites Seeell sheers ie Professional development Advancement. Within. the context of quality control, the purpose of - * continuing professional education and training activities is to enable 2 ° CCPA firm to provide its personnel with: 2° Technical taining that assures proficiency asa valuation expert. __b Professional eduition thats requied in order to perform with sve profesioaal ere” Knowledge required to fulfil assigned responsibilities. 4. Knowledge required to perform a peer review. Ta compliance with the clement of human resources the firm should address issues relating to a Bngagement performan Assignment of b. Consultation a. Differences of opinion Scanned with CamScanner54, prone one to engagement, the auditors may use poles ad 2 Designating senior qualified personnel to provide advice on Accounting or auditing questions throughout the engagement. b. Requiring timely identification of the staffing requirements of specific engagements to that enough qualified personnel can be made available. : Establishing at entry levels a polcy for recruiting that iicludes | minimum standards of academic preparation and. - ~ accomplishments. d. Evaluate clients -upon occurrence of. specified events. to 55. In connection with the element of assignment, a CPA firm's system of = 2 b. c da 56. Which of the following is a policy that must be established to comply Tn pursuing the firm's quality control objectives with respect to determine whether the relationships ought to be continued. ty conttol should ordinarily establish procedures that <, Provide adequate supervision at all levels, considering the | training, ability and experience of the personnel assigned. Encourage petsonne! to use authoritative sources on complex or ‘unusual matter. Require preparation of time budgets for audits to determine 4 requitemen's and to schedule the audit work. Establish qualifications deemed necessary for vatious levels of responsibility within the firm. with the quality control engagement performance? a b. The firm is to be staffed by personnel who have attained and maintained the technica standards and professional competence , .. fequired to enable them to fulfill their responsibilities. “There is sufficient diection, supervision, and review of work performed at all levels to provide reasonable assurance that the work performed meets appropriate standards of quality. 60 ‘The fim should assign responsibility for each engagement to an ‘engagement partner. ‘The continued adequacy and operational effectiveness of quality control polices and procedures are to be observed. ‘The work performed by the assistants should be reviewed by personnel of at least equal competence to consider all ofthe following except: 2 Whether the conclusions expressed are consistent with the results of the work performed. b. Whether the'work was performed snd documented. c _ Whether the objectives ofthe audit have been achieved. 4. Whether the engagement personnel maintained independence. ‘The primary factor that should be considered in determining the extent of supervision needed by an assistant is the assstant’s a. Willingness to exercise due care b. Competence © Professional certification 4 Independence ‘The auditor with final responsibilty for an engagement and one of the assistants havea difference of opinion about the resus of an inciting procedure. If the assistant believes itis necessary to be disassociated ~ from the mattet's resolution, the CPA firm's procedures should enable othe assistant to, 2. Refer the dishgreement to the Quality Review Committee. b. | Document the details of the disagreement with the condusion reached, " eDiseussthe'disigfeement withthe entiy’s management oF its audit comminee.” © * 4. - Report the disagreement to an impartial peer review monitoring . team. : 6 Scanned with CamScanner60. ‘The. primary purpose of establishing quality control policies and procedures for deciding whether to accept a new client is to a. “Enable the CPA firm to attest to the integrity of the client management. : b. Satisfy the CPA firm's duty to the public concerning the acceptance of new clients f © Minimize the likelihood of association with clients. whose management lacks integrity. a ‘tigate before performing any field work whether an ‘unmodified opinion can be expressed. 61, ° In, making'a ‘decision to accept or retain a client, the firm should consider a. Itseompetence + 1b. Its ability to comply with ethical requirements c. The integrity of the client's management: 4. All three should be considered. 62. ACPA firm’s quality control procedures pertaining to the acceptance of a prospective audit cient would most likely include - a: Inquiry of management as to whether disagreements between the vs. predecessor auditor and the prospective client were’ resolved | satisfactorily. be» Consideration of whether sufficient competent evidential matter ray be obtained to afford a reasonable basis for an opinion. Inquiry of third parties, such as the prospective clients bankers and attorneys, about information repardiag the prospective client and its management. ; sufficiently effective to permit a reduction in the required substantive tests, ’ 63. Quality control policies arid procedises should provide the firm reasonable assurance that the policies and procedures relating to the other elements of quality contol are being effctively applid. This statement defines the qutity control element of 62 Consideration of whether. the internal control. striictute “is 66. a. 4 Planning b. Independence, integrity and objectivity © Assignment 4 Monitoring In connection with the clement of monitoring a CPA firm’s system of quality control should ordinarily provide for the maintenance of "a A file of minutes of staff meetings b. Updated personnel fils. : © Documentation to demonstrate compliance with its policies and procedures. 4 Documentation to demonstrate compliance with peer review disectives. : ‘A deficiency inthe firs system of quality controls an indication that 2.” The auditengagement was not performed in accordance with the professional standards, : b. The audit reports issued were not appropriate. Bothaandb . 4. Neithera norb Tt involves a study of appraisal by the Board or its duly authorized fepresentatives, of the quality of audit of financial statements through an evaluation of the quality control measures instituted by the CPA firm to ascertain compliance with ethical and technical standards af public practice A” Quality review b.. Peer review © Compliance audit d. External audit Which of the following is responsible: for. establishing auiditing standards that willbecome generally accepted inthe Philippines? a. Securities and Exchange Commission b. Finasicial Reporting Standards Council Commission on Audit d._.. Auditing and Assurance Standards Council 63 Scanned with CamScannerChapter 3 AUDITOR'S RESPONSIBILITY ‘The fur presentation of the financial statements in accordance with the ‘ppliible financial reponing framewockis the responsiblity ofthe cen’ management. The auditor's responsibilty is to design the audit to provide easonable assurance of detecting material misstatements inthe fisancial Statements, These misstatements may emanate from: | ~ 1. Error, 2. Fraud; or 3. Noncompliance with Laws and Regulations ® ERROR : ‘The term “error” the financial statements, including the such a; “7 Mathematical ‘or clerical mistakes in the underlying records and > Incomect "accounting estimates arising from oversight or __ misinterpretation of facts; or > Mistakes in the application of accounting policies, @ FRAUD Fraud teers. to intentional act by one ot more individuals among management, those chged with governance, employes, or third partes, involving the use of deception to obtain an unjust ot Fag a ord Eg cana Oe me oe concerned with fraudulent acts that cause material misstatements in the financial statements. 65 Scanned with CamScannerTypes of Fraud ‘There are two:types of fraud that are relevant to financial statement audit- misstatements resulting from fraudulent financial reporting and misstatements resulting from misappropriation of assets. Fraudulent financial reporting involves intentional misstatements” or omissions of amouats or disclosures in the BSto | Statement users: TAS type of frauds aso Known as ; Because it_uswaly invalves_members_of Se a ether Thy vee > Manipulation, falsification or alteration of records or documents; > Miscepresentation in or intential-omission of the effects of transactions from records or documents is ions without subst Intentional misapplication of accounting policies. Misappropriation of assets involves theft of an entity's assets committed by the entity's employees. Ths is also cued oiploges) 4 fraud?" because’it is often perpetrated by employees.’ in relatively" small and immaterial amouats. This may include: e > Embezzling receipts; i : ea Sain en’ a8 such'as cash, marketable securities, and inventory; or i i > Lapping of aconunts receivable. Employee fraud is often accompanied by false or misleading records ,_ or documents in order to'conceal the fact that the assets are missing. Fraud. involves. motivation to commit, the act and_a vesssred _ portunity to do so, For example, an employee might be motivated to : cause this employee lives beyond his means. ‘Also, a member of management may be forced to manipulate the financial statements in order to meet an overly optimistic projection. > > i 66. AA petceived believes ‘opportunity to commit fraud mi exist when an individual (isos that he can gst avay with it This is sully the case whea there on 2 anon of ‘The primary factor that distinguishes fraud from titotis whether the underlying cause of misstatement in the financial statements is oe a areca ing the auditormay be able to. ‘identify opportunites for Fad tobe perpetuated itis aftcadifical f* ‘not impossible, forthe auditor to determine intent, paticulaly in matters invOlving managemeat judgment, such as accounting éstimates and the approptiate application of accounting principles. Consequeatly, the auditor's responsibility for the detection of fraud and error is essentially the same. ot S>Responsibility of Management and Those Charged with * Governance ' ° The responsibilty forthe preventiin and detection of fraud and error fests with both management and those charged with the governance ofthe entity. tn this regard, PSA 240 requies<) vl > Management’-to establish’ 4 “control environment and to ‘3. “implement internal control policies and procedures designed to ensure, among others, the detection and prevention of fraud and tots? ‘etna viet + 9D Individuals charged with governance of an entity ensure the integrity of an entity's accounting and financial reporting % systems and that appropriate controls are in place. SE Auditor's Responsibility ‘Although anntial audits of financial statements may act as deterrent to fraud and error, the “auditor is not and cannot be held resporisible for the prevention of fraud and error. The auditor's esporisible for the prevention of fraud and error. 61 Scanned with CamScannerWac tot of! ort ‘ou responsibility isto desi nable assurance that the financial statements are free from material misstatements, whether caused by ertororfraud.=SOSC~SsS*~S Planning Phase © 1. When planning an audit, the auditor should make inquiries of management about the possiblity of misstatements due ‘0 ftaud and error. Such inquiries may include: > Management's assessment of risks due to fraud, > Controls established to address the risks; or } Any material error ot fraud that has affected the entity or suspected fraud thatthe en ‘The auditor's inquiries of management may provide useful information concerning the tsk of material misstatements in the financial statements resulting from employee fraud. However, such inquiries are unlikely to provide useful ‘information regarding the risk of material misstatements in the financial statements resulting from management fraud. j the auditor 0 ose individuals in change of governance to seck their views on the adequacy of accounting and internal control systems in place, the risk of fraud and error, and the integrity of management. 2. The auditor should assess the risk that fraud or error may cause the financial statements—to—contai—mearerial is - is ‘auditor, to specifieallrassess the risk of material misstatements due to fraud both atthe financial statement level and assertions level. § ‘The fact that fraud is usually concealed can make it very difficult to detect it. NeverthelessUsing the aiditor’s knowledge ofthe business, the auditor may identify events ot 68 means to commit fra, or indicate that aud may already have occured. Such events ot condtions ae ieee to a “fraud risk factore”, Fraud risk factors do not necessaily indicate the existence of feaud, however, they often have been present in circumstances where frauds have occurred. Examples of ftaud tisk factors taken from PSA 240 are set outa the end of this chapter. _ Judgments about the increased risk of material misstatements due to fraud may influence the auditor’s response aad professional judgments inthe folowing ways: > The auditor may approach the audit with a heightened {evel of professional skepticism; The aut cam may be tcc in ways hat cae hat auditor's assessment of risk; of > ‘The auditor may design mote effective “audit ‘procedures or may increase the extent of the ‘proceducesto-be peeformed. Testing Phase 3. During the course of the audit, the auditor may encounter circumstances that may indicate the possibly of fraud ot error, For eximple, there are discrepancies found in the accounting records, conflicting or missing documents, or ack o Scanned with CamScanner