OVERVIEW OF THE

FINANCIAL STATEMENT
AUDIT PROCESS

 Auditing includes the phrase systematic

process because an audit involves a logical
series of steps that lead to the rendering of
an opinion on the fairness of financial
statements
FS refers to a structured representation of
financial information
FS are complex documents and ,
consequently the process of auditing FS
requires a systematic and rational approach

Objective of the Independent

Auditor

Objective of the Audit of FS is to enable the auditor

to express an opinion whether the FS are prepared,
in all material respects, in accordance with an
applicable financial reporting framework.
overall objective of the independent auditor is to
obtain reasonable assurance about whether the FS
as a whole are free from material misstatements
Due to fraud or error
To report the FS in accordance with the auditors findings
PSAs require that the auditor modifies the auditors
opinion accordingly or withdraw from the engagement.

Responsibilities of
Management
1. Identifying the financial reporting framework

to be used in the preparation of the FS

2. Preparing and presenting the FS in
accordance with that applicable financial
reporting framework
3. Designing, implementation and maintaining
internal control relevant to the preparation and
presentation of FS that are free from material
misstatement, whether due to fraud or error
4. Selecting and applying appropriate
accounting policies
5. Making accounting estimates that are
reasonable on the circumstances

Basic Concepts Underlying a FS

Audit
1. Auditor Independence
2. Professional skepticism
3. Conduct and Scope of an Audit in
Accordance with PSAs
4. Audit evidence and FS Assertions
5. Audit Materiality
6. Audit Risk
7. Professional judgment
8. Inherent limitations of an audit
PSA 200

Auditor Independence
Refers both to the state of mind of auditor and
independence in appearance
Safeguards the auditors ability to form an audit
opinion without being affected by influences
that might compromise that opinion
Enhances the integrity, to be objective and
maintain the attitude of Professional skepticism

Professional Skepticism
-makes critical assessment, with a
questioning mind, of the validity of audit
evidence obtained and is alert to audit
evidence that contradicts or brings into
question the reliability of documents
When making inquiries and performing other
audit procedures - the auditor is not
satisfied with less than persuasive audit
evidence.

Conduct of an Audit and Scope of

an Audit in accordance with PSAs
Conduct an audit in accordance with PSAs
PSAs contain basic principles and essential
procedures together with related guidance
on the form of explanatory and other
materials including appendices
Are designed to support eh achievement of the
overall objective of the auditor.
Auditor shall comply with all PSAs relevant to
the audit.

 The auditor shall consider the entire text of a

PSA to understand its requirement.
The nature of the PSA requires the auditor to
exercise professional judgment in applying
them

The auditor shall not represent compliance

with PSAs unless the auditor has complied
with all the PSAs relevant to the audit.

Philippine Auditing Practice

Statements (PAPSs)
Provide interpretative guidance and practical
assistance to auditors in implementing PSAs.
An auditor who does not apply the guidance
included in a relevant PAPS needs to be
prepared to explain how the basic principles
and essential procedures in the Standard
addressed by the PAPS have been complied
with.

Scope of an Audit
-refers to the audit procedures that, in the
auditors judgment and based on the PSAs,
are deemed appropriate in the
circumstances to achieve the objective of
the audit.
In determining the audit procedures - the
auditor should comply with each of the PSAs
relevant to the audit.

Scope of an Audit
- may required to comply with other
professional, legal or regulatory
requirements in addition to the PSAs.
In the event that those laws and regulations
differ form the PSAs, an audit conducted in
accordance with the local laws and
regulations will not automatically comply
with PSAs

Audit Evidence and Financial

Statement Assertion
Auditors Responsibility
An audit involves performing procedures to
obtain audit evidences about the amounts and
disclosures in the FS. The procedures selected
depend on the auditors judgment, including
the assessment of the risks of material
misstatement of the financial statements,
whether due to fraud or error.
Conclude that an audit involves gathering
evidence about amounts and disclosures in the
FS (assertions)

Audit Evidence
-information used by the auditor in arriving
at the conclusions on which the audit opinion
is based, and includes the information
contained in the accounting records
underlying the FS and other information

Accounting
Records

Other Information

The records of initial

entries

Minutes of the meetings

Supporting records

Confirmation from third parties

Checks and records

of electronic fund
transfers

Analysts reports

Invoices

Comparable data about competitors

(benchmarking))

contracts

Control manuals

The general and

subsidiary ledgers

Information obtained by the auditor from

such audit procedures as inquiry,
observation and inspection

Journal entries
Other adjustments to
the financial
statements that are
not reflected in
formal journal
entries

Other information developed by or

available to, the auditor that permits the
auditor to reach conclusions through valid
reasoning

PSAs 3 categories of procedures

for gathering audit evidence
Category

Description/Purpose

Risk Assessment Procedures

Used for obtaining an

understanding of the client entity
and its environment, including
internal control.
Risk assessment procedures are
performed during the audit
planning and internal control
phases of the audit

Tests of Controls

Used to test the operating

effectiveness of controls in
preventing, or detecting and
correcting, material misstatement

Substantive tests

Used to detect material

misstatements in account
Audit Procedures According to balances,
Purpose classes of transactions
and disclosures

Management Assertions
Management implicitly or explicitly makes
assertions regarding the recognition,
measurement, presentation and disclosure of
the various elements of FS and related
disclosures
Based on this assertions the auditor shall
assess the risks material misstatement and
the design and performance of test of
controls and substantive tests.

PSA 500 Audit Evidence groups FS

assertions into the following categories
1. Assertions about classes of transactions
and events for the period under audit
2. Assertions about account balances end
3. Assertions about presentation and
disclosures

Assertions about classes of transactions

and events for the period under audit
1. Occurrence transactions and events that have
been recorded have occurred and pertain to the
entity
2. Completeness all transactions and events that
should have been recorded have been recorded
3. Accuracy amounts and other data relating to
recorded transactions and events have been
recorded appropriately
4. Cut off transactions and events have been
recorded in the correct accounting period
5. Classification transactions and events have
been recorded in the proper accounts

Assertions about account

balances at the period end
1. Existence assets, liabilities, and equity interest
exist
2. Rights and obligations the entity holds or controls
the rights to assets and liabilities are the obligations
of the entity
3. Completeness all assets, liabilities and equity
interests that should have been recorded have been
recorded
4. 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

Assertions about presentation

and disclosure
1. Occurrence and rights and obligations
disclosed events, transactions and other matters
have occurred and pertain to the entity.
2. Completeness all disclosures that should have
been included in the FS have been included
3. Classification and understandability financial
information is appropriately presented and
described, and disclosures are clearly expressed
4. Accuracy and valuation financial and other
information are disclosed fairly and at appropriate
amounts

Audit Materiality
Concept of materiality is inherent in the work of the
auditor
Materiality is a relative concept.
2008 IAAB Handbook :
Information is material if its omission or misstatement could
influence the economic decisions of users taken on the basis
of the FS.
Assessment of what is material is a matter of professional
judgment
-Auditor considers materiality twice :
Planning the engagement
And at audit completion

Steps in Applying Materiality

During Planning
1. Establish a preliminary judgment about
materiality
2. Determine tolerable misstatement
At Audit Completion
3. Estimate likely misstatements and compare
the totals to the preliminary judgment about
materiality

Establish a Preliminary Judgment

about Materiality
Preliminary judgment or estimate about materiality
- represents the maximum amount by which a set of FS
could be misstated and still not cause the auditor to
believe that the decisions of reasonable users would be
affected.
AASC issued standards do not require that the
preliminary judgemnt be quantified.

The materiality criteria used by

selected practicioners
1. Percentage effect on net income before
taxes
2. percentage effect on total revenues
3. percentage effect on total assets
Planning Materiality resulting materiality
amount in pesos

Tolerable misstatement
Is the amount of planning materiality that is
allocated to an account balance or class of
transactions
- process of allocation may be done
judgmentally using formal quantitative
approaches.

The Effect of Materiality on Audit

Procedures
The lower the tolerable misstatement, the more
extensive the required audit procedures
Example : assume that tolerable misstatement for
accounts payable is zero- this means that any
amount of misstatement in accounts payable even
one centavo misstatement can affect the decision of
the users of FS.
Auditor should have to test every transactions
making up the account.

Aggregate of the uncorrected

misstatement
- approach the materiality level, the auditor
would consider reducing audit risk by
performing additional audit procedures
Or by requesting management to adjust the
FS for identified misstatements

Audit Risk
Is the risk that the auditor expresses an inappropriate
audit opinion when the FS are materially misstated
Is a function of the risk f material misstatement and
the risk that the auditor will not detect such
misstatement
May be assessed either in
1. Quantitative terms ex. 8% of total assets
2. Non quantitative terms ex. High, moderate or low

Inherent Risk
- is the susceptibility of an assertion to a
misstatement that could be material,
individually or when aggregated with other
misstatements assuming that there were no
related internal controls

Control Risk
Is the likelihood that a misstatement that
could occur in an assertion and that could be
material, individually or when aggregated
with other misstatement, will not be
prevented or detected and corrected on a
timely basis by the entitys internal control
Is a function of the effectiveness of the
design and operation of internal control in
achieving the entitys objectives relevant to
preparation of the entitys FS

Detece tion Risk

- is the likelihood that thauditor will not
detect misstatement that exists in an
assertion that could be material, either
individually or when aggregated with other
misstatements.
Is a function of the effectiveness of an audit
procedure and of its application by the
auditor.
Relates to the nature, timing and extent of
the auditors procedures that are determined
by the auditor to reduce audit risk to an

 The greater the risk of material

misstatement the auditor believes exists,
the less the detection risk can be accepted
The less risk of material misstatement the
auditor believes exists, the greater the
detection risk that can be accepted

Effect of Audit Risk on Audit

Procedures
The higher the combined assessment of IR
and CR
- the lower the amount of the DR that can
be accepted
The lower the acceptable DR, the greater the
amount of audit procedures to be performed
in order to reduce the chances of not
detecting misstatements

Relationship between Audit Risk

and Materiality
The higher the materiality level - the lower
the audit risk and vice versa
The auditor takes the inverse relationship
between materiality and audit risk into
account when determining the nature, timing
and extent of audit procedures.

Professional Judgment
Described as the applicationof relevant
knowledge, and experience, within which the
context provided by auditing, accounting and
ethical standards, in reaching decisions about
the courses of action that are appropriate in
the circumstances of the audit engagement.
Materiality and audit risk
The nature, timing and extent of audit
procedures used to gather audit evidence

Phases of the Audit Process

1. Pre-engagement carrying out initial audit
activities , such as client acceptance and continuance,
and agreement on the terms of engagement.
2. Audit Planning developing an over-all audit
strategy and preparing the detailed audit plan
3. Study and Evaluation of Internal Controls
documenting and evaluating the auditors
understanding of the internal control structure of the
client. Based on the understanding of internal control,
the auditor assess risk and determines the appropriate
audit approach.

Phases of the Audit Process

4. Substantive testing gathering of
evidence by performing substance audit
procedures
5. Completing the audit wrapping-up
procedures and review of audit conclusions
prior to issuance of the audit report
6. issuance of audit report preparation and
issuance of the audit report
7. post audit responsibilities - debriefing

Terms of Engagement
Engagement Letter - documents and
confirms the auditors acceptance of the
appointment , the objective and scope of the
audit, the extent of his responsibilities to the
client and the form of any reports

Principal contents of an
Engagement Letter
Please see on your reference book

Changes in the terms of

engagement
A request from the client for the auditor to
change the engagement may result from:
1. a change in circumstances affecting the
need for the service
2. a misunderstanding as to the nature of an
audit or related service originally requested
or
3. a restriction on the scope of the
engagement, whether imposed by
management or caused by cir

Audit Planning
The audit work is to be adequately planned and
assistants, if any are to be properly supervised.
Audit planning involves the following activities
1. Obtaining an understanding of the client and
its environment
Understanding the entity and its environment
including its internal control
Enables the auditor to identify the events,
transactions, and practices that significantly
affect the FS under audit.
Provides an overview about the possible causes
and sources of misstatements

Audit Planning
2. Determining the need for experts
The auditor considers whether the clients
line of business involves certain matters that
would require the knowledge of professionals
from other disciplines
3. Establishing materiality and assessing risk
The auditor establishes the preliminary
judgment about materiality and makes
preliminary assessments of inherent risk and
control risk.

Audit Planning
4. Assessing the possibility of non-compliance
PSA state that when designing and performing audit procedures and
in evaluating and reporting the results thereof, the auditor should
recognize that noncompliance by the entity with laws and regulations
may materially affect the FS
5. Identifying related parties (subsidiaries)- identified because related
parties transactions are usually not conducted at arms length
Related parties includes:

Affiliates of the clients

Investee companies using equity method
Trust for the benefits of the employees
Principal owners of the enterprise
Management and immediate families of the principal owners of the client

Audit Planning
6. Performing preliminary analytical procedures
PSA 520 on Analytical Procedures
Involve the evaluation of FS through a study of
plausible relationship among both financial and
non financial data.
Helps strengthen the auditors understanding of
the clients business transactions and help
identify potential problem areas within the FS

Audit Planning
7. Development of the overall audit strategy
and detailed audit plan
Auditor now develops the audit strategy ( the
approach to be taken in order to effectively
achieve the objective
Strategy must be converted into a more
detailed audit plan contains the action points
to be performed In order to implement the
strategy.

Audit Planning
8. Preparation of preliminary audit programs
Audit programs contain the procedures to be
performed for each account or classes of
transactions
Subject to change depending results of
consideration of internal control

Study and Evaluation of Internal

Controls
PSA 315 - requires auditor to obtain and
understanding of the clients internal control
structure. On recurring engagement, the
auditor should focus on aspects of the
control structure that have been added,
changed or assumed increased importance
since the previous audit

Five steps in the study and

evaluation of internal control

1. Obtain and document an understanding of

internal control
2. Make a preliminary assessment of control risk
3. Determine the auditors response to the risk
assessment
4. Reassess control risk - Test control confirm the
preliminary risk assessment controls are effective
5. Determine the nature, extent and timing of
substantive tests
6.

Substantive Testing (Evidence

Gathering)
- includes inquiry, observation, inspection,
confirmation , recalculation tests, analyses of
many types and analytical reviews,

Description of Substantive
Tests
Audit
Procedures

Description

Test of details

Involve the examination of items or

details that comprise an account
balance (test of balances) or class of
transactions (test of transactions)
Every audit involves the performance
of test of details

Substantive analytical
procedures

Applied specifically for the purpose of

testing the reasonableness of account
balances and identifying significant
fluctuations or differences which may
require further audit investigation.
Substantive analytical procedures
require less time and effort, but are
also less reliable as compared to test
of details.
Substantive analytical procedures are

Reporting of Audit Findings

The auditor considers the nature of the audit
findings
And the circumstances of the engagement.
Irregularities the auditor considers the
likelihood of management involvement
Report the matter to a level of clients
organizations