Practical Auditing

Chapter 1
Auditing
is a systematic process by which a competent, independent person objectively
obtains and evaluates 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
interested users.
Overall Objective of the Independent
Auditor

1. To obtain reasonable assurance about whether the financial statements

as a whole are free from material misstatement, whether due to fraud o
error, thereby enabling the auditor to express an opinion on whether the
financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework; and

2. To report on the financial statements, and communicate as required by

the PSAs, in accordance with the auditor’s findings.
• *The purpose of the audit is to enhance the degree of confidence of intended
users in the financial statements.

• - The auditor must express an opinion whether the financial statements are
prepared, in all material respects, in accordance with an applicable financial
reporting framework.

• -Audit of financial statements is an assurance engagement

Ethical Requirements

• -must be based on PSA 220 “Quality Control for an Audit of Financial

Statements”
Conduct of an Audit of Financial
Statements

• -It must be in accordance with Philippine Standards on Auditing

• PSAs contain the basic principles and essential procedures together with
related guidance in the form of explanatory and other material, including
appendices.

• Philippine Auditing Practice Statements are also taken into consideration. It

provides interpretative guidance and practical assistance to auditors in
implementing PSAs.
Scope of an Audit of Financial
Statements

• -Refers to the audit procedures deemed necessary in the circumstances to

achieve the objective of the audit.

• -The auditor should not represent compliance with PSAs unless the auditor
has complied fully with all of the PSAs relevant to audit.

• -departure may be allowed in exceptional circumstances in order to achieve

the objective of the audit.
Professional Skepticism

• -The auditor should plan and perform an audit with an attitude of

professional scepticism recognizing that circumstances may exist that cause
the financial statements to be materially misstated.

• -auditors must make a critical assessment, with 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 and
responses to inquiries and other information obtained from management
and those charged with governance.
Reasonable Assurance

• An auditor conducting an audit in accordance with PSAs obtains reasonable

assurance that eh FS taken as a whole are free from material misstatement,
whether due to fraud or error.

• -accumulation of audit evidence necessary to conclude that there are no

material misstatements in the FS taken as a whole.
Limitation to Absolute Assurance

• The use of testing

• The inherent limitation of internal control

• The fact that most audit evidence is persuasive rather than conclusive.
The opinion of an auditor is permeated
by judgment as to:

• The gathering of audit evidences

• The drawing of conclusion based on the audit evidence

An audit is not a guarantee that the Financial statements are free from
material misstatement.
Audit Risk and Materiality

• Audit risk is the risk that the auditor expresses an inappropriate audit
opinion when the financial statements are materially misstated

• -the auditor should plan and perform the audit to reduce audit risk to an
acceptably low level that is consistent with the objective of an audit.

• -reduction of audit risk is attained by designing and performing audit

procedures to obtain sufficient appropriate audit evidence to be able to draw
conclusions on which to base an audit opinion.
Responsibility for the Financial
Statements

• Auditor is responsible for forming and expressing an opinion on the financial

statements, the responsibility for the preparation and presentation of the
financial statements in accordance with the applicable financial reporting
framework is that of the management of the entity, with oversight from
those charged with governance. The audit of financial statement does not
relieve management or those charged with governance of their
responsibilities.
Risk Based Audit Process
Risk-based audit model

– begins with assessment of the types and likelihood of misstatement in

account balances and then adjusts the amount and type of audit work to the
likelihood of material misstatement.

-views all activities in the organization in terms of risk to strategies and

objectives then in terms of plans and processes to mitigate the risk
Risk Based Audit Process
Account based audit

– the auditor obtains an understanding of control and assesses control risk for
particular types of errors and frauds in specific accounts and cycle.
Phase I. Risk Assessment

A. Performance of preliminary engagement activities to decide whether to

accept/continue and audit engagement.

B. Planning the audit to develop an overall audit strategy and audit plan.

C. Performance of risk assessment procedures to identify/assess risk of

material misstatement through understanding the entity
Phase II. Risk Response
A. Designing overall responses and further audit procedures to develop
appropriate responses to the assessed material misstatement.

B. Implementing responses to assessed risk of material misstatement to

reduce audit risk to an acceptably low level.
Phase III. Reporting
A. Evaluating the audit evidence obtained to determine what additional audit
work (if any) is required.

B. Forming an opinion based on audit findings and preparing the auditor’s

report.
Understanding the Audit Risk Model
Audit Risk – the risk that the auditor may give an unqualified opinion on
materially misstated financial statements.
-determined and managed by the auditor.

Engagement Risk – deals with whether the auditor wants to be associated with a
particular client including loss of reputation, inability of the client to pay the
auditor or financial loss because management is not honest and inhibits the audit
process.

Business Risk – affects the operations and potential outcomes of organizational

activities.

Financial Reporting Risk relates to the recording of transactions and the

presentation of the financial data in an organization’s financial statements.
Considerations

1. Audits involve testing or sampling and thus cannot provide absolute (100%)
assurance that the financial statements are free of material misstatements
without inordinately driving up cost of audits.
2. Not all clients are worth accepting.
3. Competition for clients among audit firm is high.
4. Auditors should understand society’s expectations of financial reporting to
reduce audit risk to an acceptably low level and therefore minimize lawsuits
that the users may possible bring forth.
5. Risky areas of a business must be identified by the auditors to determine which
account balances are more prone to material misstatements, how the
misstatements might occur and how a client might be able to cover them up.
6. Auditors need to develop approaches and methodologies to allocate overall
assessments of materiality to individual account balances because some
account balances may be more important users.
Observations that influences the
implementation of the audit risk model

• The better the company’s internal controls, the lower the likelihood of
material misstatement.

• Unusual or complex transactions are more likely to be erroneously recorded

than are recurring or routine transactions.

• The amount and persuasiveness of audit evidence gathered should vary

inversely with audit risk; i.e., lower audit risk requires gathering more
persuasive evidence.
AR = IR x CR x DR
Factors to consider in Implementing the
Audit Risk Model

1. High Risk activities

-Includes operations or events where a material misstatement could easily occur.

2. Existence of large non-routine transactions

-Identified significant related party transactions outside the entity’s

normal course of business are to be treated as giving rise to
significant risks.

3. Matters requiring judgment or management intervention

4. Potential for Fraud

Limitations of Audit Risk Model

a) Inherent risk is difficult to formally assess

b) The model treats each risk component as separate and independent when
in fact components are not independent.

c) Audit risk is judgmentally determined

d) Audit technology is not so fully developed that each component of the

model can accurately be assessed.
Practical Auditing
Chapter 2
Client Selection and Retention

• The firm shall implement policies and procedures for the acceptance and
continuance of client relationships and specific engagements, designed to
provide the form with reasonable assurance that it will only undertake or
continue relationships and engagements where the firm:
a. Is competent to perform the engagement and has the capabilities,
including time and resources, to do so;
b. Can comply with relevant ethical requirements; and
c. Has considered the integrity of the client, and does not have information
that would lead it to conclude that the client lacks integrity.
Activities prior to starting an initial
audit:

a. Performing procedures regarding the acceptance of the client relationship

and the specific audit engagement; and

b. Communicating with the predecessor auditor, where there has been a

change of auditors, in compliance with relevant ethical requirements.
Establishing the preconditions for an
audit, auditor shall do the following:
a) Determine whether the financial reporting framework to be applied in the
preparation of the financial statements is acceptable; and
b) Obtain the agreement of management that it acknowledges and
understands its responsibility:
i) For the preparation of the financial statements in accordance with the
practicable financial reporting framework, including where relevant
their fair presentation;
ii) For such internal control as management determines is necessary to
enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error; and
iii)To provide he auditor with:
 Access to all information of which management is aware that is
relevant to the preparation of the financial statements such as
records, documentation and other matters;
 Additional information that the auditor may request from
management for the purpose of the audit; and
 Unrestricted access to persons within the entity from whom the
auditor determines is necessary to obtain audit evidence
Agreeing the Terms of Engagement
What should be included in the written
agreement:
a) The objective and scope of the audit of the financial statements
b) The responsibilities o the auditor
c) The responsibilities of management
d) Identification of the applicable financial reporting framework for the
preparation of the financial statements; and
e) Reference to the expected form and content of any reports to be issued by
the auditor and a statement that there may be circumstances in which a
report may differ from its expected form and content.

• If there are changes both the auditor and the client must agree to the
change and such change must be properly reflected in the engagement
letter.
If auditor and management did not agree
to a new term and auditor is precluded
from continuing the original
engagement, the auditor shall:
a. Withdraw from the audit engagement where withdrawal is possible under
applicable law or regulation; and

b. Determine whether there is any obligation, either contractual or otherwise,

to report the circumstances to other parties, such as those charged with
governance, owners and regulators.
PLANNING THE AUDIT
Nature and Scope of Audit Planning
• Audit planning involves the establishment of the overall audit strategy for
the engagement and developing an audit plan, in order to reduce audit risk
to an acceptably low level.

• Planning is a continuous and iterative process that often begins shortly after
or in connection with the completion of the previous audit and continues
until the completion of the current audit engagement.
Benefits of Audit Planning

1. It helps ensure that appropriate attention is devoted to important areas of

the audit.

2. It aids in identifying potential problems and resolving them on a timely

basis.

3. It helps ensure that the audit is properly organized, managed, and

performed in an effective and efficient manner.

4. It assists in the proper assignment and review of the work of the

engagement team members.

5. It helps coordinate the work to be done by auditors of components and

other parties involved such as experts, specialists, etc.
Overall Audit Strategy
The process of establishing audit
strategy:
a. Determining the characteristics of the engagement that define its scope

b. Ascertaining the reporting objectives of the engagement to plan the timing

of the audit and the nature of the communication required such as
i. Deadlines for interim and final reporting, and
ii. Key dates for expected communications wit management and those
charged with governance.

c. Considering the important factors that will determine the focus of the
engagement teams efforts such as
i. Determination of appropriate materiality levels
ii. Preliminary identification of areas where there may be higher risks of
material misstatement.
iii. Preliminary identification of material components and account balances.
iv. Evaluation of whether the auditor may plan to obtain evidence regarding
the effectiveness of internal control, and
v. Identification of recent significant entity-specific, industry, financial
reporting or other relevant developments
Other Benefits of Developing the Audit
Strategy

• -helps the auditor to ascertain the nature, timing and extent of resources
necessary to perform the engagement.
Consideration:

a) The resources to deploy for specific audit areas, such as the use of
appropriately experienced team members for high risk areas or the
involvement of experts on complex matters;
b) The amount of resources to allocate to specific audit areas, such as
i) The number of team members assigned to observe the inventory count at
material locations,
ii) The extent of review of other auditors’ work in the case of group audits, or
iii) The audit budget in hours to allocate to high risk areas;
c) When these resources are deployed, such as whether at an interim audit
stage or at key cut-off dates; and
d) How such resources are managed, directed and supervised, such as when
team briefing and defriefing meetings are expected to be held, how
engagement partner and manager reviews are expected to take place, and
whether to complete engagement quality control reviews.
Scope of the Audit Engagement
Some Considerations
• The financial reporting framework on which the financial information to be
audited has been prepared, including any need for reconciliations to another
financial reporting framework.
• Industry-specific reporting requirements such as reports mandated by industry
regulators.
• The expected audit coverage, including requirements such as reports mandated
by industry regulators.
• The nature of the control relationships between a parent and its components that
determine how the group is to be consolidated.
• The extent to which components are audited by other auditors
• The nature of the business segments to be audited, including the need for
specialized knowledge.
• The reporting currency to be used, including any need for currency translation
for the financial information audited.
Scope of the Audit Engagement
Some Considerations
• The need for a statutory audit of stand alone financial statements of the
auditor’s potential reliance on such work.

• The entity’s use of service organizations and how the auditor may obtain
evidence concerning the design or operation of controls performed by them.

• The expected use of audit evidence obtained in prior audits, for example,
audit evidence related to risk assessment procedures and tests of controls.

• The effect of information technology on the audit procedures, including the

availability of data and the expected use of computer-assisted audit
techniques.
Scope of the Audit Engagement
Some Considerations
• The coordination of the expected coverage and timing of the audit work with
any reviews of interim financial information and the effect on the audit of
the information obtained during such reviews.

• The discussion of matters that may affect the audit with firm personnel
responsible for performing other services to the entity.

• The availability of client personnel and data.

Reporting Objectives, Timing of the
Audit, and communications required
Considerations:
• The entity’s timetable for reporting, such as at interim and final stages.

• The organization of meetings with management and those charged with

governance to discuss the nature, extent and timing of the audit work.

• The discussion with management and those charged with governance

regarding the expected type and timing of reports to be issued and other
communications both written and oral, including the auditor’s report,
management letters and communications to those charged with governance

• The discussion with management regarding the expected communications on

the status of audit work throughout the engagement and the expected
deliverables resulting from the audit procedures.
Reporting Objectives, Timing of the
Audit, and communications required
Considerations:
• Communication with auditors of components regarding the expected types
and timing of reports to be issued and other communications in connection
with the audit of components.

• The expected nature and timing of communications among engagement

team members, including the nature and timing of team meetings and
timing of the review of work performed.

• Whether there are any other expected communications with third parties,
including any statutory or contractual reporting responsibilities arising from
the audit.
The Audit Plan
• The Audit plan is more detailed than the audit strategy and includes the
nature, timing, and extent of audit procedures to be performed by
engagement team members in order to obtain sufficient appropriate audit
evidence to reduce audit risk to an acceptably low level.
Audit plan includes:

• A description of the nature, timing and extent of planned risk assessment

procedures sufficient to assess the risk of material misstatement under PSA
315

• A description of the nature timing and extent of planned further audit

procedures at the assertion level for each material class of transactions,
account balance, and disclosure, as determined under PSA 330

• Such other audit procedures required to be carried out for the engagement in
order to comply with PSAs.
Changes to Planning Decisions
During the Course of the Audit
• -Audit strategy and plan should be updated and changed as necessary
during the course of the audit.
Direction, Supervision, and Review

• The auditor should plan e nature, timing and extent o direction and
supervision of engagement team and review their work.
Documentation

• The auditor should document the overall audit strategy and the audit plan,
including any significant changes made during the audit engagement.
• -overall audit strategy records the key decisions considered necessary to properly
plan the audit.
• -documentation of the audit plan is sufficient to demonstrate the planned nature,
timing and extent of risk assessment procedures, and further audit procedures at
the assertion level for each material class of transaction, account balance, and
disclosure in response to the assessed risks.
• -documentation of any significant changes to the originally planned overall audit
strategy and to the detailed audit plan includes the reasons for the significant
changes and the auditor’s response to the events, conditions or results of audit
procedures that resulted in such changes.
• -Form and extent of documentation depend on such matters as the size and
complexity of the entity, the extent of other documentation, and the
circumstances of the specific audit engagement.
Communication with Those Charged
with Governance and Management
• -may be required to be made

• -may be made to improve the effectiveness and efficiency of the audit

Additional Consideration in Initial Audit
Engagements

• Unless prohibited by law or regulation, arrangements to be made with the

previous auditor

• Any major issues discussed with management in connection with the initial
selection as auditors, the communication of these matters to those charged
with governance and how these matters affect the overall audit strategy and
audit plan.

• The planned audit procedures to obtain sufficient appropriate audit evidence

regarding opening balances – PSA 510

• The assignment of firm personnel with appropriate levels of capabilities and

competence to respond to anticipated significant risks.

• Other procedures required by the firm’s system of quality control for initial
audit engagements
Other Critical Matters in Engagement
Planning

1. Application of Analytical Procedures in Planning the Audit

-aimed to assist in understanding the business and in identifying areas of

potential risk

-Assists in planning the nature, timing and extent of audit procedures that
will be used for the specific accounts.

-Requirement of PSA 520

2. Establishment of an Engagement or Audit Team

-Audit team consists of people with different levels of expertise and

experience.
Other Critical Matters in Engagement
Planning

3. Consideration of Work Performed by Other Auditors/Parties

Considerations:

• The involvement of other auditors in the audit of components

• The involvement of experts

• The number of locations.

 Other Critical Matters in Engagement
Planning
a. Predecessor Auditor

-Auditors work may be greatly facilitated by consulting with predecessor auditor and reviewing their work.

-disclosure of confidential information obtained in the course of an audit without the consent of the client is
ethically prohibited.

b. Other CPAs

-when a portion the client is audited by another CPA firm, efforts may be coordinated.

c. Specialists

-CPAs may lack qualifications necessary to perform certain technical tasks relating to the audit.

-Specialist brings unique knowledge and judgment in a field other than accounting and auditing.

d. Use of Client’s staff

-understanding must be obtained as to the extent of which the client’s staff can help prepare for the audit.

e. Internal Auditors

-can affect the audit in enhancing internal control and in assisting during the performance of audit
procedures
Other Critical Matters in Engagement
Planning

4. Assessment of Going Concern Assumption

-appropriateness of the use of this assumption must be performed by the

auditor under PSA 570.
 Other Critical Matters in Engagement
Planning
Examples of Going Concern Issues

Financial

Net liability or net current liability position

Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive
reliance on short-term borrowings to finance long term assets.

indications of withdrawal of financial support by debtors and other creditors

Negative operating cash flows indicated by historical or prospective financial statements.

Adverse key financial ratios

Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.

Arrears or discontinuance of dividends

Inability to pay creditors on due dates

Inability to comply with the terms of loan agreements

Change from credit to cash-on-delivery transactions with suppliers

Inability to obtain financing for essential new product development or other essential investments
 Other Critical Matters in Engagement
Planning
Examples of Going Concern Issues

Operating

Loss of key management without replacement

Loss of a major market, franchise, license, or principal supplier

Labor difficulties or shortages of important supplies

Other

Non Compliance with capital or other statutory requirements

Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that are
unlikely to be satisfied.

Changes in legislation or government policy expected to adversely affect the entity.

Other Critical Matters in Engagement
Planning

5. Identification of Related Parties

-related party transactions are to disclosed in the FS if they are material.

-all related parties must be identified and included in the permanent files
early in the engagement.

6. Client’s Legal Obligations

Current year information that must be reviewed:

Minutes of director’s and stockholders’ meetings

Changes to articles of incorporation or by-laws

Any significant contracts executed during the year

Other Critical Matters in Engagement
Planning

7. Completion of the Initial Audit Program

-Audit program is a set of audit procedures specifically designed for each

audit.

-Includes both substantive tests and test of control

-should set out the nature, timing and extent of planned audit procedures
required to implement the overall audit plan.

-serves as instructions to assistants involved in the audit and as a means to

control and record the proper execution of the work.

-may also contain the audit objectives for each work area and a time budget

- it is required to have a written audit program

Other Critical Matters in Engagement
Planning
7. Completion of the Initial Audit Program

-things to consider

specific assessments of inherent and control risks

the required level of assurance

Timing of tests of controls and substantive testing

Coordination of assistance from the entity

Availability of assistants

Other matters

-Three stages

1) Broad phases of the program can be outlined at the time of engagement

2) Other details can be identified after the review of internal control structure and
accounting procedures has begun

3) Procedures on specific phases of the audit can be further challenged and revised as
the work progresses
Other Critical Matters in Engagement
Planning
8. Preparation of a Time budget

-it is an estimate of the total hours an audit is expected to take based on the information
gathered in the previous steps.

-Considerations:

The client’s size as indicated by its gross assets, sales, number of employees

Location of client facilities

The anticipated accounting and auditing problems

The competence and experience of staff available

Other Critical Matters in Engagement
Planning
9. Assignment of Personnel to the Engagement

-Assignment of personnel must be with standard in mind

-major consideration is the need for continuity from year to year

-familiarity with the client’s industry is also a consideration.

-PSA 220 states that the auditor, and assistants with supervisory responsibilities, will
consider the professional competence of assistants performing work delegated to them when
deciding the extent of direction, supervision and review appropriate for each assistant.

-any delegation of work to assistants would be in a manner that provides reasonable

assurance that such work will be performed with due care by persons having the degree of
professional competence required in the circumstances
Other Critical Matters in Engagement
Planning
10. Scheduling of Work

-interim procedures includes consideration of internal control, issuance of management letter

and substantive tests of transactions that have occurred to the interim date.

-Factors in considering near at year-end procedures:

a) Deadline for submitting final audit report and filing of income tax returns

b) Ability of the client’s staff to submit required schedules

c) Other audit clients

Planning a Repeat Engagement
• -refer to prior year audit program, changes may be introduced but you may copy
exactly what was done previously.
Special Considerations
• Special Consideration in the Audit of Small Entities (PAPS 1005)

• Consideration of Environmental Matters in the Audit of Financial Statements (PAPS

1010)

• a) The auditor’s main considerations in an audit of financial statements with

respect to environmental matters;

• b) Examples of possible impacts of environmental matters on financial

statements; and

• c) Guidance that the auditor my consider when exercising professional judgment

in this context to determine the nature, timing, and extent of audit procedures with
respect to:

• Understanding the entity and its environment and assessing the risks of
material misstatement (PSA 315);

• Consideration of laws and regulations (PSA 250); and

• Other substantive procedures (PSA 620 and some others)