Bicol University

College of Business, Economics, and Management

Department of Accountancy

AUDITING AND ASSURANCE PRINCIPLES MARK FRANCIS G. NG, CPA, MBA

ANALIZA O. PABILONA, CPA, MAEd

LECTURE GUIDE

OVERVIEW OF AUDITING AND THE AUDIT PROCESS

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THE PHILOSOPHY OF AN AUDIT
§ Auditing lends credibility to the financial statements.
§ When financial statements are audited, they more believable, credible, or reliable because of the assurance
given by auditing.
§ Auditing instills public confidence on the financial information.

DEFINITION OF AUDITING

The American Accounting Association defines auditing as “a systematic process of objectively obtaining and
evaluating evidence regarding assertions about economic actions and events to ascertain the degree of
correspondence between those assertions and established criteria and communicating the results to
interested users”.

Systematic process
ü auditing consists of a structured, logical, and organized series of steps and procedures.
ü the audit process is made up of a sequential series of steps that independent auditors follow to ensure that
the audit is conducted in an organized, effective, and efficient manner

Objectively obtaining and evaluating evidence

ü the bulk of the work of the auditor in the conduct of the audit
ü the auditor has to obtain or gather sufficient appropriate audit evidence and evaluate them through audit
tests and procedures to warrant the expression of an opinion
ü the auditor has to examine the bases for the assertions or representations made by management and
judiciously evaluate the results without bias or prejudice either in favor of or against the individual or entity
making the representations

Assertions about economic actions and events

ü assertions are the representations (whether express or implied) made by the individual or entity under audit
and comprise the subject matter (information) of auditing
ü these include information contained in the financial statements, internal operating reports, and tax returns
and are representations made by management as to the fairness of the financial statements

Degree of correspondence
ü the closeness or proximity with which the assertions made by management can be identified with established
criteria

Established criteria
ü criteria are “the benchmarks used to evaluate or measure the subject matter including, where relevant,
benchmarks for presentation and disclosure.”
ü in a financial statement audit, criteria are the standards against which the assertions or representations are
judged to warrant degree of correspondence

Communicating the results

ü the manifestation of an auditor’s attest function in an audit.
ü the final stage in the audit process is the issuance of the audit report or the communication of the audit
findings to the users
ü the auditor attests as to the degree of correspondence between the assertions of management with the
established criteria and thereby enhances and lends (or weakens) credibility of the representations or claims
made by management in the financial statements

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Interested users
ü these are the individuals or entities which use or rely on the auditor’s findings.
ü in the business environment, these users may include the stockholders, management, creditors, investors,
government agencies, and the public in general

FINANCIAL STATEMENT ASSERTIONS

§ To assert means “to tell the whole world”
§ In a financial statement audit, the auditor establishes the degree of correspondence between assertions and
established criteria
§ These assertions are in the form of representations made by management and are contained in the financial
statements.
§ the responsibility for the preparation and presentation of the financial statements ultimately rests
with management
§ management either expressly or impliedly makes representations in the financial statements in the form of
assertions
§ the task of the auditor is to test the fairness or reasonableness of these assertions and determine whether
they comply with the provisions of the Philippine Financial Reporting Standards (PFRS)

CLASSIFICATIONS OF FINANCIAL STATEMENT ASSERTIONS

• Existence. Assets, liabilities, and equity interests exist.
• Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity.
• Completeness. All transactions and events that should have been recorded have been recorded.
• Rights and obligations. Assets are the rights, and liabilities are the obligations, of the entity.
• Valuation or allocation. Assets, liabilities, equities, revenues, and expenses are included in the financial
statements at appropriate amounts; revenues, costs, and expenses are allocated to the proper accounting
periods; and any resulting valuation or allocation adjustments are appropriately recorded.
• Accuracy. Amounts and other data relating to recorded transactions and events have been recorded
appropriately.
• Cutoff. Transactions and events have been recorded in the correct accounting period.
• Classification. Transactions and events have been recorded in the proper accounts.
• Presentation and disclosure. Financial statement components are properly classified, described, and
disclosed

TRANSACTION CYCLES
§ Various accounts may exist in the financial statements of a company and it would be unrealistic for an auditor
to examine all these accounts and perform a 100% examination on them.
§ This is the reason why auditors usually narrow down the activities of the business under audit into
homogeneous classes called as transaction cycles
§ A class of transactions is a group of transactions of similar activities that are processed by the accounting
system in a similar manner and subject to similar control to ensure proper processing
§ A transaction cycle is all of the classes of transactions for a group of related business activities.
§ The division of the audit into transaction cycles makes the audit more manageable and aids in the assignment
of tasks to different members of the audit team

CLASSIFICATIONS OF TRANSACTION CYCLES

• Revenue/ Receipt Cycle
ü includes procedures and policies for obtaining orders from customers, approving credit, shipping
merchandise, preparing sales invoices, recording revenue and accounts receivable, and handling and
recording cash receipts
• Expenditure/ Disbursement Cycle
ü includes procedures for initiating purchases of raw materials, other assets or services; placing purchase
orders; inspecting goods upon receipt and preparing receiving reports; recording liabilities to suppliers;
authorizing payment; and making and recording cash disbursements
• Conversion Cycle
ü includes procedures for storing materials, placing materials into production, assigning production costs
to inventories, and accounting for the cost of goods sold
• Personnel/ Payroll Cycle
ü includes procedures for hiring, terminating, and determining pay rates; timekeeping; computing gross
payroll, payroll taxes and amounts withheld from gross pay; maintaining payroll records and preparing
and distributing paychecks

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 • Financing Cycle
ü includes procedures for authorizing, executing, and recording transactions involving purchase and sale
of marketable equity securities, temporary as well as long-term; fixed tangible assets (excluding
inventory); bank loans; leases; bonds payable; and capital stock

OBJECTIVE AND SCOPE OF A FINANCIAL STATEMENT AUDIT

(PSA 120, par. 11)

“The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial
statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.”

Expression of an opinion
§ This is the primary responsibility of the auditor in an audit
§ The auditor expresses an opinion as to the fairness or reasonableness of the financial statements and issues
a written audit report as the output of the audit
§ Note that the words fair and reasonable are used instead of correct. This is due to the fact that an audit has
certain limitations which preclude the practitioner from giving an absolute guarantee that the financial
statements are free from material misstatement
§ Rather, the auditor only provides reasonable assurance, which is a high but not absolute level of assurance,
and vouches as to the accuracy instead of correctness of the preparation and presentation of the financial
statements

In all material respects

§ This phrase emphasizes that the concept of materiality is recognized in the conduct of an audit
§ Materiality is viewed as a threshold or cutoff point instead of a mere quantitative figure which makes
information useful for decision making

Applicable financial reporting framework

§ This is the framework through which the financial statements are prepared
§ In the case of an audit, the applicable financial reporting framework is specifically the Philippine Financial
Reporting Standards (PFRS)

Taken as a whole
§ Although this phrase is not included in the objective of an audit, it should be emphasized that the opinion
expressed by the auditor is based on the financial statements taken as a whole, which means the entirety
of all the information contained in a complete set of financial statements
§ It should be noted with emphasis that the primary responsibility of the auditor lies in the expression of
an opinion on the financial statements taken as a whole
§ All other objectives of the auditor other than this is merely secondary
§ This means that an auditor cannot be sued for the identification of all fraud, errors, or noncompliance in the
conduct of an audit because this responsibility is only secondary, unless the auditor is asked to conduct a
fraud audit
§ Furthermore, the primary responsibility for the preparation and presentation of financial statements rests
with management

SCOPE OF A FINANCIAL STATEMENT AUDIT

§ refers to the audit procedures or tests the auditor decides to perform
§ in the observance of Generally Accepted Auditing Standards or GAAS, the auditor must exercise his judgment
in determining which auditing procedures are necessary in the circumstances to afford a reasonable basis for
his opinion

INFORMATION RISK
§ the risk that information is misstated or misleading
§ brought about by factors such as:
ü remoteness of information users from information provider – also called as agency problem
ü potential bias and motives of information provider
ü voluminous data
ü complex exchange transaction

REDUCING INFORMATION RISK

§ Allow users to verify information
§ User shares information risk with management
§ Have the financial statements audited

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CONCEPT OF THE AUDIT REPORT
§ the end product or output of the financial statement audit is the independent auditor’s report
§ the means through which the auditor provides reasonable assurance that the financial statements are fairly
stated
§ the manifestation of the practitioner’s attest function of communicating the results of the audit to interested
users
§ this report is uniform in format and suitably titled to avoid confusion regarding the level of assurance being
provided and to differentiate it from other reports which client management might include with the financial
statements
§ addressed to intended users, usually to the Board of Directors and/ or stockholders of the company under
audit

THE AUDIT OPINION

§ Manifests the attest function of an auditor
§ The assurance provided in the audit report is contained in the audit opinion expressed in the report
§ Ordinarily, the opinion expressed by the auditor is an unmodified opinion, which communicates that the
financial statements, taken as a whole, are presented fairly, in all material respects, in accordance with an
applicable financial reporting framework
§ There might be cases where an auditor expresses a modified opinion, and sometimes reaches a decision
that an opinion cannot be expressed, depending on the circumstances surrounding the audit

TYPES OF OPINION
§ Unmodified opinion (previously unqualified opinion)
§ Modified opinion
ü Qualified opinion
ü Adverse opinion

IMPORTANT NOTE:
§ A disclaimer of opinion is not an opinion
§ Instead, it is an expression of no opinion

INHERENT LIMITATIONS OF AN AUDIT

§ The use of selective testing
§ The inherent limitations of any accounting and internal control system
§ The fact that most audit evidence is persuasive rather than conclusive
§ The work undertaken by the auditor to form an opinion is permeated by judgment

OVERVIEW OF THE FINANCIAL STATEMENT AUDIT PROCESS

1. Determine that the three general standards have been met (GAAS)
2. Obtain a preliminary understanding of the client’s operations, business, and industry (PSA 315)
3. Decide whether to enter into the engagement with the client (PSA 210)
4. Plan the audit (PSA 300)
5. Obtain an understanding of the client and its internal control (PSA 315)
6. Assess the risks of misstatement and design further audit procedures (PSA 330)
7. Perform tests of controls
8. Perform substantive tests
9. Complete the audit
10. Form an opinion and issue the audit report (PSA 700)

“The hardest test in life is having the patience to wait for the right moment.”

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