Audit of Historical Financial Information PDF

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Audit of Historical Financial Information SOURCES: Philippine Framework for Assurance Engagements, PSA 120, PSA 200, Public Accountancy Profession (Cabrera 2013-2014 Edition)

AUDITING - Defined by the American Accounting Association, 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. 1. Systematic process – auditing involves structured/logical series of sequential steps or procedures known as the audit process. 2. Objectively obtaining and evaluating evidence – auditing involves gathering and evaluating sufficient appropriate audit evidence that will support the auditor’s opinion ○ Objectivity refers to the combination of impartiality, intellectual honesty and freedom from conflicts of interest. ○ Audit evidence is the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. 3. Assertions about economic actions and events – assertions are the subject matter of auditing ○ In the context of audit of financial statements, assertions are representations of management, explicit or otherwise, that are embodied in the financial statements. Assertions include the accounts, balances/amounts and disclosures appearing on the face of the financial statements (and in the notes to financial statements) and which the management claims to be free of misstatements. ○ Audit evidence gathered and evaluated by the auditor may support or contradict the assertions of management. 4. Established criteria – the standards or benchmarks that are needed to judge the validity of the assertions on the financial statements. ○ In the context of audit of financial statements, the established criteria are the applicable financial reporting framework (for example, the PFRS). 5. Ascertain the degree of correspondence between assertions and established criteria – The auditor’s objective is to determine whether the assertions conform with established criteria, that is, whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework (such as the PFRS). 6. Communicating the results to the interested users – The ultimate objective of audit is the communication of audit findings/opinion on the fairness of the financial statements to interested users. ○ Communicating results is achieved through issuance of a written audit report which contains the audit opinion (or disclaimer of opinion).

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

Assurance, Attestation and Audit Services Distinguished -

Similarity: These services are often used interchangeably because they encompass the same decision-process Differences: Scope of services a. “Assurance services” is broader in scope and in concept than either auditing or attestation. It encompasses both audit and attestation services. Otherwise stated, attestation and audit services are subsets of assurance services. b. “Attestation services” is broader than audit because attest function is beyond historical FS. Attestation services cover even non-GAAP FS. c. Auditing, particularly FS audit, is a type of assurance and attestation service that involves examination of historical FS prepared in accordance with GAAP.

Types of Audits 1. According to objectives or nature of assertion. ● Financial statement audit – an audit conducted to determine whether the financial statements of an entity are fairly presented in accordance with an identified financial reporting framework (or PFRS) ○ An audit of financial statements is the type of audit most frequently performed by CPAs (due to the widespread use of audited financial statements) on a fee basis and for more than one client. Financial audit is also called: ■ External audit – because it is performed by external auditors, whether individual CPAs or CPA firms, who are not employees of the client ■ Independent audit – because the auditor is independent of the client subject to audit ■ Financial Audit ● Compliance audit: a review of an entity’s degree of compliance with applicable laws and rules/regulations or contracts; usually performed by government auditors. ● Operational audit involves a systematic review and evaluation of the specific operating units (or procedures, methods or activities) of an organization in relation to specified objectives for the purpose of measuring/assessing its performance in terms of efficiency and effectiveness of operations, identifying opportunities for improvement and making recommendations to improve performance (such as introduction of controls to reduce waste). - Also called performance audit or management audit - Usually performed by internal auditors - Efficiency relates to use of its resources, while effectiveness relates to accomplishing objectives. Major differences between financial and operational auditing:

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The financial audit is oriented to the past whereas an operational audit concerns performance for the future. The financial audit report is distributed to many readers whereas the operational audit report goes to a few managers. Financial audits are limited to matters that directly affect the financial statements whereas operational audits cover any aspect of efficiency and effectiveness.

2. According to types of auditor or their affiliation with the entity being examined: ● External / Independent Audit - performed by practitioners or independent CPAs who offer their professional services for a fee to various clients on a contractual basis - Independent or external auditors are not employees of the client - External audit complements internal audit ● Internal Audit - performed by the entity's own employees known as internal auditors. - internal auditors investigate and appraise the effectiveness and efficiency of operations and internal controls of the firm Internal auditing is defined as "an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes." Internal auditing includes the audit of: ● Financial and operating information ● Compliance with policies, plans, procedures, laws, regulations, and contracts ● The means of safeguarding assets and verifying their existence ● The economy and efficiency with which resources are employed; and ● Operations or programs to ascertain whether results are consistent with established objectives and goals and whether they are being carried out as prescribed. -

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Internal auditing is an appraisal control that measures and evaluates other controls. The increased complexity and sophistication of business operations have required management to rely on this appraisal control. Internal auditors review the adequacy of the company's internal control system primarily to ascertain whether the system provides reasonable assurance that the company's objectives and goals will be achieved efficiently and economically. a. Efficient performance implies the use of minimal resources to meet the company's objectives and goals. b. Economical performance is the accomplishment of objectives and goals at a cost commensurate with the task.

The overall objective of Internal Auditing is to assist the members of the organization, particularly management and board of directors, in the effective discharge of their responsibilities ●

Government Auditing - A governmental audit is typically designed to determine whether the auditee has complied with applicable laws and regulations. The scope of government audit may extend beyond FS audit to include: A. FS audit B. Performance Audit (includes: program results (effectiveness) audit and economy and efficiency audit) C. Compliance Audit

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Government auditors are required to prepare a written report on the entity's internal control and assessment of control risk made as part of a financial statement audit. The auditor's report should include the following: 1. The scope of the auditor's work in obtaining an understanding of the entity's internal control and in his/her assessment of control risk. 2. The entity's significant controls including those that are established to ensure compliance with laws and regulations that have a material impact on the financial statements. 3. The conditions, including the identification of material weaknesses, identified as a result of the auditor's work.

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The Government Auditing Standards require auditors to prepare a written report on the entity's internal control. This report should include the conditions, including the identification of material weaknesses, discovered as a result of the auditor's work. However, the report should not give any form of assurance on the design and effectiveness of the entity's internal control. Government auditors are required to obtain an understanding of the possible financial statement effects of laws and regulations having direct and material effects on amounts reported. Also, they are required to make an assessment whether management has identified such laws that might have such effects. The audit of a government program involves obtaining information about the costs, outputs, benefits, and effects of the program. Auditors attempt to measure the accomplishments and relative success of the program based on the actual intent of the legislation that established the program.

Objective, Scope and Limitations of Financial Statement Audit -

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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 identified financial reporting framework. The phrase used to express the auditor’s opinion is “present fairly, in all material respects”. A similar objective applies to the audit of financial or other information prepared in accordance with appropriate criteria. The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, in accordance with the framework. An audit conducted in accordance with PSAs and relevant ethical requirements enables the auditor to form that opinion. Scope of the Audit - The auditor’s opinion on the financial statements deals with whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. Such an opinion is common to all audits of financial statements. The auditor’s opinion therefore does not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity. - In some jurisdictions, however, applicable laws and regulations may require auditors to provide opinions on other specific matters, such as the effectiveness of internal control, or the consistency of a separate management report with the financial statements. Overall Objectives of the Auditor In conducting an audit of financial statements, the overall objectives of the auditor are: I. To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or 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 II. To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditor’s findings. In all cases of when reasonable assurance cannot be obtained and a qualified opinion in the auditor’s report is insufficient in the circumstances for purposes of reporting to the intended users of the financial statements, the PSAs require that the auditor disclaim an opinion or withdraw from the engagement, where withdrawal is legally permitted. Ethical Requirements Relating to an Audit of Financial Statements The auditor shall comply with relevant ethical requirements, including those pertaining to independence, relating to financial statement audit engagements.

The auditor is subject to relevant ethical requirements, including those pertaining to independence, relating to financial statement audit engagements. Relevant ethical requirements ordinarily comprise Parts A and B of the Code of Ethics for Professional Accountants in the Philippines (the Code of Ethics) related to an audit of financial statements together with national requirements that are more restrictive. Part A of the Code of Ethics establishes the fundamental principles of professional ethics relevant to the auditor when conducting an audit of financial statements and provides a conceptual framework for applying those principles. The fundamental principles with which the auditor is required to comply by the Code of Ethics are: ● Integrity ● Objectivity ● Professional competence and due care ● Confidentiality ● Professional behavior. Part B of the Code of Ethics illustrates how the conceptual framework is to be applied in specific situations. In the case of an audit engagement it is in the public interest and, therefore, required by the Code of Ethics, that the auditor be independent of the entity subject to the audit. The Code of Ethics describes independence as comprising both independence of mind and independence in appearance. The auditor’s independence from the entity safeguards the auditor’s ability to form an audit opinion without being affected by influences that might compromise that opinion. Independence enhances the auditor’s ability to act with integrity, to be objective and to maintain an attitude of professional skepticism. Professional Skepticism The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. Professional skepticism includes being alert to, for example: ● Audit evidence that contradicts other audit evidence obtained. ● Information that brings into question the reliability of documents and responses to inquiries to be used as audit evidence. ● Conditions that may indicate possible fraud. ● Circumstances that suggest the need for audit procedures in addition to those required by the PSAs. Maintaining professional skepticism throughout the audit is necessary if the auditor is, for example, to reduce the risks of: ● Overlooking unusual circumstances. ● Over generalizing when drawing conclusions from audit observations. ● Using inappropriate assumptions in determining the nature, timing, and extent of the audit procedures and evaluating the results thereof.

The auditor cannot be expected to disregard past experience of the honesty and integrity of the entity’s management and those charged with governance. Nevertheless, a belief that management and those charged with governance are honest and have integrity does not relieve the auditor of the need to maintain professional skepticism or allow the auditor to be satisfied with lessthan- persuasive audit evidence when obtaining reasonable assurance. Professional Judgment The auditor shall exercise professional judgment in planning and performing an audit of financial statements. Professional judgment is essential to the proper conduct of an audit. This is because interpretation of relevant ethical requirements and the PSAs and the informed decisions required throughout the audit cannot be made without the application of relevant knowledge and experience to the facts and circumstances. Professional judgment is necessary in particular regarding decisions about: ● Materiality and audit risk. ● The nature, timing, and extent of audit procedures used to meet the requirements of the PSAs and gather audit evidence. ● Evaluating whether sufficient appropriate audit evidence has been obtained, and whether more needs to be done to achieve the objectives of the PSAs and thereby, the overall objectives of the auditor. ● The evaluation of management’s judgments in applying the entity’s applicable financial reporting framework. ● The drawing of conclusions based on the audit evidence obtained, for example, assessing the reasonableness of the estimates made by management in preparing the financial statements. Professional judgment needs to be exercised throughout the audit. It also needs to be appropriately documented. In this regard, the auditor is required to prepare audit documentation sufficient to enable an experienced auditor, having no previous connection with the audit, to understand the significant professional judgments made in reaching conclusions on significant matters arising during the audit. Inherent Limitations of an Audit The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error. This is because there are inherent limitations of an audit, which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive. The inherent limitations of an audit arise from: ● The nature of financial reporting The preparation of financial statements involves judgment by management in applying the requirements of the entity’s applicable financial reporting framework to the facts and

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circumstances of the entity. In addition, many financial statement items involve subjective decisions or assessments or a degree of uncertainty, and there may be a range of acceptable interpretations or judgments that may be made. The nature of audit procedures There are practical and legal limitations on the auditor’s ability to obtain audit evidence. For example: - There is the possibility that management or others may not provide, intentionally or unintentionally, the complete information that is relevant to the preparation and presentation of the financial statements or that has been requested by the auditor. Accordingly, the auditor cannot be certain of the completeness of information, even though the auditor has performed audit procedures to obtain assurance that all relevant information has been obtained. - Fraud may involve sophisticated and carefully organized schemes designed to conceal it. Therefore, audit procedures used to gather audit evidence may be ineffective for detecting an intentional misstatement that involves, for example, collusion to falsify documentation which may cause the auditor to believe that audit evidence is valid when it is not. The auditor is neither trained as nor expected to be an expert in the authentication of documents. - An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given specific legal powers, such as the power of search, which may be necessary for such an investigation. The need for the audit to be conducted within a reasonable period of time and at a reasonable cost. - The matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive. Appropriate planning assists in making sufficient time and resources available for the...