Auditing and Assurance Principle (Lecture Notes) PDF

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Auditing and Assurance Principle CPA Subject

Chapter 1

Review of Corporate Governance Auditing and Assurance Principle CPA Subject

Review of Corporate Governance Corporate Governance Basis of why there is audit. Ensures all people processes activities are in place. To help ensure that there is a proper stewardship of the entity’s resources. Ensures that there is proper utilization of resources. Board of Director – body responsible for management oversight and to those charged with governance (BOD and Audit Committee) Stewardship Theory/Principal Agency Theory – Principal (stockholders); management provides reports and auditors are the link for the two users.

Corporate Governance Exist to create value for their stakeholders. Stakeholders are those parties interested to the business; whether internal or external users. Shareholders are those who invest money to buy a share of the company. All shareholders are stakeholders, but not all stakeholders are shareholders.

Terms Mission – why the company has been established; purpose Vision – dream for the company Objectives – from mission, vision and goals, you come up with objectives. Goals – SMART Strategies – strategies need to implement Processes – 5 business processes Transactions – processes have transactions; to capture every detail of the processes Controls – ideally, the number of transactions = number of controls Reports – must be capable of providing reports.

Code of Corporate Governance for Publicly-Listed Companies •

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Intended to raise the corporate governance standards of Philippine corporations to a level at par with its regional and global counterparts. A new feature of this Code is the adoption of the “comply or explain” approach. The Code does not in any way prescribe a “one size fits all framework”. The Principle of Proportionality will be considered in the application of its provisions. The code is arranged as follows: 1. Principle 2. Recommendations 3. Explanations

Corporate Governance (defined by the Code) The system of stewardship and control to guide organizations in fulfilling their long-term economic, moral, legal and social obligations towards their stakeholders. Its purpose is to maximize the organization’s long-term success, creating sustainable value for its shareholders, stakeholders, and the nation.

16 Principles and 5 Main Sections A. Board’s Governance Responsibilities 1. Establishing a Competent Board 2. Establishing Clear Roles and Responsibilities of the Board 3. Establishing Board Committees a. Audit Committees – mandatory for publicly listed and those with secondary licenses like banks and insurance. Audit Committee enhances the board’s oversight capability over the company’s financial reporting internal control system, internal and external processes and compliance with applicable laws and regulations. Must have finance, accounting and audit experience. b. Nomination Committees c. Compensation and Remuneration - independent d. Corporate Governance – If no 2, 3, and 4 committee, corporate governance can overtake e. Board Risk Oversight f. Related Party Transactions Committee

4. 5. 6. 7.

Fostering Commitment Reinforcing Board Independence Assessing Board Performance Strengthening Board Ethics

B. Disclosure and Transparency 8. Enhancing Company Disclosure Policies and Procedures. Should be made available for public use. 9. Strengthening the External Auditor’s Independence and Improving Audit Quality. Determine audit committee approved by shareholders 10. Increasing Focus on Non-financial and Sustainability Reporting. Environment, Society, and Government (ESG) 11. Promoting a Comprehensive and Cost-efficient Access to Relevant Information (in connection with Principle 10)

C. Internal Control System and Risk Management Framework 12. Strengthening the Internal Management Framework

Control

System

and

Enterprise

Risk

D. Cultivating a Synergic Relationship with Shareholders 13. Promoting Shareholder Rights

E. Duties to Stakeholders 14. Respecting Rights of Stakeholders and Effective Redress for Violation of Stakeholder’s Rights 15. Encouraging Employees’ Participation 16. Encouraging Sustainability and Social Responsibility

In general, the New Corporate Governance Code aims to: 1. 2. 3. 4.

Increase the responsibilities of the board. Ensure the competence and commitment of the directors. Strengthen the protection of shareholders and other stakeholders. Promote full disclosure and transparency in both financial and non-financial reporting.

Chapter 2

Introduction to Assurance and Auditing Services Auditing and Assurance Principle CPA Subject

Introduction to Assurance and Auditing Services Need for Assurance -

Potential Bias in providing information Remoteness between a user and the organization or trading partner Complexity of the transactions, information or processing systems

Potential Bias in providing information -

Sellers Management Inside information Compensation of management Stock options held by management

Remoteness of users -

Global Society Lack of personal interaction Can’t physically inspect goods Can’t interview management Can’t inspect facility Can’t review books and records

Assurance Services (or Assurance Management) -

Are three-party contracts in which assures reports on the quality of information Performed by CPAs are intended to enhance the credibility of information about a subject matter by evaluating whether the subjected matter conforms in all material respect with suitable criteria.

Scope of Assurance Services Assurance is a broad concept. Assurance services cover: -

A wide spectrum of services A more diverse group of users Greater potential users

Value of Assurance -

The assurance functions gives investors, creditors and users of information confidence in the accuracy of data. The value of assurance, then is in the confidence it generates in users of the information

Elements of Assurance Services 1. Three-party relationship: Practitioner, Intended users and management (responsible party); experts 2. Subject matters have different characteristics which may affect the precision which the subject matter can be evaluated or measured against criteria and the persuasiveness of available evidence. 3. Evidence. Professional skepticism to obtain sufficient (quantity) appropriate (quality: (1) relevance, and (2) reliability) information. • External is more reliable • Written is more reliable • inquiry is the least effective • direct and original copy is more reliable 4. Suitable criteria - established (PFRS) and specifically developed (company policies) a. Relevance (timely) b. Completeness c. Reliability (competent) d. Neutrality (free from bias) e. Understandability 5. Written report

Professional Skepticism -

Involving questioning mind Critical assessment of evidence Unbiased and being objective in making professional judgment Neither assume that client is honest or dishonest “I trust you, but I need to verify”

Assurance Report -

The practitioner provides a written report containing a conclusion that conveys the assurance obtained about the subject matter information. Two levels of assurance in an assurance service • Reasonable (but not absolute) level – positive, high • Limited level of assurance – negative, moderate • No assurance

Types of Assurance According to Structure 1. Assertion-based Engagements (Attestation) 2. Direct-reporting Engagements – no interference from the management

Limitations of Assurance Engagements -

Use of selective testing Inherent limitations of internal control Much of the evidence available is persuasive rather than conclusive Use of judgment Characteristics of subject matter (in some cases)

The Relationship Between Auditing, Attestation and Assurance Services

Services Auditing Attest Assurance

Value Added to Information Reported on Reliability, Credibility Reliability, Credibility Reliability, Credibility, Relevance, Timeliness

* All audits are assurance, but not all assurance services are auditing (or even attestation services)

Auditing Auditing is 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. * Recommendations makes the auditor more value-adding

Different Types of Audit Financial Statement Audit -

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Gathering of evidence on the assertions embodied on the FS of an entity and using the evidence to determine whether the assertions adhere to Philippine financial reporting framework or another comprehensive and authoritative financial reporting framework Sampling; materiality; most commonly performed type of audit The Special Role of FS Audit • The reliability of financial information • CPAs provide independent evaluations and reports • CPA career is one of the most important and most highly regarded public functions • Independence in mind – how you perceive yourself • Independence in fact – how the public perceive you

Compliance Audits -

Adhered to provisions of a contract, laws and regulations Similar nature as FS Audit Subject matter, processes

Operational Audits

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Efficiency, effectiveness and the economy of operations

Forensic Audits Government Audits

Management Representation Letter It is a required audit documentation, prepared by the management and sent to auditor.

Management Letter It is not required documentation, however publicly listed companies are required to have this documentation. The auditors prepare and sent to the management, this contains recommendation.

Types of Auditors 1. External Auditors • More independent than internal auditor • FS audit, Operational audit, Compliance audit 2. Internal Auditors • Independent appraisal function established within an organization • Operational audit, Compliance audit 3. Government Auditors • Can perform FS audit, Operational audit, Compliance audit 4. Forensic Auditors • Fraud detection Fraud detection is not required or the responsibility of FS auditor.

Objectives of Independent (understand and evaluate) Auditor in the audit of Financial Statements

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To obtain reasonable assurance whether the FS as a whole are free from material misstatement, whether due to fraud or error. To express an opinion on whether the FS are prepared, in all material respect, in accordance with an applicable financial reporting framework (PFRS).

Responsibilities of Management and those charged with Governance -

Preparation and presentation of the FS in accordance with the applicable financial reporting framework. Design, implementation and maintenance of internal control relevant to the preparation and presentation of FS. Provide the auditor with all information needed by the auditor in connection with the audit of FS. Unrestricted access to those within the entity from whom the auditor determines necessary to obtain sufficient appropriate evidence.

Limitation of the Audit -

The nature of financial reporting The nature of audit procedure Nature of audit evidence available Timeliness of financial reporting

Demand for Audit Business risk. Fails to achieve its objective Information risk -

Remoteness of information Biases and motives of the provider Voluminous Data Complex exchange transactions

How to reduce information risk

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Allow users to verify information Users share information risks to the management Have the FS audited

Principle Underlying an Audit Purpose of audit. Provide an opinion. Premise of audit.

Management has responsibility for preparing FS and providing auditor with all the needed information.

Professional skepticism of auditor. Competence, follow ethical requirements, maintain professional skepticism.

Auditor actions in audit.

Provide procedures to obtain reasonable assurance about whether FS are free from material misstatements.

Reporting results of an audit. Written report with an opinion, or a statement that an opinion cannot be obtained.

Diagram of an Audit

Chapter 3

Introduction to FS Audit Auditing and Assurance Principle CPA Subject

Introduction to FS Audit Objectives of Independent Auditor in the Audit of FS -

To obtain reasonable assurance about whether the FS as a whole are free from material misstatement, whether due to fraud or error. To express an opinion on whether the FS are prepared, in all material respect, in accordance with an applicable financial reporting framework.

Responsibilities of Management and Those Charged with Governance -

Preparation and presentation of the FS in accordance with the applicable financial reporting framework Design, implementation and maintenance of internal control relevant to the preparation and presentation of FS.

Basic Concepts Underlying a FS Audit -

Auditor Independence Professional Skepticism – how we decide or practice tamang-hinala in a professional way Conduct and Scope of an Audit Audit Evidence and FS Assertions Audit Materiality Audit Risk Professional Judgment – hallmark (experience and knowledge) of knowledge Inherent Limitations of an Audit

Professional Skepticism An auditor should be alert about: -

Audit evidence that contradicts other audit evidence obtained

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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

Conduct and Scope of and Audit in Accordance with PSAs -

The auditor shall comply with all PSAs relevant to the audit If compliance with PSA cannot be achieved, the auditor shall modify his opinion or withdraw from the engagement Scope of an audit refers to the audit procedures that, in the auditor’s judgment and based on the PSAs are deemed appropriate to achieve the objective of the audit.

Audit Evidence -

Audit evidence is all the information obtained and used by the auditor in arriving at the conclusions on which the audit opinion is based. The auditor should obtain sufficient appropriate audit evidence.

Management Assertions Auditor shall gather audit evidence regarding the assertions (representations) of management in their FS. Broadly speaking, assertions include:

Assertions (Account balances) 1. 2. 3. 4. 5.

Presentation and disclosure* Existence and occurrence Rights and obligations Completeness Valuation and allocation

Audit of liability – completeness should be the focus. Audit of assets – existence should be the focus.

Assertions (Classes of transactions and events) 1. 2. 3. 4. 5.

Occurrence Completeness Accuracy Classification Cut-off

Assertions (Presentation and Disclosure) 1. 2. 3. 4.

Occurrence and Rights & Obligations Completeness Accuracy and valuation Classification and understandability

Materiality -

Is a relative concept Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the FS. The assessment of what is material is a matter of professional judgment of the auditor.

Should we disclose the materiality level? No, but inform the management or the client about the materiality, not the threshold. Determine materiality as a whole. Basis: Pre-tax income, sales, assets; IF NPO – expenses; Start-up company – equity

Audit Risk -

The likelihood or possibility that the auditor expresses an inappropriate audit opinion when the FS are materially misstated. Audit risk may be assessed in either quantitative or non-quantitative terms. It is a function of the possibility (Detection) of Material Misstatement (Inherent and Control) and the possibility that the auditor will not detect such misstatement. Auditor uses judgment in establishing acceptable level of AR Lower acceptable level of AR achieved through obtaining more audit evidence

Components of Audit Risk 1. Risk of Material Misstatement a. Inherent Risk o The susceptibility of an assertion to a misstatement that could be material assuming that there were no related internal controls. o Beyond the control of the auditor and, generally, the management. o May be due to complexity of transactions or calculations, ease of theft, or lack of available objective information. o Assessed using various analytical techniques such as available information from the company and within the industry and even overall auditing knowledge. o Broad assessment, understand the company, industry and audit knowledge because there are different risk per account and assertion o Default o Based on the nature of the account o Exist independent of the audit b. Control Risk o The likelihood that a misstatement that could occur in an assertion and that could be material and will not be prevented, detected or corrected on a timely basis by the entity’s internal control. o Beyond the control of the auditor but within the control of entity o Internal control may be poorly designed or poorly executed o Assessed using the result of test of controls. o Exist independent of the audit 2. Detection Risk • The likelihood that the auditor will not detect a misstatement that exists in the FS. • Within the control of the auditor • Auditor may not properly plan audit procedures • The likelihood that the auditor’s procedures can lead to an improper conclusion that no material misstatement exist when in fact such material misstatement does exist. • Substantive procedures are primarily relied upon to restrict the detection risk. Auditors increase the nature, timing and extent of the substantive procedure to decrease the assessed level of detection risk. • Dependent on the auditor’s procedure performed

There is an inverse relationship between the risk of material misstatement and the detective risk.

Professional Judgment -

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In auditing, professional judgment is the application of relevant knowledge and experience, within 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. Professional judgment needs to be exercised throughout the audit like Professional skepticism. Application and exercise of professional judgment shall be appropriately documented. Hallmark of audit

Stages in Audit Process 1. 2. 3. 4. 5. 6. 7.

Pre-audit responsibilities Audit Planning Study and Evaluation of Internal Control Substantive Testing Completing the Audit Issuance of the Audit Report Post-audit responsibilities

Accepting the Engagement Requirements of PSQC 1 Accepting the Engagement -

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If the engagement partner obtains information that would have caused the firm to decline the audit engagement had that information been available earlier, the engagement partner shall communicate that information promptly to the firm, so the firm and the engagement partner can take the necessary action. (PAS 220) Things to consider with regards to accepting the client • As an auditor, do we have the necessary independence (mind and appearance) in performing the engagement

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