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AC17&18:ASSURANCEPRINCIPLES,PROFESSIONALETHICSANDGOODGOVERNANCEREVIEWER ALAMO, MARK JOSEPHS.AC17&18: ASSURANCE PRINCIPLES,PROFESSIONAL ETHICS ANDGOODGOVERNANCE AUDIT –ANOVERVIEW THE PROFESSIONALSTANDARDS THE AUDITOR’SRESPONSIBILITY THE AUDIT PROCESS – ACCEPTINGANENGAGEMENT AUDIT...

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AC17&18: ASSURANCE PRINCIPLES, PROFESSIONAL ETHICS AND GOOD GOVERNANCE REVIEWER ALAMO, MARK JOSEPH S.

AC17&18: ASSURANCE PRINCIPLES, PROFESSIONAL ETHICS AND GOOD GOVERNANCE             

AUDIT – AN OVERVIEW THE PROFESSIONAL STANDARDS THE AUDITOR’S RESPONSIBILITY THE AUDIT PROCESS – ACCEPTING AN ENGAGEMENT AUDIT PLANNING CONSIDERATION OF INTERNAL CONTROL AUDITING IN AN COMPUTERIZED ENVIRONMENT PERFORMING SUBSTANTIVE TESTS AUDIT SAMPLING COMPLETING THE AUDIT AUDIT REPORTS ON FINANCIAL STATEMENTS ASSURANCE AND RELATED SERVICES THE CODE OF ETIHICS AND REPUBLIC ACT 9298

AUDIT – AN OVERVIEW “An audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to interested users.” – AASC Types of Audit 1. Financial Statement Audit – audit conducted to determine whether the FSs of an entity are fairly presented with an identified financial reporting framework. (Conducted by EXTERNAL AUDITORS) 2. Compliance Audit – a review of an organization’s procedures to determine whether the organization adhered to specific procedures, rules, contracts, or regulations. (Conducted usually by GOVERNMENT AUDITORS) 3. Operational Audit – study of a specific unit of the organization for the purpose of measuring its performance. (Conducted usually by INTERNAL AUDITORS) The Independent Financial Statement Audit   

MANAGEMENT is responsible for preparing and presenting the FSs in accordance with the financial reporting framework. The AUDITOR’S RESPONSIBILITY is to form and express an opinion on the FSs based on his audit. An audit conducted with PSA is designed to provide only REASONABLE ASSURANCE that the FSs taken as a whole are free from material misstatements.

Limitations of an Audit 1. Sampling Risk/ Use of Testing 2. Error in Application of Judgment/ Non-sampling risk 3. Reliance on Management’s Representation

4. Inherent Limitations of the Client’s Accounting and Internal Control Systems 5. Nature of Evidence

General Principles Governing the Audit of Financial Statements 1. Code of Professional Ethics 2. Philippine Standards on Auditing (PSA)

3. Attitude of Professional Skepticism

Need for an Independent Financial Statement Audit 1. 2. 3. 4.

Conflict of Interest Expertise Remoteness Financial Consequences

Theoretical Framework of Auditing (Assumptions or Ideas that Support the Audit Function) 1. 2. 3. 4. 5. 6. 7.

Financial Data are Verifiable Independence No Long-Term Conflict Effective Internal Control Consistent application of GAAP/PFRS Continuity Benefits the Public

THE PROFESSIONAL STANDARDS Generally Accepted Auditing Standards (GAAS) It represents measures of the quality of auditor’s performance. These standards should be looked as MINIMUM STANDARD of performance that auditors should follow. General Standards

Standards of Fieldwork

Technical Training and Proficiency

Planning

Standards of Reporting GAAP

Independence

Internal Control Consideration

Inconsistency

Professional Care

Evidential matter

Disclosure Opinion

PHILIPPINE STANDARDS ON AUDITING (PSA) The Philippine Standard on Auditing (PSA) establishes the independent auditor’s overall responsibilities when conducting an audit of financial statements in accordance with PSAs. These are issued by AASC as interpretations to GAAS. Practice Statements – are additions to these standards to provide practical assistance to auditors in implementing the standards and to promote good practice in the accountancy profession. SYSTEM OF QUALITY CONTROL Quality controls are policies and procedures adopted by CPAs to provide reasonable assurance of conforming to professional standards in performing audit and related services. Elements of Quality Control (PSA 220) 1. Leadership Responsibilities for Quality on Audits 2. Ethical Requirements (Integrity, Objectivity, Professional Competence & Due Care, Confidentiality, Professional Behavior) 3. Independence 4. Acceptance and Continuance of Client Relationships 5. Human Resources and Assignment (Recruitment, Performance evaluation, Capabilities, Career Dev’t, Engagement Team Assignment) 6. Engagement Performance (Direction, Supervision, Review, Consultation, Engagement Quality Control Review, Differences of Opinion) 7. Monitoring QUALITY CONTROL REVIEW The government thru the Professional Regulatory Board of Accountancy (BOA) has required all CPA firms and individual CPA firms and individual CPAs in public practice to obtain a certificate of accreditation to practice public accountancy. Quality Review Committee (QRC) – created by PRC which shall conduct a quality review on applicants for registration to practice public accountancy.

AUDITOR’S RESPONSIBILITY The auditor’s responsibility is to design the audit to provide reasonable assurance of detecting material misstatements in the FSs. These misstatements may emanate from:  Error  Fraud  Noncompliance with Laws and Regulations ERROR – refers to unintentional misstatements in the financial statements Examples: Mathematical or clerical mistakes, incorrect accounting estimates, mistake in application of accounting policies FRAUD – refers to intentional act by one or more individuals among management, employees, or third parties which results in misrepresentation of financial statements. Types of Fraud: 1. Management Fraud/ Fraudulent Financial Reporting – involves intentional misstatements or omissions of amounts or disclosures, usually done by members of management or those charged with governance. Examples: manipulation of documents or records, misrepresentation of effects of transactions, recording of transactions w/o substance, intentional application of accounting policies 2. Employee Fraud/ Misappropriation of assets – fraud that is accompanied by false or misleading records in order to conceal the fact that assets are missing. Examples: embezzling receipts, stealing entity’s assets, lapping of AR RESPONSIBILITY OF MANAGEMENT AND THOSE CHARGED WITH GOVERNANCE (PSA 240) Management – to establish a control environment and to implement internal control policies designed to ensure the DETECTION AND PREVENTION of fraud and error. Individuals charged with governance – to ensure the integrity of entity’s accounting and financial reporting systems AUDITOR’S RESPONSIBILITY: The auditor is not and cannot be held responsible for the prevention of fraud and error. The auditor’s responsibility is to design the audit to obtain reasonable assurance that the FS are free from material misstatements whether caused by error or fraud. PLANNING PHASE

TESTING PHASE

3. Perform procedures necessary to 1. Make inquiries of about determine whether material management misstatements exist. f misstatement e risk that fraud/error may cause the FS to contain material 4. Consider whether such a nts. misstatement resulted from error or fraud. (Errors will only result to adjustment of FS but fraud may have other implications on an audit)

COMPLETION PHASE

5. The auditor should obtain a written representation from the client’s management 6. When the auditor believes that material error/fraud exists, he should request the mgmt. to revise the FS. 7. If the auditor is unable to evaluate the effect of fraud on FS, the auditor should either qualify or disclaim his opinion on the FS.

FRAUD RISK FACTORS RELATING TO MISSTATEMENTS RESULTING FROM FRAUD FRAUDULENT FINANCIAL REPORTING (MANAGEMENT FRAUD) 1. Management’s Characteristics and Influence Over Control Environment  These fraud risk factors pertain to 5mgmt.’s abilities, pressures, styles, and attitude relating to internal control and financial reporting process. (Ex.: non-financial 5mgmt. participates excessively, high turnover of 5mgmt.., etc.) 2. Industry Conditions  These fraud risk factors involve the economic and regulatory environment in which the entity operates. (Ex.: new accounting/statutory req. that impairs financial stability of the entity) 3. Operating Characteristics and Financial Stability  These fraud risk factors pertain to the nature and complexity of the entity and its transactions, the financial condition, and profitability. (Ex.: inability to generate cash flows while reporting earnings)

MISAPPROPRIATION OF ASSETS (EMPLOYEE FRAUD) 1. Susceptibility of Assets to Misappropriation - These fraud risk factors pertain to the nature of an entity’s assets and the degree to which they are subject to theft. (Ex.: large amount of cash on hand, inventory characteristics, easily convertible assets, etc.) 2. Controls - These fraud risk factors involve the lack of controls designed to prevent or detect misappropriation of assets. (Ex.: lack of appropriate 5mgmt. oversight, inadequate record keeping of assets, poor physical safeguards, lack of timely documentation for transactions)

NONCOMPLIANCE WITH LAWS AND REGULATIONS – refers to acts or commission by the entity being audited, either intentional or intentional, which are contrary to the prevailing laws or regulations. Examples: Tax evasion, violation of environmental protection laws, inside trading of securities, violation of SEC requirements MANAGEMENT’S RESPONSIBILITY (PSA 250) – to ensure that the entity’s operations are conducted in accordance with laws and regulations. The responsibility for the prevention and detection of noncompliance rests with management. AUDITOR’S RESPONSIBILITY: An audit cannot be expected to detect noncompliance with all laws and regulations. Nevertheless, the auditor should recognize that noncompliance by the entity with laws and regulations may materially affect the FS. PLANNING PHASE

TESTING PHASE

COMPLETION PHASE

4. When the auditor is aware 1. Obtain a general 6. The auditor should obtain a written concerning instance of the legal from the client’s representation ramework of noncompliance, evaluate management. tity the possible effect on the FS. dures to help identifyinstancesof noncompliance with laws and believes that there is When the auditor noncompliance, auditor should request the mgmt. to revise the FS. Otherwise, a qua 5. When the the auditor believes there maybe noncompliance, the Ifauditor a scope should limitation has precluded document the the auditor from obtaining sufficient appropriate evide qualified opinion or a disclaimer of opinion. findings, discuss them with 3. Design audit procedures to mgmt. and consider the obtain audit sufficient appropriate implication on other aspects of evidence about the audit. compliancewithlaws and regulations  

Auditors are primarily concerned with the noncompliance what will have a direct and material effect in the FS. Noncompliance may involve conduct designed to conceal it such as collusion, forgery, senior 5mgmt. override of controls, failure to record transactions, or intentional misrepresentations being made to auditor.

THE AUDIT PROCESS – ACEEPTING AN ENGAGEMENT FINANCIAL STATEMENT ASSERTIONS Assertions about classes of Assertions about account balances at transactions and events for the the period end: period under audit:  Completeness  Rights and Obligations  Occurrence  Existence  Cutoff  Completeness  Valuation and allocation  Accuracy  Classification

Assertions about presentation and disclosure:    

Completeness Occurrence and rights and obligations Classification and understandability Accuracy and valuation

AUDIT PROCEDURES The procedures selected should enable the auditor to gather sufficient appropriate evidence about a particular assertion.  Inspection – involves examining of records, documents, or tangible assets.  Observation – consists of looking a process or procedure being performed by others.  Inquiry – consists of seeking information from knowledgeable persons inside or outside the entity.  Confirmation – consists of the response to an inquiry to corroborate information contained in the accounting records.  Computation – consists of checking the arithmetical accuracy of source documents and accounting records or performing independent calculations.  Analytical Procedures – consist of the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from particular amounts. Audit evidence – refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence will comprise source documents and accounting records underlying the financial statements and corroborating information from other sources. ISSUING A REPORT COMPLETING THE AUDIT

OVERVIEW OF THE AUDIT PROCESS

Forms a conclusion on FS (in the form of opinion)

Satisfy that the evidence gathered is consistent with auditor’s report.

PERFORMING SUBSTANTIVE TESTS Examination of documents and evidences supporting the amounts and disclosures in the FS

CONSIDERING INTERNAL CONTROL Obtaining understanding of entity’s control systems and assessing level of control risk

AUDIT PLANNING ACCEPTING AN ENGAGEMENT Evaluation of auditor’s qualification and auditability of prospective client’s FS

Obtaining detailed knowledge about the entity and preliminary assessment of risk and materiality

ACCEPTING AN ENGAGEMENT In deciding whether to accept or reject an engagement, the firm should consider: 1. Competence – acquired through a combination of education, training, and experience. The auditor should obtain a preliminary knowledge of client’s business and industry to determine whether the auditor has the degree of competence required by the engagement. 2. Independence – the auditor should consider whether there are threats to audit team’s independence and objectivity and, if so, whether adequate safeguards can be satisfied. 3. Ability to serve the client properly – An engagement should not be accepted if there are no enough qualified personnel to perform the audit. PSA 220 suggests that the audit work should be assigned to personnel who have the appropriate capabilities, competence, and time to perform the audit engagement in accordance with professional standards. 4. Integrity of the management – PSA 220 requires the firm to conduct a background investigation of the prospective client in order to minimize the likelihood of association with clients whose mgmt. lacks integrity. This involves:  Making inquiries of appropriate parties in the business community  Communicating with the predecessor auditor RETENTION OF EXISTING CLIENTS  Clients should evaluate at least once a year or upon occurrence of major events such as changes in mgmt., ownership, nature of client’s business, etc.  In general, conditions that would cause the firm to reject the prospective client may also lead to decision of terminating an audit engagement. ENGAGEMENT LETTER  This serves as the written contract between the auditor and the client. This letter sets forth:  The objective of the audit of FS which is to express an opinion on the FS.  The mgmt.’s responsibility for the fair representation of the FS.  The scope of the audit.  The forms or any reports or other communication that the auditor expects to issue.  The fact that because of limitations of the audit, there is an unavoidable risk that material misstatements may remain undiscovered.  The responsibility of the client to allow the auditor to have unrestricted access to whatever records, documentation, and other information requested in connection with the audit.  Billing arrangements  Expectations of receiving mgmt. representation letter.  Arrangements concerning the involvement of others (experts, other auditors, internal auditors, etc.)  Request for the client to confirm the terms of the engagement  Importance of the engagement letter – (1) to avoid misunderstanding with respect to the mgmt. and (2) document and confirm the auditor’s acceptance of the appointment  Recurring audits – the auditor does b=not normally send new engagement letter every year, unless (1) client misunderstands the objective and scope of audit, (2) revised or special terms of the engagement (3) recent change of senior mgmt., (4) significant change in nature or size of business (5) legal and gov’t pronouncements  Audit of components – the auditor will consider the factors whether they will send a separate letter to component: (1) who appoints the auditor of component, (2) whether a separate audit report is to be issued on the component, (3) legal requirements, (4) the extent of any work performed by other auditor (5) degree of ownership by parent, (6) degree of independence of the component’s mgmt.

AUDIT PLANNING Audit planning – involves developing a general audit strategy and a detailed approach for the expected conduct of the audit. The auditor’s main objective in planning the audit is to determine the scope of the audit procedures to be performed. PSA 315 requires the auditor to obtain sufficient understanding of the entity and its environment including the internal control. Such understanding involves obtaining knowledge of entity’s:  Industry, regulatory, and other external factors, including financial reporting framework  Nature of the entity  Objectives and strategies and the related risks that may result in material misstatement of FS  Measurement and review of entity’s performance  Internal control Additional Consideration on New Engagements PSA 510 requires the auditor to obtain sufficient appropriate audit evidence that:  The opening balances do not contain misstatements that materially affect the current year’s FS  The prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, have been restated  Appropriate accounting policies are consistently applied or changes in accounting policies have been properly accounted for and properly disclosed Developing an Overall Audit Strategy The best strategy is the approach that results in the most efficient audit – that is, an effective audit performed at the least possible cost. An audit plan should be made regarding:  How much evidence to accumulate  How and when this should be done When developing an audit strategy, the auditor must consider carefully the appropriate levels of materiality and audit risk. MATERIALITY  “Information is material if its omission or misstatement could influence the economic decision of users”  In designing an audit plan, the auditor should make a preliminary estimate of materiality.  Materiality may be viewed as: (1) the largest amount of misstatement that the auditor could tolerate in the FS or (2) the smallest aggregate amount that could misstate the FS  There is an inverse relationship between materiality and evidence.  Use of materiality: (1) in the planning stage, to determine the scope of the audit and (2) in the completion stage, to evaluate the effect of misstatements in the FS  Using materiality levels: Step 1. Determine the Overall Materiality – Financial Statement Level* PLANNING STAGE Step 2. Determine the Tolerable Misstatement – Account Balance Level** Perform audit procedures Step 3. Compare the aggregate amount of misstatements with overall materiality COMPLETION STAGE * Common method of estimating materiality at FS level is statement base (total assets, sales, etc.) x certain % ** Also known as performance materiality. This process is highly subjective and requires the exercise of great deal of auditor’s judgment  Bases that can be used to determine materiality level: alternative for annual FS if not available – annualized interim FS, prior year’s FS, budgeted FS for the current year

AUDIT RISK  AUDIT RISK refers to the risk that the auditor gives an inappropriate audit opinion on the FS. This occurs because the auditor believ...