AUDITING THEORY SUMMARY PDF

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AUDITING THEORYASSURANCE, PRINCIPLES, PROFESSIONAL ETHICS & GOOD GOVERNANCEHANNAJ MAY BUENAVENTURAJUNE 8, 2020PROF. NORMAND MIRANDATable of Contents CHAPTER 1: AUDIT – AN OVERVIEW CHAPTER 2: THE PROFESSIONAL STANDARDS CHAPTER 3: AUDITOR’S RESPONSIBILITY CHAPTER 4: THE AUDIT PROCESS – ACCEPTI...

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AUDITING THEORY ASSURANCE, PRINCIPLES, PROFESSIONAL ETHICS & GOOD GOVERNANCE HANNAJ MAY BUENAVENTURA JUNE 8, 2020 PROF. NORMAND MIRANDA

Table of Contents CHAPTER 1: AUDIT – AN OVERVIEW ................................................................................................ 2 CHAPTER 2: THE PROFESSIONAL STANDARDS .............................................................................. 5 CHAPTER 3: AUDITOR’S RESPONSIBILITY ....................................................................................... 9 CHAPTER 4: THE AUDIT PROCESS – ACCEPTING AN ENGAGEMENT ........................................ 12 CHAPTER 5: AUDIT PLANNING ........................................................................................................ 18 CHAPTER 6: CONSIDERATION OF INTERNAL CONTROL ........................................................... 24 CHAPTER 7: AUDITING IN A COMPUTERIZED ENVIRONMENT ................................................ 29 CHAPTER 8: PERFORMING SUBSTANTIVE TESTS ......................................................................... 30 CHAPTER 9: AUDIT SAMPLING ....................................................................................................... 37

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CHAPTER 1: AUDIT – AN OVERVIEW Auditing Defined: •

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. (PSA: Philippine Standards on Auditing) •

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 these assertions and established criteria and communicating the

Comparison among the different types of audit

Established criteria

Objective: Content of the auditor’s report

Auditors who generally perform

Financial Audit That the financial statements are fairly presented

Compliance Audit That the organization has complied with laws, regulations or contracts

Financial reporting standards or other financial reporting framework An opinion about whether the financial statements are fairly presented in conformity with an identified financial reporting framework External auditors – independent CPA

Laws, regelation and contracts

Operational Audit That the organizations activities are conducted effectively and efficiently Objectives set by the board of directors

Reports on the degree of compliance with applicable laws, regulations and contracts

Recommendations on how to improve operations

Government auditors – government employees

Internal auditors – entity’s own employees

The Independent Financial Statement Audit •

Commented [HMDG2]: Without bias Commented [HMDG3]: Inquiry, observatio inspection external confirmation, documentation, recalculation, reperformance analytical procedure

results to interested users. (AAA: American Accounting Association)

Assertions made by the auditee

Commented [HMDG1]: Ordered and structured series of steps

Responsibility for the financial statements o Management – preparing and presenting the financial statements in accordance with the financial reporting framework o Auditor – to form and express an opinion on these financial statements.

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Commented [HMDG4]: Financial statemen Commented [HMDG5]: Representations made by the client management Commented [HMDG6]: Corroborates or refutes Commented [HMDG7]: Financial reporting framework Commented [HMDG8]: Audit findings Commented [HMDG9]: Internal: Owners, Managers, Employees External: Investors, Creditors, Suppliers, Customers, Government, General Public

•

Assurance provided An audit conducted in accordance with the Philippine Standards on Auditing (PSA) is designed t0 provide only reasonable assurance.

•

Factors resulting to Inherent Limitations of detecting material misstatements o Sampling Risk / The Use of Testing

Commented [HMDG10]: High but not absolute assurance that the financial statements taken as a whole are free from material statements

The possibility that the sample selected are not truly representative of the population being tested. o Non-Sampling Risk / Error in Application of Judgement The probability of arriving at an incorrect conclusion o Reliance on Management’s Representation Management may provide false representation causing the auditor to rely on unreliable evidence o Client’s Accounting and Internal Control Systems Collusion among employees or management’s circumvention of internal control o Nature of Evidence Audit evidence is generally persuasive rather than conclusive in nature. •

General principles governing the audit of financial statements o Code of Professional Ethics To retain public confidence in the credibility of the auditor’s work o Philippine Standards on Auditing Commented [HMDG11]: Management may provide overly optimistic or false financial information Users want unbiased, realistic financial statements

To assist auditors in interpreting and applying the auditing standards o Professional Skepticism An attitude that includes a questioning mind •

Need for an independent financial statement audit o Conflict of interest between management and users of financial statements o Expertise

Commented [HMDG12]: A qualified person is hired by users to verify the reliability of financial statements Commented [HMDG13]: Users do not have access to the entity’s records to verify the quality of the financial information

o Remoteness o Financial Consequences

Commented [HMDG14]: Misleading financial information could have substantial economic consequences for a decision maker PAGE 3

•

Theoretical Framework of Auditing o Audit function operates on the assumption that all financial data are verifiable It must have supporting documents or evidence to prove their validity o The auditor should always maintain independence with respect to the financial statement under audit Independence is essential for ensuring the credibility of auditor’s report o There should be no long-term conflict between the auditor and the client management Both must be interested in the fair presentation of the financial statement o Effective internal control system reduces the possibility of errors and fraud affecting the financial statements The entity’s internal control system directly affects the reliability of the financial statements o Consistent application of GAAP or PFRS results in fair presentation of financial statements The criteria are usually the PFRS o What was held true in the past will continue to hold true in the future in the absence of known conditions to the contrary Experience and knowledge accumulated in auditing a client in prior years can be used to determine the appropriate audit procedures that need to be performed o An audit benefits the public Users who rely on the financial statements are the primary beneficiaries of the financial statement audit

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Commented [HMDG15]: Postulates, assumptions or ideas

CHAPTER 2: THE PROFESSIONAL STANDARDS Generally Accepted Auditing Standards GAAS represents measures of the quality of the auditor’s performance.

Commented [HMDG16]: Minimum standar of performance that auditors should follow

Philippine Standards on Auditing (PSA) The Philippine Standards 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.

Commented [HMDG17]: General Standards •Training and Proficiency – gained through formal education, continuing education programs and experience. Auditors should stay current with the latest accounting and auditing pronouncements and developments with the business world. •Independence – precludes relationships that may impair the auditor’s objectivity. Independence in fact and appearance •Due Professional Care – auditors must no act negligently or in bad faith Standard of Fieldwork •Planning and Supervision – plan to ensure adequate, more effective audit and supervision because field work is done by less experienced staff •Internal Control Consideration – requires that the auditor gain sufficient understanding of an entity’s internal contr to effectively plan the scope - nature (what procedures are performed), timing (when audit work is done: interim or period end) and extent (how much work is done) of audit procedures •Evidential Matter – search for and evaluation of managements assertions Standard of Reporting The four reporting standards require the auditor to prepare a report on the financial statements taken as a whole, including informative disclosures.

System of Quality Control Quality Controls are policies and procedures adopted by CPA’s to provide reasonable assurance of conforming to professional standards in performing audit and related services.

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Commented [HMDG18]: It comprises methods used to ensure that the firm meets its professional responsibilities to clients and others.

Elements of Quality Control (PSA 220) 1. Leadership Responsibilities for Quality on Audits (“tone at the top”) – The firm should promote a culture that quality is essential in performing engagements and should establish policies and procedures that support that culture 2. Ethical Requirements a. Integrity. A professional accountant should be straightforward and honest in all professional and business relationships. b. Objectivity. A professional accountant should not allow bias, conflict of interest or undue influence of others to override professional or business judgments. c. Professional Competence and Due Care. A professional accountant has a continuing

Commented [HMDG19]: Example of a procedure: The firm’s training program emphasize the importance of quality work, and this is reinforced in performance evaluation and compensation decisions Commented [HMDG20]: Example of a procedure: Each partner and employee must answer an “independence questionnaire” annually, dealing with such things as stock ownership and membership on board of directors

duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques d. Confidentiality. A professional accountant should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose. e. Professional Behavior. A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession. 3. Independence

-

Independence

in

fact

indicates

that

the

auditor

possesses

an independent mindset when planning and executing an audit, and that the resulting audit report is unbiased. Independence in appearance indicates whether the auditor appears to be independent. 4. Acceptance and Continuance of Client Relationships – Policies and procedures should be established for deciding whether to accept or continue a client relationship to minimize the risk of associating with a client whose management lacks integrity. 5. Human Resources and Assignment - The firm should only undertake engagements that can be completed with professional competence

Commented [HMDG21]: Example of a procedure: A client evaluation form, dealing with such matters as predecessor auditor comments an evaluation of management, must be prepared for every new client before acceptance Commented [HMDG22]: Example of a procedure: Each professional must be evaluated on every engagement using the firm’s individual engagement evaluation report

a. Recruitment b. Performance Evaluation c. Capabilities d. Career Development

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e. Engagement Team Assignment 6. Engagement Performance – policies and procedures should exist to ensure that the work performed by engagement personnel meets applicable professional standards, regulatory requirements and the firm’s standards of quality a. Direction. Direction of the engagement team involves informing the members of the engagement team of matters such as: • Their responsibilities, including the need to comply with relevant ethical requirements, and to plan and perform an audit with professional skepticism. • Responsibilities of respective partners where more than one partner is involved in the conduct of an audit engagement. • The objectives of the work to be performed. • The nature of the entity’s business. • Risk-related issues. • Problems that may arise. • The detailed approach to the performance of the engagement. b. Supervision. Supervision includes matters such as: • Tracking the progress of the audit engagement. • Considering the competence and capabilities of individual members of the engagement team, including whether they have sufficient time to carry out their work, whether they understand their instructions and whether the work is being carried out in accordance with the planned approach to the audit engagement. • Addressing significant matters arising during the audit engagement, considering their significance and modifying the planned approach appropriately. • Identifying matters for consultation or consideration by more experienced engagement team members during the audit engagement c. Review. A review consists of consideration whether, for example: • The work has been performed in accordance with professional standards and applicable legal and regulatory requirements; • Significant matters have been raised for further consideration; • Appropriate consultations have taken place and the resulting conclusions have been documented and implemented; • There is a need to revise the nature, timing and extent of work performed;

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Commented [HMDG23]: Example of a procedure: The firm’s director of accounting and auditin is available for consultation and must approv all engagements before their completion

• The work performed supports the conclusions reached and is appropriately documented; • The evidence obtained is sufficient and appropriate to support the auditor’s report; and • The objectives of the engagement procedures have been achieved. d. Consultation. Effective consultation on significant technical, ethical and other matters within the firm or, where applicable, outside the firm can be achieved when those consulted: • Are given all the relevant facts that will enable them to provide informed advice; and • Have appropriate knowledge, seniority and experience. e. Engagement Quality Control Review. Matters that may be considered in an engagement quality review include: • Significant risks identified during the engagement and the responses to those risks including the engagement team’s assessment of, and response to, the risk of fraud • Judgments made, particularly with respect to materiality and significant risks. • The significance and disposition of corrected and uncorrected misstatements identified during the audit. f.

Differences of Opinion. If differences of opinion arise within the engagement team, with those consulted or, where applicable, between the engagement partner and the engagement quality control reviewer, the engagement team shall follow the firm’s policies and procedures for dealing with and resolving differences of opinion.

7. Monitoring – policies and procedures should exist to ensure that the other quality control elements are being effectively applied

Quality Control Review

Commented [HMDG24]: Example of a procedure: The quality control partner must test the quality control procedures at least annually t ensure the firm is in compliance

The government thru the Professional Regulatory Board of Accountancy (BOA) has required all CPA firms and individual CPAs in public practice to obtain a certificate of accreditation to practice public accountancy Quality Review Committee (QRC) is created by PRC which shall conduct a quality review on applicants for registration to practice public accountancy.

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Commented [HMDG25]: Valid for 3 years and can be renewed after complying with the requirements of BOA

CHAPTER 3: AUDITOR’S RESPONSIBILITY The auditor’s responsibility is to design the audit to provide reasonable assurance of detecting material misstatements in the financial statements. These misstatements may emanate from: •

Error – refers to unintentional misstatements in the financial statements, including the omission of an amount or a disclosure:

•

o

Mathematical or clerical mistakes in the underlying records and accounting data

o

An incorrect accounting estimate arising from oversight or misrepresentation of facts

o

Mistake in the 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 o

Fraudulent Financial Reporting or Management Fraud – involves intentional misstatements or omissions of amounts or disclosures in the financial statements to deceive financial statements users committed by management or those charged with governance: ▪

Manipulation, falsification or alteration of records or documents

▪

Misrepresentations in or intentional omission of the effects of transactions from records or documents

o

▪

Recording of transactions without substance

▪

Intentional misapplication of accounting policies

Misappropriation of Assets or Employee Fraud – theft of an entity’s assets committed by the entity’s employees ▪

Embezzling receipts

▪

Stealing entity’s assets

▪

Lapping of accounts receivable

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Commented [HMDG26]: It indicates that assurance is high but not absolute. Commented [HMDG27]: Materiality is relative in nature. Commented [HMDG28]: Misstatements are usually considered material if the combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decision of a reasonable user. Commented [HMDG29]: The primary facto that distinguishes fraud from error is whethe the underlying cause is intentional or unintentional Commented [HMDG30]: The risk of not detecting misstatements from fraud is higher than for error Commented [HMDG31]: The risk of not detecting material misstatement resulting from management fraud is greater than for employee fraud

Responsibility of Management and Those Charged with Governance (PSA 240) ➢ Management to establish a control environment and to implement internal control policies and procedures designed to ensure, the detection and prevention of fraud and error ➢ Individuals charged with governance to ensure the integrity of an entity’s accounting and financial reporting systems and that appropriate controls are in place

Auditor’s Responsibility The auditor is not and cannot be held responsible for the preventi...