04 Introduction To Auditing
04 Introduction To Auditing
04
INTRODUCTION TO AUDITING
RAYMUND FRANCIS A. ESCALA, CPA, MBA
AUDITING
Definition
As defined by the American Accounting Association, 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 results thereof.
The following are key concepts obtained from the definition of an audit:
a. A systematic process
b. It involves objectively obtaining and evaluating evidence about assertions.
c. It ascertains the degree of correspondence between assertions and established criteria
d. It includes communication of the results to interested users
Types of audit
In compliance with the syllabus in Auditing of the Philippine CPA Licensure Examination, the following are the types of
audit.
1. Nature of assertion or data
a. Financial statement (FS) audit
b. Operational audit
c. Compliance audit
2. Types of auditor
a. External audit
b. Internal audit
c. Government audit
PSA 200 (Revised and Redrafted) further supported the above objective by stating that “in conducting an audit of financial
statements, the overall objectives of the auditor are:
a. 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
b. To report on the financial statements, and communicate as required by the PSAs, in accordance with the auditor’s
findings.”
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C. Suitable criteria
Criteria used in audit of financial statements generally include the PFRS, GAAP and other applicable financial
reporting framework
The opinion to be expressed by the auditor depending on the evidence obtained may include either of the following:
Type Common phrase used
Unmodified or unqualified Presents fairly, in all material respect
Qualified Except for
Adverse Do not present fairly, in all material respect
Disclaimer of opinion We do not express a conclusion
To warrant the issuance of an unmodified opinion, the auditor determines whether there is
a. a limitation on the scope of the auditor’s work (Qualified or Disclaimer of Opinion); or
b. a disagreement with management regarding the acceptability of the accounting policies selected, the method of
their application or the adequacy of financial statement disclosures. (Qualified or Adverse Opinion)
Furthermore, investors, creditors, and other users of financial information demand high-quality, relevant, and
reliable information in order to come up with educated financial decisions.
2. Information risk
Information risk the risk that the information prepared and presented by the entity contains misstatement.
Information risk is the mathematical complement of reliability level. This means that as information risk increases
(from 5% to 10%), reliability level decreases (from 95% to 90%).
Value of FS audit
Based from the discussions of the demand for FS audit, the following may be construed as the value of a FS audit
• Audit reduces information risk that may lead to lower cost of capital.
• Audit may be used to deter inefficiency and fraud.
The following are some of the assumptions, postulates or concepts included in this conceptual structure:
1. All financial data are verifiable through existence of supporting documents and records
2. Auditor should always maintain independence with respect to the financial statements under audit
3. No long-term conflict between the auditor and the client’s management
4. Audit benefits the public
5. Effective internal control systems reduces the possibility of errors and fraud
To achieve the overall objectives of the audit, the auditor shall design and perform audit procedures which enable the
gathering of audit evidence. Procedures to be performed may be categorized into (1) major audit procedures and (2)
specific audit procedures.
2. Planning an audit Audit planning involves the development of an overall audit strategy, audit plan and audit
of financial program. The auditor usually obtained more detailed knowledge about the client’s business and
statements industry in order to understand the transactions and events affecting the financial statements.
Preliminary assessment of risk and materiality is also made during this phase.
3. Study and Since entity’s internal control directly affects the reliability of the financial statements, it is
evaluation of appropriate to study and evaluate these controls.
internal control
4. Evidence-gathering Using the information obtained in audit planning and consideration of internal controls, the auditor
(Substantive performs substantive test to determine whether entity’s financial statements are presented fairly in
testing) accordance with financial reporting standards. Substantive procedures could either be analytical
procedures or test of details of transactions and balances
ILLUSTRATIVE QUIZZERS
1. Which of the following statements refers to the definition of auditing?
A. A service activity which function is to provide quantitative information primarily financial in nature about economic
entities that is intended to be useful in making economic decisions.
B. The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and
events which are in part at least of a financial character and interpreting the results thereof.
C. The process of identifying, measuring and communicating economic information to permit informed judgment and
decisions by users of the information.
D. 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 results thereof.
6. To provide for the greatest degree of independence in performing internal auditing functions, an internal auditor most
likely should report to
A. Board of Directors.
B. Corporate Controller.
C. Vice-President for Finance.
D. Corporate Stockholders.
7. The scope and objectives of internal auditing vary widely and depend on the size and structure of the entity and the
requirements of its management. Ordinarily, internal auditing activities include one or more of the following:
A. B. C. D.
Review of the accounting and internal control Yes Yes Yes Yes
systems
Examination of financial and operating Yes Yes Yes No
information
Review of the economy, efficiency and Yes Yes No No
effectiveness of operations
Review of compliance with laws, regulations and Yes No No No
other external requirements
8. Which statement is correct regarding the relationship between internal auditing and the external auditor?
A. Some judgments relating to the audit of the financial statements are those of the internal auditor.
B. The external audit function's objectives vary according to management's requirements.
C. Certain aspects of internal auditing may be useful in determining the nature, timing and extent of external audit
procedures.
D. The external auditor is responsible for the audit opinion expressed, however that responsibility may be reduced by
any use made of internal auditing.
9. AAA Corp. has engaged a public accounting firm to issue a report on the accuracy of product quality
specifications included in trade sales agreements. This is an example of a (an):
A. Financial statement audit
B. Attestation service
C. Compliance audit
D. Operational audit
10. Which of the following terms best describe the audit of a taxpayer’s return by a BIR auditor?
A. Operational audit
B. Internal audit
C. Compliance audit
D. Government audit
11. The overall objectives of the auditor in conducting an audit of financial statements are
I. To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether caused by fraud or error.
II. To report on the financial statements.
III. To obtain conclusive rather than persuasive evidence.
IV. To detect all misstatements, whether due to fraud or error.
A. I and II only
B. II and IV only
C. I, II and III only
D. I, II, III and IV
12. Which of the following best describes the objective of an audit of financial statements?
A. To express an opinion whether the financial statements are prepared in accordance with prescribed criteria.
B. To express an assurance as to the future viability of the entity whose financial statements are being audited.
C. To express an assurance about the management's efficiency or effectiveness in conducting the operations of
entity.
D. To express an opinion whether the financial statements are prepared, in all material respect, in accordance with
an identified financial reporting framework.
14. Third-party users of the audit report expect the auditor to do all of the following except:
A. To evaluate measurements and disclosures made by management
B. To provide a biased evaluation of the FSs
C. To determine whether financial statements are presented in accordance with GAAP
D. To gather sufficient evidence to support their opinion
17. Absolute assurance cannot be provided in an audit because of: (Choose the exception)
A. Human errors in judgment
B. The employment of test procedures
C. The need to obtain conclusive evidence
D. Limitations inherent in the client’s internal controls
18. The need for an independent audit arises due to the following reasons. (Choose the expectation)
A. Expertise of auditors
B. Competing interests
C. Remoteness of users
D. Complexity of decision-making
19. Which of the following statements does not describe a condition that creates a demand for auditing?
A. Conflict between an information preparer and a user can result in biased information.
B. Information can have substantial economic consequences for a decision maker.
C. Expertise is often required for information preparation and verification.
D. Users can directly assess the quality of information.
20. Which of the following is incorrect regarding the general principles of an audit?
A. The auditor should comply with the "Code of Ethics for Professional Ethics for Certified Public Accountants"
promulgated by the Philippine Professional Regulation Commission.
B. The auditor should conduct an audit in accordance with PSAs.
C. The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that
circumstances may exist that cause the financial statements to be materially misstated.
D. The auditor would ordinarily expect to find evidence to support management representations and assume
they are necessarily correct.
22. Auditing is based on the assumption that the financial data are verifiable. Data are verifiable when two or more
qualified individuals,
A. Working together, can prove, beyond doubt, the accuracy of the data.
B. Working independently, each reach essentially similar conclusions.
C. Working independently, can prove, beyond reasonable doubt, the truthfulness of the data.
D. Working together, can agree upon the accuracy of the data.
24. Which of the following is not a financial statement assertion relating to account balances?
A. Completeness.
B. Existence.
C. Rights and obligations.
D. Valuation and competence.
27. Audit procedures performed to obtain an understanding of the entity and its environment, including its internal control,
and to assess the risks of material misstatements at the financial statement and assertion levels.
A. Risk assessment procedures
B. Tests of control
C. Substantive procedures
D. Analytical procedures
28. Audit procedures to test the operating effectiveness of controls in preventing or detecting and correcting material
misstatements at the assertion level.
A. Risk assessment procedures
B. Tests of control
C. Substantive procedures
D. Analytical procedures
29. An auditor may achieve audit objectives related to particular assertions by:
A. Performing analytical procedures.
B. Preparing audit documentation.
C. Adhering to a system of quality control.
D. Increasing the level of detection risk.
30. If a company’s external auditor expresses an unqualified opinion as a result of the audit of the company’s financial
statements, readers of the audit report can assume that
A. The external auditor found no fraud
B. The company is financially sound and the financial statements are accurate
C. Internal control is effective
D. All material disagreements between the company and the auditor about the application of accounting principles
were resolved in the satisfaction of the external auditor.
We are what we repeatedly do. Excellence, therefore, is not an act but a habit.
Aristotle