The document summarizes the preliminary engagement activities of a financial statement audit. It discusses (1) evaluating whether the auditor is competent and independent to perform the audit, (2) assessing the integrity of the client's management, and (3) determining whether the financial statements are auditable. The auditor considers their own expertise, any threats to independence, ability to properly serve the client, and conducts background checks on management. Permission is required to communicate with the predecessor auditor to obtain information about reasons for change or any disagreements. The goal is to decide whether to accept or continue the audit engagement.
The document summarizes the preliminary engagement activities of a financial statement audit. It discusses (1) evaluating whether the auditor is competent and independent to perform the audit, (2) assessing the integrity of the client's management, and (3) determining whether the financial statements are auditable. The auditor considers their own expertise, any threats to independence, ability to properly serve the client, and conducts background checks on management. Permission is required to communicate with the predecessor auditor to obtain information about reasons for change or any disagreements. The goal is to decide whether to accept or continue the audit engagement.
The document summarizes the preliminary engagement activities of a financial statement audit. It discusses (1) evaluating whether the auditor is competent and independent to perform the audit, (2) assessing the integrity of the client's management, and (3) determining whether the financial statements are auditable. The auditor considers their own expertise, any threats to independence, ability to properly serve the client, and conducts background checks on management. Permission is required to communicate with the predecessor auditor to obtain information about reasons for change or any disagreements. The goal is to decide whether to accept or continue the audit engagement.
Financial statement audit generally begins with the financial statements of the client entity. because there would be no audit to perform without these said financial statements General approach to financial statement audit: requires consideration of the (1) financial statement assertions, (2) audit evidence, and (3) audit procedures
(1) Financial statement assertions Management: responsible for the fair presentation of the financial statements that reflect the nature and operations of the client entity implicitly or explicitly makes assertions regarding the recognition, measurement, presentation and disclosure of the various elements of the financial statements and related disclosures
Financial statement assertions are categorized as follows: 1. assertions about classes of transactions and events for the period under audit - COCAC 1. Completeness all transactions and events that should have been recorded are recorded 2. Occurrence the transactions and events that have been recorded have occurred and pertained to the entity 3. Classification transactions and events have been recorded in the proper accounts 4. Accuracy amounts and other data relating to recorded transactions and events have been recorded appropriately 5. Cut-off Transactions and events have been recorded in the correct accounting period
2. assertions about account balances at the period end under audit: - ERoVaC 1. Existence assets, liabilities, and equity interests exist 2. Rights and obligations entity holds or controls the rights to assets and liabilities are obligations of the entity 3. Valuation and allocation assets, liabilities, and equity interests are included in the financial statements at the appropriate amounts and any resulting valuation or allocation adjustments are properly and appropriately recorded 4. Completeness all assets, liabilities, and equity interests that should have been recorded have been recorded
3. assertions about presentation and disclosure - COCA 1. Completeness all disclosures that should have been included in the financial statements have been included 2. Occurrence and rights and obligations disclosed events, transactions, and other matters have occurred and pertained to the entity 3. Classification and understandability financial information has been appropriately presented and described and disclosures are clearly expressed 4. Accuracy and valuation financial and other information are disclosed fairly and at appropriate amounts
(2) Audit evidence Audit evidence: refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is actually based will either prove or disprove the validity of the client managements assertions at the conclusion of the audit: auditor should carefully evaluate the audit evidence gathered in order to come up with an appropriate audit opinion audit evidence comprises: 1. source documents and accounting records underlying the financial statements 2. corroborating information from other relevant sources
(3) Audit procedures Auditor uses the financial statement assertions tin assessing the risks by considering the different types of potential misstatements that may occur: thereby designing the audit procedures that are responsive to the assessed risks
Audit procedures selected should enable the auditor to gather sufficient appropriate audit evidence about some particular assertion: regardless of the audit procedures selected
Commonly-used audit procedures include: - COICAI 1. Confirmation: consists of response to an inquiry to confirm or corroborate information contained in the accounting records 2. Observation consists of looking at the process or procedure being performed by others 3. Inspection involves examining the records, documents, or tangible assets of the entity being audited 4. Calculation or computation consists of checking the arithmetical accuracy of source documents and accounting records or performing independent calculations 5. Analytical procedures consists of the analysis of significant ratios and trends including the resulting investigation of fluctuations and some relationships that are inconsistent with other relevant information or deviate from predicted amounts 6. Inquiry consists of the seeking of information from knowledgeable persons inside or outside the entity being audited
Audit process Audit process: sequence of different audit activities
Emphasis and order of certain activities may vary depending upon a particular audit, but basically this process should include the following audit activities: - PACPCI 1. Preliminary engagement activities 2. Audit planning 3. Considering the internal control system 4. Performing substantive tests 5. Completing the audit 6. Issuing the audit report
1. Preliminary engagement activities refer to PSA 300 undertaken to determine whether or not to accept the audit engagement!
Preliminary engagement activities: performed (1) to know if the auditor is qualified to handle the engagement and (2) to evaluate whether the financial statements are auditable or not in making this assessment, the auditor should consider the following: 1. his competence 2. his independence 3. his ability to serve the client 4. integrity of the prospective clients management I. Auditors competence Code of Ethics mandates that the auditors should not portray themselves as having expertise which they do not possess. auditor should obtain a preliminary knowledge of the clients business and industry to know if (1) he has the necessary skills and the competence to handle the engagement or (2) whether such competence can be obtained before the completion of the audit competence can be acquired through a combination of education, training, and expertise
II. Auditors independence Code of Ethics states that essential to the credibility of the auditors report is the concept of independence auditor should consider if there are any threats to the audit teams independence and objectivity, and if so, whether adequate safeguards can be established
III. Auditors ability to serve the client properly (PSA 220) engagement should not be accepted if there are not enough qualified personnel to perform the audit audit work should be assigned to personnel who have the appropriate capabilities, competence, and time to perform the audit engagement in accordance with the professional standards there should be sufficient direction, supervision, and review of work at all levels to provide reasonable assurance that the firms standard of quality is maintained in the performance of the engagement
IV. Integrity of the prospective clients management (PSA 220) auditors should conduct a background investigation of the prospective client in order to minimize the likelihood of association with clients whose management lacks integrity This task would involve: (1) Inquiring appropriate parties in the business community inquiring the prospective clients banker, legal counsel, or underwriter to obtain information about the reputation of the prospective client
(2) Communicating with the predecessor auditor Communication with the predecessor auditor is not only a matter of courtesy to the predecessor auditor: it also allows the incoming auditor to obtain info. about the prospective client to determine whether to accept or reject the engagement But before the incoming auditor can contact the predecessor auditor of the prospective client: incoming auditor should obtain prospective clients permission to communicate with the predecessor auditor because the Code of Ethics prevents an auditor from disclosing any information obtained about the client without the clients explicit permission
Refusal of the prospective clients management to permit this: will raise serious questions as to whether or not the engagement will be accepted!
Once permission of the client is obtained, the incoming auditor should inquire into matters that may affect the decision to accept the engagement, which includes: 1. predecessor auditors understanding as to the reasons for the change of auditors 2. any disagreement between the predecessor auditor and the client 3. facts that might have bearing on the integrity of the prospective clients management like fraud or non- compliance with laws and regulations Code of Ethics requires the predecessor auditor to respond fully to the incoming auditors inquiry and advise the incoming auditor if there are any professional reasons why the engagement should not be accepted.
Retention of existing clients: Clients should be evaluated (1) at least once a year or (2) upon occurrence of major events such as changes in management, directors, ownership, nature of clients business, or other changes that may affect the scope of the examination. In general: conditions which would have caused an accounting firm to reject a prospective client may also result or lead to a decision of terminating an audit engagement
Before performing any significant audit activities, PSA 300 requires the auditor to undertake the following preliminary engagement activities: - PEE 1. Performing procedures regarding the continuance of the client relationship and the specific audit engagement 2. Evaluating compliance with ethical requirements, including independence 3. Establishing an understanding of the terms of the engagement
Performing the preliminary engagement activities at the beginning of the current audit engagement assists the auditor in: - PI Planning the audit, and Identifying areas that may affect the auditors ability to perform the audit engagement adversely
Engagement letter: Engagement letter: written contract between the auditor and the client Engagement letter should be prepared: after accepting the audit engagement Engagement letter sets forth: - OMS-FFR 1. objective of the audit of financial statements which is to express an opinion on them 2. managements responsibility for the fair presentation of the financial statements 3. scope of the audit 4. forms or any reports or other communication that the auditor expects to issue 5. fact that there is an unavoidable risk that material misstatements may remain undiscovered because of the limitations of the audit 6. responsibility of the client to allow the auditor to have unrestricted access to whatever records, information, or documentation requested in connection with the audit Engagement letter may also include: - BEAR 1. billing arrangements 2. expectations of receiving management letter 3. arrangements concerning the involvement of others (experts, other auditors, internal auditors) 4. request for the client to confirm the terms of the engagement
Importance of the engagement letter: to avoid misunderstanding with respect to the audit engagement, and to document and confirm the auditors acceptance of the appointment
Recurring audits: auditor does not normally send new audit engagement letter every year The following factors may cause the auditor to send a new engagement letter: - LIARS 1. legal requirements and other government agencies pronouncements 2. indication that the client misunderstands the objective and scope of the audit 3. any revised or special terms of the engagement 4. recent change of senior management, BODs, or of ownership 5. significant change in the nature or size of the clients business If the auditor decides not to send a new engagement letter: it may be appropriate for the auditor to remind the client of the original arrangements
Audit of components: If the auditor of a parent entity is also the auditor of its subsidiary, branch, or division (component): auditor should consider the following factors in making a decision of whether to send a separate letter to the component: 1. who appoints the auditor of the component 2. whether a separate audit report is to be issued on the component 3. legal requirements 4. extent of work performed by other auditor 5. degree of ownership by parent 6. degree of independence of the components management
2. Audit planning In audit planning, auditor obtains sufficient understanding of the entity and its environment: to understand the transactions and events affecting the financial statements, and to identify potential problems
A preliminary assessment of risk and materiality is made: to develop an overall audit strategy, and to develop a detailed approach for the expected conduct and scope of the examination
3. Considering the internal control system involves obtaining an understanding of the entitys control systems and assessing the level of control risk Control risk: risk that the clients internal control may not prevent or detect material misstatements in the financial statements
Auditor considers the entitys internal control system because the condition of the entitys internal control directly affects the reliability of the financial statements i.e. the stronger the internal control system, the more assurance it provides about the reliability of the entitys financial statements
If auditor wants to assess control risk at less than high level: sufficient appropriate audit evidence must be obtained to prove that the internal control is functioning as intended (i.e. effectively) and that it can be relied upon sufficient appropriate audit evidence can be obtained by performing tests of controls
4. Performing substantive tests involves examining the documents and the evidence supporting the amounts and disclosures in the financial statements
Using the information obtained in the audit planning and in the consideration of internal control system: auditor performs substantive tests to determine if the entitys financial statements are presented fairly and in accordance with the financial reporting standards
Extent of substantive tests is highly dependent on the results of the auditors consideration of the internal control system. if the entitys internal control system is functioning as intended, the scope of the auditors substantive tests can be reduced if the entitys internal control system cannot be relied upon, the scope of the auditors substantive tests will be expanded and will be more extensive
5. Completing the audit involves performing additional audit procedures to complete the audit and to become satisfied that the evidence gathered is consistent with the auditors report, after the auditor has completed testing the account balances in the financial statements Completing the audit procedures include: - RAPO 1. Review of subsequent events and contingencies 2. Assessing the going concern assumption 3. Performing overall analytical procedures 4. Obtaining written representations from management
Auditor must have sufficient appropriate audit evidence in order to reach a conclusion about the fairness of the entitys financial statements.
6. Issuing a report On the basis of audit evidence gathered and evaluated: auditor forms a conclusion about the given financial statements this conclusion is communicated to various interested users through an audit report
Sample of an engagement letter: To the Board of Directors of UP-CM company:
You have requested that we audit the balance sheet of UP-CM Company as of December 31, 2013 and the related statements of income and cash flows for the year then ended. We are pleased to confirm our acceptance and our understanding of this engagement by means of this letter. Our audit will be made with the objective of our expressing an opinion on the financial statements.
We will conduct our audit in accordance with the Philippine Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amount and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
Because of the test nature and other inherent limitations of an audit together with the inherent limitations of any accounting and internal control system, there is an unavoidable risk that even some material misstatements may remain undiscovered.
In addition to our report on the financial statements, we expect to provide you with a separate letter concerning any material weaknesses in accounting and internal control systems which come to our notice.
We remind you that the responsibility for the preparation of the financial statements including adequate disclosure is that of the management of the company. This includes the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies, and the safeguarding of the assets of the company. As part of our audit process, we will request from the management written confirmation concerning representation made to us in connection with the audit.
We look forward to full cooperation with your staff and we trust that they will make available to us whatever records, documentation, and other information that are requested in connection with our audit. Our fees, which will be billed as work progresses, are based on the time required by the individuals assigned to the engagement plus out-of-pocket expenses. Individual hourly rates vary according to the degree of responsibility involved and the experience and skill required.
This letter will be effective for future years unless it is terminated, amended, or superseded.
Please sign and return the attached copy of this letter to indicate that it is in accordance with your understanding of the arrangement for our audit of the financial statements.
Herrera, Santos, Manolong & Company
Acknowledged on behalf of UP-CM company by (signed)