2020 - 2021

Edition

AUDITING AND ASSURANCE

 Based on ISAs, PSAs, Framework, PSQC,

PAPSs, PSREs, PSAEs, PSRSs,
Revised Code of Ethics (2018)

MA. ELENITA BALATBAT CABRERA

BBA MBA CPA CMA

GILBERT ANTHONY B. CABRERA

BBA MBA CPA
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Contents
Preface i

UNIT I INTRODUCTION TO ASSURANCE AND

AUDITING SERVICES 1

Chapter 1 THE DEMAND FOR ASSURANCE AND

AUDITING SERVICES 2

Expected Learning Outcomes 2

Economic Demand for Auditing 3
What are Assurance Services? 4
Philosophy of an Audit 4
Importance of Audited Financial Statements 6
Users of Audited Financial Statements 8
The Assurance Analogy and the Philippine
Standards on Auditing (PSAs) 8

Review Questions 9

Chapter 2INTRODUCTION TO PROFESSIONAL

PRACTICE OF ACCOUNTANCY 11

Expected Learning Outcomes 11

Accountancy as a Profession 12
Who is a Professional Accountant? 13
Scope of Practice 14
Assurance, Attest, and Auditing Services Defined 15
Assurance Services 15
Attest Services 16
Audit Services 16
Relationship Among Assurance, Attest, and
Auditing Services 17
Types of Auditors 18
External Auditors 18
Internal Auditors 19
Government Auditors 19
Forensic Auditors 20
Types of Other Audit Services 21
Internal Audit 21
Compliance Audit 22
Operational Audit 22
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Forensic Audit 23
Types of Other Attest Services 23
Other Non-Assurance Services 23
Agreed-Upon Procedures 23
Tax Preparation and Planning Services 23
Management Advisory Services 24
Compilation, Accounting and Data Processing
System Services 24

Review Questions 25

Chapter 3 THE PUBLIC ACCOUNTING

PROFESSION ENVIRONMENT 33

Expected Learning Outcomes 33

Practice of Public Accountancy Defined 34
Certified Public Accountant 35
Requirements to Enter the Accountancy Profession 35
A. Pre-Qualification Education Requirements 35
B. CPA Licensure Examination 38
C. Other Legal Regulatory Requirements 39
Developing Capabilities and Competence after
Admission to the Profession 40
Core Values and Competency Requirements for
CPAs in Public Practice 42
Regulatory and Professional Organizations that
Influence the Profession 44
A. Regulatory Government Agencies 44
B. Professional Organizations 45
C. Standard-Setting Bodies 46
CPA’s Legal Liability 48
Legal Concepts Related to Auditor’s Liability 48
Legal Liability of the Independent Auditor 50
Limitation on Auditor’s Responsibility 51
Auditor’s Defenses Against Client Suits 51
Auditor’s Defenses Against Third-Party Lawsuits 52
Minimizing Exposure to Legal Liability 52
Society’s Expectations and Auditor’s
Responsibilities 53
Challenges Faced by the Public Accounting
Profession 53
The Accounting Profession’s Credibility Crisis 54

Review Questions 56
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Chapter 4 MANAGEMENT OF A PUBLIC

ACCOUNTING PRACTICE 65

Expected Learning Outcomes 65

Establishment and Organization of Public
Accountancy Practice 66
Marketing Professional Services 70
Sources of Clients 70
Professional Fees 71
Methods of Billing Clients 72
Auditing in a Globalized Environment 72
Regulation within the Firm 73
System of Quality Control 73
Elements of a System of Quality Control 74
A. Leadership Responsibilities of Quality Within
the Firm 75
B. Ethical Requirements 76
C. Acceptance and Continuance of Client
Relationships and Specific Engagements 80
D. Human Resources 83
E. Engagement Performance 85
F. Monitoring 93

Review Questions 104

Chapter 5 PROFESSIONAL ETHICS

114

Expected Learning Outcomes 114

Introduction 115
Why do People Act Unethically 116
The Need for Professional Ethics 118
Characteristics and Values Associated with
Ethical Behavior 119
The Code of Ethics for Professional Accountants
in the Philippines 121
Threats to Compliance with Rules 123
Safeguards to Mitigate or Eliminate Threats 125
Code of Ethics, Applicability to CPAs in
Public Practice 127
Resolving Ethical Conflict 139

Review Questions 140

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UNIT II FUNDAMENTALS OF ASSURANCE SERVICES

AND FINANCIAL STATEMENT AUDIT 151

Chapter 6 FUNDAMENTALS OF
ASSURANCE SERVICES 152

Expected Learning Outcomes 152

Assurance Engagements 153
Nature of Assurance Engagements 153
Objective of An Assurance Engagement 154
Types of Assurance Engagements 154
Reasonable Assurance Engagement 154
Limited Assurance Engagement 154
Other Assurance Services 155
Assertion-Based Engagements vs.
Direct Reporting Engagements 155
Elements of An Assurance Engagement 155
Brief Description of Assurance Services 164
Independent Financial Statements Audit 164
Review of Financial Statements 165
Other Review Engagements 165
Other Assurance Services 166
Assurance Services and Information Technology 166
CPA Web Trust Service 166
Information System Reliability Service 166
Assurance Services on Other Types of Information 167
Business Performance Measurement 167
Health Care Performance Measurement 167
Risk Assessment 167
Eldercare Plus 167
Brief Description of Non-Assurance Services 168
Agreed-Upon Procedure Services 168
Compilation of Financial and Other Information 168
Tax Services 169
Management Consulting / Advisory Services 169
Accounting and Data Processing or
Information Technology System Services 169

Review Questions
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Chapter 7 INTRODUCTION TO FINANCIAL

STATEMENT AUDIT 174

Expected Learning Outcomes 174

Independent Auditing Defined 175
Objectives of Auditing 177
Scope of Independent Audit 178
Why Independent Auditing Is Necessary 178
How Information Risk may be Reduced 180
Advantages and Practical Benefits of
An Independent Audit 181
Overview of the Audit Opinion Formulation Process 182
Activities of each Phase of the Audit Opinion
Formulation Process 184
Management Assertions and Financial Statements 185
Core Concepts of Financial Statement Audit 187
Materiality 188
Audit Risk 188
Audit Evidence Regarding Management
Assertions 189
General Principles of an Audit 190
Compliance of Ethical Requirements 190
Reasonable Assurance 190
Responsibility for the Financial Statements 191
Skills and Knowledge Needed in Financial
Statement Audit 191
Parties Involved in Preparing and Auditing
Financial Statements 192
The Context of Financial Statement Auditing 192
The Business Entity as the Primary Context of
Auditing 193
Relating the Audit Process Components to the
Business Model 193

Review Questions 194

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UNIT III RISK-BASED AUDIT OF FINANCIAL

STATEMENTS 198

Chapter 8 OVERVIEW OF RISK-BASED AUDIT

PROCESS 199
Expected Learning Outcomes 199
Introduction 200
Risk-Based Audit Process Defined 200
Factors to Consider in Implementing the
Audit Risk Model 201
Limitation of the Audit Risk Model 202
Risk-Based Audit vs. Account-Based Audit 203
The Risk-Based Audit Process 203
Phase I. Risk Assessment 203
Phase II. Risk Response 203
Phase III. Reporting 203
Relevant Philippine Standards on Auditing (PSAs)
to be used in the Risk-Based Audit Process 206
Understanding the Audit Risk Model 209

Review Questions 212

Chapter 9 RISK ASSESSMENT – PART I 216

Expected Learning Outcomes 216
PHASE I-A. PERFORMANCE OF PRELIMINARY
ENGAGEMENT ACTIVITIES 216
Introduction 217
Client Selection and Retention 217
Client Acceptance / Retention Decisions 218
Audit Firm Limitations 219
Engagement Letters 220
Recurring Audits 221
PHASE I-B. PLANNING THE AUDIT TO DEVELOP
AN OVERALL AUDIT STRATEGY AND AUDIT
PLAN 224
Nature and Scope of Audit Planning 225
Benefits of Audit Planning 226
The Overall Audit Strategy 226
Benefits of Developing the Audit Strategy 227
A. Materiality 228
B. Audit Plan 234

Review Questions and Exercises 249

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Chapter 10
RISK ASSESSMENT – PART II
PHASE I-C.1 PERFORMANCE OF RISK
ASSESSMENT PROCEDURES TO
IDENTIFY / ASSESS RISK OF MATERIAL
MISSTATEMENT THROUGH
UNDERSTANDING THE ENTITY 255

Expected Learning Outcomes 255

Introduction 256
I. Risk Assessment Procedures and Sources of
Information About the Entity and Its Environment,
Including Its Internal Control 257
Risk Assessment Procedures 257
II. Understanding the Entity and Its Environment
Including Its Internal Control 259
III. Identifying and Assessing the Risk of Material
Misstatement 260
IV. Material Weakness an Internal Control 260
V. Documentation 261
Assessing Inherent Risk and Control Risk at the
Assertion Level 261
Using the Audit Risk Model to Determine the
Nature, Timing, and Extent of Audit Procedures 267
Audit Risk in the Small Business 272

Review Questions and Exercises 273

Chapter 11 RISK ASSESSMENT – PART III

PHASE I-C.2 CONSIDERATION OF
INTERNAL CONTROL IN A FINANCIAL
STATEMENT AUDIT 279

Expected Learning Outcomes 279

Nature and Purpose of Internal Control 280
Internal control System Defined 281
Components and Principles of Internal Control 281
A. Control Environment 284
B. Entity’s Risk Assessment Process 285
C. Information System, including the Business
Processes, Relevant to Financial Reporting and
Communication 286
D. Control Activities 286
E. Monitoring of Controls 287
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Objectives of the Study of internal Control 287

Documentation of Understanding 289
How adequacy of Inadequacy of Internal Control
Affects Audit Procedures 299
Communication of Performance, Improvements and
Observations in Internal Control to Management 301
Reportable Conditions 302
Reporting – Form and Content 303

Review Questions and Exercises 305

Chapter 12 FRAUD AND ERROR 315

Expected Learning Outcomes 315

Introduction 316
Characteristics of Fraud 316
Fraudulent Financial Reporting 316
Misappropriation of Assets 317
Responsibility for the Prevention and Detection of
Fraud 318
Responsibilities of the Auditor 318
Risk Assessment 318
Detection 319
Inherent Limitations of an Audit 319
Examples of Fraud Risk Factors 320
Procedures when Errors or Irregularities are
Suspected 324
Reporting of Fraud and Error 324
Documentation 325
Withdrawal from the Engagement 325

Review Questions 326

UNIT IV RISK RESPONSE 333

Chapter 13 RISK RESPONSE – PART I

DESIGNING AN EFFECTIVE RESPONSE
TO ASSESSED RISK 334
Expected Learning Outcomes 334
Introduction 335
Types of Response 336
Nature of Audit Procedures 337
Tests of Controls or Compliance Tests 337
Types of Compliance Tests 337
Substantive Procedures 338
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Types of Substantive Tests 338

The Relationship of Audit Techniques, Audit
Procedures and Assertions 340
Deciding the Number of Items to Audit 341
Timing of Testing 341
Timing of Tests of Controls 342
Timing of Substantive Procedures 343
Selecting the Audit Procedures that will be Applied 344

Review Questions 345

RISK RESPONSE – PART II

Chapter 14 IMPLEMENTING THE DESIGNED RISK RESPONSE
AND OBTAINING AUDIT EVIDENCE 348

Expected Learning Outcomes 348

Introduction 349
Nature and Significance of Audit Evidence 349
What Constitutes Audit Evidence 350
Sufficient Appropriate Audit Evidence 351
Interrelationship Between Risk, Appropriateness
and Sufficiency of Audit Evidence 351
Competence or Appropriateness of Evidence 353
Sufficiency of Evidence 355
Procedures for Obtaining Audit Evidence 355
Inspection of Records or Documents 355
Inspection of Tangible Assets 356
Confirmation 356
Inquiry 357
Written Representation 358
Observation 359
Recalculation 359
Reperformance 359
Analytical Procedures 359
Relationship of Types of Evidence to
Audit Objectives 360
Evidence About Accounting Estimates 369
Nature of Accounting Estimates 369
Audit Procedures 370
Reviewing and Testing the Process Used by
Management 370
Evaluation of Results of Audit Procedures 371
Evidence for Related Party Transactions 371

Review Questions and Exercises 372

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Chapter 15 BASIC AUDIT SAMPLING CONCEPTS 378

Expected Learning Outcomes 378

Introduction 379
Nature and Purpose of Audit Sampling 379
Why Auditors Sample 379
Testing Procedures which do not Involve Sampling 380
Sampling vs. Non-Sampling Risk 381
Sampling Risk 381
Non-Sampling Risk 381
Nonstatistical and Statistical Sampling 382
Nonstatistical Sampling 382
Statistical Sampling 383
Attribute and Variables Sampling Techniques 387
Attribute Sampling Technique 387
Design of the Sample 388
Audit Objectives 389
Population 389
Risk and Assurance 390
Tolerable Error 392
Expected Error in the Population 392
Stratification 393
Performing the Audit Procedure 400
Evaluation of Sample Results 400
Analysis of Errors in the Sample 400
Projection of Errors 402
Assessing Sampling Risk 403
Conclusion 404
Detailed Audit Sampling Plan 405
Definition / Description of Audit Sampling Plans 405

Review Questions 408

Chapter 16 AUDIT SAMPLING FOR TEST OF

CONTROLS 413

Expected Learning Outcomes 413

Test of Controls 414
Steps in the Application of Sampling in
Test of Controls 414
Illustration of Attributes Sampling 415
Nonstatistical Attributes Sampling 427

Review Questions 428

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Chapter 17 AUDIT SAMPLING FOR

SUBSTANTIVE TESTS 435

Expected Learning Outcomes 435

Substantive Procedures 436
Risks in Substantive Tests 436
Probability-Proportional-To-Size Sampling (PPS) 437
Advantages and Disadvantages of PPS Sampling 438
Classical Variables Sampling 438
Variations of Classical Variables Sampling 439
Steps in Variables Sampling for Substantive Tests 441
Application of the Steps in Variables Sampling Plan
Using PPS Technique for Substantive Tests 441
Reaching a Conclusion in PPS Sampling 454
Application of Classical Variables Sampling Plan
Using Classical Techniques 455

Review Questions 428

Chapter 18 AUDIT DOCUMENTATION 475

Expected Learning Outcomes 475

Introduction 475
Nature of Audit Documentation 475
Objectives of Audit Documentation 477
Form, Content and Extent of Audit Documentation 477
Characteristics of Quality Audit Documentation 479
Documenting Planning and Risk Assessment
Procedures 479
Documenting Audit Work Performed 480
Documenting Significant Issues and Their
Resolution 480
Copies of Documentation 481
Types of Working Papers 481
Relationship of Working Papers to Financial
Statements 484
Content of a Year-End Audit File Index 488
Mechanics of Working Paper Preparation 491
Computer-Generated Working Papers 491
Ownership and Custody of Working Paper 492
Confidentiality of Working Papers 492

Review Questions 428

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UNIT V REPORTING 505

Chapter 19 AUDIT EVIDENCE EVALUATION 506

Expected Learning Outcomes 506

Introduction 507
Evaluating the Sufficiency and Appropriateness of
Audit Evidence 508
Factors to Consider 510
Final Analytical Procedures 511
Documentation 512

Review Questions 515

Chapter 20 COMPLETING THE AUDIT AND POST –

AUDIT RESPONSIBILITIES 516

Expected Learning Outcomes 516

Introduction 516
Completing the Audit
Related arty Transactions 517
Subsequent Events Review 523
Letters of Inquiry / Review for Contingent
Liabilities 528
Evaluation of Going Concern Assumption 533
Management Representation 541
Analytical Procedures 547
Evaluating Findings, Formulating an Opinion
and Drafting the Audit Report 550
Post-Audit Responsibilities 553

Review Questions and Exercises 556

Chapter 21 FORMING AN OPINION AND REPORTING

ON FINANCIAL STATEMENTS 571

Expected Learning Outcomes 571

Introduction 572
Forming an Opinion on the Financial Statements 573
Forms of Opinion 574
Preparation of the Auditor’s Report for Audits
Conducted in accordance with International
Standards on Auditing 583
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Responsibilities for the Financial Statement 586

Auditor’s Responsibilities for the Audit of the
Financial Statements 587
Other Reporting Responsibilities 590
Name of the Engagement Partner 591
Signature of the Auditor 591
Auditor’s Address 591
Date of the Auditor’s Report 592
Supplementary Information Presented with
Financial Statements 592

Review Questions and Exercises 593

Chapter 22 MODIFICATIONS TO THE INDEPENDENT

AUDITOR’S REPORT 598

Expected Learning Outcomes 598

Introduction 599
Types of Modified Opinions 599
Objective 600
Determining the Type of Modification to the
Auditor’s Opinion 601
Form and Content of the Auditor’s Report when the
Opinion is Modified 603
Description of Auditor’s Responsibility When the
Auditor Expresses a Qualified or Adverse
Opinion 604
Description of Auditor’s Responsibility When the
Auditor Disclaims an Opinion 605
Communication with Those Charged with
Governance 605
Illustrative Audit Reports with Modified Opinion 605

Review Questions and Exercises 619

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UNIT VI AUDITING IN AN INFORMATION

TECHNOLOGY (IT) SYSTEM ENVIRONMENT 635

Chapter 23 AUDITING IN AN INFORMATION

TECHNOLOGY (IT) SYSTEM
ENVIRONMENT – PART I 636

Expected Learning Outcomes 636

Introduction 637
Nature of IT and Its Capabilities 637
Major Components of an Information System 638
Functions of an Information System 639
Characteristics of Various Types of IT-Based
Systems 640
Auditor’s Responsibilities 642
Internal Control in an IT Environment 642
General Controls 642
Application Controls 650

Review Questions 654

Chapter 24 AUDITING IN AN INFORMATION

TECHNOLOGY (IT) SYSTEM
ENVIRONMENT – PART II 668

Expected Learning Outcomes 668

Introduction 669
Impact of Computers on Accounting System 669
Major Types of Computer Fraud 671
Effects of Computers on the Audit Process 672
Auditing Clients Using Information technology (IT)
Systems 676
Audit Techniques Using Computers 678
Specialized Audit Programs and Additional
Techniques 682
Internal Control Considerations 682
The Effect of Electronic Records on Audit
Evidence 685

Review Questions and Exercises 686

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UNIT VII OTHER SERVICES AND REPORTS 693

Chapter 25 PROCEDURES AND REPORTS ON

SPECIAL PURPOSE AUDIT
ENGAGEMENTS 694

Expected Learning Outcomes 694

Introduction 695
A. Audits of Financial Statements Prepared in
Accordance with Special Purpose Frameworks 697
B. Audits of Single Financial Statements and
Specific Elements, Accounts or Items of a
Financial Statements 704
C. Summarized Financial Statements 713

Review Questions and Exercises 722

Chapter 26 NON-AUDIT ENGAGEMENTS;

PROCEDURES AND REPORTS 731

Expected Learning Outcomes 731

Examination of Prospective Financial Information 732
Engagements to Review Financial Statements 741
Engagements to Perform Agreed – Upon Procedures
Financial Information 752

Review Questions and Exercises 773

List of References 782