Introduction to Audit

Introduction to Financial Statements Purpose of Financial Statements

Financial statements are a structured representation of the financial position (Balance Sheet) and financial performance (Income Statement) of an entity. The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of managements stewardship of the resources entrusted to it.

Introduction to Financial Statements

(a) assets (b) liabilities (c) equity (d) income and expenses, including gains and losses (e) other changes in equity; and (f) cash flows This information, along with other information in the notes, assists users of financial statements in predicting the entitys future cash flows and, in particular, their timing and certainty.

Introduction to Financial Statements User of Financial Statements

User of the financial statements Equity investors (existing and potential) Loan creditors i.e, existing and potential holders of debentures and loan stock, and providers of short-term loans Employees (existing, potential and past) Business contacts including customers, trade creditors, competitors and potential take-over bidders Government, including tax authorities, government departments and local authorities Public, including tax payers, ratepayers and environmental groups Interest of the user They are interested whether buy, hold or sell the shares in hand and also enable them in payment of dividends. The amount will be paid when due and for continuation of the business. Interested in stability and profitability for employment opportunities, remuneration and retirement benefits. Whether the payment of loan will be made in due dates and enable sustainability of business for future business with the enterprise. Interested in allocation of resources and also to regulate the activities of an enterprise and determining tax policies and as a basis for national income. Trends and recent development in the prosperity of the entity and range of its activities.

What is Auditing?
It 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 to interested users.

Auditing is a systematic approach

It follows an ordered and structured series of steps.

An audit involves obtaining and evaluating evidence regarding assertions about economic actions and events

Assertions are representations made by an auditee about economic actions and events. An auditor determines whether these assertions are valid.

An audit is conducted objectively

The auditor should conduct the audit without bias. Impartial attitude must be maintained by the auditor when evaluating evidence as well as formulating a report.

ascertain the degree of correspondence between these assertions and established criteria
Established criteria are needed to judge the validity of the assertions. These criteria are important because they establish and inform the users of the basis against which the assertions have been evaluated or measured.

Auditors communicate the audit results to various interested users.

The communication of audit findings is the ultimate objective of any audit. For the audit to be useful, the results must be communicated to interested users on a TIMELY BASIS.

Why do we audit them

In this section we look at the following: Need for audit Objective of the audit

Why do we audit them- Need for Audit

Principle provides capital and hires manager to manage it.

Principle (Shareholders)

Information asymmetry and conflict of interest lead to information risk for the principle Director is accountable to Principle; provides financial reports.

Directors

Auditor gathers evidence to evaluate fairness of manager financial statements.

Auditor

Directors hires audit to report on the fairness of manager financial statements. Risk information asymmetry of principle reduce.

Why do we audit them Objective of Audit

The objective of the audit is to express an opinion on the financial statements whether or not the financial statements present fairly.

Basic Accounting Principles

Over all considerations of preparing and presenting financial statements Fair Presentation and Compliance with IFRS. Going Concern Accrual Basis of Accounting Consistency of Presentation Materiality and Aggregation Off setting Comparative Information

Areas of Balance Sheet

In this section we will cover the following important areas of the Balance Sheet: Property, Plant and Equipments Investments Loans and Advances Stock in Trade Trade Debtors Cash and Bank Balances Deferred Liabilities Long term Loans from Baking Companies Trade Creditors Taxation Contingencies and Commitments

Assurance Engagements
Performed to enhance the credibility of information

about a subject matter by evaluating whether the

subject matter conforms in all material respects with suitable criteria, thereby improving the likelihood that the information will meet the needs of an intended user. Independence is required of an auditor.

Assurance Services
Audit
- performed to enable the auditor to express an

opinion whether the financial statements are prepared, in all material respects, in accordance with identified financial reporting framework (e.g. Philippine Financial Reporting Standards)

Assurance Services
Review
- involves investigations of limited scope than an

audit and are undertaken for the purpose of expressing LIMITED ASSURANCE that the statements are presented in accordance with GAAP.

Other Assurance Services

Examination of future-oriented financial information Effectiveness of internal control Compliance with statutory, regulatory and contractual obligations

Trivia Question
The review of a companys financial statements by a CPA firm: a. Is substantially less in scope of procedures than an audit b. Requires detailed analysis of the major accounts c. Is of similar scope as an audit and adds similar credibility to the statements d. Culminates in issuance of a report expressing the CPAs opinion as to the fairness of the statements

Non-Assurance Engagements
Engagements that do not provide any assurance

Independence is not required of a CPA performing nonassurance engagement.

Non-assurance Services
Related services
- include agreed-upon procedure engagements

(AUP) and information.

compilation

of

financial

or

other

Other non-assurance engagements

- preparation of income tax returns with no conclusion conveying assurance is expressed and consulting or advisory engagements.

Related services
Agreed-upon procedures (AUP)
- the CPA is engaged to carry out those

procedures to which he and the client entity and any appropriate third parties have agreed and to report on factual findings.

Compilation
- the CPA is engaged to collect, classify and summarize information.

Agreed-upon Procedures

Agreed-upon Procedures

Compilation

Trivia Question
Which of the following engagements is covered by the Framework for Assurance Engagements? a. Consulting engagements b. Preparation of tax returns c. Independent financial statements audit d. Agreed-upon procedures engagement

Standards Related to Services Provided by CPAs

A. Quality Control * Phil. Standards on Quality Control (PSQC 1) Quality Control for Firms that Perform Audits and Review of Historical Information and Other Assurance and Related Services Engagements
procedures and provides guidance regarding a firms responsibilities for its system of quality control for audits and reviews historical information and other assurance and related services engagements
- establishes the basic principles and essential

Quality Control System

A set of policies and procedures designed to provide reasonable assurance that the public accounting firm complies with professional standards and regulatory and legal requirements. Checklist:
Leadership responsibilities for quality within the firm Ethical requirements Acceptance and continuance of client relationships and specific arrangements Human resources Engagement performance monitoring

Standards Related to Services Provided by CPAs

B. Assurance Engagements * Phil. Framework for Assurance Engagements
defines and describes the elements and objectives of an assurance engagements - although the framework serves as a basis for the standards, it DOES NOT itself establish standards or provide procedural requirements for the performance of assurance engagements.
-

Phil. Framework for Assurance Engagements

Phil. Standards on Auditing (PSAs) Phil. Standards on Review Engagements (PSREs) Phil. Standards on Assurance Engagements (PSAEs) Practice Statements are also issued to: Provide interpretative guidance and practical assistance to professional accountants in implementing standards Promote good practice PAPSs, PREPSs and PAEPSs

Standards Related to Services Provided by CPAs

C. Related Services * Phil. Standards on Related Services (PSRSs)
PSRSPs)
-

defines and describes the elements and objectives of an assurance engagements - although the framework serves as a basis for the standards, it DOES NOT itself establish standards or provide procedural requirements for the performance of assurance engagements.

D. Ethics * Code of Ethics for Professional Accountants in

the Philippines

Assurance vs. Consulting services

ASSURANCE
Parties to the contract Purpose Three To lend credibility to the subject matter provided by management in the eyes of the intended users.

CONSULTING
two To be used by the client in improving the matter subjected to consultancy.

Trivia Question:
Who has the primary responsibility for the fairness of the representations made in the financial statements? a. clients management b. Audit committee c. Independent auditor d. Board of accountancy

Elements of an Assurance Engagement

A three-party relationship
a. practitioner b. responsible party c. intended user

An appropriate subject matter

Suitable criteria
Criteria standards or benchmarks used to evaluate or measure the subject matter of an assurance engagement. a. relevance b. reliability c. neutrality d. understandability e. completeness

Elements of an Assurance Engagement

The outcome of the evaluation or measurement of a subject matter is the information that results from applying the criteria to the subject matter. For example: The recognition, measurement, presentation and disclosure represented in the financial statements (outcome) result from applying a financial reporting framework for recognition, measurement, presentation and disclosure, such as Philippine Financial Reporting Standards, (criteria) to an entitys financial position, financial performance and cash flows (subject matter).

Elements of an Assurance Engagement

Sufficient appropriate evidence
a. sufficient the measure of QUANTITY of evidence obtained b. appropriate evidence measure of the QUALITY of evidence obtained
Reliability of evidence is influenced by its source and its nature. Sources of evidence: a. evidence from external sources b. evidence generated internally c. evidence obtained directly from practitioner d. evidence in the form of documents
The practitioner should document matters that are important (auditor uses professional judgement) in providing evidence to support the conclusion expressed in the report and in providing that the assurance engagement was performed in accordance with applicable standards.

Elements of an Assurance Engagement

Written assurance report
- contains a conclusion conveying the assurance obtained about the subject matter - it should include:
a. title b. addressee c. description of the engagement d. identification of subject matter e. statement to identify the responsible party and describe the practitioners responsibility f. identification of the parties to whom the report is restricted g. purpose when restricted h. identification of the standards under which the engagement was conducted i. report date j. name of the firm of the practitioner k. place of issue of the report

Trivia Question
Assurance engagements should exhibit the following elements except: a. Subject matter b. Suitable criteria c. An engagement process d. Appropriate professional fees

Assertion-based engagements
Engagements where the evaluation or measurement of the subject matter is performed by the responsible party and the subject matter information is in the form of an assertion by the responsible party that is made available to the intended users. ASSERTION responsible partys conclusion about the subject matter based on identified suitable criteria Example: In our opinion, the responsible partys assertion that the internal control is effective, in all material respects, based on XYZ criteria, is fairly stated.. Or : In our opinion, internal control is effective, in all material respects, based on XYZ criteria.

Direct Reporting engagements

Engagements where the practitioner either directly performs the evaluation or measurement of the subject matter or obtain representation from the responsible party that has performed the evaluation or measurement that is not available to the intended users. The subject matter information is made available to the intended users in the assurance report. Example: In our opinion, internal control is effective, in all material respects, based on XYZ criteria.

Trivia Question
The level of assurance provided by a professional accountant on an audit report is: a. low b. reasonable c. moderate d. absolute assurance

Assurance Provided by the Practitioner

Reasonable assurance engagement
- an engagement performed to reduce assurance

engagement risk to an acceptably low level to be able to express a positive form of conclusion. - The practitioner uses extensive evidence to support his conclusion. - high but not absolute assurance

Assurance Provided by the Practitioner

Limited assurance engagement
- an engagement performed to reduce assurance engagement risk to a level acceptable for a specific engagement to be able to express a negative form of conclusion. -practitioner uses only a significant amount if evidence as a basis for his conclusion.

Remember these..
Engagement Audit Level of Assurance High, but not absolute assurance Limited Form of Conclusion Positive

Review

Negative

Agreed-upon procedures Compilation

No assurance

Findings

No assurance

Identification of information complied

Reports on Non-assurance Engagements

A practitioner reporting on an engagement that is not an assurance engagement within the scope of this Framework, clearly distinguishes that report from an assurance report. So as not to confuse users, a report that is not an assurance report avoids, for example: Implying compliance with this Framework, PSAs, PSREs or PSAEs. Inappropriately using the words assurance, audit or review. Including a statement that could reasonably be mistaken for a conclusion designed to enhance the degree of confidence of intended users about the outcome of the evaluation or measurement of a subject matter against criteria. Exception: The practitioner and the responsible party may agree to apply the principles of this Framework to an engagement when there are no intended users other than the responsible party but where all other requirements of the PSAs, PSREs or PSAEs are met. In such cases, the practitioners report includes a statement restricting the use of the report to the responsible party.

Important Considerations
Ethical considerations

a practitioner should comply with the requirements of the Code of Ethics for Professional Accountants(to be thoroughly discussed in the next chapters to follow) Engagement Acceptance
-

- a practitioner should accept an engagement only if the subject matter is the responsibility of another party. - acknowledgement by the responsible party in written form is secured to form part of the documentation

Important Considerations
Engagement Acceptance (cont.)

- a practitioner should accept an engagement only if the subject matter is identifiable and in a form that can be subjected to evidence gathering procedures and the practitioner is not aware of any reason for believing that a conclusion about the subject matter based on suitable criteria cannot be established Planning - a practitioner should plan and conduct the assurance engagement in an effective manner to meet the objective of the engagement - the practitioner should plan and conduct an assurance service engagement with an attitude of professional skepticism

Important Considerations
Planning - a practitioner should obtain knowledge of the engagement sufficient to identify and understand the events, transactions, and practices that may have a significant effect on the subject matter and engagement - a practitioner should assess whether the criteria are suitable to evaluate the subject matter - a practitioner should consider materiality and engagement risk when planning and conducting an assurance engagement in order to reduce the risk of expressing an inappropriate conclusion that the subject matter conforms in all material respects with suitable criteria

Engagement risk
It is the risk that the practitioner will express an inappropriate conclusion that the subject matter conforms in all material respects with suitable criteria.
(i)Inherent risk: the susceptibility of the subject matter information to a material misstatement, assuming that there are no related controls; and (ii) Control risk: the risk that a material misstatement that could occur will not be prevented, or detected and corrected, on a timely basis by related internal controls. When control risk is relevant to the subject matter, some control risk will always exist because of the inherent limitations of the design and operation of internal control; and (iii) Detection risk: the risk that the practitioner will not detect a material misstatement that exists.

Other factors:
Reducing assurance engagement risk to zero is very rarely attainable or cost beneficial as a result of factors: The use of selective testing. The inherent limitations of internal control. The fact that much of the evidence available to the practitioner is persuasive rather than conclusive. The use of judgment in gathering and evaluating evidence and forming conclusions based on that evidence. In some cases, the characteristics of the subject matter when evaluated or measured against the identified criteria.

Materiality
relevant when the practitioner determines the nature, timing and extent of evidence-gathering procedures, and when assessing whether the subject matter information is free of misstatement Professional Skepticism
- An attitude of professional skepticism means the practitioner makes a critical assessment, with a questioning mind, of the validity of evidence obtained and is alert to evidence that contradicts or brings into question the reliability or documents or representations by the responsible party.

Important Considerations
Subsequent events - a practitioner should consider the effect of subsequent events up to the date of the practitioners report. Using the work of an expert - the practitioner and the expert, on a combined basis, possess adequate knowledge and proficiency pertaining to the subject matter - things to consider by the practitioner:
a. professional competence of the experts b. reasonableness of assumptions used, methods and data c. reasonableness and significance of the experts findings in relation to the objective of the engagement and the conclusion on the subject matter

Trivia Question
An assurance engagement should involve three separate parties. Which of the following statements concerning these parties is incorrect? a. The responsible party and intended users may be from different entities or the same entity. b. The term practitioner as used in the Framework for Assurance Engagements is broader than the term auditor as used in PSAs and PSREs. c. In an assertion based engagement, the responsible party is responsible for the subject matter information (the assertion) and may be responsible for the subject matter d. An entitys senior management (the responsible party) may engage a practitioner to perform an assurance engagement on a particular aspect of the entitys activities that is the immediate responsibility of a lower level of management (the intended user)

Trivia Question
In an assurance engagement, the person or class of person for whom the professional accountant prepares the report for a specific use or purpose is the a.Intended user b.Responsible party c.Management d.client

Trivia Question
What type of assurance engagement is involved when the practitioner expresses a positive form of conclusion? a.Limited assurance engagement b.Positive assurance engagement c.Reasonable assurance engagement d.Absolute assurance engagement

Trivia Question
In assertion-based assurance engagements, the evaluation or measurement of the subject matter against criteria is performed by the a.Intended users b.Responsible party c.Practitioner d.AASC

Trivia Question
Which of the following standards are to be applied, as appropriate, in the audit of historical financial information? a.PSREs b.PSAEs c.PSRSs d.PSAs

Trivia Question
Which of the following standards are to be applied to compilation engagements, engagements to apply agreed-upon procedures to information and other related services engagements as specified by the AASC? a.PSRSs b.PSAs c.PSAEs d.PSREs

Trivia Question
These statements are issued by the AASC to provide interpretative guidance and practical assistance to auditors in the implementation of PSAs and to promote good practice a.PREPSs b.PAPSs c.PAEPs d.PRSPSs

Trivia Question
What assurance is provided by the auditor in an agreed-upon procedures engagement? a.Reasonable b.Absolute c.Moderate d.No assurance

Trivia Question
Which of the following least likely indicate an objective of an assurance engagement?
a.It is intended to enhance the credibility of information about a subject matter b.It is intended to prevent the issuance of materially misleading information c.It is intended for a professional accountant to express a conclusion that provides the intended users with a level of assurance about the subject matter. d.It is intended to provide a level of assurance to be issued by a professional accountant about the information of being in conformity, in all material respects, with suitable criteria.

Trivia Question
Which of the following statements are correct?
I. The subject matter of an assurance engagement may take any forms. II. Internal control may be the subject matter of an assurance engagement. a. b. c. d. I only II only Both I and II Neither I nor II

Trivia Question
Which of the following statements is false?
a. Evidence is more persuasive when items of evidence from different sources or of different nature are consistent. b. In case of evidence from different sources that are consistent, the practitioner may obtain cumulative degree of confidence that is higher than from items of evidence considered individually c. When evidence obtained from one source is inconsistent with that obtained from another, the practitioner refrains the gathering of further evidence. d. It is generally more difficult to provide assurance on subject matter covering a period of time than on subject matter covering a point in time.

Trivia Question
Which of the following statements is true?
a. The extent of documentation is not within the discretion of the practitioner. b. It is neither necessary nor practical to document every matter the practitioner considers. c. It is necessary but not practical to document every matter the practitioner considers. d. Documentation includes a record of the practitioners reasoning on all matters considered by the practitioner.

Trivia Question
The following should be included in the practitioners report except one:
a. Identification of the parties to whom the report is restricted b. A statement to identify the responsible party and described the practitioners responsibilities c. Report date d. Name of the firm or the practitioner

Trivia Question
Which of the following statements is true?
a. A practitioner should assume that the responsible party is dishonest. b. The practitioner should assume that the responsible party has unquestioned honesty c. Both A and B d. Neither A nor B

Any Questions Thank You