Auditing: An Overview

Auditing Defined
Auditing is a systematic process of obtaining and evaluating evidence about assertions
regarding economic actions and events. It is conducted objectively to ascertain the degree of
correspondence between assertions and established criteria. The ultimate objective is to
communicate the audit results to various interested users.

Key thoughts conveyed by the definition:

1. Systematic Process: Auditing follows an ordered and structured series of steps.

2. Obtaining and Evaluating Evidence:
Auditors gather and assess proof related to claims made by an entity about its economic
activities.
Assertions: These are representations made by an entity about economic actions and
events.

3. Objective Conduct: Audits must be performed without bias.

4. Ascertaining Correspondence:
Auditors determine how well assertions match established criteria.
Established Criteria: These are necessary standards or benchmarks against which
assertions are judged for validity.

5. Communication of Results: The final stage involves sharing the audit findings with interested
parties.

Types of Audit Reports

The communication of audit results is typically done through an auditor's report, which
expresses an opinion. The main types of opinions are:

1. Unqualified Opinion (Unmodified Opinion):

Issued when the auditor concludes that the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.
This does not guarantee that no misstatements were found or corrected. It implies that any
misstatements, if present, were either corrected or were not material (quantitatively or
qualitatively).

2. Qualified Opinion:
Issued when the auditor cannot provide an unqualified report due to specific reasons, such
as:
Financial records not adhering to standards (e.g., GAAP).
Discovery of material but isolatable misstatements that do not severely affect the entire
financial statement.
 An auditor declares a qualified opinion if:
Sufficient appropriate evidence has been gathered, and misstatements exist that are
material but not pervasive to the financial statements.
Sufficient appropriate evidence cannot be collected, and the potential effects of
undetected misstatements could be material but not pervasive.

3. Disclaimer Opinion:
Issued when the auditor cannot form an opinion. This occurs when:
Sufficient appropriate evidence cannot be gathered, and the potential effects of
undetected misstatements are both material and pervasive.
In rare situations with multiple uncertainties, it's impossible to form an opinion due to
the interaction of these uncertainties on the entire financial statement.

The auditor deems they cannot provide concrete audit evidence, and the situation has a
severe negative effect. This can also happen if certain operational procedures could not be
reviewed for compliance with standards.

4. Adverse Opinion:
Issued when sufficient appropriate audit evidence has been obtained, and the auditor
concludes that misstatements are both material and pervasive to the entire financial
statement.
These errors are very serious, indicating gross misstatement and potentially fraud.
This opinion is also declared when reports are not in accordance with a compliance
framework, meaning the financial statements are not prepared in accordance with the
applicable framework in all material respects.

Types of Audits
Audits can be categorized based on their primary objective and subject matter:

1. Financial Statement Audit:

Objective: To determine whether the financial statements of an entity are fairly presented in
accordance with the applicable financial reporting framework.
Subject Matter: Assertions that the financial statements are presented in accordance with
an identified financial reporting framework (e.g., GAAP, PFRS).
Typical Auditor: Independent/external auditors.

2. Compliance Audit:
Objective: To review an organization's procedures to determine adherence to specific rules,
regulations, or laws established by an authoritative body.
Subject Matter: Assertions that the organization has complied with applicable laws,
regulations, and specific procedures.
Typical Auditor: Government auditors.

3. Operational Audit:
Objective: To study a specific unit of an organization to measure its performance in terms
 of efficiency and effectiveness. Also known as performance audit or management audit.
Subject Matter: Assertions that the organization's activities/operations are conducted
effectively and efficiently relative to specified objectives.
Typical Auditor: Internal auditors.

Types of Auditors
Auditors can be classified based on their employment and independence:

1. External Auditors (Independent Auditors):

Independent Certified Public Accountants (CPAs) who provide professional services to
clients on a contractual basis.
Generally perform financial statement audits.

2. Internal Auditors:
Employees of the entity who investigate and appraise the effectiveness and efficiency of
operations and internal controls.
Usually perform operational audits.

3. Government Auditors:
Government employees whose primary concern is to determine whether persons or entities
comply with government laws and regulations.
Usually perform compliance audits.

The Independent Financial Statement Audit

The core objective of an independent financial statement audit is to enable the auditor to express
an opinion on whether the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework.

Need for Independent Financial Statement Audit

Several factors create the need for independent audits:

Potential Conflict of Interest: Between users (investors, creditors) and preparers

(management) of financial information.
Remoteness of Users: Users are often geographically distant from the company and cannot
directly observe its operations.
Consequences for Decision Making: Financial statements are crucial for economic decisions,
making their reliability important.
Complexity of Subject Matter: Financial reporting involves complex rules and judgments that
require expertise to assess.

Other Facts About Audit Reports

An FS audit is:

NOT a certification or guarantee of the accuracy or fairness of the financial statements.

NOT an assurance of future viability of the entity.
NOT an assurance of the efficiency or effectiveness of the client's business operations.
NOT a statement about the financial strength, wisdom of management decisions, or the risk
of doing business with an entity.

Responsibility for the Financial Statements

Management is responsible for preparing and presenting the financial statements in accordance
with the applicable financial reporting framework. The auditor's role is to express an opinion on
these statements.

Assurance Provided by the Auditor

An audit conducted in accordance with Professional Standards on Auditing (PSA) provides

reasonable assurance, not absolute assurance, that the financial statements, taken as a whole,
are free from material misstatements.

Nature of Procedures and Limitations

The auditor's ability to obtain evidence is subject to practical and inherent limitations:

Use of Testing/Sampling: Auditors often use sampling, which introduces sampling risk (the
risk that the sample is not representative of the population).
Judgment and Non-Sampling Risk: Errors can occur in the application of professional
judgment.
Nature of Financial Reporting: The application of accounting standards (like PFRS) involves
judgment and estimation.
Nature of Evidence: Audit evidence is generally persuasive rather than conclusive, meaning it
supports a conclusion but doesn't definitively prove it.

General Requirements When Auditing Financial

Statements
To conduct an audit effectively, auditors must adhere to several key requirements:

1. Comply with Ethical Requirements: Adhere to relevant professional ethical codes (e.g.,
integrity, objectivity, professional competence, confidentiality, professional behavior).
2. Conduct Audit in Accordance with PSAs: Follow the Philippine Standards on Auditing (PSA) or
equivalent auditing standards.
3. Apply Professional Judgment: Use professional judgment throughout the planning and
performance of the audit.
4. Obtain Sufficient Appropriate Audit Evidence: Gather enough relevant and reliable evidence to
reduce audit risk to an acceptably low level.
5. Plan and Perform with Professional Skepticism: Maintain an attitude of questioning mind and
critical assessment of audit evidence.

Theoretical Framework of Auditing

Auditing operates under certain fundamental assumptions and principles:

1. Verifiability: All financial data is assumed to be verifiable.

2. Independence: The auditor must maintain independence from the financial statements under
audit.
3. No Long-Term Conflict: It's assumed there will be no long-term conflict between the auditor
and client management.
4. Internal Control Effectiveness: An effective internal control system reduces the possibility of
material misstatements.
5. Consistency of Framework Application: Consistent application of the financial reporting
framework results in fair presentation.
6. Continuity: What was true in the past is likely to remain true in the future, absent contrary
conditions.
7. Public Benefit: Audits benefit the public by enhancing the reliability of financial information.

Assurance and Non-Assurance Services

Auditors and accountants offer a range of services, which can be broadly categorized as
assurance or non-assurance.

Assurance Engagements

An assurance engagement involves a practitioner expressing a conclusion designed to enhance

the degree of confidence of intended users (other than the responsible party) about the outcome
of the evaluation or measurement of a subject matter against criteria.

Key elements:

Express Conclusion: The practitioner provides a formal opinion or conclusion.

Enhance Confidence: The aim is to increase users' assurance.
Evaluation against Criteria: The subject matter is assessed against specific standards or
benchmarks.

Types of Assurance Engagements and Objectives:

1. Reasonable Assurance Engagements (High-Level Engagements):
Provide a high, but not absolute, level of assurance.
Objective: Reduce assurance engagement risk to an acceptably low level as the basis for a
positive form of expression of the practitioner's conclusion.
 Example Conclusion: "In our opinion, internal control is effective, in all material respects..."

2. Limited Assurance Engagements (Moderate/Limited Level Engagements):

Provide only a moderate or limited level of assurance.
Objective: Reduce assurance engagement risk to an acceptable level as the basis for a
negative form of expression of the practitioner's conclusion. The risk is greater than in
reasonable assurance engagements.
Example Conclusion: "Based on our work described in this report, nothing has come to our
attention that causes us to believe that internal control is not effective, in all material
respects..."

Assurance versus Attestation Versus Audit

Assurance Services: Improve the quality of information for better decision-making. They can
cover financial and non-financial areas.
Attestation Services: Involve issuing a report on a subject matter or an assertion about the
subject matter, where the responsibility lies with another party.
Auditing: A specific type of attestation service focused on enabling the auditor to express an
opinion on whether financial statements are prepared in accordance with an applicable
financial reporting framework.

Non-Assurance Services

These are services that do not meet the definition of an assurance engagement. They may
include:

Accounting and bookkeeping

Administration
Valuation
Tax services
Financial planning

Categories of Services / Engagements

Assurance Services
Audit of Financial Statements: Provides reasonable assurance.
Audit of Internal Control over Financial Reporting: Provides reasonable assurance.
Review of Financial Statements: Provides limited (moderate) assurance.
Review of Interim Financial Information: Provides limited (moderate) assurance.
Other Assurance Services: Such as e-commerce, risk assessment, information systems
reliability.

Non-Assurance Services (Related Services)

Agreed-Upon Procedures: No assurance is expressed; a report of factual findings is provided.
Compilation of Financial or Other Information: No assurance is expressed, though the
accountant's involvement provides some benefit due to professional skill.
Preparation of Tax Returns: When no conclusion is expressed.
 Consulting or Advisory Services: Tax consulting, management consulting, etc.

Engagements and Level of Assurance

1. Audit: Provides reasonable (high, but not absolute) assurance. Expressed positively.
2. Reviews: Provides moderate/limited assurance. Expressed in the form of negative assurance.
3. Agreed-Upon Procedures: No assurance is expressed. The auditor reports factual findings
based on agreed procedures.
4. Compilation: No assurance is expressed. The accountant assists in preparing financial
statements using accounting expertise.

Distinctions Between Assurance and Non-

Assurance Services
Point of Audit Review Agreed-Upon Compilation
Distinction Procedures
Objective To express an To report whether To perform audit To assist the
opinion on the anything has procedures agreed client in preparing
fairness of come to the upon with the financial
financial auditor's attention client and any statements using
statements. that causes him to appropriate third accounting
believe the parties. Recipients expertise.
statements are must form their
not fair. own conclusions.
Characteristics Enhances Substantially less Report is restricted Users derive
credibility of scope of to contracting benefit from the
financial procedures than parties. accountant's
statements. an audit. involvement and
professional skill.
Evidence Risk Inquiry and As agreed upon. Reading of the FS
Gathering assessment, analytical for obvious
tests of procedures. misstatements
controls, (limited).
substantive
tests.
Level of Reasonable Moderate (limited) No assurance is No assurance is
Assurance assurance assurance. expressed. expressed.
Provided (high, but not
absolute).
Report Audit Report Review Report Report of factual Compilation
Provided containing containing findings of Report which
positive negative procedures. identifies
assurance on assurance on information
assertion. assertion. compiled.
Skills Used by Audit skills. Audit skills. Audit skills. Accounting skills.
the Auditor