Chapter 4 - Overview of the Audit Process and Preliminary Activities CHAPTER 4 OVERVIEW OF AUDIT PROCESS AND PRELIMINARY ACTIVITIES Chapter Overview and Objectives: ——— This Chapter discusses the audit process and presents the activities involved in its preliminary phase. At the end of this chapter, readers should be able to discuss 1. The activities conducted in performing a financial statement audit The different categories and types of management assertions The different categories and types of audit procedures The major preliminary engagement activities The objective and process of accepting or continuing an audit client relationships The process of agreeing on the terms of the audit engagement The form and content of the engagement letter 8. The considerations taken in accepting a change in an engagement Relevant references: PSA 200 - Overall Objectives of the Independent Auditor and the Conduct of an ‘Audit in Accordance with International Standards on Auditing PSA 210 - Agreeing the Terms of Audit Engagement PSA 500 - Audit Evidence Page 129chapter 4 Overview of the Audit Process and Preliminary Activities ION heer RON statements is normally performed BY an indepen, qualified auditor on an annual Basle to meet the information needs entity's financial statement users. The entity is required to prepare it statements by complying with the applicable financial reporting framewoy, PERS, PFRS for SME, PFRS for Small Entities). To audit the entitys fgate statements, auditors must adhere tO applicable auditing standards (e.g, oa is a systematic process of objectively obtain ding assertions about economic actions and 7 correspondence between these assertions jcate the results thereof. fina As defined, an"eudit i evaluating evidence reg! ascertain the degree of ¢ established criteria and communi The logic and objective of an audit of firancial statements are smiar g revit af financial statements. To attain the objective of the audi, the aie needs to undergo a systematic process comprising certain activities, ~ ang an audit engagement is performed using an orderay Being a systematic process, This process is commonly cateq or structured series of steps. “AUDIT PROCESS". Exhibit 4-1 depiets the general overview of the audit process. Exhibit 4-1] General Overview of the Audit Process: r uit Enily Teun ‘The auditor The auditor prepares and performs ee oe gathers audit expresses an evidence ‘audit opinion financial procedures statements An audit in accordance with PSAs is conducted on the premise that management and, where appropriate, those charged with governance have responsbiies that are fundamental to the conduct of the audit. The inancial statements subject to audit are those it of the entity, prepared and Seat iat the management of the enti h oversight from those governance. The audit of the financial statements does not relieve management or those na charged responsibilities. =n cena a —_—_—_—_——_—_— Page 130 Aim... Believe... Clai-Chapter 4 — Overview of the Audit Process and Preliminary Activities The financialstatements are considered as assertions"orrepresentations smadesbysthesentity, through its management and those charged with governance, as appropriate. These assertions may be explicitly or implicitly included in the financial statements, Previously, these-assertions*may-fall = Assertions Occurrence - transactions, and events that have been recorded have occurred and pertain to the entity. Completeness - all transactions and events that should have been recorded have been recorded. Cutoff - transactions and events have been recorded in the correct accounting period. ¥ Accuracy = amounts and other data relating to recorded transactions and events have been recorded appropriately. Y Classification - transactions and events have been recorded in the proper accounts. ‘Account balances at | ¥ Completeness - all assets, liabilities, and equity the period end interests that should have been recorded have been (ACERV) recorded. Y Existence - assets, liabilities, and equity interests exist. ¥ Rights and obligations - the entity holds or controls the rights to assets, and liabilities are the obligations of the entity ¥ Valuation and allocation - assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately, recorded. Presentation and | “ Occurrence and rights and obligations - disclosed disclosure (POCAC) events, transactions, and other matters have ‘occurred and pertain to the entity ¥ Completeness - all disclosures that should have been included in the financial statements have been included. ¥ Accuracy and valuation - financial and other information are disclosed fairly and at appropriate amounts. Classification and understandability - financial information is appropriately presented and described, and disclosures are clearly expressed. oe Aim... Believe... Claim. Page 131™ Chapter 4 - Overview of the Audit Process and Preliminary Activities However, a new set of categories for assertions were provided by p, These assertions are used by the auditor in considering the differe, at ty of potential misstatements that may occur may fall into the folog . ing SA 315 categories: Assertions_— ciuaat of | 7 Presentation - transactions and events are ao Transactions and | aggregated or disaggregated and clearly deserve, events and | __related disclosures are relevant and understandabe in related context of the requirements of the applicable fip disclosures. reporting framework. (Poccac) Y Occurrence ~ transactions, and events that have been recorded or disclosed have occurred, and. gue transactions and events pertain to the entity. | ¥ Completeness - all transactions and events that show have been recorded have been recorded, and all relatey disclosures that should have been included in the financa} statements have been included. YY Gutoff- transactions and events have been recorded inthe correct accounting period. Y Accuracy - amounts and other data relating to recorded transactions and events. have been recorded appropriately, and related disclosures have been appropriately measured and described. Y Classification - transactions and events have been recorded in the proper accounts, ‘Account Y Presentation - assets, liabilities, and equity interests are balances and | __ appropriately aggregated or disaggregated and cleatly related described, and related disclosures are relevant and disclosures ‘understandable in the context of the requirements of the | (PACER C) applicable financial reporting framework. ‘Accuracy, valuation, and allocation - assets, liabilities, and equity interests have been included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments have bee? tely recorded, and related disclosures have bee” appropriately measured and described. Completeness - all assets, liabilities, and equity interests that should have been recorded have been recorded, 2nd all related disclosures that should have been included in the financial statements have been included. Existence - assets, liabilities, and equity interests exist: Rights and obligations - the entity holds or controls the Tights to assets, and liabilities are the obligations of the entity Classification - assets, liabilities, and equity interests have been Fecorded in the proper accounts. — Page 132 Aim... Believe... Claim NanciChapter 4 ~ Overview of the Audit Process and Preliminary Activities Additional responsibilities Moreover, PSA 200 provides that management and, where appropriate, those charged with governance have the responsibility: a. For the preparation and presentation of the financial statements in accordance with the applicable financial reporting framework; this includes the design, implementation, and maintenance of internal control relevant to the preparation and presentation of financial statements that are free from material misstatement, whether due to fraud or error; and b. To provide the auditor with: i. All information, such as records and documentation, and other matters that are relevant to the preparation and presentation of the financial statements; Any additional information that the auditor may request from management and, where appropriate, those charged with governance; and ili, Unrestricted access to those within the entity from whom the auditor determines it necessary to obtain audit evidence. As part of their responsibility for the preparation and presentation of the financial statements, management and, where appropriate, those charged with governance are responsible for: ‘© The identification of the applicable financial reporting framework, in the context of any relevant laws or regulations. The preparation and presentation of the financial statements by that framework. * An adequate description of that framework in the financial statements. The preparation of the financial statements requires management to ‘exercise judgment in making accounting estimates that are reasonable in the circumstances, as well as to select and apply appropriate accounting policies. These judgments are made in the context of the applicable financial reporting framework. 1, The auditor performs audit procedures 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 Aim... Believe... Claim. Page 133~ Chapter 4 ~ Overview of the Ault Process and Preliminary Activities b. To report on the financial statements, and communicate ag the PSAs, in accordance with the auditor's findings. "eduiredy, To achieve the overall objectives of the audit, the auditor perform audit procedures that enable the gathering of evidence will be used as a basis for expressing the opi audit of financial statements, shall des audit evidence cn non ease When selecting procedures, the auditor considers various fac assertions made by the entity, assessed level of risks, Procedures to be performed may be categorized into procedures and (2) specific audit procedures tOFS inclu and materia (1) major aude, Major audit procedures 1 Risk assessment procedures. The audit procedures are performed obtain an understanding of the entity and its environment, ined the entity's internal control, to identify and assess the risks of mateng misstatement, whether due to fraud or error, at the finanda, statement and assertion levels. 2. Test of controls. An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level, 3. Substantive procedure. An audit procedure designed to detec ‘material misstatements at the assertion level. Substantive procedures comprise: i. Tests of details (of classes of transactions, account balances, and disclosures), and Substantive analytical procedures. Specific audit procedures 1. Inspection of Records or Documents. It consists of examining records or documents, whether internal or external, in paper form, electronic form, or other media. 2. Inspection of Tangible Assets. It consists of a physical examination of the assets. 3. Observation. It consists of looking at a process or procedure bens performed by others. 4. Inquiry. It consists of seeking information from kt Persons, both financial and non-financial, throughout # outside the entity, This procedure may be used extensively t the audit as a complement to other audit procedures. seam, Page 134 Air... Believe nowledgeadle he entity O° fhroughoutChapter 4 ~ Overview of the Audit Process and Preliminary Activities 5. Confir i witha ee type of inquiry is the process of obtaining a r ion of information i i a third party. or of an existing condition directly from 6. Recalculation, documents or electronically, It consists of checking the mathematical accuracy of records. This procedure may be performed manually or 7. Repestormance. It involves the auditor's independent execution of Procedures Or controls that were originally performed as part of the entity's internal control. 8 Analytical Procedures. Procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. Analytical procedures also encompass the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. 2. The auditor gathers audit evidence Through the procedures performed, the auditor obtains sufficient ‘appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. Audit evidence refers to information used by the auditor in arriving at the conclusions on which the auditor's opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information. 3, The auditor expresses an audit opinion The auditor provides a written audit report containing a conclusion or an opinion regarding the fairness of preparation and presentation of financial statements in accordance with the applicable financial reporting framework. Opinion to be expressed by the auditor may include either of the following: a. Unmodified opinion. The opinion is expressed by the auditor when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. This type of opinion is also known as an unqualified opinion. oe b. Modified opinion. A qualified opinion, an adverse opinion, or a disclaimer of opinion. The auditor shall modify the opinion in the auditor's report when: a Aim... Believe... Claim. Page 135y chapter 4 - Overview of the Audit Process and Preliminary Activities 1. A choice between Qualified and Adverse. The aul that, based on the audit evidence obtained, — Statements as a whole are not free from material miss, ie 2, Achoice between Qualified and Disclaimer of opinion ee ‘1 is unable to obtain sufficient appropriate audit “The diy v nelude that the financial statements as @ whole -— ree fg, material misstatement. sub-phases of the audit process see epove aut process may be divided into two sub-Phases, the inves ibatve hase, and. the reporting phase. The investigative phate incudes Ferformance of audit procedures and the gathering of audit evidence, On re ‘other hand, reporting phase includes the expression of opinion, prepetn. one ert, and communication of the results to the different users of ie audited financial statements. AUDIT PROCESS: A (MORE DETAILED APPROACH The specific sequence or order of activities in performing financial statements salt may vary from firm to firm depending on thelr Po icies and procedures However, such a sequence of different activities normally will include the following steps: Planning an audit of Preliminary financial statements engagement activities Evidence-gathering study and evaluation of (Substantive testing) internal control Completing the audit Issuance of the audit report Page 136Chapter 4 ~ Overview of the Audit Process and Preliminary Activities ‘The activities presented in Exhibit 4-2 are further discussed in the table below. [PHASE HI {_______ DESCRIPTION, This phase will require a decision from the auditor whether OF not to accept a new client or continue a relationship with an existing one. This process would require evaluation not only of the auditor's qualification, but also the integrity and auditability of the client's financial statements. Primary objective: To minimize the likelihood of being associated with a client whose management lacks integrity [Ry Audit planning involves the development of an overall audit strategy, audit plan, and audit program. The auditor usually obtained more detailed knowledge about the client's business and industry to understand the transactions and events affecting the financial statements. A preliminary assessment of risk and materiality is also made during this phase. Primary objective: To assess the different risks associated with the audit to determine the nature, timing, and extent of further audit procedures necessary to be performed 3. Studyand | ‘internal contra! ‘Since an entity's internal control directly affects the reliability, of the financial statements, it is appropriate to study and evaluate these controls, Primary objective: To establish a basis for reliance on internal controls, in determining the nature, timing, and extent of audit procedures to be performed Using the information obtained in audit planning and consideration of internal controls, the auditor performs a substantive test to determine whether the entity's financial statements are presented fairly in accordance with financial standards. Substantive procedures could either be ‘This phase will always be performed by the auditor. Primary objective: To ascertain the degree of correspondence between the financial statements prepared by the client's management and the financial reporting framework. With this, the auditor will be able to conclude whether or not the financial statements are presented fairly in accordance with financial reporting standards ——— Aim... Believe... Claim. Page 137Chapter 4 - Overview of the Audit Process and Preliminary Activities | Wrapping: are reviewe phase sr rocedures ae petorme rr oneliions erall opinion is Mh and an overall opinion is formed q,,*ehap ing tive: To assist the auditor in asses ed is consistent with evidence gather ® the alti ered aulor prepares and sues an sie scope of the audit and star, regarding the fairness of the Primary objes conclusion reaché the | In this stage, th which describes the auditor's conclusion statements. primary objective: To communicate the conclusion re by the auditor to various intended users ache gagement, the acim jation of the audit engagement, the angry that will enable him/her to ig itor inthe current and faa re eS the finan ‘After compl performs procedures ‘areas. for improvement engagements. [Link]: To assess and evaluate the quality oy services delivered by the engagement team regret | PRELIMINARY ENGAGEMENT ACTIVITIES ‘MAJOR AUDIT PROCEDURES in deciding whether to accept should consider the following: 1. Its competence, 2. Itsindependence, 3. Its abilty to serve the client properly, and 4. The integrity of the prospective client’s management. the auditor is expected to perform the 1 or reject an engagement, the auditor's fim To adequately address the above items, followi 1. Obtain a preliminary knowledge of the client's business and industry fe determine whether the auditor has the degree of competence required) the engagement. ‘as prescribed by the Code of Ethics for Professional Accountants ® professional accountant in public practice should agree to provide om those services that the professional accountant in public practice © competent to perform. This means that the auditor can only accel engagements whose requirements are within the auditor's capacly = capability. Page 138 Believe... cla —