REVIEW NOTES IN AUDITING AND ASSURANCE PRINCIPLES
CHAPTER 4
Audit Process – Accepting an Engagement
General Approach to Auditing Financial Statements
1. Financial Statement Assertions
a. Existence or Occurrence
b. Completeness
c. Rights and Obligations
d. Presentation and Disclosure
e. Valuation and Allocation
2. Audit Procedures
3. Audit Evidence
4. Audit Opinion
Financial Statement Assertions according to categories of Financial Statements
1. Assertions about classes of transactions and events for the period under audit
a. Occurrence
b. Completeness
c. Accuracy
d. Cutoff
e. Classification
2. Assertions about account balances at the period end
a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation and Allocation
3. Assertions about Presentation and Disclosure
a. Occurrence and rights & obligations
b. Completeness
c. Classification and Understandability
d. Accuracy and valuation
Audit Procedures
1. Inspection
2. Observation
3. Inquiry
4. Confirmation
5. Computation
6. Analytical Procedures
Steps in the Audit Process
1. Accepting an Engagement
2. Audit Planning
3. Considering Internal Control
4. Performing Substantive Tests
5. Completing the audit
6. Issuing a report
PSA 300 – procedure performed in accepting an engagement “preliminary planning activities”
1. Performing procedures regarding the continuance of the client relationship and the specific audit
engagement;
2. Evaluating compliance with ethical requirements, including independence; and
3. Establishing an understanding of the terms of the engagement.
Accepting an Engagement, the firm should consider:
1. Its competence
2. Its independence
3. Ability to serve the client properly
4. The integrity of the prospective client’s management; and
5. The adequacy of the accounting records
Engagement Letter sets forth (PSA 210):
1. The objective of the audit of financial statements which is to express an opinion on the financial
statements;
2. The manager’s responsibility for the fair presentation of the financial statement;
3. The scope of the audit
4. The forms, any reports or other communications that the auditor expects to issue;
5. The fact that because of the limitations of the audit, there is an unavoidable risk that material
misstatements may remain undiscovered; and
6. The responsibility of the client to allow the auditor to have unrestricted access to whatever
records, documentation and other information requested in connection with the audit.
Another items:
1. Billing arrangements
2. Expectations of receiving management representation letter;
3. Arrangements concerning the involvement of others (experts, other auditors, internal auditors
and other client personnel); and
4. Request for the client to confirm the terms of the engagement
Importance of Engagement Letter
1. Avoid misunderstandings with respect to the engagement;
2. Document and confirm the auditor’s acceptance of the appointment.
Factors that may cause the auditor to send new engagement letter
1. Any indication that the client misunderstands the objective and scope of the audit;
2. Any revised or special terms of the engagement
3. A recent change of the senior management, board of directors or ownership
4. A significant change in the nature or size of the client’s business; or
5. Legal requirements and other government agencies’ pronouncements.
Factors in making decision of whether to send a separate engagement letter
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. The extent of any work performed by other auditor
5. Degree of ownership by parent; or
6. Degree of independence of the component’s management
CHAPTER 5
Audit Planning
Importance of adequate audit planning
1. Planning helps ensure that appropriate attention is devoted to important areas of the audit;
2. It helps identify potential problems
3. It allows the work to be completed expeditiously
4. It assists in the proper assignment and coordination of work; and
5. It helps ensure that the audit is conducted effectively and efficiently.
Sources of Information of business and industry
1. Review of prior years’ working papers;
2. Tour of the client’s facilities
3. Reading relevant books, periodicals and other publications
4. Discussion with people within and outside the entity; or
5. Reading corporate documents and financial reports
Materiality may be viewed as:
1. The largest amount of misstatement that the auditor could tolerate in the financial statements;
or
2. The smallest aggregate amount that could misstate any one of the financial statements
Steps in Using Materiality in an Audit
Step 1: Determine the overall materiality – Financial Statement Level
Step 2: Determine the tolerable misstatement – Account Balance Level
- Perform audit procedures
Step 3: Compare the aggregate amount of uncorrected misstatements with the overall materiality
Bases that can be used to determine the materiality level
1. Annualized interim financial statements;
2. Prior year financial statements; or
3. Budgeted financial statement of the current year
Factors that may influence the auditor’s assessment of the risk of misstatement at the FINANCIAL
STATEMENT LEVEL
1. Management integrity
2. Management characteristics (e.g. aggregate attitude toward financial reporting);
3. Operating characteristics (e.g. profitability of the entity relative to its industry is inadequate);
and
4. Industry characteristics (e.g. the industry experiencing a large number of business failures)
Factors affecting inherent risk at the account balance level
1. Susceptibility of the account to theft;
2. Complexity of calculations related to account;
3. The complexity underlying transactions and other events; and
4. The degree of judgment involved in determining account balances
Steps in using the Audit Risk Model
Step 1: Set the Acceptable Level of Audit Risk
Step 2: Assess the Level of Inherent Risk
Step 3: Assess the Level of Control Risk
Step 4: Determine the Acceptable Level of Detection Risk
Step 5: Design Substantive Tests
Audit Risk = Inherent Risk * Control Risk * Detection Risk
Acceptable level of Audit Risk
Acceptable Level of Detection Risk =
Inherent Risk∗Control Risk
Risk Assessment Procedures
1. Inquiries of management and others within the entity
2. Analytical procedures; and
3. Observation and inspection
Steps in Applying Analytical Procedures
Step 1: Develop expectation regarding financial statements using:
a. Prior years’ financial statements
b. Anticipated results such as budgets or forecasts
c. Industry averages or financial statements of other entities operating within the same
industry
d. Non-financial information relevant to the financial statements
e. Typical relations among financial statement account balances
Step 2: Compare the expectations with the financial statements under audit
Step 3: Investigate significant unexpected differences (unusual fluctuations) to determine whether
financial statements contain material misstatements.
Uses of Analytical Procedures
1. As a planning tool, to determine the nature, timing, and extent of other auditing procedures
2. As a substantive tests to obtain corroborative evidence about particular assertions related to the
account balance or transaction class; or
3. As an overall review of the financial of the financial statements in the completion phase of the
audit.
CHAPTER 6
Consideration of Internal Control
Definitions embodies four essential concepts of Internal Control
1. Internal Control is a process
2. Internal Control is effected by those charged with government, management and other
personnel.
3. Internal control can be expected to provide reasonable assurance of achieving the entity’s
objectives
4. Internal control is designed to help achieve the entity’s objectives.
Inherent Limitations that may affect the internal control’s effectiveness
1. Management’s usual requirement that the cost of an internal control should not exceed the
expected benefits to be derived;
2. Most internal controls tend to be directed at routine transactions rather than non-routine
transactions;
3. The potential for human error due to carelessness, distraction, mistakes of judgment and the
misunderstanding of instructions;
4. The possibility of circumvention of internal controls through the collusion among employees;
5. The possibility of management overriding the internal control;
6. The possibility that procedures may become inadequate due to changes in conditions, and
compliance with procedures may deteriorate.
Entity’s objectives:
1. Operational objective
2. Compliance objective
3. Financial reporting objective
Components of Internal Control
1. Control environment
2. Risk assessment
3. Information and communication systems
4. Control activities
5. Monitoring
Factors reflected in the control Environment
1. Integrity and ethical values
2. Management philosophy and operating style
3. Active participation of those charged with governance
4. Commitment to competence
5. Personnel policies and procedures
6. Assignment of responsibility and authority/ Organizational structure
Specific Control Procedures that are relevant to financial statements audit (Control Activities)
1. Performance reviews
2. Information processing
3. Physical controls
4. Segregation of duties
Consideration of the entity’s internal control systems
1. Obtaining understanding of the internal control
2. Documenting the understanding of accounting and internal control systems
3. Assessing the level of control risk
4. Performing tests of controls
5. Documenting the assessed level of control risks
Nature of tests of control
1. Inquiry
2. Observation
3. Inspection
4. Reperformance