BASIC AUDITING CONCEPTS 1.

DEFINE AUDITING AUDITING is a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertion about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. (common definition) AUDIT ENGAGEMENT is an assurance engagement to provide a high level of assurance that financial statements are free of material misstatement, such as an engagement in accordance with Philippine Standards on Auditing. This includes a Statutory Audit which is an audit required by national legislation or other regulation. (based on Code of Ethics) 2. PHILOSOPHY OF AUDIT Financial statements are the responsibility of the management. General purpose financial statements are to be prepared by the management. There are many users of the financial statements with conflicting interest. Adds value to published financial statements by providing independent expert opinion as to the fairness with which the statements present financial position, results of operations, and cash flows. Learn how to gather and evaluate evidence supporting an entitys financial statements. Apply the myriad accounting principles and concepts that you learned in previous accounting courses. 3. WHAT IS A REASONABLE ASSURANCE? In an audit engagement, the auditor provides a high, but not absolute, level of assurance, expressed positively in the audit report as reasonable assurance, that the information subject to audit is free of material misstatement. (based on the glossary of terms) An audit in accordance with PSAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement. Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance relates to the whole audit process. (based on paragraph 8 of PSA 200) 4. DEFINE AUDITOR The auditor is the person with final responsibility for the audit. This term is also used to refer to an audit firm. (For ease of reference, the term "auditor" is used throughout the PSAs when describing both auditing and related services which may be performed. Such reference is not intended to imply that a person performing related services need necessarily be the auditor of the entity's financial statements.) (based on the glossary of terms) 5. DEFINE AUDIT FIRM Audit firm is either a firm or entity providing audit services, including where appropriate its partners, or a sole practitioner. (based on the glossary of terms)

6. TYPES OF AUDITOR (based on the glossary of terms) a. Continuing auditor The continuing auditor is the auditor who audited and reported on the prior period's financial statements and continues as the auditor for the current period. b. External auditor Where appropriate the terms "external auditor" and "external audit" are used to distinguish the external auditor from an internal auditor and to distinguish the external audit from the activities of internal auditing. c. Incoming auditor The incoming auditor is a current period's auditor who did not audit the prior period's financial statements. d. Other auditor The other auditor is an auditor, other than the principal auditor, with responsibility for reporting on the financial information of a component which is included in the financial statements audited by the principal auditor. Other auditors include affiliated firms, whether using the same name or not, and correspondents, as well as unrelated auditors. e. Personnel Personnel includes all partners and professional staff engaged in the audit practice of the firm. f. Predecessor auditor The auditor who was previously the auditor of an entity and who has been replaced by an incoming auditor. g. Principal auditor The principal auditor is the auditor with responsibility for reporting on the financial statements of an entity when those financial statements include financial information of one or more components audited by another auditor. 7. OBJECTIVE OF AN AUDIT The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. The phrase used to express the auditor's opinion is present fairly, in all material respects. (based on the glossary of terms and paragraph 2 of PSA 200)) Although the auditors opinion enhances the credibility of the financial statements, the user cannot assume that the opinion is an assurance as to the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity. (based on paragraph 3 of PSA 200) 8. CLASSIFICATION OF AUDITS a. According to Person 1. Financial audit (External) - an examination conducted by an independent public accountant intended to serve as a basis for an expression of an opinion regarding the fairness, consistency and conformity with GAAP prepared by corporate or other entity for submission to the public. 2. Internal Audit - is an independent appraisal of business activity within an organization for the review of accounting, financial and other operation as a basis for service to management.

b.

According to Scope 1. Detailed Audit - involves the examination in details of all transactions and records. 2. Test Audit - involves the test of selected records and transactions sufficient to obtain an opinion as to the overall reliability of the transaction and records. According to Time 1. Interim - examination done at regular intervals during the year. 2. Periodic - examination done after year end transactions. According to Restrictions 1. Partial Audit - auditor is entrusted to any particular work only and is restricted as to his process of injury or examination. 2. Complete Audit - auditor is given restricted scope to the work he is to perform. Others: 1. Vouching Audit - involves examination or vouching of document as well as investigation of transaction for the representation as a whole. 2. Balance Sheet Audit - a partial audit involving the complete verification of every item in the balance sheet together with a series of nominal accounts. 3. Management Audit - a constructive examination of a company's organization structures, objectives, means of operation, use of human and physical facilities. 4. System - based audit emphasizes an investigation of the system of internal control, audit operation to test the accuracy and reliability of records.

c.

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9. GENERAL PRINCIPLES GOVERNING AN AUDIT (based on paragraph 4 of PSA 200) The auditor should comply with the Code of Ethics for Professional Accountants in the Philippines promulgated by the Board of Accountancy and approved by the Philippine Professional Regulation Commission. Ethical principles governing the auditors professional responsibilities are: a. b. c. d. e. f. g. Independence Integrity Objectivity Professional Competence and due care Confidentiality Professional Behavior; and Technical Standards

10. SCOPE OF AN AUDIT The term scope of an audit refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the audit. The procedures required to conduct an audit in accordance with PSAs should be determined by the auditor having regard to the requirements of PSAs, relevant professional bodies, legislation, regulations and, where appropriate, the terms of the audit engagement and reporting requirements. (based on paragraph 7 of PSA 200) 11. COMPLETE SET OF FINANCIAL STATEMENTS The balance sheets, income statements or profit and loss accounts, statements of changes in financial position (which may be presented in a variety of ways, for example, as a statement of cash flows or a statement of fund flows), notes and other statements and explanatory

material which are identified as being part of the financial statements. (based on the glossary of terms) 12. FINANCIAL STATEMENT ASSERTIONS (based on the glossary of terms) Financial statement assertions are assertions by management, explicit or otherwise, that are embodied in the financial statements and can be categorized as follows: a. existence: an asset or a liability exists at a given date; b. rights and obligations: an asset or a liability pertains to the entity at a given date; c. occurrence: a transaction or event took place which pertains to the entity during the period; d. completeness: there are no unrecorded assets, liabilities, transactions or events, or undisclosed items; e. valuation: an asset or liability is recorded at an appropriate carrying value; f. measurement: a transaction or event is recorded at the proper amount and revenue or expense is allocated to the proper period; and g. presentation and disclosure: an item is disclosed, classified, and described in accordance with the applicable financial reporting framework. 13. RESPONSIBILITY FOR THE FINANCIAL STATEMENTS While the auditor is responsible for forming and expressing an opinion on the financial statements, the responsibility for preparing and presenting the financial statements is that of the management of the entity. The audit of the financial statements does not relieve management of its responsibilities. (based on paragraph 12 of PSA 200) 14. DIFFERENTIATE INTERNAL FROM EXTERNAL AUDIT
A. As to purpose B. C. D. E. F. As to person As to scope As to qualification As to compensation As to control INTERNAL Independent appraisal for service to management. Internal auditor; regular employee. All phases of business activities. Need not be a CPA. Salary Organizational EXTERNAL Expression of an opinion on financial statements. External auditor; contractual Financial aspects. Must be a CPA. Professional Fee. Societal control.

BASIC AUDITING CONCEPT Exercise I Multiple Choice : Write only the letter of your correct choice. 1. The process of recording, classifying, and summarizing economic events in a logical manner for the purpose of providing financial information for decision-making is a. finance. b. auditing. c. accounting. d. economics. 2. Internal auditors cannot be independent a. since they do not possess the CPA license. b. as long as an employer-employee relationship exists. c. because they dont audit financial statements. d. unless their immediate supervisor is a CPA. 3. Providing quantitative information that management and others can use to make decisions is the function of a. management information systems. b. auditing. c. finance. d. accounting. 4. The statements most commonly included in an audit of financial statements are the a. statement of financial position, the income statement, and the statement of changes in financial position. b. income statement, the statement of changes in financial position, and the statement of net working capital. c. statement of changes in financial position, the statement of cash flows, and the retained earnings statement. d. statement of financial position, the income statement, and the statement of cash flows. 5. Certified public accounting (CPA) firms provide audit services for all, but which of the following entities? a. privately-held corporations. b. corporations listed on the Philippine Stock Exchange. c. publicly-traded companies. d. CPA firms provide audit services for all of these entity types. 6. The use of the title Certified Public Accountant (CPA) is regulated by a. the Bureau of Internal Revenue. b. state law through the Board of Accountancy/Professional Regulation Commission. c. the Philippine Institute of Certified Public Accountants (PICPA). d. the Securities and Exchange Commission (SEC). 7. A typical objective of an operational audit is for the auditor to a. determine whether the financial statements fairly present the entitys operations. b. evaluate the feasibility of attaining the entitys operational objectives. c. make recommendations for improving performance. d. report on the entitys relative success in attaining profit maximization. 8. An audit of financial statements is conducted to determine whether the a. organization is operating efficiently and effectively. b. auditee is following specific procedures or rules set down by some higher authority. c. members of the management team are fulfilling their fiduciary responsibilities to shareholders.

d. none of the above. 9. An examination of part of an organizations procedures and methods for the purpose of evaluating efficiency and effectiveness is what type of audit? a. Operational audit. b. Compliance audit. c. Financial statement audit. d. Production audit. 10. An audit to determine whether the auditee is following specific procedures or rules set down by some higher authority is classified as a(n) a. audit of financial statements. b. compliance audit. c. operational audit. d. production audit. 11. The criteria for evaluating quantitative information vary. For example, in the audit of historical financial statements by CPA firms, the criteria are usually a. generally accepted accounting principles. b. generally accepted auditing standards. c. regulations of the Internal Revenue Service. d. regulations of the Securities and Exchange Commission. 12. In auditing financial accounting data, the primary concern is with a. determining whether recorded information properly reflects the economic events that occurred during the accounting period. b. determining if fraud has occurred. c. determining if taxable income has been calculated correctly. d. analyzing the financial information to be sure that it complies with government requirements. 13. Which one of the following is more difficult to evaluate objectively? a. Presentation of financial statements in accordance with generally accepted accounting principles. b. Compliance with government regulations. c. Efficiency and effectiveness of operations. d. All three of the above are equally difficult. 14. To operate effectively, an internal auditor must be independent of a. the line functions of the organizations. b. the entity. c. the employer-employee relationship which exists for other employees in the organization. d. all of the above. 15. The trait that distinguishes auditors from accountants is the a. auditors ability to interpret generally accepted accounting principles. b. auditors education beyond the Bachelors degree. c. auditors ability to interpret FASB Statements. d. auditors accumulation and interpretation of evidence related to a companys financial statements. 16. The primary goal of the CPA in performing the audit function is to a. Detect fraud. b. Examine individual transactions so that the auditor may certify as to their validity. c. Determine whether the client's assertions are fairly stated. d. Assure the consistent application of correct accounting procedures.

17. Internal auditing often extends beyond examinations leading to the expression of an opinion on the fairness of financial presentation and includes audits of efficiency, effectiveness, and a. Internal control. b. Evaluation. c. Accuracy. d. Compliance. 18. The auditor's judgment concerning the overall fairness of the presentation of financial position, results of operations, and changes in equity is applied within the framework of a. Generally accepted accounting principles. b. Generally accepted auditing standards. c. Internal control. d. Information systems control. 19. The best description of the scope of internal auditing is that it encompasses a. Primarily operational auditing. b. Both financial and operational auditing. c. Primarily the safeguarding of assets and verifying the existence of such assets. d. Primarily financial auditing. 20. Which of the following statements is not a distinction between independent auditing and internal auditing? a. Independent auditors represent third party users external to the auditee entity, whereas internal auditors report directly to management. b. Although independent auditors strive for both validity and relevance of evidence, internal auditors are concerned almost exclusively with validity. c. Internal auditors are employees of the auditee, whereas independent auditors are independent contractors. d. internal auditor's span of coverage goes beyond financial auditing to encompass operational and performance auditing. 21. In determining estimates of fees, an auditor may take into account each of the following, except the a. Value of the service to the client. b. Degree of responsibility assumed by undertaking the engagement. c. Skills required to perform the service. d. Attainment of specific findings. 22. An audit designed to evaluate the efficiency and effectiveness of an organization or some part thereof would not come under the title of a. Performance audit. b. Management audit. c. Operational audit. d. Compliance audit. Exercise II TRUE OR FALSE: Write TRUE if the statement is correct and FALSE if the statement is false. 1. The criteria by which an auditor evaluates the information under audit may not vary regardless of the information being audited. 2. The criteria used by an external auditor to evaluate published financial statements are known as generally accepted auditing standards. 3. The primary purpose of a compliance audit is to evaluate the efficiency and effectiveness of an organizations operating procedures and methods.

4. All companies filing annually with the Securities and Exchange Commission are required to have an annual external audit. 5. The financial statements most commonly audited by external auditors are the statement of financial position, income statement, and statement of cash flows. 6. The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. 7. While the auditor is responsible for forming and expressing an opinion on the financial statements, the responsibility for preparing the financial statements is that of the management of the entity. 8. The objective of financial reporting is to provide useful information to interested users. Exercise III FILL IN THE BLANKS The objective of an audit of financial statements is to enable the auditor to express an ______(1)________ whether the financial statements are prepared, in all material respects, in accordance with the ______(2)_______. The auditor should comply with the Code of Professional Ethics promulgated by the _____(3)_______ and approved by the ______(4)__________. The auditor should conduct an audit in accordance with ________(5)__________. The auditor should plan and perfrom the audit with an attitude of _______(6)_________ recognizing the that circumstances may exist which cause the financial statements to be materially misstated. _________(7)__________ is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. While _____(8)_________ is responsible for forming and expressing an opinion on the financial statements, the responsibility for preparing and presenting the financial statements is that of the ________(9)_________ of the entity. Auditors opinion enhances the credibility of _______(10)_________.