Chapter 1 Audit - An Overview
The primary function of an independent audit is to lend credibility to the financial statements prepared by an entity. The
auditor’s opinion enhances the value and usefulness of the financial statements. By attaching report to the financial
statements, the auditor provides increased assurance to users that the financial statements are reliable.
Auditing Defined
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.” A similar objective applies to the
audit of financial or other information prepared in accordance with appropriate criteria.
(Ref: PSA 120, Glossary of Terms)
An audit 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.
(Ref: American Accounting Association)
This definition conveys the following thoughts.
1. Auditing is a systematic process.
- Auditing proceeds by means of ordered and structured series of steps.
2. An audit involves obtaining and evaluating evidence about assertions regarding economic actions and events.
- Assertions are representations made by an auditee about economic actions and events. The auditor’s objective is to
determine whether these assertions are valid. To satisfy this objective, the auditor performs audit procedures and gathers
evidence that corroborates or refutes the assertions.
3. An audit is conducted objectively.
- The auditor should conduct the audit without bias. Impartial attitude must be maintained by the auditor when evaluating
evidence and formulating his conclusion.
4. Auditors ascertain the degree of correspondence between 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. In an audit, the auditor
determines the degree by which the assertions conform to the established criteria. For example, when auditing financial
statements, the auditor judges the fair presentation of the financial statements (assertions) by comparing the statements
with an identified financial reporting framework (criteria).
5. 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.
Financial statement assertions - 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.
(Ref: Glossary of Terms)
Audit Procedures (Ref: PSA 500, A14-A25)
a. Inspection
- Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or
other media, or a physical examination of an asset.
b. Observation
- Observation consists of looking at a process or procedure being performed by others, for example, the auditor’s
observation of inventory counting by the entity’s personnel, or of the performance of control activities.
c. External Confirmation
- An external confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor
from a third party (the confirming party), in paper form, or by electronic or other medium.
d. Recalculation
- Recalculation consists of checking the mathematical accuracy of documents or records.
e. Reperformance
- Reperformance involves the auditor’s independent execution of procedures or controls that were originally performed as
part of the entity’s internal control.
f. Analytical Procedures
- Analytical 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.
g. Inquiry
- Inquiry consists of seeking information of knowledgeable persons, both financial and nonfinancial, within the entity or
outside the entity. Inquiry is used extensively throughout the audit in addition to other audit procedures.
Types of Audits
- Based on primary audit objectives, there are three major types of audit:
1. Financial Statement Audit
- This is an audit conducted to determine whether the financial statements of an entity are fairly presented in accordance
with an identified financial reporting framework. This type of audit will be the focus of the discussion in this text.
2. Compliance Audit
- Compliance audit involves e review of an organization’s procedures to determine whether the organization has adhered
to specific procedures, rules or regulations. The performance of compliance audit is dependent upon the existence of
verifiable data and recognized criteria established by an authoritative body. A common example of this type of audit is the
examination conducted by BIR examiners to determine whether entities comply with tax rules and regulations.
3. Operational Audit
- An operational audit is a study of a specific unit of an organization for the purpose of measuring its performance. The
main objective of this type of audit is to assess entity’s performance, identify areas for improvements and make
recommendations to improve performance. This type of audit is also known as performance audit or management audit.
All audits possess the same general characteristics which involve:
1. Systematic examination and evaluation of evidence which are undertaken to ascertain whether assertions comply with
established criteria
2. Communication of the results of examination, usually in a written report, to the party by whom, or on whose behalf, the
auditor was appointed.
Unlike compliance and financial statement audits, where the criteria are usually defined, criteria used in operational audit
to evaluate the effectiveness and efficiency of operations are not clearly established.
