1.

Which of the following is a principle underlying an audit conducted in accordance with generally
accepted auditing standards? 

a. The audit provides reasonable assurance the client will remain in business for at least one year

b. The audit report expresses an opinion on whether the financial statements are free of material and
immaterial misstatements

c. Auditors are responsible for, among other things, maintaining professional objectivism, exercising
professional engagement, and obtaining appropriate documentation

d. An auditor’s opinion enhances the degree of confidence that intended users can place in the financial
statements

2.An attitude that includes a questioning mind, being alert to conditions that may indicate possible
misstatements, and a critical assessment of audit evidence is referred to as: *

a. Reasonable assurance

b. Professional skepticism

c. Audit neutralism

d. Auditing mindset

3.The auditor must be qualified to understand the criteria used and the competence to know how and
what evidence to accumulate to reach the proper conclusion is known as: 

a. Systematic process

b. Competent, independent person

c. Degree of correspondence

d. Assertions about economic actions and events

4.These are the representations made by the individual or entity. They comprise the subject matter of
auditing *

a. Systematic process

b. Competent, independent person

c. Degree of correspondence

d. Assertions about economic actions and events

5.Statement no. 1: This refers to the closeness with which the assertions can be identified with
established criteria also known as systematic process. Statement no. 2: Communicating the results is
often referred to as attestation. The final stage in the audit process is the audit report the communication
of the findings to users *

a. First statement if true, second statement is false

b. First statement is false, second statement is true

c. Both statements are true

d. Both statements are false

6.An audit should be designed to obtain reasonable assurance of detecting material misstatements due
to: *

a. Errors

b. Errors and fraud

c. Errors, fraud, and noncompliance with laws with a direct effect on financial statement amounts and
others

d. Errors, fraud and noncompliance with all laws

7.Statement no. 1: 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. Statement no. 2: The auditor’s opinion helps establish the credibility of the
financial statements. *

a. First statement if true, second statement is false

b. First statement is false, second statement is true

c. Both statements are true

d. Both statements are false

8.A set of criteria used to determine measurement, recognition, representation, and disclosure of all
material misstatements due to: *

a. Financial reporting framework

b. Public Company Accounting Oversight Board Criteria

c. Quality control presentation standard

d. Special purpose audit standard

9.Some of the factors that contribute to information risk are: *

a. Remoteness of information users from information providers

b. Potential bias and motives of information provider

c. Voluminous data

d. All of the above

10.Identification of the risk of material misstatement in a specialized industry should be approached in the
same was as in any other audit. This may be done through: *

a. Assisting audit team members assigned to a specialized industry client.

b. obtaining appropriate understanding of the business and its environment

c. Identification of the risk of material misstatement in a specialized industry

d. None of the above

11.Which of the following is included as part of the principles governing an audit? *

a. Auditors need to obtain a high level of assurance that the financial statements are free of all
misstatements

b. An audit has inherent limitations such that auditor cannot provide absolute assurance about whether
the financial statements are free of misstatements

c. Auditors need to maintain professional skepticism only on audits where there is a high risk of material
misstatement

d. All of the above are included as part of the principles governing an audit

12.Which of the following activities is not part of the activities within the audit opinion formulation
process? *

a. The auditor develops a common understanding of the audit engagement with the client

b. The auditor determines the appropriate nonaudit consulting services to provide to the client

c. The auditor identifies and assess risks of material misstatements and then responds to those identified
risks

d. The auditor determines the appropriate audit opinion(s) to issue

13.Statement no. 1: Account-based approach is an audit approach that begins with an assessment of the
types and likelihood of misstatements in account balance and then adjusts the amount and type of audit
work, to the likelihood of material misstatements occurring in account balances. Statement no. 2: Given
the rapidly changing environment in which today’s businesses operate, management, internal auditors
and external auditors must focus on the risks to the entity’s operations and ensure controls are in place to
eliminate, mitigate, or compensate for those risks. 

a. First statement if true, second statement is false

b. First statement is false, second statement is true

c. Both statements are true

d. Both statements are false

14.Identified significant related party transactions outside of the entity’s normal course of business are to
be treated as giving rise to significant risks is one of the factors to be considered which refers to: 

a. Existence of large non-routine transactions

b. High-risk activities

c. Matters requiring judgment or management intervention

d. Potential for fraud

15.This includes operations or events where a material misstatement could easily occur. Example, an
inventory of high-value diamonds or gold bars in a specialized industry. 

a. Existence of large non-routine transactions

b. High-risk activities

c. Matters requiring judgment or management intervention

d. Potential for fraud

16.Which of the following is not one of the management assertions? 

a. Completeness

b. Existence

c. Rights and obligations

d. They are all management assertions

17.Statement no. 1: In risk-based auditing, auditors first obtain an understanding of control and assess
control risk for particular types of error and frauds in specific accounts and cycle. Statement no. 2: In
account-based audit, the audit team views all activities in the organization first in terms of risks to
strategies and objectives and then in terms of management’s plans and processes to mitigate the risk 

a. First statement if true, second statement is false

b. First statement is false, second statement is true

c. Both statements are true

d. Both statements are false

18.Which of the following is a true statement regarding audit evidence and audit procedures? 

a. The auditor has a responsibility to design and perform audit procedures to obtain sufficient appropriate
audit evidence

b. Inquiry is a type of audit procedure that typically does not require corroborating evidence

c. The audit procedures that are performed during an audit are summarized in a document referred to as
an audit engagement letter

d. Reperformance involves checking the mathematical accuracy of a document or record, such as an

inventory count sheet

19.Which of the following are the responsibilities of the external auditor in auditing financial statements? 

a. Maintaining internal controls and preparing financial reports

b. Providing internal assurance on internal control and financial reports

c. Providing internal oversight of the reporting process

d. None of the above

20.Which of the following parties are involved in preparing and auditing financial statements? 

a. Management

b. Audit committee

c. Internal audit function

d. External auditor
Auditing & Assurance: Specialized Industries

Introduction to Financial Statement Audit

Independent Auditing Defined:

► The definition given by the American Accounting Association defines auditing:

► Auditing is a systematic process by which a competent, independent person objectively

obtains and evaluates evidence regarding assertions about economic actions and events to
ascertain the degree of correspondence between those assertions and established criteria and
communicating the results to interested users

The definition includes several key words:

► Systematic process - this implies a structured, logical, and organized series of steps

► Competent, independent person - the auditor must be qualified to understand the criteria used
and the competence to know how and what evidence to accumulate to reach the proper
conclusion

► Objectively obtains and evaluates evidence - This means examining the bases for the assertions
(representations)

► Assertions about economic actions and events - These are the representations made by the
individual or entity. They comprise the subject matter of auditing

► Degree of correspondence - Refers to the closeness with which the assertions can be identified
with established criteria

► Established criteria - This are the standards against which the assertions or representations are
judged

► Communicating the results - This is often referred to as attestation. The final stage in the audit
process is the audit report the communication of the findings to users

► Interested users - These are individuals who use (rely on) the auditor’s findings. In a business
environment, this includes stockholders, management, creditors, governmental agencies, and
the public

Objectives of Auditing

► The Philippine Standards on Auditing (PSA) 120 “Framework of Philippine Standards on

Auditing” states the objective of an audit as follows:

❖ “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.”

► The auditor’s opinion helps establish the credibility of the financial statements

► The user, however, should not assume that the auditor’s opinion is an assurance as to the future
viability of the entity nor an opinion as to the efficiency or effectiveness with which
management has conducted the affairs of the entity

► In conducting an audit of financial statements, the overall responsibilities of the auditor are:

(a.) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due of fraud or error

(b.) To report on the financial statements, and communicate as required by the Philippine Standards on
Auditing (PSAs), in accordance with the auditor’s findings

Scope of Independent 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, relevant professional
bodies, legislation, and, where appropriate, the terms of the audit engagement and reporting
requirements

► The auditor will conduct a critical and systematic examination of the statements and of the
related documents, records, procedures, and control

► Audit evidences may be gathered to enable him to substantiate the representations in the
financial statements

► Internal controls will be evaluated for effectiveness since they affect the reliability of the
financial records> By inquiry, observation, confirmation and inspection, the auditor can test the
existence and validity of assets, liabilities, overall reasonableness of other account balances in
the financial statements

► When sufficient and competent audit evidences have been gathered, the auditor can formulate
his opinion on the fairness with which the financial statements have been prepared

Why Independent Financial Auditing is Necessary?

► Without wide public acceptance, professions cannot exist, and independent auditing is no
exception

► Over the years, society has perceived a need for audits of publicly held companies, which has
developed as a result of the separation of ownership and management
 ► Auditing services are used extensively by business, government, and other not-for-profit
organizations

► As society becomes more complex, there is an increased likelihood that unreliable information
will be provided to decision makers

► This is referred to as “Information Risk”

Some of the factors that contribute to information risk are:

► a. Remoteness of information users from information providers

► b. Potential bias and motives of information provider

► c. Voluminous data

► d. Complex exchange transactions

► e. Consequences

How Information Risk May be Reduced

► 1. Allow users to verify information - The user may go to the business establishment to examine
records and information about the reliability of the statement

► 2. User shares information risk with management - It is important to emphasize the fact that
management has the primary responsibility of providing reliable information to users

► 3. Have a financial statement audited - To obtain reliable information, the user can have an
independent audit performed

Advantages and Practical Benefits of Independent Audit

A. To the Auditor or Client

1. Independent audit makes the financial statements more credible and reliable

2. Management is the beneficiary of constructive suggestions in improving business operations

3. Commission of fraud by management and employee is minimized

4. Audited financial statements provide a more credible basis for the preparation of tax return

5. Better and sound management decisions may be made if financial records and reports are accurately
maintained and provided

B. To Creditors, Prospective Investors, Employees

1. Financial institutions have more credible basis in deciding whether financial assistance will be
extended to the auditee

2. Suppliers and other creditors will have reliable basis in making decisions related to extension of credit

3. Potential and current investors will have more credible basis in evaluating managerial efficiency
4. Employees will have a better and credible basis in requesting for fringe benefits and wage
adjustments

5. In the event of sale, purchase, or merger of a business, both buyer and seller will have more confident
basis for aiming at a decision as to the terms and conditions of the arrangements

C. To Government Agencies and Legal Community

1. BIR has more assurance concerning accuracy and dependability of tax return if they have been based
on audited financial statements

2. Government institutions like GSIS, SSS, DBP will have better basis in extending financial assistance to
business enterprises

3. Audited statements provide the legal community an independent basis for administering estates and
trusts, setting action in bankruptcy and insolvency, etc.

Overview of the Audit Opinion Formulation Process

Risk-Based Audit of Financial Statements

Overview of Risk-Based Audit Process

Risk-Based Audit Approach Defined

► Risk-based audit approach is an audit approach that begins with an assessment of the types and
likelihood of misstatements in account balance and then adjusts the amount and type of audit
work, to the likelihood of material misstatements occurring in account balances

► Given the rapidly changing environment in which today’s businesses operate, management,
internal auditors and external auditors must focus on the risks to the entity’s operations and
ensure controls are in place to eliminate, mitigate, or compensate for those risks
The Auditor must perform the following:

► 1. Identification of the client’s strategy and the processes for developing that strategy

► 2. Examination of the core business process and resource management

► 3. Identification for each of the key processes (as well a sub-processes) the objectives, inputs,
activities, outputs, systems and transactions

► 4. Assessment of the risks that the processes will not meet the goals and controls related to
those risks

Factors to Consider in Implementing the Audit Risk Model

1. High-risk activities - This includes operations or events where a material misstatement could
easily occur. Example, an inventory of high-value diamonds or gold bars (specialized industry)

2. Existence of large non-routine transactions - Identified significant related party transactions

outside of the entity’s normal course of business are to be treated as giving rise to significant
risks. This includes infrequent and large transactions such as: Unusual volume of routine
transactions with a related party; A major sales or supply contract; The purchase or sale of major
business assets or business segments; and Sale of the business to a third party

3. Matters requiring judgment or management intervention - Examples: assumptions and

calculations used by management in developing major estimates; Complex calculations or
accounting principles; Revenue recognition (presumed to be significant risk)

4. Potential for fraud - The risk of not detecting a material misstatement resulting from fraud
(intentional and deliberately concealed) is higher than the risk of not detecting one resulting
from error

Limitation of the Audit Risk Model

► Audit risk is a concept that drives the auditor’s thinking about planning the audit and then
executing an audit

► CPA firms in determining their approach to implementing the audit risk model should consider
the following limitations:

a. Inherent risk is difficult to formally assess. Some transactions because of their

complexity are more susceptible to error but it is quite difficult to assess that level of
risk independent of the client’s accounting system

b. The model treats each risk component as a separate and indepent when in fact the
components are not independent

c. Audit risk is judgmentally determined

d. Audit technology is not so fully developed that each component of the model can be
accurately assessed

Risk-Based Audit vs Account-Based Audit

 ► In account-based auditing, auditors first obtain an understanding of control and assess control
risk for particular types of error and frauds in specific accounts and cycle

► In risk-based audit, the audit team views all activities in the organization first in terms of risks to
strategies and objectives and then in terms of management’s plans and processes to mitigate
the risk

The Risk-Based Audit Process

► Phase I. - Risk Assessment

This phase involves the following activities:

a. Performance of preliminary engagement activities

b. Planning the audit to develop overall strategy and audit plan

c. Performance of risk assessment procedures to identify/assess risk of material

misstatement

► Phase II. - Risk Response

This phase involves the following activities:

a. Designing overall responses and further audit procedures

b. Implementing responses to assessed risk of material misstatement to reduce

audit risk to an acceptably low level

► Phase III. - Reporting

This phase involves the following activities:

a. Evaluating the audit evidence obtained

b. Forming an opinion based on audit findings and preparing the auditor’s report
Risk Assessment - Part 1

At the beginning of the current audit engagement, the auditor should perform the following
activities:

a. Perform procedures required by PSA 220, “Quality Control of an Audit of Financial Statements”
regarding the continuance of the client relationship and the specific audit engagement

b. Evaluate compliance with ethical requirements, including independence as required by PSA 220

c. Establish an understanding of the terms of engagement as required by PSA 210,”Agreeing the

terms of Audit Engagements.”

Client Selection and Retention

► The auditor’s consideration of clent continuance and ethical requirements, including

independence, occurs throughout the performance of the audit engagement as conditions and
changes in circumstances occur

► The auditor’s initial procedures on both client continuance and evaluation of ethical requirements
(including independence) are performed prior to performing other significant activities for the
current audit engagement

► The purpose of performing these preliminary engagement activities is to help ensure that the
audtor has considered any events or circumstances that may adversely affect the auditor’s ability
to plan and perform the audit engagement to reduce audit risk to an acceptably low level

Performing these preliminary engagement activities helps to ensure that the auditor plans an
audit engagement for which:

► The auditor maintains the necessary independence and ability to perform the engagement

► There are no issues with management intregrity that may affect the auditor’s willingness to
continue the engagement

► There is no misunderstanding with the client as to the terms of the engagement

Client Acceptance / Retention Decisions

► Strict client acceptance/continuance guidelines should be established to screen out the following:

• Clients that are in financial and/or organizational difficulty

• Clients that constitute a disproportionate percentage of the firm’s total practice

• Disreputable clients

• Clients that offer an unreasonable low fee for the auditor’s services

Audit Firm Limitations

 ► An external audit firm should not not undertake an engagement that it is not qualified to handle

► It is essential for a CPA firm to maintain its integrity, objectivity and reputation for providing high
quality services

► No auditor can afford to be regularly associated with clients who are engaging in management
fraud of unlawful activities

► Before accepting the engagement, the CPA should investigate the history of the prospective
client

► To reduce their own business risk, the auditor should assess whether they can ccomplete the
audit in accordance with the Philippine Standards on Auditing

In summary, before accepting an engagement with a new client, the CPA firm shall assess
whether it

► Is competent to perform the engagement and has the capabilities, including time and resources to
do so

► Can comply with the relevant ethical requirements, and

► has considered the integrity of the client and does not have information that would lead it to
conclude that the client lacks integrity

The CPA firm shall likewise estblish whether preconditions for an audit are present such as:

❖ Whether the financial reporting framework to be applied in the financial statements are
acceptable

❖ Agreement of management that it acknowledges and understands its responsibility

Engagement Letter

► The engagement letter, which includes audit fee, also includes a description of the timing of the
external auditor’s work and a description of documentation that the client iexpected to provide to
the external auditor

► Care should be taken when describing the degree of responsibility the auditor takes with respect
to discovering fraud and misstatements

► As a final step, the CPA firm will confer and agree with management or those in charge with
governance the appropriate terms of the audit engagement

► The agreed terms of the audit engagement shall be recorded in an audit engagement letter or
other suitable form of written agreement and shall iinclude:

(a.) The objective and scope of the audit of the financial statements;

(b.) The responsibilities of the auditor

(c.) The responsibilities of management

(d.) Identification of the applicable financial reporting framework for the preparation of the financial
statements; and

(e.) Reference to the expected form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its expected form and
content
Recurring Audits

► On recurring audits, the auditor shall assess whether circumstances require the terms of the audit
engagement to be revised and whether there is a need to remind the entity of the existing terms
of the audit engagement

► It the terms of audit engagement are changed, auditor and management shall agree on and
record the new terms of the engagement in an engagement letter

► If the auditor is unable to agree to a change in the terms of the audit engagement and is not
permitted by management to continue the original audit engagement, the auditor shall:

(a.) Withdraw from the audit engagement where withdrawal is possible under

applicable law or regulation; and

(b.) Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators

Keep

It

Simple

Student

Planning the Audit to Develop an Overall Audit Strategy and Audit Plan

► Once the client has been obtained and the engagement letter signed by both parties (auditor and
client), the planning process intensifies as the auditors concentrate their efforts in obtaining a
detailed understanding of the client’s business in developing an overall audit strategy and assess
the risks of material misstatement of the financial statements

► Planning an audit of Financial Statements establishes standards and provides guidance on the
considerations and activities applicable to planning and audit of financial statements

Nature and Scope of Audit Planning

► Audit planning involves the establishment of the overall audit strategy for the engagement and
developing an audit plan, in order to reduce risk to an acceptably low level

► Planning involves the engagement partner and other key members of the engagement team to
benefit from their experience and insight and to enhance the effectiveness of the planning
process

► The nature and extent of planning activities will vary according to the size and complexity of the
entity, the auditor’s previous experience with the entity, and changes in circumstances that occur
during the audit engagement

► Planning is a continuous and iterative process that often begins shortly after or in connection with
the completion of the previous audit and continues until the completion of the current audit
engagement

Benefits of Audit Planning

► (a.) It helps ensure that appropriate attention is devoted to important areas of the audit

► (b.) It aids in identifying potential problems and resolving them on a timely basis
 ► (c.) It helps ensure that the audit is properly organized, managed and performed in an effective
and efficient manner

► (d.) It assists in the proper assignment and review of the work of the engagement team members

► (e.) It helps coordinate the work to be done by auditors of components and other parties involved
such as experts, specialists, etc.

The Overall Audit Strategy

► PSA 300 requires that the auditor establishes the overall strategy for the audit

► This overall audit strategy sets the scope, timing and direction of the audit and guides the
development of the more detailed audit plan

► The process of establishing the audit strategy involves:

❖ Identifying the characteristics of the engagement that define its scope. examples are:

1. The financial reporting framework

2. Industry specific reporting requirements, and

3. The locations of the components of the entity

❖ Ascertaining the reporting objectives of the engagement to plan the timing of the
audit and the nature of the communication required

1. Deadlines for interim and final reporting, and

2. Key dates and organization of meetings with management and those in charge with
governance
3. Discussion with management regarding the expected communication on the status of audit
work

❖ Considering the important factors that will determine the focus and direction of the
engagement teams efforts

1. Determination of appropriate materiality levels

2. Preliminary identification of areas where there may be higher risks of material misstatements
3. Preliminary identification of material components and account balances
4. Evaluation of whether the auditor may plan to obtain evidence regarding the effectiveness of
internal control
5. Identification of recent significant entity-specific, industry, financial reporting or other relevant
development

❖ Considering the results of preliminary engagement activities and, where

applicable, whether knowledge gained on other engagements performed by the the
engagement partner

❖ Ascertaining the nature, timing and extent of resources necessary to perform the
engagement