05/06/2021

INTRODUCTION TO FINANCIAL 
STATEMENT AUDIT AND 
PRE‐ENGAGEMENT ACTIVITIES
Rainiel C. Soriano, CPA, MBA

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INTRODUCTION TO FINANCIAL 
STATEMENT AUDIT

Systematic process of objectively 
obtaining and evaluating evidence 
regarding assertions about economic 
AUDITING  actions and events to ascertain the 
(AAA) degree of correspondence between 
these assertions and established 
criteria and communicating the results 
to interested users.

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Auditing is a systematic process.

An audit involves obtaining and evaluating evidence about 
Key  assertions regarding economic actions and events.

Concepts  An audit is conducted objectively.
from the 
Definition Auditors ascertain the degree of correspondence between 
assertions and established criteria.

Auditors communicate the audit results to various 
interested users.

Auditing is a systematic 
process
Auditing proceeds by means of an 
ordered and structured series of 
steps.

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An audit involves obtaining and evaluating 
evidence about assertions regarding 
economic actions and events

ASSERTIONS – REPRESENTATIONS MADE BY THE CLIENT  EVIDENCE – INFORMATION 

ABOUT ECONOMIC ACTIONS AND EVENTS. OBTAINED BY THE AUDITOR IN 
ARRIVING AT THE CONCLUSIONS ON 
WHICH THE AUDIT OPINION IS BASED.

An audit is conducted objectively
The auditor should conduct the audit without bias.

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Auditors 
ascertain the 
degree of 
Established criteria – standards or 
correspondence 
benchmark used to verify the validity of 
the assertions given by the audit client.
between 
assertions and 
established 
criteria

Auditors communicate 
the audit results to 
various interested users
Communication of audit findings is the ultimate 
objective of any audit.

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Types of Audit

Financial Statement  Operational Audit Compliance Audit

Audit

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Comparison of Different 
Types of Audit

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Financial  Operational  Compliance 

Statement  Audit Audit
Audit
Financial  Operations  Organization 
Assertions statements  are  has complied 
are fairly  conducted  with laws, 
presented effectively  regulations or 
and  contracts
efficiently

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Financial  Operational  Compliance 

Statement  Audit Audit
Audit
Established 
IAS, IFRS,  Objectives set  Laws, 
Criteria GAAP,  by the  regulations 
Conceptual  management and contracts
Framework

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Financial Statement  Operational Audit Compliance Audit

Audit
An opinion about  Recommendations  Degree of 
whether the FS are  on how to improve  compliance with 
fairly presented in  operations applicable laws, 
conformity with an  regulations and 
identified financial  contracts
reporting framework

Report

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Auditors  Financial  Operational  Compliance 

Statement  Audit Audit
who  Audit
generally  External  Internal  Government 
perform Auditors Auditors Auditors

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Is a service activity. Its function is to 
provide quantitative financial 
ACCOUNTING information, primarily financial in 
nature, about economic entities, that is 
useful in making economic decisions.

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Objective of Financial Statement Audit
To enable the auditor to express an opinion whether the FS are prepared, in all 
material respects, in accordance with an identified financial reporting 
framework.

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Responsibility of the Client’s 
Management

The management is responsible for preparing and 
presenting the FS in accordance with the financial 
reporting framework.

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Auditor’s Responsibility
To form and express an opinion on the 
FS prepared by the management based 
on his/her audit.

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Assurance provided by 
the auditor

An audit conducted in accordance with 
PSAs is designed to provide only 
REASONABLE ASSURANCE and NOT 
ABSOLUTE ASSURANCE.

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Inherent Limitations of 
an Audit

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Use of Testing/ 
Sampling Risk
PSAs do not require auditors 
to examine all available 
information.

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Error in Application of 
Judgment
The work undertaken by 
the auditor to form an 
opinion is permitted by 
judgment.

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Reliance on  Some evidence supporting the FS must be 
Management’s  obtained by obtaining oral or written 
Representations representations from management.

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Inherent  Audit procedures may not be effective in 
detecting misstatements resulting from 
limitations of 
collusions among employees or 
internal  management’s circumvention of internal 
control control.

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Evidence obtained by the auditor 
does not consist of “hard facts” 
which prove or disprove the 
accuracy of the financial statements.
Nature of 
Evidence
Most of audit evidence are 
persuasive rather than conclusive in 
nature.

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The auditor should comply with the “Code 
of Professional Ethics for CPA” 
promulgated by the BOD.
General 
Principles of  The auditor should conduct an audit in 
accordance with PSAs.
An FS Audit
The auditor should plan and perform the 
audit with an attitude of professional 
skepticism.

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Theoretical Framework 
of Auditing

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All financial 
data are 
Verifiable
All balances reported in the FS must 
have supporting documents or 
evidence to prove their validity.

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Independence 
The auditor should 
is essential for  always maintain 
ensuring the 
credibility of  independence with 
the auditor’s 
report.
respect to the FS under 
audit

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There should 
be no long‐ Short‐term conflicts may exist regarding the 
term conflict  application of auditing procedures and 
accounting principles, but in the end, both the 
between the  auditor and the management must be 
auditor and  interested in the fair presentation of the 
financial statements.
the client 
management

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Effective 
internal control 
system reduces  The condition of the entity’s internal 
the possibility  control system directly affects the 
of errors and  reliability of the financial statements.
fraud affecting 
the FS

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Consistent application of 
GAAP and IFRS results in 
fair presentation of FS
GAAP and IFRS are usually the 
criteria in an independent audit 
of FS.

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What was held 
true in the past 
will continue 
to hold true in  Experience and knowledge accumulated 
from auditing a client in prior years can be 
the future in  used to determine the appropriate audit 
the absence of  procedures that need to be performed.
known 
conditions to 
the contrary

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An audit benefits the 
public
FS are ordinarily prepared in order to meet the 
common information needs of wide range of users.

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Conflict of interest between management 
and users of financial statements

Need for an  Expertise
independent 
FS audit Remoteness

Financial consequences

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Step 1 Entity prepares financial statements.

Audit  Step 2 The auditor performs audit procedures.

Process: A 
general 
Step 3 The auditor gather audit evidence.
approach

Step 4 The auditor expresses audit opinion.

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Step 1: Entity prepares 
financial statements

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1 2
The financial statements are  These assertions may fall into 
considered as ASSERTIONS  three categories (Classes of 
made by the entity. transactions, Account balances, 
Presentation and disclosure)

Assertions

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Classes of transactions and events 
for the period under audit

• Completeness
• Occurrence
• Cutoff
• Accuracy
• Classification

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Account balances 
at the period end

• Completeness
• Rights and obligations
• Valuation and allocation
• Existence

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Presentation and disclosure

• Completeness
• Occurrence and rights and obligations
• Classification and understandability
• Accuracy and valuation

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Step 2: The auditor performs audit 
procedures

Regardless of the procedures 
selected, the only basic criterion 
Selection of the appropriate 
is that those procedures selected 
procedures to satisfy a particular 
should enable the auditor to 
assertion is affected by a number 
gather sufficient appropriate 
of factors.
audit evidence about a particular 
assertion.

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Specific Audit Procedures

INSPECTION INQUIRY CONFIRMATION COMPUTATION OBSERVATION ANALYTICAL 

PROCEDURES

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Step 3: The auditor 
gathers audit evidence

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Audit evidence

refers to the information obtained by the  Evidence will prove of disprove the validity of 
auditor in arriving at the conclusions on which  management assertions.
the audit opinion is based.

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Step 4: The auditor 
expresses audit opinion

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Step 1: Accepting  Step 2: Audit 
an engagement planning

Audit 
Process: A 
Step 3: Evaluation  Step 4: Performing 
more  of internal control substantive testing

detailed 
approach
Step 5: Completing  Step 6: Issuing a 
the audit report

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The first step in the audit 
process is to make decision 
of whether to accept or 
reject an audit engagement.

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Competence

Considerations 
Independence
in Accepting 
an  Ability to serve the client properly
engagement

Integrity of the management

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Evaluation of  Making Communicating

the integrity 
Making inquiries of  Communicating 
of the client  appropriate parties  with the 
in the business  predecessor auditor.
would  community (Bank, 
involve: Lawyer, 
Underwriter, etc.)

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Before the communication, 
the auditor should obtain 
Communication  the client’s permission.
with the 
predecessor 
auditor
Refusal to permit will raise 
questions as to integrity of 
the client.

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The predecessors auditor’s 
understanding as to the reasons for the 
change of auditors.
Permission 
Any disagreement between the 
is obtained  predecessor auditor and the client.
‐ Inquiry
Any facts that might have a bearing on 
the integrity of the prospective client’s 
management.

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Clients should be evaluated at least 
once a year or upon occurrence of 
major events such as changes in 
management, directors, ownership, 
nature of client’s business, or other 
changes that may affect the scope of 
the examination.

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After accepting an audit 
engagement, an 
engagement letter should 
be prepared.

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Engagement Letter
Serves as the written contract between the auditor 
and the client.

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The objective of the audit of financial 
statements which is to express an 
opinion on the financial statements.
Content of 
The management’s responsibility for 
the 
the fair presentation of the financial 
Engagement  statements.
Letter (1)
The scope of the audit.

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The forms or any reports or other communication 
that the auditor expects to issue.

Content of 
the  The fact that because of the limitations of the 
audit, there is an unavoidable risk that material 
Engagement  misstatements may remain undiscovered.
Letter (2)
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.

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Other information in the Engagement Letter

Expectations of receiving 
Billing arrangements. management 
representation letter.

Arrangements 
Request for the client to 
concerning the 
confirm the terms of the 
involvement of others 
engagement.
(experts).

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Purpose of engagement letter

Avoid misunderstanding with respect  Document and confirm the auditor’s 
to the engagement. acceptance of the appointment.

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Recurring audits
The auditor does not normally send new engagement letter 
every year.

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Factors that  • Any indication that the client misunderstands the 
objective and scope of the audit.
may cause  • Any revised or special terms of the engagement.
auditor to send  • A recent change of senior management, board of 
directors or ownership.
a new  • A significant change in the nature or size of the 
engagement  client’s business.
• Legal requirements and other government agencies’ 
letter pronouncements

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When the auditor decides not to send a 
new engagement letter, it may be 
appropriate for the auditor to remind the 
client of the original arrangements.

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Knowledge 
Check

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An audit involves ascertaining the degree of correspondence

between assertions and established criteria. In the case of financial
statement audit, which of the following is not a valid criterion?

a. International accounting standards

b. Generally accepted accounting principles
c. Philippine standards on auditing
d. Philippine financial reporting framework

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An audit involves ascertaining the degree of correspondence

between assertions and established criteria. In the case of financial
statement audit, which of the following is not a valid criterion?

a. International accounting standards

b. Generally accepted accounting principles
c. Philippine standards on auditing
d. Philippine financial reporting framework

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An audit of financial statements is conducted to determine if the

a. Organization is operating efficiently and effectively

b. Auditee is following specific procedures or rules set down by some higher authorities
c. Overall financial statements are stated in accordance with the applicable financial reporting
framework
d. Client’s internal control is functioning as intended

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An audit of financial statements is conducted to determine if the

a. Organization is operating efficiently and effectively

b. Auditee is following specific procedures or rules set down by some higher authorities
c. Overall financial statements are stated in accordance with the applicable financial
reporting framework
d. Client’s internal control is functioning as intended

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Which of the following statements does not describe a condition

that creates a demand for auditing?

a. Conflict between an information preparer and a user can result in biased information.
b. Information can have substantial economic consequences for a decision maker.
c. Expertise is often required for information preparation and verification.
d. Users can directly assess the quality of information.

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Which of the following statements does not describe a condition

that creates a demand for auditing?

a. Conflict between an information preparer and a user can result in biased information.
b. Information can have substantial economic consequences for a decision maker.
c. Expertise is often required for information preparation and verification.
d. Users can directly assess the quality of information.

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An audit of the financial statements of Ivana Corporation is being

conducted by an external auditor. The external auditor is expected
to

a. Express an opinion as to the fairness of Ivana's financial statements.

b. Express an opinion as to the attractiveness of Ivana for investment purposes.
c. Certify to the correctness of Ivana's financial statements.
d. Critique the wisdom and legality of Ivana's business decisions.

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An audit of the financial statements of Ivana Corporation is being

conducted by an external auditor. The external auditor is expected
to

a. Express an opinion as to the fairness of Ivana's financial statements.

b. Express an opinion as to the attractiveness of Ivana for investment purposes.
c. Certify to the correctness of Ivana's financial statements.
d. Critique the wisdom and legality of Ivana's business decisions.

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An attitude that includes a questioning mind and a critical

assessment of audit evidence is referred to as

a. Due professional care

b. Professional skepticism
c. Reasonable assurance
d. Supervision

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An attitude that includes a questioning mind and a critical

assessment of audit evidence is referred to as

a. Due professional care

b. Professional skepticism
c. Reasonable assurance
d. Supervision

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The following matters are generally included in an auditor’s

engagement letter, except

a. Management’s responsibility for the financial statements

b. The scope of the audit
c. The fact that because of the test nature and other inherent limitations of the audit, together
with the inherent limitations of internal control, there is an unavoidable risk that even some
material misstatements may remain undiscovered.
d. The factors to be considered in setting preliminary judgments about materiality

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The following matters are generally included in an auditor’s

engagement letter, except

a. Management’s responsibility for the financial statements

b. The scope of the audit
c. The fact that because of the test nature and other inherent limitations of the audit, together
with the inherent limitations of internal control, there is an unavoidable risk that even some
material misstatements may remain undiscovered.
d. The factors to be considered in setting preliminary judgments about materiality

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Which of the following is(are) proper when a change of auditors has

taken place or is in process?

a. The successor auditor should advise the client of his intention to contact the predecessor
auditor and request permission for the contact
b. The integrity of management should not be subject of communication between the
predecessor and successor auditors
c. Communication between the predecessor and successor auditors should take place only after
the successor auditor has accepted the engagement
d. All of the above

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Which of the following is(are) proper when a change of auditors has

taken place or is in process?

a. The successor auditor should advise the client of his intention to contact the
predecessor auditor and request permission for the contact
b. The integrity of management should not be subject of communication between the
predecessor and successor auditors
c. Communication between the predecessor and successor auditors should take place only after
the successor auditor has accepted the engagement
d. All of the above

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Before accepting an audit engagement, a successor auditor should

make specific inquiries of the predecessor auditor regarding the
predecessor’s

a. opinion of any subsequent events occurring since the predecessor’s audit report was issued
b. understanding as to the reasons for the change of auditors
c. awareness of the consistency in the application of GAAP between periods
d. evaluation of all matters of continuing accounting significance

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Before accepting an audit engagement, a successor auditor should

make specific inquiries of the predecessor auditor regarding the
predecessor’s

a. opinion of any subsequent events occurring since the predecessor’s audit report was issued
b. understanding as to the reasons for the change of auditors
c. awareness of the consistency in the application of GAAP between periods
d. evaluation of all matters of continuing accounting significance

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Before accepting an audit engagement, a successor auditor should

make specific inquiries of the predecessor auditor regarding

a. Disagreements the predecessor had with the client concerning auditing procedures and
accounting principles
b. the predecessor’s evaluation of matters of continuing accounting significance
c. the degree of cooperation the predecessor received concerning the inquiry of client’s lawyer
d. the predecessor auditor’s assessment of inherent risk and judgments about materiality

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Before accepting an audit engagement, a successor auditor should

make specific inquiries of the predecessor auditor regarding

a. Disagreements the predecessor had with the client concerning auditing procedures
and accounting principles
b. the predecessor’s evaluation of matters of continuing accounting significance
c. the degree of cooperation the predecessor received concerning the inquiry of client’s lawyer
d. the predecessor auditor’s assessment of inherent risk and judgments about materiality

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The successor auditor requested permission to communicate with

the predecessor auditor and review certain portions of the
predecessor auditor’s working papers. The prospective client’s
refusal to permit this will bear directly on the successor auditor’s
decision concerning the

a. adequacy of the preplanned audit program

b. ability to establish consistency in application of accounting principles between years
c. apparent scope limitation
d. integrity of management

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The successor auditor requested permission to communicate with

the predecessor auditor and review certain portions of the
predecessor auditor’s working papers. The prospective client’s
refusal to permit this will bear directly on the successor auditor’s
decision concerning the

a. adequacy of the preplanned audit program

b. ability to establish consistency in application of accounting principles between years
c. apparent scope limitation
d. integrity of management

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End of Discussion

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