AT 101-23: OVERVIEW OF INDEPENDENT FINANCIAL AUDIT September 4, 2023

ALDIN L. PANTALEON, CPA

Auditing- is a systematic, integrated process of accumulating and evaluating evidence by competent, independent
person(s) about economic information, actions and events of an entity; the purpose of which is to assess and report
on the degree of correspondence between the information and established criteria for the entity’s actions and/or the
reporting thereof. It involves gathering and evaluating evidence relating to management’s assertion as reflected in
the financial statements.

OBJECTIVE OF AN AUDIT (PSA 200)

Objective of an Audit

The auditor’s over-all objectives in a risk-based audit are:

1.) To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether
the financial statements are prepared, in all material aspect, in accordance with an applicable financial
reporting framework, and;
2.) To report in the financial statements and communicate as requires by the PSAs, in accordance with the
auditor’s findings.
GENERAL PRINCIPLES OF AN AUDIT
The auditor should comply with the “Code of Ethics for Certified Public Accountants” promulgated by the Board of
Accountancy and Approved by the Philippine Regulation Commission. Ethical principles governing the auditor’s
responsibilities are:
1.) Independence
2.) Integrity
3.) Objectivity
4.) Professional competence and due care
5.) Confidentiality
6.) Professional behavior, and
7.) Technical standards
The auditor should conduct the audit in accordance with the Philippine Standards on Auditing, plan and perform the
audit with an attitude of professional skepticism recognizing the circumstances may exist which cause the financial
statements to be materially misstated.
SCOPE OF AN AUDIT
Scope of the auditor’s work and opinion provided are confined to whether the financial statements are prepared, in
all material respects, in accordance with the applicable financial reporting framework. An unmodified auditor’s
report does not provide any assurance about the viability of the entity, nor efficiency or effectiveness the
management has conducted the affairs of the entity.
REASONABLE ASSURANCE
Philippine Standards in Auditing require the auditor to obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatements, whether due to fraud or error. Reasonable assurance is
a high but not absolute level of assurance. It is obtained when the auditor has obtained sufficient appropriate audit
evidence to reduce audit risk (risk that the auditor expresses an inappropriate opinion when the financial statements
are materially misstated) to an acceptably low level. The auditor cannot provide absolute assurance due to inherent
limitations in the work carried out. Audit evidence (on which the auditor draws its conclusions and bases of the
auditor’s opinion) being persuasive rather than conclusive.
THE NEED OF INDEPENDENT AUDITING
Without wide public acceptance, professions cannot exist, and independent auditing is of no exception. Over the
years, society perceived a need for audits of public held entities, which has developed as a result of 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. The following are factors that contribute to information risk:
1. Remoteness of information users from providers
Decision makers always do not get first hand knowledge about the business enterprise with which they do
business for the reason that in many cases,
a. Owners are divorced from management
b. Directors are not involved in a day-to-day operations or decisions.
c. Business may be dispersed among numerous geographic locations and complex corporate structures.
2. Potential bias and motives of information provider
Conflict of interest maybe assumed to exist between management and owners regarding financial
statements. Management usually desires to present of its stewardship in the most favorable light.
Information may possibly be biased in favor of the provider when his goals are inconsistent with the decision
maker.
3. Voluminous data
Rapid business growth, possibly millions of business transactions are processed daily via manual or
sophisticated computerized systems. This increases therefore the likelihood that improperly recorded
information may be included or buried in the records.
4. Complex exchange of transactions
New and changing business relationships may lead to innovative accounting and reporting problems. Some
transactions are so complex hence more difficulty to record it properly.
MATERIAL MISSTATEMENTS
A material misstatement (the aggregate of all uncorrected misstatements and missing/misleading disclosures in the
financial statements, including omissions) has occurred when they could reasonably be expected to influence the
economic decisions of users made on the basis of the financial statements.
AUDIT RISK AND MATERIALITY
Auditors obtains and evaluates audit evidence to obtain reasonable assurance about whether the financial
statements give a true and fair view or are presented fairly, in all material respect, in accordance with the applicable
financial reporting framework. The concept of reasonable assurance acknowledges that there is a risk the audit
opinion is inappropriate. The risk that the auditor expresses an inappropriate audit opinion/report when the financial
statements are materially misstated is known as “audit risk”.
The auditor should plan and perform the audit to reduce the risk to an acceptably low level that is consistent the
objective of an audit. The auditor reduces audit risk when by designing and performing audit procedures to obtain
sufficient appropriate evidence to be able to draw reasonable conclusions on which to base an audit opinion.
Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level.
RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
While the auditor is responsible for forming and expressing an opinion on the financial statements, the responsibility
for the preparation and presentation of the financial statements in accordance with the applicable financial reporting
framework is that of the management of the entity, with oversight from those charged with the governance. The
audit of the financial statements does not relieve the management or those charged with governance of their
responsibilities.
ELEMENTS OF AUDIT RISK
1. Inherent and Control Risk

Inherent risk refers to susceptibility of an account balance to material misstatement assuming that the client
does not have any related internal control.
Control risk refers to the risk of a material misstatement in an account balance that will not be prevented or
detected on a timely basis by the client’s system of internal control.
2. Detection risk refers to the risk to detect material misstatement or error in the financial statements.
To reduce audit risk to an acceptably low level, the auditor is required to:
a) Asses the risk of material misstatement, and;

b) Limit detection risk. This may be achieved by performing procedures that respond to the assessed risk of
material misstatement, both at the financial statement level and the assertion level for classes of
transactions, account balance and disclosures.

STEPS IN THE SYSTEMATIC PROCESS OF FINANCIAL STATEMENT AUDIT

Phase I- Pre-engagement and Audit Planning Activities
Audit process begins with the preliminary arrangement with the client. Once the client has signed the
engagement letter, the planning process starts as the auditors concentrates his efforts in obtaining a detailed
understanding of the client business and an overall audit strategy. The auditor should observe PSA 300 on
“planning”. Basically, audit planning includes understanding the client’s (1) industry environment, (2) business
and management, (3) accounting and reporting system, and internal control.
On the basis of the initial information gathered by the auditor, he then assesses the “audit risk” relative to the
engagement.
Based on the initial understanding, the auditor may decide to assess control risk at the maximum level for some
assertions and below maximum for the others. Maximum control risk is defined at the greatest probability of
material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the
entity’s internal control structure.
Assessment of materiality, acceptable audit risk, inherent and control risk are used to develop an overall audit
plan and audit program.
Phase II-Gathering and Evaluating Audit Evidence
Upon gathering and evaluating audit evidence, auditors perform two types of audit tests:
1. Test of controls
2. Substantive tests

I-INTERIM PHASE
Auditor focuses his attention on both design and operating aspect of the internal control structure to be able to
determine whether controls were functioning as intended. If the auditor’s preliminary assessment of control risk
is below the maximum level, he may decide to perform tests of controls to established the effectiveness of
controls in preventing or detecting material misstatements in the financial statement assertion. When the
auditor assessed control risk at maximum level, they are not required to perform any tests of controls. Tests of
controls are performed to determine whether control is working. Test of controls may require inquiry,
observation, or inspection of documents.
Tests of controls involve the following procedures:
1. Inquiries of client personnel
2. Inspection of documents and records.
3. Observation of the application of specific policies and procedures.
4. Reperformance of the application of specific policies and procedures.
Compliance to tests of controls over basic transaction cycle, (1) revenue and collection cycle may be done on this
stage. Tests of controls precede substantive testing and are performed to reduce the assessed level of control risk
below the maximum level.
Substantive testing of transactions may also be conducted at this stage. In fact, both types of tests, test of
controls and test of transactions are done simultaneously on the same transactions. If controls are not
 considered effective, or when control deviations are discovered, substantive tests can be expanded in this phase
or in the final phase of the audit.
III-FINAL AUDIT PHASE
This phase involves substantive tests of details of balances and analytical procedures. Substantive audit testing is
the process of obtaining evidence in support of transactions and balance. The nature, timing and extent of
substantive testing is a function of the auditor’s judgement concerning audit risk and materiality.
Nature of Substantive tests
Test of balances refer to
1. Substantive tests of transactions and balances, and
2. Analytical review procedures performed at or near the balance sheet date that are directed at the
verification of an account balance.
In designing audit programs for test of balances in a typical audit engagement, the following approaches are
often used:
a. When test of control over a specific class of transactions are effective, test of balances is placed primarily on
internal control and analytical review procedures for related income statement account balances.

b. When internal control over a specific class of transactions is not tested or cannot be relied upon, tests of
balances are applied both to resulting balance sheet and income statement account balances.
In performing substantive tests, the auditor aims to detect errors in account balances that are large enough,
individually or in the aggregate, to be material to financial statements. These tests relate to “detection risk” that
is a key part of audit risk.
Substantive tests may be performed before the balance sheet date when the auditor can:
a. Control the added audit risk that errors existing in the account balance sheet date will not be detected, and
b. Reduce the cost of substantive tests at the statement date.
Audit objectives for substantive tests are to determine:
1. Existence or occurrence and validity
This relates to whether specific assets and liabilities exist at a given point in time and whether recorded
transactions represent economic events that occurred during the year.
2. Completeness and accuracy
This involves determining whether all transactions that should have been recorded by the client are
accurately included in the accounts.
3. Rights and obligations
This requires the auditor obtain evidence that the client has right to existing assets and that existing liabilities
and owner’s equity claims against the entity are valid.
4. Proper valuation and allocation
This involves determining whether financial statement elements are stated at the proper amount in
accordance with applicable financial reporting framework.
5. Proper statement presentation and disclosure
This involves determining whether statement items are properly identified, classified and arranged in the
statements and whether accompanying disclosure are adequate.

MULTIPLE CHOICE QUESTIONS

1. Auditing is a systematic process that includes all of the following except:
a. Systematic process
b. Assertions about economic actions and events
c. Objectively obtaining and evaluating assurance
d. Degree of correspondence between assertions and GAAP
2. The definition of auditing includes both a(an)
a. Documentation process and an evaluation process.
b. Evaluation process and a reporting process.
c. Investigative process and a reporting process.
d. Documentation process and a reporting process.

3. Auditing is important in a free-market society because

a. The public requires CPAs functioning as divisions of regulatory bodies
b. Auditors detect all errors and fraud made by company employees
c. It provides reliable information based upon which to judge economic performance
d. The auditor is an amiable insurance policy for investors

4. An independent audit is important to readers of financial statements because it

a. Provides a measure of management's stewardship function.
b. Measures and communicates the financial data included in financial statements.
c. Objectively examines and reports on management's financial statements.
d. Reports on the accuracy of information in the financial statements.

5. Which one of the following is a potential problem with management's communication of financial information that causes third
parties to desire the independent auditor's assessment of the financial statement presentation?
a. Complexity of transactions affecting the financial statements
b. Lack of criteria on which to base information
c. Remoteness of the user from the organization
d. A and C

6. The objective of an operational audit is to

a. Evaluate whether laws have been broken by management
b. Evaluate fairness of presentation of financial statements
c. Evaluate compliances with company rules and regulations
d. Evaluate the effectiveness and efficiency with which resources are employed

7. What are the criteria used in an operational audit?

a. GAAP
b. Effectiveness and efficiency
c. Rules and regulations
d. Company policies

8. Before an operational audit for effectiveness can be performed, there must be:
a. a financial audit by an independent auditor.
b. a financial audit by an internal auditor.
c. a review performed by either an independent or an internal auditor.
d. specific criteria developed to define effectiveness.

9. A primary purpose of an operational audit is to provide

a. A means of assurance that internal accounting controls are functioning as planned.
b. The results of internal examination of financial and accounting matters to a company’s top-level management.
c. A measure of management performance in meeting organizational goals.
d. Aid to the independent auditor, who is conducting the examination of the financial statements.

10. The main objective of operations auditing is

a. To verify fulfillment of plans and sound business requirements.
b. To evaluate the integrity of accounting information.
c. To measure and evaluate the effectiveness of controls.
d. To produce results as desired or directed.

11. Which type of auditor would typically perform an operational audit?

a. External auditor
b. Internal auditor
c. Governmental auditor
d. Both B and C

12. Usually, an operational audit is performed

a. By independent external auditors.
b. By a team consisting of an equal number of external and internal auditors.
c. Only when an operating division is experiencing declines in productivity or profitability.
d. By internal auditors at the request of top management or the board of directors.
13. This is an independent appraisal activity established within an entity as a service to the entity:
a. Internal audit function
b. Independent auditing
c. Government auditing
d. Compliance audit function

14. Internal auditors may perform all of the following types of audits except
a. Operational audits
b. Compliance audits
c. Computer system audits
d. All of the above may be performed by internal auditors

15. Internal auditing relates to an

a. Audit which is performed by professional practitioner as an independent contractor
b. Audit which is incidentally concerned with the detection and prevention of fraud
c. Audit wherein the auditor should be independent of management both in fact and in mental attitude
d. Audit which serves the needs of management

16. To provide for the greatest degree of independence in performing internal auditing functions, an internal auditor most likely
should report to the
a. Financial vice-president.
b. Corporate controller.
c. Those charged with governance.
d. Corporate stockholders.

17. For an internal auditor to render impartial and unbiased judgments, he or she must be independent of the entity's
a. Stockholders.
b. Personnel and operating activities (line functions of the organization).
c. Independent (external) auditors.
d. Board of directors.

18. Government auditing often extends beyond expressing an opinion on the fairness of the financial presentation and includes
audits of efficiency, effectiveness and
a. Internal control
b. Efficiency
c. Accuracy
d. Compliance

19. An “integrated audit” includes an audit of

a. The company’s internal controls
b. The company’s financial statements
c. The company’s compliance with its rules and policies
d. Both A and B

20. Which type of auditor may perform a financial statement audit?

a. External auditor
b. Internal auditor
c. Governmental auditor
d. Both A and C

21. Which of the following is true?

a. External auditors may perform operational audits and internal auditors may perform financial audits.
b. The criteria for any audit (an operational audit or a financial audit) are GAAP.
c. Both external and internal auditors can provide management advice to the company.
d. A financial audit is designed to determine if the company is acquiring resources at the lowest cost.

22. Which of the following statements comparing external auditing to internal auditing is true?
a. Both produce reports addressed to the company’s management and board of directors.
b. They have the same concern with the company’s day-to-day operations.
c. They have different scopes of work.
d. They are paid in the same way.

23. Which of the following types of audits are most similar?

a. Operational audits and compliance audits.
b. Independent financial statement audits and operational audits.
c. Compliance audits and independent financial statement audits.
d. Internal audits and independent financial statement audits.

Independent FSs Audit

24. An audit of financial statements is a non-assurance engagement. The auditor is engaged for purposes of expressing an opinion
designed to enhance the degree of confidence of intended users in the financial statements.

In conducting the audit so as to achieve its objective, the overall objective of the independent auditor is to obtain reasonable
assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or
error, and to report on the financial statements in accordance with the auditor’s findings.
a. True, True c. False, True
b. False, False d. True, False

25. In order to obtain reasonable assurance, the auditor shall obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the audit opinion. Reasonable assurance is obtained when the auditor has thereby
reduced audit risk to an acceptably low level.

The objective of an audit cannot be fulfilled unless the auditor achieves the overall objective of the auditor. In all cases when
the overall objective of the auditor cannot be achieved, the PSAs require that the auditor modifies the auditor’s opinion
accordingly or withdraws from the engagement.
a. True, False c. False, False
b. False, True d. True, True

26. The reason an independent auditor gathers evidence is to

a. Form an opinion on the financial statements.

b. Detect fraud.

c. Evaluate management.

d. Evaluate internal controls.

27. The auditor shall plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may
exist that cause the financial statements to be materially misstated.

The auditor shall not represent compliance with PSAs unless the auditor has complied with majority of the PSAs relevant to the
audit.
a. True, True c. False, True
b. False, False d. True, False

28. Which of the following is least likely an application of maintaining an attitude of professional skepticism?
a. The auditor does not consider representations from management as substitute for obtaining sufficient appropriate audit
evidence to be able to draw reasonable conclusions on which to base the audit opinion.
b. In planning and performing an audit, the auditor assumes that management is dishonest.
c. The auditor is alert to audit evidence that contradicts or brings into question the reliability of documents or management
representations.
d. The auditor makes a critical assessment, with a questioning mind, of the validity of audit evidence

29. As it relates to an audit, materiality is

a. Not taken into consideration
b. Related only to the sufficiency of procedures performed
c. Based upon audit fees
d. Determined based upon the importance to a user of the financial statements

30. Which of the following statements is correct concerning an auditor’s responsibilities regarding financial statements?
a. An auditor’s responsibilities for audited financial statements are not confined to the expression of the auditor’s opinion.
b. Making suggestions that are adopted about the form and content of an entity’s financial statements impairs an auditor’s
independence.
c. An auditor may draft an entity’s financial statement-based information from management’s accounting system.
d. The fair presentation of audited financial statements in conformity with GAAP is an implicit part of the auditor’s
responsibilities.

31. The auditor’s opinion

a. Guarantees the credibility of the financial statements.
b. Is an assurance as to the future viability of the entity.
c. Is not an assurance as to the efficiency with which management has conducted the affairs of the entity.
d. Certifies the correctness of the financial statements.

32. The independent auditor lends credibility to client financial statements by

a. Stating in the auditor’s management letter that the examination was made in accordance with generally accepted auditing
standards
b. Maintaining a clear-cut distinction between management’s representation and the auditor’s representations
c. Attaching an auditor’s opinion to the client’s financial statements
d. Testifying under oath about client financial information
33. The independent auditor’s responsibility in a regular audit is to express an opinion on the financial statements. The auditor’s
opinion:
a. Helps the company adopt sound accounting policies.
b. Assists the company in maintaining an adequate and effective system of accounts.
c. Helps establish the credibility of the financial statements.
d. Helps management safeguard the company assets.

34. Third-party users of the audit report expect the auditor to do all of the following except:
a. To evaluate measurements and disclosures made by management
b. To provide a biased evaluation of the financial statements
c. To determine whether financial statements are presented in accordance with GAAP
d. To gather sufficient evidence to support their opinion

35. The following are the general principles governing an audit of FS Audit, except
a. Independence c. Confidentiality
b. Professionalism d. Professional behavior

36. An audit is conducted on the premise that management and, where appropriate, those charged with governance, have
acknowledged and understand that they have responsibilities that are fundamental to the conduct of an audit in accordance
with PSAs. Which of the following is not one of those responsibilities?
a. To provide the auditor unrestricted access to persons within the entity from which the auditor determines it necessary to
obtain audit evidence
b. The preparation and presentation of financial statements in accordance with the pronouncements issued by AASC
c. The establishment and maintenance of internal control relevant to the preparation and presentation of financial
statements that are free from material misstatement, whether due to fraud or error
d. To provide complete information to the auditor.

37. Management of a company is responsible for

a. Hiring the auditor
b. Preparing the financial statements
c. The audit workpapers
d. Independence and obtaining evidence

38. Absolute assurance is generally not attainable as a result of such factors as:
a. b. c. d.

The use of testing Yes Yes Yes No

The inherent limitations of internal

control
Yes Yes Yes Yes

The use of judgment Yes No Yes No

Most audit evidence are persuasive

rather than conclusive

No Yes Yes Yes

39. Users of the audit report can reasonably expect the audited financial statements to be
a. Include complete information and contain all financial disclosures
b. Presented fairly according to the substance of GAAP
c. Free from all errors
d. All of the above

40. Results of the financial statement audit are communicated to users through a(n)
a. Financial statement
b. Written management assertion
c. Audit report
d. none of the above