FEU - Makati

Auditing Theory AT – Lecture 1

Prof. Francis H. Villamin
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Preface to Philippine Standards on Quality Control, Auditing, Review, Other Assurance

and Related Services

1. Auditing and Assurance Standards Council (AASC) has its mission to promulgate the auditing
standards, practices and procedures which shall be generally accepted by the accounting profession
in the Philippines.

2. To facilitate the preparation by the AASC of its pronouncements and to attain uniformity of those
pronouncements with international accounting standards , the AASC has approved the adoption of
the International Standards on Auditing (ISAs), International Standards on Assurance Engagements
(ISAEs), International Standards on Review Engagements (ISREs) and International Standards on
Related Services (ISRSs) issued by International Auditing and Assurance Board (IAASB) created by
the International Federation of Accountants (IFAC).

3. Pronouncements of the AASC shall be in the form of:

• Philippine Standards on Quality Control (PSQCs)
• Philippine Standards on Auditing (PSAs)
• Philippine Standards on Review Engagements (PSREs)
• Philippine Standards on Assurance Engagements (PSAEs)
• Philippine Standards on Related Services (PSRSs)
• Philippine Auditing Practice Statements (PAPSs)
• Philippine Review Engagement Practice Statements (PREPSs)
• Philippine Assurance Engagement Practice Statements (PAEPSs)
• Philippine Related Services Practice Statements (PRSPSs)

4. AASC was created by the Professional Regulation Commission upon the recommendation of the
Board of Accountancy (BOA) to assist the BOA in the establishment and promulgation of auditing
standards in the Philippines. The AASC replaced the Auditing Standards and Practices Council
(ASPC) which was established by the Philippine Institute of CPAs (PICPA) and the Association of
CPAs in Public Practice (ACPAPP) and previously set generally accepted auditing standards in the
Philippines, also based on International Standards and Practice Statements.

5. Authority attaching to the Philippine Standards issued by the AASC:

• PSAs are to be applied, as appropriate, in the audit of historical financial statements.

• PSREs are to be applied in the review of historical financial information.
• PSAEs are to be applied in assurance engagements dealing with subject matters other than
historical information.
• PSRSs are to be applied to compilation engagements, engagements to apply agreed-upon
procedures to information and other related services engagements as specified by the AASC.
• PSAs, PSREs, PSAEs, PSRSs are collectively referred to as the AASC’s Engagements
Standards.
• PSQCs are to be applied for all services falling under the AASC’s Engagement Standards.
• The AASC’s engagement standards contain basic principles and essential procedures
(identified in bold type lettering) together with related guidance in the form of explanatory and
other material, including appendices. The basic principles and essential procedures are to be
understood and applied in the context of the explanatory and other materials that provide
guidance for their application. It is therefore necessary to consider the whole text of a Standard
to understand and apply the basic principles and essential procedures.

They also represent “pronouncements on generally accepted auditing standards, interpretations

and opinions issued by the AASC to apply whenever an independent examination of financial
statements of any entity, whether profit-oriented or not, for the purpose of expressing an opinion
thereon. They may have application, as appropriate, to other activities of the auditor.

6. The nature of the Philippine Standards issued by the AASC requires professional
accountants to exercise professional judgment in applying them. In exceptional
circumstances, a professional accountant may judge it to depart from a basic principle or essential
procedure of an Engagement Standard to achieve more effectively the objective of the engagement.
When such a situation arises, the professional accountant should be prepared to justify the
departure.
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7. Authority attaching to the Practice Statements issued by the AASC:

• PAPS are issued to provide interpretative guidance and practical assistance to professional
accountants in implementing PSAs and to promote good practice.
• PREPSs, PAEPSs and PRSPSs are issued to serve the same purpose for the implementation of
PSREs, PSAEs and PSRSs, respectively.
8. Professional accountants should be aware of and consider Practice Statements applicable to the
engagement. A professional accountant who does not consider and apply the guidance included in a
relevant Practice Statement should be prepared to explain how the basic principles and essential
procedures in the Engagement Standard(s) addressed by the Practice Statement have been
complied with.

9. Exposure period for the proposed Philippine Standard or Practice Statement is generally not shorter
than 90 days. Exposure draft is widely distributed to interested organizations and persons for
comment. The exposure draft shall also be published in the PICPA Accounting Times and ACPAPP
Bulletin to give it further exposure.

10. Issuance of exposure drafts requires approval by a majority of the members of the Council; issuance
of the Philippine Standards and Practice Statements, as well as interpretations, requires approval of
at least ten (10) members.

11. Each final Philippine Standard and Practice Statement, as well as interpretations, if deemed
appropriate, shall be submitted to the Professional Regulation Commission (PRC) through the Board
of Accountancy (BOA) for approval after which the pronouncements shall be published in the Official
Gazette. After publication, the AASC pronouncement becomes operative from the effective date
stated therein.

12. Numbering of Philippine Standards and Practice Statements that are Philippine specific and are not
adopted from International pronouncements will be numbered consecutively with suffix “Ph” as
follows:
• For Philippine Standards – starting from 100Ph
• For Philippine Practice Statements – starting from 1000Ph

Philippine Standards and Practice Statements adopted from International pronouncements will use the
same numbers as their counterpart International pronouncements.

Philippine Framework for Assurance Engagements

1. “Assurance engagement” means an engagement in which a practitioner expresses a conclusion

designed to enhance the degree of confidence of the intended users other than the responsible party
about the outcome of the evaluation or measurement of a subject matter against criteria.

2. Objective of an Assurance Engagement

The objective of an assurance engagement is for a professional accountant to evaluate or measure a

subject matter that is the responsibility of another party against identified suitable criteria, and to
express about the subject matter. Assurance engagements performed by professional accountants
are intended to enhance the credibility of information about a subject matter by evaluating whether
the subject matter conforms in all material respects with suitable criteria, thereby improving the
likelihood that the information will meet the needs of an intended user. In this regard, the level of
assurance provided by the professional accountant’s conclusion conveys the degree of confidence
that the intended user may place in the credibility of the subject matter.

Assurance is a broad concept. Assurance services are designed to improve the quality of decision
making by improving confidence in the information on which decisions are made; the process by
which that information is developed, and the context in which the information is presented to users.
The field of assurance services is much broader than the traditional audits of financial statements.

3. Classification of Assurance Engagements

According to Level of Assurance

a. Reasonable assurance engagement

b. Limited assurance engagement

The objective of a reasonable assurance engagement is a reduction in assurance engagement risk

to an acceptably low level in the circumstances of the engagement as the basis for a positive form of
expression of the practitioner’s conclusion.

The objective of a limited assurance engagement is a reduction in assurance engagement risk to a

level that is acceptable in the circumstances of the engagement, but where that risk is greater than for
a reasonable assurance engagement, as the basis for a negative form of expression of the
practitioner’s conclusion.
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According to Structure

a. Assertion-based Engagement (Attestation)

b. Direct Reporting Engagement

In assertion-based engagement, the evaluation or measurement of the subject matter is performed

by the responsible party, and the subject matter information is in the form of assertion by the
responsible party that is made available to the intended users.

Examples of Assertion-based Engagements

a. An independent audit engagement provides a reasonable (but not absolute) level of assurance
that the subject matter (financial statements) is free of material misstatement.
b. A review engagement provides a moderate level of assurance that the information subject to
review is free from material misstatement; this is expressed in the form of negative assurance
(i.e. “nothing has come to the auditor’s attention”). For the purpose of expressing negative
assurance in the review report, the auditor should obtain sufficient appropriate evidence primarily
through inquiry and analytical procedures to be able to draw conclusions

In direct reporting engagement, the practitioner either directly performs the evaluation or
measurement of the subject matter, or obtains a representation from the responsible party that has
performed the evaluation or measurement that is not available to the intended users. The subject
matter is provided to the intended users in the assurance report.

4. Elements of an Assurance Engagement

1. Three-party relationship involving

a. A practitioner (broader than the term “auditor”)
b. A responsible party (a private company, a government entity, etc)
1. In a direct reporting engagement, is responsible for the subject matter
2. In an assertion-based engagement, is responsible for the subject matter information (the
assertion), and may be responsible for the subject matter.
c. An intended user (often members of the public or investors or regulatory bodies)
- Are person, persons or class of persons for whom the practitioner prepares the
assurance report.
- Can be any one of the intended users, but not the only one.

2. An appropriate subject matter

a. Financial performance or conditions (e.g. historical or prospective financial position, financial
performance and cash flows) for which the subject matter information may be the recognition,
measurement, presentation and disclosure represented in the financial statements.
b. Non financial performance or conditions (e.g. performance of an entity) for which the subject
matter information may be key indicators of efficiency and effectiveness.
c. Physical characteristics (e.g. capacity of a facility) for which the subject matter information
may be specifications document.
d. Systems and processes (e.g. an entity’s internal control or IT system) for which the subject
matter information may be an assertion about effectiveness.
e. Behavior (e.g. corporate governance, compliance with regulation, human resource practices)
for which the subject matter information maybe a statement of compliance or a statement of
effectiveness.

An appropriate subject matter is:

1. Identifiable, and capable of consistent evaluation or measurement against the identifiable
criteria, and
2. Such that the information about it can be subjected to procedures for gathering sufficient
appropriate evidence to support a reasonable assurance or limited assurance conclusion, as
appropriate.

3. Suitable criteria (PFRS – formal; Code of Conduct – less formal)

- are the benchmarks used to evaluate or measure the subject matter including, where relevant,
benchmarks for presentation and disclosure.
- are required for reasonably consistent evaluation or measurement of a subject matter within the
context of professional judgment.

Characteristics of suitable criteria:

a. Relevance – contribute to conclusions that assist decision-making by the intended users.

b. Completeness – no omissions of relevant factors that could affect the conclusions in the
context of the engagement circumstances.
c. Reliability – allow reasonably consistent evaluation or measurement of the subject matter
d. Neutrality – contribute to conclusions that are free from bias.
e. Understandability – contribute to conclusions that are clear, comprehensive, and not subject to
significantly different interpretations.
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Criteria are made available to the intended users in one or more of the following ways:
a. Publicly
b. Through inclusion in a clear manner in the presentation of the subject matter information
c. Through inclusion in a clear manner in the assurance report
d. By general understanding, for example the criterion for measuring time in hours and minutes.

Criteria may also be available to specific intended users, for example, the terms of a contract, or
criteria issued by an industry association that are available only those in the industry. When
identified criteria are available only to specific intended users, or are relevant only to a specific
purpose, use of the assurance report is restricted to those users or for that purpose.

4. Sufficient appropriate evidence

Sufficiency is the measure of the quantity of evidence.

Appropriateness is the measure of quality of evidence that is relevance and its reliability.

Generalizations about the reliability of evidence:

• Evidence is more reliable when it is obtained from independent sources outside the entity.
• Evidence that is generated internally is more reliable when the related controls are effective.
• Evidence obtained directly by the practitioner (observation) is more reliable than evidence
obtained indirectly or by inference (inquiry).
• Evidence is more reliable when it exists in documentary form.
• Evidence provided by original documents is more reliable than evidence provided by
photocopies or facsimiles.

5. A written assurance report in the form appropriate to a reasonable assurance engagement

or a limited assurance engagement.

In a reasonable assurance engagement, the practitioner expresses the conclusion in the positive
form, for example: “In our opinion internal control is effective, in all material respects, based on
XYZ criteria.” This form of expression conveys “reasonable assurance”.

In a limited assurance engagement, the practitioner expresses the conclusion in the negative form,
for example: “Based on our work described in this report, nothing has come to our attention that
causes us to believe that the internal control is not effective, in all material respects, based on XYZ
criteria. This form of expression conveys a level of “limited assurance” that is proportional to the
level of the practitioner’s evidence –gathering procedures given the characteristics of the subject
matter and other engagement circumstances described in the assurance report

Limitations of Assurance Engagements

a. The use of selective testing.

b. The inherent limitations of internal control.
c. The nature of evidence. (persuasive rather conclusive)
d. The use of judgment in gathering and evaluating evidence and forming conclusions based on that
evidence.
e. The characteristics of the subject matter when evaluated or measured against the identified
criteria.

Engagements Provided by Practitioners:

Assurance Engagements

1. Audits – high level of assurance that the financial statements are free of material misstatements

2. Reviews – limited investigation of much narrower scope than the audit and undertaken for the
purpose of providing limited (negative) assurance that the statements are presented in
accordance with identified Financial Reporting Standards. For example, a financial institution
may require debtors to engage CPAs to provide assurance about the debtor’s compliance with
certain covenant provisions stated in the loan agreement. It may also include providing
assurance about the effectiveness of a client’s internal controls over financial reporting,
review of investment performance statistics for organizations such as mutual funds and
computer software review.

3. Other assurance services

• CPA Web Trust – provide assurance to users of web sites in the Internet. The CPA’s
electronic Web Trust Seal is affixed to the website. This seal assures the user that the
website owner has met established criteria related to business practices, transaction integrity
and information processes. Web Trust is an attestation service and Web Trust seal s a
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symbolic representation of the CPA’s report on management assertions about its disclosure
of electronic commerce practices.

• SysTrust – provide assurance on any defined electronic system. The system components
include its infrastructure, software, personnel, procedures and data, In a SysTrust
engagement, the CPA is engaged to examine only that a client maintained effective controls
over the system based on the Trust Services Principles and Criteria. The practitioner
performs tests to determine whether those controls were operating as effectively during the
specified report.

Both WebTrust and SysTrust are designed to incorporate a seal management process by
which a seal (logo) may be included on a client’s Web site as an electronic representation of
the practitioner’s unqualified WebTrust report. If a client wishes to use the seal (logo), the
engagement must be updated at least annually. Also, the initial reporting period must include
at least two months.

• Eldercare Plus – focuses on the needs of the elderly and whether caregivers are providing
services that meet the specified objectives or at an acceptable level.

• Business Performance Measurement Services – provide assurance about whether

financial and non-financial information being reported from the entity’s performance
measurement system (e.g. balanced scorecard) is reliable and whether the performance
measures being used are accurately leading the entity toward meeting its strategic goals and
objectives.

• Corporate Sustainability Reporting – also known as triple-bottom line reporting involves

reporting of non-financial and financial information to a broader set of stakeholders than just
shareholders. The reports inform stakeholder groups of the reporting organization’s ability to
manage key risks.

• Information Reliability Services – provide assurance that information system has been
designed and operated to produce reliable data including tests of the system to determine
whether the system protects against potential causes of data defects

• Risk Assessment Services – involves the study of the link between risks and organization’s
vision, mission, objectives and strategies and development of new and relevant measures to
address these risks.

• CPA Performance View. This service is intended to demonstrate that the public
accountants can aide client firms in developing an integrated set of financial and non financial
performance and measures to employ in managing the client’s business. It also identifies
and measures key activities that are critical to the entity.

• Health Care Performance Measurement – involves the evaluation of the quality of health
care, medical services and outcome.

Non Assurance Engagements

1. Agreed-upon procedures – an engagement in which the auditor is engaged to carry out those
procedures of an audit nature to which the auditor and the entity and any appropriate third parties
have agreed and to report on factual findings. The recipients of the report must form their own
conclusions from the report issued by the auditor. The report is restricted to those parties who
have agreed to the procedures to be performed since others, unaware of the results may
misinterpret the results.

2. Compilation of financial or other information – an engagement in which the accountant is

engaged to use his accounting expertise as opposed to auditing expertise to collect, classify and
summarize financial information. This ordinarily entails “presenting in the form of financial
statements that is the representation of management (owners) without undertaking to express
any assurance engagements.” The procedures employed are not designed and do not enable
the accountant to express any assurance on the financial information. Users of the compiled
financial information derive some benefit as a result of the accountant’s involvement because the
service has been performed with due professional skill and care.

3. Preparation of tax returns where no conclusion is expressed, and tax consulting.

4. Management consulting and other advisory services – professional services that employ the
practitioner’s technical skills, education, observation, experiences and knowledge of the analytical
approach and procedures used in consulting engagement. Those procedures may involve
determining client objectives, fact-finding definition of problems or opportunities, evaluation of
alternatives, formulation of proposed action, and communication of results, implementation and
follow-up.
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Management consulting and other advisory services

• Design and installation of accounting system
• Computer risk management
• Corporate finance
• Tax services
• E-businesses
• Disaster recovery planning

8. Assurance Engagement Risk

Assurance engagement risk is the risk that the practitioner expresses an inappropriate conclusion
when the subject matter information is materially misstated.

In a reasonable assurance engagement, the practitioner reduces assurance engagement risk to an

acceptably low level in the circumstances of the engagement to obtain reasonable assurance as
the basis for a positive form of expression of the practitioner’s conclusion. The level of assurance
engagement risk is higher in a limited assurance engagement than in a reasonable assurance
engagement because of the different nature, timing or extent of evidence-gathering procedures.
However, in a limited assurance engagement, the combination of the nature, timing and extent of
evidence gathering procedure is at least sufficient for the practitioner to obtain a meaningful level of
assurance as the basis for a negative form of expression. To be meaningful, the level of assurance
obtained by the practitioner is likely to enhance the intended users’ confidence about the subject
matter information to a degree that is clearly more than inconsequential.

In general, assurance engagement risk can be represented by the following components, although
not all of these components will necessarily be present or significant for all assurance
engagements:

a) The risk that the subject matter information is materially misstated, which in turn consists of:
i) Inherent risk: the susceptibility of the subject matter information to a material
misstatement, assuming that there are no related controls; and

ii) Control risk: the risk that a material misstatement that could occur will not be prevented,
or detected and corrected, on a timely basis by related internal controls. When control
risk is relevant to the subject matter; some control risk will always exist because of the
inherent limitations of the design and operation of internal control; and

b) Detection risk: the risk that the practitioner will not detect a material misstatement that
exists.

The degree to which the practitioner considers each of these components is affected by the
engagement circumstances, in particular by the nature of the subject matter and whether a
reasonable assurance or a limited assurance engagement is being performed.

Introduction to Auditing

Auditing is a systematic process of objectively obtaining and evaluating evidence regarding

selected 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.

Key elements:

1. Systematic process – audits are structured activities

2. Objectivity – freedom from bias
3. Obtaining and evaluating evidence – allows the auditor to determine the support for assertions or
representations. The auditor must gather evidence that the client’s processes are working correctly,
the financial data are recorded and presented correctly and the financial statements as a whole are
fairly presented. The requirement is that the auditor is systematic and objective in obtaining and
evaluating evidence.
4. Assertions about economic actions and events – describes the subject matter of the audit. An
assertion is a positive statement about an action, event, condition, or performance over a specified
period of time.

5. Degree of correspondence between those assertions and established criteria – the purpose of the
audit is to determine conformity with some specified criteria. To have unbiased and clear
communication, criteria must exist whereby independent observers can assess whether or not such
assertions are appropriate. When management prepares financial statements, they assert those
statements are fairly presented with GAAP. Generally accepted accounting principles become the
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criteria by which “fairness” of a financial statement presentation is judged. Other criteria exist for
other types of audits.
6. Communicating the results – the results must be communicated to interested parties. Communication
of audit results to management and interested third parties completes the audit process. To minimize
understandings, this communication generally follows a prescribed format by clearly outlining the
nature of the work performed and the conclusions reached. Most audits result in audit reports that do
not contain any reservations about the fairness of the organization’s presentation of its financial
statements. This is referred to as an unqualified audit report.

The audit adds value if the auditor:

a. Has expertise in both obtaining and evaluating evidence regarding the financial statements and
the economic assertions embodied in the financial statements.

b. Is independent of management and the third-parties, and can thus provide an objective opinion
on the fairness of financial statements.

PSA 200 Revised and Redrafted, “Overall Objectives of the Independent Auditor and the Conduct
of an Audit in Accordance with PSAs” sets out the overall objective of the independent auditor, and
explains the nature and scope of an audit designed to enable the independent auditor to meet those
objectives.

The general purpose of an audit is to enhance the credibility of the financial statements, thus ensuring the
user of the financial statements can make reasonable, informed decisions about an entity. This is
achieved by the expression of an opinion by the auditor on whether the information contained within the
financial statements is presented fairly, in all material respects, in accordance with applicable financial
reporting framework. Auditors who follow the PSAs and the ethical guidelines will be able to form an
opinion provided evidence is available to support their opinion. If the evidence is lacking, the auditor will
not able to form an opinion and should modify their report accordingly.

Overall Objectives of the Auditor

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

a. 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 respects, in accordance with
an applicable financial reporting framework,
b. To report on the financial statements, and communicate as required by the PSAs, in accordance with
the auditor’s findings.

Applicable Financial Reporting Framework

- The financial reporting framework adopted by management and, where appropriate, those charged
with governance in the preparation and presentation of the financial statements that is acceptable in
view of the nature of the entity and the objective of the financial statements, or that is required by law
or regulation.

“Fair presentation framework” is used to refer to a financial reporting framework that requires
compliance with the requirements of the framework and
1. Acknowledges explicitly or implicitly that, to achieve fair presentation of the financial statements, it
may be necessary for management to provide disclosures beyond those specifically required by
the framework.
2. Acknowledges explicitly that it may be necessary for management to depart from a requirement
of the framework to achieve fair presentation of the financial statements. Such departures are
expected to be necessary only in extreme rare circumstances.

“Compliance framework” is used to refer to a financial reporting framework that requires

compliance with the requirements of the framework, but does not contain the acknowledgements in 1
or 2 above.

Scope of an Independent Audit

The term “scope of the 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.

Types of Procedures

1. Risk Assessment Procedures

2. Tests of Control or Compliance Tests.
3. Substantive Tests or Direct Tests
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Types of Audits

1. Financial Statements Audit

- Also referred to as Independent Audit or External Audit involves the examination of financial
statements to determine whether they are presented in accordance with applicable reporting
framework (generally accepted accounting principles).

2. Operational Audit
- Also known as Management Audit and Performance Audit are examination of all or part of an
organization for the purpose of determining the effectiveness and/or efficiency of its operations.
- Management implies that the information obtained in the audit process is useful to management.
- Performance implies an evaluation of the performance of persons or units executing the entity’s
objectives.

- Effectiveness is the measure of how well an entity or unit of an entity achieves its goal or
purpose.
- Efficiency is the measure of minimization of cost in the achievement of its objective.

Characteristics:
a. Auditors performing the audit are independent of the activity they audit.
b. The audit report is directed to an official or department within the organization that employs the
auditor.

3. Compliance Audit
- Determination of whether the auditee is following specific procedures or rules set down by some
higher authority.
- Are performed by auditors independent of the activity being audited.
- Results are generally reported to someone within the organization/unit audited rather than a
broad spectrum of users.

4. Government audit – determination of whether government funds are being handled properly and in
compliance with existing laws and whether the programs are being conducted efficiently and
economically.

Scope of Government Audit

 Financial and compliance audit – determines whether financial operations are properly
conducted, the financial reports of an audited entity are presented fairly, and the entity has
complied with applicable laws and regulations.
 Economy and efficiency audit – determines whether the entity is managing and utilizing its
resources economically and efficiently, the causes of inefficiencies or uneconomical practices and
whether the entity has complied with laws and regulations concerning matters of economy and
efficiency.
 Programs results – determines if the desired results and benefits are being achieved, if the
objectives established by the legislative or other authorizing body are being met and if the agency
has considered alternatives which might yield results at a lower cost.

The Commission on Audit (formerly General Auditing Office) is recognized as the Supreme Audit
Institution in the Republic of the Philippines. It is the highest and final authority in state auditing,

Three Main Divisions of State Audit (based on 1984 Primer on Government and Auditing in the
Philippines)
a. Compliance Audit - examination, audit, and settlement in accordance with laws and regulations.
b. Financial Audit – audit of the accounting, and financial system and controls to ensure reliability of
recorded financial data. The objective of this audit is the expression of an opinion on the fairness
with which the financial condition and results of operation are presented
c. Performance audit – objective examination of the financial and operational performance of an
organization, program, activity or function and is oriented towards opportunities for greater
economy, efficiency and effectiveness.

Two forms of performance audit

1. Management audit (economy and efficiency audit) – appraisal of management performance
from a least cost point of view and the analysis of relationship between benefits attained and
cost incurred.
2. Program results audit (effectiveness audit) – evaluation of program results vis-à-vis
management goals and objectives.

5. Internal audit – an independent, objective assurance and consulting activity designed to add value
and improve an organization’s operations. It helps an organization to accomplish its objectives by
bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk
management, control and governance processes.
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a. Management audit - future-oriented, independent, systematic evaluation of the activities of all

levels of management performed by internal auditor for the purpose of improving the
organizational profitability and increasing attainment of other organizational objectives.

b. Operational audit – future-oriented, independent, systematic evaluation performed by internal

auditor for management of the operational activities controlled by top, middle and lower-level
management for the purpose of improving organizational profitability and increasing attainment of
other organizational objectives.

c. Financial audit – historically oriented, independent evaluation performed by the internal auditor for
the purpose of ensuring the fairness, accuracy, and reliability of the financial data.

6. Comprehensive audit – usually includes the components of compliance, performance and financial
statements audit.

7. Integrated audit - covers financial statements audit and internal control audit.

8. Environmental audit – covers environmental issues which may have an impact on the financial
statements.

9. Forensic audit (Fraud Audit) – refers to the examination of evidence regarding an assertion to
determine its correspondence to established criteria carried out in a manner suitable to the court.

Types of auditors

1. External (independent) auditors – public accountants, both individuals and firms, who perform audit,
tax, consulting and other types of services for external clients.
2. Internal auditors – perform services for a single organization for which they are employed on a full-
time basis, typically reporting to the board of directors who are the primary users of their work.
3. Government auditors – are full-time employees of the government tasked to determine compliance
with laws, statutes, policies and procedures.
4. Forensic auditors – financial auditing specialists who focus on unearthing the truth and/or providing
evidence in a legal/financial disputes and/or irregularities (including fraud), as well as providing
preventive advice on the subject.

Audit Risk Engagement Process

1. Pre-engagement
2. Audit Planning
3. Study and Evaluation of Internal Control
4. Substantive Testing
5. Completing the Audit
6. Issuance of the Audit Report
7. Post-audit Responsibilities

General Principles Governing The Audit of Financial Statements

a. The auditor should comply with the “Code of Professional Ethics for Certified Public Accountants”
promulgated by the Board of Accountancy and approved by Professional Regulations Commission.

Part A of the Code sets out the fundamental ethical principles that all professional accountants are
required to observe, including: (P O P I C)
1. Professional competence and due care;
2. Objectivity;
3. Professional behavior;
4. Integrity and
5. Confidentiality

b. The auditor should conduct an audit in accordance with Philippine Standards on Auditing.

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

Why Financial Statements Are Audited

1. Remoteness of information users from information providers

2. Potential bias and motives of information providers.
3. Voluminous data.
4. Complex exchange transactions
5. Consequences

Information Risk – risk that information upon which a business decision is made is inaccurate,
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How Information Risk May Be Reduced

1. Allow the users to verify information.

2. Users share information risk with management.
3. Have the financial statements audited.

Philosophical Theories of Audit

1. Stewardship or Agency Theory

2. Motivational Theory
3. Information Theory
4. Insurance Theory

Elements of the Theoretical Framework of Auditing

1. The data to be audited can be verified.

2. Short-term conflicts may exist between managers who prepare data and auditors who examine the
data.
3. Auditors must have independence and freedom from managerial constraint.
4. Effective internal control system reduces the possibility of errors and fraud affecting the financial
statements.
5. Consistent application of generally accepted accounting principles (GAAP) or financial reporting
standards results in fair presentation of financial statements.
6. What was held true in the past will continue to hold true in the future in the absence of known
conditions to the contrary.
7. An audit benefits the public.

Economic Benefits of a Financial Statement Audit

1. Access to Capital Markets

2. Lower Cost of Capital
3. Deterrent to Inefficiency and Fraud
4. Control and Operational Improvements

Characteristics Which Make Accounting and Auditing a Profession

1. Systematic body of theory

2. Professional authority
3. Community sanction
4. Regulative code
5. Culture

Core Values are the essential and enduring beliefs that a CPA professional upholds over time. These
enable the CPAs to retain their unique character and value as they embrace the changing dynamics of
the global economy.

1. Integrity
2. Competence
3. Lifelong Learning
4. Objectivity
5. Commitment to Excellence
6. Relevance in the Global Marketplace

Core Competencies are the unique combination of human skills, knowledge and technology that
provides value and results to users.

1. Communication Skills
2. Leadership Skills
3. Critical Thinking and Problem – Solving Skills
4. Anticipating and Serving Evolving Needs
5. Synthesizing Intelligence to Insight
6. Integration and Collaboration

Organization of CPA Firms

1. Sole Proprietorships
2. Partnerships.

Sycip, Gorres, Velayo & Co. Ernst & Young

Isla Lipana & Associates PriceWaterhouse Coopers
R. G. Manabat & Co,. KPMG
Punongbayan, Araullo & Co. Grant Thornton
Navarro Amper Co. Deloitte Touche Tohmatsu
AT – Lecture 1 “Overview of Auditing and Assurance Services” 11

Roxas Cruz Tagle & Co. BDO International (Binder Dijker Otte & Co)
Reyes Tacandong & Co RSM

Ranks Within An Accounting Firm

1. Partner
- Concerned about the overall quality of each audit and ultimately responsible for the resolution of
technical matters, such as application of accounting principles or which auditing procedures are to be
performed. An audit partner signs the audit report and is generally involved in maintaining client
relationships, planning audits and evaluating the audit findings.
2. Manager/Supervisor
- Administers important aspects of audit engagements, scheduling the audit work to be done with
client personnel, assigning work to audit staff, supervising audit staff and reviewing staff work.
3. In Charge (Senior) Auditor
- Works under the direction of audit managers and assist in the administration of audit. He
participates in the audit planning and provides supervision to staff auditors.
4. Junior or staff assistant
- Performs various audit procedures that relate to a variety of aspects of a client’s activities and
gathers audit evidence to use as a basis for the audit reports

Factors That Influence the Setting of Audit Fees - (Fair reflection of the value of work)

1. Risks involved.
2. Complexity.
3. Time and volume involved.
4. Responsibility involved.
5. Conditions of accounting records and supporting documents.
6. Cooperation to be extended by the client’s staff.

Methods of Setting-Up the Audit Fee

1. Per Diem or hourly rate basis. (also known as Actual Time charge basis)
- Billing is done on the basis of actual time spent by the staff multiplied by the hourly rates agreed
upon.
2. Flat fee basis (Lump-sum).
- Client is billed a flat but all-inclusive pre-arranged amount for the entire engagement.
3. Maximum fee basis (similar to per diem or hourly rate but a maximum limit is imposed by the
agreement between the client and the auditing firm).
4. Retainer fee basis
- Uniform monthly retainer fee and an additional amount as annual charge upon submission of the
audit report).

Influential Accounting and Auditing Standard Setting Bodies/Organizations/Regulatory Bodies

Regulatory Government Agencies

1. Professional Regulation Commission (PRC).

The agency that administers implements and enforces regulatory policies of the National Government
with respect to the regulation and licensing of the various professions under its jurisdiction including
the maintenance of professional standards and ethics and the enforcement of the rules and
regulations thereto. It derives its authority from RA 8981 or PRC Modernization Act of 2000.

2. Professional Regulatory Board of Accountancy (BOA)

It is the body that regulates the practice of accountancy in the Philippines and empowered to
administer the Philippine Accountancy Act of 2004 or RA 9298.

a. It is composed of a chairman and six (6) members to be appointed by the President of the Phils.
from a list of three (3) recommendees for each position ranked by the Commission from a list of
five (5) nominees for each position submitted by the APO.
b. The chairman and members of the BOA shall hold office for a term of three (3) years.
c. Any vacancy occurring within the term shall be filled for the unexpired portion of the term only.
No person who has served two (2) successive complete terms as chairman or member shall be
eligible for reappointment as chairman or member until the lapse of one (1) year.
d. Appointment to fill up an unexpired term is not to be construed as a complete term.
e. No person shall serve the BOA for more than twelve (12) years.

Qualifications
1. Must be a natural-born citizen and resident of the Philippines.
2. Must be a duly registered CPA with at least ten (10) years of work experience in any scope of
practice of accountancy.
AT – Lecture 1 “Overview of Auditing and Assurance Services” 12

3. Must be of good moral character and must not have been convicted of crimes involving moral
turpitude.
4. Must not have any pecuniary interest, directly or indirectly, in any school, college, university or
institution conferring an academic degree necessary for the admission to the practice of
accountancy.
5. Must not be a Director or Officer of the APO at the time of his appointment.

3. Securities and Exchange Commission (SEC)

The government agency that regulates the registration and operations of corporations, partnerships,
and other forms of associations in the Philippines.

The overall objective of SEC is to assist in providing investors with reliable information upon which to
make investment decisions. It has considerable influence in setting financial reporting standards for
specifying reporting requirements considered necessary for fair disclosure to investors. It is
represented in standard-setting bodies such as PFRSC, AASC, and in the Philippine Interpretations
Committee (PIC). The SEC has power to establish roles for any CPA associated with audited
financial statements submitted to the Commission.

SEC is composed of a chairman and four (4) commissioners for a term of seven (7) years.

4. Commission on Audit (COA).

This constitutional commission has the power, authority, and duty to examine, audit, and settle all
accounts pertaining to the revenue and receipts of, and expenditures or uses of funds and property,
owned or held in trust by, or pertaining to, the government, or any of its subdivisions, agencies, or
instrumentalities, including government-owned or controlled corporations and recommend measures
to improve the efficiency and effectiveness of government operations.

The COA is composed of a chairman and two (2) commissioners. Together they are called the
“Commission Proper” appointed by the President of the Philippines with the consent of Commission
on Appointment for a term of seven (7) years.

5. Bangko Sentral ng Pilipinas (BSP).

The primary objective of this government agency is to maintain price stability conducive to a balanced
and sustainable economic growth. It also aims to promote and preserve monetary stability and the
convertibility of the peso.

The powers and functions of the BSP shall be exercised by the BSP Monetary Board composed of
seven (7) members appointed by the President of the Philippines for a term of six (6) years.

6. Bureau of Internal Revenue

This agency aims to raise revenues for the government through the effective and efficient collection of
taxes, provide quality service to taxpayers and enforce tax laws in an impartial and uniform manner.

7. Insurance Commission

Its mandate is to regulate and supervise the insurance industry for the promotion of national interest.

Professional Organizations

1. Philippine Institute of Certified Public Accountants (PICPA)

This is the accredited national professional organization of CPAs in the Philippines (October 2, 1975
SEC Accreditation No. 15). It serves all members in the different sectors of the accounting profession
which include public practice, education, government and commerce and industry, through a set of
technical and social services. It aims to maintain a responsive organizational structure, committed
leadership, effective professional development programs abreast with state-of-art technology, strict
implementation of professional ethics, promotion of high standards of accounting education and
advocacy and participation in relevant national issues.

PICPA, being a member body of the International Federation of Accountants (IFAC) had initiated
through PFRSC the adoption of IASs in the Philippines.

On December 26, 2004, the PRBOA upon the recommendation of the PFRSC’s approved adoption in
the Philippines of all the new, revised and improved IASs and IFRSs effective January 1, 2005 and
designated them as Philippine Financial Reporting Standards (PFRSs).

Sectoral Organizations
a. Association of CPAs in Public Practice (ACPAPP)
b. Association of CPAs in Education (ACPAE)
c. Association of CPAs in Commerce and Industry (ACPACI)
d. Government Association of CPAs (GACPA)
AT – Lecture 1 “Overview of Auditing and Assurance Services” 13

Standard – Setting Bodies

1. Philippine Financial Reporting Standards Council (PFRSC)

A new standard setting body that is intended to replace the Accounting Standards Council (ASC)
through the Interpreting Rules and Regulations (IRR) of the Philippine Accountancy Act of 2004. It is
responsible for the promulgation of generally accepted accounting principles in the Philippines.

The PFRSC shall be composed of fifteen (15) members with a Chairman who had been or presently
a senior accounting practitioner in any of the scope of accounting practice and fourteen (14)
representatives/members from the following:

Chairman 1
Representatives/Members
a. Board of Accountancy 1
b. Securities and Exchange Commission 1
c. Bangko Sentral ng Pilipinas 1
d. Bureau of Internal Revenue 1
e. A major organization composed of preparers
and users of financial statements 1
f. Commission on Audit 1

g Accredited National Professional Organization of CPAs

Public Practice 2
Commerce and Industry 2
Academe/Education 2
Government 2 8
____ ____
Total 15
____
Term is three (3) years and renewable for another term

2. Auditing and Assurance Standards Council (AASC)

This is also an independent body. Its main task is to define the auditing standards and procedures
that will govern the examination of financial statements and shall guide the members of the
profession in the Philippines.

The AASC shall be composed of seventeen (17) members with a Chairman who had been or
presently a senior practitioner in public accountancy and sixteen (16) representatives/members from
various sectors of the profession:

Chairman 1
Representatives/Members
a. Board of Accountancy 1
b. Securities and Exchange Commission 1
c. Bangko Sentral ng Pilipinas 1
d. An association or organization of CPAs in active
public practice of accountancy 1
e. Commission on Audit 1
f Accredited National Professional Organization of CPAs
Public Practice 9
Commerce and Industry 1
Academe/Education 1 11
____ ____
Total 17 ***
____
*** In 2009, the Board of Accountancy amended the composition of the AASC.

Term is three (3) years and renewable for another term

3. International Federation of Accountants (IFAC)

It is the worldwide organization for the accountancy profession. Founded in 1977, it is comprised of
173 members and associates in 129 countries worldwide, representing approximately 2.5 million
accountants in public practice, industry and commerce, the public sector, and education.
AT – Lecture 1 “Overview of Auditing and Assurance Services” 14

Primary activities:
a. Serving the public interest.
b. Contributing to the efficiency of global economy
c. Providing leadership and spokesmanship

4. International Accounting Standards Board (IASB)

This board is began its operations in 2001 and is based in London. It is composed of fourteen board
(14) members of whom are full-time and is committed to developing in the public interest, a single
set of high quality, global accounting standards that require transparent and comparable information
in general-purpose financial statements.

In April 2001, the IASB assumed from the IASC the responsibility for setting international accounting
standards. IASB adopted the IASs issued by the IASC and retained designation and format of the
Standards. New standards issued by the IASB were designated as International Financial Reporting
Standards (IFRS). In December 2003, the IASB issued 15 revised IASs, withdrew IAS 15,
“Information Reflecting the Effects of Changing Prices” and issued IFRS 1 to 5.

5 International Auditing Practices Committee (IAPC)

It is a standing committee of the Council of IFAC and is responsible for the development and
issuance on behalf of the Council, standards and statements on a variety of audit and attest
functions in order to improve the degree of uniformity of auditing practices and related services
throughout the world. IASPC issues the International Standards in Auditing (ISAs) that are to be
applied in the audit of financial statements, audit of other information and related services.

Other Bodies
1. Education Technical Council
This council was created by PRC upon the recommendation of BOA to assist the Board in carrying
out its powers and functions provided in the RA 9298 in the attainment of objective of continuously
upgrading the accountancy education in the Philippines to make the Filipino CPAs globally
competitive.
The ETC shall be composed of seven (7) members with a Chairman who had been or presently a
senior practitioner in the academe/education and six (6) representatives from the following:
Chairman 1
Representatives/Members
a. Board of Accountancy 1
b Accredited National Professional Organization of CPAs
Public Practice 1
Commerce and Industry 1
Academe/Education 2
Government 1 5
____ ____
Total 7
____
Term is three (3) years and renewable for another term
2. Quality Review Committee
This committee is created by PRC upon the recommendation of BOA to conduct an oversight into the
quality of audit of financial statements through a review of the quality control measures instituted by
Individual CPAs, Firms or Partnerships in order to ensure compliance with accounting and auditing
standards and practices.
The QRC shall be composed of seven (7) members with a chairman, who had been or presently a
senior practitioner in public accountancy and six (6) representatives from the following:

Chairman 1
Representatives/Members
b. Board of Accountancy 1
b Accredited National Professional Organization of CPAs
Public Practice 2
Commerce and Industry 1
Academe/Education 1
Government 1 5
____ ____
Total 7
____

Term is three (3) years and renewable for another term

3. PRC CPD Council

The Board upon approval by PRC, shall create a Council which shall assist the Board in
implementing its CPD program.
AT – Lecture 1 “Overview of Auditing and Assurance Services” 15

It shall be composed of a chairperson and two (2) members. The chairperson of CPD Council shall
be chosen from among the members of the Board by the members themselves. The first member
shall be the president or, in his or her absence or incapacity, any officer chosen by the Board of
Directors of PICPA. The second members shall be the president or, in his or her absence or
incapacity, any officer of the organization of deans or department heads of schools, colleges or
universities offering the degree requiring licensure examination.

The term of the office of the Chairman of the PRC-CPD Council shall be co-terminus with his/her
incumbency in the PRC. The terms of the members will be co-terminus with their respective terms in
the PICPA and in the organization of deans or department heads.

The chairperson, first member and second member shall continue to function as such in the PRC-
CPD Council until the appointment or election of their respective successors in the BOA, PICPA or
organization of deans or department heads.

4. PICPA CPD Council

The PRC CPD Council may delegate if the need arises to the PICPA CPD Council the processing of
application, keeping of all records for CPD providers and their respective programs and credit units
earned by each CPA who avails of the CPD program and related functions.

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