Module 1 Lecture 2012

FUNDAMENTALS OF AUDITING AND

ASSURANCE SERVICES

Auditing and Assurance Services

MODULE ONE:

Overview to Module 1 1.1 Introduction to assurance

engagementsNature, objective, and elementsTypes of assurance engagementsAssurance service vis-à-vis attestation services

1.2 Introduction to auditingNature, philosophy, and objectivesTypes of audit

○ According to nature of assertion / data○ According to types of the auditor

1.1 Introduction to assurance engagements

-from Phil. Framework for Assurance Engagements

Assurance defined

The auditor’s satisfaction as to the reliability of an assertion being made by one party for use by another party.

Assurance engagement defined

“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.

Nature

Objective

… 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 a conclusion that provides the intended user with a level of assurance about the subject matter.

Elements A three party relationship involving:

A practitioner;A responsible party; andIntended users.

An appropriate subject matter; Suitable criteria; Sufficient appropriate evidence; A written assurance report.

Types of assurance engagements REASONABLE

ASSURANCE (High Level)OBJECTIVE:

Reduction in assurance engagement risk to an acceptably low level in the circumstances of the engagement.

PRACTITIONER’S CONCLUSION: Positive

LIMITED ASSURANCE (Moderate Level)OBJECTIVE: Same

as in reasonable assurance but where that risk is greater than for a reasonable assurance engagement.

PRACTITIONER’S CONCLUSION: Negative

Forms of conclusions POSITIVE

“In our opinion, internal controls are effective, in all material respects, based on XYZ criteria."

NEGATIVE

“Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.”

Classification of Assurance Engagements According to level of

assuranceReasonable

assuranceLimited assurance

According to structureAssertion based

engagement (Attestation)

Direct reporting engagement

According to structure Assertion based

(Attestation)The evaluation or

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

Direct reporting 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 directly available to the intended users. The subject matter information is provided to the intended users in the assurance report.

Comprehensive ExampleProven oil reserves

Co. 1 5,200

Co. 2 725

Co. 3 3,260

Co. 4 15,000

Co. 5 6,700

Co. 6 39,126

Co. 7 345

Co. 8 175

Co. 9 24,135

Co. 10 9,635

Total 104,301

ASSERTION BASEDEach company measures its

reserves and provides an assertion to the firm and to intended users.

An entity other than the companies measures the reserves and provides an assertion to the firm and to intended users.

Comprehensive ExampleProven oil reserves

Co. 1 5,200

Co. 2 725

Co. 3 3,260

Co. 4 15,000

Co. 5 6,700

Co. 6 39,126

Co. 7 345

Co. 8 175

Co. 9 24,135

Co. 10 9,635

Total 104,301

DIRECT REPORTINGEach company measures its

reserves and provides the firm with a written representation and measures its reserves against the established criteria for measuring proven reserves. The representation is not available to the intended users.

The firm directly measures the reserves of some of the companies.

Assurance vs Attestation vs Audit Assurance

o Three party contracts in which an assurer reports on (or improves) the quality of information

Attestation Type of assurance service

in which an attestor (an independent accountant) offers assurance about a subject matter (e.g. compliance with debt covenants) that is the responsibility of another party.

Audit Auditing is a systematic

process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

ASSURANCE ENGAGEMENTS

ASSERTION BASED

ENGAGEMENTS

DIRECT REPORTING

AUDIT

Related Services

(Non-assurance services)

Audit

ReviewOthers

ASSURANCE

• Examination of prospective FS• CPA performance review• CPA Risk Advisory

• Review of FS• Review of interim

information

• Agreed upon procedures• Compilation • Preparation of tax returns• Tax consulting• Management consulting• Other advisory services

Other Assurance Services Business Performance Measurement

Provides 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.

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

Elder Care Plus An evaluation designed to provide assurance to the elderly and their relatives about the

quality of care being provided by various care givers by comparing their specific objectives in providing care with actual services rendered.

Risk Assessment Services Identifies a set of risks that affect the organization and involves the study of the link between

risks and the organization’s vision, mission, objectives, and strategies and development of new and relevant measures to address these risks.

CPA Web Trust WebTrust is a seal of assurance service developed jointly by AICPA and CICA which

enables consumers and businesses to purchase goods and services over the Internet with the confidence that the Web site business meet high standards of business practice.

Information Systems Reliability Involves evaluating whether financial and non financial information systems provide reliable

information for operating and financial decisions by an entity’s management.

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Comparison of Auditing, Review, and Related Services

Aspect of Comparison Auditing Review Related Services

Nature of service Audit Review Agreed Upon Compilation Level of assurance provided

High, but not absolute Moderate None None

Report provided Positive assurance on assertion(s)

Negative assurance on assertion(s)

Factual findings procedures

Identification of information compiled

Procedures

Select from all available procedures any combination that can limit audit risk to an appropriately low level.

Inquiry and analytical procedures designed to review reliability of an assertion.

Procedures agreed upon with the specified user(s)

Reduce detailed data to a manageable and understandable form

Features

Auditor's opinion enhances credibility of FS; absolute assurance non-attainable.

Audit skills & techniques applied but accounting & internal control systems not assessed.

Recipients of the report from their own conclusions; report is restricted to the parties in the contract.

Accounting, not auditing expertise, used; benefits derived by users arise from the service that was rendered with due professional skill and care.

Note: When to accept assurance engagements

Relevant ethical requirements, such as independence & competence, is satisfied.

Engagement circumstances exhibits ALL of the following:Subject matter is appropriate.Criteria to be used are suitable and are available

to the intended users.Practitioner has access to sufficient appropriate

evidence to support his conclusion.Practitioner’s conclusion is to be contained in a

written report.Practitioner is satisfied that there is a rational

purpose for the engagement.

1.2 Introduction to auditing

Independent Auditor

Following a systematic process

Objectively obtains & evaluates evidence

Communicates results to interested users

Establishes degree of correspondence between

ESTABLISHEDCRITERIA

ASSERTIONS

Role of management and independent auditor

ManagementIndependent

Auditor

Prepares FS

Unaudited FS

Audited FS

Evaluates FS

Audit Reporton FS

Users of Financial Statements

Will an audit guarantee dependable financial statements?

NO.An audit conducted

in accordance with PSAs is designed to provide only reasonable assurance (NOT ABSOLUTE) that the FS as a whole are free from material misstatements.

If it does not guarantee dependability, why is there a need for independent FS audit?

The need for an independent FS audit stems from the following:Conflict of interest

between management and users of FS.

ExpertiseRemotenessFinancial consequences Information riskCost of capital

Because of the ffg LIMITATIONS: The use of testing /

Sampling risk Error in application of

judgment / Non-sampling risk

Reliance on management’s representation

Inherent limitations of the client’s accounting and internal control systems

Nature of evidence

Why can an audit NOT provide

absolute assurance?!

Objective of an audit

The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared in all material respects, in accordance with applicable financial reporting framework.

-Philippine Standards on Auditing (PSA) 200

Types According to nature of

assertion / data

Financial statement auditOperational auditCompliance audit

According to types of auditor

External independent FS auditInternal auditGovernment audit

Financial Audit Compliance Audit Operational Audit

Assertions made by auditee

Established criteria

Content of auditor’s report

Auditors who generally perform

FS are fairly presented.

Organization has complied with laws, regulations or contracts.

Organization’s activities are conducted efficiently & effectively.

Financial reporting standards or other financial reporting framework.

Laws, regulations, and contracts.

Objectives set by the board of directors.

Opinion whether FS are fairly presented in conformity with an identified financial reporting framework.

Degree of compliance with applicable laws, regulations & contracts.

Recommendations or suggestions on how to improve operations.

External auditors Government auditors

Internal auditors

-END OF MODULE 1-

Three party relationship

Practitioner

Responsible party

Intended Users

Broader than the “term” auditor.

May or may not be the engaging party (the party who engages the practitioner).

The person, persons or class of persons for whom thepractitioner prepares the assurance report.

Subject matter

An “appropriate subject matter” is:Identifiable, and capable of consistent

evaluation or measurement against the identified criteria.

Can be subjected to procedures for gathering sufficient appropriate evidence to support a reasonable assurance or limited assurance conclusion, as appropriate.

Subject Matter Subject matter information

Financial performance or conditions

Historical or prospective financial position, financial performance, cash flows

Recognition, measurement, presentation and disclosure represented in financial statements

Non financial performance or conditions

Performance of an entity Key indicators of efficiency and effectiveness

Physical characteristics Capacity of a facility Specifications document

Systems and processes An entity’s internal control or IT system

An assertion about effectiveness

Behavior Corporate governance, compliance with regulation, human resource practices

A statement of compliance or a statement of effectiveness

Subject matter Financial position, financial performance, and cash flows of an enterprise

Subject matter information The financial statements of the enterprise

Responsible party Client or entity management

Responsible for Sample assurance engagement

Subject matter information only A government organization engages a practitioner to perform an assurance engagement regarding a report about a private company’s sustainability practices that the organization has prepared and is to distribute to intended users.

Subject matter and subject matter information

An entity engages a practitioner to perform assurance engagement regarding a report it prepared about its own sustainability practices.

Suitable criteria Criteria are the benchmarks

used to evaluate or measure the subject matter including, where relevant, benchmarks for presentation and disclosure.

Can be formal or less formal (i.e. PFRS vs internal code of conduct or agreed level of performance).

May be: Established criteria

Are those embodied in laws or regulations, or issued by authorized or recognized bodies or experts that follow a transparent due process.

Specifically developed criteria Those designed for the purpose of

the engagement.

Characteristics: CNUR2

Completeness Neutrality Understandability Reliability Relevance

Sufficient appropriate evidence

Written assurance report Must be in the form

appropriate to a reasonable assurance engagement or a limited assurance engagement.