LECTURE NOTES

PHASE 1 - A
PERFORMANCE OF PRELIMINARY ENGAGEMENT ACTIVITIES

THE RISK-BASED AUDIT PROCESS

Phase 1: RISK ASSESSMENT

A. Preliminary engagement activities to decide whether to accept or continue an Audit

Engagement
B. Planning the Audit for overall Strategy and Audit Plan Development
C. Risk Assessment Procedures to identify and assess risk of material misstatement
through understanding the entity.

PRELIMINARY ENGAGEMENT ACTIVITIES

 Perform procedures required by PSA 220 "Quality Control of an Audit of Financial

Statements regarding the continuance of the client relationship and the specific
audit engagement
 Evaluate compliance with ethical requirements, including independence are
required by PSA 220 (Redrafted)
 Establish an understanding of the terms of engagement as required by PSA 210
"Agreeing the terms of Audit Engagements.

GENERAL PRINCIPLES REGARDING THE INDEPENDENT AUDIT OF FINANCIAL

STATEMENTS (PSA 200)

1. The auditor should comply with relevant ethical requirements.

2. The auditor should conduct the audit in accordance with the PSA.
3. The auditor should exercise professional judgement in planning and performing an
audit
4. The auditor should obtain sufficient appropriate audit evidence to reduce audit risk.
5. The auditor should plan and perform the audit with an attitude of professional
skepticism.

PRELIMINARY ENGAGEMENT ACTIVITIES

 Purposes of Preliminary Activities

 Assists the auditor in identifying and evaluating events or circumstance

adversely affecting planning and performing the audit engagement
 To reduce audit risk to an acceptably low level

 Vital considerations before preparing the audit plan

 Independence and capability to perform the audit

  no issues on management integrity affecting ability to continue with the
engagement
 no misunderstanding with the client as to terms of the engagement

 In accepting new clients, the auditor should consider the following:

 Competence to perform the audit

 Capacity and Capability of Resources and Time to perform the audit
 Consideration of the Integrity of the client
 Compliance to ethical requirements

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

No auditor can afford to be regularly associated with clients engaged in

management fraud or other unlawful activities

 Prior to accepting new clients, the CPA should:

 Investigate the history of the prospective client

 Establish identities and reputation of the directors, officers, and major
stockholders
 Obtain management's permission to inquire on third parties

Decisions should involve more than just a consideration of management's

integrity

 Strict client acceptance/continuance guidelines should be established to

screen out:

 clients that are in financial and/or organizational difficulty

 clients that constitute a disproportionate percentage of the firm's total
practice
 disreputable clients
 clients that offer unreasonably low fee for the auditor's services

PRELIMINARY ENGAGEMENT ACTIVITIES

 The auditor is not obliged to accept new clients

 The auditor is not obliged to continue servicing existing clients if:
 Relationships had deteriorated
 Management integrity has become doubtful

 The CPA must determine:

 conditions that would prevent performing an independent audit of the client

 competence and capability of partners and staff to conduct an audit
Summary:

 Before accepting new client:

 Assess competence to perform the engagement and capabilities, time, and

resources
 Determine compliance with the relevant ethical requirements
 Consider the integrity of the client
 Obtain information that concludes client's lack of integrity

PRELIMINARY ENGAGEMENT ACTIVITIES

 The CPA firm shall establish the following pre-conditions:

 Acceptability of Financial Reporting Framework to be applied in the

Financial Statements
 Management acknowledges and understands its responsibilities:

- Preparation of financial statements in accordance with

- Establishment of internal control system applicable financial reporting
framework
- Provide auditors with access to all information relevant to the financial
statement, additional information needed in the engagement,
unrestricted access to personnel in gathering evidences

ACCEPTABLE FINANCIAL REPORTING FRAMEWORK

The Financial Reporting Framework adopted by management and, where appropriate,

those charged with governance in the preparation of the financial report that is acceptable
in view of the nature of the entity and the objective of the financial report, or that is
required by law or regulation.

PRELIMINARY ENGAGEMENT ACTIVITIES

 Without the Acceptable Financial Reporting Framework:

 Management has no appropriate basis of preparing Financial Statements

 Auditor does not have a suitable criteria for evaluating the entity's financial
statements

REPORTING FRAMEWORK

 IFRS/PFRS
 Full IFRS
 IFRS for SMEs
 NIRC and Revenue Regulation
 Cash Basis (IPSAS)
 Bank- BSP Circulars and Relevant Laws
  Government-NGAS

The CPA and the Management or Those Charged with Governance should confer and agree
to the appropriate terms of the audit as recorded in the audit engagement letter

AUDIT ENGAGEMENT LETTER

- A written agreement that describes the business relationship to be entered into by a

client and a company.
- The letter details the scope of the agreement, its terms, and costs.
- The purpose of an engagement letter is to set expectations on both sides of the
agreement.

CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS IN THE PHILIPPINES

- The Professional Regulation Commission and The Board of Accountancy approved

on February 20, 2018 Resolution No. 18, Series of 2018.
- This resolution provided for the Adoption of the 2016 Code of Ethics.
- Code of Ethics for Professional Accountants of the IESBSA as “The Code of Ethics for
Professional
- Accountant in the Philippines ” and Prescribing Amendments Thereof”.
- Revised Code of Ethics for Professional Accountants in the Philippines (effective
June 4, 2014)
- Amended: PRBOA Res. No. 263
- Based on the IESBA Code Developed by the International Ethics Standards Board for
Accountants (IESBA) of the IFAC
- This supersedes the Revised Code of Ethics for Professional Accountants in the
Philippines (effective June 30, 2008)

THE UNDERLYING REASON FOR A CODE OF PROFESSIONAL ETHICS IS

a. That it is required by legislation

b. To provide the licensing agencies with a basis or measuring the performance of the
practitioners
c. The need for public confidence in the quality o service of the profession
d. That it provides a safeguard against unscrupulous people

IMPORTANCE OF ETHICS

 A distinguishing characteristics of any profession is the existence of code of ethics

for its members.
 The code of ethics signifies the acceptance of responsibility to those wjo belong to it.
 That members of the accounting profession adheres to such code provides a set of
confidence and expectations about the quality of service the CPA provides.

IMPORTANCE OF CODE OF CONDUCT TO CPAS:

  The reliance that investors, he public, government and business management place
on the accounting profession.
 The public’s knowledge that members of the accounting profession must adhere to
such a code provides a set expectations about the quality of service CPAs provide.
 Furthermore, a code benefits individual members and the profession as a whole by
providing minimum standards all members are expected to follow.

DEFINITIONS OF ETHICS

A. Discipline dealing with what is good or bad, right or wrong, with moral duty and
obligation
B. Deals with the study of the rightness or wrongness of human actions
C. Consist of moral principles and standards of conduct

ETHICS ATTEMPT TO:

a. Ensure high standards of competence among members

b. Regulate and strengthen their relationships
c. Promote and protect the image of the profession and the welfare of the community

SALIENT POINTS

 Extend beyond moral principles

 Behaviours designed for practical and idealistic purposes
 Idealistic but practical and enforceable
 Should be above the law but below the ideal
 Mixture of moral and practical concepts

Morals or morality refers to the actual patterns of conduct and the direct working rules of
moral action.

Morality refers to the set of standards that enable people to live cooperatively in groups. Its
what societies determine to be “right” and “acceptable”.

DIFFERENCE BETWEEN ETHICS AND MORALS

 Ethics are rules of conduct recognized to a particular group or culture; morality is

ultimately a personal compass of right and wrong
 Ethics come from social system (external); Morals come from the individual
(internal)
 Ethics are more practical, conceived as shared principles promoting fairness in
social and business interactions; Morals are more abstract, subjective, and often
personal or religion-based.

PRIMARY REASON FOR UNETHICAL CONDUCT:

  Difference in personal ethical standards against the whole society
 Choice to act selfishly

COMMON CHARACTERISTICS OF RECOGNIZED PROFESSION

 Responsibility to serve the pubic

 Complex body if knowledge
 Standards of admission
 Public confidence

RATIONALIZING UNETHICAL ERRORS

 No one will know

 I don’t have time to do it right
 That’s close enough
 Some rules are meant to be broken
 It’s not my job

CHARACTERISTICS AND VALUES

 Integrity
 Honesty
 Promise keeping
 Loyalty (fidelity)
 Fairness

International Ethics Standards Board for Accountants

Purpose Develop and promote ethical standards for
accountants
Official language English
Parent organization International Federation of Accountants

The IESBA Code establishes ethical requirements for professional accountants in the world
A member body of IFAC or firm shall not apply less strict or severe standards than those
stated in the IESBA Code.

The PICPA has adopted the Code of Professional Ethics (IESBA CODE) effective June 4, 2014

It supersedes the Revised Code of Ethics for Professional Accountants in the Philippines
last June 30, 2008

The conceptual framework approach (also known as the “threats and safeguards”
approach) provides a system of identifying and evaluating threats to compliance with
ethical standards and determining whether safeguards would eliminate threats or reduce
them to an acceptable level.

CODE OF ETHICS
Section 100.1

A distinguishing mark of the accountancy profession its acceptance of the responsibility to

act in the public interest.

Therefore, Professional accountant’s responsibility is not exclusively to satisfy the needs of

an individual client or employer

A professional accountant’s responsibility is not limited to satisfy the needs of an individual

client

The interest of the public must always be at the utmost importance

FRAMEWORK FOR PROPER HUDGMENT

1. Protect the Public Interest
2. Professional Services to Clients

Judgment

Integrity Objectivity Professional

Skepticism

Independence of Mind & Appearance

RESPONSIBILITY TO SERVE THE PUBLIC

 The role of the independent accountant is to ensure that information is fair to all
parties and not biased to benefit one group at the expense of another
 Public accountants must remain a high degree of independence for their clients if we
are to remain credible to the community.

Example:
 A client with a losing business asks the auditor to present a profitable business in
the report
 The auditor refuses because to do so would mislead the public or interested users
with the false information

Sample question:
1. The Accountant’s Code of Ethics is distinguishing mark of the profession and
signifies the accountant’s acceptance of the responsibility in the interest of:
a. The client
b. The employer
c. The public
 d. PICPA

Important Note!!!
 This does not connote inappropriate abandonment of the client
 We serve both the client and public with the public at the utmost importance.
 They rely professional accountants in assessing the reliability of this information

AN ACCOUNTANT WHO IS –

 Independent and neutral

 A professional with code of ethics
 A member of profession with systematic theory

DISAPPOINTMENT TO THE PROFESSION

- Every failure by an Accountant to comply with professional standards is a step

backward to the professional for integrity, objectivity and competence it has
acquired over many years of service to the public.

Example:
 Turned down audit of entity which the auditor own 20% equity
 The auditor is partying weekly with the company directors
 The auditor refused to accept the three iPhone watches as token from the client

CODE OF PROFESSIONAL ETHICS

Contents

PART A: GENERAL APPLICATION OF THE CODE

 Introduction and Fundamental Principles
 Integrity
 Objectivity
 Professional Competence and Duo Care
 Confidentiality
 Professional Behaviour

PART B: PROFESISONAL ACCOUNTANTS IN PUBLIC PRACTICE

 Professional Appointment
 Certificate of Interest
 Second Opinions
 Fees and Other Types of Remuneration
 Marketing Professional Services
 Gifts and Hospitality
 Custody of Clients Assets
 Independence – Assurance engagements
PART C: PROFESSIONAL ACCOUNATNTS IN BUSINESS
 Potential Conflicts
 Preparation and Reporting of Information
 Acting with Sufficient Expertise
 Financial Interests
 Inducements

CODE OF ETHICS: APPLICABLE TO CPAs IN PUBLIC PRCATICE

- Conflicts of Interest (Sec. 220)
- Marketing and professional Service (250)
- Gifts and hospitality (260)
- Custody of client assets (270)
- Independence (290)
- Financial Relationships
- Loans and guarantees (290.117)

Noted changes

Conceptual Framework Approach

Old: 100.5
"...... This Code provides a framework to assist a professional accountant to identify,
evaluate and respond to threat to compliance with the fundamental principle...”
New: 100.6
"... ... Therefore, this Code establishes a conceptual framework that requires a professional
accountant to identify, evaluate, and address threats to compliance with the fundamental
principle...”

Situation
Fundamental Principle
Threat
Safeguard

FUNDAMENTAL PRINCIPLES

Members should:

 At all times maintain the good reputation of the profession and its ability to serve
the public interest, perform the integrity, due care, professional competence,
independence, objectivity, confidentiality, and
 Not be associated with any misleading information or misrepresentation

Section 100.5

A professional accountant shall comply with the following fundamental principles:

1. Integrity
2. Objectivity
 3. Professional Competence and Due Care
4. Confidentiality
5. Professional Behavior

FUNDAMENTAL PRINCIPLES

1. Integrity (Sec. 110.1)

 To be straightforward and honest in all professional and business
relationships
 Integrity also implies fair dealing and truthfulness

Integrity
 A professional accountant shall not knowingly be associated with reports,
returns, communications or other information which:
 Contains a materially false or misleading statement
 Contains statements or information furnished recklessly
 Omits or obscures information required to be included where such
omission or obscurity would be misleading

Example:
 Truthful declaration of the SALN
 Issues an audit report without audit engagement
 Refused an audit engagement for Janet Napoles for P5,000,000 audit
fee

2. Objectivity (Sec. 120)

 A professional accountant shall not allow bias, conflict of interest or undue
influence of others to override professional or business judgments.

Independence
 Requires integrity and an objectivity approach to the audit process
 Requires the auditor to carry out his or her work freely and in an
objective manner
 Taking an unbiased viewpoint in the performance of the examination
and in the preparation of the report.
 Refers to the independence of the auditor from parties that may have
a financial interest in the business being audited.

Two phases of independence

a. Independence of mind
 The state of mind that permits the expression of a conclusion
without being affected by influences that compromise
professional judgment thereby allowing an individual to act
with integrity and exercise objectivity and professional
skepticism

State of mind
 Auditor's own opinion of his own independence
  The state of mind that permits the provision of an opinion
without being affected by influences that compromise
professional judgment, allowing an individual to act with
integrity, and exercise objectivity and professional skepticism.

b. Independence in Appearance
 The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party would
be likely to conclude, weighing all the specific facts and
circumstance, that a firm's, or a member of the audit or
assurance team's integrity, objectivity or professional
skepticism has been compromised

Independence
 Public's perception of the professional accountant's independence
 The avoidance of facts and circumstances that are so significant that a
reasonable and informed third party, having knowledge of all relevant
information, including safeguards applied, would reasonably conclude
a firm's, or a member of the assurance team's, integrity, objectivity or
professional skepticism had been compromised.

Example:
o turned down audit of entity which the auditor owns 20% equity
o the auditor is partying weekly with the company directors
o the auditor refused to accept the three iPhone watches as token from
the client

Question:
Independence in auditing means
a. remaining aloof from client
b. not being financially dependent on client
c. taking an unbiased viewpoint
d. being an advocate for the client

3. Professional Competence and Due Care (Sec. 130.1)

 To maintain professional knowledge and skill at the level required to ensure
that a client or employer receives competent professional service based on
current developments in practice, legislation and techniques.
 To act diligently in accordance with applicable technical and professional
standards
 Competent professional service requires the exercise of sound judgment in
applying professional knowledge and skill

Professional competence may be divided into two separate phases:

 Attainment of professional competence
 Maintenance of professional competence

Due Care
  Diligence covers the responsibility to act in accordance with the
requirements of an assignment, carefully, thoroughly and on a timely
basis
 Professional accountants to take steps to ensure all members of the
audit team have appropriate training and supervision
 Communication to clients, employers, or other users of the
professional services aware of limitation inherent in the services

4. Confidentiality

Refrain from:
 Disclosing or employing confidential information acquired without proper
and specific authority except under legal or professional duty or right to
disclose
 Using confidential information or personal advantage or third party
advantage

Instances when disclosure is allowed:

 Written consent by the party
 Upon the order of competent court
 Professional right or duty to disclose

Example
- The auditor is accredited with the Board of Accountancy as a practitioner
- The auditor attends seminars on tax updates regularly
- Observation of year-end’s inventory count of client

Maintain Confidentiality
 In a social environment particularly to a close business associate or
immediate family members
 Of information disclosed by a prospective client or employer
 Within the firm or employing organization
 Even after the end of relationships with a client or employers
 By staff members who shall respective professional accountant’s duty of
confidentiality

5. Professional Behavior (Sec. 150)

 Comply with relevant laws and regulations
 Avoid actions that discredits the profession
 Make exaggerated claims about services
 Make damaging references or comparisons with others

Threats to compliance with the fundamental principles

Threats to Fundamental Principles

Obstructions that auditors may face or expect to face while carrying requirements of
engagements which could compromise a professional accountant's compliance with the
fundamental principles.

Threats to compliance with the fundamental principles

1. Self-interest threats
 A financial or other interest will inappropriately influence the professional
accountant’s judgement or behavior.
 May occur as a result of the financial or other interests of a professional
accountant or of an immediate family

More actual examples

 Undue total dependence on total fees in client
 Possibility losing a major client
 Audit team member entering employment with client
 Holding of client's assets or money
 Audit engagement for a long time
 Performing assurance and non-assurance services at same time
 Providing recruiting services for client
 Fees due remain unpaid
 Concern over employment security
 Accepting gifts or preferential treatment from client

2. Self-review threats
 A professional accountants will not appropriately evaluate the results of a
previous judgment made or service performed by the professional
accountant, or by another individual within the professional accountant’s
firm employing organization, on which the accountant will rely when
forming a judgment as part of providing a current service.
 When the auditor is asked to report on or examine his own assessment,
opinion, judgement or work and thus he is basically self-reviewing his work

Examples:
 The auditor has previously established the internal control system of
the audit client
 The auditor is providing payroll. services to the audit client
 The auditor designed the IT system of his audit client

More actual situations

 Performing tax services reflected in the financial statements
 Performing assurance report on a system designed formerly by the
firm
 Audit member serving as director/officer of client
 Auditor serving as corporate secretary of client
 Performing internal audit services for client
 Providing corporate finance services
 Lending of staff to client temporarily
  Providing accounting and bookkeeping services to audit client
 Original data prepared which is subject matter of assurance
 Preparation of feasibility study for client

3. Advocacy threats
 When a professional accountant promotes a position or opinion of a client to
the point that subsequent objectivity may be compromised.
 The threat that a professional accountant will promote a client’s or
employer’s position to the point that the professional accountant’s objectivity
is compromised

Examples:
 The auditor assisted client in settling a tax case with the BIR
 The auditor is also the stock broker of the audit client
 The firm is providing legal services to the audit client

Other advocacy situations

 Auditor serving as corporate secretary
 Auditor is promoting the stock offerings of the client
 Auditor is acting as advocate in behalf of the client
 Providing assurance and non-assurance to client Performing tax
services
 Representing client in resolution of tax dispute
 Performing litigation support services
 Authorization of transaction for client
 Preparation of the client's bank reconciliation statement
 Preparation and posting of journal entries for the client

4. Familiarity threats
 Familiarity threat is different from Self-Interest threat.
 In Familiarity threat auditor feels sympathetic for others' interests whereas
in self-interest threat auditor weighs his own interest above ethical
requirements of the code.
 Due to a long or close relationship with client or employer, a professional
accountant will be too sympathetic to their interests or too accepting of their
work

The auditor and the CEO entity are brods in Kappa Kappa Muks Mamau
fraternity

During the engagement, the auditor fills gasoline for his car full tank for free
in the gas station owned by the entity

More actual illustrations

 Member of team with immediate member in the client's business
 Member of the team with family as employee of the firm
  Officer of client (former team member) exerting influence over
subject matter of engagement
 Accepting gifts or preferential treatment from client
 Senior officer of the firm with long association with client
 Family with personal relationship with client Audit engagement for a
long time
 Providing security services to client
 Team member becomes employed with client
 Officer of the firm is town mate, classmate, fraternity brod of the client

5. Intimidation threats
 Arises when auditor, directly or indirectly, threatened physically or mentally
to keep him from working objectively.

Examples:
 The audit team is using IT facilitiesand gadgets of the entity
 The auditor is threatened with litigation
 The client has more expertise on a certain matter in question
 Client is a politician

More intimidating situations

 The firm is threatened with dismissal from client
 Cancellation of possible non-assurance services over adverse report
 Pressure to reduce the extent of work to reduce fees No endorsement
to client's friends due to disagreement Family or personal
relationship with client
 Fees from client represent a large proportion of total revenue
 Actual or threatened litigation
 business relationship
 dominant personality attempting to influence the decision
 team member with running feud with client

SAFEGUARDS

Sec. 100.13

Actions or other measures that may eliminate threats or reduce them to an acceptable level

Broad categories:
 Created by the profession, legislation or regulation
 In the work environment
 Firm-wide safeguards
 Engagement-specific safeguards
 Within the client system

Examples:

- 85% of the total audit fees of the firm comes from their biggest single client
 - Potential employment with an audit client
- Having a close business relationship with the audit client

SAFEGUARD CREATED BY THE PROFESSIONAL, LEGISLATION OR REGULATION

 Education, training and experience requirements for entry into the profession
 Continuing professional development requirements
 Corporate governance regulations
 Professional standards
 Professional or regulatory monitoring and disciplinary procedures

CLIENT ACCEPTANCE

Threat to Fundamental Principle:

 Integrity
 Professional competence & due care

Kinds of threat:
 All kinds of threats

Safeguards:
 Obtain knowledge & understanding of client
 Secure commitment to improve governance & control

MARKETING AND PROFESSIONAL SERVICES

Solicitation of new work through advertising or other form of marketing is not allowed
Violation: Professional Behavior Threat: Self Interest

CONFLICT OF INTEREST

The new guidance states that a professional accountant must not allow a conflict of interest
to compromise professional or business judgement, provides examples of possible conflicts
of interest, and explains how to manage conflicts of interest while maintaining
confidentiality and complying with the other provisions of the code. Violation: Objectivity,
Confidentiality Threat: self-interest, intimidation

Examples:
a. Auditor competes directly with a client
b. Has joint venture or similar arrangements with a major competitor of a client
c. Performing services to clients whose interests are in conflict
d. Performing services to clients in dispute with each other on matter of transactions

CONFLICT OF INTEREST
 Safeguards:
1. Do not accept the engagement of one
2. Notify all clients concerned and secure their consent
 3. Use separate engagement teams (strict physical separation of the team)
4. Secure written agreement for strict confidentiality within the firm

 Situations:
o Changes in professional appointment
o Second opinions
o Fees and other types of remunerations
o Custody of client assets
o Loans and guarantees
o Litigation support services
o Temporary staff assignments

November 29, 2021

Risk – Based Audit Process

Phase 1: RISK ASSESSMENT

A. Preliminary engagement activities to decide whether to accept or continue an Audit
Engagement
B. Planning the Audit for overall strategy and Audit Plan Development
C. Risk Assessment Procedures to identify and assess risk material misstatement
through understanding the entity

Relationships in Audit Planning

- The Audit Strategy
- The Audit Plan
- The Audit Program
- The Audit Procedures

PHASE 1-B – Planning the audit to develop an overall audit strategy and audit plan

Start of Planning? “As the client has been obtained and the engagement letter signed by
both parties (audit and client), planning process intensifies…..” – Cabrera
Start of Planning Activities – Even before the client is obtained and the engagement letter
signed by both parties (audit and client), planning activities should be initiated by the
auditor….

PSA 300 “Planning an Audit of Financial statement”

- Established standards and provides guidance on the consideration and activities
applicable to planning and audit of financial statements.
- It states that the auditor should plan the audit so that the engagement will be
performed in an effective manner

AUDIT PLANNING

Definitions:
 Audit planning involves the establishment of the overall audit strategy for the
engagement and developing an audit plan, in order to reduce audit risk to an
acceptably low level (CABRERA)
  Audit planning means establishing of the overall audit strategy for the engagement
and developing an audit plan to reduce to an acceptably low level (MARK FRANCIS
NG)
 Audit planning means developing a general audit strategy and a detailed approach
for the expected conduct of the audit (SAOSAGCOL, TIU, HERMOSILLA)

Planning the Audit

Auditing is:
 Systematic process of objectivity obtaining and evaluating evidence
 Regarding assertions about economic actions and events
 To assertion the degree of correspondence
 Between these assertions and established criteria
 And communicating the result interested user.

(American Accounting Association)

Systematic Process

Auditing consist of:

 Structured, logical and organized of steps and procedures
 A series of sequential steps that independent Auditors follow
 To ensure that the audit is conducted in an :
- Organized
- Effective
- Efficient manner
 Systematic process involves complete planning

Features in audit planning:

- Establish overall strategy for the engagement and audit plan to reduce risk
- Team members benefit form experience and insight
- Nature and extent of activities ill vary according to size and complexity of the entity
- Continuous and iterative, not discrete
- Enhance effectiveness and efficiency of the planning process
- Timing of planning activities and procedures prior to considering other procedures

Benefits of Audit Planning

 It helps ensure that appropriate attention is devoted to important areas of the audit.
 It aids in identifying potential problems and resolving them on a timely basis.
 It helps ensure that the audit is properly organized, managed and performed in an
effective and efficient manner.
 Assists in proper manner, coordination, and review of the work of the team
 Allow the work to be completed expeditiously
 Helps coordinate the work by other auditors and other parties

Two Levels of Planning

1. Overall Audit strategy
 Scope
 Objective and Timing
  Materiality
 Key aspects of focus
 Staffing needs, selection and supervision
 Approach to audit

2. Detailed Audit Plan

 Understanding the entity and its environment (PSA 315)
 Auditors response to assessed risk (PSA 330) (risk-based audit)
 Other planned audit procedures for compliance to PSA (various PSA)

Overall Audit strategy – Identify the characteristic of the Engagement that defines the
scope
- Financial reporting framework
- Industry specific reporting requirements
- Locations of the components of the entity

Audit Strategy
PSA 300 par 6
- Requires the auditor establishes the overall strategy for the audit
- This overall audit strategy sets the scope, timing, and direction of the audit and
guides the development of the more detailed audit plan

The Audit Strategy

- An abstract idea that occurs in the brainstorming stage of the audit planning process
- Main ideas of the auditor on how to plan and conduct he audit and set the scope,
timing and direction of the audit
- This guides the development of the more detailed audit plan

The Process of establishing the audit strategy should involve:

 Identifying the characteristics of the engagement that defines the scope
 Ascertaining the reporting objectives of the engagement to plan the timing of the
audit and the nature of the communication required
 Considering the important factors that will determine the focus and direction of the
engagement team efforts
 Considering the results of preliminary engagement activities, and relevance of
knowledge gained by the team on other engagements performed
 Ascertaining the nature, timing and extent of resources necessary to perform the
engagement

December 1, 2021

OVERALL AUDIT STRATEGY

- Financial Reporting Framework

 Identifying the characteristic of the Engagement that defines the scope

 Industry specific reporting requirements
 Locations of the components of the entity
 - Ascertaining the reporting objectives of the engagement to plan the timing of the
audit and the nature of the communication required

 Deadline for interim and final reporting

 Key dates and organizations of meeting with management and those
charged with governance to discuss the nature and extent of audit work
 Discussion with management regarding the expected communication on
the status of audit work

- Considering the important factors that will determine the focus and direction of the
engagement team efforts

 Determination of appropriate materiality level

 Identification of areas where there may be higher risks of material
misstatements
 Identification of material components and account balances
 Evaluation whether the auditor plan to obtain evidence on effectivity of
internal control
 Identification of recent entity specific, industry, financial reporting, or
other relevant developments

- Considering the results of preliminary engagement activities, and relevance of

knowledge gained by the team on other engagements performed

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

AUDIT STRATEGY

- Other Benefits of Audit Strategy:

 Resources to deploy for specific areas
 Amount of resources to be allocated in specific areas
 When the resources are to be deployed
 How such resources are managed, directed and supervised

- The Best Audit Strategy:

 The approach that results in the most efficient and effective audit at the least
possible cost.

- When developing an audit strategy, the auditor must consider the appropriate levels
of materiality and audit risk

THE AUDIT PLAN

- Formalizes the audit strategy and is more detailed than the Audit Strategy
- It includes the nature, timing, and extent of audit procedures to be performed
 - The purpose is to obtain sufficient appropriate audit evidence to reduce risk to an
acceptably low level

THE AUDIT PROGRAM

- A more detailed plan of the procedures to be used in the audit of specific accounts
and transactions
- Includes detailed instructions and procedures to be performed by audit team
members

MATTERS OF IMPORTANCE

Difference between audit strategy and audit plan

 An AUDIT STRATEGY is about implementing a program for tackling the audit, and
the AUDIT PLAN is about how you will use this strategy to tackle the audit.

 AN AUDIT PLAN is more detailed than the AUDIT STRATEGY and includes the
nature, timing, and extent of audit procedures to be performed to obtain sufficient
evidence to reduce the audit risk at an acceptable low level.

Take note:
 Development of audit strategy and audit plans is not sequential
 Audit strategy and audit plans should be updated and changed as necessary during
the course of the audit

MATERIALITY

Definition:

 Misstatements, including omissions, are considered to be material if they,

individually or in the aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial statements

 Judgement about materiality are made in light of surrounding circumstances, and

are affected by the size and nature of misstatement, or a combination of both; and

 Judgement about matters that are material to users of the financial statements are
based on a consideration of the common financial information needs of users as a
group.
- (PSA 320 par 2)

 Information is material if its omission or misstatement could influence the economic

decision of users taken on the basis of the financial statements.

 Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
  Thus, materiality provides a threshold or cut-off point rather than being a primary
qualitative characteristic which information must have if it is to be useful.
- Financial Reporting Standard Council (FRSC)

Features of Materiality

 An error may not be material quantitatively but material qualitatively

 Small amounts but collectively could have a material effect
 Materiality refers to an amount or transaction that would influence the decision of
users
 Materiality depends on the size of the item
 It is a threshold point not a characteristic it is to be useful
 Involves both quantitative and qualitative considerations
 Relative to size and particular circumstance of the entity
 To determine what is material is a matter of professional judgment of the auditor
 In designing audit plan, the auditor should establish materiality level to detect
material misstatements
 Even immaterial matters can have material effect in the Financial Statements
 Materiality may be influenced by legal and regulatory requirements
 In designing an audit plan, make a preliminary estimate of materiality for use during
the examination
 Some matters are important for fair presentation while other matters are not that
important
 The largest amount of misstatement that the auditor could tolerate in the Financial
Statement
 The smallest aggregate amount that could misstate the Financial Statement

Materiality therefore relates to:

 the significance of transactions
 balances and errors contained in the financial statements.
 threshold or cut-off point after which financial information becomes relevant to the
decision - making needs of the users.

Concept of Materiality:

 The largest amount of misstatement that the auditor could tolerate

 The smallest aggregate amount that could misstate the financial statement

Consideration of Materiality

Materiality should be considered by the auditor

 Determining the nature, timing and scope of the audit engagement
 Identifying and assessing the risks of material misstatements
 Adjustments, revisions of audit plan

The auditor's determination of materiality is

 A matter of professional judgment,

  Affected by the auditor's perception of the financial information needs of the users
of financial information.

The auditor can assume that users:

 Have knowledge of the business, economic and accounting activities of the firm and
will diligently study the information in the financial statement
 Understand that FS are prepared and audited to levels of materiality
 Recognize uncertainties that measurement used are based on estimates, judgment,
forecasts
 Make economic decision bases on the information in the financial statement
- (PSA 320 par 4)

Relationship Between Materiality and Risk

Materiality Level Risk Materiality Level Risk

Higher Lower Lower Higher

Materiality in Terms of Amount and Level

2,000,001 to 5,000,000 Assumption: P100,001 as the base amount

1,000,001 to 2,000,000
500,001 to 1,000,000 High level of materiality
200,001 to 500,000  Lower the amount to P50,001
100,001 to 200,000  More strict in the conduct of the audit
 More evidence to gather
50,001 to 100,000  More extensive procedures
10,001 to 50,000  Only below P50,000 is tolerated
5,001 to 10,000
1,001 to 5,000 Low level of materiality
0 to 1,000  Increase the amount to P200,001
 The auditor is more lax in the conduct of the audit
 Lesser evidence to gather
 Toleration of more errors

Use of Materiality

 Planning and performing the audit

  Evaluating effect of identified misstatements and uncorrected misstatements
 Forming the opinion in the auditor's report

Importance of materiality

 To determine the volume of evidence to be accumulated

Overall materiality

 Based on financial statement as a whole

 The highest amount of misstatement without affecting the economic decision of the
users
 Financial Statements are interrelated
 Based on the common financial information needs of the users.
 Percentage is often applied to a chosen benchmark as starting point

Materiality Benchmarks

 The elements of financial statements

 Items which users tends to be focused
 Life cycle of the entity
 Economic environment which the entity operates
 Ownership structure and the way it is financed

Technical Benchmark

 Reported income such as profit before tax, total revenue

 Gross profit and total expense
 Total equity or net asset value
 Total Assets
 Total Revenues
 Profit before tax from continuing operations (for profit-oriented entities)
 Average of three years' net income before taxes

Starting Points

PSA does not require any range of percentages, based in actual practice

 Income from continuing operations - 3% to 7%

 Assets - 1% to 3%
 Equity-3% to 5%
 Revenues - 1% to 3%
 Less than 5% immaterial & greater than 10% materiality
 1% to 1.5% larger of total assets or revenue
 Suggestion: ranges from 5% - 20% of the factor
Specific Materiality

 Lesser amount than the overall materiality that may be relevant to users
 Refers to sensitive accounts in the financial statements or disclosures
 Done by allocating the overall materiality to the respective account balances
 Allows the auditor to determine audit procedures to each specific account
 Allocation is not provided in the standards and highly subjective

Factors affecting application of specific materiality:

 Law, regulation or applicable reporting framework affect user's expectations on

measurement or disclosures on accounts
 Key disclosures in relation to industry it operates
 Certain aspect in the business that is separately disclosed in the financial statements

Tolerable misstatement: The allocated materiality to an account

Steps in using Materiality

 Done near the end of the audit when gathered evidences are evaluated
 Aggregates misstatements gathered from specific accounts and previous identified
unacted & unadjusted misstatements in the prior periods
 Comparison of these aggregate misstatements against the adjusted preliminary
materiality
 If aggregate misstatements are less than adjusted preliminary materiality, there is
fair presentation
 Conversely, if greater the auditor should recommend adjustments of the financial
statements.
 If client refuses, the auditor should issue a qualified or adverse opinion

Performance Materiality

Definition (PSA 320 par 9)

The amount or amounts set by the auditor at less than materiality for the financial statements as a
whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the financial statements as a whole. If applicable,
performance materiality also refers to the amount set by the auditor at less than the materiality
level or levels for particular classes of transactions, account balances or disclosures

Performance Materiality

 Margin of safety or buffer against undetected misstatement and uncorrected errors

 Consideration of immaterial items on the aggregate to cause misstatement exceeding
materiality level
 Set at lower amount than the overall materiality and specific materiality
 To lower audit risk to an appropriately low level
WARNING!!!

NEVER MENTION THE LEVEL OF MATERIALITY TO THE CLIENT OR AUDITEE OTHERWISE

EVIDENCE COULD BE MANIPULATED BY THE MANAGEMENT

Documentation

 The overall audit strategy

 The audit plan
 Significant changes discovered during the audit engagement and the reasons for such
changes
 Pre-engagement activities
 Letter of engagement
 Materiality level

Initial Audit Engagements

Considerations in initial audit engagements:

 Acceptability of the client relationship and specific engagement

 Communication with the previous auditor, if there is a change, in compliance with ethical
requirements
 Review the previous auditor's working paper but consider the ethical requirements

Direction, Supervision and Review

Auditor plans the nature, timing, and extent of direction and supervision of engagement and review
their work

Direction and supervision:

 extent of instructions to team members on procedures to undertake

 supervising how procedures are undertaken

Review: to determine if members have conducted the procedures properly and effectively

Nature & timing varies and dependent on:

 size and complexity of the entity

 area of the audit
 assessed risk of material misstatement
 capabilities and competence of individual team members

Additional Matters

 Unless prohibited by law, review the previous auditor's working paper

 Major issued discussed with management (accounting issues and reporting standards)
 Planned audit procedures regarding opening balances (PSA 520 par 3)
 Assignment of firm personnel regarding competence and capabilities
 Other procedures required of the firm's system of quality control
Other Critical Matters in Engagement Planning

 Application of Analytical Procedures

 Establishment of an engagement or audit team
 Consideration of work performed by others:
- predecessor auditor
- other CPA specialists
- use of client's staff
- internal auditors
 Assessment of going concern
 Identification of related parties

Other Critical Matters in Engagement Planning

 client's legal obligation

 completion of the initial audit program
 preparation of time budget
 assignment of personnel to the engagement
 scheduling of work

Analytical Procedures

Involves analysis of significant ratios and trends, including the resulting investigation of
fluctuations and relationships that are inconsistent with other relevant information or deviations
from predicted amounts.

Importance: It helps the auditor in identifying unusual transactions and events that may affect fair
presentations of the FS and material misstatements.

Compare and investigate:

 Prior years' Financial Statements

 Anticipated results such as budget forecast (income & expense performance)
 Industry averages
 Non-financial factors
 Typical relationships among Financial Statement balances
 Analysis of significant ratios and trends
 Changes in the industry in which the entity operates
 Changes in key personnel
 Observation and inspection

PSA 520 "Analytical procedures requires the auditor to use analytical procedures in the planning a
review stages of the audit,

Substantive Analytical procedures:

 Existence of unusual transactions or events

 Amounts, ratios, and trends that might indicate matters that have financial statement and
audit implications
 Development of expectations about plausible relationships that are reasonably expected to
exist
 Ratios and trends should be compared with a certain benchmark
  Ratios and balance indications may contradict each other

Analytical Procedures

Analytical procedures used in planning an audit

 Simple comparisons
 Ratio analysis
 Common-size statements
 Trend statements
 Time series
 Comparison of client ratio vs. industry

Consideration of Work Performed by Other Auditors/Parties

 Predecessor Auditor
 Other CPA
 Specialists
 Use of Client Staff
 Internal Auditors

Consideration of Work Performed by Other Auditors/Parties

To be considered:
 Involvement of other auditors in the audit components
 Involvement of experts
 Number of locations

Assessment of Going Concern Assumption

 Financial
 Operations
 Loss of customers
 Availability of capital and credit
 Others Matters
 DANGER OF COMMITING MANAGEMENT FRAUD
 Non-compliance capital or statutory requirements
 Legislations or government policy expected to adversely affect the entity

Identification of Related Parties

Related party: if one party has the ability to control the other part or exercise significant influence
over the other party in making financial and operations decisions

Examples of related party transactions:

 sales or purchase transactions between parent company and subsidiary
 cash advances between branches
 inventory warehousing among offices within the holding company
 foreign currency transactions between offices
 intercompany loans: significant transactions with related parties
Client's Legal Obligation

 Changes to articles of incorporation

 Minutes of meeting
 Significant contracts executed during the major agreements or contracts
 current situation and future plans
 authorization of dividends
 Inquiries into the entity's operations or financial results by regulatory or government
bodies.
 Pending litigation and contingent liabilities

AUDIT PROGRAM

Definitions
 Set of instructions or manuals to assistants or the audit team as a mean to control the
proper execution of the work. A program sets out the nature, timing and extent of the
planned audit procedures required to implement the overall audit plan.

 A detailed list of procedures to be performed in an audit.

 A list of audit procedures to be performed so that the auditor will have evidence as a basis
for expressing an opinion on the financial statements

Types of Audit Program

 Standard All-Purpose Audit Program

 Tailor-Made Audit Program
 Modified Standard Form

AUDIT PLAN

Detailed Audit Plan

 Understanding the entity and an environment (PSA 315)

 Auditor's response to assessed risk (PSA 330)
 Other planned audit procedures for compliance to PSA (various PSA)

Typical Audit Plan

 Description of the client company

- Structure
- Nature of business
- Organization
 Audit objectives (tax filing, for end users)
 Description of the nature and extent of other services such as tax returns
 Required governmental reports

Typical Audit Plan

 Timetable of the audit work

 Work to be done by the client's employer
 Assignment of audit staff
  Target completion dates
 Preliminary evaluation and judgement about materiality level
 Any special problems to be resolved during the engagement
 Conditions that may require revision in materiality

The auditor shall update and change the overall audit strategy and the audit plan as necessary
during the course of the audit

Preparation of the Time Budget

Definition
An estimated total hours to finish the audit engagement
 Based on information obtained in understanding the client
 Allocated to work schedules indicating who, what to do, and length of time
 Basis for determining fees
 Used to measure efficiency of staff
 Indicates progress of the engagement

Personnel Assignment

PSA 220 par 8 to 25

The auditor, and assistants with supervisory responsibilities, will consider the professional
competence of assistants performing work delegated to them when deciding the extent of direction,
supervision and review appropriate for each assistant

Scheduling of Work

The firm should consider:

 Type of engagement
 Deadline for submission of final audit report
 Ability of the audit staff
 Costs
 Other audit clients
 Manpower availability

Documentation of Audit Plan / Audit Program

 Audit Strategy
 Audit Plans
 Audit Programs
 Time Budget
 Significant Changes
 Letter of Engagement

PAPS 1005
Special Consideration in the Audit of Small entities (PAPS 1005)

Definition of small entity:

 there is concentration of ownership and management in a small number of individuals

 one or more of the following are also found:
 few sources of income (limited range of products or services)
  unsophisticated record-bookkeeping - done by non knowledgeable in accounting
 limited internal controls with the potential for management override of controls

FROM BOOK

Chapter 4: Management of a Public Accounting Practice

ESTABLISHMENT AND ORGANIZATION OF PUBIC ACCOUNTANCY PRACTICE

Public accounting firms are usually organized as a sole proprietorship or partnerships.

Whatever the legal form of organization, the hierarchy in the public accounting firm usually
includes partners, managers or supervisor in-charge auditors (sometimes called senior and
staff auditors). Although the titles of these positions vary from firm to firm; the structure is
substantially present in all firms

A corporation is not allowed to engage in the practice of public accounting in the

Philippines and therefore the Securities and Exchange Commission shall not register any
corporation organized for the practice of public accountancy. However, a growing number
of practitioners now seen to favor the adoption of “professional corporations” which are
allowed in the United states and other parts of the world. This organizational structure of
CPA firms is influenced by the following factors:
(1) The need to be independent form clients to enable the auditor to remain unbiased in
drawing conclusions about financial statements;
(2) The need of structure to encourage competence to enable the auditor to conduct
audits efficiently and effectively; and
(3) The increased risk of litigation faced by auditors.

Many people think that public accounting financial statement auditing and information
assurance services in terms of the largest international accounting firms. Notwithstanding
this perception, the practice of public accounting is conducted in thousands of practice
units ranging in size from sole proprietorship to the largest international firms with
thousands of professionals. Further, many public accounting firms no longer designate
themselves as CPA firms. Many of them describe their businesses and their organizations as
professional services firms or some variation on these terms. Figure 4- shows an
organization for a large public accounting firm. However, some firms differ in their
organization. Some have other department such as small business advisory and forensic
accounting. Other firms have organized by industry (e.g., oil and gas, health care, financial
institutions) to take advantage of firms wide expertise. Some firms have other names for
their staff and management positions.

Usually in a CPA firm, there are fewer partners than managers and senior accountants and
fewer senior accountants than staff. Assistants or staffs spend two or three years in each
classification before achieving partner status. Promotions are made from within and direct
entry into a firm at a rank above staff rarely occurs.

The following describes the auditing position and tasks in a public accounting firm:
Audit Partner
Audit partners are concerned about the overall quality of each audit. An audit
partner signs the audit report, accepting ultimate responsibility for each audit, and
is generally involved in maintaining client relationships, planning audits, and
evaluation the audit findings. Audit partners have ultimate responsibility for
resolving technical matters, such as the application of accounting principles or
which auditing procedures are to be performed.
Among the duties of a partner are:
1. To plan and review all phases of an audit engagement
2. To sign the audit report
3. To approve the firm’s billing to the client
4. To obtain/ establish contracts with clients.
5. To determine office operating policies

Audit Manager/ Supervisor

- An audit manager administers important aspects of audit engagements, scheduling
the audit work to be dome with client personnel, assigning work to audit staff,
supervising staff, and reviewing staff work. Audit managers are often responsible
for controlling staff time and overseeing billing and collections. They must keep the
audit partner apprised of significant developments during the audit.

Among the tasks of a manager or supervisor are:

1. To act a liaison officer between partners and other members of the staff
2. To discuss with the client problems that the audit
3. To exercise direct supervision on seniors in charge of specific audit may arise in
the course of engagements.
4. To review working papers and drafts of audit report
5. To discuss reports and results of audit with clients
6. To take direct charge of training programs

In-Charge (Senior) Auditor

In-charge auditors work under the direction of audit managers and assist the, with
in administering the audit. They generally participate in audit planning and provide
direct supervision to staff auditors. They also review work performed by staff
auditors and summarize audit findings for the audit partner to review.

Among the duties of an in-charge (senior) auditors are:

1. To prepare the audit program for an engagement subject to review by the
partner, principal or supervisor.

Among the duties of an in-charge (senior) auditors are:

1. To prepare the audit program for an engagement subject to review by the partner,
principal or supervisor.

2. To ass g particular phases of the audit work to staff and to exercise direct supervision
over them.

3. To perform certain audit procedures requiring skill and experience such as:
 (a) Review of articles of incorporation, by-laws, and other nonfinancial records.

(b) Verification of assets and liabilities and the basis of valuation.

(c) Comparison of the current period's operating results with that of the preceding year or
years for the purpose of noting and investigating any unusual variations.
(d) Examination of adequacy of allowances for depreciation, bad debts, provision for
income taxes, etc.
4. To take up with the client or with the partner or principal, problems or questions that
arise in the course of the audit.
5. To assemble the working papers in an audit, and prepare a draft of the report and
financial statements for review and approval by the partner or supervisor .

Staff Auditor

Staff auditors perform various audit procedures and gather audit evidence to use as a basis
for the audit reports. They may perform procedures that relate to a variety of aspects of a
client's activities. For example, one staff auditor might test payroll, the value of inventory, or
whether all accounts payable are recorded. Another staff auditor might test internal control
procedures over cash payments and test cash balances.

Among the tasks of a staff auditor are:

1. To prepare schedules and reports of findings.
2. To work on tax returns.
3. To check the accuracy of footings and extensions on books of accounts and other
records.
4. To check the postings of entries from the j ournals to the ledger
5. To examine vouchers supporting minor disbursements.
6. Generally, to serve as an assistant

MARKETING PR, OFESSIONNAL SERVICES

Sections 250.1 and 250.2 of the Revised Code of Ethics for Professional Accountants
in the Philippines, provide the guidelines in marketing professional services as follows:
·

1. When a professional accountant in public practice solicits new work through

advertising or other forms of marketing, there may be potential threats to
compliance with the fundamental principles. For example, a self-interest
threat to compliance with the principle of professional behavior is created if
services, achievements or products are marketed in a way that is inconsistent
with that principle .

2. A profession al accountant in public practice should not bring the profession into
disrepute when marketing professional services. The professional accountant
in public practice should be honest and truthful and should not:
,.

 Make exaggerated claims for services offered, qualifications possessed or

experience gained;

 Make disparaging references to unsubstantiated comparisons to the work

 of another. ·

The practitioner should be guided by the provisions in the PRCBOA· Resolution

No. 126, Series of 2008.' on Rules on Advertising and Promotion for the Practice
of Accountancy in the Philippines.

If the professional accountant in public practice is in doubt whether a

proposed form of advertising or marketing is appropriate, the professional
accountant in public practice should consult with the relevant professional
body.

SOURCES OF CLIENTS

The CPA may count on the following as his possible sources of clients:
1) Referrals from businessmen through active participation in civic and community
affairs.
2) Referrals from clients by maintaining his integrity and rendering prompt and
efficient services to them
3) Referrals from financial and government institutions by keeping hsi standards
high .
4) Referrals from other CPAs by active involvement in professional organizations
of CPAs, e.g., PICPA, ACPAE, ACPACI, ACPAPP, GACPA, etc.
5) Referrals from legal and other professional firms.

PROFESSIONAL FEES

The CP in public practice shall comply with the provision s of Section 240 of the Revised
Code of Ethics for Profession al Accountants on professional fees and other types of
remuneration .
1. When entering into negotiation s regarding professional services, a professional
accountant in public practice may quote whatever fee deemed to be appropriate. The
fact that one professional accountant in public practice may quote a fee lower than
another is not in itself unethical. Nevertheless, there may be threats to compliance with
the fundamental principles arising from the level of fees quoted. For example, a self-
interest threat to profession al competence and due care is created if the fee quoted is so
low that it may be difficult to perform the engagement ·in accordance with applicable
technical and professional standards for that price.
2. The significance of such threats will depend on factors such as the level of fee quoted
and the services to which it applies. In view of these potential threats, safeguards
should be considered and applied as necessary to eliminate them or reduce them to
an acceptable level. Safeguards which may be adopted include:

• Making the client aware of the terms of the engagement and, in particular, tJ1e basis
on which fees are charged and which services are covered by the quoted fee.
• Assigning appropriate time and qualified staff to the task:

Fees charged for assurance engagements should be a fair reflection of the value of the
work involved and should take into account, among others:
(a) the skill and knowledge required for the type of work involved; .
(b) the level of training and experience of the persons necessarily engaged on the work;
_
(c) the time necessarily occupied by each person engaged on the work and the degree of
responsibility and urgency that the work entails

METHODS OF BILLING CLIENTS

The CPA can collect the professio nal fees using any of the following bases:

1. Actual time charges basis or Per Diem basis

- Billing is done on the basis of actual time spent by the staff multiplied by the hourly
rates agreed upon.
2. Flat or Fixed fee basis ·
- Client is billed a flat but all-inclusive pre-arranged amount for the entire engagement.
3. Maximum fee basis
- Client is charged on a per diem basis, with the agreement that the total charges will not
exceed a pertain agreed maximum amount.
4. Retainer basis
- The auditor is paid a fixed 'pre-determine d fee for_ all services rendered during a
designated period of time either on a monthly, semi-annual or annual basis.

Out-of-pocket expenses such as traveling expenses, supplies, and the like, attributable directly
to the professional services performed for, a particular client would normally be charged to that
client in addition to the professional fees.

AUDITING IN A GLOBALIZED ENVIRONMENT

All kinds of businesses have for the last forty years expanded their operations in foreign
countries. Some companies invest in foreign firms while others establish foreign production
facilities to service their companies in a particular region. Sometimes companies buy or sell
only in foreign markets. When companies engaged in foreign business require funds in a
foreign market, they seek the services auditors in the foreign country to audit their financial
statements and report on them. In the United States and many European countries, big
numbers of businesses have foreign business activities and auditors should therefore be
familiar with accounting and auditing practices throughout the world.

While differing traditions and experiences led to the development of alternative financial r
porting models, the pressures for intensified development in the global environment have
been evident as the needs for the ever-changing economy demand international
harmonization.
From the accounting perspective, the complexity of conducting international business
operations across national borders each with a different set of business regulations, tax rules, and
often different accounting methods presents a daunting challenge for account ants and
professional bodies that establish accounting and auditing rules. The globalization of capital
markets has also contributed to the need to address harmonization of financial reporting
requirement. The is presently is what the International Accounting Standards Board (IASB) is
tasked to accomplish and to date the standard-setting program of the IASB has gained
worldwide recognition and acceptance.
 Public accounting firms have found that to retain their multinational clients they have had to
develop the capacity to provide services worldwide. The largest firms have organized
worldwide partnerships to achieve a greater uniformity of quality, to facilitate management
of personnel and to coordinate research and professional development of personnel.
Figure 4-2 presents the tie-up between some local firms in the Philippines and international
accounting firms in the United States and other countries in the world.

REGULATION WITHIN THE FIRM SYSTEM OF QUALITY CONTROL

To ensure that a public accounting fim1 adheres to the standards of the
accounting profession it shall establish and implement a system of quality control. Regulation
within the fi m is generally the most effective firm of regulation because problems can be
dealt with 11nmed1ately and authoritatively at the level at which they occur.

The firm shall establish a system of quality control designed to provide it with reasonable
assurance that the firm and its personnel comply with professional standards on every
engagement, regulatory and legal requirements, and that reports issued by the firm or
engagement partners are appropriate in the circumstances.

The Philippine Standard on Quality Control (PSQC) I was promulgated to deal with the
responsibilities of a firm for each system of quality control for audits of financial statements and
other services engagements.

A quality control system is a set of policies and procedures designed to provide reasonable
assurance that the public accounting firm complies with professional standards and regulatory /
legal requirements. The system should be designed to achieve the objective and the procedures
necessary to implement and monitor compliance with those policies.

The nature and extent of a particular firm' s quality control policies and procedures
depend on such factors as:
I. Its size and nature of its policies;
2. Degree of operating autonomy allowed to its personnel;
3. The nature of its practice;
4. ts organization;
5. Its geographic dispersion; and
6. Appropriate cost / benefit consideration

Accordingly, the policies and procedures adopted by individual audit firms will vary, as will
the extent of their documentation.

The quality control policies and procedures shall be documented and communicated to the
firm's personnel. The firm should encourage its person el to communicate their views or
concerns on quality control matters.

ELEMENTS OF A SYSTEM OF QUALITY CONTROL

. ,
The firm's system of quality control shall include policies and procedures addressing each of
the following elements:

a) Leadership responsibilities for quality within the firm·

b) Ethical requirements; '
c) Acceptance and continuance of client relationship and specific engagements;
d) Human Resources
e) Engagement performance; and
f) Monitoring

A. Leaders/tip Respo11sibilities for Quality Within the Firm

The firm shall establish polici s and procedures designed to promote an internal
culture based on the recognitior, that quality is essential in performing
engagements. Such policies and procedures should require the firm's chief
executive officer (or equivalent) or, if appropriate, the firm's managing board of
partners (or equivalent), to assume ultimate responsibility for the firm's system
of quality control.

The firm's leadership and the examples it sets signi fican tly influence the internal culture of the
firm. The promotion of a quality-oriented internal culture depends on clear, cons is tent and
freque nt actions and messages from all levels of the firm' s management emphasizing the firm'
s quality control policies and procedures, and the requirement to:

(a) Perform work that complies with professional standards and regulatory and legal
requirement s; and

(b) Issue reports that are appropriate in the circumstances.

Such action s and messages encourage a culture that recognizes and rewards high quality work.
They may be communicated by training seminars, meetings, formal or informal dialogue, miss ion
statements. Newsletters, or briefing memoranda. They are incorporated in the firm' s internal
documentation and training materials, and in partner and staff appraisal procedures such that
they will support and rein force the firm 's view on the importance of quality and how , practically,
it is to be achieved.

Of particular importance is the need for the firm's leadership to recognize that the firm's
business strategy is subject to the overriding requirement for the firm to achieve quality in all
the engagements that the firm performs.
Accordingly: ·
(a) The firm assigns its management responsibilities so that commercial considerations do not
override the quality of work performed;
(b) The firm' s policies and procedures addressing performance evaluation , compensation, and
promotion (including incentive systems) with regard to its personnel, are designed to
demonstrate the firm ' 3 overriding commitment to quality; and
(c) The firm devotes sufficient resources for the development, documentation and
support of its quality control policies and procedures.
Any person or person's assigned operational responsibility for the firm's quality
control system by the firm's chief executive officer or managing board of partners
shall have sufficient and appropriate experience and ability, and the necessary
authority, to assume that responsibility.

Sufficient and appropriate experience and ability enables the responsible person or
persons to identify and understand quality control issue and to develop appropriate
policies and procedures. Necessary authority enables the person or persons to
implement those policies and procedures.

A. Ethical Requirements

The firm shall establish policies and procedures designed to provide it with reasonable
assurance that the firm and its personnel comply with relevant ethical requirements.

Ethical requirements relating to audits and reviews of historical financial information,

and other assurance and related services engagements ordinarily comprise Parts A
and B of the Revised Code of Ethics for Professional Accountants in the Philippines. The
Revised Code of Ethics for Professional Accountants in the Philippines establishes the
fundamental principles of professional ethics, which include:
(a) Integrity;
(b) Objectivity;
(c) Professional competence an-d due care;
(d) Confidentiality; and
(e) Professional behavior.

Part B of the Revised Code of Ethics for Professional Accountants in the Philippines
includes a conceptual approach to independence for assurance engagements that
takes into account threats to independence, accepted, safeguards and the public
interest.
'

The firm's policies and procedures emphasize the fundamental principles, which
are reinforced in particular by (a) the leadership of the firm, ( b). education and
training, (c) monitoring and (d) a process for dealing with non-compliance.
Independence for assurance engagements is so significant that it is addressed
_separately in paragraph. s 18- 27 below. These paragraphs need to be read m conjunction
with· the Revised Code of Ethics for Professional Accountants in the Philippines.

Independence

The firm shall establish policies and procedures designed to provide it with reasonable
assurance that the firm its personnel and where applicable, others subject to
independence requirements (including experts contracted by the firm and network firm
personnel), maintain independence where required by the Philippine Code. Such
policies and procedures shall enable the firm to:

(a) Communicate its independence requirements to its personnel and, where

applicable, others subject to them; and
(b) Identify and evaluate circumstances and relationships that create threats to
independence, and to take appropriate action to eliminate those threats or reduce them
to an acceptable level by applying safeguards, or, if considered appropriate, to
withdraw from the engagement. .

Such policies and procedures shall require:

(a) Engagement · partners to provide the firm with relevant information about client
engagements, including the scope of services, to enable the firm to evaluate the
overall impact, if any, on indepe ndence requirements;
(b) Personnel to pro promptly notify the firm of circumstances and relationships
that create a threat to independence so that appropriate action can be taken;
and
(c) The accumulation and communication of relevant information to appropriate
personnel so that:
(i) The firm and its personnel can readily determine .whether they satisfy
independence requirements;
(ii) The firm can maintain and update its records relating to independence and
(iii) The firm can take appropriate action regarding identified threats to
independence

The firm shall establish policies and procedures designed to provide it with
reasonable assurance that it · is notified of breaches of independence
requirements, and to enable it to take appropriate actions to resolve such
situations. The policies and procedures should include requirements for:

(a) All who are subject to independence requirements to promptly notify the
firm of independence breaches of which they become aware;
(b) The firm to· promptly communicate identified breaches of these policies and
procedures to:
(i) The engagement partner who, with the firm, needs to address the breach;
and
(ii) Other relevant personnel in the firm and those subject to the
independence requirements who need to take appropriate action; and
(iii) Prompt communication to the firm, if necessary, by the engagement
partner and "the other individuals referred to in subparagraph (b) (ii) of
the actions taken to resolve the matter, so that the firm can determine
whether it should take further action.

Comprehensive guidance on threats to independence and safeguards, including application to

specific situations, is set out in Section 200 of the Revised Code of Ethics for Professional
Accountants in the Philippines.

A firm receiving notice of a breach of independence policies and procedures promptly

communicates relevant information to engagement partners, others in the firm as appropriate
and, where applicable, experts contracted by the firm and network firm personnel, for
appropriate action. Appropriate action by the firm and the relevant engagement partner
includes applying appropriate safeguards to eliminate the threats to independence or to
reduce them to an acceptable level, or withdrawing from the engagement. In addition, the
firm provides independence education to personnel who are required to be independent.

At least annually, the firm shall obtain written confirmation of compliance with its
policies and procedures on independence from all firm personnel required to be
independent by the Revised Code of Ethics for Professional Accountants in the
Philippines.

Written conformation may be in paper or electronic from. By obtaining confirmation and

taking appropriate action on information indicating noncompliance, the firm
demonstrate the importance that it attaches to independence and makes the issue
current for, and visible to, its personnel.

The Revised Code of ethics for Professional Accountants in the Philippines discusses the
familiarity that may be created by using the same senior personnel on an assurance
engagement over a long period of time and the safeguards that might be appropriate to
address such a threat.
Accordingly, the firm should establish policies and procedures:

(a) Setting out criteria for determining the need for safe uards to' reduce the
familiarity threat to an acceptable level when using the same senior personnel
on an assurance engagement over a long period of time; and

(b) Requiring, for audits of financial statements of listed entities, the rotation of the
engagement partner and the individuals responsible fQr engagement quality control
review, and where applicable, others subject to rotation requirements, after a
specified period in compliance with the Revised Code of Ethics for Professional
Accountants in the Philippines.

Using the same senior personnel on assurance engagements over a prolonged period
may create a familiarity threat or otherwise impair the quality of performance of the
engagement. Therefore, the Firm establishes criteria for determining the need for
safeguards to address this threat. In determining' appr9priate criteria, the firm considers
'such matters as (a) the nature of the engagement, including the extent to which it
involves a matter of public interest, and (b) the length of service of the senior personnel
on the engagement. Examples of safeguards include rotating the senior personnel or
requiring an engagement quality control review.

The Philippine Ethics Code recognizes that the familiarity threat is particularly relevant
in the context of financial statement audits of listed entities. For these audits, the
Philippine Ethics Code requires the rotation of the key audit partner after a pre-defined
period, normally 'no more than five years, and provides related standards and guidance.

B. Acceptance and Continuance of Client Relationships and Specific Engagements

The firm shall establish policies and procedures for the acceptance and· continuance of
client relationships and specific engagements, designed to provide it with reasonable
assurance that.it will only undertake or continue relationships and engagements
where it:
(a) Is competent to perform the engagement and has the capabilities, time and resources to do
 so; and
(b) Can comply with ethical requirements.
(c) Has considered the integrity of the client and does not have information that would
lead it to conclude that the client lacks integrity.

The firm shall obtain such information as it considers necessary in the circumstances before
accepting an engagement with a new client, when deciding whether to continue an existing
engagement, and when considering acceptance of a new engagement with an exi sting client. If a
potential conflict of interest is identified in accepting an engagement from a new or an
existing client, the firm should determine whether it is appropriate to accept the engagement.
Where issues have been identified, and the firm decides to accept or continue the client
relationship or a specific engagement, it should document how the issues were resolved.

With regard to the integrity of a client, matters that the firm considers include, for
example:
 The identity and business reputation of the client's principal owners, key
management, related, parties and those charged with its governance.
 The nature of the client's operations, including its business practices.
 Information concerning the attitude of the client's principal owners, key
management and those charged with its governance towards such matters as
aggressive interpretation of accounting standards and the internal control
environment.
 Whether the client is aggressively concerned with maintaining the firm's fees as
low as possible.
 Indications of an inappropriate limitation in the scope of work
 Indications that the client might be involved in money laundering or other criminals
activities
 The reasons for the proposed appointment of the firm and non-reappointment of the
previous firm.

The extent of knowledge a firm will have regarding the integrity of a client will generally grow
within the context of an ongoing relationship with that client. Information on s uch matters
that the firm obtains may come from, for example:
 Communications with existing or previous providers of professional accountancy
services to the client in accordance with the Philippine Code, and discuss ions with o
the r third parties.
 Inquiry of other firm personnel or third parties such as bankers, legal counsel and
industry peers. .
 Background searches of relevant databases.
In considering whether the firm has the capabilities, competence, time and resources to
undertake a new engagement from a new or an existing client, the firm reviews the specific
requirements of the engagement and existing partner and staff profiles at all relevant levels.
Matters the firm considers include whether:

 Firm personnel have knowledge of relevant industries or subject matters;

 Firm personnel have experience with relevant regulatory or reporting

 requirements, or the ability to gain the necessary skills and knowledge
effectively;

 The firm has sufficient personnel with the necessary capabilities and competence;

 Experts are available, if needed;

 Individuals meeting the criteria and eligibility requirements to perform engagement

quality control review are available, where applicable; and . ·

 The firm is able to complete the engagement within the reporting deadline.

The firm also considers whether accepting an engagement from a new or an existing
client may give rise to an actual or perceived conflict of interest. Where a potential conflict
is identified, the firm considers whether it is appropriate to accept the engagement.

Deciding whether to continue a client relationship includes consideration of significant

matters that have risen during the current or previous engagements, a client may have
started to expand its business operations into an area where the fir, does not possess that
necessary knowledge or expertise.

Where the firm obtains information that would have caused it to decline an engagement if
that information had been available earlier, policies and procedures on the continuance of
the engagement and the client relationship shall include consideration of:
(a) The professional and legal responsibilities that apply to the circumstances, including
whether there is a requirement for the firm to report to the person and persons
who made the appointment or, in some cases to regulatory authorities; and
(b) The possibility of withdrawing from the engagement or both the engagement and
the client relationship

Policies and procedures on withdrawal from an engagement or from both

the engagement and the client relationship address issues that include the
following:
 Discussing with the appropriate level of the client’s management and
those charged with its governance regarding the appropriate
action that the firm might take based on the relevant facts and
circumstances.
 If the firm determines that it is appropriate to withdraw,
discussing With the appropriate level of the client's management
and those charged with its governance withdrawal from the
engagement or from both the engagement and the client
relationship, and the reasons for the withdrawal.
 Considering whether there is a professional, regulatory or legal
requirement for the firm to remaining place, or for the firm to
report the withdrawal from the engagement, or from both the
engagement and the client relationship, together with the reasons
for the withdrawal to regulatory authorities . · '
 Documenting significant issues, consultations, conclusions and
 the basis for the conclusions

D. Human Resources
The firm shall establish policies and procedures designed to provide at
with reasonable assurance that it has sufficient personnel with the
capabilities, competencies, and commitment to ethical principles
necessary
(a) To perform its engagement in accordance with professional
standards and regulatory and legal requirements, and
(b) To enable the firm or engagement partners to issue reports that are
appropriate in the circumstances

Such policies and procedures address the following personnel issues:

 Recruitment
 Performance evaluation
 Capabilities
 Competence
 Career development
 Promotion
 Compensation; and
 The estimation of personnel needs

Addressing these issues enables the firm to ascertain the number and characteristics of
the individuals required for the firm's engagements. The · firm's recruitment processes
include procedures that help the firm select individuals of integrity with the capacity to
develop the capabilities and competence necessary to perfon,1 the firm' s work.
Capabilities and c ompetence are developed through a variety of methods, including the
following:

 Professional education

 Continuing professional development, including training

 Work experience.

 Coaching by more experienced staff, for example, other members of the engagement
team.

The continuing competence of the firm's personnel depends to a significant extent on an

appropriate level of continuing professional development so that personnel maintain
their knowledge and capabilities. The firm therefore' emphasizes in its policies and
procedures the need for continuing training for all levels of firm personnel, and provides the
necessary training resources and assistance to enable personnel to develop and maintain
the required capabilities and competence. Where internal technical and training
resources are unavailable, or for any other person, the firm may use a suitably qualified
external person for that purpose.
The firm’s performance evaluation, compensation and promotion procedures give due
recognition and reward to the development and maintenance of competence and commitment
to ethical principles in particular, the firm:

(a) Makes personnel aware of the firm’s expectations regarding performance and ethical
principles;
(b) Provides personnel with evaluation of, and counseling on, performance, progress and
career development; and
(c) Helps personnel understand that advancement to positions of greater responsibility
depends, among other things, upon performance quality and adherence to ethical
principles, and that failure to comply with the firm’s policies and procedures may result in
disciplinary action.

The size and circumstance of the firm will influence the structure of the firm’s performance
evaluation process. Smaller firms in particular, may employ less formal methods of evaluating
the performance of their personnel.
Assignment of Engagement

Team The firm shall assign responsibility for each engagement to an engagement
parh1er. The firm should establish policies and procedures requiring that:

(a) The identity and role of the engagement partner are communicated to
key member s of client managen1ent and those charged with governance;
(b) The engagement partner has the appropriate capabilities, competence,
authority and time to perform the role; and
(c) The responsibilities of the engagement partner are clearly declined and
communicated to that partner.

Policies and procedures include systems to monitor the workload and availability of
engagement partners so as to enable these individuals to have sufficient time to adequately
discharge their responsibilities.

The firm shall also assign appropriate staff with the necessary capabilities, competence and
time
(a) To perform engagements in accordance with p rofcsc;ion1 standards and
regulatory and legal requirement s , and
(b) to enable the firm or engagement partners to issue reports that are appropriate in
the circumstances.

The firm establishes procedures to assess its staff's capabilities and competence. The
capabilities and competence considered when assigning engagement teams, and in
determining the level of supervision required, include the following:

 An understanding of, and practical experience with, engagements of a similar

nature and complexity through appropriate training and participat1on.
 An understanding of professional standards and regulatory and legal
requirements
 Appropriate technical know ledge including knowledge of relevant · information
technology.
  Knowledge of relevant industries in which the clients operate.
 Ability to apply professional judgment.
 An understanding of the firm’s quality control policies and procedures.

E. Engagement Performance

The firm shall establish policies and procedures designed to provide it with reasonable
assurance that engagements arc performed in accordance with professional standards and
regulatory and legal requirements, and that the firm or the engagement partner issue
reports that are appropriate In the circumstances.

The firm promotes consistency in the quality of engagement performance through its
policies and procedures. This is often accomplished through written or electronic manuals,
software tools or other forms of standardized documentation, and industry or subject
matter-specific guidance material s. Matters addressed may include:
 How engagement teams are briefed on the engagement to obtain an
understanding of the objectives of their work.
 Processes for complying with applicable engagement standards.
 Processes of engagement supervision, staff training and couching
 Methods of reviewing the work performed, the significant judgments made and
the form of report being issued
 Appropriate documentation of the work performed and of the timing and extent of
the review
 Processes to keep all policies and procedures current

Appropriate teamwork and training assist less experienced members of the engagement
team to clearly understand the objectives of the assigned work.
Engagement supervision includes the following:
 Tracking the progress of the engagement.
 Considering the competence and capabilities of individual members of the
engagement team, whether they have sufficient time to carry out their work
whether they understand their instructions and whether the work is being carried
out in accordance with the planned approach to the engagement;
 Addressing significant matters arising during the engagement. considering their
significance and modifying the planned approach appropriately; and ·
 Identifying matters for consultation or consideration by more experienced
engagement team members during the engagement.
A review consists of consideration of whether:
(a) The work has been performed and accordance with professional standards and
regulatory and legal requirements;
(b) Significant matters have been raised for further consideration;
(c) Appropriate consultations have taken place and the resulting conclusions have been
documented and implementing
(d) There is a need to revise the nature, timing performed and extent of work
(e) The work performed supports the conclusions reached and is
appropriately documented;
(f) The evidence obtained is sufficient and appropriate to support the report; and
(g) The objectives of the engagement procedures have been achieved.
Consultation
The firm shall establish policies and procedures designed to provide it with
reasonable assurance that:

(a) Appropriate consultation takes place on difficult or contentious matters;

(b) Sufficient resources are available to enable appropriate consultation to take place;
·
(c) The nature and scope of such consultations are documented; and
(d) Conclusions resulting from consultations are documented and
implemented.

Consultation includes' discussion, at the appropriate professional level, with

individuals within or outside the firm who have specialized expertise, to resolve a
difficult or contentious matter.

Consultation uses appropriate research resource: as well as the collective experience

and technical expertise of the firm. Consultation helps to promote quality and
improves the application of professional judgment. The firm seeks to establish a
culture in which consultation is recognized as strength and encourages personnel to
consult on difficult or contentious matters.

Effective consultation with other professionals requires that those consulted be given
all the relevant facts that will enable them to provide informed advice on technical,
ethical or other matters. Consultation procedures require consultation with those having
appropriate knowledge, seniority and experience within the firm (or, where applicable
outside the firm) on significant technical, ethical and other matters and appropriate
documentation and implementation of conclusions resulting from consultations.
A firm needing to consult externally, for example, a firm without appropriate internal
resources may take advantage of advisory services provided by (a) other firms, (b)
professional and regulatory bodies, or (c) commercial organizations that provide
relevant quality control services. Before contracting for such services, the firm
considers whether the external provider is suitably qualified for that purpose.

The documentation of consultations with other professionals that involve difficult or contentious
matters is agreed by both the individual seeking consultation and the individual consulted. The
documentation is sufficiently complete and detailed to enable an understanding of:
(a) The issue on which consultation was sought; and
(b) The results of the consultation, including any decisions taken, the basis for those
decisions and how they were implemented.

Differences of Opinion

The firm shall establish policies and procedures for dealing with and resolving
differences of opinion within the engagement team, with those consulted and, where
applicable, between the engagement partner and the engagement quality control
reviewer.

Such policies and procedures shall require that:

(a) Conclusions reached be documented and implemented; and
(b) The report not be dated until the matter is resolved.

The firm shall establish policies and procedures for engagement teams to complete the
assembly of final engagement tiles on a timely basis after the engagement reports have been
finalized.

The firm shall establish policies and procedures designed to maintain the confidentiality,
safe custody, integrity, accessibility and retrievability of engagement documentation. ·

The firm shall establish policies and procedures for the retention of engagement
documentation for a period sufficient to meet the needs of the firm or as required by law or
regulation.

Engagement Quality Control Review

The firm shall establish policies and procedures requ1nng, for appropriate
engagements, an engagement quality control review that provides an objective
evaluation of the significant judgments made by the engagement team and the
conclusions reached in formulating the report. Such policies and procedures should:

(a) Require an engagement quality contro review for all audits of financial statements
of listed entities;
(b) Set out criteria which all other audits and review of historical financial information,
and other assurance and related services engagements should be evaluated to
determine whether an engagement quality control review should be performed; and
(c) Require an engagement quality control review for all engagement meeting the
criteria established in compliance with subparagraph (a).

Criteria for determining which engagements other than audits of financial statements of
listed entities are to be subject to an engagement quality control review may include, for
example:

 The nature of the engagement, including the extent to which it involves a matter of
public interest.

 The identification of unusual circumstances or risks in an engagement or class of

engagements. -

 Whether laws or regulations require an engagement quality control review.

The firm shall establish policies and procedures setting out the nature, timing and extent
of an engagement quality control review. Such policies · and procedures shall require that
the engagement report not be dated until the completion of the engagement quality control
review.
. .
The firm shall establish policies and procedures to require the engagement
quality control review to include:
(a) Discussion of significant matters with the engagement partner;
(b) Review Of the financial statements or other subject
matter information and the proposed report;
(c) Review of selected engagement documentation relating to significant · judgments
the engagement team made and the· conclusions it reached; and
_
(d) Evaluation of the conclusions reached in formulating the report and consideration of
whether the proposed report is appropriate.

For audits, of financial statements of listed entities , the firm shall establish policies and
procedures to require the engagement quality control review to also 'include consideration of
the following:

(a) The engagement team' s evaluation of the firm' s independence in relation to the specific
engagement;
(b) Whether appropriate consultation has taking place on matters involving differences
of opinion or other difficult or contentious matters, and the conclusions arising from those
consultat1ons;

The firm shall establish policies and procedures setting out:

(a) The nature, timing and extent of an engagement quality control review;
(b) Criteria for the eligibility of engagement quality control reviewer;
and
(c) Documentation requirements for an engagement quality control review.

Nature, Timing and Extent of the Engagement Quality Control Review

An engagement quality control review ordinarily involves discussion with the engagement
partner, a review of the financial statements or other subject matter information and the
report, and, in particular, consideration of whether the report is appropriate. It also
involves a review of selected working papers relating to the significant judgments the
engagement team made and the conclusions they reached. The extent of the review
depends on the complexity of the engagement and the risk that the report might not be
appropriate in the circumstances. The review does not reduce the responsibilities of the
engagement partner.

An engagement quality control review for audits of financial statements of listed entities
includes considering the following:
 The engagement team's evaluation of the firm's independence in relation to the
specific engagement. .
 Significant risks identified during the engagement and the
responses to those risks.
 Judgments made, particularly with respect to materiality and significant risks.
  Whether appropriate consultation ' has taken place on matters involving
differences of opinion or other difficult or contentious matters, and the
conclusions arising from those consultations.
 The significance and disposition of corrected and uncorrected misstatements
identified during the engagement.
 The matters to be communicated to management and those charged with
governance and, where applicable, other parties such as regulatory bodies.
 Whether working papers selected for review reflect the work performed in relation
to the significant judgments and support the conclusions reached.
 The appropriateness of the report to be issued.

Engagement quality control reviews for engagements other than audits of financial statements
of listed entities may, depending on the circumstances, include some or all of these
considerations.

The engagement quality control reviewer conducts the review in a timely manner at
appropriate stages during the engagement so that significant matters may be promptly
resolved to the reviewer's satisfaction before the report is issued.

Where the engagement quality control reviewer makes recommendations that the
engagement partner does not accept and the matter is not resolved to the reviewer's
satisfaction, the report is not issued until the matter is resolved by following the firm's
procedures for dealing with differences of opinion.

Criteria for the Eligibility of Engagement Quality Control Reviewers

The firm's policies and procedures should address the appointment of engagement
quality control reviewers and establish their eligibility through:
(a) The technical qualifications .required to perform the role, including the
necessary experience and authority; and
(b) The degree to which an engagement quality control reviewer can be consulted
on the engagement without compromising the reviewer's objectivity.

The firm's policies and procedures on the technical qualifications of engagement quality
control reviewers address the technical expertise, experience and authority necessary to
perform the role. What constitutes sufficient and appropriate technical expertise, experience
and authority depends on the circumstances of the engagement. In addition, the
engagement quality control reviewer for an audit of the financial statements of a listed entity is
an individual with sufficient and appropriate experience and authority to act as an audit
engagement partner on audits of financial statements of listed entities.

The firm's policies and procedures are designed to maintain the objectivity of the engagement
quality control reviewer. For example, the engagement quality control reviewer:
(a) is not selected by the engagement partner;
(b) Does not otherwise participate in the engagement during the period of review;
(c) Does not make decisions for the engagement team; and
 (d) Is not subject to other considerations that would threaten the reviewer's objectivity. ·

The engagement partner may consult the engagement quality control reviewer during the
engagement. Such consultation need not compromise the engagement quality control reviewer's
eligibility to perform the role. Where the nature and extent of the consultations become
significant, however, care is taken by both the engagement team and the reviewer to
maintain the reviewer's objectivity. Where this is not possible-, another individual within
the firm or a suitably qualified external person is appointed to take on the role of either
the engagement quality control reviewer or the person to be consulted on the
engagement. The firm's policies provide for the replacement of the engagement quality
control reviewer where the ability to perform an objective review may be impaired.
i,
It may not be. practicable, in the case of firms with few partners, for the engagement partner not
to be involved in selecting the engagement quality control reviewer. Suitably qualified
external persons may be contracted where sole practitioners or small firms identify
engagements requiring engagement quality control reviews. Alternatively; some sole
practitioners or small firms may wish to use other firms to facilitate engagement quality
control reviews. Where the firm contracts suitably qualified external persons, the
requirements in paragraphs 39-41 and guidance in paragraphs A47-A48 of PSQC I
(Redrafted) apply.

Documentation of the Engagement Quality Control Review

Policies and procedures on documentation of the engagement quality control review
should control documentation that:
(a) The procedures required by the firm's policies on engagement quality control review
have been performed·
(b) The engagement quality control review has been completed 'before the report as issued;
and
(c) The reviewer is not aware of any unresolved matters that would cause the reviewer to
believe that the significant judgments the engagement team made and the conclusions
they reached were not appropriate.
Monitoring

The firm should establish policies and procedures designed to provide it with
reasonable assurance that the policies and procedures relating to the system of
quality control are relevant, adequate, operating effectively and complied with in
practice. Such policies and procedures should include an ongoing consideration and
evaluation of the firm's system of quality control, including a periodic inspection
of a selection of completed engagements.

The purpose of monitoring compliance with quality control policies and procedures is to
provide an evaluation of: '
(a) Adherence to professional standards and regulatory and legal requirements;
(b) Whether the quality control system has been appropriately designed and effectively
implemented; and
(c) Whether the firm's quality control policies and procedures have been appropriately
applied, so that reports that are issued by the firm or engagement partners arc
appropriate in the circumstances.
The firm entrusts responsibility for the monitoring process to a partner or partners or
other persons with sufficient and appropriate experience an authority in the firm
to assume that responsibility, monitoring of the firm's system of quality control is
performed by competent individuals and covers both the appropriateness of the design
and the effectiveness of the o peration of the system of quality control.
Ongoing consideration and evaluation of the system of quality control includes matter such as
the following:
 Analysis of:

- New developments in professional standards and regulatory and legal requirements,

and how they are reflected m the firm' s policies and procedures where appropriate
- Written confirmation of compliance with policies and procedures on independence;
- Continuing professional development including training a nd
- Decisions related to acceptance and continuance of client relationships and
specific engagements.

 Determination of corrective actions to be taken and improvements to be made in the

system, including the provision of feedback into the firm's policies and procedure
relating to education and training.
 Communication to appropriate firm personnel of weaknesses identified in the
system, in the level of understanding of the system, or compliance with it.
 Follow-up by appropriate firm personnel so that necessary modifications are
promptly made to the quality control policies and procedures.

The inspection of a selection of completed engagements is ordinarily performed on a cyclical

basis. Engagements selected for inspection include at least one engagement for each
engagement partner over an inspection cycle, which ordinarily spans no more than three
years. The manner, in which the inspection cycle is organized, including the timing of
selection of individual engagements, depends on many· factors, including the following:

 The size of the Firm.

 The number and geographical location of offices.

 The results of previous monitoring procedures.

 The degree of authority both personnel and offices have (for example, whether
individual offices are authorized to conduct their own inspections or whether only
the head office may conduct them).

 The nature and complexity of the firm's practice and organization.

 The risks associated with the firm’s clients and specific engagements.

The inspection process includes the selection of individual engagements, some of which
may be selected without prior notification to the engagement team. Those inspecting the
engagements are not involved in performing the engagement or the engagement quality
control review. In determining the scope of the inspection, the firm may take into account
the scope or conclusions of an independent external inspection program. However, an
independent external inspection program does not act as a substitute for the firm’s own
internal monitoring program.

Small firms and sole practitioners may wish to use a suitably qualified external person or
another firm to carry out engagement inspections and other monitoring procedures.
Alternatively, they may wish to establish arrangements to share resources with other
appropriate organization to facilitate monitoring activities.

The firm should evaluate the effect of deficiencies noted as result of the monitoring
process and should determine whether they are either:
(a) Instances that do not necessarily indicate that the firm’s system of quality control is
insufficient to provide it with reasonable assurance that it complies with professional
standards and regulatory and legal requirements, and that the reports issued by the
firm or engagement partners are appropriate in their circumstances; or
(b) Systematic, repetitive or other significant deficiencies that require prompt corrective
action.

The firm should communicate relevant engagement partners and other appropriate
personnel deficiencies noted as result of the monitoring process and recommendations for
appropriate remedial action.

Complaints and Allegations

The firm should establish policies and procedures designed to provide it with reasonable
assurance that it deals appropriately with:
(a) Complaints and allegations that the work performed by the firm fails to comply with
professional standards and regulatory and legal requirements; and
(b) Allegations of non-compliance with the firm’s system of quality control.
Complains and allegations (which do not include those that are clearly frivolous) may
originate from within or outside the firm. They may be made by the firm personnel, clients
or other third parties. They may be received by engagement team members or other firm
personnel.

As part of this process, the firm establishes clearly defined channels firm personnel to raise
any concerns in a manner that enables them to come forward without fear of reprisals.
The firms investigate such complaints and allegations in accordance with established
policies and procedures. The investigation is supervised by a partner with sufficient and
appropriate experience and authority within the firm but who is not otherwise involved in
the engagement, and includes involving legal counsel as necessary. Small firms and sole
practitioners may use the services of a suitably qualified external person or another firm to
carry out the investigation. Complaints, allegations and the responses to then are
documented.

Where the results of the investigation indicate deficiencies in the design or operation of the
firm’s quality control policies and procedures, or noncompliance with the firm’s system of
quality control by an individual or individuals, the firm takes appropriate action as
discussed in paragraph 83.
Documentation
The firms should establish policies and procedures requiring appropriate documentation
to provide evidence of the operation of each element of its system of quality control.
How such matters are documented is the firm’s decision. For example, large farms may use
electronic databases to document matters such as independence confirmations,
performance evaluations and the results of monitoring inspections. Smaller firms may use
more informal methods such as manual notes, checklists and forms.

Factors to consider when determining the form and content of documentations evidencing
the operation of each of the elements of the system of quality control include the following
 The size of the firm and the number of offices
 The degree of authority both personnel and offices have
 The nature and complexity of the firm’s practice and organization
The firm retains this documentation for a period of time sufficient to permit those
performing monitoring procedures with its system of quality control, or for a longer period
or required by law or regulation.

Chapter 8 : OVERVIEW OF RISK BASED AUDIT PROCESS

Expected Learning Outcomes
After studying this chapter, you should be able to:
1. Understand the concept of risk-based audit approach.
2. Know the factors to be considered in implementing the risk based audit model.
3. Understand the limitation in applying the risk-based audit model.
4. Distinguish between risk-based audit and account-based audit.
5. Discuss the activities in risk-based audit. 6. Identify the PSAs to be applied in the
activities in the risk based audit.
INTRODUCTION
Risk-Based Audit Approach Defined
Risk-based audit approach is an audit approach that begins with an assessment of the
types and likelihood of misstatements in account balance and then adjusts the amount
and type of audit work, to the likelihood of material misstatements occurring in account
balances.

Given the rapidly changing environment in which today's businesses operate, management,
internal auditors and external auditors must focus on the risks to the entity's operations and
ensure controls are in place to eliminate, mitigate, or compensate for those risks.

Many public accounting firms find themselves using a risk-based auditing approach that
employs a top-down evaluation of the client's risk that goes beyond the financial statements.
For instance, audit teams' now devote a significant amount of their engagement planning to
their clients' business risks (i.e., the risks that the client will fail to achieve its objectives). Firms
adopting this approach believe they must learn more about their clients' strategies and
processes to understand whether the financial statements are fairly presented.

Under this approach, the auditor performs the following:

1. Identification of the client's strategy and the processes for developing that strategy,
2. Examination of the core business process and resource management.
 3. Identification for each of the key processes (as well as sub-processes) the objectives, inputs,
activities, outputs, systems and transactions
4. Assessment of the risks that the processes will not meet the goals and controls related to
those risks.

FACTORS TO CONSIDER IN IMPLEMENTING THE AUDIT RISK MODEL

The following general observations on an audit client influence the implementation of the
audit risk model:
1. High-risk activities
• This includes operations or events where a material misstatement
could easily occur. For example, an inventory of high-value diamonds or
gold bars held by a jeweler, or a new / complex accounting system being
introduced.
2. Existence of large non-routine transactions
Identified significant related party transactions outside the entity's
normal course of business are to be treated as giving rise to significant
risks. This includes infrequent and large transactions. .
For example:
 Unusual volume of routine transactions with a related party;
 A major sales or supply contract;
 The purchase or sale of major business assets or business
segments; and
 Sale of the business to a third party.
 Routine non-complex transactions that are subject to systematic processing
are less likely to give rise to significant risks.
3. Matters requiring judgment or management intervention
Examples would include:
 The assumptions and calculations used by management in developing
major estimates;
 Complex calculations or accounting principles;
 Revenue recognition (presumed to be a significant risk) that is subject to
differing interpretation;
 Where management intervention is required to specify the accounting
treatment to be used.

4. Potential for fraud

 The risk of not detecting a material misstatement resulting from fraud (which is
intentional and deliberately concealed) is higher than the risk of not detecting one
resulting from error.
 In evaluating whether significant risk could result from the identified fraud risk
factors and the possible scenarios and schemes identified in team discussions,
consider the following:
 Skillfulness of the potential perpetrator;
 Relative size of individual amount manipulated;
 Level of authority of management or employee to:
- directly or indirectly manipulate accounting records, and –
- override control procedures;
 Significant fraud risks may be identified at any stage in the audit as a result of
new information being obtained.
 LIMITATION OF THE AUDIT RISK MODEL
Audit risk is a concept that drives the auditor's thinking about planning the audit and
then executing an audit. The illustrations are designed to provide guidance, but should not
be applied rotely to any audit client.

CPA firms in determining their approach to implementing the audit risk model should
consider the following limitations:
a) Inherent risk is difficult to formally assess. Some transactions because of their
complexity are more susceptible to error but it is quite difficult to assess that level of
risk independent of the client's accounting system.
b) The model treats each risk component as separate and independent when in fact
the components are not independent. It is also quite difficult to separate a client's
material controls and inherent risk.
c) Audit risk is judgmentally determined.
d) Audit technology is not so fully developed that each component of the model can be
accurately assessed. Auditing is based on testing and precise estimates of the model's
components are not possible. Auditors can, however, make subjective assessments and
use the audit risk model as guide.
203
RISK-BASED AUDIT VS. ACCOUNT-BASED AUDIT
In account-based auditing, auditors first obtain an understanding of control and
assess control risk for particular types of error and frauds in specific accounts and
cycle.

In risk-based audit, the audit team views all activities in the organization first in
terms of risks to strategies and objectives and then in terms of management's plans
and processes to mitigate the risk The auditors obtain an understanding of the client's
objectives. Then risks are identified and the auditors determine how management
plans to mitigate the risk and whether those plans are in place and operating
effectively.
THE RISK - BASED AUDIT PROCESS

Although specific audit procedures vary from one engagement to the next, the
following stages are involved in every engagement?

Phase I. Risk Assessment

This phase involves the following activities:
a. Performance of preliminary engagement activities to decide whether to accept /
continue an audit engagement.
b. Planning the audit to develop an overall audit strategy and audit plan.
c. Performance of risk assessment procedures to identify / assess risk of material
misstatement through understanding the entity.

Phase II. I Risk Response

This phase covers the following activities:
a. Designing overall responses and further audit procedures to develop appropriate
responses to the assessed risk of material misstatement.
b. Implementing responses to assessed risk of material misstatement to reduce audit risk to
 an acceptably low level.

Phase III. Reporting

This phase involves the following activities:
a. Evaluating the audit evidence obtained to determine what additional audit work (if any)
is required.
b. Forming an opinion based on audit findings and preparing the auditor's report.

The audit approach discussed in this book has been divided into three phases.
This is illustrated in Figure 8-2. For each of the Audit phases the diagram outlines the
major activities, their purpose and the resulting documentation.

The audit process is primarily an evidence-gathering process. As we discussed previously, the

audit process can be viewed as having three phases:
1. Risk assessment
2. Risk response
3. Reporting

Although in theory the audit process can be divided into the three distinct phases, the actual
performance of the engagement may not occur in that particular order. Issuing a report is, of
course, always the final phase, but the other two phases are more fluid. During the
engagement, the auditor may obtain information that necessitates modifying the audit
program or accumulating additional evidence. Or the auditor may proceed to gather evidence
and then go back to planning. For example, auditors often finalize the audit program after
performing the tests of controls. However, the structure assists in understanding the audit
process.

The auditor's standard report states, “We conducted our audits in accordance with Philippine
Standards on Auditing. Those standards require that we comply with the ethical requirements
and plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements."

The phrase reasonable assurance is intended to inform the users that auditors do not guarantee
or insure the fair presentation of the financial statements. This phrase communicates that
there is some risk that the financial statements are not fairly stated even when the opinion of
the auditor is unqualified.
The phrase free of material misstatement is intended to inform the users that the auditor's
responsibility is limited to material financial information. Materiality is important because it is
impractical for auditors to provide assurance on immaterial amounts. Thus, materiality and
risk are fundamental concepts that are important to planning the audit and designing the audit
approach.

RELLEVANT PHILIPPINE STANDARDS ON AUDITING (PSAs) TO BE USED IN THE RISK-

BASED AUDIT PROCESS GUIDANCE ON FUNDAMENTAL CONCEPTS
TOPIC Applicable PSA (s)
General Principles PSA 200, Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance
with International Standards on Auditing
Quality Control PSA 200, Quality Control for an audit of Financial
 Statements
Management Assertions PSA 315, Identifying and Assessing the Risks of
Material Misstatement through Understanding the
Entity and Its Environment (Newly Revised
Standard effective for audits of financial statements
for periods ending on or after December 15, 2013)
Audit Evidence PSA 500. Audit Evidence
Audit Documentation PSA 230, Audit Documentation

PHASE I- RISK ASSESSMENT INCLUDING MAKING CLIENT ACCEPTANCE AND

CONTINUANCE DECISIONS
Client Acceptance and Continuance PSA 210, Agreeing the Terms of Audit
Engagements
Considering Fraud PSA 240, The Auditor's Responsibilities
Relating to Fraud in an Audit of
Financial Statements
Consideration of Laws and PSA 250, Consideration of Laws and Regulations
Regulations in Planning the in an Audit of Financial Statements
Audit
Planning an Audit PSA 300, Planning an Audit of Financial
Statements
Assessing Risk of Material PSA 315, Identifying and Assessing the Risks of
Misstatements Material Misstatement through Understanding
the Entity and its Environment (Newly Revised
Standard effective for audits of financial
statements for periods ending on or after
December 15, 2013)
PSA 320, Materiality in Planning and performing
an Audit
Planning Audit Procedures PSA 330, The Auditor's Responses to Assess
Risks
Understanding related PSA 550, Related Parties
Parties
Communicating with those charged with PSA 360, Communication with Those Charged with
Governance about the Audit Plan Governance

PHASE II - RISK RESPONSE

Testing Controls for the Financial PSA 330, The Auditor's Responses to
Statement Audit Assessed Risks
Testing Sampling for Tests of Control PSA 530, Audit Sampling
Testing Controls in an Integrated Audit
Obtaining Evidence about Compliance PSA350, Consideration of Laws and
with laws and Regulations regulations in an Audit of Financial
statements
Substantive Audit Procedures PSA 330, The Auditor’s Responses to
Assessed Risks
PSA 500, Audit Evidence
Audit Evidence regarding the PSA 501, Audit Evidence Specific
a. Valuation of investments in Considerations for Selected Items
 securities and derivative
instruments;
b. Existence and condition of
inventory;
c. Completeness of litigation, claims
and assessments involving the
entity; and
d. Presentation and disclosure of
segment information, in
accordance with the applicable
financial reporting framework
External Confirmation PSA 505, External Confirmations
Audit Sampling for Substantive Tests PSA 530m Audit Sampling
Obtaining Evidence about Related PSA 550, Related Parties
Parties
Auditing Accounting Estimates PSA 540, Auditing Accounting Estimates,
Including Fair Vale Accounting
Estimates and related Disclosures
Analytical Proocedures as a Substantive PAS 520, Analytical Procedures
Using an Auditor’s Specialist/ Expert PAS 620, Using the Work of an Auditor’s
Expert

PHASE III - REPORTING

Evaluating the Implications of PSA 250. Consideration of Laws and Regulation
Noncompliance with Laws and in an Audit of Financial Statements
Regulations
Evaluating Financial Statement PSA 450, Evaluation of Misstatements Identified
Misstatements during the Audit
Subsequent Events PSA 560, Subsequent Events
Disclosures about Related Parties PSA 550, Related Parties
Going Concern PSA 570, Going Concern
Management Representations PSA 580, Written Representation
Omitted Procedures
Communicating with those Charged PAS 260, Communication with Those Charged
with Governance with Governance
Supervision
Engagement Quality Review
Audit Opinion PAS 700, Forming an Opinion and Reporting on
Financial Statements
Audit Opinion Modifications PAS 705, Modifications to the opinion in the
Independent Auditor’s Report
Matter Paragraphs in the Audit Report PAS 706, Emphasis of matter Paragraphs and
Other Matter Paragraphs in the Independent
Auditor’s Report
Special Considerations PAS 800, Special Considerations – Audits of
Financial Statements Prepared in Accordance
with Special Purpose Frameworks
PSA 805, Special Considerations – Audit of
Single Financial Statements and Specific
elements, Accounts or Items of a Financial
 Statements

UNDERSTANDING THE AUDIT RISK MODEL

Nature of Risk

Risk is a concept used to express uncertainty about events and/or their outcomes that
could have a material effect on the organization.
The four critical components of risk that are relevant to conducting the audit are:
1. Audit Risk. The risk that an auditor may give an unqualified opinion on financial
statements that are materially misstated.
2. Engagement Risk, The economic risk that a CPA Firm is exposed to simply because it is
associated with a particular client including loss of reputation, inability of the client to
pay the auditor, or financial loss because management is not honest and inhibits the
audit process. Engagement risk is controlled by careful selection and retention of client.
3. Financial Reporting Risk. Those risks that relate directly to the recording of
transactions and the presentation of financial data in an organization's financial
statements.
4. Business Risk. Those risks that affect the operations and potential outcomes of
organizational activities.

Audit risk is defined as the risk that the auditor fails to find material misstatements in the
client's financial statements and thereby inappropriately issues an unqualified opinion on
the financial statements. The auditor can control audit risk in two different ways:
1. Avoid audit risk by not accepting certain companies as client, i.e. reduce
engagement risk to zero.
2. Set audit risk at a level that the auditor believes will mitigate the likelihood that the
auditor will fail to identify material misstatements.
In controlling audit risk, the auditor must recognize that it is not possible to ever
completely eliminate audit risk, but it can be reduced by doing more work. However doing
more work raises audit fees, which may create tension with the client and its
management.

At the broadest level, business risk and financial reporting risk originate with the audit
client and its environment, and these risks then affect the auditor's engagement risk and
audit risk. The effectiveness of risk management processes will determine whether a
company or audit firm continues to exist.

A number of factors affect a client's business risk. For example, the overall economic climate -
favorable or unfavorable - can have a tremendous effect on the organization's ability to operate
effectively. Economic downturn, technological change, competitor actions, new product lines
also affect business risk.

Financial reporting risk could arise from issues such as asset impairments, mark-to-market
accounting, warranties, pensions, estimates as well as competence and integrity of management
and its incentives to misstate the financial statements.

Business risk and financial reporting risk may affect each other. For instance, management
 facing strong competition and weak financial results may be motivated to circumvent a weak
internal control system or to take advantage of complex financial instruments to achieve
desired financial reporting results that do not necessarily portray economic reality. Audit firms
have discovered that being associated with companies with poor integrity creates risk that can
destroy the audit firm or significantly increase the cost of conducting the audit..

Integration of Concepts of Materiality and Risk in a Risk-Based Audit

The following considerations are important in integrating the concepts of materiality
and risk in the conduct of a risk-based audit:
1. Risky areas of a business must be identified by the auditors to determine which
account balances are more prone to material misstatements, how the misstatements
might occur and how a client might be able to cover them up.
2. Auditors need to develop approaches and methodologies to allocate overall
assessments of materiality to individual account balances because some account
balances may be more important to users.
3. Audits involve testing or sampling and thus cannot provide absolute (100%)
assurance that the financial statements are free of material misstatements without
inordinately driving up the cost of audits.
4. Not all clients are worth accepting. Since audits rely on testing and to some extent on
the integrity of management, there are some clients that an audit firm should not
accept because the engagement risk is too high.
5. Competition for clients among audit firms is high. Clients choose auditors based on a
number of factors including fees, service, industry knowledge, personal rapport and
ability to assist the client.
6. Auditors should understand society's expectations of financial reporting to reduce
audit risk to an acceptably low level and therefore minimize lawsuits that the users
may possibly bring forth.

Although audit risk is a concept, it is often illustrated using quantitative examples. For
instance, the relationship between engagement risk and audit risk may be presented as
follows:
Engagement Risk
Audit Risk Do not accept Set very low (1%) Set within
client professiona
standards but can
be highr than
companies with
highr engagement
risk (5%)

 LOW Setting audit risk at 1% is equivalent to performing a statistical test using 99%
confidence level. Audit risk set at 1% implies that the auditor is willing to take a 1%
chance of issuing an unqualified opinion on materially misstated financial statements.
212
 Audit risk set at 5% implies that the auditor is willing to take a 5% chance of
issuing an unqualified opinion on materially misstated financial statements.
 High levels of audit risk are appropriate for client with lower levels of engagement
risk.
Based on the assessment of engagement risk, the auditor sets the desired audit risk.
Audit risk oftentimes illustrated using numeric or quantitative examples. In fact,
many audit firms use the measures associated with statistical sampling to set audit
risk, e.g., setting audit risk at a 1% level for high-risk clients and 5% for lower-risk
clients. Other auditing firms use a broader description of audit risk as high,
moderate or low and adjust the nature of their audit procedures according

CHAPTER 9
RISK ASSESSMENT - PART I

PHASE I-A: PERFORMANCE OF PRELIMINARY ENGAGEMENT ACTIVITIES

Introduction

At the beginning of the current audit engagement, the auditor should perform the following
activities:
a. Perform procedures required by PSA 22, “Quality Control of an Audit of Financial
Statements” regarding the continuance of the client relationship and the specific
audit engagement.
b. Evaluate compliance with ethical requirements, including independence as required
by PSA 220.
c. Establish an understanding of the terms of engagement as required by PSA 210,
“Agreeing the Terms of Audit Engagements."

Client Selection and Retention

The auditor's consideration of client continuance and ethical requirements, including

independence occurs throughout the performance of the audit engagement as conditions
and changes in circumstances occur. However, the auditor’s initial procedures on both
client continuance and evaluation of ethical requirements (including independence) are
performed prior to performing other significant activities for the current audit
engagement. For continuing audit engagements, such initial procedures often occur shortly
after (or in connection with) the completion of the previous audit.

The purpose of performing these preliminary engagement activities is to help ensure·

that the auditor has considered any events or circumstances that may adversely affect the
auditor' s ability to plan and perform the audit engagement to reduce audit risk to an
acceptably low level.

Performing these preliminary engagement activities auditor plans an audit

engagement for which:
 The auditor maintains the necessary independence and ability to perform the
engagement.
 There are no issues with management ·m tegr1·ty that may affect the auditor's
willingness to continue the engagement.
  There is no misunderstanding with the client as to the terms of the engagement.

Most CPA firms are desirous and anxious to obtain new clients. Some new engagements are
easily obtained through business transactions such as the acquisition of a company by an
existing client and the client's desire to have the entire audit performed by one CPA firm.
Others are obtained competitively through social contacts which lead to a request that the
CPA firm submit a proposal for performing the company's annual audit. Such prospective
clients may range from start-up companies seeking a first audit to long established
companies seeking replacement of their current auditor.
.

Clients Acceptance/ Retention Decisions

Another element of quality-control deals with accepting and retaining clients. This decision
should involve more than just a consideration of management's integrity. Strict client
acceptance/continuance guidelines should be established to screen out the following:
.
 Clients that are in financial and/or organizational difficulty.
- For example, clients that could go bankrupt or client with poo accounting
controls and sloppy records

 Clients that constitute a disproportionate percentage of the firm's total

practice.
- Clients may attempt to influence the auditor into allowing unacceptable
accounting practices or issuing inappropriate opinions.

 Disreputable clients.
- External audit firms cannot afford to have their good reputation
tarnished by serving a disreputable client or by associating with a clear
that has disreputable management.

 Clients that offer an unreasonably low free for the auditor's services.
- In response, the auditor may attempt to cut corners imprudently or lose
money on the engagement. Conversely, auditors may bid for audits at
unreasonably low prices.

Audit Firm Limitations

An external audit firm should not undertake an engagement that is not qualified to handle.
Doing is so is especially important for smaller, growing firms that may be tempted to agree
to conduct an audit for which they are not qualified or not large enough to perform.
Statistics show that firms covered by a professional liability insurance plan that are most
susceptible to litigation are those with staffs of eleven to twenty-five auditors. They appear
to become overzealous, leading to low. audit quality and exposure to subsequent litigation.

It is essential for a CPA firm to maintain its integrity, objectivity and reputation for
providing high quality services. No auditor can afford to be regularly associated with
clients who are engaging in management fraud or other unlawful activities. Before
accepting an engagement, the CPA should investigate the history of the prospective client,
including such matters as the identities and reputation of the directors, officers, and major
shareholders. To help assess engagement risk, the auditors generally obtain management's
permission to make inquiries of other third parties (e.g., client's banker or legal counsel)
about a prospective client. Generally, CPAs choose to avoid engagements entailing a
relatively high engagement risk; others may accept such engagements. recognizing the
need to expand audit procedures to offset the unusually high levels of risk.

To reduce their own business risk, public accounting firms try to carefully manage their
audit engagements. An important element of a public accounting firm's quality control
policies and procedures is a system for deciding whether to accept a new client and, on a
continuing basis, deciding whether to continue providing services to existing clients. Public
accounting firms are not obligated to accept undesirable clients, nor are they obligated to
continue to serve clients when relationships deteriorate or when the management comes
under a cloud of suspicion.

In addition to evaluating engagement risk, the auditor should assess whether they can
complete the audit in accordance with the Philippine Standards on Auditing which are
based on international Standards on Auditing. The CPA must determine whether there are
conditions that would prevent them from performing an independent audit of the client.
Consideration will also be given to whether the partners and staff have the necessary
competence and capability to conduct the audit.

In summary, before accepting an engagement with a new client, the CPA firm shall
assess whether it
1. is competent to perform the engagement and has the capabilities, including time and
resources to do so,
2. can comply with the relevant ethical requirements, and
3. has considered the integrity of the client and does not have information that would
lead it to conclude that the client lacks integrity

The CPA firm shall likewise establish whether the preconditions for an audit are present
such as:
 Whether the financial reporting framework to be applied in the financial statements
are acceptable;
 Agreement of management that it acknowledges and understands its responsibility.
1. for the preparation of financial statements in accordance with applicable
financial reporting framework including where relevant to their fair
presentation,
2. for such internal control as management determines is necessary to enable
the preparation of financial statements that are free from material
misstatement whether due to fraud or error, and
3. to provide the auditor with:

a) Access to all information of which management is aware that is

relevant to the preparation of financial statements such as records,
documentation and other matters
b) Additional information that the auditor may request from
management for the purpose of the audit; and
 c) Unrestricted access to persons within the entity from whom the
auditor determines it necessary to obtain audit evidence.

Engagement letter

The engagement letter, which includes the audit free, also includes a description of the
timing of the external auditor's work and a description of documentation that the client is
expected to provide to the external auditor. In writing an engagement letter, care should be
taken when describing the degree of responsibility, the auditor takes with respect to
discovering fraud and misstatements. If the client wants its auditors to go beyond the
requirements of the auditing standards, the auditors should have their attorneys review
the wording to make sure that it says not only what is intended but also what is possible.
As a final step, the CPA firm will confer and agree with management or those charged with
governance the appropriate terms of the audit engagement.

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

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

b) The responsibilities of the auditor;
c) The responsibilities of management;
d) Identification of the applicable financial reporting framework for the preparation of
the financial statements; and
e) Reference to the expected form and content of any reports to be issued by the
auditor and a statement that there may be circumstances in which a report may
differ from its expected form and content.

Recurring Audits

On recurring audits, the auditor shall-assess whether circumstances require the terms of
the audit engagement to be revised and whether there is a need to remind the entity of the
existing terms of the audit engagement. The auditor shall not agree to the change in the
terms of the audit engagement where there is no reasonable justification for doing so.

If the terms of audit engagement are changed, auditor and management shall agree on and
record the new terms of the engagement in an engagement letter or other suitable form of
written agreement.

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

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

applicable law or regulation; and
b) Determine whether there is any obligation, either contractual or otherwise, to
report the circumstances to other parties, such as those charged with governance,
owners or regulators.
Figure 9-1: Illustrative Engagement Letter

Valderama & Co. CPA

7560 Sen. Gil Puyat Avenue, Makati City

October 15, 2020

Mr. Alberto Santos,

Managing Director ABC, Inc.
165 Tandang Sora, Quezon City Dear Mr. Santos:

You have requested that we audit the financial statements of ABC, Inc. which comprise the
statement of financial position as at December 31, 2020, and the income statement,
statement of changes in equity and cash-flow statement for the year ended, and a summary
of significant accounting policies and other explanatory information. We are pleased to
confirm our acceptance and our understanding of this audit engagement by means of this
letter. Our audit will be conducted with the objective of our expressing an opinion on the
financial statements.

Our Responsibilities

We will conduct our audit in accordance with Philippine Standards on Auditing. Those
standards require that we comply with ethical requirements and plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free from
material misstatement. An audit involves performing procedures to obtain audit evidence
about the amounts and disclosures in the financial statements. The procedures selected
depend on the auditor's judgment, including the assessment of the risks of material
misstatement of the financial statements, whether due to fraud or error. An audit also
includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating the
overall presentation of the financial statements.

Because of the inherent limitations of an audit, together with the inherent limitations of
internal control, there is an unavoidable risk that some material misstatements may not be
detected, even though the audit is properly planned and performed in accordance with
PSAS.

In making our risk assessments, we consider internal control relevant to the entity's
preparation of the financial statements in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the entity's internal control. However, we will communicate to you in
writing any significant deficiencies in internal control relevant to the audit of the financial
statements that we have identified during the audit

Unless unanticipated difficulties are encountered, our report will be substantially in the
following form:

[Form and content of the auditor's report has not been reproduced.]
The form and content of our report may need to be amended in the light of our audit
findings.

Management's Responsibility

Our audit will be conducted on the basis that management and those charged with
governance acknowledge and understand that they have responsibility:

a) For the preparation and fair presentation of the financial statements in accordance
with Philippine Financial Reporting Standards;
b) For such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement,
whether due to fraud or error, and
c) To provide us with:
i. Access to all information of which you are aware that is relevant to the
preparation of the financial statements such as records, documentation and
other matters;
ii. Additional information that we may request from you for the purpose of the
audit; and
iii. Unrestricted access to persons within the company from whom we
determine it necessary to obtain audit evidence.

As part of our audit process, we will request from management and, where appropriate.
those charged with governance written confirmation concerning representations made to
us in connection with the audit

We look forward to full cooperation from your staff during our audit.

Fees

Our fees which are based on the time required by individuals assigned to the engagement
will be Php100,000 plus out-of-pocket expenses and will be billed as work progresses.
Individual hourly rates vary according to the degree of responsibility involved and the
expenence and skill required.

This letter will be effective for future periods unless it is terminated, amended, or
superseded.

Please sign and return the attached copy of this letter to indicate that it is accordance with
your understanding of the arrangements for our audit of the financial statements.

Yours truly, Acknowledged on behalf of ABC,

Inc. by
Alvin Monico Valderama & Co., CPAS Mr. Alberto Santos
Managing Director
(Date)
PHASE I-B PLANNING THE AUDIT TO DEVELOP AN OVERALD (AUDIT STRATEGY AND
AUDIT PLAN

Introduction

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

PSA 300, "Planning an Audit of Financial Statements" establishes standards and

provides guidance on the considerations and activities applicable to planning and audit of
financial statements. It states that the auditor should plan the audit so that the engagement
will be performed in effective manner.

The auditor-in-charge must develop a "plant of action" to organize, coordinate, and

schedule activities of the audit staff. An audit plan is normally drafted prior to starting the
work at the client's offices.

Nature and Scope of Audit Planning

Audit planning involves the establishment of the overall audit strategy for the engagement
and developing an audit plan, in order to reduce audit risk to an acceptably low level.
Planning involves the engagement partner and other key members of the engagement team
to benefit from their experience and insight and to enhance the effectiveness and efficiency
of the planning process.

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

Planning is a continuous and iterative process that often begins shortly after or in
connection with the completion of the previous audit and continues until the completion of
the current audit engagement. However, in planning an audit, the auditor considers the
timing of certain planning activities and audit procedures that need to be completed prior
to the performance of further audit procedures, For example, the auditor plans the
discussion among engagement team members, the analytical procedures to be applied as
risk assessment procedures, the obtaining of a general understanding of the legal and
regulatory framework applicable to the entity and how the entity is complying with that
framework, the determination of materiality, the involvement of experts and the
performance of other risk assessment procedures prior to identifying and assessing the
risks of material misstatement and performing further audit procedures at the assertion
level for classes of transactions, account balances, and disclosures that are responsive to
those risks.
The auditor may decide to discuss elements of planning with the entity's management to
facilitate the conduct and management of the audit engagement (for example, to coordinate
some of the planned audit procedures often occur, the overall audit strategy and the audit
plan remain the auditor's responsibility.

Benefits of Audit Planning

Audit planning generally involves the determination of the expected nature, timing and
extent of the audit. Among the benefits derived from audit planning are the following:

a) It helps ensure that appropriate attention is devoted to important areas of the audit.
b) It aids in identifying potential problems and resolving them on a timely basis.
c) It helps ensure that the audit is properly organized, managed and performed in an
effective and efficient manner.
d) It assists in the proper assignment and review of the work of the engagement team
members.
e) It helps coordinate the work to be done by auditors of components and other parties
involved such as experts, specialists, etc.

The Overall Audit Strategy

PSA 300 requires that the auditor establishes the overall strategy for the audit. This overall
audit strategy sets the scope, timing and direction of the audit and guides the development
of the more detailed audit plan. In developing the audit strategy, the auditor considers the
results of the preliminary activities described in the preceding section.

The process of establishing the audit strategy involves:

a. Identifying the characteristics of the engagement that define its scope.

Examples are:
1. The financial reporting framework
2. Industry specific reporting requirements, and
3. The locations of the components of the entity.

b. Ascertaining the reporting objectives of the engagement to plan the timing of

the audit and the nature of the communication required such as:
1. Deadlines for interim and final reporting, and
2. Key dates and organization of meetings with management and those charged
with governance to discuss the nature and extent of audit work.
3. Discussion with management regarding the expected communication on the
status of audit work throughout the engagement.

c. Considering the important factors that will determine the focus and direction
of the engagement teams’ efforts, such as:
 1. Determination of appropriate materiality levels
2. Preliminary identification of areas where there may be higher risks of
material misstatement.
3. Preliminary identification of material components and account balances.
4. Evaluation of whether the auditor may plan to obtain evidence regarding the
effectiveness of internal control, and
5. Identification of recent significant entity-specific, industry, financial
reporting or other relevant developments.

d. Considering the results of preliminary engagement activities and, where

applicable, whether knowledge gained on other engagements performed by
the engagement partner for the entity is relevant; and

e. Ascertaining the nature, timing and extent of resources necessary to perform

the engagement.

Benefits of Developing the Audit Strategy

 The resources to deploy for specific audit areas, such as the use of appropriately
experienced team members for high risk areas or the involvement of experts on
complex matters.
 The amount of resources to allocate to specific audit areas, such as the number of
team members assigned to observe the inventory count at material locations, the
extent of review of other auditors' work in the case of group audits, or the audit
budget in hours to allocate to high risk areas;
 When these resources are to be deployed, such as whether at an interim audit stage
or at key cut-off dates; and
 How such resources are managed, directed and supervised, such as when team
briefing and debriefing meetings are expected to be held, how engagement partner
and manager reviews are expected to take place (for example, on-site or off-site),
and whether to complete engagement quality control reviews.

Once the overall audit strategy has been established, an audit plan can be developed to
address the various matters identified in the overall audit strategy, taking into account the
need to achieve the audit objectives through the efficient use of the auditor's resources. The
establishment of the overall audit strategy and the detailed audit plan are not necessarily
discrete or sequential processes, but are closely inter-related since changes in one may
result in consequential changes to the other.

In audits of small entities, the entire audit may be conducted by a very small audit team.
Many audits of small entities involve the engagement partner (who may be a sole
practitioner) working with one engagement team member (or without any engagement
team members). With a smaller team, co-ordination of, and communication between, team
members are easier. Establishing the overall audit strategy for the audit of a small entity
need not be a complex or time consuming exercise; it varies according to the size of the
entity the complexity of the audit, and the size of the engagement team. For example, a brief
memorandum prepared at the completion of the previous audit, based on a review of the
working papers and highlighting issues identified in the audit just completed, updated in
the current period based on discussions with the owner manager, can serve as the
documented audit strategy for the current audit engagement if it covers the matters noted
in paragraph 7 of PSA 300.

A. Application of the Concept of Materiality to Audit

PSA 320, "Materiality in Planning and Performing an Audi" establishes standards

and deals with the auditor's responsibility to apply the concept of materiality in
planning and performing an audit of financial statements.

To reiterate the importance of the concept of materiality to audit, the definition of

materiality in accordance with the FRSC's "Framework for the Preparation and
Presentation of Financial Statements" follows:

"Information is material if its omission or misstatement could influence the

economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. Thus, materiality provides a
threshold or cut-off point rather than being a primary qualitative
characteristic which information must have if it is to be useful."

This definition emphasizes the importance of materiality to reasonable users who

rely on the statements to make decisions. Auditors, therefore, must have knowledge
of the likely uses of their client's statements and the decisions that are being made.

Materiality involves both quantitative and qualitative considerations. In assessing

the quantitative importance of a misstatement, it is necessary to relate the peso
amount of the error to the financial statements under examination, Qualitative
considerations; on the other hand, relate to the causes of misstatement. An error
that may not be material quantitatively, may be material qualitatively. This may
occur, for instance, when the misstatement is attributed to an irregularity or an
illegal act by the client.

The objective of an audit of financial statements is to enable the auditor to express

an opinion whether the financial statements are prepared, in all material respects, in
accordance with an identified financial reporting framework. The assessment of
what is material is a matter of professional judgment.

In planning the audit, materiality should be considered by the auditor when:

a. determining the nature timing and extent of audit procedures;

b. identifying and assessing the risks of material misstatement; and
c. determining the nature, timing and extent of further audit.

The auditor's determination of materiality is a matter of professional judgment and

is affected by the auditor's perception of the financial information needs of users of
the financial statements. In this context, it is reasonable for the auditor to assume
that users:
 a. Have a reasonable knowledge of business and economic activities and
accounting and a willingness to study the information in the financial
statements with renewable diligence;
b. Understand that financial statements at prepared mud and audited to levels
of materiality;
c. Recognize the uncertainties inherent in the measurement of amounts based
on the use of estimates, judgment and the consideration of future events; and
d. Make reasonable economic decisions on the basis of the information in the
financial statements.

Levels of Materiality

The auditor assesses materiality at two levels:

 First is the overall materiality (or materiality level for the financial statements as a
whole)
 Second is the specific materiality (or materiality level for particular classes of
transactions, account balances or disclosures)

The auditor considers materiality at both the overall financial statement level and in
relation to individual account balances, classes of transactions and disclosures. Materiality
may be influenced by considerations such as legal and regulatory requirements and
considerations relating to individual financial statement account balances and
relationships. This process may result in different materiality levels depending on the
aspect of the financial statements being considered.

1. Overall materiality

Materiality for the financial statements as a whole (overall materiality) is based on

the auditor's professional judgment as to the highest amount of misstatement(s)
that could be included in the financial statements without affecting the economic
decisions taken by a financial statement user. If the amount of unconnected
misstatements, either individually or in the aggregate, is higher than the overall
materiality established for the engagement, it would mean that the financial
statements are materially misstated.

Overall materiality is based on the common financial information needs of the

various users as a group. Consequently, the possible effect of misstatements on
specific individual users, whose needs may vary widely, is not considered.

2. Specific materiality

In some cases, there may be a need to identify misstatements of lesser amounts than
overall materiality that would affect the economic decisions of financial statement
users. This could relate to sensitive areas such as particular note disclosures (i.e.,
management remuneration or industry-specific data), compliance with legislation
or certain terms in a contract, or transactions upon which bonuses are based. It
could also relate to the nature of a potential misstatement.
 PSA 320 likewise requires that performance materiality be set.

Performance Materiality

Performance materiality is used by the auditor to reduce the risk to an appropriate low
level that the accumulation of uncorrected and unidentified misstatements exceeds
materiality for the financial statements as a whole (overall materiality), or materiality
levels established for particular classes of transactions, account balances, or disclosures
(specific materiality).

Performance materiality is set at a lower amount (or amounts) than overall specific
materiality. The objective is to perform more audit work than would be required by
the overall or a specific materiality to:

 Ensure that misstatements less than overall or specific materiality are detected, so
as to appropriately reduce the probability that the aggregate of uncorrected errors
and undetected misstatements exceed materiality for the financial statements as a
whole; and thus
 Provide a margin or buffer for possible undetected misstatements. This buffer is
between detected but uncorrected misstatements in the aggregate and the overall
or specific materiality.

The margin provides some assurance for the auditor that undetected misstatements, along
with all uncorrected misstatements, will not likely accumulate to reach an amount that
would cause the financial statements to be materially misstated.

Performance materiality is set in relation to overall materiality or specific materiality. For

example, a specific performance materiality can be set at a lower amount than overall
performance materiality for testing repairs and maintenance expenses if there is a higher
risk of assets not being capitalized. Specific performance materiality may also be used to
perform additional work in areas that may be sensitive due to the nature of potential
misstatements and their occurrence, rather than their monetary size.

For example, if overall materiality was set at P200,000 and the audit procedures were
planned to detect all errors in excess of P200,000, it is quite possible that an error of say
P80,000 would go undetected. If three such errors existed totaling to P240,000, the
financial statements would be materially misstated. If performance materiality was set at
P120,000, it would be much more likely that at least one or all of the P80,000 errors would
be detected. Even if only one of the three errors is identified and corrected, the remaining
P160,000 misstatement would still be less than P200,000 and the financial statements as a
whole would not be materially misstated.

How to Determine Materiality

Auditors make a preliminary assessment of materiality of the financial statements as a

whole by determining the amount by which they believe the financial statements could be
misstated without affecting users' decisions. This-amount is called "preliminary judgment
about materiality" or "planning materiality". This judgment need not be quantified but
often is. It is called a preliminary judgment about materiality because it is a professional
judgment and may change during the engagement if circumstances change. The reason for
determining "planning materiality is to help the auditor plan the appropriate evidence to
accumulate. If the auditor sets a low peso amount, more evidence is required than for a
high amount.

In establishing planning materiality or preliminary judgment about materiality, an auditor

must also consider any potential effect a misstatement might have which may be greater
than the peso amount involved. A misstatement which may not be material based on
quantitative factors but that does not allow a client to meet a condition in a contractual
obligation or expectations of a financial statement user may be considered material. In
these instances, amount of planning materiality based on the user’s expectations of income
or alter those working on the engagement to the potential for these types of material
misstatement.

Rules of Thumb (For Use as a Starting Point)

Overall Specific Performance

Materiality is a matter of Establish a lower, specific No specific guidance is

professional judgment materiality amount (based provided in the PSAs.
rather than a mechanical on professional judgment) Percentages range from
existence. As a result, no for the audit of specific or 60% (of overall or specific
specific guidance is sensitive financial materiality). where there is
provided in the PSA. statement areas. a higher risk of material
However, profit from misstatement, up to 85%
continuing profit from where the assessed risk of
continuing operations (3% material misstatement is
to 7%) is often used in less.
practice as having the
greatest significance to
financial statement users. If
this is not a useful measure
(such as for a not-for-profit
entity or where profit is not
a stable base), then
consider other bases such
as:
 Revenues or
expenditures-1% to
3%
 Assets-1% to 3%.
 Equity-3% to 5%
Other Considerations

 When accepting new audit engagement, inquire about the overall materiality used
by the previous auditor. If available, this would help in determining whether further
audit procedures may be required on the opening asset and liability balances.
 Ensure that any experts employed by the entity (to assist the entity in preparing the
financial statements). or used by the audit team are instructed to use an appropriate
materiality level in relation to the work they perform.

Relationship between Materiality and Audit Risk

When planning the audit, the auditor considers what would make the financial statements
materially misstated. The auditor's assessment of materiality, related to specific account
balances and classes of transactions, helps the auditor decide such questions as what items
to examine and whether to use sampling and analytical procedures. This enables the
auditor to select audit procedures that, in combination, can be expected to reduce audit
risk to an acceptably low level.

There is an inverse relationship between materiality and the level of audit risk, that is, the
higher the materiality level, the lower the audit risk and vice versa. The auditor takes the
inverse relationship between materiality and audit risk into account when determining the
nature, timing and extent of audit procedures For example, if, after planning for specific
audit procedures, the auditor determines that the acceptable materiality level is lower,
audit risk is increased.

The auditor would compensate for this by either:

a. reducing the assessed level of control risk, where this is possible, and
supporting the reduced level by carrying out extended or additional tests of
control; or
b. reducing detection risk by modifying the nature, timing and extent of
planned substantive procedures.

B. Audit Plan

The auditor should develop an audit plan for the audit in order to reduce audit risk
to an acceptably low level.

The audit plan shall include a description of:

a. The nature, timing and extent of planned risk assessment procedures, as

determined under PSA 315, "Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its Environment."
b. The nature, timing and extent of planned further audit procedures at the
assertion level, as determined under PSA 330, "The Auditor's Responses to
Assessed Risks."
 c. Other planned audit procedures that are required to be carried out so that
the engagement complies with PSAs. The auditor shall update and change the
overall audit strategy and the audit plan as necessary during the course of
the audit.

The auditor shall plan the nature, timing and extent of direction and supervision
of engagement team members and the review of their work.

The auditor shall document:

a. The overall audit strategy,
b. The audit plan; and
c. Any significant changes made during the audit engagement to the overall
audit strategy or the audit plan, and the reasons for such changes.
Once the audit strategy has been established, the auditor is able to start the
development of a more detailed audit plan to address the various matters identified
in the audit strategy, taking into account the need to achieve the audit objectives
through the efficient use of the auditor's resources. Although the auditor ordinarily
establishes the audit strategy before developing the detailed audit plan, the two
planning activities are not necessarily discrete or sequential processes but are
closely inter-related since changes in one may result in consequential changes to the
other.

The audit plan is more detailed than the audit strategy and includes the nature,
timing and extent of audit procedures to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit
risk to an acceptably low level. Documentation of the audit plan also serves as a
record of the proper planning and performance of the audit procedures that can be
reviewed and approved prior to the performance of further audit procedures.

Direction, Supervision and Review

The auditor should plan the nature, timing and extent of direction and supervision of
engagement team members and review of their work.

The nature, timing and extent of the direction and supervision of engagement team
members and review of their work vary depending on many factors, including:
 The size and complexity of the entity.
 The area of the audit.
 The assessed risks of material misstatement (for example, an increase in the
assessed risk of material misstatement for a given area of the audit ordinarily
requires a corresponding increase in the extent and timeliness of direction and
supervision of engagement team members, and a more detailed review of their
work)
 The capabilities and competence of the individual team members performing the
audit work. PSA 220 contains further guidance on the direction, supervision and
review of audit work.
Changes to Planning Decisions during the Course of the Audit

The overall audit strategy and the audit plan should be updated and changed as necessary
during the course of the audit.

Planning an audit is a continual and iterative process throughout the audit engagement. As
a result of unexpected events, changes in conditions, or the audit evidence obtained from
the results of audit procedures, the auditor may need to modify the overall audit strategy
and audit plan, and thereby the resulting planned nature, timing and extent of further audit
procedures. Information may come to the auditor's attention that differs significantly from
the information available when the auditor planned the audit procedures. For example, the
auditor may obtain audit evidence through the performance of substantive procedures that
contradicts the audit evidence obtained with respect to the testing of the operating
effectiveness of controls. In such circumstances, the auditor reevaluates the planned audit
procedures, based on the revised consideration of assessed risks at the assertion level for
all or some of the classes of transactions, account balances or disclosures.

Consideration Specific to Smaller Entities

In audits of small entities, an audit may be carried out entirely by the audit engagement
partner (who may be a sole practitioner). In such situations, questions of direction and
supervision of engagement team members and review of their work do not arise as the
audit engagement partner, having personally conducted all aspects of the work, is aware of
all material issues. The audit engagement partner (or sole practitioner) nevertheless needs
to be satisfied that the audit has been conducted in accordance with PSAs. Forming an
objective view on the appropriateness of the judgments made in the course of the audit can
present practical problems when the same individual also performed the entire audit.
When particularly complex or unusual issues are involved, and the audit is performed by a
sole practitioner, it may be desirable to plan to consult with other suitably experienced
auditors or the auditor's professional body.

A suitable, brief memorandum may serve as the documented strategy for the audit of a
smaller entity. For the audit plan, standard, audit programs or checklists (see paragraph
A18 of PSA 300) drawn up on the assumption of few relevant control activities, as is likely
to be the case in a smaller entity, may be used provided that they are tailored to the
circumstances of the engagement, including the auditor's risk assessments.

Documentation

The auditor should document the overall audit strategy and the audit plan. including any
significant changes made during the audit engagement.

The auditor's documentation of the overall audit strategy records the key decisions
considered necessary to properly plan the audit and to communicate significant matters to
the engagement team. For example, the auditor may summarize the overall audit strategy
in the form of a memorandum that contains key decisions regarding the overall scope,
timing and conduct of the audit.
The auditor's documentation of any significant changes to the originally planned overall
audit strategy and to the detailed audit plan includes the reasons for the significant changes
and the auditor's response to the events, conditions, or results of audit procedures that
resulted in such changes. For example, the auditor may significantly change the planned
overall audit strategy and the audit plan as a result of a material business combination or
the identification of a material misstatement of the financial statements. A record of the
significant changes to the overall audit strategy and the audit plan, and resulting changes to
the planned nature, timing and extent of audit procedures, explains the overall strategy and
audit plan finally adopted for the audit and demonstrates the appropriate response to
significant changes occurring during the audit.

The form and extent of documentation depend on such matters as the size and complexity
of the entity, materiality, the extent of other documentation, and the circumstances of the
specific audit engagement

Additional Considerations in Initial Audit Engagements

The auditor should perform the following activities prior to starting an initial audit;
a) Perform procedures regarding the acceptance of the client relationship and the
specific audit engagement [see PSA 220 for additional guidance].
b) Communicate with the previous auditor, where there has been a change of auditors,
in compliance with relevant ethical requirements.

Other Critical Matters in Engagement Planning

1. Application of Analytical Procedures in Planning the Audit

The purpose of applying analytical procedures in planning the audit is to assist in

understanding the business and in identifying areas of potential risk. It will
therefore assist the auditor in planning the nature, time, and extent of auditing
procedures that will be used to obtain evidential matter for specific account
balances or classes of transactions. By identifying such things as the existence of
unusual transactions and events, and amount ratios and trends, matters that have
financial statement and audit planning ramifications might be brought to light.
Likewise, relevant non-financial information such as number of employees, area of
selling Space, volume of goods produced may also contribute to the accomplishment
of the purpose of the analytical procedures. PSA 520 requires the auditors to
perform analytical procedures as a part of the planning process for every audit.

2. Establishment of an Engagement or Audit Team

An audit team consists of people with different levels of expertise and experience.
The team usually is composed of an engagement partner, a manager, at least one
senior, and one or more staff auditors. In determining the number of people who
will be assigned to an engagement, an auditor normally considers the audit's size
and complexity, the availability and experience of personnel, the necessity for
 special expertise, and the opportunity to train personnel, and the continuity and
rotation of personnel. The audit team assembled for a larger engagement typically is
larger than that needed for a smaller engagement. An engagement involving an
entity in a regulated industry, such as banking, also requires that the major
members of the audit team have necessary knowledge and experience in that
industry.

3. Consideration of Work Performed by Other Auditors/Parties

The following factors should be considered in assessing the work performed by

other auditors/ parties:
 The involvement of other auditors in the audit of components, for example,
subsidiaries, branches and divisions.
 The involvement of experts.
 The number of locations.

a. Predecessor Auditor

The successor auditor's examination may be greatly facilitated by consulting

with the predecessor auditors and reviewing the predecessor's working papers.
Communication with the predecessor auditors can provide the successor CPA
with background information about the client, details about the client's system
of internal control, and evidence as to the account balances at the beginning of
the year under audit.

Auditors are ethically prohibited from disclosing confidential information

obtained in the course of an audit without the consent of the client. The
successor auditor should therefore obtain the client's consent before inquiries
from the predecessor auditors.

If the auditor is unable to obtain cooperation from the preceding auditors, or if

he feels that the work done by the preceding auditors does not meet the
requirements of generally accepted auditing standards, he may have to treat the
audit of the new client, previously audited by other accountants, just as he would
the first audit of a client who has never been audited before.

b. Other CPAS

Large companies generally consist of divisions and subsidiaries located in many

different parts of the country or the world. For a variety of reasons, one or
several of the subsidiaries or divisions may have different auditors.

To be able to report on the statements of the combined entity, an auditor must

determine that she or he is able to be the principal auditor. Principal auditor
means the auditor with responsibility for reporting on the financial statements
of an entity when those financial statements include financial information of one
or more components audited by another auditor. Other auditor means an
auditor, other than the principal auditor, with responsibility for reporting on the
financial information of a component which is included in the financial
 statement audited by the principal auditor. Other auditors include affiliated
firms whether using the same name or not, correspondents as well as unrelated
auditors, Component means a division, branch, subsidiary, joint venture,
associated company or other entity whose financial information is included in
financial statements audited by the principal auditor.

c. Specialists

CPAS may lack the qualifications necessary to perform certain technical tasks
relating to the audit. A specialist brings unique knowledge and judgment in a
field other than accounting and auditing. An auditor might decide to have an art
appraiser place values on works of art, a mineralogist determine the physical
characteristics of mineral reserves, or an actuary provide data related to a
group's life expectancy. Effective planning involves arranging for the appropriate
use of specialists both inside and outside of the client organization.

d. Use of Client's Staff

The client's staff should have the accounting records up-to-date when the
auditors arrive. In addition, many audit working papers can be prepared for the
auditors by the client's staff, thus reducing the cost of the audit and freeing the
auditors from routine work. The auditors may set up the columnar headings for
such working papers and give instructions to the client's staff as to the
information to be gathered. These working papers should bear the label
Prepared by Client, or PBC, and also the initials of the auditor who verifies the
work performed by the client's staff.

Working papers prepared by the client should never be accepted at face value;
such papers must be reviewed and tested by the auditors. Among the tasks that
may be assigned to the client's employees are the preparation of a trial balance
of the general ledger, preparation of an aged trial balance of accounts receivable,
analyses of accounts receivable written off, lists of property additions and
retirements during the year, and analyses of various revenue and expense
accounts. Many of these "working papers" may be in the form of computer
spreadsheets and other computerized data files.

e. Internal Auditors

Internal auditors can affect the audit in two ways. First, they can enhance
internal control. In deciding whether to reduce the amount of testing for specific
assertions because of work performed by internal auditors, the independent
auditor should consider (1) the materiality of the amount, (2) the risk of
misstatement, and (3) the degree of subjectivity involved in evaluating the
accumulated audit evidence. As these factors increase, the auditor is less likely to
rely on the internal auditor's work.

The second way internal auditors affect an audit is by assisting independent

auditors in performing specific audit procedures. For example, an internal
auditor may observe client personnel taking the inventory.
4. Assessment of Going Concern Assumption

PSA 570 requires auditors to evaluate whether substantial doubt exists about an
entity's ability to continue as a going concern, based on procedures planned and
performed to obtain evidence about the management assertions embodied in e
financial statements. That is, an auditor is not required to design specific procedures
to evaluate whether an entity is a going concern.

When planning and performing audit procedures and in evaluating the results
thereof, the auditor should consider the appropriateness of management's use of the
going concern assumption in the preparation of the financial statements.

Examples of events or conditions, which individually or collectively, may cast

significant doubt about the going concern assumption are set out below. This listing
is not all-inclusive nor does the existence of one or more of the items always signify
that a material uncertainty exists.

Financial
 Net liability or net current liability position.
 Fixed-term borrowings approaching maturity without realistic prospects of
renewal or repayment; or excessive reliance on short-term borrowings to
finance long-term assets.
 Indications of withdrawal of financial support by debtors and other creditors.

Operating
 Loss of key management without replacement.
 Loss of a major market, franchise, license, or principal supplier.
 Labor difficulties or shortages of important supplies.

Other
 Non-compliance with capital or other statutory requirements.
 Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that are unlikely to be satisfied.
 Changes in legislation oh government policy expected to adversely affect the
entity.

The significance of such events or conditions often can be mitigated by other factors.
For example, the effect of an entity being unable to make its normal debt
repayments may be counter-balanced by management's plans to maintain adequate
cash flows' by alternative means, such as by disposal of assets, rescheduling of loan
repayments, or obtaining additional capital. Similarly, the loss of a principal supplier
may be mitigated by the availability of a suitable alternative source of supply.

5. Identification of Related Parties

 A related party is defined as an affiliated company, a principal owner of the client
company, or any other party with which the client deals where one of the parties
can influence the management or operating policies of the other. A related party
transaction is any transaction between the client and a related party. Common
examples include sales or purchase transactions between a parent company and its
subsidiary, exchanges of equipment between two companies owned by the same
person, and loans to officers. A less common example is the exercise of significant
management influence on an audit client by its most important customer.

Because material related party transactions must be disclosed, it is important that

all related parties be identified and included in the permanent files early in the
engagement. Finding undisclosed related party transactions is thereby enhanced.
Common ways of identifying related parties include inquiry of management, review
of SEC filings, and examination of stockholders' listings to identify principal
stockholders.

6. Client's Legal Obligations

Pertinent current-year information that auditors should review includes (1)

minutes of directors and stockholders' meetings. (2) changes to articles of
incorporation or by-laws, and (3) any significant contracts executed during the year.
By reading the minutes, an auditor will obtain information about significant events
that have or will have an impact on the client.

For new clients for which historical information relating to these matters is
unavailable, the auditor should review information relating to prior years.

7. Completion of the Initial Audit Program

An audit program is a set of audit procedures specifically designed for each audit.
The program which includes both substantive tests and tests of controls will enable
the auditor to express an opinion on the financial statements taken as a whole.

The auditor should develop and document an audit program setting out the nature,
timing and extent of planned audit procedures required to implement the overall
audit plan. The audit program serves as a set of instructions to assistants involved in
the audit and as a means to control and record the proper execution of the work.
The audit program may also contain the audit objectives for each area and a time
budget in which hours are budgeted for the various audit areas or procedures.
Considering materiality, risk of misstatement, and the relative cost of performing
audit procedures, auditors determine the procedures to test the assertions
embodied in the financial statements.

Auditing standards require that a written audit program be prepared as a part of

each engagement.

In preparing the audit program, the auditor would consider the specific assessments
of inherent and control risks and the required level of assurance to be provided by
substantive procedures. The auditor would also consider the timing of tests of
 controls and substantive procedures, the coordination 0 any assistance expected
from the entity, the availability of assistants and the involvement of other auditors
or experts. Other matters may also need to be considered in more detail during the
development of the audit program.

On initial engagements, the audit program typically will develop in three

Stages:
1) the broad phases of the program can be outlined at the time of engagement;
2) other details of the program can be identified after the review of internal
control structure and accounting procedures has begun; and
3) procedures on specific phases of the audit can be further challenged and
revised as the work progresses.

On recurring engagements, the program for the preceding audit should be studied
before preparing the program for the current audit. The program for the current
audit should reflect modifications or are required by the experience gained in the
business, internal control or accounting methods of the client.

8. Peparation of a Time Budget

A time budget is an estimate of the total hours an audit is expected to take. It is

based on the information obtained in the first major step in the audit that is,
obtaining an understanding of the client. It takes into consideration such things as:
a) the client's size as indicated by its gross assets, sales, number of employees
b) location of client facilities
c) the anticipated accounting and auditing problems
d) the competence and experience of staff available.

The total time must be allocated by the preparation of work schedules indicating
who is to do what and how long it should take. Thus, total hours are budgeted by
major categories and may be scheduled on a weekly basis. Time budget also serves
as the basis for estimating fees. [t is also an important tool to communicate to the
audit staff those areas the manager or partner believes
are critical and require more time. Furthermore, a time budget is used to measure
the efficiency of the staff and to determine at each stage of the engagement whether
the work is progressing at a satisfactory rate. An illustration of an Audit Budget and
Time Summary is shown in Figure 9-2.

Figure 9-2: Portion of an Audit Budget and Time Summary

Total Actual Weekly Hours (by date)

Budgete
d hours // // //

Total hours:
Partner
Manager
Senior
Staff
Hours by type of work:
General
Supervision
Preparation of audit program
Trial balance and adjusting entries
Permanent file
Financial statement comparisons
Transactions subsequent to year-end
Preparation of reports

Sales and collections cycle

Study and evaluation of internal
control
Tests of controls-sales
Substantive tests-sales
Tests of controls-collection

For repeat engagement, the development of time budgets is facilitated by reference

to the preceding year's detailed time records.

Managing time is an important consideration because billing is often based on the

amount of time charged to the engagement. Indeed, the most costly element of an
engagement is the auditor's time. Time budgets can motivate staff to perform
 efficiently, and one criterion by which audit personnel are evaluated is their ability
to complete assignments within the allotted time. (However, placing too much
emphasis on time management can lower the quality of the audit.)

A periodic accounting of time and budget may be prepared as a basis for

determining the cause(s) of the variance between actual and budgeted hours. This is
illustrated in Figure 9-2. This report will also serve as a guide in projecting the audit
time for the succeeding audits.

9. Assignment of Personnel to the Engagement

Staff must, therefore, be assigned with that standard in mind. On larger

engagements, there are likely to be one or more partners and staff at several
experience levels doing the audit. Specialists in such technical areas as statistical
sampling and computer auditing may also be assigned. On smaller audits there may
be only one or two staff members.

A major consideration affecting staffing is the need for continuity from year to year.
An inexperienced staff assistant is likely to become the most experienced non-
partner on the engagement within a few years. Continuity helps the CPA firm
maintain familiarity with the technical requirements and closer interpersonal
relations with client personnel.

Another consideration is that the persons assigned be familiar with the client's
industry.

In PSA 220, "Quality Control for an Audit of Financial Statements," the auditor, and
assistants with supervisory responsibilities, will consider the professional
competence of assistants performing work delegated to them when deciding the
extent of direction, supervision and review appropriate for each assistant.

Any delegation of work to assistants would be in a manner that provides reasonable

assurance that such work will be performed with due care by persons having the
degree of professional competence required in the circumstances.

10.Scheduling of Work

Audit work that can always be performed during the interim period includes the
consideration of internal control, issuance of management letter, and substantive
tests of transactions that have occurred to the interim date.
Interim tests of certain financial statement balances, such as accounts receivable,
may also be performed, but this results in additional risk that must be controlled by
the auditors. Significant errors or irregularities could arise in these accounts during
the remaining period between the time that the interim test was performed and the
statement of financial position date. Thus, to rely on the interim test of a significant
account balance, the auditors must perform additional tests of the account during
the remaining period.
 Performance of other substantive tests is scheduled near at, and after year end.
Consideration should be given to such factors as:

a) Deadline for submitting final audit report and filing of income tax returns
b) Ability of the client's staff to submit required schedules
c) Other audit clients

Documentation of Audit Plan / Audit Program

Documentation of the planning process is done through the preparation of working papers
showing:
1) Audit Plans (discussed in this section)
2) Audit Programs
3) Time Budget (refer to page 245)

An audit plan contains the overview of the engagement, outlining the nature and
characteristics of the client's business operations and the overall audit strategy.

The following information are included in a typical audit plan:

1. Description of the client company its structure, nature of business and organization.
2. Audit objectives (i.e., if the audit is for stockholders, creditors or it is special-
purpose audit) such as tax
3. Description of the nature and extent of other services returns preparation, etc.
4. Timetable of the audit work
5. Work to be done by the client's employer
6. Assignment of audit staff
7. Target completion dates of the major segments of the engagement
8. Preliminary evaluation and judgment about materiality level for the engagement
9. Any special problems to be resolved during the engagement particularly those
revealed by analytical procedures
10.Conditions that may require changes in audit test

Normally, the audit plan is prepared before starting work at the client's office. It may,
however be modified throughout the engagement as the auditor deems necessary
depending on his consideration of internal control or as special are encountered.

The auditor may wish to prepare a memorandum setting forth the preliminary audit
plan, particularly for large and complex entity.

Planning a Repeat Engagement

It is far easier to plan for a repeat engagement than planning for a first audit of a new
client. The working papers in the previous year's audit provide a wealth of information
useful in planning the recurring engagement. Of course, the auditor-in-charge of a
repeat engagement would have a good working knowledge of the client's business. Th
auditor however should not merely duplicate last year 5 audit program but should
 modify his approach to the audit for any changes in the client's operations, internal
control structure, or business environment.

QUIZZES

QUIZ NO. 4: PERFORMANCE OF THE PRELIMINARY ENGAGEMENT ACTIVITIES

1. The preliminary engagement activities in the risk assessment phase of risk-based

audit process does not include this activity: *
Establishing an understanding of the terms of engagement by the client and auditor.
Planning the audit to develop an overall audit strategy and audit plan
Performing procedures regarding continuance of client relationships
Risk assessment procedures identifying and assessing risk of material misstatement

2. Other than preparation of the financial statements and designing an accounting and
internal control system, management has this responsibility: *
Capacity to accommodate the audit engagement
Communicate to intended users the financial data prepared by the auditor
Allow the auditor unrestricted access to staff deemed necessary to obtain audit
evidence.
Compliance to relevant ethical requirements

3. An engagement letter would not normally include: *

Arrangement concerning client’s assistance
Description of the auditor’s detailed audit strategy and plan
The auditor’s audit fee
Client’s confirmation on the terms of the engagement
4. What is the most likely course of action to be taken by an auditor in assessing
management integrity? *
Research the background and histories of officers
Tour the plant and warehouses
Review the minutes of the minutes of meeting of those charged with governance
Request for the covering bank statement for the month

5. Engagement letters *
May be either oral or written
May be oral but approved by those charged with governance
Must be written if the client is regulated by the SEC
Must be written

6. The purpose of an engagement letter is to: *

Notify all audit partners and staff for the forthcoming audit engagement
Establish a legal defense for auditors that contracts for services should be in writing
Minimize the auditor’s responsibilities to external users of the financial data
Reduce the terms to writing to minimize misunderstandings

7. Which following statement is not true about the purpose of performing preliminary
engagement activities? *
Resolves issues that ensures absolute assurance to the financial data
Helps to consider circumstances adversely affecting performance of audit
engagements
Ensures anticipation of risks that may counteract the planning phase effectively
Reduce audit risk to an acceptably low level

8. Which of the following factors most likely would impress an auditor for a successful
audit engagement of a client’s financial statement? *
The complexity of the accounting system
The operating effectiveness of control procedures
The client’s ability to pay the auditor’s fee even at a premium
The adequacy of the accounting records

9. What factor below most likely would cause an auditor not to accept a new audit
engagement? *
Inability of the management to express acceptance of the proposed audit fee
Concluding that the entity’s management lacks integrity
The close proximity to the end of the entity’s fiscal cycle
Inadequate understanding of the entity’s internal control structure

10. Engagement letter that documents and confirms the auditor’s acceptance of the
engagement would normally be signed by the client *
After the audit report is issued
At the end of the fieldwork
Before the audit report is issued
Before the commencement of the engagement
11. Even if the prospective client may have the integrity, the auditing firm should apply
strict client acceptance guideline to screen out which of the following: *
Clients with respectable integrity
Management with an effective internal control system
Client who would not pay the agreed audit fee as provided in the letter of
engagement
Management with a strong organizational set-up

12. In addition to minimizing engagement risk by avoiding undesirable clients, the

auditors should determine whether there are conditions that would prevent them
from performing an independent audit of the client with the objective of: *
Completing the audit in accordance with the Philippine Standards on Auditing
Collecting the audit fee in its entirety as proposed in the agreed terms
Imposing the auditor’s responsibilities on a selective basis
Beginning the audit phase by performing preliminary engagement activities

13. Management’s integrity affects all of the following risks except: *

Business risk
Financial reporting risk
All of these mentioned risks are affected
Engagement risk

14. An engagement letter should be written before the start of an audit because *
it specifies the basis for billing audit for the upcoming year
it will limit the auditor’s legal liability by specifying auditor’s responsibilities
all the choices given are correct
it specifies the client’s responsibilities of preparing the documents for the auditor

15. For continuing audit engagements of existing clients, initial procedures of

assessment often occur- *
At the end of the current accounting period.
Preferably at the beginning of the next audit engagement
After the completion of the previous audit in preparation for the next audit period.
Only when management communicates its preparedness for the next audit period.

16. Which reference is not generally included in an audit engagement letter? *

Management’s responsibility for the financial statement
Objective of the audit of financial statements
Official list of the members of the audit team
Scope of the audit

17. An initial audit requires more audit time to complete than a recurring audit. One of
the reasons for this is that: *
Need to carefully study internal control system that the auditor is still unfamiliar
New auditors are usually assigned to an initial audit unassisted
Former auditors need to be consulted even without client’s consent
The accounting system was designed by an unknown program consultant
18. The auditor’s consideration of client continuance and ethical requirements,
including independence, occurs- *
At the beginning of the current audit engagement until the auditor decides to quit.
At any phase within the current audit engagement as planned by the audit team
From beginning up to the completion of the current audit engagement
At the onset of the current engagement until mutual agreement to terminate by both
parties

19. What is the most likely course of action to be taken by an auditor in assessing
management style? *
Research the background and histories of officers
Tour the plant and warehouses
Request the bank reconciliation statements
Review the minutes of meeting of those charged with governance

20. To reduce engagement risks, public accounting firms should carefully manage their
audit assignments. Which following statements is not true among them? *
An auditor is not obliged to accept new clients
Auditors accept high engagement risks to increase client base and profit for the firm.
Auditors can refuse to accept clients under a cloud of suspicion
Auditors can discontinue serving existing clients if relationships had deteriorated

21. Arrangements concerning which of the following are not likely to be included in
engagement letter? *
Other forms of report to be issued in addition to the audit report
Management’s responsibilities
Fees and billing
CPAs investment in the client’s business, if any

22. Prior to accepting an engagement with a new client, the CPA firm shall assess
whether it can comply to the necessary conditions to deliver excellent quality of
engagement, except: *
Compliance with the relevant ethical requirements
Time and available resources to provide the needed audit services
Preparation of financial statements in accordance with the PFRS.
Competence and capabilities of resources

23. Which of the following a CPA firm may not assess in accepting an engagement with a
new client? *
If the client has the financial capacity to pay the audit fee
If the auditor has the competence, capabilities including time and resources to do so
If the client has the integrity
If the auditor can comply with the relevant ethical requirements

24. If an auditor believes that an understanding with the client has not been established,
the auditor should ordinarily *
Assess the control risk at the maximum to submit the audit report
Modify the scope of the audit in the manner of a review engagement
Decline to accept or perform the audit
 Perform the audit with increased professional skepticism

25. Which of the following matters is generally included in an auditor’s engagement

letter? *
Auditor’s conditions to quit the engagements
Report that will detail the fraud committed by management employees
Management’s responsibilities
The Auditor’s opinion