Rodriguez, Zyra Denelle M.

A-331 AAPRINCIPLES

OVERVIEW OF THE FINANCIAL STATEMENT AUDIT PROCESS

1. Outline the Financial Statement Audit process. Provide a brief summary of

activities performed in each of the steps.

According to Cabrera, M. & Cabrera, G. (2020), the Financial Statement Audit

Process is a process of conducting a financial statement audit, from the beginning

where the management and auditor will come upon an agreement, up to the end

where the financial statements are issued to the users. The Overview of the

Financial Statement Audit Process was provided by Cabrera, M. & Cabrera, G. in

their Principles of Auditing and Assurance Services book.

According to Blasutti (2017), the Financial Statement Audit Process

basically involves five major steps namely: Planning, Risk Assessment, Audit

Strategy, Collection of Evidence, and Completion.

Planning involves the meeting of the minds of the management and the

auditor. The management will ask for the auditor to conduct the financial

statement audit, the auditor on the other hand, will evaluate if there is no

potential conflict that may arise if the proposal to conduct the audit is accepted.

They will establish the terms of the engagement, the payment terms, and the

extent of the audit.

In order to plan the terms of the engagements properly, the auditor will

conduct a risk assessment and gather information to know the nature, the

industry, commercial environment, and the management properly. The auditor’s

aim is to identify if there are possible material misstatements in the entity’s

financial statements. This is where the auditor will require preliminary reports to

identify the high risk areas that will require more of the auditor’s attention during

the audit.

In the Audit Strategy, the auditor will plan on the specific steps and

processes needed for the audit. This detailed audit plan will contain the auditor’s

strategies, the timings of the procedures, the degree of reliance of the

management to the company’s internal control, and the assignment of specific

duties in the audit team.

The critical step is the Collection of Evidence. In this step, the auditor will

gather the needed evidence whether the internal control is properly implemented,

on the transactions conducted, and in the account balances of these

transactions. The auditor will also understand all internal control procedures of

the entity. This step will test the validity of the entity’s transactions. The auditor

may conduct: Substantive Testing, where the auditor will verify the account

balances, interview parties relating to these balances, and verify the calculations

of the financial statement balances; or Controls Testing, where the auditor will

review the internal control of the entity, how they monitor and implement the

controls, the division of responsibilities of the management, and how they

reconcile accounts.

The last step is called the Completion of the audit process. In this step, the

auditor has obtained sufficient and appropriate evidence to reach a definite

conclusion regarding the entity’s financial statements. The audit report is

constructed with the corresponding opinion of the auditor regarding the audit

process and the management assertions. Whether the financial statements are

presented with fairness and followed the required standards. The audit report is

then communicated to the management and to the users of financial statements.

The management and the auditor must continuously interact before,

during, and after the audit process for the audit process is not simply verification

but determining whether everything is presented in the proper way. In some

sources, the financial statement audit process involves six steps but it is still

contain the same process.

2. What are the management assertions in the financial statements? Identify

and provide definition and example for each.

Management Assertions are claims of the management regarding the

information that is reflected in their financial statements. The auditor will do the

audit process to evaluate and collect evidence if these assertions are correct.

There are two aspects of the information in the financial statements: transactions

and related disclosure and account balances and related disclosure. The

management’s assertions are tested by the auditor where the auditor identify

which of the two aspects they belong to identify the audit procedures to be done

(Cabrera, M. & Cabrera, G., 2020).

Assertions about the transactions and related disclosure include:

Occurrence, where the assertion is that the transactions recorded and disclosed

have already occurred and they pertain to transactions made by the entity;

Completeness is where the management claims that all transactions that needs

to be recorded are recorded with the needed disclosures; Authorization refers to

the claim that all the transactions and disclosures made are authorized by the

proper authority; Accuracy is where the management asserts that all transactions

and disclosures are accurately recorded; Cutoff, in which the management

asserts that all the transactions recorded are recorded at the correct accounting

period; Classification, where the transactions are recorded in their proper

account classifications; and Preparation, where the management’s assertion is

that all the transactions and events prepared and recorded in accordance to the

appropriate standards. An example is the claim that the Land bought by the entity

is properly recorded with the land registration on the entity’s name supported by

complete documents of ownership, purchase of such land is authorized by the

owners, and the purchase is properly recorded in the books at the correct date.

Assertions about account balances and related disclosures include

assertions regarding: Existence, that all the assets, liabilities, and equity interests

of the entity clearly exist; Rights and obligations refers to the claim that the entity

has control over their assets and liabilities; Completeness, is where the

management claims that all the assets and liabilities that are needed to be

recorded are recorded with all the related disclosures; Accuracy, valuation, and

allocation is the claim that all assets, liabilities, and equity interests are recorded

in appropriate amounts in the financial statements with correct and appropriate

disclosures; Classification, where the management asserts that all assets,

liabilities, and equity are recorded in proper account classifications; and

Presentation is the claim of the management that all assets, liabilities, and equity

interest are presented with related disclosures in accordance to the required

standards. An example is the claim of the entity that the cash balance is correct

supported by all the documents that the amount is correct and is in the proper

classification with all related disclosures on how the balance is computed.

3. What is audit risk? What are its components and what is its objective?
Rodriguez, Zyra Denelle M. A-331 AAPRINCIPLES

Audit risk is defined as the risk that the financial statements are materially

misstated even though the auditor’s opinion states that they are free from

material misstatements. It is the risk that the auditor may have issued an

incorrect opinion regarding the entity’s financial statements. The main purpose of

an audit is to reduce the audit risk into an acceptable level. A level with

absolutely no audit risk cannot be achieved, but an appropriately low level of risk

can be. Audit risk has three components namely: Inherent risk, Control risk, and

Detection risk. The auditor must assess the level of the risk in each component of

the audit risk.

Inherent risks refers to the risk that is present due to the complex business

nature and its environment. It may be an error or an omission due to the failure to

in the entity’s internal control or the risk that cannot be known by the auditor as

the auditor do not really know all the things that is happening in the entity. This is

the hardest risk to detect and requires a high degree of judgement in regards to

the entity’s financial estimates.

Control Risk are risk arising due to failure to control or the absence of

control in the entity. These controls are important in an entity to determine the

presence of fraud and error. Like inherent risk, the control risk requires a high

degree of judgment from the auditor. This risk is usually high when the entity has

failed to have an adequate internal control that is needed to prevent fraud and

error occurring in their financial statements.

Detection risk refers to the risk that the auditor may fail to detect the

material misstatements in the entity’s financial statements. This risk may be

reduced or controlled by the auditor through application of the proper audit

process and through proper judgment of the evidences gathered. This risk does

not require a very high degree of judgment unlike the inherent risk and the

control risk.

The audit risk model can be defined as: Audit Risk = Inherent Risk x

Control Risk x Detection Risk (Ali, n.d.).

4. How do we determine that a sound judgment is made in the conduct of a

financial statement audit?

Sound judgment means that the auditor was able to assess the situations

and circumstances of the entity and draw conclusions objectively. The way to

know if sound judgement is made in the financial statement audit is through the

sufficiency and appropriateness of the audit evidences. Audit evidences are

sufficient when they are available at the right quantity. The auditor will apply

various procedures to gather all the evidences necessary in order to arrive at a

proper conclusion on whether the statements are presented in accordance to the

standards required. Although these evidences need not only be sufficient but

also appropriate. Appropriate evidences are relevant and reliable to the financial

statements being audited. They are persuasive rather than conclusive. When the
Rodriguez, Zyra Denelle M. A-331 AAPRINCIPLES

auditor has sufficient and appropriate audit evidences, it may be able to reach a

sound judgement after conducting the audit (Toppr, n.d.).

After gathering the evidences, the auditor must test them with the use of

the applicable standards and framework. In the absence of standards, the auditor

must: consider the relevant principles, treatments of the related transactions, or

what is being used in practice. The auditor must perform the audit with

professional skepticism and identify those portions of the financial statements

where possible errors or fraud may and be more cautious in analyzing them. All

these must be documented in the audit report prepared by the auditor to support

the opinion made by the auditor at the end of the financial statement audit

(Institute of Chartered Accountants of Scotland, 2012).

5. In the PSA Glossary of terms, identify 5 words that you have learned after

reading the document.

After reading the PSA Glossary of terms from the Auditing Standards and

Practices Council (2002), I learned various words that were unfamiliar before.

Five of these words include:

Anomalous Error, which is defined as the error that arises due to events

that are unfamiliar. It occurred from isolated events that has not occurred other

than specifically identified occasions. They do not represent the errors in the

population.
Rodriguez, Zyra Denelle M. A-331 AAPRINCIPLES

Component, another unfamiliar term, is defined as the entity’s division,

branch, subsidiary, joint venture, or associated company’s financial information

that is included or is part of the financial statements being audited by the auditor.

Encryption is a term that is familiar but I didn’t know is used in auditing. It

is defined as the process of transforming information into forms that cannot be

easily understood unless decoded. It provides and effective control in confidential

information and programs.

Programming Controls is a process to detect or prevent any improper or

incorrect changes in the computer programs that are accessed online through

devices. It is very important that computer programs are monitored, controlled,

and documented since data may be hacked or changed.

Walk-through test is a type of test where the auditor will trace the

transactions made by the entity by accessing the accounting system. This

process may be not new to me but the word or phrase on how it is called is quite

unfamiliar.
Rodriguez, Zyra Denelle M. A-331 AAPRINCIPLES

References

Ali, A. (n.d.). Audit Risk Model: Inherent Risk, Control Risk & Detection Risk.

https://accounting-simplified.com/audit/risk-assessment/audit-

risk/#:~:text=Control%20Risk%20is%20the%20risk,instances%20of%20fraud

%20and%20error.

Auditing Standards and Practices Council (2002). Glossary of Terms.

https://aasc.org.ph/downloads/PSA/publications/PDFs/Glossary-of-Terms-

December-2002.pdf

Blasutti, J. (2017, January 10). An Overview of the Financial Statement Audit Process.

https://fcrcpa.com/news/overview-financial-statement-audit-process/

Cabrera, M.E.B. & Cabrera, G.A.B. (2020). Principles of Auditing and Assurance

Services (2020-2021 ed.). GIC Enterprise & Co., Inc.

Institute of Chartered Accountants of Scotland (2012). A Professional Judgement

Framework for Financial Reporting.

https://www.ifac.org/system/files/uploads/PAODC/A-Professional-Judgement-

Framework-for-Financial-Reporting.pdf

Toppr (n.d.). Audit Evidence. https://www.toppr.com/guides/accounting-and-

auditing/tools-of-auditing/audit-evidence/#:~:text=Sufficiency%20of%20audit

%20evidence%20is,as%20information%20from%20other%20sources.