Nicodemus, Daena D.

A-331 AAPRINCIPLES

Journal 10: Internal Auditing (Auditing and Assurance Principles)

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

activities performed in each of the steps.

Terms of Engagement

Management Auditor

Implements Internalevidence
Obtains
Evidence
Controls

Tests managements
Conducts assertions against
x Transactions
criteria (IFRS)

Assertions
Accumulates
Determines overall
transactions into
fairness of financial
accounts balance
statements

Prepares financial
statements Communication Issues audit report to
accompany financial
statements
Issue financial
statements to users

Figure 1.0 shows the outline of the financial statement audit process as illustrated in

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

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In this outline, we can see that there are four steps in the financial statement

audit process which are: Terms of Engagement, Evidence, Assertions, and

Communication. In the first step which is Terms of Engagement, the management and

the auditor enters into an agreement that the auditor will perform an audit for the

management under the terms of engagement that the management has set. Next is the

Evidence step wherein internal controls are implemented, transactions are conducted,

and transactions are accumulated into account balances. This step includes the

processes from where financial information will be gathered in which they will be the

information to be audited. In the evidence phase of the financial auditing process, the

auditor obtains evidence from the available information in the management.

The third step in the financial statement auditing process is the Assertions phase.

Basically, in this part, the management’s prepared financial statements are used to test

the assertions of the management against criteria in which in auditing, it is the IFRS.

The auditor then uses the evidence gathered from the financial information to determine

the financial statements’ overall fairness. The fourth and final step in the auditing

process is the Communication phase where the auditor has already concluded and

issues an audit report for such. The auditor also issues the audit in which it

accompanies the financial statements and the management then issues the audited

financial statements to the intended users.

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

and provide definition and example for each.

Management assertions in financial statements are those claims of the

management on the information included in the financial statements. The

management’s financial statement assertions are where the auditor’s efforts of

collecting and evaluating evidence revolves around (Cabrera, M. & Cabrera, G.,

2020).

Furthermore, Cabrera, M. Cabrera, G. (2020) also categorized the assertions

into two: assertions about the classes of transactions and events and assertions

about account balances. The former includes the following:

a. Occurrence – this is about the events and transactions that occurred in

which they have been recorded and disclosed.

b. Completeness – this is portrayed when the events and transactions that

should be included in the records are actually recorded and when the

disclosures that are related are also included.

c. Authorization – occurs when the transactions that the entity engaged in

are all properly authorized.

d. Accuracy – this is when the data pertaining to the transactions are

recorded appropriately and they are also measured and described

accurately.

e. Cutoff – the events and transactions are recorded in the accounting period

where they should rightfully be in.

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f. Classification – the transactions and the events are recorded in the

accounts where they appropriately belong to.

g. Preparation – here, the events and transactions are aggregated or

disaggregated in which they are also described clearly. There exist related

disclosures that are understandable and relevant as required by the

financial reporting framework.

On the other hand, the assertions about account balances are as follows:

a. Existence – in existence, there exist the assets, liabilities, and the equity

interests of the entity.

b. Rights and obligations – in the rights and obligations, the entity has rights

to the assets, and it has obligations over the liabilities.

c. Completeness – in completeness, the assets, liabilities, and equity are all

recorded as they should be in a sense that they are complete.

d. Accuracy, valuation, and allocation – in this assertion, the assets,

liabilities, and the equity interests of the company are included in the

financial statements in which their amounts are appropriate. The valuation

and allocation adjustments for these are also recorded appropriately, and

there is proper measurement and description on the related disclosures.

e. Classification – the three elements which are assets, liabilities, and equity

are properly classified.

f. Presentations – in presentations, the assets, liabilities, and equity are

clearly described and properly aggregated or disaggregated. There are

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also disclosures that are relevant and understandable with regards to the

financial reporting framework.

An example of a scenario which depicts these assertions is for example, on April

8, 2020, an entity purchased machinery on account for Php 700,000. On the occurrence

element, this event of purchase is recorded on the date when it was incurred. For

completeness, in case that the machinery is second hand and it already depreciated,

the proper disclosures for its depreciation and its remaining useful life must be

indicated. For authorization, the sale of the machinery must have been agreed upon by

the entity and the seller. There must be an invoice or receipt which shows that the

transaction is valid, and it must be a transaction pertaining to the entity. For accuracy,

the amounts are recorded as they are which in this case, Php 700,000. Since the

transaction occurred in April, it must be included the first quarter financial statements or

for the month of April. It must also be included in the 2020 financial statements as it

occurred as of that date for the cutoff. On classification, they are classified into asset

and liability as should be. They are also prepared properly as part of the assets and

liabilities and machinery and accounts payable in particular for the financial statements.

Furthermore, for the assertions about account balances, in this transaction, there

is the asset of the machinery and the liability for the account that must be paid as part of

Existence. In the rights and obligations, the entity has a right on the recently purchased

machinery and it has the obligation to pay its liability. For completeness, the records of

the asset and the liability are recorded accordingly. With classification, they are

recorded as Machinery of Php 700,000 for debit and Accounts Payable of Php 700,000
Nicodemus, Daena D. A-331 AAPRINCIPLES

for credit. For presentations, the balances are aggregated into their proper

classification.

3. What is audit risk? What are its components and what is its objective?

According to Tuovila (2019), audit risk is the risk in which the financial

statements may be materially incorrect although the opinion of the auditor states that

they are free from material misstatements.

There are three components of audit risk as stated by Prasad (2017) which

are inherent risk, control risk, and detection risk. Inherent risk is the risk that lies in

the audit in which the systems may not be implemented as they should be.

Furthermore, as stated in Audit Risk: Components of Audit Risk (n.d.), inherent risk

is the risk that there is material misstatement in the entity’s financial statements due

to error or omission of information. It also described control risk as the risk in which

there will be material misstatements included in the financial statements that

occurred due to the failure of or of the absence of relevant controls. Lastly, detection

risk is the risk that the material misstatements would not be detected by auditors.

Also in Audit Risk: Components of Audit Risk (n.d.), it states that the objective

in such is that the audit risk model is used to manage the possible risks in an audit

engagement. Here, the auditors examine the control and inherent risks of the

engagement and they take into consideration these risks for the detection risk. They

also lower the risk of detection as they increase the sample size in the audit. It is
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imperative that the auditor knows these risks to be able to properly control the

amount of risk and lower them to an acceptable level.

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

financial statement audit?

Sound judgment in Vocabulary.com Dictionary (n.d.) is “the capacity to

assess situations or circumstances shrewdly and to draw sound conclusions”.

If you look at sound judgment as related to Auditing, it is the way auditors

assess the audit information in which they garner the necessary information and

they work with accordance to their task and what they must do. They do their jobs

ethically and as required by the management as stated in their agreement, by the

standards, by the laws, and any other related regulation.

In financial statement audit, sound judgment is made in which according to

Tysiac (2014), there are five elements which prove effective judgment process for

auditors. These elements are the following:

a. Identify and define the issue

b. Gather the facts and information, and identify the relevant literature

c. Perform the analysis and identify alternatives

d. Make the decision

e. Review and complete the documentation and rationale for the conclusion
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Tysiac also mentioned that the public relies on the auditors to conduct their

audit in a professionally skeptical manner with critical professional judgments since

the audit of the financial statements of the company could affect the investment

decisions of those participating in capital markets.

Additionally, to conduct audit in a manner that employs sound judgment,

there are factors that must be considered with regards to the audit evidence. In

audit, there is a systematic examination of the records and documents or of the

financial statements themselves of the company in which they are used by the

auditor to express an opinion about the financial statements as to their fairness

(Toppr, n.d.). For an audit evidence to be considered good, it must be sufficient,

reliable, the source may be internal or external in which external sources are more

reliable, the nature can be documentary, visual, or oral, and it must be relevant.

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

reading the document.

In reading the PSA Glossary of Terms, I learned the following words. The

following definitions are given by the Auditing Standards and Practices Council

(2002):

a. Assertions – this are the management’s representations which may be explicit or

not as embodied in the financial statements.

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b. Audit evidence – audit evidence is the information that the auditor obtained to

arrive at the conclusions from which the audit opinion is based upon.

c. Audit risk – audit risk is defined as the risk that the auditor provides an

inappropriate opinion on the financial statements which are actually materially

misstated.

d. Misstatement – this is the mistake in the financial information which arises from

fraud or error.

e. Opinion – this is included in the report of the auditor in which the opinion is

expressed if the financial statements are fairly presented and are with

accordance to the financial reporting framework.

In an audit engagement, there exists the assertions of the management which

are the representations. They are in the financial statements which would be used

as audit information or audit evidence that will be used in the engagement. The

auditor then examines the evidence and checks the audit risk to ensure that the

engagement is free from material misstatements. The audit risk must be minimized,

and the misstatements must be corrected. Then the results of the audit will be

communicated by the auditor to the management by means of a conclusion in which

an opinion is included.
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References

Audit Risk: Components of Audit Risk. (n.d.). iEduNote. https://www.iedunote.com/audit-

risk

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

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

December-2002.pdf

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

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

Prasad, M. V. K. (2017, November 15). The components of audit risk. Business Line.

https://www.thehindubusinessline.com/news/education/The-components-of-audit-

risk/article20399923.ece

Sound Judgment. (n.d.). In Vocabulary.com dictionary.

https://www.vocabulary.com/dictionary/sound%20judgment#:~:text=n%20the

%20capacity%20to%20assess,by%20emotions%20or%20personal

%20prejudices

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.
Nicodemus, Daena D. A-331 AAPRINCIPLES

Tuovila, A. (2019, May 23). Audit Risk. Investopedia.

https://www.investopedia.com/terms/a/audit-risk.asp

Tysiac, K. (2014, August 27). Five elements of effective judgment process for auditors.

Journal of Accountancy.

https://www.journalofaccountancy.com/news/2014/aug/201410836.html