Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 1

OVERVIEW OF FINANCIAL STATEMENTS

Objectives of financial statement audit

PSA 120 states that the objective of an audit of financial statements is to enable to auditor
to express an opinion whether the financial statements are prepared in all material respect, in
accordance with the identified financial reporting framework. Although the auditor’s opinion
enhances the credibility if the financial statements, the user cannot assume that the opinion is an
assurance as to the future viability of the entity nor the efficiency o effectiveness with which
management has conducted the affairs of the entity.
While the auditor is responsible for performing and expressing an opinion on the
financial statements, management has the primary responsibility of preparing and presenting this
financial statements in conformity with accounting standards generally accepted in the
Philippines.

General principles of an audit

1. The Code of Professional Ethics for Professional Accountants in the Philippines
promulgated by the Board of Directors of the Philippine Institute of CPAs (PICPA) and
recommended for adoption by the Board of Accountancy (BOA) and approved by the
Professional Regulation Commission. Ethical principles governing the auditor’s
professional responsibilities include: (a) independence, (b) integrity, (c) objectivity, (d)
professional competence and due care, (e) confidentiality, (f) professional behavior, and
(g) technical standards.
2. The audit should be conducted in accordance with the Philippine Standards on Auditing.
The procedures required in the conduct of the audit should also give consideration to the
requirements of relevant professional bodies, legislation, and regulation and where
appropriate, the terms of the engagement and reporting requirements.
3. The auditor should plan and perform the audit with and attitude of professional
skepticism. It is expected that evidence should be obtained about management’s
representations and should not be assumed as necessarily correct.

Assurances provided by auditor

When the auditor renders an opinion on the audited financial statements, three important
concepts underlie the assurances that the auditor makes to users of the financial statements:
 On the basis of evidence gathered ( which include sampling)
 The auditor provides reasonable assurance (an implicit risk that the overall audit
conclusion is not correct)
 That the financial statements are free form material misstatements (materiality)
 Material misstatement – the auditor’s report contains no guarantee that the
financial statements are accurate. Rather, the auditor provides reasonable
assurance concerning material misstatements and an opinion on fairness, in all
material respects.
 Reasonable assurance – the concept of reasonable assurance alludes to the
concept of audit risk which is implicit in the audit function and implied in the
scope paragraph of the auditor’s report. It is a concept relating to the
accumulation of audit evidence necessary for the auditor to conclude that there
are no material misstatements in the financial statements taken as a whole.
 Sampling – this test basis states explicitly that sampling is used to gather
evidence on financial statement amounts and disclosures.

Inherent limitations of the audit

There are inherent limitations in an audit that affect the auditor’s ability to detect material
misstatement as a result of the use of testing, the inherent limitations of accounting and internal
control systems such as collusions, and the fact that most audit evidence is persuasive rather than
conclusive.
Collusion arises when two or more individuals work together to affect misappropriations
or concealment. For instance, a person having custody over incoming cash receipts might
conspire with a person responsible for processing and recording those receipts. Together, these
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 2

individual could divert the cash and conceal the same through various irregularities such as
failing g to record the receipt, overstating discounts, recording of fictitious returns, or writing off
an accounts receivable.

Overview of the audit function for a financial statement audit

The overall objective of the audit of the financial statement of an entity is to gather and
evaluate audit evidence of sufficient quantity and appropriate quality (i.e. appropriate relevance
and reliability) in order to form, and of the assertion of management inherent in those financial
statements for the purpose of adding credibility to those assertions.
\ Figure 2.1 is a pictorial diagram of a simplified overview of the audit function for
financial statement audit. The auditor gathers evidence about the business transactions that have
occurred and about management. These evidences are used to compare the assertions contained
in the financial statements to the established criteria for the purpose of determining the degree of
their correspondence and thus become the basis of the report to be issued in the engagement.

Auditing in management assertions

PSA “Glossary of Terms” defines assertions as representations by management, explicit
or otherwise, that are embodied in the financial statements. Generally, there are two categories
of management assertions: (1) internal control assertions, and (2) financial statement assertions.

Internal control assertions

Management is responsible for the internal procedures it establishes. There is an implied
assertion by management that such internal control are effective as to both their design and
operation.

Financial statement assertions

Management is responsible for the preparation of the financial statements of an entity.
The financial statements so prepared are a collection of assertion as to both the state of affairs of
the entity at balance sheet date and the results of its operations for the period then ended. In
broad terms, managements assertions that the financial statements, and by implication the
financial statement items and underlying account balances and classes of transactions, are free of
material misstatements. That is, that the financial statement items, and underlying account
balances and classes of transactions are, in all material respects, complete, valid, and accurate.
This broad concept of financial statement assertions can be broken down by level of
aggregation: (1) financial statements level, (2) account balance level, and (3) class of transaction
level and depicted in tabular form in figure 2.2
Most reader of financial statements tends to focus on highly aggregated assertions about
gross profit, income and assets. However, these financial statement assertions are decomposed
into a more detailed set of statements referred to as management or financial assertions. As such,
they are considered to be the basic building blocks of accounting information in our generally
susceptible to examination by the auditor (refer to figure 2.4 showing the relationship of
management assertions and audit objective of the inventory account). Auditing standards (PSA
500, evidence) classify management assertion into seven categories:
1. Existence – an asset or liability exist at a given date
2. Rights and obligations – an asset or liability pertains to the entity at a given date
3. Occurrence – a transaction or event took place which pertain to the entity during the
period
4. Completeness – there are no unrecorded assessments, liabilities, transactions or events, or
undisclosed items
5. Valuation – an asset or liability is recorded at appropriate carrying value
6. Measurement – a transaction or event is recorded at the proper amount and revenue or
expenses are allocated to the proper period; and
7. Presentation and disclosure – an item is disclosed, classified, and described in accordance
with the applicable financial reporting framework

Audit Objectives
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 3

The auditor’s work consist of accumulating and evaluating evidence concerning

assertions. This accomplished by developing audit objectives that relates to the management
assertions. In order to meet the audit objectives developed by management assertions, audit
procedures are performed by the auditor in gathering evidence which is evaluated to form the
basis of the audit report. The evidence needs to be of such quantity and quality that the auditor is
able to form an opinion on the financial statements.
Thus, it may be stated that the objective of the audit of the financial statement of an entity
is to gather and evaluate evidence of sufficient quantity and appropriate quality in order to form
an opinion on the financial statements prepared by management. The word ‘quality’ refers to the
relevance and reliability of the evidence and ‘entity’ includes entities such as partnerships, trust,
government departments, quasi-government organizations as well as corporate entities. The
objectives of the audit of financial statements are the same, irrespective of the entity to which
the financial statements relate.
Financial statements are considered ‘reliable’ if they are, in all material respects,
complete, valid, and accurate. That is, financial statements are reliable when they contain no
material misstatements, which are in effect what management asserts when they prepare the
financial statements.

Three Fundamental Concepts in Conducting an Audit

A financial statement audit requires an understanding of three fundamental concepts:
materiality, audit risk and evidence. These three concepts interact during the course of the audit
and determine the manner in which to conduct the audit. The auditor gathers evidence to
determine the risk that a material misstatement exists in one or more assertions made by the
client. The more evidence the auditor obtains, the more convinced he/she that there are no
undetected material misstatements on the assertions being examined.
The concept of materiality recognizes that certain matters are clearly important to
investors and other parties, while others are less important. PSA 320, audit materiality, requires
the auditor to assess materiality at both financial statements level and in relation to individual
account balance, class of transactions and disclosure. When establishing materiality levels on a
financial statement basis, it is important for the auditor to consider the interrelationships that
exist between the financial statements. Further, materiality is measured in terms of quantitative
and qualitative factors.
The second concept is audit risk. Risk in an audit deals with the reality that auditors can
never be completely certain that the assertions they are auditing, be they single accounts of full
financial statements are entirely free of omissions or misstatements. In theory, audit risk ranges
anywhere from zero (0.0), where there is complete certainty of no material misstatement, to one
(1.0), where there is complete certainty of a material misstatement. In practice, however, audit
risk is always greater than zero. There is always some risk of material misstatement as it is not
possible, (except for the audit of the simplest financial statements), due to the limitations
inherent in both accounting and auditing, to be absolutely certain that a material misstatement
does not exist.
The third concept is audit evidence, which refers to the necessary information that an
auditor gathers in order to form a credible opinion on the assertions on the clients management
that are inherent in the financial statements. These evidence
will therefore often include information related to the completeness, validity and accuracy of the
recorded value of assets, liabilities and equity of the client entity.
The risk of material misstatement is an important concept for auditors as, for a given
acceptable level of audit risk, the greater the risk of material misstatement, the greater is both the
quantity and quality of evidence that is required to be gathered and evaluated by the auditor.

THE AUDITOR’S RESPONSIBILITY FOR ERRORS, FRAUD, AND ILLEGAL ACTS

The auditor has a responsibility to plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement whether
caused by error or fraud. Likewise, the auditor should recognize that non-compliance by the
entity with laws and regulations may materially affect the financial statements.

Approaches to auditing financial statements

Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 4

Auditing is a profession in transition. Tremendous changes have affected the practice of

public accounting especially in the manner of conducting an audit of financial statements. Over
the years, audit practitioners have used and shifted to various audit approaches, depending on the
circumstances obtained in the client entity. The audit approach refers, in broad terms, to the
manner in which the evidence in relation to each material financial statement assertion is to be
gathered and evaluated during the final three audit stages. In particular, the audit approach refers
to the planned extent to which reliance will be place on (i) management internal control
procedures, (ii) test of transactions underlying account balances and (iii) the extent of analytical
procedures.
Auditors determine the audit approach for each assertion relating to each account balance
during the audit planning stage. However, as the audit progress and the auditor obtain more
knowledge of the entity’s business, the auditor subsequently may amend the audit approach.
Following is discussion of various types of audit approaches, which have evolved over time.

Top-down Approach
This audit approach starts with the identification of strategic issues affecting the audit,
uses them to determine an overall audit strategy for the audit and arrives at the detailed work on
the basis of the audit strategy. Strategic issues include: (1) materiality, (2) audit objectives, (3)
audit risk, and (4) the control environment.

Balance Sheet Approach

An approach that involves auditor auditing the assets and liabilities of the entity with
little emphasis on profit and loss account items.

Transaction Cycle Approach

This audit approach emphasizes the review of controls which operate within each
transaction cycle and provides for limited testing of balance sheet items. Typical transaction
cycles include: revenue, expenditure, conversion, and administrative.

Systems Approach
Where, in relation to a particular account balance assertion, the auditor plans significant
reliance on controls over management’s accounting information system, the approach for that
account balance assertion is referred to as a systems approach. In such instances, the auditor
performs tests of controls to gather evidence of the effectiveness of operation of the systems
control procedures upon which reliance is planned. As a general rule, the auditor adopts a
systems approach when control risk relating to a particular account balance assertion is evaluated
as low.

Verification or Substantive Approach

Where the auditor does not plan any reliance on the system’s control, the audit approach
for that assertion is referred to as a verification approach or a substantive approach. In this
instance, the auditor performs no tests of control and instead plans total reliance on the results of
substantive audit procedures. Normally, the auditor adopts this approach when control risk
relating to a particular account balance assertion is evaluated as high.

Risk-based Audit Approach

An audit in which the auditor carefully analyzes the entity and its existing internal
controls, identifies areas that post a high risk [probability] of financial statement errors, and
[therefore] allocates a greater proportion of audit resources to those areas.

Financial risk-analysis approach

In this approach, the auditor considers relative financial risk and materiality in planning
the audit, such that audit work is concentrated in areas where there is a high risk of misstatement

Strategic business risk approach

Instead of testing internal control procedures at a single interim time period, the auditor
applies this tests, along with tests of tests of transaction with frequents intervals throughout the
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 5

year with sophisticated computer-based accounting applications who do not contain permanent
records of audit trail. By frequently testing both control procedures and transactions during the
year, the auditor is able to locate and substantiate controls and transactions before audit trail is
lost.

In-depth vs. non In-depth Approach

Where the auditor plans significant reliance on the results of test of classes of transactions
that underlie, for example, a particular account balance assertion, the approach, in respect of that
account balance assertion, is referred to as in-depth approach. A non in-depth approach is where
the auditor does not perform any transaction testing other than the scanning of underlying classes
of transactions. In other words, a non in-depth approach is where the auditor does not perform
any other test of controls or tests of details of classes of transactions underlying an account
balance and instead plans total reliance on the results of tests of the account balances
(substantive procedures and possibly tests of controls) and the scanning of underlying classes of
transactions.
The extent of transaction testing (in-depth approach) relating to a particular account
balance assertion depends on the quantity and quality of evidence required by the auditor to form
an opinion as to the extent of misstatements in the account balance. When the allowable level of
detection risk is evaluated as moderate or high and control risk is evaluated as moderate or low,
there is generally no need for an in-depth approach.
The general rule is the higher the quantity and quality of evidence required in relation to
an account balance assertion, the greater the need for the testing of transactions underlying the
account balance level. This means that auditor will often adopt an in-depth approach for those
revenue and expense account balances that have been selected for examination in order to gather
the quantity and quality of evidence required to form an opinion as to the extent of misstatements
in the account balance. For example, when a very high quantity of evidence is required, such as
when the allowable level of detection risk for a particular balance assertion is evaluated as low
and control risk is evaluated as high, the auditor adopts an in-depth approach for that account
balance assertion. On the other hand, when the allowable level of detection risk is evaluated as
moderate or high and control risk is evaluated as moderate or low, there is generally no need for
an in-depth approach.
The general rule is the higher the quantity and quality of evidence required in relation to
an account balance assertion, the greater the need for the testing of transactions underlying the
account balance. Note that when auditors gather evidence in relation to revenue and expense
account balances, there is often little evidence available at the account balance level. This means
that auditors will often adopt an in-depth approach for those revenue and expense account
balances that have been selected for examination in order to gather the quantity and quality of
evidence required to form an opinion as to the extent of the misstatements in the account
balance.

ANALYTICAL VS. NON-ANALYTICAL APPROACH

In relation to the planned substantive procedures referred to above, where the auditor
plans significant reliance on the results of analytical procedures as opposed to the results of tests
of detail, the approach for that account balance assertion is referred to as an analytical approach.
A non-analytical approach is where the auditor does not perform any analytical procedures and
instead plans total reliance on the results of tests of detail.
In broad terms, an auditor adopts an analytical approach for an account balance assertion
when the allowable level of detection risk is evaluated as high, a part analytical approach when it
is moderate and a non-analytical approach when it is low.

COMMUNICATING THE RESULTS OF THE AUDIT

At the end of the audit, the auditor will have obtained sufficient competent appropriate
evidential matter concerning the fairness of management assertions embodied in the financial
statements. The conclusions reached are formally communicated to users of financial statements
through the ‘independent auditor’s report’.
PSA 7000, The Auditor’s Report on Financial Statements, provides guidance on the form
and content of reports that should be used under different circumstances. There are five types of
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 6

reports and the formats that are used in a specific situation depending on the conclusions reached
by the auditor.

STANDARD UNQUALIFIED AUDITOR’S REPORT

The most commonly used report is the standard unqualified report, which is issued when
the auditor concludes that the evidential matter obtained supports the fairness and completeness
of all management assertions as embodied in the financial statements. The standardization of the
form and content of the auditor’s report helps promote the reader’s understanding and the
identification of unusual circumstances when they occur. Any deviation from the expected
wording inevitably raises questions in the minds of attentive readers.
A standard unqualified report asserts that an auditory understands the standards of the
profession and has made sure that the report measures up to them; that the financial statements
being reported on present what they purport to present fairly, in accordance with GAAP; and that
those principles have been applied on a basis consistent with that of the preceding year. In short,
a standard report signifies that the auditor found no problems or deficiencies, either in carrying
out the audit or in the financial statement under examination, of which the auditor believes a
reader of the financial statements should be aware.

MODIFIED REPORTS
When the eight basic elements of the auditor’s report are not kept intact (for example, a
fourth paragraph is added), the report is said to be modified. These modifications may or may
not affect the auditor’s opinion depending on the matters, including their level of maturity, which
had come to the attention of the auditor in the course of the audit examination. These matters or
circumstances, which will be discussed in-depth in a subsequent chapter, include:
 Matters that do not affect the auditor’s opinion, such as emphasis of matter
 Matters that do affect the auditor’s opinion: qualified opinion, disclaimer of
opinion, or adverse opinion.

Emphasis of a Matter
Under certain circumstances, an auditor may wish to emphasize specific matters
regarding the financial statements and still issue an unqualified opinion by adding an explanatory
paragraph after the opinion paragraph. The emphasis of a matter paragraph may either precede
or follow the opinion paragraph. The following are examples(PSA 700) of explanatory
information the auditor may consider to be expressed:
 Going concern problem
 Uncertainties (other than a going concern problem) whose resolution is dependent upon
future events
 Inconsistency – where the entity refuses to make necessary amendment to other
information in a document containing audited financial statements
 Additional statutory reporting responsibilities

A major assumption underlying the inclusion of an emphasis of a matter paragraph is that

the matter is adequately disclosed in the note to financial statements. The auditor simply chooses
to emphasize it. In situations involving multiple uncertainties that are significant to the financial
statements, the auditor may consider it appropriate to express a disclaimer of opinion instead of
adding an emphasis of a matter paragraph.

Reasons for Departure from the Wording of the Standard Audit Report
In addition, the reasons for the departures from the standard unqualified auditors report
may be grouped into three general categories: auditing-related, accounting-related, and the
auditor is not independent.
Auditing related. In cases where the auditor is unable to conduct the audit in accordance
with GAAS, there results a scope limitation which may be imposed by the client or by prevailing
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 7

conditions. Accordingly, the opinion rendered should be qualified or a disclaimer depending on

the materiality of the item involved.
Accounting-related. In cases where the auditor discovers that the clients financial
statements contain a departure from GAAP for which proposed audit adjustments were not
approved, the auditor should modify the opinion. Depending on the materiality of the unadjusted
departure, the opinion should be a choice between qualified or adverse.
Auditor not independent. Regardless of materiality level, the auditor should refrain from
expressing an opinion on a client’s financial statements if independence is impaired.

Other types of opinions

Qualified - opinion is issued when the financial statement present the entities financial
position, results of operation, and cash flows in conformity with GAAP except for the matter of
the qualification
Adverse – opinion is issued when the auditor concludes that the financial statements do
not present an entities financial position, results of operation, and cash flows in conformity with
GAAP. This type of opinion is only issued when the departure from GAAP is so significant that
the overall financial statements may not be fairly presented.
Disclaimer – opinion is issued when the auditor is unable to form an opinion or an
entity’s financial statements because of lack of sufficient competent evidence, or because of lack
of independence.

Summary of Key Points:

1. The audit enables the auditor to express an opinion whether financial statements are
prepared, in all material aspects, in accordance with the identified financial reporting
framework.
2. The phase used to express the auditor’s opinion is “present fairly in all material respects”.
3. The auditor’s opinion enhances the credibility of financial statements.
4. The user of audited financial statements cannot assume that the auditor’s opinion is an
assurance as to the future viability of the entity nor the efficiency or effectiveness with which
has conducted the affairs of the entity.
5. The auditor should comply with the Code of Professional Ethics for Professional Accountants
in the Philippines promulgated by the Board of Directors of the Philippine Institute of CPAs
(PICPA) and recommended for adoption by the Board of Accountancy (BOA) and approved
by the Professional Regulation Commission.
6. Ethical principles governing the auditor’s professional responsibilities include: (a)
independence, (b) integrity, (c) objectivity, (d) professional competence and due care,(e)
confidentiality, (f) professional behavior, and (g) technical standards.
7. Independence is the ability to act with integrity and objectivity.
8. A financial statement audit requires an understanding of 3 fundamental concepts: materiality,
audit risk, and evidence. The auditor’s judgment of materiality and audit risk establishes the
type and amount of the audit work to be performed (referred to as scope of the audit). In
establishing the scope of the audit, the auditor must make decisions about the nature, timing,
and extent of evidence to be gathered.
9. The auditor should conduct in accordance with the Philippine Standard in Auditing.
10. The auditor should plan and perform the audit with an attitude of professional skepticism
recognizing that circumstances may exist which caused the financial statements to be
materially misstated.
11. The auditor is responsible for forming and expressing an opinion on the financial statements,
the responsibility for preparing and presenting financial statements is that of the management
of the entity.
12. Three important concepts underlie the assurances that the auditor makes to user of financial
statements: (a) on the basis of evidence gathered, which include sampling, (b) the auditor
provides reasonable assurance or an implicit risk that the overall audit is not correct, and (c)
the financial statements are free from material misstatements.
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 8

13. Reasonable assurance is a concept relating to the accumulation of the audit evidence
necessary for the auditor to conclude that there are no material misstatements in the financial
statements taken as a whole.
14. An audit in accordance with PSAs is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatements.
15. The auditor’s opinion is not an assurance as to the future viability of the entity nor the
efficiency or effectiveness with which management has conducted the affairs of the entity.
16. The PSAs contain basic principles and essential procedures together with related guidance in
the form of explanatory and other material.
17. Reasonable assurance relates to the whole audit process.
18. Management assertions are categorized into: (a) existence, (b) rights and obligations, (c)
occurrence, (d) completeness, (e) valuation, (f) measurement, and (g) management and
disclosure.
19. The auditor’s report communicates the auditor’s opinion concerning the financial statements
to the users of those financial statements. This report is addressed to the parties who retained
the auditors (shareholders and/or board of directors). It is dated as of the last date of the
CPA’s fieldwork and is signed by a partner of the CPA firm.
20. The audit of the financial statements does not relieve management of its responsibilities for
preparing and presenting the financial statements.

MULTIPLE CHOICE:

1. Which of the following terms does not belong to the group

a. Financial Audit
b. Internal Audit
c. External audit
d. Independent audit

2. An external audit
a. Supports an internal audit
b. Duplicates an internal audit
c. Overlaps an internal audit
d. Complements an internal audit

3. The primary objective of the ordinary examination of financial statements by a CPA is the
expression of an opinion on the
a. Competence of management in accounting matters which is implied by whether the
opinion is qualified or not.
b. Conformity of the statements is qualified or not.
c. Conformity of the financial statements with generally accepted auditing standards applied
on a basis consistent with that of the preceding year.
d. Fairness with which the financial statements present financial position and results of
operations.

4. Although the CPA does not guarantee his findings, his opinion is nevertheless valuable to
various third parties. The value of the CPA’s opinion lies in the fact that
a. He has the qualifications required by law to be a CPA
b. He is under the supervision of the Board of Accountancy
c. He has gathered sufficient, competent evidential matter to support his opinion.
d. He has followed generally accepted auditing standards.

5. The independent auditor lends credibility to client’s financial statements by

a. Stating in the auditor’s management letter that the examination was made in accordance
with generally accepted auditing standards.
b. Maintaining a clear-cut distinction between management’s representations and the
auditor’s representation.
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 9

c. Attaching an auditor’s opinion to the client’s financial statements

d. Testifying under oath about client’s financial statements.

6. Which of the following best describes the reason why an independent auditor reports on
financial statements?
a. A management fraud may exist and it is more likely to be detected by independent
auditors.
b. Different interests may exist between the company preparing the statements and the
persons using the statements.
c. A misstatement of account balances may exist and is generally corrected as a result of the
independent auditor’s work.
d. A poorly designed internal control system may be in existence.

7. The major reason an independent auditor gathers audit evidence is to

a. Form an opinion on the financial statements
b. Detect fraud
c. Evaluate management
d. Evaluate internal control
e.
8. The primary responsibility for the adequacy of disclosure in the financial statements and
accompanying notes rests with the
a. Audit partner assigned to the engagement
b. Senior auditor in charge of field work
c. Staff auditor who drafts the statements and notes
d. Client management.

9. An audit should be designed to achieve reasonable assurance of detecting material

a. Errors
b. Errors and irregularities
c. Errors, irregularities, and those illegal acts with a direct effect on financial statement
amounts
d. Errors, irregularities and illegal acts

10. The criteria for evaluating quantitative information vary. For example, in the audit of
historical financial statements by CPA firms, the criteria are usually
a. Generally accepted auditing standards
b. Generally accepted accounting principles.
c. Regulations of Bureau of Internal Revenue
d. Regulations of the Security and exchange Commission

11. The process of recording, classifying, and summarizing economic events in a logical manner
for the purpose of providing financial information for decision making is
a. Accounting
b. Auditing
c. Management
d. Economics.

12. An audit of financial statements is conducted to determine if the

a. Organization is operating efficiently and effectively
b. Auditee is following specific procedures or rules set down by some higher authorities
c. Overall financial statements are stated in accordance with specified criteria
d. None of the above.

13. Auditing is based on the assumption that financial data and statements are
a. In conformity with GAAP
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 10

b. Verifiable
c. Presented fairly
d. Consistently applied

14. The essence of the attest function is to

a. Detect fraud
b. Examine individual transactions so that the auditor may certify as to their validity
c. Determine whether the client’s financial statements are fairly stated.
d. Assure the consistent application of correct accounting procedures.

15. A CPA’s opinion on financial statements is of little value to those who relied on him unless he
a. Issues an unqualified opinion
b. Maintains a program of continuing education
c. Serves his clients with professional concern for their best interests
d. Maintains his independence.

16. When an auditor expresses an opinion on financial statements, his responsibilities extend to
a. The underlying wisdom of his client’s management decisions
b. Whether the results of his client’s operating decisions are fairly presented in the financial
statements.
c. Active participation in the implementation of the advice given to his client.
d. An ongoing responsibility for his client’s solvency.

17. A limitation on the scope of an audit sufficient to preclude an unqualified opinion will
usually result when management
a. Is unable to obtain audited financial statements supporting the entity’s investment in a
foreign subsidiary
b. Refuses to disclose in the notes to financial statements related party-transactions
authorized by the board of directors.
c. Does not sign an engagement letter specifying the responsibilities of both the entity and
the auditor.
d. Fails to correct a reportable condition communicated to the audit committee after the
prior year’s audit.

18. For an entity’s financial statements to be presented fairly in conformity with GAAP, the
principles selected should
a. Be applied on a basis consistent with those followed in the prior year.
b. Be approved by the Auditing Standards and Practice Council or the appropriate industry
committee.
c. Reflect transactions in a manner that presents the financial statements with a range of
acceptable limits.
d. Match the principles used by most other entities within the entity’s particular industry.

19. The existence of audit risk is recognized by the statement in the auditor’s standard report that
the auditor
a. Obtains reasonable assurance about whether the financial statements are free of material
misstatements
b. Assesses the accounting principles used and also evaluates the overall financial statement
presentation.
c. Realizes some matters, either individually or in the aggregate, are important.
d. Is responsible for expressing an opinion on the financial statements that are the
responsibility of management.’

20. An auditor may reasonably issue a qualified opinion for a

Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 11

Scope Unjustified
Limitation Accounting Change
a. YES NO
b. NO YES
c. YES YES
d. NO NO

RPCPA BOARD EXAMINATIONS

MULTIPLE CHOICE

21. The value of the auditor’s attest function involves the application of
a. The general standards
b. The standards of fieldwork
c. The standards of reporting
d. Due professional care

22. The independent audit is important to users of financial statements in as much as it

a. Reports on the validity of all accounting data in the financial statements.
b. Involves the objective examination of and reporting on financial statements prepared by
management.
c. Determines the management capability of the client whose financial statements are under
review.
d. Evaluates and communicates financial data included in financial statements.

23. The independent audit is important to readers of financial statements because it:
a. Determines the future stewardship of the management of the company whose financial
statements are audited.
b. Measures and communicates financial and business data included in financial statements.
c. Involves the objective examination of and reporting of management prepared statements.
d. Reports on the accuracy of all information in the financial statements.

24. Auditing standards differ from auditing procedures in that procedures relate to:
a. Measures of performance
b. Audit principles
c. Acts to be performed
d. Audit judgments

25. The principal reason for an independent auditor to gather and evaluate audit evidence is to:
a. Form an opinion on the financial statements
b. Detect fraud
c. Evaluate management
d. Evaluate internal control

26. An independent audit aids in the communication of economic data because the audit:
a. Confirms the accuracy of management’s financial representations.
b. Lends credibility to the financial statements.
c. Guarantees that financial data are fairly presented.
d. Assures the readers of financial statements that any fraudulent activity has been
corrected.

27. Broadly defined, the subject matter of any audit consists of

a. Financial statements
b. Economic data
c. Assertions about economic actions and events
d. Operating data
28. What is the essence of the external audit function?
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 12

a. To detect fraud
b. To examine individual transactions so that the auditor may certify their validity
c. To determine whether the client’s financial statements are fairly stated
d. To assure the consistent application of correct accounting procedures

29. The primary reason for an audit of financial statements is to

a. Satisfy government regulatory requirements
b. Guarantee that there are no misstatements in the financial statements
c. Relieve management of responsibility for the financial statements
d. Provide increased assurance to users as to the fairness of the financial statements

30. Most of the independent auditor’s work in formulating an opinion on financial statements
consists of:
a. Studying and evaluating internal control
b. Obtaining and examining evidential matter
c. Examining cash transactions
d. Comparing recorded accountability with assets

31. In financial statement audits, the audit process should conform with
a. Generally accepted auditing standards (GAAS)
b. Generally accepted accounting principles (GAAP)
c. The audit program
d. The auditor’s judgment

32. The primary purpose of an independent financial statement audit is to:

a. Provide a basis for assessing management’s performance
b. Comply with state regulatory requirements
c. Assure management that the financial statements are unbiased and free from material
error
d. Provide users with an unbiased opinion about the fairness of information reported in the
financial statements

33. An external audit

a. Supports an internal audit
b. Duplicates an internal audit
c. Overlaps an internal audit
d. Complements an internal audit

34. The primary objective of the ordinary examination of financial statements by a CPA is the
expression of an opinion on
a. The competence of management in accounting matters which is implied by whether the
opinion is qualified or not
b. The conformity of the statements with the books of account
c. The conformity of the financial statements with generally accepted auditing standards
applied on a basis consistent with that of the preceding year
d. The fairness with which the financial statements present financial position and results of
operations

35. Although the CPA does not guarantee his findings, his opinion is nevertheless valuable to
various third parties. The value of the CPA’s opinion lies in the fact that
a. He has the qualifications required by law to be a CPA
b. He is under the supervision of the Board of Accountancy
c. He has gathered sufficient, competent, evidential matter to support his opinion
d. He has followed generally accepted auditing standards

36. The independent auditor lends credibility to client’s financial statements by

Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 13

a. Stating in the auditor’s management letter that the examination was made in accordance
with generally accepted auditing standards
b. Maintaining a clear-cut distinction between management’s representations and the
auditor’s representation
c. Attaching an auditor’s opinion to the client’s financial statements
d. Testifying under oath about client’s financial statements

37. Which of the following best describes the reason why an independent auditor reports on
financial statements?
a. A management fraud may exist and it is more likely to be detected by independent
auditors
b. Different interests may exist between the company preparing the statements and the
persons using the statements
c. A misstatement of account balances may exist and is generally corrected as a result of the
independent auditor’s work
d. A poorly designed internal control system may be in existence

38. Which of the following best describes why publicly-traded corporations follow the practice
of having the outside auditor appointed by the board of directors elected by the stockholders?
a. To comply with the regulations of the Financial Accounting Standards Board
b. To emphasize auditor’s independence from the management of the corporation
c. To encourage a policy of rotation of the independent auditors
d. To provide the corporate owners with opportunity to voice their opinion concerning the
quality of the auditing firm selected by the directors

39. The process of recording, classifying, and summarizing economic events in a logical manner
for the purpose of providing financial information for decision making is
a. Accounting
b. Auditing
c. Management
d. Economics

40. An audit of financial statements is conducted to determine if the

a. Organization is operating efficiently and effectively
b. Auditee is following specific procedures or rules set down by some higher authority
c. Overall financial statements are stated in accordance with specified criteria
d. None of the above

41. An audit can have a significant effect on

a. Information risk
b. Business risk
c. The risk-free interest rate
d. All of these

42. Auditing is based on the assumption that financial data and statements are
a. In conformity with GAAP
b. Verifiable
c. Presented fairly
d. Consistently applied

43. The risk that the client’s financial statements may be materially false and misleading is
referred to as the
a. Business risk
b. Information risk
c. Client risk
d. Risk assessment
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 14

44. Which of the following is not one of the concepts in the framework of auditing theory?
a. Ethical conduct
b. Conflict of interest
c. Evidence
d. Fair presentation

45. Which of the following is an incorrect phrase?

a. Auditing is a systematic process
b. Auditing subjectively obtains and evaluates evidence
c. Auditing evaluates evidence regarding assertions
d. Auditing communicates results to interested users

46. Which of the following is a correct statement relating to the theoretical framework of
auditing?
a. The financial data to be audited can be verified
b. Short-term conflicts do not exist between managers who prepare data and auditors who
examine data
c. Auditors do not necessarily need independence
d. An audit is of benefit only to the owners

47. Which of the following is an incorrect statement relating to the theoretical framework of
auditing?
a. Effective internal control structure reduces the probability of fraud or irregularities in an
organization
b. Application of generally accepted accounting principles results in a fair presentation of
financial statements
c. When examining financial data for the purpose of expressing an independent opinion
thereon, the auditor acts exclusively in the capacity of an auditor
d. In collecting evidence, auditors should maintain an attitude of trust about their client’s
assertions

48. Which of the following statements does not describe a condition that creates a demand for
auditing?
a. Conflict between an information preparer and a user can result in biased information
b. Information can have substantial economic consequences for a decision maker
c. Expertise is often required for information preparation and verification
d. Users can directly assess the quality of information

49. Which of the following criteria is unique to the independent auditor’s attest function?
a. General competence
b. Familiarity with the particular industry of each client
c. Due professional care
d. Independence

50. Users of financial statements demand independent audit because

a. Users demand assurance that fraud does not exist
b. Management may not be objective in reporting
c. Users expect auditors to correct management errors
d. Management relies on the auditor to improve internal control

51. The market for auditing services is driven by

a. The regulatory authority of the Securities and Exchange Commission
b. A demand by external users of financial statements
c. Pronouncements issued by the Auditing Standards and Practices Council
d. Congress at the state level

52. Financial statement audits

Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 15

a. Reduce the cost of the capital

b. Report on compliance with laws and regulations
c. Assess management’s efficiency
d. Overlook information risk

53. Which of the following is an example of an assertion made by management in an entity’s

financial statements?
a. The financial statements were prepared in an unbiased manner
b. Reported inventory balances reflect all related transactions for the period
c. Reported accounts receivable do not include any uncollectible accounts
d. The scope of the auditor’s investigation was not limited in any way by management

54. Which of the following statements reflects an auditor’s responsibility for detecting fraud and
error?
a. An auditor is responsible for detecting employee errors and simple fraud, but not for
discovering fraud involving employee collusion or management override
b. An auditor should plan the audit to detect errors and fraud that are caused by departures
from GAAP
c. An auditor is not responsible for detecting errors and fraud unless the application of
GAAS would result in such detection
d. An auditor should design the audit to provide reasonable assurance of detecting errors
and fraud that are material to the financial statements

55. Which of the following is not an example of error?

a. Client personnel make mistakes in gathering or processing accounting data from which
financial statements are prepared
b. Client personnel alter accounting records from which financial statements are prepared
c. Client personnel overlook or misinterpret facts, causing accounting estimates to be
incorrect
d. Client personnel make mistakes in the application of accounting principles

56. An auditor’s report may be addressed to the company whose financial statements have been
examined or to that company’s:
a. President
b. Board of Directors
c. Controller
d. Chief accountant

57. Which is now known as the “third statement” in accounting reports?

a. The balance sheet
b. The income statement
c. The statement of retained earnings
d. The statement of cash flows

58. The adequacy of disclosures in the financial statements and footnotes is the primary
responsibility of the
a. Client
b. Auditor in charge of field work
c. Partner assigned to engagement j
d. Staff member who drafted the statements

59. Which of the following must accompany unaudited financial statements which are prepared
by a CPA?
a. Qualified opinion
b. Adverse opinion
c. Piecemeal opinion
d. Disclaimer opinion
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 16

60. Mr. Flores has been retained as auditor of White Company. The function of his opinion on
financial statements of White Company is to:
a. Improve financial decisions of company management
b. Lend credibility to a management’s representations
c. Detect fraud and abuse in management operations
d. Serve requirements of BIR, SEC or Central Bank

61. On September 22, 20x3, the auditor completed the required field work on a client’s financial
statements for the fiscal year ended June 30, 20x3. The date when the audit report was finally
drafted, the auditor learned from one of the officials that one of their factories including a
stock of finished goods was destroyed by fire. This loss was soon after confirmed in a written
report dated October 30, 20x3. What date should the audit report bear?
a. September 22, 20x3
b. October 23, 20x3
c. October 30, 20x3
d. June 30, 20x3

62. An unqualified opinion may be submitted only:

a. If an audit has been conducted in accordance with generally accepted auditing standards
b. If it has been possible to apply all procedures necessary in the circumstances
c. If the auditor has no reservations concerning the fairness of the financial statements
d. All of the above

63. When the auditor believes that the financial statements are misleading or do not reflect the
proper application of generally accepted accounting principles, the report will contain:
a. Disclaimer of opinion
b. Qualified opinion
c. Unqualified opinion
d. Adverse opinion

64. Material weaknesses in internal controls prevent the auditor’s collection of sufficient,
competent evidential matter and will justify the issuance of:
a. Disclaimer of opinion
b. Qualified opinion
c. Unqualified opinion
d. Adverse opinion

65. An auditor, depending upon a given situation, may express an unqualified opinion, a
qualified opinion, an adverse opinion or a disclaimer. Accordingly, what is the most suitable
opinion if a CPA has made an examination in accordance with generally accepted auditing
standards, and financial statement presentation conforms with generally accepted accounting
principles applied on a consistent basis and includes all informative disclosures necessary to
make the statements not misleading?
a. Unqualified
b. Qualified
c. Adverse
d. Disclaimer

66. When a CPA who is deemed not independent is “associated” with financial statements, this
suggests:
a. Unqualified opinion
b. Qualified opinion
c. Adverse opinion
d. Disclaimer
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 17

67. If a CPA has not obtained sufficient competent evidential matter to form an opinion on the
fairness of the presentation of the financial statement as a whole:
a. Unqualified opinion
b. Qualified opinion
c. Adverse opinion
d. Disclaimer

68. When the financial statements do not fairly present the financial position in conformity with
generally accepted accounting principles?
a. Unqualified opinion
b. Qualified opinion
c. Disclaimer opinion
d. Adverse opinion

69. If the auditor has no reservations concerning the fairness of the financial statements:
a. Unqualified opinion
b. Qualified opinion
c. Disclaimer opinion
d. Adverse opinion

70. If the scope of the examination has been satisfactory for all items except for one of material
amount?
a. Unqualified opinion
b. Qualified opinion
c. Disclaimer opinion
d. Adverse opinion

71. When the auditor associated with the financial statements considers himself or herself not to
be independent with respect to the auditee or its agents and affiliates?
a. Unqualified opinion
b. Qualified opinion
c. Disclaimer opinion
d. Adverse opinion

72. When the auditor’s exceptions are of such significant materiality that the financial
statements, taken as a whole, would be misleading to the users?
a. Unqualified opinion
b. Qualified opinion
c. Disclaimer opinion
d. Adverse opinion

73. The auditor, if he believes that required disclosures of a significant nature are omitted from
the financial statements under examination, should decide between issuing:
a. A qualified opinion or an adverse opinion
b. A disclaimer opinion or a qualified opinion
c. An adverse opinion or a disclaimer of opinion
d. An unqualified opinion or a qualified opinion

74. The adequacy of disclosure in the financial statements and footnotes is the primary
responsibility of:
a. Partner assigned to the engagement
b. Auditor in charge of field work
c. Staff who drafts the statement and footnotes
d. Client

75. When an auditor expresses an opinion on financial statements, his responsibilities extend to:
a. The underlying wisdom of his client’s management decisions
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 18

b. Whether the results of his client’s operating decisions are fairly presented in the financial
statements
c. Active participation in the implementation of the advise given to his client
d. An ongoing responsibility for his client’s solvency
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 19
Chap 2 Overview of Financial Statement Audit (Evangelista & Racasa) page 20