AUDITING THEORY

AT. Fundamentals of Assurance and Non-assurance Engagements

LECTURE NOTES

Introduction

Public practitioners offer a wide aray of professional services to various clients,

profit or non-profit, private or public, mainly dealing wit its financial aspects.
These may include the traditional audit and review of FSs, tax compliancce
and consuting, transaction and financial advisory into two: assurance ad
non-assurance.

Practice of Public Accountancy

RA 9298 deines practice of public accountancy as when a person is skilled in

the knowledge, science and practice of accounting and as a qualified person to
render professional services as a CPA to more than one client on a free basis.

CPAs in public accoountanncy shall practice under individual capacity, firm

(sole proprietorship) or partnership name, and shall not include any fictitious
namen, indicates specialiazation, or is misleading as to the type of
organization (prorietorship or partnership). The SEC shall public all the other
partner surviving the death or withdrawal of all other partners in a Partnership
may continue to practice under the Partnership name for a period of not more
than two years after becoming a sole prorietorship.

Accreditation to Practice Public Accountancy

CPAs shall first obtain a certificate of accreditation from the Boa/PPRC before
they can be allowed to practice public accountancy after attaining a minimum
of three years meaningful experience.

Meaningful Experience

Commerce and Industry Significant involvement in general

accounting, budgeting, tax
administration, auditing, liason with
external auditors, representing his/her
employer before gov’t agencies on tax
and matters related to accounting
functions; or
Academe/Education Teaching for at least three trimesters or
two semesters accounting related
subjects. The accumulated teaching
experience on these subjects shall not
be less than three school years; or

Government Significant involvement in general

accounting, budgeting, tax
administation, internal auditing, liaison
with the CoA or any other related
functions

Public practice At least one year as audit asssitance

and at least two years as auditor in
charge of audit engagement covering
full audit functions of significant clients.

Renewal of Certificate of Accreditation

The registration shall be valid for a period of three years and may be renewed
every three years on or bfore September 30 in the year of expiry. The
registration of applicants approved during any month of the year shall expire
on December 31 in the third year following its approval. The BoA shall require
public practitioners to undergo quality review conducted by Quality Review
Committee (QRC) before granting renewal of accreditation.

Death, Disability, Dissolution and Liquidation

The death or disability of an individual CPA and/or the dissolution and

liquidation of a firm or partnership of CPAs shall be reported to the BoA, in the
form of affidavit, not later than 30 days from the date of such death, dissolution
or liquidation.

Ownership of Working Papers

Confidential and privileged and remain the property of such CPA in the
absence of a written agreement between the CPA and the client, to te contrart
unless such documents are required to be produced through subpoena issued
by any court, tribunal , or government regulatory or administrative body in
accordance with Philippine laws.
Seal and Use of Seal
The auditor’s report shall stamped with said seal, indicating therein his/her
current Professional Tax Receipt (PTR) number, date/place of payment when
filed with government authorities or when professionally.
Circular in form with a smaller circle within and in the upper portion of the
space between the circles shall be partnership as the case maybe, the lower
portion thereof shall be engraved the CPA Registration Number of the
individual CPA, proprietor of the firm and the signing partner of the partnership
and in the middle of the smaller circle shall be engraved the letters “CPA”.
Affixing the CPA’s seal and signature is an indication of compliance by the
CPA of the requisite accounting and auditing standard and rules.

Definition and Objective of an Assurance Engagement

In an assurance engagement, a practitioner expressess a conclusion designed

to enchance the degree of confidence of the intend users other than the
responsible party about the outcome of the evaluation or measurement of
engagemennt of subject matter against criteria. Hence, an assurance
engagement is an independet professional service that improves is a quality
(credibility) of information for decision makers.

Assurance services are very broad, and can be done by CPAs or by a variety
of other professionals.

Need for Unbiased Reporting and Independent Assurance

The demand for assurance services emanate from the following reasons:

 Potential bias in providing information

 Remoteness between a user and the organization or trading partner
 Complexity of the transactions, information or processing systems
 Investors need to manage their risk and thereby minimize financial
suprises as consequences to investors, and others, of relying on
inaccurae information can be quite significant. Assurance engagements
reduce information risks of he subject matter.

Types of Assurance Engagement

1. As to level of assurance conveyed:

a. Reasonable assurance engagement. The objective is a reduction

in assurance engagement risk to an acceptably low level as the
basis for a positive form of expression of the practitioner’s
conclusion.
 An example is audit of historical FFs.

b. Limited assurance engagement. The objective is areduction in

assurance engagement risk to a level that is acceptable in the
circumstances of te engagement, but where that risk is greater
than for a reasonable assurance engagement, as the basis for a
negative form of expression of the practitioner’s conclusion. An
exampple is review of historical FFs.

2. As to structure of engagement:

a. Assertion-based engagement. In this type of engagement, the

evaluation or measurement of the subject matter is performed by
the responsible party, and the subject matter information is in the
form of assertion by the responsible party that is made available
to the intended users. Independent financial statements audit
normally falls under this type.

b. Direct reporting engagement. In this type of engagements, the

practitioner either directly performs the evaluation or
measurements of the subject matter, or obtains a representation
from the responsible party that has performed the evaluation of
measurements that is not available to the intended users. The
subject matter information is provided to the intended users in
the assurance report.

Elements of an Assurance Engagement

The five elements of an assurance engagement are:

a. A three party relationship involving a practitioner, a responsible party,

and intend users;

b. An appropriate subject matter;

c. Suitable criteria;

d. Sufficient approriate evidence; and

e. A written assurance report in the form approriate to a reasonable

assurance engagement or a limited assurance engagement.

Three-party Relationship
Assurance engagements involve three separate parties:
 1. Practitioner – the person, who performs the engagement, and is
broader than the term “auditor” which release only to practitioners
performing audit or review engagements with respect to historical
financial information.
2. Responsible party – is the person responsible for
a. Direct reporting engagement – subject matter; or
b. Assertion-bassed engagement – a subject matter information
(the assertion), and may be the subject matter. The responsible
party may or may not be the party who engages the practitioner
(the engaging party).
3. Intended party – for whom the assurance report is prepared. The
responsible party can be one of the intended users, but not the only
one.

Appropriate subject matter

The subject matter, and subject matter information, of an assurance
engagement can take many forms, such as;
a. Financial performance or conditions (for example, historical or
prospective financial statements)
b. Non-financial performance or conditions (for example, performance key
indicators of efficiency and effectiveness of an entity)
c. Physical characteristics (for example, capacity of a facility)
d. Systems and processes (for example, an entity’s internal control or IT
system)
e. Behavior (for example, corporate governance, compliance with
regulation, human resource practices)
An approriate subject matter is:
a. Identifiable, and capable of consistent evaluation or measurement
against the identified criteria; and
b. Such that the information about it can be subjected to procedures for
granting sufficient appropriate evidence to support a reasonable
assurance or limited assurance conclusion, as appropriate.

Suitable criteria
Benchmark used to evaluate or measure the subject matter.
Examples of formal criteria are the following:
 In the preparation of financial statements, the criteria may be Philippine
Financial Reporting Standards;
 When reporting on internal control, the criteria may be an established
internal control frameworks; and
  When reporting on compliance, the criteria may be the applicable law,
regulation or contact.

Examples of less formal criteria are an internally developed code of conduct or

an agreed level of performance (such as the number of times a particular
committee is expected to meet in a yea

Suitable criteria are required for reasonably consistent evaluation or

measurement of a subject matter within the context of professional judgment.
Without the frame of reference provided by suitable criteria, any conclusion is
open to individual interpretation and misunderstanding.

The criteria must have the following characteristic to be considered suitable:

a. Relevance – relevant criteria contribute to conclusions that assits
decision - making by the intended users.
b. Completeness – criteria are sufficiently complete when relevant factors
that could affect the conclusions in the context of the engagemet
circumstances are not benchmarks for presentation and disclosure.
c. Reliability – reliable criteria allow reasonbale consistent evaluation or
measurement of the subject matter inluding, where relevant,
presentation and disclosure, when used in similar circumstances by
similarly qualified practitioners.
d. Neutrality – neutral criteria contribute to conclusions that are free basis
from bias.
e. Understandability – inderstanding criteria contribute to conclusions that
are clear, comprehensive, and not subject to significantly different
interpretations.
The criteria need to be available to the intended users to allow them to
understand how the subject matter has been evaluated or measured.

Sufficient appropriate evidence

Evidence is the information obtained by te practitioner in arriving at the
conclusions on which the opinion is based.
The practitioner plans and performs an assurance engagement with an
attitude of professional skepticism.
In addition, the practitioner recognize the existence of assurance engagement
risk (sysnoymous to audit risk) – the risk that the practitioner expresses an
inappropriate conclusion when then subject matter information is a materially
misstated.
Written assurance report
The practitioner provides a written report containing a conclusion that conveys
the assurance obtained about the subject matter information.
The practitioner’s conclusion can be worded depending on the type of
assurance engagement:
1. As to structure:

a. Assertion-based engagement, either:

I. In terms of the responsible party’s assertion (for example:

“In our opinion the responsible party’s assertion that
internal control is effective, in all material respects, based
on XYZ criteria, is fairly stated”); or

II. Directly in terms of the subject matter and the criteria (for
example: “In our opinion internal control is effective, in all
material respects, based on XYZ criteria”).

b. Direct reporting management – directly in terms of the subject

matter and the criteria.

2. As to level of assurance:

a. Reasonable assurance engagement – positive form, for

exampleL “In our opinion internal control is effective, in all
material respects, based on XYZ criteria.”
b. Limited assurance engagement – negative form, for example,
“Based on our work described in this reports, nothing has come
to our attention that causes us to believe that internal control is
not effective, in all material respects, based on XYZ criteria.”

The conclusions above are exampples of an “unqualified conclusion”. However,

not all conclusions are unqualified.
The following table summarizes conclusions other tan unqualified depending
on the resultys of the engagement:
Engagement Result Significance Conclusion
Material Qualified
Practitioner unable to obtaine
Disclaimer
sufficient appropriate evidence Material and Pervasive
Subject matter/subject matter Material Qualified
information contains material
Material and Pervasive Adverse
misstatement
Limitations of Assurance Engagements
The highest level of assurance that may be provided by the practitioner is
reasonable assurance (less than absolute) as a result of the following factors;
a. Use of selective testing
b. Use of judgment
c. Inherent limitations on internal control;
d. Persuasive evidence rather than conclusive; and
e. In certain cases, characteristics of the subject matter.

Non-assurance Engagements
Engagements are considered non-assurance engagements if they lack one or
more of the five elements of an assurance engagement.
Common example of non-assurance engagements are;
a. Agreed-upon procedures engagement;
b. Compilations engagements;
c. Preparation of tax returns where no conclusion conveying
assurance is expressed;
d. Consulting (or advisory) engagements such as management and
tax consulting;
e. Engagement to testify in legal proceedings regarding accouting,
auditing, taxation or other matters and;
f. Engagemennts that include professional opinions not intended to
be an assurance report.

Relevant Ethical Requirements

Relevant ethical requirements to which the p are subject, ordinarilly comprise
Parts A and B of the Code of Ethics for Professional Accountants in the
Philippines together with national requirements that are more restrictive.

Fundamental Principles
The fundamental priinciples applicable to both assurance and non-assurance
engagements, are:
1. Integrity. A professional accountant should be straightforward and
honest in all professional and business relationship.
2. Objectivity. A professional accountant should not allow bias, conflict of
interest or undue influence of others to override professional or
business judgments.
3. Professional competence and due care. A professional accountant has
a contunuing duty to maintain professional knowledge and skill at the
 level required to ensure that a client or employer recieves competent
professional service based on current developmets in practice,
legislation and techniques. A professional accountant should be act
diligently and in accordance with applicable technical and professional
standards when providing professional services.
4. Confidentiality. A professional accountant respect the confidentiality of
information acquired as a result of professional and business
relationships and should not disclose any such information to third
parties without proper and specific authority unless there is a legal or
professional right or duty to diclose.
5. Professional behavior. A professional accountant should comply with
relevant laws and regulations and should avoid any action that
discredits the profession.

Independence
In addition to fundamental principles, the code also requires professional
accountants to be independent when performing assurance engagements. It is
not requires for non-assurance engagements. Independence comprises
independence of mind and in appearance.

Many threats fall into the following categories:

a) Self-interest threats – may occur as a result of the financial or other
interest of a professional accountant or of an safeinterest of a
professional accountant or of an immediate or close family member;
b) Self-review threats – may occur when a previous judgment needs to be
re-evaluated by the professional accountant responsible for that
judgment;
c) Advocacy threats – may occur when a professional accountant
promotes a position or opinion to the point that subsequent objectivity
may be compromised;
d) Familiarity threats – may occur when, because of a close relationship, a
professional accountant becomes too sympathetic to the interest of
others; and
e) Intimidation threats – may occur when a professional accountant may
be deterred from acting objectively by threats, actual or perceived.

Safeguards Against Threats

Safeguards that may eliminate or reduce such threats to an acceptable level
fall into two broad categories:
1) Safeguards created by the professionm legislation or regulation; and
2) Safeguards in the work environment
  Firm-wide safeguards; and
 Engagement specific safeguards
Conceptual Framework Approach to Compliance with Fundamental Principles
The circumstances in which professional accountants operate may give rise to
specific threats to compliance with fundamental principles. A conceptual
framework that requires a professional accountant to identify, evaluate and
address threas to compliance with the fundamental principles, rather than
merelt comply with a set of specific rules, which may be arbitrary, is, therefore,
in the public interest. If identified threats are other than where appropriate,
apply safeguards to eliminate the threats or reduce them to an acceptable
level, such that compliance with the fundamental principles is not
compromised.

Audit, Review and Related Services

The following table presents comparison of audit, review and related services
(comprising agreed-upon procedures and compilation engagements).
Nature of
Audit Review Agreed-upon Compilation
Service
Objective To enable the To enable a To enable To enable the
auditor obtain practitioner to the auditor accountant to
reasonable state wether carry out use accounting
assurance anything has procedures exoertise, as
about whether come to the of an audit opposed to
the financial practitioner’s nature to auditing
statement, as a attention that which the expertise, to
whole, are free causes the auditor and collect, classify
from material practitioner to the entity and summarize
misstatement, believe that the and any financial
whether due to financial appropriate information.
fraud or error, statements are third parties
and to express not prepared, have agreed
an opinion in all material and to report
thereon. respects, in on factual
accordance findings.
with the
applicable
financial
reporting
framework
Level of Ressonable Limited None None
assurance (High) (Moderate)

Type of report Positive Negative Description Indentification

assurance assurance of of information
procedures complied
 performed
and factual
findings
Basic Primarily, Primarily As agreed Reading the
procedure among others, inquiry and (Audit financial
risk analyticak nature) statemets for
assessment procedures obvious
procedures, misstatements
test of controls
and substantive
procedures
Independence Required required Not required Not required

- Done –