Chapter 3

General Types of
Auditing
 3 General Types of Audit

I. External Independent Financial

Statements Audit
II. Internal Audit
III. Government Auditing
 I. External Independent Financial
Statements Audit
Independent Audit consists of methodical review and objective
examination of financial statements prepared by an enterprise
(auditee) to determine if such statements have been prepared in
conformity with financial reporting practices that are appropriate for
the auditee.

Attest function refers to the expression of opinion by the independent

auditor.

Without a report from the independent auditor, a company’s financial

statement would have little meaning or reliability because the
company would be reporting on itself. If audit reports are not
prepared, monetary losses can result both to the audited entity and
to those who rely on its financial statements.
 Overall Objectives of the Auditor
(a) To obtain reasonable assurance
about whether the financial
statements as a whole are free from
material misstatement, whether due
to fraud or error, thereby enabling the
auditor to express an opinion on
whether the financial statements are
prepared, in all material respects, in
accordance with an applicable
financial reporting framework; and

(b) To report on the financial

statements, and communicate as
required by the PSAs, in accordance
with the auditor’s findings.
 Scope of the audit
The scope of the audit refers to the audit procedures deemed
necessary in the circumstances to achieve the objective of the audit.

Since the primary objective of an independent audit is to express an

opinion on the company’s financial statements, the auditor will
Conduct a critical and
Audit evidence may be Internal controls will be
systematic examination
gathered to enable him evaluated for
of the statements and of
to substantiate the effectiveness since they
the related documents,
representations in the affect the reliability of
records, procedures,
financial statements. the financial records.
and control

The auditor formulates Test the existence and

The auditor then his opinion when validity of assets,
prepares the audit sufficient appropriate liabilities, and
report. evidences have been reasonableness of the
gathered. account balances.
 Advantages of Independent Audit
CREDITORS,
PROSPECTIVE
AUDITEE INVESTORS,
EMPLOYEES
• makes the FS more • more credible basis in
credible and reliable deciding whether financial
assistance will be extended
• improvement of to the auditee
business operations • suppliers and creditors will
• minimize commission have reliable basis in
of fraud by extension of credit
management and • potential investors will have
employee more credible basis in
evaluating managerial
• provides a more efficiency
credible basis for • employees will have basis
preparation of tax in requesting for fringe
returns benefits and wage
• better and sound adjustments
management • In terms of sale, purchase,
both the buyer and seller
will have a basis in the
terms and conditions of the
arrangements
GOVERNMENT
AND LEGAL
COMMUNITY
• BIR has more assurance
concerning the accuracy
and dependability of tax
return
• GSIS, SSS, DBP and other
government institutions will
have basis in extending
financial assistance
• provide the legal
community an independent
basis for administering
estates and trust, setting
action in bankruptcy and
insolvency.
 General Principles of an Audit
1. The auditor should comply with the “Revised Code of
Ethics for Professional Accountants in the Philippines”
promulgated by the Board of Accountancy and
approved by the Professional Regulation Commission.

2. The auditor should conduct the audit in accordance with

Philippine Standards on Auditing.

3. The auditor should plan and perform the audit with an

attitude of professional skepticism.
 Ethical principles governing the auditor’s
professional responsibilities:

• independence
• integrity
• objectivity
• professional competence and due care
• confidentiality
• professional behavior
• technical standards
 Reasonable Assurance

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.
not absolute

Limitations that affect the auditor’s ability to detect material

misstatements:

•The use of testing

•The inherent limitations of any accounting and internal control system
•The fact that most audit evidence is persuasive rather than conclusive.
Responsibility for the Financial Statements

While the auditor is

responsible for forming and
expressing an opinion on the
financial statements, the
responsibility for preparing
and presenting the financial
statements is that of the
management of the entity.
The audit of the financial
statement does not relieve
management of its
responsibilities.
 Major Steps in Systematic Process of
Financial Statements Audit
Phase I
Pre-engagement
Activities and Audit
Planning Activities
Once the client has signed the
engagement letter, the planning
process starts as the auditor
concentrates his efforts in
obtaining a detailed
understanding of the client’s
business and an overall audit
strategy.
Audit planning includes
understanding the client’s
(1) industry environment
(2) business and management
(3) Accounting and reporting
systems
(4) Internal control
On the basis of initial information,
the auditor then assess the
audit risk
Phase II
Gathering and
Evaluating Audit
Evidence
In this phase, auditor focuses his
attention on both the design and
operation of aspects of the
internal control structure to
determine whether the necessary
controls were functioning as
intended.
a) Interim Audit Phase (Test of
Controls)
-In this phase, auditor
focuses on both the design
and operation of aspects of
internal control.
b) Final Audit Phase
-involves substantive tests of
transactions, tests of details
of balances and analytical
procedures.
Phase III
Issuing the Audit
Report
The culminating step in the audit
process is the preparation of the
audit report. The type of audit
report issued depends on the
evidence accumulated and the
audit findings.
Types of Opinion:
1) Unqualified Opinion
2) Qualified Opinion
3) Adverse Opinion
4) Disclaimer Opinion
5) Piecemeal Opinion
 Types of Audit Risk
a) Inherent risk
- the susceptibility of an account balance to material errors assuming that the client
does not have any related internal controls.

b) Control risk
- the risk that a material error in an account will not be prevented or detected on a
timely basis by the client’s system of internal control.

Based on the initial understanding, the auditor may decide to assess control risk at the
maximum level for some assertions and below maximum for others.

Maximum control risk is defined at the greatest probability that a material misstatement
that could occur in an assertion will not be prevented or detected on a timely basis
by the entity’s internal control structure.
 Objectives of Test of Controls

The tests of controls involve the following:

1) Inquiries of client personnel
2) Inspection of documents and records
3) Observation of the application of specific policies and procedures
4) Reperformance of the application of specific policies and
procedures.

The audit objectives of compliance tests of controls are determine

whether
(1) the transactions are properly executed
(2) the transactions are properly recorded
(3) there is proper custody of assets, liabilities and other related
resources
 Substantive Tests

Substantive audit testing is the process of obtaining evidence in

support of transactions and balance. The nature, timing and extent
of substantive testing is a function of the auditor’s judgment
concerning audit risk and materiality.

Objectives of Substantive Testing are to substantiate management’s

assertions about:
(1) existence or occurrence
(2) completeness
(3) rights and obligations
(4) valuation
(5) presentation and disclosure of the items in the financial statements
 Unqualified Opinion
This is an opinion in which the
auditor concludes that the financial
statements present fairly the
financial position, results of
operations and cash flows
consistently in all material
respects, in accordance with the
identified financial reporting
framework.

When issued:
1. The audit has been performed in
accordance with Standards of
Auditing.
2. The FS are presented fairly in
conformity with Financial Reporting
Standards and include all
disclosures necessary to make the
statements not misleading.
 Qualified Opinion
It is one in which the auditor states that
“except for” or “with exception of” the
effect of the matter to which the
qualification relates, the financial
statements present fairly the financial
position, results of operations and
changes in financial position in
conformity with Financial Reporting
Standards consistently applied.

When Issued:
1. The auditor, having obtained sufficient
appropriate audit evidence, concludes
that misstatements, individually or in the
aggregate, are material, but not
pervasive, to the financial statements; or
2. The auditor is unable to obtain sufficient
appropriate audit evidence on which to
base the opinion, but the auditor
concludes that the possible effects on the
FS of undetected misstatements, if any,
could be material but not pervasive.
 Adverse Opinion
It is an opinion in which the
auditor states that the financial
statements in which the auditor
states that the financial
statements do not present fairly
the financial position, results of
operation or changes in financial
position in conformity with the
financial reporting framework.

When Issued:
The auditor is unable to obtain sufficient
appropriate audit evidence on which to base
the opinion and concludes that
misstatements, individually or in aggregate,
are both material and pervasive to the
financial statements.
 Disclaimer Opinion
It is a statement by the auditor that
he does not express an opinion on
the financial statements.

When issued:
The auditor shall disclaim an opinion when
the auditor is unable to obtain sufficient
appropriate audit evidence on which to base
the opinion, and the auditor concludes, that
the possible effects on the financial
statements of undetected misstatements, if
any, could be both material and pervasive.

The auditor shall disclaim an opinion when, in

extremely rare circumstances involving
multiple uncertainties, the auditor concludes
that, notwithstanding having obtained
sufficient appropriate audit evidence
regarding each of the individual uncertainties,
it is not possible to form an opinion on the
financial statements due to the potential
interaction of the uncertainties and their
cumulative effect on the FS.
 Piecemeal Opinion

A piecemeal opinion is an expression of opinion as to

certain identified items in the financial statements when
the auditor either disclaimed an opinion or expressed an
adverse opinion on the financial statements.

When Issued:
Because piecemeal opinions tend to overshadow or contradict a disclaimer of opinion or
an adverse opinion, they are considered inappropriate and should not be issued in
any situation.
 Relevant Qualities of an Auditor Must Possess for
an Effective FS Audit

1. The auditor must have a thorough understanding of the entity being audited
and the industry of which it is a part.
2. The auditor must have a comprehensive knowledge of Financial Reporting
Standards (FRS) in order to audit effectively.
3. The auditor must have a solid grasp of the concepts of internal control and
comprehensive in reviewing and evaluating the client’s underlying system
of internal control.
4. The auditor must also be knowledgeable in the area of evidence gathering
and evaluation
 II. Internal Audit
Internal auditing is an independent, objective assurance
and consulting activity designed to add value and
improve an organization’s operations. It helps an
organization accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and
improve the effectiveness of risk management, control,
and government processes.
Objective of Internal Auditing:
- to assist all members of management in the effective discharge of their
responsibilities, by furnishing them with analyses, appraisals,
recommendations, and pertinent comments concerning the activities
reviewed.
 Activities of Internal Audit
• Reviewing and appraising the soundness, adequacy, and
application of accounting, financial, and other operational controls,
and promoting effective control at reasonable cost.
• Ascertaining the extent of compliance with established policies,
plans, and procedures
• Ascertaining the extent to which the company assets are accounted
for and safeguarded from losses of all kinds.
• Ascertaining the reliability of management data developed within the
organization
• Appraising the quality of performance in carrying out assigned
responsibilities
• Recommending operating improvements
 Responsibilities and Authority of Internal Auditor
The responsibilities of internal auditing in the organization should be
clearly established by management policy. The related authority
should provide the internal auditor full access to all of the
organization’s records, properties, and personnel relevant to the
subject matter under review.

The internal auditor’s responsibilities should be:

- To inform and advise the management and to discharge this responsibility in a
manner that is consistent with the Code of Ethics of the Internal Auditors.
- To coordinate activities with others so as to best achieve audit objectives of the
organization.
 Independence of Internal Auditor
Independence is essential to the effectiveness of internal auditing.

• Organizational status
- The head of the internal auditing function should be responsible to an officer whose
authority is sufficient to assure both a broad range of audit coverage and the
adequate consideration of an effective action on the audit findings and
recommendations.
• Objectivity
- The internal auditor should not develop and install procedures, prepare records, or
engage in any other activity which he or she would normally review and appraise and
which could reasonably be construed to compromise his or her independence.
 Relationship of Internal Auditor to External Auditor
The public accountant and the internal auditor are not competitors.
Work done by internal auditors cannot be substituted for work that
should be performed by the independent auditor. However, the
public accountant may rely on the work of internal auditors of the
auditee. To be able to do this, the independent auditor should show
that the internal auditor has been objective and unbiased in the

1) preparation of audit programs,

2) selection of areas to be audited, and
3) reporting the internal audit results.
 Types of Internal Audit
1) Operational auditing
This is future-oriented, independent and systematic evaluation performed by the
internal auditor for management of the operational activities controlled by top-,
middle-, and lower-level management for the purpose of improving organizational
profitability and increasing the attainment of the other organizational objectives.
2) Management auditng
This is future-oriented, independent and systematic evaluation of the activities of all
levels of management performed by the internal auditor for the purposes of
improving organizational profitability and increasing the attainment of other
organizational objectives.
3) Financial audting
An internal financial audit is a historically oriented, independent evaluation
performed by the internal auditor for the purpose of ensuring the fairness, accuracy,
and reliability of the financial data.
 Major Internal Audit Activities based on the
Institute of Auditor’s Statement of Responsibilities:

1. Appraisal of controls
- the evaluation of the auditee’s policies, programs, and/or procedures to determine whether they
are operating satisfactorily and assure compliance with organizational goals and objectives.
2. Protection of Assets
- operational audit activities designed to determine whether assets are properly accounted for and
safeguard from losses.
3. Verification of Internal Management Reports
- this is done to verify the accuracy and reliability of the internal management reports which
needed to provide sound basis for management decisions.
4. Appraisal Performance
- interpretation and appraisal of employee efficiency and effectiveness.
5. Recommendations for Operating Improvement
- the internal auditor’s operational audit activities should be designed to generate
recommendations for improvements. It is not enough for internal auditors to criticize but they must
also be creative in developing recommendations for improvements.
 Characteristics of Internal Audit Report

The internal audit reports are not standardized. It is left to the discretion
of the internal auditor.

Components of Internal Audit Report:

1. Description of the purpose of the audit
2. Scope of the audit
3. Auditing standards complied
4. Audit results describing the areas in which deficiencies were found to exist
5. Description of the relationship of these deficiencies to the whole activity being audited
6. Description of the nature and importance of those operations that are being effectively
and efficiently accomplished
7. Recommendation for remedial or correctable actions that may possibly correct the
deficiencies.

Activity: Watch a video on “Recap of the Work of an Internal Audit” – (8:38)

 III. Government Auditing
Government auditing involves the determination of whether government
funds are being handled properly and in compliance with existing laws
and whether the programs are being conducted effectively and
economically.
Scope of Government Auditing:
1. Financial and Compliance Audit
Determines whether financial operations are properly conducted, the financial reports of an audited
entity are presented fairly, and the entity has complied with applicable laws and regulations.
2. Economy and Efficiency Audit
Determines whether the entity is managing and utilizing its resources (such as personnel, property,
space) economically and efficiently, the causes of inefficiencies or uneconomical practices and
whether the entity has complied with laws and regulations concerning matters of economy and
efficiency.
3. Program Results
Determines if the desired results and benefits are being achieved, if the objectives established by
the legislative or other authorizing body are being met and if the agency has considered alternatives
which might yield at a lower cost.
 Divisions of the State Audit in accordance with the
Primer on Government Accounting and Auditing
1. Compliance Audit
- the examination, audit and settlement in accordance with law and regulation,
2. Financial Audit
- the audit of the accounting and financial system and controls to ensure reliability of recorded financial
data. The objective of this audit is the expression of an opinion on the fairness with which the financial
condition and results of operation are presented, and
3. Performance Audit
- an objective examination of the financial and operational performance of an organization,
programme, activity or function and is oriented towards opportunities for greater economy, efficiency
and effectiveness.
Performance audit may take in the form of:
(1) Management Audit (Economy and Efficiency Audit) which is the appraisal of management
performances from a least cost point of view and the analysis of relationship between benefits attained
and cost incurred, and
(2) Program Results Audit (Effectiveness Audit) which is the evaluation of program results vis-à-vis
management goals and objectives.

A comprehensive audit consists of a proper balance among compliance audit, financial audit, and
performance audit.
 Commission on Audit
The Commission on Audit (COA, formerly General Auditing Office) is the highest and final
authority in state auditing, which was created under Sec. 1, Art. XII-D of the Philippine
Constitution, whose jurisdiction and responsibility is defined by the law of the land. As the
highest audit office of the Republic Act of the Philippines, the COA wields the final authority
in the audit of the government and its instrumentalities.

Principal Duties of COA:

a. Examine, audit, and settle all accounts pertaining to the revenue or receipts and expenditures or uses
of government funds and property;
b. Keep the general accounts pertaining thereof;
c. Preserve the vouchers pertaining thereof;
d. Promulgate accounting and auditing rules and regulations including those for the prevention of
irregular, unnecessary, excessive or extravagant expenditures or uses of funds and property;
e. Submit to the President, and the time fixed by law, an annual financial report of the government, its
subdivisions, agencies, and instrumentalities, including government-owned or controlled corporations,
and recommend measures necessary to improve their efficiency and effectiveness;
f. Decide any case brought before it within sixty days from date of its submission for resolution; and
g. Perform such other duties and functions as may be prescribed by law.
 Special Audits: Other Audits or Limited
Assurance Engagements
There are other types of audit services that fall within the auditing
standards but are not audits of historical FS in accordance with
PFRS. These include:
(a) audits of FS prepared on another comprehensive basis of accounting
(PSA 700 Redrafted)
(b) audits of specified elements, accounts or items in a FS
(c ) audits of information accompanying the basic FS (PSA 720 Redrafted)
(d) compliance with contractual agreements
(e) summarized FS