REVIEWER IN AUDIT ACN001

AUDITING AND ASSURANCE : PRINCIPLES

PRELIMINARY PHASES

 Evaluation of current and future clients.

CURRENT AND FUTURE CLIENTS

 Audit engagement is a public engagement meaning as you offer your services to the public, you are building your client
relationship.
 Integrity of the client is one of the essential factors to consider in whether a future client is to be accepted or a current
client is to be maintained. Remember that your independence is at stake if you associate yourself with management which
lacks integrity. Trust and confidence are essential investment with the public. Consider evaluating your independence in
mind / in fact (your perception) and in appearance (public’s perception).
 Reviewing your relationship with your current clients as well conducting background checks to your potential and current
clients help you decide on whether an engagement can be made or not. Remember that your association with a client
which does not bear strong integrity will give predicament along the way so be cautious.
 Communicating with the predecessor auditor is also one way to consider in accepting a potential engagement. However,
take note that you still have to ask permission from your potential client(s) before going to the predecessor auditor.
 When your client does not permit you to go its predecessor auditor, this will raise awareness on your part on whether to
accept the engagement or not.
 When your client allows you to go to its predecessor auditor, bear in mind that your inquiry should focus on (DIR):
1. Disagreements with client.
2. Integrity.
3. Reasons for change in audit.

THE ENTITY

 It is not only the client whom to be evaluated but also the entity. Take into account, that as the entity, for the engagement
to be successful the following must be considered:
1. Code of Ethics
2. System of Quality Control (PSQC # 1)
- Leadership Responsibilities
- Human Resources
- Ethical Requirements – PICPO (Professional Behavior, Integrity, Confidentiality, Professional Competence
and Due Care, Objectivity)
- Acceptance and Continuance of Client Relationship
- Engagement Performance
- Monitoring

ENGAGEMENT LETTER

 Once both the entity and the client are evaluated, the entity can now prepare an engagement letter…it is like a onerous
contract binding the two parties to perform respective responsibilities throughout the engagement. This is also to clear any
misunderstanding that could arise.
 At the minimum, it must contain the following:
- Scope and Objective of the Engagement, in particular the audit.
- Responsibilities of the Engagement Partner or the Auditor
- Responsibilities of the those charged with governance and the management.
 Signatories in the Engagement:
- Entity – Lead Engagement Partner
- Client – Top Management (CEO and CFO)
 Bear in mind that there is no need to send an engagement letter to a recurring client every engagement unless significant
change happen to the client. Examples of significant change are: 1) Change in Top Management and Those Charged with
Governance;
2) Legal Structure of the Business
 If client is an affiliate company, such that the group of companies is being audited, consider evaluating whether there is a
need to send an engagement letter to the client as you are now considered as component auditor.
AUDIT PLANNING

UNDERSTANDING THE BUSINESS AND ITS ENVIRONMENT

 After creating an agreement with your client through the establishment of an engagement letter, the first phase of formal
audit is the evaluation of the business and its environment. 

 Even if you have audited similar businesses, it is still important to evaluate the business of the client as every business
possesses uniqueness within its operation.

 Evaluation involves the procedure called risk assessment procedures to establish the materiality level, then determine the
degree of audit risk that will affect the flow of engagement. Business risk is also evaluated along the way which will also
affect the audit risk. Aside from audit risk, inherent risk will be also evaluated when doing the risk assessment procedures.

 Business risk is the risk that the client’s business will suffer business losses and eventually closure (economic
consequences) brought about by the client’s industry, business environment (competition and customers within the area),
and operation.

 Risk assessment procedures involve conducting INQUIRY with the client as well resource individuals, INSPECTION of
documents such as articles of incorporation or partnership, and bank loan agreements, OBSERVATION mainly involving the
client’s operation, and ANALYTICAL PROCEDURES to evaluate the financial statements of the client in order to find any
irregularities that would be significant in the conduct of the audit engagement.

 The result of risk assessment procedures will give the auditor the initial assessment of AUDIT RISK.

 Audit Risk – the risk that the auditor will issue an unmodified/unqualified opinion, yet in contrary risk of material
misstatements is present. Normally, the audit risk is set within the range of 5 to 10%. If the auditor wants to reduce the
audit risk to an acceptable low level, then he/she must carefully craft an audit strategy to hit the desired level.

 Audit risk is said to have an inverse relationship with materiality. Materiality, as used in the conceptual framework, is an
attribute of an information, mainly financial information, which could affect in the decision making process of
stakeholders. In audit, we say materiality as the lowest value that could affect the financial statements of the client. 
 In relation, when the auditor found a high audit risk initially, he/she should establish a low materiality level so that he/she
would not make incorrect audit opinion. 
 Audit risk is said to have an inverse relationship with materiality. Materiality, as used in the conceptual framework, is an
attribute of an information, mainly financial information, which could affect in the decision making process of
stakeholders. In audit, we say materiality as the lowest value that could affect the financial statements of the client.

 In relation, when the auditor found a high audit risk initially, he/she should establish a low materiality level so that he/she
would not make incorrect audit opinion.

 Low materiality level; High audit risk – accumulation of sufficient appropriate evidences by conducting more extensive
audit procedures (Nature), evaluating year-end balances of financial statements (Timing), and larger sample sizes involved
(Extent).
Note: Need to bring audit risk an acceptable low level.

 High materiality level; Low audit risk – accumulation of sufficient appropriate evidences by conducting less extensive audit
procedures (Nature), evaluating interim rather than year-end balances of financial statements (Timing), and small sample
sizes involved (Extent).

 The materiality level is divided into two level: at the financial statement level (overall materiality) and at the account
balance level (performance materiality). I have included readings on materiality level see the references / additional
readings. 

 Inherent risk is also being evaluated upon performing the risk assessment procedures. It is the risk associated to accounts
being susceptible to misstatements (without considering the impact of internal control) due to FRAUD, ERRORS, and
NON-COMPLIANCE to Laws and Regulations (SOURCES OF MISSTATEMENTS)
COMPONENTS OF AN AUDIT RISK:

 In the functional equation, you can say that audit risk and detection risk have direct relationship, that is, higher audit risk
means higher detection risk so there is high probability that the auditor cannot detect the sources of misstatements so
auditor must use “Low Materiality Level; High Audit Risk Concept” discussed in the previous slide)
 Risk of material misstatements has inverse relationship with detection risk, that is, when there is higher risk of material
misstatements, the auditor must use “Low Materiality Level; High Audit Risk Concept” to lower the detection risk.
 After evaluation of the business and its environment as well as its internal control (separate discussion), the auditor will
now proceed on establishing its overall audit strategy. The strategy contains the audit plans to be used throughout the
engagement. The audit plan contains the specific activities to be done which are presented in the audit program.
 Remember, that the first formal phase of the audit is normally conducted months prior to year end because audit involves
higher level of assurance as compared to review.