Learn: Audit Report Preparation

Overview

Welcome, future audit experts! In this session, we'll demystify key concepts behind audit report preparation, with a focus on how findings are evaluated, audit reports are drafted, and representation letters are managed. You'll gain practical insight into related party transactions, subsequent events, opinion formulation, and the documentation that supports audit conclusions. By the end, you'll be able to confidently navigate the core standards and reasoning processes expected in professional audits—especially as tested in the CPA Licensure Exam Philippines.

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Concept-by-Concept Deep Dive

Understanding Related Party Transactions

What it is:
Related party transactions are deals or arrangements between a company and persons or entities with close ties to it, such as subsidiaries, shareholders, or management. These transactions can pose significant risks to the fairness of financial statements due to potential conflicts of interest or non-arm's-length terms.

Key Components:

• Identification: Auditors must recognize who qualifies as a related party under the applicable financial reporting framework.
• Disclosure Requirements: Standards (such as PSA 550) require that material related party transactions be disclosed transparently in the financial statements.
• Audit Objectives: The primary goal is to ensure all related party transactions are properly identified, authorized, measured, and disclosed.

Reasoning Process:

1. Obtain information from management about related parties and their transactions.
2. Inspect relevant documents (contracts, minutes, etc.).
3. Assess completeness and accuracy of disclosures.

Common Misconceptions:

• Believing only material transactions need to be identified (all must be identified, though only material ones may need disclosure).
• Assuming that routine transactions with related parties are always at fair value.

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Subsequent Events: Types and Audit Implications

What it is:
Subsequent events are events that occur after the balance sheet date but before the issuance of the financial statements. These events may require adjustment or disclosure in the financial statements depending on their nature.

Subtopics:

• Type I (Adjusting) Events: Provide additional evidence about conditions existing at the balance sheet date—these require adjustment of the financial statements.
• Type II (Non-Adjusting) Events: Relate to conditions that arose after the balance sheet date—these require disclosure but not adjustment.

Step-by-Step Approach:

1. Identify events occurring between the reporting date and the date of the auditor’s report.
2. Determine if the event reveals conditions existing at balance sheet date (Type I) or arose after (Type II).
3. Decide on appropriate action: adjust, disclose, or no action needed.

Common Misconceptions:

• Confusing the timing or type of event and incorrectly adjusting or failing to disclose.

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Audit Opinions and Reporting

What it is:
The auditor’s opinion is the formal statement regarding the fairness, in all material respects, of the entity’s financial statements. The nature of this opinion depends on the sufficiency and appropriateness of audit evidence and the auditor’s findings.

Types of Opinions:

• Unmodified (Unqualified): Financial statements are presented fairly.
• Qualified: Except for a specific issue, financials are fairly presented.
• Adverse: Financials are not fairly presented due to material misstatements.
• Disclaimer: Unable to obtain sufficient audit evidence.

Reasoning Process:

1. Gather and assess all audit evidence.
2. Evaluate materiality and pervasiveness of any misstatements or scope limitations.
3. Determine appropriate opinion and draft the report accordingly.

Common Misconceptions:

• Misapplying opinion types (e.g., issuing an unmodified opinion despite significant disagreements).
• Forgetting to modify the opinion when required by standards.

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Audit Documentation: Reports and Representation Letters

What it is:
Audit documentation serves as the written record of the auditor’s work, judgments, and conclusions. Two fundamental documents are the audit report (auditor’s report) and the management representation letter.