AUDIT PLANNING SECTION 6

1. AUDIT PLANNING SECTION 6

2. Accepting the Engagement • Competition among firms • Change in auditors • Mergers • Expanded services • Dissatisfaction • Audit fee • Factors in accepting an engagement

3. Also engagement continuance • Does the auditor have the obligation to perform an audit when requested? • Three steps: • Integrity of management • GAAS • Engagement letter

4. Evaluating the Integrity of Management • Trust in management • Management lacking in integrity? • Evaluation of Management Integrity • Make inquiries of third parties • Who to ask?

5. Prior auditor • Successor auditor should take initiative • Client’s permission • Code of conduct

6. Review Previous Experience with Existing Clients • Engagement continuance • Consider prior experience • Material error, fraud, illegal acts

7. Assess the Ability to Meet GAAS • Can the auditor complete the engagement in accordance with GAAS? • What does the general standard refer to? • Technical training and proficiency • Entry into the profession • Practical training • Continuing professional education

8. Due care • Based primarily on custom, convention, and judgment • Prudent, reasonably competent practitioner • Objective state of mind • Independent in fact and appearance • Integrity and objectivity

9. Prepare an Engagement Letter • Good professional practice • Clear statement of the nature of the auditor’s examination and the responsibilities assumed by the auditor • Legal contract

10. [Date] Dear [client name]: We have reviewed the Arizona State Board for Charter Schools (ASBCS) audit guidelines dated June 1, 2004 and are pleased to confirm our understanding of the services we are to provide [name of organization] for the year ending XX. We will audit the statement(s) of financial position of the Organization as of XX and the related statement of activities and cash flows for the year then ended. We will also complete the appropriate compliance questionnaire(s) as required by the ASBCS. Audit Objectives The objective of our audit is the expression of an opinion as to whether your financial statements are fairly presented, in all material respects, in conformity with U.S. generally accepted accounting principles. Our audit will be conducted in accordance with U.S generally accepted auditing standards and the standards for financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States, and will include tests of your accounting records and other procedures we consider necessary to enable us to express such an opinion. If our opinion on the financial statements is other than unqualified, we will discuss the reason with you in advance. If, for any reason, we are unable to complete the audit or are unable to form or have not formed an opinion, we may decline to express an opinion or to issue a report as a result of this engagement. We will also provide a report (which does not include opinions) on internal controls related to the financial statements and compliance with laws, regulations and the provisions or grant agreements, noncompliance with which could have a material effect on the financial statements as required by Government Auditing Standards.

11. Management Responsibilities Management is responsible for establishing and maintaining internal controls and for compliance with laws, regulations, contracts, and agreements. In fulfilling this responsibility, estimates and judgments by management are required to assess the expected benefits and related costs of the controls. The objectives of internal control are to provide management with reasonable, but not absolute, assurance that assets are safeguarded against loss from unauthorized use or disposition, that transactions are executed in accordance with management’s authorizations and recorded properly to permit the preparation of financial statements in accordance with U. S generally accepted accounting principles. Management is responsible for making all financial records and related information available to us. We understand that you will provide us with such information required for our audit and that you are responsible for the accuracy and completeness of that information. We will advise you about appropriate accounting principles and their application and will assist in the preparation of your financial statements, but the responsibility for the financial statements remains with you. That responsibility includes the establishment and maintenance of adequate records and effective internal control over financial reporting, the selection and application of accounting principles, and the safeguarding of assets. Management is responsible for adjusting the financial statements to correct material misstatements and for confirming to us in the representation letter that the effects of any uncorrected misstatements aggregated by us during the current engagement and pertaining to the latest period presented are immaterial, both individually and in the aggregate, to the financial statements taken as a whole. You are responsible for the design and implementation of programs and controls to prevent and detect fraud, and for informing us about all known or suspected fraud affecting the Organization involving (1) management, (2) employees who have significant roles in internal control, and (3) others where the fraud could have a material effect on the financial

12. statements. You are also responsible for informing us of your knowledge of any allegations of fraud or suspected fraud affecting the Organization received in communications from employees, former employees, grantors, regulators, or others. In addition, you are responsible for identifying and ensuring that the Organization complies with applicable laws and regulations. Audit Procedures – General An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements; therefore, our audit will involve judgment about the number of transactions to be examined and the areas to be tested. We will plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Because an audit is designed to provide reasonable, but not absolute, assurance and because we will not perform a detailed examination of all transactions, there is a risk that material errors, fraud or other illegal acts may exist and not be detected by us. In addition, an audit is not designed to detect immaterial errors, fraud or other illegal acts that do not have a direct effect on the financial statements. However, we will inform you of any material errors and any fraud that comes to our attention. We will also inform you of any other illegal acts that come to our attention, unless clearly inconsequential. Our responsibility as auditor is limited to the period covered by our audit and does not extend to any later periods for which we are not engaged as auditor. Our procedures will include tests of documentary evidence supporting the transactions recorded in the accounts, and may include tests of the physical existence of inventories, and direct confirmation of receivables and certain other assets and liabilities by correspondence with selected funding sources, creditors, and financial institutions. We will request written representations from the Organization’s attorneys as part of the engagement, and they may bill you for responding to this inquiry. At the conclusion of our audit, we will require certain written representations from you about the financial statements and related matters. Identifying and ensuring that the Organization complies with laws, regulations, contracts, and agreements is the

13. responsibility of management. As part of obtaining reasonable assurance about whether the financial statements are free of material misstatement, we will perform tests of the Organization’s compliance with applicable laws and regulations and the provisions of contracts and agreements. However, the objective of our audit will not be to provide an opinion on overall compliance and we will not express such an opinion. Audit Procedures – Internal Control In planning and performing our audit, we will consider the internal control sufficient to plan the audit in order to determine the nature, timing, and extent of our auditing procedures for the purpose of expressing our opinion on the Organization’s financial statements. We will obtain an understanding of the design of the relevant controls and whether they have been placed in operation, and we will assess control risk. Tests of controls may be performed to test the effectiveness of certain controls that we consider relevant to preventing and detecting errors and fraud that are material to the financial statements and to preventing and detecting misstatements resulting from illegal acts and other noncompliance matters that have a direct and material effect on the financial statements. Our tests, if performed, will be less in scope than would be necessary to render an opinion on internal control and, accordingly, no opinion will be expressed. An audit is not designed to provide assurance on internal control or to identify reportable conditions. However, we will inform the governing body or audit committee of any matters involving internal control and its operation that we consider to be reportable conditions under standards established by the American Institute of Certified Public Accountants. Reportable conditions involve matters coming to our attention relating to significant deficiencies in the design or operation of the internal control that, in our judgment, could adversely affect the entity’s ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements.

14. Audit Administration, Fees, and Other The work papers for this engagement are the property of [name of audit firm] and constitute confidential information. However, we may be requested to make certain work papers available to your sponsor, pursuant to the authority given to them by law or regulation. If requested, access to such workpapers will be provided under the supervision of [name of audit firm]. Furthermore, upon request, we may provide photocopies of selected workpapers to your sponsor. Your sponsor may intend, or decide, to distribute the photocopies or information contained therein to others, including other governmental agencies. All audit working papers will be retained in their entirety for a period of 5 years after the date of issuance of the audit reports unless the State Board for Charter Schools requests a longer retention period. Our fees will be $XX for the audit of your financial statements (Audit firms may also include a separate price for the informational returns, if applicable.) The aforementioned audit fee does not include additional time required for 1) expansion of the scope of the audit to render an unqualified opinion, nor 2) expansion of the scope of the audit to eliminate findings. Our fee estimates are based on anticipated cooperation from your personnel and the assumption that unexpected circumstances will not be encountered during the audit. If significant additional time is necessary, we will discuss it with you and arrive at a new fee estimate before we incur the additional costs. Our invoices for these fees will be rendered as the work progresses and are payable on presentation. In accordance with our firm policies, work may be suspended if your account becomes XX days or more overdue and will not be resumed until your account is paid in full. If we elect to terminate our services for nonpayment, our engagement will be deemed to have been completed upon written notification of termination, even if we have not completed our report. You will be obligated to compensate us for all time expended and to reimburse us for all out-of-pocket expenditures through the date of termination.

15. This engagement letter and all work hereunder are subject to the laws, rules, regulations, and decrees of the State of Arizona. In the event of litigation between the Organization and us, litigation shall be commenced and prosecuted in an appropriate court of competent jurisdiction within the State of Arizona. This engagement will not be assigned by us without the prior written consent of both the Organization and the ASBCS. Any changes in scope, character, or complexity of the work may be negotiated if it is mutually agreed that such changes are necessary. Government Auditing Standards require that we provide you with a copy of our most recent quality control review report. Our XX [insert year] peer review report accompanies this letter. We appreciate the opportunity to be of service to the Organization and believe this letter accurately summarizes the significant terms of our engagement. If you have any questions, please let us know. If you agree with the terms of our engagement as described in this letter, please sign the enclosed copy and return it to us. Sincerely A.N. Auditor, CPA Accepted by: Title:

16. Preliminary Audit Planning • Planning results in an orderly arrangement of the parts or steps to achieve the desired objective • First examination standard? • Amount required of planning required?

17. Obtain an understanding of the clients business, industry, and accounting policies Assess materiality and risk Identify audit objectives Design audit programs Schedule the audit work Assign professional staff to the engagement Components of Audit Planning

18. Obtain an Understanding of the Client • The auditor should obtain sufficient knowledge of the client’s business • The auditor needs knowledge about: • The business • Industry • Government regulations • Accounting policies and procedures • EDP • Reports and data • How to acquire this knowledge?

19. Communicate with the Audit Committee • Special insights into the clients business and the industry • Internal control • Significant changes in management • Government regulations

20. Review Prior Years’ Working Papers • Recurring engagement • Problem areas • How about a new client?

21. Review Industry and Business Data • Article and bylaws • Minutes • Financial statements • Government regulations • Contracts • Publications

22. Review Accounting Manuals • Accounting policies and procedures can often be summarized in accounting manuals • Policies unique to the client • New accounting and auditing pronouncements • Tour Client Operations • Significant help for obtaining knowledge about a client’s operations • Key people

23. Inquiries of Management • May reveal current business developments affecting the entity that may have audit significance • Perform Analytical Review • Use of analytical procedures to see trends

24. Assess Materiality and Audit risk • Underlie the application of GAAS • Consider materiality and audit risk in: • Planning the audit; and • Evaluating the F/S

25. Identify Audit Objectives • To meet this overall objective, it is customary to identify specific objectives for each account reported in the F/S • E.g. Asset assertions • Existence • Ownership • Value • Completeness • Presentation and disclosure

26. Audit Objectives for Inventory • Physically exists; • Show effects of all merchandise transactions; • Owned by the entity; • LCM or NRV; • Proper classification on the balance sheet.

27. Audit Objectives for Accounts Payable • Payables exist; • Amount owed includes all obligations; • Actual obligations; • Properly reported at amount owed; • Proper classification on the balance sheet.

28. Design Audit Programs • Flow out of the previous step • Should meet all audit objectives • Provide: • An outline of the work to be done • Basis for co-ordination • A record of work done

30. Audit Programs in Initial Engagements • Have uncertainties with a new client • It may not be possible to obtain a good understanding of: • Control risk • Inherent risk • Other problems

31. Two additional concerns: • Beginning account balances • Ascertaining the accounting principles used in the preceding period

32. Audit Programs in Recurring Engagements • Have access to prior years programs • Can use them for designing, on a preliminary basis, all the current years audit programs • Evaluation of internal control

33. Schedule the Audit Work • Field work may be performed at almost any time during the year, or shortly after the end of the client's fiscal year • Two main flied work times • Interim • Year-end

34. Accept Engagement Plan Audit Perform Field Work Report Findings Time Dimensions of an Audit Engagement 1 2 3 4 6 1/1 4/1 6/1 7/1 11/1 12/31 2/15 2/25 y/e 5 7

35. Assign Professional Staff to Engagement • Give consideration to the composition of the audit team in terms of overall experience, responsibility, supervision, and technical expertise • Of what does a typical team consist?

36. Audit Supervision • First examination standard • Supervision includes: • Instructing assistants • Determining that work is properly performed • Keeping informed of audit problems

37. Problem 1: Jennifer Bailey is an experienced senior auditor who is in charge of several important audits for a medium-sized firm. Her philosophy of conducting audits is to ignore all previous years’ and permanent working papers until near the end of the audit as a means of keeping from prejudicing herself. She believes this enables her to perform the audit in a more independent manner because it eliminates the tendency of simply doing the same things in the current audit that were done on previous audits. Near the end of the audit, Bailey reviews the working papers from the preceding year, evaluates the significance of any items she has overlooked, and modifies her evidence if she considers it necessary. Evaluate Bailey’s approach to conducting an audit.

38. Problem 2: In late spring, you are advised of a new assignment as the in-charge accountant of your public accounting firm’s recurring annual audit of a major client, Lancer Inc. You are given the engagement letter for the audit covering the current fiscal year and a list of personnel assigned to this engagement. It is your responsibility to plan and supervise the field work for the engagement. Required: Discuss the necessary preparation and planning for the Lancer Inc. annual audit prior to beginning field work at the client’s office. In your discussion, include the sources you should consult, the type of information you should seek, the preliminary plans and preparation you should make for the field work, and any actions you should take relative to the staff assigned to the engagement. (AICPA adapted)

39. Problem 3: CA has been the auditor of Niles Ltd., a medium-sized manufacturing company, for just over two years. After CA billed the company for the first year audit, Mr. Hiles, the president, called CA to his office to discuss the audit fee, expressing surprise and concern as to its size. CA pointed out that an audit fee for a first-time audit is always higher than normal and gave Mr. Hiles several examples of the work he had to do that would not be required in subsequent years. CA reminded Mr. Hiles that they had previously discussed this point in broad terms and Mr. Hiles accepted the explanation. CA suggested that the audit fee for subsequent years could be reduced if the staff of Niles Ltd. were to prepare some of the schedules for CA’s working papers. Mr. Hiles agreed with this suggestion. For the second year audit, Niles Ltd.’s staff prepared several of the schedules, and CA was able to reduce his fee. However, Mr. Hiles, on receiving the billing for the second year's audit, was still concerned as to its size. When discussing the results of the audit with CA, Mr. Hiles expressed surprise as to the quantity of schedules that had to be prepared by his staff, particularly considering the fact that CA and his staff prepared additional working papers themselves. He asked CA what were the purposes of audit working papers. Mr. Hiles also expressed concern about all the information in the working papers on his company being in CA’s files and asked who owned the working papers.

40. Required: • What are the purposes or functions of audit working papers? (Include the benefits to the client and the auditor.) • What records may be included in the audit working papers? • What factors affect the public accountant’s judgment of the type ands content of the working papers for a particular engagement? • Who owns or has access to audit working papers? • (CICA adapted)

41. Problem 4: • You are engaged in the annual audit of the financial statements of Maulack Corp., a medium-sized wholesale company that manufacturers light fixtures. The company has 25 shareholders. During your review of the minutes, you observe that the president’s salary has been increased substantially over the preceding year by action of the board of directors. His present salary is much greater than salaries paid to presidents of companies of comparable size and is clearly excessive. You determine that the method of computing the president’s salary was changed for the year under audit. In previous years, the president’s salary was consistently based on sales. In the latest year, however, his salary was based on net income before taxes. Maulack Corp. is in a cyclical industry and would have had an extremely profitable year except that the increase in the president's salary siphoned off much of the income that would have accrued to the shareholders. The president is a substantial shareholder. • Required: • What is the implication of this condition on the fair presentation of the financial statements? • Discuss your responsibility for disclosing the situation. • Discuss the effect, if any, that the situation has on your auditor’s opinion as to • The fairness of the presentation of the financial statements. • The consistency of the application of accounting principles. • (AICPA adapted)