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Chapter 3

Chapter 3. Engagement Planning. 1. Audit Process. Stages of an audit 1. Initial audit planning 2. Obtain an understanding of the client and its environment, including internal control 3. Assess the risks of material misstatement and design further audit procedures

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Chapter 3

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  1. Chapter 3 Engagement Planning Chapter 3

  2. 1. Audit Process • Stages of an audit 1. Initial audit planning 2. Obtain an understanding of the client and its environment, including internal control 3. Assess the risks of material misstatement and design further audit procedures 4. Perform further audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report Chapter 3

  3. 1. Audit Process • AU-C 300 Planning an Audit • Performance Principle (FW Std. No. 1): The auditor must adequately plan the work and must properly supervise any assistants. • Planning involves developing an overall audit strategy • Not a discrete phase of audit • Supervision involves directing the efforts of all assistants involved in the audit • Objective is to plan the audit so that it will be performed in an effective manner Chapter 3

  4. 1. Audit Process • AU-C 210 Terms of Engagement • Objective of auditor is to accept an engagement for a new or existing audit client only when the basis upon which it is to be performed has been agreed upon • establishing whether the preconditions for audit are present • confirming that common understanding exists between auditor and management Chapter 3

  5. 1. Audit Process • Preconditions of audit • determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable • obtain the agreement of management that it acknowledges and understands its responsibility • for preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework • for the design, implementation, and maintenance of internal control • to provide the auditor with • access to all information that is relevant to the preparation and fair presentation of the financial statements • additional information that the auditor may request from management for the purpose of the audit • unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence Chapter 3

  6. 2. Structure of CPA Firm • Positions in firm • Up or out • Partnership potential • Women in public accounting • Work load • Busy season • Size of firm • Size of engagement team Chapter 3

  7. 3. Preliminary Arrangements • Early appointment of auditors • Evaluate client • integrity of management • special risks • Evaluate your resources • staffing • interim vs. year-end work • time budget • independence • Quality assurance partner • required on issuer engagements • provides second review on high risk areas of audit Chapter 3

  8. 3. Preliminary Arrangements (continued) • Communicate with predecessor auditor (AU-C 210) • integrity of management • disagreements with management • reason for auditor change • required communications • Engagement letter (AU-C 210) • purpose • First time audits • auditing opening balances (AU-C 510) Chapter 3

  9. 3. Preliminary Arrangements (continued) • Using work of internal auditors (AU-C 610) • objectivity • competence • Identification of related parties (AU-C 550) • IT in an audit • IT audit specialist • CAATs in an audit • ACL, IDEA, proprietary software Chapter 3

  10. 4. Evidence Provided bySpecialists • AU-C 620 • Definition - a person (or firm) possessing special skill or knowledge in a particular field other than accounting or auditing • Examples: actuaries, appraisers, engineers, environmental consultants, geologists, and attorneys • Consider qualifications, experience, reputation • Independence • Review of work • Effect on audit report Chapter 3

  11. 5. Understanding Client’s Business • Sources of information • AICPA Audit and Accounting Guides • Industry information • Regulatory, SEC, governmental reports • Company information • Examine • Nature of business • Business objectives & strategies • Management methods • Internal control • Business risks Chapter 3

  12. 5. Understanding Client’s Business (continued) • Risk-based auditing • Top down approach • identify client’s strategy and process for developing strategy • examine core business processes • identify key processes • for each key process identify • objectives, inputs, activities, outputs, systems, and transactions • assess risks key processes are meeting objectives • Tie audit procedures to accounts and assertions Chapter 3

  13. 6. Assess RMM & Design Further Tests (con’t) • Overall responses when RMM high • Heightened professional skepticism • Assigning more experienced staff • Assigning staff with specialized skills • Providing more supervision Chapter 3

  14. 7. Effect of Electronic Environment on Audit • Risks • risks related to hardware and software • reduced audit trail • need for IT experience and separation of IT duties • No effect on • purpose of audit (e.g., gathering sufficient appropriate evidence) • importance of management’s assertions Chapter 3

  15. 8. Materiality • AU-C 320 – Materiality in Planning and Performing the Audit • Definition • Assessing materiality • quantitative factors • qualitative factors • Materiality guidelines • SEC caution • Accounting materiality • ex post decision process • Auditing materiality • ex ante decision process Chapter 3

  16. 8. Materiality (continued) • Financial statement level materiality • methods to establish • annualizing financial results • Account balance level materiality • performance materiality • tolerable error • Top down approach • Bottom up approach • Planning materiality vs. final evaluation level materiality • Cost benefit considerations Chapter 3

  17. 8. Materiality (continued) • Cumulative effects • Known error and likely error • (factual vs judgmental misstatements) • Relationship between audit risk and materiality • Nonadditive nature of tolerable error • Materiality exampleexample2 Chapter 3

  18. 9. Audit Tests and Procedures • Risk assessment procedures • procedures to obtain understanding of client, its environment, including IC • observation, inquiry, inspection, and analytics (walkthrough) • Tests of controls • procedures to determine the operating effectiveness of controls • inquiry, observation, inspection, reperformance • Substantive tests • procedures to verify account balances • activities performed to detect material misstatement or fraud at assertion level • includes tests of balances, transactions, and SAP Chapter 3

  19. 9. Audit Tests and Procedures • inspecting • observing • confirming • inquiring • tracing • vouching Chapter 3

  20. 9. Audit Tests and Procedures • scanning • counting • recalculating • reperforming • analytical procedures Chapter 3

  21. 10. Audit Programs • Transactions cycles • Audit plans • Audit programs Chapter 3

  22. 11. Audit Documentation • AU-C 230 • Purpose • Factors affecting type and content • Ownership • Organization • permanent file • current file • Electronic workpapers • AS 3 requirements • completion date – 45 days after report date • Retention – at least 7 years • additions/amendments – no deletions; fully documented additions Chapter 3

  23. 11. Audit Documentation (con’t) • Types • working trial balance • lead schedules • supporting schedules • adjusting journal entries • reclassification journal entries • Indexing • Tick marks Chapter 3

  24. APOLLO SHOES, INC. C-1 Inventory Lead Schedule APOLLO SHOES, INC. B-1 Accounts Receivable Lead Schedule Current File Other Lead Schedules APOLLO SHOES, INC. A-3 Bank Confirmation APOLLO SHOES, INC. A-2 First National Bank Reconciliation APOLLO SHOES, INC. A-1 Cash Lead Schedule 12/31/04 Ref Account Unaudited AJE Balance C-1 1rst Natl $484,000 $50,000 $534,000 Supporting Schedules APOLLO SHOES, INC. TB-1 Working Trial Balance 12/31/04 Ref Account Unaudited AJE Balance A-1 Cash $484,000 $50,000 $534,000 B-1 A/R C-1 Inventory APOLLO SHOES, INC. TB-2 Adjusting Entries dr cr Cash $50,000 Expenses $50,000 Chapter 3

  25. Audit Documentation • Information on Workpaper • Name, date, purpose, page number • Procedures performed and conclusions reached by the auditor • Evidence that auditor followed general standards and standards of field work • Audit Mark Legend • Reviewers’ initials Chapter 3

  26. 12. Review Questions for Discussion • Chapter 3 3.2 3.3 3.6 3.9 3.10 3.11 3.13 3.16 3.19 3.20 3.23 3.24 Chapter 3

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