Auditing Principles - CH6 - Audit Planning Understaning Client, Assessing Risks

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Auditing Principles - CH6 - Audit Planning Understaning Client, Assessing Risks
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2014-09-28 21:52:30
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Auditing Principles CH6 Audit Planning Understaning Client Assessing Risks
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Auditing Principles - CH6 - Audit Planning Understaning Client, Assessing Risks
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  1. Obtaining Client
    • ØSubmit a proposal
    • ØCommunicate with the predecessor auditor
  2. The Audit Process--Steps
    • 1. Plan the audit
    • 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
  3. The Audit Process - Plan the Audit
    ØEstablish an understanding with the client

    lThis is ordinarily accomplished through use of an engagement letter

    • lRelated, determine that
    • •The firm meets professional independence
    • requirements
    • •There are no issues relating to management integrity
    • •The client understands the terms of the
    • engagement
  4. Items Included in Engagement Letters
    ØName of the entity

    • ØManagement responsibilities:
    • lFinancial statements
    • lEstablishing effective internal control over financial reporting
    • lCompliance with laws and regulations
    • lMaking records available to the auditors
    • lProviding written representations at end
    • of the audit, including that adjustments discovered by the auditors and not recorded
    • to the financials are not material

    • ØAuditor responsibilities:
    • lConducting an audit in accordance with
    • GAAS
    • lObtaining an understanding of internal
    • control to plan audit and to determine the nature, timing and extent of procedures
    • lMaking communications required by GAAS
  5. Audit Planning—Overall
    ØDevelop an overall audit strategy and an audit plan

    ØPlan use of client’s staff

    ØPlan involvement of other CPAs

    ØArrange for specialists

    • ØOn first year audits:
    • lCommunicate with predecessor auditors
    • lEstablish opening balances on the
    • financial statements
  6. The Audit Process - Obtain an Understanding of the Client and its Environment
    ØPerform risk assessment procedures, including:

    • lInquiries of management and others within the entity
    • lAnalytical procedures
    • lObservation and inspection relating to client activities, operations, documents, reports
    • and premises.
    • lOther procedures, such as inquiries of others outside the company (e.g., legal counsel, valuation experts) and reviewing information from external sources such as analysts, banks, rating organizations, journals.
  7. Understanding the Client’s Business—Nature of the Client
    ØCompetitive position

    ØOrganizational structure

    ØAccounting policies and procedures

    • ØOwnership: 
    • lCapital structure
    • lProduct and service lines
    • lCritical business processes
    • lInternal control
  8. Understanding the Client’s Business – Internal Control
    • ØNeed knowledge and understanding of how a client’s internal control works:
    • lWhat controls exists
    • lWho performs them
    • lHow various types of transactions are processed and recorded
    • lWhat accounting records and supporting documentation exist
  9. Understanding the Client’s Business—Sources of Information
    ØInquiries of management

    ØIndustry Accounting and Auditing Guides

    ØIndustry Risk Alerts

    ØTrade journals and news stories

    ØGovernment publications

    ØPrior company annual reports and SEC filings

    ØPrior tax returns

    • ØElectronic sources
    • lEx. www.fasb.org, web pages for company

    ØTour of plant and offices

    ØAnalytical procedures

    ØThe statement of cash flows and obtaining an understanding of the client
  10. Determining Materiality
    ØUse professional judgment and based on reasonable person

    • ØConsiders both:
    • lQuantitative and qualitative factors
  11. Materiality Definitions
    • ØFASB (reasonable person)
    • (included in SASs)—The magnitude of an omission or misstatement of financial
    • information that, in the light of surrounding circumstances, makes it probable
    • that the judgment of a reasonable person relying on the information could have
    • been changed or influenced by the omission or misstatement.

    • ØPCAOB (investor)
    • interpretation of federal securities laws—A fact is material if there is a substantial likelihood that the… fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made
    • available
  12. Planning Materiality
    At beginning of of planning stage so scope of audit can be determined

    Audit procedures should be designed to detect material misstatements so that the auditors do not waster time searching for immaterial misstatements that cannot affect the auditors report.
  13. Performance Materiality
    Materiality allocated to a paticular account
  14. Evaluation Materialality
    Involves circumstances in which one or more misstatements have been identified and the auditors should evaluate whether the amounts involved are material.
  15. The Audit Process - Assess the Risks of Material Misstatement and Design Further Audit Procedures
    ØOverall approach

    lWhat could go wrong?

    lHow likely is it that it will go wrong?

    lWhat are the likely amounts involved?

    • ØParticularly consider
    • lInherent risks
    • lRisks of material misstatement due to
    • fraud (fraud risks)

    ØDesign further audit procedures
  16. Assessing Fraud Risks
    Two types
    • lFraudulent financial reporting
    • (management fraud)

    lMisappropriation of assets (defalcations)
  17. Considerationsin identifying fraud risks
    lType

    lSignificance

    lLikelihood that it will result in a material misstatement

    lPervasiveness
  18. Considering Fraud Risks
    TRIANGLE
    • Incentives
    • Opportunity
    • Attitude
  19. Responding to Fraud Risks - Overall Response
    lProfessional skepticism and audit evidence

    lAssigning personnel and supervision

    lAccounting principles

    lPredictability of auditing procedures
  20. Responding to Fraud Risks - Alterations in audit procedures
    lMore reliable evidence

    lShifting timing to year end

    lIncreasing sample sizes
  21. Responding to Fraud Risks - Response to the possibility of management override
    lExamining journal entries

    lReview accounting estimates for biases

    • lEvaluating the business rationale for
    • significant unusual transactions
  22. Discovery of fraud - Communication
    to appropriate level of management
    Usually 1 level above
  23. Design Further Audit Procedures
    • ØTypes:
    • lTests of controls

    lAnalytical procedures

    • lTests of details of transactions and
    • balances 

    ØAudit procedures

    lInspection

    lObservation

    lInquiry

    lConfirmation

    lRecalculation

    lReperformance
  24. Audit Documentation

  25. Audit Trail
    • ØA trail of evidence that links source documents, journal entries and ledger
    • entries

    ØAuditor may follow the audit trail in either of two directions related to the direction of testing

    • lTest for existence or occurrence
    • lTest for completeness
  26. Test for existence or occurrence
    • Left to Right
    • From end to origin 
    • financial statements to source documents
  27. Test for completeness
    • Right to left
    • From origin to end
    • source documents to financial statements
  28. Transaction cycles
    • ØAuditors’ consideration of internal control is often organized around client’s major
    • transaction cycles (examples)
    • lRevenue  cycle
    • lAcquisition cycle
    • lConversion cycle
    • lPayroll cycle
    • lInvesting cycle
    • lFinancing cycle
  29. Audit Program
    • ØSystems portion:
    • lDeals with client’s internal control
    • lEvidence of test of controls and assessing control risk

    • ØSubstantive test portion
    • lDeals with financial statement account balances
    • lIndirect and direct verification of income statement accounts
  30. Income Statement
    Revenue =
    • cash receipts from customers 
    • - Begin Balance of AR
    • + Ending balance of AR
  31. Income Statement
    COGS =
    • Cash Payments for merchandise
    • - Beg bal AP
    • +End bal AP
    • + Beg bal Inventory
    • - End bal Inventory
  32. Income Statement
    Expenses =
    • Cash payments for expenses
    • - beg bal accrued expenses
    • + end bal accrued expenses
    • + beg bal prepaid expenses
    • - end bal prepaid expenses
  33. Objectives of Substantive Programs for Asset Accounts
    ØEstablish the existence of assets

    • ØEstablish that the company has rights to
    • the assets

    ØEstablish the completeness of recorded assets

    ØVerify the cutoff of transactions

    • ØDetermine the appropriate valuation of
    • the assets and accuracy of related transactions

    • ØDetermine the appropriate financial statement presentation and disclosure of
    • the assets
  34. Relationship of Financial Statement Assertions to the Audit
    • Financial Statements
    • (following GAAP)

    • Management Assertions
    • (Existence, Rights, Completeness, Cutoff, Valuation, Presentation)

    • Audit Objectives
    • (Designed based on Mgmt Assertions)

    • Audit Procedures
    • (Determined based on the risks of material misstatement at the Assertion level)

    • Audit Evidence
    • (Summarized in audit documentation)

    Audit report on financial statements

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