-
Obtaining Client
- ØSubmit a proposal
- ØCommunicate with the predecessor auditor
-
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
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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
-
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
-
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
-
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.
-
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
-
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
-
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
-
Determining Materiality
ØUse professional judgment and based on reasonable person
- ØConsiders both:
- lQuantitative and qualitative factors
-
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
-
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.
-
Performance Materiality
Materiality allocated to a paticular account
-
Evaluation Materialality
Involves circumstances in which one or more misstatements have been identified and the auditors should evaluate whether the amounts involved are material.
-
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
-
Assessing Fraud Risks
Two types
- lFraudulent financial reporting
- (management fraud)
lMisappropriation of assets (defalcations)
-
Considerationsin identifying fraud risks
lType
lSignificance
lLikelihood that it will result in a material misstatement
lPervasiveness
-
Considering Fraud Risks
TRIANGLE
- Incentives
- Opportunity
- Attitude
-
Responding to Fraud Risks - Overall Response
lProfessional skepticism and audit evidence
lAssigning personnel and supervision
lAccounting principles
lPredictability of auditing procedures
-
Responding to Fraud Risks - Alterations in audit procedures
lMore reliable evidence
lShifting timing to year end
lIncreasing sample sizes
-
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
-
Discovery of fraud - Communication
to appropriate level of management
Usually 1 level above
-
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
-
-
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
-
Test for existence or occurrence
- Left to Right
- From end to origin
- financial statements to source documents
-
Test for completeness
- Right to left
- From origin to end
- source documents to financial statements
-
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
-
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
-
Income Statement
Revenue =
- cash receipts from customers
- - Begin Balance of AR
- + Ending balance of AR
-
Income Statement
COGS =
- Cash Payments for merchandise
- - Beg bal AP
- +End bal AP
- + Beg bal Inventory
- - End bal Inventory
-
Income Statement
Expenses =
- Cash payments for expenses
- - beg bal accrued expenses
- + end bal accrued expenses
- + beg bal prepaid expenses
- - end bal prepaid expenses
-
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
-
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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