Chapter 6

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Chapter 6
2011-03-14 20:15:00
Audit Planning Understanding Client Assessing Risks Responding

Midterm 1
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  1. Obtaining Clients
    • Submit proposal- contact the audit committee, make fee arangements
    • Communicate with the predecessor auditor
  2. The Audit Process- Steps
    • Plan the audit
    • Obtain an understanding of the client and its enviornment, including internal control
    • Assess the risks of material misstatement and design further audit procedures
    • Perform further audit procedures
    • Complete the audit
    • Form and Opinion and issue the audit report
  3. Planning the Audit- Step 1
    • Establish an understanding with the client
    • this is ordinarily accomplished through use of an engagement letter
    • engagement letter- is a contract with client

    • Must also determine
    • the firms meets professional indpendence requirements
    • there are no issues with management integrity
    • The client understands the terms of the engagement
  4. Items To include in Engagement Letters
    • Name of entitiy
    • Managment responsibilities
    • Auditor responsibiities
  5. Audit Planning-Overall
    • Develop an overall audit strategy and an audit plan
    • Plan use of clients staff
    • Plan involvement of other CPA's
    • Arrange for specialist
    • On first year audits:
    • comunicate with redecessor auditors
    • establish opening balances on the FS
    • obtain information for permanent files
  6. Obtain an Understanding of the Client and its Enviornment Step 2
    • Perform risk assesment procedures:
    • Inquires of management and others within the entity
    • observation and inspection relating to client activities, operation, document, reports and premises.
    • Plan tour and discussion with proces owners
  7. Plant tour Assignment
    • Understand the company's business enviornment, valueproposition and business model
    • Observe the operation and internal control environment
    • do you see any poetential weakness?
  8. Understanding the clients Business
    • Nature of the client
    • Industry, regulatory and related factors
    • Objectives, strategies, business risk
    • Measuring and review performance
    • Internal controls
  9. Understanding-The nature of the Clients Business
    • Competitive position
    • Organizational structure
    • Accounting Policies and procedures
    • Ownership
    • Capital Structure
    • Product and service lines
    • Critical business processes
    • Internal control
  10. Understanding the Clients Business- Industry, Regulatory, and other Factors
    • Competitive enviornment
    • Supplier and customer relationships
    • Technology developments
    • Major laws and regulations
    • Economic conditions
    • Attractiveness of the industry
    • barriers of entry
    • strength of competitors
    • Bargaining power of supliers of raw materials and labor
    • Bargainin power of customers
  11. Understanding the Clients Business- Objectives, Strategies & Business Risks
    • Objectives- Overall plans
    • Operating and financial strategies- operational actioins to achieve objectives
    • Business risks-Threats to achieveing objectives
  12. Understanding the Client's Business- Measuring and Reviewing Performance
    • Budgets
    • key Performance Indicators
    • Variance analysis
    • Segment performance reports
    • Balance Scorecard
    • External parties
  13. Understanding the Clients Busines-Internal Control
    • Need knowledge and understanding of how a client's internal control work
    • what controls exist
    • who performs them
    • how variouos types of transaction are processed and recorded
    • what accounting records and supporting documentation exist
  14. Undrstanding the Client's Business- Source of Information
    • Inquires of managment
    • industry accounting and auditing guides
    • industry risk alerts
    • Trade journals and news stories
    • government publicaiton
    • prior compnay annual reprots and SEC filings
    • Prior tax returns
    • the statement of cash flows and obtaining an understanding of the client.
  15. Determining Materiality
    • Use professional judgement and bsed on reasonable person
    • Considers both : quantative and qualitative factors
  16. Materiality is used in:
    • Planning the audit: at the overall financial statement level and when allcating to individual accounts
    • Evaluating audit findings
    • Materiality criteria impact audit scope
  17. Materiality Definition- FASB statement of Financial Statement No.2 "Qualitative Characteristics of Accounting Concepts"
    The magnitude of an ommision or msistatement of accounting infomationthat in the light of surrounding makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatements.
  18. Determining Materiality
    • Reasonable assurance, not absolute
    • Rule of thumbs
    • 5-10% of profit before taxes
    • .5-1% of total assets
    • .5-1% of total revenues
    • 1% of total equity
    • Qualitative considerations
    • Compliance with laws and regulations
    • Compliance with contracts, loans, leases
  19. Assess the Risks of Material Misstatement and Design Further Audit Procedures- step 3
    • overall approach
    • what could go wrong
    • how likely is it that it will go wrong
    • what are the likely amounts involved?

    • Particularly consider
    • Inherent risks
    • risks of material misstatement due to fraud (fraud risks)

    Design further audit procedures
  20. Assessing Fraud Risks
    • Two Types
    • Procedures to assess fraud risks
    • Consider materiality
  21. Two types of Fraud risk
    • Fraudulent financial reporting (management fraud)
    • Missappropriation of assets (defalcation)
  22. Procedures to aseess fraud risks
    • Discussion among engagement team
    • inquiries of mangment and other personnel
    • planning analytical procedures
    • considering fraud risk factors
    • incentives
    • opportunity
    • attitude
  23. Responding to Fraud Risks
    • Response to the possibility of management override
    • Examining jounal entries-non-routine
    • Review accounting estimates for biases
    • evaluating the business rationale for significant unusual transactions
  24. Discovery of Fraud
    If fraud involve senior managment or material misstatemetn communicate to audit committee
  25. Evaluating results of audit test
    Are errors or lack of documentaiton an oversight (unintientional error) or fraud
  26. Design further audit procedures-types
    • Test of controls
    • Analytical procedures
    • Tests of details of transactions and balances
  27. Design further Audit Procedures- Audit Procedures
    • Inspection
    • observation
    • Inquiry
    • Confirmation
    • Recalculation
    • Reperformance
  28. further Audit Procedures should include
    • Substantive procedures for all relevant assertions
    • Test of controls when auditors risk assessment includes an expectation that controls are operating effectively.
  29. Overall responses when asseessed risks of material misstatement are high
    • Heightened professional skepticism
    • assinging more experienced staff
    • assigning staff with specialized skills
    • providing more supervision
  30. Financial Statement Assertions: Auditing Standards board and Internation Standards-PIC
  31. Audit Documentation
    • Risk Assessment
    • Procedure Results
    • consideration of fraud
  32. Audit Trail
    • Transaction History
    • A trail of evidence that links source documents, journal entries and ledger entries
    • auditor may follwo the audit trail in either of twodirections related to the direction of testing
  33. Two test used in audit trail
    • Test for existenc or occurrence
    • test for completeness
    • Full or False inclusion
  34. Direction of Audit Testing-Pic
  35. Direction of Testing- inventory Example
    • Select 10 purchase orders and trace to inventory records, receiving reports, invoice, payment
    • Select 10 receiving reports and trace to inventory records, PO, invoice, payment
    • Select 10 inventory records and trace to PO, receiving reports, invoice, payment
  36. Transaction cycles
    Audtitors consideration of internal contorl is often organizaed around clients major transaction cycles
  37. Audit Program- systems Portion
    • Deals with clients internal control
    • evidence of test of controls and assessing control risk
  38. Substantive test portion
    • Deals with financial statement account balances
    • Indirect and direct verificaiton of income statment accounts
  39. Objective of Substantive Programs: Example for Asset Accounts
    • Establish the existence of assets
    • Establish that the company has rights to the assets
    • Establish the completeness of recorded assets
    • Verify the cutoff of transactions
    • Determine the appropriate valuation of the assets and accuracy of related transaactions
    • Determine the appropriate valuation of the assets and its accuracy
    • Determine the appropriate financial statement presentation and disclosure of the assets
    • These match mangements assertions
  40. Indirect Verification of Income Statement Accounts- Pic