Ch 3 Flashcards
What does risk refer to in an audit engagement?
Probability that firm could blow the audit opinion
risk engagements
Activities before beginning audit engagement
Predecessor auditor
Public accounting firm that has been terminated
Or has voluntarily withdrawn from engagement
To reduce risk of accepting a problem client, auditing standards require a prospective auditor to…
Find out from predecessor auditor integrity of management
Before taking on a client what is looked into by accounting firm? 3 things
1 check financial records
2 criminal background check on management
3 inquiries with people who do business with company
(Bankers, lawyers, underwriters, analysts)
What must an accounting firm evaluate about itself before taking on a new audit client?
1 risks of taking engagement
2 accounting firms independence with regard to client
3 consider need for individuals possessing special skills
(IT auditor, valuation specialist, industry specialist)
Form 8-K: special events report
Filed with SEC when public company changes auditors
Required when significant events such as changes in control
Or legal proceedings occur
Independence in fact
Independence in state of mind of auditor
Independence in appearance
Others’ perceptions of auditors’ independence
If an auditor is not considered independent from the company’s managment, the audited statement is considered…
Unaudited
When is an engagement letter prepared?
When a new client is accepted
or when an audit engagement continues from year to year
What 4 things does an engagement letter set forth about the understanding with the client?
1 objectives of engagement
2 management’s responsibilities
3 auditor’s responsibilities
4 limitations if the engagement
Termination letter
Documentation provided to former clients dealing with subject
Of future services
4 ways termination letter is helpful?
1 access to audit documentation by new auditors
2 reissuance of auditors report for SEC reporting
3 fee arrangements for future services
4 provides reasons for termination
Audit plan
Comprehensive list of audit procedures audit team needs to
Perform
To gather evidence for auditors opinion on financial statements
Primary reason for engagement planning
Mitigating risks
3 additional goals of audit planning
1 make sure qualified staff to conduct audit
2 determine materiality
3 audit procedures: control tests and substantive tests in line with
Professional standards
Audit engagement partner
Person with final responsibility for audit and usually industry
Specialist
Quality assurance partner
Second audit partner who reviews audit team’s work in critical
Audit areas
Objectivity: internal vs. External auditors
Internal auditors can never be considered independent in same
Sense as external auditors
Because internal auditors are employed and compensated by client
How is an internal auditor’s competence investigated?
Obtaining evidence about educational and experience qualifications
Audit specialists
Persons skilled in fields other than accounting and auditing
Ex. Actuaries, appraisers, attorneys, environmental engineers,
Geologists
Interim audit work
Procedures performed several weeks or months before date of
Financial statements
Year end audit work
Procedures performed shortly before and after date of
Financial statements
Materiality
Amount or event likely to influence financial statement users
decisions
Performance materiality
Amount less than materiality for financial statements as whole
Materiality calculation
Materiality is matter of professional judgement that each
Engagement partner must decide on an audit engagement
3 ways audit team uses materiality
1 planning substantive testing procedures
2 determining performance materiality
3 guide decisions about audit report
Substantive testing procedures
Directing attention and audit work to items/accounts that are
Important, uncertain, susceptible to material misstatement
Performance materiality
Make sure aggregate uncorrected/undetected immaterial
Misstatements don’t exceed materiality level of financial
Statement as whole
3 purposes for auditors using audit procedures
1 gain understanding of client and client’s risks
2 test operating effectiveness and internal controls
3 produce evidence about management’s assertions
Substantive audit plan
Contains list of audit procedures for gathering evidence
Related to relevant assertions
Relevant assertions identified for audit client’s significant
Financial statement accounts and disclosures
2 ways to conduct substantive tests
1 substantive analytical procedures
2 tests of details
Analytical procedures, what must the auditor develop?
Auditor must develop an independent expectation of what
He or she thinks the account balance should be
8 general audit procedures used to gather evidence
1 inspection of records/documents 2 inspection of tangible assets 3 observation 4 inquiry 5 confirmation 6 recalculation 7 reperformance 8 analytical procedures
Substantive Test of details
Auditor must seek to understand account balance/economic
Transaction
And that it was recorded in accordance with GAAP
Vouching
Audit procedure in which an auditor selects an item of financial
Info (usually from journal or ledger)
And follows back through the processing steps to origin
Tracing direction
Auditor selects basic source document and follows its
Processing path forward to find its final recording
Final recording found in journal or ledger and ultimately
Financial statements
What assertions does vouching adequately support?
Existence and occurrence
What assertion does tracing support?
Completeness assertion
Inspection of tangible assets provides evidence of? 2 things
Existence and valuation
Observation
Auditors use observation when they view client’s physical
Facilities and personnel on an inspection tour
They observe personnel carry out accounting and control
Activities and participate in surprise payroll distribution
Inquiry
Procedure involves collection of oral/sometimes written evidence
From independent parties and management
Confirmation
Direct correspondence with independent parties
What can correspondence produce evidence of? 5 things
1 Existence 2 rights 3 obligations 4 valuation 5 cutoff
Recalculation
Auditor recalculation of computations previously performed by
Client personnel produces compelling evidence
Mathematical recalculation so serve which 2 assertions?
Existence and valuation
CAATs
Computer assisted audit techniques
Analytical procedures
When auditor compares expectation of recorded balance
Computerized environment: Audit trail
Chain of evidence provided through coding, cross references
and documentation
connecting account balances And other summary results with the original transaction source Documents
Less human involvement in handling transactions processed by computers can…
Reduce potential for observing errors and fraud
5 considerations auditors should make about client’s computerized processing on an audit of financial statements
1 complexity of computer operations
2 organizational structure of computerized processing activities
3 availability of data required by auditor
4 CAAT computer assisted audit techniques available
5 need for specialized skills
An engagement is not complete without…
Audit documentation
Audit documentation
Written record of basis for auditor’s conclusions that provides
Support for auditor’s representations
Whether those representations are contained in auditor’s report
Or otherwise
Audit documentation provides…
The auditors’ record of compliance with GAAS
Permanent files AKA continuing audit files
Contain info of continuing audit significance over many years
Audits of the same client
Current files
Include all client acceptance and continuance documentation
Include planning documentation for year under audit
Planning memorandum
Summary of data with specific directions about effect on audit
Lead schedule
Summary of accounts or components in an account group
Indexing
Each document given an index number
Cross referencing
Numbers or memoranda related to other documents carry the
Index of other documents so connections can be followed
Heading
Each document is titled with name of company, balance sheet date
And title of documents contents
Audit marks AKA Tick marks
Abbreviated comments about auditor’s work performed
