Chapter 3 Flashcards
Client Acceptance/Continuance
Looking for clients that have integrity and who we would want to do business with.
Required by SEC to do, every year and for every client!
Discuss with Predecessor Auditor
You want to ask them various types of questions.
Entity needs to give consent to predecessor auditor to talk to us about the client.
Any extraordinary items? What happened in previous audit?
Ask why they are not continuing with the client? Any fraud?
What was the environment like working with managers?
Has management changed/went against decisions? How active is the audit committee?
Can you use Internal Auditors (I/A)
Evaluate I/A staff.
Direct or Indirect use.
Relationship of materiality and risk of use.
Evaluate the I/A staff
Objectivity, Competence, and Systematic Disciplined Approach.
Direct Use
Treat the internal auditor just as one of your staff, use them directly.
Indirect Use
Use what they have already done or part of normal audit procedures.
Key Points to remember using I/A Directly or Indirectly
You have to do some reperformance of they work and review. Supervise them too!
Relationship of Materiality and Risk on use
As risk and materiality increase, internal auditors aren’t used as much (less).
Audit Committee
Understand their view of their responsibilities. Must be on the board (to be a member). Audit committee appoints the auditor.They determine audit fee. Approve any services external auditors do/suggest. “Whistle blower” procedures: report to company illicit actions without fear from employees.
Letter of Arrangement/Engagement Letter
Our formal contract with the client. Says auditors responsibilities and the clients responsibilities (and limitations). How much it costs. From the audit firm to the client (chairman of audit committee). Must be done before we can start!
Plan Audit: Laws & Regs
Direct and material (taxes, contracts, etc.) our responsibilities.
Material but indirect (FDA, OSHA, EEOC, etc.) our responsibilities.
Direct and material (Taxes, Contracts, etc.) Our responsibilities
We have a responsibility to directly find these. We have direct audit procedure to catch that illegal act or violations.
Ex: Taxes and government contracts. We have proper tax laws.
Material but indirect (FDA, OSHA, EEOC, etc.) Our responsibilities
We just need to be “aware” or “attentive”, and if we find something material then we will do something. Can not ignore though! We do not go directly looking for these or build our audit program to find these.
Related Parties (See handout)
“Arms-Length”. Procedures to find.
What does “arms-length” mean?
Transaction strangers would do with each other, a true fair market value transaction.
Procedures to find
Conflict of interest. Financial Statements. Board minutes.
Document: Overall strategy, plan, and detail audit program steps
All part of the workpapers!
Types of tests
Risk Assessment (Chapter 4). Controls (Procedures). Substantive tests ($ Dollars).
Controls (Procedures)
Tests of procedures. We do these test to make sure controls will detect material misstatements and work like they are supposed to.
Ways to Test Controls
Inquiries, Inspect Documents; Observe, Walkthroughs; Reperformance (include recompute) Table 3-4.
Non public (Consider); Public (Test)
Non-Public: We need to understand controls but do not need to test them.
Public: Required to test key controls.
Substantive tests ($ Dollars)
Sub analytics (trends, ratios - Chapter 5). Tests of detail (Count, Confirm, Look at invoices, Test recons etc. Chapter 5).
Interplay among approaches (3 Key Points)
- The more effective controls are, the less substantive testing you need to do!
- The less effective controls are, the more substantive testing you need to do!
- Papandria interplay: There will be circumstances where you will need to test a lot of both (controls and tests).
Some examples of Papa interplay: more audit comfort needed, new controls, new client, may cause you to do a lot of substantive testing and both in general.
Timing of Controls/Substantive Tests
You really need to test controls first to see if they are effective, then see how many substantive tests will be needed!
For a new client, NEVER do at the same time. Depends on client if you want to do both simultaneously.
If you test a sample with an unacceptable error correctly, the sample represents the population, because you extrapolate, so no need to keep testing!
Materiality
A matter of professional judgement. That amount that if we knew about it, then we would do something differently.
Steps in applying/determining materiality
- Determine overall materiality.
- Determine tolerable misstatement.
- Evaluate audit findings-determine impact on opinion.
Determine overall materiality
The maximum amount financial statements can be wrong/misstated that can’t influence/affect the users.
Determine tolerable mistatement
How much we can stand in each major area or account.
As amount you can stand comes smaller, you need to do more testing (less room for error).
We are auditing the entire F/S and individual account balances.
Evaluate audit findings-determine impact on opinion
Hard entry
Soft entry
Look at rollover of prior period items: make sure not ‘material’ for this year or next year.
Quantitative vs. Qualitative.
Hard entry
Did something wrong, mistake, or goofed. Ex: Recording 84 instead of 48 for truck.
Soft entry
Wiggle room or flexibility. Judgement Call! Ex: Allowance for bad debts; we think should be 1MM, client thinks 1.1MM).
Quantitative vs. Qualitative
Qualitative issues: not significant in dollar amount but has a significant influence on the financial statements. Ex: $2 adjusting entry to not violate debt covenant.
Materiality can change throughout the audit, you can move up or down, but you need to document why that is changing in those circumstances!
NOT appropriate to change materiality to fix a problem!
Another key point
We do not want overstated or understated, we want to be fairly stated/reasonably stated!
