Chapter 3 (Engagement Planning) Flashcards
Stages of an audit
- obtain (or retain) engagement
- engagement planning
- risk assessment
- substantive procedures
- reporting
issues related to Pre-Engagement Arrangements
- Client selection and retention
- Communication between predecessor and successor auditors
- Engagement letters
- Staff assignment
- Time budget
client selection and retention
the avoidance of high risk clients
- Inadequate capital
- Lack of long run strategic plans
- Low cost of entry into the market
- Dependence on a limited product range
- Dependence on technology that may become obsolete
- Instability of future cash flows
- History of questionable accounting practices
- Previous inquiries by SEC or other regulatory agencies
Client Selection and Retention: The Avoidance of High Risk Clients
Client Selection and Retention
Sources of Information and Items to Consider
- Obtaining and reviewing financial info about the client: Annual reports, reports to regulatory agencies, etc.
- Inquiry of bankers, legal counsel, underwriters, people who do business with the client.
- Does the engagement require special attention or involve unusual risks.
- Evaluate our independence.
- Consider the need for special skills.
- Mgmt. integrity is the main consideration
Why do clients change auditors?
Fees, Internal Rotation Requirements, Disagreements
What form must the client file when there is a disagreement with the auditor?
8-K disagreement
Who initiates the communication between the Predecessor and Successor Auditors?
Successor
the only requirement to communicate is to…
attempt
If you take to an auditor that was dismissed by a company, you need to discuss these three issues.
- Disagreements about accounting principles or audit procedures.
- Communications the predecessor gave the former client about fraud, illegal acts, and internal control recommendations.
- The predecessor’s understanding about the reasons for the change of auditors (particularly about the predecessor’s termination).
- Standards require auditors to reach a mutual understanding with the client concerning engagement requirements and expectations and to document this understanding.
- It sets forth the following:
> Objectives of the engagement
> Managements responsibilities
> Auditors responsibilities
> Any limitations of the engagement - It acts as a Contract
- Helps to manage engagement risk, because responsibilities and expectations of each party are outlined.
Engagement letter
- Helps to establish an understanding of the terms of the engagement and nature of the work.
- Helps avoid quarrels and misunderstandings between client and auditors.
- Helps to avoid disputes over fees.
- Helps to avoid legal liability for work CPA did not agree to do.
Benefits of the engagement letter
A partner who is not directly involved with the audit. One more set of eyes to look at the auditor before you sign.
concurring partner
- Usually, Audit Partner, Audit Manager, Industry Specialist, Senior Auditors, Staff Auditors, IT Specialist and a Concurring Partner as is required by Standards.
- Assignments vary with the risk involved with the client
- Concurring Partner is required and is supposed to give the audit a detached, unbiased review.
staff assignments
- Internal auditors-Objectivity and Competence
- Use of specialists-qualifications, experience and reputation
- Use of IT auditors
Identification of related parties - Materiality
Aspects of planning
first: are you independent (objectivity)
second: are you competence (background)
interna auditors
a person that is specialized in something other than tax and accounting, they do to need to be independent but the standards say it is preferably, if no independent we better dig into their background in order to know what we are dealing with. We do not mention them in the report unless we need to modify the opinion letter based on what they told us.
use of specialists
The auditor is expected to plan and perform an audit that provides reasonable assurance that material misstatements will be detected
Materiality
“magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement”
Materiality definition by FASB
three significant dimensions of materiality
- Size of the misstatement (dollar amount)
- Circumstances - some things are viewed more critically than others
- User impact - impact on potential users and the type of judgments made
- Although this makes determination more difficult, it allows the auditor to adjust the rigor of the audit to reflect the risk of the engagement
- The lower the dollar amount of set materiality, the more rigorous the examination
determination of materiality
- Guidelines usually involve applying percentages to some base
- Guidelines may also be based on nature of the industry or other factors
materiality guidelines
refers to an amount (or transaction) that would influence the decisions of users (i.e., an amount (or event) that would make a difference). The emphasis is on user, rather than management or the audit team.
materiality
- Absolute size
- Relative size
- Cumulative effects
Quantitative criteria
- Nature of the item or issue (illegal payment or liquid assets)
- Circumstances (number that could turn a net loss into a profit)
qualitative criteria
materiality is a matter of….
professional judgment
Audit Procedures
Used for Three Purposes:
- Risk assessment-used to gain an understanding of the client and the risks associated.
- Tests of Controls-used to test the operating effectiveness of the clients internal control procedures.
- Substantive procedures: Analytical procedures and tests of details for account balances.
- Aware of Assertions: Existence
- Key Question: Do the assets recorded really exist
- Example of evidence available: The physical presence of the assets
- Audit Procedure: Inspection of tangible assets
Example of how to use Audit Procedures
General Audit Procedures
- Inspection of records and documents (watch for source of docs)-invoices, p.o.s, loan apps, bank statements, title papers
> Vouching
> Tracing
> Scanning-debits in revenue accts, credits in expense accts, etc. - Inspection of tangible assets-Existence, valuation, not ownership
- Observation-used in tests of controls heavily
- Inquiry-mgmt representations-good starting place-must corroborate
- Confirmation-existence, ownership, valuation, cutoff
- Recalculation-existence, valuation-depreciation, interest expense, pension liabilities, etc.
- Reperformance-reperform a control activity-broader in nature
- Analytical Procedures
What does A CORRVIIITS stand for?
- analytical procedures
- confirmations
- observations: watching people work
- recalculation
- reperformance: related to internal controls
- vouch
- inspection of records and documents
- inquiry
- inspect tangible assets
- trace
- scan
tracing is just the opposite of…
vouching
What assertion does vouching go with?
existence or occurrence assertion
What assertion does tracing go with?
completeness
