Chapter 3 (Engagement Planning)

Question 1

Stages of an audit

Answer 1

• obtain (or retain) engagement
• engagement planning
• risk assessment
• substantive procedures
• reporting

Question 2

issues related to Pre-Engagement Arrangements

Answer 2

• Client selection and retention
• Communication between predecessor and successor auditors
• Engagement letters
• Staff assignment
• Time budget

Question 3

client selection and retention

Answer 3

the avoidance of high risk clients

Question 4

• 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

Answer 4

Client Selection and Retention: The Avoidance of High Risk Clients

Question 5

Client Selection and Retention

Sources of Information and Items to Consider

Answer 5

• 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

Question 6

Why do clients change auditors?

Answer 6

Fees, Internal Rotation Requirements, Disagreements

Question 7

What form must the client file when there is a disagreement with the auditor?

Answer 7

8-K disagreement

Question 8

Who initiates the communication between the Predecessor and Successor Auditors?

Answer 8

Successor

Question 9

the only requirement to communicate is to…

Answer 9

attempt

Question 10

If you take to an auditor that was dismissed by a company, you need to discuss these three issues.

Answer 10

• 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).

Question 11

• 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.

Answer 11

Engagement letter

Question 12

• 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.

Answer 12

Benefits of the engagement letter

Question 13

A partner who is not directly involved with the audit. One more set of eyes to look at the auditor before you sign.

Answer 13

concurring partner

Question 14

• 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.

Answer 14

staff assignments

Question 15

• Internal auditors-Objectivity and Competence
• Use of specialists-qualifications, experience and reputation
• Use of IT auditors
  Identification of related parties
• Materiality

Answer 15

Aspects of planning

Question 16

first: are you independent (objectivity)
second: are you competence (background)

Answer 16

interna auditors

Question 17

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.

Answer 17

use of specialists

Question 18

The auditor is expected to plan and perform an audit that provides reasonable assurance that material misstatements will be detected

Answer 18

Materiality

Question 19

“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”

Answer 19

Materiality definition by FASB

Question 20

three significant dimensions of materiality

Answer 20

• 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

Question 21

• 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

Answer 21

determination of materiality

Question 22

• Guidelines usually involve applying percentages to some base
• Guidelines may also be based on nature of the industry or other factors

Answer 22

materiality guidelines

Question 23

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.

Answer 23

materiality

Question 24

• Absolute size
• Relative size
• Cumulative effects

Answer 24

Quantitative criteria

Question 25

• Nature of the item or issue (illegal payment or liquid assets)
• Circumstances (number that could turn a net loss into a profit)

Answer 25

qualitative criteria

Question 26

materiality is a matter of….

Answer 26

professional judgment

Question 27

Audit Procedures

Used for Three Purposes:

Answer 27

• 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.

Question 28

• 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

Answer 28

Example of how to use Audit Procedures

Question 29

General Audit Procedures

Answer 29

• 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

Question 30

What does A CORRVIIITS stand for?

Answer 30

• 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

Question 31

tracing is just the opposite of…

Answer 31

vouching

Question 32

What assertion does vouching go with?

Answer 32

existence or occurrence assertion

Question 33

What assertion does tracing go with?

Answer 33

completeness