Chapter 8

Question 1

AICPA auditing standards states what about planning an audit?

Answer 1

The Auditor must plan the work and properly supervise any assistants.

Question 2

Three main reasons that the auditor should properly plan the audit engagement:

Answer 2

1. Enable the auditor to obtain sufficient appropriate evidence for the circumstances.
2. Help keep audit costs reasonable.
3. Avoid misunderstandings with the client.

Question 3

Three risk terms relevant to audit planning:

Answer 3

1. Acceptable audit risk
2. Client business risk
3. Risk of material misstatement:

Question 4

Acceptable audit risk:

Answer 4

a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unmodified opinion has been issued.

Question 5

Client business risk:

Answer 5

The risk that the entity fails to achieve its objectives or execute its strategies.

Question 6

Risk of material misstatement:

Answer 6

The risk that the financial statements contain a material misstatement due to fraud or error prior to the audit.

Question 7

What are the steps of for planning an audit and designing? (4 in total for chapter 8)

Answer 7

1. ACCEPT CLIENT AND PERFORM INITIAL AUDIT PLANNING
2. UNDERSTAND THE CLIENT’S THE CLIENT’S BUSINESS AND BUSINESS AND INDUSTRY
3. PERFORM PRELIMINARY ANALYTICAL PROCEDURES
4. MAKE A PRELIMINARY MATERIALITY JUDGMENT

Question 8

Client Acceptance and Continuance:

Answer 8

CPA firms must take care in accepting new clients. Auditing standards require the new (successor) auditor to communicate with the predecessor auditor to determine if the client lacks integrity or if there were disputes about accounting principles. However, because of client confidentiality, the client must consent to this communication. CPA firms also evaluate existing clients to determine whether a continuing client presents risks due to lack of integrity.

Question 9

Identify Client’s Reasons for Audit:

Answer 9

There may be risk factors associated with the client’s reasons for an audit.

Question 10

Obtain an Understanding with the Client: Develop Overall Audit Strategy:

Answer 10

The auditor should develop and document a preliminary audit strategy. Auditing standards require that auditors obtain an understanding with the client in an engagement letter (See Figure 8-2 in the text), which includes the

(1) engagement objectives,
(2) the responsibilities of the auditor and management,
(3) identification of the financial reporting framework used by management,
(4) reference to the expected form and content of the audit report, and
(5) the engagement limitations.

Question 11

Select Staff for Engagement and Evaluate Need for Outside Specialists:

Answer 11

Auditors are responsible for having available and competent staff who are knowledgeable about the client’s business to perform the audit. If the CPA firm lacks expertise in an area, they may need to hire outside specialists.

Question 12

Industry and External Environment—There are three primary reasons:

Answer 12

1. Risks associated with specific industries may affect the auditor’s assessment of client business risk.
2. Many risks are common to all clients in certain industries
3. Many industries have unique accounting requirements that the auditor must understand to evaluate whether the financial statements are in accordance with accounting standards.

Question 13

Business Operations:

Answer 13

Major sources of revenue, key customers and suppliers, sources of financing, and information about related party transactions.

Question 14

Management and Governance:

Answer 14

Auditors must assess management’s philosophy, operating style and its ability to identify and respond to risk. Governance includes the organizational structure, operations of the board of directors and the audit committee, information regarding a code of ethics, and minutes of meetings of the board of directors. Board minutes reflect key authorizations and summaries of important topics discussed.

Question 15

Client Objectives and Strategies—The auditor should understand the client’s objectives related to:

Answer 15

1. Reliability of financial reporting
2. Effectiveness and efficiency of operations
3. Compliance with laws and regulations.

Business risks can arise that threaten management’s objectives. Knowledge of management’s objectives and strategies help the auditor to assess client business risk and the risk of misstatements.

Question 16

Measurement and Performance—

Answer 16

A client’s performance measurement system includes key performance indicators (KPIs) that management uses to evaluate progress toward its objectives.

Question 17

Perform preliminary analytical procedures.

Answer 17

Key financial ratios, along with industry standards, are presented to the right. Common-size financial statements are also often used for one or more years for comparison as a preliminary analytical procedure.

Question 18

The fourth step in audit planning is to make a preliminary judgment about materiality for the audit.

Answer 18

Auditing standards define materiality as the magnitude of misstatements that individually, or when aggregated with other misstatements, could reasonably be expected to influence the economic decision of users.

Performance materiality represents the allocation of the preliminary judgment about materiality to segments. PCAOB standards refer to performance materiality as tolerable misstatement.

Auditors document all misstatements found for each audit segment. These may be known misstatements or likely misstatements. Known misstatements are those that the auditor can determine the amount of misstatement in the account. Likely misstatements include differences between management’s and the auditor’s judgment about estimates of account balances and projections of misstatements based on the auditor’s tests of a sample

Question 19

THE PROCESS OF SETTING MATERIALTY

Answer 19

Set materiality for the financial statements as a whole as part of the planning process. Factors Affecting preliminary materiality judgment are:

a. Materiality is a relative rather than an absolute concept.
b. Benchmarks are needed for evaluating materiality.
c. Qualitative factors also affect materiality.