Audit%20Planning,%20Understanding%20the%20Client,%20Assessing%20Risks%20and%20Responding

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Audit Planning, Understanding the Client,
Assessing Risks and Responding
Chapter 6
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Obtaining Clients

• Submit a proposal
• Contact the audit committee
• Make fee arrangements
• Communicate with the predecessor auditors
• Topics
• Disagreements over accounting principles
• Predecessors understanding of reason for change
  of auditors
• Other
• Overall procedure is important for evaluation of
  management integrity

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The Audit Process--Steps

• After obtaining a client, the audit process
  includes
• 1. Plan the audit
• 2. Obtain an understanding of the client and its
  environment, including internal control
• 3. Assess the risks of material misstatement and
  design further audit procedures
• 4. Perform further audit procedures
• 5. Complete the audit
• 6. Form an opinion and issue the audit report
• This chapter emphasizes obtaining a client and
  steps 1-3.

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1. Planning the Audit

• Establish an understanding with the client
• This is ordinarily accomplished through use of an
  engagement letter
• Related, determine that
• The firm meets professional independence
  requirements
• There are no issues relating to management
  integrity
• The client understands the terms of the
  engagement

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Items Included in Engagement Letters

• Name of the entity
• Management responsibilities
• Financial statements
• Establishing effective internal control over
  financial reporting
• Compliance with laws and regulations
• Making records available to the auditors
• Providing written representations at end of the
  audit, including that adjustments discovered by
  the auditors and not recorded to the financials
  are not material
• Auditor responsibilities
• Conducting an audit in accordance with GAAS
• Obtaining an understanding of internal control to
  plan audit and to determine the nature, timing
  and extent of procedures
• Making communications required by GAAS

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Engagement Letters--Optional Items

• Arrangements regarding
• Conduct of the audit (e.g., timing, client
  assistance)
• Use of specialists or internal auditors
• Obtaining information from predecessor auditors
• Fees and billing
• Other services to be provided, such as
  examination of internal control over financial
  reporting
• Limitation of or other arrangements regarding
  liability of auditors or client
• Conditions under which access to the auditors
  working papers may be granted to others

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Audit planningoverall

• Develop an overall audit strategy and an audit
  plan
• Plan use of clients staff
• Plan involvement of other CPAs
• Arrange for specialists
• On first year audits
• Communicate with predecessor auditors
• Establish opening balances on the financial
  statements

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2. Obtain an understanding of the client and its
environment

• Perform risk assessment procedures, including
• Inquiries of management and others within the
  entity
• Analytical procedures
• Observation and inspection relating to client
  activities, operations, documents, reports and
  premises.
• Other procedures, such as inquiries of others
  outside the company (e.g., legal counsel,
  valuation experts) and reviewing information from
  external sources such as analysts, banks, rating
  organizations, journals.

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Understanding the Clients BusinessNature of the
Client

• Competitive position
• Organizational structure
• Accounting policies and procedures
• Ownership
• Capital structure
• Product and service lines
• Critical business processes
• Internal control

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Understanding the Clients Business,Industry,
Regulatory, and Other Factors

• Competitive environment
• Supplier and customer relationships
• Technology developments
• Major laws and regulations
• Economic conditions

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Understanding the Clients BusinessAttractiveness
of the Industry

• Barriers to entry
• Strength of competitors
• Bargaining power of suppliers of raw materials
  and labor
• Bargaining power of customers

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Understanding the Clients BusinessObjectives,
Strategies Business Risks

• ObjectivesOverall plans
• Operating and financial strategiesOperational
  actions to achieve objectives
• Business risksThreats to achieving objectives

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Understanding the Clients Business--Basic
Strategy

• Product differentiation
• Cost leadership

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Understanding the Clients BusinessMeasuring and
Reviewing Performance

• Budgets
• Key performance indicators
• Segment performance reports
• Balanced scorecard
• External parties

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Understanding the Clients BusinessSources of
Information

• Inquiries of management
• Industry Accounting and Auditing Guides
• Industry Risk Alerts
• Trade journals and news stories
• Government publications
• Prior company annual reports and SEC filings
• Prior tax returns
• Electronic sources
• Tour of plant and offices
• Analytical procedures

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3. Assess the risks of material misstatement and
design further audit procedures

• Overall approach
• What could go wrong?
• How likely is it that it will go wrong?
• What are the likely amounts involved?
• Particularly consider
• Inherent risks
• Risks of material misstatement due to fraud
  (fraud risks)
• Design further audit procedures

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Assessing Fraud Risks

• Two types
• Fraudulent financial reporting (management fraud)
• Misappropriation of assets (defalcations)
• Procedures to assess fraud risks
• Discussion among engagement team
• Inquiries of management and other personnel
• Planning analytical procedures
• Considering fraud risk factors
• Incentives
• Opportunity
• Attitude

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Assessing Fraud RisksIdentifying Fraud Risks

• Considerations in identifying fraud risks
• Type
• Significance
• Likelihood that it will result in a material
  misstatement
• Pervasiveness

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Responding to Fraud Risks

• Overall response
• Professional skepticism and audit evidence
• Assigning personnel and supervision
• Accounting principles
• Predictability of auditing procedures
• Alterations in audit procedures
• More reliable evidence
• Shifting timing to year end
• Increasing sample sizes
• Response to the possibility of management
  override
• Examining journal entries
• Review accounting estimates for biases
• Evaluating the business rationale for significant
  unusual transactions

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Consideration of Fraud Throughout the Audit

• Evaluating the results of audit tests
• Discovery of fraud
• Communication to appropriate level of management
• If fraud involves senior management or material
  misstatement communicate to audit committee

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Design further audit procedures--I

• Types
• Tests of controls
• Analytical procedures
• Tests of details of transactions and balances
• Audit procedures
• Inspection
• Observation
• Inquiry
• Confirmation
• Recalculation
• Reperformance

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Design further audit procedures--II

• Further audit procedures should include
• Substantive procedures for all relevant
  assertions
• Tests of controls when the auditors risk
  assessment includes an expectation that controls
  are operating effectively, or when substantive
  procedures alone are not sufficient
• Procedures should be linked with the assessed
  risks of material misstatement at the relevant
  assertion level
• Overall responses when assessed risks of material
  misstatement are high
• Heightened professional skepticism
• Assigning more experienced staff
• Assigning staff with specialized skills
• Providing more supervision

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Objectives of Substantive Programs for Asset
Accounts

• Establish the existence of assets
• Establish that the company has rights to the
  assets
• Establish the completeness of recorded assets
• Determine the appropriate valuation of the assets
• Determine the appropriate financial statement
  presentation and disclosure of the assets

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Transactions Affecting Accounts Receivable
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Direction of Audit Testing