Audit Planning and Documentation

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Chapter 7

• Audit Planning and Documentation

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Audit Planning

• Examination Standard auditor must plan and
  perform the audit to reduce audit risk to an
  acceptably low level that is consistent with the
  objective of an audit. If assistants are
  employed, they should be properly supervised.

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Planning the audit

• Planning is the development of a general
  strategy and a detailed approach for the expected
  nature, extent, and timing of the audit
• What are you going to do, why and how!
• Reasons to properly plan
• Obtain sufficient appropriate audit evidence
• Keep costs reasonable
• Avoid misunderstandings with client

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Preplanning

• New client acceptance or client continuance
• Clients reasons for audit
• Independence threat analysis
• Engagement letter
• Staffing capabilities and meetings

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Preplanning New client acceptance or client
continuance

• Would you accept a client where the owner had
  filed for bankruptcy three times, is currently
  being sued for tax evasion, and is considering a
  public offering of shares?
• Both new and existing clients should be
  re-evaluated for every engagement

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Preplanning New client acceptance or client
continuance

• Client lacks integrity, argue about proper
  conduct of audit and fees, cause more problems
  then they are worth
• Refuse if it is a high risk industry
• New clients
• Investigate company (standing in business
  community, financial stability, relations with
  prior auditors)
• Required to communicate with predecessor
  auditors helps to evaluate whether the
  engagement is acceptable
• Need permission from client
• Predecessor auditor is required to respond (if
  legal problems or disputes state no info will be
  provided)
• Internet searches

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Preplanning New client acceptance or client
continuance

• Continuing clients
• Annual evaluation
• Conflicts-scope of audit, type of opinion,
  fees-then discontinue association
• Cant audit if they are suing you or you are
  suing them (independence)

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Preplanning Clients reasons for audit

• Who are the users?
• What are the intended uses of the financial
  statements?
• Accumulate more evidence when statements are used
  extensively

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Preplanning Independence threat analysis

• Recall the five potential threats to independence
  (self-interest, self-review, advocacy,
  familiarity, intimidation)
• These need to be explicitly addressed, potential
  threats described, safeguards put into place to
  mitigate the threat
• If independence cannot be achieved, the
  engagement must be declined
• Threats without safeguards or safeguards do not
  adequately mitigate the threat
• Communicate to Audit Committee any threats and
  how they are dealt with

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Preplanning Engagement letter

• Provides documentation of a clear understanding
  of the terms of the engagement between the client
  and the public accounting firm
• Should be in writing to minimize misunderstandings

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Preplanning Engagement letter

• Specify
• Engagement (audit, review, compilation, tax
  services)
• Restrictions imposed on auditors work
• Deadlines
• Assistance to be provided by clients staff and
  schedules staff will prepare
• Role of internal audit dept
• Fees
• Informs client that auditor is not responsible
  for discovery of all acts of fraud

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Preplanning Staffing capabilities and meetings

• Overall, the audit team needs to have sufficient
  training and proficiency to conduct the
  engagement
• This includes continuity of staff and assigning
  internal or external specialists as needed
• Extent of work provided by client also impacts
  staffing

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Develop Client Risk Profile

• Need for extensive understanding of business,
  industry, and companys operations for an
  adequate audit

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Client risk profile

• Obtain knowledge of industry and business
  environment
• Obtain knowledge of clients business
• Assess control environment and corporate
  governance process

• Assess risks of fraud
• Decide on need for outside specialists
• Determine audit risk
• Determine inherent risk
• Calculate materiality

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Client risk profile Obtain knowledge of industry
and business environment

• 1. Many industries have unique accounting
  environments that need to be understood to
  evaluate f/s
• 2. Risks in the industry may affect the auditors
  assessment of audit risk for this client or
  whether the auditor should audit companies within
  this industry
• 3. Some inherent risks are common to all
  businesses in an industry aids auditor in
  identifying risks in clients business

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Client risk profile Obtain knowledge of industry
and business environment

• Obtain knowledge
• Discussion within audit team about engagement in
  prior years and similar engagements
• Conferences with clients personnel
• Audit guides/textbooks/technical magazines for
  major industries
• Participate actively in industry associations and
  training programs

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Client risk profile Obtain knowledge of clients
business

• Finding out about your client helps you to decide
  what questions to ask

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How to obtain knowledge of clients business

• Tour the plant and offices
• Observe operations and meet key personnel
• See physical safeguards over assets
• Identify related parties
• Need to disclose a description, amount, and
  amounts due to/from
• Related Party-ability to exercise, directly or
  indirectly, control, joint control or significant
  influences over operating and financial decisions
  of another party
• Identify and include in permanent file
• Ways to identify enquiry of management and
  examine shareholder listing

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How to obtain knowledge of clients business

• Review the articles of incorporation-legal
  document recognizes company as a separate entity
• Name, date of incorporation, types of business
  activities authorized to conduct
• Kind and amount of capital stock authorized to be
  issues (voting rights, preferences, dividends)

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How to obtain knowledge of clients business

• Review the by-laws-rules/procedures adopted by
  shareholders
• Year end, frequency of shareholder meeting,
  method of voting for directors, duties, powers of
  corporate officers
• Read the corporate minutes-official records of
  meeting of BOD and shareholders
• Summaries of topics discussed and decisions made
• Authorizations-compensation of officers, new
  contracts/agreements, loans, purchase of assets,
  dividend payments
• Items of risk-lawsuits
• Auditor summarizes key points from minutes for
  audit file

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How to obtain knowledge of clients business

• Review significant contracts
• Notes payable/bonds, stock options, pension
  plans, future delivery of supplies, royalty
  agreements, leases, union contracts
• Info used in individual parts of audit
• Perform preliminary analytical procedures
• Chapter 6
• Document control environment and corporate
  governance processes
• Controls established by management
• BOD, audit committee, and management have a
  pervasive effect on company

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Client risk profile Assess control environment
and corporate governance process

• Corporate governance processes include tone at
  the top, how senior executive is monitored, how
  management is managed
• Control environment includes policies and
  procedures that affect all aspects of the
  business
• Management does not pay attention to ethical
  environment or condones poor business practices,
  increases risk

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Client risk profile Assess risks of fraud

• Use knowledge of clients business to consider
  whether there are fraud risk factors present
• Risks documented and will impact audit procedures
  to be completed
• Management bonus based on net income, bias
  management toward overstating net income

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Client risk profile Decide on need for outside
specialists

• If require specialized knowledge consult
  specialist
• Need to evaluate professional qualifications of
  specialist and understand objectives and scope of
  specialists work
• Consider relationship including circumstances
  that would impair the specialists objectivity

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Primary purposes of audit planning

• Provide information to assist in assessing audit
  risk and inherent risk
• Affects client acceptance or continuance decision
• Obtain information that influences evidence
  collection process

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Working papers

• Can be stored in paper or electronic form
• Procedures applied and results thereof, info
  obtained and conclusions reached
• Include all info auditor considers necessary to
  conduct the examination adequately and to provide
  support for auditors report

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Purposes of working papers

• Aid the auditor in providing reasonable assurance
  that an adequate audit was conducted in
  accordance with GAAS
• Basis for planning the audit
• Conclusions on risks, internal control
  descriptions, time budgets, audit programs,
  results of prior years audit
• Record of the evidence accumulated and the
  results of the tests

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Purposes of working papers

• Data for determining the proper type of auditors
  report
• Also helps to prepare f/s
• Basis for review by managers/partners
• Evaluate whether sufficient appropriate evidence
  was accumulated to justify report
• Basis for tax returns
• Source of info for issuing communications to
  audit committee and management (internal control
  weaknesses)
• Aids in planning and coordinating subsequent
  audit

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How are working papers organized?

• Each firm has its own approach for organizing
  working papers
• Organization will depend upon whether they are
  manual or electronic
• Depends upon the firm standards used for
  documentation may be firm specific or standard
  approaches that can be purchases

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Types of working paper files

• Permanent file-intended to contain data of a
  historical or continuing nature
• Extracts of articles of incorporation, bylaws,
  bond agreements, contracts, pensions, leases,
  stock options
• Analysis of accounts that have a continuing
  importance
• Long-term debt, shareholders equity, goodwill,
  capital assets
• Focus on analyzing changes only
• Info related to understanding internal controls
• Flowcharts, org charts, questionnaires
• Analytical procedures related to prior years
• Ratios and percentages to do comparisons
• Other history of company, list of major lines of
  businesses, related parties, important accounting
  policies

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Types of working paper files

• Current files-all working papers applicable to
  the year under audit
• Risk assessment and materiality
• Audit program-procedures (signed off and dated)
• General information
• Staff scheduling and budgets, abstracts of
  minutes, agreements, notes on discussions with
  clients, working paper review comments
• Working trial balance

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Types of working paper files

• Current files-all working papers applicable to
  the year under audit
• Adjusting and reclassification entries
• Material misstatements must be adjusted
• Auditor identified and prepares AJEs but client
  approves them
• Reclassification entry are made for statement
  presentation but client does not need to do a
  journal entry
• Credit balance for cash account-move to bank
  indebtedness (liability)
• Summarize unadjusted errors in order to
  accumulate the effect
• Supporting schedules
• Prepared by client or auditor in support of
  specific amounts from f/s

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Supporting Schedules

• Analysis-designed to show activity in G/L account
  for period (tying together beginning and ending
  balances)
• Capital assets, long-term debt, equity
• Lists
• AR, AP
• Reconciliation of amounts-supports a specific
  amount and is normally expected to tie the amount
  recorded in clients record to another source of
  information
• Bank reconciliation

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Supporting Schedules

• Tests of Reasonableness-contains info that
  enables auditor to evaluate whether clients
  balance appears to include a misstatement
• Test of amortization
• Summary Procedures-summarizes results of audit
  procedure performed
• Results of AR confirmation
• Examination of supporting documents-document
  tests performed and results found (showing no
  totals)

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Supporting Schedules

• Informational
• info for tax returns (not audit evidence)
• Outside documentation
• Confirmation replies
• Copies of client agreements

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Standards for preparing working papers

• Properly identified
• Clients name, period covered, description of
  contents, initials of who prepared and date
  prepared
• Well organized (indexed and cross-referenced)
• Clearly indicate the work performed (including
  supervision)
• Use tick marks with a legend to outline work
  completed
• Sufficient documentation to indicate that it
  meets the purpose for which it was prepared (tie
  back to G/L)
• Conclusions clearly stated

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Ownership and confidentiality of working papers

• Ownership auditor
• Client documentation must be kept confidential
  may be disclosed only to peer review, when
  subpoenaed, or in other circumstances with the
  consent of the client