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ACCEPTING AN ENGAGEMENT
The first step in planning an engagement is to decide whether to accept the
engagement based on the preconditions of an audit. These 2 preconditions are:
1. The use by mgt of an AFRF in the preparation of the F/S.
2. The agreement of mgt to the premise on which the audit is conducted
Prepn of F/S in accordance with AFRF
DIM of I/C is free from material misstatement, whether due to fraud/error.
Full access to all info and no client-imposed scope limit.
The auditor will need to evaluate mgt integrity.
One of the required steps towards the end of the audit is to obtain a client repn letter
from mgt on certain key terms.
PRE-ENGAGEMENT ACTIVITIES
Perform appropriate procedures to address QC issues associated with the
acceptance/continuance of the audit engagement.
Evaluate the audit teams compliance with relevant ethical reqs especially
independence.
Establish an understanding in writing of the terms of engagement.
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The auditor will make inquiries of the predecessor auditor with regard to several key
issues: RIDC
1. Reasons for change
2. Integrity of Mgt
3. Disagreements during audit the predecessor shud provide necessary details
for the successor to understand the nature of the disagreements and how they
were resolved.
4. Communication with Mgt or those charged with Governance such as the audit
committee, regarding fraud and non-compliance with applicable laows and
regulations incl illegal acts, and sgf deficiencies in I/C.
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Fees, and the basis for billing
Auditors responsibilities conducting an audit in acc with GAAS, informing
the client of any improvements in control or economy of operations that come to
the auditors attention during the engagement. Also, include a statement of
inherent limitations of an audit that there may be material misstatements
undetected.
Confirmation of Engagement
Scope & Objective of Engagement (statements auditing and obj is an opinion on
F/S)
Internal control common sgf deficiencies and material weakenesses in I/C)
Managements responsibility in preparing for an audit presentation &
preparation of F/S, design implementation maintenance (DIM) of I/C, making
available all records, not limiting the scope of the auditors work and paying the
fees. Also shud include a written confirmation that the mgt will give a MGT REP
LETTER that talks about all the representations made during the audit. Client usu
prepares the lead schedules. Mgts responsibility regarding correcting any
material misstatements
Irregularities Fraud reasonable rather than absolute assurance
Illegal acts non-compliance with applicable laws and regulations
Errors - A statement that due to the inherent limitations of an audit and internal
control, material misstatements may not be detected.
A statement identifying the AFRF.
The need for other services to be performed.
In case the auditor plans to use specialists in the performance of audit then must
document in engagement letter.
Reporting auditor has to mention in the letter that they cannot provide
assurance that an unmodified opinion will be given. Reference to the expected
form and content of the report with an indication that the actual report may differ.
A written document must be obtained for engagements to audit, review or
compile an entitys F/S under AICPA professional standards.
Note: an auditor is not expected to discuss the audit procedures with the client, those
are a matter of judgement and not subject to disclosure to the client.
Reasons why a CPA may refuse an engagement
Mgts disregard of its responsibility to maintain an adequate I/C environment.
Lack of mgt integrity
Lack of Mgts consent to communicate with predecessor auditor.
Existence of business risk either CPA b/s risk and /or clients b/s risk - The
clients b/s risk is the risk that the client will fail to meet its objectives particularly
with regard to survival and profitability. CPAs b/s risk is the risk that the CPAs
b/s will suffer due to association with the client.
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PLANNING PROCEDURES
Audit planning involves developing an overall strategy for the expected conduct and
scope of the audit. The nature, extent and timing of planning will vary with:
1. The size and complexity of the entity
2. The auditors experience with the entity
3. Knowledge of the entitys b/s and industry
4. Knowledge of the entity and its environment, including I/C.
3 planning related issues that shud be included in the auditors documentation are:
1. An overall audit strategy this deals with higher level issues, such as allocating
audit resources
2. The audit plan or program is a step-by-step list of audit procedures, which is
required for every GAAS audit. There are several key considerations in the
development of the audit program/plan.
3. Any sgf changes made to the audit strategy or the audit plan during the
engagement, along with the reasons for any such changes.
Key considerations in the development of audit program/plan:
1. Materiality generally misstatements and omissions are considered material if
they are expected to, individually or in aggregate, influence the decisions a
user will make on the basis of the F/S. Judgements about materiality consider
users of F/S as a group rather than the effects of misstatements on individual
users.
Planning stage materiality is the size of the misstatements that the
audit program was designed to detect.
Evaluation stage materiality the determination of whether the F/S were
fairly stated in all material respects at the completion of field work. The
terms planning stage materiality and evaluation stage materiality have
now been replaced by performance materiality in the clarity stds.
Performance materiality - are the amounts set by the auditor at less than
materiality for the F/S as a whole, to reduce to an appropriately low level
of probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the F/S as a whole.
Performance materiality is largely established to help provide assurance
that several immaterial misstatements do not combine to a material
undetected amount of misstatement; accordingly it ordinarily is established
at a level lower than that of materiality for the F/S.
Materiality is based on auditors judgement.
Materiality judgements involve both quantitative and qualitative factors.
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For planning purposes, materiality is measured using the smallest
aggregate level of misstatement that could be considered material to any
one of the F/S.
There is an inverse r/ship btw materiality and audit risk.
An auditor most likely would use an entitys annualized interim FS in
determining his preliminary judgement about materiality.
If the materiality amount used in evaluating audit findings decreases from
the amount used in planning, the auditor shud apply additional substantive
tests.
Tolerable misstatement is the application of performance materiality to
a particular sampling procedure or application. The auditor shud establish
performance materiality for the F/S as a whole to allow for the possibility of
uncorrected and undetected misstatements.
An auditor is allowed to pass on aggregated errors that are not material
but such errors must be summarized and documented along with a
conclusion that the errors do not cause the F/S to be misstated.
In order to issue an unqualified opinion, the auditor must be confident that
no material misstatements exist in the F/S. While misstatements may
exist, in total they must be believed to be less than a material amount.
Materiality considerations
1. Materiality for the F/S as a whole
2. Materiality level(s) for applicable transactions, a/c balances or disclosures
3. Performance materiality
4. Any revision of those considerations during the audit engagement.
Planning considerations
Entitys a/cing policies and procedures
Materiality levels
RMM
b/s and industry in which the b/s operates to understand the events and
transactions that may have an effect on the clients F/S.
Methods used to process a/cing info, which influence the design of I/C
F/S items likely to req adjustment
Conditions that may require extension or modification of audit tests
Nature of reports expected to be issued.
Steps in Planning/Planning Procedures (BRAINSTOPS)
1. Basic discussions with the client nature of engagement, meet key employees,
discuss overall strategy but not audit procedures.
2. Review of audit documentation incl that of predecessors
3. Ask about recent developments mergers, new product lines.
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4. Interim F/S are analyzed to identify a/cs and transactions that differ from
expectations. The performance of analytical procedures is mandatory in the
planning of the audit to identify a/cs that may not be misstated and that
deserve specific emphasis in the audit program.
5. Non-audit personnel consult tax prep dept and others
6. Staffing shud be determined and meeting to discuss the engagement.
7. Timing of the various audit procedures shud be determined. E.g. I/C testing is
done early in the engagement, inventory counts usu near b/s date, client repn
letter cannot be obtained until the end of the audit fieldwork,.
8. Outside assistance - need a specialist? Eg for inventory valuation like
diamonds.
9. Pronouncements recent changes in a/cing prins and audit stds must be
reviewed to assist in development of audit prog tailored to the unique needs of
clients b/s and industry.
10. Scheduling with the client to coordinate activities such as prepn of lead
schedules by clients and the client needs to be informed of dates when they will
be prohibited from accessing bank safe deposit boxes to ensure the integrity of
security counts held at banks.
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Fraudulent financial reporting mgt fraud (cooking the books). These
are misrepresentation of facts and affect Mgt integrity.
Misappropriation of assets defalcation schemes: including,
embezzlement of funds, theft of other assets and misuse of entity assets.
An auditor evaluates both known misstatements (specifically identified during
audit) and likely misstatements (considered to exist based on auditors
knowledge of the entity, industry, environment, disparity of info in F/S, sample %
to population).
Mgt must correct all known misstatements and shud evaluate items for which
there are likely misstatements.
AU-C 240 states that, while the auditor is not required to plan the audit to
discover info that is indicative of financial stress of employees etc such
conditions must be considered when an auditor becomes aware of them.
Non recording of transactions are most difficult to detect.
An auditor may withdraw from an engagement if employees actions (small bribes
to public officials) affect the auditors ability to rely on Mgt representations. If Mgt
fails to respond appropriately to the auditors discovery of bribes, it may indicate
a more pervasive problem, even though amounts involved were small. This
failure may impact the auditors ability to rely on mgts representations and result
in withdrawal from the engagement.
A properly designed audit may not detect a material fraud becoz xtics of fraud
esp those involving forgery and collusion. Audits procedures effective for
detecting errors may be ineffective for frauds thru collusion.
The risk of fraudulent financial reporting is heightened by existence of an overly
complex orgn structure involving unusual lines of authority.
Bearer bonds are easily convertible assets which pose a FRF for
misappropriation of assets.
Fraud is a broad legal concept and auditors do not make legal determinations of
whether the fraud has occurred.
Fraud risk factors are factors whose presence often have been observed in
circumstances where frauds have occurred.
Fraud triangle: 3 main categories of fraud-related risk factors
1. reason/motivation/incentive/pressure
2. opportunity
3. rationalization.
Stds Require the Auditor to perform the following:
Understand the nature and xtics of fraud
Hold a brainstorming session with engagement staff to assess the risk of
material misstatement due to fraud.
Obtain the information needed to identify RMM due to fraud:
Auditor shud perform appropriate risk assessment procedures.
Inquiry of mgt and others about knowledge or suspicion of fraud
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Evaluation of results of analytical procedures performed in the planning of
the audit.
Identify the risk of RMM
The auditor shud ordinarily plan to perform appropriate analytical
procedures related to revenue recognition, since there is a presumption
that revenue recognition is a fraud risk.
Auditors shud consider the possibility of mgt override of I/C
Assess the risk of fraud
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The auditor needs to make inquiries of mgt and those charged with
governance about the entitys compliance with applicable laws.
Inspection of correspondence with regulatory authorities
Reading the minutes of meeting of those charged with governance.
When an illegal act is detected the auditor has the following responsibilities:
Gather additional evidence to determine relevant facts
Discuss the matter with the appropriate level of mgt
Consider consulting with the entitys attorney and/or relevant specialists
Consider the implications to other audit areas.
Where after notifying the BOD there is no action taken, the auditor may consider
withdrawing from the audit engagement and disassociating from future r/ships
with the client since mgts failure to take remedial action means that the auditor
cannot rely on mgt repns.
CPAs are required under the law to deliver a report on illegal acts to the SEC
within one b/s day in circumstances when BOD refuses to take remedial action
and refuses to inform SEC that it had received such notification from the auditor.
The auditor has less responsibility to detect illegal acts having material F/S
consequences related to the entitys operating activities compared to financial
reporting activities.
Illegal acts relating to the operating aspects of an entity are often highly
specialized and complex and often are far removed from the events and
transactions reflected in F/S.
The auditor must document the following:
The results of the discussion with mgt, and those charged with
governance and others if applicable.
Any identified or suspected non-compliance with applicable laws and
regulations.
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The specialist is not required to be independent. The auditor however, must
evaluate the nature of the r/ship of the specialist to the client and assess
ability to be objective.
The auditor has responsibility for understanding the assumptions and
methods used by the specialist and evaluating whether the specialists
findings support the related F/S assertions. The auditor is not responsible
for the reasonableness of the methods and assumptions used by the
specialist.
The specialist shud also understand how the auditor plans to use the
specialists findings. The documentation shud cover this understanding.
A CPA may hire a non-CPA systems analyst provided that the CPA can
supervise the specialist and evaluate his/her work. The CPA shud be able to
define the tasks to be performed and evaluate the end product.
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Estimates in the a/cing records and the process used to obtain them (FV
estimates).
No need to discuss matters previously discussed and also no need for details of audit
procedures and/or materiality levels to be given as this might reduce the effectiveness
of the audit. Direct communication by the auditor is not reqed for selection of a/cing
prins. The auditor only needs to make sure that Mgt has communicated.
Communication with the audit committee may occur at any time, as long as it is timely.
TBS NOTES:
1. Inherent risk for a co if a co depends on mainly one product the risk
of obsolescence wud be its inherent risk.
2. Involvement of principal shareholder in Mgt decreases audit risk and
is not a fraud risk factor.
3. Moving to computerized system increases audit risk in the initial stages
but is not a fraud risk factor.
4. Volatility of interest rates increases audit risk but is not a fraud risk
factor.
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