MODERN AUDITING 7th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan Developed by: Dr. Raymond N. Johnson, CPA Gregory K. Lowry, MBA, CPA John Wiley & Sons, Inc.

CHAPTER 5 OVERVIEW OF THE AUDIT PROCESS Knowledge of the Business and Industry Management’s Assertions Materiality Audit Risk Evidence Consideration of Value-Added Services Communication of Findings

Overview of the Audit Process Figure 5-1

Overview of the Audit Process Figure 5-1

Knowledge of the Business and Industry Understand the Entity’s Business Risks Developing Expectations of Financial Statements Industry Impact on Information Systems Evaluation of Reasonableness of Accounting Estimates GAAP for Specific Industries Foundation for Other Value-Added Services

Consider 2 Industries Airline Household appliance manufacturer Understand Business Risk Developing Expectations of Financial Statements Industry Impact on Information Systems Evaluation of Reasonableness of Accounting Estimates GAAP for Specific Industries Foundation for Other Value-Added Services Airline Household appliance manufacturer

Overview of the Audit Process Figure 5-1

Proposed SAS Audit Evidence - Assertions Assertions about classes of transactions Occurrence Completeness Accuracy Cutoff Classification Assertions about account balances Existence Rights and obligations Valuation and allocation Assertions about presentation and disclosure Occurrence and rights and obligations Understandability Accuracy and Valuation

Why are assertions important? Divide and Conquer Assertions (and related audit objectives) guide the auditor in the collection of evidence. The auditor needs to obtain sufficient, competent evidential matter for each assertion in the financial statements.

Overview of the Audit Process Figure 5-1

Materiality FASB Concept Statement No. 2 Influence on the judgment of a reasonable person relying on the financial statements

Materiality How does the concept of materiality influence the audit process? 1. The auditor makes a judgment about materiality while planning the engagement in order to make important decisions about the scope of the audit. 2. The concept of materiality guides the auditor when evaluating audit findings.

Chapter 5 Part I Review Explain how the auditor uses his or her understanding of the client’s business and industry. Why are financial statement assertions important? Relate the following specific audit objectives to the five financial statement assertions. All inventory that is present in the warehouse is counted on inventory tags. Inventories are properly stated at the lower of cost or market. The client has legal title to inventory Inventories are properly classified in the financial statements. All inventory counted on inventory tags is present in the warehouse.

Chapter 5 Part I Review Identify two ways in which knowledge of materiality is used in the financial statement audit. Explain the relationship between materiality and the scope of audit work.

Overview of the Audit Process Figure 5-1

Summary of Audit Risk Components Figure 5-3

Audit Risk Model AR = IR x CR x DR

Audit Risk Model AR = IR x CR x DR .02 1.0 .07 ??

Audit Risk Model AR = IR x CR x DR .02 1.0 .07 .29 .35 .5 ??

Audit Risk Model AR = IR x CR x DR .02 1.0 .07 .29 .35 .5 .11 .80 ??

Audit Risk Model AR = IR x CR x DR .02 1.0 .07 .29 .35 .5 .11 .80 .05

Overview of the Audit Process Figure 5-1

Evidence Sufficiency of Evidential Matter 1. Materiality and Risk 2. Economic Factors 3. Size and Characteristics of the Population

Competency of Evidential Matter Figure 5-4

Classification of Audit Procedures 1. Procedures to Obtain an Understanding (Of the entity and its environment, including its system of internal control) 2. Tests of Controls 3. Substantive Tests

Evaluation of Evidence Obtained 1. The auditor is not expected, or required, by the third standard of field work to have an absolute, certain, or guaranteed basis for an opinion. 2. The requirement of a reasonable basis pertains to the overall level of assurance the auditor needs at the conclusion of the audit to express an opinion on the financial statements.

Chapter 5 Part I Review Explain the relationship between control risk and the type of audit procedures performed. Explain the relationship between detection risk and the scope of audit work. Provide examples of evidence related to the existence and occurrence assertion that is more competent vs. evidence that is less competent. What is the purpose of a test of control? What is the purpose of a substantive test?

Overview of the Audit Process Figure 5-1

Professional Requirements Evaluate fair presentation in the financial statements. Required communications Internal controls Other required communications

Consideration of Value-Added Services 1. Benchmarking Company Performance and Performance Measurement 2. Business Planning 3. Risk Assessment 4. Business Valuation 5. Information System Design and Reliability

Communication of Findings 1. The Auditor’s Report on Financial Statements 2. Other Required Communications 3. Communication of Other Findings

CHAPTER 5 OVERVIEW OF THE AUDIT PROCESS

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