Chapter 3 Engagement Planning ACCT-4080 Chapter 3

1. Audit Process Stages of an audit 1. Initial audit planning 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 ACCT-4080 Chapter 3

1. Audit Process AU-C 300 Planning an Audit Performance Principle (FW Std. No. 1): The auditor must adequately plan the work and must properly supervise any assistants. Planning involves developing an overall audit strategy Not a discrete phase of audit Supervision involves directing the efforts of all assistants involved in the audit Objective is to plan the audit so that it will be performed in an effective manner ACCT-4080 Chapter 3

1. Audit Process AU-C 210 Terms of Engagement Objective of auditor is to accept an engagement for a new or existing audit client only when the basis upon which it is to be performed has been agreed upon establishing whether the preconditions for audit are present confirming that common understanding exists between auditor and management ACCT-4080 Chapter 3

1. Audit Process Preconditions of audit determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable obtain the agreement of management that it acknowledges and understands its responsibility for preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework for the design, implementation, and maintenance of internal control to provide the auditor with access to all information that is relevant to the preparation and fair presentation of the financial statements additional information that the auditor may request from management for the purpose of the audit unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence ACCT-4080 Chapter 3

2. Structure of CPA Firm Positions in firm Up or out Partnership potential Women in public accounting Work load Busy season Size of firm Size of engagement team ACCT-4080 Chapter 3

3. Preliminary Arrangements Early appointment of auditors Evaluate client integrity of management special risks Evaluate your resources staffing interim vs. year-end work time budget independence Quality assurance partner required on issuer engagements provides second review on high risk areas of audit ACCT-4080 Chapter 3

3. Preliminary Arrangements (continued) Communicate with predecessor auditor (AU-C 210) integrity of management disagreements with management reason for auditor change required communications Engagement letter (AU-C 210) purpose First time audits auditing opening balances (AU-C 510) ACCT-4080 Chapter 3

3. Preliminary Arrangements (continued) Using work of internal auditors (AU-C 610) objectivity competence Identification of related parties (AU-C 550) IT in an audit IT audit specialist CAATs in an audit ACL, IDEA, proprietary software ACCT-4080 Chapter 3

4. Evidence Provided by Specialists AU-C 620 Definition - a person (or firm) possessing special skill or knowledge in a particular field other than accounting or auditing Examples: actuaries, appraisers, engineers, environmental consultants, geologists, and attorneys Consider qualifications, experience, reputation Independence Review of work Effect on audit report ACCT-4080 Chapter 3

7. Effect of Electronic Environment on Audit Risks risks related to hardware and software reduced audit trail need for IT experience and separation of IT duties No effect on purpose of audit (e.g., gathering sufficient appropriate evidence) importance of management’s assertions ACCT-4080 Chapter 3

8. Materiality AU-C 320 – Materiality in Planning and Performing the Audit Definition Assessing materiality quantitative factors qualitative factors Materiality guidelines SEC caution Accounting materiality ex post decision process Auditing materiality ex ante decision process ACCT-4080 Chapter 3

8. Materiality (continued) Financial statement level materiality methods to establish annualizing financial results Account balance level materiality performance materiality tolerable error Clearly trivial Top down approach Planning materiality vs. final evaluation level materiality Cost benefit considerations ACCT-4080 Chapter 3

8. Materiality (continued) Cumulative effects Factual (no doubt actual error), judgmental (arise from management estimates), and projected (from sampling projections) errors (known error and likely error) Relationship between audit risk and materiality Nonadditive nature of tolerable error Materiality example example2 ACCT-4080 Chapter 3

9. Audit Tests and Procedures Risk assessment procedures procedures to obtain understanding of client, its environment, including IC observation, inquiry, inspection, and analytics (walkthrough) Tests of controls procedures to determine the operating effectiveness of controls inquiry, observation, inspection, reperformance Substantive tests procedures to verify account balances activities performed to detect material misstatement or fraud at assertion level includes tests of balances, transactions, and SAP ACCT-4080 Chapter 3

9. Audit Tests and Procedures inspecting observing confirming inquiring tracing vouching ACCT-4080 Chapter 3

9. Audit Tests and Procedures scanning counting recalculating reperforming analytical procedures ACCT-4080 Chapter 3

10. Audit Programs Transactions cycles Audit plans Audit programs ACCT-4080 Chapter 3

11. Audit Documentation AU-C 230 Purpose Factors affecting type and content Ownership Organization permanent file current file Electronic workpapers AS 3 requirements completion date – 45 days after report date Retention – at least 7 years additions/amendments – no deletions; fully documented additions ACCT-4080 Chapter 3

11. Audit Documentation (con’t) Types working trial balance lead schedules supporting schedules adjusting journal entries reclassification journal entries Indexing Tick marks ACCT-4080 Chapter 3

Current File Other Lead Schedules Supporting Schedules APOLLO SHOES, INC. C-1 Inventory Lead Schedule Current File APOLLO SHOES, INC. B-1 Accounts Receivable Lead Schedule Other Lead Schedules APOLLO SHOES, INC. A-3 Bank Confirmation APOLLO SHOES, INC. A-2 First National Bank Reconciliation APOLLO SHOES, INC. A-1 Cash Lead Schedule 12/31/04 Ref Account Unaudited AJE Balance C-1 1rst Natl $484,000 $50,000 $534,000 Supporting Schedules APOLLO SHOES, INC. TB-1 Working Trial Balance 12/31/04 Ref Account Unaudited AJE Balance A-1 Cash $484,000 $50,000 $534,000 B-1 A/R C-1 Inventory APOLLO SHOES, INC. TB-2 Adjusting Entries dr cr Cash $50,000 Expenses $50,000 ACCT-4080 Chapter 3

Audit Documentation Information on Workpaper Name, date, purpose, page number Procedures performed and conclusions reached by the auditor Evidence that auditor followed general standards and standards of field work Audit Mark Legend Reviewers’ initials ACCT-4080 Chapter 3

12. Review Questions for Discussion Chapter 3 3.2 3.3 3.6 3.7 3.9 3.10 3.11 3.13 3.16 3.19 3.20 3.23 3.24 ACCT-4080 Chapter 3