Copyright © 2007 Pearson Education Canada 7-1 Chapter 7: Audit Planning and Documentation
Copyright © 2007 Pearson Education Canada 7-2 Chapter 7 objectives Explain the importance of audit planning Identify the steps to preplanning Note the contents and relevance of an engagement letter Discuss the role of a client risk profile Explain the purposes of audit working papers and their typical characteristics
Copyright © 2007 Pearson Education Canada 7-3 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! Three distinct phases: Preplan Develop client risk profile Assess control risk and design testing plans
Copyright © 2007 Pearson Education Canada 7-4 Practice problem 7-19 (p. 205) What do you do before you begin fieldwork? What are your resources?
Copyright © 2007 Pearson Education Canada 7-5 Preplanning New client acceptance or client continuance Client’s reasons for audit Independence threat analysis Engagement letter Staffing capabilities and meetings
Copyright © 2007 Pearson Education Canada 7-6 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? Why or why not? Both new and existing clients should be re- evaluated for every engagement
Copyright © 2007 Pearson Education Canada 7-7 Communication with predecessor When the auditor is asked to take on a new client, he/she is required to communicate with the predecessor auditor Why? What could go wrong if this communication is not initiated?
Copyright © 2007 Pearson Education Canada 7-8 Preplanning: Client’s reasons for audit Who are the users? What are the intended uses of the financial statements? For publicly held companies, the auditor is likely to set audit risk to low because of the large number of users
Copyright © 2007 Pearson Education Canada 7-9 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 If independence cannot be achieved, the engagement must be declined
Copyright © 2007 Pearson Education Canada 7-10 Preplanning: Engagement letter Provides documentation of a clear understanding of the terms of the engagement between the client and the public accounting firm What are several of the issues that are included in the engagement letter?
Copyright © 2007 Pearson Education Canada 7-11 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, complying with rules of conduct (familiarity threat), and assigning internal or external specialists as needed
Copyright © 2007 Pearson Education Canada 7-12 Client risk profile: to assess the client’s business risk and document portions of the audit risk model Obtain knowledge of industry and business environment Obtain knowledge of client’s business Assess control environment and corporate governance process Assess risks of fraud Decide on need for outside specialists Chapter 8: Determine audit risk Determine inherent risk Calculate materiality
Copyright © 2007 Pearson Education Canada 7-13 Client risk profile: Obtain knowledge of industry and business environment Why is this necessary? 1. Many industries have unique accounting environments 2. Risks in the industry may affect the auditor’s assessment of audit risk for this client 3. Some inherent risks are common to all businesses in an industry
Copyright © 2007 Pearson Education Canada 7-14 Client risk profile: Obtain knowledge of industry and business environment What are some examples of sources that you could use to find out about the car dealership industry? What about the health care industry, in particular, hospitals?
Copyright © 2007 Pearson Education Canada 7-15 Client risk profile: Obtain knowledge of client’s business Finding out about your client helps you to decide what questions to ask in the balance of the planning process
Copyright © 2007 Pearson Education Canada 7-16 How to: obtain knowledge of client’s business (Table 7-1) Tour the plant and offices Identify related parties Review articles of incorporation and bylaws Read minutes of directors’ meetings Review significant contracts Perform preliminary analytical procedures Document control environment and corporate governance processes
Copyright © 2007 Pearson Education Canada 7-17 Practice problem 7-20 (p. 205) What is some of the type of information that you would find in board of director’s minutes? Examine an extract of minutes to assess the impact on the audit engagement
Copyright © 2007 Pearson Education Canada 7-18 Related parties What is a related party? Why is it important to find out about related parties as part of our knowledge of business? What could go wrong if we did not find out about related parties?
Copyright © 2007 Pearson Education Canada 7-19 Practice problem 7-24 (p. 207) Here’s an example of a possible related party situation How does this affect your audit opinion?
Copyright © 2007 Pearson Education Canada 7-20 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
Copyright © 2007 Pearson Education Canada 7-21 Corporate governance and control environment What happens when management does not pay attention to the ethical environment? If a business is well run, with a corporate code of ethics that is demonstrated and enforced by management, what is the effect upon the auditor’s assessment of inherent risk?
Copyright © 2007 Pearson Education Canada 7-22 Client risk profile: Assess risks of fraud Why does the auditor need to assess risks of fraud? Have you read anything recently that illustrates what can go wrong with senior management fraud?
Copyright © 2007 Pearson Education Canada 7-23 Client risk profile: Decide on need for outside specialists What type of specialist would you need for the following types of clients? Why? A retail store that sells fashion clothing A distributor of electronics products An insurance company A fuel oil exploration and development company
Copyright © 2007 Pearson Education Canada 7-24 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
Copyright © 2007 Pearson Education Canada 7-25 Working papers Can be stored in paper or electronic form Aid the auditor in providing reasonable assurance that an adequate audit was conducted in accordance with GAAS
Copyright © 2007 Pearson Education Canada 7-26 Purposes of working papers Basis for planning the audit Record of the evidence accumulated and the results of the tests Data for determining the proper type of auditor’s report Basis for review
Copyright © 2007 Pearson Education Canada 7-27 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
Copyright © 2007 Pearson Education Canada 7-28 Types of working paper files Permanent Current – Risk assessment and materiality – Audit program – General information – Working trial balance – Adjusting and reclassification entries – Supporting schedules
Copyright © 2007 Pearson Education Canada 7-29 Standards for preparing working papers Properly identified Well organized (indexed and cross- referenced) Clearly indicate the work performed (including supervision) Sufficient documentation to indicate that it meets the purpose for which it was prepared Conclusions clearly stated
Copyright © 2007 Pearson Education Canada 7-30 Practice problem 7-21 (p. 206) Let’s look at an example working paper What have they done appropriately? What is missing or what needs to be done differently?
Copyright © 2007 Pearson Education Canada 7-31 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