2. 1 chapter 8 audit planning analytical procedures

3. 2 Test no 2 Internal Controls are effective / ineffective Extensive substantive tests Limited substantive tests Tests of Controls v. Substantive Tests If DR – Lowextensive Substantive Tests If CR – highwe don’t Test Controls Definition of Audit Risk

4. 3 Indirect – my brother Nondependent Does it impair independence Yes or No You memorized scenarios –Answer the question that was asked Material is not 5% What am I trying to say when –A mother lives in her son’s house –Steve is a partner in the engagement office

5. 4 #12.90variance of POP B > POP A #33.03sample variance less than planning #52.24compare ̅ X to Critical Value #7close relative #83.15101-1 part A #133.47primary beneficiary #142.03foreseen party #202.97SEC Act issuer in an IPO #243.00PDR low => extensive subst tests #252.56V&T project #271.97Acc Rec project

6. 5 Enron Related Party Transactions No one could explain how Enron actually made money Incredibly complicated business structure “What we are looking at here is an example of superbly complex financial reports. They didn’t have to lie. All they had to do was to obfuscate it with sheer complexity,” John Dingell, U.S. Congressman Michigan

7. 6 Obtain engagement Analytical procedures Understand the client Internal controlsAU-c 315 Assess RoMM Tests of controls if RoMM < 1.00 Substantive tests of transactions AU-c 500 Substantive Analytical procedures Substantive tests of details of balances ReportingAU-c 700

8. 7 environmental clientauditor

9. 8 Jonathan What is the definition of audit risk?

10. 9 AU-C Section 200 The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the Risk of Material Misstatement and Detection Risk

11. 10 Yu What is the definition of control risk?

12. 11 The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

13. 12 Stages of the AuditAccepting the engagement client acceptance 1) integrity of management

14. 13 Client Acceptance page 79-80 Why the client needs an audit New client investigation Competency, industry knowledge Communicate with predecessor auditor Risks –Intended users of the financial statements Independence Engagement Letter

15. 14 AICPA February 1997 84 Statement on Auditing Standards Communications between Predecessor and Successor Auditors

16. 15 Lauren what issues need to be discussed with the predecessor auditor ?

17. 16 Integrity of senior management Disputes with the client over accounting principles Disputes with the client over audit procedures Disputes with the client over fees page 80 Communications with Predecessor Auditor

18. 17 Giselle who is responsible for initiating the communication between the successor auditor and the predecessor auditor ?

19. 18 AICPA Code of Professional Conduct Rule 301 – Confidential Client Information

20. 19 Michael Do we care about the nature of the client’s business? Do we care about the reasons they are having their financial statements audited? Do we care who is going to rely on the audited financial statements?

21. 20 RISK RISK RISK identify the users of the financial statements

22. 21 Elizabeth W How does the AICPA’s Code of Professional Conduct define the Ethical Principle “Objectivity and Independence?”

23. 22 Objectivity and Independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attest services.

24. 23 Jennifer Does this effect our decision whether to accept the engagement ?

25. 24 Eric When an accounting firm considers a new client, “who” needs to be independent?

26. 25 independence memo to partners and staff Partners in the engagement office Everyone in the engagement office Everyone in the firm Consulting and tax employees or just auditors must consider spouses & dependents

27. 26 Ellen How might the financial investments of non-dependent, close relatives affect the firm’s decision whether to accept a new client ?

28. 27 Brenda If a non-dependent, close relative is employed by a potential client, what issues does the audit firm need to consider in their decision whether to accept the client?

29. 28 Anyone on the engagement team Anyone in position to influence the engagement All partners in the engage partner’s office Close relatives (including immediate family): parent, sibling or nondependent child, spouse, dependents Holding a key position with the client Holding a financial interest in the client that is material to the relative (covered member must know) Holding a financial interest that enables the relative to exercise significant influence over the client

30. 29 Key positions –positions that allow significant influence over the client’s, accounting, financial or operating policies –positions subject to significant internal accounting controls –positions that are an element of significant internal accounting controls

31. 30 Phases of the AuditAccepting the engagement Engagement Letter page 82

32. 31 Understand the Client’s Business

33. 32 Ryan M what is the objective of AU-c 315?

34. 33 AU-C Section 315 The objective of the auditor is to identify and assess the risk of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity’s internal control, thereby providing a basis for designing and implementing responses to the assessed risk of material misstatement.

35. 34 Many litigation cases result from the auditor’s failure to fully understand the nature of transactions in the client’s industry. ZZZZ Best ESM

36. 35 RISK of Material Misstatement Declines in economic conditions Information technology Expansion Accounting COMPLEXITY of JUDGMENTS Accounting COMPLEXITY of ESTIMATES C OMPLEX financial instruments Page 134/135 Related Party transactions Complex transactions Nonroutine transactions Judgment Chapter 9

37. 36 Steffan how does the Auditor’s Responsibility Paragraph in the independent auditor’s report describe the auditor’s responsibility to detect material misstatements? Does the auditor’s responsibility differ for misstatements that are the result of an error or a fraud?

38. 37 Auditor’s Responsibility Paragraph standard unmodified opinion Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

39. 38 Suiting what is the overall objective of the indepent auditor?

40. 39 Overall Objective AU-C 200 …obtain reasonable assurance about whether the financial statements as a whole are free of material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are presented fairly, in accordance with an applicable financial reporting framework.

41. 40 Related Parties --- RISK p. 86.. an affiliated company, principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other. investors are concerned that the terms of the transaction may not reflect “arms length” bargaining. There is risk that the transaction may not be valued at the same amount as a transaction with a non- related party.

42. 41 Related Parties --- RISK p 77 Enron Enron- Andy Fastow

43. 42 Related Parties --- RISK Essentially a related party is one that can exert significant influence over another party. Related parties are frequently involved in fraudulent transactions because they can conceal problems that the auditor would likely detect if the transactions occurred between unrelated parties.

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48. 47 Catherine what is Client Business Risk?

49. 48 Box at the Bottom of P AGE 89 increased emphasis on how the client manages risk

50. 49 Analytical Procedures Pages 93-102 Look at Figure 6 on page 94 Go to links on web page

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57. 56 Analytical Procedures Reasonableness tests evaluations of financial information by a study of plausible relationships among financial and nonfinancial data … ….involving comparisons of recorded amounts … to expectations developed by the auditor.

58. 57 Dev at which stages of the audit are Analytical Procedures required ?

59. 58 Analytical Procedures  planning phase testing phase (as substantive tests)  completion phase (as an overall review)

60. 59 Nicho why do we perform analytical procedures during the planning stage ?

61. 60 Analytical Procedures During the Planning Phase Understand the client’s business & industry Assess going concern Indicate possible misstatements (attention directing) Reduce detailed tests

62. 61 Analytical Procedures in the planning phase understand the client’s industry and business to identify potential misstatements attention directing design audit procedures that reduce the risk we might fail to detect a material misstatement

63. 62 Steps in performing Analytical Procedures Develop expectations Define significant difference (what is reasonable) Compare our predictions with recorded amount Investigate Significant differences DOCUMENT the above steps

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