1. Copyright © 2007 Pearson Education Canada 7-1 Chapter 7: Audit Planning and Documentation

2. 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

3. 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

4. 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?

5. 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

6. 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

7. 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?

8. 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

9. 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

10. 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?

11. 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

12. 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

13. 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

14. 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?

15. 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

16. 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

17. 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

18. 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?

19. 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?

20. 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

21. 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?

22. 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?

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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?

31. 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