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  1. ACCT 4240: AUDITING Audit Planning

  2. Overview of the Audit Process Last day of field work Beginning of the Year Interim period Balance sheet date Review of internal control Final substantive tests Interim substantive tests Tests of controls Planning

  3. Phases of the Audit and the Auditing Environment Public Expectations Quality Control Standards Legal Liability Generally Accepted Auditing Standards General Standards Professional Ethics Field Work Standards Reporting Standards Public Company Accounting Oversight Board Accepting the audit engagement Planning the audit Performing audit tests Reporting the findings Firm Regulation Government Regulation

  4. Audit Planning Decide whether or not to accept the prospective client Make preliminary arrangements with the client Obtain knowledge of the client’s business and industry Prepare the engagement letter Prepare the audit plan, preliminary program, and time budget

  5. Steps in Accepting an Audit Engagement Evaluate integrity of management Identify special circumstances and unusual risks Assess competence to perform audit Evaluate independence Determine ability to use due care Prepare engagement letter

  6. Client Screening • Evaluate relationship between auditor and client • Evaluate the integrity of the potential client’s management team • Communicate with predecessor auditors • Agree on fee arrangements • Determine auditability • Obtain engagement letter

  7. Communication between Predecessor and Successor Auditors (SAS 84) • Attempt to communicate required • If client permits, issues to discuss • Disagreements about accounting principles or audit procedures. • Communications the predecessor gave the former client about fraud, illegal acts, and internal control recommendations. • The predecessor’s understanding about the reasons for the change of auditors (particularly about the predecessor’s termination).

  8. KPMG’s KRisk • A client acceptance/continuous decision-aid • Evaluates the following factors • Specific factors about the entity • Independence/relationship issues • Third party information/due diligence issues • Quantitative information • Qualitative information • Entity’s organization/operations • Financial reporting and recent audit results

  9. Engagement Letter • Documents the contractual duties agreed to by the auditor and the client • Description of scope of services to be provided • Obligation of client’s staff in assisting auditor • Fee or method of determining fee • Other services to be provided

  10. Items Usually Included in Audit Engagement Letters • Name of the entity • Statements to be examined • Scope of services, including any limitations • Type of opinion expected to be issued if other than unqualified • Disclaimer of responsibility for detecting fraud • Obligations of the client’s staff to prepare schedules and statements

  11. Items Usually Included in Audit Engagement Letters • Requirement that auditors read all printed material in which the report appears • Responsibility for preparation or review of tax returns • Fee or method of determining fee • Provision for client’s acceptance signature and date

  12. Steps in Planning the Audit Obtain understanding of client’s business and industry Perform analytical procedures Make preliminary judgments about materiality levels Consider audit risk Develop preliminary audit strategies for significant assertions Obtain understanding of client’s internal control structure

  13. Planning the Audit • Obtain an understanding of the client’s industry and business • Perform analytical procedures • Identify other critical matters • Related parties and related party transactions • Internal auditors • Is a specialist needed?

  14. Exhibit 4.2Enterprise Risk Management Framework Monitoring Internal Environment Objective Setting Event Identification Information and Communication Risk Assessment Risk Response Control Procedures

  15. Steps in Applying Analytical Procedures in the Planning Phase • Identify the calculations/comparisons to be made • Absolute data comparisons • Common-size financial statements • Ratio analysis • Trend analysis • Develop expectations (estimated probable outcomes) • Client financial information for comparable prior period(s) giving consideration to know changes • Anticipated results based on formal budgets or forecasts • Relationships among elements of financial information within the period • Industry data • Relationships of financial information with relevant non-financial information

  16. Steps in Applying Analytical Procedures in the Planning Phase • Perform the calculations/comparisons • Analyze data and identify significant differences • Investigate significant unexpected differences • Determine effects on audit planning

  17. Analytical Procedures • Assist in planning the nature, timing and extent of other audit procedures • Used as a substantive test of management’s assertions • Used in final review of overall reasonableness of financial statements • SAS No. 56 requires Analytical Procedures in planning and final review

  18. Analytic Procedures:Sources of Information

  19. Analytical Procedures • Compare recorded amounts or ratios to expected amounts the auditor develops • Financial information from prior periods • Anticipated results, such as budgets • Relationships among accounts • Industry averages • Relationships with non-financial data

  20. Types of Analytical Procedures • Trend Analysis - Change of an account balance over time • Ratio Analysis - Comparison of relationships among accounts • Reasonableness Tests - Computations used to estimate an account balance

  21. Trend Analysis • Causal approach - Attempt to predict what current year account balance should be • Diagnostic approach - Judge if current year balance appears reasonable • Simple trend analysis - Estimate current year based on prior year amount • Regression - Statistical analysis, possible incorporation of additional variables

  22. Ratio Analysis • Time-series analysis (horizontal analysis) • Cross-sectional analysis (vertical analysis) • Methods: • Financial Ratios • Common-size Statements (e.g. each expense account as a percentage of sales) • Industry ratios

  23. Considerations When Using Analytical Procedures • Reliability of data used to develop expectations • Accuracy and precision of expectations • Conclusions regarding outcomes

  24. Other Types of Analytical Procedures • Compare client data with client-determined expected results (budgets) • Compare client data with auditor-determined expected results, e.g. • Interest expense • Depreciation • Compare client data with expected results, using non-financial data, e.g. • Total hours worked times avg. wage rate

  25. Types of Analytical Procedures • Compare client data with similar prior-period data Client 1997 1996 Inventory Turnover 3.4 3.5 Gross Margin Pct. 26.30% 26.40%

  26. Types of Analytical Procedures • Compare client data with similar prior-period data • Compare client and industry data Client Industry 1997 1996 1997 1996 Inventory Turnover 3.4 3.5 3.9 3.4 Gross Margin Pct. 26.30% 26.40% 27.30% 26.20%

  27. Typical Transaction Cycles • Sales and collections • Conversion (Production) and warehousing • Payroll and personnel • Acquisitions and payments • Investing and financing

  28. Identify Management Assertions • Existence or occurrence • Completeness • Rights and obligations • Valuation or allocation • Presentation and disclosure

  29. Planning the Audit • Evaluate the likelihood of fraud • Prepare a time budget • Schedule the work • Interim • Final (year-end) • Assign appropriate personnel

  30. Reliability of Certain Types of Audit Evidence R E L I A B I L I T Y

  31. Categories and Types of Evidential Matter

  32. Types of Evidence and Related Audit Procedures

  33. Direction of Audit Testing Test of Existence or Validity (Overstatement) End Begin Source Documents Financial Statements Journals Ledgers Test of Completeness (Understatement) Begin End

  34. Competency of Evidential Matter

  35. Obtaining and Evaluating Audit Evidence Obtain evidential matter through audit procedures Dual Purpose tests Procedures to obtain understanding of internal control structure Tests of controls Substantive tests: Analytical procedures Details of transactions Details of balances Evaluate for sufficiency and competence Disclaim or qualify opinion as appropriate Express unqualified, qualified, or adverse opinion as appropriate Reasonable basis for opinion? No Yes

  36. Audit Working Papers

  37. Audit Working Papers • Required by SAS No. 41 • Principal record that the audit conforms to GAAS • Aids the auditor in the conduct and supervision of the audit • Planning • Review

  38. WORKINGPAPERS NATURE PURPOSE TYPES • RECORDS OF • Procedures applied • Tests performed • Information obtained • Conclusions reached • Principle support for auditor’s report • Evidence that examination was made in accordance with GAAS • Means for coordinating and supervising the examination • Working trial balance • Schedules and analyses • Audit memoranda and corroborating info • Adjusting and reclassifying entries

  39. Functions of Working Papers • Provide a means of assigning and coordinating audit work • Aid in supervising and reviewing the audit work • Provide the support for the auditors’ report • Document the auditors’ compliance with the generally accepted auditing standards, especially the standards of field work • Aid in planning and conducting future audits

  40. Types of Files • Permanent Files - information with continuing relevance • Information on client • Chart of accounts • Organization charts • Contracts, agreements • Pension plans • Deferred tax and other schedules

  41. Types of Files • Current Files - information specific to current year audit • Audit program • Time budget • Working trial balance • Lead schedules • Detailed schedules

  42. Types of Files • Detailed schedules • Analyses • Listings • Reconciliations • Reasonableness tests • Memos • Third-party documentation

  43. Workpaper Format • Headings • Client name • Title of workpaper • Date of financial statements • Identification of preparer and reviewer • Indexing - a predetermined code for organizing workpapers

  44. Workpaper Format • Tick marks - symbols, letters or numbers used to explain some item • Standardized • Ad hoc

  45. Workpaper Considerations • Workpapers must be clear and understandable • Workpapers should identify: • the source of the information presented • the nature and extent of the work done • appropriate cross references to related workpapers

  46. Workpaper Considerations • Before completion of the audit, all questions or exceptions must be resolved • Information and comments represent: • Statements of fact • Professional conclusions • Conclusions must be supported by documented facts

  47. Workpaper Considerations • To meet requirements of Sarbanes-Oxley Act, SEC now requires a 7-year retention period for • workpapers and other documents that form the basis of the audit or review, and • memoranda, correspondence, communications, other documents, and records (including electronic records), which are created, sent or received in connection with the audit or review, and contain conclusions, opinions, analyses, or financial data related to the audit or review.

  48. Workpaper Considerations • Ownership • Workpapers belong to the auditor • Copies may be given to client, but client should never have access to originals • Workpapers may be subpoenaed (no auditor/client privilege)

  49. Effect of Electronic Environment on Audit Engagement • The definition of auditing is not changed. • The purposes of auditing are not changed. • The generally accepted auditing standards are not changed. • The assertions of management embodied in financial statements are not changed. • The requirement to gather sufficient competent evidence is not changed. • The independent auditor's report on financial statements is not changed.

  50. What has changed? • The auditor must evaluate the impact of technology on the client’s operations. • The auditor must evaluate computer controls implemented by the client in the auditor’s study and evaluation of the client’s internal controls. • The auditor can use the computer’s speed and accuracy to assist in the audit.