Professional Auditing Standards and the Audit Opinion Formulation Process

1. AuditingA Risk-Based Approach To Conducting A Quality Audit 10th edition Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg Chapter 5 Professional Auditing Standards and the Audit Opinion Formulation Process

2. Learning Objectives • Identify and compare the auditing standards that provide guidance on the audit opinion formulation process • List and discuss the foundational principles underlying the auditing standards • List the phases and related activities in the audit opinion formulation process • Explain the concept of accounting cycles and discuss their importance to the audit opinion formulation process

3. Learning Objectives • Describe the assertions that are inherent to the financial statements and explain their importance to the audit opinion formulation process • Define audit evidence and describe the purpose of audit procedures used to obtain audit evidence • Discuss the importance of audit documentation and provide examples • Discuss audit activities in Phase I of the audit opinion formulation process

4. Learning Objectives • Discuss audit activities in Phase II of the audit opinion formulation process • Discuss audit activities in Phase III of the audit opinion formulation process • Discuss audit activities in Phase IV of the audit opinion formulation process • Discuss audit activities in Phase V of the audit opinion formulation process

5. Learning Objective 1 Identify and Compare the Auditing Standards that Provide Guidance on the Audit Opinion Formulation Process

6. Professional Auditing Standards • Auditors in the United States follow auditing guidance issued by: • American Institute of Certified Public Accountants (AICPA) • Public Company Accounting Oversight Board (PCAOB) • International Auditing and Assurance Standards Board (IAASB) • Common objective - Provide assurance to public that audits are conducted in a quality manner

7. Professional Auditing Standards • Auditing standards apply: • To the auditor’s task of developing and communicating an opinion on financial statements and, as part of an integrated audit, on a client’s internal control over financial reporting. • Relevant auditing standards depend on: • The nature of organization audited • On the domicile of the organization • On where its stock is publicly traded

8. Exhibit 5.1 - Comparison of U.S. and International Auditing Standards

9. Learning Objective 2 List and Discuss the Foundational Principles Underlying the Auditing Standards

10. PCAOB Guidance - the Ten standards • General standards are applicable to the auditor and audit firm and provide guidance in selecting and training its professionals to meet the public trust. • Fieldwork standards are applicable to the conduct of the audit • Reporting standards are applicable to communicating the auditor’s opinion

11. AICPA Guidance • AICPA has developed seven fundamental principles that govern audits. The principles are included in four categories • Purpose of an Audit and Premise upon Which an Audit Is Conducted • Responsibilities • Performance • Reporting

12. Learning Objective 3 List the Phases and Related Activities in the Audit Opinion Formulation Process

13. Exhibit 5.3 - Activities of each Phase of the Audit Opinion Formulation Process

14. Important Concepts pervasive throughout the Audit Opinion Formulation Process • Accounting cycles • Management assertions • Audit evidence and audit procedures • Documentation

15. Learning Objective 4 Explain the Concept of Accounting Cycles and Discuss Their Importance to the Audit Opinion Formulation Process

16. Accounting Cycles • Similar transactions that are linked by procedures and controls and that affect related accounts • Convenient way to break the audit up into manageable sections of related accounts • Individual auditors or teams of auditors are typically assigned to audit a particular accounting cycle

17. Accounting Cycles • Auditor focuses on: • Flow of transactions within a particular cycle • Identifying: • Points where material misstatement can occur • Controls that have been designed and implemented to mitigate those risks • Understanding risks and controls within each cycle • Helps determine specific audit procedures to be used and specific audit evidence to be obtained

18. Learning Objective 5 Describe the Assertions that Are Inherent to the Financial Statements and Explain Their Importance to the Audit Opinion Formulation Process

19. MANAGEMENT’S FINANCIAL STATEMENT ASSERTIONS IN PCAOB STANDARDS

20. Learning Objective 6 Define Audit Evidence and Describe the Purpose of Audit Procedures Used to Obtain Audit Evidence

21. Audit Evidence and Procedures • Audit evidence: Information used by auditor in arriving at conclusions on which the opinion is based • Audit procedures: Procedures designed to obtain audit evidence to support audit opinion(s) • Sufficient appropriate audit evidence: Measure of the quantity and quality of audit evidence • Audit program • Lists audit procedures to be followed in gathering evidence • Helps monitor progress and supervising work

22. Categories of audit Procedures • Risk assessment procedures: Provide information for assessing the risks of material misstatement in the financial statements • Used for purposes of planning the audit • Tests of controls: Designed for evaluating operating effectiveness of controls • Substantive procedures: Designed for detecting material misstatements at assertion level • Comprising of tests of details and substantive analytical procedures

23. Learning Objective 7 Discuss the Importance of Audit Documentation and Provide Examples

24. Audit Documentation • Record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached • Known as working papers or workpapers • Examples include: • Audit programs • Analyses prepared by client or auditor • Memorandums • Summaries of significant findings or issues • Letters of confirmation and representation

25. Purposes of Audit Documentation • Assisting engagement team in: • Planning and performing audit • Supervising and reviewing audit work • Retaining a record of matters of continuing significance to future audits • Enabling internal or external inspections of completed audits • Assisting auditors in understanding work performed in prior year

26. Learning Objective 8 Discuss Audit Activities in Phase I of the Audit Opinion Formulation Process

27. Phase I - Making Client Acceptance and Continuance Decisions • Preconditions for accepting auditing engagements • Use of an acceptable financial reporting framework • Agreement of management to acknowledge and understand its responsibilities

28. Learning Objective 9 Discuss Audit Activities in Phase II of the Audit Opinion Formulation Process

29. Phase II - Performing Risk Assessment • Identifying and assessing risks of material misstatement • Requires identification of significant accounts, disclosures, relevant assertions • Auditor establishes a materiality level overall and for specific accounts and disclosures • Responding to identified risks • Determining audit procedures required to address them

30. Risk assessments - assertion level • Inherent risk • Susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls • Control risk • 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 organization’s internal control

31. control risk ASSESSMENT • Focuses on design effectiveness and implementation • High control risk • Weak or ineffective internal controls • Auditor cannot rely on controls to reduce substantive procedures for account balances • Low control risk • Effective internal controls • Auditor will test operating effectiveness of controls to reduce substantive procedures for account balances

32. Responding to Identified Risks of Material Misstatement • Purpose of risk assessment procedures • Identify risks of material misstatement • Determine where misstatements in financial statements may occur • Design appropriate audit strategy • Controls reliance audit: Includes tests of controls and substantive procedures • Substantive audit: Includes substantive procedures and does not include tests of controls

33. Learning Objective 10 Discuss audit activities in Phase III of the audit opinion formulation process

34. PHASE III - Obtaining Evidence about Internal Control Operating Effectiveness • Auditor tests controls to determine whether controls are operating effectively • At year-end (for opinion on internal control effectiveness) • Throughout the year (for the financial statement audit)

35. Selecting Controls to Test • Involves choosing controls that effectively indicate capability to address the assessed risk of material misstatement for relevant assertions • Includes controls in all five COSO components • Types of tests of controls • Inquiry • Observation • Inspection of relevant documentation • Reperformance of a control

36. Impact of Tests of Controls For financial statement audit • If control deficiencies are identified • Assess them to determine whether preliminary control risk assessment should be modified • Record the implications for substantive procedures • If no control deficiencies are identified • Assess whether preliminary control risk assessment is still appropriate • Determine extent that controls can provide evidence on accuracy of account balances • Determine planned substantive audit procedures

37. impact of Tests of Controls For financial statement audit • Determine how much assurance about reliability of account balances can be obtained from the effective operation of controls • Within any audit, level of assurance will vary across: • Accounts • Disclosures • Assertions

39. Learning Objective 11 Discuss audit activities in Phase IV of the audit opinion formulation process

40. Phase IV - Obtaining Substantive Evidence about Accounts, Disclosures, and Assertions • Substantive procedures include: • Substantive analytical procedures • Tests of details of account balances • Considerations in determining appropriate substantive procedures: • Source of potential misstatement • Extent and type of potential misstatement

41. Learning Objective 12 Discuss audit activities in Phase V of the audit opinion formulation process

42. Phase V - Completing the Audit and Making Reporting Decisions • Completing various review and communication activities • Making a decision about what types of opinions should be issued • Deciding on the appropriate opinion to be issued • It can be based on financial statements and internal control • It can be issued in one report or in two separate reports