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Audit Planning

Audit Planning. Need an effective and efficient audit plan Underaudit - see you in court Overaudit - lose clients to competitors. Planning. Accept client and perform initial planning Understand client’s business and industry

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Audit Planning

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  1. Audit Planning • Need an effective and efficient audit plan • Underaudit - see you in court • Overaudit - lose • clients to competitors

  2. Planning • Accept client and perform initial planning • Understand client’s business and industry • Assess client business risk • Perform preliminary analytical procedures • Note: Planning also includes fraud risk brainstorming required by SAS #99

  3. Client Acceptance • Do we want this client? • -Are we independent? • - Are we technically competent? • - Is client reputable? • Who will use financial statements? • (Key part of acceptable audit risk - discussed in Ch. 9)

  4. Communication With Predecessor • Required by SAS #84 • Purpose is to assess whether to accept client • Successor initiates • - predecessor needs client • permission to release information

  5. Successor - Predecessor Communication • Usually review prior auditor workpapers • Determine whether problems exist that impact client acceptance • Support beginning asset balances (why?)

  6. Multiple Choice #1 • A successor auditor most likely would make specific inquiries of the predecessor auditor regarding: • Specialized accounting principles of the client’s industry. • The competency of the client’s internal audit staff. • The uncertainty inherent in applying sampling procedures. • Disagreements with management as to auditing procedures.

  7. Understanding with Client • Must obtain and document understanding (SAS #108) • Written engagement letter now required • -Engagement objectives • - Management responsibilities • - Responsibilities of auditor • - Limits of engagement

  8. Specialists • Used to address complex issues where auditor is not qualified • May be hired by client or auditor • Auditor should evaluate qualifications, and relationship with client • May refer to specialist in audit report only when opinion is qualified or explanatory paragraph added based on specialist’s report

  9. MC #2 • An auditor may refer to the specialist in the auditor’s report if the: • 1. Specialist’s findings provide the auditor • greater assurance of reliability about • management's representations. • 2. The auditor qualifies the opinion as a • result of the specialist’s findings. • 3. Auditor’s use of the specialist’s findings is • different from that of prior years. • 4. Specialist is a related party whose findings • fully corroborate management’s financial • statement assertions.

  10. Understanding of the Client’s Business and Industry Understand Client’s Business and Industry Industry and External Environment Business Operations and Processes Management and Governance Objectives and Strategies Measurement and Performance

  11. Related Parties • Concern is that they are adequately disclosed • By nature, are not arm’s length

  12. MC #3 • When auditing related party transactions, an auditor places primary emphasis on: • 1. Confirming the existence of the related • parties. • 2. Verifying the valuation of the related • parties. • 3. Evaluating the disclosure of the related • party transactions. • 4. Ascertaining the rights and obligations of • the related parties.

  13. MC #3 • When auditing related party transactions, an auditor places primary emphasis on: • 1. Confirming the existence of the related • parties. • 2. Verifying the valuation of the related • parties. • 3. Evaluating the disclosure of the related • party transactions. • 4. Ascertaining the rights and obligations of • the related parties.

  14. Purpose Common form of Test • Understand client Comparison to industry • business using broad ratios • Going Concern Statistical prediction model based on key ratios (plus auditor judgment) • Attention directing Comparison to prior year or expected value • Reduce detail tests Comparison using highly predictable relationships or nonfinancial data

  15. Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence? • 1. Accounts payable • 2. Advertising expense • 3. Accounts receivable • 4. Interest expense

  16. 8-27(d) • Which of the following situations has the best chance of being detected when a CPA compares 2009 revenues and expenses with the p/y, and investigates all changes exceeding a fixed %? • 1. Increase in property tax rates has not • been recognized in the 2009 accrual. • 2. Cashier began lapping A/R in 2009. • 3. Because economy worsened, 2009 • provision for bad debts is insufficient. • 4. Company changed capitalization for small • tools in 2009.

  17. Materiality of Fluctuation • 2009 Gross Margin 42% • 2008 Gross Margin 40% • 2009 Sales $20,000,000 • 2009 Net Income $ 1,000,000 • Materiality $ 50,000 • Is the change material?

  18. Change in gross margin • (2009=49%, 2005=40%) 2% • Sales $ 20,000,000 • Dollar change $ 400,000 • Change is material (> materiality of $50,000)

  19. Materiality of Fluctuation • 1. Determine fluctuation • = Actual - Expected amount • 2. Compare to net income or other • base to determine if material • For gross margin, change = change as % of sales

  20. For balance sheet accounts, need to compute expected amount (alternate method % change in ratio) • Predicted inventory if turnover constant: • 20092008 • Inv. Turn (Cos/EI) 3.25 5.20 • 2009 COS/2008 Turn = 194,371/5.2 = • Predicted inventory = 37,379 • Recorded inventory = 59,864 • Increase in inventory 22,485

  21. Alternate method - % change in ratio • For turnover ratios, can’t subtract ratio since involves B/S and I/S amounts • can computer dollar change as percentage change in ratio20092008 • Inv. Turn (Cos/EI) 3.25 5.20 • % Change in turn = • (2008 – 2009) /2008 = • 5.20 - 3.25 = 1.95/5.20 = 37.5 % • x EI 59,864 • Increase in inventory 22,449

  22. Problem 8-33 • Change in Gross Margin: • (36.0 - 35.1) x 14,211 = 128 • Explanations: • Industry GP decline • Decrease % of sales from drugs

  23. Problem 8-33 • Explanations: • Industry GP decline - True • Decrease % of sales from drugs - True • Our concern is not whether the statements are true, but whether they fully account for the decline in gross margin.

  24. Total GP decline 128 • Industry (.2% x 14,211) (28) • Change in mix: • 09 Drugs = 39% sales • 08 Drugs = 36% • (3% x 14,211) = 426 (decline in • drug sales) • Drug - Nondrug GP = • (40.6 - 32.0) = 8.6 %(37) • Unaccounted for 63

  25. Problem 8-33: • Drugs Nondrugs • 2009 40.6% 32.0% • 2008 42.2% 32.0% • 2007 42.1% 31.9% • 2006 42.3% 31.8% • The change in drug gross margin is much larger than for the industry, and appears to be material ([42.2 - 40.6] x 5,126,000 = $82,000). (drug sales)

  26. Assessment of Going Concern • Auditor must assess whether client will continue in existence for a reasonable period of time. • Required on all audit engagements • Reasonable period is usually one year from f/s date • Auditor should consider management plans affect going concern status

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