Chapter 3Engagement PlanningACCT-4080*Chapter 3

Chapter 3

Chapter 3*1. Audit Process Stages of an audit1. Initial audit planning2. Obtain an understanding of the client and its environment, including internal control3. Assess the risks of material misstatement and design further audit procedures4. Perform further audit procedures5. Complete the audit6. Form an opinion and issue the audit reportACCT-4080

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Chapter 3*1. Audit ProcessAU-C 300 Planning an AuditPerformance Principle (FW Std. No. 1): The auditor must adequately plan the work and must properly supervise any assistants.Planning involves developing an overall audit strategyNot a discrete phase of auditSupervision involves directing the efforts of all assistants involved in the auditObjective is to plan the audit so that it will be performed in an effective mannerACCT-4080

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Chapter 3*1. Audit ProcessAU-C 210 Terms of EngagementObjective of auditor is to accept an engagement for a new or existing audit client only when the basis upon which it is to be performed has been agreed uponestablishing whether the preconditions for audit are presentconfirming that common understanding exists between auditor and management ACCT-4080

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Chapter 3*1. Audit ProcessPreconditions of auditdetermine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptableobtain the agreement of management that it acknowledges and understands its responsibilityfor preparation and fair presentation of the financial statements in accordance with the applicable financial reporting frameworkfor the design, implementation, and maintenance of internal controlto provide the auditor withaccess to all information that is relevant to the preparation and fair presentation of the financial statementsadditional information that the auditor may request from management for the purpose of the auditunrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence

ACCT-4080

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Chapter 3*2. Structure of CPA FirmPositions in firmUp or outPartnership potentialWomen in public accountingWork loadBusy seasonSize of firmSize of engagement teamACCT-4080

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Chapter 3*3. Preliminary ArrangementsEarly appointment of auditorsEvaluate clientintegrity of managementspecial risksEvaluate your resourcesstaffinginterim vs. year-end worktime budgetindependenceQuality assurance partnerrequired on issuer engagementsprovides second review on high risk areas of auditACCT-4080

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Chapter 3*3. Preliminary Arrangements (continued)Communicate with predecessor auditor (AU-C 210)integrity of managementdisagreements with managementreason for auditor changerequired communicationsEngagement letter (AU-C 210)purposeFirst time auditsauditing opening balances (AU-C 510)ACCT-4080

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Chapter 3*3. Preliminary Arrangements (continued) Using work of internal auditors (AU-C 610)objectivitycompetenceIdentification of related parties (AU-C 550)IT in an auditIT audit specialistCAATs in an auditACL, IDEA, proprietary softwareACCT-4080

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Chapter 3*4.Evidence Provided bySpecialistsAU-C 620Definition - a person (or firm) possessing special skill or knowledge in a particular field other than accounting or auditingExamples: actuaries, appraisers, engineers, environmental consultants, geologists, and attorneysConsider qualifications, experience, reputationIndependenceReview of workEffect on audit reportACCT-4080

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Chapter 3*7. Effect of Electronic Environment on AuditRisksrisks related to hardware and softwarereduced audit trailneed for IT experience and separation of IT dutiesNo effect onpurpose of audit (e.g., gathering sufficient appropriate evidence)importance of managements assertionsACCT-4080

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Chapter 3* 8. MaterialityAU-C 320 Materiality in Planning and Performing the AuditDefinitionAssessing materialityquantitative factorsqualitative factorsMateriality guidelinesSEC cautionAccounting materialityex post decision processAuditing materialityex ante decision processACCT-4080

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Chapter 3*8. Materiality (continued)Financial statement level materialitymethods to establishannualizing financial resultsAccount balance level materialityperformance materialitytolerable errorClearly trivialTop down approachPlanning materiality vs. final evaluation level materialityCost benefit considerationsACCT-4080

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Chapter 3*8. Materiality (continued)Cumulative effectsFactual (no doubt actual error), judgmental (arise from management estimates), and projected (from sampling projections) errors(known error and likely error)Relationship between audit risk and materialityNonadditive nature of tolerable errorMateriality example example2ACCT-4080

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Chapter 3*9. Audit Tests and ProceduresRisk assessment proceduresprocedures to obtain understanding of client, its environment, including ICobservation, inquiry, inspection, and analytics (walkthrough)Tests of controlsprocedures to determine the operating effectiveness of controlsinquiry, observation, inspection, reperformanceSubstantive testsprocedures to verify account balancesactivities performed to detect material misstatement or fraud at assertion levelincludes tests of balances, transactions, and SAPACCT-4080

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Chapter 3*9. Audit Tests and ProceduresinspectingobservingconfirminginquiringtracingvouchingACCT-4080

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Chapter 3*9. Audit Tests and Proceduresscanningcountingrecalculatingreperforminganalytical proceduresACCT-4080

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Chapter 3*10. Audit ProgramsTransactions cyclesAudit plansAudit programsACCT-4080

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Chapter 3*11. Audit DocumentationAU-C 230PurposeFactors affecting type and contentOwnershipOrganizationpermanent filecurrent fileElectronic workpapersAS 3 requirementscompletion date 45 days after report dateRetention at least 7 yearsadditions/amendments no deletions; fully documented additionsACCT-4080

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Chapter 3*11. Audit Documentation (cont)Typesworking trial balancelead schedulessupporting schedulesadjusting journal entriesreclassification journal entriesIndexingTick marks

ACCT-4080

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Chapter 3*APOLLO SHOES, INC.C-1Inventory Lead Schedule

APOLLO SHOES, INC.B-1Accounts Receivable Lead Schedule

Current FileAPOLLO SHOES, INC.A-3Bank Confirmation

APOLLO SHOES, INC.A-2First National Bank Reconciliation

APOLLO SHOES, INC.A-1Cash Lead Schedule12/31/04

Ref Account Unaudited AJE BalanceC-1 1rst Natl $484,000 $50,000 $534,000

APOLLO SHOES, INC.TB-1Working Trial Balance12/31/04

Ref Account Unaudited AJE BalanceA-1 Cash $484,000 $50,000 $534,000B-1 A/R C-1 InventoryAPOLLO SHOES, INC.TB-2Adjusting Entries

dr crCash $50,000 Expenses $50,000 Other Lead SchedulesSupporting SchedulesACCT-4080

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Chapter 3*Audit DocumentationInformation on WorkpaperName, date, purpose, page numberProcedures performed and conclusions reached by the auditorEvidence that auditor followed general standards and standards of field workAudit Mark LegendReviewers initialsACCT-4080

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Chapter 3*12. Review Questions for DiscussionChapter 33.23.33.63.73.93.103.11

ACCT-40803.133.163.193.203.233.24

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