CHAPTER 7CHAPTER 7ACCEPTING THE ENGAGEMENT AND ACCEPTING THE ENGAGEMENT AND

PLANNING THE AUDITPLANNING THE AUDITFall 2007Fall 2007

CHAPTER 7CHAPTER 7ACCEPTING THE ENGAGEMENT AND ACCEPTING THE ENGAGEMENT AND

PLANNING THE AUDITPLANNING THE AUDITFall 2007Fall 2007

Client Acceptance and Retention

Planning the Audit

Obtaining an Understanding of the

Client’s Business and Industry

Overview of a Financial Overview of a Financial Statement AuditStatement Audit

Overview of a Financial Overview of a Financial Statement AuditStatement Audit

4 Phases of an Audit1. Client Acceptance and Retention2. Planning the Audit3. Performing Audit Tests (field work)4. Reporting the Findings

Client Acceptance: GuidanceClient Acceptance: GuidanceClient Acceptance: GuidanceClient Acceptance: Guidance

Authoritative Guidance– SAS’s (AICPA)– Quality Control Standards (AICPA)– Court cases– SOX if public company (available at

www.pcaobus.org)

Client Acceptance: StepsClient Acceptance: StepsClient Acceptance: StepsClient Acceptance: Steps

• This is a two way street• Clients solicit proposals• Auditors investigate situation considering

their own business risk1. Evaluate the integrity of management2. Identify special circumstances and unusual risks3. Assess competence to perform audit4. Evaluate independence5. Decision to accept or decline6. Prepare engagement letter for accepted clients

Client Acceptance: Management Integrity

Client Acceptance: Management Integrity

• Required communication with the

predecessor auditor

• Make inquiries of other third parties

• Review previous experience with

existing clients

Client Acceptance: Identify Special Circumstances & Unusual

Risks

Client Acceptance: Identify Special Circumstances & Unusual

Risks Focus on the auditor’s business risks

• Identify intended f/s users

• Assess prospective client’s legal and

financial stability

• Identify scope limitations

• Evaluate the entity’s financial

reporting systems and auditability

Client Acceptance: Assess Competence to Perform the

Audit

Client Acceptance: Assess Competence to Perform the

Audit • Services desired

• Identify the audit team

• Need for consultation and use of

specialists

Client Acceptance: Evaluating Independence & Decision to

Accept

Client Acceptance: Evaluating Independence & Decision to

Accept • Evaluate whether there are any

circumstance that would impair independence– Other services performed by the firm– Engagement team

• Put it all together and decide if you want this client! And if you do….

Client Acceptance: Prepare Engagement Letter

Client Acceptance: Prepare Engagement Letter

• Identify entity and F/S to be audited• Objective and purpose of the audit• Reference to professional standards to be used• Nature and scope of audit and responsibilities• Audit may not detect all material irregularities• Management is responsible for F/S & I/C• Timetable and client support• Management asked for written representations• Any auxiliary services to be provided• Basis for fees and billing arrangements• Request for client signature and return of letter

Audit Planning and Risk Assessment

Audit Planning and Risk Assessment

1. Identify relevant f/s objectives2. Obtain understanding of entity & its

environment3. Make preliminary judgments about

materiality4. Perform analytical procedures5. Consider audit risk including fraud risk6. Develop preliminary audit strategies7. Obtain understanding of I/C

Understanding the Entity and Its Environment

Understanding the Entity and Its Environment

• Fundamental assumption: Client’s business risks correlated with the auditor’s audit risk.

• Basic Idea: – Think about business & industry in

context of larger economic situation. Where “problems” likely for the business, the f/s are most likely to be misstated.

– Where the f/s most likely to be misstated, we need to do the most audit work.

• Pervasive vs. account specific factors

The Entity and Its Environment: Factors to Consider

The Entity and Its Environment: Factors to Consider

• Difficult Economic Times– Reductions in capital spending– Restructurings, inventory liquidations, write-offs– Downward pressure on earnings – Liquidity issues

• Pressures to Perform– Analysts, creditors and shareholders focus on

short-term performance– Earnings targets, debt covenants, performance

based compensation

The Entity and Its Environment: Factors to Consider

The Entity and Its Environment: Factors to Consider

• Complexity and Sophistication of Business Structures and Transactions– Goal is to meet specific reporting and economic

objective– Purchase/sales of assets, derivative transactions,

SPE’s etc to transfer risk of ownership

• Complex and Voluminous Standards– Complex accounting rules follow complex

transactions– Opens up opportunities to “get around rules”