copyright © 2016 south-western/cengage learning professional auditing standards and the audit...

Copyright © 2016 South-Western/Cengage Learning

PROFESSIONAL AUDITING STANDARDS AND THE AUDIT OPINION FORMULATION PROCESS

CHAPTER 5

AuditingA Risk-Based Approach To Conducting A Quality Audit

10th edition

Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg

Copyright © 2016 South-Western/Cengage Learning 5-2

LEARNING OBJECTIVES

1. Identify and compare the auditing standards that provide guidance on the audit opinion formulation process

2. List and discuss the foundational principles underlying the auditing standards

3. List the phases and related activities in the audit opinion formulation process

4. Explain the concept of accounting cycles and discuss their importance to the audit opinion formulation process

Karla Johnstone

I would suggest that we DON't include the LO about ethical decision making since we don't really have text discussion about it.KMJ: I defer to what you decided on the instructor filesAnother thing. YOu have 42 slides in this chapter, and I have about half that in chapter 1. I guess the idea is to be flexible across chapters depending on the number of LOs and differential depth


LEARNING OBJECTIVES

5. Describe the assertions that are inherent to the financial statements and explain their importance to the audit opinion formulation process

6. Define audit evidence and describe the purpose of audit procedures used to obtain audit evidence

7. Discuss the importance of audit documentation and provide examples

8. Discuss audit activities in Phase I of the audit opinion formulation process


LEARNING OBJECTIVES

9. Discuss audit activities in Phase II of the audit opinion formulation process

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

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

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


IDENTIFY AND COMPARE THE AUDITING STANDARDS THAT PROVIDE GUIDANCE ON THE

AUDIT OPINION FORMULATION PROCESS

LEARNING OBJECTIVE 1


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


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


EXHIBIT 5.1 - COMPARISON OF U.S. AND INTERNATIONAL AUDITING STANDARDS


LIST AND DISCUSS THE FOUNDATIONAL PRINCIPLES UNDERLYING THE AUDITING

STANDARDS



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


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


LIST THE PHASES AND RELATED ACTIVITIES IN THE AUDIT OPINION FORMULATION PROCESS



EXHIBIT 5.3 - ACTIVITIES OF EACH PHASE OF THE AUDIT OPINION FORMULATION PROCESS

AAG

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IMPORTANT CONCEPTS PERVASIVE THROUGHOUT THE AUDIT OPINION

FORMULATION PROCESS• Accounting cycles• Management assertions• Audit evidence and audit procedures• Documentation


EXPLAIN THE CONCEPT OF ACCOUNTING CYCLES AND DISCUSS THEIR IMPORTANCE TO THE AUDIT

OPINION FORMULATION PROCESS



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


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


DESCRIBE THE ASSERTIONS THAT ARE INHERENT TO THE FINANCIAL STATEMENTS AND EXPLAIN THEIR

IMPORTANCE TO THE AUDIT OPINION FORMULATION PROCESS



MANAGEMENT’S FINANCIAL STATEMENT ASSERTIONS IN PCAOB STANDARDS


DEFINE AUDIT EVIDENCE AND DESCRIBE THE PURPOSE OF AUDIT PROCEDURES USED TO

OBTAIN AUDIT EVIDENCE



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


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


DISCUSS THE IMPORTANCE OF AUDIT DOCUMENTATION AND PROVIDE EXAMPLES



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


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


DISCUSS AUDIT ACTIVITIES IN PHASE I OF THE AUDIT OPINION FORMULATION PROCESS



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


DISCUSS AUDIT ACTIVITIES IN PHASE II OF THE AUDIT OPINION FORMULATION PROCESS



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


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


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


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


DISCUSS AUDIT ACTIVITIES IN PHASE III OF THE AUDIT OPINION FORMULATION PROCESS



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)


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


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


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


DISCUSS AUDIT ACTIVITIES IN PHASE IV OF THE AUDIT OPINION FORMULATION PROCESS



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


DISCUSS AUDIT ACTIVITIES IN PHASE V OF THE AUDIT OPINION FORMULATION PROCESS



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

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