Chapter 3

Question 1

Client Acceptance/Continuance

Answer 1

Looking for clients that have integrity and who we would want to do business with.
Required by SEC to do, every year and for every client!

Question 2

Discuss with Predecessor Auditor

Answer 2

You want to ask them various types of questions.
Entity needs to give consent to predecessor auditor to talk to us about the client.
Any extraordinary items? What happened in previous audit?
Ask why they are not continuing with the client? Any fraud?
What was the environment like working with managers?
Has management changed/went against decisions? How active is the audit committee?

Question 3

Can you use Internal Auditors (I/A)

Answer 3

Evaluate I/A staff.
Direct or Indirect use.
Relationship of materiality and risk of use.

Question 4

Evaluate the I/A staff

Answer 4

Objectivity, Competence, and Systematic Disciplined Approach.

Question 5

Direct Use

Answer 5

Treat the internal auditor just as one of your staff, use them directly.

Question 6

Indirect Use

Answer 6

Use what they have already done or part of normal audit procedures.

Question 7

Key Points to remember using I/A Directly or Indirectly

Answer 7

You have to do some reperformance of they work and review. Supervise them too!

Question 8

Relationship of Materiality and Risk on use

Answer 8

As risk and materiality increase, internal auditors aren’t used as much (less).

Question 9

Audit Committee

Answer 9

Understand their view of their responsibilities. Must be on the board (to be a member). Audit committee appoints the auditor.They determine audit fee. Approve any services external auditors do/suggest. “Whistle blower” procedures: report to company illicit actions without fear from employees.

Question 10

Letter of Arrangement/Engagement Letter

Answer 10

Our formal contract with the client. Says auditors responsibilities and the clients responsibilities (and limitations). How much it costs. From the audit firm to the client (chairman of audit committee). Must be done before we can start!

Question 11

Plan Audit: Laws & Regs

Answer 11

Direct and material (taxes, contracts, etc.) our responsibilities.
Material but indirect (FDA, OSHA, EEOC, etc.) our responsibilities.

Question 12

Direct and material (Taxes, Contracts, etc.) Our responsibilities

Answer 12

We have a responsibility to directly find these. We have direct audit procedure to catch that illegal act or violations.
Ex: Taxes and government contracts. We have proper tax laws.

Question 13

Material but indirect (FDA, OSHA, EEOC, etc.) Our responsibilities

Answer 13

We just need to be “aware” or “attentive”, and if we find something material then we will do something. Can not ignore though! We do not go directly looking for these or build our audit program to find these.

Question 14

Related Parties (See handout)

Answer 14

“Arms-Length”. Procedures to find.

Question 15

What does “arms-length” mean?

Answer 15

Transaction strangers would do with each other, a true fair market value transaction.

Question 16

Procedures to find

Answer 16

Conflict of interest. Financial Statements. Board minutes.

Question 17

Document: Overall strategy, plan, and detail audit program steps

Answer 17

All part of the workpapers!

Question 18

Types of tests

Answer 18

Risk Assessment (Chapter 4).
Controls (Procedures).
Substantive tests ($ Dollars).

Question 19

Controls (Procedures)

Answer 19

Tests of procedures. We do these test to make sure controls will detect material misstatements and work like they are supposed to.

Question 20

Ways to Test Controls

Answer 20

Inquiries, Inspect Documents; Observe, Walkthroughs; Reperformance (include recompute) Table 3-4.

Question 21

Non public (Consider); Public (Test)

Answer 21

Non-Public: We need to understand controls but do not need to test them.
Public: Required to test key controls.

Question 22

Substantive tests ($ Dollars)

Answer 22

Sub analytics (trends, ratios - Chapter 5).
Tests of detail (Count, Confirm, Look at invoices, Test recons etc. Chapter 5).

Question 23

Interplay among approaches (3 Key Points)

Answer 23

1. The more effective controls are, the less substantive testing you need to do!
2. The less effective controls are, the more substantive testing you need to do!
3. Papandria interplay: There will be circumstances where you will need to test a lot of both (controls and tests).
   Some examples of Papa interplay: more audit comfort needed, new controls, new client, may cause you to do a lot of substantive testing and both in general.

Question 24

Timing of Controls/Substantive Tests

Answer 24

You really need to test controls first to see if they are effective, then see how many substantive tests will be needed!
For a new client, NEVER do at the same time. Depends on client if you want to do both simultaneously.
If you test a sample with an unacceptable error correctly, the sample represents the population, because you extrapolate, so no need to keep testing!

Question 25

Materiality

Answer 25

A matter of professional judgement. That amount that if we knew about it, then we would do something differently.

Question 26

Steps in applying/determining materiality

Answer 26

1. Determine overall materiality. 2. Determine tolerable misstatement. 3. Evaluate audit findings-determine impact on opinion.

Question 27

Determine overall materiality

Answer 27

The maximum amount financial statements can be wrong/misstated that can't influence/affect the users.

Question 28

Determine tolerable mistatement

Answer 28

How much we can stand in each major area or account. As amount you can stand comes smaller, you need to do more testing (less room for error). We are auditing the entire F/S and individual account balances.

Question 29

Evaluate audit findings-determine impact on opinion

Answer 29

Hard entry Soft entry Look at rollover of prior period items: make sure not 'material' for this year or next year. Quantitative vs. Qualitative.

Question 30

Hard entry

Answer 30

Did something wrong, mistake, or goofed. Ex: Recording 84 instead of 48 for truck.

Question 31

Soft entry

Answer 31

Wiggle room or flexibility. Judgement Call! Ex: Allowance for bad debts; we think should be 1MM, client thinks 1.1MM).

Question 32

Quantitative vs. Qualitative

Answer 32

Qualitative issues: not significant in dollar amount but has a significant influence on the financial statements. Ex: $2 adjusting entry to not violate debt covenant. Materiality can change throughout the audit, you can move up or down, but you need to document why that is changing in those circumstances! NOT appropriate to change materiality to fix a problem!

Question 33

Another key point

Answer 33

We do not want overstated or understated, we want to be fairly stated/reasonably stated!