Chapter 3: Engagement Acceptance, Planning, and Risk Assessment Flashcards
Before the auditor accepts an engagement, what communication between the predecessor and the auditor should be made?
- Obtain client’s permission to make inquiries of the predecessor auditor.
Specific inquiries include: - information that might bear on management integrity
- disagreements with management over accounting principles, auditing procedures, or other similarly significant matters
- the predecessor’s understanding as to the reasons for the change of auditors; and
- communication to management, the audit committee, and those charged with governance regarding fraud, illegal acts by clients, and matters relating to internal control
After accepting the engagement, what communication between the auditor and the predecessor can be made?
The auditor may:
- make specific inquiries regarding matters that may affect the conduct of the audit (e.g., audit problems)
- Review the predecessor’s audit documentation related to matters of continuing accounting and auditing significance
note that the auditor should not make reference to the work of the predecessor as the basis for the opinion (do your own work).
What should the auditor assess when considering the firm’s client acceptance and continuance policies?
The auditor should assess:
- the firm’s ability to meet reporting deadlines
- the firm’s ability to staff the engagement
- independence
- integrity of client management
- the group engagement’s team ability to obtain sufficient appropriate audit evidence
What topics should be included in the agreement to audit engagement terms? What is the purpose of establishing such an understanding?
An understanding should include:
- objectives and the scope of the audit
- Management’s responsibilities
- the auditor’s responsibilities
- the limitations of the engagement
- other matters, such as timing, client assistance, fees and billing, etc.
The purpose of the agreement is to reduce the risk of misunderstanding. Note that an agreement letter documenting the understanding is a requirement under PCAOB standards.
Name the six main financial statement assertions for nonissuer and issuers
[COVERU and CEO APPROVED]
Nonissuer: Completeness cutOff Valuation, allocation, and accuracy Existence and occurence Rights and obligations Understandability and classification
Issuer:
Completeness
Existence
Occurrence {CEO}
Allocation
Presentation
Rights
Obligation
Valuation
E
Disclosure {APPROVED}
Name the relevant assertions for “transactions and events”
Completeness (Proper Period) Cutoff Accuracy Classification Occurence
Name the relevant assertions for “account balances”
Completeness
Allocation and Valuation
Rights and Obligations
Existence
Name the relevant assertions for “presentation and disclosure”
Completeness
Understandability and Classification
Rights and Obligations, and Occurrence
Valuation and Accuracy
What is the audit strategy?
The audit strategy outlines the scope of the audit engagement, the reporting objectives, timing of the audit, and required communications, and the factors that determine the focus of the audit. The audit strategy also includes a preliminary assessment of materiality and tolerable misstatement.
Define materiality and tolerable misstatement
Materiality:
is the amount of error or omission that would affect the judgment of a reaonsable person. The auditor uses judgment to set the initial levels of materiality (including materiality for the financial statements as a whole, performance materiality, and materiality for particular classes of transactions, account balances, and disclosures), and to revise them appropriately throughout the audit.
Tolerable misstatement:
is the maximum error in a population that the auditor is willing to accept. Tolerable misstatement is the application of performance materiality to a particular sampling procedure
What is an audit plan?
A written audit plan (required for every audit) is a listing of audit procedures that the auditor believes are necessary to accomplish the objectives of the audit. The audit plan typically follows development of the audit strategy.
What should be included in each step of the audit plan?
we cast our NET over the audit!
Each step of the audit plan should set out the procedure in detail, specifying the Nature, Extent, and Timing of the work to be performed and including a reference to the assertion under consideration.
(NET - Nature, Extent, Timing)
List the three types of audit procedures and tell why each is used
Risk assessment procedure - to obtain an understanding of the entity and its environment, including its internal control
Test of controls - to evaluate the operating effectiveness of internal control in preventing or detecting material misstatements
Substantive procedures - to detect material misstatements in the financial statements
What are the responsibilities of assistants when there are disagreements?
Assistants have a responsibility to exercise due professional care and to observe the standards of fieldwork. They should bring any disagreements with the conduct of the audit to the attention of the auditor-in-charge.
The assistant also has the right to document the disagreement, and, if necessary, to disassociate from the opinion.
What factors determine the amount of reliance an independent auditor may place on the work of internal auditors?
The following factors affect the amount of reliance:
- The objectivity of internal auditors (level of reporting within the organizational structure)
- The competence of internal auditors
- an evaluation of the work performed by internal auditors
Note that the external auditor remains solely responsible for the audit report, and may not share judgment responsibility with the internal auditor.
Should an auditor refer to the work of a specialist in the auditor’s report?
Generally, in the case of an unmodified opinion, no reference is made to the work of a specialist. If, however, the auditor decides to express a modified opinion due to the work of the specialist, reference to the specialist may be made. The auditor may need the permission from the specialist before making reference to the specialist.
Under ISAs, the auditor is required to obtain permission from the specialist before making reference to the specialist in the report.
Under PCAOB standards, what factors affect the nature and extent of necessary planning activities?
- The size and complexity of the company
- The auditor’s previous experience with the company
- Changes in circumstances that occur during the audit
According to PCAOB standards, what factors indicate less complex operations?
- fewer business lines
- less complex business processes and financial reporting systems
- more centralized accounting functions
- extensive involvement of senior management in day to day operations
- fewer levels of management
The engagement partner is responsible for:
- planning the audit
- supervising the work of engagement team members
- complying with relevant audit standards
What factors determine the nature, extent, and timing of supervision?
- the size and complexity of the entity
- the nature of the work assigned to each engagement team member
- the assessed risk of material misstatement
- the qualifications of the assistants
Distinguish between the three types of material misstatements
Three types of material misstatements are:
- Factual misstatements: there is no doubt
- Judgmental misstatements: management and the auditor have material judgment differences on accounting estimates or the application of accounting policies
- Projected misstatements: this represents the auditor’s best estimate of misstatements in an audit sample to the population that the samples were drawn.
What is audit risk? List and define the two elements of audit risk.
Audit risk is the risk that the auditor may unknowingly fail to modify appropriately the opionn on financial statements that are materially misstate. It is comprised of:
- Risk of Material Misstatement - the risk that the financial statements are materially misstated.
- Detection Risk - the risk that the auditor will not detect a material misstatement that exists in a relevant assertion.
State the audit risk model including the relationship of detection risk to substantive tests
AR = RMM x DR
Audit Risk = Risk of Material Misstatement x Detection Risk
RMM = IR + CR
Note that as the acceptable level of detection risk increases, the assurance required from substantive tests decreases. As the acceptable level of detection risk decreases, the assurance require from substantive testing must increase
