Engagement Planning, Obtaining an Understanding, and Assessing Risks

Question 1

1. Management is responsible for the fair presentation of financial statements. Management explicitly or implicitly makes assertions relating to account balances, transaction classes, and disclosures.
2. Relevant assertions are those that have a meaningful bearing on whether an account balance, transaction, or disclosure is fairly stated.
3. In planning and performing an audit, the auditor considers these assertions for the various transaction classes, financial statement accounts, and disclosures. Errors and fraud may be viewed as having the effect of misstating one or more of the assertions.

Answer 1

1. Financial statement assertions

Question 2

1. An audit should be designed to limit audit risk to an appropriately low level. Audit risk consists of 1) the risk that an account and its related assertions contains material misstatements and 2) the risk that the auditor will not detect such misstatements.
2. Inherent risk refers to the likelihood of material misstatements of an assertion, assuming no related internal control.
3. Control risk is the likelihood of material misstatement will not be prevented or detected on a timely basis by internal control.

Answer 2

2. Audit risk

Question 3

4. Detection risk is the likelihood that an auditor’s procedures lead to an improper conclusion that no material misstatement exists in an assertion when in fact such a misstatement does exist.
5. Inherent risk and control risk differ from detection risk in that they exist independently of the audit, whereas detection risk relates to the effectiveness of the auditor’s procedures.

Answer 3

2. Audit risk

Question 4

1. Materiality is “the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.”
2. An auditor’s consideration of user needs is as a group, not on specific individual users, whose needs may vary widely.
3. Operationally, the measure of materiality may be either quantitative or non quantitative.

Answer 4

3. Materiality

Question 5

4. The auditor plans the audit to obtain reasonable assurance of detecting misstatements that could be large enough, individually or when combined, to be quantitatively material to the financial statements.
5. After determining a materiality level for the various financial statements, the auditor then apportions the amount among the various accounts.
6. The measures of materiality used for evaluation purposes will ordinarily differ from the measures used for planning.

Answer 5

3. Materiality

Question 6

1. An audit should be planned and performed to obtain reasonable assurance aboput whether the financial statements are free of material misstatements, whether caused by error or fraud.
2. The 2 types of fraud considered in an audit are 1) fraudulent financial reporting that makes the financial statements misleading and 2) misappropriation of assets.
3. Fraudulent financial reporting occurs when the financial statements are intentionally misstated. Misappropriation of assets occurs when assets are stolen (theft or embezzlement)

Answer 6

4. Errors and fraud

Question 7

4. All fraud involving management should be communicated to the audit committee. All material fraud should be communicated to the audit committee. The auditor should reach an understanding with the audit committee regarding other communications.

Answer 7

4. Errors and fraud

Question 8

1. Certain laws have a direct effect on the financial statement amounts. The effects of the violation of them require an accounting journal entry.
2. Other laws do not have a direct effect in the determination of amounts but compliance with them is required to stay in business or to avoid material penalties.
3. Auditors should obtain an understanding of the legal and regulatory framework applicable to the entity and how the organization complies with that framework. Concerning illegal acts with a direct effect on financial statement amounts, the auditors should obtain sufficient appropriate audit evidence to provide reasonable assurance regarding laws with a material direct effect on financial statement amounts.

Answer 8

5. Laws and regulations

Question 9

4. Throughout the audit, auditors should remain alert for the possibility that other audit procedures bring forth instances of noncompliance or suspected noncompliance with any laws.
5. In situations where illegal acts of noncompliance is identified or suspected, auditors should obtain an understanding of the act and circumstances surrounding it and obtain further information to evaluate the possible effect on the financial statements.
6. Unless all those charged with governance are involved with management are aware of the matters involved, the auditor should communicate to them any identified or suspected noncompliance with laws identified, other than matters that are clearly inconsequential.

Answer 9

5. Laws and regulations

Question 10

7. If auditors suspect that management or those charged with governance are involved in noncompliance, they should communicate the matter to the next higher level of authority in the organization, if it exists, such as the audit committee.
8. If no higher authority exists or the auditors believe communication will not be acted upon, they should consider the need to obtain legal advice.

Answer 10

5. Laws and regulations

Question 11

1. Prior to acquiring a client, an auditor should attempt communication with the predecessor auditor and obtain a general understanding of the nature of the organization and its industry.

Answer 11

6. Audit planning

Question 12

1. Initiating the communication is the responsibility of the successor.
2. If the prospective client to refuses to permit the predecessor to respond or limit the predecessor’s response, the successor should inquire as to the reasons and consider the implication in deciding whether to accept the engagement.
3. The successor’s inquiries of the predecessor should include information bearing on integrity of management, disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters, communications to audit committee regarding fraud and illegal acts, and predecessor’s understanding of the reasons for the change in auditors

Answer 12

7. Communicating with predecessor auditors

Question 13

1. The understanding should include 4 general topics: 1) objectives of the engagement, 2) management’s responsibilities, 3) auditor’s responsibilities, and 4) limitations of the audit.

Answer 13

8. Establishing an understanding with the client

Question 14

1. The auditor performs procedures to determine whether continuance of the client relationship is appropriate and to evaluate the auditor’s compliance with ethical considerations

Answer 14

9. Preliminary engagement activities

Question 15

1. The auditor should develop and document an audit plan in which the auditor determines the audit procedures to be used that, when performed, are expected to reduce audit risk to an acceptably low level

Answer 15

10. The audit plan

Question 16

1. A written audit program should be developed and used to implement the audit plan.

Answer 16

11. Audit program

Question 17

1. Before applying procedures at an interim date, an auditor should consider the incremental audit risk involved as well as whether performance of such interim procedures is likely to be cost-effective.
2. Appropriate auditing procedures should be applied to provide a reasonable basis for extending November 30th interim date results to the remaining period (December 1-30).
3. A properly performed audit involves coordination of the timing of procedures. This especially applies to 1) related-party transactions, 2) interrelated accounts and cutoffs, and 3) negotiable assets.

Answer 17

12. Coordination of the timing of audit procedures

Question 18

1. Risk assessment procedures include inquiries of management and others within the entity, analytical procedures, and observations and inspections.

Answer 18

13. Obtain an Understanding of the Entity and Its Environment

Question 19

1. Although strongly recommended, no second communication with the predecessor auditor is required after accepting a new client. This second communication would normally involve review of working papers related to opening balances and the consistency of application of accounting principles.
2. If in reviewing the working papers the successor identified financial statement misstatements, the successor should request that the client inform the predecessor and arrange a meeting of the three parties.
3. Reaudits may be necessary, for example, when a change in auditors has occurred and the predecessor refuses to reissue his or her audit report on previous year financial statements that are to be reissued.

Answer 19

14. Communicate with predecessor auditors

Question 20

1. AU-C 315 requires that analytical procedures be performed as a risk assessment procedure in planning the audit.

Answer 20

15. Analytical procedures

Question 21

1. In all audits, the CPA should obtain an understanding of internal control sufficient to assess the risk of material misstatements of the financial statements, and to design the nature, timing, and extent of further audit procedures

Answer 21

16. Consideration of internal control

Question 22

1. Supervision includes instructing assistants, being informed on significant problems, reviewing audit work, and dealing with differences of opinion among audit personnel

Answer 22

17. Supervision requirements

Question 23

1. The auditor should perform the risk assessment to identify and assess the risks of material misstatements at the financial statement level and at the relevant assertion level for classes of transactions, account balances, and disclosures.
2. As part of the risk assessment the auditor is required to identify significant risks that require special audit attention. Although determining the significant risks is a matter of professional judgment, the standards provide some guidance. Routine, noncomplex transactions that are subject to systematic processing are less likely to give rise to significant risks because they have lower inherent risks.

Answer 23

18. Assess the risks of material misstatements and design further audit procedures

Question 24

1. The Statements on Quality Control Standards apply to the auditing and accounting practice of CPA firms. While the generally accepted auditing standards and the Code of Professional Conduct are primarily directed at the individual practitioner level, the quality control standards apply to the CPA firm itself.
2. CPA firms undergo a peer review performed directly by a CPA, a CPA firm, or a team of CPAs. There are 2 types of reviews: system review and engagement review.
3. The approach of the system review is to obtain an understanding of the CPA firm through inquiry of CPA firm personnel, review of documentation about the quality control system, and selection of a sample of the CPA firm’s engagements for review. In an engagement review, peers select a sample of CPA firm’s accounting work, including accounting reports issued and CPA firm documentation to evaluate whether the reports and procedures are appropriate.

Answer 24

19. Quality Control

Question 25

1. A system of quality control consists of policies designed to achieve the objective of the firm to establish and maintain a system of quality control to provide reasonable assurance that 1) The firm and its personnel comply with professional standards and applicable legal and regulatory requirements and 2) Reports issued by the firm or engagement partners are appropriate in the circumstances

Answer 25

20. Overall on a system of quality control