What is Planning (in general)?
- 1st Standard of Fieldwork - The auditor must adequately plan the work and must properly supervise any assistants
- Two types of Risk are Acceptable Audit Risk and Inherent Risk
What is Acceptable Audit Risk?
- A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued
- Firm level decision, stays constatns, and usually relatively low
What is Inherent Risk?
A measure of the auditor's assessment of the likelihood that there are material misstatemements in an account balance before considering the effectiveness of internal control
What are the 4 Key Parts of Planning?
- Accept Client and Perform Initial Audit Planning
- Understand the Client's Business and Industry
- Assess Client Business Risk
- Perform Preliminary Analytical Procedures
What are the subparts of Accepting a Client and Performing Intiial Audit Planning?
- Client Acceptance and Continuance
- Identify Client's Reasons for Audit
- Obtain an Understanding with the Client
- Develop Overall Audit Strategy & Staff the Engagement
What does Client Acceptance and Continuance consist of?
- May ultimately refuse new high-risk clients or discontinue existing ones
- Smaller firms may refuse publicly-traded clients
- Do an extensive examination of client
- Asses whether the CPA firm has the competency (indsutry knowledge) to perform the engagement
- Assess Independence
What is meant by Assess Independence?
- AU 315 requires new (successor) auditor to communicate with predecessor (old auditor)
- Successor is responsible for intiating this
- Predecessor must obtain client's permission
- Beware of a potential new client who won't give permission for the old auditors to communicate with you
- Should evaluate existing clients annually. Consider previous conflicts over fees, scope of the audit, type of opinion to issue, adjustments to statements
What does Identifying Client's Respons for Audit consist of?
- Who are the likely statement users and what are their intended uses of the statements?
- More extensively used financial statements will result in the accumulation of more audit evidence
What does Obtain an Understanding with the Client consist of?
- AU 311 requires that auditor document (must be written) their understanding with the client in an engagement letter. Engagement objectives, Responsiblities of management and auditor, Engagement limitations, Other services to be provided, Any restrictions on auditor's work, Deadlines, and Assistance to be provided by client (make use of their employees as much as they can)
- Management (private) or audit committe (public) will sign the letter
What does Develop Overall Audit Strategy & Staff the Engagement?
- Consider the nature of the client's business and industry, areas of greater risk of misstatement, number of client locations, past effectiveness of internal controls
- Select staff for enagagement
- Evaluate need for outside specialists (AU 336) e.g. actuaries, attorneys, geologists
What are the details of Selecting staff for engagement?
- 1st General Standard - The auditor must have adequate technical training and proficiency to perform the audit
- Size of engagement team, possbily multiple offices
- Need for specialized skills on the engagement team (e.g. statical sampling, business valuation, computer risk assessment)
- Should try to maintain continutiy from year to year
What is the evaluation needs for outside specialists?
- Auditor must have a sufficient understanding of the client's business to recognize whether a specialist is needed
- Auditor must evaluate the specialist's professional qualifications and understand the objectives and scope of the specialist's work
- Should also consider the specialist's relationship to the client (objectivity)
- Auditor report doesn't refer to the work of the specialist (i.e. auditor has full responsibility) unless the specialist's report results in a modification of the audit opinion
What does Understand the Client's Business and Industry consist of?
- 2nd Standard of Fieldwork
- 3 primary reasons: Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk, Certain inherent risks are typically common to all clients in certain industries (e.g. obsolete inventory), and Many industries have unique accounting requirements that the auditor must understand (e.g. gov audit)
- Should also learn about external environment (economic conditions, extent of competition, regulatory requirements)
- Business Operations and Processes
- Client objectives and strategies related to reliaility of financial reporting, effectiveness and efficency of operations to assess client business risk and inherent risk, and compliance with laws and regulations (know terms of contracts and other legal obligations)
- Know key performance indicators that management uses to measure progress toward its objectives, if unreasonable inherent risk may be increased
- Perform ration analysis and benchmark against key competitors
What is meant by Business Operations and Processes?
- Understand major sources of revenues, key cusomter, suppliers, sources of inancing, informatin about related parties
- Tour the Plant and Offices (for new clients and sometimes ongoign audits) - helps in learning about operations, can assess physical safeguards over assets, and can talk with non-accounting personnel
- Identify Related Parties - affiliated companies, principal owner, or toehr party with which the client deals, where once can influence the other, GAAP requires transactions between related parties to be disclosed if material, inquire and review SEC flings, examine stockholder listing, SOX prohibits personal loans to directors or officers
- Assess management's phiosophy and operating style, ability to repsond to risk and governance includes the organizational structure, activities of the BOD and audit committee
- Understand the Corporate Charter and Bylaws
- Review th company's code of ethics (required by the SEC) and examine any changes and waivers in these
- Read the BOD minutes (corporate minutes)
What is Business risk?
- Risk that the client will fail to achieve its objectives
- Directly linked to risk of material misstatement in the financial statements
- Considers the client's industry, other external factors, business strategies, processes and toehr internal factors
- Auditor should also consider management controls that may mitigate business risk (effective risk assessment practices and Corporate Governance)
What does Assess Client Business Risk consist of?
- Evaluate business risk
- After evaluating business risk the auditor then can assess the risk of material misstatement and apply the Audit Risk Model
- Since management certifies financial statements, it should conduct thorough evaluations of relevant business risks that affect financial reporting
- SOX also requires management to certify that it has designed disclosure controls and procedures to ensure material information about business risk are communicated to the audit committee and disclosed to external stakeholders
- SOX also requires management to certify that it has informed the auditor and audit committee of any significant deficiencies in internal control, including material weaknesses
What does Perform Preliminary Analytical Procedures consist of?
- Helps to understnad client's business and assess business risk
- These procedures are attention-directing, which reveal unusual changes from prior years or when compared to industry averages and auditors will then plan to do more work in these areas
What is Analytical Procedures?
- AU 329 defines as evaluations of financial infromation made by a study of plausible relationships among financial and nonfinancial data...involving comparisons of recorded amounts...to expectations developed by the auditor
- Required to be performed during planning and at the completion phase of the audit
- Often used during the testing phase as well (but not required)
What are the 5 Types of Analytical Procedures?
- Auditor first devleops an expectation of what an account balance should be (5 ways to do this) and then compares to client's actual balance
- 1. Industry data - can be purchased from analysts such as Dun & Bradstreet, Rober Morris Associates and others
- 2. Similar prior-period data
- 3. Client-determined expected results (budgets)
- 4. Auditor-detrmined expected results (e.g. calculate interest expense)
- 5. Expected results using nonfinancial data
What are Short-term debt-paying ability ratios?
- Cash ratio
- Quick ratio
- Current Ratio
Whar are Liquidity activity ratios?
- A/R turneover - days to collect receivalbes
- Inventory turnover - days to sell inventory
What are the Ability to meet long-term debt obligation ratios?
- Debt to equity
- Times interest earned
What are profitability ratios?
- Earnings per share
- Gross profit percent
- Profit margin
- Return on assets
- Return on common equity