Chapter 3

Engagement Planning

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1. Audit Process Stages of an audit

1. Initial audit planning2. Obtain an understanding of the client and

its environment, including internal control3. Assess the risks of material misstatement

and design further audit procedures4. Perform further audit procedures5. Complete the audit6. Form an opinion and issue the audit report

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1. Audit Process AU-C 300 Planning an Audit

Performance Principle (FW Std. No. 1): The auditor must adequately plan the work and must properly supervise any assistants.

Planning involves developing an overall audit strategy Not a discrete phase of audit

Supervision involves directing the efforts of all assistants involved in the audit

Objective is to plan the audit so that it will be performed in an effective manner

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1. Audit Process AU-C 210 Terms of Engagement

Objective of auditor is to accept an engagement for a new or existing audit client only when the basis upon which it is to be performed has been agreed upon

establishing whether the preconditions for audit are present

confirming that common understanding exists between auditor and management

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1. Audit Process Preconditions of audit

determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable

obtain the agreement of management that it acknowledges and understands its responsibility

for preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework

for the design, implementation, and maintenance of internal control to provide the auditor with

access to all information that is relevant to the preparation and fair presentation of the financial statements

additional information that the auditor may request from management for the purpose of the audit

unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence

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2. Structure of CPA Firm Positions in firm Up or out Partnership potential Women in public accounting Work load Busy season Size of firm Size of engagement team

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3. Preliminary Arrangements Early appointment of auditors Evaluate client

integrity of management special risks

Evaluate your resources staffing interim vs. year-end work time budget independence

Quality assurance partner required on issuer engagements provides second review on high risk areas of audit

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3. Preliminary Arrangements (continued) Communicate with predecessor auditor (AU-C

210) integrity of management disagreements with management reason for auditor change required communications

Engagement letter (AU-C 210) purpose

First time audits auditing opening balances (AU-C 510)

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3. Preliminary Arrangements (continued)

Using work of internal auditors (AU-C 610) objectivity competence

Identification of related parties (AU-C 550) IT in an audit

IT audit specialist CAATs in an audit

ACL, IDEA, proprietary software

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4. Evidence Provided bySpecialists

AU-C 620 Definition - a person (or firm) possessing special skill or

knowledge in a particular field other than accounting or auditing

Examples: actuaries, appraisers, engineers, environmental consultants, geologists, and attorneys

Consider qualifications, experience, reputation Independence Review of work Effect on audit report

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7. Effect of Electronic Environment on Audit

Risks risks related to hardware and software reduced audit trail need for IT experience and separation of IT duties

No effect on purpose of audit (e.g., gathering sufficient

appropriate evidence) importance of management’s assertions

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8. Materiality AU-C 320 – Materiality in Planning and Performing the

Audit Definition Assessing materiality

quantitative factors qualitative factors

Materiality guidelines SEC caution

Accounting materiality ex post decision process

Auditing materiality ex ante decision process

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8. Materiality (continued)

Financial statement level materiality methods to establish annualizing financial results

Account balance level materiality performance materiality tolerable error

Clearly trivial Top down approach Planning materiality vs. final evaluation level materiality Cost benefit considerations

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8. Materiality (continued) Cumulative effects Factual (no doubt actual error), judgmental

(arise from management estimates), and projected (from sampling projections) errors

(known error and likely error) Relationship between audit risk and materiality Nonadditive nature of tolerable error Materiality example example2

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9. Audit Tests and Procedures Risk assessment procedures

procedures to obtain understanding of client, its environment, including IC

observation, inquiry, inspection, and analytics (walkthrough) Tests of controls

procedures to determine the operating effectiveness of controls inquiry, observation, inspection, reperformance

Substantive tests procedures to verify account balances activities performed to detect material misstatement or fraud at

assertion level includes tests of balances, transactions, and SAP

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9. Audit Tests and Procedures inspecting observing confirming inquiring tracing vouching

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9. Audit Tests and Procedures

scanning counting recalculating reperforming analytical procedures

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10. Audit Programs Transactions cycles Audit plans Audit programs

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11. Audit Documentation AU-C 230 Purpose Factors affecting type and content Ownership Organization

permanent file current file

Electronic workpapers AS 3 requirements

completion date – 45 days after report date Retention – at least 7 years additions/amendments – no deletions; fully documented additions

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11. Audit Documentation (con’t)

Types working trial balance lead schedules supporting schedules adjusting journal entries reclassification journal entries

Indexing Tick marks

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APOLLO SHOES, INC. C-1Inventory Lead Schedule

APOLLO SHOES, INC. B-1Accounts Receivable Lead Schedule

Current File

APOLLO SHOES, INC. A-3Bank Confirmation

APOLLO SHOES, INC. A-2First National Bank Reconciliation

APOLLO SHOES, INC. A-1Cash Lead Schedule12/31/04

Ref Account Unaudited AJE BalanceC-1 1rst Natl $484,000 $50,000 $534,000

APOLLO SHOES, INC. TB-1Working Trial Balance12/31/04

Ref Account Unaudited AJE BalanceA-1 Cash $484,000 $50,000 $534,000B-1 A/R C-1 Inventory

APOLLO SHOES, INC. TB-2Adjusting Entries

dr crCash $50,000 Expenses $50,000

Other Lead Schedules

Supporting Schedules

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Audit Documentation Information on

Workpaper Name, date, purpose,

page number Procedures

performed and conclusions reached by the auditor

Evidence that auditor followed general standards and standards of field work

Audit Mark Legend Reviewers’ initials

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12. Review Questions for Discussion

Chapter 33.23.33.63.73.93.103.11

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3.133.163.193.203.233.24