Chapter 8 audit planning and analytical procedures, Lecture notes of Accounting

Download Chapter 8 audit planning and analytical procedures and more Lecture notes Accounting in PDF only on Docsity! Chapter 8--Audit Planning and Analytical Procedures 8-1 The Need for Adequate Audit Planning Your text points out three reasons why proper planning of an engagement is crucial: 1) to obtain sufficient competent evidence, 2) to keep audit costs reasonable, and 3) to avoid misunderstandings with the client. Ultimately, planning the audit pays off in minimizing legal entanglements and maintaining good relations with your customer-- the client. Audit planning consists of eight steps, illustrated in Table 8-1: 1. Accept the client and perform initial audit planning 2. Understand the client's business and industry 3. Assess client business risk 4. Perform preliminary analytical procedures 5. Set materiality and assess acceptable audit risk and inherent risk 6. Understand internal control and assess control risk 7. Gather information to assess fraud risks 8. Develop overall audit plan and program Only the first four of the steps listed above are covered in this chapter. The author points out two types of risk that the auditor must consider: acceptable audit risk and inherent risk. Acceptable audit risk measures how willing the auditor is to accept that the financial statements may be materially misstated at completion of the audit. Inherent risk measures the likelihood of a material misstatement before considering the effectiveness of internal control. These two measures of risk are important in determining the quantity of evidence that must be accumulated. The higher the risk, the more evidence it is necessary to acquire. 8-2 Make Client Acceptance Decisions and Perform Initial Audit Planning This first step can be broken down in to four tasks: Client Acceptance and Continuance: Not every client is acceptable. The auditor must consider the client's integrity, as well as the industry in which the client operates. In short, the audit risk must be measured against the auditor's threshhold. The CPA firm should conduct an investigation of a company to assess its desirability as a client. If the would-be client has been audited previously by another CPA firm, that firm must be contacted, with the client's permission. The auditor may even go further in the investigation by contacting other entities that have had dealings with the client, in order to further assess the client's situation. For a continuing client, the auditor must reflect upon previous relations with the client, evidence of the client's integrity, whether the audit fees have been paid (which could introduce an independence violation if the fees are one year or more in arrears), and the industry in which the client operates. Identify the Client's Reasons for an Audit: Two factors will affect audit risk--the likely statement users and their intended use of the statements. If the statements are to be used widely, the auditor will need to amass more information in the audit. Obtain an Understanding with the Client: The auditor must document the understanding of the engagement by submitting an engagement letter to the client. A good example of an engagement letter is shown in Figure 8-2. The engagement letter will carefully specify what work the auditor will perform (audit, compilation, review, tax return preparation) and should indicate that there is no guarantee of fraud discovery. You should be aware of the stipulation by the Sarbanes-Oxley Act that it is the audit committee of the firm being audited that is considered the client. Select Staff for the Engagement: The staffing of the audit must meet the first general standard of the Generally Accepted Auditing Standards relating to adequate technical training and proficiency. Additional specialists should also be considered, if appropriate. SAS 73 (AU 336) sets requirements for selecting and reviewing the work of specialists. Also, continuity of personnel from year to year may help to improve efficiency of the audit. 8-3 Understand the Client's Business and Industry An auditor must have a thorough knowledge of the client's business and industry. This need has been accentuated by the prevalence of information processing systems, global operations, intangible asset complexities, as well as to provide consulting or other services to the client. The author of your text refers to the strategic systems approach to understanding the client's business. This approach examines a number of dimensions: 1. Industry and the external environment 2. Business operations and processes 3. Management and governance 4. Objectives and strategies 5. Measurements and performance Industry and the external environment: There are risks associated with certain industries; there are risks associated to all clients in certain industries. Additionally, there are varying accounting requirements that the auditor must take into account in assessing whether or not to serve a particular client. The auditor must also consider