Chapter 7 Slides-NEW.ppt

Chapter 7 Client Evaluation and Planning the Audit Acceptance and continuance of client relationships The decision to accept (or continue) an audit engagement depends on the client evaluation and ethical and legal considerations – Client evaluation involves in...

Chapter 7 Client Evaluation and Planning the Audit Acceptance and continuance of client relationships The decision to accept (or continue) an audit engagement depends on the client evaluation and ethical and legal considerations – Client evaluation involves integrity of management and unusual risks associated with the entity – Ethical considerations – Legal considerations 2  5 Stages of Audit Client Acceptance/retention Audit Planning Control Testing Substantive Testing Opinion Formulation Client acceptance  Engagement letter As a final step in the acceptance phase, in compliance with auditing standards and good professional practice, it is important to confirm the terms of each engagement in an engagement letter Refer to ASA 210 Terms of Audit Engagements for details of an engagement letter which includes scope of audit procedures, quality control, fees and other matters Prepared by auditor & addressed to BOD or Management Refer P/231 for typical format such as: Objectives, nature & scope of audit Mgt’s responsibility in preparing financial stat. Auditors to follow standards Statement on weaknesses in client’s accounting systems Mgt’s representations & disclosures Mgt’s responsibility to safeguard assets Basis for audit fees Request client to sign and return copy. 5  Planning the audit ASA 300 Planning an Audit of a Financial Report provides the guidelines for the auditor to follow: – Audit planning involves the development of an overall plan for the conduct and scope of the audit – Adequate planning helps to ensure that appropriate attention is given to important areas of the audit and that problems are identified properly Planning starts with obtaining an understanding of the entity and its environment, to understand events, transactions and practices affecting the entity Planning also involves setting materiality levels, assessing audit risk and its components and obtaining an understanding of the internal control structure. 6 Steps in planning the audit Obtaining an understanding of the entity and its environment (ASA 315) To plan an audit, the auditor should obtain an understanding of the entity and its environment, to understand events, transactions and practices that may have a significant effect on the financial statements This understanding provides a framework for planning an overall audit approach that responds to the unique characteristics of the entity 8  Industry conditions Understanding industry conditions includes understanding the market for a client’s products, the capacity of competitors relative to market conditions, and price competition Certain industries may also have transactions that increase the risks of material misstatements 9  Regulatory issues The regulatory environment can have direct economic consequences or affect the accounting and disclosure requirements Specific regulatory requirements for particular industries must be considered The auditor should be aware that non-compliance with relevant laws and regulations may materially affect the financial statements 10  Economic factors Factors include the general level of economic activity, interest rates, the availability of financing and the level of inflation Economic downturns can create circumstances that require write-offs of receivables or inventory etc. These conditions increase the inherent risk of misstatements and require close examination by the auditor 11  The nature of the entity Business operations The auditor needs to gain knowledge of issues such as products and markets, conduct of operations, transactions with related parties etc. Need to match accounting policies with the type of business operations Business Risks Risk that the entity will not achieve its objectives or execute its strategies. 12  Investments and financing Capital investment activities, including investments in technology and non-consolidated activities such as joint ventures, are of significance from an audit perspective Issues such as debt structure, leasing arrangements, guarantees etc. are also important 13 Measurement and review of financial performance Accounting for fair values, revenue recognition practices and knowledge of industry-specific accounting practices are all important Such measures from an audit perspective would include: – Key ratios and operating statistics – Key performance indicators – Industry trends – Forecasts, budgets and variance analyses 14 Performing analytical procedures Analytical procedures involve a study and comparison of relationships among data to identify expected or unexpected fluctuations and other unusual items – Refer ASA 520 Analytical Procedures The common types of analytical procedures involve a comparison of the entity’s financial information with: – comparable information for a previous period or periods – anticipated results such as budgets and forecasts – industry averages 15  Special areas of audit risk Fraud Earnings management Illegal acts Related parties Going concern basis  Bernard Madoff For the perfect example, look no further than Bernard Madoff. Orchestrated a $65 billion Ponzi Scheme, the biggest fraud in US history. In total, he fleeced more than 1,300 investors, many of their life savings. Two notable victims were filmmaker Steven Spielberg and actor Kevin Bacon  Albert Gonzalez American Hacker Computer criminal Arrested 2008 Make 75k a year 18 Consideration of fraud in planning The importance of considering fraud in the planning of an audit has increased in recent years ASA 240 – – When obtaining an understanding of the entity and its environment, including its internal control, the auditor shall consider whether the information obtained indicates that one or more fraud risk factors are present. 19 CONSIDERATION OF FRAUD AT PLANNING STAGE At planning stage, auditor must consider the risk that misstatements from fraud or error will not be detected. Auditor will use their experience, knowledge and training to determine whether fraud could occur. Auditor needs thorough understanding of client’s business in order to identify opportunities for perpetration of fraud. Auditor will need to consider: Business environment Internal control structure  1. Fraud Irregularities include: Fraud Illegal acts Intentional/illegal misstatements Errors/unintentional mistakes Other acts that contravene the constitution of an entity  Distinction between fraud & errors A fraudulent/illegal act is premeditated. An error is accidental. Fraud may involve: Manipulation, falsification or alteration of records. Omission of effects of transactions from records. Recording transactions without substance. Intentional misapplication of accounting policies. Errors may involve: Mathematical or clerical mistakes. Oversight or misinterpretation of facts. Misapplication of accounting policies.  The Fraud Triangle Opportunity 3 - Key Areas of Fraud Triangle Incentives/ Attitudes/ Pressures Rationalization  Audit Documentation – Audit Working papers These are the specific means used to record audit evidence. Working papers aid in: – Planning and performing the audit – Supervising and reviewing the audit work – Gathering evidence and providing essential support for the auditor’s opinion. Two main divisions: – Permanent file – Current working paper file  Current working paper file 2 categories: 1-Permanent File Contains data for future engagements such as objectives of company, type of shares, rights, contracts, leases, bonus, debts, analytical review schedules, internal control structure, flowcharts, audit program, correspondence. 2-Current File Contains evidence gathered in current year’s audit such as details of work, documentation, working trial balance, schedules & analysis, audit programs & audit memoranda. Audit memoranda-written data in narrative form prepared by auditor including comments on performance of auditing procedures & conclusions reached and documentation of corroborating information such as board minutes. Audit program – listing of the audit procedures to be performed and are used for evaluation of internal controls & substantive procedures. Eg. Audit working paper-Working T/B  Legal aspects of working papers working papers be properly prepared and maintained. Courts have determined that working papers are the property of the auditor. Auditor should not permit access to audit files by client’s staff. Working papers must be kept for 7 years. End of Lecture Wk 6