Auditing Theories.pdf

AUDITING THEORIES List of Relevant Standards Practice of Accountancy Profession Fundamentals of Assurance Services System Quality Control Introduction to Auditing & the Audit Process Preliminary Engagement Activities Audit Planning Internal Control Consideration Transactio...

AUDITING THEORIES List of Relevant Standards Practice of Accountancy Profession Fundamentals of Assurance Services System Quality Control Introduction to Auditing & the Audit Process Preliminary Engagement Activities Audit Planning Internal Control Consideration Transaction Cycles Consideration of Fraud, Error & Compliance Substantive Testing Audit Sampling Completing the Audit Audit Documentation & Communication with TCWG Audit Reporting Auditing in an IT environment Code of Ethics GATO, Abdul Barri Indol MSU - Main Campus 09452146094 PSAs PHILIPPINE STANDARDS ON AUDITING PSQC PHILIPPINE STANDARDS ON QUALITY CONTROL 120 Framework on PSAs 1 Quality Control 200 Objectives & General Principles governing FS Audits 210 Terms of Audit Engagements PAPSs PHILIPPINE AUDITING PRACTICE STATEMENTS 220 Quality Control for Audits of Historical Information 1000 Inter-bank Confirmation Procedures 230 Audit Documentation 1000Ph Audit Evidence: Practical Problems in FS Audits 240 Auditor’s Responsibility: Fraud & Error 1001Ph Guidance in dealing with Tentative FS 250 Consideration of Laws & Regulation in FS Audits 1002Ph Auditor’s Report on General Purpose FS prepared in accordance 260 Communications of Audit Matters with TCWG with a Philippine Financial Reporting Framework other than PFRS 1004 Relationship between BSP & Bank’s External Auditors 300 Planning an FS Audit 1005 Special Consideration: Audit of Small Entities 315 Understanding the Entity & its Environment and Assessing RMM 1006 FS Audits of Banks 320 Audit Materiality 1010 Consideration of Environmental Matters in FS Audits 330 Auditor’s Response to Assessed Risks 1012 Auditing Derivative Financial Instruments 1013 Electronic Commerce: Effect on FS Audits 402 Audit Consideration: Entities using Service Organizations 1014 Reporting by Auditors on Compliance with IFRS 450 Evaluation of Misstatements Identified during Audit PSREs PHILIPPINE STANDARDS ON REVIEW ENGAGEMENTS 500 Audit Evidence 501 Audit Evidence: Additional Considerations to Specific Items 2400 FS Review Engagements 505 External Confirmations 2410 Review of Interim Financial Information 510 Initial Engagements: Opening Balances 520 Analytical Procedures 530 Audit Sampling & Other Selective Testing Procedures PSAEs PHILIPPINE STANDARDS ON ASSURANCE ENGAGEMENTS 540 Audit of Accounting Estimates 3000 Assurance Engagements Other than Audits & Reviews of Historical FS 545 Auditing FV Measurements & Disclosures 3400 Examination of Prospective Financial Information 550 Related Parties 560 Subsequent Events 570 Going Concern PSRSs PHILIPPINE STANDARDS ON RELATED SERVICES 580 Management Representations 4400 Engagements to Perform Agreed-upon Procedures 600 Using another Auditor’s Work 4410 Engagements to Compile Financial Information 610 Considering Internal Auditor’s Work 620 Using Expert’s Work 700 Independent Auditor’s Report on General Purpose FS 701 Communicating Key Audit Matters in the Auditor’s Report 705 Modifications to the Opinion in the Auditor’s Report 706 Emphasis of Matters Paragraphs & Other Matters Paragraphs 710 Comparative Information 720 Other Information in documents containing Audited FS 800 FS Audits prepared in accordance with Special Purpose Framework 805 Special Consideration: Audit of Single FS & Specific FS Accounts / Items 810 Engagement to Report on Summary FS  PRACTICE OF ACCOUNTANCY PROFESSIONRA 9298 SCOPE OF ACCOUNTANCY PROFESSION (SECTORS) DISTINGUISHING CHARACTERISTICS OF ACCOUNTANCY PROFESSION COMMERCE & INDUSTRY ACADEME PUBLIC PRACTICE GOVERNMENT Mastery of a particular intellectual skill, acquired by training and education (PRIVATE PRACTICE) (EDUCATION) - obtain BS Accountancy degree & obtain CPA license by passing CPA Board Exam - constitutes in a qualified - constitutes in a person involved - involve teaching of - person who holds a Adherence by its members to a common code of values and conduct person (be it in his in decision making requiring accounting, auditing, position in an accounting established by its administrating body individual capacity or as a professional knowledge in the MAS, finance and professional group in partner or as a staff member science of accounting, as well as business law and government or in a - thru the revised Code of Ethics which is mandatory for all CPAs in an accounting or auditing accounting aspects of finance & taxation subjects GOCC, including those Acceptance of a duty to society as a whole firm) to render professional taxation OR when he represents performing proprietary - CPAs’ paramount concern is the public services as a CPA to more his employer before government functions than one client on a fee agencies on tax & other matters REGULATION OF ACCOUNTANCY PROFESSION basis related to accounting 1) RA 9298 and its implementing rules & regulations (IRR) ** CPAs are not prohibited to practice in more than one sector! - Philippine Accountancy Act of 2004, an act regulating the practice PROVIDED that there is no impairment in CPA’s integrity, objectivity or independence of accountancy in the Philippines signed on May 13, 2004 ORGANIZATIONS THAT AFFECT ACCOUNTANCY PROFESSION - the act provides & governs: Standardization & regulation of accounting education GOVERNMENT AGENCIES STANDARD-SETTING BODIES PROFESSIONAL ORGANIZATIONS Examination of registration of CPAs MM PRC ETC Local Foreign MM PICPA Supervision, control & regulation of practice of accountancy in PH MM BOA QRC FRSC MM IASB MM MM Sectoral Organizations - violator or RA 9298 & its IRR: fine of >P50,000 and/or imprisonment indirectly obtained evidence MM OBJECTIVE: To provide high or moderate level of assurance - inspection, observation is better than inquiry - absolute assurance is rarely attainable as a result of factors such as: external > internal evidence MM MM Use of selective testing - provided source is independent & knowledgeable MM Use of judgment in gathering & evaluating evidence and in forming conlusions internal evidence only available? MM MM Inherent limitations of internal controls - can be used only if: internal controls are effective Human limitations documented/written > oral/electronic evidence MM Management override original > photocopied document MM Collusion between employees 5) Written Assurance Report MM The fact that most evidence available is persuasive rather conclusive - contains conclusion of practitioner that conveys assurance obtained about subject matter ELEMENTS CREST FORMS 1) Three-party relationship a. Positive assurance - for audit engagements Practitioner Responsible Party Intended Users b. Negative assurance - for review engagements CPA that performs Responsible for the For whom practitioner - methods used: inquiry & analytical procedures only the engagement subject matter prepares report - no internal control consideration 2) Subject matter TYPES - information to be evaluated against the criteria 1) Direct Reporting Engagements - example: FS is the subject matter of audits - example: voting audits in Pinoy Big Brother 3) Suitable Criteria - practitioner performs evaluation and results are directly reported to the intended users - benchmarks used to evaluate subject matter - responsible party is not asserting something but auditor gives assurance that subject - example: PFRS is the criteria for FS matter is fair and unbiased 2) Attestation Engagements (Assertion-based Engagements) TYPES - responsible party is asserting something i.e fairness of FS a. Established criteria b. Specifically developed criteria - practitioner evaluates subject matter and assertions made by responsible party - those issued by authorized - designed for the specific purpose a. Audit engagements bodies of experts (i.e PFRS) of the engagement b. Review engagements c. Others (business performance measurement, ris assessment services, CPA Webtrust service)  NON-ASSURANCE ENGAGEMENTS FINANCIAL STATEMENT (FS) AUDITS - practitioner does not convey any assurance to intended users OBJECTIVE: Expression of an opinion on the fairness of FS in which examination (audit) as to the reliability of subject matter should have been made in accordance with PSAs and FS in conformity with GAAP 1) Related Services SCOPE: Auditor normally determines the scope of an audit with an exercise of - ordinarily performed in connection with an entity’s FS just like audit professional judgment by the auditor - no independence required but must be stated in the report LIMITATIONS a. Agreed-upon Procedures Nature of financial reporting - carrying out procedures of audit nature to which auditor, entity and MM Within a reasonable Timeliness of MM Nature of audit procedures period of time financial reporting any appropriate 3rd parties have agreed to MM Need for audit to be conducted - auditor reports the actual findings At a reasonable cost Nature of evidence - recipient of report must form their own conclusion to which report DOES NOT EXPRESS OPINION ON is restricted to those parties who agreed to the engagement Future viability of entity MM b. Compilation of Financial or Other Information Efficiency & effectiveness of management conduct of entity affairs MM - engaged to use accounting experience to collect, classify and Extent of compliance with all laws & regulations applicable to entity MM summarize financial information as opposed to auditing expertise CHARACTERISTICS 2) Other Non-assurance Engagements Auditors who perform FS audits are independent of management & FS users MM a. Tax Services Auditors base their opinions on sample of financial data rather than every FS item MM MM Tax Compliance - preparation of ITR (tax returns) Auditors obtain only reasonable assurance whether FS is free of material misstatement MM MM Tax Planning - determination of tax consequences of planned or potential Auditors express an opinion on FS as a whole & not individually MM transactions & suggestion of desirable course of action to minimize tax liability THEORETICAL FRAMEWORK OF AUDITING b. Management Advisory Services Audit function operates on the assumption that all financial data are verifiable MM - may include design & installation of accounting systems, computer Auditor should always maintain independence with respect to FS being audited MM risk management and corporate finance There should be no long-term conflict between auditor & client management MM - pervasive character of a CPA’s role in a consulting services engagement Effective internal control system reduces possibility of errors & fraud affecting FS MM is that of being objective advisor on the use of information An audit benefits the public MM GENERAL PRINCIPLES COVERING FS AUDITS PSA 200 AUDIT ENGAGEMENTS MM Auditor shall comply with relevant ethical requirements relating to FS audit MM Auditor shall plan and perform an audit with professional skepticism MM Auditor shall obtain SAAE to reduce audit risk to an acceptably low level FS AUDITS OPERATIONAL AUDITS COMPLIANCE AUDITS to obtain reasonable assurance MM Auditor shall exercise professional judgment in planning & performing the audit OBJECTIVE Determine whether FS Management/performance Systematic review of an MM Auditor shall comply with all PSAs relevant. PSAs are relevant when: of entity are fairly audit for purpose of organization’s procedures to PSAs are in effect; and stated in accordance measuring or assessing determine whether such has Circumstances addressed by PSAs exist with an identified effectiveness & adhered to government laws MM Auditor shall not represent compliance with PSAs in the auditor’s report unless reporting framework efficiency of operations & organization policies auditor has complied with requirements of PSA 200 and all other PSAs relevant ASSERTION Fair presentation of FS Effective-efficient operations Compliance CRITERIA Established (i.e PFRS & Specifically developed Established (i.e laws, MANAGEMENT & AUDITOR’S RESPONSIBILITY other rep framework) (i.e objectives set by BOD) regulations, contracts) MANAGEMENT: FS preparation & presentation in acc with applicable financial rep framework END Opinion plus Design, implementation & maintenance of internal controls Opinion Opinion PRODUCT Recommendations Provide auditor unrestricted access to all info & records relevant to audit WHO AUDITOR: Form and express an opinion on the FS based on his audit External auditor Internal auditor Government auditor * FS Audits DOES NOT relieve management of its responsibilities USUALLY?  NEED FOR AN INDEPENDENT FS AUDIT SYSTEM OF QUALITY CONTROL PSQC 1 QUALITY CONTROL 4) Human Resources & Assignment CRAP-C AS A REQUIREMENT INFORMATION RISK STEWARDSHIP THEORY - policies & procedures adopted by CPAs to Capabilities & Competence Mme Bank loan application Risk that the info that will (Agency Theory) provide reasonable assurance that services - personnel has professional education Mme Establishing credit worthiness be used in decision-making States that management provided have “quality” & continuing professional development for purchase of assets is materially misleading, wants credibility; an audit - Point of View: Accounting & Audit Firms Recruitment Mme Reporting to absentee owners inaccurate, unreliable enhances stewardship and - serves as the internal control system of - selection of individuals who has Regulatory requirement lessens the mistrust of owners accounting & audit firms capacity to develop competence Mme CONTRIBUTORY FACTORS Mme Sale of business (merger) Remoteness of users towards the management - applicable to all engagements, may it be and capability necessary in Mme Termination of partnership Potential bias & motives assurance or non-assurance engagements performing engagements Voluminous data Mme Preparation of ITR OBJECTIVES Assignment of Engagement Teams Complex transactions Mme Bankruptcy & insolvency cases APPROACHES TO REDUCE RISK The firm & its personnel comply with - assign responsibility for each Allow users to verify info professional standards and regulatory/ engagement to an engagement Let users share info risk partner with management legal requirements Have FS audited Reports issued by the firm or engagement - engagement team composition: partners are appropriate Partner GENERALLY ACCEPTED AUDITING STANDARDS ELEMENTS LEAHEM 1) Leadership Responsibilities Manager GFR - promote internal culture within the firm recognizing that quality is Staff-in-charge GENERAL STANDARDS TIP FIELDWORK STANDARDS PIE REPORTING STANDARDS GIDO (personal qualifications) (audit proper) (content of auditor’s report) essential in performing engagements - measures the quality of engagement Staff assistant name Technical training am Planning - determine audit procedures name GAAP - explicitly stated CEO or managing BOD of firm Performance evaluation & promotion and proficiency am Internal Control MM Inconsistency - state if material - assumes ultimate responsibility for - policies for recognitions & rewards mm Independence considerations MM Disclosure - adequacy is implicit firm’s system of quality control Career development MM Professional care MM Evidential Matter - SAAE MM Opinion - explicitly stated 2) Ethical Requirements 5) Engagement Performance DSRC GENERALLY ACCEPTED AUDITING STANDARDS (GAAS) - engagements are performed in - revised Code of Ethics PICPO - minimum auditing standards (basis for PSAs) accordance with professional Professional Competence & Due Care - measures the quality of auditor’s performance standards & applicable legal & Integrity regulatory requirements promulgated Confidentiality AASC 10 Generally Accepted Auditing Standards PSAs Professional Behavior Direction - inform staff’s responsibilities Objectivity Supervision Tracking the progress of engagement AUDITING & ASSURANCE STANDARDS COUNCIL (AASC) Independence? Identifying matters for consultation - promulgates auditing standards, practices & procedures - only required for assurance engagements Review COMPOSITION STANDARDS 3) Acceptance & continuance: client relationship Review of experienced members the 1 Chairman (senior practitioner in an auditing firm) Assurance Engagements: PFAEs MM Client’s integrity has been considered work of less experienced members 14 Members from different sectors, namely: Audit Engagements: PSAs Boo reputation of client Engagement Quality Control Review 1 from Association of CPAs in Public Practice Reviews Engagements: PSREsBoo nature of client’s operations - or EQCR; done by EQCR(er), who is 1 each from BOA, SEC, COA Other A. Engagements: PSAEs ooo attitude of management a ‘concurring’ partner of the firm 9 from PICPA, composing of: Non-assurance Engagements ooo Firm’s competence has been assessed outside engagement team, one who - 6 from the Public Practice Related Services: PSRSs am am Firm can comply with ethical requirements reviews performance of team that’s - 1 each from Academe, Private Practice done before audit report issuance and Government - required for listed entities  Consultation - of arguable matters; AUDITOR’S LEGAL LIABILITY & RESPONSIBILITY document the ff upon consulting: Issues sought DEGREES OF WRONGDOING AUDITOR CAN COMMIT : Results of consultation ORDINARY GROSS (including decisions taken & how they were implemented) NONE ACTUAL FRAUD NEGLIGENCE NEGLIGENCE Other Considerations (constructive fraud or reckless disregard) Differences in opinion Auditor Absence of Auditor fails Auditor issues an audit report with - firm shall establish policies & procedures for dealing performed & reasonable care consistently to intent to deceive despite knowing with & resolving differences of opinion within the issued the that can be follow standards FS are misstated and auditor did team, with those consulted and between the appropriate expected of a of profession on not take appropriate actions to engagement partner & EQCR(er) audit report person engagements report the misstatements - such policies & procedures shall require that: OTHER CONCEPTS ACTIONS TO MINIMIZE EXPOSURE TO LEGAL LIABILITY conclusions reached be documented & implemented audit report not be dated until matter is resolved 1) Lack of privileged communication Comply with GAAS, Code of Ethics and Documentation GR: Auditor shall not disclose confidential client info appropriate GAAP - firm shall establish policies & procedures for the ff: Except: Law requires (i.e court proceedings) Avoid companies in which risk of litigation is high completion of assembly of final engagement files 2) Liability for acts of others? Thoroughly investigate prospective clients confidentiality, safe custody, integrity, accessibilit - partners in an accountingfirm are jointly liable Exercise extreme care in audit of clients in and retrievability of engagement documentation LEGAL LIABILITY financial difficulties retention of engagement documentation Establishing and following appropriate 1) To his clients quality control procedures PSA 230: 5 yrs (if silent also) Exercise due professional care Use of engagement letters Regulation (SRC Rule #68): 7 yrs Adherence to professional standards and ethics Conduct audit with professional skepticism 6) Monitoring - ongoing consideration & evaluation of 2) To 3rd parties Provide opportunity for auditor to consult with firm’s system of quality controls Liable to all foreseeable 3rd parties for losses more experienced auditors about difficult issues PERIODIC INSPECTION caused by auditor’s negligence when they relied Maintain adequate professional liability - done once every 3 years upon auditor’s work insurance coverage - maintenance of quality controls by someone Seek legal counsel when serious problems occur within the organization AVAILABILITY EXTERNAL PEER REVIEW against against - review by a firm (peer) of the quality controls DEFENSES AVAILABLE client suits 3rd parties of another firm 1) Non-negligent performance - audit was conducted in accordance with standards 2) Lack of duty to perform - it was not specified or implied in the contract 3) Absence of causal connection - reliance on FS did not cause the loss 4) Statute of limitation on actions has expired - thru prescription 5) Lack of privity of contract 6) Contributory negligence - client’s own actions contributed to the loss  RECURRING AUDITS? - audits of recurring/repetitive in nature (same auditor) FINANCIAL STATEMENTS AUDIT - auditor does not normally send new engagement letter every year, 1 3 5 DOCUMENTING? except in the ff cases: ACCEPTING UNDERSTANDING COMPLETING Happens all Any indication of misunderstanding - AND throughout Revised terms of audit engagement IN H OES HAN D the audit Recent change in senior management G 2 4 6 Significant change in ownership PLANNING TESTING REPORTING Significant change in nature or size of entity’s business Change in financial reporting framework Change in legal or regulatory requirement ACCEPTING - to assess whether to accept engagement of proposed client PSQC 1 Change in other reporting requirement (preliminary engagement activities) CHECKLIST AUDITS OF COMPONENTS (i.e subsidiaries) 1) Auditable entity 3) Preconditions for audit - when the auditor of a parent is also the auditor of a component, Adequate records PREMISE OF AUDIT MM factors that may influence decision whether to send a separate Good control environment acceptable framework by management is used audit engagement letter includes: responsibilities of management are acknowledged Who appoints component auditor 2) Integrity of client - most important FS preparation MM REQUIRED TO DO Whether a separate auditor’s report is to be issued on component Design, implementation and MM Legal requirements Background search of client maintenance of controls Degree of ownership by parent - internet articles, FS review, etc Auditor access: unlimited Degree of independence of component management from parent entity Make inquiries to 3rd parties 4) Relevant Ethical Requirements of engagement team - banks, lawyers,etc (as applicable) Competence PLANNING & UNDERSTANDING - not discrete; a continuous or iterative process Communicate with predecessor auditor HOW? Obtain knowledge OBJECTIVE: To determine scope of audit procedures to be performed - for initial audit engagements : Engage experts ONLY IF: client permits FACTORS THAT AFFECT PLANNING Independence WHAT TO ASK Size or complexity of entity 5) Mutual Understanding between auditor & client PSA 210 MM client integrity MM Changes in circumstances that occur during audit MM reasons for auditor change - terms of audit engagement MM Key mgmt team members’ previous experience MM any disagreements with client - auditor is hired by: 1 BOD 2 Audit Committee; or BENEFITS OF PLANNING MM 3 Shareholders ISSUES - contract is in engagement letter prepared by auditor Devotes appropriate attention to important areas of audit MM - assess implication for each item to the and signed by him & client which contains: Identify & resolve potential problems on a timely basis MM acceptance of proposed engagement Form of report required MM Properly organize & manage audit engagement MM Low Audit fee Assist in selection of engagement team members Objective of audit - audit inherent limitations MM MM MM MM Identity of ff are ‘concealed’ Facilitating direction and supervision of team members Responsibilities MM MM - principal owners Assist in coordination of work done by auditors of components & experts a. Auditor - for audit report MM - related parties b. Management - for FS & internal controls ACTIVITIES - BOD Management’s expectations MM Obtaining an Establishing Development of MM Attitude of management towards Preparation of - must be explicitly stated understanding of materiality overall audit aggressive reporting preliminary audit - i.e other reports needed client and its and assessing strategy and (i.e meeting target earnings, etc) programs Audit Feemm environment risk detailed audit plan MM Reasons for change of auditor Others MM MM Scope limitations Identifying related parties CONSIDERATIONS - Need for experts OTHER CONSIDERATIONS: (i.e limited access to records) Performing analytical procedures Discussions with management - Restriction for auditor’s liability Arrangement for client’s assistance Determining need for an auditor’s expert - Arrangements to be made with predecessor auditor Considering the work of internal auditors Establishing audit team - Internal auditor involvement Scheduling of audit work ACTIVITIES b. Performance (planning) materiality AUDIT RISK MODEL - certain % of overall materiality to capture any 1) Obtaining an understanding of client & its environment PSA 315 uncorrected misstatements - also called Risk Assessment - may exceed overall materiality as a result of RAP RISK OF DETECTION REQUIRED UNDERSTANDING MATERIAL c. Individual (specific) materiality RISK (DR) Relevant industry, regulatory & other factors inc applicable FRF MISSTATEMENTS - lower than overall materiality which is expected Nature of entity (its business operations) inc internal controls to influence economic decisions of FS users Entity’s selection and application of accounting policies INHERENT CONTROL Objectives, strategies and related business risks BASES/SOURCES OF BENCHMARK AMOUNTS RISK (IR) RISK (CR) Measurement & review of entity’s financial performance Annualized Interim FS MM Prior year FS STEPS RISK ASSESSMENT PROCEDURES (in general) I-O-A-I MM - procedures performed to obtain understanding Budgeted FS of current year MM a. Set desired level of audit risk of the entity & its environment STEPS IN APPLYING MATERIALITY - risk that the auditor gives an inappropriate audit opinion a. Inquiries of management & others within entity DURING PLANNING PHASE - use of judgment in determining risk that - directed towards: 1 Determine overall materiality the auditor is willing to take Employees 2 Determine tolerable misstatement (planning materiality) - if assurance level is set at 95%, audit risk TCWG (those charged with governance) - determine procedures to be applied to specific accounts shall be set at 5% Internal audit personnel b. Assess level of inherent risk In-house legal counsel AT COMPLETION STAGE - susceptibility of FS to a material 3 Estimate likely misstatements and compare totals b. Observation of processes & people doing them misstatement without any internal c. Analytical Procedures - examines trends, ratios, etc to preliminary judgments about materiality control consideration d. Inspection of records, documents, properties (tour) - assess whether total uncorrected misstaments is material - auditor relies primarily on his knowledge - auditor would consider reducing audit risk as total of client’s business & industry Additional Consideration: PSA 510 uncorrected misstatements approach materiality level by: c. Assess level of control risk - Opening balances (FS) are correctly brought forward performing additional audit procedures; or - related to the effectiveness of client’s by reviewing predecessor auditor’s working papers requesting management to adjust FS internal controls to prevent, detect and 2) Establishing materiality level PSA 320 NOTES correct misstatements - largest amount of misstatement auditor could tolerate; or MM Materiality can be revised all throughout the audit in the - identification of major transaction cycles smallest aggregate amount that could misstate the FS event of becoming aware of pertinent facts that would have and controls put in place - matter of professional judgment & necessarily involves - amount of substantive test procedures caused auditor to have determined a different amount initially both quantitative (amount) & qualitative factors (nature) depends on the extent of reliance on MM If auditor concludes that a lower materiality is appropriate, USES auditor should determine whether it is necessary to revise the internal controls In planning stage, to determine scope of audit procedures nature, timing and extent of further audit procedures Reliability of Control Risk and In completion phase, to evaluate effect of misstatements 3) Identifying and assessing Risk of Material Misstatements (RMM) controls ST procedures LEVELS - to provide basis for designing and performing further d. Determine acceptable level of detection risk a. Overall materiality audit procedures (FAP) - risk that the practitioner will not detect - if misstatements exceed this level, auditor may need - auditor is required to: material misstatement that exists to adjust FS (the smallest aggregate amount) identify risks throughout the process of obtaining - auditor identifies acceptable level in which understanding of entity & its environment detection risk must not exceed 1 Identify an appropriate benchmark assess identified risks and evaluate whether they relate Audit Risk = IR x CR x DR For profit-oriented firms: PROFIT before tax MM more pervasively to FS as a whole & potentially affect DR = Audit Risk / (IR x CR) For non-profit firms: TOTAL EXPENSE MM any assertions *IR & CR (RMM) is inversely related to DR so: 2 Choose an appropriate % to be applied relate identified risks to what can go wrong at assertion Overall Materiality = % x Benchmark IR, CR (RMM) then DR level, taking account of relevant controls auditor intend to test consider likelihood of misstatement IR, CR (RMM) then DR  e. Design substantive tests (for testing phase) AUDITOR’S RESPONSIBILITY FURTHER AUDIT PROCEDURES (responses to RAP) Determine existence of RP a. For identified significant RP transactions Nature - effective procedures Identify RP transactions PLANNING Obtain SAAE that such transactions have been appropriately DR then ST Extent - sample size Examine RP transactions TESTING authorized & approved (extensive) Timing - testing @ year-end Consider audit disclosures COMPLETION Inspect underlying contracts/agreements and evaluate whether: Nature - effective procedures Audit documentation MM business rationale suggests that such have been entered into DR then ST Extent - sample size SPECIFIC RISK ASSESSMENT PROCEDURES to conceal asset misappropriation or to engage in fraudulent (bit relaxed) Timing - testing @ interim financial reporting a. Inquire of management * Only the detection risk can be controlled by auditor Identity of RP (those significant) MM terms of transactions are consistent with mgmt’s explanations (IR & CR not controllable) Nature of relationships MM transactions have been accounted for & disclosed RELATIONSHIP BETWEEN MATERIALITY & AUDIT RISK Type & purpose of transactions, if any b. If auditor identifies RP that mgmt has not previously identified: - inverse relationship ( materiality, audit risk) *Simultaneously, check info completeness by: promptly communicate relevant info - compensate for this by either: Reviewing the ff: to other engagement team members MM reducing assessed RMM (if possible) and support prior MM year working papers request mgmt to identify such & inquire as the reduced level by testing additional controls; or procedures MM for RP identification to why they were failed to be identified MM reducing the nature, extent and timing of planned shareholder’s MM (SH) records reconsider risk & evaluate audit implications substantive procedures minutes MM of meetings of SH & BOD perform other appropriate procedures NOTE Inquiry of the ff: 5) Performing Analytical Procedures PSA 520 *Throughout risk assessment, identify any significant risks affiliations of directors & officers with - analysis of significant ratios and trends, including resulting MM - require special audit considerations, which includes: other entities investigation of fluctuations and relationships that are not Significant non-routine/unusual transactions other auditors currently involved in MM consistent from predicted amounts Those with greater mgmt intervention audit or predecessor auditors as to their USES MM MM Those with greater manual intervention knowledge of any RP b. Perform other RAP appropriate to obtain In planning stage MM Those that require complex calculations understanding that mgmt has established to: - to understand client’s business and identify and/or accounting principles Judgmental matters auditor may consider Identify and disclose RP transactions areas that may represent risks (required) Authorize and approve such transactions As a substantive test 4) Identifying related party relationships & transactions PSA 550 - to obtain evidence to confirm individual c. Remain alert when inspecting records & A PARTY IS RELATED TO AN ENTITY IF: documents that may indicate RP transactions account balance (not required) Directly or indirectly, that party that mgmt has not previously identified or As an overall review in completion phase MM controls, is controlled by or under common control disclosed to auditor - to identify unusual fluctuations not identified MM has an interest in the entity (significant influence) initially & to confirm conclusions reached (required) has joint control over entity TRANSACTIONS THAT MAY INDICATE EXISTENCE STEPS IN APPLYING ANALYTICAL PROCEDURES MM Party is an associate or joint venture OF RELATED PARTY NOT PREVIOUSLY IDENTIFIED Party is a member of a key management personnel of entity Those having abnormal terms of trade a. Develop expectations about FS Party is a close family member of first or third item Those lacking an apparent logical business b. Compare FS with the expectations developed Party is controlled, jointly controlled reason for their occurrence c. Is the difference between the two significant? or significantly influenced Those where substance differs from form NO: Design less extensive audit procedures Party is a post-employment benefit plan Those processed with biased manner YES: Conduct further investigation for benefit of employees Those high volume transactions with certain - inquire management & corroborate info customers/suppliers as compared to others - apply other procedures as appropriate AUDITOR NEEDS TO BE AWARE OF SUCH TRANSACTIONS BECAUSE: PAS 24 disclosure requirements Those that are unrecorded ANALYTICAL PROCEDURES USED IN PLANNING PHASE Existence of such may affect FS Simple comparisons Source of audit evidence affects auditor’s assessment Ratio analysis of its reliability Vertical analysis They maybe motivated by other than ordinary Trends statement business considerations Time series analysis 6) Determining need for Auditor’s Expert PSA 620 7) Considering the work of Internal Auditors PSA 610 9) Developing the detailed Audit Plan - auditor may require audit evidence in form of report, opinions, - external auditor (practitioner) should obtain sufficient - contains overview of engagement, including: valuation and statements of an expert understanding of internal audit functions to assist in N, T, E of planned RAP Expert - an individual or organization possessing expertise in a audit planning & develop effective audit approach N, T, E of planned FAP (TOC and/or ST) field other than accounting/auditing: ACTIVITIES other planned audit procedures Valuation of complex financial instrument, PPE, Monitoring of internal control - takes place over the course of audit assets acquired in business combination and Examining financial & operating info 10) Preparation of Preliminary Audit Programs assets that may have been impaired Reviewing operating activities - most important control mechanism in audit Actuarial calculation of liability associated with Reviewing compliance with laws & regulations - sets out in detail the audit procedures to be insurance contracts or employee benefit plans Risk management performed in each segment of audit Estimation of oil & gas reserves Governance - serves as set of instructions to assistants Valuation of environmental liability and REQUIRED TO DO - for initial engagements: not usually prepared site clean-up costs until client’s control structure has been Interpretation of contracts, laws & regulations Making preliminary assignment of internal auditing - only when relevant to external audit reviewed & documented Analysis of complex/unusual tax compliance issue - in most firms, these are already pre-printed Evaluating & testing the work of internal auditors Auditor’s expert: to assist auditor in obtaining SAAE but auditor would normally modify such to - examination of items already examined by them Management’s expert: to assist management in FS preparation suit clients conditions - examination of other similar items CONSIDERATIONS WHEN DECIDING WHETHER TO USE AN EXPERT - observation of procedures performed by them - also includes the time budget (estimate of Whether mgmt has used a mgmt’s expert in FS preparation MM Document conclusions regarding evaluation of adequacy time for audit procedures) Nature & significance of matter including its complexity MM of work of internal auditors if used in external audit FORM & CONTENT Expected nature of procedures MM Audit report should not include any reference to work - may vary for each engagement but Risk of Material Misstatement (RMM) in the matter MM performed by internal auditing should always include detailed list of audit WHEN AUDITOR CONCLUDES THAT WORK OF AN EXPERT IS NEEDED, 8) Establishing the Over-all Audit Strategy procedures that auditor believes are AUDITOR SHOULD necessary to accomplish audit objectives - design optimized audit approaches that seek to Assess auditor’s expert’s achieve necessary audit assurance @ lowest cost 11) Discussions with management Competence - professional certification/license MM regardless internal controls can be reliable or not - coordinate some of planned audit Capability - time availability & resources, geographic location MM STEPS procedures but care is required in Objectivity - considered impaired if expert is also MM order not to compromise audit a. Identify characteristics of engagement (scope definition) employed by entity or related in other manner effectiveness b. Ascertain reporting objectives of engagement Evaluate scope of expert’s work c. Consider factors that are, in auditor’s judgment, 12) Arrangement for client’s assistance - auditor shall first obtain sufficient understanding of significant in directing engagement team’s effort - extent of assistance to be provided field of expertise of expert MM determination of appropriate materiality levels should be determined early as possible Assess work of auditor’s expert MM preliminary identification of areas with possible RMM - listing of schedules, analyses should be - auditor shall evaluate adequacy or expert’s work MM impact of assessed RMM at FS level provided - if not adequate, auditor should: MM emphasis of professional skepticism agree with the expert on the nature & extent MM 13) Establishing Audit Team MM significant industry developments of further work to be performed by expert - composed of: engagement partner, MM significant changes in financial reporting framework perform FAP appropriate to circumstances MM a manager, at least one senior and MM evidence of mgmt’s commitment to internal controls (could also use work an another expert) one or more staff auditors MM results of previous audits EFFECT OF USE OF AUDITOR’S EXPERT d. Ascertaining nature, timing & extent of resources - consists of people with different level - auditor has sole responsibility for audit opinion NOT REDUCED necessary to perform engagement of expertise & experience by auditor’s use of an expert selection of engagement team & assignment of 14) Scheduling of Audit Work - if at the end of the engagement, the audit report renders: audit work to team members (i.e assign experienced - efficient scheduling & regular reviews Unmodified opinion: don’t refer to expert’s work unless law requires team members to areas with higher RMM) of work by team members are the key Modified opinion: may indicate reference to expert’s work engagement budgeting (time allocation) takeaways here (case to case basis)  AUDIT EVIDENCE & PROCEDURES ASSERTIONS: claims or representations of management (explicit or implicit thru FS) RAP IOAI TOC IWORI ST NoRep CPA INQUIRY Classes of Transactions COCAC Presentation & Disclosure COCAV Account Balances VaCER OBSERVATION Classification MM Classification Recording in proper accounts Valuation & allocation Or accuracy MM ANALYTICAL PROCEDURES - mm Occurrence MM Occurrence Those recorded occurred/existed Completeness MM INSPECTION mm Completeness MM Completeness All that should be recorded Existence MM RECALCULATION - - MM are recorded Accuracy Recording at correct amounts Accuracy & Valuation MM Rights & obligations MM REPERFORMANCE - - MM Cut-off Recording in the correct accounting period MM All assets & liabilities pertain to the client WALKTHROUGH - AUDIT PROCEDURES AUDIT EVIDENCES 1) Based on their purpose - consists of: RISK ASSESSMENT PROCEDURES FURTHER AUDIT PROCEDURES Underlying accounting records - accounting records underlying the FS Corroborating information - those that validate underlying accounting records obtain understanding of entity TEST OF SUBSTANTIVE and its environment, including CHARACTERISTICS CONTROLS TESTS its internal controls 1) Sufficient - quantity of evidence needed evaluate operating effectiveness of detection of material CONSIDERATIONS controls in preventing, detecting & misstatements at Risk of Material Misstatement - RMM, evidences needed correcting material misstatements assertion level Cost-benefit theory MM Many alternatives to produce evidence: select one with the least cost 2) Based on their nature MM No alternative: cost & general inconvenience are ignored MA INQUIRY - most used; not that reliable procedure 2) Appropriate - quality of evidence BA OBSERVATION - of the process & people doing the process CONSIDERATIONS Reliability BA ANALYTICAL PROCEDURES Source - consider independence & qualification of source - test of reasonableness BA Nature - consider if internal controls are effective - examines trends relationships, ratios, etc BA Relevance - if relevant/useful to audit BA INSPECTION - of assets thru “touring” (exc: goodwill recalculation) USING THE INFO PRODUCED BY ENTITY AS EVIDENCE - records & documents thru directional testing: 1) Produced by entity a. Vouching b. Tracing - obtain evidence first about accuracy & completeness of such info - from records to documents - from documents to records 2) Produced by management’s expert - test of validity - technique: T-C-U-P-S - evaluate competence, capability & objectivity of expert - technique: O-V-E-R Tracing - evaluate the appropriateness of expert’s work also Overstatements Completeness assertion IF ENGAGED BY ENTITY: inspect their agreement Vouching or Validity test Understatements IF EMPLOYED BY ENTITY: make inquiry to expert & mgmt members Existence assertion Pre-numbering of documents Records Documents Supporting docu Records BA RECALCULATION - for mathematical accuracy (including goodwill) BA REPERFORMANCE - independent execution of auditor of a process BA WALKTHROUGH - testing of internal controls by “walking through” from the start up to the end of the control system  INTERNAL CONTROL CONSIDERATION OTHER TYPES OF CONTROLS d. Performing a transaction WALKTHROUGH a. Preventive Controls - segregation of incompatible duties - to verify/confirm auditor’s understanding INTERNAL CONTROLS: policies or procedures to help (CARE functions) of entity’ control system and to determine meet company’s objectives b. Detective Controls - bank reconciliations, trial balances, whether controls are being implemented IT error logs, etc as documented RELIABLE EFFECTIVE & EFFICIENT COMPLIANT c. Corrective Controls - backup copies of IT transactions - should be done EVERY YEAR financial reporting operations to laws & regulations 5) Monitoring of controls - auditor who prepared the flowchart or any documentation should be the one to (relevant to FS audit) (relevant only if they affect FS) - process to assess effectiveness of internal control do the walkthrough performance over time e. Identify controls that are potentially reliable COMPONENTS CRIME - necessary as internal control systems change over time and its relevance may lessen and might not be able REQUIRED UNDERSTANDING 1) Control Environment - foundation for all other components of internal controls to address new risks As to control environment MM - attitude, awareness and actions or the over-all culture made by ACTIVITIES Mgmt has created & maintained those responsible for internal controls: management & TCWG a. Ongoing monitoring activities a culture of honesty & ethical behavior ELEMENTS IM CPA HO - often done to those normal recurring activities which Strengths in control environment elements include regular management & supervisory activities collectively provide an appropriate MM Integrity & ethical values followed foundation for other control components Management’s philosophy & operating style b. Separate Evaluations Other components are not undermined by MM Commitment to competence - activities performed on a non-routine basis by: