Chapter 5 – Preliminary Audit Planning: Understanding theAuditee’s Business
Overview of the Financial StatementAudit Process
• The overall objectives of a financial statement auditor are:
To obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion.
To report on the financial statements, and communicate as required by CAS/ISAs, in
accordance with the auditor’s findings.
• The CAS set out additional dimensions required to complete the audit that complies with GAAS
Communications among audit team members throughout the process.
Documentation of the audit decisions and findings.
Revisions to risk assessments and planned responses if appropriate due to knowledge
obtained during the audit process.
Communications with those charged with the auditee’s governance and management.
IndependentAudit Engagement Characteristics
• Those charged with governance – Person(s) or organization(s) with responsibility for overseeing
the strategic directions of the entity and obligations related to the accountability overseeing the
financial reporting process.
Ex: management, board of directors, sole shareholder
Audit EngagementAcceptance Decision
Risk management and Quality management before taking on a client for audit:
• Pre-EngagementActivities – Whether to undertake the audit engagement at all.
Pre-Audit risk management activities – Procedures performed before accepting an audit
engagement to ensure the client and the engagement do not pose an unacceptably high risk
of audit failure.
• Auditor’s risk from taking the engagement:
Damage to professional reputation, getting sued, or financial loss.
• Quality management must also be monitored on individual engagements. The objective of the
FIRM is to establish and maintain a system of quality control to provide it with reasonable
The firm and its personnel comply with professional standards and applicable
legal/regulatory requirements, and
Reports issued by the firm partners are appropriate in the circumstances.
The objective of theAUDITOR is to implement quality control procedures at the engagement level that provide the auditor with reasonable assurance that:
The audit complies with professional standards and applicable legal/regulatory
The auditor’s report issued is appropriate in the circumstances.
Audit EngagementAcceptance and Continuance
• Auditors are not obligated to accept undesirable clients, nor retain existing audit clients.
Acceptance and continuance decisions involve the following policies and procedures:
1. Obtain and review financial information about the prospective auditee organization to determine
the purpose and main users of the f/s and the basis of accounting being used.
2. Evaluate the accounting firm and individual auditor’s independence and compliance.
3. Evaluate whether the accounting firm has the competence and resources for the audit.
4. Obtain information in order to understand the business and its risks and determine management’s
willingness to accept responsibility.
5. Consider whether the engagement requires special attention or involves unusual risks.
6. Search for information about the management’s integrity through new reports, bankers, legal
7. For new audits, communicate with the previous auditor.
The auditor considers:
• Whether the financial statements presented in accordance with GAAP.
• Whether management understands its responsibility for preparing the financial statements, and for
designing and implementing adequate internal controls
• Management’s commitment to providing written representations or other scope limitations
Communication between Predecessor and SuccessorAuditors
• Predecessor – The previous auditor.
• Successor – New auditor taking over.
• Former auditor can provide information on:
Whether to accept the new audit, and how to plan the new audit if accepted.
• Predecessor must obtain permission from the organization to discuss these details with the new
auditor beforehand. (confidentiality)
If the organization refuses, it is TOO RISKY to accept the engagement.
Risk from Accepting an Audit Engagement
Key Factors to consider:
• How widely distributed are the audited financial statements?
If widely distributed, (reputation) risk is higher.
• How strong is the financial condition of the auditee?
If condition is poor, (legal liability) risk is higher because financial failure can cause
lawsuits/investor losses.Also risk of not collecting payment.
• How trustworthy is auditee management?
If you doubt management’s integrity, (misstated financial reporting) risk is higher.
• How complex is the financial reporting required?
Complicated/unusual accounting requirements means a higher (misstated financial
• How knowledgeable are the people likely to be using the financial statements?
If the users are naïve and entirely dependent on the f/s there is a higher (legal liability) risk. Engagement Letters
When a new audit is accepted, the auditor must obtain an engagement letter.
• Engagement Letter – Sets forth terms of the engagement including an agreement about the fee,
when a new audit client is accepted. (reduces auditor’s risk)
• For continuing audits, the auditor confirms the terms of the engagement annually, in writing.
Staff Assignment and Time Budgets
• InterimAudit work – Covers procedures performed several weeks or months before the balance
• Year-End Audit Work –Audit procedure performed at end shortly after the balance sheet date.
Understanding the Business and Its Environment and Risks
• Understanding the client’s business and operating environment is very important in an audit.
It helps to assess the risk that financial statements might contain material misstatements.
Used to establish and overall audit strategy, design the audit plan and audit programs.
• OverallAudit Strategy –An audit planning document that sets the scope, timing and direction of
the audit, and that guides the development of the audit plan, including:
Extent of resources necessary
To perform the engagement.
• Audit Plan – Document containing all the detailed auditing programs with procedure to be
performed in response to the assessed risk of material, misstatement on an audit, guided by the