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RSM323 Audit I Textbook Ch 6

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Rotman Commerce
Vicki Zhang

RSM323 Chapter 6 - Preliminary Auditing Planning: Understanding the Auditee  Learning Objectives o Describe the activities PAs undertake before beginning a financial statement audit engagement. o Explain why auditors need knowledge of the client’s business, its environment, and the client’s risks at the start of a financial statement audit. o Explain the purpose of preliminary analytical procedures and business risk analysis in the audit planning process. o Apply preliminary analytical procedures to management’s draft financial statements in order to identify areas where misstatements are most likely. o Learning Objectives o Explain the materiality concept, the materiality levels used for planning the audit and how these amounts are determined. o Describe the principal assertions in management’s financial statements and their application in establishing audit objectives. o Explain how the preliminary planning activities are integrated in the overall audit strategy.  Chapter Overview o Pre-engagement Arrangements o Preliminary Understanding of Auditee’s Business, Environment and Risks o Preliminary Analytical Procedures for Audit Planning o Applying Analytical Procedures to Management’s Draft Financial Statements o Materiality Levels for Audit Planning o Financial Statement Assertions and Audit Objectives o Developing the Overall Audit Strategy  Pre-engagement Arrangements o Auditors undertake two types of activities before beginning an audit:  Risk management:  Auditors try to reduce the risk (probability of something going wrong) by carefully managing the engagement.  Quality management:  Auditors manage audit in accordance with quality control standards.  Audit Engagement Acceptance and Continuance o Client selection and retention:  An important element of an accounting firm’s quality control policies and procedures is a system for deciding:  to accept a new client, and  whether to resign from audit engagements.  Accounting firms are not obligated to accept undesirable clients, nor retain existing audit clients.  Client Acceptance and Retention Policies o Client acceptance and retention procedures should include:  Obtaining and reviewing financial information about prospective client.  Evaluation of independence.  Evaluation of competency and resources  Understand business risks and determine management’s willingness to accept responsibility for financial statements  Look for news reports, consult with auditee’s banker, legal counsel or others to assess integrity of management  Communicate with previous auditor.  Determining Auditability o 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  Auditee Retention o Decisions to continue auditing an organization are similar to acceptance decisions.  The public accounting will have more first-hand experience with the auditee.  Annual retention reviews take into account changes for the auditee.  Communication Between Predecessor and Successor Auditors o When companies change auditors, the former auditor is the predecessor auditor, and the new auditor is the successor auditor. o Rules of professional conduct require the successor auditor to contact the predecessor auditor.  Ask if there are issues that should be considered in accepting the client.  Obtain information from the predecessor auditor for planning the audit. o Predecessor auditor is required by the rules of conduct to respond to the communication. o Successor auditor should ask the client to consent to discussions with the predecessor auditor.  Consent is not required, the communication must take place.  Consent allows the predecessor auditor to relay more information.  Predecessor auditor still has a duty to maintain confidentiality.  Audit files belong to the auditor, not the client. o Auditor should be wary of any client who refuses consent.  Engagement Letters o When a new audit client is accepted an engagement letter must be obtained.  The engagement letter forms the contract for the audit.  Standards require the auditor and management to agree on the terms of the audit engagement. o A new engagement letter should be obtained every year of a continuing audit.  Staff Assignment o When the new client is obtained, accounting firms assign a full-service team to the new client.  Engagement partner  Audit manager  One or more senior audit staff members  Staff assistants  Specialists  A tax partner, a consulting services partner and a second audit partner o For a small firm or client, audit team may be just one or two people. o The partner or manager propose a plan for the timing of the work based on previous experience and knowledge of the business. o The time budget allows the audit firm to spread its workload between interim and year-end periods. o Interim – weeks or months before the statement date. o Year-end – shortly before or after the statement date. o Everyone on the audit reports the time taken to perform the audit procedures. o Time reports are recorded by the time budget categories to all for:  evaluation of the efficiency of audit team members,  billing the client, and  planning the next audit of the client.  Preliminary Understanding of Auditee’s Business, Environment and Risks o Understanding the client’s business and operating environment is very important in an audit. o It helps to assess the risk that financial statements might contain material misstatements. o Used to establish and overall audit strategy, design the audit plan and audit programs.  Understanding the Client’s Business o In order to design an effective audit, auditors must understand the business and the economic environment of the business including factors such as:  national economic condition and policies,  geographic location,  developments in taxation and regulation, and  specific industry characteristics.  Analytical Procedures Requirements o Although particular analytical procedures are not required by audit standards, the timing of these procedures is specified:  at the beginning of the audit when planning is taking place, and  at the end of the audit when the partners in charge review the overall quality of the work and form an opinion.  General Analytical Procedures o Compare current-year account balances with one or more comparable periods. o Compare current-year account balances and financial relationships with similar information for the auditee’s industry. o Compare current-year account balances with the company’s anticipated results. o Evaluate the relationships of current-year balances to other current-year balances for conformity to predictable patterns. o Study the relationships of current-year balances to relevant nonfinancial information.  Preliminary Analytical Procedures o Analytica
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