chapter 8
audit planning
analytical procedures
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Problems with lowest scores
#13
#28
#14
#3
0.70
2.43
2.68
3.19
key positions
if CR = low then Extensive ToC
Tort the plaintiff must prove
calc CV and evaluate results
2
• ≤ 5% is not immaterial (you weren’t bad)
• Use words of the profession
– Covered member
– Immediate family or close relative
• Foreseeable Parties is not everyone
– 3rd party investors
• If CR – low
we Test Controls extensively
• Definition of Audit Risk
3
• Some of you memorized scenarios
– Answer the question that was asked
– YOU WERE BETTER THAN PAST CLASSES
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Enron
Related Party Transactions
No one could explain how Enron actually made money
Incredibly complicated business structure
“What we are looking at here is an example of
superbly complex financial reports. They didn’t have
to lie. All they had to do was to obfuscate it with
sheer complexity,”
John Dingell, U.S. Congressman Michigan
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Obtain engagement
Analytical procedures
Understand the client
Internal controls
AU-c 315
Assess RoMM
Tests of controls if RoMM < 1.00
Substantive tests of transactions AU-c 500
Substantive Analytical procedures
Substantive tests of details of balances
Reporting
AU-c 700
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DR
IR
RoMM
CR
AAR =
auditor
client
environmental
balances
transactions
tests of details of balances
substantive analytical procedures
substantive tests of transactions
tests of controls
analytical procedures (planning)
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Sam
What is the definition of audit risk?
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AU-C Section 200
The risk that the auditor expresses an
inappropriate audit opinion when the
financial statements are materially
misstated.
Audit risk is a function of the Risk of Material
Misstatement and Detection Risk
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Jake S
What is the definition of control risk?
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The risk that a misstatement that could
occur in an assertion about a class of
transaction, account balance, or disclosure
and that could be material, either individually or
when aggregated with other misstatements, will not
be prevented, or detected and corrected,
on a timely basis by the entity’s internal
control.
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Stages of the Audit
Accepting the engagement
client acceptance
1) integrity of management
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Client Acceptance
page 79-80
• Why the client needs an audit
• New client investigation
• Competency, industry knowledge
• Communicate with predecessor auditor
• Risks
– Intended users of the financial statements
• Independence
• Engagement Letter
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Statement
on Auditing
Standards
February 1997
84
AICPA
Communications
between Predecessor and
Successor Auditors
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Janet
what issues need to be discussed with
the predecessor auditor ?
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Communications with
Predecessor Auditor
•
•
•
•
Integrity of senior management
Disputes with the client over accounting principles
Disputes with the client over audit procedures
Disputes with the client over fees
page 80
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Vivian
who is responsible for initiating the
communication between the successor
auditor and the predecessor auditor ?
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AICPA Code of Professional Conduct
1.300.001 – Confidential Client Information
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Bryce
Do we care about the nature of the client’s
business?
Do we care about the reasons they are
having their financial statements audited?
Do we care who is going to rely on the
audited financial statements?
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RISK
RISK RISK
identify the users of the financial statements
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Ashley
How does the AICPA’s Code of
Professional Conduct define the Ethical
Principle “Objectivity and Independence?”
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Objectivity and Independence
A member should maintain objectivity and
be free of conflicts of interest in
discharging professional responsibilities.
A member in public practice should be
independent in fact and appearance when
providing auditing and other attest
services.
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Julia
Does this effect our decision whether to
accept the engagement ?
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Tim
When an accounting firm considers a
new client, “who” which employees of
the accounting firm need to be
independent?
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independence
memo to partners and staff
Partners in the engagement office?
Everyone in the engagement office?
Everyone in the firm?
Consulting and tax employees or just
auditors
must consider spouses & dependents
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Romy
How might the financial investments
of non-dependent, close relatives affect
the firm’s decision whether to accept a
new client ?
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Christina
If a non-dependent, close relative is
employed by a potential client, what
issues does the audit firm need to
consider in their decision whether to
accept the client?
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Covered Members
Close relatives (including immediate family):
parent, sibling or nondependent child, spouse, dependents
Holding a key position with the client
Holding a financial interest in the client that is material to the
relative (covered member must know)
Holding a financial interest that enables the relative to exercise
significant influence over the client
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Key positions
Individual has primary responsibility for
– significant accounting functions that
support material components of the
financial statements
– preparation of the financial statements
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Key positions
Individual has the ability to influence contents
– Board of Directors
– Chief Executive Officer
– President
– Chief “xxxxx” Officer
– General Counsel
– Controller
– Director of Internal Audit
– Director of Financial Reporting
– Treasurer
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How do we identify these Key Positions
When we obtain an understanding of the IC
– positions subject to significant internal
accounting controls
– positions that are an element of significant
internal accounting controls
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Phases of the Audit
Engagement Letter
Accepting the engagement
page 82
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Understand the Client’s Business
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Jake M
what is the objective of AU-c 315?
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AU-C Section 315
The objective of the auditor is to identify and
assess the risk of material misstatement,
whether due to fraud or error, at the financial
statement and relevant assertion levels
through understanding the entity and its
environment, including the entity’s internal
control, thereby providing a basis for
designing and implementing responses to the
assessed risk of material misstatement.
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Many litigation cases result from the auditor’s
failure to fully understand the nature of
transactions in the client’s industry.
ZZZZ Best
ESM
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RISK of Material Misstatement
Declines in economic conditions
Information technology
Expansion
Accounting COMPLEXITY of JUDGMENTS
Accounting COMPLEXITY of ESTIMATES
COMPLEX financial instruments
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Christine
how does the Auditor’s Responsibility
Paragraph in the independent auditor’s report
describe the auditor’s responsibility to detect
material misstatements?
Does the auditor’s responsibility differ for
misstatements that are the result of an error
or a fraud?
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Auditor’s Responsibility Paragraph
standard unmodified opinion
Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits in
accordance with auditing standards generally accepted in the United
Those standards require that we
plan and perform the audit to obtain
reasonable assurance about whether
the financial statements are free of
material misstatement.
States.
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Loren
what is the overall objective of the
indepent auditor?
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Overall Objective
AU-C 200
…obtain reasonable assurance about whether
the financial statements as a whole are free
of material misstatement, whether due to
fraud or error, thereby enabling the auditor to
express an opinion on whether the financial
statements are presented fairly, in accordance with
an applicable financial reporting framework.
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Related Parties --- RISK
p. 86
.. an affiliated company, principal owner of the client
company, or any other party with which the client
deals, where one of the parties can influence the
management or operating policies of the other.
investors are concerned that the terms of the
transaction may not reflect “arms length” bargaining.
There is risk that the transaction may not be valued
at the same amount as a transaction with a nonrelated party.
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Related Parties --- RISK
Enron
p 77 Enron
- Andy Fastow
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Related Parties --- RISK
Essentially a related party is one that can
exert significant influence over another party.
Related parties are frequently involved in
fraudulent transactions because they can
conceal problems that the auditor would likely
detect if the transactions occurred between
unrelated parties.
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45
RELATED PARTIES
Sources:
SECTION R36
ARB 43, Chapter 1A; FASB Statement 57; FASB Statement 109
Summary
Financial statements shall include disclosures of
material related party transactions, other than compensation arrangements, expense
allowances, and other similar items in the ordinary course of business. The nature of certain common
control relationships shall be disclosed if the nature of those relationships could significantly affect the
reporting enterprise. The reporting of certain related party transactions is specified in other sections.
-------------------Introduction
a parent
company and its subsidiaries; (b) subsidiaries of a common parent;
(c) an enterprise and trusts for the benefit of employees, such as pension
.101
Examples of transactions between related parties include transactions between (a)
and profit-sharing trusts that are managed by or under the trusteeship of the enterprise's management; (d)
an enterprise
and its principal owners, management, or members of
their immediate families; and (e)affiliates. Transactions between related parties commonly
occur in the normal course of business. Some examples of common types of transactions with related
parties are: sales, purchases, and transfers of realty and personal property; services received or furnished,
for example, accounting, management, engineering, and legal services; use of property and equipment by
lease or otherwise; borrowings and lendings; guarantees; maintenance of bank balances as compensating
balances for the benefit of another; intercompany billings based on allocations of common costs; and
filings of consolidated tax returns. Transactions between related parties are considered to be related party
transactions even though they may not be given accounting recognition. For example, an enterprise may
receive services from a related party without charge and not record receipt of the services. [FAS57, 1]
Disclosures
Financial statements shall include disclosures of material
related party
.102
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AU Section 334
Related Parties
(Supersedes Statement on Auditing Standards No. 6, AICPA, Professional Standards,
vol. 1, AU sec. 335.01ÄÄ.19)
Source: SAS No. 45.
See section 9334 for interpretations of this section.
Effective for periods ended after September 30, 1983, unless otherwise indicated.
.01 This section provides guidance on procedures that should be considered by the
auditor when he is performing an audit of financial statements in accordance with
generally accepted auditing standards to identify related party
relationships and transactions and to satisfy himself
concerning the required financial statement accounting and
disclosure. The procedures set forth in this section should not be
considered all-inclusive. Also, not all of them may be required in every audit.
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Aleksandr
what is Client Business Risk?
49
Box at the Bottom of PAGE 89
increased emphasis on
how the client manages risk
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Analytical Procedures
Pages 93-102
Look at Figure 6 on page 94
Go to links on web page
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Analytical Procedures
Reasonableness tests
evaluations of financial information by a
study of plausible relationships among
financial and nonfinancial data …
….involving comparisons of recorded
amounts … to expectations developed
by the auditor.
58
Madyson
at which stages of the audit are
Analytical Procedures required ?
59
Analytical Procedures
planning phase
• testing phase (as substantive tests)
completion phase (as an overall
review)
60
Fiona
why do we perform analytical
procedures during the planning stage ?
61
Analytical Procedures
During the Planning Phase
Understand the client’s business & industry
Assess going concern
Indicate possible misstatements (attention directing)
Reduce detailed tests
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Steps in performing Analytical Procedures
Develop expectations
Define significant difference (what is reasonable)
Compare our predictions with recorded
amount
Investigate Significant differences
DOCUMENT the above steps
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