Auditing
A Risk-Based Approach To Conducting A Quality Audit
10th edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 5
PROFESSIONAL AUDITING STANDARDS AND THE AUDIT
OPINION FORMULATION PROCESS
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVES
1.
2.
3.
4.
Identify and compare the auditing standards that
provide guidance on the audit opinion formulation
process
List and discuss the foundational principles
underlying the auditing standards
List the phases and related activities in the audit
opinion formulation process
Explain the concept of accounting cycles and
discuss their importance to the audit opinion
formulation process
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LEARNING OBJECTIVES
5.
6.
7.
8.
Describe the assertions that are inherent to the
financial statements and explain their importance
to the audit opinion formulation process
Define audit evidence and describe the purpose of
audit procedures used to obtain audit evidence
Discuss the importance of audit documentation and
provide examples
Discuss audit activities in Phase I of the audit
opinion formulation process
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LEARNING OBJECTIVES
9.
10.
11.
12.
Discuss audit activities in Phase II of the audit
opinion formulation process
Discuss audit activities in Phase III of the audit
opinion formulation process
Discuss audit activities in Phase IV of the audit
opinion formulation process
Discuss audit activities in Phase V of the audit
opinion formulation process
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LEARNING OBJECTIVE 1
IDENTIFY AND COMPARE THE AUDITING
STANDARDS THAT PROVIDE GUIDANCE ON THE
AUDIT OPINION FORMULATION PROCESS
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PROFESSIONAL AUDITING STANDARDS
• Auditors in the United States follow auditing
guidance issued by:
• American Institute of Certified Public Accountants
(AICPA)
• Public Company Accounting Oversight Board (PCAOB)
• International Auditing and Assurance Standards Board
(IAASB)
• Common objective - Provide assurance to public that
audits are conducted in a quality manner
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PROFESSIONAL AUDITING STANDARDS
• Auditing standards apply:
• To the auditor’s task of developing and communicating
an opinion on financial statements and, as part of an
integrated audit, on a client’s internal control over
financial reporting.
• Relevant auditing standards depend on:
• The nature of organization audited
• On the domicile of the organization
• On where its stock is publicly traded
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EXHIBIT 5.1 - COMPARISON OF U.S. AND
INTERNATIONAL AUDITING STANDARDS
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LEARNING OBJECTIVE 2
LIST AND DISCUSS THE FOUNDATIONAL
PRINCIPLES UNDERLYING THE AUDITING
STANDARDS
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PCAOB GUIDANCE - THE TEN
STANDARDS
• General standards are applicable to the auditor and
audit firm and provide guidance in selecting and
training its professionals to meet the public trust.
• Fieldwork standards are applicable to the conduct of
the audit
• Reporting standards are applicable to communicating
the auditor’s opinion
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AICPA GUIDANCE
• AICPA has developed seven fundamental principles
that govern audits. The principles are included in
four categories
• Purpose of an Audit and Premise upon Which an Audit
Is Conducted
• Responsibilities
• Performance
• Reporting
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LEARNING OBJECTIVE 3
LIST THE PHASES AND RELATED ACTIVITIES IN
THE AUDIT OPINION FORMULATION PROCESS
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EXHIBIT 5.3 - ACTIVITIES OF EACH PHASE OF THE
AUDIT OPINION FORMULATION PROCESS
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IMPORTANT CONCEPTS PERVASIVE
THROUGHOUT THE AUDIT OPINION
FORMULATION PROCESS
• Accounting cycles
• Management assertions
• Audit evidence and audit procedures
• Documentation
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LEARNING OBJECTIVE 4
EXPLAIN THE CONCEPT OF ACCOUNTING
CYCLES AND DISCUSS THEIR IMPORTANCE TO
THE AUDIT OPINION FORMULATION PROCESS
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ACCOUNTING CYCLES
• Similar transactions that are linked by procedures
and controls and that affect related accounts
• Convenient way to break the audit up into
manageable sections of related accounts
• Individual auditors or teams of auditors are typically
assigned to audit a particular accounting cycle
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ACCOUNTING CYCLES
• Auditor focuses on:
• Flow of transactions within a particular cycle
• Identifying:
• Points where material misstatement can occur
• Controls that have been designed and implemented to
mitigate those risks
• Understanding risks and controls within each cycle
• Helps determine specific audit procedures to be used and
specific audit evidence to be obtained
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LEARNING OBJECTIVE 5
DESCRIBE THE ASSERTIONS THAT ARE INHERENT TO
THE FINANCIAL STATEMENTS AND EXPLAIN THEIR
IMPORTANCE TO THE AUDIT OPINION
FORMULATION PROCESS
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MANAGEMENT’S FINANCIAL STATEMENT
ASSERTIONS IN PCAOB STANDARDS
Existence or Occurrence
• Refers to existence of assets and liabilities
• Refers to occurrence of recorded transactions
Completeness
• Refers to inclusion of all transactions and accounts in financial statements
Valuation or Allocation
• Refers to inclusion of accounts in financial statements at appropriate
amounts
Rights and Obligations
• Refers to assets being the rights of an organization
• Refers to liabilities being the obligations of an organization
Presentation and Disclosure
• Refers to components of financial statement being properly classified,
described, and disclosed
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LEARNING OBJECTIVE 6
DEFINE AUDIT EVIDENCE AND DESCRIBE THE
PURPOSE OF AUDIT PROCEDURES USED TO
OBTAIN AUDIT EVIDENCE
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AUDIT EVIDENCE AND PROCEDURES
• Audit evidence: Information used by auditor in
arriving at conclusions on which the opinion is based
• Audit procedures: Procedures designed to obtain
audit evidence to support audit opinion(s)
• Sufficient appropriate audit evidence: Measure of the
quantity and quality of audit evidence
• Audit program
• Lists audit procedures to be followed in gathering
evidence
• Helps monitor progress and supervising work
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CATEGORIES OF AUDIT PROCEDURES
• Risk assessment procedures: Provide information for
assessing the risks of material misstatement in the
financial statements
• Used for purposes of planning the audit
• Tests of controls: Designed for evaluating operating
effectiveness of controls
• Substantive procedures: Designed for detecting
material misstatements at assertion level
• Comprising of tests of details and substantive
analytical procedures
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LEARNING OBJECTIVE 7
DISCUSS THE IMPORTANCE OF AUDIT
DOCUMENTATION AND PROVIDE EXAMPLES
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AUDIT DOCUMENTATION
• Record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor
reached
• Known as working papers or workpapers
• Examples include:
•
•
•
•
•
Audit programs
Analyses prepared by client or auditor
Memorandums
Summaries of significant findings or issues
Letters of confirmation and representation
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PURPOSES OF AUDIT
DOCUMENTATION
• Assisting engagement team in:
• Planning and performing audit
• Supervising and reviewing audit work
• Retaining a record of matters of continuing
significance to future audits
• Enabling internal or external inspections of
completed audits
• Assisting auditors in understanding work performed
in prior year
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LEARNING OBJECTIVE 8
DISCUSS AUDIT ACTIVITIES IN PHASE I OF THE
AUDIT OPINION FORMULATION PROCESS
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PHASE I - MAKING CLIENT ACCEPTANCE
AND CONTINUANCE DECISIONS
• Preconditions for accepting auditing engagements
• Use of an acceptable financial reporting framework
• Agreement of management to acknowledge and
understand its responsibilities
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LEARNING OBJECTIVE 9
DISCUSS AUDIT ACTIVITIES IN PHASE II OF THE
AUDIT OPINION FORMULATION PROCESS
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PHASE II - PERFORMING RISK
ASSESSMENT
• Identifying and assessing risks of material
misstatement
• Requires identification of significant accounts,
disclosures, relevant assertions
• Auditor establishes a materiality level overall and for
specific accounts and disclosures
• Responding to identified risks
• Determining audit procedures required to address
them
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RISK ASSESSMENTS - ASSERTION LEVEL
• Inherent risk
• Susceptibility of an assertion about a class of transaction, account
balance or disclosure to a misstatement that could be material, either
individually or when aggregated with other misstatements, before
consideration of any related controls
• Control risk
• 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 organization’s internal control
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CONTROL RISK ASSESSMENT
• Focuses on design effectiveness and implementation
• High control risk
• Weak or ineffective internal controls
• Auditor cannot rely on controls to reduce substantive
procedures for account balances
• Low control risk
• Effective internal controls
• Auditor will test operating effectiveness of controls to
reduce substantive procedures for account balances
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RESPONDING TO IDENTIFIED RISKS OF
MATERIAL MISSTATEMENT
• Purpose of risk assessment procedures
• Identify risks of material misstatement
• Determine where misstatements in financial
statements may occur
• Design appropriate audit strategy
• Controls reliance audit: Includes tests of controls
and substantive procedures
• Substantive audit: Includes substantive procedures
and does not include tests of controls
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LEARNING OBJECTIVE 10
DISCUSS AUDIT ACTIVITIES IN PHASE III OF THE
AUDIT OPINION FORMULATION PROCESS
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PHASE III - OBTAINING EVIDENCE ABOUT
INTERNAL CONTROL OPERATING EFFECTIVENESS
• Auditor tests controls to determine whether controls
are operating effectively
• At year-end (for opinion on internal control
effectiveness)
• Throughout the year (for the financial statement audit)
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SELECTING CONTROLS TO TEST
• Involves choosing controls that effectively indicate
capability to address the assessed risk of material
misstatement for relevant assertions
• Includes controls in all five COSO components
• Types of tests of controls
•
•
•
•
Inquiry
Observation
Inspection of relevant documentation
Reperformance of a control
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IMPACT OF TESTS OF CONTROLS FOR
FINANCIAL STATEMENT AUDIT
• If control deficiencies are identified
• Assess them to determine whether preliminary control
risk assessment should be modified
• Record the implications for substantive procedures
• If no control deficiencies are identified
• Assess whether preliminary control risk assessment is still
appropriate
• Determine extent that controls can provide evidence on
accuracy of account balances
• Determine planned substantive audit procedures
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IMPACT OF TESTS OF CONTROLS FOR
FINANCIAL STATEMENT AUDIT
• Determine how much assurance about reliability of
account balances can be obtained from the effective
operation of controls
• Within any audit, level of assurance will vary across:
• Accounts
• Disclosures
• Assertions
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LEARNING OBJECTIVE 11
DISCUSS AUDIT ACTIVITIES IN PHASE IV OF THE
AUDIT OPINION FORMULATION PROCESS
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PHASE IV - OBTAINING SUBSTANTIVE EVIDENCE ABOUT
ACCOUNTS, DISCLOSURES, AND ASSERTIONS
• Substantive procedures include:
• Substantive analytical procedures
• Tests of details of account balances
• Considerations in determining appropriate
substantive procedures:
• Source of potential misstatement
• Extent and type of potential misstatement
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LEARNING OBJECTIVE 12
DISCUSS AUDIT ACTIVITIES IN PHASE V OF THE
AUDIT OPINION FORMULATION PROCESS
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PHASE V - COMPLETING THE AUDIT
AND MAKING REPORTING DECISIONS
• Completing various review and communication
activities
• Making a decision about what types of opinions
should be issued
• Deciding on the appropriate opinion to be issued
• It can be based on financial statements and internal
control
• It can be issued in one report or in two separate
reports
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