CHAPTER 4: THE AUDIT PROCESS– ACCEPTING AN ENGAGEMENT
Audit of FS heoretically begins with FS prepared by the management
T
In reality begins with TB
General Approach to Auditing FS
1. FS Assertions (PRECV) FS Assertions (PRECV)
.
a resentation and Disclosure
P ● In representing that FS are in accordance with applicable
b. Rights and Obligations framework, management explicitly and implicitly makes
c. Existence or Occurence assertions
d. Completeness ● Auditor uses this assertions to consider different types of
e. Valuation and Allocation
potential misstatements that may occur in FS
. A
2 udit Procedures
3. Audit Evidence
1. Presentation and Disclosure(Test: Application ofrelevant
4. Audit Opinion accounting standards)
● A ssets/liabilities are properly classified and
disclosures are adequate
● Auditor may review major contracts (loan
agreements) to identify important info that needs to
be disclosed
2. Rights and Obligations(Test: Examining ownershipdocuments)
● Entity has right over assets and it has valid
obligation to settle liabilities
. Existence or Occurrence(Test: Physical examinationor ocular
3
inspection, if former not feasible = external confirmation)
● A
ssets/liabilities = exists as of the FS date ;
Revenues/expense = occurred during the reporting
period
4. C
ompleteness(Test: Start with source documents todetermine
if it is recorded in the sales journal)
● All items should be reported in FS are included
5. Valuation and Allocation(Test: Recalculation of FSvalues)
● Assets/liabilities = properly valued ;
● Revenue/expense = properly measured
xistence and Completeness = Opposite audit concerns
E
Existence = concerned w/ potential overstatement EVRO
a. Tracing Backward or Vouching(test for overstatement)
○ When auditor works from accounting records back
to source documents = Auditor is obtaining
evidence that the recorded items exist and are
supported by documents
Completeness = concerned w/ potential understatement
a. Tracing Forward(test for understatement)
○ When auditor traces items from source documents
to the accounting records = Auditor is obtaining
evidence that all transactions have been
completely recorded
Audit Procedures
● To accomplish the objective of audit = Auditors develop
specific audit objectives for each relevant assertions
● Audit objectives: a guide in assessing the risks and in
designing appropriate audit procedures
● C riterion: Procedures selected should enable the audit to
gather sufficient appropriate evidence about the validity of
an assertion
Common audit procedures to gather sufficient appropriate evidence
1. Inspection- examining
2. Observation- looking at a process
3. Inquiry- seeking info from knowledgeable person
4. Confirmation- response to an inquiry to corroborate info
5. Computation- checking arithmetical accuracy of source
documents
6. Analytical Procedures- analysis of significant ratios and
trends including the resulting investigation of fluctuations
and relationship that are inconsistent or deviated
udit Evidence
A
Audit procedure = Means to obtain sufficient appropriate evidence
Audit evidence
● Info obtained by the auditor in arriving at a conclusion on
which the opinion is based
● Comprise of source documents and accounting records
● Will either prove or disprove the validity of assertion
udit Opinion
A
Results of the procedures and evidence obtained are carefully
evaluated to arrive at appropriate opinion
Audit Process
Audit Process Sequence of different activities involved in an audit
●
● Its emphasis and order may vary
F
● irst step is to make a decision whether to accept or reject
● Requires evaluation of the auditor’s qualification and
auditability of the client’s FS
● Preliminary understanding of the client’s business and
1. A
ccepting an background investigation of a client
Engagement
Procedure: Preliminary Planning Activities
Steps in Audit a. Continuance of the client relationship
Process b. Compliance with ethical requirements
c. Terms of the engagement
● T he auditor obtains more detailed knowledge about the
client’s business and industry. This helps in understanding
2. Audit Planning the transactions and events affecting the FS and early
identification of potential problems
● Auditor’s understanding + Assessment of risk and materiality
= Develop an overall audit plan and detailed approach
C
● ondition of internal control affects the reliability of FS
● Considerations:
1. Obtaining understanding of the internal control
system
3. C
onsidering Internal 2. Assessing the level of control risk(the risk thatthe
Control internal control may not prevent or detect material
misstatement)
est of controls- used to obtain evidence to prove effective and
T
reliable internal control resulting to control to be less than high level
ubstantive Test- audit procedures designed to detect material
S
misstatements
4. P
erforming
Substantive Test ● N ature, timing and extent of this test are highly dependent
on the results of internal control
● If internal control is functioning effectively = Scope of
substantive test can be reduced. Vice versa
● A uditor must have a sufficient appropriate evidence to reach
a conclusion on the fairness of FS
● Additional audits must be performed to complete the audit
and be satisfied that the evidence is consistent with the
opinion
5. C
ompleting the Common Procedures:
Audit 1. Review of subsequent events and contingency
2. Assessing the appropriateness of the use of going concern
assumption
3. Performing overall analytical review procedures
4. Obtaining written representation from the management
6. Issuing a Report Audit report- conclusion communicated to various interested users
Preliminary Planning
Accepting an Engagement
In making decision whether to Competence
accept/reject an engagement, the firm ● If the auditor has necessary skills and competence to handle
should consider: engagement
.
1 ompetence
C ● According to Code of Ethics, auditors should not portray themselves
2. Independence as having expertise which they do not possess
3. Ability to serve client properly ● Acquired through combination of education, training and expertise
4. Integrity of the client’s management
5. Adequacy of the accounting records
Independence
● Essential to the credibility of the auditor’s report
● Before accepting, auditor should consider if there are threats to the
audit team’s independence and if so, adequate safeguards can be
established
Ability to serve client properly
● Closely related to competence
● E ngagement should not be accepted if there are no enough qualified
personnel
● There should be a sufficiency direction, supervision and review of work
at all levels
Integrity of the client’s management
● The recent wave of litigation involving auditors has made
preacceptance investigation procedures very important
● PSA 220 requires background investigation to client to minimize
association with clients whose management lacks integrity
This would involve:
1. Making inquiries of appropriate parties in the business community
2. Communicating with the predecessor auditor (allows the successor
auditor to obtain info about the client)
a. His understanding as to the reason of change of auditors
b. Any disagreement between the predecessor and the client
c. Any facts that have bearing on the integrity of client’s
management
Adequacy of the accounting records
● Audit is performed on the assumption that FS are verifiable
● Inadequacy is sufficient reason to decline the engagement
Retention of Existing Clients
Evaluation of client is not a 1-time consideration as they should be evaluated once a year upon occurrence of major events
Additionals
Engagement Letter: A written contract that recordsthe agreed terms between client and auditor
Non-negotiables:
a. Objective of audit
b. Management’s responsibility for the fair presentation of FS
c. Scope of audit
d. Forms/reports that the auditor expects to issue
e. The fact that because of limitations, there is an unavoidable risk that material misstatement may
remain undiscovered
f. Responsibility of the client to allow auditor to have unrestricted access to records or other info
requested for audit
Negotiables(may or may not)
a. Billing arrangements
b. Expectations of receiving management representation letter
c. Arrangements concerning the involvement of others
d. Request for the client to confirm the terms of engagement
Importance
1. Avoid misunderstandings
2. Document and confirm the auditor's acceptance of the appointment
Recurring Audits- auditor does not normally send newengagement letter every year
Factors that may cause auditors to send new engagement letter:
a. Indication that the client misunderstands the objective and scope of audit
b. Revised or special terms of the engagement
c. Recent change of senior management, BOD or ownership
d. Significant change in the nature/size of client’s business
e. Legal requirements and other government agencies pronouncements
If there’s no new letter = Auditor should remind the client of the original terms and their responsibilities
udits of Components- when the auditor of a parentis also the auditor of its subsidiary, the auditor should
A
consider whether to send a separate letter to a component:
a. Who appoints the auditor of component
b. Whether a separate audit report is to be issued to a component
c. Legal requirements
d. Extent of any work performed by the auditor
e. Degree of ownership by parent
f. Degree of independence of the component’s management