Week 3
The ISA that deals with Audit Planning is “ISA 300: Planning an
Audit of Financial Statements”
Benefits of Audit Planning:
helping the auditor to devote appropriate attention to important
areas of the audit
helping the auditor to identify and resolve potential problems on
a timely basis
helping the auditor organize and manage the audit engagement
so that it is performed in an effective and efficient manner
assisting in the selection of staff with appropriate experience to
respond to anticipated risk and the proper assignment of work to
them
allowing for the direction and supervision of staff and review of their
work.
The Fall Of Enron: Did Anyone Understand Its Business?
The bankruptcy of Enron Corporation represents one of the biggest
corporate collapses in American history. Despite being listed as
number seven on the Fortune 500 list with a market capitalization of
$75 billion before its collapse, Enron’s meltdown was rapid. The fall
began in October 2001 when Enron officials reported a shocking
$618 million quarterly loss related to allegedly mysterious and
hidden related party partnerships with company insiders. Then, in
early November 2001, company officials were forced to admit that
they had falsely claimed almost $600 million in earnings dating back
to 1997, requiring the restatement of four years of audited financial
statements. By the end of 2001, the company was in bankruptcy.
Enron was created in 1985 out of a merger of two gas pipelines, and
was a pioneer in trading natural gas and electricity in the newly
deregulated utilities markets. In its earlier years, Enron made its
money from hard assets like pipelines. However, by the end of the
1990s, 80 percent of Enron’s earnings came from a more vague
business known as “wholesale energy operations and services.”
Enron had built new markets, such as in the trading of weather
securities. In early 2001, speculation about Enron’s business
dealings began to surface. One highly regarded investment banker
publicly stated that no one could explain how Enron actually made
money.
In the wake of the collapse, many wondered how these issues could
have gone undetected for so long. Many point to Enron’s incredibly
complicated business structure and related vague and confusing
financial statements. “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,” noted John
Dingell, U.S. Congressman from Michigan. Others even allege that
the men running the company never understood their business
concept because it was too complicated.
Apparently, the complexity and uncertainty surrounding Enron’s
business and financial statements fooled its auditors, too. Enron’s
auditor faced a flurry of attacks, class action lawsuits, and a criminal
indictment that ultimately led to the firm’s demise. In December
2001 congressional testimony, the audit firm’s CEO admitted that
the firm’s professional judgment “turned out to be wrong” and that
they mistakenly let Enron keep the related entities separate when
they should have been consolidated.
The Enron disaster continues to provide many lessons for the
auditing profession. One to be underscored for auditors is the
paramount importance of understanding the company’s business
and industry to identify significant business risks that increase the
risk of material misstatements in the financial statements. Without
that understanding, it will be almost impossible to identify the next
Enron.
Source: Based on Bethany McLean, “Why Enron Went Bust,”
Fortune, December 24, 2001, pp. 58–68.
PRINCIPAL ACTIVITIES DURING AUDIT:
Engagement Letter:
Having accepted an appointment as auditor of a client company, the
audit firm should submit an engagement letter to the board of
directors of the client company. The engagement letter can be seen
as the basis for the contract between the company and the auditor.
Main Contents of the engagement letter:
The engagement letter should include details of the following:
The objective and scope of the audit.
The responsibilities of the auditor.
The responsibilities of management.
Identification of the underlying financial reporting framework.
Reference to the expected form and content of any reports to be
issued.
Additional Contents:
In addition to the above, the auditor may feel that it is appropriate
to include additional points in the engagement letter, such as:
Arrangement regarding the planning and performing the audit
including the composition of an audit
Arrangement regarding involvement of internal auditor
Expectation that management will provide written representation
The fact that because of the inherent limitations of an audit, and
the inherent limitations of internal control, there is an
unavoidable risk that some material misstatements may not be
detected even though the audit was properly planned and
performed in accordance with ISAs
To inform the auditor about events occurred after the date of
auditor’s report
Any restriction of auditor’s liability
The expectation that management will provide access to all
information that is relevant to the preparation of the financial
statements and its disclosures
The agreement of management to make available to the auditor
draft financial statements, including all information relevant to
their preparation, whether obtained from within or outside of the
general and subsidiary ledgers (including all information relevant
to the preparation of disclosures), and the other information if
any, in time to allow the auditor to complete the audit in
accordance with the proposed timetable
The basis on which fees are computed and any billing
arrangements
A request for management to acknowledge receipt of the
engagement letter and to agree to its terms
A reference to any further agreements between the auditor and
the entity
Any obligations to provide audit working papers to other parties
Assignment 2 Engagement Letter