Chapter 8: Audit Planning and Analytical Procedures
These are the 8 steps of Planning and Audit and Designing an Audit Approach:
1. Accept client and perform initial audit planning.
2. Understand the client’s business and industry.
3. Assess client business risk.
4. Perform preliminary analytical procedures.
5. Set materiality and assess acceptable audit risk and inherent risk.
6. Understand internal control and assess control risk.
7. Gather information to assess fraud risks.
8. Develop overall audit plan and audit program.
The Audit Risk Model: AR = IR x CR x DR
Audit risk (AR) = The risk that the CPA issues an unqualified opinion when the financial statements contain material misstatements. • The auditor determines the amount of AR that is acceptable. Audit risk is usually predetermined by company policy.
Inherent risk (IR) = The risk that misstatements exist before the internal controls are applied to the financial reporting process. • IR occurs based on industry or economy that can’t be dealt with through internal control procedures. It’s outside of the company’s control. • Example: Mortgage Industry = interest rates • It is accessed in the planning stage and IR is set in stone.
Control risk (CR) = The risk that internal controls fail to detect F/S misstatements. • It is accessed in the planning stage in order to determine initial control risk. • It is also accessed in the preliminary field work in order to determine actual control risk.
Detection risk (DR) = The risk that audit procedures fail to detect F/S misstatements. • It is accessed in the year-end procedures (year-end field work).
The auditor engages in initial audit planning through 4 steps:
1. The auditor decides whether to accept a new client or continue serving an existing client.
The client retention policy is:
a. Previous conflicts over the appropriate scope of the audit, type of opinion to issue or unpaid fees may cause the auditor to not retain that client. b. The auditor may not retain a client because of excessive risk. • Ex: Regulatory conflict may occur between the client and the government agency which could lead to financial failure of the client or lawsuits against the CPA firm. c. If the audit risk is extremely low, the auditor may not accept the engagement especially when the client has a reputation of taking aggressive financial risks. • An audit that has low audit risk will result in higher audit costs which will lead to higher audit fees.
2. The auditor identifies why the client wants or needs an audit.
3. The auditor obtains an understanding with the client about the terms of the engagement in order to avoid misunderstandings.
4. The auditor develops an overall strategy for the audit including engagement staffing and any required audit specialists.
These are the steps taken by the CPA after obtaining a new client:
1. Submit proposal to the audit committee (AC).
2. Agree to audit fees.
3. Communicate with predecessor auditor. • The auditor talks with the predecessor auditor to determine why they aren’t auditing that client anymore.
4. Perform 1st year audit procedures to become comfortable with beginning balances. • The auditor can review work papers from the predecessor auditor in order to learn about the new client.
5. Determine the role of the client’s staff and necessary provided by client (PBC’s) documents. • Example: The auditing of accounts receivable may require the auditor to have an Aged Trial Balance and a list of customers from the client.
6. Consider the need for a specialist. • Example: Biotechnology = The client hires an expert to help the auditor understand the business processes.
7. Create an engagement letter. • The engagement letter is a contract between the auditor and the client. • Refer to Figure 8-2…