CHAPTER OVERVIEW OF THE AUDIT PROCESS 1-1 Auditor’s reports are important to users of financial statements because they inform users of the auditor’s opinion as to whether or not the statements are fairly stated or whether no conclusion can be made with regard to the fairness of their presentation Users especially look for any deviation from the wording of the standard unqualified report and the reasons and implications of such deviations 1-2 Other requirements for an effective audit are: a b c d Comprehensive knowledge of GAAP; Understanding of internal control concepts; Understanding of the client’s unique system of internal control; and Knowledge of evidence gathering and evaluation methodology 1-3 The scope paragraph tells what the auditor did, and whether or not the examination was conducted in accordance with generally accepted auditing standards (GAAS) The opinion paragraph tells what the auditor found, and whether or not the financial statements conform to generally accepted accounting principles (GAAP) in all material respects 1-4 An engagement letter is the agreement or understanding between the CPA and his/her client concerning the nature of the engagement It provides protection for the CPA in the event of subsequent legal action alleging negligence or breach of contract By committing the agreement to writing, the engagement letter also minimizes future misunderstandings between the CPA and client concerning the services to be performed by the CPA 1-5 The audit program is an important part of the systematic approach to auditing, and demonstrates that the audit was properly planned 1-6 The pre-audit conference should be attended by all members of the audit team, including the partner in charge of the examination The conference should cover the following areas: a b c d e Nature of the client’s activities; General nature of the client’s system of internal control; Unique accounting practices; Duties of individual audit team members; and Known areas of high audit risk 1-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition 1-7 The main feature distinguishing the interim audit phase from the final audit phase is the focal point In the interim audit, the primary focus is on testing the client’s internal controls as a means for further reduction of assessed control risk In the final audit, the auditor is primarily concerned with the examination of transactions and balances 1-8 The accuracy of transactions and balances is a function of the reliability of the information system An effective control environment, accounting system, and control activities (the information system), together with a system of monitoring such that controls adapt to a changing environment, serves to produce accurate financial data Weak controls are more likely to produce inaccurate financial data By first testing the information system, the auditor is able to increase or decrease the nature, timing, and extent of transaction and balance testing according to his/her assessment of control risk 1-9 The ten generally accepted auditing standards, along with the related statements on auditing standards, provide a framework by defining the requisite quality to be achieved in performing an audit 1-10 Attestation refers to an expert communicating a conclusion about the reliability of someone else’s assertion Auditing is a form of attestation in that the auditor communicates, to third party financial statement users, his/her conclusions regarding the fairness of management’s assertions contained in the financial statements The independent auditor is considered an “expert” in both accounting and auditing 1-11 In planning an audit, an auditor must be familiar with the client’s industry, business activities, accounting system, and policies and procedures Once the assertions to be tested have been identified, the auditor must assess the risk of their being misstated Auditors must be reasonably sure of issuing an appropriate opinion Hence, they must consider the risk of misstatements and the various procedures available for gathering audit evidence as a basis for forming an opinion Audit planning includes designing the specific procedures to be performed and assigning personnel to work on the audit The audit report indicates that auditors conduct audits in accordance with generally accepted auditing standards Further, the report communicates the role of risk in the audit process by stating that those standards require auditors to plan and perform the audit to obtain reasonable assurance about (not to prove) whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements Hence, an audit involves risk Finally, auditors express an opinion, not a guarantee However, they believe that their audit provides a reasonable basis for their opinion Overview of the Audit Process 1-3 1-12 Auditing standards indicate that auditors should report major issues discussed with the entity’s management prior to being retained as auditor, including discussions regarding the application of accounting principles and auditing standards Discussion of such matters may place pressure on the auditor to yield to management’s view Making the audit committee members aware of such matters should enable them to better monitor the auditor’s independence Standards not preclude clients from making suggestions about audit staff Clients frequently make requests to have persons on the audit who have experience in the industry If a client requests that minority persons not be assigned to an audit, however, the auditor must carefully consider the ethical implications of that request 1-13 Auditing standards require auditors associated with financial statements to issue a report on them An auditor is associated with financial statements when he or she (a) “has consented to the use of his [her] name in a report, document, or written communication containing the statements,” or (b) has prepared or assisted in preparing the financial statements An auditor who prepares or assists in preparing financial statements is associated even if his or her name is not included with the statements Typing the financial statements on plain paper rather than on the auditor’s letterhead therefore cannot be used to avoid association and the requirement to issue a report 1-14 In determining whether financial statements are presented fairly in conformity with GAAP, the auditor should consider whether: The accounting principles selected and applied have general acceptance The accounting principles followed in preparing the financial statements must have general acceptance, which means that the principles must be GAAP Auditing standards define GAAP as a “technical accounting term which encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.” No single reference source exists for GAAP Rather, auditing standards establish a hierarchy of sources to be followed when determining which principle applies to a particular situation The accounting principles are appropriate in the circumstances The statements contain appropriate disclosures The financial statements reflect the underlying events and transactions in a manner that presents the financial position, results of operations, and changes in financial position within a range of acceptable limits; that is, limits that are reasonable and practicable to attain in financial statements 1-15 Auditing standards require the auditor to disclose the effects of deviations from GAAP on the financial statements As a result, clients often choose to adjust the financial statements for the deviations 1-16 An auditor may not offer reasons for the lack of independence since such explanations might mitigate the lack of independence in the view of the reader 1-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition ... of control risk 1-9 The ten generally accepted auditing standards, along with the related statements on auditing standards, provide a framework by defining the requisite quality to be achieved...1-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition 1-7 The main feature distinguishing the interim audit... auditors conduct audits in accordance with generally accepted auditing standards Further, the report communicates the role of risk in the audit process by stating that those standards require