CHAPTER AUDIT PLANNING, SUPERVISION AND MONITORING I Review Questions Audit planning means developing a general strategy and a detailed approach for the expected nature, timing, and extent of the audit The auditor plans to perform the audit in an efficient and timely manner Adequate planning of the audit work accomplishes among others the following: (1) It ensures that appropriate attention is devoted to important areas of the audit, (2) It enables the auditor to identify potential problems, (3) It enhances completion of audit expeditiously, and (4) It assists in proper assignment of work to assistants and in coordination of work done by other auditors and experts Significant matters to be considered by the auditor in developing the overall audit plan include Knowledge of the Business Understanding of the Accounting and Internal Control System Assessment of Risk and Materiality Nature, Timing and Extent of Audit Procedures Coordination, Direction, Supervision and Review Other matters, such as assessment of the going concern assumption, related parties, nature and timing of reports and other communications with the entity To obtain information about the client’s business and industry, an auditor can review prior-year working papers, review current-year client information, inquire of management and the audit committee, read PICPA, AICPA, industry audit and accounting guides relevant to the client, and read significant industry publications and manuals maintained by the firm on the industry Specific audit procedures presented in the auditing standards as methods of detecting related-party transactions are as follows: • Examine company procedures for identifying and accounting for related-party transactions 9-2 Solutions Manual - Assurance Principles, Professional Ethics… • • • • • • Inquire of management about related parties and any transactions that occurred during the period Review entity filings with the SEC and other regulatory authorities for named related parties and other entities in which officers and directors serve in management or directorship positions Determine the names of all pension and other employee benefit trusts and the names of officers and trustees Review stockholder listings of closely held companies to identify principal shareholders Review prior-year working papers for names of related parties Inquire of auditors of related entities regarding management’s involvement in material transactions Warning signs that materially question management integrity impact the client acceptance decision The auditor must determine whether the suspicions aroused by such warning signs have validity and, if so, whether, under the circumstances, the auditor can continue to be associated with the financial statements Additionally, the auditor has a responsibility to communicate known illegal acts, as well as other findings of this nature, to the audit committee of the client’s board of directors Preliminary audit programs are designed on the basis of the auditor’s initial assessment of inherent risk and control risk The preliminary programs may be modified as a result of auditor testing of control procedures and revised assessment of control risk The preliminary programs, as modified by the results of control testing, are referred to as final audit programs The audit time budget facilitates staff scheduling and fee estimating, in that it displays the audit in terms of hours required to complete each phase and level of staff required for each sector A second purpose served, when actual times are recorded in the time budget, is that variances are isolated and may be investigated for cause This, in turn, facilitates preparation of next year’s time budget, and also isolates added hours which may be chargeable to the client because of client-caused audit problems and delays The preaudit conference conducted by the audit manager and the in-charge senior auditor and comprising the audit team assigned to the engagement, increases audit effectiveness by: a b c Discussing the results of audit risk analysis with the audit team; Familiarizing the audit team members with the nature of the client; and Making each team member aware of how identified warning signs impact the audit tasks assigned to him/her Audit Planning, Supervision and Monitoring 9-3 The three primary reasons an auditor should obtain a good understanding of the client’s industry are: • • • to enable the auditor to evaluate whether the client’s financial statements are in accordance with GAAP, since many industries have unique accounting requirements to enable the auditor to identify risks in the industry that may affect the auditor’s assessment of acceptable audit risk to enable the auditor to assess the client’s areas of high inherent risk The auditor can obtain a sound understanding of the client’s industry through several means, including discussions with previous auditors and by reviewing the permanent files for the client; conferences with the client’s personnel; studying textbooks, technical magazines and specialized journals; and by participating in industry associations and training programs 10 Paragraph 12 of PSA 300 provides the following: “The overall audit plan and the audit program should be revised as necessary during the course of the audit Planning is continuous throughout the engagement because of changes in conditions or unexpected results of audit procedures The reasons for significant changes would be recorded.” 11 The purpose of applying analytical procedures in planning the audit is to assist in understanding the business and in identifying areas of potential risk It will therefore assist the auditor in planning the nature, time, and extent of auditing procedures that will be used to obtain evidential matter for specific account balances or classes of transactions By identifying such things as the existence of unusual transactions and events, and amount ratios and trends, matters that have financial statement and audit planning ramifications might be brought to light Likewise, relevant non-financial information such as number of employees, area of selling space, volume of goods produced may also contribute to the accomplishment of the purpose of the analytical procedures 12 Refer to page 372 (letter a) of the textbook 13 Refer to page 372 (letter b) of the textbook 14 Refer to page 375 of the textbook 9-4 Solutions Manual - Assurance Principles, Professional Ethics… II Multiple Choice Questions 10 c d d d b a b d b d 11 12 13 14 15 16 17 18 19 20 b b a c b b a b c d 21 22 23 24 25 26 27 28 29 30 b d a c a b c a c a 31 d 32 b III Comprehensive Cases Case a CPAs should not follow clients’ suggestions about the conduct of an audit unless the suggestions clearly not conflict with his professional competence, judgment, honesty, independence, or ethical standards Where there is no disagreement about the results to be accomplished and the client’s suggestion represents a good idea a CPA can accept it Within professional bounds, mutual agreement with the client is all right The CPA must never agree to any arrangement which violates generally accepted auditing standards or the Code of Ethics for Professional Accountants b The reasons against dividing the assignment of audit work solely according to assets, liabilities and income and expenses include the following: Work should be assigned to staff members by considering the degree of difficulty in relation to the technical competence and experience of individual staff members Sequence of work performed on an examination should be in accordance with an overall audit plan It is impossible to segregate work areas by major captions because often a close relationship exists among a number of accounts in more than one category, as for example where income is based on assets or expense is based on liabilities Often a single audit work paper is desirable to substantiate balances in accounts of various types, such as an insurance analysis supporting premium disbursements, the expense portion and the prepaid balance Duplication of staff effort would be more likely to occur if assignments were made on such a basis Frequently, the scope of work regarding a single account requires simultaneous participation by the staff, such as in the observation of inventories Audit Planning, Supervision and Monitoring c 9-5 Many audit operations are not susceptible to division by category, as for example investigating internal control, testing transactions and writing the report The suggested three-way split will usually not result in an approximately equal allocation of audit hours since the examination of assets is usually the most time-consuming The CPA’s staff member whose uncle owns the advertising agency should not be assigned to examine Brilliant’s advertising account The CPA firm is responsible for avoiding relationships which might suggest a conflict of interest Regardless of whether this staff member could be independent and unbiased in such a situation, outsiders probably will be influenced in their thinking by the fact that his uncle is the owner of the advertising agency Even if a problem of ethics were not involved, it would be unwise for the CPA to assign this staff member because the client’s attitude could change significantly and the CPA firm’s position would be jeopardized if difficulties later arose in connection with the contract Any situation in which bias exists or might arise should be avoided Case Additional procedures to be performed prior to the beginning of audit field work are the following: a b c d e f g h i j Review client for continuance Lack of management integrity may be cause for rejecting the current year’s audit; Obtain copy of physical inventory instructions and examine for completeness Request client to revise where necessary; Determine work to be performed by client’s staff and arrange with client for timely completion of these tasks; Prepare engagement letter and obtain signed copy from the client; Prepare time budget and determine staff scheduling; Make a preliminary determination (using last year as a basis) of the timing of application of substantive audit procedures (e.g., interim v final audit application); Inquire of client as to changes in internal control; Inquire of client as to related party transactions during the current year, and receivables from and/or payables to related parties; Perform the planning portion of analytical procedures and investigate any significant abnormalities; and Arrive at preliminary assessments of inherent risk and control risk and design substantive audit programs ...9-2 Solutions Manual - Assurance Principles, Professional Ethics… • • • • • • Inquire of management about... preaudit conference conducted by the audit manager and the in-charge senior auditor and comprising the audit team assigned to the engagement, increases audit effectiveness by: a b c Discussing the... previous auditors and by reviewing the permanent files for the client; conferences with the client’s personnel; studying textbooks, technical magazines and specialized journals; and by participating