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Electronic Presentations in Microsoft® PowerPoint®
Prepared by
Brad MacDonald
SIAST
© 2003 McGraw-Hill Ryerson Limited
Copyright © 2003 McGraw-Hill Ryerson Limited
Chapter4
2
Audit Objectives, Procedures, Audit Objectives, Procedures, and Working Papersand Working Papers
Copyright © 2003 McGraw-Hill Ryerson Limited 3Chapter 4
Chapter 4 OverviewChapter 4 Overview
Pre-engagement
arrangements
Activities
Managementassertions &
audit objectives
Basic Concepts
Understand the client’s business
Obtain thefinancial
statements
Sufficientappropriate
evidence
Generalaudit
procedures
Audit workingpapers
Copyright © 2003 McGraw-Hill Ryerson Limited 4Chapter 4
Learning Objective 1Learning Objective 1
Describe the activities auditors undertake before beginning an audit.
Copyright © 2003 McGraw-Hill Ryerson Limited 5Chapter 4
Pre-engagement ArrangementsPre-engagement Arrangements
Auditors undertake two types of activities before beginning an audit:
– Risk management: • Auditors try to reduce the risk (probability of
something going wrong) by carefully managing the engagement.
– Quality management: • Auditors manage audit in accordance with quality
control standards.
Copyright © 2003 McGraw-Hill Ryerson Limited 6Chapter 4
Pre-engagement ArrangementsPre-engagement Arrangements
Client selection and retention:– An important element of an accounting firm’s quality
control policies and procedures is a system for deciding
• (a) to accept a new client, and • (b) whether to resign from audit engagements.
– Accounting firms are not obligated to accept undesirable clients, nor retain existing audit clients.
Copyright © 2003 McGraw-Hill Ryerson Limited 7Chapter 4
Client Acceptance and Client Acceptance and Retention PoliciesRetention Policies
Client acceptance and retention procedures should include:
– Obtain and review financial information about prospective client.
– Enquire of bankers, legal counsel, other.– Communication with predecessor auditor.– Consider unusual risks.– Evaluate independence.– Consider needs for special skills.
Copyright © 2003 McGraw-Hill Ryerson Limited 8Chapter 4
Communication Between Predecessor Communication Between Predecessor and Successor Auditorsand Successor Auditors
When companies change auditors, the former auditor is the predecessor auditor, and the new auditor is the successor auditor.
– Rules of professional conduct require the successor auditor to contact the predecessor auditor.
• Ask if there are issues that should be considered in accepting the client.
• Obtain information from the predecessor auditor for planning the audit.
– Predecessor auditor is required by the rules of conduct to respond to the communication.
Copyright © 2003 McGraw-Hill Ryerson Limited 9Chapter 4
Communication Between Predecessor Communication Between Predecessor and Successor Auditorsand Successor Auditors
Successor auditor should ask the client to consent to discussions with the predecessor auditor.
– Consent is not required, the communication must take place.
– Consent allows the predecessor auditor to relay more information.
• Predecessor auditor still has a duty to maintain confidentiality.
• Audit files belong to the auditor, not the client.– Auditor should be wary of any client who refuses
consent.
Copyright © 2003 McGraw-Hill Ryerson Limited 10Chapter 4
Engagement LettersEngagement Letters
When a new audit client is accepted an engagement letter should be obtained.
– The engagement letter forms the contract for the audit.• Engagement letters are highly
recommended to reduce the risk of misunderstandings.
– A new engagement letter should be obtained every year of a continuing audit.
Copyright © 2003 McGraw-Hill Ryerson Limited 11Chapter 4
Pre-engagement ArrangementsPre-engagement Arrangements
Staff assignment:– When the new client is obtained, accounting firms
assign a full-service team to the new client. • Engagement partner• Audit manager• One or more senior audit staff members• Staff assistants• Specialists• A tax partner, a consulting services partner and a
second audit partner– For a small firm or client, audit team may be just one
or two people.
Copyright © 2003 McGraw-Hill Ryerson Limited 12Chapter 4
Pre-engagement ArrangementsPre-engagement Arrangements
Time budget:– The partner or manager propose a plan for the timing
of the work (interim and year-end).– Time reports are recorded by budget categories for
• evaluation of the efficiency of audit team members
• billing the client
• planning of the next audit
– Time budget allows the audit firm to spread its workload between interim and year-end periods.
• Interim – before the statement date• Year-end – at or after the statement date
Copyright © 2003 McGraw-Hill Ryerson Limited 13Chapter 4
Example Time BudgetExample Time Budget
Audit Time Budget (hours)Interim Year-End
Knowledge of the business 15Internal audit familiarization 10Assessment of control risk 30 10Audit program planning 25Related parties investigation 5 15Client conferences 10 18Cash 10 15Accounts receivable 15 5Inventory 35 20Accounts payable 5 35Representation letters 20Financial statement review 25Report preparation 12Total 160 175
Copyright © 2003 McGraw-Hill Ryerson Limited 14Chapter 4
Learning Objective 2Learning Objective 2
Identify the procedures and sources of information that auditors can use to obtain knowledge of a client’s business and industry.
Copyright © 2003 McGraw-Hill Ryerson Limited 15Chapter 4
Understanding the Client’s Understanding the Client’s BusinessBusiness
Auditing standards require a sufficient understanding of the business to plan and perform audit work.
– Objectives:• Effective audit: identify and address all significant
risks of material misstatement• Efficient audit: provides sufficient appropriate audit
evidence in an economical manner• Enhance accuracy of auditor’s evaluation• Provide better ancillary services to client
Copyright © 2003 McGraw-Hill Ryerson Limited 16Chapter 4
Strategic Systems Approaches Strategic Systems Approaches to Auditingto Auditing
A recent trend in audit practice, referred to as “strategic systems approach” (SSA), is to base more of the audit on knowledge of the business.
– Used by two of the Big four firms, but has not yet filtered down to smaller firms.
– SSA is a top-down approach.• Starts with corporate strategy to determine effects
on financial statements (Ch. 13).– Traditional audits use a bottom-up approach.
• Gather evidence on individual transactions and aggregate to financial statement level.
Copyright © 2003 McGraw-Hill Ryerson Limited 17Chapter 4
Understanding the Understanding the Client’s BusinessClient’s Business
Methods and sources of information:– For continuing audits, information is available in the
permanent files.– Enquiry and interview with client management and
personnel to • obtain information for computer based audit work• determine needs of users of the statements
– Observation and tour of company’s physical facilities – Study and review of published materials, guides and
reference materials on the industry and the client.
Copyright © 2003 McGraw-Hill Ryerson Limited 18Chapter 4
Understanding the Understanding the Client’s BusinessClient’s Business
Other aspects of understanding the business:
– First-time audits require more work.– Audit efficiency can be realized by working in
tandem with the internal auditors.– Analysis of client financial statements and
ratios contribute a significant understanding of the business.
– Understanding enables the auditor to determine the need for specialists.
Copyright © 2003 McGraw-Hill Ryerson Limited 19Chapter 4
Learning Objective 3Learning Objective 3
Name the principal accounts in each cycle in accounting and business processes.
Copyright © 2003 McGraw-Hill Ryerson Limited 20Chapter 4
Management’s Financial Management’s Financial StatementsStatements
There are two important points to remember about client financial statements:
• Management is responsible for preparing them, and they contain management’s assertions about economic actions and events.
• The financial statement numbers are produced by the company's accounting system and summarized by the trial balance.
Copyright © 2003 McGraw-Hill Ryerson Limited 21Chapter 4
Management’s Financial Management’s Financial StatementsStatements
To simplify the audit plan, auditors typically group the accounts into several cycles.
– This text contains four cycles: (1) revenues and collection (2) acquisition and expenditure (3) production and conversion (4) finance and investment
– The purpose of using cycles is to group together related accounts by transactions that normally affect them all.
Copyright © 2003 McGraw-Hill Ryerson Limited 22Chapter 4
Trial Trial BalanceBalance
Revenue and collection cycleAcquistion and expenditure cycle
Production and conversion cycleFinancing and investment cycle
Debit CreditX X Cash 484 X Accounts receivable 400 X Allowance for doubtful accounts 30 X Sales 8,500 X Sales returns 400 X Bad debt expense 50
X X Inventory 1,940 X Capital assets 4,000 X Accum. Amortization 1,800 X Accounts payable 600 X Accrued expenses 10 X General expenses 1,955
X Cost of goods sold 5,265 X Amortization expense 300
X Bank loans 750 X Long term notes 400 X Accrued interest 40 X Share capital 2,000 X Retained earnings 900 X Dividends declared - X Interest expense 40 X Income tax expense 196
Accounts are organized by
cycle
Should list comparative
period
Copyright © 2003 McGraw-Hill Ryerson Limited 23Chapter 4
Learning Objective 4Learning Objective 4
Describe and define the five principal management assertions in financial statements, and explain their role for establishing audit objectives.
Copyright © 2003 McGraw-Hill Ryerson Limited 24Chapter 4
Management Assertions Management Assertions and Audit Objectivesand Audit Objectives
Existence or occurrence:– Establish with evidence that assets, liabilities
and equities actually exist and that revenue and expense transactions actually occurred as of a proper date.
– Cut-off: No transactions from the next period are recorded at the statement date.
Copyright © 2003 McGraw-Hill Ryerson Limited 25Chapter 4
Management Assertions Management Assertions and Audit Objectivesand Audit Objectives
Completeness:– Establish with evidence that all transactions
and accounts that should be presented in the financial reports are included.
– Cut-off: All transactions from the period are recorded in the period.
Copyright © 2003 McGraw-Hill Ryerson Limited 26Chapter 4
Management Assertions Management Assertions and Audit Objectivesand Audit Objectives
Rights and obligations:– Establish with evidence that amounts
reported as assets of the company represent property rights and the amounts reported as liabilities represent obligations.
Valuation or allocation:– Determine whether proper values have been
assigned to assets, liabilities, equities, revenues, and expenses.
Copyright © 2003 McGraw-Hill Ryerson Limited 27Chapter 4
Management Assertions Management Assertions and Audit Objectivesand Audit Objectives
Presentation and disclosure:– Determine whether the accounting principles
are properly selected and applied and whether disclosures are adequate.
Copyright © 2003 McGraw-Hill Ryerson Limited 28Chapter 4
Management Assertions Management Assertions and Audit Objectivesand Audit Objectives
A compliance assertion:– Management asserts compliance with laws
and regulations.– Not normally listed as a separate
management assertion.
Importance of assertions– Financial statement assertions are the focal
points for audit procedures.
Copyright © 2003 McGraw-Hill Ryerson Limited 29Chapter 4
AssertionsAssertions
7 assertions listed in CICA Handbook
Existence
Occurrence -> transactions
Completeness
Ownership
Valuation
Measurement
Statement presentation
5 textbook categories of assertions
Existence or occurrence Completeness
Rights & obligations
Valuation or allocation
Presentation & disclosure
Copyright © 2003 McGraw-Hill Ryerson Limited 30Chapter 4
Learning Objective 5Learning Objective 5
Explain audit evidence in terms of its appropriateness and relative strength of persuasiveness.
Copyright © 2003 McGraw-Hill Ryerson Limited 31Chapter 4
Appropriateness of EvidenceAppropriateness of Evidence
To be considered appropriate, evidence must be relevant and reliable.
– Relevant: audit evidence must relate to one of the management assertions.
– Reliability: of audit evidence depends on nature and source.• Reliability combined with relevance
determine the persuasiveness of evidence.• The following hierarchy of evidence can be
used to judge reliability.
Copyright © 2003 McGraw-Hill Ryerson Limited 32Chapter 4
Reliability of EvidenceReliability of Evidence
1. Auditors direct, personal knowledge:– Gained though observation and recalculation– This is the most reliable evidence.
2. External evidence:– Documentary evidence that is obtained
directly from independent sources.– Very reliable evidence
Copyright © 2003 McGraw-Hill Ryerson Limited 33Chapter 4
Reliability of EvidenceReliability of Evidence
3. External-internal evidence:– Documentary evidence that originates outside the
client’s system, but that has been received and processed by the client:
– This is reliable evidence (although circumstances of internal control are important).
4. Internal evidence:– Evidence that is produced within the client’s system.– Low reliability, but used extensively under
satisfactory internal control conditions.– Plentiful and easy to obtain, less costly than other
evidence.
Copyright © 2003 McGraw-Hill Ryerson Limited 34Chapter 4
Reliability of EvidenceReliability of Evidence
5. Spoken and written representations:– Evidence that comes from the client’s
officers, directors, management, and employees in response to enquiry.
– Generally considered the weakest form of evidence.• Representations should be corroborated
with other types of evidence.
Copyright © 2003 McGraw-Hill Ryerson Limited 35Chapter 4
Sufficiency of EvidenceSufficiency of Evidence
Sufficiency of evidence is a question of how much appropriate evidence is enough.
– No official standard, the auditor must use professional judgement.• Test of sufficiency is whether you can
persuade someone else that you have collected enough evidence to support your conclusion.
Copyright © 2003 McGraw-Hill Ryerson Limited 36Chapter 4
Learning Objective 6Learning Objective 6
List and describe six general types of audit techniques for gathering evidence.
Copyright © 2003 McGraw-Hill Ryerson Limited 37Chapter 4
General Audit ProceduresGeneral Audit Procedures
The third examination standard identifies six techniques for gathering evidence:
– computation– observation– confirmation– enquiry– inspection– analysis
Copyright © 2003 McGraw-Hill Ryerson Limited 38Chapter 4
General Audit ProceduresGeneral Audit Procedures
Computation:– Performing independent calculations or
recalculating the client’s calculations.• Computation produces highly reliable
mathematical evidence.• Computation addresses existence and
valuation for calculated amounts.
Copyright © 2003 McGraw-Hill Ryerson Limited 39Chapter 4
General Audit ProceduresGeneral Audit Procedures
Observation: – Looking at the application of policy or
procedures by others.• Reliable evidence as to performance at the
time of observation.• Produces a general awareness of events.
Copyright © 2003 McGraw-Hill Ryerson Limited 40Chapter 4
General Audit ProceduresGeneral Audit Procedures
Confirmation:– Consists of (written) enquiry to verify
accounting records.• Confirmation with independent parties is
used widely for a variety of transactions and balances.
• Confirmation can produce evidence regarding existence, ownership, valuation and cut-off.
Copyright © 2003 McGraw-Hill Ryerson Limited 41Chapter 4
General Audit ProceduresGeneral Audit Procedures
Confirmation procedures:– Confirmations should be printed on the
client’s letterhead, signed by a client officer.– Auditor needs to ensure that the address on
the confirmation is legitimate.– The recipient should be able to provide the
information.– The auditor must mail the confirmations.– Responses must be returned directly to the
auditor.
Copyright © 2003 McGraw-Hill Ryerson Limited 42Chapter 4
General Audit ProceduresGeneral Audit Procedures
Forms of confirmations:– Positive confirmations: request a reply in all
cases.• Follow-up is required for all exceptions
reported, and for all unreturned confirmations.
– Negative confirmations: request a reply only where information is incorrect.• Only exceptions need to be followed up.
Copyright © 2003 McGraw-Hill Ryerson Limited 43Chapter 4
General Audit ProceduresGeneral Audit Procedures
Enquiry:– Involves the collection of oral evidence from
the client and independent third parties.• Evidence from enquiry requires
corroboration.• Evidence from enquiry is important in
understanding the client’s business.• SSA audits put increasing stress on
enquiry.
Copyright © 2003 McGraw-Hill Ryerson Limited 44Chapter 4
General Audit ProceduresGeneral Audit Procedures
Inspection:– Looking at records, documents, or assets
having physical substance.• Reliable evidence for existence, supports
valuation.• Documents can be prepared by
independent outside parties as either formal authoritative or ordinary documents.
• Documents can also be prepared by the entity under audit.
Copyright © 2003 McGraw-Hill Ryerson Limited 45Chapter 4
Particular Inspection TechniquesParticular Inspection Techniques
Vouching:– Information is selected from an account or
other summary of information and the auditor goes back through the control system to find the source documentation.• Vouching supports existence.
Source documents
Account / other
summary
Vouch
Copyright © 2003 McGraw-Hill Ryerson Limited 46Chapter 4
Particular Inspection TechniquesParticular Inspection Techniques
Tracing:– Auditor selects source documents and
proceeds forward through the control system to the final recording of the transaction.• Tracing supports completeness
Source documents
Account / other
summary
Vouch
Trace
Copyright © 2003 McGraw-Hill Ryerson Limited 47Chapter 4
Particular Inspection TechniquesParticular Inspection Techniques
Scanning:– An eyes-open approach of looking for
anything unusual.• Does not produce direct evidence, but can
raise questions.• Computers can be used to scan electronic
data files.• Scanning can be used to reduce sampling
risk by scanning the items not selected.
Copyright © 2003 McGraw-Hill Ryerson Limited 48Chapter 4
General Audit ProceduresGeneral Audit Procedures
Analysis:– Evaluation of financial items in determining other
audit programs and performing analytic procedures that compare recorded amounts to expectations.
• Analysis is the “other” category in the list of audit techniques.
• Analytical procedures are both important and effective.
• Analysis is used in planning, execution, and completion of the audit.
Copyright © 2003 McGraw-Hill Ryerson Limited 49Chapter 4
Analytic ProceduresAnalytic Procedures
Some typical analytic procedures:– Compare current year to prior year.– Compare current year to budget.– Evaluate current year balances against other
current year balances.– Compare financial ratios to industry
standards.– Study relationship of balances and non-
financial information.
Copyright © 2003 McGraw-Hill Ryerson Limited 50Chapter 4
Learning Objective 7Learning Objective 7
Discuss the effectiveness of various audit procedures.
Copyright © 2003 McGraw-Hill Ryerson Limited 51Chapter 4
Effectiveness of Effectiveness of Audit ProceduresAudit Procedures
Audits are designed to provide reasonable assurance of detecting misstatements that are material to the financial statements.
– Soft procedures (enquiry and analysis) account for 45% to 50% of discovered errors.• Note: these procedures are applied first.
– Detail procedures are also effective.• Misstatements uncovered by soft
procedures will be quantified by detail procedures.
Copyright © 2003 McGraw-Hill Ryerson Limited 52Chapter 4
Learning Objective 8Learning Objective 8
Review an audit working paper for proper form and content.
Copyright © 2003 McGraw-Hill Ryerson Limited 53Chapter 4
Audit Working PapersAudit Working Papers
Working papers are the auditors’ record of compliance with GAAS.
– Working papers should contain support for the decisions made in the course of the audit.
– The auditor is the owner of the working papers.• Confidentiality requires client consent
before the file is opened to third parties.– There are three categories of working papers,
generally stored in two files.
Copyright © 2003 McGraw-Hill Ryerson Limited 54Chapter 4
Audit Working PapersAudit Working Papers
Permanent file:– Permanent file papers: information of
continuing interest.
Current file:– Audit administrative papers: documentation
of early planning.– Audit evidence papers: evidence obtained
and decisions made.
Copyright © 2003 McGraw-Hill Ryerson Limited 55Chapter 4
Working Paper Arrangement Working Paper Arrangement and Indexingand Indexing
Working papers (W/P) are grouped in order according to financial statement captions.
– Each page in the file must have:• Index: A page number that allows a W/P
to be removed and replaced properly.• Cross-referencing: Connects information
between pages in the W/P file.• Heading: Includes the entity under audit,
period being audited, and a descriptive title.
Copyright © 2003 McGraw-Hill Ryerson Limited 56Chapter 4
Working Paper Arrangement Working Paper Arrangement and Indexingand Indexing
W/P are grouped in order according to financial statement captions.
– Each page in the file must have:• Initials: from the auditor and the reviewer. • Dates: of the preparation and review.• Tick marks: to indicate the work
performed.• Tick marks should be appropriately described.
Copyright © 2003 McGraw-Hill Ryerson Limited 57Chapter 4
Audit W/P SoftwareAudit W/P Software
Specialized W/P software is becoming very popular. Advantages include:
– increase in productivity by automating tasks– integration with client database (extraction of
trial balance or transactions)– facilitation of analysis, links to other
databases, and websites
Copyright © 2003 McGraw-Hill Ryerson Limited 58Chapter 4
Framework for Strategic Framework for Strategic Analysis (Appendix 4A)Analysis (Appendix 4A)
PEST analysis:– Political factors
• Stability, tax policy, spending, international– Economic factors
• Inflation, employment, interest rates, GNP– Social and cultural factors
• Demographics, education, lifestyle, income– Technological factors
• New developments, speed of technology transfer, rate of obsolescence
Copyright © 2003 McGraw-Hill Ryerson Limited 59Chapter 4
Porter’s Five Forces ModelPorter’s Five Forces Model(Appendix 4A)(Appendix 4A)
Firm
Industry competitors
Intensity of rivalry
New EntrantsThreat of new entrants
Suppliers
Bargaining power of suppliers
Substitutes
Threat of substitutes
Buyers
Bargaining power of buyers