CHAPTER

OVERVIEW OF THE
1 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. Comprehensive knowledge of GAAP;
b. Understanding of internal control concepts;
c. Understanding of the client’s unique system of internal control; and
d. 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. Nature of the client’s activities;
b. General nature of the client’s system of internal control;
c. Unique accounting practices;
d. Duties of individual audit team members; and
e. 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 do
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.