Chapter 3

Engagement Planning

ACCT-4080

Chapter 3

1. Audit Process

Stages of an audit
1. Initial audit planning
2. Obtain an understanding of the client and
its environment, including internal control
3. Assess the risks of material misstatement
and design further audit procedures
4. Perform further audit procedures
5. Complete the audit
6. Form an opinion and issue the audit report

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Chapter 3

1. Audit Process

AU-C 300 Planning an Audit

Performance Principle (FW Std. No. 1): The auditor

must adequately plan the work and must properly
supervise any assistants.

Planning involves developing an overall audit strategy

ACCT-4080

Not a discrete phase of audit

Supervision involves directing the efforts of all assistants

involved in the audit

Objective is to plan the audit so that it will be

performed in an effective manner
Chapter 3

1. Audit Process

AU-C 210 Terms of Engagement

Objective of auditor is to accept an engagement

for a new or existing audit client only when the
basis upon which it is to be performed has been
agreed upon

ACCT-4080

establishing whether the preconditions for audit are

present
confirming that common understanding exists between
auditor and management

Chapter 3

1. Audit Process

Preconditions of audit

determine whether the financial reporting framework to be applied in

the preparation of the financial statements is acceptable
obtain the agreement of management that it acknowledges and
understands its responsibility

for preparation and fair presentation of the financial statements in accordance

with the applicable financial reporting framework
for the design, implementation, and maintenance of internal control
to provide the auditor with

ACCT-4080

access to all information that is relevant to the preparation and fair presentation of
the financial statements
additional information that the auditor may request from management for the purpose
of the audit
unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence

Chapter 3

2. Structure of CPA Firm

Positions in firm
Up or out
Partnership potential
Women in public accounting
Work load
Busy season
Size of firm
Size of engagement team

ACCT-4080

Chapter 3

3. Preliminary
Arrangements
Early appointment of auditors

Evaluate client

Evaluate your resources

integrity of management
special risks
staffing
interim vs. year-end work
time budget
independence

Quality assurance partner

ACCT-4080

required on issuer engagements

provides second review on high risk areas of audit
Chapter 3

3. Preliminary
Arrangements
Communicate with predecessor auditor (AU-C
(continued)
210)

Engagement letter (AU-C 210)

integrity of management
disagreements with management
reason for auditor change
required communications
purpose

First time audits

auditing opening balances (AU-C 510)

ACCT-4080

Chapter 3

3. Preliminary
Arrangements
Using work of internal auditors (AU-C 610)
(continued)
objectivity

competence

Identification of related parties (AU-C 550)

IT in an audit

IT audit specialist
CAATs in an audit

ACCT-4080

ACL, IDEA, proprietary software

Chapter 3

4. Evidence Provided by
Specialists
AU-C 620

Definition - a person (or firm) possessing special skill or

knowledge in a particular field other than accounting or
auditing
Examples: actuaries, appraisers, engineers,
environmental consultants, geologists, and attorneys
Consider qualifications, experience, reputation
Independence
Review of work
Effect on audit report

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Chapter 3

10

7. Effect of Electronic
Environment on Audit

Risks

risks related to hardware and software

reduced audit trail
need for IT experience and separation of IT duties

No effect on

ACCT-4080

purpose of audit (e.g., gathering sufficient

appropriate evidence)
importance of managements assertions
Chapter 3

11

8. Materiality

AU-C 320 Materiality in Planning and Performing the Audit

Definition
Assessing materiality

Materiality guidelines

SEC caution

Accounting materiality

quantitative factors
qualitative factors

ex post decision process

Auditing materiality

ACCT-4080

ex ante decision process

Chapter 3

12

8. Materiality (continued)

Financial statement level materiality

Account balance level materiality

methods to establish
annualizing financial results
performance materiality
tolerable error

Clearly trivial
Top down approach
Planning materiality vs. final evaluation level materiality
Cost benefit considerations

ACCT-4080

Chapter 3

13

8. Materiality (continued)

Cumulative effects
Factual (no doubt actual error), judgmental
(arise from management estimates), and
projected (from sampling projections) errors

(known error and likely error)

Relationship between audit risk and materiality

Nonadditive nature of tolerable error
Materiality example example2

ACCT-4080

Chapter 3

14

9. Audit Tests and Procedures

Risk assessment procedures

Tests of controls

procedures to obtain understanding of client, its environment,

including IC
observation, inquiry, inspection, and analytics (walkthrough)
procedures to determine the operating effectiveness of controls
inquiry, observation, inspection, reperformance

Substantive tests

procedures to verify account balances

activities performed to detect material misstatement or fraud at
assertion level
includes tests of balances, transactions, and SAP

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Chapter 3

15

9. Audit Tests and

Procedures

inspecting
observing
confirming
inquiring
tracing
vouching

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Chapter 3

16

9. Audit Tests and Procedures

scanning
counting
recalculating
reperforming
analytical procedures

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Chapter 3

17

10. Audit Programs

Transactions cycles
Audit plans
Audit programs

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Chapter 3

18

11. Audit Documentation

AU-C 230
Purpose
Factors affecting type and content
Ownership
Organization

permanent file
current file

Electronic workpapers
AS 3 requirements

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completion date 45 days after report date

Retention at least 7 years
additions/amendments no deletions; fully documented additions
Chapter 3

19

11. Audit Documentation

(cont)

Types

working trial balance

lead schedules
supporting schedules
adjusting journal entries
reclassification journal entries

Indexing
Tick marks

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Chapter 3

20

APOLLO SHOES, INC.

C-1
Inventory Lead Schedule
APOLLO SHOES, INC.
B-1
Accounts Receivable Lead Schedule
APOLLO SHOES, INC.
A-3
Bank Confirmation
APOLLO SHOES, INC.
A-2
First National Bank Reconciliation
APOLLO SHOES, INC.
A-1
Cash Lead Schedule
12/31/04

Current File
Other Lead
Schedules
Supporting
Schedules

Ref Account Unaudited AJE

Balance
C-1 1rst Natl $484,000 $50,000 $534,000

APOLLO SHOES, INC.

Working Trial Balance
12/31/04

TB-1
APOLLO SHOES, INC. TB-2
Adjusting Entries

Ref Account Unaudited AJE

Balance
A-1 Cash
$484,000 $50,000 $534,000
B-1 A/R
C-1 Inventory
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dr
cr
Cash
$50,000
Expenses
$50,000
Chapter 3

21

Audit Documentation

Information on
Workpaper

Name, date, purpose,

page number
Procedures performed
and conclusions
reached by the
auditor

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Chapter 3

Evidence that
auditor followed
general standards
and standards of
field work
Audit Mark Legend

Reviewers initials
22

12. Review Questions for

Discussion

Chapter 3
3.2
3.3
3.6
3.7
3.9
3.10
3.11

ACCT-4080

3.13
3.16
3.19
3.20
3.23
3.24
Chapter 3

23