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Audit Planning
Decide whether or not to accept the prospective client Obtain knowledge of clients business and industry Prepare the audit plan, preliminary program, and time budget Make preliminary arrangements with the client
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Obtaining Clients
Engagement risk auditors overall risk of association with a client. Reduce engagement risk by considering managements reputation and the financial strength of the prospective client. With clients permission contact third parties concerning:
Financial history and credit rating (banker) Legal environment (attorneys)
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Obtaining Clients
SAS 84 (AU 315) requires the successor auditor to attempt to communicate with the predecessor auditor before accepting the engagement.
Recall Rule 301 pertaining to confidential client information. Must ask client to authorize the communication.
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Engagement Letters
Management responsibilities
Financial statements Establishing effective internal control over financial reporting Compliance with laws and regulations Making records available to the auditors Providing written representations at end of the audit, including that adjustments discovered by the auditors and not made to the financials are not material
Conducting an audit in accordance with GAAS Obtaining an understanding of internal control to plan audit and to determine the nature, timing and extent of procedures Making communications required by GAAS
Auditor responsibilities
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Engagement Letters
Other Items
Arrangements regarding
Conduct of the audit (e.g., timing, client assistance) Use of specialists or internal auditors Obtaining information from predecessor auditors Fees and billing
Limitation of or other arrangements regarding liability of auditors or client Conditions under which access to the auditors working papers may be granted to others
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Clients operations
Accounting policies Industry and regulatory factors Strategies and related business risks Measurement and review of performance Internal control
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Basic strategies
Product differentiation Cost leadership
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ROA = (NI / Sales) x (Sales / TA) = Net Profit Margin x Asset Turnover
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Materiality
Consideration (but not quantification) of materiality is required most firms do quantify. No universal rules for assessing materiality only guidelines and professional judgment Some methods for quantifying overall materiality 5 to 10% of net income before taxes to 1% of total assets to 1% of total revenues 1% of total equity AICPA table
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Materiality
Multiply overall materiality by a factor (usually 1.5 to 2.0) and allocate to the various accounts.
Multiplying by a factor before allocating alleviates excessive conservatism Allocation is typically to balance sheet accounts (balance sheet approach)
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Materiality
Class Example
Relevant base = $4,000,000 Overall planning materiality = $38,300 + (0.0067 x $1,000,000) = $45,000 Allocation of planning materiality Allocated amount = $45,000 x 2.0 = $90,000 Base = $2,000,000 Cash allocation = (500,000 / 2,000,000) x 90,000 = $22,500 Similarly, A/R = $13,500, Inv = $31,500, A/P = $14,625, A/L = $5,625 and T/P = $2,250 Total = $90,000
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Qualitative Considerations
Remember materiality depends not only on amount, but also on nature of transaction, for example: Illegal payments Compliance with contractual agreements Reversal of earnings trend Changes a loss into income, or vice versa Items that can be measured with precision versus items that arise from estimates
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Materiality
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Two types
Fraudulent financial reporting (management fraud) Misappropriation of assets (defalcations)
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Overall response
Professional skepticism and audit evidence Assigning personnel and supervision Accounting principles Predictability of auditing procedures
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First-year Procedures
SAS 84 recommends second communication with predecessor CPA
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Audit Plans
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Audit Programs
Organization of the Audit Program
Systems (Internal Control)
Revenue Cycle Acquisition Production Payroll Investing/Financing
Substantive tests
Organized by major balance sheet accounts
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Finish
Start
Source Documents
Journals
Ledgers
Start
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Finish
Interim Work
Consideration of Internal Controls Substantive work on transactions to date
It should be remembered that interim work should be supplemented with additional work covering the period between the interim date and the end of the year
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