chapter 1 = Overview of the Audit Process and Pre-engagement Activities Courste ction #9 done CHAPTER 1 OVERVIEW OF THE AUDIT PROCESS AND PRE-ENGAGEMENT ACTIVITIES ee OO TOPIC OVERVIEW: This chapter discusses the definition of audit, audit process and the differ engagement. ‘rent considerations of auditor in accepting and changing an audit LEARNING OBJECTIVES: ‘After studying this chapter, you should be able to: 1. Describe what an audit is. 2, Enumerate and describe the different phase of an audit. 3, Enumerate and explain pre-engagement activities. 4 Identify the different considerations in accepting and changing an audit. AUDIT jogicat steps _.! , Tn MiG is a Systematic process of objectively obtaining and evaluating to evidence regarding and (American ‘Accounting Association) AUDIT PROCESS ‘The This process normally includes the following steps: is the sequeniéelo Wifferentactivities involved in an audit. PHASE DESCRIPTION 1-Pre-engagement This phase will réquinesaldecision from the or This process would but also require of the Primary objective: To 2. Audit planning serformance of RAP 4 ‘Audit planning involves the and ie auditor e about the in order to understand the transactions and events affecting the financial statements. will usually Setting preliminary materiality and_audit_risk_and 1chapter 1 - SV +5 Consideration 0 ment of risk is also performed during preliminary assess this phase. Primary obj associated wit the jective: TO h the audit necessary to be whether it can in FT consideration of internal controls involves the ad f internal controls manner. primary objective: To a — (eanaleliahagabentifor in determining the nature, timing an extent of audit procedures to be performed. ene 07 ‘aap. | internal controls se Acces THE ONO 10 nck revenge erty tevel pence # #7 a in [oe fy [4 Evidence- wens gathering (Substantive testing) Using the information obtained in audit planning and consideration of internal controls, the auditor performs asa accordance with .. Substantive procedures her be analytical procedures or test of details of could eit! transactions and balances. ‘This phase will always be performed by the auditor. primary objective: To between the the and the 5. Completing the audit * ~ Notes are performed; ached nd an luring this : To assist the auditor in assessing is consistent with a phase. Primary object whether the conclusion reached responsibilities evidence gathered. Gissuance ofthe | In this phase, the and the uit audit report which egarding the fairness of the financial statements. Primary objective: To of work of the audi 5 rs Postale uditor to various intended use She autor with performs procedures to ‘quality;controls and to Pri aaa rimary objective: To assess and evaluat: the quality of ent team: the audit services delivered by the engagem™ 2chapter 1 - Overview of the Audit Process and Pre-engagement Activities pRE-ENGAGEMENT ‘Acceptance of an engagement In making a decision whether to accept or reject an engagement, the auditor should perform the following: 4, BWaliiatélpreconditions for an audit reconditionstofanvaudit is the \usélby management of an acceptable) in the preparation of the financial statements and the nd, where appropriate, those charged with governance to the premise on which an audit is conducted. 2, Byaliiate"auditability of the prospective client. 3. Itivestigatelthesintegrityrof the client's management through appropriate parties or Matters to be disctissed!withipredecessonauditor include the following: (RID) a. The predecessor's understanding as to the Reasonsiforichangeyin auditors; b. Information that might bear on the=integrityyofithelmanagemient; and c. Disagreements between the predecessor auditor and management as to accounting principles, auditing procedures, etc. Note: Every time communication is made to parties other than the client, the auditor shall'seekypermission from theleli¢nitiand document) the items discussed. , including independence. Relevant part of the Code of Ethics includes Part 1, Part 3 and Part 4A. 5. Evaluate of the firm’s ability to serve the prospective client. 6. Obtain a preliminary knowledge of the client's business and industry to determine whether the auditor has the degree of competence required by the engagement. 7. = the terms of the engagement and prepare an engagement Continuance of an Engagement To ensure the audit firm's continuing compliance with the continuance Procedures, the auditor ; and their implicationsChapter 1 - Overview of the Audit Process and Pre-engagement Activities _ ts ‘cing the Terms of Audit Engagemen ; areevditor and the client shall agree on the terms of engagement, The eee need to be"F€cordedjin an quditengagementilettersy It is in the interest of both client and the auditor that the auditor sends an agement letter, preferabl i tell with respect to the engagement. The to help engagement letter documents and confirms: a. Auditor's acceptance of the engagement b. Objective and scope of the audit c. Extent of auditor’s responsibilities to the client d. Form of any reports Contents of engagement letter The form and content of audit engagement letters mayivarysforveach’client, but they would generally include reference to: The presence of audit risk Unrestricted access to whatever records The financial reporting framework used Objective of the audit The form of any reports or other communication Management's responsibility The scope of the audit Brepooe The auditor may also wish to include in the letter: a. Basis in which fees are computed and any billing arrangements b. Expectation of receiving representation letter ¢ Acknowledgment of management of terms of agreement d. Arrangements regarding the planning of the audit e. Description of any other letters or reports When relevant, the following points could also be made: Y Arrangements concerning the and expertsin some aspects of the audit; ¥ Arrangements concerni ing the involvementiorinteralauditors and other staff, Y Arrangements to be made with thepredecessorauditor, if any, in the case of initial audit engagement; vA % Ara when such possibility exists; athe, to any further agreements between the auditor and the Audit of Components Whe i anche a oem are entity is also the ; (component), the 4Chapter 1 - Overview of the Audit Process and Pre-engagement Activities _ whether t6'sendayseparaterengagementiletter to the component include the followin; Who appoints the component auditor; « Legal requirements in relation to audit appointments; «Degree of ownership by parent; « Whether a separate auditor's report is to be issued on the component; and «Degree of independence of the component's management from the parent entity. Recurring Audits On recurring audits, the auditor should consider whether circumstances require the termsjofithelengagementitolbelrevised and whether there is a need to remind the client of the existing terms of the engagement. The auditor However, the following factors may make it appropriate to send a new letter: «Any indication that the client misunderstands the objective and scope of the audit. Any revised or special terms of the engagement. Arecent change of top level management or board of directors. A significant change in ownership. A significant change in nature or size of the client's business. Achange in legal or regulatory requirements. ‘A change in financial reporting framework adopted in the preparation of the financial statements. * Achange in other reporting requirements. Acceptance of a Change in Engagement a. Stop performing the old engagement . Stop referring to the old engagement, except Yes }| when the new engagement involves agreed- upon procedures c. Start performing the new engagement Istherea d. Issue a report based on the new engagement reasonable justification? a. Continue the original audit engagement b. When prohibited to continue, withdraw from No b>] the audit engagement Note: Every time withdrawal is made, the auditor should consider the necessity of ‘communicating the reasons to appropriate level ‘of management.St tts... Overview of the Audit Process and Pre-engagement Activities X_Circumstances that could lead to Change in Engagement Circumstances Justifiable? 1.Change in circumstances affecting the need for the service 2.A misunderstanding as to the nature of the engagement originally requested 3.A restriction on the scope of the engagement (whether Chapter imposed by management or caused by circumstances} [ 4.Change related to information that is incorrect, incomplete |p or otherwise unsatisfactory 5.The auditor is unable to obtain sufficient appropriate audit |p evidence regarding assertions * Low to High Level of Atsuyanc - ¥ bacta May abiuiy to comply w/ code of # High to LN ; ~ Generally, NOT ALLOWED oc peacecmer ~ Is there a reasonable Sta Mstification 7 * \LU Overview of the Audit Process and Pre-engagement Activities chapter 1 - ‘CHAPTER 1: REVIEW QUESTIONS - THEORETICAL Which of the following is an incorrect phrase regarding auditing? a. Auditing is a systematic process. by Auditing subjectively obtains and evaluates evidence. cc. Auditing evaluates evidence regarding assertions. 4. Auditing communicates results to interested users. set the following phases in proper order: 1. Pre-Engagement V. Planning Il, Internal Controls VI, Post-Audit Responsibilities Il. Evidence-Gathering _VII. Reporting IV. Completing the Audit a. LILIULIV, V, VL VI b. LIV, IIL, I, VIL V, VI c, LV, IL IU, 1V, Vil, VE dL 1V, 1,11, V, VL, VI 3, Which of the following procedures is n auditor? a, Risk assessment procedures b. Substantive procedures c, Tests of control d. Analytical procedures 4, Which of the following procedures should be performed by the auditor 2 prior to starting an initial audit? 1. Perform procedures regarding the acceptance of the client relationship and the specific audit engagement. Ik Communicate with the previous auditor, where there has been a change liance with relevant ethical requirements. ot required to be performed by the of auditors, in comp! a, Lonly b. Ionly c, Both Iand Il d. Neither I nor I 5. Confirmation of receivable or bank balance is performed during what phase? a, Studying and evaluating internal controls phase b,, Substantive testing phase c. Pre-engagement phase d. Completing the audit phase 6. Which of the following would not be a consideration of a CPA firm in deciding whether to accept a new client? a, The client's financial ability. b. The client's relations with its previous CPA firm. ¢. The client's standing in the business community. dv The client's probability of achieving an unqualified opinion. 7Chapter 1 ~ Overview of the Audit Process and Pre-engagement Activities 7. Management's integrity affects all of the following risks except: a. Business risk b, Audit risk c. Financial reporting risk d. Allof these risks are affected 8 Prior to the acceptance of an audit engagement with a client who has terminated the services of the predecessor auditor, the CPA should a. Contact the predecessor auditor without advising the prospective client and request a complete report of the circumstances leading to the termination of the engagement with an understanding that ai information disclosed will be kept confidential. b. Accept the engagement without contactin; since the CPA can include audit procedure: by the client for the termination. Not communicate with the predecessor a effect be asking the auditor to violate between an auditor and the client. d, Advise the client of the intention to contact the request a permission for the contact. ig the predecessor auditor to verify the reason given tuditor because this would in the confidential relationship predecessor auditor and 9. When an independent auditor is approached to perform an audit for the first time, he or she should make inquiries of the predecessor auditor. Inquiries are necessary because the predecessor may be able to provide the Successor with information that will assist the successor in determining whether a. The company rotates auditors b, The engagement should be accepted ©. The predecessor's work should be used 4._In the predecessor's opinion, control risk is less than high 10. Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding: a The predecessor's evaluation of matter: significance » Disagreement which the predecessor had with the client concerning auditing procedures and accounting principles ¢ The degree of cooperation the predecessor received concerning the inquiry of the client's legal counsel The predecessor's assessment of inherent risk and judgments about materiality ‘Sof continuing accounting b 11. If the prospective client refuses to permit the predecessor to respond or limits the predecessor's response, the successor should : Continue to ask the predecessor auditor questions on facts that might bear on the integrity of management b. Accept the engagement but only after an equitable increase in the professional feeChapter 1 - Overview of the Audit Process and Pre-engagement Activities G a. 12. Inquire as to the reasons and consider the implications in deciding whether to accept the engagement Issue a disclaimer of opinion because the limited response of the predecessor auditor constitutes a significant scope limitation If permission from the client to discuss its affairs with the proposed auditor is denied by the client, the predecessor auditor should: a. by © a Keep silent of the denial Disclose the fact that the permission to disclosure is denied by the client Disclose adequately to proposed auditor all noncompliance made by the client Seek legal advice before responding to the proposed auditor 13. Which of the following factors would most likely cause a CPA to decide not to accept a new audit engagement? a The CPA's lack of understanding of the prospective client's internal auditor's computer-assisted audit techniques. Management's disregard of its responsibility to maintain an adequate internal control environment. The CPA's inability to determine whether related-party transactions were consummated on terms equivalent to arm’s-length transactions. Management's refusal to permit the CPA to perform substantive tests before the year-end. 14. In deciding whether to accept a new audit client, an auditor considers: I Ml. Ml. Iv. pose 15. Part 1 of the Code of Ethics Part 2 of the Code of Ethics Part 3 of the Code of Ethics Part 4 of the Code of Ethics 1&1V only Iand Ill only Mand Ill only LMl,and1V Ultimately, the decision about whether or not an auditor is independent must be made by av b. c 4. Auditor Client's management Public Audit committee 16. With regard to independence, which of the following statements is correct? ‘Audit engagements provide assurance to a wide range of potential users; consequently, both independence in mind and independence in appearance are of particular importance. : Only the’engagement partner is required by the Code of Ethics to be independent from their assurance clients. 9Chapter 1 - Overview 17. 18. 19. 20. 21. of the Audit Process and Pre-engagement Activities , Code of Ethics requires it ncial statements, the © aan ee team, the firm but not network firms to be member i dent of the client. aap ndits of financial statements, the Code of Ethics requires the aoe cose to be independent from their assurance team from the start of performing procedures required by the engagement up to the issuance of the report. i wing factors most likely would influence an auditor's elton ofthe uatablity ofan entity’ Rina statements? a, The operating effectiveness of control procedures b. The existence of related-party transactions c. The complexity of the accounting system d, The adequacy of the accounting records A firm has obtained information that would have caused it to decline an engagement had the information been available earlier. Actions available to the auditor would include the following, except: a. Reporting the information and its implications to the person/s who appointed the CPA be Withdraw from the client relationship . Withdraw from the engagement d, Issue a disclaimer of opinion According to PSA 210, the auditor and the client should agree on the terms of engagement. The agreed terms would need to be recorded in a(n) a. Memo placed in the permanent section of the working papers b. Client representation letter c. Engagement letter 4. Comfort letter Which of the following statements is/are correct? Statement 1: The auditor and the client should agree on the terms of the engagement, Such an agreement m: ay be in the form of audit engagement letter or other suitable form of contract, Statement 2: Even in those countries where the scope of the audit is established by law, an engagement letter may be informative for the chent, Only statement 1 is correct Only statement 2 is correct Both statements are correct Both statements are incorrect oe 7 av Before the commencement of the engagement b. Before the auditor Teport is issued c. After the audit report is issued At the end of the fieldwork 10Chapter 1 ~ Overview of the Audit Process and Pre-engagement Activities 22. An engagement letter is best described as a. A letter from the company to the auditors specifying management's b. A letter from the auditors to com management is responsible for tl auditors will issue an opinion on the financial statements, ©, A letter from the auditors to company management that specifies the responsibilities of both the company and the auditors in completing the audit and the timing for its completion, d. A letter from the Board of that indicates the auditor the fees to be paid. pany management specifying that he financial statements, and the Directors’ audit committee to the auditor has been engaged to perform the audit and 23. An engagement letter is prepared with the interest(s) of a. The auditor only b. The public c. The client only d, Both the client and the auditor 24. Engagement letters are widely used in practice for: a, Professional engagements of all types. b. Assurance engagements only c. Related services only d. Audits only 25. Which of the following matters is generally included in an auditor's engagement letter? a, The factors to be considered in setting preliminary judgments about materiality b. Management's vicarious liability for illegal acts committed by its employees c, Management's responsibility for the entity's compliance with laws and regulations d. The auditor's responsibility to search for significant internal control deficiencies 26. Arrangements concerning with which of the following are least likely to be included in the engagement letter? a. Fees and billing b. A predecessor auditor c! CPA investment in client securities d. Other services to be provided in addition to the audit 27. An audit engagement letter least likely include: : a. A reference to the inherent limitations of an audit that there is an unavoidable risk that some material misstatements may remain undiscovered b. Description of any letters or reports that the auditor expects to submit to the client 11ter 1 - Overview of the Audit Process and Pre-£n9 jement Activities Chapte Tdeneicanion-of specific euniie precediaran. St the auditor needs to er undertake d. Basis on which 28. When a CPA is the au‘ subsidiary, branch or d n need not be considered in dec letter to the component? peeeWho appoints the auditor of the component Legal requirements oe ether of reports to be prepared during the peak audit season co Whether a separate audit report is to be issued on the component 29, Which of the following statements is/are correct? / Statement 1: On recurring audits, the auditor should consider whether Sreumstances require the terms of the engagement to be revised and Whether there is a need to remind the client of the existing terms of fees are computed and any billing arrangements ditor of a parent entity and also the auditor of its iivision (component), which of the following factors, ing whether to send a separate engagement engagement. Statement 2: The auditor should send a new engagement letter each year to an established client. a. Only statement 1 is correct b. Both statements are correct c. Only statement 2 is correct d. Both statements are incorrect 30. On recurring audit engagements, the auditor may decide not to send a new engagement letter each period. In which of the following situations will there be no need to send anew letter? a. Revisions or special terms of the engagement b. Significant change in nature or size of the client's business c. Indications of misunderstanding of the objective and scope of the audit dv Recent change of middle management and rank and file organizational structure 31. If the auditor concludes that there is reasonable justification for the change in engagement, the report to be issued would a. Include reference to the original engagement by Be appropriate for the revised terms of the engagement c. Includ ‘Teference to any procedures that may have been performed in 4 the original engagement . bee reference to any procedures that may have bee" ed, particularly when the new i indertake agreed-upon procedures ees 12Chapter 1 - Overview of the Audit Process and Pre-engagement Activities 32. Which of the following statements is/are correct? Statement 1: Where the terms of the engagement are changed, the auditor and the client should agree on the new terms, Statement 2: The auditor should not agree to a change of engagement when there is no reasonable justification for doing so, Statement 3: If the auditor is unable to agree to a change of the engagement and Is not permitted to continue the original engagement, the auditor should withdraw and consider whether there is any obligation, either contractual or otherwise, to report to other parties, such as the board of directors or shareholders, the circumstances necessitating the withdrawal a. Only one statement is correct by Only two statements are correct ¢. Allstatements are correct d. Allstatements are incorrect 33. If a change in the type of engagement from higher to lower of assurance is not justified, the auditor should: a. Withdraw from the engagement. b. Qualify the report on the original engagement. . Continue with the revised engagement, but make explicit reference about the original engagement. d. Refuse to agree to management's request on the change of engagement and continue with the original engagement. 34. One of the first things that the auditor will do after accepting a new client is: a. Contact the client's attorney to discover legal obligations. b. Communicate with the predecessor auditor. c. Study the client's internal control structure. d, Tour the client's facilities. 35. Ifa company’s external auditor expresses an unqualified opinion as a result of the audit of the company’s financial statements, readers of the audit report can assume that a. The company is financially sound and the financial statements are accurate b. The external auditor found no fraud ¢._ Internal control is effective d, All material disagreements between the company and the auditor about the application of accounting principles were resolved in the satisfaction of the external auditor. 13