Overview of the Audit Process 1-1

CHAPTER

OVERVIEW OF THE
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
 Overview of the Audit Process 1-2

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.
1-7. 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
 Overview of the Audit Process 1-3

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.

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
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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.