ACCO 30043 Assignment Number 3

I. Answer the following questions briefly and concisely.

1. What are financial statement assertions?
 Financial statement assertions, also known as management assertions,
are explicit or implicit statements made by a business about the
fundamental correctness of the data in its financial statements: the
balance sheet, income statement, and cash flow statement. The
assertions of existence, completeness, rights, and obligations, accuracy
and valuation, and presentation and disclosure are among the various
financial statement assertions attested to by a company's statement
preparer. The assertion of existence means that the assets, liabilities, and
equity balances appearing on the financial statements really do exist and
there has been no overstatement. The assertion of completeness, on the
other hand, claims every item in the financial statements is included and
there are no omissions. Rights and obligations are an assertion that
means that the entity has a legal title or controls on the rights to an asset
or has an obligation to repay a liability. The assertion of accuracy and
valuation is the statement that all figures presented in a financial
statement are accurate and based on the proper valuation of assets,
liabilities, and equity balances. Lastly, when it comes to presentation and
disclosure, the company declares that all appropriate information and
disclosures are included in the financial statements which are both fair and
easy to understand.   

2. Define audit evidence. What are the different sources of evidence?

 Audit evidence is the information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. These include both
information contained in the accounting records underlying the financial
statements and other information. Information contained in the accounting
 records generally includes information that supports and corroborates
management’s assertions and any information that contradicts such
assertions. Accounting records generally include the book of accounts,
checks and electronic fund transfers, invoices, contracts, general and
subsidiary ledgers, worksheets, spreadsheets, and others. Audit evidence
can also be obtained from other sources such as previous audits and a
firm’s quality control procedure for client acceptance and continuance.
Other sources of information that the auditor may use as audit evidence
include minutes of meetings, confirmation from third parties, analysts’
reports, comparable data about competitors, control manuals, and other
information that can be useful in helping the auditor to form an opinion. 

3. What is materiality in the audit process?

 In auditing, the auditor must make judgements about materiality in
determining the nature, timing, and extent of procedures to apply and in
evaluating the results. Information is said to be material if its omission or
misstatement could influence the economic decisions of users taken on
the basis of the financial statements. The concept of materiality is applied
by the auditor both in planning and performing the audit, and in evaluating
the effect of identified misstatements on the audit and of uncorrected
misstatements, if any, on the financial statements and in forming the
opinion in the auditor’s report. In the planning phase, materiality is applied
to identify and assess the risks of material misstatement and also to
determine the nature, timing, and extent of further audit procedures. On
the other hand, materiality is also use in the concluding phase of an audit
to evaluate the effect of uncorrected misstatements, if any, on the financial
statements and in forming the opinion in the auditor’s report.
4. What is audit risk?
 Audit risk is the risk that the auditor may give an inappropriate or incorrect
audit opinion when the financial statements are materially misstated. In
setting the desired audit risk, the auditor must balance the costs of an
incorrect audit opinion and the costs of performing the additional
procedures necessary to reduce audit risk. This step usually involves
obtaining an understanding of the entity and assessing the level of
business risk and then consider the effect of these factors on the risk of
material misstatements at the financial statement level. 

5. What are the components of audit risk? Explain each one briefly.
 The components of audit risk are the risk of material misstatements
(RoMMs) and the risk of not detecting the misstatement. The risk of
material misstatements is the possibility that material misstatements exist
on the financial statements prepared and presented by the entity. Items
contributing to RoMMs are the inherent risk and control risk. Inherent risk
is the susceptibility of an assertion about a class of transaction, account
balance, or class of transactions that could be material before the
consideration of any control. On the other hand, control risk is the
possibility of misstatement that could occur in a transaction or account
balance that could be material and will not be prevented or detected on a
timely basis by the entity’s internal control. The other component of audit
risk is the risk of not detecting the misstatement or the detection risk.
Detection risk is the risk that the auditor’s substantive procedures will not
detect a misstatement that exists in an account balance or class of
transactions that could be material. 
6. Can risk be eliminated? Explain your answer.
 Different risks, especially risks in auditing cannot be eliminated, but
can only be mitigated or reduced to an acceptable level. The nature of
audit procedures itself proves that some risks will always exist.
Auditors, for example, frequently sample a specific sort of firm
transaction because it is impractical to examine every transaction.
Although increasing the sample size can minimize the likelihood of
detection, there will always be some risk. What the auditor can do to
lower the level of different risks is to design tests or policies and
procedures and apply sampling to help give reasonable assurance that
a control is in place and operating effectively.

7. What activities does the auditor perform during the initial phase of the audit
engagement?
 The first phase of an audit process is the preliminary engagement
activities where it will require a decision from an auditor whether or not
to accept a new client or continue the relationship with an existing one.
This process will require the evaluation of the auditor’s qualification as
well as the integrity and auditability of the client’s financial statements.
The activities required to be done during the initial phase of the audit
engagement are first, to 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. Next, is to consider
whether there are any threats to the firm or auditor’s independence
and objectivity, and the safeguards needed to be established to
maintain it. The firm will also need to evaluate its ability to serve a
prospective client properly. In addition, the auditor should also evaluate
the auditability of the prospective client and check whether it has
sufficient records, documents, etc., and if it is readily available for the
auditor. Moreover, the auditor must investigate the integrity of the
 prospective client’s management by either reading published articles,
inquiry to appropriate parties, and communicating with the previous
auditor. Lastly, based on consideration of different factors, the auditor
must decide whether to accept or decline the client and if the auditor
decided to accept the client, the auditor and the client shall agree on
the terms of the engagement and prepare an engagement letter. 

8. What are the situations that we do not continue or reject the audit
engagement?
 During the preliminary engagement phase of auditing, the process
includes the evaluation of the integrity and auditability of the client’s
financial statements. If the auditor found out based on his evaluation
that the client has some weighty issues, the auditor can decline the
client or discontinue its engagement. Some circumstances that cause
a firm to withdraw or discontinue from an audit engagement is there
are some concerns about the integrity of the client’s management or
the withholding of evidence that is requested during an audit. A client’s
refusal to correct material misstatements in the financial statements is
another implication that a firm might withdraw from an audit
engagement. Another situation is when a client refuses to take
appropriate steps to remedy fraud or illegal acts discovered during an
audit. A disagreement when it comes to audit fees is another cause of
discontinuity of an audit engagement. Conflicts over accounting and
auditing issues are another indication that a firm might stop its audit
engagement with the client.  

9. What is the importance of an engagement letter?

 When an auditor decided to accept a client, the auditor and the client
shall agree on the terms of the engagement. The engagement letter
serves as a written contract between the auditor and the client,
outlining and communicating clearly the respective responsibilities of
 the client and the auditor to prevent misunderstanding between the two
parties. It also confirms the acceptance of the auditor of the audit
engagement and includes the objective and the scope of the
engagement, management responsibilities, auditor’s responsibilities,
the form of any reports and the limitations of the engagement. A letter
of engagement serves the same purpose as a contract between two
parties. In addition, because of an engagement letter, the client has the
peace of mind of knowing when and how much a service will cost. The
letter also clarifies if there are any other expenditures that are not
covered by the agreement, such as essential software that the client
must acquire independently.

10. What is the product of the audit process? Cite instances when it is
appropriate to issue each type of audit report.
 The product of an audit process is what we called an audit report. It is
a written report where the expression of the audit opinion is contained.
There are four known types of auditor’s reports which are unmodified/
unqualified opinion, qualified opinion, adverse opinion, and disclaimer
of opinion. An auditor might issue an auditor’s report with unmodified/
unqualified opinion when the financial statements are presented fairly,
in all material respects, per the applicable financial reporting
framework. On the other hand, the auditor shall express a qualified
opinion when the auditor concludes that misstatements, individually or
aggregate, are material, but not pervasive, to the financial statements,
or when the auditor is unable to obtain sufficient appropriate evidence
on which to base the opinion, and the possible effects of the financial
statements of undetected misstatements are material but not
pervasive. Auditor’s report with an adverse opinion is issued when the
auditor concludes that the misstatements, that are material individually,
or in the aggregate, are pervasive to the financial statements. Lastly,
an auditor shall disclaim an opinion on the financial statements when
 the auditor is unable to obtain sufficient appropriate evidence on which
to base the opinion, and the possible effects on the financial
statements of that inability are both material and pervasive. 

II. For each of the following descriptions, indicate which type of audit
(financial statement audit, audit of internal control, compliance audit, operational audit,
or forensic audit) best characterizes the nature of the audit being conducted. Also
indicate which type of auditor (external auditor, internal auditor, government auditor, or
forensic auditor) is likely to perform the audit engagement.

a. Evaluate the policies and procedures of the Food and Drug Administration in terms of
bringing new drugs to market.

 Operational Audit; Government Auditor

b. Determine the fair presentation of Ajax Chemical’s balance sheet, income statement,
and statement of cash flows.

 Financial Statement Audit; External Auditor

c. Review the payment procedures of the accounts payable department for a large
manufacturer.

 Compliance Audit; Internal Auditor

d. Examine the financial records of a division of a corporation to determine if any

accounting irregularities have occurred.

 Forensic Audit; Forensic Auditor

e. Evaluate the feasibility of forecasted rental income for a planned low-income public
housing project.

 Operational Audit; Government Auditor

f. Evaluate a company’s computer services department in terms of the efficient and

effective use of corporate resources.
  Operational Audit; External Auditor

g. Audit the partnership tax return of a real estate development company.

 Compliance Audit; Government Auditor

h. Investigate the possibility of payroll fraud in a labor union pension fund.

 Forensic Audit; Forensic Auditor