Gloria Ivana - 211526334

Audit Engagement and Audit Planning

HAR Ch.6; BJK Ch. 7; TUA Ch. 15, 16

Key Points :
1. Accept or reject clients
2. Make an Audit Planning
3. Assess the Client's Business Risk
4. Understand the Entity and its Environment

[CLIENT ACCEPTANCE AND RETENTION]

During deciding the client acceptance and retention, auditor should identify why the client requested
to be audited and analyze the client. there are steps that CPA firms should take to ensure acceptance
of only those audit engagements that can be completed in accordance with all applicable professional
standards

1. Evaluate the integrity of management

: auditor should accept an audit engagement only if the management can be trusted to reduce
the risk of material errors or fraud that may occur
● Communicate with the Predecessor Auditor Before accepting the engagement, A
successor auditor needs the knowledge of client’s management by the predecessor auditor.
In the communication, the successor auditor should make specific and reasonable inquiries
regarding matters that may affect the decision to accept an engagement, such as:
➢ Information that might bear on the integrity of management.
➢ Disagreements with management about accounting principles and auditing
procedures.
➢ Communications to audit committees or others with equivalent authority and
responsibility regarding fraud, illegal acts by clients, internal control related matters,
and quality of accounting principles.
➢ The predecessor’s understanding of the reasons for a change in auditors.
● Make Inquiries of Other Third Parties Information about management’s integrity may also
be obtained from knowledgeable persons such as attorneys, bankers, and others in the
financial and business community who have had business relationships with the prospective
client.
● Review Previous Experience with Existing Clients Before making a decision to continue
an engagement with an audit client, the auditor should carefully consider prior experiences
with the client’s management. For example, the auditor should consider any material errors,
fraud, or illegal acts discovered in prior audits.

2. Identifying Special Circumstances and Unusual Risks

● Identify Intended Users of Audited Statements points out that the auditor’s legal
responsibilities in an audit may vary based on the intended users of the statements. Thus, the
auditor should consider any named beneficiaries or foreseen or foreseeable third parties
regarding whom the potential for liability exists under the common law.
● Assess Prospective Client’s Legal and Financial Stability If an entity experiences legal
difficulties, as discussed above, such litigation will likely involve the auditors, who are often
thought to have “deep pockets.” Thus, auditors may incur the financial and other costs of
defending themselves no matter how professionally they perform their services.
● Identify Scope Limitations When considering whether to accept an engagement, the auditor
should evaluate whether any scope limitations increase the risk that he or she may not be
able to issue an unqualified opinion.
● Evaluate the Entity’s Financial Reporting Systems and Auditability Before accepting an
engagement, the auditor should evaluate whether other conditions exist that raise questions
 as to the prospective client’s auditability. Such conditions might include the absence, or poor
condition, of important accounting records, the absence of a sufficient audit trail, or
management’s disregard of its responsibility to maintain other elements of adequate internal
controls.

3.Assessing Competence to Perform the Audit

before accepting an audit engagement, auditor should identify the key members of the audit
team and considering the need to seek assistance from consultants and specialists during the
course of the audit
● Services Desired Most clients that need an audit also require additional services. Smaller
organizations that do not have a CPA working within the organization may require a variety of
accounting services, such as having the auditor perform key accounting work, make journal
entries, or draft the financial statements.
● Identify the Audit Team
The typical audit team consists of:
1. A partner, who has both overall and final responsibility for the engagement.
2. One or more managers, who usually have significant expertise in the industry and
who coordinate and supervise the execution of the audit program.
3. One or more seniors, who may have responsibility for planning the audit, executing
parts of the audit program, and supervising and reviewing the work of staff assistants.
4. Staff assistants, who perform many of the required audit procedures.
● Consider Need for Consultation and the Use of Specialists In determining whether to
accept an engagement, it is appropriate for an auditor to consider using consultants and
specialists to assist the audit team in performing the audit.

4. Evaluate Independence: auditing firm should :

Identify Circumstances Impairing Independence
Identify any prohibited Financial or Business Relationships
Determine that acceptance of the client wouldn’t result in any Conflicts of Interest with Other Clients

5. Making the decision to accept or decline the audit

common reasons for refusing to accept an audit client include :
● integrity of management
● special risks such as scope limitations audibility concerns or disagreements with predecessor
auditors (Special circumstance and unusual risks)
● problems associated with obtaining the necessary expertise for the audit (competence issue)
● independence problems.

Circumstances that might cause a firm to withdraw from an audit might include:
● Concerns about the integrity of management or the withholding of evidence that surfaces
during the audit.
● The client’s refusal to correct material misstatements in the financial statements.
● The client’s failure to take appropriate steps to remedy fraud or illegal acts discovered during
the audit.
Ideally, a CPA firm will make decisions about the continuation of audit clients before commencing the
engagement. However, if there are concerns about the integrity of management, withholding
 evidence, or other auditability problems, they should be brought to a partner’s attention. A CPA firm
will usually consult with outside legal counsel when considering whether it should withdraw from an
engagement in progress.

6. Prepare the engagement Letter

● Clear identification of entity and financial statements to be audited
● Objective or purpose of the audit
● Reference to professional standards to be followed
● Explain nature and scope of audit and auditor’s responsibilities
● Statement that not all material fraud may be detected
● Reminder of management responsibility for financial statements and internal controls
● Indicate potential request for written representations
● Describe any auxiliary services to be provided
● Basis on which fees will be computed and billing arrangements
● Request to confirm terms of engagement by signing and returning a copy to the auditor

here are the Factor that influence client acceptance and retention :
[AUDIT PLANNING AND RISK ASSESSMENT PROCEDURES]
Audit planning involves performing risk assessment procedures, assessing the risk of material
misstatement in the financial statements, and developing an overall audit strategy to respond to those
risks.
Supervision involves directing the assistants on the audit team who participate in completing the
various phases of the audit.

Steps in performing risk assessment procedures

Auditor also required to make documentation of their audit planning. Auditor has to :
1. Overall audit strategy
2. audit plan
3. any significant changes made during the audit engagement to the audit strategy or audit plan,
and the reasons for making those changes
 documentation can use memos, standard audits, or a list of testers in the audit completion
checklist

[UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT]

auditor use this information to :
1. develop a knowledgeable perspective about the entity and its financial statements.
(attempting to develop expectations about amounts and disclosures that should be reported in
the financial statements)
2. knowledge of the entity and its environment will assist the uditor in assessing the risk of
material misstatement.
Here’s the key factor associated with understanding the entity and its environment along with
(1) how the auditor uses this information to develop a knowledgeable perspective about the entity
(2) assesses the risk of material misstatement

Industry, regulatory and other external factors

The following discussion addresses how the auditor would use knowledge of industry condition, the
client’s regulatory environment, and other external factors affecting the client’s business, when
planning the audit.
Industry Conditions includes understanding the market for a client’s products, the competition,
the entity’s and competitor’s capacity relative to market conditions, and price competition. For
example, if an entity has high fixed cost, low contributions margins, and is faced with intense price
competition, the auditor should expect the company to be financially challenged.
Regulatory Environment including the degree to which the entity and its products or services are
regulated by government or private agencies. For example, the pharmaceutical
Other External Factors Affecting the Entity’s Business include the general level of economic
activity, changes in interest rates, availability of financing, and other broad economic factors such
as inflation or currency revaluation.

The Nature of the Entity and Accounting Policies

the following discussion addresses both what the auditor should understand and how the auditor
would employ this knowledge in audit planning
● Business Operations. business operations includes understanding such matters as the
entity’s:
 - Method of obtaining revenues (e.g., manufacturing, retailing, import-export trading,
banking, utility, etc.).
- Products or services and markets (e.g., major customers and contracts, terms of
payment, profit margins, market share, competitors, exports, pricing policies,
reputation of products, warranties, back orders, marketing strategy, and objectives).
- Conduct of operations (e.g., stages and methods of productions, business segments,
fixed vs. variables costs, details of declining or expanding operations).
- Location of production facilities, warehouses, and offices.
- Employment (e.g., wages levels, union contracts, postemployment benefits, incentive
bonus programs and government regulation related to employment matters).
- Transactions with related parties.
● Investments. investing activities includes understanding the entity’s:
- Capital investment activities, including investments in plant and equipment and
technology, and any recent or planned changes.
- Acquisitions, mergers, or disposals of business activities (planned or recently
executed).
- Investments and disposition of securities and loans.
- Investments in unconsolidated entities, including partnerships, joint ventures, and
special-purpose entities.
● Financing. financing activities includes understanding the entity’s:
- Debt structure, including covenants, restrictions, guarantees, and off-balance sheet
financing arrangements.
- Group structure—major subsidiaries and associated entities, including consolidated
and unconsolidated structures.
- Leasing of property, plant, and equipment for use in the business.
- Beneficial owners.Use of derivative financial instruments.
● Financial Reporting. financial reporting activities includes understanding such matters as the
entity’s:
- Accounting principles and industry-specific practices.
- Revenue recognition practices.Accounting for fair values.
- Inventories (e.g., locations and quantities).
- Industry-specific significant accounts and transaction classes (e.g., loans and
investments for banks, accounts receivable and inventory for manufacturers,
research and development for pharmaceuticals).
- Accounting for unusual or complex transactions, including those in controversial or
emerging areas, for example, accounting for stock-based transactions.
- Financial statement presentation and disclosure.

Entity’s Objectives, Strategies, and Related Business Risks

these terms are defined as :
● An entity’s objectives are the overall plans for the entity as defined by those charged with
governance and management.
● An entity’s strategies are the operational approaches by which management intends to
achieve it objectives.
● Business risks result from significant conditions, events, circumstances, or actions that could
adversely affect the entity’s ability to achieve its objectives and execute its strategies.

Objectives, Strategies, and Related Business Risks and the Effects of Implementing a Strategy
● Industry developments (potential related business risk: the entity does not have the
personnel or expertise to deal with the changes in the industry).
● New products and services (potential related business risk: increased product liability)
● New accounting requirements (potential related business risk: incomplete or improper
implementation and increased costs).
 ● Regulatory requirements (potential related business risk: increased legal exposure).
● Current and prospective financing requirements (potential related business risk: loss of
financing due to inability to meet requirements).
● Use of information technology (potential related business risk: systems and processes not
compatible).
● The effects of implementing strategy, particularly any effects that will lead to new
accounting requirements (potential related business risk: incomplete or improper
implementation).

measurement and review of the entity’s financial performance

internal and external measures. Such measures might include:
● Key ratios and operating statistics
● Key performance indicators
● Employee performance measures and incentive compensation plans
● Industry trends
● The use of forecasts, budgets, and variance analysis
● Analyst reports and credit rating reports

Analytical Procedures
Analytical procedures are an assessment of the accounting information contained in the books by
calculating ratios and developing other relationships to be compared with the expectations developed
by the auditor.

In analytical procedures, the auditor compares the client's data with:

1. industry data
2. data similar to the previous period
3. client's expected results
4. the results of the auditor's expectations
5. expected results with non-financial data