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Chapter 4

Engagement Planning

"Vision without action is a daydream.

Action without vision is a nightmare.”

- - Japanese Proverb

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Chapter 4 Learning Objectives

1. List and describe the activities auditors undertake before beginning an engagement.

2. Identify the procedures and sources of auditors can use to obtain knowledge of a client’s business and industry.

3. Perform analytical procedures to identify potential problems.

4. List and discuss matters of planning auditors should consider for clients who use computers and describe how a computer can be used as an audit tool.

5. Review audit documentation for proper form and content.

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Goals of Planning

• Obtain (or update) an understanding of IMPORTANT EVENTS that have affected the client and its operations

• Identify areas of the audit engagement that may represent SPECIAL RISKS to the auditor

• Ensure that the audit is completed in a TIMELY fashion

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Pre-Engagement Arrangements

• Client selection and retention

• Communication between predecessor and successor auditors

• Engagement letters• Staff assignment• Time budget

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Understanding the Client’s Business

• Methods and sources of information– Inquiry, including prior year working

papers– Observation– Study

• Other aspects of planning– Materiality and planning– First-time audits– Internal auditors– Identification of related parties– Specialists– Analytic procedures

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Planning Memorandum

• Summary of planning procedures

• Considerations– Audit or review

– Need for specialists

– Staff assignment and timing schedules

– Assessed level of control risk

– Significant client or industry risks

– Utilization of internal auditors

– Identification of unusual accounting principle problems

• Basis for audit program

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PRELIMINARY ANALYTIC PROCEDURES

RECORDED ACCOUNT BALANCE

ESTIMATED ACCOUNTBALANCE

• Attention directing – Identify potential problem areas

• An organized approach– A standard starting place to start examining the financial statements

• Describe the financial activities – Identify unusual changes in relationships in the data

• Ask relevant questions– What could be wrong?– What legitimate reasons are there for these results?

• Cash flow analysis

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Analytic Procedure Steps

1. Develop an expectation.

2. Define a significant difference.

3. Calculate predictions and compare them with the recorded amount.

4. Investigate significant differences.

5. Document each of the above steps.

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Analytic Procedures:Sources of Information

Analytic Procedures Sources of Information

Comparison of current-year account balances to those of one or more comparable periods

Financial account information for comparable periods.

Comparison of the current-year account balances to anticipated results found in the company’s budgets and forecasts.

Company budgets and forecasts.

Evaluation of the relationships of current-year balances to other current-year balances for conformity with predicable patterns based on the company’s experience.

Financial relationships among accounts in the current period (ratios).

Comparison of the current-year account balances and ratios with similar industry information.

Industry statistics.

Study of the relationships of current-year balances with relevant nonfinancial information (e.g., production statistics).

Nonfinancial information, such as production statistics.

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Analytic Procedures: Stages of Use

• Preliminary -- required• Substantive testing -- optional• Final Review -- required

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Effect of Electronic Environment on Audit Engagement

• The definition of auditing is not changed.• The purposes of auditing are not changed.• The generally accepted auditing standards are not changed.• The assertions of management embodied in financial

statements are not changed.• The control objectives are not changed.• The requirement to gather sufficient competent evidence is

not changed.• The independent auditor's report on financial statements is

not changed.

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What has changed?

• The auditor must evaluate the impact of technology on the client’s operations.

• The auditor must evaluate computer controls implemented by the client in the auditor’s study and evaluation of the client’s internal controls.

• The auditor can use the computer’s speed and accuracy to assist in the audit.

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Effect of Computer Processing on Transactions• Transaction trails• Uniform processing of transactions• Segregation of duties• Potential for fraud• Potential for increased management

supervision• Initiation or subsequent execution of

transactions by computer

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Planning considerations

• Extent to which computers are used

• Complexity of computer operations

• Organizational structure of computer processing

• Availability of data

• Use of CAATS

• Need for specialized skills

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Computer Assisted Audit Tools and Techniques (CAATTs)

• CAATTs - the use of software to perform audit procedures • With CAATTS, the auditor is able to access and extract client

information without disrupting data processing• Some CAATTs Procedures:

– Calculate field statistics (totals, high, low and average value)– Performing complex recalculations – Join, concantenate and compare different files– Perform detailed analysis

• Stratification• Gap and duplicate key detection• Sample selection

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Audit Documentation (PCAOB 3)• Definition

– The written record of the basis for the auditor’s conclusions that provides the support for the auditor's representations, whether those representations are contained in the auditor's report or otherwise.

• Objectives– Improve audit quality– Enhance public confidence

• Contents – Planning and performance of the work– Procedures performed– Evidence obtained– Conclusions reached by the auditor

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Purposes of Audit Documentation

• Integral part of audit quality• Nature timing and extent of work performed• Professional judgments• Basis for conclusion• Facilitates planning, performance and

supervision• Provides basis for review

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Audit Documentation Files

• Current

• Permanent

• Prior Year Working Papers

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APOLLO SHOES, INC. C-1Inventory Lead Schedule

APOLLO SHOES, INC. B-1Accounts Receivable Lead Schedule

Exhibit 4-5Current File

APOLLO SHOES, INC. A-3Bank Confirmation

APOLLO SHOES, INC. A-2First National Bank Reconciliation

APOLLO SHOES, INC. A-1Cash Lead Schedule12/31/04

Ref Account Unaudited AJE BalanceC-1 1rst Natl $484,000 $50,000 $534,000

APOLLO SHOES, INC. TB-1Working Trial Balance12/31/04

Ref Account Unaudited AJE BalanceA-1 Cash $484,000 $50,000 $534,000B-1 A/R C-1 Inventory

APOLLO SHOES, INC. TB-2Adjusting Entries

dr crCash $50,000 Expenses $50,000

Other Lead Schedules

Supporting Schedules

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Audit Documentation Requirement

• Audit documentation should be prepared in sufficient detail to provide a clear understanding of its purpose, source, and the conclusions reached.

• Clear link to significant findings or issues.• Demonstrate

– Compliance with PCAOB standards– Support basis for conclusions on every relevant

assertion– Accounting records agreed with financial statements

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Significant Findings or Issues

• Selection, application and consistency of accounting principles, including disclosures,

• Results of procedures that indicate need for significant modification of procedures, existence of material misstatements, significant deficiencies in controls

• Audit adjustments• Disagreements• Circumstances that cause significant difficulty• Significant changes In assessed audit risk• Matters that could result in report modification

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4-22Exhibit 4-6Audit Documentation

• Information on Workpaper– Name, date, purpose, page

number– Procedures performed and

conclusions reached by the auditor

• Evidence that auditor followed general standards and standards of field work

• Audit Mark Legend

– Reviewers’ initials

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Documentation Requirement

• Sufficient to enable an experienced auditor, having no previous connection with the engagement, to:– Understand the nature timing, extent and

results of procedures, evidence and conclusions

– Determine who performed the work, date of work, reviewer and date of review

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Specific Audit Documentation Matters

• Should include identification of items inspected, confirmed or tested.– Satisfied by indicating source and selection criteria.

• Documentation of inspected agreements should include abstracts or copies.

• Should include contradictory information found– Information the auditor has identified relating to significant

findings or issues that is inconsistent with or contradicts the auditor’s final conclusions.

• Procedures performed in response.• Records documenting consultation on or resolutions of differences

among team and with others consulted.

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Engagement Completion Document (PCAOB 3)

• Include all significant findings or issues.• Include items identified during interim review.• Must have completed all necessary procedures and

obtained sufficient evidence before report release date.

• Documentation should be complete (documentation completion date) no more than 45 days after report release date.

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Documentation Retention (PCAOB 3)• Seven years from report release date.

– If no report—from last day of fieldwork

• Additions/Amendments– Documentation may not be deleted or discarded

after report release date.– Additions must indicate

• date the information was added, • Name of preparer• Reason

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Specific Documentation Retention Requirements (PCAOB 3)

• Issuing office must retain prior to report release date– Engagement completion

document– List of significant fraud risk

factors, responses and results of related procedures

– Inconsistent or contradictory information

– Finding affecting consolidating or combining of accounts

– Information to reconcile amounts audited by other auditors to consolidated financial statements

– Schedule of audit adjustments

– All significant control deficiencies and material weakness and clear distinction between categories

– Representation letters– Matters to be communicated

to audit committee

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Audit Documentation Review

• Hierarchical review process• Reviewers include

– New auditors

– Supervisory personnel

– Engagement supervisors and quality reviewers

– Successor auditor

– Inspection teams

– Others including advisors engaged by the audit committee or parties to an acquisition

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Other Issues Related to Audit Documentation

• Ownership– Auditors maintain ownership, even after auditor-client

relationship is over.• Confidentiality

– Only can be made public with permission, or if subpoenaed, or as part of a peer review of firm practices, or as part of an ethics investigation of firm personnel.