Summary Auditing Theory Chapter 1-15 book "Principles of Auditing "
Auditing Theory (FEM11109)
Erasmus Universiteit Rotterdam
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AT Learning Objectives
Chapter 1: International Audit Overview
Relate Some of the early history of Auditing Discuss some of the Audit expectations of the general public Audit expectation gap: a gap that results from the fact that users of audit services have expectations regarding the duties of auditors that exceed the current practice in professions. Is the company a going-concern?; Is it free from fraud?; Is there integrity? Etc. Identify organizations that affect international accounting and auditing Name the standards set by the International Auditing and Assurance Standards Board (IAASB) o International Standards on Assurance Engagements (ISAEs) – in assurance engagements dealing with subject matters other than historical financial information. o ISAs o International Standards on Quality Control (ISQCs) – relating to the quality of audit applied to all services. o International Standards on Related Services (ISRSs) – applied to compilation engagements; apply agreed-upon procedures to information and other related service engagements. o International Standards on Reviw Engagements (ISREs) – applied to the review of historical financial information. Give an overview of the IFAC International Standards on Auditing (ISA). o Requirements ISA 200: Comply with ethical requirements; Professional skepticism that materially misstated; Professional judgment; Sufficient appropriate audit evidence. o Appropriate in the audit or review of historical financial information Understand the basic definition of auditing in an international context o The objective of an audit of FS to enable the auditor to express an opinion whether the FS are prepared, in all material respects, in accordance with an identified financial reporting framework. The phrases used to express the auditor’s opinion are “give a true and fair view” or ‘ present fairly, in all material respects’. It is systematic process, obtaining and evaluating evidence in regard of the assertions + established criteria and communicating the results to users. Distinguish between the different types of audits o Audit of FS o Operational Audit o Compliance Audit Distinguish between the types of auditors and their training, licensing and authority o Internal auditors o External Auditor o Public/Government auditors o Accountant in Business. Name and categorise the key management assertions.
o Representations by management that are embodied in the FS as used by the auditor to consider the different types of potential misstatement that may occurred. Existence – BS exists Rights and obligations – has control/rights to BS. Occurrence – took place during the period. Completeness – What should have been recorded, is recorded. Valuation – appropriate amount and valuation properly recorded Accuracy – Amounts are recorded appropriately Cut-off – Recorded in the correct period Classification – Recorded in the proper accounts Understandability – appropriately classified and readable. Measurement Presentation and Disclosure – item is disclosed/classified with framework. Give the components of the Audit process model o Phase 1: Client Acceptance o Phase 2: Planning o Phase 3: Testing and evidence o Phase 4: Evaluation and judgment Describe how international accounting firms are organized and the responsibilities of auditors at the various level of the organization.
Chapter 2 The Audit Market
Distinguish between different theories of audit services including Agency theory. o Agency theory: Viewed as contracts in which groups make contribution. Auditor is principal for third parties and management. o Inspired confidence theory: Demand service is consequence of participation of stakeholders (3rd party) in company. For contribution, they demand accountability from managements. Information management might be biased, because of interest, an audit of this information is required. o Policeman theory: Auditor’s job to focus on arithmetical accuracy and prevention and detection of fraud. o Lending Credibility Theory: Audited FS are used by management to enhance the stakeholder’s faith in management’s stewardship Understand drivers for audit regulation o Listed rules for listed companies; money companies; statutory audits. Understand the role of public oversight o Legal liability – check auditor: Common law; Civil liability under statutory law; Criminal liability under statutory law; Liability for members of professional accounting organizations. Distinguish between different audit firms
Discuss the responsibilities of an accounting in public practice in dealing with ethical conflicts that apply to his clients and colleagues. o Provides professional services. State the topics of guidance that are particularly relevant to professional accountants working in industry, commerce, the public sector or education. Summarise the possible disciplinary actions for violation of ethics codes. o IESBA has no authority to require disciplinary action o Penalties reprimand to expulsion or fine/prison.
Chapter 4 An Auditor’s services
Understand the general definition in assurance services o At the request of the client, the auditor provides an assurance report on the controls of the client. Identify the assurance and non-assurance services normally performed by auditors. Explain what an assurance engagements entails o Engagements in which a practitioner expresses a conclusion that is designed to enhance the degree of confidence intended users can have about the evaluation or measurement of a subject matter, which is the responsibility of a party other than the inted users or the practitioner, against criteria. Describe the five elements exhibited by all assurance engagements o Three party relations Practitioner Responsible party Intended users o Subject matter o Suitable criteria o Evidence o Written report Distinguish between the different suitable criteria applicable to an assurance service. o Benchmarks (standards, objectives or set of rules) used to evaluate the subject matter of an assurance engagement. (IFRS; US GAAP; National Standards etc). o Required: Relevance; Completeness; Reliability; Neutrality; Understandability Understand what distinguishes a review from a compilation o Review – The objective of a review of FS engagement is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would be required in an audit, anything has come to the auditor’s attention that causes the auditor to believe that the FS are not prepared, in all material respects, in accordance with an identified financial reporting framework. o Compilation engagement – the accountant is engaged to use accounting expertise as opposed to auditing expertise to collect, classify and summarise financial information. Understand the place of professional judgment in audits
o The application of relevant training, knowledge and experience within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement. Describe professional skepticism o Having a question mind an performing a critical assessment of audit evidence through the audit process. Give the inherent limitations of an audit o Limitation of scope – a limitation of the scope of the auditor’s work may sometimes be imposed by the entity (term engagement specify that the auditor will not carry out the procedure as he believes); by circumstances (timing of the auditor’s appointment makes him unable to observe the counting of physical inventories); in the opinion of the auditor, the entity’s accounting records are inadequate or when the auditor is unable to carry out an audit procedure believed desirable. o Ability to detect material misstatement; Risk by poor control environment. Discuss the requirements of International Standard on Quality Control # o Applies to all firms of professional accountants to audits and reviews, other assurance and related services. o Requirements designed; related guidance. o ISA 220 deals with the quality control procedures for audits FS>
Chapter 5: Client Acceptance
Explain what is meant by client acceptance o Examination of proposed client, to see if there is any reason to object. (Acceptance OF client) and convincing the client to hire (Acceptance BY client) o Decide on acquiring a new client or continuation with existing client o Determine the type and amount of staff Describe the seven primary procedures involved in the client acceptance process o Evaluate the Background and reasons of the client o Determine if auditor is able to meet ethical requirements o Need for other professional o Communicate with predecessor auditor o Prepare client proposal o Select staff to perform audit o Obtain an engagement letter Understand the main reasons for obtaining an understanding of client’s business and industry. o Evaluate the engagements risks o Determining professional and ethical requirements Know the sources of client information and the methods for gathering the information. o Publicly available information; Audit firm experience; Information from client Discuss the ethical and competency requirements of the audit team
o Industry/Regulation/Financial reporting framework; Nature of the entity; Accounting policies; Objectives and strategies; Measurement and review Describe what is done during initial interviews, discussions and site visits with the client. o Checked what objectives, expectations and reports are + Business activities o Observe the core activity, read reports and manuals + view the facilities. Know how legal obligations of the client are investigated. Give examples of management objective, the related strategy and the resultant business risk. Identify the steps in the strategy-oriented framework for understanding the entity. o Understand the client’s strategic advantages o Understand the risks that threaten the client’s objectives o Understand the key processes and related competences to realize advantages o Measure and benchmark process performance o Document the understand of client to create value and generate CF, use a client business model, key performance indicators. o Use comprehensive business knowledge, develop assertions o Compare reported financial results to expectations and design audit tests. List the different types of risk that the auditors must assess in planning. o Inherent Risk o Control Risk o Detection Risk Define each type of risk. o IR= knowing the industry o CR = misstatements not prevented/detected/corrected by IC o DR = an auditor’s substansive procedures that will not detect a misstatement that exist. Understand what is meant by ‘significant Risk’. o A type of business risk that generally relates to judgmental matters and significant non- routine transactions requiring special audit considerations. Know the auditor’s definition of materiality o Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the FS. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Provides a threshold or cut-off point rather than being a primary qualitative characteristics which information must have if it is to be useful. Illustrate the conditions that determine materiality o Size of item o Nature of the item o Circumstances o Materiality level Understand the difference between financial statement fraud and misappropriation of assets. o Intentional act by one/more individuals in misrepresentation of FS.
o Misappropriation – theft of assets. Especially susceptible accounts are inventory and cash Discuss the fraud triangle factors that may lead to fraud. o Perceived pressure = someone believes to commit o Perceived opportunity = favorable circumstances to commit o Rationalisation = self-satisfying but incorrect reasons. Identify responses to fraud assessments o Test appropriateness of journal entries recorded o Review accounting estimates for biases o Review significant transactions outside the normal course Grasp the role of the auditor’s expert in the audit. o Duty to communicate to the management/with governance o Report to third party Be acquainted with the relationship between the external auditor and the auditee’s internal auditor. o Internal function is a service to the entity, perform the activities of the internal audit functions. Be aware of the audit procedures when the entity uses third-party service organization for activities that impact the financial statements. o Part of IS relevant to financial reporting. Must ask management for appropriate persons Comprehend inherent risk and the procedures to assess it. Be familiar with the planning memorandum and audit plan. o Audit plan – work plan that reflects the design and performance of all audit procedures, consisting of a detailed approach for the nature, timing and extent of audit procedures to be performed and the rationale for their selection. The audit plan begins by planning risk assessment procedures and once these procedures have been performed it is updated and changed to reflect the further procedures needed to responds to the results of the risk assessment. Planning memorandum: overview of client company; industry environment; significant audit concern; areas of interest in audit team; audit approach; audit budget.
Chapter 7 Internal Control and Control Risk
Understand the basic definition of internal control o A process, effected by an entity’s board of directors, management and other personnel designed to provide reasonable assurance regarding the achievement of objectives in the following categories: effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations – Committee of Sponsoring Organisations of the Treadway Commission Discuss why internal controls are important to the auditor o To understand the entity and to evaluate the desing o If it can detect and correct material misstatements in classes of transactions
o Hard controls: set of rules; constraints and activities. Tangible character (formal and visible) o Intangible factors – influence behavior of managers and employees. (in culture or climate) Know what is meant by design of controls Follow what an auditor does in preliminary planning assessments of internal control risk o Inquiring; Observing and re-performing application; inspecting; tracing transactions.
Chapter 9 Auditor’s response to assessed risk (ISA 330, ISA 500)
List audit procedures responsive to assessed risk o Design and perform audit procedures: nature; timing and extent to assessed risk. Emphasising professional skepticism; assigning more experienced staff; providing supervision; Incorporating unpredictability; General changes. Know the definition of evidence in an audit and legal sense o Higher the assessment of risk – the more persuasive audit evidence needed. More relevant or reliable. Everything that can make a person believe an assertion is true or false. o In civil law suit the evidence must be strong to incline. In criminal case: beyond reasonable doubt. Audit evidence provides only reasonable doubt. Differentiate between nature, extent and timing of audit procedures o Nature: its purpose&its type o Timing : when performed o Extent: quantity to perform Understand the difference between legal evidence and audit evidence o Legal evidence must be strong enough to incline, audit evidence only provides reasonable doubt. Identify the common management assertions for classes of transactions, account balances and disclosure o Classes of transactions and events: Occurrence; Completeness; Accuracy; Cut-off; Classification o Account Balance: Existence; Rights and obligations; Completeness & Valuation o Presentation and disclosure: Occurrence and rights and obligations; Completeness; Classification and Understandability; Accuracy and valuation Define the management standard assertions: completeness; occurrence; accuracy; rights & obligations; valuation; existence; cut-off; classification; understanding; presentation and disclosure; and measurement Discuss the systematic process of gathering evidence Recognise tests of controls for design and effectiveness o Audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements considering the circumstances
Charaterise a substantive procedure o An audit procedure designed to detect material misstatement at the assertion level. o Alone it is not sufficient appropriate evidence Explain what is meant by the nature, timing and extent of substantive procedures o How controls are applied, inquire, consistency, by whom or what. Tested upon other controls? List and define the two types of substantive procedures o Compromise: Test of details (classes of transactions, account balances and disclosures.) and Substantive analytical procedures Realise the process of search for unrecorded liabilities o On accounts payable = completeness ; evaluation as to valuation. Auditor reviews disbursements for period after BS date. Paid within reasonable time after BS -> potential population. Describe the components of and the meaning of ‘sufficient appropriate audit evidence’ o ISA 500 to draw reasonable conclusions o ISA 200 reduce audit risk o an acceptable low level o Sufficiency & Appropriateness o Results; Source; Responses etc Determine which evidence is relevant and which evidence is reliable o Relevance is the appropriateness o Reliable is the quality when free from material error and bias.
Chapter 10 Audit evidence
Define auditing evidence o The information obtained by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence will compromise source documents and accounting records underlying the FS and corroborating information from other sources Discuss what constitutes accounting records Characterise risk assessment procedures regarding evidence Understand the seven evidence-gathering techniques: inquiry; observations; inspections; re- performance; recalculation; confirmation; and analytical; procedures Discuss evidence-gathering procedures for physical inventory counting; confirmation of AR; and search for unrecorded liabilities o Inquiry; Observation; Inspection; Recalculation; Re-performance; Confirmation; Analytical Procedures. Explain the confirmation process o Response to an inquiry of a third party to corroborate information contained in the accounting records. Process of obtaining and evaluating audit evidence through a direct communication from a third party in response to a request for information about a particular item affecting assertions made by management in the FS
o Commitments: Agreements that entity holds to fixed set of conditions, regardless of what happens. Conduct a review after the BS date for subsequent events and understand what events cause FS adjustments o Subsequent events: between date of FS and auditor’s report. Facts after auditor’s report. o After end before report: Adjustment to FS o After report: No adjustment, but material than disclosures. Know the auditor’s responsibilities when facts are discovered after the issuance of the audit report o Before issuance FS: when amended Carries out procedures; provide new report with amended FS. When not amended: Release a qualified or adverse opinion. Notify governance body to not issue FS and report. Explain the procedures involved in the review of FS including disclosures and other information presented with the audited FS o Obtaining & Understanding procedures established o Inquiring management o Reading minutes of meetings o Reading the entity’s interims FS o Reading latest budgets o Consider if written representations covers up the event. Design and perform the wrap-up procedures o End of audit, when complete. Supervisory review; Final analytical procedures; Working capital review Evaluating audit findings for material misstatements; Client approval of adjusting entries; review of laws and regulation; evaluation of going concern. Determine procedures to evaluate going concern issues o Foreseeable future. In preparation of FS. Inquire management; evaluate proposed future actions; Analyse management cash flows; Request written representation from management. Discuss the design and use of matters for attention of partners o Report by audit managers, reviewed by partners detailing audit decisions and reasons.
Chapter 12 Audit reports and communication
Grasp who has responsibility for the FS and why o Management is responsible for audit report / FS - SOX Understand the basic elements of the auditor’s report: contents and form o ISA 700: Title; Addressee; Introductory paragraph (management responsibility; Auditors Responsibility; Opinion); Report on Other legal and regulatory requirements; Signature; Date; Adressee Explain the contents and importance of the unmodified (Unqualified) audit opinion o FS are prepared, in all material respects, in accordance with framework. – Clean opinion. List the considerations of an auditor in giving an unmodified (unqualified) opinion
Distinguish between the different types of opinions given in audit reports of FS o FS adequately disclosed the policies; Estimates are reasonable; Information is relevant; Disclosures intended users to understand the effect; Terminology used is appropriate; Fair presentation of framework. Describe the circumstances under which the auditor will modify an opinion o When evidence is not material, but could be persuasive. o Unable to obtain sufficient appropriate audit evidence. Possible effect could be material/persuasive. Understand how some uncertainties lead to qualification of opinions in the audit report on FS o Not obtained enough sufficient evidence to give reasonable assurance. Provide circumstances in which the unmodified opinion requires an emphasis of a matter paragraph o After the opinion paragraph: matter being emphasized and disclosures. o Uncertainty upon future: Existence of related party transactions; Accounting matters; Comparability issues; Losses; Regarding going-concern. State the two circumstances that require an auditor’s report containing an opinion other than an unmodified (unqualified) one o Limitation in scope o Auditors judgment about pervasiveness of the effects on matter Discuss the audit matters of governance interest arising from the audit of FS that the auditor must communicate to those charged with governance of an entity o Material weakness in IC; non-compliance; fraud; integrity; general approach; selection/changes in policies. Give details contained in the long-form audit report o Long-form report is to Audit Committee including: Overview Audit Engagement; Analysis of FS; Risk Management and IC; Optional Topics; Auditor Independence and quality control; Fees. List the general content of a management letter o Issues not required to be disclosed in Annual Financial report. – Auditors concerns & suggestions during audit, evaluation present system, problem areas, improvements, discussions may require immediate action. Reasons why an auditor may attend a meeting of the stockholders of a corporation
Chapter 14 Other Assurance and Non-Assurance engagements
Give the distinguishing characteristics of the special area reports o Based on historical financial information; but not FS as a whole or IFRS. Understand what distinguishes a review from a compilation o Review: “nothing has come to our attention” - Negative assurance o Describe the key users of reports on prospective financial information Explain the requirements of internal control reporting standards
Summary Auditing Theory Chapter 1-15 book "Principles of Auditing "
Course: Auditing Theory (FEM11109)
University: Erasmus Universiteit Rotterdam
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