ACYAUDI: The Audit Process - Accepting an Engagement

Financial Statement Assertions

The implicit or explicit assertions made by the management in representing that financial statements are in accordance with the applicable financial reporting framework. It regards recognition, measurement, and presentation of classes of transactions and events, account balances and disclosures.

Financial Statement Assertions

The auditor uses these to consider the different types of potential misstatements that may occur in the financial statements.

Rights and Obligation, Valuation and Allocation, Presentation and Disclosure, Existence or Occurrence, and Completeness

These are the classifications of financial statement assertions.

Rights and Obligations

Assert that the entity has rights over the reported assets and that it has valid obligation to settle the reported liabilities. An example of an audit procedure to test this assertion is to examine ownership documents such as certificate of title for real property.

Valuation and Allocation

Assert that assets and liabilities are properly valued and that revenues and expenses are properly measured.

Recalculation

A typical audit procedure to test the assertion of valuation and allocation. Mostly focuses on FS values such as depreciation, accrued interest, and amortized costs of financial assets and liabilities.

Presentation and Disclosure

Assert that assets and liabilities are properly classified and that disclosures in the notes to the FS are adequate.

Presentation and Disclosure

Testing this assertion will require the application of the relevant accounting standards. In addition, the auditor may review major contracts such as loan agreements to identify important information that needs to be disclosed in the notes to the FS.

Existence or Occurrence

Assert that assets and liabilities exist as of the financial statement date and that revenues and expenses occurred during the reporting period.

AVOE/OS

Mnemonic for existence or occurrence (Accounting records -> Vouching -> Overstatement -> Existence/Occurrence -> Source Documents)

Physical Examination or Ocular Inspection of the Asset

One of the most effective audit procedures to test the existence of an asset.

External Confirmation

An audit procedure to be resorted in circumstances where physical examination is not feasible, the auditor may obtain evidence about the existence of an asset.

Completeness

Assert that all items that should be reported in the financial statements are so included. A typical procedure to satisfy this assertion is to start with source documents such as sales invoice and determine if it is recorded in the sales journal

STUCA

The mnemonic for the Completeness assertion (Source Documents -> Tracing -> Understatement -> Completeness -> Accounting Records)

Existence/Occurrence Assertion

Is concerned with the potential overstatement of accounts.

Completeness Assertion

Is concerned with potential understatement of accounts.

Completeness Assertion

When the auditor traces items from the source documents to the accounting records, the auditor is obtaining evidence that at all transactions (as represented by source documents) have been completely recorded.

Existence/Occurrence Assertion

When the auditor works from the accounting records back to the supporting documents, the auditor is obtaining evidence that the recorded items exist and are supported by documents.

Tracing

___________ forward from the source documents to the accounting records is performed primarily to test for understatements. This procedure will satisfy the completeness assertion.

Vouching

Is performed primarily in order to satisfy the existence/occurrence assertion. It is performed to test for possible overstatement of an account.

Occurrence, Completeness, Accuracy, Cutoff and Classification

These are the assertions about classes of transactions and events for the period under audit.

Occurrence

Transactions and events that have been recorded have occurred and pertain to the entity.

Completeness

All transactions and events that should have been recorded have been recorded.

Accuracy

Amounts and other data relating to recorded transactions and events have been recorded appropriately.

Cutoff

Transaction and events have been recorded in the correct accounting period.

Classification

Transaction and events have been recorded in the proper accounts.

Existence, Rights and Obligations, Completeness, and Valuation and Allocation

These are assertions about account balances at the period end.

Existence

Assets, liabilities, and equity interests exist.

Rights and Obligations

The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.

Completeness

All assets, liabilities and equity interests that should have been recorded are in fact recorded.

Valuation and Allocation

Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

Occurrence and Rights & Obligations, Completeness, Classification and Understandability, and Accuracy and Valuation

These are assertions about presentation and disclosure.

Occurrence and Rights and Obligations

Disclosed events, transactions, and other matters have occurred and pertain to the entity.

Completeness

All disclosures that should have been included in the financial statements are in fact included.

Classification and Understandability

Financial information is appropriately presented and described, and disclosures are clearly expressed.

Accuracy and Valuation

Financial and other information are disclosed fairly and at appropriate amounts.

Inspection, Observation, Inquiry, Confirmation, Computation, and Analytical Procedures

These are the following specific audit procedures.

Inspection

Involves examining of records, documents, or tangible assets.

Observation

Consists of looking at a process or procedure being performed by others.

Inquiry

Consists of seeking information from knowledgeable persons inside or outside the entity.

Confirmation

Consists of the response to an inquiry to corroborate information contained in the accounting records.

Computation

Consists of checking the arithmetical accuracy of source documents and accounting records or performing independent calculations.

Analytical Procedures

Consist of the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predicted amounts.

Audit Procedures

Are the means used by the auditor to obtain sufficient appropriate evidence.

Audit evidence

Refers to the information obtained by the auditor in arriving at the conclusions on which the audit opinion is based.

Audit evidence

Will comprise source documents and accounting records underlying the financial statements and corroborating information from other sources. This evidence will either prove or disprove the validity of the assertions made by management on the financial statements.

Audit Opinion

The evaluation and opinion of the auditor on the fair presentation of financial statements, after the results of the audit procedures are performed and the audit evidence is obtained.

Audit Process

The sequence of different activities involved in an audit.

Accepting an Engagement, Audit Planning, Consideration of Internal Control, Performing Substantive Tests, Completing the Audit, and Issuing a Report

The following steps in the audit process.

Accepting an Engagement

Making a decision of whether to accept or reject an audit engagement. This process requires evaluation of the auditor's qualification as well as the auditability of the prospective client's financial statements.

Accepting an Engagement

A preliminary understanding of the client's business and background investigation of a prospective client are usually performed at this stage of the audit.

Accepting an Engagement

The procedures performed at this stage of the audit are referred to in PSA 300 as the Preliminary Engagement Activities.

Preliminary Engagement Activities

Would involve:

a. Performing procedures regarding the continuance of the client relationship and the specific audit engagement.

b. Evaluating compliance with ethical requirements, including independence.

c. Establishing an understanding of the terms of the engagement.

Audit Planning

The auditor obtains more detailed knowledge about the client's business and industry.

Knowledge of the Client's Business and Industry

Is important because it helps the auditor in understanding the transactions and events affecting the financial statements. Such knowledge also helps in the early identification of the potential problems that might be encountered in the audit.

Understanding of the Client and the Assessment of Risk and Materiality

Should enable the auditor to develop an overall audit plan and a detailed approach for the expected conduct and scope of the audit.

Considering the Internal Control

Is required since the condition of the entity's internal control directly affects the reliability of the financial statements.

True

(True or False) The stronger the internal control is, the more assurance it provides about the reliability of the accounting data and the financial statements.

Consideration of Internal Control

Involves obtaining understanding of the entity's internal control systems and assessing the level of control risk.

Control Risk

Risk that the client's internal control may not prevent or detect material misstatements in the financial statements.

True

(True or False) If the auditor decides to assess control risk at less than high level, sufficient appropriate audit evidence must be obtained to prove that the internal control is functioning effectively and that it can be relied on.

Tests of Controls

Needed by an auditor who relies on the internal controls of the client, so that such an auditor can gain evidence that the company's controls can be relied on.

Substantive Tests

Needed to obtain reasonable assurance that the financial statements are presented fairly in accordance with the applicable financial reporting framework.

Substantive Tests

Are audit procedures designed to detect material misstatements in the the financial statements.

True

(True or False) The nature, timing and extent of the substantive tests are highly dependent on the results of the auditor's consideration of internal control.

True

(True or False) If based on the evaluation of internal control, the auditor has obtained evidence that the internal control is functioning effectively; the scope of the auditor's substantive tests can be reduced.

Completing the Audit

After the auditor has completed testing the account balances, the auditor performs additional audit procedures to complete the audit and become satisfied that the evidence gathered is consistent with the opinion to be expressed in auditor's report.

Completing the Audit

Some of the common procedures performed at this stage of the audit include review of subsequent events and contingencies, assessing the appropriateness of the use of the going concern assumption, performing overall analytical review procedures, and obtaining written representations from the client's management.

Issuing a Report

On the basis of audit evidence gathered and evaluated, the auditor forms a conclusion about the financial statements.

Accepting an Engagement

In making this decision, the firm should consider:

a. Its competence

b. Its independence

c. Its ability to serve the client properly

d. The integrity of the prospective client's management

e. The adequacy of the accounting records

Competence

It is acquired through a combination of education, training and experience. Before accepting an audit engagement, the auditor should 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 or whether such competence can be obtained before the completion of the audit.

Independence

It is essential to the credibility of the auditor's report. Before accepting an engagement, the auditor should consider whether there are any threats to the audit team's independence and objectivity and, if so, whether adequate safeguards can be established.

Ability to Serve the Client Properly

An engagement should not be accepted if there are no enough qualified personnel to perform the audit.

PSA 220 requires that audit work be assigned to personnel who have the appropriate capabilities, competence and time to perform the audit engagement in accordance with the professional standards. In addition, there should be sufficient direction, supervision and review of work at all levels in order to provide reasonable assurance that the firm's standard of quality is maintained in the performance of the engagement.

Integrity of Management

PSA 220 requires the firm to conduct a background investigation of the prospective client in order to minimize the likelihood of association with clients whose management lacks integrity.

This would involve:

a. Making inquiries of appropriate parties in the business community.

b. Communicating with the predecessor auditor.

Communicating with the Predecessor Auditor

This communication allows the successor auditor to obtain information about the client that will be useful in determining whether the engagement will be accepted.

The successor auditor should obtain the client's permission first to communicate with the predecessor auditor.

Refusal of the prospective client's management to permit the successor auditor from communicating with the predecessor auditor will raise serious questions as to whether the engagement will be accepted.

Communicating with the Predecessor Auditor

Once permission of the client is obtained, the successor auditor should inquire into matters that may affect the decision to accept the engagement. This includes questions regarding:

a. The predecessor auditor's understanding as to the reasons for the change of auditors.

b. Any disagreement between the predecessor auditor and the client.

c. Any facts that might have a bearing on the integrity of the prospective client's management.

Inadequacy of the Accounting Records

Is sufficient reason for the auditor to decline an audit engagement.

True

(True or False) The audit of the financial statements is performed on the assumption that the financial statements are verifiable. Therefore, the client's accounting records and documents supporting the amounts and disclosures in the financial statements must be adequate enough to permit the examination of the accounts. .

True

(True or False) The auditor's evaluation of clients is not a one-time consideration. Clients should be evaluated at least once a year or upon occurrence of major events, such as change in management, directors, ownership, nature of client's business, or other changes that may affect the scope of the examination.

Engagement Letter

The auditor and the client's terms of the engagement. It serves as the written contract between the auditor and the client.

Engagement Letter

This letter sets forth:

a. The objective of the audit of the financial statements.

b. The management's responsibility for the fair presentation of the FS.

c. The scope of the audit.

d. The forms or any reports or other communication that the auditor expects to issue. The fact that because of the limitations of the audit, there is an unavoidable risk that material misstatements may remain undiscovered.

e. The responsibility of the client to allow the auditor to have unrestricted access to whatever records, documentation and other information requested in connection with the audit.

In addition:

a. Billing arrangements

b. Expectations of receiving management representation letter.

c. Arrangements concerning the involvement of others. (Experts and Internal Auditors)

d. Request for the client to confirm the terms of the engagement.

Engagement Letter

Intended to avoid misunderstandings with respect to the engagement and document and confirm the auditor's acceptance of the appointment.

True

(True or False) For recurring audit engagements, an auditor does not normally send new engagement letters every year.

Recurring Audits

The following factors that may cause the auditor to send a new engagement letter:

a. Any indication that the client misunderstands the objective and scope of the audit.

b. Any revised or special terms of the engagement.

c. A recent change of senior management, board or directors or ownership.

d. A significant change in the nature or size of the client's business.

e. Legal requirements and other government agencies' pronouncements.

Audit of Components

When the auditor of a parent entity is also the auditor of its subsidiary, branch, or division (component), the auditor should consider the following factors in making a decision of whether to send a separate letter to the component:

a. Who appoints the auditor of the component.

b. Whether a separate audit report is to be issued on the component.

c. Legal requirements

d. The extent of any work performed by other auditor.

e. Degree of ownership by parent.

f. Degree of independence of the component's management.