Day 14 PCAOB AS 1100 & AS 1101: In-Depth Notes

PCAOB AS 1100: General Concepts

  • PCAOB AS 1101 Overview
    • Focus on auditor's consideration of audit risk.
    • Applicable to two scenarios:
    • Integrated audit of financial statements (f/s)
    • Audit of f/s only
    • Auditor's Main Objective: Reduce audit risk to an appropriately low level (but not zero!).

Audit Risk

  • Definition: The risk of issuing an incorrect opinion regarding the financial statements.
  • Significant Risk: biggest risk is issuing an unqualified opinion when the f/s are materially misstated.
  • Components of Audit Risk:
    • Risk of Material Misstatement: Likelihood that the f/s are materially misstated due to fraud or error.
    • Detection Risk: Probability that auditor's procedures fail to detect material misstatement.

Assessing Risks of Material Misstatement

  • Assessment must occur at:
    • Financial Statement Level
    • Affected by ineffective internal control environments, fraud.
    • Assertion Level
    • Includes inherent risk and control risk.

Objective of the Auditor

  • Primary Goal: Identify and assess risks of material misstatement.
  • Risk Factors: External economic conditions, company-specific conditions influencing inherent and control risk.

Top-Down Approach to Risk Assessment

  • Concept: Start from the financial statement level, then delve into significant account balances and relevant assertions.
  • Example: Identify risks, like demand slump in client’s industry, then assess specific accounts and assertions.

Understanding the Client

  • Essentials to Understand:
    • Industry insights, products/services offered, relationships with stakeholders, sources of financing, organizational structure, and overall business strategy.
    • Evaluate management integrity and competence as well as compensation structures.

Understanding the Accounting System

  • Auditor must grasp the client's accounting system, assessing:
    • GAAP policies, changes to standards, need for management estimates, past issues, and internal control effectiveness.

Understanding Internal Controls

  • Methods to Gain Understanding:
    • Inquiry, observation, document inspection, re-performance of controls, and walkthroughs.

Analytical Procedures

  • Purpose: Used to evaluate the risk of misstatement by forming expectations on financial variables and comparing them with unaudited values.
  • Significant discrepancies must be investigated to ascertain risk levels.

Communication and Fraud Risk Discussion

  • Audit teams are required to discuss risks of material misstatement and brainstorm regarding potential fraud risks under GAAS guidelines.

Accounts and Assertions

  • Assessment of significant accounts and their assertions involves evaluating the risk of material misstatement.
  • Key Factors: Size of account, complexity, volume of transactions, exposure to losses, and related parties.

PCAOB AS1105: Audit Evidence

  • All information used to draw conclusions regarding the audit report, sourced through various audit procedures and corroborating or contradictory evidence.
  • Objective: To gather enough appropriate evidence to substantiate opinions stated in the auditor's report.

Management Assertions

  • Types of Assertions:
    • Existence: Validity of recorded transactions.
    • Completeness: All transactions are recorded.
    • Accuracy/Valuation: Right amounts and valuations.
    • Rights/Obligations: Legal ownership of assets/liabilities.
    • Presentation & Disclosure: Correct classifications and disclosures in accordance with GAAP.

Auditor's Response to Risks

  • Responses includes:
    • Overall and assertion level responses (vary nature, timing, and extent of tests).

Types of Tests

  • Tests of Controls: Evaluate the effectiveness of internal controls and may include dual-purpose tests.
  • Substantive Procedures: Include tests of details and analytical procedures tailored to respond to significant risks.

Quality of Audit Evidence

  • Reliability: Higher reliability generally indicates higher associated costs.
  • Relevance: Evidence must support conclusions regarding the assertions being tested.

Reconciliations and Rollforward Procedures

  • Compare G/L balances to detail to prevent inaccuracies.
  • Rollforward involves capturing account balance changes over periods by adjusting prior balances through scrutiny of affecting activities.