Chapter 6

Audit Planning,
Understanding
the Client,
Assessing Risks
and Responding

Chapter Objectives
After completing this chapter you should be
able to:
1.
2.
3.
4.

Explain the auditing standard that relates to auditor

changes.
Understand the stages of an audit.
Describe the auditors responsibility for fraud detection.
Identify the audit objectives of a balance sheet audit.

Chapter 6

Objective 1
Explain

the auditing standard that relates to

auditor changes.

Chapter 6

Accepting New Clients: Auditing

Standard on Auditor Changes

SAS 84 (AU 315) requires a successor auditor to initiate

discussions with the predecessor to discuss the reasons
for the change in auditors

Because of the confidentiality rule, the successor must

first obtain client permission to talk with predecessor

SEC requires an 8-K explaining the reason for the

auditor change
Chapter 6

Accepting New Clients: Auditing

Standard on Auditor Changes
The successor auditor wants information related to:

Management integrity
Disagreements with management on any substantive
auditing or accounting issues
The predecessor's understanding of the reasons for the
change
Any communications between the predecessor and
management or audit committee regarding fraud, illegal
acts or internal control matters

Chapter 6

Criticisms of the accounting

profession
#

of wins drives the profitability of the

partners

Quantity vs quality
Keep the client happy
Advocate/approve

aggressive accounting methods

Chapter 6

Objective 2
Understand

the stages of an audit.

Chapter 6

The Audit Process

After obtaining a client, the audit process includes:
1. Planning the audit
2. Obtaining an understanding of the client and its
environment, including internal control
3. Assessing the risks of material misstatement and design
further audit procedures
4. Performing further audit procedures
5. Completing the audit
6. Forming an opinion and issuing the audit report

Chapter 6

Stages of an Audit-Diagram

Chapter 6

1. Plan the Audit

Establish

an understanding with the client

This is ordinarily accomplished through use of an

engagement letter (letter not required)
Clear

cut explanation of managements and auditors

responsibilities
Identify timing issues
Obtain approval to contact predecessor auditor
Plans to use specialist, internal auditor, other CPA,
clients staff
Communicate fees and billing arrangements

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Chapter 6

Key Planning Issues

Establish key dates and deadlines

Understand industry-specific reporting requirements
Preliminary assessment of materiality
Preliminary audit program
Use of others
On first year audits:
Establish validity of opening balances on the
financial statements
Obtain

satisfactory evidence of significant account

balances

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Chapter 6

2. Obtain an Understanding of the Client

and its Environment (SAS 109, AU 314)

Second standard of field work

Perform risk assessment procedures, including

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Inquiries of management and others within the entity

Analytical procedures
Observation and inspection relating to client activities,
operations, documents, reports and premises.
Other procedures, such as inquiries of others outside the
company (e.g., legal counsel, valuation experts) and
reviewing information from external sources such as
analysts, banks, rating organizations, journals.
Chapter 6

Design Further Audit Procedures

Types

Tests of controls
Perform

when auditor expects controls to be

effective or substantive tests alone are not
sufficient for an opinion

Substantive tests
Analytical

procedures
Tests of details of transactions and balances

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Chapter 6

Objective 3
Describe

the auditors responsibility for fraud

detection.

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Chapter 6

Fraud Statistics

USA-annual losses near $600 billion = 6%-7% of

revenue
CEO/CFO involved in over 80% of fraud cases
Fraud occurs over an extended period of time
Fraud occurs more often in smaller companies that
are not profitable
80% chance that someone will get away with fraud

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40% not discovered

40% discovered and not reported or prosecuted
20% discovered and reported or prosecuted
Chapter 6

Assessing Fraud Risks SAS 99 (AU

230,316,333)

Fraudulent financial reporting (management fraud)

Falsified accounting records

Intentional misapplication of GAAP
Omission of transactions (unrecorded liabilities)

Misappropriation of assets (defalcations)

Theft (lapping receivables)

Fraudulent expenditures
90% in cash

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70% fraudulent disbursements

Chapter 6

Assessing Fraud Risks SAS 99 (AU

230,316,333)

Procedures to assess fraud risks

Discussion among engagement team

17

Presume fraud in revenue

Inquiries of management and other personnel

Analytical procedures
Considering fraud risk factors
Incentives
Opportunity
Attitude/rationalizations

Chapter 6

Assessing Fraud Risks SAS 99 (AU

230,316,333)
Fraud

signals

Unusual entries
Amounts
Payments

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to consultants

Management override in recording transactions

Unusual number of related party transactions

Chapter 6

Responding to Fraud Risks

Professional skepticism and due care

Assigning personnel and supervision

Accounting principles
Predictability of auditing procedures

More reliable evidence

Shifting timing to year end
Increasing sample sizes
Response to the possibility of management override
Examining journal entries
Review accounting estimates for biases
Evaluating the business rationale for significant unusual
transactions

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Chapter 6

Communication of Fraud Findings

Communication

to appropriate level of

management
If fraud involves management or material
misstatement communicate to audit
committee
All material fraud report to audit committee
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Chapter 6

Objective 4
Identify

the audit objectives of a balance

sheet audit.

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Chapter 6

Objectives of Substantive Tests

for Asset Accounts

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Establish the existence of assets

Establish that the company has rights to the assets
Establish the completeness of recorded assets
Verify the cutoff of transactions
Determine the appropriate valuation of the assets and
accuracy of related transactions
Determine the appropriate financial statement presentation
and disclosure of the assets

Chapter 6

Financial
Statement
Assertions
and the
Audit

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Chapter 6

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Chapter 6