SECTION 2 - PLANNING ACTIVITIES (10)

ACCEPTING AN ENGAGEMENT
The first step in planning an engagement is to decide whether to accept the
engagement based on the preconditions of an audit. These 2 preconditions are:
1. The use by mgt of an AFRF in the preparation of the F/S.
2. The agreement of mgt to the premise on which the audit is conducted
Prepn of F/S in accordance with AFRF
DIM of I/C is free from material misstatement, whether due to fraud/error.
Full access to all info and no client-imposed scope limit.
The auditor will need to evaluate mgt integrity.
One of the required steps towards the end of the audit is to obtain a client repn letter
from mgt on certain key terms.

PRE-ENGAGEMENT ACTIVITIES
Perform appropriate procedures to address QC issues associated with the
acceptance/continuance of the audit engagement.
Evaluate the audit teams compliance with relevant ethical reqs especially
independence.
Establish an understanding in writing of the terms of engagement.

FIRST YEAR AUDITS (AU-C 510) Predecessor audit/Reaudits

The term initial audit means that the prior year F/S were audited by another auditor.
When an auditor accepts an engagement for the initial audit the auditor is expected to
obtain sufficient appropriate audit evidence regarding opening balances.
Check for consistency in the application of AFRF
review the predecessors documentation, if modified opinion, evaluate
effect on current period F/S.
In this case, the auditor shud request that mgt authorize the predecessor to provide
reqed info to successor. This permission is reqed before any communication btw the
new auditor and predecessor. After obtaining authorization, the auditor initiates the
communications btw the predecessor auditor and successor auditor. The reqed
communication with the predecessor can be oral or written.

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The auditor will make inquiries of the predecessor auditor with regard to several key
issues: RIDC
1. Reasons for change
2. Integrity of Mgt
3. Disagreements during audit the predecessor shud provide necessary details
for the successor to understand the nature of the disagreements and how they
were resolved.
4. Communication with Mgt or those charged with Governance such as the audit
committee, regarding fraud and non-compliance with applicable laows and
regulations incl illegal acts, and sgf deficiencies in I/C.

Other points to note;

These issues may cause the successor to refuse the engagement of the
prospective client.
When a successor auditor becomes aware of info that indicates that F/S reported
on by the predecessor may req revision, the successor would request that the
client arrange a meeting among the 3 parties to discuss and attempt to resolve
the matter.
AICPA stds state that an auditor shud not accept an engagement unti the
successor auditors reqed communications with the predecessor auditor have
been evaluated.
Normally, the successor auditor reviews the following planning, I/C, audit
results, B/S accounts and contingencies.
The predecessor auditor has no professional obligation to allow an entitys new
auditor to review the predecessors audit documentation.
AU-C 210 does not suggest any arrangements concerning CPA investment in
client securities. In fact such investments are prohibited by the Code of
Professional Conduct.

ENGAGEMENT LETTER (FACSIMILE)

Once the auditor has made the decision to accept the engagement, the auditor is reqed
to establish an understanding with the client and document it thru a written
communication with the client. This communication is reqed and is recommended in
the form of an engagement letter (note: an engagement letter is not reqed but
recommended), or other suitable form, as this reduces the risks of miscommunications
btw the parties. The engagement letter is the contract btw the auditor and the client and
sets forth the nature of the engagement, timing, anticipated completion dates and client
assistance to be rendered. The understanding includes the following sections:

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 Fees, and the basis for billing
Auditors responsibilities conducting an audit in acc with GAAS, informing
the client of any improvements in control or economy of operations that come to
the auditors attention during the engagement. Also, include a statement of
inherent limitations of an audit that there may be material misstatements
undetected.
Confirmation of Engagement
Scope & Objective of Engagement (statements auditing and obj is an opinion on
F/S)
Internal control common sgf deficiencies and material weakenesses in I/C)
Managements responsibility in preparing for an audit presentation &
preparation of F/S, design implementation maintenance (DIM) of I/C, making
available all records, not limiting the scope of the auditors work and paying the
fees. Also shud include a written confirmation that the mgt will give a MGT REP
LETTER that talks about all the representations made during the audit. Client usu
prepares the lead schedules. Mgts responsibility regarding correcting any
material misstatements
Irregularities Fraud reasonable rather than absolute assurance
Illegal acts non-compliance with applicable laws and regulations
Errors - A statement that due to the inherent limitations of an audit and internal
control, material misstatements may not be detected.
A statement identifying the AFRF.
The need for other services to be performed.
In case the auditor plans to use specialists in the performance of audit then must
document in engagement letter.
Reporting auditor has to mention in the letter that they cannot provide
assurance that an unmodified opinion will be given. Reference to the expected
form and content of the report with an indication that the actual report may differ.
A written document must be obtained for engagements to audit, review or
compile an entitys F/S under AICPA professional standards.
Note: an auditor is not expected to discuss the audit procedures with the client, those
are a matter of judgement and not subject to disclosure to the client.
Reasons why a CPA may refuse an engagement
Mgts disregard of its responsibility to maintain an adequate I/C environment.
Lack of mgt integrity
Lack of Mgts consent to communicate with predecessor auditor.
Existence of business risk either CPA b/s risk and /or clients b/s risk - The
clients b/s risk is the risk that the client will fail to meet its objectives particularly
with regard to survival and profitability. CPAs b/s risk is the risk that the CPAs
b/s will suffer due to association with the client.

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PLANNING PROCEDURES
Audit planning involves developing an overall strategy for the expected conduct and
scope of the audit. The nature, extent and timing of planning will vary with:
1. The size and complexity of the entity
2. The auditors experience with the entity
3. Knowledge of the entitys b/s and industry
4. Knowledge of the entity and its environment, including I/C.

3 planning related issues that shud be included in the auditors documentation are:
1. An overall audit strategy this deals with higher level issues, such as allocating
audit resources
2. The audit plan or program is a step-by-step list of audit procedures, which is
required for every GAAS audit. There are several key considerations in the
development of the audit program/plan.
3. Any sgf changes made to the audit strategy or the audit plan during the
engagement, along with the reasons for any such changes.
Key considerations in the development of audit program/plan:
1. Materiality generally misstatements and omissions are considered material if
they are expected to, individually or in aggregate, influence the decisions a
user will make on the basis of the F/S. Judgements about materiality consider
users of F/S as a group rather than the effects of misstatements on individual
users.
Planning stage materiality is the size of the misstatements that the
audit program was designed to detect.
Evaluation stage materiality the determination of whether the F/S were
fairly stated in all material respects at the completion of field work. The
terms planning stage materiality and evaluation stage materiality have
now been replaced by performance materiality in the clarity stds.
Performance materiality - are the amounts set by the auditor at less than
materiality for the F/S as a whole, to reduce to an appropriately low level
of probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the F/S as a whole.
Performance materiality is largely established to help provide assurance
that several immaterial misstatements do not combine to a material
undetected amount of misstatement; accordingly it ordinarily is established
at a level lower than that of materiality for the F/S.
Materiality is based on auditors judgement.
Materiality judgements involve both quantitative and qualitative factors.

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 For planning purposes, materiality is measured using the smallest
aggregate level of misstatement that could be considered material to any
one of the F/S.
There is an inverse r/ship btw materiality and audit risk.
An auditor most likely would use an entitys annualized interim FS in
determining his preliminary judgement about materiality.
If the materiality amount used in evaluating audit findings decreases from
the amount used in planning, the auditor shud apply additional substantive
tests.
Tolerable misstatement is the application of performance materiality to
a particular sampling procedure or application. The auditor shud establish
performance materiality for the F/S as a whole to allow for the possibility of
uncorrected and undetected misstatements.
An auditor is allowed to pass on aggregated errors that are not material
but such errors must be summarized and documented along with a
conclusion that the errors do not cause the F/S to be misstated.
In order to issue an unqualified opinion, the auditor must be confident that
no material misstatements exist in the F/S. While misstatements may
exist, in total they must be believed to be less than a material amount.
Materiality considerations
1. Materiality for the F/S as a whole
2. Materiality level(s) for applicable transactions, a/c balances or disclosures
3. Performance materiality
4. Any revision of those considerations during the audit engagement.
Planning considerations
Entitys a/cing policies and procedures
Materiality levels
RMM
b/s and industry in which the b/s operates to understand the events and
transactions that may have an effect on the clients F/S.
Methods used to process a/cing info, which influence the design of I/C
F/S items likely to req adjustment
Conditions that may require extension or modification of audit tests
Nature of reports expected to be issued.
Steps in Planning/Planning Procedures (BRAINSTOPS)
1. Basic discussions with the client nature of engagement, meet key employees,
discuss overall strategy but not audit procedures.
2. Review of audit documentation incl that of predecessors
3. Ask about recent developments mergers, new product lines.

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 4. Interim F/S are analyzed to identify a/cs and transactions that differ from
expectations. The performance of analytical procedures is mandatory in the
planning of the audit to identify a/cs that may not be misstated and that
deserve specific emphasis in the audit program.
5. Non-audit personnel consult tax prep dept and others
6. Staffing shud be determined and meeting to discuss the engagement.
7. Timing of the various audit procedures shud be determined. E.g. I/C testing is
done early in the engagement, inventory counts usu near b/s date, client repn
letter cannot be obtained until the end of the audit fieldwork,.
8. Outside assistance - need a specialist? Eg for inventory valuation like
diamonds.
9. Pronouncements recent changes in a/cing prins and audit stds must be
reviewed to assist in development of audit prog tailored to the unique needs of
clients b/s and industry.
10. Scheduling with the client to coordinate activities such as prepn of lead
schedules by clients and the client needs to be informed of dates when they will
be prohibited from accessing bank safe deposit boxes to ensure the integrity of
security counts held at banks.

FRAUD AND ERRORS (AU-C 240)

The auditors fundamental responsibilities are:
1. Must plan and perform audit to obtain reasonable assurance that no
errors or acts of fraud have caused the F/S to be materially misstated.
2. Auditors are reqed to specifically assess the RMM due to fraud.
3. Auditors must document the assessment of RMM due to fraud and the
resulting responses associated with any risk factors identified.
Following points to be considered:
Misstatements include diffs in the amounts presented and that shud have been
presented; omissions, partial omission, disclosure not presented in acc with
GAAP.
Misstatements shud be evaluated both quantitatively and qualitatively.
The use of estimates in a/cing increases the risk of material misstatements bcoz
it involves judgement.
Misstatements detected in sample often indicate comparable misstatements may
be present in % population, implying a likely greater misstatement of the
population.
Missing documents are indicative of fraud as per AU-C 240
Errors are ALWAYS unintentional mistakes, misjudgments or omissions.
Fraud is an intentional act by one or more individuals resulting in a
misstatement in F/S that are subject of an audit. Could be

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 Fraudulent financial reporting mgt fraud (cooking the books). These
are misrepresentation of facts and affect Mgt integrity.
Misappropriation of assets defalcation schemes: including,
embezzlement of funds, theft of other assets and misuse of entity assets.
An auditor evaluates both known misstatements (specifically identified during
audit) and likely misstatements (considered to exist based on auditors
knowledge of the entity, industry, environment, disparity of info in F/S, sample %
to population).
Mgt must correct all known misstatements and shud evaluate items for which
there are likely misstatements.
AU-C 240 states that, while the auditor is not required to plan the audit to
discover info that is indicative of financial stress of employees etc such
conditions must be considered when an auditor becomes aware of them.
Non recording of transactions are most difficult to detect.
An auditor may withdraw from an engagement if employees actions (small bribes
to public officials) affect the auditors ability to rely on Mgt representations. If Mgt
fails to respond appropriately to the auditors discovery of bribes, it may indicate
a more pervasive problem, even though amounts involved were small. This
failure may impact the auditors ability to rely on mgts representations and result
in withdrawal from the engagement.
A properly designed audit may not detect a material fraud becoz xtics of fraud
esp those involving forgery and collusion. Audits procedures effective for
detecting errors may be ineffective for frauds thru collusion.
The risk of fraudulent financial reporting is heightened by existence of an overly
complex orgn structure involving unusual lines of authority.
Bearer bonds are easily convertible assets which pose a FRF for
misappropriation of assets.
Fraud is a broad legal concept and auditors do not make legal determinations of
whether the fraud has occurred.
Fraud risk factors are factors whose presence often have been observed in
circumstances where frauds have occurred.
Fraud triangle: 3 main categories of fraud-related risk factors
1. reason/motivation/incentive/pressure
2. opportunity
3. rationalization.
Stds Require the Auditor to perform the following:
Understand the nature and xtics of fraud
Hold a brainstorming session with engagement staff to assess the risk of
material misstatement due to fraud.
Obtain the information needed to identify RMM due to fraud:
Auditor shud perform appropriate risk assessment procedures.
Inquiry of mgt and others about knowledge or suspicion of fraud

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 Evaluation of results of analytical procedures performed in the planning of
the audit.
Identify the risk of RMM
The auditor shud ordinarily plan to perform appropriate analytical
procedures related to revenue recognition, since there is a presumption
that revenue recognition is a fraud risk.
Auditors shud consider the possibility of mgt override of I/C
Assess the risk of fraud

Communication of fraud identified by the Auditor

The auditor cannot be ultimately held responsible for the detection of fraud.
The auditor is reqed to document the fraud in writing.
The Auditor must communicate all known and likely misstatements, even if
not material, identified during the audit to the appropriate level of mgt.
The auditor is reqed to communicate this knowledge either orally/written to
Mgt and/or Governance (for misappropriation of assets).
If fraud is not material and does not involve senior mgt then must inform
the appropriate level of Mgt (at least one level above the level where the
fraud occurred).
If fraud is material, auditor shud inform governance.
Regarding fraudulent financial reporting when senior mgt is involved the
auditor is required to communicate those charged with governance
even if it the fraud is not material.
The auditor may be required to inform others outside of the audited entity
under the following circumstances:
In response to a valid subpoena
To comply with applicable legal and regulatory reqs
To respond properly to successor auditor inquiries once permission is
granted
To report fraud to the applicable funding agency under the reqs of
government auditing stds.

ILLEGAL ACTS (AUC 250)

Legal and Regulatory Framework refers to those laws and regulations to which
an entity is subject; non-compliance may result in fines, litigation or other
consequences that may have a material effect on the F/S.
The auditor shud design the audit to provide reasonable assurance of
detecting illegal acts having a direct and material effect on the F/S.
Audit procedures to detect illegal acts

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 The auditor needs to make inquiries of mgt and those charged with
governance about the entitys compliance with applicable laws.
Inspection of correspondence with regulatory authorities
Reading the minutes of meeting of those charged with governance.
When an illegal act is detected the auditor has the following responsibilities:
Gather additional evidence to determine relevant facts
Discuss the matter with the appropriate level of mgt
Consider consulting with the entitys attorney and/or relevant specialists
Consider the implications to other audit areas.
Where after notifying the BOD there is no action taken, the auditor may consider
withdrawing from the audit engagement and disassociating from future r/ships
with the client since mgts failure to take remedial action means that the auditor
cannot rely on mgt repns.
CPAs are required under the law to deliver a report on illegal acts to the SEC
within one b/s day in circumstances when BOD refuses to take remedial action
and refuses to inform SEC that it had received such notification from the auditor.
The auditor has less responsibility to detect illegal acts having material F/S
consequences related to the entitys operating activities compared to financial
reporting activities.
Illegal acts relating to the operating aspects of an entity are often highly
specialized and complex and often are far removed from the events and
transactions reflected in F/S.
The auditor must document the following:
The results of the discussion with mgt, and those charged with
governance and others if applicable.
Any identified or suspected non-compliance with applicable laws and
regulations.

COMMUNICATION WITH SPECIALISTS

Specialist is an individual or orgn possessing expertise in a field other than
a/cing or auditing, which will assist the auditor in obtaining sufficient
appropriate audit evidence. E.g. actuaries, appraisers, engineers, geologists.
The auditor should NOT reference the specialist in an unmodified
opinion.
The auditor may reference the specialist, if that will facilitate the readers
understanding of the reasons for modified opinion.
The auditor when selecting a specialist must consider his competence,
capabilities, objectivity, professional credentials, reputation and any r/ship to
the client.

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 The specialist is not required to be independent. The auditor however, must
evaluate the nature of the r/ship of the specialist to the client and assess
ability to be objective.
The auditor has responsibility for understanding the assumptions and
methods used by the specialist and evaluating whether the specialists
findings support the related F/S assertions. The auditor is not responsible
for the reasonableness of the methods and assumptions used by the
specialist.
The specialist shud also understand how the auditor plans to use the
specialists findings. The documentation shud cover this understanding.
A CPA may hire a non-CPA systems analyst provided that the CPA can
supervise the specialist and evaluate his/her work. The CPA shud be able to
define the tasks to be performed and evaluate the end product.

COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE

Those charged with governance are the person(s) or orgn(s) with responsibility for
overseeing the strategic direction of the entity and the obligations related to the
accountability of the entity. In owner-managed entities, Mgt and governance are the
same. Certain matters shud be communicated. These communications may be
oral/written, and may be communicated during the audit or after the audit report is
issued. Matters communicated orally shud be documented by the auditor. These
matters include: DISAPPROVE remember this mnemonic that the audit
committee wud disapprove if the auditor fails to communicate the ff:
Disagreements with Mgt about a/cing policies or audit procedures,
including why the auditor believes that the AFRF being used is not the
appropriate one, even if the disagreements are resolved.
Illegal acts including non compliance with laws and regulations and
sgf errors discovered during the audit and fraud involving senior mgt.
Significant errors are to be communicated even if they are resolved by Mgt.
Significant accounting policies adopted or changed by Mgt.
Adjustments proposed by the auditor with a sgf impact on the financial
records AJE/RJE and uncorrected misstatements must be communicated
unless they are deemed to be trivial.
Prior discussions with Mgt before acceptance of the engagement.
Problems arising during the audit in obtaining evidence and employee
cooperation.
Responsibilities of the auditor under GAAS to obtain reasonable
assurance.
Other information regarding responsibilities
View of other accountants who were contacted by Mgt on sgf matters

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 Estimates in the a/cing records and the process used to obtain them (FV
estimates).
No need to discuss matters previously discussed and also no need for details of audit
procedures and/or materiality levels to be given as this might reduce the effectiveness
of the audit. Direct communication by the auditor is not reqed for selection of a/cing
prins. The auditor only needs to make sure that Mgt has communicated.
Communication with the audit committee may occur at any time, as long as it is timely.

TBS NOTES:
1. Inherent risk for a co if a co depends on mainly one product the risk
of obsolescence wud be its inherent risk.
2. Involvement of principal shareholder in Mgt decreases audit risk and
is not a fraud risk factor.
3. Moving to computerized system increases audit risk in the initial stages
but is not a fraud risk factor.
4. Volatility of interest rates increases audit risk but is not a fraud risk
factor.

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