Ch. 6 Rittenberg PPT Ch6

8/3/2019 Ch. 6 Rittenberg PPT Ch6

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Chapter 6

Performing an

Integrated Audit

Copyright 2010 South-Western/Cengage Learning


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Audit Opinion Formulation Process


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LO1: Evolution in Standards on

Conducting Integrated Audits AS 2, approved by SEC on June 17, 2004 and was effective

for audits of internal control over financial reporting requiredby Section 404(b)

AS 5, approved by SEC on July 25, 2007 and is effective for

audits of fiscal years ending on or after November 15, 2007 Major changes in guidance since the original issuance of AS 2

include:

Encouragement to both management and auditors to implement atop-down, risk-based approach

Clarity in the definition of material weakness that there shouldbe a reasonable possibility that a material misstatement couldoccur in an account balance


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Evolution in Standards on Conducting

Integrated Audits (continued)

Recognition that the external auditor can rely on the work of

management in assessing internal controls, particularly on work

performed by a competent and independent internal audit

function

Additional emphasis on the need to document the auditorsreasoning process linking control deficiencies to specific tests of

account balances

Increased focus on improving audit efficiency by encouraging

greater reliance on effective internal controls


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LO2: Audit Reports on Internal

Control over Financial Reporting

Requirements for the audit of internal control set outin Audit Standard No. 5 (AS 5), Para. 3

The auditors objective in an audit of internal control overfinancial reporting is to express an opinion on the effectiveness

of the companys internal control over financial reporting.Because a companys internal control cannot be consideredeffective if one or more material weaknesses exist, to form abasis for expressing an opinion, the auditor must plan andperform the audit to obtain competent evidence that is sufficient

to obtain reasonable assurance about whether materialweaknesses exist as of the date specified in management sassessment. A material weakness in internal control overfinancial reporting may exist even when financial statements arenot materially misstated


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The auditors report on internal control is integrated withthe report on the companys financial statements

The internal control report is contained in the same report thatcontains the opinion on the financial statements. An acceptable

alternative is to issue two reports: one on the financial statementsand the other on internal controls. However, if separate reportsare issued, each report must refer to the other report

The auditor provides an opinion on the effectiveness of internalcontrol in the context of agreed upon criteria, that is, the COSO

Internal Control, Integrated Framework The auditor recognizes and conveys to users that there are

limitations of internal control that can affect its effectiveness inthe future

Unqualified Opinion on Internal

Control over Financial Reporting


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Adverse Audit Opinion on Internal Control

over Financial Reporting

An adverse report is issued when the auditor finds

one or more material weaknesses in the clients

internal control over financial reporting

Auditor describes the weaknesses identified inmanagements report but does not discuss the actions

being taken to overcome those problems

Does not discuss whether the control weakness was

first identified by management or by the auditor


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LO3: Steps in an Integrated Audit

The Sarbanes-Oxley Act of 2002 requires publiclyheld companies to report on the effectiveness of theirinternal controls over financial reporting

The Public Company Accounting Oversight Boardrequires external auditors to perform an integratedaudit of the effectiveness of internal controls andfinancial reporting

In essence, the auditor must attest to both thefinancial statements and management's assertionsregarding the effectiveness of internal controls overfinancial reporting


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Framework for Audit Evidence in an

Integrated Audit


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Important Elements of the Integrated

Audit

Quality of internal control affects the reliability offinancial statement data

Control environment is pervasive and affects the

process of recording transactions, making estimates,and making adjusting entries

If the control environment is strong and the controlsover transaction processing, adjusting, and estimating

are good, then both management and the auditorwould have a high degree of confidence that thefinancial accounts are fairly stated and financialdisclosures are adequate


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Important Elements of the Integrated

Audit (continued) A potential for misstatements exists in inputting, processing,

estimating, or adjusting account balances

There is always a need to perform some substantive testingof material account balances, but the nature, timing, and

extent of that testing will depend on the quality of internalcontrols

The auditors evidence is based on testing internal controls,testing transactions, and substantive tests of account

balances, including substantive analytical procedures and

direct tests of account balances


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Implementing the Integrated Audit Within the

Audit Opinion Formulation Process

Steps to implement an Integrated Audit

Update information about various risks

Consider the possibility of account misstatements

Complete preliminary analytical procedures Understand the clients internal controls

Identify controls to test

Make a plan to test the controls and execute that plan

Consider the results of control testing

Conduct substantive audit tests


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Phases I and II of the Audit Opinion

Formulation Process

Step1: Update Information about Various Risks This requires auditors to identify

Account balances or related disclosures that are more likelyto be materially misstated

Potential causes of the misstatement Important processes that may affect one or more account

balances

Step2: Consider the Possibility of AccountMisstatements

Step3: Complete Preliminary Analytical Procedures Step4: Understand the Clients Internal Controls


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Types of Controls identified by

PCAOB

Controls over significant, unusual transactions,particularly those that result in late or unusual journalentries

Controls over journal entries and adjustments made inthe period-end financial reporting process

Controls over related-party transactions;

Controls related to significant management estimates

Controls that mitigate incentives for, and pressureson, management to falsify or inappropriately managefinancial results


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Step2: Consider the Possibility of

Account Misstatements


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Step4: Understand the Clients Internal

Controls Documenting significant accounts (including the relevant

assertions of those accounts), the processes related to thoseaccounts, and controls within those processes

Documenting the other COSO control components, especiallythe control environment, risk assessment, and monitoring

How management tests the effectiveness of important controls

Identifying how management has corrected identified controldeficiencies, where applicable

Understanding managements monitoring of previously

identified effective controls Evaluating how management assimilates data and the approachit


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Phases III and IV of the Audit Opinion

Formulation Process

Step 5: Identify Controls to Test

For formulating an opinion on the entitys internalcontrols

For reducing substantive testing for the financialstatement audit

Evaluating the Control Environment, RiskAssessment, Information and Communication, and

Monitoring Managements Process of Evaluating Internal

Control


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Managements Process of Evaluating

Internal Control

In assessing whether the work of the internal auditorcan be relied on, the auditor considers

The independence of the internal audit function frommanagement

The competency of the internal audit department

The design and comprehensiveness of the internal audittesting approach

The documentation of the internal audit testing

Corroborating evidence, for example, selected tests of thesame controls to validate the results achieved by internalaudit


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Step 6: Make a Plan to Test the Controls and Execute

that Plan

Concepts Affecting Control Testing

Computerized Controls Manual Controls:

Authorizations

Reconciliations

Segregation of duties

Review for unusual transactions

Adjusting Entries

Accounting Estimates

Phases III and IV of the Audit Opinion

Formulation Process


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Step 6: Make a Plan to Test the Controls

and Execute that Plan


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LO4: Step 7: Consider the Results of

Control Testing

Potential outcomes, with associated alternativecourses of action in the audit If deficiencies are identified, assess those deficiencies

to

determine whether they are significant deficiencies ormaterial weaknesses

determine whether the preliminary control risk assessmentshould be modified and document the implications forsubstantive testing

determine the impact of these deficiencies, and any revisionon the control risk assessment, and on planned substantiveaudit procedures by determining the types of misstatementsthat are most likely to occur


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Step 7: Consider the Results of Control

Testing(continued) If no control deficiencies are identified, assess

whether the preliminary control risk assessment is stillappropriate,

determine the extent that controls can provide evidence onthe correctness of account balances, and

determine planned substantive audit procedures The level of substantive testing in this situation will be less

than what is required in circumstances where deficiencies ininternal control were identified


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Questions that must be addressed by

Auditor How much assurance can be obtained regarding audit risk

when internal control is present and working?

If control activities within major processes are workingproperly throughout the year, what is the residual risk thatremains that an account balance can still be misstated?

What is the risk that the auditors evaluation of internalcontrols might be incorrect?

Which account balances contain more than an acceptableamount of risk that a material misstatement could occur?

How would a misstatement in a material account balance mostlikely occur?

What are the most effective substantive tests of accountbalances to determine whether there is a misstatement in theaccount balance?


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Factors affecting extent of direct testing to

be performed


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Likely Nature of Misstatements and

Efficiency of Audit Tests


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Step 8: Conduct Substantive Audit

Tests

Identification of material account balance Input from the audit teams brainstorming analysis

regarding potential for fraud

Review of market expectations of company performance

Trends in performance, including trends in key businesssegments

The size of the account balance

The subjectivity used in making the accounting estimate

Comparison of account balances with industry trends,

averages Other important factors specific to the client


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Linking Controls Testing and Substantive

Testing in an Integrated Audit


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LO5: Integrated Audit Example: Judging the Severity

of Control Deficiencies and Implications for the

Financial Statement Audit


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Managements Assessment of Controls

In deciding how to categorize a weakness,management and auditors should consider thefollowing factors Risk that is being mitigated and whether other controls

operate effectively to mitigate the risk of materialmisstatement

Materiality of the related account balances

Nature of the deficiency

Volume of transactions affected

Subjectivity of the account balance that is subject to thecontrol

Rate at which the control fails to operate


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Auditor Assessment of Controls

Control Environment

Design of controls addresses the relevant assertionsor not

Documentation is sufficient to test whether thecontrols were working properly or not

Determining which control to test deficienciesidentified

Auditors testing of internal controls Examination of all adjusting entries by auditor

Testing of inventory quantities at year end

Documents

Ch. 6 Rittenberg PPT Ch6