MODERN AUDITING MODERN AUDITING 7th Edition7th Edition

MODERN AUDITING MODERN AUDITING 7th Edition7th Edition

William C. BoyntonWilliam C. BoyntonCalifornia Polytechnic State California Polytechnic State

University at San Luis University at San Luis ObispoObispo

Raymond N. JohnsonRaymond N. JohnsonPortland State UniversityPortland State University

Walter G. KellWalter G. KellUniversity of MichiganUniversity of MichiganDeveloped by:

Dr. Raymond N. Johnson, CPAGregory K. Lowry, MBA, CPA

John Wiley & Sons, Inc.

CHAPTER 7CHAPTER 7ACCEPTING THE ENGAGEMENT AND ACCEPTING THE ENGAGEMENT AND

PLANNING THE AUDITPLANNING THE AUDIT

CHAPTER 7CHAPTER 7ACCEPTING THE ENGAGEMENT AND ACCEPTING THE ENGAGEMENT AND

PLANNING THE AUDITPLANNING THE AUDIT

Overview of a Financial Statement Audit

Client Acceptance and Retention

Planning the Audit Obtaining an Understanding of the

Client’s Business and Industry Performing Analytical Procedures

Overview of a Financial Overview of a Financial Statement AuditStatement Audit

Overview of a Financial Overview of a Financial Statement AuditStatement Audit

4 Phases of an Audit1. Client Acceptance and Retention2. Planning the Audit3. Performing Audit Tests4. Reporting the Findings

Steps in Accepting an Audit Steps in Accepting an Audit EngagementEngagementFigure 7-1Figure 7-1

Steps in Accepting an Audit Steps in Accepting an Audit EngagementEngagementFigure 7-1Figure 7-1

Management Integrity Management Integrity

• Communication with the Predecessor Auditor• Make inquiries of other third parties• Review previous experience with existing clients

– Knowledge of critical success factors & competition

• Client background checks– Previous bankruptcy– Previous convictions– Suspected ties to organized crime

• Industry experience

Identify Special Circumstances and Unusual Risks

Identify Special Circumstances and Unusual Risks

Focus on the auditor’s business risks• Identify intended users of audited statements

– Purchase and sale of business

• Assess prospective client’s legal and financial stability– Client’s need for capital

• Identify scope limitations• Evaluate the entity’s financial reporting systems and

auditability– Inadequate internal controls

Assess Competence to Perform the Audit

Assess Competence to Perform the Audit

• Services desired

• Identify the audit team

• Need for consultation and use of specialists

• Trend in industry specialization

Evaluating Independence Evaluating Independence

• Evaluate whether there are any circumstance that would impair independence

Decision to AcceptDecision to Accept

• 80’s: Accept clients as route to partnership, but not as cognizant of risks

• 90’s: Clean up client list during good times with a focus on growth oriented clients

Steps in Accepting an Audit Steps in Accepting an Audit EngagementEngagementFigure 7-1Figure 7-1

Steps in Accepting an Audit Steps in Accepting an Audit EngagementEngagementFigure 7-1Figure 7-1

Page 241

Key Steps in Planning the AuditKey Steps in Planning the AuditFigure 7-3Figure 7-3

Key Steps in Planning the AuditKey Steps in Planning the AuditFigure 7-3Figure 7-3

Chapter 7Chapter 7 Chapter 8

Chapter 8 Chapter 8 Chapter 9

Overview of Business CycleOverview of Business CycleFigure 7-4Figure 7-4

Overview of Business CycleOverview of Business CycleFigure 7-4Figure 7-4

Consider LiventConsider Livent

• Theater company producing shows like Phantom of the Opera, Showboat, etc.

• Financial statement misstatements:– Capitalized cost of shows as pre-production costs– Revenue recognition for tickets given away

• Cost structure– Heavy fixed costs– Predictable costs

• Need for ticket revenues and cash flows

Overview of Business CycleOverview of Business CycleFigure 7-4Figure 7-4

Overview of Business CycleOverview of Business CycleFigure 7-4Figure 7-4

Understand and Quantify

Understand, Quantify,and Correlate with Outcomes

Understanding the Business and Industry

Understanding the Business and Industry

• The clients business risks are strongly correlated with the auditor audit risk.

• Do audit tests ensure that the entity’s outcomes associated with business risks are fairly presented in the financial statements?

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Key Issues What to Understand

Senior Management Does management depend on one or a few key individuals? How experienced is the entity’s management? What is management’s attitude toward accepting risks? How does management delegate authority and responsibility? What is management’s reputation for integrity and business ethics?

Management Goals What are management’s primary goals?and Objectives Obtaining additional market share?

Growth in sales? Growth in profits? Growth in operating cash flows? Growth in market valuation?

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Understanding the Client’s BusinessUnderstanding the Client’s BusinessFigure 7-5Figure 7-5

Analytical procedures are used in auditing for the following purposes:1. In the planning phase of the audit, to

assist the auditor in planning the nature, timing, and extent of other auditing procedures2. In the testing phase, as a substantive test to obtain evidential matter about

particular assertions related to account balances or classes of transactions3. At the conclusion of the audit, in a final

review of the overall reasonableness of the audited financial statements

Performing Analytical Performing Analytical ProceduresProcedures

Performing Analytical Performing Analytical ProceduresProcedures

The following steps are involved in performing analytical procedures:1. Identify calculations and comparisons to be made2. Develop expectations3. Perform the calculations/comparisons4. Analyze data and identify significant

differences5. Investigate significant unexpected

differences6. Determine effects on audit planning

Performing Analytical Performing Analytical ProceduresProcedures

Performing Analytical Performing Analytical ProceduresProcedures

New Technology, Inc.New Technology, Inc.

• Evaluate the data presented on pp 260-261.

• Develop your own expectations

• Compare company data with expectations

• Identify issues that need audit attention.

CHAPTER 7CHAPTER 7 ACCEPTING AND PLANNING ACCEPTING AND PLANNING

THE AUDIT ENGAGEMENTTHE AUDIT ENGAGEMENT

CHAPTER 7CHAPTER 7 ACCEPTING AND PLANNING ACCEPTING AND PLANNING

THE AUDIT ENGAGEMENTTHE AUDIT ENGAGEMENT

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