Which procedures should an auditor perform when determining whether to accept a client? (name a few)
- Obtain and review client financial information (e.g. annual reports)
- Evaluate the integrity of client management
- Communicate with previous auditor, after asking for permission by company
- Determine the independence of your firm with respect to the client
- Inquire third parties about the client (banks, lawyers, credit agencies)
- Understand the business
- Are there special circumstances that will require certain attention
- Consider whether issues such as litigation or going concern problem exists for client
- Perform preliminary analytical procedures
- Evaluate opportunities and business risks posed by the client to your auditing firm
Name a few ratios relevant for analytical procedures
- ROE
- ROA
- Accounts receivables turnover
- Inventory turnover
- Profit Margin
Name a few possible negative non-financial matters relevant for accepting a client (ocean case examples)
- Staff/auditor turnover
- Complicated new computer system
- Communication
- IPO
Are you able to provide consulting and auditing at the same time?
- Some argue that this might impair objectivity
- Others argue that efficiency is gained
- For public companies under SOX, the auditor is not permitted to perform certain consulting services (US since 2002)
- In Switzerland, some services are allowed
In Art. 728 in CO the following are constituting the cornerstones of auditor independence
- Membership of board or any other decision making function
- A direct or indirect significant financial interest (equity or debt)
- Close relationship between auditor and the board, a member in decision making position or a major shareholder is not allowed
If being offered to audit a firm, what are the first steps after accepting the client?
- Send a letter of acceptance
- The letter will be sent to the commercial register and the audit firms name and function will be entered
Afterwards: - Write an engagement letter
What are the components of an engagement letter? Is the auditor required to write one every year?
- The objective and scope of the audit of the financial statements
- The responsibilities of the auditor
- The responsibilities of the management
- Identification of applicable financial reporting framework for the preparation of financial statements
- Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form an content
Every year? - No, recurring audits do not need it, unless the terms of engagement has changed; e.g. misunderstandings, change in senior management, significant change in ownership, change in legal or regulatory environment
Why is the client acceptance process important?
- Auditors are liable both to the company, individual shareholders and creditors for the losses arising from intentional or negligent breach of duties
Assume you have a population value of 2 500 000, tested inventory amounts of 1 000 000 and found 10 000 in overstatements. What is your estimate of the total misstatement in inventory?
The direct projection of error =
(Misstatements/amount sampled)population value
=> (10 000/1 000 000)2 500 000= 25 000
What should an auditor do if the analytical procedures performed indicate overstatement errors (i.e. estimations above materiality)
- The auditor should either propose an audit adjustment so that the unadjusted amounts is less than materiality, and/or perform more testing to obtain a better estimate of the population misstatements
What factors should be considered when setting performance materiality for the asset accounts?
- Overall audit assurance desired
- Expected misstatements in a particular segment
- Cost of obtaining audit evidence (efficiency)
Why is cash able to have the lowest performance materiality?
- Cash can be completely audited
- Typically there are no misstatements
- Evidence is objective (more subjective when estimations and calculations are included)
Give an example of why you could set performance materiality for inventory at a lower amount as to compared to accounts receivables, PP&E, and other assets
- It could be concerns that the inventory is out of date (obsolescence) and because inventory turnover is a ratio which is of interest to analysts. (Auditing standards suggest auditors should consider setting a lower materiality for segments of the audit where there is increased attention)
Give an example of giving accounts receivables the highest performance materiality
- The account is large and requires sampling to test the balance
- Customers generally pay their balance on time
Does setting materiality at a lower level result in collecting more or less audit evidence? (as compared to setting materiality at a higher level)
- Setting materiality at a lower level results in collecting more audit evidence
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: A new client
Risk of material misstatements:
- Increases
Audit risk model component
- Inherent risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: Operating in regulated industry, which increases regulatory oversight and need for compliance with regulations
Risk of material misstatements:
- Increases
Audit risk model component
- Acceptable audit risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: Public stock
Risk of material misstatements:
- Increases
Audit risk model component
- Acceptable audit risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: Company is more profitable than competitors, but recent growth has strained operations
Risk of material misstatements:
- Increases
Audit risk model component
- Acceptable audit risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: Company has expanded its use of derivatives and hedging
Risk of material misstatements:
- Increases
Audit risk model component
- Inherent risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: Company has added competent accounting staff and has an internal audit function with direct reporting to the audit commitee
Risk of material misstatements:
- Decreases
Audit risk model component
- Control risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: The financial statements contain several accounting estimates that are based on management assumptions
Risk of material misstatements:
- Increases
Audit risk model component
- Inherent risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: The company has struggled in tracking property, plant & equipment
Risk of material misstatements:
- Increases
Audit risk model component
- Control risk
Indicate whether the factor increases or decreases the risk of material misstatements. Which audit risk model component is affected by the factor: The company has acquired a regional electric company
Risk of material misstatements:
- Increases
Audit risk model component
- Inherent risk
