Chapter 4

Engagement Planning

"Vision without action is a daydream.

Action without vision is a nightmare.”

- - Japanese Proverb

McGraw-Hill/Irwin

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Goals of Planning

• Obtain (or update) an understanding of important events that have affected the client and its operations

• Identify areas of the engagement that may represent special risks to the public accounting firm.

• Ensure that the engagement can be completed in a timely fashion

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Pre-Engagement Arrangements

• Client selection and retention

• Communication between predecessor and successor auditors

• Engagement letters• Staff assignment• Time budget

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Communication between Predecessor and Successor Auditors (SAS 84)

• Attempt to communicate required• If client permits, issues to discuss

– Disagreements about accounting principles or audit procedures.

– Communications the predecessor auditors gave the former client about fraud, illegal acts, and internal control recommendations.

– The predecessor auditors’ understanding about the reasons for the change of auditors (particularly about the predecessor auditors’ termination).

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Understanding the Client’s Business

• Methods and sources of information– Inquiry, including prior year working

papers– Observation– Study

• Other aspects of planning– Materiality and planning– First-time audits– Internal auditors– Identification of related parties– Specialists– Analytic procedures

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Enterprise Risk Management Framework

Internal Environment

Monitoring

Information and

Communication

RiskResponse

RiskAssessment

ObjectiveSetting

EventIdentification

ControlProcedures

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Planning Memorandum

• Summary of planning procedures• Considerations

1. Investigation or review of the prospective or continuing client relationship.

2. Provision of special services or reports and needs for special technical or industry expertise.

3. Staff assignment and timing schedules.4. Assessed level of control risk.5. Significant industry or company risks. 6. Computer system control environment. 7. Utilization of the company’s internal auditors. 8. Identification of unusual accounting principles problems.9. Schedules of work periods, meeting dates with client personnel, and

completion dates. • Basis for audit program

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Preliminary Analytic Procedures (SAS 56)

RECORDED ACCOUNT BALANCE

ESTIMATED ACCOUNTBALANCE

• Attention directing – Identify potential problem areas

• An organized approach– A standard starting place to start examining the financial statements

• Describe the financial activities – Identify unusual changes in relationships in the data

• Ask relevant questions– What could be wrong?– What legitimate reasons are there for these results?

• Cash flow analysis

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Analytic Procedure Steps

1. Develop an expectation.

2. Define a significant difference.

3. Calculate predictions and compare them with the recorded amount.

4. Investigate significant differences.

5. Document each of the above steps.

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Analytic Procedures:Sources of Information

Analytic Procedures Sources of Information

Comparison of current-year account balances to those of one or more comparable periods

Financial account information for comparable periods.

Comparison of the current-year account balances to anticipated results found in the company’s budgets and forecasts.

Company budgets and forecasts.

Evaluation of the relationships of current-year balances to other current-year balances for conformity with predicable patterns based on the company’s experience.

Financial relationships among accounts in the current period (ratios).

Comparison of the current-year account balances and ratios with similar industry information.

Industry statistics.

Study of the relationships of current-year balances with relevant nonfinancial information (e.g., production statistics).

Nonfinancial information, such as production statistics.

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Analytic Procedures:Stages of Use

• Preliminary planning-- required• Substantive testing -- optional• Final review -- required

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Effect of Electronic Environment on Audit Engagement

• The definition of auditing is not changed.• The purposes of auditing are not changed.• The generally accepted auditing standards are not

changed.• The assertions of management embodied in

financial statements are not changed.• The requirement to gather sufficient competent

evidence is not changed.• The independent auditor's report on financial

statements is not changed.

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What has changed?

• The auditor must evaluate the impact of technology on the client’s operations.

• The auditor must evaluate computer controls implemented by the client in the auditor’s study and evaluation of the client’s internal controls.

• The auditor can use the computer’s speed and accuracy to assist in the audit.

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Effect of Computer Processing on Transactions

• Transaction trails• Uniform processing of transactions• Segregation of duties• Potential for fraud• Potential for increased management

supervision• Initiation or subsequent execution of

transactions by computer

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Planning considerations

• Extent to which computers are used• Complexity of computer operations• Organizational structure of computer

processing• Availability of data• Use of CAATs- the use of software to perform

audit procedures

• Need for specialized skills

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Computer Assisted Audit Tools and Techniques (CAATs)

• With CAATS, the auditor is able to access and extract client information without disrupting data processing.

• Some CAATs Procedures:– Calculate field statistics (totals, high, low and average

value)– Perform complex recalculations – Join, concantenate and compare different files– Perform detailed analysis

• Stratification• Gap and duplicate key detection• Sample selection

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Audit Documentation (AS 3)

• Definition– The written record of the basis for the auditor’s conclusions that

provides the support for the auditor's representations, whether those representations are contained in the auditor's report or otherwise.

• Objectives– Improve audit quality– Enhance public confidence

• Contents – Planning and performance of the work– Procedures performed– Evidence obtained– Conclusions reached by the auditor

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Purposes of Audit Documentation

• Integral part of audit quality• Documents the nature, timing and extent of

work performed• Evidence of due professional care• Basis for conclusion• Facilitates planning, performance and

supervision• Provides basis for review

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Audit Documentation Files

• Current files

• Permanent files

• Prior year files

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Exhibit 4.6Current Audit Documentation File

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Exhibit 4.7Illustrative Audit Documentation

• Information on Workpaper– Name, date, purpose, page

number– Procedures performed and

conclusions reached by the auditor

• Evidence that auditor followed general standards and standards of field work

• Audit Mark Legend

– Reviewers’ initials

Insert Exhibit 4.7

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Audit Documentation Requirements

• Audit documentation should be prepared in sufficient detail to enable an experienced auditor having no previous connection with the engagement to:– Understand the nature timing, extent and results of procedures,

evidence obtained and conclusions reached.– Determine who performed the work, date of work, reviewer and

date of review.• Audit documentation should provide a clear link to

significant findings or issues and – Demonstrate compliance with PCAOB standards.– Support basis for conclusions on every relevant assertion.– Document that accounting records agree with financial statements.

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Significant Findings or Issues

• Selection, application and consistency of accounting principles, including disclosures

• Results of procedures that indicate need for significant modification of procedures, existence of material misstatements, significant deficiencies in controls

• Audit adjustments• Disagreements• Circumstances that cause significant difficulty• Significant changes in assessed audit risk• Matters that could result in report modification

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Specific Audit Documentation Matters

• Should include identification of items inspected, confirmed or tested.– Satisfied by indicating source and selection criteria.

• Documentation of inspected agreements should include abstracts or copies.

• Should include contradictory information found– Information the auditor has identified relating to significant

findings or issues that is inconsistent with or contradicts the auditor’s final conclusions.

– Procedures performed in response.– Records documenting consultation on or resolutions of differences

among team and with others consulted.

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Engagement Completion Document (AS 3)

• Must include all significant findings or issues.• Must include items identified during interim review.• Must have completed all necessary procedures and

obtained sufficient evidence before report release date.

• Documentation should be complete (documentation completion date) no more than 45 days after report release date.

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Documentation Retention (AS 3)

• Documentation must be retained seven years from report release date.– If no report—from last day of fieldwork

• Additions/Amendments– Documentation may not be deleted or discarded after

report release date.– Additions must indicate

• Date the information was added • Name of preparer• Reason

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Specific Documentation Retention Requirements (AS 3)

• Issuing office must retain prior to report release date– Engagement completion

document– List of significant fraud risk

factors, responses and results of related procedures

– Inconsistent or contradictory information

– Finding affecting consolidating or combining of accounts

– Information to reconcile amounts audited by other auditors to consolidated financial statements

– Schedule of audit adjustments

– All significant control deficiencies and material weakness and clear distinction between categories

– Representation letters– Matters to be communicated

to audit committee

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Audit Documentation Review

• Hierarchical review process• Reviewers include

– New auditors

– Supervisory personnel

– Engagement supervisors and quality reviewers

– Successor auditor

– Inspection teams

– Others including advisors engaged by the audit committee or parties to an acquisition

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Other Issues Related to Audit Documentation

• Ownership– Auditors maintain ownership, even after auditor-client

relationship is over.• Confidentiality

– Only can be made public with permission, or if subpoenaed, or as part of a peer review of firm practices, or as part of an ethics investigation of firm personnel.

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