Chapter 4 - Overview of the Audit Process and Preliminary Activities ODUCTION ; iit of financial statements is normally Pare ston necanten . qualified auditor on an annual basis to meet tl aia to prepare entity, financial statement users. The entity is requires tn fs ts Finan statements by complying with applicable financial a ne framework ; PERS, PFRS for SME, PFRS for Small Entities). To au eon Y'S Financ statements, auditors must adhere to applicable auditing standards (e.g, Psa) As defined, an audit is a systematic process of objectively obtaining ang evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results thereof. Basically, the logic and objective of audit of financial statements are similar in ay audits of financial statements. In order to attain the objective of the audit, the auditor needs to undergo a systematic process comprising certain activities, Being a systematic process, an audit engagement is performed by means of an ordered or structured series of steps. This process is commonly called as “AUDIT PROCESS”. AUDIT PROCESS: A GENERAL APPROACH Ageneral overview of the audit process may be best represented by the following diagram: Entit The auditor prepares and performs The auditor The auditor presents audit gathers audit expresses an financial procedures evidence audit opinion statementsChapter 4 ~ Overview of the Audit Process and Preliminary Activities The financial statements are considered as assertions or representation made by the entity, through its management and those charged with governance, as appropriate. These assertions may be explicitly or implicitly included in the financial statements and may fall into the following categories (TAP); Category Classes of | Transactions and events for the period under audit |v (TOCCAC) es Assertions Y Occurrence - transactions and events that have been recorded have occurred and pertain to the entity. Completeness - all transactions and events that should have been recorded have been recorded, Cutoff - transactions and events have been recorded in the correct accounting period. Accuracy - amounts and other data relating to “recorded transactions and events have been recorded appropriately. Y Classification - transactions and events have been recorded in the proper accounts. Account balances | ¥ Completeness - all assets, liabi v v ies and equity at the period end interests that should have been recorded have (ACERV) been recorded, ¥ Existence - assets, liabilities, and equity interests exist. Rights and obligations - the entity holds or ‘controls the rights to assets, and liabilities are the obligations of the entity. valuation and allocation - assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. Presentation and |“ Occurrence and rights and obligations - v disclosure disclosed events, transactions, and other (POCAC) matters have occurred and pertain to the entity. ¥ Completeness - all disclosures that should have been included in the financial statements have been included. Y Accuracy and valuation - financial and other information are disclosed fairly and at appropriate amounts. k a Page 123Chapter 4 ~ Overview of the Audit Process and Preliminary Activities ¥ Classification and understandability - finang information is appropriately presented aa | described, and disclosures are dleaty | 1 _inessed Additional responsibilities Moreover, PSA 200 provides that management and, where appropri those charged with governance have responsibility: ate, a. For the preparation and presentation of the financial statements j accordance with the applicable financial reporting framework; thi includes the design, implementation and maintenance of internay control relevant to the preparation and presentation of financial statements that are free from material misstatement, whether due to fraud or error; and b. To provide the auditor with: i. All information, such as records and documentation, and other matters that are relevant to the preparation and presentation of the financial statements; ii, Any additional information that the auditor may request from management and, where appropriate, those charged with governance; and ii, Unrestricted access to those ) the entity from whom the auditor determines it necessary to obtain audit evidence. As part of their responsibility for the preparation and presentation of the financial statements, management and, where appropriate, those charged with governance are responsible for: The identification of the applicable financial reporting framework, in the context of any relevant laws or regulations. « The preparation and presentation of the financial statements in accordance with that framework. * An adequate description of that framework in the financial statements. The preparation of the financial statements requires management to exercise judgment in making accounting estimates that are reasonable in the circumstances, as well as to select and apply appropriate accounting policies. These judgments are made in the context of the applicable financial reporting framework. 1. The auditor performs audit procedures ; h In conducting an audit of financial statements, the overall objectives of the auditor are: Page 124 Aim... Believe... Claim.Chapter 4 - Over ‘ if To eo es Process and Preliminary Activities asa whole are free fron eared about whether the financial statements or error, thereby enabl material misstatement, whether due to fraud ence the auditor to express an opinion on whether accordance with an ae are prepared, in all material respects, b. Toreport on the fi applicable financial reporting framework and the PSAs, nancial statements, and communicate as required PY , in accordance with the auditor’s findings. e auditor shall design and it evidence. uired BY in To achieve the overall objectives of the audit, th onan procedures which enable the gathering of audi uch evidence will be used as a basis in expressing the opinion req! the audit of financial statements. When selecting procedures, the auditor considers various factors including assertions made by the entity, assessed level of risks, and materiality. Procedures to be performed may be categorized into ot procedures and (2) specific audit procedures. (1) major Major audit procedures 1. Risk assessment procedures. The audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, jal statement and assertion levels. 2. Test of controls. An audit procedure designe’ effectiveness of controls in preventing, or material misstatements at the assertion level. 3, Substantive procedure. An audit procedure designed to detect material misstatements at the assertion level. Substantive procedures comprise: 1. Tests of details (of classes of transactions, account balances, and disclosures), and ii, Substantive analytical procedures. at the financi d to evaluate the operating detecting and correcting, Specific audit procedures 1. Inspection of Records or Docu documents, whether internal or external, in paper form, or other media. 2. Inspection of Tangible Assets. It consists of physical examination of the | assets. 3. Observation. It | performed by others. inquiry. It consists of seeking information of knowledgeable persons both financial and non-financial, throughout the entity or outside the ments. It consists of examining records or electronic form, consists of looking at a process or procedure being SS Page 125Ny inary Activiti Chapter 4 — Overview of the Audit Process and cen fe ae entity. This procedure may be used extensively throug! © au, @ complement of other audit procedures. ee 5. Confirmation. A specific type of inquiry that i ree Obtaining a representation of information or of an existing rectly from a third party. , : 6. Recalculation, It consists of checking the aerate ACCUraKy documents or records. This procedure may be performed manyayy . electronically. ae ' 7. Reperformance. It involves the auditor's independent X€CUtion procedures or controls that were originally performed as part of the entity's internal control. : 8. Analytical Procedures. Procedures consist of evaluations of finan, information made by a study of plausible relationships among both financial and non-financial data. Analytical procedures also encompax the investigation of identified fluctuations and relationships that ate inconsistent with other relevant information or deviate Significantiy from predicted amounts. tla, 2. The auditor gathers audit evidence Through the procedures performed, the auditor obtains sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. Audit evidence refers to information used by the auditor in arriving at the Conclusions on which the auditor's Opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information, The auditor expresses an audit opinion The auditor provides a written audit report containing a conclusion or an pinion regarding the fairness of preparation and Presentation of financial statements i ofchapter 4— Overview of the Audit Process and Pret 2. Achoiee between Qualified and Dieatmer of onion: is unable to obtain suffic sclalmer of opini ain sufficient a pinion, The auditor anes appropriate a that the tania statoments a pro aut evidence to conclude misstatement. ole are free from material hases of audit process dit process ivided ir ‘ sanity phase divided into two sub-phases, the investigative . Investigative phase includes performance of he other hand, reporting e report, and dited financial sub-P! qhe above | nase and t pie procedures and gathering of audit evidence. Ont nase includes the expression of opinion, ‘ «atic |, preparati communication of the results to the different ised te wu statements. ROCESS: A (MORE DETAILED APPROACH fence or order of activities in perform from firms to firms depending on such sequence of different activities n jing financial statements their own policies and ‘ormally will include aupiT PI the specific seau! audit May vary vacedures. HOWEVET, the following StePS: Preliminary planning an audit of START engagement financial statements : activities Completing the nce-gathering Study and audit (Substantive testing) evaluation of : internal control Issuance of the Post-audit audit report responsibilities END AUDIT PROCESS: A MORE DETAILED APPROACH i PHASE [__ DESCRIPTION the autor | |. Preliminary This phase will require a decision from the auditor | engagement whether or not to accept a new client or continue existing one. This process would relationship with an require evaluation not only of the auditor's qualification, Page 127Chapter 4 ~ Overview of the Audit Process and Preliminary Activities 2. Planning an audit of financial statements but also the integrity and auditability of the client's financial statements. Primary objective: To minimize the likelihood of being associated to a client whose management lacks integrity | Audit planning involves the development of an overal audit strategy, audit plan and audit program. The auditor usually obtained more detailed knowledge about the client’s business and industry in order to understang the transactions and events affecting the financial statements. Preliminary assessment of risk and materiality is also made during this phase. Primary objective: To assess the different risks associated with the audit to determine the nature, timing and extent of further audit procedures necessary to be performed 3. Study and evaluation of internal control Since entity's internal control directly affects the reliability of the financial statements, it is appropriate to study and evaluate these controls. Primary objective: To establish a basis for reliance on internal controls, in determining the nature, timing and extent of audit procedures to be performed 4. Evidence- gathering (Substantive testing) Using the information obtained in audit planning and consideration of internal controls, the auditor performs substantive test to determine whether entity's financial statements are presented fairly in accordance with financial reporting standards. Substantive procedures could either be analytical procedures or test of details of transactions and balances This phase will always be performed by the auditor. Primary objective: To ascertain the degree of correspondence between the financial statements prepared by client’s management and the financial reporting framework. With this, the auditor will be able to conclude whether or not the financial statements are Presented fairly in accordance with financial reporting standards 5. Completing the audit Wrapping-up procedures are performed; conclusions reached are reviewed; and an overall opinion is formed d :‘4 — Overview of the Audit Process and Preliminary Activities chapter a ine in as Primary objective: To assist the auditor in ened i i ce Bal conclusion reached is consistent with evident 5 audit report fairness ance of the | In this stage, auditor prepares and i he igsuance of the , eis | awit report which describes the scope of the audit and stat auditor’s conclusion regarding the | financial statements. ions unicate the conclusion’ Primary objective: To comm a reached by the auditor to various intended us ee ee ieee ee itor 17 Post-audit After completion of the audit eneagemert ae |” responsibilities | performs procedures that will enable him, aaa | areas for improvement in the current ani | cmcemeit | ity of Primary objective: To assess and evaluate the quality services delivered by the engagement team Le PRELIMINARY ENGAGEMENT ACTIVITIES JOR AUDIT PROCEDURES : seen a decision whether to accept or reject an engagement, the auditor's firm should consider the following: 1. Its competence; 2. Itsindependence; 3. Its ability to serve the client properly; and 4, The integrity of the prospective client’s management. To adequately address the above items, the auditor is expected to perform the following: 1. Obtain a preliminary knowledge of the client’s business and industry to determine whether the auditor has the degree of competence required by the engagement, : Ordinarily, to determi hb ‘ermine whether the auditor ha: ie s the degr eked by the engagement, auditor obtains a Prelimi noe valase: "Ws business and industry, naV knowledge of the PgChapter 4 — Overview of the Audit Process and Preliminary Activities 2. Consider whether there are any threats to the firm’s independence al objectivity, and if so, whether adequate safeguards can be establisheq. Before accepting a specific audit engagement, the auditor considers whether there are any threats to the firm's independence and objectivity, and if 50, whether adequate safeguards can be established. , Independence consists of both independence of mind and independence in appearance. Independence of mind is the state of mind that permits the expression of a conclusion without being affected by influences that Compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism. On the other hand, independence in appearance is the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm's, or a member of the assurance team’s, integrity, objectivity or professional skepticism had been compromised. In an audit engagement, the Code of Ethics for Professional Accountants requires all members of the audit team to be independent from the client. Audit team includes members of the engagement team, the firm, and its network firm/s. 3. Evaluate the firm’s ability to serve the prospective client. Prior to acceptance of an engagement, the firm considers its resources (e.g. Personnel) in evaluating whether the firm has the ability to serve the prospective client properly. 4. Evaluate auditability. In an audit engagement, auditor gathers sufficient appropriate evidence to form and express an opinion as to the fairness of preparation and Presentation of the client’s financial statements. For the auditor to do this, accounting records, documents and other information that supports the client's financial statements should be made available to the auditor. Absence of records, documents and other information raises significant doubt about client's auditability. Investigate the integrity of the prospective client's management The proposed auditor (previously called successor auditor) considers whether acceptance of a new or continuing an existing client relationship would create any threats to compliance with the fundamental principles. Potential threats to integrity or professional behavior may be created from, for example, questionable issues associated with the client (its owners, management and activities). re ir ie . Claim...chapter 4 ~ Overview of the Audit Process and Preliminary Activities ‘The main objective of this procedure is to minimize the likelihood of being associated to a client whose management lacks integrity. investigation of the integrity of the client’s management may be performed through reading published articles, inquiry to appropriate parties, or communication with the previous auditor (previously called predecessor quditor) subject to client’s permission. Note: Every time communication is made to parties other than the client, the auditor shall seek permission from the client and document the items discussed. Matters to be discussed with previous auditor include the following: (RID) a. The previous auditor’s understanding as to the Reasons for change in auditors; b. Information that might bear on the Integrity of the management; and <. Disagreements between the previous auditor and management as to accounting principles, auditing procedures, etc. 6. Agree on the terms of the engagement and prepare an engagement letter. After considering the above factors, the auditor shall decide whether to accept or decline the proposed audit engagement. If the auditor decided to accept the engagement, the auditor and the client shall agree on the terms of the engagement ACCEPTANCE OF AN ENGAGEMENT Objective The objective of the auditor is to accept or continue an audit engagement only when the basis upon which it is to be performed has been agreed, through: a. Establishing whether the preconditions for an audit are present; and b. Confirming that there is a common understanding between the auditor and management and, where appropriate, those charged with governance of the terms of the audit engagement. ze 4 salte A. Preconditions for an Audit es > The use by management of an acceptable financial reporting framewothes in the preparation of the financial statements; and BA eS > The agreement of management and, where appropriate, those charg hich an audit is conducted. with governance to the premise on w! In order to establish whether the preconditions for an audit are present, auditor shall: 3. Determine whether the financial reportin the preparation of the financial statements is acceptable; and g framework to be appl e Aim... Believe... Claim.chapter 4 ~ Overview of the Audit Process and Preliminary Activities b. Obtain the agreement of management that it acknowledges ang understands its responsibility: \. For the preparation of the financial statements in accordance With the applicable financial reporting framework, including Wher, relevant their fair presentation; ii, For such internal control as management determines is necessary 1, enable the preparation of financial statements that are free from Material misstatement, whether due to fraud or error; and ili, To provide the auditor with: ‘a. Access to all information of which management is aware that ig relevant to the preparation of the financial statements such a, records, documentation and other matters; b. Additional information that the auditor may request from management for the purpose of the audit; and c. Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence. Limitation on Scope Prior to Audit Engagement Acceptance If management or those charged with governance impose a limitation on the scope of the auditor’s work in the terms of a proposed audit engagement such that the auditor believes the limitation will result in the auditor disclaiming an opinion on the financial statements, the auditor shall not accept such a limited engagement as an audit engagement, unless required by law or regulation to do so. Other Factors Affecting Audit Engagement Acceptance if the preconditions for an audit are not present, the auditor shall discuss the ‘matter with management. Unless required by law or regulation to do so, the auditor shall not accept the proposed audit engagement: a. {f the auditor has determined that the financial reporting framework to be applied in the preparation of the financial statements is unacceptable; or b. If the agreement of management that it acknowledges and understands its responsibility has not been obtained. AGREEING THE TERMS OF AUDIT ENGAGEMENTS The auditor shall agree on the terms of engagement with the client, represented by management or those charged with governance, as appropriate. The agreed terms shall be recorded in an audit engagement letter or other suitable form of written agreement. Itis in the interest of both the entity and the auditor that the auditor sends an engagement letter, preferably before the commencement of the audit to help avoid misunderstandings with respect to the audit,chapter 4— Overview of the Audit Process and Preliminary Activities Form and Content of engagement letter The form and content of audit engagement letters may vary for each client, but they would generally include reference to: a, The objective and scope of the audit of the financial statements; The responsibilities of the auditor; The responsibilities of management; Identification of the applicable financial reporting framework for the preparation of the financial statements; and e. 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 and content. IMPORTANT NOTES: > Iflaw or regulation prescribes in sufficient detail the terms of the audit engagement, the auditor need not record them in a written agreement, except for the fact that such law or regulation applies and that management acknowledges and understands its responsibilities. > Even if the objective and scope of an audit and the responsibilities of management and of the auditor may be sufficiently established by law of a particular country, the auditor may nevertheless consider it appropriate to include the matters in an engagement letter for the information of management. aos Furthermore, an audit engagement letter may make reference to, for example: (RA FORMS) a, The presence of audit Risk (unavoidable risk because of inherent limitations of audit) Unrestricted Access to whatever records The financial reporting Framework used Objective of the audit The form of any Reports or other communication Management's responsibility Elaboration of the Scope of the audit amepaos The auditor may also wish to include in the letter: (FRAP Reports) a. Basis in which Fees are computed and any billing arrangements Expectation of receiving Representation letter ‘Acknowledgment of management of terms of agreement Arrangements regarding the Planning of the audit Description of any other letters or Reports b. c d. e. Page 133.d Preliminary Activities Iso be made: her auditors and Chapter 4 - Overview of the Audit Process ant ints could al When relevant, the following poil Arrangements concerning the involvement of ot! . some aspects of the audit. ester uditors and Arrangements concerning the involve! other staff of the entity. * Arrangements to be made with the previous 2} of initial audit. h «Any restriction of the auditor's liability when er «© Areference to any further agreements between ment of internal uditor, if any, in the case possibility exists, e auditor and the entity. * Any obligations to provide audit working papers to other parties. nt Letter PSA 210. The following is an example of an audit |-purpose financial statements prepared Example of an Audit Engageme Below example was lifted from engagement letter for an audit of general in accordance with Philippine Financial Reporting Standards. To the appropriate representative of management or those charged with governance of ABC Company: [The objective and scope of the audit] You have requested that we audit the financial statements of ABC Company, which comprise the balance sheet as at December 31, 20X1, and the income eae of changes in equity and cash flow statement for the year ee ae ae of significant accounting policies and other oie allel ion. We are pleased to confirm our acceptance and our ig of this audit engagement by means of this letter. Our audit will be conducted with the objective of our expressing an he financial jective o i an ; essing an opinion on the financial [The responsibilities of the auditor} We will conduct our audit in accordance wit (PSAs). Those standards require that we co} th Philippine Standards on Auditing mply with ethical requirements and i is i evidence a disclosures in the financial statements, The erseeainae da the amounts and selected depend o1 in the auditor's judgment, including the as misstatement of the financial statements, whether d Of the Fisks “of material also includes evaluating the appropriateness of acconnte ed Of error. An audit reasonableness of accounting estimates made by ne Policies used and the evaluating the overall presentation of the financial sateen nen aS Well a5 fements, Believe... Claim. Page 134Chapter 4 — Overview of the Audit Process and Preliminary Activities pecause of the inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with PSAs, In making our risk assessments, we consider internal control relevant to the entity's preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. However, we will communicate to you in writing concerning any significant deficiencies in internal control relevant to the audit of the financial statements that we have identified during the audit. [The responsibilities of management and identification of the applicable financial reporting framework] Our audit will be conducted on the basis that [management and, where appropriate, those charged with governance] acknowledge and understand that they have responsibility: a. For the preparation and fair presentation of the financial statements in accordance with Philippine Financial Reporting Standards; b. For such internal control as [management] determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; and c. To provide us with: i. Access to all information of which [management] is aware that is relevant to the preparation of the financial statements such as records, documentation and other matters; ii. Additional information that we may request from [management] for the purpose of the audit; and iii, Unrestricted access to persons within the entity from whom we determine it necessary to obtain audit evidence. As part of our audit process, we will request from [management and, where appropriate, those charged with governance], written confirmation concerning representations made to us in connection with the audit. We look forward to full cooperation from your staff during our audit. [Other relevant information] Unsert other information, such as fee arrangements, billings and other specific terms, as appropriate.] [Reporting] Insert appropriate reference to the expected form and content of the auditor's report.) rc NE Aim... Believe... Claim... Page 135oss and Preliminary Activities ew of the Audit Process ar Chapter 4 - Overvi need to be amended in the light of, nt of our report may The form and conten Oy audit findings. f this letter to indicate , rm the attached copy 0 f shemuattubeineney nent with, thearrangements for aur audi gf acknowledgement of, and agree! Sata A financial statements including our respective respon’ es, XYZ.& Co. Acknowledged and agreed on behalf of ABC Company by (Signed) Name and Title Date Audit of Components When the auditor of a parent entity is also the auditor of its Subsidiary, branch, or division (component), the factors that influence the decision whether to send a separate engagement letter to the component include the following (CLOSI): Who appoints the Component auditor; Legal requirements in relation t * Degree of Ownership by parent, . . '0 audit appointments; Whether a Separate auditor's rey Port is to be issued on the component; and * Degree of Independence of the component's management from the Parent entity, Recurring Audits However, the following factors may make it appropriate to revise the terms of the engagement, remind the entity of existing terms, and/or send a new letter: . Any indication that the client ‘misunderstands the objective and scope of the audit, * Any revised or 5 + Arecent chang Pecial terms of the engagement, fof management, board of directors or ownership. Page 136chapter 4 — Overview of the Audit Process and Preliminary Activities significant change in ownership. Asignificant change in nature or size of the client’s business. + Achange in legal or regulatory requirements, « Achange in financial reporting framework adopted in the preparation of the financial statements. + Achange in other reporting requirements, ACCEPTANCE OF A CHANGE IN ENGAGEMENT {f, prior to completing the audit engagement, the auditor is requested to change the audit engagement to an engagement that conveys a lower level of assurance, the auditor shall determine whether there is reasonable justification for doing so, The auditor shall not agree to a change in the terms of the audit engagement where there is no reasonable justification for doing so. Below are examples of circumstances that could lead to change in engagement and whether or not they are reasonably justifiable: Circumstances Reasonably justifiable? 1.Change in circumstances affecting the need for the service v 2.A misunderstanding as to the nature of an audit or related v services originally requested 3.A restriction on the scope of the engagement, whether x imposed by management or caused by circumstances 4.lf the change relates to information that is incorrect, x incomplete or otherwise unsatisfactory 5.The auditor is unable to obtain sufficient appropriate audit x evidence regarding assertions Auditor’s response Ifthe terms of the audit engagement are changed, the auditor and management shall agree on and record the new terms of the engagement in an engagement letter or other suitable form of written agreement. the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by management to continue the original audit engagement, the auditor shall: 3. Withdraw from the audit engagement where possible under applicable law or regulation; and ». Determine whether there is any obligation, either contractual or Otherwise, to report the circumstances to other parties, such as those charged with governance, owners or regulators. Air Believe... Claim... Page 137Chapter 4 — Overview of the Audit Process and Preliminary Activities In summary, the auditor's response would be: a. Stop performing the old engagement b.Stop referring to the old engagement, except when the new engagement involves agreed-upon procedures c. Start performing the new engagement, Ajj procedures to be performed, information to be obtained, and reports to be issueq should be related to new engagement. Yes >> Istherea reasonable justification? a.Continue the original audit engagement b.When prohibited to continue, withdraw from the audit engagement No |) Note: Every time withdrawal is made, the auditor should consider the necessity of communicating the reasons to appropriate level of management. anne Aim... Believe... Claim... Page 138Sore Speen priur wu lo CUTIpICUUI. 4—3 MULTIPLE CHOICE QUIZZERS 1. Acts to be performed in order to obtain audit evidence. A. Audit standards C. Audit program B. Audit procedures D. Audit strategy Aim... Believe... Claim... Z Page 140Chapter 4 - Overview of the Audit Process and Preliminary Activities 2, Audit procedures performed to obtain an understanding of the entity and its environment, including its internal control, and to assess the risks of material misstatements at the financial statement and assertion levels. A. Risk assessment procedures C. Substantive procedures B. Tests of control D. Analytical procedures 3. Audit procedures to test the operating effectiveness of controls in preventing or detecting and correcting material misstatements at the assertion level. A. Risk assessment procedures _C. Substantive procedures 8, Tests of control D. Analytical procedures 4. Audit procedures to detect material misstatements at the assertion level. A. Risk assessment procedures _C. Substantive procedures B. Tests of control D. Analytical procedures 5. If a company’s external auditor expresses an unqualified opinion as a result of the audit of the company’s financial statements, readers of the audit report can assume that ‘A. The external auditor found no fraud B. The company is financially sound and the financial statements are accurate C. Internal control is effective D. All material disagreements between the company and the auditor about the application of accounting principles were resolved in the satisfaction of the external auditor. 6. Ultimately, the decision about whether or not an auditor is independent must be made by A. Auditor C. Client’s management B. Public D. Audit committee With regard to independence, which of the following statements is correct? A. Audit engagements provide assurance to a wide range of potential users; consequently, both independence in mind and independence in appearance are of particular importance. B. Only the engagement partner is required by the Code of Ethics to be independent from their assurance clients. C._In case of audits of financial statements, the Code of Ethics requires member of the assurance team, the firm but not network firms to be independent of the client. D. In case of audits of financial statements, the Code of Ethics requires the auditor to be independent from their assurance team from the start of performing procedures required by the engagement up to the issuance of the report. ea Aim... Believe... Claim. Page 141Chapter 4 - Overview of the Audit Process and Preliminary Activities 8. Prior to beginning the fieldwork on a new audit engegement in 7 = : does not possess expertise in the industry in which the client operates the CPA should A B. 9. When one auditor succeeds another, the proposed auditor shi imi vels of materi Reduce audit risk by lowering the preliminary lero wet 7 Design special substantive tests to compensate for the lack o' expertise, / a Engage financial experts familiar with the nature _ Obtain knowledge of matters that relate to the nature of the business. dustry. the A. 10. On an audit engagement performed by 3 CPA firm with one o} minimum, knowledge of the relevant professional accounting end sud: standards should be held by: A B. c. dD. 11. Prior to acceptance of the en; A. B. Cc D. 12. Which of the following would not be a cor whether to accept a new client? A. B. Cc D. Client to instruct its attorney to send a letter of audit inquiry the status of the prior year’s litigation, claims, and essessm: Previous auditor to submit a list of internal control weaknesses tt not been corrected. Client to authorize the previous auditor to respond to inquiries. Previous auditor to update the prior year’s report to the date of the change of auditors. COntEring ate a The auditor with final responsibility for the audit. All professionals working upon the audit All professionals working upon the audit and the Partner in char; CPA firm. All professionals working in the office. geof 'gagement, a CPA firm is not likely to Make inquiries of previous auditor Make inquiries of the proposed client’s legal counsel Review financial statements of Proposed client Review the personnel practices of the proposed client, nsideration of a CPA firm in deciding The client's financial ability. The client's standing in the business community. The client's relations with its previous CPA firm, The client's probability of achieving an unqual Aim... Believe... Claim... Page 142chapter 4 ~ Overview of the Audit Proce \d Preliminary Activities 13. Auditors must not only decide whether to accept new clients; they also should periodically review their list of current clients and reriove those clients the firm no longer wants to be associated with. Reasons for discontinuing clients might include the following, except: A. Difficulty in working with client personnel, 8, Inability to negotiate an acceptable increase in the audit fee. ¢, Evidence indicating a client’s management has integrity. D. Client need for specialized services the current firm is unable or unwilling to provide. 14, Before accepting an engagement to audit a new client, a CPA is required to obtain: A, An understanding of the prospective client's industry and business. B, The prospective client's signature to the representation letter. Cc. A preliminary understanding of the prospective client's control environment. D. The prospective client's consent to make inquiries of the previous auditor, if any. 45, Prior to the acceptance of an audit engagement with a client who has terminated the services of the previous auditor, the CPA should A. Contact the previous auditor without advising the prospective client and request a complete report of the circumstances leading to the termination of the engagement with an understanding that all information disclosed will be kept confidential B. Accept the engagement without contacting the previous auditor since the CPA can include audit procedures to verify the reason given by the client for the termination. C. Not communicate with the previous auditor because this would in effect be asking the auditor to violate the confidential relationship between an auditor and the client. D. Advise the client of the intention to contact the previous auditor and request a permission for the contact. 4-4 MULTIPLE CHOICE QUIZZERS 1. If permission from the client to discuss its affairs with the proposed auditor is denied by the client, the previous auditor should: A. Keep silent of the denial B. Disclose the fact that the permission to disclosure is denied by the client C.. Disclose adequately to proposed auditor all noncompliance made by the dient D. Seek legal advice before responding to the proposed auditorChapter 4 ~ Overview of the Audit Process and Preliminary a : 2. Which of the following factors most likely would cause # CPA to not accene . new audit engagement? i hysical in A. The prospective client has already completed its pny Venton, count. oo a. lient's operati B. The CPA lacks an understanding of the prospective ¢ PETation, lea auditor's audit documentatig, C. The CPA is unable to review the previou' D. The prospective client is unwilling tom? to the CPA. ke all financial records availayy 3. Which of the following factors most likely a a CPA to conclude thy cted? jal audit engagement should be rejec ; A the detas of most recorded transactions are not available after specified period of time. B. Internal control activities requit to management override. : C. itis unlikely that sufficient appropriate evidence is available to support an opinion on the financial statements. D. Management has a reputation for consulting with several accounting firms about significant accounting issues. ring the segregation of duties are subjec: 4, Before accepting an audit engagement, a proposed auditor should make specific inquiries of the previous auditor regarding: A. The previous auditor's evaluation of matters of continuing accounting significance B. Disagreement which the previous had with the client concerning auditing procedures and accounting principles C._ The degree of cooperation the previous received concerning the inquiry of the client’s legal counsel D. The previous auditor's assessment of inherent risk and judgments about materiality 5. If the prospective client refuses to permit the previous to respond or limits the previous auditor’s response, the proposed should: A. Continue to ask the previous auditor questions on facts that might bea! on the integrity of management B. Accept the engagement but only after an equitable increase in thé professional fee C. Inquire as to the reasons and consider the implications in deciding whether to accept the engagement D. Issue a disclaimer of opinion because the limited response of thé previous auditor constitutes a significant scope limitationChapter 4 ~ Overview of the Audit Process and Preliminary Activities 6. A firm has obtained information that would have caused it to decline an engagement had the information been available earlier. Actions availabl the auditor would include the following, except: ‘A. Reporting the information and its implications to the person/s who appointed the CPA 8. Withdraw from the engagement C. Withdraw from the client relationship D. Issue a disclaimer of opinion o 7. According to PSA 210, the auditor and the client should agree on the terms of engagement. The agreed terms would need to be recorded in a(n) A. Client representation letter 8. Memo placed in the permanent section of the working papers C. Engagement letter D. Comfort letter 8. An engagement letter is best described as A. Aletter from the company to the auditors specifying management's expectations for completion of the audit on a timely basis and the fees. B. Aletter from the auditors to company management specifying that management is responsible for the financial statements, and the auditors will issue an opinion on the financial statements. C. Aletter from the auditors to company management that specifies the responsibilities of both the company and the auditors in completing the audit and the timing for its completion. D. Aletter from the Board of Directors’ audit committee to the auditor that indicates the auditor has been engaged to perform the audit and the fees to be paid. 9. Engagement letters are widely used in practice for: A. Audits only B. Related services only C. Assurance engagements only D. Professional engagements of all types 10. Which of the following statements is/are correct? Statement 1: The auditor and the client should agree on the terms of the engagement. Such an agreement may be in the form of audit engagement letter or other suitable form of contract. Statement 2: Even in those countries where the scope of the audit is established by law, an engagement letter may be informative for the client. A. Only statement 1 is correct C. Both statements are correct B. Only statement 2 is correct D. Both statements are incorrect a Aim... Believe... Clai Page 145 wiielChapter 4 - Overview of the Audit Process and Preliminary Activities 11. Engagement letter that documents and confirms the auditor's acceptancs the engagement would normally be sent to the client. : A. Before the auditor report is issued B. Atthe end of the fieldwork C. After the audit report is issued D. Before the commencement of the engal most likely would include @ stateme., gement 12. An auditor's engagement letter Te anegerent' responsibility to provide certain written representation. B. evans under which the auditor may modify the Preliminary Cc. jument to festa would reduce the auditor's assessment o¢ D. ie matters that could modify the auditor's preliminary assessment of fraud risk. ly include: 43. An audit engagement letter least likel ‘tations of an audit that there is an A. A reference to the inherent limit unavoidable risk that some material misstatements may remain undiscovered B. Description of any letters or reports that the auditor expects to submit to the client C. Identification of specific audit procedures that the auditor needs to undertake D. Basis on which fees are computed and any billing arrangements 14. Which of the following statements would least likely appear in an auditor's engagement letter? A. Fees for our services are based on our regular per diem rates, plus travel and other out-of-pocket-expenses. B. Management is responsible for making all financial records and related information available to us. C. Our engagement is subject to the ri: i eager risk that materi aud, they exist, will not be detected. arial errors. oF D. oa performing our preliminary analytical procedures, we will discuss with you the other procedures we consider necessary to complete the engagements.