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Professional Auditing Standards and The Audit Opinion Formulation Process
Professional Auditing Standards and The Audit Opinion Formulation Process
A RISK-BASED APPROACH TO
CONDUCTING A QUALITY AUDIT
9th Edition
CHAPTER 5
PROFESSIONAL AUDITING STANDARDS AND THE
AUDIT OPINION FORMULATION PROCESS
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LEARNING OBJECTIVES
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THE AUDIT OPINION FORMULATION
PROCESS
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PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE
OF ADHERING TO PROFESSIONAL AUDITING STANDARDS
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PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE
OF ADHERING TO PROFESSIONAL AUDITING STANDARDS
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PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE
OF ADHERING TO PROFESSIONAL AUDITING STANDARDS
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LEARNING OBJECTIVE 1
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PROFESSIONAL AUDITING STANDARDS
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AICPAS AUDITING STANDARDS BOARD
- CLARITY PROJECT
Made standards easier to read, understand, and
apply
Converged its standards with the International
Standards on Auditing (ISAs), issued by the IAASB
Standards were written using drafting convention
called the clarity format
Issued the clarified standards in a single Statement
on Auditing Standard (SAS No. 122) in 2012
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EACH STANDARD OF CLARITY FORMAT
PRESENTED IN FOLLOWING SECTIONS
Introduction
Purpose and scope of the standard
Objective
Context in which the requirements are set
Definitions
Relevant meanings of terms in standards
Requirements
Actions required to achieve objective of the standard
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AUDITING STANDARDS ISSUED BY THE
IAASB
Standards should to be understandable, clear, and
consistent
Launched a program in 2004 to enhance clarity of its
ISAs
Clarity Project was completed in 2009
As of 2013, a set of its clarified standards comprises
of:
36 ISAs
1 International Standard on Quality Control (ISQC)
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EACH STANDARD OF CLARITY FORMAT
PRESENTED IN FOLLOWING SECTIONS
Introduction
Purpose and scope of subject matter of ISA
Objective
Clear statement of the objective of the auditor
Definitions
For applicable terms included
Requirements
For each objective are provided
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AUDITING STANDARDS ISSUED BY THE
PCAOB
Apply to auditors of U.S. public companies
Issued sixteen Auditing Standards (ASs) as of 2013
PCAOB interim standards - Standards adopted from
AICPA
Requirement for public company auditors, unless
superseded by a PCAOB standard
Standards issued by AICPA after April 16, 2003, not
included
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EXHIBIT 5.1 - COMPARISON OF U.S. AND
INTERNATIONAL AUDITING STANDARDS
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LEARNING OBJECTIVE 2
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PCAOB GUIDANCE - FIELDWORK
STANDARDS
Applicable to conduct of the audit
Require auditors to:
Properly plan and supervise the audit
Develop an understanding of clients controls
Prerequisite for developing audit tests
Obtain audit evidence by performing audit procedures
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PCAOB GUIDANCE - REPORTING
STANDARDS
Applicable to communicating auditors opinion
Require auditors to:
State whether financial statements are presented in
accordance with the applicable financial reporting
framework (i.e., GAAP or IFRS)
Identify conditions where accounting principles are not
consistently observed
Review disclosures for adequacy and state in the report if
disclosures are not reasonably adequate
Express an opinion on financial statements as a whole or
state that an opinion cannot be expressed
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AICPA GUIDANCE - PURPOSE AND
PREMISE OF AUDIT
Purpose - Enhance degree of confidence that users
can place in financial statement
Premise - Management has responsibility to:
Prepare financial statements
Maintain internal control over financial reporting
Provide auditor with relevant information and access
to personnel
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AICPA GUIDANCE - RESPONSIBILITIES
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AICPA GUIDANCE - PERFORMANCE
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AICPA GUIDANCE - REPORTING
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INTEGRATED AUDIT
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AUDITING IN PRACTICE - BENEFITS OF
INTEGRATING THE AUDITS
Integrating audits of internal controls and of financial
statements makes sense
Both the tests of controls and direct tests of account
balances provide evidence related to each other
Example:
Tests of controls provide indirect evidence that financial
statements are free from misstatement
Further, if material misstatements found in account
balances or disclosures, it implies that there were
material weaknesses in internal controls
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LEARNING OBJECTIVE 3
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EXHIBIT 5.3 - ACTIVITIES OF EACH PHASE OF THE
AUDIT OPINION FORMULATION PROCESS
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IMPORTANT CONCEPTS AFFECTING AUDIT
OPINION FORMULATION PROCESS
Accounting cycles
Management assertions
Audit evidence and audit procedures
Documentation
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LEARNING OBJECTIVE 4
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ACCOUNTING CYCLES
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EXHIBIT 5.4 - ILLUSTRATIONS OF CYCLES
AND RELATED ACCOUNTS
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LEARNING OBJECTIVE 5
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MANAGEMENTS FINANCIAL STATEMENT
ASSERTIONS IN PCAOB STANDARDS
Existence or Occurrence
Refers to existence of assets and liabilities
Refers to occurrence of recorded transactions
Completeness
Refers to inclusion of all transactions and accounts in financial statements
Valuation or Allocation
Refers to inclusion of accounts in financial statements at appropriate
amounts
Rights and Obligations
Refers to assets being the rights of an organization
Refers to liabilities being the obligations of an organization
Presentation and Disclosure
Refers to components of financial statement being properly classified,
described, and disclosed
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LEARNING OBJECTIVE 6
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AUDIT PROCEDURES
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LEARNING OBJECTIVE 7
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PURPOSES OF AUDIT
DOCUMENTATION
Assisting engagement team in:
Planning and performing audit
Supervising and reviewing audit work
Retaining a record of matters of continuing
significance to future audits
Enabling internal or external inspections of
completed audits
Assisting auditors in understanding work performed
in prior year
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EXAMPLES OF AUDIT
DOCUMENTATION
Audit programs
Analyses prepared by client or auditor
Memorandums
Summaries of significant findings or issues
Letters of confirmation and representation
Checklists
Correspondence concerning significant findings or
issues
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LEARNING OBJECTIVE 8
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AUDITING IN PRACTICE - ACCEPTING A
NEW AUDIT ENGAGEMENT
Communicate with predecessor auditor
Following issues should be addressed
Information regarding integrity of management
Disagreements with management about accounting
policies, auditing procedures
Communications to management and those in charge
with governance regarding:
Fraud and noncompliance with laws
Deficiencies and material weaknesses in internal control
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AUDIT ENGAGEMENT LETTER
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IDENTIFYING AND ASSESSING RISKS OF
MATERIAL MISSTATEMENT
Essential to audit planning
Requires identification of significant:
Accounts
Disclosures
Relevant assertions
Auditor establishes a materiality level overall and for
specific accounts and disclosures
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EXHIBIT 5.7 - EXAMPLES OF SOURCES
OF RISK OF MATERIAL MISSTATEMENT
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RISKS AT ASSERTION LEVEL
Inherent risk
The susceptibility of an assertion to a misstatement, due to
error or fraud, that could be material, individually or in
combination with other misstatements, before
consideration of any related controls
Control risk
The risk that a misstatement due to error or fraud that
could occur in an assertion and that could be material,
individually or in combination with other misstatements,
will not be prevented or detected on a timely basis by the
organization's internal control
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RISK ASSESSMENT PROCEDURES
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TYPES OF CONTROLS
Entity-wide controls
Transaction controls
Fraud-related controls
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AUDITING IN PRACTICE - CONTROLS TO
ADDRESS FRAUD RISK
PCAOB has identified the following
Controls over significant, unusual transactions, particularly
those resulting in unusual journal entries
Controls over journal entries and adjustments made in the
period-end financial reporting process
Controls over related-party transactions
Controls related to significant management estimates
Controls mitigating incentives for, and pressures on,
management to falsify financial results
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TYPES OF PROCEDURES TO
ASSESS DESIGN EFFECTIVENESS
Inquiry of appropriate personnel
Observation of the organizations operations
Inspection of relevant documentation
Performance of walkthroughs
Documentation of preliminary assessment of control
design and basis for that assessment
Understand the approach used by management for
conclusions on effectiveness of internal control
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AUDITING IN PRACTICE - DOCUMENTING AUDITORS
UNDERSTANDING OF AN ORGANIZATIONS INTERNAL
CONTROLS
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ASSESSING RANGE OF CONTROL RISK
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AUDITING IN PRACTICE EXAMPLE FOR WEAK INTERNAL
CONTROL DESIGN AND LINKS TO SUBSTANTIVE AUDIT
PROCEDURES
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AUDITING IN PRACTICE EXAMPLE FOR WEAK INTERNAL
CONTROL DESIGN AND LINKS TO SUBSTANTIVE AUDIT
PROCEDURES
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ADDITIONAL CONSIDERATIONS FOR AN
INTEGRATED AUDIT
Risk assessment procedures apply to:
Audit of internal control over financial reporting
Audit of financial statements
Top-down approach - Used for audit of internal control
over financial reporting to select controls to test
Begins at financial statement level
Focuses on entity-wide controls
Works down to significant accounts and disclosures and
their relevant assertions
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RESPONDING TO IDENTIFIED RISKS OF
MATERIAL MISSTATEMENT
Purpose of risk assessment procedures
Identify risks of material misstatement
Determine where misstatements in financial
statements may occur
Design appropriate audit strategy
Controls reliance audit: Includes tests of controls
and substantive procedures
Substantive audit: Includes substantive procedures
and does not include tests of controls
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RESPONDING TO IDENTIFIED RISKS OF
MATERIAL MISSTATEMENT
Selecting specific audit procedures to respond to
identified risks
Assembling an audit team having knowledge, skill,
and ability needed to address assessed risks
Emphasizing the need for professional skepticism
Providing an appropriate level of supervision for
assessed risks
Incorporating elements of unpredictability in
selection of audit procedures
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EXHIBIT 5.8 - RESPONDING TO IDENTIFIED RISKS
THROUGH EVIDENCE DECISIONS
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ADDITIONAL CONSIDERATIONS FOR AN
INTEGRATED AUDIT
Audit strategy that includes tests of controls to
accomplish objectives of both audits
Sufficient evidence related to operating effectiveness
of controls to support auditors:
Control risk assessments for purposes of the audit of
financial statements
Opinion on internal control over financial reporting as
of year-end
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FRAUD CONSIDERATIONS
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LEARNING OBJECTIVE 10
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AUDITING IN PRACTICE - RISK ASSESSMENT PROCEDURES
AND TESTS OF OPERATING EFFECTIVENESS OF CONTROLS
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SELECTING CONTROLS TO TEST
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EXHIBIT 5.9 - LINKING FINANCIAL STATEMENT
ASSERTIONS AND SELECTING CONTROLS TO TEST
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TYPES OF CONTROLS AND EXAMPLES OF
CONCEPTS AFFECTING CONTROL TESTING
Computerized Controls
Reviewing
Taking a random
exception reports
Considering sample of
and determining:
If there are changes, submitting test transactions for
determining: a) Proper exceptions
testing integrity of transactions through
being noted
controls after the system to a) Operations of key
changes determine its controls b) Exceptions go to
performance authorized
b) Completion of
personnel with
process
adequate follow-up
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TYPES OF CONTROLS AND EXAMPLES OF
CONCEPTS AFFECTING CONTROL TESTING
Manual Controls
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TYPES OF CONTROLS AND EXAMPLES OF
CONCEPTS AFFECTING CONTROL TESTING
Controls over Accounting
Estimates
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FIRST APPROACH TO TESTING
CONTROLS
Take sample of customer orders and trace it through
the system to determine whether:
There was proper review of credit and
Credit authorization or denial was proper
Advantage - Most effective because it helps in
determining that the control worked effectively
Requires documentation of all credit applications and
purchase orders required
Based on audit sampling
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SECOND APPROACH TO TESTING
CONTROLS
Taking a sample of recorded items and tracing back
to credit approval process
Provides evidence on proper credit approval for all
items presently recorded
Does not provide evidence as to whether other items
should have been approved for credit, but had not
been approved
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THIRD APPROACH TO TESTING
CONTROLS
Uses a computer audit program and develops a print-
out of account balances exceeding their credit
authorization
Cost-effective
Requires an inference about the control
Covers only the operation of the controls related to
the current account balances
100% evaluation of each item currently recorded
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TESTING THE OPERATING
EFFECTIVENESS
Auditor tests relevant principles of components of:
Control environment
Risk assessment
Information and communication
Monitoring
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RESULTS OF TESTS OF CONTROLS FOR
FINANCIAL STATEMENT AUDIT
If control deficiencies are identified
Assess them to determine whether preliminary control
risk assessment should be modified
Record the implications for substantive procedures
If no control deficiencies are identified
Assess whether preliminary control risk assessment is still
appropriate
Determine extent that controls can provide evidence on
accuracy of account balances
Determine planned substantive audit procedures
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RESULTS OF TESTS OF CONTROLS FOR
FINANCIAL STATEMENT AUDIT
Determine how much assurance about reliability of
account balances can be obtained from the effective
operation of controls
Within any audit, level of assurance will vary across:
Accounts
Disclosures
Assertions
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LEARNING OBJECTIVE 11
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EXHIBIT 5.12 - FACTORS AFFECTING
SUBSTANTIVE PROCEDURES TO BE PERFORMED
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LEARNING OBJECTIVE 12
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LEARNING OBJECTIVE 13
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MANAGEMENT ASSESSMENT OF
CONTROLS
Deficiency of lack of approval considered as a
significant deficiency based on the following
rationale:
Major departure from an approved process
Could lead to purchase of unauthorized goods
Could be shipped elsewhere and lead to material
misstatement in financial statements
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AUDITOR ASSESSMENT OF CONTROLS
Auditor reviews:
Managements documentation of its internal control
Managements evaluation and findings related to
internal control effectiveness
Auditor then gathers evidence on operating
effectiveness of these controls
By taking a random sample auditor needs to
independently determine that the controls are working
or not
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AUDITOR ASSESSMENT OF CONTROLS
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