A3-T1

A. Quality Control Policies and Procedures –

a. As part of the pre-acceptance phase of any engagement, the accountant must
document compliance with the firm’s quality control policies and procedures regarding
acceptance or continuance of clients and engagements.

IV Establish an understanding with the client

An ENGAGEMENT LETTER is a presumptively mandatory requirement (it is required in most
circumstances = signed contract.

A. Management Responsibility
a. F/S and tax returns and selection of acct policies
b. Establishing and maintaining effective I/C over F/S reporting
c. Identifying and ensuring that the entity complies with the laws and regulations
applicable to its activities, and preventing/detecting fraud.
d. Making all financial records and related information available to the auditor
e. Providing the Rep Letter the auditor
f. Adjusting the F/S to correct material misstatements
g. Affirming to the auditor --------------------------------
B. Auditors responsibilities
a. Follow GAAS
b. Obtain reasonable assurance
C. Limitations of the Engagement
a. An audit is not designed to detect error or fraud that is immaterial to the F/S
b. An audit is not designed to provide assurance on I/C or to Identify significant
deficiencies
i. If we discover fraud auditor report them
ii. Audit is subject to inherent risks that errors and fraud will not be detected
D. Documentation
i. The auditor should document the understanding with the client through a
written communication (A CLIENT ENGAGEMENT LETTER). The engagement
letter should be accepted (signed and dated by the client.
1. An engagement letter includes discussion of both the auditor’s
responsibilities and the limitations of the engagement. The fact that
audit risk exists and that an audit may not detect material errors and
fraud is typically included in this letter.
V. Planning the Audit
A. The NATURE, EXTENT AND TIMING =” NET” of planning procedures will vary based
on the size and complexity of the entity, and on the auditors experience with and
understanding of the entity.
B. Requirements
a. Obtain an understanding of the entity and its environment, including its I?C
sufficient to asses risk and design audit procedures.
C. Knowledge of CLIENTS INDUSTRY
D. Knowledge of CLLIENTS BUSINESS
a. Tour client facility
b. Review the financial history of the client
c. Obtain an understanding of client accounting
d. Inquire of Client Personnel
E. Analytical Procedures
a. Use of Analytical Procedures
i. For planning the “N-E-T ” of other auditing procedures (mandatory)
ii. As substantive tests to obtain audit evidence (optional)
iii. As an overall review in the final review stage of the audit
( mandatory)
b. Analytical procedures performed during PLANNING STAGE
i. During planning, analytical procedures consist of a review of data
aggregated at a high level, such as comparing f/s to budgeted or
anticipated results.
ii. Consider financial data and nonfinancial data (employee turnover)
iii. Purpose:
1. Enhance the auditors understanding of client
2. Indentify unusual transactions and events, and amounts

F. The Audit Plan – must be written and is required

a. Components of an Audit Plan:
i. The auditor must develop an audit plan in which specific audit
procedures are documented. The AUDIT PLAN should include a
description of the nature, extent, and timing of:
1. Planned risk assessment procedures
a. Required in all F?S audits
2. Planned further audit procedures-
ii. Relationships of audit strategy and audit plan
iii. The possibility of a specialist
iv. Timing of audit procedures
VI. Misstatements and Materiality
I.
A. Misstatements may be either known or likely
a. Known misstatements are specific misstatements identified during the audit.
b. Likely misstatements are misstatements that the auditor considers likely to exist, either
due to differences between auditor and management judgments regarding estimates or
based on extrapolation from audit evidence.
B. Tolerable Misstatement ( Tolerable Error)
a. TE – is the maximum error in a specific population ( ex: an account balance) that the
auditor is willing to accept.
C. Communication to Management
a. All
II. Materiality
a. Preliminary Judgments about Materiality
i. b/c the F/S are interrelated, the auditor should use the smallest level of
misstatement that could be material to any on of the F/S.
ii. Materiality ordinarily will be revised as the audit progresses.
b. Evaluation of Audit Findings
i. The auditor must consider the effects, both individually and in the aggregate of
uncorrected misstatements (both known and likely)
ii. Qualitative Considerations
1. Misstatements are more likely to be considered material if they:
a. Affect trends in profitability
b. Affect the entity’s compliance with loan covenants, contracts, or
regulatory provisions.
c. Increase managements compensation
d. Affect significant F/S elements
e. Can be objectively determined, as opposed to including an element
of subjectivity.
2. Whether or not a misstatement is considered material is ultimately a matter
of professional judgment.
 c. Documentation Requirements
i. Planning levels of materiality and T/E, the basis for those levels, and any subsequent
changes.
ii. Known and likely misstatements that were corrected by management
iii. A summary of uncorrected misstatements (both known and likely), the auditor’s
conclusion regarding whether such misstatements cause the F/S to be materially
misstated and the basis for this conclusion.
1. Documentation of uncorrected misstatements should include:
a. Separate identification of known and likely misstatements
b. The aggregate effect on the F/S
c. Relevant qualitative factors affecting materiality judgments
III. AUDIT RISK
a. Audit risk is the risk that the auditor may unknowingly fail to modify appropriately the
opinion on the F/S that are materially misstated
b. The Audit risk Model = The risk that the auditor will give the wrong opinion.
i. AR = Risk of Material Misstatement x Detection Risk

AR= IR x CR x DR
IR= inherent Risk = the clients system made a mistake

CR= Control Risk = the risk the clients internal control didn’t catch it and fix it.

DR= Detection Risk = that audit didn’t find and fix it

c. Inherent Risk (“IR) – the susceptibility of a relevant assertion to a material misstatement,

assuming there are no related controls. It’s a mistake in the clients accounting system. The
auditor assesses the risk but can’t change the risk.
i. RMM / IR x CR = DR
d. Control Risk (“CR) – the risk that a material misstatement that could occur in a relevant
assertion will not be prevented or detected on a timely basis by the entity’s internal control.
Client’s internal control does not catch it. Independent of the auditor generally cannot
change this risk.
e. Detection Risk (“DR”) – the risk that the auditor will not detect a misstatement that exists in
a relevant assertion. The auditor will miss the mistake.
i. DR is a function of the effectiveness of audit procedures and of the manner in which
they are applied. (lot of work – low) (little work- high)
ii. The Auditor can change the risk
 f. EFFECT ON THE AUDIT
i. Inverse relationship of RMM ( IR x CR) to the DR
1. When the auditor determines that the risk of material misstatement is high,
detection risk should be set at a low level. Conversely, when the risk of
material misstatement is low the auditor can justify a higher detection risk.
2. The auditor can change the detection risk
a. The auditor can change the level of detection risk by varying the
nature, extent, and timing of audit procedures.
b. Substantive Procedures is always necessary and is required.
IV. AUDIT RISK AND MATERIALITY: CONSIDERATION DURING AN AUDIT
a. Overall Considerations
i. Considerations of audit risk and materiality are affected by the size and complexity
of the entity, as well as the auditors experience with and knowledge of the entity,
its environment, and its internal control.
ii. Audit risk and materiality must be considered at both the f/s level and the account
balance, individual transaction class, or disclosure item level.
b. Consideration at the f/s level – at the f/s level they should consider risks that have a
pervasive effect on the f/s, potentially affecting many relevant assertions. Audit risk at the
f/s level often relates to the entity’s control environment.
c. Consideration at the account balance, transaction class, or disclosure item level
i. Used to determine the nature, extent, and timing of audit procedures
ii. Inverse relationship b/w Audit Risk and Materiality
V. Developing the Audit Plan
a. Audit Procedures
i. Risk Assessment Procedures
ii. Test of Controls = Auditor tests internal controls
1. Tests of controls are used to evaluate the operating effectiveness of internal
control in preventing or detecting material misstatements.
iii. Substantive Procedures = Auditor tests $$ balances
1. Used to detect material misstatements
b. Financial Statement Assertions - PG 19 – “A CPA CO CAREs about CURVed
assertions”
i. Categories
1. Transactions and Events
a. Completeness
b. Proper Period Cutoff
c. Accuracy
d. Classification
e. Occurrence
 2. Account Balances
a. Completeness
b. Allocation and Valuation
c. Rights and Obligations
d. Existence
3. Presentation and Disclosure
a. Completeness
b. Understandability and Classification
c. Rights and Obligations
d. Valuation and Accuracy
c. Drafting the Audit Plan- Required
i. After sufficient planning information has been gathered, an audit plan should be
drafted. A written audit plan is required for every audit. – “N-E-T”
d. Important to remember that the CPA gathers evidence to support the expression of an
opinion.
VI. Supervision of Assistants
a. Proper Supervision (“TIP – PIE – ACDO”)
b. Extent of Supervision – depends on:
i. The complexity of the subject matter, and
ii. The qualifications of the assistant
VII. The Role of the Client’s Internal Auditors- They can’t make
judgments for us.
a. When planning the audit, the auditor should consider the extent of involvement of the
clients internal auditors in the performance of the audit. While internal auditors must
maintain objectivity and integrity, that are not independent of the client, their employer.
Thus the independent external auditor cannot share with the internal auditor any of the
responsibility for audit decisions, judgments, or assessments made as part of the audit...
i. External Auditor Responsibilities
1. Obtain an understanding of the Internal Audit Functions
2. If the auditor decides to make use of the internal auditors work,
competence and objectivity must be assessed.
3. The external auditor remains solely responsible for the report on the f/s.
While the internal auditor may assist with regards to routine ministerial
tasks, he or she may not be utilized to make judgment calls, which remain
the responsibility of the independent auditor. CPA must decide judgment
and assessments, NOT the internal auditors.
VIII. Using the work of specialists (actuaries, appraisers, attorneys
etc.)
a. The specialists should have an understanding of the auditor’s use of the specialist findings.
The specialist does not have to use the same methods as the client in calculating amounts.
The auditor must understand the nature of the specialist’s work and be able to evaluate the
findings for their suitability in corroborating f/s amounts.
b. Competence and Objectivity
i. The auditor must be satisfied as to the professional competence and reputation of
the specialist.