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1、Chapter 8 Audit Planning and Analytical Procedures < Review Questions 8-1 There are three primary benefits from planning audits: it helps the auditor obtain sufficient appropriate evidence for the circumstances, helps keep audit costs reasonable, and helps avoid misunderstandings with the c

2、lient. 8-2 Eight major steps in planning audits are: 1. Accept client and perform initial planning 2. Understand the client’s business and industry 3. Assess client business risk 4. Perform preliminary analytical procedures 5. Set materiality, and assess acceptable audit risk and inherent

3、risk 6. Understand internal control and assess control risk 7. Gather information to assess fraud risks 8. Develop overall audit plan and audit program 8-3 The new auditor (successor) is required by SAS 84 (AU 315) to communicate with the predecessor auditor. This enables the successor to obt

4、ain information about the client so that he or she may evaluate whether to accept the engagement. Permission must be obtained from the client before communication can be made because of the confidentiality requirement in the Code of Professional Conduct. The predecessor is required to respond to the

5、 successor’s request for information; however, the response may be limited to stating that no information will be given. The successor auditor should be wary if the predecessor is reluctant to provide information about the client. 8-4 Prior to accepting a client, the auditor should investigate th

6、e client. The auditor should evaluate the client’s standing in the business community, financial stability, and relations with its previous CPA firm. The primary purpose of new client investigation is to ascertain the integrity of the client and the possibility of fraud. The auditor should be especi

7、ally concerned with the possibility of fraudulent financial reporting since it is difficult to uncover. The auditor does not want to needlessly expose himself or herself to the possibility of a lawsuit for failure to detect such fraud. 8-5 SAS 108 requires the auditor to document their understand

8、ing of the terms of the engagement with the client in an engagement letter. The engagement letter should include the engagement’s objectives, the responsibilities of the auditor and management, and the engagement’s limitations. An engagement letter is an agreement between the CPA firm and the client

9、 concerning the conduct of the audit and related services. It should state what services will be provided, whether any restrictions will be imposed on the auditor’s work, deadlines for completing the audit, and assistance to be provided by client personnel. The engagement letter may also include the

10、 auditor’s fees. In addition, the engagement letter informs the client that the auditor cannot guarantee that all acts of fraud will be discovered. 8-6 Because the Sarbanes-Oxley Act of 2002 explicitly shifts responsibility for hiring and firing of the auditor from management to the audit committee

11、 for public companies, the audit committee is viewed as “the client” in those engagements. 8-7 All audit and non-audit services must be preapproved in advance by the audit committee for public companies. 8-8 The second standard of fieldwork requires the auditor to obtain an understanding of th

12、e entity and its environment. Auditors need an understanding of the client’s business and industry because the nature of the business and industry affect business risk and the risk of material misstatements in the financial statements. Auditors use the knowledge of these risks to assess the risk of

13、material misstatement and to determine the appropriate extent of further audit procedures. The five major aspects of understanding the client’s business and industry, along with potential sources of information that auditors commonly use for each of the five areas are as follows: 1. Industry an

14、d External Environment – Read industry trade publications, AICPA Industry Audit Guides, and regulatory requirements. 2. Business Operations and Processes – Tour the plant and offices, identify related parties, and inquire of management. 3. Management and Governance – Read the corporate charter and

15、 bylaws, read minutes of board of directors and stockholders, and inquire of management. 4. Client Objectives and Strategies – Inquire of management regarding their objectives for the reliability of financial reporting, effectiveness and efficiency of operations, and compliance with laws and regula

16、tions; read contracts and other legal documents, such as those for notes and bonds payable, stock options, and pension plans. 5. Measurement and Performance – Read financial statements, perform ratio analysis, and inquire of management about key performance indicators that management uses to measur

17、e progress toward its objectives. 8-9 During the course of the plant tour the CPA will obtain a perspective of the client’s business, which will contribute to the auditor’s understanding of the entity and its environment. Remember that an important aspect of the audit will be an effective analys

18、is of the cost system. Therefore, the auditor will observe the nature of the company’s products, the manufacturing facilities and processes, and the flow of materials so that the information obtained can later be related to the functions of the cost system. 8-9 (continued) The nature of the com

19、pany’s products and the manufacturing facilities and processes will reveal the features of the cost system that will require close audit attention. For example, the audit of a company engaged in the custom-manufacture of costly products such as yachts would require attention to the correct charging

20、of material and labor to specific jobs, whereas the allocation of material and labor charges in the audit of a beverage-bottling plant would not be verified on the same basis. The CPA will note the stages at which finished products emerge and where additional materials must be added. He or she will

21、also be alert for points at which scrap is generated or spoilage occurs. The auditor may find it advisable, after viewing the operations, to refer to auditing literature for problems encountered and solved by other CPAs in similar audits. The auditor’s observation of the manufacturing processes wil

22、l reveal whether there is idle plant or machinery that may require disclosure in the financial statements. Should the machinery appear to be old or poorly maintained, the CPA might expect to find heavy expenditures in the accounts for repairs and maintenance. On the other hand, if the auditor determ

23、ines that the company has recently installed new equipment or constructed a new building, he or she will expect to find these new assets on the books. In studying the flow of materials, the auditor will be alert for possible problems that may arise in connection with the observation of the physica

24、l inventory, and he or she may make preliminary estimates of audit staff requirements. In this regard, the auditor will notice the various storage areas and how the materials are stored. The auditor may also keep in mind for further investigation any apparently obsolete inventory. The auditor’s st

25、udy of the flow of materials will disclose the points at which various documents such as material requisitions arise. He or she will also meet some of the key manufacturing personnel who may give the auditor an insight into production problems and other matters such as excess or obsolete materials,

26、and scrap and spoilage. The auditor will be alert for the attitude of the manufacturing personnel toward internal controls. The CPA may make some inquiries about the methods of production scheduling, timekeeping procedures and whether work standards are employed. As a result of these observations, t

27、he internal documents that relate to the flow of materials will be more meaningful as accounting evidence. The CPA’s tour of the plant will give him or her an understanding of the plant terminology that will enable the CPA to communicate fluently with the client’s personnel. The measures taken by

28、the client to safeguard assets, such as protection of inventory from fire or theft, will be an indication of the client’s attention to internal control measures. The location of the receiving and shipping departments and the procedures in effect will bear upon the CPA’s evaluation of internal contro

29、l. The auditor’s overall impression of the client’s plant will suggest the accuracy and adequacy of the accounting records that will be audited. 8-10 One type of information the auditor obtains in gaining knowledge about the clients’ industry is the nature of the client’s products, including the

30、likelihood of their technological obsolescence and future salability. This information is essential in helping the auditor evaluate whether the client’s inventory may be obsolete or have a market value lower than cost. 8-11 A related party is defined in SAS 45 (AU 334) as an affiliated company, p

31、rincipal owner of the client company, or any other party with which the client deals where one of the parties can influence the management or operating policies of the other. Material related party transactions must be disclosed in the financial statements by management. Therefore, the auditor mus

32、t identify related parties and make a reasonable effort to determine that all material related party transactions have been properly disclosed in the financial statements .8-12 Because of the lack of independence between the parties involved, the Sarbanes-Oxley Act prohibits related party transac

33、tions that involve personal loans to executives. It is now unlawful for any public company to provide personal credit or loans to any director or executive officer of the company. Banks or other financial institutions are permitted to make normal loans to their directors and officers using market ra

34、tes, such as residential mortgages. 8-13 In the audit of a client previously audited by a different CPA firm, it would be necessary to obtain a copy of the corporate charter and bylaws for the permanent files and to read these documents and prepare a summary abstract of items to test for complia

35、nce. In an ongoing engagement, this work has been performed in the past and is unnecessary each year. The auditor’s responsibility is to determine what changes have been made during the current year and to update and review the summary abstract prepared in previous years for compliance. 8-14 The

36、information in a mortgage that is likely to be relevant to the auditor includes the following: 1. The parties to the agreement 2. The effective date of the agreement 3. The amounts included in the agreement 4. The repayment schedule required by the agreement 5. The definition and terms of def

37、ault 6. Prepayment options and penalties specified in the agreement 7. Assets pledged or encumbered by the agreement 8. Liquidity restrictions imposed by the agreement 9. Purchase restrictions imposed by the agreement 10. Operating restrictions imposed by the agreement 11. Requirements for aud

38、it reports or other types of reports on compliance with the agreement 12. The interest rate specified in the agreement 13. Any other requirements, limitations, or agreements specified in the document 8-15 Information in the client’s minutes that is likely to be relevant to the auditor includes

39、the following: 1. Declaration of dividends 2. Authorized compensation of officers 3. Acceptance of contracts and agreements 4. Authorization for the acquisition of property 5. Approval of mergers 6. Authorization of long-term loans 7. Approval to pledge securities 8. Authorization of individ

40、uals to sign checks 9. Reports on the progress of operations It is important to read the minutes early in the engagement to identify items that need to be followed up on as a part of conducting the audit. For instance, if a long-term loan is authorized in the minutes, the auditor will want to ma

41、ke certain that the loan is recorded as part of long-term liabilities. 8-16 The three categories of client objectives are (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with laws and regulations. Each of these objectives affects the audi

42、tor’s assessment of inherent risk and evidence accumulation as follows: 1. Reliability of financial reporting – If management sees the reliability of financial reporting as an important objective, and if the auditor can determine that the financial reporting system is accurate and reliable, then

43、the auditor can often reduce inherent risk and planned evidence accumulation for material accounts. In contrast, if management has little regard for the reliability of financial reporting, the auditor must increase inherent risk assessments and gather more evidence during the audit. 2. Effectivenes

44、s and efficiency of operations – This area is of primary concern to most clients. Auditors need knowledge about the effectiveness and efficiency of a client’s operations in order to assess client business risk and inherent risk in the financial statements. For example, if a client is experiencing in

45、ventory management problems, this would most likely increase both the auditor’s assessment of inherent risk for the planned evidence accumulation for inventory. 3. Compliance with laws and regulations – It is important for the auditor to understand the laws and regulations that affect an audit clie

46、nt, including significant contracts signed by the client. For example, the provisions in a pension plan document would significantly affect the auditor’s assessment of inherent risk and evidence accumulation in the audit of unfunded liability for pensions. If the client were in violation of the prov

47、isions of the pension plan document, inherent risk and planned evidence for pension-related accounts would increase. 8-17 The purpose of a client’s performance measurement system is to measure the client’s progress toward specific objectives. Performance measurement includes ratio analysis and be

48、nchmarking against key competitors. Performance measurements for a chain of retail clothing stores could include gross profit by product line, sales returns as a percentage of clothing sales, and inventory turnover by product line. An Internet portal’s performance measurements might include numbe

49、r of Web site hits or search engine speed. A hotel chain’s performance measures include vacancy percentages and supply cost per rented room. 8-18 Client business risk is the risk that the client will fail to achieve its objectives. Sources of client business risk include any of the factors affect

50、ing the client and its environment, including competitor performance, new technology, industry conditions, and the regulatory environment. The auditor’s primary concern when evaluating client business risk is the risk of material misstatements in the financial statements due to client business risk.

51、 For example, if the client’s industry is experiencing a significant and unexpected downturn, client business risk increases. This increase would most likely increase the risk of material misstatements in the financial statements. The auditor’s assessment of the risk of material misstatements is t

52、hen used to classify risks using the audit risk model to determine the appropriate extent of audit evidence. 8-19 Management establishes the strategies and business processes followed by a client’s business. One top management control is management’s philosophy and operating style, including ma

53、nagement’s attitude toward the importance of internal control. Other top management controls include a well-defined organizational structure, an effective board of directors, and an involved and effective audit committee. If the board of directors is effective, this increases management’s ability to

54、 appropriately respond to risks. An effective audit committee can help management reduce the likelihood of overly aggressive accounting. 8-20 Analytical procedures are performed during the planning phase of an engagement to assist the auditor in determining the nature, extent, and timing of work

55、 to be performed. Preliminary analytical procedures also help the auditor identify accounts and classes of transactions where misstatements are likely. Comparisons that are useful when performing preliminary analytical procedures include: < Compare client and industry data < Compare client data

56、with similar prior period data < Compare client data with client-determined expected results < Compare client data with auditor-determined expected results < Compare client data with expected results, using nonfinancial data 8-21 Analytical procedures are required during two phases of the audi

57、t: (1) during the planning phase to assist the auditor in determining the nature, extent, and timing of work to be performed and (2) during the completion phase, as a final review for material misstatements or financial problems. Analytical procedures are also often done during the testing phase of

58、the audit as part of the auditor’s further audit procedures, but they are not required in this phase. 8-22 Gordon could improve the quality of his analytical tests by: 1. Making internal comparisons to ratios of previous years. 2. In cases where the client has more than one branch in differen

59、t industries, computing the ratios for each branch and comparing these to the industry ratios. 8-23 Roger Morris performs his ratio and trend analysis at the end of every audit. By that time, the audit procedures are completed. If the analysis was done at an interim date, the scope of the audit c

60、ould be adjusted to compensate for the findings. SAS 56 (AU 329) requires that analytical procedures be performed in the planning phase of the audit and near the completion of the audit. The use of ratio and trend analysis appears to give Roger Morris an insight into his client's business and affo

61、rds him an opportunity to provide excellent business advice to his client. 8-24 The four categories of financial ratios and examples of ratios in each category are as follows: 1. Short-term debt-paying ability – Cash ratio, quick ratio, and current ratio. 2. Liquidity activity – Accounts rece

62、ivable turnover, days to collect receivables, inventory turnover, and days to sell inventory. 3. Ability to meet long-term debt obligations – Debt to equity and times interest earned. 4. Profitability – Earnings per share, gross profit percent, profit margin, return on assets, and return on common

63、 equity < Multiple Choice Questions From CPA Examinations 8-25 a. (3) b. (3) c. (4) d. (1) 8-26 a. (1) b. (4) c. (4) 8-27 a. (4) b. (1) c. (2) d. (4) < Discussion Questions And Problems 8-28 Audit Activities Related Planning Procedure 1. Send an engagement letter to the c

64、lient. (1) Accept client and perform initial audit planning 2. Tour the client’s plant and offices. (2) Understand the client’s business and industry 3. Compare key ratios for the company to industry competitors. (4) Perform preliminary analytical procedures 4. Review management’s controls

65、 and procedures. (3) Assess client’s business risk 5. Identify potential related parties that may require disclosure. (2) Understand the client’s business and industry 6. Review the corporate charter and bylaws (2) Understand the client’s business and industry. 7. Identify whether any specia

66、lists are required for the engagement. (1) Accept client and perform initial audit planning 8. Review the accounting principles unique to the client’s industry. (2) Understand the client’s business and industry. 9. Determine the likely users of the financial statements. (1) Accept client and perform initial audit planning. 8-29 a. A related party transaction occurs when one party to a transaction has the ability to impose contract terms that would not have occurred if the parties had bee