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LEARNING OBJECTIVES
1.
2.
3.
A u d it
E ngagem ent
A u d it
P la n n in g
A u d it
D o c u m e n t a t io n
S o u rc e o f
K n o w le d g e
o f C lie n t
B e n e f its
P u rp o s es
K e y M a t te r s to
U n d e rs ta n d
C lie n t 's B u s in e s s
O p e r a t io n
A u d it
S tra te g y
C o n te n t
C o n t in u a n c e o f
a n E x is t in g
A u d it
P r e lim in a r y
A n a ly t ic a l
P ro c e d u re s
S t a n d a r d is e d
W o r k in g
P a p e rs
F a c to rs fo r
A c c e p t in g
N e w C lie n t
M a t e r ia lity
in A u d it
P la n n in g
A u d it
F ile s
C h a n g e s in
P r o f e s s io n a l
A p p o in t m e n t
A s s e s s R is k
o f M a t e r ia l
M is s t a t e m e n ts
E ngagem ent
L e tte r
N5-1
1.
Audit Engagement
1.1
The following issues must be considered when deciding the acceptance and
retention of client because this may affect the reliability of financial information
provided by the client.
(a)
Knowledge of existing or potential clients business and industry.
(b)
Code of ethics for professional accountants (refer to Chapter 3).
(c)
Independence of the audit team (refer to Chapter 3).
(d)
Terms of engagement.
1.2
1.2.1
HKSA 315 Understanding the Entity and Its Environment and Assessing the Risks
of Material Misstatement requires auditors to acquire knowledge of clients
business before and during the audit engagement.
Before accepting an engagement, auditors would obtain a preliminary knowledge
of the industry and of the background of the entity to be audited so as to assess their
ability to undertake the audit.
1.2.2
Review of previous years audit files to obtain previous experience with the
entity and its industry.
Discussions with management of the entity.
Discussions with internal auditor and review of internal audit report.
Discussions with specialists including other auditors, legal advisors, and
other knowledgeable people.
Publications related to the industry.
Legislation and regulations that significantly affect the entity.
Visits to the entitys premises and plant facilities.
Internal documents of the entity.
N5-2
Nature of revenue sources all over the world or just in certain locations?
Key customers large number of customers across the whole population?
Products or services and markets facing with keen competition?
Different types of products for sales?
Conduct of operations Mainly on cash sales or credit sales? Operate in a
computerized billing system?
Employment mainly in full-time staff or part-time staff?
Geographical dispersion
Alliances, joint ventures, and outsourcing activities
Research and development activities and expenditures
Question 1
HKSA 315 Understanding the Entity and Its Environment and Assessing the Risks of
Material Misstatement requires auditors to acquire knowledge of clients business before
and during the engagement.
From what sources can David acquire knowledge of BFLs business and industry?
(5 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2009 Q1(a))
Question 2
HKSA 315 (Clarified) requires the auditor to obtain an understanding of the entity and its
environment, including the entitys internal control. An understanding of the nature of an
entity enables the auditor to understand the classes of transactions, account balances, and
disclosures to be expected in the financial statements.
What are the matters regarding the business operations of JPL that the auditor may
consider when obtaining an understanding of the nature of the business operations of
JPL?
(10 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2011 Q1(a))
N5-3
1.3
1.4
The integrity of the principal owners, key management and those charged
with governance of the entity.
Whether the engagement team is competent to perform the audit engagement
and has the necessary capabilities, including time and resources.
Whether the firm and the engagement team can comply with relevant ethical
requirements.
Significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
1.4.2 Preconditions before accepting a new engagement under HKSA 210 (Clarified)
(Jun 12)
(a)
(b)
(ii)
(iii)
1.5
(c)
Find out whether the change of auditor was properly dealt with in
accordance with the Companies Ordinance and/or other legislation; and
request the prospective clients permission to communicate with the
auditor last appointed. If the prospective client does not permit the member
to do so, he should decline the offer.
After receiving the permission to communicate with the previous auditor, the
new auditor should write to previous auditor to obtain professional
clearance; that is, a request in writing to previous auditor to establish if
there are any unusual circumstances surrounding the proposed change which
the new auditor should be aware of, so that the new auditor may determine
whether he or she should accept such nomination.
Question 3
(a)
(b)
(c)
What are the responsibilities of the auditors regarding the acceptance of the audit
engagement?
(5 marks)
What are the obligations of the incoming auditors regarding the change in auditors
of GF Limited?
(5 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2010 Q1(a)&(b))
What matter should be considered by CBA & Co. for the acceptance of a new
client?
(4 marks)
N5-5
(HKIAAT PBE Paper III Auditing and Information Systems December 2011
Q1(a))
1.6
Engagement letter
1.6.1
HKSA 210 Terms of Audit Engagement requires an auditor to agree the terms of
engagement with the new client and to issue letters of engagement to new clients
before the new audit assignments begin.
On recurring audits, the auditor should consider whether circumstances require the
terms of engagement to be revised so that a new engagement letter should be
issued.
1.6.2
N5-6
2.
Audit Planning
2.1
2.1.1
An effective and efficient audit relies on proper planning procedures. The planning
process is covered in general terms by HKSA 300 (Clarified) Planning an Audit of
Financial Statements which states that the auditor shall plan the audit so that the
engagement is performed in an effective manner.
2.1.2 HKSA 300 (Clarified) states that auditors should undertake the following:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
2.1.3
Plan the audit to enable it to be carried out in the most effective and
efficient manner.
Consider whether to continue the entity relationship in the case of an
existing entity.
Ensure the terms of the engagement are understood.
Consider ethical guidance including independence.
Consider entity acceptance procedures and professional clearance.
Establish the overall audit strategy for the audit and update any changes
during the course of the audit.
Develop and document an overall audit strategy for the expected scope
and conduct of audit in order to reduce audit risk to an acceptably low level.
Develop and document an audit plan which sets out the nature, extent and
timing of planned audit procedures.
The audit strategy and plan should be revised during the audit when there are
changes in conditions or unexpected results are obtained.
financial reporting.
Question 4
Discuss the benefits of audit planning.
(6 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2010 Q2(a))
2.2
2.2.1
The audit strategy sets the scope, timing and direction of the audit, and guides
the development of the more detailed audit plan.
Each entity is unique and an audit strategy should be adapted to suit the particular
requirements and characteristics of the entity concerned.
A strategy should be derived from the audit engagement partner's understanding of
the entity and its particular environment, which indicate where the most significant
risks of misstatements lie. The audit partner's responsibilities in this regard are set
out in HKSA 315 (Clarified).
However, there are common elements to all strategies which are presented in the
table that follows:
2.2.2
2.2.3
2.2.4
of
the
Reporting
objectives,
nature of
communications
Significant factors,
preliminary engagement
activities, and
knowledge gained on
other engagements
Determination of materiality
Areas identified with higher risks of material
misstatement
Results of previous audits
Need to maintain professional scepticism
Evidence of management's commitment to design,
implementation and maintenance of sound internal
controls
Volume of transactions
Significant business developments
Significant industry developments and conditions
Significant changes in financial reporting framework
Other significant recent developments
Any going concern issues
2.3
2.3.1
The audit plan converts the audit strategy into a more detailed plan and
includes the nature, timing and extent of audit procedures to be performed by
engagement team members in order to obtain sufficient appropriate audit evidence
to reduce audit risk to an acceptably low level.
The audit plan shall include the following:
(a)
A description of the nature, timing and extent of planned risk assessment
procedures
(b)
A description of the nature, timing and extent of planned further audit
procedures at the assertion level
(c)
Other planned audit procedures required to be carried out for the
engagement to comply with HKSAs
2.3.2
2.4
2.4.1
2.4.2
N5-9
(d)
(e)
(f)
(g)
(h)
(i)
(Jun 11)
(Jun 11)
To understand the clients business and industry in order to assess the clients
business risk.
To understand the clients classes of transactions and account balances.
To indicate aspects of the entity of which the auditor was unaware and will
assist in assessing the risks of material misstatement, in particular risks of
material misstatement due to fraud in order to determine nature, timing and
extent of further audit procedures.
To identify financial statement accounts that are likely to contain errors.
To provide an indication of the companys performance by comparing
clients ratios to ratios of industry or competitors.
To identify areas of increased risk of misstatements that may require further
attention during the audit where unusual changes in ratios compared to prior
years or industry average.
To identify areas of specific risk by comparing the liquidity and activity
ratios with prior years.
To allocate more resources for investigation of areas of high risk of material
misstatement.
To help identify the existence of unusual transactions or events, and
amounts, ratios, and trends that might indicate matters that have audit
implications.
N5-10
Question 5
The firm of WM & Co., your employer, is the external auditor of North West Limited
(NWL) which is a company in the manufacturing and retail business.
You have worked on this audit assignment for a few years and this year you are the senior
in charge of the audit. You have to prepare the audit plan. The audit team consists of three
members. You decide to let the senior assistant carry out the preliminary risk assessment
procedures. The other assistant, Mary, a newly recruited accounting graduate, has no
practical experience. Mary requested you to assign more tasks to her as she wants to
accumulate more experience. She is confident that she can carry out the tasks effectively
and efficiently because her boyfriend works at NML as the accounting manager.
Required:
(a)
(b)
(c)
(d)
2.5
2.5.1
2.5.2
N5-11
Revenue
Operating
profit
Total assts
Net assets
$m
$m
$m
$m
2011
1,324
56
1,555
755
2010
1,266
72
1,494
685
2009
1,275
90
1,617
615
2008
1,512
78
1,387
580
2007
1,739
67
1,629
605
Required:
Determine the audit planning materiality figure to be adopted in the audit of J's financial
statements for the year ended 31 December 2011. Discuss and justify your selection of
the key financial data used as bases for the materiality calculations and the percentages
applied to these bases.
2.6
2.6.1
Before accepting an audit appointment, auditors should screen potential new clients
in order to identify the risk which may be attached to accepting the audit of that
client.
After materiality level and acceptable audit risk have been determined, the auditor
2.6.2
N5-12
2.7
2.7.1
2.7.2
3.
Audit Documentation
3.1
Definition
Audit documentation means the record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor reached (terms such as
working papers () or workpapers are also sometimes used). (HKSA
230)
3.2
(d)
(e)
A sufficient and appropriate record of the basis for the auditors report;
and
Evidence that the audit was performed in accordance with HKSAs and
applicable legal and regulatory requirements.
Assisting or enable the audit team to:
(i)
plan and perform the audit;
(ii)
direct and supervise the audit work;
(iii) discharge their review responsibilities; and
(iv)
be accountable for its work.
Retaining a record of matters of continuing significance to future audits.
Enabling an experienced auditor to conduct:
(i)
quality control reviews and inspections; and
(ii)
external inspections in accordance with applicable legal, regulatory
or other requirements.
N5-13
Question 7
According to HKSA 230 (Clarified), the auditor should prepare, on a timely basis, audit
documentation that provides:
A sufficient and appropriate record of the basis for the auditors report and
Evidence that the audit was planned and performed in accordance with HKSAs and
applicable legal and regulatory requirements.
What are the purposes of preparing audit working papers?
(6 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2010 Q3(e))
3.3
3.3.1
Working papers should include contents of audit objective, audit testing, evaluation
of results and conclusion.
(a)
Audit objectives that is the purpose of the audit testing recorded on that
working paper.
(b)
Sampling method
(i)
Definition of population, sampling units, error or deviation.
(ii)
Means of determining the sample size.
(iii)
The sampling method selected.
(c)
Audit tests carried out
(i)
Details of the items selected.
(ii)
Details of test and checking on documents, records, etc.
(iii)
Errors or deviations noted and the explanations as to their causes.
(d)
Interpretation of the results
(i)
Projection of error or deviations.
(ii)
Auditors assessment of the assurance obtained as to the possible
size of actual error or deviation rate.
(e)
Conclusions
(i)
Nature and details of the conclusion drawn from the sample testing
results.
(ii)
Details of further action taken where required.
Working papers should show:
(a)
The name of the client
(b)
The balance sheet date
(c)
The file reference of the working paper
3.3.2
N5-14
3.3.3
(d)
The name of the person preparing the working paper
(e)
The date the working paper was prepared.
(f)
The subject of the working paper
(g)
The name of the person reviewing the working paper
(h)
The date of the review
Sample working paper
3.4
3.4.1
3.4.2
N5-15
3.5
3.5.1 Definition
There are two types of audit files:
(a)
Permanent file ( ) it is kept to record all data of a
permanent nature which provides the necessary background information to
the auditor from year to year.
(b)
Current file () it is kept to record all audit work programs and
working papers for the year under review.
3.5.2
3.5.3
N5-16
Question 7
The auditors have two types of working paper files, the current file (CF) and the
permanent file (PF). Using the initials and the spaces provided, indicate which file each of
the following documents would most likely be filed.
1.
A lease agreement.
PF
2.
CF
3.
Articles of incorporation.
PF
4.
PF
5.
A pension agreement.
PF
6.
CF
7.
CF
8.
CF
9.
CF
10.
A chart of accounts.
PF
3.6
3.6.1
Judgement may have to be used in deciding the length of holding working papers,
and further consideration should be given to the matter before their destruction. As
HKSQC 1 indicates, the retention period for audit engagements ordinarily is no
shorter than five years from the date of the auditors report, or, if later, the date of
the group auditors report.
Working papers are the property of the auditors. They are not a substitute for, or
part of, the entitys accounting records.
Auditors should not release parts of or whole working papers to third parties
without permission of the entity. Auditors can disclose the working papers to the
entity as long as it does not undermine ( ) the independence or validity of the
audit process.
3.6.2
3.6.3
N5-17