The Audit Process

An Overview

THE AUDIT PROCESS

MAJOR PHASES IN AN AUDIT

Client acceptance and retention

Establish terms of the engagement

Plan the audit

Consider internal control

MAJOR PHASES IN AN AUDIT

Conduct substantive tests

Complete the audit

Issue audit report

The audit firm must have existing policies andprocedures on client acceptance and retention

The purpose is to minimize association with clientwho lacks integrity

Investigation on prospective client prior toacceptance must be documented in a memo orcompletion of client acceptance questionnaire orchecklist.

CLIENT ACCEPTANCE ANDRETENTION

1.Obtain and review available financialinformation

annual reports

 interim financial statements

 income tax returns

2.Inquire of third parties about anyinformation concerning the integrityof the prospective client and itsmanagement

Bankers

Lawyers

Credit agency

Members of the business community

List ofprocedures

EVALUATING APROSPECTIVECLIENT

3.Communicate with predecessor auditors about whether therewere any disagreements about:

•Accounting principles

•Audit procedures

•Other similar related matters

Successor auditor should request permission of the prospective client beforecontacting the predecessor auditors

Inquiry should include questions related to

 integrity of management,

disagreements over accounting and auditing issues

Communications with audit committees or group regarding fraud, illegalacts, and internal control related matters

The predecessor’s understanding of the reason for the change in auditors

Predecessor auditors should respond fully unless an unusual circumstancesexists (lawsuit)

If predecessor auditors’ response is limited, the successor auditor must beinformed that the response is limited.

If prospective client refuses to permit the predecessor auditors to respond, thesuccessor auditor should have reservations about acceptance.

4.Consider whether prospective client has anycircumstances that will require special attention or thatmay represent unusual business or audit risks:

•Litigation

•Going-concern problems

5.Determine if the firm is independent of the client and ifable to provide the desired service

6.Determine if the firm has the necessary technical skillsand knowledge of the industry to complete theengagement

7.Determine if acceptance of the client would violate anyapplicable regulatory agency requirements or the Code ofProfessional Conduct.

1.What services to be performed

2.Engagement letter should document the termsagreed to:

Responsibilities of the management’

Responsibilities of the auditors

Assistance to be provided by the client personnel andinternal auditors

Expected audit fees.

ESTABLISH TERMS OF THEENGAGEMENT

1.Owner-manager ( in smallprivately held companies)

2.Large private companies”

Auditor is appointed by voteof the stockholders afterrecommendation by theboard or audit committee.

Audit committee iscomposed of the members ofthe board of directors who donot hold positions in thecompany.

THE AUDITCOMMITTEE

1.Financial reporting and disclosure process

2.Encourage fair reporting from the perspective of:

Stockholders

Creditors

Employees

3.Provide for the independence of the external and internalauditors

4.Meets with the external auditor to discuss about

 responsibilities

significant accounting policies

Scope of the auditor’s work

Conduct of special investigations

RESPONSIBILITIES OF AUDITCOMMITTEES

1.Formalizes the arrangementreached between the auditor andthe client.

2.Serves as a contract

3.Outlines the responsibilities of theparties

4.Includes arrangements involvingthe use of specialists or internalauditors

5.Includes any limitations of theliability of the auditor or client like:

Misrepresentations to the auditor by themanagement

6.Additional services to be providedrelating to regulatory requirements

7.Arrangements regarding otherservices (assurance, tax, consulting)

THEENGAGEMENTLETTER

1.Gather information about theiractivities

2.Assess the competence andobjectivity of the internal auditorsand the effect of their work to theaudit

3.Consider the effect of the internalauditors’ work on the audit process

Understanding of the internal control’

Risk assessment

Substantive procedures

THEINTERNALAUDITORS

1.Consider the extent of the effect of the internalauditors’ work

2.Coordinate audit work with internal auditors

3.Evaluate and test the effectiveness of the internalauditors’ work.

CONSIDERING EFFECTS OF THE INTERNALAUDITORS’ WORK ON THE AUDIT

1.Educational level and professional experience

2.Professional certification and continuing education’

3.Audit policies, procedures and checklists

4.Practices regarding their assignments

5.Supervision and review of their audit activities

6.The quality of their working paper documentation,reports and communications

7.Evaluation of their performance.

FACTORS IN ASSESSING THECOMPETENCE OF INTERNAL AUDITORS

1.Organizational status of the internal auditor for theinternal audit function

Coverage

Access to board of directors

Access to audit committee

2.Policies to maintain internal auditors’ objectivityabout the areas audited

FACTORS IN ASSESSING THE OBJECTIVITYOF INTERNAL AUDITORS

ENGAGEMENTPLANNING