5 Knowledge of the Business Organization structureOperations and legal structureKnowledge of operationsTour of plantLegal documentsMinutes, contracts, and correspondenceIndustry and economic conditions
6 General Planning Decisions Anticipated assessed level of control riskPreliminary estimates of materialityRisk conditions or financial statement items likely to require adjustmentOverall timing of audit workExtent of involvement of specialists and internal auditorsStaffingResult: Preliminary audit plan and time budget
7 Knowledge -- Preliminary Audit Plan BusinessIndustryControl environment, risk assessment, and monitoringAccounting systemControl activitiesManagement integrity
8 At the CPA Firm Review of files Discussion with firm personnel Correspondence filesprior year’s work paperspermanent filesprior years’ financial statements and audit reportsDiscussion with firm personnelnonaudit services provided to clientexperts in the industry
9 At the CPA Firm (continued) Review of industry informationAICPA industry guidesTrade publicationsAnnual reports of other companies in industryReview of authoritative pronouncementsExisting or newAccounting or auditingIdentify reports to be issuedSEC filingsSpecial report on contractual complianceetc.
10 At the Client Inquiry of management Reading current year’s interim financial statementsAgreement on engagementTypeScopeTimingTour facilities
11 At the Client (continued) Reading legal documents and minutescorporate charter, bylawsmajor contractsminutes of directors’ and stockholders’ meetingsAnalytical procedures - calculating general profitability, liquidity, and solvency ratios and trends and comparing to:client experienceclient plansindustry ratios and trends
12 Audit Decisions in Preliminary Planning MaterialityControl riskAudit risk
13 MaterialityThe magnitude of an omission or misstatement of accounting information that in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement
18 Red Flags Management Characteristics Management operating and financing decisions are dominated by a single person.Management’s attitude toward financial reporting is unduly aggressive.Management (particularly senior accounting personnel) turnover is high.Management places undue emphasis on meeting earnings projections.Management’s reputation in the business community is poor.
19 Red Flags (continued) Operating and Industry Characteristics: Profitability of entity relative to its industry is inadequate or inconsistent.Sensitivity of operating results to economic factors (inflation, interest rates, unemployment, etc.) is high.Rate of change in entity’s industry is rapid.
20 Red Flags (continued)Operating and Industry Characteristics (continued):Direction of change in entity’s industry is declining with many business failures.Organization is decentralized without adequate monitoring.Internal or external matters that raise substantial doubt about the entity’s ability to continue as a going concern are present.
21 Red Flags (continued) Engagement Characteristics: Many contentious or difficult accounting issues are present.Significant difficult-to-audit transactions or balances are present.Significant and unusual related-party transactions not in the ordinary course of business are present.
22 Red Flags (continued) Engagement Characteristics (continued): Nature, cause (if known), or the amount of known and likely misstatements detected in the audit or prior period’s financial statements is significant.It is a new client with no prior audit history or sufficient information is not available from the predecessor auditor.
23 Related-Party Transactions Identify related partiesIdentify material transactionsExamine identified material related-party transactionsEvaluate disclosure
24 Illegal ActsSAS 53 vs. SAS 54“direct and material effect on the determination of a financial statement line item amount”Violations with indirect effectsloss contingencieseffect on auditCommunication responsibilities
28 Analytical Procedures In planning the audit*To understand the client and industryTo identify transactions and events since the last audit dateTo identify a risk requiring more than normal audit attentionTo plan the nature, timing, and extent of other audit procedures.*Required by SAS No. 56
29 Analytical Procedures (continued) As substantive testsTo obtain evidential matter about assertionsIn overall review at end*Identify any unusual or unexpected balances not previously notedConsider going concern statusTo assess the conclusions the auditor has reachedTo evaluate overall financial statement presentation* Required by SAS No. 56