1. Auditing A Risk-Based Approach To Conducting A Quality Audit
10th edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
Chapter 5
Professional Auditing Standards and the Audit Opinion Formulation Process

2. Learning Objectives
Identify and compare the auditing standards that provide guidance on the audit opinion formulation process
List and discuss the foundational principles underlying the auditing standards
List the phases and related activities in the audit opinion formulation process
Explain the concept of accounting cycles and discuss their importance to the audit opinion formulation process

3. Learning Objectives
Describe the assertions that are inherent to the financial statements and explain their importance to the audit opinion formulation process
Define audit evidence and describe the purpose of audit procedures used to obtain audit evidence
Discuss the importance of audit documentation and provide examples
Discuss audit activities in Phase I of the audit opinion formulation process

4. Learning Objectives
Discuss audit activities in Phase II of the audit opinion formulation process
Discuss audit activities in Phase III of the audit opinion formulation process
Discuss audit activities in Phase IV of the audit opinion formulation process
Discuss audit activities in Phase V of the audit opinion formulation process

5. Learning Objective 1
Identify and Compare the Auditing Standards that Provide Guidance on the Audit Opinion Formulation Process

6. Professional Auditing Standards
Auditors in the United States follow auditing guidance issued by:
American Institute of Certified Public Accountants (AICPA)
Public Company Accounting Oversight Board (PCAOB)
International Auditing and Assurance Standards Board (IAASB)
Common objective - Provide assurance to public that audits are conducted in a quality manner

7. Professional Auditing Standards
Auditing standards apply:
To the auditor’s task of developing and communicating an opinion on financial statements and, as part of an integrated audit, on a client’s internal control over financial reporting.
Relevant auditing standards depend on:
The nature of organization audited
On the domicile of the organization
On where its stock is publicly traded

8. Exhibit 5.1 - Comparison of U.S. and International Auditing Standards

9. Learning Objective 2
List and Discuss the Foundational Principles Underlying the Auditing Standards

10. PCAOB Guidance - the Ten standards
General standards are applicable to the auditor and audit firm and provide guidance in selecting and training its professionals to meet the public trust.
Fieldwork standards are applicable to the conduct of the audit
Reporting standards are applicable to communicating the auditor’s opinion

11. AICPA Guidance
AICPA has developed seven fundamental principles that govern audits. The principles are included in four categories
Purpose of an Audit and Premise upon Which an Audit Is Conducted
Responsibilities
Performance
Reporting

12. Learning Objective 3
List the Phases and Related Activities in the Audit Opinion Formulation Process

13. Exhibit 5.3 - Activities of each Phase of the Audit Opinion Formulation Process

14. Important Concepts pervasive throughout the Audit Opinion Formulation Process
Accounting cycles
Management assertions
Audit evidence and audit procedures
Documentation

15. Learning Objective 4
Explain the Concept of Accounting Cycles and Discuss Their Importance to the Audit Opinion Formulation Process

16. Accounting Cycles
Similar transactions that are linked by procedures and controls and that affect related accounts
Convenient way to break the audit up into manageable sections of related accounts
Individual auditors or teams of auditors are typically assigned to audit a particular accounting cycle

17. Accounting Cycles Auditor focuses on:
Flow of transactions within a particular cycle
Identifying:
Points where material misstatement can occur
Controls that have been designed and implemented to mitigate those risks
Understanding risks and controls within each cycle
Helps determine specific audit procedures to be used and specific audit evidence to be obtained

18. Learning Objective 5
Describe the Assertions that Are Inherent to the Financial Statements and Explain Their Importance to the Audit Opinion Formulation Process

19. MANAGEMENT’S FINANCIAL STATEMENT ASSERTIONS IN PCAOB STANDARDS
Existence or Occurrence
Refers to existence of assets and liabilities
Refers to occurrence of recorded transactions
Completeness
Refers to inclusion of all transactions and accounts in financial statements
Valuation or Allocation
Refers to inclusion of accounts in financial statements at appropriate amounts
Rights and Obligations
Refers to assets being the rights of an organization
Refers to liabilities being the obligations of an organization
Presentation and Disclosure
Refers to components of financial statement being properly classified, described, and disclosed

20. Learning Objective 6
Define Audit Evidence and Describe the Purpose of Audit Procedures Used to Obtain Audit Evidence

21. Audit Evidence and Procedures
Audit evidence: Information used by auditor in arriving at conclusions on which the opinion is based
Audit procedures: Procedures designed to obtain audit evidence to support audit opinion(s)
Sufficient appropriate audit evidence: Measure of the quantity and quality of audit evidence
Audit program
Lists audit procedures to be followed in gathering evidence
Helps monitor progress and supervising work

22. Categories of audit Procedures
Risk assessment procedures: Provide information for assessing the risks of material misstatement in the financial statements
Used for purposes of planning the audit
Tests of controls: Designed for evaluating operating effectiveness of controls
Substantive procedures: Designed for detecting material misstatements at assertion level
Comprising of tests of details and substantive analytical procedures

23. Discuss the Importance of Audit Documentation and Provide Examples
Learning Objective 7
Discuss the Importance of Audit Documentation and Provide Examples

24. Audit Documentation
Record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached
Known as working papers or workpapers
Examples include:
Audit programs
Analyses prepared by client or auditor
Memorandums
Summaries of significant findings or issues
Letters of confirmation and representation

25. Purposes of Audit Documentation
Assisting engagement team in:
Planning and performing audit
Supervising and reviewing audit work
Retaining a record of matters of continuing significance to future audits
Enabling internal or external inspections of completed audits
Assisting auditors in understanding work performed in prior year

26. Learning Objective 8
Discuss Audit Activities in Phase I of the Audit Opinion Formulation Process

27. Phase I - Making Client Acceptance and Continuance Decisions
Preconditions for accepting auditing engagements
Use of an acceptable financial reporting framework
Agreement of management to acknowledge and understand its responsibilities

28. Learning Objective 9
Discuss Audit Activities in Phase II of the Audit Opinion Formulation Process

29. Phase II - Performing Risk Assessment
Identifying and assessing risks of material misstatement
Requires identification of significant accounts, disclosures, relevant assertions
Auditor establishes a materiality level overall and for specific accounts and disclosures
Responding to identified risks
Determining audit procedures required to address them

30. Risk assessments - assertion level
Inherent risk
Susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls
Control risk
Risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the organization’s internal control

31. control risk ASSESSMENT
Focuses on design effectiveness and implementation
High control risk
Weak or ineffective internal controls
Auditor cannot rely on controls to reduce substantive procedures for account balances
Low control risk
Effective internal controls
Auditor will test operating effectiveness of controls to reduce substantive procedures for account balances

32. Responding to Identified Risks of Material Misstatement
Purpose of risk assessment procedures
Identify risks of material misstatement
Determine where misstatements in financial statements may occur
Design appropriate audit strategy
Controls reliance audit: Includes tests of controls and substantive procedures
Substantive audit: Includes substantive procedures and does not include tests of controls

33. Learning Objective 10
Discuss audit activities in Phase III of the audit opinion formulation process

34. PHASE III - Obtaining Evidence about Internal Control Operating Effectiveness
Auditor tests controls to determine whether controls are operating effectively
At year-end (for opinion on internal control effectiveness)
Throughout the year (for the financial statement audit)

35. Selecting Controls to Test
Involves choosing controls that effectively indicate capability to address the assessed risk of material misstatement for relevant assertions
Includes controls in all five COSO components
Types of tests of controls
Inquiry
Observation
Inspection of relevant documentation
Reperformance of a control

36. Impact of Tests of Controls For financial statement audit
If control deficiencies are identified
Assess them to determine whether preliminary control risk assessment should be modified
Record the implications for substantive procedures
If no control deficiencies are identified
Assess whether preliminary control risk assessment is still appropriate
Determine extent that controls can provide evidence on accuracy of account balances
Determine planned substantive audit procedures

37. impact of Tests of Controls For financial statement audit
Determine how much assurance about reliability of account balances can be obtained from the effective operation of controls
Within any audit, level of assurance will vary across:
Accounts
Disclosures
Assertions

39. Learning Objective 11
Discuss audit activities in Phase IV of the audit opinion formulation process

40. Substantive procedures include:
Phase IV - Obtaining Substantive Evidence about Accounts, Disclosures, and Assertions
Substantive procedures include:
Substantive analytical procedures
Tests of details of account balances
Considerations in determining appropriate substantive procedures:
Source of potential misstatement
Extent and type of potential misstatement

41. Learning Objective 12
Discuss audit activities in Phase V of the audit opinion formulation process

42. Phase V - Completing the Audit and Making Reporting Decisions
Completing various review and communication activities
Making a decision about what types of opinions should be issued
Deciding on the appropriate opinion to be issued
It can be based on financial statements and internal control
It can be issued in one report or in two separate reports