MODERN AUDITING 7th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan Developed by: Dr. Raymond N. Johnson, CPA Gregory K. Lowry, MBA, CPA John Wiley & Sons, Inc.

CHAPTER 7 ACCEPTING THE ENGAGEMENT AND PLANNING THE AUDIT Overview of a Financial Statement Audit Client Acceptance and Retention Planning the Audit Obtaining an Understanding of the Client’s Business and Industry Performing Analytical Procedures

Overview of a Financial Statement Audit 4 Phases of an Audit 1. Client Acceptance and Retention 2. Planning the Audit 3. Performing Audit Tests 4. Reporting the Findings

Steps in Accepting an Audit Engagement Figure 7-1

Management Integrity Communication with the Predecessor Auditor Make inquiries of other third parties Review previous experience with existing clients Knowledge of critical success factors & competition Client background checks Previous bankruptcy Previous convictions Suspected ties to organized crime Industry experience

Identify Special Circumstances and Unusual Risks Focus on the auditor’s business risks Identify intended users of audited statements Purchase and sale of business Assess prospective client’s legal and financial stability Client’s need for capital Identify scope limitations Evaluate the entity’s financial reporting systems and auditability Inadequate internal controls

Assess Competence to Perform the Audit Services desired Identify the audit team Need for consultation and use of specialists Trend in industry specialization

Evaluating Independence Evaluate whether there are any circumstance that would impair independence

Decision to Accept 80’s: Accept clients as route to partnership, but not as cognizant of risks 90’s: Clean up client list during good times with a focus on growth oriented clients 2002: Fee competition as auditor’s compete for Anderson clients How much will audit fees increase in the next few years?

Steps in Accepting an Audit Engagement Figure 7-1 Page 241

Key Steps in Planning the Audit Figure 7-3 Chapter 7 Chapter 7 Chapter 8 Chapter 8 Chapter 8 Chapter 9

Overview of Business Cycle Figure 7-4

Knowledge of the Business and Industry Understand the Entity’s Business Risks Developing Expectations of Financial Statements Industry Impact on Information Systems Evaluation of Reasonableness of Accounting Estimates GAAP for Specific Industries Foundation for Other Value-Added Services

Consider Livent Theater company producing shows like Phantom of the Opera, Showboat, etc. Financial statement misstatements: Capitalized cost of shows as pre-production costs Revenue recognition for tickets given away Cost structure Heavy fixed costs Predictable costs Need for ticket revenues and cash flows

Overview of Business Cycle Figure 7-4 Understand and Quantify Understand, Quantify, and Correlate with Outcomes

Understanding the Business and Industry The clients business risks are strongly correlated with the auditor audit risk. Do audit tests ensure that the entity’s outcomes associated with business risks are fairly presented in the financial statements?

Understanding the Client’s Business Figure 7-5

Understanding the Client’s Business Figure 7-5

Understanding the Client’s Business Figure 7-5

Understanding the Client’s Business Figure 7-5

Performing Analytical Procedures Analytical procedures are used in auditing for the following purposes: 1. In the planning phase of the audit, to assist the auditor in planning the nature, timing, and extent of other auditing procedures 2. In the testing phase, as a substantive test to obtain evidential matter about particular assertions related to account balances or classes of transactions 3. At the conclusion of the audit, in a final review of the overall reasonableness of the audited financial statements

Performing Analytical Procedures The following steps are involved in performing analytical procedures: 1. Identify calculations and comparisons to be made 2. Develop expectations 3. Perform the calculations/comparisons 4. Analyze data and identify significant differences 5. Investigate significant unexpected differences 6. Determine effects on audit planning

New Technology, Inc. Evaluate the data presented on pp 260-261. Develop your own expectations Compare company data with expectations Identify issues that need audit attention.

CHAPTER 7 ACCEPTING AND PLANNING THE AUDIT ENGAGEMENT

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