Principles of Auditing and Other Assurance Services

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Unformatted text preview: CHAPTER 6 Planning the Audit; Linking Audit Procedures to Risk Review Questions 6-1 In their investigation of a prospective client, the CPAs should assess the backgrounds and reputations of the prospect and its major shareholders, directors, and officers. Thus, inquiries are made of underwriters, bankers, and attorneys that conduct business with the prospective client. Also, the CPAs are required to make inquiries of the prospect's predecessor auditors to obtain information that might enter into the acceptance decision, such as information regarding the integrity of management. The prospect's financial reports, SEC filings, credit reports, and tax returns are used as sources of financial background information. 6-2 The audit committee of a board of directors must be composed of at least three independent directors. Independent directors are those who are outside directors (not officers or employees) who have no relationships that might impair their independence. This would include relationships such as performing consulting services for company management. In addition, the members must be financially literate, and the chairman must have a financial background. 6-3 An engagement letter is sent to the client by the auditors to make clear the nature of the engagement, any limitations on the scope of the audit, work to be performed by the client's staff, and the basis for computing the auditors' fee. The engagement letter represents the written contract for the engagement, and its primary objective is to prevent possible misunderstandings between the client and the auditors. It constitutes an executory contract between the auditors and the client. 6-4 “Shopping for accounting principles” is a practice whereby management changes auditors to a CPA firm that is more likely to allow an accounting principle that has been the subject of dispute with the company’s prior auditors. A number of mechanisms serve to discourage the practice, including: (1) the requirements under SAS No. 84 for the successor auditors to inquire of the predecessors about the reasons for the change in auditors, (2) the SEC 8-K requirements for management to report the reasons for a change in auditors which also require the auditors to express their agreement with the details, and (3) the requirements under SAS No. 97 that require accountants who are being asked to provide a report on the accounting treatment of an prospective or completed transaction to consult with the client’s auditors to ensure that they have a complete understanding of the form and substance of the transaction. In addition, the Sarbanes-Oxley Act of 2002 requires the audit committee to assume responsibility for engaging, compensating, and overseeing the auditors. 6-5 The approach described in the statement is not appropriate. Materiality depends on both the dollar amount and the nature of the item. For example, auditors apply a more rigorous standard of materiality in evaluating transactions between related parties and potentially illegal acts than they apply...
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ch06 - CHAPTER 6 Planning the Audit Linking Audit...

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