“ CHAPTER 3: PRE-ENGAGEMENT PROCEDURES AUDITING STANDARD REFERENCE(S): PSA 200 ~ Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with International Standards on Auditing psa 210 — Agreeing on the Terms of Audit Engagement relimi En ment preliminary engagement activities assist the auditor in identifying and evaluating Cents or circumstances that may adversely affect the auditor's ability to plan Gnd perform the audit engagement. Such activities help ensure that: ‘a, There are no issues with client management's integrity that may affect the willingness to continue the engagement. b. The auditor maintains the necessary independence and ability to perform the engagement. c. There is no misunderstanding with the client as to the terms of the engagement. ni jement Activities 4. Perform procedures regarding acceptance or continuance of the client relationship b Acceptance or selection procedures - in case of initial audit (prospective/new client) a, Evaluate integrity of the client's management % Evaluation of management integrity is necessary to avoid association with clients whose management lacks integrity. “+ Most of litigations involving CPAs are due to lack of integrity of client’s management, ++ Lack of management integrity usually results to high audit risk. insider in evaluating cli s ‘ity: ¥ Identity, attitude, and business reputation of the client (such as its principal owners, key management or those charge with corporate governance, and related parties, if any) ¥ Nature of the client's operations ¥ Indications of an inappropriate limitation in the scope of work ¥ Involvement in money laundering or other criminal activities 89Y The reasons for the proposed appointment of the CPA firm or auctor and nonreappoiniment of the previous CPA firm or b. Investigate/research the client's background (LOOK) , ¥ Look up through the Internet Y Obtain and review the entity's financial statements ¥ — Obtain credit ratings and reports, if necessary ¥ Know principals associated with the prospective client, Consider Engaging professionals/Investigators. ¢._ Inquiring from other firm personnel or third parties (such as” bankers, legal counsel/advisors, industry peers and others in the financial or business community who may have knowledge regarding the client). d. Communicate with prospective client's predecessor auditor: > Matters to be inguired of or discussed with the predecessor (previous/former) auditor by the ncoming/successor auditor: a) Facts/information that might bear on the integrity of the prospective client. b) Predecessor auditor's understanding as to the reasons for the change of auditors. Any disagreement between the predecessor auditor and the client regarding accounting principles or auditing procedures or other similarly significant matters. ~ 9 d) Communication to management, the audit committee, and those charged with governance regarding fraud, illegal acts by the client, and matters relating to internal control. Under the Code of Ethics for CPAs, the successor auditor has the | responsibilty to initiate communication with the predecessor auditor. However, the communication requires prior client's permission/consent (preferably in writing) to avoid violation of confidentiality principle. If the client is unwilling to agree to such communication (communication is not permitted by the client or the client limits ad responses of the predecessor auditor), the successor auditor should:2 Chapter 3: Pre- Engagement Procedures “¥ Consider the implications of such refusal/limitation, and v_Decide whether to accept the engagement. e. Other Considerations ¥ High level of public scrutiny and media interest. v The financial health of the client. v Ability to pay audit fees. Note: > Auditability of client’s financial statements determine whether the auditor will be able to accumulate sufficient appropriate audit evidence to render an opinion on the financial statements by considering: ¥ The adequacy of accounting records ¥ Quality of internal control Continuance or retention procedures — in case of recurring audit (or existing client) To ensure the audit firm's continuing compliance with acceptance and continuance procedures, existing clients should be evaluated ‘once a year or upon occurrence of the following: ¥ Changes in management, directors, or ownership. Nature of client's business. Evaluate compliance with ethical requirements, including independence > Independence — The CPA firm or auditor shall identify, evaluate, and respond to any threat to independence. * The CPA firm or auditor must be independent of the client whose financial statements are subject to audit. + Audit opinion is not credible or of little or no value if the auditor is not independent. > Professional competence — determine if the CPA firm or auditor has the necessary skills and competence. “Professional accountants should not portray themselves as having the required expertise which they do not possess. ‘+ The auditor should obtain preliminary understanding of prospective client’s business and industry to determine Whether the auditor has the required degree of competence. ‘If the auditor does not possess the industry expertise, he should obtain knowledge of matters that relate to the nature of the entity's business and industry. 91> Ability to serve the client properly - the CPA firm or auditor must have capability, time, and resources to perform the audit, Examples Y Availability of appropriately qualified staff when the work is required. Y The firm can complete the engagement within the reporting deadline (proximity of the deadline). ¥ Consider the need for expert's assistance and any conflicts of interest. “Firm personnel have knowledge of relevant industries. > The firm has sufficient personnel with the necessary capabilities and competence. 3. Establish an understanding of the terms of the engagement > The CPA firm or auditor shall accept or continue an audit engagement only when: The preconditions for an audit are present: ¥ Management has used acceptable financial reporting framework (or suitable criteria or appropriate basis for) in the preparation of the financial statements. Note: > Factors to consider in determining the acceptability of the financial reporting framework: ¥ The nature of the entity (for example, whether it is a business enterprise, 2 public sector entity or a not-for-profit organization). “The purpose of the financial statements (for example, whether they are prepared to meet the common financial information needs of a wide range of users or the financial information needs of specific users). ¥ Financial statements prepared in accordance with a financial reporting framework designed to meet the common financial | ' information needs of a wide range of users are referred to aS general purpose financial statements. ¥ Financial statements prepared in accordance with a financial reporting framework designed to meet the financial information needs of specific users are referred to as special purpose financial statements, 92Chapter 3; Pre- Engagement Procedures The nature of the financial statements (for example, whether the financial statements are a complete set of financial statements or a single financial statement); arid ¥ Whether law or regulation prescribes the applicable financial reporting framework. Examples of financial reporting frameworks: v IFRSs v PFRSs ¥__IPSASs — International Public Sector Accounting Standards jote: : > Management agrees to the premise that it has acknowledged and understood its responsibilities: + If the preconditions for an audit are not present, the auditor shall not accept the proposed audit engagement, unless acceptance is required by law or regulation, Preconditions for an audit are within the control of the entity. ‘+ There is a common understanding between the auditor and management (and, where appropriate, those charged with governance) of the terms of the audit engagement. Agreement on audit engagemeht terms: > The auditor shall agree on the terms of the audit engagement with management or those charged with governance, as appropriate. Such agreed terms shall be recorded in an audit engagement letter or other suitable form of written engagement. . > Preliminary conference: A preliminary conference with the client is ” scheduled after the CPA has determined that: “The firm is independent. The firm is competent to perform the audit. The firm can serve the client properly, and The client's reputation is one of integrity. S684 The terms of engagement are usually agreed with the client during a preliminary conference with the client and formalized through a signed engagement letter. During the preliminary conference, the auditor and client agree on the following issues: > The specific services to be rendered. > The cooperation and work expected to be performed by the client's personnel. > Expected start and completion dates of the engagement. > The possibility that the completion date may be changed if unforeseen audit problems arise if unforeseen audit problems 93Comprehensive Reviewer in Haditing and Assurance Principles arise if adequate cooperation from client's personnel is not > The nature and limitations of the audit engagement. > An estimate of the fee to be charged for the engagement Engagement letter ~ an agreement between the CPA firm or auditor and the client for the conduct of the audit. It is a letter from the auditor to the client management, and when signed by the client it serves as a formal written contract between them. Note Engat fer dc nts and confirms the: ¥ Auditor's acceptance of the appointment. Y Gient’s acceptance of the terms of the audit engagement. Y Responsibilities of both the client management and the auditor. Arrangements or. agreed terms of the engagement (such as the objectives and scope of the audit, the form of any reports, etc.) Importance (primary reason) of an engagement letter: It clarifies the nature of the engagement and the responsibilities of management and those of the auditor. _ Form and Contents of the Engagement Letter: The form and content of engagement letters may vary for each client. Engagement letters should be adapted according to individual requirements and Grumstances ofthe engagement General, engagement eters should include feference to: 1. Principal Contents: a. Objective and scope of the audit of the financial statements. 'b. Responsibilities of the auditor. c. Responsibilities of management. d. Identification of financial reporting framework for the preparation of the financial statements. fe. Reference to any form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content. 94Chapter 3: Pre- Engagement Procedines Note: In addition, and audit engagement letter may refer to the following: ¥ Elaboration of the scope of the audit, including reference to applicable legislation, regulations, PSAs, and ethical and other pronouncements of professional bodies to which the auditor adheres. ¥ The form of any other communication of results of the audit engagement. - Y The fact that because of the inherent limitations of ‘an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatement may not be detected, even though the audit was properly planned and performed in accordance with the PSAs. VY Arrangements regarding the planning and performance of the audit, including the composition of the audit team. v Expectation that management will provide written representations. v The agreement of management to make available to the auditor draft financial statements and any accompanying other information in time to allow the auditor to complete the audit in accordance with the proposed timetable. ¥ ‘The agreement of management to inform the auditor of facts that, may affect the financial statements, of which management may become aware during the period from the date of the auditor's report to the date the financial statements are issued. Y Basis on which fees are computed and any billing arrangements. YA request for management to. acknowledge ‘receipt of the engagement letter and to agree to the terms of the engagement outlined therein. 2. Other arrangements, when relevant: > Involvement of other auditors and experts in some aspects of the audit. > Involvement of internal auditors and other staff of the entity. > Arrangements to in the case of an ade with the predecessor auditor, if any, | audit. > Any restriction of the auditor's liability when such possibility exists. > A reference to any further agreements between the auditor and the client. 95> Any obligations to provide audit working papers to othe, patties. udits of Compons Factors to consider vihether to send a separate engagement letter to the component when the auditor of the parent company is also the auditor of jg ‘component (subsidiary, branch or division): Who appoints the auditor of the component? Whether a separate aucitor’s report is to be issued oh the component Legal requirements in relation to audit appointments The extent of any work performed by other auditors Degree of ownership by parent, and Degree of independence of the component's management from the parent entity Sawer > The auditor may decide not to send a new engagement letter or other written agreement each period. > The following factors may make it appropriate to’ send a new engagement letter: 2 Revision ofthe terms of aud engagement due to Any revised or special terms ofthe engagement. > Arecent change of senior management or those charged with: governance. : ¥Asignificant change in ovinership. ¥ Assignificant change in nature or size of the client’s business. Y Achange in legal or regulatory requirements, ¥ Achange in the financial reporting framework adopted in the preparation the financial statements. Y Achange in other reporting requirements. b. Reminder to the client of the existing terms of the engagement Any indication that the client misunderstands the objective and scope of the audit. dures_wheh the client for_a ge engagement: > Consider the appropriateness of reasons for the engagement © If there is a reasonable justification for the change — stop the orignal engagement and agree on the new terms of engagement and then proceed with the new engagement. - 96Chapter 3: Pre- Engagement Procedures Note: To avoid confusing the users of the new report, do not mention the following in the new report: x The original engagement. x Any, procedures that may have been performed in the original engagement. “+ Except where the engagement is changed to an engagement to undertake agreed- upon procedures and thus the reference to the procedures performed is a normal part of the report), 0 If there is no reasonable justification — refuse the client's request, and continue to perform the original engagement and issue the original report Note: If the auditor is not permitted to continue the original engagement, the auditor should withdraw from the engagement and consider reportorial responsibilities to the BOD or shareholders of the client, Whether or not to accept a change in engagement: > Change in the terms of the audit engagement: The auditor shall not agree where there is no justification/basis for the change in the terms of the audit engagement. Note: Reasonable basis includes: ¥ Achange in circumstances affecting the entity's requirements For example: the client's bank required an audit before committing toa loan, but the client subsequently acquired alternative financing. v A misunderstanding as to the nature of the service originally requested Not a reasonable basis: ¥ Change that relates to information that is incorrect, incomplete, or otherwise unsatisfactory. For example, the entity asks for the audit engagement to be changed to a review engagement to avoid a qualified opinion or disclaimer of opinion. > Change to a lower-level assurance engagement: The auditor -shall not agree where there is no justification/basis for the change to a lower-level assurance engagement, The auditor should agree if there is reasonable basis, such as: *-¥- Achange in circumstances affecting the entity’s requirements or néed for the service. For example, the client's bank required an audit before committing to a loan, but the client subsequently acquired alternative financing. YA misunderstanding as to the nature of an audit or related service originally requested. 97Camprchensive Reviewer tn Auditing and Arsunance Prtuciples : v Arrestriction on the scope of the engagement, whether imposed by management or caused by circumstances ‘The auditor should not agree if there is no reasonable justification ~ the change relates to incorrect, incomplete, or otherwise unsatisfactory information. ++ For example, in an audit engagement, the auditor is unable to obtain sufficient appropriate audit evidence regarding receivables and the client asks for the engagement to be changed to a revie W engagement to avoid a qualified audit opinion or a disclaimer of opinion. If there is a reasonable change, no reference of the same shall be _ included in the report. > Withdraw from the engagement — if the auditor is unable to agree to the change and is not permitted/allowed to continue the original engagement because of his disagreement. Auditing Standards > Popularly known as the Generally Accepted Auditing Standards (GAAS). > The general guidelines that the auditors must follow in conducting the audit. > The minimum standards of auditor's performance that must be achieved on each audit engagement. > The guidance for measuring the quality of the auditor's performance. GAAP vs. GAAS: f ¥ GAAP. the principles for the preparation and presentation of financial statements that are used by the auditor as criteria in determining the| overall fairness of the financial statements; foundation of accounting. Y GAAS: standards/measures/guidance that the auditors must fallow when conducting an audit; foundation of auditing. a. Definition | + Auditing standards: the measures of the quality or minimu) standard of auditor's performance. « Auditing procedures: the means used (or the acts to b performed) by the auditor to attain the quality or minimum standard of auditor’s performance. 98Chapter 3: Pre Engagement Pracedanes b. Basic difference: “auditing procedures" relate to acts to be performed, whereas “auditing standards" deal with measures of audit quality and the objectives to be achieved in an audit. ¢. Relationship: Every independent. audit engagement involves both auditing standards and auditing procedures. From one engagement to another engagement, auditing standards are applied uniformly but auditing procedures may vary. The 10 Gene Standards (Gi > GENERAL STANDARDS — standards/criteria which present guidarice in the personal qualifications an auditor must possess to undertake the audit engagement. . 1. Technical training and proficiency: This standard refer to professional competence. + Professional competence of the auditor is primarily met by having professional education/training and practical experience in auditing. . © Competence can also be acquired by the auditor through the following: Y Continuing professional development ¥ Consulting others if additional technical information is needed Y Coaching by more experienced staff ¥ Research to obtain knowledge of client business and industry « Competence does not include warranting the infallibility of the work performed. 2. Independence: This standard requires that the auditor must be impartial when dealing with the client or without bias with respect to the client entity. The auditor must be independent in fact and in appearance. a. Independence of mind - The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism; this is’ also known as “independence in fact" or “independence in mental attitude.” b. Independence in appearance — The avoidance of facts and circumstances or situations that are so significant that _ would lead a reasonable and informed third party or the public to believe or conclude that the auditor is not independent. In 99Comprchensine Reviewer in Auditing and Assurance Principles . other. words, independence in appearance requires that activities or relatioriships that even suggest or imply a possible lack of independence must be avoided by the auditor. Note: Independence is often called the cornerstone of the profession since it is Necessary to add credibility to the auditor’s work. 1 Auditor strives to ‘achieve independence in appearance to maintain public confidence in the profession or to achieve public confidence. The audit opinion and the audit report would be of little or no value if auditor is not independent because of absence of public confidence, ¥ The auditor ultimately decides whether he/she is iridependent. ¥ Independence in mental attitude cannot be regulated. However, to encourage independence in fact and to maintain the appearance of independence: “The auditor can have no direct financial interest in the client, “Direct” includes the auditor and members of immediate family, “Financial interest” is ownership of equity: hares, cther client financial instruments, or any other potential financial benefit. In addition, there can be no material indirect financial interest such as ownership through a mutual fund. To ensure independence, auditor cannot render an opinion on ‘statements of one year until all fees from ‘the prior year audit have been paid. “To emphasize independence from. management, auditor is usually appointed by audit committee of the board of directors. Independence may be impaired by performing consulting services, especialy those that involve making management decision: 3. Professional care: This standard requires that an auditor, in fulfiling his duties, should act diligently and carefully, exercise reasonable prudence, and apply judgment in a conscientious manner, carefully weighing the relevant factors before reaching a decision. 7 Not Due professional care is often called the "average auditor” concept. The auditor should do what the average auditor would do and never less, including review of work performed by assistants and maintaining: an attitude. of professional skepticism. fi Exercise of due professional care in the performance of the audit requires: ¥__ Observance of the standards of field work and reporting. 4 100supervision. reasonable auditor would exercise. + Exercise of professional skepticism. Critical review of the audit work performed at every level of Degree of skill commonly possessed by others in the profession. Exercise of the same. components of professional care as a ACRONYM: Before you start an audit, you would need a “TIP” DARDS OF FIELD WORK ~ the standards / criteria for planning and -gathering. Planning and proper supervisioi Planning involves establishing the overall audit strategy for the engagement and developing an audit plan. The auditor should also supervise the work of assistants. Supervision is critical because of assistants’ lack of experience. Vv” Audit programs are designed to enumerate appropriate action, and all work of staff auditors should be reviewed by a, qualified auditor. Audit program is developed before substantive testing to ensure that adequate planning has occurred. Internal Control Consideration of the client’s established controls v As part of the planning activities, the auditor is required to obtain sufficient understanding of the entity and its environment. This means that the auditor should obtain a more detailed knowledge of the client's business ‘and the environment/industry in which the entity operates. A sufficient understanding of internal control is to be obtained to plan the audit. Appropriate internal controls provide .the auditor with confidence that material misstatements will be prevented or detected on a timely basis. + Strong internal control implies that the auditor will require less evidence. 7 + Weak internal control implies that the auditor will require more evidence. “Evidence and Controls have an Inverse Relationship” Evidence should be sufficient and Appropriate © The auditor should obtain sufficient appropriate audit evidence by performing audit procedures to be able to draw reasonable conclusions on which to base the opinion regarding the financial statements under audit, 101. | +4 ‘cower tn Auditing and. a Asean Acronym: PIE evidence gathering is sometimes called substantive testing, testing that confirms the ending balance of an account is known a a test of a balance. Evidence gathered to support an account ooking at the various transactions that have affected it during the period is called a test of details. Al specific audit work is performed to gather evidence, ¥_ The quantity and quality of evidence to be gathered depends on the judgment of the auditor. The decision as to how much evidence to be accumulated requires professional judgment; not provided in the PSAs; the rule is, evidence must be sufficient to afford a reasonable basis for opinion i L— > STANDARDS OF REPORTING — standards on’ auditor's expression of zudit opinion through a medium known as the auditor's report 1, Standards in Accordance with GAAP/PFRS: Conformity with GAAP/PFRS is explicit in the auditor's report ¥ Explicit statement means that the auditor should state whether the financial statements subject to audit are prepared in accordance with GAAP/PFRS. When an overall opinion cannot be expressed, as where the auditor disclaims an opinion, the reasons therefore shouid be stated. 2. Historical and Consistent application of GAAP/PFRS: Consistencyis implicit in the auditor's report If there is no material consistency as to application of GAAP/PERS, no statement as to consistency is required in the auditor's report. However, if a material inconsistency exists, auditor shall ,identify such inconsistency in the auditor's report. ‘ Note: i > If GAAP/PFRS is consistently applied: no express statement asto consistency is necessary because consistency is implicit in the auditors report. - > If GAAP/PFRS is not consistently applied: auditor shall identify in the auditor's report such inconsistency. 102Chapter 3: Pre- Engagement Procedanes 3. Opinion regarding the financial statements taken as a whole: expression of audit opinion is explicit in the auditor’s report Objective of 4'* standard of reporting: ¥ To indicate the character of the engagement and the degree of responsibility assumed by the auditor. This would prevent financial statements users from misinterpreting the degree of responsibility the auditor is assuming/taking. . ¥ Reference to the expression "taken as a whole" in the fourth generally accepted auditing standard of reporting means that the audit opinion applies equally to a complete set of financial statements and to each individual financial statement. 4. While also having Adequate Disclosure of Information: Adequacy of disclosure is implicit in the auditor's report. If informative disclosure is adequate, no statement as to adequacy of disclosure is required in the auditor's report. However, if informative disclosure is inadequate, auditor must state such inadequacy in the auditor's report. Note: > If disclosure is adequate: no statement as to adequacy of disclosure is necessary because adequacy of disclosure is implicit in the auditor's report: > If disclosure is inadequate: auditor must state in the audit report such inadequacy. Acronym: “SHOW” Philippine Standards on Auditing (PSAs): > The PSAs are interpretations of GAAS, meaning, they are intended to clarify the meaning of "generally accepted auditing standards." > The PSAs contains basic audit principles and essential procedures together with related guidance in the form of explanatory and other material which the auditor should follow when conducting financial statements audit. > Application of PSAs: PSAs apply to independent examination of (historical) financial statements of any entity conducted for the purpose of expressing an opinion. > Compliance with PSA: The auditor should conduct an audit in accordance with PSA. Compliance with PSAs means application of basic audit principles and performance of essential audit procedures. Compliance with relevant PSAs is mandatory. Only in exceptional instances where departure from relevant PSA is allowed such as when the auditor believes that the: ¥ Amount involved is insignificant; or . ¥ Requirement of the PSA is impractical to perform; or ¥ Requirement of the PSA is impossible to perform,Comprchensive Reviewer tn Auditing and. Abarance Principles Nature. f Quali > A system of quality control refers to quality control policies ang procedures adopted by CPA firms that are designed to provide reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements and that reports issued by the firm or engagement partners are appropriate in the circumstances, Ll ee Lee > System of Quality Control in an Audit Engagement: Policies ay procedures to provide reasonable assurance that all audits are condy in accordance with PSAs and that adit reports issued are appropriate), the circumstances. > Mandatory requirement for CPA firms to establish SQC: Unis Philippine Standard on Quality Control 1 (PSQC 1) CPA firms are requiry to establish and implement a system of quality control. — QC policies vs. QC procedures: > Quality contro! policies - are the objectives and goals to’ be achieved. - > Quality contro! procedures ~ are steps/procedures to be taken to; + accomplish the policies adopted, or + implement and monitor compliance with those policies Nature and Extent of a System of Quality Control: The nature and extent of the SQC developed by CPA firms vary from firm to firm due to various factors such as: Size of the CPA firm Nature of ts practice Operating characteristics Its organization Geographical dispersion Cost-benefit consideration Whether it is part of a network empaose Si > Although the nature and extent of the system of quality control developed by CPA firms vary from one firm to another, a system of quality control must have the following elements: 1, Human resources - The CPA firm should establish policies and procedures to provide reasonable assurance that it has'sufficent personnel with the capabilities, competence, and commitment to ethical principles necessary to perform the engagement. 2. Ethical requirements, including independence © The CPA firm should establish policies and procedures to provide reasonable assurance that the firm and its personnel 104Chapter 8: Pre- Engagement Procedines comply with relevant ethical requirements (including independence). Acceptance and continuance of client relationships and specific engagements — The CPA firm should establish policies and procedures to provide reasonable assurance that the CPA firm will only undertake or continue relationships and engagements where it: v Has considered the client's integrity v Is competent to perform the engagement and has the capabilities, time, and resources to do so; and ¥ Can comply with ethical requirements Leadership responsibilities for quality within the firm - The CPA firm should establish policies and procedures that: Promote an internal culture based on recognition that quality is essential in the performance of the engagements. ‘© Require CPA firm's leader (CEO/ managing board of partners or its equivalent), to assume ultimate responsibility for the firm's system of quality control, Monitoring - The CPA firm should establish policies and procedures to provide reasonable assurance that quality control are relevant, adequate and operating effectively and complied with in practice and should include an ongoing consideration and evaluation of the firm’s system of quality control, including 2 periodic inspection of a selection of completed engagements. Engagement performance — The CPA firm should establish policies and procedures to provide reasonable assurance that engagements are performed in accordance with professianal standards and regulatory and legal requirements, and that the firm or engagement partner issue reports that are appropriate in the circumstances. Acronym: HEALME The purpose of monitoring compliance with quality control policies and procedures is to provide an evaluation of: a. Adherence to professional standards and regulatory and legal requirements. Whether the quality control system has been appropriately designed and effectively implemented; and Whether the firm’s quality control policies and procedures have been appropriately applied, so that reports that are issued by the firm or engagement partners are appropriate in the circumstances. 105Comprchensive Reviewer in Auditing and Aeaurance Principles . The following shall also be included in the CPA firm’s SQC: } 1, Complaints and Allegations: The firm should establish policies ang) procedures designed to provide it with reasonable assurance that it deals| appropriately wit! : | . Complaints and allegations that the work performed by the fitm fails to comply with professional standards and regulatory and legal requirements; and b. Allegations of non-compliance with the firm’s system of quality control, 2. Documentation: The firm should establish policies and procedures requiring appropriate documentation to provide evidence of the operation of each element of its system of quality control. tinction between GAAS/PSA and SQC: GAAS/PSAs relate to each individual. audit engagement, whereas SQC relates to all professional actvities/services of the firm's practice. uality Review Committee ¥ To ensure that CPAs work to the highest standards, the government thu the Professional Regulatory Board of Accountancy (BOA) has required all CPA firms and individual CPAs in public practice to obtain a cettificate of accreditation to practice public accountancy. Such certificate is valid for three (3) years and can be renewed after complying with the requirements of the BOA. Y Asa condition to the renewal of the certificate of accreditation to practice public accountancy, the BOA requires individual CPAs and CPA firms to undergo a quality control review to ensure that these CPAs comply with accounting and auditing standards and practices. ¥ The BOA has created a Quality Review Committee (QRC) which shall conduct a quality review on applicants for registration to practice public accountancy. Functions of the Quality Review Committee: Conducts quality review on applicants for registration, or renewal thereof, to practice public accountancy. ¥ Render a report on such quality review, which shall be attached to the application for registration, ¥ Recommend to BOA revocation of registration and professional ID cards of CPAs for not observing the SQC requirements. Quality review ~ an oversight into (or study or appraisal of) the quality of audit of FS through a review of quality control measures established by CPA firms and individual CPAs in public practice to ensure compliance with accounting and auditing standards and practices. 106Chapter 3: Pre- Engagement Pracedanes EXERCISES 1 Stans Which of the following has the highest level of accounting authority within the "GAAP Hierarchy"? 7 A. Authoritative body pronouncements. B. Pronouncements of bodies composed of expert accountants - exposed for public comment. C. Pronouncements of bodies composed of expert accountants, not exposed for public comment. D. Pronouncements of the Federal Accounting Reserve Board. 2. Which of the following is one of the elements of quality control? A. Assurance of proper levels of association. B. Due professional care. CC. Engagement performance. D. Supervision. 3. A procedure in which a quality control partner periodically tests the - application of quality control procedures is most directly related to which quality control element? A. Engagement performance. B. Human resources. C. Leadership responsibilities for quality with the firm. D. Monitoring 4. Requirements for training, independence and due professional care are included in which group of the GAAS? A. Fieldwork. B. Gene C. Repo D. Quality control. 5. Which of the following is considered an interpretive publication in the GAAS Hierarchy? A. Appendices to Statements on Auditing Standards. B. Statements on Auditing Standards. C. Interpretations of FASB Standards. D. Auditing articles Statements on Auditing Standards in the Journal of Accountancy. 6. The GAAS require that the CPAs: ‘A. Assume responsibility for any losses to the client from fraud which existed during the audit but was not detected by the auditors. 8. Follow accounting principles adopted by the SEC. C. Not accept as audit clients’ companies which compete directly with one another. D. Exercise due professional care in the performance of the examination and the preparation of the report. 107Comprehensive Reviewer in Auditing and Arsunance Principles a. “10. iL. When a Statement Auditing Standards uses the word "should" relating to a requirement, it means that the auditor: A. Must fulfill the responsibilities under all circumstances. B. Must-comply with requirements unless the auditor demonstrates and documents that alternative actions that were sufficient to achieve the objectives of the standards. C. Should consider whether to follow the advice based on the exercise of professional judgment in the circumstances, D. May choose to change responsibilities relating to various professional standards that remain under consideration. Which of the following best describes a portion of the auditors responsibilty regarding illegal acts by clients? A.” The auditors have a responsiiity to discover all material ilega acts. 8. If audit procedures reveal ilegal acts, the auditors should take appropriate actions. C. If the auditors suspect illegal acts have been performe should conduct a legal audit ofthe company. er they: D. The aucitors responsiblity forthe detection ofall legal acts is : bility For the the same as their responsibilty regarding material misstet to errors and fraud. ements due ‘The auditors who find that the client has committed Incor i laws and regulations, what would be most likely the ete aie ity from the engagement: raw A. Management fails to take appropriate corrective action, B, Illegal act has material financial statement implications, C._ilegal act has received widespread publicity. 7 D. Auditors cannot reasonably estimate the effe l the financial statements. ctof the illegal act on \h of the stand: ‘ vie frst parasrap ard unqualified audit report is referred A. Introductory paragraph. B. Opening paragraph. C. Opinion paragraph. D. Scope paragraph. When a conflict’ between an accounting princi pronouncement of an authoritative body and on acc cPperted bya supported by other widely recognized pronouncement meg. prmcpe standard prevails? . odies, which ‘A. The authoritative body pronouncement. B. The widely recognized pronouncement. C._ Both are of equal authority and the form : over its substance... : ofthe transaction prevails D. Neither other accounting literature must p determine the appropriate accounting treatment. 108, e consulted. to12. 14. 15. 16. 17. Chapter 3: Pre- Engagement Procedures Which of the following is not one of the six elements of quality control? A. Engagement performance. B. Monitoring. C, Relevant ethical requirements. D. Review. . A requirement that working papers be reviewed by the supervisor, and any lapses be discussed with the preparer is an example of what quality control procedure in: A. Acceptance and continuance of client relationships and specific engagements, B, Engagement performance. C. Human resources. D. Relevant ethical requirements. ‘A requirement to design recruitment processes and procedures to help the firm select individuals meeting minimum academic requirements established by the firm is an example of a quality control procedure in: A. Acceptance and continuance of client relationships and specific engagements. B. Engagement performance. C. Human resources, D. Relevant ethical requirements. The body that issues international pronouncements providing auditing procedural and reporting guidance is the: - A. International Federation of Auditors. B. Multinational Reporting Commission. C._ International Auditing and Assurance Standards Board. + D. Auditing Standards Board. To present fairly in conformity with generally accepted accounting pririciples the financial statements must: Be consistently applied. . Inform users of all matters that could materially affect a decision. Reflect transactions and events within a range of reasonable limits. Be considered preferable to the users of those financial statements. pog> What is the general character of the three generally accepted auditing standards classified as general standards? A. Technical Training and Proficiency, independence, and professional care of individuals performing the audit. B. Criteria for the content of the financial statements and related footnote disclosures. C. Criteria for the content of the auditors’: report on financial statements and related footnote disclosures. D. The requirements for the planning of the audit and supervision of assistants, if any. 109Comprehensive Resiewer in Auditing and. As Deine ' 18. An audit performed in accordance with generally accepted auditing standards generally should: A. Be expected to provide absolute assurance that illegal acts will be detected where internal control is effective. Be relied upon to disclose violations of truth in lending laws. B. C, Encompass a plan to actively search for all illegalities which relate to operating aspects. D. Not be relied upon to provide absolute assurance that all illegal 15. 2 21. 22. S acts will be detected. When the auditors express an opinion on financial statements their responsibilities extend to: A. The underlying wisdom of their client's management decisions, B, Whether the results of their client's operating decisions are fairly presented in the financial statements, C. Active participation in the implementation of the advice given to theirclient, D. An ongoing responsibility for their client's solvency. ‘The standard auditors' report for the audit of a nonpublic company generally includes an introductory paragraph, a scope paragraph, and an opinion paragraph. In the report the auditors refer to both accounting principles generally accepted, and auditing standards generally accepted. In which of the paragraphs are these terms used? A. GAAP in the scope paragraph and GAAS in the opinion paragraph, B, GAAS in the scope paragraph and GAAP in the opinion paragraph, CC. GAAS in all paragraphs and GAAP in the scope paragraph. D. GAAP in all paragraphs and GAAS in the opinion paragraph. An investor reading the financial statements of the BSV Corporation observes that the statements are accompanied by an unqualified auditors’ report. From this the investor may conclude that: A. Any disputes over significant accounting issues have been settled to the auditors’ satisfaction, B. The auditors are satisfied that BSV Corporation is operationally efficient. C. The auditors have ascertained that BSV Corporation's financial statements have been prepared accurately. . Informative disclosures in the financial statements but not: necessarily in the footnotes are to be regarded as reasonably adequate. The auditors’ report may be addressed to the company whose financial statements are being examined or to that company's: ‘A. Chief operating officer. B. President. C._ Board of Directors, D. Chief financial officer. 11023, 24, 25. 26. 27, Chapter 3: Pre- Eagagement Procedures Which of the following best describes what is meant by generally accepted auditing standards? _ A. Acts to be performed by the auditors. B. Measures of the quality of the auditors’ performance. C. Procedures to be used to gather evidence to support financial statements. D. Audit objectives generally determined on audit engagements. “If an illegal act is discovered dufing the audit of a publicly company, the auditors should first: A. Notify the regulatory authorities. B, Determine who was responsible for the illegal act. C. Intensify the examination to identify all illegal acts. D. Report the act to high level personnel-within the client's organization and to the audit committee. Which of the following is not a requirement of the generally accepted auditing standard which states that due professional care is to be exercised in the performance of the audit? ‘A. Observance of the standards of field work and reporting. B. Critical review of the audit work performed at every level of supervision. C. Degree of skill commonly possessed by others in the profession. D. Responsibility for losses because of errors of judgment. Which of the following statements best describes the purpose of Statements on Generally Accepted Auditing Standards? “A. They are guides intended to set forth auditing procedures which are applicable to a variety of situations. B. They are procedural outlines which are intended to narrow the areas of inconsistency and divergence of auditor opinion. C. They are authoritative statements, enforced through the Code of + Professional Conduct. D. They are interpretations which may be useful guidance to auditors. The primary responsibility for the adequacy of disclosure in the financial statements of a publicly held company is with whom? Partner assigned to the audit engagement. Management and Those Charged with Governance. Auditor in charge of the fieldwork. Securities and Exchange Commission. pomP> .1itComprehensive Reviewer tx Auditing aud Aaunance Principles 28, Within the context of aualty control, the primary purpose of Continuing Professional Development and training seminar activities is to enable a CPA firm to provide personnel within the firm with A. Technical training that assures proficiency as an auditor. B. Professional education that is required to perform with due professional care. C. Knowledge required to fulfill assigned responsibilities and to progress within the firm, D. Knowledge required to perform a peer review. In pursuing a CPA firm's quality control objectives, a CPA firm may maintain records indicating which partners or employees of the CPA firm were previously employed by the CPA firm's clients. Which quality control objective would this be most likely to satisfy? ‘A. Acceptance and continuance of clients and engagements. B, Engagement performance. - C. Personnel management. D. Relevant ethical requirements. 2 S 30. A CPA firm establishes quality control policies and procedures in accepting a new client or continue to perform in a current client. The primary purpose of such policies and procedures is: To enable the auditor to attest to the integrity or reliability of a client. B. To comply with the quality control standards established by regulatory bodies. C. To minimize the likelihood of association with clients whose managements lack integrity. D. To lessen the exposure to litigation resulting from failure to detect fraud in client financial statements. Which of the following is not an element of quality control? A. Documentation. B. Engagement performance. C.. Monitoring. D. Relevant ethical requirements. 31. 32. The he general accepted auditing standards established: Have been accepted as interim standards by the Public Company ‘Accounting Oversight Board. B. Provide accounting guidance for nonpublic companies. C. Have been superseded by Public Company Accdunting Oversight Board standards for all audits. . D. Are now developed by the Securities and Exchange Commission. 112Chapter 3: Pre- Engagement Procedures 33, An engagement review form of peer review would be least likely to have a peer reviewer's detailed analysis of: A. “B. c D. ‘Compilation reports. Documentation of procedures followed on a review Overall system of quality control. Review reports. 34, Which of the following factors most likely would cause a CPA to reject a new audit engagement? A B. G3 'D. The prospective client has fired its prior auditor. ‘The CPA lacks a thorough understanding of the prospective client's -operations and industry. The CPA is unable to review the predecessor auditor's working papers. The prospective client is unwilling to make financial records available to the CPA. 35. Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting? A. B, CG D. Large amounts of liquid assets that are easily convertible into cash. Low growth and profitability as compared to other entities in the same industry. Financial management's participation in the initial selection of accounting principles. An overly complex organizational structure involving unusual lines of authority. 36. Which of the following factors would most likely cause a CPA to decide Reject a,new audit engagement? A. 999 Lack of understanding .of the potential client's internal auditors’ computer-assisted audit techniques. Management's disregard for internal control. The existence of related party transactions. Management's attempt to meet earnings per share growth rate goals. 19 matters is generally included in an auditor's engagement letter? A B. Lo D. Limitations of the engagement. Factors to be considered in establishing preliminary judgments about materiality. Management's liability for illegal acts committed by its employees. The auditor's responsibility to obtain negative assurance relating to the occurrence of illegal acts. 113Comprchansioe Revtwerin editing and Ascorance Principles 38. 3 40. 41. 4 43. s The auditors’ understanding established with a client should be established through a(n) A. Oral communication with the client. B. Written communication with the client. C. Written or oral communication with the client. D. Completely detailed audit plan. ). Which of the following would be least likely to be considered an audit planning procedure? ‘A. Use an engagement letter. B. Develop the overall audit strategy C. Perform the risk assessment. D. Develop the audit plan. While assessing the risks of material misstatement the auditors identification of risks, relate risk to what is the worst-case scenario, consider the magnitude of risks and A. Assess the risk of misstatements due to illegal acts. B. Consider the complexity of the transactions involved. C. Consider the likelihood that the risks could result in material misstatements. D. Determine materiality levels. A predecessor auditor is required to attempt to initiate communication with the successor auditor: L Prior to the Successor’s Acceptance of the Engagement Tl. After the Successor’s Acceptance of the Engagement AL B, C. None of the Given D. * Both I and IT G ! Which of the following factors most likely would lead a CPA to assume tat ‘a potential audit engagement should be rejected? ‘There are significant related party transactions that management claims occurred in the ordinary course of business, B. Internal control activities requiring the segregation of duties ate subject to management override. C. Management continues to employ an inefficient system ‘of information technology to record financial transactions. . D. It is unlikely that sufficient eviderice is available to support an opinion on the financial statements. Inusing the information on the statement of cash flows while obtaining an understanding of a profitable, growing company, which of the following would ordinarily be least surprising to an auditor? ‘A. Decreases in accounts payable. . B. Decreases in accounts receivable. C. Negative cash flows from investing. 114Chapter 8: Pre- Engagement Procedares D. Negative operating cash flows. 44, When a company has changed auditors, according to the Professional Standards: A. The successor auditor has the responsibilty to initiate contact with the predecessor auditor to ask about the client before the engagement is accepted; the predecessor has no responsibility to initiate this contact, even when aware of matters bearing on the integrity of management. B, The predecessor must respond fully to all inquiries made by the successor auditor. C. The successor must discuss with the predecessor matters bearing on the engagement prior to accepting the engagement. D. The successor may choose not to attempt any communication with the predecessor auditor. . 45. Which of the following procedures would not be performed as a part of planning an audit engagement? * A. Reviewing the working papers of the prior year. B. Performing analytical procedures. C. Confirmation of all major accounts. D. Designing an audit program. 46. The risk of a material misstatement occurring in an account, assuming an absence of internal control, is referred to as: A. Account risk. B. Control risk. C., Detection risk. D. Inherent risk. 47. Which of the following is not to be required on an audit? A. Evaluate the business rationale for significant, unusual transactions. B. Make a legal determination of whether fraud has occurred. C. Review accounting estimates for biases. D. Test appropriateness of journal entries and adjustments. 48. A successor auditor is required to attempt communication with the predecessor auditor prior to : A. Performing test of controls. B. Testing beginning balances for the current year. CC. Making a proposal for the audit engagement. D. Accepting the engagement. usComprehensive Reviewer tn Huditing and Asaunance Principles 49. Which of the following statements is correct regarding the auditor's determination of materiality? A. The planning level of materiality should normally be the larger of the amount considered for the balance sheet versus the income statement. B, The auditors’ planning level of materiality may be disaggregate into smaller "tolerable misstatements" for the various accounts, C. Auditors may use various rules of thumb to arrive at an evaluation level of materiality, but not for determining the planning level of materiality. D. The amount used for the planning should equal that used for evaluation. 50. The auditors must consider materiality in planning an audit engagement. Materiality for planning purposes is: A. The auditors’ preliminary estimate of the largest amount of misstatement that would be material to any one of the client's financial statements. B, The auditors’ preliminary estimate of the smallest amount of misstatement that would be material to any one of the client's financial statements. C. The auditors’ preliminary estimate of the amourit of misstatement that would be material to the client's balance sheet. D. An amount that cannot be quantitatively stated since it depends on the nature of the item. . 51. Which of the following topics is not normally included in an engagement letter? A. The auditors' preliminary assessment of internal control. B. The auditors’ estimate of the fee for the engagement. Limitations on the scope of the engagement. D. A description of responsibility for the detection of fraud. 52. The first standard of field work recognizes that an early appointment of the external auditors has many advantages to the auditors and the client. Which of the following advantages is least likely to occur because of early appointment of the auditors? A. The auditors will be able to plan the audit work so that it may be done expeditiously. B. The auditors will be able to complete substantive procedures prior to year-end." * C.. The auditors will be able to better plan for the observation of the D. physical inventories. The auditors will be able to perform the examination .more efficiently and will be finished at an early date after the year-end. 116, Chapter 3: Pre- Engagement Procedares 53, Preliminary arrangements agreed to by the auditors and the client should be in writing by the auditors. The best place to set forth these arrangements is in: ‘A. A memorandum to be placed in the permanent section of the auditing working papers. B, An engagement letters. C. Aclient representation letter. D. A confirmation letter attached to the constructive services letter. 54, The auditors are planning an audit engagement for a new client in a business that is unfamiliar to the auditors. Which of the following would be a useful source of information for the auditors during the preliminary planning stage when they are trying to obtain an understanding of audit problems that might be encountered? “A. Client manuals of accounts and charts of accounts. B. PICPA Industry Audit Guides. CC. Prior-year working papers of the predecessor auditors. D._ Latest annual and interim financial statements issued by the client. ‘55. The auditors will not usually initiate discussion with the audit committee concerning the: . ‘A. Extent to which the work of internal auditors will influerice the scope of the examination. B> Extent to which change in the company’s organization will influence the scope of the examination. C. Details of potential problems which the auditors believe might cause a qualified opinion... D. Details of the procedures which the auditors intend to apply. 56. Which statement is correct relating to a successor auditor's responsibility for communicating with the predecessor auditors in connection with a prospective new audit client? A. The successor auditors have no responsibility to contact the predecessor auditors, B. The successor auditors should obtain permission from the’ prospective client to contact the predecessor auditors. C. The successor auditors should contact the predecessors regardless of whether the prospective client authorizes contact. D. The successor auditors need not contact the predecessors if the successors are aware°of all available relevant facts. Audit Documentation 57. Which of the following is required documentation in an audit? A. Awriten engagement letter formalizing the evel of services to be provided. B, A flowchart of the client's organization. C. Awritten audit program. D. Amemo setting forth the scope of the audit,Comprehensive Resiewer in Auditing and. Abscrance Principles 58, Which of the following is not a function of the audit working papers? A. Provide support for the auditors’ report. B, Provide support for the accounting records. C._ Aid partners in planning and conducting future audits. D. Document staff compliance with generally accepted auitng standards. . 59. The inspection of a vendor's invoice by the auditors is: ‘A. Direct evidence about occurrence of a transaction. B. Physical evidence about occurrence of a transaction. C. Documentary evidence about occurrence of a transaction. D. Part of the client's accounting system, 60. The date where no information should be deleted from audit documentation is the A. Client's year-end. B. Documentation completion date. C._ Last date of significant fieldwork. D. All the above are incorrect in that no, information may ever be deleted from audit documentation 61, The date of the management representation letter should coincide with the: A. Date of the auditor's report. B. Balance sheet date. C. Date of the latest subsequent event referred to in the notes to the financial statements. D. Date of the engagement agreement. 62. Which of the following expressions would not to be included in a clients management representation letter? A. No events have occurred after the balance sheet date that require adjustment to, or disclosure in, the financial statements. B. The company has complied with all aspects of contractial agreements that would have a material effect on the financial statements in the event of noncompliance. C. Management acknowledges responsibility for illegal actions committed by employees. Management has made available all financial statements, including notes. 63. Which of the following is not a primary purpose of audit working papers? To coordinate the examination. To assist in preparation of the audit report, To support the financial statements, To provide evidence of the audit work performed, poeE 118 q