Chapter 7 Engagement Planning and Management.docx

Chapter 7 Engagement Planning and Management.docx

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Chapter7EngagementPlanningandManagement

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UnitedStates\PwCMaterial\Montgomery'sAuditing,TwelfthEdition\Part2:

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7

EngagementPlanningandManagement

7.1ACCEPTINGORRETAININGTHECLIENT

7.2CLIENTSERVICEANDCOMMUNICATION 

（a）EstablishingEngagementTermsandGoals

（b）WorkingwithManagementandOtherPersonnel

（i）ChiefExecutiveOfficer

（ii）ChiefFinancialOfficer

（iii）HeadofInternalAudit

（iv）Staff

（c）WorkingwithAuditCommitteesandBoardsofDirectors

（i）AuditCommittees

（ii）BoardsofDirectors

（iii）StockholderMeetings

7.3USINGTHEWORKOFOTHERS

（a）InternalAuditors

（b）Specialists

（c）OtherAuditors

7.4MANAGINGTHEENGAGEMENT 

（a）EngagementControl

（b）StaffingtheEngagement

（c）SupervisionandReview

7.5WORKINGPAPERS 

（a）FormandContentofWorkingPapers

（b）WorkingPaperOrganization

（c）TypicalWorkingPapers

（i）GroupedAccountsSchedule

（ii）OtherSchedulesandAnalyses

（iii）DocumentationofSignificantIssues

（iv）PermanentWorkingPapers

（d）CommonWorkingPaperDeficiencies

Thefirststandardoffieldworkrequiresthattheauditbeadequatelyplanned.Goodmanagementpracticesrequirethatitbecontrolledtoensurethatitisperformedefficientlyandonatimelybasis,aswellasinaccordancewithprofessionalstandards-thatis,effectively.Engagementplanningandmanagementinvolvenumerousplanningdecisionsandongoingactivitiesforcontrollingallaspectsoftheperformanceoftheaudittoensurethatitiscarriedouteffectivelyandefficiently.

Fromthetimeanengagementisfirstconsidered-evenbeforeitisaccepted-untiltheresultsaresummarizedandevaluatedattheendoftheengagement,theauditormakesnumerousdecisions,whichcollectivelyconstitutetheplanfortheengagement.Planningtakesplacethroughouttheengagementandincludesvariousactivitiesnecessarytoensurethattheauditiscarriedouteffectivelyandefficiently.Intheearlystagesoftheengagement,planningentailsdeterminingwhethertoacceptorcontinuewiththeclientandestablishingengagementtermsandgoals.Understandingtheclient'sexpectationsandplanningtomeetorexceedthem,withinthecontextoftheauditor'sprofessionalresponsibilities,andcommunicatingwiththeclientregardingengagementarrangementsandissues,facilitatestheauditprocess.

Formulatingtheengagementplanalsoinvolvesdecidingsuchmattersaswhethertousetheworkoftheentity'sinternalauditors,whethertheassistanceofaspecialistisneeded,andwhethertousetheworkofotherauditorswhohaveauditedanyoftheentity'scomponents.Theactivitiesinvolvedinplanningtheauditandtheorderinwhichtheyaredonevarywiththeengagement;oftenthevariousactivitiesoverlap.

7.1ACCEPTINGORRETAININGTHECLIENT

Beforetheauditorcanbegintoplanthedetailsoftheengagement,heorshemustconsiderwhethertoacceptor,forarecurringengagement,retaintheclient.Decidingwhethertoacceptorcontinuewithaclientrequirestheexerciseofprofessionalskepticismandjudgmentaboutavarietyofrisksaffectingboththeentityandtheauditor.

Allentitiesfacebusinessrisk,thatis,theriskthattheywillnotbeprofitableorwillnotremainagoingconcern.Anentitywithincreasedbusinessriskmaybemorelikelytoengageinfraudulentfinancialreportingorbeinvolvedinunwarrantedlitigationthanonenotfacingsignificantrisks.Thosefactorsmayincreasetheauditor'sbusinessrisk-intheformoftheriskofpotentiallitigationcostsanddamagetohisorherreputation,andthreatstofeerealization-fromassociationwiththeentity.Indecidingwhethertobeassociatedwithaclient,theauditoralsoshouldconsiderfactorsthatmayincreaseauditrisk.Tomanagetherisksinherentinbecomingorremainingassociatedwithaclient,auditfirmsusuallyestablishprocedures,inadditiontothoserequiredbygenerallyacceptedauditingstandards,tobeperformedbeforeanewclientisacceptedorarecurringoneretained.Inthecourseofperformingthoseprocedures,muchinformationabouttheentityisgathered,whichformsthefoundationoftheauditor'sknowledgeabouttheentity'sbusiness.

Ininvestigatingaprospectiveclient,aprincipalconcernoftheauditoristheintegrityofmembersoftheentity'smanagement.Accordingly,auditorstypicallyconsiderthegeneralreputationofhighrankingemployees,suchasexecutivesandotherswithbroadfinancialandoperatinginfluence,andinfluentialdirectorsandshareholders,aswellastheentityitself.Thismayinvolvediscussionswithcommercialandinvestmentbankersandlawyers,andobtainingaDun&Bradstreetreport.Generally,auditorsalsoobtainandreadthemostrecentfinancialstatementsofaprospectiveclientandcommunicatewiththepredecessorauditor,withemphasisonquestionsofmanagement'sintegrityandthereasonforthechangeinauditor.Otherconsiderationsinconnectionwithinvestigatingaprospectiveclientincludemanagement'sresponsetosuggestionsforimprovinginternalcontrolmadebythepredecessorauditorortheinternalauditors,whetherthereareanyindependenceissues,whethertheauditorhaspersonnelwiththeindustryandotherexpertisetoprovidethedesiredservice,andwhethertheentity'smanagementisableandwillingtopayanacceptablefee.

Today'srapidlychangingbusinessenvironmentmakesitnecessarytoreevaluateperiodically,perhapsasoftenasannually,whethertocontinuetobeassociatedwithaclient.Theevaluationcanpointtorisksstemmingfromchangesaffectingmanagement'sintegrity,managementpractices,theentity'sfinancialcondition,oroperationalmatters.

TheDetectionandPreventionofFraudTaskForceoftheSECPracticeSectionoftheAICPADivisionforCPAFirmshasidentifiedanumberoffactorsthatmayindicateincreasedriskassociatedwithanengagementandthatauditorsmaywanttoconsiderintheirdecisionsaboutclientacceptanceorcontinuance.Therisksarecategorizedaseitherbusinessrisksoftheentity,businessrisksoftheauditor,orauditrisks,andareshowninFigure7.1.

Figure7.1RiskFactorsAssociatedwithanEngagement

1.Entity'sBusinessRisk

∙Management:

-Engagesinactivitiesindicativeofalackofintegrity.

-Ispronetoengageinspeculativeventuresoracceptunusuallyhighbusinessrisks.

-Displaysapoorattitudetowardcompliancewithoutsideregulatoryorlegislativeobligations.

-Engagesincomplextransactionsorinnovativedealsthatmakethedeterminationoftheeffectsonthefinancialstatementsdifficulttoassessorhighlysubjective.

-Lacksaproventrackrecord.

-Isevasive,uncooperativeorabusivetotheauditteam.

∙TheEntity:

-Hasproductsthatarenewandunproven.

-Dependsonalimitednumberofcustomersorsuppliers.

-Isexperiencingadeterioratingfinancialconditionorliquiditycrisis.

-Issubjecttouncertaintiesthatraisesubstantialdoubtaboutitsabilitytocontinueasagoingconcern.

-Operatesincountrieswherebusinesspracticesarequestionable.

-Hasaninadequatecapitalbaseorishighlyleveraged.

-Isexperiencingdifficultyinmeetingrestrictivedebtcovenants.

-Generatesnegativecashflowsfromoperationsbutreportsoperatingprofits.

-Haspubliclytradeddebtoutstandingthatisbelowinvestmentgrade.

-Isalowtierfirminanemergingormaturingindustrywhereweakcompetitorsareexitingthemarket.

-Issubjecttounpredictablechangesinpriceandavailabilityofproductinputsthatcausesignificantvarianceinprofitability.

-Isvulnerabletorapidlychangingtechnology.

-Isinvestingcashfromshort-termborrowingsinlong-termassets.

∙TheIndustry:

-Isundergoingrapidchange.

-Issubjecttohighcompetition,marketsaturation,productobsolescence,ordecliningdemand.

-Hashighoperatingleveragedemonstratedbyhighfixedcostsandlowvariablecosts.

-Ishighlycyclicalorcountercyclical.

-Hasalowentrybarrier.

-Isfacingregulationsthatwilladverselyimpactprofitabilitythroughouttheindustry.

2.Auditor'sBusinessRisk

-Theentityispronetoahighnumberoflawsuitsorcontroversies.

-Therearefrequentchangesintheentity'sauditors.

-Theentityplanstoengageinaninitialpublicofferingorusethefinancialstatementstoengageinadebtorequityoffering.

-Thefinancialstatementswillbeusedinconnectionwithanacquisitionordisposalofabusinessorsegment.

3.Auditor'sAuditRisk

TheauditorshouldfollowSASNo.47,AuditRiskandMaterialityinConductinganAudit,whichprovidesguidanceontheauditor'sconsiderationofauditriskwhenplanningandperforminganauditoffinancialstatements.Examplesoffactorsthatmayincreaseauditriskinclude:

-Operationsthataredominatedbyasingleindividual.

-Undueemphasisonachievingearningspershare;maintainingthemarketpriceofthecompany'sstock;ormeetingearningsprojections.

-Unreliableprocessesformakingaccountingestimatesorquestionableestimatesbyexecutives.

-Unrealisticbudgetlevelsthatencourageunrealisticobjectives.

-Ahighvolumeofsignificantyear-endtransactions.

-Compensationbasedtoasignificantdegreeonreportedearnings.

-Anunnecessarilycomplexcorporatestructure.

-Prior-yearfinancialstatementsthatwererestatedforcorrectionofanerrororirregularity.

-Attemptsbymanagementtoreducethescopeoftheaudit.

-Substantiallitigationinvolvingtheentity'sbusinesspractices.

-Materialweaknessesorotherreportableconditionsintheinternalcontrolstructure.

-Significantandunusuallycomplexrelatedpartytransactions.

-Affiliatesthatareunauditedorauditedbyothers.

-Managementespousesaggressiveaccountingprinc