Johnstone 9e Auditing

AUDITING
A RISK-BASED APPROACH TO
CONDUCTING A QUALITY AUDIT
9th Edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 5
PROFESSIONAL AUDITING STANDARDS AND THE
AUDIT OPINION FORMULATION PROCESS
Copyright 2014 South-Western/Cengage Learning
LEARNING OBJECTIVES
1.
2.
3.
4.
Identify and compare the various 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
5-2
LEARNING OBJECTIVES
5.
6.
7.
8.
Describe the assertions that are inherent to

financial statements and explain their importance
to the audit opinion formulation process
Define audit evidence and describe the purpose
and types 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
5-3
LEARNING OBJECTIVES
9.
10.
11.
12.
Discuss audit activities in Phase II of the audit

Discuss audit activities in Phase III of the audit
Discuss audit activities in Phase IV of the audit
Discuss audit activities in Phase V of the audit
5-4
LEARNING OBJECTIVES
13.
14.
Apply the concepts related to the auditors

assessment of internal control design effectiveness,
implementation, and operating effectiveness
Apply the frameworks for professional decision
making and ethical decision making to issues
involving conducting an audit
5-5
THE AUDIT OPINION FORMULATION

PROCESS
5-6
PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE

OF ADHERING TO PROFESSIONAL AUDITING STANDARDS
Adhering to the professional auditing standards is

viewed as conducting a quality audit
Lack of adherence heightens the risk of issuing an
unqualified audit opinion on financial statements
that are materially misstated
Highlighted in the 2004-2006 audits of Thornton
Precision Components, Limited (TPC) performed by
Ernst & Young, LLP UK (E&Y UK)
5-7

What is the role of auditing standards and their

underlying principles in promoting a quality audit?
(LO 1, 2)
How does the fundamental concept of professional
skepticism relate to audit quality? (LO 2)
What audit evidence is necessary for opining on a
clients financial statements? (LO 6)
How does audit documentation provide evidence
related to audit quality? (LO 7)
5-8

What audit activities are conducted during the audit

opinion formulation process to provide reasonable
assurance about a clients financial statements? (LO
8, 9, 10, 11, 12)
How does professional judgment and ethical decision
making contribute to audit quality? (LO 14)
5-9
LEARNING OBJECTIVE 1
IDENTIFY AND COMPARE THE VARIOUS

AUDITING STANDARDS THAT PROVIDE
GUIDANCE ON THE AUDIT OPINION
FORMULATION PROCESS
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
5-11
PROFESSIONAL AUDITING STANDARDS

Require auditors to develop and communicate:
Opinion on financial statements
Clients internal control over financial reporting
Vary according to the nature of organization audited

Audit compliance depends on:
Domicile of the organization
Where its stock is publicly traded
5-12
AICPAS AUDITING STANDARDS BOARD

- CLARITY PROJECT
Made standards easier to read, understand, and
apply
Converged its standards with the International
Standards on Auditing (ISAs), issued by the IAASB
Standards were written using drafting convention
called the clarity format
Issued the clarified standards in a single Statement
on Auditing Standard (SAS No. 122) in 2012
5-13
EACH STANDARD OF CLARITY FORMAT

PRESENTED IN FOLLOWING SECTIONS
Introduction
Purpose and scope of the standard
Objective
Context in which the requirements are set
Definitions
Relevant meanings of terms in standards
Requirements
Actions required to achieve objective of the standard
Application and other explanatory material

Cross-references to the requirements
Guidance for applying requirements of standard
5-14
AUDITING STANDARDS ISSUED BY THE

IAASB
Objectives
Set auditing, assurance, and other related standards
Facilitate convergence of international and national
auditing and assurance standards
Enhance quality and consistency of practice throughout
the world
Strengthen public confidence in the global auditing and
assurance profession
5-15

IAASB
Standards should to be understandable, clear, and
consistent
Launched a program in 2004 to enhance clarity of its
ISAs
Clarity Project was completed in 2009
As of 2013, a set of its clarified standards comprises
of:
36 ISAs
1 International Standard on Quality Control (ISQC)
5-16
EACH STANDARD OF CLARITY FORMAT

PRESENTED IN FOLLOWING SECTIONS
Introduction
Purpose and scope of subject matter of ISA
Objective
Clear statement of the objective of the auditor
Definitions
For applicable terms included
Requirements
For each objective are provided
Application and other explanatory material

Explains what a requirement means or intends to cover
5-17

PCAOB
Apply to auditors of U.S. public companies
Issued sixteen Auditing Standards (ASs) as of 2013
PCAOB interim standards - Standards adopted from
AICPA
Requirement for public company auditors, unless
superseded by a PCAOB standard
Standards issued by AICPA after April 16, 2003, not
included
5-18
EXHIBIT 5.1 - COMPARISON OF U.S. AND

INTERNATIONAL AUDITING STANDARDS
5-19
LIST AND DISCUSS THE FOUNDATIONAL

PRINCIPLES UNDERLYING THE AUDITING
STANDARDS
PCAOB GUIDANCE - GENERAL

STANDARDS
Require
Audit to be performed by individuals having adequate
technical training and proficiency as an auditor
Auditors to be independent:
In fact, i.e., in reality in terms of mental attitude and
In appearance, i.e., in how the auditor is perceived by
users
Audit to be conducted with professional care expected

of a prudent auditor
5-21
PCAOB GUIDANCE - FIELDWORK

STANDARDS
Applicable to conduct of the audit
Require auditors to:
Properly plan and supervise the audit
Develop an understanding of clients controls
Prerequisite for developing audit tests
Obtain audit evidence by performing audit procedures
5-22
PCAOB GUIDANCE - REPORTING

STANDARDS
Applicable to communicating auditors opinion
Require auditors to:
State whether financial statements are presented in
accordance with the applicable financial reporting
framework (i.e., GAAP or IFRS)
Identify conditions where accounting principles are not
consistently observed
Review disclosures for adequacy and state in the report if
disclosures are not reasonably adequate
Express an opinion on financial statements as a whole or
state that an opinion cannot be expressed
5-23
AICPA GUIDANCE - PURPOSE AND

PREMISE OF AUDIT
Purpose - Enhance degree of confidence that users
can place in financial statement
Premise - Management has responsibility to:
Prepare financial statements
Maintain internal control over financial reporting
Provide auditor with relevant information and access
to personnel
5-24
AICPA GUIDANCE - RESPONSIBILITIES

The auditors responsibilities include
Having appropriate competence and capabilities to
perform audit
Complying with ethical requirements
Maintaining professional skepticism throughout the
audit
5-25
AICPA GUIDANCE - PERFORMANCE

Obtain assurance that financial statements are free
from material misstatement
Limitations - Lack of absolute assurance about financial
statements being free from misstatement
Requires an auditor to:
Plan and supervise work

Determine materiality levels
Identify risks of material misstatement
Design and implement audit responses to assessed risks
5-26
AICPA GUIDANCE - REPORTING

Expressing either of the following
Financial statements are free of material misstatement
Stating that an opinion cannot be expressed
5-27
INTEGRATED AUDIT
Combines audits of an organizations financial
statements and its internal control over financial
reporting
In this audit:
Opinion provided on effectiveness of internal control
over financial reporting
Additional audit work done to be able to issue that
opinion
5-28
AUDITING IN PRACTICE - BENEFITS OF

INTEGRATING THE AUDITS
Integrating audits of internal controls and of financial
statements makes sense
Both the tests of controls and direct tests of account
balances provide evidence related to each other
Example:
Tests of controls provide indirect evidence that financial
statements are free from misstatement
Further, if material misstatements found in account
balances or disclosures, it implies that there were
material weaknesses in internal controls
5-29
LIST THE PHASES AND RELATED ACTIVITIES IN

THE AUDIT OPINION FORMULATION PROCESS
EXHIBIT 5.2 - OVERVIEW OF CLIENTS PREPARATION OF

FINANCIAL STATEMENTS AND MANAGEMENT REPORT ON
INTERNAL CONTROL
5-31
EXHIBIT 5.3 - ACTIVITIES OF EACH PHASE OF THE

5-32
IMPORTANT CONCEPTS AFFECTING AUDIT

OPINION FORMULATION PROCESS
Accounting cycles
Management assertions
Audit evidence and audit procedures
Documentation
5-33
EXPLAIN THE CONCEPT OF ACCOUNTING

CYCLES AND DISCUSS THEIR IMPORTANCE TO
THE AUDIT OPINION FORMULATION PROCESS
ACCOUNTING CYCLES
Recording and processing transactions that affect a
group of related accounts
Begin when a transaction occurs and ends when it is
recorded in financial statements
Break the audit into manageable sections of related
accounts
5-35
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
5-36
EXHIBIT 5.4 - ILLUSTRATIONS OF CYCLES

AND RELATED ACCOUNTS
5-37
DESCRIBE THE ASSERTIONS THAT ARE INHERENT TO

FINANCIAL STATEMENTS AND EXPLAIN THEIR
IMPORTANCE TO THE AUDIT OPINION
FORMULATION PROCESS
FINANCIAL STATEMENT ASSERTIONS

Assertions made by management
Existence
Completeness
Rights and obligations
Valuation
Presentation and disclosure
Related evidence is obtained for accounts and

disclosure in financial statements
5-39
MANAGEMENTS 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
5-40
DEFINE AUDIT EVIDENCE AND DESCRIBE THE

PURPOSE AND TYPES OF AUDIT PROCEDURES
USED TO OBTAIN AUDIT EVIDENCE
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)
Risk assessment procedures
Provide information for assessing the risks of material
misstatement in the financial statements
Do not provide sufficient evidence upon which to base an
audit opinion
Used for purposes of planning the audit
5-42
AUDIT EVIDENCE AND PROCEDURES

Tests of controls: Designed for evaluating operating
effectiveness of controls in preventing, or detecting
and correcting, material misstatements, typically at
assertion level
Substantive procedures
Designed for detecting material misstatements at
assertion level
Comprising of tests of details and substantive
analytical procedures
5-43
AUDIT PROCEDURES
Sufficient appropriate audit evidence: Measure of the
quantity of audit evidence about following factors of
audit procedures
Nature
Timing
Extent
Audit program
Lists audit procedures to be followed in gathering
evidence
Helps monitor progress and supervising work
5-44
EXHIBIT 5.6 - TYPES OF AUDIT

PROCEDURES
5-45
DISCUSS THE IMPORTANCE OF AUDIT

DOCUMENTATION AND PROVIDE EXAMPLES
AUDIT DOCUMENTATION
Record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor
reached
Known as working papers or workpapers
5-47
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
5-48
EXAMPLES OF AUDIT
DOCUMENTATION
Audit programs
Analyses prepared by client or auditor
Memorandums
Summaries of significant findings or issues
Letters of confirmation and representation
Checklists
Correspondence concerning significant findings or
issues
5-49
DISCUSS AUDIT ACTIVITIES IN PHASE I OF THE

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
5-51
AUDITING IN PRACTICE - ACCEPTING A

NEW AUDIT ENGAGEMENT
Communicate with predecessor auditor
Following issues should be addressed
Information regarding integrity of management
Disagreements with management about accounting
policies, auditing procedures
Communications to management and those in charge
with governance regarding:
Fraud and noncompliance with laws
Deficiencies and material weaknesses in internal control
5-52
AUDIT ENGAGEMENT LETTER

Document specifying responsibilities of client and
auditor that includes the following:
Objective and scope of audit of financial statements
Responsibilities of auditor and management
Statement that some material misstatements may not be
detected due to inherent limitations of audit and internal
control
Identification of applicable financial reporting framework
for preparation of financial statements
Reference to expected form and content of any reports to
be issued
5-53
DISCUSS AUDIT ACTIVITIES IN PHASE II OF THE

PHASE II - PERFORMING RISK

ASSESSMENT
Identifying relevant risks and determining audit
procedures required to address them
Continuing clients - Update information from
previous years audit
New clients - the risk assessment process is more
time consuming
5-55
IDENTIFYING AND ASSESSING RISKS OF

MATERIAL MISSTATEMENT
Essential to audit planning
Requires identification of significant:
Accounts
Disclosures
Relevant assertions
Auditor establishes a materiality level overall and for

specific accounts and disclosures
5-56
EXHIBIT 5.7 - EXAMPLES OF SOURCES

OF RISK OF MATERIAL MISSTATEMENT
5-57
RISKS AT ASSERTION LEVEL

Inherent risk
The susceptibility of an assertion to a misstatement, due to
error or fraud, that could be material, individually or in
combination with other misstatements, before
consideration of any related controls
Control risk
The risk that a misstatement due to error or fraud that
could occur in an assertion and that could be material,
individually or in combination with other misstatements,
will not be prevented or detected on a timely basis by the
organization's internal control
5-58
RISK ASSESSMENT PROCEDURES

Inquiries for information to assist in identifying risks
of material misstatement due to fraud or error
Preliminary analytical procedures
Observation and inspection of documentation
5-59
TYPES OF CONTROLS
Entity-wide controls
Transaction controls
Fraud-related controls
5-60
AUDITING IN PRACTICE - CONTROLS TO

ADDRESS FRAUD RISK
PCAOB has identified the following
Controls over significant, unusual transactions, particularly
those resulting in unusual journal entries
Controls over journal entries and adjustments made in the
period-end financial reporting process
Controls over related-party transactions
Controls related to significant management estimates
Controls mitigating incentives for, and pressures on,
management to falsify financial results
5-61
TYPES OF PROCEDURES TO
ASSESS DESIGN EFFECTIVENESS
Inquiry of appropriate personnel
Observation of the organizations operations
Inspection of relevant documentation
Performance of walkthroughs
Documentation of preliminary assessment of control
design and basis for that assessment
Understand the approach used by management for
conclusions on effectiveness of internal control
5-62
AUDITING IN PRACTICE - DOCUMENTING AUDITORS

UNDERSTANDING OF AN ORGANIZATIONS INTERNAL
CONTROLS
Process of documentation uses:

Narratives
Flowcharts
Questionnaires
Once documented, in subsequent years audit firms

focus on:
Changes in the system
Effectiveness of monitoring controls
5-63
ASSESSING RANGE OF CONTROL RISK

High control risk
Weak internal controls
Auditor cannot rely on controls to reduce substantive
procedures for account balances
Assessing control risk as low

Strong internal controls
Auditor will test operating effectiveness of controls to
reduce substantive procedures for account balances
5-64
AUDITING IN PRACTICE EXAMPLE FOR WEAK INTERNAL

CONTROL DESIGN AND LINKS TO SUBSTANTIVE AUDIT
PROCEDURES
Scenario - Clients internal control design assessed

as ineffective that makes a preliminary assessment of
control risk as high
Requires expanding substantive tests for sales
returns by:
Arranging to be on hand at year end to observe the
taking of physical inventory
Determining if receipts for items returned by
customers are issued in the correct time period
5-65
AUDITING IN PRACTICE EXAMPLE FOR WEAK INTERNAL

CONTROL DESIGN AND LINKS TO SUBSTANTIVE AUDIT
PROCEDURES
Reviewing credit memos issued shortly after year end

Increasing number of accounts receivable
confirmations sent to the clients customers
5-66
ADDITIONAL CONSIDERATIONS FOR AN

INTEGRATED AUDIT
Risk assessment procedures apply to:
Audit of internal control over financial reporting
Audit of financial statements
Top-down approach - Used for audit of internal control

over financial reporting to select controls to test
Begins at financial statement level
Focuses on entity-wide controls
Works down to significant accounts and disclosures and
their relevant assertions
5-67
RESPONDING TO IDENTIFIED RISKS OF

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
5-68
RESPONDING TO IDENTIFIED RISKS OF

Selecting specific audit procedures to respond to
identified risks
Assembling an audit team having knowledge, skill,
and ability needed to address assessed risks
Emphasizing the need for professional skepticism
Providing an appropriate level of supervision for
assessed risks
Incorporating elements of unpredictability in
selection of audit procedures
5-69
EXHIBIT 5.8 - RESPONDING TO IDENTIFIED RISKS

THROUGH EVIDENCE DECISIONS
5-70
ADDITIONAL CONSIDERATIONS FOR AN

INTEGRATED AUDIT
Audit strategy that includes tests of controls to
accomplish objectives of both audits
Sufficient evidence related to operating effectiveness
of controls to support auditors:
Control risk assessments for purposes of the audit of
financial statements
Opinion on internal control over financial reporting as
of year-end
5-71
FRAUD CONSIDERATIONS
Performing tests of controls and substantive
procedures susceptible to fraud risks
Performing procedures related to risk of
management override of controls
Examining journal entries
Reviewing accounting estimates for biases
Evaluating business rationale for significant unusual
transactions
5-72
DISCUSS AUDIT ACTIVITIES IN PHASE III OF THE

PHASE III - OBTAINING EVIDENCE ABOUT

INTERNAL CONTROL OPERATING EFFECTIVENESS
Auditor tests controls
Determine whether controls are operating effectively
at year-end or throughout the year
Auditor obtains more persuasive audit evidence

As the reliance auditor places on effectiveness of a
control increases
5-74
AUDITING IN PRACTICE - RISK ASSESSMENT PROCEDURES

AND TESTS OF OPERATING EFFECTIVENESS OF CONTROLS
Auditors risk assessment procedures include

Inquiring about managements use of budgets
Inspecting documentation of managements
comparison of monthly budgeted and actual expenses
Inspecting reports pertaining to the investigation of
variances between budgeted and actual amounts
5-75
SELECTING CONTROLS TO TEST

Involves choosing controls that effectively indicate
capability to address the assessed risk of material
misstatement for relevant assertions
Auditor selects:
Entity-wide controls
Reduce number of control activities selected for testing
Transaction controls
5-76
EXHIBIT 5.9 - LINKING FINANCIAL STATEMENT

ASSERTIONS AND SELECTING CONTROLS TO TEST
5-77
TYPES OF CONTROLS AND EXAMPLES OF

CONCEPTS AFFECTING CONTROL TESTING
Computerized Controls
Determining changes to important

computer applications during the
year
If there are changes,

testing integrity of
controls after
changes
Considering
submitting test
transactions through
the system to
determine its
performance
Taking a random
sample of
transactions for
determining:
a) Operations of key
controls
b) Completion of
process
Reviewing
exception reports
and determining:
a) Proper exceptions
being noted
b) Exceptions go to
authorized
personnel with
adequate follow-up
5-78

Manual Controls
Documented evidence for control
to be working; taking sample of
transactions to determine control
operation evidence
Taking a sample of
transactions and
examining
evidence
supporting that the
controls are
working
Authorizations
Taking a sample of
reconciliations to
determine that:
a) They were
performed by an
authorized person
b) They were
performed properly
Reconciliations
Reviewing
documentation of
selected
transactions to
determine:
a) Proper
authorization
b) Recorded in
correct time period
Taking a sample of
reports used to
identify unusual
transactions and
review them to
determine:
a) Regular usage
b) Identification of
unusual items
Reviews for unusual transactions
5-79

Controls over Adjusting
Entries
Documented evidence for
controls over normal journal
entries and their regular
application
Taking a sample of adjusting entries and
reviewing to determine:
a) Supporting documentation
b) Appropriate entry
c) Entry made in correct accounts
Giving special attention to significant entries

made near year end
d) Proper authorization of entry
5-80

Controls over Accounting
Estimates
Documented evidence for

controls over estimates ensuring
accuracy of data, consistency in
performance, regularly updating
the model
All entries being properly

authorized
Ensuring estimates are

updated for current
economic conditions
Finding evidence that data

used for estimation come
from reliable sources
5-81
FIRST APPROACH TO TESTING

CONTROLS
Take sample of customer orders and trace it through
the system to determine whether:
There was proper review of credit and
Credit authorization or denial was proper
Advantage - Most effective because it helps in

determining that the control worked effectively
Requires documentation of all credit applications and
purchase orders required
Based on audit sampling
5-82
SECOND APPROACH TO TESTING

CONTROLS
Taking a sample of recorded items and tracing back
to credit approval process
Provides evidence on proper credit approval for all
items presently recorded
Does not provide evidence as to whether other items
should have been approved for credit, but had not
been approved
5-83
THIRD APPROACH TO TESTING

CONTROLS
Uses a computer audit program and develops a printout of account balances exceeding their credit
authorization
Cost-effective
Requires an inference about the control
Covers only the operation of the controls related to
the current account balances
100% evaluation of each item currently recorded
5-84
TESTING THE OPERATING

EFFECTIVENESS
Auditor tests relevant principles of components of:
Control environment
Risk assessment
Information and communication
Monitoring
5-85
RESULTS 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
5-86
RESULTS 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
5-87
DISCUSS AUDIT ACTIVITIES IN PHASE IV OF THE

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
5-89
EXHIBIT 5.12 - FACTORS AFFECTING

SUBSTANTIVE PROCEDURES TO BE PERFORMED
5-90
DISCUSS AUDIT ACTIVITIES IN PHASE V OF THE

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
5-92
APPLY THE CONCEPTS RELATED TO THE AUDITORS
ASSESSMENT OF INTERNAL CONTROL DESIGN
EFFECTIVENESS, IMPLEMENTATION, AND OPERATING
EFFECTIVENESS
MANAGEMENT ASSESSMENT OF
CONTROLS
Factors considered in deciding whether to categorize
a deficiency as significant or not
Risk that is being mitigated and whether other controls
operate effectively
Materiality of related account balances
Nature of deficiency
Volume of transactions affected
Subjectivity of account balance that is subject to
control
Rate at which control fails to operate
5-94
CONTROLS
Deficiency of segregation of duties
Did not rise to a significant deficiency or a material
weakness
Management decides to use this deficiency as a
motivation to centralize purchases
5-95
CONTROLS
Deficiency of lack of approval considered as a
significant deficiency based on the following
rationale:
Major departure from an approved process
Could lead to purchase of unauthorized goods
Could be shipped elsewhere and lead to material
misstatement in financial statements
5-96
AUDITOR ASSESSMENT OF CONTROLS

Auditor reviews:
Managements documentation of its internal control
Managements evaluation and findings related to
internal control effectiveness
Auditor then gathers evidence on operating

effectiveness of these controls
By taking a random sample auditor needs to
independently determine that the controls are working
or not
5-97
AUDITOR ASSESSMENT OF CONTROLS

Implications for substantive procedures in financial
statement audit:
Auditor will do limited testing of inventory quantities
at year end
Auditor will assess year-end inventory for potential
obsolescence
Auditor will continue to examine all adjusting entries at
the end of the year
5-98

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AUDITING

Copyright 2014 South-Western/Cengage Learning

Identify and compare the various auditing standards

Describe the assertions that are inherent to

Discuss audit activities in Phase II of the audit

Copyright 2014 South-Western/Cengage Learning

Apply the concepts related to the auditors

Copyright 2014 South-Western/Cengage Learning

THE AUDIT OPINION FORMULATION

Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE

Adhering to the professional auditing standards is

Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE

What is the role of auditing standards and their

PROFESSIONAL JUDGMENT IN CONTEXT - IMPORTANCE

What audit activities are conducted during the audit

Copyright 2014 South-Western/Cengage Learning

IDENTIFY AND COMPARE THE VARIOUS

Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL AUDITING STANDARDS

Common objective - Provide assurance to public that

PROFESSIONAL AUDITING STANDARDS

Vary according to the nature of organization audited

Copyright 2014 South-Western/Cengage Learning

AICPAS AUDITING STANDARDS BOARD

Copyright 2014 South-Western/Cengage Learning

EACH STANDARD OF CLARITY FORMAT

Application and other explanatory material

AUDITING STANDARDS ISSUED BY THE

Copyright 2014 South-Western/Cengage Learning

AUDITING STANDARDS ISSUED BY THE

EACH STANDARD OF CLARITY FORMAT

Application and other explanatory material

AUDITING STANDARDS ISSUED BY THE

Copyright 2014 South-Western/Cengage Learning

EXHIBIT 5.1 - COMPARISON OF U.S. AND

Copyright 2014 South-Western/Cengage Learning

LIST AND DISCUSS THE FOUNDATIONAL

Copyright 2014 South-Western/Cengage Learning

PCAOB GUIDANCE - GENERAL

Audit to be conducted with professional care expected

Copyright 2014 South-Western/Cengage Learning

PCAOB GUIDANCE - FIELDWORK

Obtain audit evidence by performing audit procedures

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PCAOB GUIDANCE - REPORTING

AICPA GUIDANCE - PURPOSE AND

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AICPA GUIDANCE - RESPONSIBILITIES

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AICPA GUIDANCE - PERFORMANCE

Requires an auditor to:

Plan and supervise work

AICPA GUIDANCE - REPORTING

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AUDITING IN PRACTICE - BENEFITS OF

LIST THE PHASES AND RELATED ACTIVITIES IN

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EXHIBIT 5.2 - OVERVIEW OF CLIENTS PREPARATION OF

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EXHIBIT 5.3 - ACTIVITIES OF EACH PHASE OF THE