Miles CPA Review AUD-Intro

AUD Intro
Generally Accepted Auditing
Standards (GAAS)

0.1) Introduction to F/S Auditing

0.2) GAAS - Traditional Framework

I) General Standards
II) Fieldwork Standards
III) Reporting Standards

0.3) GAAS - As Codified in AU-C Sections of Statements of Auditing

Standards (SAS) [AU-C 200: Overall Objectives of Auditor &
Conduct of an Audit in accordance with GAAS]
I) Purpose & Premise of an Audit
II) Overall Objectives of the Independent Auditor
III) Conduct of an Audit in accordance with GAAS
IV) Inherent Limitations of an Audit

Appendix: AU-C (Research)

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0.1) Introduction to F/S Auditing

What? Examination of F/S

Why? To give objective opinion as to fairness of F/S in conformity with US GAAP

When? After the management prepares the F/S (Management = Prepare F/S)

Who? Independent & expert external auditor (Auditor = Express Opinion on F/S)

Where? Report audit findings in Audit Report

How? By performing audit as per GAAS (non-issuers) and/or PCAOB AS (issuers)

Audited F/S
(Ma age e t’s
Responsibility)

Ma age e t’s F/S CPA Auditor’s audit

per GAAP per GAAS

Audit Report with

Opinion on F/S
(Auditor’s
Responsibility)

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0.2) GAAS - Traditional Framework

 10 Generally Accepted Auditing Standards (GAAS) - Traditional Framework

{General TIP to take a Field PIC and Report All Clean & Dirty Elements}

Note:
- Traditionally, auditors have classified the GAAS into the 10 basic standards as above with 3 groups -
general, fieldwork and reporting. Until December 15, 2012, these were authoritative standards and
were directly reflected in the Statements of Auditing (SAS) issued by the Auditing Standards Board
(ASB) of the AICPA
- However, effective December 15, 2012, the ASB issued larified SAS for larity a d for o erge e
with ISA (International Standards of Auditing). Though the above classification of GAAS has now been
incorporated into various clarified SAS and are still broadly applicable, the above classification is no
longer authoritative
- In short, the standards have remained the same but the classification has been modified.
Nevertheless, throughout the course, e ill o ti ue to use the GAAS framework as it is very
effective in understanding and recapitulating the audit process
- Refer to Topic 0.3 for further information on clarified SAS

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I) General Standards
 3 General Standards {General TIP} - Auditor qualification and quality of work

1) Training & Proficiency - Auditor must have adequate technical training and proficiency to
perform the audit. Attained by:
 Accounting education
 Auditing experience
 Industry knowledge

2) Independence - Auditor must maintain independence in mental attitude in all matters relating
to the audit
 In an audit engagement, requirement for independence is in the public interest
 Auditor’s independence from the entity safeguards the auditor’s ability to form an audit
opinion without being affected by influences that might compromise that opinion
 Independence enhances the auditor’s ability to act with integrity, to be objective, and to
maintain an attitude of professional skepticism
 Independence implies an impartiality that recognizes an obligation to be fair not only to
management and those charged with governance of an entity but also users of F/S who
may rely upon the independent auditor’s report
 Concept of independence refers to independence both in fact and appearance
 Fact is the real state of mind (e.g., material direct interest in client)
 Appearance is how it appears to outsiders (e.g., immaterial direct interest in client)

3) Professional care - Auditor must exercise due professional care in the performance of the audit
and the preparation of the report
 Maintain an attitude of professional skepticism throughout the audit
 Questioning mind - alert to conditions that may indicate possible misstatement due to
fraud/error (e.g., contradictory evidence, info that questions reliability of documents/
responses, conditions that may indicate fraud, need for additional audit procedures)
 Critical assessment of audit evidence if sufficient & appropriate (e.g., questioning
contradictory audit evidence and reliability of documents/responses)
 Neither assume management is dishonest nor assume unquestioned honesty
 Note: Auditor may accept records & documents as genuine unless the auditor has
reason to believe the contrary
 Exercise professional judgment in planning & performing the audit - Make informed
decisions about courses of action appropriate in the circumstances
 E.g., Decisions relating to audit risk, materiality, audit procedures, audit evidence
(sufficient & appropriate?), evaluating management judgments, audit opinion
 Needs to be exercised throughout the audit; also needs to be appropriately documented
 Professional judgment can be evaluated based on whether the judgment reached
reflects a competent application of auditing standards and accounting principles and is
appropriate given the facts & circumstances that were known to the auditor
 Provide reasonable assurance (though not absolute assurance) that F/S are free of material
misstatement (whether caused by error or fraud)

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II) Fieldwork Standards

 3 Fieldwork Standards {Field PIC} - Planning audit and accumulating/evaluating evidence

1) Planning & Supervision

 Auditor must adequately plan the work
 Auditor should establish an overall audit strategy that sets the scope, timing, and
direction of the audit and that guides the development of the audit plan
 Auditor should take responsibility for the direction, supervision, and performance of the
audit engagement

2) Internal Controls -
 Auditor must obtain a sufficient understanding of the entity and the environment, including
its I/C, to
 Assess risk of material misstatement (RMM) of F/S whether due to error or fraud
 Determine the nature, extent and timing (NET) of audit procedures
 Appropriate I/C provide confidence to the auditor that material misstatements will be
prevented, or detected and corrected, on a timely basis
 Strong I/C = Substantive testing = Evidence 
 Weak I/C = Substantive testing = Evidence 

3) Corroborative audit evidence

 Auditor must obtain sufficient & appropriate (corroborative) audit evidence by performing
audit procedures to afford a reasonable basis for an opinion regarding the F/S under audit
 Auditor needs to:
 Determine overall responses to address RMM at the F/S level
 Design and perform further audit procedures to respond to the assessed RMM at F/S
and relevant assertion levels
 Evaluate the sufficiency and appropriateness of the audit evidence obtained
 Note: Sufficiency & appropriateness of audit evidence is based on the auditor’s judgment

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III) Reporting Standards

 4 Reporting Standards {Report All Clean & Dirty Elements} - GAAS audit to check for GAAP
1) Accounting Principles = US GAAP
 Auditor must state in auditor’s report whether F/S are presented in compliance with an
applicable financial reporting framework (e.g., US GAAP)
 Explicit statement in audit report

2) Consistency
 Auditor must identify in the auditor’s report those circumstances in which accounting
principles have not been consistently observed in the current period in relation to the
preceding period
 Implicit in audit report (i.e., implied that GAAP is applied consistently unless otherwise
stated by the auditor in the auditor’s report)

3) Disclosures
 When the auditor determines that informative disclosures are not reasonably adequate, the
auditor must so state in the auditor’s report
 Implicit in audit report (i.e., implied that disclosures are reasonably adequate unless
otherwise stated by the auditor in the auditor’s report)

4) Expression of an Opinion
 The auditor must either express an opinion regarding the F/S, taken as a whole, or state
that an opinion cannot be expressed, in the auditor’s report
 2 choices
 Express an opinion on F/S taken as a whole (complete F/S including footnotes)
- Different opinions are ok (e.g., unqualified opinion on one of the F/S while having a
qualified opinion on another)
- One statement opinions are ok in limited reporting engagements
 Disclaim an opinion stating reasons for the same (e.g., auditor was not independent,
audit work was inadequate)
 In all cases where an auditor’s name is associated with F/S, the auditor should clearly
indicate the scope of audit in the audit report
 Character of the auditor’s work
 Degree of responsibility the auditor is taking
 Explicit statement in audit report

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0.3) GAAS - As Codified in AU-C Sections of

Statements of Auditing Standards (SAS)
 In the US, AICPA’s ASB (Auditing Standards Board) develops and issues GAAS in the form of SAS
(Statements on Auditing Standards) which are codified as AU-C sections
 Internationally, ISA (International Standards on Auditing) are issued by the IAASB (International
Auditing and Assurance Standards Board)

 Clarified SAS - In an effort to make US GAAS easier to read, understand, and apply, the ASB
redrafted all of the auditing sections in the Codification of SAS for clarity and to converge with ISA
 Effective for audits of F/S for periods ending on or after December 15, 2012
 Codifi atio of larified sta dards use AU-C se tio u ers i stead of AU se tio u ers

I) Purpose & Premise of an Audit

 Purpose of an audit - Provide F/S users with auditor’s opinion on whether F/S are presented fairly,
in all material respects, in accordance with an applicable financial reporting framework
 Enhances the degree of confidence that intended users can place in the F/S
 However, note that an audit of F/S does not assure the future viability of the entity nor the
efficiency or effectiveness with which management has conducted the affairs of the entity
 Nevertheless, in some circumstances, applicable law or regulation may require auditors to
provide opinion on other specific matters (e.g., effectiveness of I/C) where the auditor
would undertake further work given the responsibilities to provide such additional opinion

 Premise of an audit - Management and, when appropriate, those charged with governance have
acknowledged certain responsibilities that are fundamental to the conduct of the audit including
 Preparation and fair presentation of F/S in accordance with the applicable financial reporting
framework
 F/S may be prepared in accordance with
 General purpose framework - designed to meet the common financial information
needs of a wide range of users (e.g., US GAAP, IFRS); or
 Special purpose framework - basis of accounting other than GAAP which uses a definite
set of logical, reasonable criteria that is applied to all material items appearing in F/S
(e.g., cash, tax, regulatory, contractual basis of accounting, or other basis of accounting)
 Design, implementation, and maintenance of I/C relevant to the preparation and fair
presentation of F/S that are free from material misstatement, whether due to fraud or error
 To provide the auditor with
 Access to all information that is relevant to the preparation and fair presentation of the F/S,
such as records, documentation, and other matters
 Additional information that the auditor may request from management and, when
appropriate, those charged with governance for the purpose of the audit
 Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence
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II) Overall Objectives of the Independent Auditor

 Overall objectives of the auditor when conducting a F/S audit are:

 Obtain reasonable assurance about whether the F/S as a whole are free from material
misstatement, whether due to error or fraud - Enables the auditor to express an opinion on
whether the F/S are presented fairly, in all material respects, in accordance with an applicable
financial reporting framework
 Reasonable assurance - High, but not absolute, level of assurance
 Achieved when the auditor has obtained sufficient appropriate audit evidence to reduce
audit risk (i.e., risk that the auditor expresses an inappropriate opinion when the F/S are
materially misstated) to an acceptably low level
 Not absolute assurance because there are inherent limitations of an audit that result in
most of the audit evidence, on which the auditor draws conclusions and bases the
auditor’s opinion, being persuasive rather than conclusive
 Report on F/S, and communicate as required by GAAS, in accordance with the auditor’s
findings - Auditor expresses an opinion in accordance with the auditor’s finding, or states that
an opinion cannot be expressed
 The opinion states whether the F/S are presented fairly, in all material respects, in
accordance with an applicable financial reporting framework

III) Conduct of an Audit in accordance with GAAS

 Ethical Requirements - The auditor should comply with ethical requirements related to F/S audit
engagements, including independence in both fact and appearance
 Ethical requirements consist of the AICPA Code of Professional Conduct and the rules of the
state boards of accountancy and applicable regulatory agencies that are more restrictive
 The AICPA Code of Professional Conduct establishes the fundamental principles of professional
ethics, which include the following:
 Responsibilities
 Public interest
 Integrity
 Objectivity and independence
 Due care
 Scope and nature of services

 Note: Auditing standards (SAS/GAAS) vs. Audit procedures

 Audit procedures = Acts/procedures performed by the auditor during the audit
 Auditing standards (GAAS) = Measures of the quality of the auditor’s performance of audit
procedures
 Specific audit procedures needed to comply with GAAS may vary for each engagement

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 Compliance with GAAS - Auditor should comply with all AU-C sections relevant to the audit
 In certain audit engagements, the auditor also may be required to comply with other auditing
requirements in addition to GAAS. GAAS do not override law/regulation that govern F/S audits
 E.g., Auditor may also conduct the audit in accordance with both GAAS and
 PCAOB Auditing Standards (PCAOB AS)
 International Standards on Auditing,
 Government Auditing Standards, or
 Auditing standards of a specific jurisdiction or country
 In the event that such law or regulation differs from GAAS, an audit conducted only in
accordance with law or regulation will not necessarily comply with GAAS
 Auditor should not represent compliance with GAAS in the auditor’s report unless the auditor
has complied with the requirements of AU-C sections relevant to the audit
 If an objective in a relevant AU-C section cannot be achieved, auditor should evaluate
whether this prevents him from achieving the audit’s overall objectives and thereby
requires the auditor, in accordance with GAAS, to modify the auditor’s opinion or withdraw
from the engagement (when withdrawal is possible under applicable law/regulation)
 GAAS use the following two categories of professional requirements, identified by specific
terms, to describe the degree of responsibility it imposes on auditors:
 Unconditional requirements - Auditor must comply in all cases in which such a requirement
is relevant. GAAS use the word "must" to indicate an unconditional requirement
 Presumptively mandatory requirements - Auditor must comply in all cases in which such a
requirement is relevant except in rare circumstances. GAAS use the word "should" to
indicate a presumptively mandatory requirement
 In rare circumstances, the auditor may judge it necessary to depart from a relevant
presumptively mandatory requirement (e.g., a specific audit procedure required to be
performed would be ineffective in achieving the intent of that requirement). In such
circumstances, the auditor should perform alternative audit procedures to achieve the
intent of that requirement
 The GAAS hierarchy
 Level 1 - Auditing Standards - SAS (AU-C)
 Level 2 - Interpretive publications (not standards, but recommendations on application of
GAAS in specific circumstances, including engagements for entities in specialized industries)
 Auditing interpretations of GAAS
 AICPA Audit and Accounting Guides
 AICPA Auditing Statements of Position
 Level 3 - Other Auditing Publications (no authoritative status but may help the auditor
understand and apply GAAS)
 AICPA auditing publications not defined as interpretive publications
 Auditing articles in the Journal of Accountancy and other professional journals
 Continuing Professional Education programs and other instruction materials, textbooks,
guide books, audit programs, and checklists
 Other auditing publications from state CPA societies, other organizations/individuals

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IV) Inherent Limitations of an Audit

 The auditor is unable to obtain absolute assurance that the F/S are free from material
misstatements because of the following inherent limitations of an audit:
 Nature of Financial Reporting
 Involves judgment by management in applying GAAP (or other framework) to the facts &
circumstances of the entity
 Many F/S items involve subjective decisions/assessments or a degree of uncertainty; and
there is a range of acceptable interpretations/judgments
 Therefore, some F/S items are subject to an inherent level of variability that cannot be
eliminated by audit procedures; e.g., accounting estimates (nevertheless, the auditor
does need to evaluate whether the estimates are reasonable)
 Nature of Audit Procedures - Practical and legal limits on an auditor’s ability to obtain audit
evidence, including
 Possibility that the information provided by management may be incomplete (intentional or
unintentional)
 Possibility of fraud which may be concealed by sophisticated and carefully organized
schemes (intentional)
 Audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not
given specific legal powers, such as the power of search
 Timeliness of Financial Reporting and the Balance between Cost and Benefit - Expectation
that the auditor will form an opinion on F/S within a reasonable period of time and will achieve
a balance between benefit and cost, which makes it is impracticable for the auditor to address
all information that may exist or to pursue every matter exhaustively
 Other Matters - For certain assertions or subject matters, the inherent limitations on the
auditor’s ability to detect material misstatements are particularly significant; e.g.,
 Fraud (particularly fraud involving senior management or collusion)
 Related party relationships and transactions (existence & completeness)
 Non-compliance with laws and regulations
 Future events or conditions that may cause an entity to cease to continue as a going
concern

 Because of the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of F/S may not be detected, even though the audit is properly planned and
performed in accordance with GAAS
 Accordingly, the subsequent discovery of a material misstatement of F/S resulting from fraud or
error does not by itself indicate a failure to conduct an audit in accordance with GAAS
 However, the inherent limitations of an audit are not a justification for the auditor to be
satisfied with less than persuasive audit evidence
 Whether the auditor has performed an audit in accordance with GAAS is determined by the
audit procedures performed in the circumstances, the sufficiency and appropriateness of the
audit evidence obtained as a result thereof, and the suitability of the auditor’s report based on
an evaluation of that evidence in light of the overall objectives of the auditor

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Appendix: AU-C (Research)

 Authoritative Literature used for Auditing & Attestation:
 AU-C - Codification of Statements on Auditing Standards (SAS)

 PCAOB - PCAOB Auditing Standards

 ET - AICPA Code of Professional Conduct
 BL - Bylaws of the AICPA (for membership/governance)
 PR - AICPA Peer Review Standards
AUD-1
 CS - Statements on Standards for Consulting Services
 PFP - Personal Financial Planning
 VS - Statements on Standards for Valuation Services
 CPE - Continuing Professional Education
 QC - Statements on Quality Control Standards (SQCS) AUD-2
 AT - Statements of Standards for Attestation Engagements (SSAE)
AUD-7
 AR-C - Statements on Standards for Accounting & Review Services (SSARS)

 AU-C Codes are codified SAS (Statements on Auditing Standards):

AU-C 200s General Principles and Responsibilities
200 Overall Objectives of the Independent Auditor & Conduct of an Audit in Accordance With GAAS
210 Terms of Engagement
220 Quality Control for an Engagement Conducted in Accordance With GAAS
230 Audit Documentation
240 Consideration of Fraud in a Financial Statement Audit
250 Consideration of Laws and Regulations in an Audit of Financial Statements
260 The Auditor’s Communication With Those Charged With Governance
265 Communicating Internal Control Related Matters Identified in an Audit

AU-C 300s-400s Risk Assessment and Response to Assessed Risks

300 Planning an Audit
315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
320 Materiality in Planning and Performing an Audit
330 Performing Audit Procedures in Response to Assessed Risks & Evaluating Audit Evidence
402 Audit Considerations Relating to an Entity Using a Service Organization
450 Evaluation of Misstatements Identified During the Audit

AU-C 500s Audit Evidence

500 Audit Evidence
501 Audit Evidence - Specific Considerations for Selected Items

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505 External Confirmations

510 Opening Balances - Initial Audit Engagements, Including Reaudit Engagements
520 Analytical Procedures
530 Audit Sampling
540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates & Related Disclosures
550 Related Parties
560 Subsequent Events and Subsequently Discovered Facts
570 Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern
580 Written Representations
585 Consideration of Omitted Procedures after the Report Release Date

AU-C 600s Using the Work of Others

600 Special Considerations - Audits of Group Financial Statements (Work of Component Auditors)
610 Using the Work of Internal Auditors
620 Using the Work of an Auditor’s Specialist

AU-C 700s Audit Conclusions and Reporting

700 Forming an Opinion and Reporting on Financial Statements
705 Modifications to the Opinion in the Independent Auditor’s Report
706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in Independent Auditor’s Report
708 Consistency of Financial Statements
720 Other Information in Documents Containing Audited Financial Statements
725 Supplementary Information in Relation to the Financial Statements as a Whole
730 Required Supplementary Information

AU-C 800s Special Considerations

800 Special Considerations - Audits of Financial Statements Prepared in Accordance With Special
Purpose Frameworks
805 Special Considerations - Audits of Single Financial Statements and Specific Elements, Accounts,
or Items of a Financial Statement
806 Reporting on Compliance with Aspects of Contractual Agreements or Regulatory Requirements
in Connection with Audited Financial Statements
810 Engagements to Report on Summary Financial Statements

AU-C 900s Special Considerations in the United States

905 Alerts as to the Intended Use or Purpose of the Auditor’s Written Communication
910 Financial Statements Prepared in Accordance With a Financial Reporting Framework Generally
Accepted in Another Country
915 Reports on Application of Requirements of an Applicable Financial Reporting Framework
920 Letters for Underwriters and Certain Other Requesting Parties
925 Filings with the U.S. Securities and Exchange Commission Under the Securities Act of 1933
930 Interim Financial Information
935 Compliance Audits
940 Audit of ICFR that is integrated with an audit of F/S

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2.1) Engagement Understanding & Acceptance

I) Pre-Engagement Acceptance Activities
Check your own Accept
Check if client is Check with
Receive an firm (client engagement
auditable & previous auditor
appointment acceptance & (Engagement
ethical (RID-C, ID-D)
continuance) Letter)

 Appointment of Auditor
 Appointment by Audit Committee or those harged ith go er a e
 Pursuant to SOX (applies to issuers), the audit committee appoints & oversees the auditor
and also pre-approves all services to be provided by the auditor (e.g., tax services along with
audit; note that auditor is not allowed to provide specified non-attest services)
 Timing of appointment
 Early appointment preferred
 Late appointment (near or after year-end) is ok only if it does not pose scope limitations on
the audit that may lead to a qualified opinion or a disclaimer of opinion. Any concerns
should be discussed with the client
 Determining nature & scope of the engagement
 Integrated audit?
 Tax services along with audit?
 Single period or multiple periods?
 Government audit (for firms receiving government funding)?
 For non-issuers, consider if review or compilation is more appropriate than audit?

 Auditor s client acceptance & continuance policies

 Whether the engagement team is competent to perform the audit engagement and has the
necessary capabilities, including time/resources
 Ability to meet reporting deadlines (consider available time/resources as well as complexity
of the engagement)
 Ability to staff the engagement (with personnel having both competence and availability)
 Whether the firm and the engagement team can comply with relevant ethical requirements
(i.e., are they currently independent and will they be able to maintain their independence)

 Assessment of client s auditability

 Whether Financial Reporting Framework is acceptable (e.g., GAAP, special-purpose framework)
 Whether Accounting Records will be available & adequate. E.g.,
 Will access to all relevant info be available (e.g., records, documents)?
 Will management provide any additional info needed?
 Will auditor have unrestricted access to persons within the entity to obtain audit evidence?
 Integrity of client management (auditor may not accept if lack of integrity is concluded). E.g.,
 Does client follow ethical business practices?
 Is the client involved in money laundering or other criminal activities?
 Attitude of Management - Does management acknowledge & understand its responsibility for:
 Fair presentation of F/S
 Design, implementation & maintenance of adequate I/C
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 Communication with predecessor auditor

 Responsibility of the current auditor - Mandatory before accepting an engagement for an initial
audit (including a reaudit engagement)
 Auditor may make the engagement proposal before making inquiries of the predecessor;
but needs to advise management that auditor’s acceptance of the engagement cannot be
final until inquiries have been made and responses of the predecessor have been evaluated
 Management permission is needed - Auditor should request management to authorize the
predecessor auditor to respond fully to the auditor’s inquiries regarding matters that will assist
the auditor in determining whether to accept the engagement
 If management refuses, auditor may consider refusing the engagement
 Auditor should evaluate the predecessor’s response, or consider the implications if the
predecessor provides no/limited response, in determining whether to accept the engagement
 In accordance with the AICPA Code, the predecessor is expected to cooperate and respond
to the auditor’s inquiries promptly and fully
 If the predecessor does not respond fully due to unusual circumstances (e.g., litigation,
disciplinary proceedings), predecessor is expected to clearly state that response is limited
 Before acceptance {RID.com - I’ll track the predecessor auditor online on RID.Com!}
 Reasons for change - Predecessor’s understanding about the reasons for change of auditor
 Integrity of management - Info that might bear on the integrity of management
 Disagreements during audit - Disagreements with management about accounting policies,
auditing procedures, or other similarly significant matters
 Communications of the predecessor with the Audit Committee - Regarding fraud & non-
compliance with laws/regulations by the entity; also, regarding significant deficiencies &
material weaknesses in I/C (which are also communicated to management)
 After Acceptance {ID-D - I D Disturb the predecessor auditor again }
 Inquiries regarding specific matters
 E.g., Predecessor’s knowledge of existing relationships and the extent of management
involvement in material transactions
 Extent of response to inquiries is as per predecessor’s professional judgment
 Reviewing the predecessor’s Audit Documentation
 May provide evidence regarding opening balances & consistency of accounting principles
 Extent of access provided is as per predecessor’s professional judgment; and
predecessor is not responsible if info is not sufficient or appropriate
 Ordinarily, predecessor permits review of audit documentation relating to planning,
audit procedures, audit results, and other matters of continuing accounting/auditing
significance (e.g., uncorrected misstatements, B/S accounts, contingencies)
 Discovery of possible material misstatements in F/S reported on by the predecessor auditor
 Request management to inform predecessor of the situation and arrange for the three
parties to discuss this info and attempt to resolve the matter
 If management refuses or auditor is unsatisfied with the resolution, may consider
withdrawal from the engagement
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 Establish written understanding with client (via Engagement letter)

 Re ui ed to ha e a itten unde standing ith lient
 Auditor should agree upon the terms of the audit engagement with management or those
charged with governance
 Generally takes the form of an engagement letter which should be accepted (signed &
dated) by client
 Helps avoid misunderstandings with respect to the audit. E.g., Reduces the risk that
management may inappropriately rely on the auditor to protect management against
certain risks or to perform certain functions that are management’s responsibility
 The agreed-upon ritte terms of the audit engagement should include the following:
 Objective and scope of the audit of F/S
 Management Responsibilities
 Preparation & fair presentation of F/S
 Design, implementation & maintenance of I/C over financial reporting
 Provide auditor with access to all relevant info, any additional info requested and to
persons within the entity as auditor determines necessary
 Provide written representations to the auditor
 Auditor Responsibilities
 Conduct audit in accordance with GAAS to obtain reasonable assurance about whether
F/S are free from material misstatement
 Communicate any significant deficiencies or material weaknesses in I/C that come to the
auditor’s attention during the audit (but no assurance on I/C unless integrated audit)
 Limitations of the Audit
 Statement that because of the inherent limitations of an audit, together with the
inherent limitations of I/C, an unavoidable risk exists that some material misstatements
may not be detected, even though the audit is properly planned and performed in
accordance with GAAS
 Identification of the applicable financial reporting framework for the preparation of F/S
(e.g., US GAAP)
 Reference to the expected form and content of auditor s reports
 Statement that circumstances may arise in which a report may differ from its expected
form and content
 May include a description of the types of reports to be issued
 Other Matters (optional, not required):
 Basis on which fees are computed and any billing arrangements
 Arrangements concerning involvement of other auditors & specialists in the audit
 Arrangements concerning involvement of internal auditors & other staff of the entity
 Arrangements to be made with the predecessor auditor, if any, in case of an initial audit
 Any obligations of the auditor to provide audit documentation to other parties
 Additional services to be provided, such as those relating to regulatory requirements
 If understanding is not achieved, auditor should withdraw
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II) Sample Engagement Letter

To the appropriate representative of those charged with governance of ABC Company:
[The objective and scope of the audit]
You have requested that we audit the financial statements of ABC Company, which comprise the balance sheet as of December 31, 20XX,
and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to
the financial statements. We are pleased to confirm our acceptance and our understanding of this audit engagement by means of this
letter. Our audit will be conducted with the objective of our expressing an opinion on the financial statements.
[The responsibilities of the auditor]
We will conduct our audit in accordance with auditing standards generally accepted in the United States of America (GAAS). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the
financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material
misstatement of the financial statements, whether due to fraud or error. An audit also includes evaluating the appropriateness of
accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the
overall presentation of the financial statements.
Because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk that some
material misstatements may not be detected exists, even though the audit is properly planned and performed in accordance with GAAS.
In making our risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the entity’s internal control. However, we will communicate to you in writing concerning any significant
deficiencies or material weaknesses in internal control relevant to the audit of the financial statements that we have identified during the
audit.
[The responsibilities of management and identification of the applicable financial reporting framework]
Our audit will be conducted on the basis that [management and, when appropriate, those charged with governance] acknowledge and
understand that they have responsibility
a. for the preparation and fair presentation of the financial statements in accordance with accounting principles generally
accepted in the United States of America;
b. for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of
financial statements that are free from material misstatement, whether due to fraud or error; and
c. to provide us with
i. access to all information of which [management] is aware that is relevant to the preparation and fair presentation of
the financial statements such as records, documentation, and other matters;
ii. additional information that we may request from [management] for the purpose of the audit; and
iii. unrestricted access to persons within the entity from whom we determine it necessary to obtain audit evidence.
As part of our audit process, we will request from [management and, when appropriate, those charged with governance], written
confirmation concerning representations made to us in connection with the audit.
[Other relevant information]
[Insert other information, such as fee arrangements, billings, and other specific terms, as appropriate.]
[Reporting]
[Insert appropriate reference to the expected form and content of the auditor’s report. Example follows:]
We will issue a written report upon completion of our audit of ABC Company’s financial statements. Our report will be addressed to the
board of directors of ABC Company. We cannot provide assurance that an unmodified opinion will be expressed. Circumstances may arise
in which it is necessary for us to modify our opinion, add an emphasis-of-matter or other-matter paragraph(s), or withdraw from the
engagement.
We also will issue a written report on [Insert appropriate reference to other auditor’s reports expected to be issued] upon completion of
our audit.
Please sign and return the attached copy of this letter to indicate your acknowledgment of, and agreement with, the arrangements for
our audit of the financial statements including our respective responsibilities.
XYZ & Co.
Acknowledged and agreed on behalf of ABC Company by
___________________________
[Signed | Name and Title | Date]

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III) Audit Committee ( those charged with governance )

 Those charged with Governance (TCWG) - Persons responsible for oversight of the strategic
direction and accountability obligations of the entity (includes oversight of financial reporting)
 May include members of the entity’s legal structure (e.g., board of directors), external parties
(e.g., government agency), management personnel
 Governance structures vary by entity, reflecting influences like size & ownership characteristics
 In most entities, governance is the collective responsibility of a governing body (e.g., board
of directors, supervisory board, partners, proprietors, committee of management, trustees)
 Often, a subgroup (such as an audit committee) may be charged with specific tasks to
assist the governing body in meeting its responsibilities
 In some small entities, even one person (e.g., owner-manager, sole trustee) may be TCWG
 Note: Auditor generally reports to TCWG. In general, TCWG refer to the Board of Directors;
and, more specifically, the Audit Committee of the Board of Directors
 Audit Committee - Sub-committee made up of members of the Board of Directors who are NOT
officers/employees looking after day-to-day operations (i.e., all outside/independent directors)
 Key role:
 Oversight of the entity’s financial reporting, I/C and the internal audit function
 Appoint/oversee the external auditor (regular communications with external auditor)
 Good governance principles suggest that auditor should have access to the audit committee as
necessary, and should periodically meet (at least once annually without management present)
 Auditor communications {Auditor to o u i ate i fo AS IS ; include SUM of all VOWs}:
 Auditor’s responsibilities with regard to the F/S audit
 Scope & timing of the audit as planned
 I/C issues identified in an audit
 Significant findings & issues from the audit
 Significant difficulties encountered during the audit
 Uncorrected misstatements
 Management & auditor disagreements
 Views of auditor on qualitative aspects of the entity’s significant accounting practices
 Other findings or issues
 When not all of TCWG are involved in management
 Few communication considerations:
 Should be two-way - Even TCWG should communicate/respond (which if inadequate, may
indicate issue with I/C Control Environment and affect auditor’s RMM assessment)
 Communication should be in writing (unless auditor believes oral is ok for some matters)
 Writte o u i atio o sidered a -produ t report should i di ate restricted
use - i.e., intended solely for TCWG, management (if appropriate) and should not be
used by anyone other than these specified parties
 Auditor to retain written communication, and document oral communication
 Communication with management - Before communicating matters with TCWG, auditor
may discuss with management (or internal auditors) unless that is inappropriate
 Besides recognizing management’s responsibility, these initial discussions may clarify
facts/issues and give management an opportunity to provide further info/explanations
 However, it may be inappropriate to discuss some matters with management. E.g., fraud
involving senior management, questions on management competence/integrity
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 Auditor communications {Auditor to o u i ate i fo AS IS ; include SUM of all VOWs}:

 Auditor s responsibilities with regard to the F/S audit (which are often included in the
engagement letter, a copy of which may be provided to TCWG)
 Auditor is responsible for conducting the audit per GAAS
 To obtain reasonable assurance about whether F/S are free from material misstatement
 Will communicate any significant deficiencies or material weaknesses in I/C that come
to the auditor’s attention (but no assurance on I/C unless integrated audit)
 Audit of F/S does not relieve management or TCWG of their responsibilities
 Although the auditor’s report affirms the auditor’s independence, in certain situations,
auditor may determine that it is appropriate to communicate with TCWG circumstances or
relationships that, in the auditor’s professional judgment, may reasonably be thought to
bear on independence, and to which the auditor gave significant consideration, in reaching
the conclusion that independence has not been impaired

 Scope & timing of the audit as planned

 Care is required when communicating the planned scope & timing of the audit so as not to
compromise the effectiveness of the audit by making the procedures too predictable (esp. if
TCWG are also managing the entity)
 Matters communicated may include the following:
 How the auditor proposes to address the significant RMM, whether due to fraud/error
 Auditor’s approach to I/C relevant to the audit including, when applicable, whether the
auditor will express an opinion on the effectiveness of ICFR
 Application of materiality in the context of an audit
 Any planned use of the work of the internal auditors
 Other planning matters that may be appropriate to discuss with TCWG include:
 Views of TCWG about matters relevant to the F/S audit like
- Appropriate person(s) in entity’s governance structure with whom to communicate
- Allocation of responsibilities between TCWG and management
- Entity’s objectives/strategies and related business risks
- Matters which TCWG consider as warranting particular attention during the audit
and any areas for which they request additional procedures to be undertaken
- Significant communications with regulators
 Attitudes, awareness, and actions of TCWG concerning
- I/C and its importance in the entity (and how TCWG oversee effectiveness of I/C)
- Detection or the possibility of fraud
 Actions of TCWG in response to developments in law, accounting, corporate governance
 Actions of TCWD in response to previous communications with the auditor

 I/C issues identified in an audit {covered in AUD-3.4} - Auditor should communicate in writing
to TCWG on a timely basis, significant deficiencies and material weaknesses that happen to be
identified during the audit, including those that were remediated during the audit
 Re-communicate significant deficiencies & material weaknesses that were communicated in
a previous audit but not yet resolved
 Communication to be made no later than 60 days following the report release date; can
communicate even orally earlier but written is required by this timeline
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 Significant Findings & Issues from the audit {SUM of all VOWs}:
 Significant difficulties, if any, encountered during the audit (which may constitute a scope
limitation). E.g.,
 Significant delays in management providing required information
 Unnecessarily brief time within which to complete the audit
 Extensive unexpected effort required to obtain sufficient appropriate audit evidence
 Unavailability of expected information
 Restrictions imposed on the auditor by management
 Management not providing info on plans to deal with potential going concern issues
 Uncorrected Misstatements (that individually or in aggregate have a material effect on F/S)
 Auditor may discuss the reasons for, and the implications of, a failure to correct
misstatements, taking into account the size and nature of the misstatement judged in
the surrounding circumstances, and possible implications with regard to future F/S
 When there are a large number of individually immaterial uncorrected misstatements,
the auditor may communicate the number and overall $ effect of the uncorrected
misstatements, rather than the details of each individual uncorrected misstatement
 Management & auditor disagreements, if any (regardless of whether satisfactorily resolved)
 Disagreements with management may occasionally arise over, among other things, the
application of accounting principles to the entity’s specific transactions and events and
the basis for management’s judgments about accounting estimates
 Disagreements may also arise regarding the scope of the audit, disclosures to be
included in the entity’s F/S, and the wording of the auditor’s report
 Views of auditor on qualitative aspects of the entity’s significant accounting practices,
including accounting policies, accounting estimates, F/S disclosures. E.g.,
 Explain to TCWG why auditor considers a significant & acceptable accounting practice
not to be most appropriate to the particular circumstances of the entity
 Determine that TCWG are informed about management’s process of formulating
particularly sensitive accounting estimates (including fair value estimates) and about the
basis for the auditor’s conclusions regarding the reasonableness of those estimates
 Other findings or issues, if any, arising from the audit that are, in the auditor’s professional
judgment, significant and relevant to TCWG
 E.g., Auditor is engaged to audit per GAAS, but becomes aware that by law/regulation
the entity also is required to have an audit per Governmental Auditing Standards
 When not all of TCWG are involved in management - Auditor should also communicate
 Material, corrected misstatements that were brought to the attention of management
as a result of audit procedures; may also communicate frequently recurring immaterial
misstatements
 Significant findings or issues, if any, that were discussed with management
 Auditor’s views about significant matters that were the subject of management’s
consultations with other accountants on accounting or auditing matters when the
auditor is aware that such consultation has occurred
 Representations requested by the auditor from management; auditor may provide a
copy of the management representations to TCWG

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(This page is left blank for any reference notes on

Engagement Understanding & Acceptance)

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