4-strategy planning issues
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STUDY UNIT FOUR
ISSUES
STRATEGIC PLANNING
This study unit considers issues that are fundamental to planning an audit.Questions about the internal audit function,related parties,and accounting estimates can be expected on the exam. Moreover,most of the issues considered in this study unit have an effect on other facets of the audit, including evidence collection and reporting.We cover the additional matters here to provide comprehensive and coherent coverage.
4.1THE AUDITOR’S CONSIDERATION OF THE INTERNAL AUDIT FUNCTION(AU322)
1.The independent,external auditor(“the auditor”)considers the existence of an internal audit
function in determining the nature,timing,and extent of audit procedures.
a.The auditor must be independent of the entity.
entity.
2.Internal auditors cannot be independent because they are employees of the Array
a.Internal auditors provide analyses,evaluations,assurances,recommendations,and
other information to management and those charged with governance.
3.Understanding the Internal Audit Function
a.An understanding of internal control includes an understanding of the internal audit
function sufficient to identify activities relevant to audit planning.This function is part
of the monitoring component.
b.Inquiries should be made about the internal auditors’
1)Organizational status
2)Application of professional standards
3)Audit plan,including the nature,timing,and extent of audit work
4)Access to records and limitations on the scope of their work
c.Inquiring about the internal audit function’s charter,mission statement,or similar
directive provides information about its objectives.
d.Certain internal audit activities may not be relevant to an audit of the financial
statements,e.g.,evaluating certain management decision-making processes.
e.Relevant internal audit activities provide the following:
1)Evidence about the design and effectiveness of internal control relating to the
ability to initiate,authorize,record,process,and report financial data consistent
with relevant assertions in the financial statements
2)Direct evidence about potential misstatements of financial data
2SU4:Strategic Planning Issues
f.The following actions are helpful in assessing the relevance of internal audit activities:
1)Considering prior-year audits
2)Reviewing how the internal auditors allocate their audit resources
3)Reading internal audit reports
g.If the auditor concludes that the internal auditors’activities are not relevant,(s)he
need not further consider the function unless the auditor requests their direct
assistance.
1)The auditor may conclude that considering further the work of the internal
auditors would be inefficient,even if some of their activities are relevant.
h.The auditor may decide that it is efficient to consider how the internal auditors’work
might affect audit procedures.The auditor then should assess the competence and
objectivity of the internal auditors in relation to the intended effect of their work on
the audit.
4.Assessing Competence and Objectivity
a.Assessing competence.The auditor considers the following:
1)Educational level and professional experience
2)Professional certification and continuing education
3)Audit policies,programs,and procedures
4)Practices regarding assignment of internal auditors
5)Supervision and review
6)Quality of documentation,reports,and recommendations
7)Performance evaluation
b.Assessing objectivity.The auditor considers the following:
1)The organizational status of the chief audit executive(CAE).This assessment
includes whether
a)The CAE reports to someone with sufficient status to ensure broad audit
coverage and adequate consideration of,and action on,findings and
recommendations.
b)The CAE has direct access and reports regularly to those charged with
governance.
c)Those charged with governance oversee employment decisions by the
CAE.
2)Policies to maintain objectivity about the areas audited.These include
prohibitions against auditing areas in which
a)Relatives are employed in important or audit-sensitive positions.
b)Internal auditors were recently assigned or are scheduled to be assigned.
c.Assessing competence and objectivity involves considering information from the
auditor’s previous experience,discussions with management,and a recent external
quality review.
5.Effect of the Internal Auditors’Work
a.The internal auditors’work may affect substantive audit procedures and the
procedures performed in obtaining the understanding of internal control and
assessing risk.
b.Because a primary objective of many internal audit functions is to review,assess,and
monitor internal control,internal audit procedures may provide useful information.
c.Risk assessment at the financial-statement level involves an overall assessment of
the risk of material misstatement(RMM)and thus may affect the overall audit
strategy.
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1)The internal audit function may affect the overall risk assessment and decisions
about audit procedures.For example,the auditor may coordinate work with the
internal auditors and reduce the number of locations at which the auditor
performs procedures.
d.Risk assessment at the account-balance or class-of-transactions level involves
obtaining and evaluating evidence about relevant assertions.The auditor assesses
the RMM for each relevant assertion and performs tests of controls to support an
expectation of the operating effectiveness of controls.
1)When testing controls,the auditor may consider the results of internal audit
procedures.
e.Substantive procedures performed by the internal auditors may provide direct
evidence about material misstatements in specific relevant assertions.
f.Obtaining sufficient appropriate audit evidence and reporting on the financial
statements are solely the responsibilities of the auditor.They cannot be shared with
the internal auditors.
1)Judgments about(a)assessments of risk,(b)materiality,(c)the sufficiency of
tests,(d)the evaluation of estimates,and(e)other matters affecting the report
always should be those of the auditor.
g.The extent of the effect of the internal auditors’work depends on the materiality of
amounts,RMMs,and the subjectivity involved in evaluating audit evidence.
1)For assertions related to material amounts for which the RMM or the degree of
subjectivity is high,the internal auditors’work alone cannot reduce audit risk to
an acceptable level to eliminate direct tests of assertions by the auditor.
2)For certain assertions related to less material amounts for which the RMM or the
degree of subjectivity is low,the auditor may decide that(a)audit risk has been
reduced to an acceptable level,and(b)direct testing by the auditor may not be
necessary.
6.Coordination of Audit Work
a.If the work of the internal auditors is expected to affect the auditor’s procedures,it may
be efficient for the auditor and the internal auditors to coordinate their work by
1)Holding periodic meetings
2)Scheduling audit work
3)Providing access to internal auditors’engagement records(documentation)
4)Reviewing audit reports
5)Discussing possible accounting and auditing issues
7.Evaluating and Testing the Internal Auditors’Work
a.If the work of the internal auditors significantly affects the auditor’s work,the auditor
should evaluate the quality and effectiveness of the internal auditors’work.Thus,the
assertions.
auditor tests some of that work relevant to significant
https://www.wendangku.net/doc/c713406643.html,ing Internal Auditors to Provide Direct Assistance
a.The auditor may request direct assistance from the internal auditors when performing
an audit.When direct assistance is provided,the auditor should assess the internal
auditors’competence and objectivity and supervise,review,evaluate,and test the
work performed by internal auditors to the extent appropriate.
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4.2USING THE WORK OF A SPECIALIST(AU336)
1.A specialist is a person(or firm)possessing special skill or knowledge in a particular field
other than auditing or accounting,e.g.,actuaries,appraisers,attorneys,engineers,and
geologists.
2.Decision to Use the Specialist
a.The auditor is not expected to have the expertise of a person trained for or qualified to
engage in the practice of another profession or occupation.The auditor may use the
work of a specialist to obtain appropriate audit evidence.
b.Examples of types of matters for which the auditor may use the work of a specialist
include
1)Valuation(works of art,special drugs,restricted securities)
2)Determination of physical characteristics relating to quantity or condition(mineral
reserves,materials stored in piles above ground)
3)Determination of amounts by using special techniques or methods(certain
actuarial determinations)
4)Interpretation of technical requirements,regulations,or agreements(the
significance of contracts,legal title to property)
3.Selecting a Specialist
a.The auditor should become satisfied about the qualifications and reputation of the
specialist.Consideration should be given to the specialist’s
1)Professional certification,license,or other recognition of competence
2)Reputation and standing
3)Relationship with the client
b.The auditor should attempt to obtain a specialist who is unrelated to the client.
However,circumstances may permit using the work of a specialist having a
client.
relationship with the
4.Understanding the Specialist’s Work
a.The auditor should have an understanding of the nature of the work to be performed
by the specialist.The understanding should be documented and cover
1)The objectives and scope of the work
2)The specialist’s relationship,if any,with the client
3)The methods or assumptions to be used and a comparison with those used in
the preceding period
4)The appropriateness of using the specialist’s work
5)The form and content of the specialist’s report that will enable the auditor to
evaluate whether the findings support the assertions
https://www.wendangku.net/doc/c713406643.html,ing the Findings of the Specialist
a.The auditor should(1)obtain an understanding of the methods or assumptions used to
determine whether the findings may serve as corroboration,(2)consider whether the
findings support the assertions,and(3)test the data provided by the client.
b.If the specialist is related to the client,the auditor should consider performing
additional procedures to determine that the findings are not unreasonable or engage
an outside specialist for that purpose.
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6.Effect of the Specialist’s Work on the Auditor’s Report
a.If the specialist’s findings support the assertions,the auditor may reasonably conclude
that sufficient appropriate evidence has been obtained.
b.If the specialist’s findings and the assertions differ materially,the auditor should apply
additional procedures.
1)If(s)he is then unable to resolve the matter,the auditor should seek the opinion
of another specialist unless the matter cannot be resolved.
a)An unresolved matter is a scope limitation that will usually result in a
qualified opinion or a disclaimer of an opinion(see Study Unit16).
2)If the auditor concludes after additional procedures that the assertions are not in
conformity with GAAP,(s)he should express a qualified or adverse opinion.
7.Reference to the Specialist in the Auditor’s Report
a.When expressing an unqualified opinion,the auditor ordinarily should not refer to the
work or findings of the specialist.This reference might be misunderstood to be a
qualification of the opinion or a division of responsibility.
b.In certain circumstances,however,the auditor may express an unqualified opinion and
refer to the specialist.A specialist may be referred to and identified in the report if the
auditor believes the reference will facilitate an understanding of the reason for an
explanatory paragraph,for example,when
1)Describing a substantial doubt about the entity’s ability to continue as a going
concern
2)Emphasizing a matter
c.The auditor also may refer to the work of a specialist if(s)he departs from an
opinion.
unqualified
4.3RELATED PARTIES(AU334)
1.Accounting Considerations
a.Accounting principles ordinarily do not require transactions with related parties to be
accounted for differently from those with unrelated parties.
b.Primary emphasis should be on the adequacy of disclosure.
c.Furthermore,the auditor should understand that the substance of a transaction could
differ significantly from its form.Financial statements should recognize substance,
not legal form.
d.Transactions indicative of the existence of related parties include the following:
1)Borrowing or lending interest-free or at a rate significantly different from
prevailing market rates at the time of the transaction
2)Selling real estate at a price significantly different from appraised value
3)Making nonmonetary exchanges of similar property
4)Making loans with no scheduled terms for repayment
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2.Audit Procedures
a.An audit cannot provide assurance that all related party transactions will be detected,
but the auditor should be aware of the possible existence of material related party
transactions and of certain relationships that must be disclosed,even in the absence
of transactions.
1)Many of the procedures listed in this outline are normally performed in an audit,
even if the auditor has no reason to suspect that related party transactions
exist.
b.The auditor should obtain an understanding of management responsibilities and the
relationship of each component to the total entity.Consideration should be given to
1)Internal controls relevant to management activities,
2)The business purpose served by the components of the entity,and
3)Whether business structure and operating style are designed to obscure related
party transactions.
c.In the absence of contrary evidence,transactions with related parties should not be
assumed to be outside the ordinary course of business.But such transactions may
have been motivated solely or largely by any of the following:
1)Lack of sufficient working capital or credit to continue the business
2)A desire for favorable earnings to support the entity’s stock price
3)An overly optimistic earnings forecast
4)Dependence on one or a few products,customers,or transactions for success
5)A declining industry with many business failures
6)Excess capacity
7)Significant litigation,especially between shareholders and management
8)Significant obsolescence because the entity is in a high-technology industry
d.Determining the existence of related parties.Emphasis should be on known
related party transactions.Certain relationships,such as parent-subsidiary or
investor-investee,may be clearly evident.Determining the existence of others
requires specific audit procedures,which may include the following:
1)Evaluating the entity’s procedures for identifying and properly accounting for
related party transactions
2)Requesting from management the names of all related parties and inquiring
whether transactions occurred with them
3)Reviewing filings with the SEC and other regulatory agencies for the names of
related parties and for other businesses in which officers and directors occupy
directorship or management positions
4)Determining the names of all pensions and other trusts established for
employees and the names of their officers and trustees
5)Reviewing shareholder listings of closely held entities to identify principal
shareholders
6)Reviewing prior years’audit documentation for the names of known related
parties
7)Inquiring of predecessor,principal,or other auditors of related entities
concerning their knowledge of existing relationships and the extent of
management involvement in material transactions
8)Reviewing material investment transactions during the period to determine
whether they have created related parties
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e.Identifying related party transactions.The following procedures may identify
material transactions with known related parties or indicate the existence of
previously unknown related parties:
1)Provide personnel performing all segments of the audit with the names of known
related parties.
2)Review the minutes of meetings of the board and committees.
3)Review filings with the SEC and other regulatory agencies.
4)Review conflict-of-interest statements obtained by the entity from its
management.
5)Review business transacted with major customers,suppliers,borrowers,and
lenders for indications of undisclosed relationships.
6)Consider whether unrecognized transactions are occurring,such as receiving or
providing accounting,management,or other services at no charge or a major
shareholder absorbing entity expenses.
7)Review accounting records for large,unusual,or nonrecurring transactions or
balances,especially those near the end of the period.
8)Review confirmations of compensating balance arrangements for indications that
balances are or were maintained for or by related parties.
9)Review invoices from law firms.
10)Review confirmations of loans receivable and payable for guarantees.
f.Examining related party transactions
1)After identifying related party transactions,the auditor should become satisfied
about their purpose,nature,extent,and effect.The following should be
considered:
a)Obtain an understanding of the business purpose of the transaction.
b)Examine invoices,executed copies of agreements,contracts,and other
documents.
c)Determine whether the transaction has been approved by those charged
with governance.
d)Test for reasonableness the compilation of amounts to be disclosed or
considered for disclosure.
e)Arrange for the audits of interentity balances to be performed as of
concurrent dates,even if the fiscal years differ,and for the examination of
specified,important,and representative related party transactions by the
auditors for each of the parties,with appropriate exchange of relevant
information.
f)Inspect or confirm and obtain satisfaction concerning the transferability and
value of collateral.
2)To fully understand a particular transaction,the auditor may
a)Confirm the transaction amount and terms,including guarantees and other
significant data,with the other parties.
b)Inspect evidence in possession of the other parties.
c)Confirm or discuss significant information with intermediaries,such as
banks,guarantors,agents,or attorneys.
d)Refer to financial publications,trade journals,and credit agencies.
e)With respect to material uncollected balances,guarantees,and other
obligations,obtain information about the financial capability of the other
parties from audited financial statements,unaudited financial statements,
income tax returns,and reports issued by credit agencies.
3.Disclosure
a.For transactions or relationships for which GAAP requires disclosure,the auditor
should consider whether(s)he has obtained sufficient appropriate evidence to
understand the relationships and the effects of the transactions.
1)The auditor should evaluate the transactions or relationships and become
satisfied on the basis of professional judgment that they are adequately
disclosed in the notes to the financial statements.
b.Except for routine transactions,determining whether a transaction would have
occurred if the parties had not been related or what the terms and manner of
settlement would have been is ordinarily not possible.Accordingly,representations
by management that a transaction was consummated on terms equivalent to those
that prevail in arm’s-length transactions are difficult to substantiate.
1)If the auditor believes that a representation is unsubstantiated,(s)he should
express a qualified or adverse opinion because of a departure from GAAP,
depending on materiality.
4.4ACCOUNTING ESTIMATES AND FAIR VALUE(AU342AND AU
328)
The more you study accounting,the more you will realize the importance of estimates.Most significant
values in financial statements involve estimates in some manner.Be sure to understand the importance of
estimates and auditors’concerns with them.
1.Auditors should obtain and evaluate sufficient appropriate evidence to support significant
accounting estimates.
a.An accounting estimate in historical financial statements approximates an element,
item,or account by measuring the effects of past transactions or events or the current
status of an asset or liability.
1)Examples include(a)net realizable values of inventory and accounts receivable,
(b)property and casualty insurance loss reserves,(c)revenues from contracts
accounted for by the percentage-of-completion method,and(d)pension and
warranty expenses.
b.Such estimates often are necessary because
1)Measurement or valuation may be uncertain pending future events.
2)Relevant data for past events cannot be accumulated on a timely,cost-effective
basis.
2.Management is responsible for making the judgments about accounting estimates.
a.These judgments are normally based on subjective as well as objective factors,
including knowledge about past and current events and assumptions about future
conditions and courses of action.
3.The auditor should evaluate the reasonableness of accounting estimates in the context of
the financial statements taken as a whole.
a.Even when the estimation process involves competent personnel using relevant and
reliable data,potential bias exists in the subjective factors,and control may be
difficult to establish.
8SU4:Strategic Planning Issues
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1)When planning and performing procedures to evaluate accounting estimates,the
auditor should adopt an attitude of professional skepticism toward both the
subjective and objective factors.
2)According to AU312,Audit Risk and Materiality in Conducting an Audit,the
difference between the estimate best supported by the evidence and the
estimate in the financial statements must be reasonable.
a)If the amount in the financial statements is not reasonable,it should be
treated as a likely misstatement and aggregated with other likely
misstatements.
b)If the differences are individually reasonable but collectively indicate
possible bias(for example,when the effect of each difference is to
increase income),the auditor should reconsider the estimates as a
whole.
4.Developing Accounting Estimates
a.Management’s process of preparing accounting estimates,whether or not documented
or formally applied,normally consists of the following:
1)Determining when estimates are required
2)Identifying the relevant factors
3)Accumulating relevant,sufficient,and reliable data
4)Developing assumptions regarding the most likely circumstances and events
with respect to the relevant factors
5)Determining the estimated amount based on the assumptions and other relevant
factors
6)Determining that presentation and disclosure conform with applicable accounting
principles
5.The risk of material misstatement of accounting estimates varies with the
https://www.wendangku.net/doc/c713406643.html,plexity and subjectivity of the process
b.Availability and reliability of relevant data
c.Number,significance,and degree of uncertainty of the assumptions
6.Internal Control Related to Accounting Estimates
a.Internal control may reduce the probability of material misstatements of accounting
estimates.Specific aspects of internal control relevant to the process of arriving at
estimates include the following:
1)Management communication of the need for proper estimates
2)Accumulation of relevant,sufficient,and reliable data
3)Preparation of estimates by qualified personnel
4)Adequate review and approval by proper authority of
a)Sources of relevant factors
b)Development of assumptions
c)Reasonableness of assumptions and resulting estimates
5)Consideration by proper authority of the need to use the work of specialists
6)Consideration by proper authority of changes in methods
7)Comparison of prior estimates with results to assess the reliability of the process
8)Consideration by management of whether the resulting estimate is consistent
with operational plans
10SU4:Strategic Planning Issues
7.Evaluating Accounting Estimates
a.The auditor’s objective is to obtain sufficient appropriate evidence to provide
reasonable assurance that
1)All material accounting estimates have been developed.
2)Those estimates are reasonable(free from bias).
3)Presentation and disclosure conform with applicable accounting principles.
8.Circumstances Requiring Accounting Estimates
a.In evaluating whether all material accounting estimates have been developed,the
auditor considers the entity’s industry,its business methods,new accounting
pronouncements,and other external factors.Possible procedures include the
following:
1)Considering financial statement assertions to determine the need for estimates
2)Evaluating information obtained from other procedures
a)Changes in the entity’s business and its industry indicative of the need for
an accounting estimate
b)Changes in the methods of accumulating information
c)Litigation,claims,and assessments
d)Available minutes
e)Regulatory or examination reports,supervisory correspondence,and
similar materials from regulatory agencies
3)Inquiring of management about circumstances indicating the need for an
estimate
9.Evaluating Reasonableness
a.The evaluation concentrates on key factors and assumptions that are
1)Significant to the estimate
2)Sensitive to variations
3)Different from historical patterns
4)Subjective and susceptible to misstatement and bias
b.The auditor normally also should consider
1)The entity’s experience in making past estimates
2)The auditor’s experience in the industry
3)Any changes that may cause factors different from those previously considered
to become significant
4)The possible need to obtain written representations from management regarding
the key factors and assumptions
c.The auditor should understand how management developed the estimate and then
use one or more of the following approaches:
1)Review and test the process used by management.Procedures for this
purpose may include the following:
a)Identifying any controls over the process that might be useful in the
evaluation
b)Identifying the sources of data and factors used in forming the assumptions
and considering whether they are relevant,reliable,and sufficient in light
of information from other audit tests
c)Considering whether other key factors or alternative assumptions exist
d)Evaluating whether the assumptions are consistent with each other and
with relevant data
SU4:Strategic Planning Issues11
e)Analyzing historical data used to develop assumptions to assess
comparability,consistency,and reliability
f)Considering whether business or industry changes cause other factors to
become significant to the assumptions
g)Reviewing documentation of the assumptions and inquiring about plans
and objectives that might relate to them
h)Using the work of a specialist
i)Testing calculations used to translate assumptions and key factors into the
estimate
2)Develop an independent expectation of the estimate to corroborate
management’s estimate by using other key factors or alternative assumptions.
3)Review subsequent events or transactions occurring after the date of the
balance sheet but prior to the date of the auditor’s report that are important in
identifying and evaluating the reasonableness of accounting estimates,key
factors,or assumptions.
10.Fair Value Measurement
a.AU328,Auditing Fair Value Measurements and Disclosures,states that FVMD arise
from initial recording or from later changes in value reflected in net income or other
comprehensive income.
b.Fair value is the amount at which an asset(liability)can be bought(or incurred)or
sold(or settled)in a current transaction between willing parties,not in a forced sale.
An observable market price is the preferable measure of fair value when it is
available(SFAC7).
c.Management’s responsibility is to establish a process for(1)determining FVMD,
(2)selecting proper valuation methods,(3)identifying significant assumptions,and
(4)ensuring conformity with GAAP.
d.Absent observable market prices,assumptions(preferably those used in the market)
must be included in valuation methods(e.g.,discounted cash flows).
e.The auditor should understand the entity’s process for making FVMD and the
relevant controls.This understanding is used to assess the RMM and determine
the nature,timing,and extent of audit procedures.
f.An auditor may use the work of a specialist as evidence when evaluating FVMD.
g.The auditor evaluates internal and external evidence to determine whether significant
assumptions,individually and in the aggregate,form a reasonable basis for FVMD.
h.The auditor’s responsibility relative to a valuation model is not to act as an appraiser
but to evaluate the reasonableness of the assumptions and the appropriateness of
the model in the circumstances.
i.Tests of the data used to prepare the FVMD are performed to verify that they are
accurate,complete,and relevant.
j.The evaluation of whether fair-value disclosures conform with GAAP is based on the same kinds of procedures as those applied to measurements in the statements.
The auditor determines the adequacy of disclosures and assesses whether they are
sufficiently informative about measurement uncertainty.
k.Written management representations about FVMD normally should concern the reasonableness of assumptions and whether they properly reflect the ability and
intent to carry out specific relevant actions.
l.The auditor should communicate with those charged with governance about the process used to develop especially sensitive fair value estimates.
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4.5CONSIDERATION OF OMITTED PROCEDURES AFTER THE REPORT DATE(AU390)
1.An auditor may determine,subsequent to the date of the report,that(a)auditing procedures
considered necessary at the time of the audit were omitted,but(b)nothing indicates that
the financial statements are materially misstated.
a.However,an auditor has no responsibility to review the work once(s)he has reported.
2.When the auditor decides that a necessary procedure was omitted,(s)he should assess its
importance to his/her current ability to support the previously expressed opinion.
a.The results of other procedures applied or audit evidence obtained in a later audit
(possibly at an interim date)may compensate for an omitted procedure.
3.The auditor may determine that the omission impairs his/her current ability to support the
opinion.If(s)he believes persons are currently relying,or are likely to rely,on the report,
the auditor should promptly undertake to apply the omitted procedure or alternative
procedures that would provide a satisfactory basis for the opinion.
4.If the auditor is unable to apply the previously omitted procedure or alternative procedures,
(s)he should consult an attorney.