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c. What is an audit committee and why is it important?
– Audit committee is provide oversight of the financial reporting process, the audit process,
the system of internal controls and compliance with laws and regulations. The audit
committee can expect to review significant accounting and reporting issues and recent
professional and regulatory pronouncements to understand the potential impact on
financial statements. An understanding of how management develops internal interim
financial information is necessary to assess whether reports are complete and accurate.
The committee reviews the results of the audit with management and external auditors,
including matters required to be communicated to the committee under generally accepted
auditing standards. Audit committees will consider internal controls and review their
effectiveness. Reports on, and management responses to, observations and significant
findings should be obtained and reviewed by the committee. Controls over financial
reporting, information technology security and operational matters fall under the purview
of the committee
– Audit committees is important to enhance audit quality. Effective audit committees and
auditors build confidence in the integrity of financial reporting.
– why is it important? The audit committee is important to create the right environment
for quality auditing. It is the audit committee’s responsibility to create an environment that
accommodates an open discussion in a culture of integrity, respect and transparency
between management and auditors. Audit committees are responsible for overseeing the
work of the auditors. Among other things, they need to understand the audit strategy, be
satisfied that it addresses the major audit risks, and make sure the auditors exercise
appropriate professional skepticism. They also need to ensure that the auditor has an
appropriately independent mindset from management and is truly objective. Ultimately,
this will enable the audit committee to draw conclusions about the effectiveness of the
audit
d. What are Working Papers and why are they important?
– papers and documents, which consist of details about accounts, which are under audit. They
are the written, private materials, which an auditor prepares for each audit. They describe
the accounting information, which he obtained from his client, the method of examination
used, his conclusions and the financial statements. “Working papers provide basic evidence
of audit conducted in accordance with standard audit practices. They help the auditor in
writing the report. The quality of audit work performed by the auditor can be judged by the
character and contents of working papers prepared and maintained by the auditor.”
– Working papers are important to assist in the planning and performance of the audit,
necessary for audit quality control purposes, provide assurance that the work delegated by
the audit partner has been properly completed, provide evidence that an effective audit has
been carried out, increase the economy, efficiency, and effectiveness of the audit, contain
sufficiently detailed and up-to-date facts which justify the reasonableness of the auditor’s
conclusions, retain a record of matters of continuing significance to future, enable the
auditor to point out to the client the weakness of the internal control system in operation
and inefficiency of the accountancy He may, therefore, be in a position to advise his client
as to how to avoid such pitfalls. The working papers enable the auditor to prepare the report
to be issued without much waste of time.
c. How does materiality affect the audit of financial statements and reporting
decisions?
The auditor’s consideration of materiality is a matter of professional judgment and is
influenced by the auditor’s perception of the needs of users of financial statements. The
perceived needs of users are recognized in the discussion of materiality in Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Concepts. In an
audit of financial statements, the auditor’s judgment as to matters that are material to users
of financial statements is based on consideration of the needs of users as a group; the
auditor does not consider the possible effect of misstatements on specific individual users,
whose needs may vary widely. “The determination of materiality, therefore, takes into
account how users with such characteristics could reasonably be expected to be influenced
in making economic decisions.”
7. ASSERTIONS REGARDING FINANCIAL STATEMENTS – (4 points).
a. What are assertions?
Audit Assertions are the implicit or explicit claims and representations made by the
management responsible for the preparation of financial statements regarding the
appropriateness of the various elements of financial statements and disclosures.
“Financial statement assertions are management’s explanation about the recognition,
measurement, presentation and disclosure of information in the financial statements.”
b. Who makes these assertions?
Management make the implicit or explicit assertions that the preparer of financial
statements (management) is making to its users.
c. What is the auditor’s responsibility regarding the financial statements?
The auditor has a responsibility to plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement,
whether caused by error or fraud. The auditor responsibility to the financial statements is
the expression of an opinion on the fairness with which they present, in all material
respects, financial position, results of operations, and its cash flows in conformity with
generally accepted accounting principles.These standards require the auditor to state
whether, in his opinion, the financial statements are presented in conformity with
generally accepted accounting principles and to identify those circumstances in which
such principles have not been consistently observed in the preparation of the financial
statements of the current period in relation to those of the preceding period.
d. List and describe 7 assertions regarding the financial statements.
1.
Existence
The assertion of existence is the assertion that the assets, liabilities and shareholders’
equity balances appearing on a company’s financial statements actually exist as stated at
the end of the accounting period that the financial statement covers
“For example, any statement of inventory included in the financial statement carries the
implicit assertion that such inventory exists, as stated, at the end of the accounting period.
The assertion of existence applies to all assets or liabilities included in a financial
statement”
2. Completeness
Checking completeness of a financial statement is to analyze whether all the transactions
that are already given in the financial statement are correctly included. In order to abide
by the completeness assertion, the auditors prove with the help of sufficient evidence that
all the recorded transactions deserve to be included. This is further supported with an
external document so as to provide evidence regarding the occurrence of the transaction.
3. Rights and Obligations:
This financial statement assertion is used to check whether the assets that are included in
the financial statement are the rights and the liabilities are the obligations of the
company. In order to ensure this, sometimes special purpose entities are created.
4. Management Assertions:
In Management Assertions auditors decompose the broad assertions into a detailed set of
statements referred to as management assertions. Its has a major role in financial
statement assertions and audit assertions.
5. Accuracy and Valuation
The assertion of accuracy and valuation is the statement that all figures presented in a
financial statement are accurate and based on proper valuation of assets, liabilities and
equity balances.
6. Presentation and Disclosure
The final financial statement assertion is that of presentation and disclosure. This is the
assertion that all appropriate information and disclosures regarding the company’s
financial statement are included in the statement, and that all the information presented in
the statement is presented in a fair and clear manner that facilitates ease of understanding
the information contained in the statement.
7. Occurrence
Being sure the the transactions and events recorded actually occur and pertain to the
entity.
8. ETHICS & PROFESSIONAL RESPONSIBILITIES – (5 points).
a. What is Ethics? List and describe 3 Theories of Ethical Behavior.
Ethics are concerned with fundamental principles of right and wrong and what
people ought to do.
“Refers to a system or code of conduct based on moral duties and obligations that
indicate how an individual should interact with others in society”
Theories of Ethical Behavior.
1. Utilitarian Ethical Theory
“Utilitarian theory was first formulated in the eighteenth century by Jeremy Bentham and
later refined by John Stuart Mill. Utilitarian look beyond self-interest to consider
impartially the interests of all persons affected by an action. The theory emphasizes
consequences of an action on the stakeholders. The stakeholders are those parties
affected by the outcome of an action. Utilitarian recognize that trade-offs exist in
decision-making. Utilitarian theory is concerned with making decisions that maximize
net benefits and minimize overall harms for all stakeholders. It is similar to cost-benefit
analysis decision-making. The ultimate rule to follow is the “Greatest Good for the
Greatest Number.”
2. Virtue-Based Ethical Theory
Judgment is exercised not through a set of rules, but as a result of possessing those
dispositions or virtues that enable choices to be made about what is good and holding in
check desires for something other than what will help to achieve this goal. Thus, virtuebased ethics emphasizes certain qualities that define appropriate behavior and the right
action to take. Unlike the other standard ethical theories discussed, virtue theory does not
establish a set of criteria to evaluate potential decisions. “Rather, it emphasizes the
internal characteristics of an individual with whom we would want to enter into a
relationship of trust. The ultimate goal is for “the decision maker to do the right thing in
the right place as the right time in the right way.”
3. Rights-Based Ethical Theory
Modern rights theory is associated with the eighteenth-century philosopher Immanuel
Kant. Rights theory assumes that individuals have certain entitlements that should be
respected such as freedom of speech, the right of privacy, and due process. Kant’s theory
establishes an individual’s duty as a moral agent toward others who possess certain
rights. It is based on a moral principle that he calls the categorical imperative. “One
version of the categorical imperative emphasizes the universality of moral actions. The
principle is stated as follows: “I ought never to act except in such a way that I can also
will that my maxim (reason for acting) should become a universal law.” The ultimate
guiding principle is, “I should only act in a way in which I would be happy if everyone in
that situation would act the same.”
b. Why is it important for an Auditor to behave ethically?
It is important because the value of the ethical audit is that it enables the company to see
itself through a variety of lenses: it captures the company’s ethical profile. Companies
recognise the importance of their financial profile for their investors, of their service
profile for their customers, and of their profile as an employer for their current and
potential employees. An ethical profile brings together all of the factors which affect a
company’s reputation, by examining the way in which it does business. By taking a
picture of the value system at a given point in time, it can clarify the actual values to
which the company operates, provide a baseline by which to measure future
improvement learn how to meet any societal expectations which are not currently being
met, give stakeholders the opportunity to clarify their expectations of the company’s
behaviour. identify specific problem areas within the company. learn about the issues
which motivate employees, identify general areas of vulnerability, particularly related
to lack of openness. “In relation to the specific factors of the ethical environment, studies
on codes of ethics have dominated the ethical accounting and auditing literature. Codes
of ethics are important since they implicitly set limits for unethical behaviour and are
intended to offer guidance in ambiguous situations”
c. Summarize the auditor’s professional responsibilities.
Auditing Standards
In private company, GAAS defines some general auditing standards for private
company. GAAS mandates that auditors have adequate training and proficiency to do the
audit. This means auditors should maintain professional certifications, like the certified
public accountant designation and any specialty designations for their field. It’s crucial
that auditors maintain consistency in how they conduct the audit. GAAS mandates that
auditors obtain sufficient and appropriate audit evidence. Auditors must conduct a risk
assessment to judge what is a sufficient amount of evidence. The appropriateness of
evidence can be up for debate, but it generally means the evidence should come from a
reliable source and be relevant to the audit. The AICPA makes it clear that all audit
reports should contain specific statements and disclosures. Auditors must identify the
accounting framework they are using for the audit and offer an opinion on whether or not
the financial statements were prepared according to the framework. Most U.S. companies
follow the U.S. generally accepted accounting principles, but an audit could be conducted
on a business based on the tax code or cash accounting.
In public company, the standards are similar to the private company with some
exception “PCAOB auditing standards currently consist of two types of equally
authoritative auditing standards: (i) standards originally issued by the Auditing Standards
Board (“ASB”) of the American Institute of Certified Public Accountants (“AICPA”) and
adopted by the Board on an interim, transitional basis in April 2003 and (ii) standards
issued by the Board”
Standards of professional conduct
In private company, it established by the code professional conduct (AICPA) which is is
a necessary component to any profession to maintain standards for the individuals within
that profession to adhere. It brings about accountability, responsibility and trust to the
individuals that the profession serves. Also, three standards include : independence
decision with audit committee , certain independence implication of audits of mutual
funds and related entities, and employments with audit clients issued by ISB . ISB also
issued three interpretations include : impact on auditor independence of assisting clients
in the implementation of FAS, the applicability of ISB standards, and an amendment of
ISB interpretations.
In public company, “CPA must follow the auditing standards PCAOB. the code of
professional conduct and also the more stringent Independence requirements established
by the SEC, ISB and PCAOB”
d. What is independence? An auditor may be independent of mind but not of
appearance. Explain the difference between the two. Why are both important?
An independent auditor is a certified public accountant (CPA) or chartered
accountant (CA) who examines the financial records and business transactions of
a company with which he is not affiliated. An independent auditor is typically
used to avoid conflicts of interest and to ensure the integrity of performing an
audit.
difference between the two :
1.
independent of mind
More specifically, real independence concerns the state of mind an auditor is in, and how
the auditor acts in/deals with a specific situation. An auditor who is independent ‘in fact’
has the ability to make independent decisions even if there is a perceived lack of
independence present,or if the auditor is placed in a compromising position by company
directors..
2.
independent of appearance
The avoidance of facts and circumstances that are so significant that a reasonable and
informed third party, having knowledge of all relevant information, including safeguards
applied, would reasonably conclude a firm’s, or a member of the assurance team’s,
integrity, objectivity or professional scepticism had been compromised.
The Important for both types of independence is to keep the The auditor
independent from the client company, so that the audit opinion will not be
influenced by any relationship between them. The auditors are expected to give an
unbiased and honest professional opinion on the financial statements to the
shareholders.
e. The auditor’s independence rules also apply to covered members. Who are
covered members? List and describe 4 covered members.
1.
2.
3.
4.
An individual who was formerly employed by a client or associated with a client
as an officer, director, promoter, underwriter, voting trustee, or trustee for a
pension or profit-sharing trust of the client would impair his or her firm’s
independence if the individual participated on the attest engagement team.
An individual in a position to influence the attest engagement is one who
evaluates the performance or recommends the compensation of the attest
engagement partner; directly supervises or manages the attest engagement partner,
including all successively senior levels above that individual through the firm’s
chief executive; consults with the attest engagement team regarding technical or
industry-related issues specific to the attest engagement; or participates in or
overseas, at all successively senior levels, quality control activities, including
internal monitoring, with respect to the specific attest engagement.
A partner or manager who provides nonattest services to the attest client
beginning once he or she provides ten hours of nonattest services to the client
within any fiscal year and ending on the later of the date. First, the firm signs the
report on the financial statements for the fiscal year during which those services
were provided. Second, he or she no longer expects to provide ten or more hours
of nonattest services to the attest client on a recurring basis.
“An entity whose operating, financial, or accounting policies can be controlled (as
defined by generally accepted accounting principles [GAAP] for consolidation
purposes) by any of the individuals or entities described in (a) through (e) or by
two or more such individuals or entities if they act together.”
9. AUDITORS LIABILITY – (5 points).
a. Explain the difference between common law and statutory law.
Common law, also known as case law, allows judges to render decisions based on
the rulings of earlier cases. Common law is guided by the regulations set forth in
federal or state statutes, but it does not rely exclusively on those written laws.
Statutory law refers to the written law established by the legislative branch of the
government. Statutes may be enacted by both federal and state governments and
must adhere to the rules set in the Constitution. Proposed statutes are reviewed by
the legislature prior to being enacted into law.
b. Under common law, describe the auditor’s liability;
1.
Liability to client
The auditor can be held liable to the client for :
breach of contract
If the the auditors are not performing within the agreement set forth in the contract this will
be considered a breach of contract. Also, if the client fail to complete his obligations . “
generally occurs when one of the parties avoids or neglects their legal obligations under the
agreement. When hearing cases involving common law contracts, courts also consider
where the breach was a result of a legal excuse or defense. Under the common law breach
of contract remedies, a party filing a lawsuit could ask a court to award specific performance
remedies, compensatory damages, or remedies for unjust enrichment. In other situations, a
party may seek liquidated damages.
“
Negligence
Is a failure to exercise the appropriate and or ethical ruled care expected to be exercised
amongst specified circumstances.The area of tort law known as negligence involves harm
caused by failing to act as a form of carelessness possibly with extenuating
circumstances. The Elements of negligence claims are: duty of care; which is The legal
liability of a defendant to a plaintiff is based on the defendant’s failure to fulfil a
responsibility, breach of duty; which is provement if that the defendant owed a duty to
the plaintiff/claimant, the matter of whether or not that duty was breached must be
settled, factual causation; it must be shown that the particular acts or omissions were the
cause of the loss or damage sustained, and harm; plaintiff may not recover unless he can
prove that the defendant’s breach caused a pecuniary injury. This should not be mistaken
with the requirements that a plaintiff prove harm to recover.
Fraud
“an auditor can be held liable to clients for fraud when he or she acted with knowledge
and intent to deceive. However, action alleging fraud on the part of the auditors result
from lawsuits by Third parties”
2.
Liability to third parties
The auditor can be held liable to the third parties for:
Ordinary Negligence
s the failure to act as a reasonably prudent person. It is the failure to exercise such care as
the great mass of mankind ordinarily exercises under the same or similar circumstances.
Ordinary negligence is the want of exercise of ordinary care
Four Legal Standards for Third Parties
1.
Private
“. The traditional view held that auditors had no liability under common law to third
parties who did not have a privity relationship with the auditor. Privity here means that
the obligations that exist under a contract are between the original parties to the contract,
and failure to perform with due care results in a breach of that duty only to those parties.
Many courts have reexamined the privity notion and substituted the concept of public
responsibility”
2.
Near privity
“ third parties whose relationship with the CPA approaches privity”
3.
Foreseen third parties
“third parties whose reliance should before seen, even if the specific person is unknown
to the auditor”
4.
Reasonable foreseeable third parties
“ third parties whose reliance should be reasonably foreseeable,even if the specific person
is unknown to the auditor”
Fraud and Gross Negligence
This is a fraud committed by people outside an employee employer relationship. They
can be committed against individuals, businesses, companies, the government or any
other entity. Third party frauds are not as common as occupational frauds, but on average
each fraud is for a larger amount. Some third party frauds are not meant to remain hidden
forever. Some only remain hidden long enough for the fraudster to make their get-away.
The fraudster may not care if the fraud is eventually discovered as they do not have a
continuing relationship with the victim and they cannot be found. Third Party Must Prove
“A false representation by the CPA,knowledge or belief by the CPA that the
representation was false,the CPA intended to induce the 3rd party to rely on the false
representation, the third party relied on the false representation and the third party
suffered damages”
c. List and describe the categories of parties that may be involved? What must be
proven by the parties; what are the auditor’s possible defenses?
1.Privity: The traditional view held that auditors had no liability under common law to
third parties who did not have a privity relationship with the auditor
2. Near privity: “ third parties whose relationship with the CPA approaches privity”
3. Foreseen third parties:“third parties whose reliance should before seen, even if the
specific person is unknown to the auditor”
4. Reasonably foreseeable third parties: “ third parties whose reliance should be
reasonably foreseeable,even if the specific person is unknown to the auditor”
Must be proven for these categorize: the auditor had a duty to the plaintiff to exercise
due care,the auditor breached that duty and was negligent in following
professional standards. the auditor’s breach of due care was the direct cause of the
third party’s loss and the third party suffered and actual loss.
Auditor’s defense these categorize: no duty was owed , the client was negligent
(contributory negligence, comparative negligence, or management fraud), the audit was
performed in accordance with GAAS, the client suffered no loss, tny loss was caused by
other events, the claim is invalid because the statute of limitations has expired.
Other categorize
1.
Negligence
Is a failure to exercise the appropriate and or ethical ruled care expected to be exercised
amongst specified circumstances.The area of tort law known as negligence involves harm
caused by failing to act as a form of carelessness possibly with extenuating
circumstances. The Elements of negligence claims are: duty of care; which is The legal
liability of a defendant to a plaintiff is based on the defendant’s failure to fulfil a
responsibility, breach of duty.
Must be proven: “a duty was owed to the client, failure to act in accordance with that
duty, a causal connection between the auditor’s negligence and the client’s damage and
actual loss or damage to the client”.
Auditor’s defense against clint negligence claims include; “no duty was owed to the
client the client was negligent, the auditor’s work was performed in accordance with
professional standards, the client suffered no loss.5, lack of causal connection between
auditor negligence and the client loss and the claim is invalid because the statute of
limitations has expired”
2.
Ordinary Negligence
The failure to act as a reasonably prudent person. It is the failure to exercise such care as
the great mass of mankind ordinarily exercises under the same or similar circumstances.
Ordinary negligence is the want of exercise of ordinary care

Must be proven : the auditor had a duty to the plaintiff to exercise due care, the
auditor breached that duty by failing to act with due professional care. there was a
direct causal connection between the auditor’s negligence and the third party’s
injury, the third party suffered an actual loss as a result.
Auditor’s defense: “no duty was owed to the third party (level of duty required
depends on the case law followed by the courts), the third party was negligent, the
auditor’s work was performed in accordance with professional standards, the third
party suffered no loss, lack of causal connection between auditor negligence and
the client loss, and the claim is invalid because the statute of limitations has
expired”
3. Fraud and Gross Negligence
This is a fraud committed by people outside an employee employer relationship. They
can be committed against individuals, businesses, companies, the government or any
other entity. Third party frauds are not as common as occupational frauds, but on average
each fraud is for a larger amount. Some third party frauds are not meant to remain hidden
forever. Some only remain hidden long enough for the fraudster to make their get-away.
The fraudster may not care if the fraud is eventually discovered as they do not have a
continuing relationship with the victim and they cannot be found.


Must be proven “A false representation by the CPA,knowledge or belief by the
CPA that the representation was false,the CPA intended to induce the 3rd party to
rely on the false representation, the third party relied on the false representation
and the third party suffered damages”
Auditor’s defense: “”If the auditor has been only negligent he or she can claim
that his or her negligence did not rise to the level of gross negligence or fraud.
The auditor can also raise the statute of limitations as defenses. Finally the auditor
can claim that the plaintiff’s lack of due diligence led unjustifiably to reliance on a
false representation”
d. List and describe the SEC Act of 1933 and 1934. Who are the parties that the
auditor may be liable to under these Acts? What must be proven by them
against auditors? What are the auditor’s possible defenses?
SEC Act of 1933
The first significant case brought under the Securities Act of 1933. The auditors were
unable to establish their due diligence, especially with respect to the S-1 review for
subsequent events up to the effective date of the registration statement. Under the Securities
Act of 1933, third Party must Prove “ The third party suffered losses by investing in the
registered security and the audited financial statements contained a material omission or
misstatement”

SEC Act of 1934
Ernst and Ernst v. Hochfelder Established that the auditors could not be held liable under
Rule 10b-5 of the Act for ordinary negligence. The U.S. Supreme Court concluded that
the auditor’s’ knowledge of the fraud must be proved before damages can be recovered
under this provision of the Securities Exchange Act of 1934. Third party should improve “
a material, factual misrepresentation or omission, reliance on the financial statements,
damages suffered as a result of reliance on the financial statements, scienter (gross
negligence or recklessness may be enough)”
Who are the parties that the auditor may be liable to under these Acts?
What must be proven by them against auditors? What are the auditor’s
possible defenses?
1.
Section 11 under securities Act of 1933 which “ imposes a liability on issuers and
others,including auditors, for losses suffered by third parties when false or
misleading information is included in a registration statement”
Must be proven : “ the third party suffered losses by investing in the registered
security and the audited financial statements contained a material omission or
misstatement”
Auditor’s defense: due diligence which is the auditor should made investigation
for purpose of the facts supporting or contradicting the information included in
the registration statement”
2.
Section 18 under securities Act of 1934 which “ imposes liability on any person
who makes a material false or misleading statement in documents filed with the
SEC. Section 10(b) and Rule 10b-5 are the greatest source of liability for auditors
under this act”

Must be proven : a material, factual misrepresentation or omission, reliance on the
financial statements, damages suffered as a result of reliance on the financial
statements and scienter.
Auditor’s defense: The auditor performs the audit with enough due diligence. In
addition, prove that the plaintiff loses did not caused by reliance on financial
statement and The statute of limitations has expired.
e. List and describe 5 steps that an auditor should take in order to prevent litigation.
1.
Service-Specific Documentation. Complete separate engagement letters for each
service offered any given client, from audit, review, and compilation to tax, consulting,
and other services. For example, while bookkeeping is less complex than other
assignments and may be one of two or three services you provide to a client, it is
important to be clear about the scope of bookkeeping services, especially when bank
reconciliation is involved.
2.
Set the Scope. Define limitations of services from day one and enforce them;
clients often try to expand the scope after a problem is discovered.
3.
Set the Tone. An engagement letter is a must. Failure to create this document can
lead to broad interpretation of scope of services actually performed and lead to
misunderstandings and unrealistic expectations.
4.
Coordinate. Make sure invoices match the scope of the engagement;
embellishment could result in fraud risks.
5.
Set Realistic Standards. Don’t overpromise. It’s important that proposals align
with the promise to deliver specific services, experience in accomplishing the services as
well as the accountants’ availability and resources.
10. AUDIT ACCEPTANCE & PLANNING (4 points).
You are an experienced CPA and have been assigned to be the in-charge auditor to
audit the financial statements of Montclair Company, a publicly held company for
the first time. If you accept the engagement, you will supervise 3 assistants on the
engagement and will be required to communicate with the predecessor auditor.
a.
List the steps that you would take before accepting a new client.
1. Evaluate prospective client integrity personally
Ask for and follow up with references, including attorneys, bankers, other business
consultants, and major vendors or customers. Verify that relationships were not
terminated due to disagreements regarding business operations or outstanding invoices.
2. Perform engagements with professional competence.
Before agreeing to propose on or accept an engagement, consider whether the requested
service can be competently provided in accordance with applicable professional standards
3. Consider risks related to the particular engagement
4. Formalize the process
contact with the firms to develop a new client acceptance checklist to document the decisionmaking process. The checklist should identify what the firm deems important and provide
a written record of representations made by prospective clients and why the firm accepted
them
b.
List and describe the steps that you should take immediately after accepting
a new audit client.
1. request a permission of the new client before contacting with predecessor auditor
It is important to request a permission of the new client before contacting with
predecessor auditor due to the fact as auditor it hard to disclose confidential any
information about a client without firm’s consent.
2. Make some inquiries of predecessor auditor
These inquiries include; information that might bear on the Integrity of management,
disagreements with management about accounting policies auditing procedures or other
similarly significant matters. Communications to those charged with the government
regarding fraud and noncompliance with laws or regulations by the entity.
Communications to those charged with the government regarding regarding deficiencies
and material weakness in internal control and the predecessor auditor’s understanding
about the reasons for the change of the auditors”
3. Make engagement letter
It is necessary to save both parties rights and avoid any mistakes and misstatements in
future.
c.
List and describe the items that should be included in the engagement letter.
Describe the benefits derived from the engagement letter.
– Items that should be included in the engagement letter:
1. Name of the entity
Engagement will start with the entity’s name
2. The objectives of the engagement
Shows the purpose of the engagement and use this letter as improve between parties
3. Management’s responsibilities
The management of company is responsible for the financial statements from all sides.
4. The auditor’s responsibilities:
Ensure the validity and relevance of financial information in the financial statements and
make sure they are free of any errors and manipulation. Give an opinion about the
financial statements
5. The limitations of the engagement.
This shows what should be and what should not be during the engagement. In other
words, give the terms of engagement

d.
The benefit of the engagement letter is to formalize the arrangements reached
between the auditor and the entity. This also help to reduce the risk that any party
may misinterpret what is expected or required of other party
List and describe the steps involved in a financial statement audit.
1. Engagement Acceptance
“The American Institute of CPAs recommends that an auditor evaluate the risks
associated with each engagement.”Therefore, a CPA inquires about any special
circumstances, the integrity of management and pending lawsuits before performing an
audit.
2. Planning
Auditing standards require that an auditor prepare adequate planning for an engagement.
The amount of audit planning needed is in direct relation to the size and complexity of
the organization. Audit planning involves obtaining an understanding of the
organization’s business and industry, performing trend and ratio analysis.The auditor
utilizes the results of the planning process to determine the timing and extent of audit
testing.
3. Audit Tests
During the fieldwork process, or the time the auditor spends at the organization offices,
the auditor performs tests of financial data. “For instance, a CPA selects a random sample
of forty disbursements to ensure checks are payable to the correct vendor and are written
for the correct amount”. In addition, an auditor reviews the invoice associated with the
disbursement to ensure the expense is classified correctly and that the vendor actually
exists.
4. Account Analysis
During the account analysis process, the auditor ensures that financial statement account
balances are supported by underlying documentation and analysis. A CPA evaluates the
results of tests, reviewers responses to inquires and records audit-adjusting journal
entries.
5. Reporting
CPAs issue an opinion on audited financial statements as to whether the financial
statements are presented in accordance with accounting principles generally accepted in
the U.S. The opinion is issued on the Independent Auditor’s report.
6. Summation
An auditor is required to retain proper documentation regarding the audit and obtain
signatures from management regarding management’s responsibility for the information
reported in the financial statements. The information is retained by the CPA should
lawsuits occur regarding reported amounts and for future account analysis.
11. PROPOSED NEW U.S. AUDITING STANDARD (5 points)
In response from the outcry from the public, several countries have enacted a new
Auditing Standard. The U.S. has also proposed a new standard.
a.
What are the major components of the new U.S. Standard?
The new reproposes in 2016 retain the existing “pass/fail” opinion and asked for basic
elements of the auditor’s report with additional information in the auditor’s report about
the audit and the auditor. “The auditor would be required to communicate audit report
CAM arising from the audit of the current period’s financial statements. CAM are any
matters arising from the audit of the financial statements communicated, or required to be
communicated, to the audit committee and that: relate to accounts or disclosures that are
material to the financial statements, and Involved especially challenging, subjective, or
complex auditor judgment In determining whether a matter involved especially
challenging, subjective, or complex auditor judgment, the auditor would take into account
specific factors such as the auditor’s assessment of the risks of material misstatement,
including significant risks.”
The changes on the auditor’s report are it recognize the CAM, describe the principal
considerations that guide him to decide the matter is a CAM, describe how it was
addressed in the audit and refer to the relevant financial statement accounts and
disclosures.
So, The major component are “Limiting the source of potential CAM to matters
communicated, or required to be communicated, to the audit committee, Adding a
materiality component to the definition of CAM as it relates to accounts or
disclosures,Narrowing the definition to only those matters that involved especially
challenging, subjective, or complex auditor judgment, Narrowing the related
documentation requirement to be consistent with the definition of a CAM, and Expanding
the communication requirement so the auditor describes how the CAM was addressed in
the audit” Also, it is important that the “A statement containing the year the auditor began
serving consecutively as the company’s auditor (“auditor tenure”), The opinion to be the
first section of the auditor’s report and required section titles to guide the reader,
Enhancements to existing language in the auditor’s report, including related to the
auditor’s responsibilities for fraud, A statement that the auditor is a public accounting
firm registered with the PCAOB (United States) and is required to be independent with
respect to the company in accordance with the United States federal securities laws and
the applicable rules and regulations of the Securities and Exchange Commission and the
PCAOB”
b.Do you think that the proposed Standard will be implemented? Explain why or why
not.
Yes, I think it is important to be implemented . The new changes may appear in auditors
reporting on define facts and circumstances specially to the audit of a company. These
facts and circumstances may apply to all audits conducted under PCAOB standards, so
the communication of CAM would not be required for audits of brokers and dealers
reporting under the SEC Act of 1934 Rule 17a-5, “investment companies other than
business development companies, and employee stock purchase, savings, and similar
plans”
c.
If the new Auditing Standard was implemented, what impact will it have on the
following parties:
i.
The Financial Statement Users.
The financial statement users will get more information and a full details about
the statements and they will avoid any misunderstanding which make them take an investing
decision fairly in their relation with the company.
ii.
The Auditors.
The auditors will give more information which make them prove a clear and fair opinion of
the financial statements’ users and give a full information to their clients. So, the auditor
may attract investors, obtain loans, and improve public appearance by their auditor’s report.
iii.
The Company’s Management.
Theses changes my enhancements to existing language in the auditor’s report including the
auditor responsibility and management responsibility. Management responsibility
would be more clear for the users and decision maker about the company’s financial
statements
iv.
The Standard setters and regulators.
These changes may make the standard setters to follow up the new standard in order to
make any enhancements required to keep this standard helpfull for all company’s
parties.

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