CHAPTER 5 MANAGEMENT OF A PUBLIC ACCOUNTING PRACTICE
I.
Review Questions
1.
Identify Identify the the steps that that are involved involved in accep accepting ting an audit audit engagem engagement. ent. The steps in accepting an audit engagement engagement are (a) evaluating evaluating the integrity of management, management, (b) assessing the auditor’s ability to meet GAAS and (c) preparing an engagement letter.
2.
Contrast Contrast the manner manner in which which the auditor auditor can determ determine ine the integrit integrity y of management management between between a new and a recurring audit engagement. For a new client, the auditor can obtain information about the client’s management by (a) inquiring of know knowle ledg dgea eabl ble e pers person ons s with within in the the comm commun unit ity y and and (b) (b) comm commun unic icat atin ing g with with the the prio priorr (predecessor) (predecessor) audit if the client has been audited audited previously. previously. For a recurring recurring client, the auditor should consider consider his prior experiences experiences with the client’s client’s management. Any instances instances of material errors errors or irregul irregularit arities, ies, illegal illegal acts, acts, and untruthf untruthful ul answers answers to inquiri inquiries es should should be carefull carefully y considered.
3. a.
What What is is the the comp compos osit itio ion n of of a typi typica call audi auditt team team? ? An audit team typically consists of (1) a partner who has both overall and final responsibility for the engagement, (2) one or more managers who coordinate and supervise supervise the execution of the audit program, (3) one or more seniors who may have responsibility for parts of the audit program and who supervise and review the work of staff assistants, and (4) staff assistants who perform most of the required procedures.
b.
What types types of assist assistance ance may may client client personn personnel el provide provide in an an audit? audit? Client personnel may: •
Prepare a trial balance of the general ledger.
•
Reconcile control and subsidiary accounts.
•
Age accounts receivable (i.e., current, thirty days past due, etc.)
•
Prepare schedules of insurance policies in force, notes receivable, and plant assets.
4. What What is an “enga “engage geme ment nt lett letter er”? ”? Why Why is its its use use reco recomm mmen ende ded d prio priorr to the the rend render erin ing g of professional services by CPAs? An engagement letter is the agreemen agreementt or understand understanding ing between the CPA and his/her his/her client concerni concerning ng the nature nature of the engagemen engagement. t. It provides provides protection protection for the CPA in the event of subsequent subsequent legal action alleging negligence negligence or breach of contract. By committing the agreement agreement to writing, the engagement letter also minimizes future misunderstandings between the CPA and client concerning the services to be performed by the CPA.
5.
What sources of information can a CPA use in connection with deciding whether to accept a new audit client? A CPA can use the following sources of information to help decide whether to accept a new audit client. Financial information prepared by the prospective client: Annual reports to shareholders Interim financial statements Securities registration statements Annual report on SEC Reports to regulatory agencies Inquiries directed to the prospect’s business associates: Banker Legal counsel Underwriter Other persons, e.g., customers, suppliers Predecessor auditor , if any, communication, re: Integrity of management, Disagreements with management Analysis: Special or unusual risk related to the prospect Need for special skills (e.g., computer or industry expertise) Internal search for relationships that would comprise independence
6.
What benefits are obtained by having an engagement letter? Benefits of engagement letters are: Helps establish an understanding between client and auditor of the terms of the engagement and the nature of the work. Helps avoid quarrels and misunderstandings between client and auditor. •
• •
Helps avoid disputes over the audit fee.
Helps avoid legal liability assertions based on failure to do work that the CPA may not have contemplated or agreed to do. •
7.
What factors should an auditor consider before accepting a new client? For a proposed client, an auditor must evaluate whether any relationships violate the Code of Ethics for Professional Accountants in the Philippines. Relationships that present problems are relationships between the firm (and its personnel) and the client (and its personnel). In addition, the auditor must determine whether a potential client is auditable; that is, whether sufficient competent evidence can be accumulated to render an opinion. For smaller potential client, two issues, the adequacy of accounting records and management integrity, must be considered. For larger potential clients, the auditor must evaluate the adequacy of accounting records, management integrity, and the quality of internal control.
8.
Why is management integrity important to an auditor? Since the auditor must evaluate the financial statement assertions of the client, the integrity of the potential client’s management is of critical importance. An auditor usually does not audit 100 percent of a client’s transactions. In addition, certain assertions cannot be evaluated externally.
9.
What steps should a potential successor auditor follow in communicating with a predecessor auditor? What general types of inquiry should the successor make? The successor auditor should ask the client to authorize the predecessor auditor to respond fully to the successor’s inquiries. If the client refuses or limits the responses, the successor should ask the client to explain the reasons. After obtaining the explanation, the successor should consider whether to continue pursuing the engagement. The successor auditor is expected to make specific and reasonable inquiries. These inquiries should address facts that bear on management integrity, disagreements with management on accounting principles, and the predecessor’s understanding of the reason(s) for the change in auditor. In normal situations, the predecessor is expected to respond promptly and fully to reasonable inquiries.
10. What are the purposes of an engagement letter? What matters should be included in it? An engagement letter is designed to formalize any oral agreements made between the client and the auditor. It should include a description of the scope of services to be provided; an explanation of the services to be provided, including a disclaimer of responsibility for detecting fraud; a statement about the obligations of client’s staff to assist in the engagement; a statement about fees, or method of determining fees, and payment of expectations; and a statement about other services to be performed. 11. What procedures should an auditor undertake to obtain information about the client’s business and industry? To obtain information about the client’s business and industry, an auditor can review prior-year working papers, review current-year client information, inquire of management and the audit committee, read PICPA industry audit and accounting guides relevant to the client, and significant industry publications and manuals maintained by the firm on the industry. 12. Explain management’s responsibility for financial reporting. 13. Describe an audit committee. 14. What are the typical functions performed by an audit committee? 15. Explain how an audit committee can help an auditor be more independent. 16. Describe the financial audit process.
II.
Multiple Choice Questions
1.
Before accepting an engagement to audit a new client, an auditor is required to a.
Make inquiries of the predecessor auditor after obtaining the consent of the prospective client.
b.
Obtain the prospective client’s signature to the engagement letter.
c.
Prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan.
d.
Discuss the management representation letter with the prospective client’s audit committee.
2. Which of the following is not one of the three main reasons why the auditor should properly plan engagements?
3.
4.
5.
a.
To help keep audit costs reasonable.
b.
To avoid misunderstandings with the client.
c.
To enable the auditor to obtain sufficient competent evidence.
d.
To enable proper on-the-job training of employees.
One of the six major parts of audit planning is preplanning. Which of the following is not involved during the preplanning phase? a.
Deciding whether to accept or continue this client.
b.
Obtaining information about client’s legal obligations.
c.
Selecting staff for the engagement.
d.
Obtaining an engagement letter.
Which of the following would not be a consideration of a CPA firm in deciding whether to accept a new client? a.
Client’s probability of achieving an unqualified opinion.
b.
Client’s financial ability.
c.
Client’s relation with its previous CPA firm.
d.
Client’s standing in the business community.
Where client is changing auditors, PSA requires communication between predecessor and successor auditors. The burden of initiating the communication rests with the
6.
7.
a.
predecessor
b.
client
c. d.
successor
SEC
The purpose of an engagement letter is to a.
Reduce the terms to writing in order to minimize misunderstandings.
b.
Reduce the CPA firm’s responsibility to external users of the audited financial statements.
c.
Satisfy the Statute of Frauds which requires that contracts for professional services must be in writing to be enforceable.
d.
Notify the audit staff of an upcoming engagement so that personnel scheduling can be facilitated.
The engagement letter will do one, some, or all of the following: 1.
State whether the CPA will perform audit, review, or compilation services.
2.
State whether the CPA will perform tax or management advisory or other services.
3.
State any restriction to be imposed on the CPA’s work.
4.
Identify deadlines for completing the work.
5.
State the amount and type of work to be done by client’s personnel in generating auditor’s workpapers.
6.
State the CPA’s fees for the engagement.
7.
Inform the client that the CPA does not have responsibility for detecting fraud.
The engagement letter will do
8.
a.
Numbers 1, 2,4, and 6.
b.
Numbers 1, 2, 3, 4, and 6.
c.
Numbers 1, 3, 5, and 7.
d.
All seven of the above stated items.
The engagement letter a.
Does affect the CPA firm’s responsibility to external users of audited financial statements.
b.
Can affect legal responsibilities to the client.
9.
c.
Can be used to alter the auditor’s responsibilities under Generally Accepted Auditing Standards.
d.
Is useful only if it is an engagement, but has no effect for review or compilation services.
After preliminary audit arrangements have been made, an engagement confirmation letter should be sent to the client. The letter usually would not include a.
A reference to the auditor’s responsibility for the detection of errors or irregularities.
b.
An estimation of the time to be spent on the audit work by audit staff and management.
c.
A statement that management advisory services would be made available upon request.
d.
A statement that a management letter will be issued outlining comments and suggestions as to any procedures requiring the client’s attention.
10. Early appointment of the independent auditor will enable a.
A more thorough examination to be performed.
b.
A proper study and evaluation of internal control to be performed.
c.
Sufficient competent evidential matter to be obtained.
d.
A more efficient examination to be planned.
11. An audit engagement letter should normally include the following matter of agreement between the auditor and the client: a.
Schedules and analyses to be prepared by the client’s employees.
b.
Methods of statistical sampling the auditor will use.
c.
Specification of litigation in progress against the client.
d.
Client representations about validity of all minutes of meetings of the board of directors.
12. Any services in which the CPA firm issues a written communication that expresses a conclusion with respect to the reliability of a written assertion that is the responsibility of another party is a(n) a.
Accounting and bookkeeping service.
b.
Attestation service
c.
Management advisory service
d.
Tax service
13. The three types of assurance services are a.
Audits, reviews, and compilations.
b.
Audits, compilations, and other assurance services.
c.
Reviews, compilations, and other assurance services.
d.
Audits, reviews, and other assurance services.
14. The predominant type of assurance service performed by CPAs is a.
Audit.
c.
Compilation.
b.
Review.
d.
Management consulting.
15. Which of the following services provides a moderate level of assurance about the client’s financial statements? a.
Forecasts and projections.
c. Review
b.
Compliance.
d. Audit.
16. Which of the following services provides no assurance about the client’s financial statements? a.
Compliance
b.
Review
c.
Audit
d.
None of the above provide no assurances; they all provide some level of assurance.
17. The purpose of the requirement in PSA of having communication between the predecessor and successor auditor is a.
To allow predecessor to disclose information which would otherwise be confidential.
b.
To help the successor auditor to evaluate whether to accept the engagement.
c.
To help the client by facilitating the change of auditors.
d.
To ensure that information which is provided to the SEC will be accurate.
18. The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when a.
Predecessor auditor has poor relations with successor auditor.
b.
Client is dissatisfied with predecessor’s work.
c.
There are legal problems between client and predecessor.
d.
Predecessor believes that client lacks integrity.
19. Investigation of new clients and reevaluation of existing ones is an essential part of deciding a.
Inherent risk
c. Statistical risk
b.
Acceptable audit risk
d. Financial risk
20. One means of informing the client that the auditor is not responsible for the discovery of fraud is the a.
engagement letter.
c.
responsibility letter.
b.
representation letter.
d.
client letter.
21. Which of the following statements is correct concerning an auditor’s required communication with an entity’s audit committee? a.
This communication should include disagreements with management about significant audit adjustments, whether or not satisfactorily resolved.
b.
If matters are communicated orally, it is necessary to repeat the communication of recurring matters each year.
c.
If matters are communicated in writing, the report is required to be distributed to both the audit committee and management.
d.
This communication is required to occur before the auditor’s report on the financial statements is issued.
22. Which of the following matters is an auditor required to communicate to an entity’s audit committee? a.
The basis for assessing control risk below the maximum.
b.
The process used by management in formulating sensitive accounting estimates.
c.
The auditor’s preliminary judgments about materiality levels.
d.
The justification for performing substantive procedures at interim dates.
23. Should an auditor communicate the following matters to an audit committee of a public entity? Management’s Consultation
Significant
with Other Accountants about
Audit Adjustments
Significant
Recorded by the Entity
Accounting Matters
a.
Yes
Yes
b.
Yes
No
c.
No
Yes
d.
No
No
24. A CPA engaged to audit financial statements observes that the accounting for a certain material item is not in conformity with generally accepted accounting principles and that this fact is prominently disclosed in a note to the financial statements. The CPA should a.
express an unqualified opinion and insert a paragraph emphasizing the matter by reference to a note.
b.
disclaim an opinion.
c.
not allow the accounting treatment for this item to affect the type of opinion because the deviation from generally accepted accounting principles was disclosed.
d.
qualify the opinion because of the deviation from generally accepted accounting principles.
25. Which of the following is responsible for the fairness of representations made in financial statements? a.
Client’s management
b.
Independent auditor
c.
Audit committee
d.
Philippine Institute of Certified Public Accountants
26. The essence of attestation to financial statements is to a.
detect fraud.
b.
examine individual transactions so that the auditor may certify as to their validity.
c.
determine whether the client’s financial statements are fairly stated.
d.
assure the consistent application of correct accounting procedures.
27. The auditor’s judgment concerning the overall fairness of the presentation of financial position, results of operations, and cash flows is applied within the framework of a.
quality control.
b.
generally accepted auditing standards, which include the concept of materiality.
c.
the auditor’s evaluation of the audited company’s internal control.
d.
generally accepted accounting principles.
28. A typical objective of an operational audit is for the auditor to a.
determine whether the financial statements fairly present the entity’s operations.
b.
evaluate the feasibility of attaining the entity’s operational objectives.
c.
make recommendations for improving performance.
d.
report on the entity’s relative success in attaining profit maximization.
Answers: 1. 2. 3. 4. 5. 6. 7.
a d b a c a d
8. 9. 10. 11. 12. 13. 14.
b c d a b d a
15. 16. 17. 18. 19. 20. 21.
c a b c b a a
22. 23. 24. 25. 26. 27. 28.
b a d a c d c
