Clarified Auditing Standards—Documenting Professional Judgment and Professional Skepticism

In my last article, the definitions of professional skepticism and professional judgment from the foundational clarified standards were presented.  As required by the clarified SAS, Audit Documentation, all applicable requirements in professional standards must be documented in engagement files.  Following is an illustrative Planning Document for group audits that demonstrates an efficient way to prepare the required documentation of professional skepticism and professional judgment.

Planning Document                                                               

Client: _________________________________________________________________

Engagement Date: _______________________________________________________

Instructions:

This document should be completed by the group engagement in-charge accountant and reviewed by the group engagement leader (partner, sole proprietor) before engagement personnel begin fieldwork. It should describe engagement procedures accomplished and/or planned for both the group and component audits.  It may contain cross-references to other planning documentation as applicable.

I.                    Group Engagement Administration:

A.     Delivery of Group Engagement Letter:

The engagement letter is one of the primary tools for obtaining client understanding of their responsibilities and auditors’ responsibilities. A good understanding before the engagement begins will prevent misunderstandings from arising later. To accomplish this, the group engagement leader should deliver the letter and discuss its contents with the group CEO and/or representative member of the board of group governance. The letter should indicate the components for which the group auditor is taking audit responsibility and the component auditors’ reports to which it will refer in the group audit report.

Discussion of the letter with the party or parties engaging the CPA firm should be one of the primary sources for discovering potential misstatements, fraud or illegal acts, as well as other information relevant to the group audit. The group audit partner should determine that component auditor partners have delivered and discussed their engagement letters with responsible management persons, even if the group auditor is not taking responsibility for the component auditor’s work.

B.     Use of Client Assistance or Paraprofessionals:

Client assistance should be used to the maximum extent possible on every engagement. When client personnel are unavailable, consider using firm paraprofessionals to perform accounting services and clerical work in connection with the engagement.

              C. Planning for Proper Workspace:

The group engagement leader has the responsibility to arrange adequate workspace before the fieldwork begins. Poor lighting, lack of adequate heat or air conditioning, desks or tables that are too small, or work locations that are not near client accounting personnel are examples of situations that hinder the efficient completion of an engagement.

  D. Assignment of Staff Personnel:

Assigning the right people to engagements ensures high quality and helps complete the engagements in the minimum amount of time. SQCS No. 8, effective January 1, 2012, requires CPA firm documentation of this element of quality control. Personnel should be assigned to engagements and tasks that are commensurate with their experience and capabilities. When persons assigned don’t have experience and capabilities commensurate with engagement risks, more and more frequent supervision is required from the engagement leader. A primary audit response to risk at the financial statement level required by audit and quality control standards is to assign experienced staff persons to the high-risk area or provide more supervision to lesser experienced persons.

When the group auditor is taking responsibility for component auditor’s work, the component auditor should confirm compliance with this element of quality control and required audit standard, and that appropriate documentation has been included in its engagement documentation files.

E. Target Dates:

Timely engagement completion involves setting target dates during planning. These target dates should be entered in the firm’s staff scheduling system.

Communications to component auditors should include target dates for the group auditor’s involvement when taking responsibility for the component auditor’s work, as well as dates financial information is required by the group auditor from all components

 F. Use of Specialists:

Consider using outside specialists whenever any auditing procedures outside the firm’s expertise are expected to be performed. Such circumstances may include actuarial computations for pension funds, questions of law, observations of inventories of products or materials, required tests of client accounting software, and complex accounting and auditing problem situations.

When the auditor outsources any services in connection with an engagement, the engagement letter should contain a paragraph notifying the client. The auditor is also required to obtain a confidentiality agreement from the person or organization performing outsourced services.

When group audit specialists are engaged to perform work that will also be applicable to components, the group auditor’s communication to component auditors should discuss the selection of the specialists and their processes.

G. Electronic Auditing Opportunities:

Trial balance and financial statement preparation software, electronic practice aids, file container software, spreadsheets, word processing software, document scanners, data extraction software (such as Idea, Monarch or ACL) and “cloud” services should be used to create efficiencies on the group and component audit engagements. List the specific, planned applications for discussion among the group engagement team and for communication to component auditors.

H  Audit Budgets:

Prepare a group audit budget based on circumstances, not fees, during engagement planning. Summarize the budget here for discussion among the group engagement team.  Include a separate section for involvement in the work of component auditors.

II.                 Group Technical Audit Planning Decisions

A.  Describe the process for selecting significant components.

Cross-reference this section to a separate memorandum or other documentation summarizing organizational, operational and financial information for all components.  Summarize the components determined to be significant and whether the group engagement team will take responsibility for component auditors’ work or, instead, refer to component auditors in the group audit report.

B.  Risk of misstatement at the group financial statement level:

Use of Group Statements:

            Describe high-risk uses of statements.

Potential for Group Going-Concern Problems:

Describe continued losses, high debt and external situations that threaten the continued existence of the group or any of its components.

                        Integrity of Group Management:

Discuss specific information that could cast doubt on group or component management’s integrity.

                       

Evaluate the risk of material misstatement at the group and component financial statement levels and document the subjective impact on audit responses and engagement procedures.  

C.  Document the group and components’ risk of misstatements evaluation at the assertion level (financial statement classification level for smaller entities), and the impact on the group and components’ audit strategy by major financial statement classification. This and other sections may be cross-referenced to other documentation.

D.  Group Materiality Judgments:

Present a summary of the tolerable misstatement (performance materiality) and lower limit for individually significant items calculations and document group engagement team reasoning for group and component financial statements materiality levels.

E.  Group Sampling and Non-Sampling Decisions:

Describe the reasons for making decisions to sample or not sample at the group and component levels. If decisions are made to sample, explain the rationale for sample size calculations.

F.  Group Audit Strategies:

Describe the general group audit strategy including detailed substantive tests of balances, risk assessment procedures, tests of controls and/or extensive analytical procedures. Cross-reference this section to other group audit documentation for specific audit strategies at the group and component financial statement classification levels.

G.  Nature of Group Audit Procedures:

Summarize the nature and extent of work for significant components and components to be referred to in the group audit report. Describe the nature, extent and timing of tests of balances procedures and analytical procedures for material financial statement classifications or cross-reference to other documentation describing planned procedures for material financial statement classifications at the group and component levels.

H.  Significant Time-Savings Opportunities:

Describe here the opportunities to save time on the group and/or component audits not discussed elsewhere.

 I.    Group Engagement Team Meeting:

Summarize the significant potential risks of misstatement at the group and component levels due to error or fraud, planned audit responses and other matters discussed at the group engagement team meeting. All group engagement personnel, including partners or sole practitioners, are required to attend this meeting.  Matters discussed affecting the work of component auditors should be communicated to them.

J.   Planned Involvement with Component Auditors

Summarize here, if not present above, the extent of involvement in the work of component auditors when the group engagement team plans to take responsibility for their work and/or when component auditors reports will be referred to in the group audit report. This should include both administrative and technical activities similar to those summarized above for the group audit.  This planned involvement should be part of the group engagement team’s communication to component auditors.

Prepared by:________________________________Date:_________________________

Reviewed by:_______________________________ Date:_________________________

Numerous webcasts and self-study courses covering various applications of auditing standards can be accessed by clicking the appropriate box on the left side of my home page, www.cpafirmsupport.com. Registered users on my website can obtain a 20% discount on CPE materials presented by myself and numerous other authors on a variety of professional topics.