The extent of the auditor’s planning depends on the nature of the client and the experience of the auditor with that client. For example, planning for the audit of a new client is more extensive than planning for the audit of an existing client. In audit planning for new clients, How does an auditor learn about client’s business?
When planning the audit, the auditor should have knowledge of the client’s operations—other than macro economic and client’s industry.
For a new client, the primary sources of information are discussions with the predecessor auditor and inquiries of client management. During the discussion, the auditor should obtain enough knowledge about the client’s business, organization, and operations to understand the events, transactions, and practices that may have an effect on financial statements. According to AU 311.07, the auditor should obtain knowledge of matters such as: type of business, types of products and services, capital structure, related parties, business locations, production and distribution methods, and compensation methods.
In more detail, the auditor should learn about the client and plan the audit by doing the following:
1. Communicate with predecessor auditor – The successor auditor should obtain sufficient competent evidence to afford a basis for expressing an opinion. The audit evidence used to analyze the impact of the opening balances on the current year financial statements and consistency of accounting principles is a matter of professional judgment. Audit evidence may include:
(a). The most recent audited financial statements.
(b). The predecessor auditor’s report.
(c). The results of inquiries of the predecessor auditor.
(d). The results of the successor auditor’s review of the predecessor’s audit documentation for to the most recently completed audit.
(e). Audit procedures performed on the current period’s transactions.
The successor auditor may wish to make inquiries about the professional reputation and standing of the predecessor auditor.
2. Visit to Administrative Office – During his or her visit to the client’s administrative office, the auditor should do the following:
(a) Meet with financial and administrative officers and obtain or determine the following:
- The functions of each executive.
- The executive responsible for the audit.
- Organization charts.
- locations and relative importance of all offices, showrooms, warehouses and factories.
- Obtain corporate manuals or memoranda that provide information about the following: (1) Nature and description of the entity’s products; (2) Production and distribution methods; (3) Internal control; and (4) General ledger chart of accounts.
- Methods of financing the entity’s operations.
- Schedule of long-term debt.
- Names of banks and account executive at each bank. For each bank, determine the following: (1) Outstanding indebtedness and terms of payment; (2) Lines of credit; and (3) Other banking services.
- For nonpublic companies, a schedule of stockholders with the following information: (1) Names; (2) Addresses; (3) Certificate numbers; (4) Number of shares held; (5) Shareholder function in the business.
- Purchase terms. (1) Terms of payment; and (2) Are letters of credit used for foreign purchases?
- Sales terms; (1) Terms of payment; and (2) Are letters of credit used for foreign sales?
- The existence of related-party transactions such as the following: (1) Purchases and sales; (2) Loans; and (3) Receiving or providing services, such as management, legal, and administrative.
- Schedule of all affiliates and non-consolidated subsidiaries.
- Customers and suppliers on whom the entity is economically dependent.
- Most recent trial balance.
- General ledger and books of original entry; (1) Are accounting records up-to-date?; (2) What is the quality of accounting records?
- Extent of client responsibility for preparation of the following: (1) Trial balance; (2) Schedules; (3) Adjustments and accruals; (4) Confirmations; (5) Inventory instructions; (6) Financial statements; (7) Income tax returns.
- Tentative audit schedule. Agree to dates for the following: (1) Physical inventory; (2) Cash and securities count; (3) Mailing and confirmations; and (4) Start of fieldwork.
(b). Obtain the entity’s forms and documents, such as the following:
- Purchase requisitions.
- Purchase orders.
- Sales authorizations.
- Sales orders.
- Sales invoices.
- Production orders.
- Production requisitions.
- Payroll cards.
- Sales returns and credits.
- Purchase returns and credits.
(c). Examine work area that will be allocated to the auditor.
(d). Walk through the accounting area.
- Observe work conditions.
- Meet employees.
- Determine employee functions.
3. Visit to Facility – During the visit to the client’s facility, the auditor should do the following:
(a). Meet with management.
(b). Walk through a production cycle and note the following:
- Initiation of order.
- Requisition of materials.
- Movement of production.
- Completion of production.
- Storage of completed product.
- Shipment to customer.
(c). Document flow of production.
(d). Note conditions of facility and equipment.
(e). Visit materials stockroom, observe condition of the inventory, and review the following:
- Inventory records.
- Receiving reports.
- Inventory reports.
4. Review Year-end and Interim Report – Review year-end financial statements of prior year and interim financial statements of current and prior year.
5. Review Predecessor’s Audit Report – Review auditor’s report on prior year’s financial statements—to get know about:
- Was there a scope limitation?
- Were certain matters emphasized?
- Did the auditor disclaim an opinion or issue an adverse opinion?
- Were there other modifications of the auditor’s standard report?
6. Review Income Tax – Review prior year’s income tax returns and obtain the results of the most recent income tax examination.
7. Review Agencies’ Report – Review reports issued to agencies, such as the following:
- Securities and Exchange Commission.
- Federal Housing Administration, Small Business Administration, and Department of Labor.
- Credit agencies and banks.