Auditing 101 | Part 1: Starting the Audit | Maxwell CPA Review

Main ideas, concepts, and lessons

1) Why companies get audited

• Companies prepare financial statements, which are then used by external users—especially:
  • Investors
  • Creditors (e.g., banks)
• These users need confidence that the financial statements are legitimate (e.g., revenue isn’t fabricated).
• Because of this need for credibility, companies hire external auditors to test accounts and conclude that the financial statements are fairly presented.

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2) Audit begins with client acceptance

Before agreeing to perform an audit, auditors should not accept a client just because the client pays. The auditor’s goal is to avoid clients who:

• Lack integrity
  • If management lacks integrity, auditors can’t rely on management-provided information.

Auditors also consider:

• Firm capabilities
  • Industry experience
  • Whether they need to hire component auditors
  • Whether deadlines align with what the firm can deliver
• Management responsibilities (3 areas)
  1. Prepare and fairly present financial statements
     • Responsibility is the company’s, not the auditor’s.
  2. Internal controls
     • Design: what controls are created and what they involve
     • Implementation: whether controls are actually followed
     • Maintenance: ongoing review and updates to the controls
  3. Provide access
     • Management must provide auditors access to:
       • Documentation
       • Employees
     • So auditors can complete the audit effectively.

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3) After accepting the client: start with an engagement letter

• The engagement letter is the contract between:
  • Auditors
  • Management
• It documents:
  • What the auditors will perform
  • What management is responsible for
  • Expected audit reports

Key features mentioned:

• The letter is sent by auditors to management, signed by management, and returned.
• It states auditors provide reasonable assurance, not absolute assurance (auditors might not detect every misstatement).
• It may include:
  • Audit fees
  • Accounting method
• It does not include details that would enable manipulation, such as:
  • Specific materiality levels
  • Specific test-work plans
    • Example rationale: If materiality were disclosed (e.g., $100,000), management could exploit the threshold.

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4) Audit documentation (working papers)

• “Audit documentation” = working papers / work papers
• Working papers can be as simple as:
  • An Excel file recording audit test work

Ownership and responsibility

• Working papers belong to the auditor, not the client.
• Auditors are not responsible for sending working papers to the client.

Purpose of working papers (2 main purposes):

1. Provide enough evidence to support the auditor’s opinion
2. Show that the audit complied with auditing standards

Two key documentation quality concepts:

• Sufficient = enough quantity of evidence
• Appropriate = evidence is high enough quality

How evidence quality is improved:

• Through the nature, extent, and timing of audit procedures:
  • Nature: type of testing performed
    • Example given: searching for unrecorded liabilities when testing accounts payable
  • Extent: amount of testing performed
    • Example implied: testing 20 vs. 40 items—more testing generally yields better evidence
  • Timing:
    • Year-end procedures: performed after year-end; higher quality evidence
    • Interim procedures: performed before year-end; generally lower quality evidence

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5) Planning the audit: strategy + plan + analytics

After client acceptance and documentation basics, auditors plan the audit using two planning documents:

A) Audit strategy (high-level)

• Determines overall audit objectives
• Staffing approach
• Budgeted hours (and other big-picture elements)

B) Audit plan (detailed)

• Lists specific procedures to be performed
  • Example: for accounts payable testing, the plan may include searching for unrecorded liabilities

Analytical procedures (to identify risk)

• Auditors perform analytics such as:
  • Trend analysis
  • Ratio analysis
• Purpose: identify the more risky parts of the company

Analytics are required in:

• The planning phase
• The overall review phase

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6) Planning phase requirements: understand the client, controls, and auditor changes

During planning, auditors do:

1. Understand the client’s business and industry

   • How the company operates
   • Methods of accounting
   • What is normal for the industry vs. unusual
   • Uses tools like:
     • Tours of the business
     • Industry guidelines

2. Understand internal controls

   • Focus on:
     • Design
     • Implementation
   • Distinction:
     • Understanding design/implementation is required
     • Testing for operating effectiveness (to rely on controls) may or may not be required

3. Consider the predecessor auditor

   • Terms:
     • Current auditor = successor auditor
     • Prior auditor = predecessor auditor
   • The successor auditor should attempt to communicate with the predecessor auditor to understand:
     • Why the client changed auditors
     • Whether the reason relates to potential integrity issues
   • Communication is at least an attempted requirement.

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7) Who auditors can rely on: internal auditors, specialists, and component auditors

Auditors may rely on other people or firms, but remain responsible overall.

A) Internal auditors (company employees)

• Staff who audit parts of the company to help prepare for the external audit.
• Limitations:
  • Not independent (they work for the company)
• Therefore, they’re best used for:
  • Low complexity
  • Low subjectivity areas
• They must still be:
  • Competent
  • Objective

B) Specialists (special skills)

• Used for specialized areas, e.g.:
  • Valuing a complex investment
• Auditors must:
  • Evaluate the specialist’s skill set and approach
  • Still remain responsible for reliance decisions and conclusions

C) Component auditors (group audits)

• In multi-subsidiary companies, different firms may audit different subsidiaries in different locations.
• Example concept given:
  • Group auditor (parent) coordinates with component auditors (subsidiaries)
• Key structure:
  • Component auditors set their own materiality levels
  • Component auditors perform their own test work
  • Group auditor reviews component results and incorporates them into the group audit

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Speakers / sources featured

• Maxwell CPA Review (course/instructor content creator; speaker not named in the subtitles).