Select Auditing Considerations for the 2014 Audit Cycle

Transcription

1 Select Auditing Cnsideratins fr the 2014 Audit Cycle This Alert is intended t remind member firms f certain auditing cnsideratins that may be relevant fr the 2014 audit cycle. The Alert identifies and discusses sme f the mre judgmental r cmplex audit areas, including thse that have recently been the subject f attentin and fcus by regulatrs. The CAQ encurages member firms t cnsider the tpics addressed in this Alert in executing their 2014 audits. When cnsidering these audit areas, auditrs als shuld cnsider the elements f Public Cmpany Accunting Oversight Bard (PCAOB) Auditing Standard N. 12, Identifying and Assessing Risks f Material Misstatement (AS 12), and Auditing Standard N. 13 The Auditr s Respnses t the Risks f Material Misstatement (AS 13), as auditing issues identified in these areas may als be indicative f misapplicatin f these risk assessment standards. This Alert cvers the fllwing auditing cnsideratins: 1. Revenue Recgnitin 2. Ging Cncern 3. Internal Cntrl Over Financial Reprting 4. Auditing Accunting Estimates, Including Fair Value Measurements 5. Engagement Quality Review 6. Prfessinal Skepticism 7. Related Parties and Amendments t Certain PCAOB Auditing Standards Regarding Significant Unusual Transactins While the Alert highlights certain areas fr cnsideratin, it shuld nt be relied upn as definitive r allinclusive, and shuld be read in cnjunctin with the applicable rules, standards and guidance in their entirety. Revenue Recgnitin Revenue typically is a significant accunt, ften invlving significant risks that warrant special audit cnsideratin, and therefre ften is a fcus area in PCAOB inspectins f registered firms. The PCAOB issued Staff Audit Practice Alert N. 12, Matters Related t Auditing Revenue in an Audit f Financial Statements (Practice Alert N. 12), in September In additin, the Financial Accunting Standards Bard (FASB) and the Internatinal Accunting Standards Bard (IASB) in May 2014 jintly adpted a cnverged accunting standard n revenue recgnitin (the new accunting standard). Practice Alert N. 12 discusses the applicatin f certain requirements in PCAOB auditing standards that auditrs shuld be mindful f when auditing revenue under current accunting guidance. These auditing matters likely will cntinue t have relevance t auditing revenue under the new accunting standard. Further, althugh the new accunting standard is nt yet effective, the auditr shuld evaluate management s required disclsure f the impact the new accunting standard is likely t have n the financial statements, including evaluating the frm, arrangement, and cntent f the disclsure. Belw, we discuss sme f the tpics cvered in Practice Alert N. 12. Please refer t Practice Alert N. 12 fr the full details related t auditing revenue. 1

2 In designing the audit prcedures t be perfrmed, the auditr is required t (1) btain mre persuasive audit evidence the higher the auditr s assessment f risk; (2) take int accunt the types f ptential misstatements that culd result frm the identified risks and the likelihd and magnitude f ptential misstatement; and (3) in a financial statement audit, design tests f cntrls ver revenue t btain sufficient evidence t supprt the auditr s cntrl risk assessments when the auditr relies n cntrls. Als, in an integrated audit, the auditr is required t design the tests f cntrls t simultaneusly accmplish the bjectives f bth the financial statement audit and the audit f internal cntrl ver financial reprting. Testing Revenue Recgnitin, Presentatin and Disclsure Testing the recgnitin f revenue frm cntractual arrangements: T audit revenue, auditrs shuld understand, amng ther things, the cmpany s business, its different types f sales r service cntracts, and its cntrls ver revenue, including the cmpany s develpment f accunting estimates fr revenue. This als includes understanding the cmpany s key prducts and services and business prcesses that affect revenue, including cntractual terms by which sales are made, such as the key prvisins f cntractual arrangements and the extent t which cntractual terms are standardized acrss the cmpany s rganizatin. The auditr als is required t evaluate whether the cmpany s selectin and applicatin f accunting principles are apprpriate fr its business and cnsistent with the applicable financial reprting framewrk and accunting principles used in the cmpany s relevant industries. Examples f areas t fcus n include prductin-type r cnstructin-type cntracts (e.g., perfrm sufficient prcedures t test management s estimated csts t cmplete prjects) and multiple-element arrangements (e.g., evaluate each f the deliverables t determine whether they represent separate units f accunting). Further, revenue recgnitin ften invlves accunting estimates, such as estimates f future bligatins under the terms f sale in the cntract. If the accunting estimate is a fair value measurement, the auditr shuld apply the requirements f AU sec. 328, Auditing Fair Value Measurements and Disclsures (AU 328). Fr ther estimates, the auditr shuld apply the requirements f AU sec. 342, Auditing Accunting Estimates (AU 342). These auditing standards address, amng ther things, the auditr s respnsibilities with respect t evaluating the apprpriateness f the cmpany s methds and the reasnableness f management s assumptins used in the estimates and related disclsures, as well as the cmpleteness and accuracy f cmpany data used in the estimates. Evaluating the presentatin f revenue grss versus net revenue: When understanding the cntractual terms f sales, it is imprtant fr the auditr t evaluate whether the cmpany is the principal (i.e., the cmpany is a seller that has the primary bligatin t the custmer) r agent (i.e., the cmpany is a seller that des nt have the primary bligatin t the custmer) in the transactins. That evaluatin will determine whether revenue is prperly presented as grss (when the cmpany is acting as a principal) r net (when the cmpany is acting as an agent). 2

3 Testing whether revenue was recgnized in the crrect perid: The risk f material misstatement invlving the recgnitin f revenue in the incrrect perid might be a risk f errr (e.g., related t deficiencies in internal cntrls) r a risk f fraud (e.g., intentinally recgnizing revenue prematurely), bth resulting in imprper revenue recgnitin. Audit prcedures shuld be specifically designed t address the risk f material misstatement related t revenue recrded in the incrrect accunting perid. Examples may include: Perfrming cutff prcedures (e.g., testing sales transactins fr a sufficient perid befre and after year-end t determine that the transactins were recrded in the prper perid) Obtaining evidence abut whether the necessary delivery f gds had ccurred (r service had been rendered) Testing cmpany-generated infrmatin, such as sales invices r inventry recrds Evaluating whether the financial statements include the required disclsures regarding revenue: Auditrs shuld perfrm prcedures t identify, assess, and address risks f material misstatement f the financial statements including cnsideratin f the risk f mitted, incmplete, r inaccurate disclsures. Qualitative cnsideratins are especially imprtant t the evaluatin f misstatements in disclsures that are mre narrative in nature. PCAOB auditing standards 1 describe the auditr s respnsibilities fr cnsidering qualitative factrs in the cntext f the auditr s cnsideratin f materiality. Other Aspects f Testing Revenue Respnding t fraud risks assciated with revenue: PCAOB auditing standards require the auditr t presume that there is a fraud risk invlving imprper revenue recgnitin and t evaluate which types f revenue, revenue transactins, r assertins may give rise t such risks in the cmpany being audited. 2 Perfrming prcedures that are specifically respnsive t the assessed fraud risks invlves cnsidering the ways that revenue culd be intentinally misstated, hw the fraud might be cncealed, and designing audit prcedures directed twards detecting intentinal misstatements. When respnding t fraud risks, it is imprtant t design and perfrm prcedures that seek reliable evidence that wuld be difficult fr ptential perpetratrs t manipulate, such as evidence btained directly frm independent and knwledgeable surces utside the cmpany. Additinally, incrprating an element f unpredictability in the audit prcedures is imprtant in respnding t fraud risks. Unpredictable audit prcedures make it mre difficult fr individuals lking t perpetrate a fraud t anticipate, and therefre, mre difficult t cnceal an intentinal misstatement. Sme examples f unpredictable audit prcedures include: Varying the timing f the audit prcedures Selecting items fr testing that have lwer amunts r are therwise utside custmary selectin parameters Perfrming audit prcedures n an unannunced basis 1 Fr example, see paragraph 24 and Appendix B f Auditing Standard N. 14, Evaluating Audit Results. 2 See paragraph 68, AS 12. 3

4 Applying audit sampling prcedures t test revenue: AU sec. 350, Audit Sampling (AU 350), establishes requirements fr planning and perfrming audit sampling prcedures, and evaluating the results f such prcedures. Examples f areas t fcus n when applying audit sampling prcedures t test revenue include: Cnsidering the tlerable misstatement fr the ppulatin, the allwable risk f incrrect acceptance and the characteristics f the ppulatin when determining sample sizes Chsing a representative sample Testing sample items, including assessing the impact f nt being able t apply the planned audit prcedures because supprting dcumentatin may be missing Selecting specific items nt invlving sampling Perfrming substantive analytical prcedures t test revenue: When prperly applied under apprpriate cnditins, substantive analytical prcedures can identify a ptential material misstatement. Under PCAOB standards, substantive analytical prcedures alne are nt sufficient t respnd t significant risks, including fraud risks; therefre, tests f details als are needed in thse situatins. 3 When designing substantive analytical prcedures, the auditr shuld evaluate the risk f management verride f cntrls. As part f this prcess, the auditr shuld evaluate whether such an verride might have allwed adjustments utside f the nrmal perid-end financial reprting prcess t have been made t the financial statements. Such adjustments may have resulted in artificial changes t the financial statement relatinships being analyzed, causing the auditr t draw errneus cnclusins. T achieve the necessary level f assurance frm substantive analytical prcedures, the auditr shuld design and perfrm prcedures that apprpriately take int accunt, amng ther things: The nature f the assertin The plausibility and predictability f the relatinship The availability and reliability f the data used t develp the expectatin The precisin f the expectatin The threshld fr investigatin f differences The plausibility and predictability f relatinships is a critical factr in develping a prperly designed and perfrmed substantive analytical prcedure. Fr example, relatinships typically are less predictable when there are less stable envirnments r when amunts are determined frm cmplex prcesses, subjective judgments, r transactins subject t management discretin. On the ther hand, relatinships might be mre predictable if they are based n established relatinships, such as, cash flws based n cntract terms (when nnpayment risk is lw) and verifiable ratevlume determinatins. 3 See paragraphs 11 and 13, AS 13. 4

5 The auditr shuld assess the reliability f data used by cnsidering the surce f the data and the cnditins under which it was gathered, as well as ther knwledge the auditr may have abut the data. Befre using the results btained frm substantive analytical prcedures, the auditr shuld either test the design and perating effectiveness f cntrls ver the financial infrmatin r perfrm ther prcedures t supprt the cmpleteness and accuracy f the underlying infrmatin. The precisin f the expectatin shuld be set t an apprpriate level in rder t prvide the desired level f assurance that differences that may be ptential material misstatements individually r when aggregated with ther misstatements wuld be identified. Fr example, expectatins develped at a detailed level generally have a greater chance f detecting misstatement f a given amunt than d brad cmparisns. Further, the threshld fr investigatin (i.e., the amunt f difference frm the expectatin that can be accepted withut further investigatin) is influenced primarily by materiality. Determinatin f this amunt invlves cnsidering the pssibility that a cmbinatin f misstatements in the specific accunt balances, r class f transactins, r ther balances r classes culd aggregate t an unacceptable amunt. Finally, perfrmance f substantive analytical prcedures invlves making the cmparisns f relatinships as designed, including evaluating significant unexpected differences. This shuld include btaining sufficient evidence t crrbrate management respnses. When an auditr cannt btain an explanatin fr the difference, the auditr is required t perfrm additinal audit prcedures in respnse t significant unexpected differences. Testing revenue in cmpanies with multiple lcatins: When a cmpany has peratins in multiple lcatins r has multiple business units that generate r prcess revenue, the auditr is required t determine the extent t which audit prcedures shuld be perfrmed at selected lcatins r business units in gathering sufficient apprpriate audit evidence. Auditing Standard N. 9, Audit Planning (AS 9), includes the fllwing factrs that are relevant t the assessment f the risk f material misstatement assciated with a particular lcatin r business unit and the determinatin f the necessary audit prcedures t be perfrmed: 4 The nature and amunt f assets, liabilities, and transactins executed at the lcatin r business unit, including, fr example, significant transactins executed at the lcatin r business unit that are utside the nrmal curse f business fr the cmpany r that therwise appear t be unusual given the auditr s understanding f the cmpany and its envirnment; The materiality f the lcatin r business unit; The specific risks assciated with the lcatin r business unit that present a reasnable pssibility f material misstatement; Whether the risks f material misstatement assciated with the lcatin r business unit apply t ther lcatins r business units, such that, in cmbinatin, they present a reasnable pssibility f material misstatement; 4 See paragraph 12, AS 9. 5

6 The degree f centralizatin f recrds r infrmatin prcessing; The effectiveness f the cntrl envirnment; and The frequency, timing, and scpe f mnitring activities by the cmpany r thers at the lcatin r business unit Auditrs are encuraged t read Practice Alert N. 12 fr a mre thrugh examinatin f each f the abve tpics. Ging Cncern The FASB in August 2014 issued ASU , Presentatin f Financial Statements Ging Cncern (Subtpic ): Disclsure f Uncertainties abut an Entity s Ability t Cntinue as a Ging Cncern (the ASU), which prvides guidance n determining when and hw t disclse ging cncern uncertainties in the financial statements. The ASU requires management t perfrm an assessment every reprting perid (including interim perids) t determine whether there is substantial dubt abut a cmpany s ability t cntinue as a ging cncern and t prvide related ftnte disclsures. The ASU als defines that substantial dubt exists when relevant cnditins and events, cnsidered in the aggregate, indicate that it is prbable that the entity will be unable t meet its bligatins as they becme due within ne year after the date that the financial statements are issued (r available t be issued). The ASU applies t all entities and is effective fr annual perids ending after December 15, 2016, and interim perids thereafter, with early adptin permitted. In light f the ASU, the PCAOB issued Staff Audit Practice Alert N. 13, Matters Related t the Auditr s Cnsideratin f a Cmpany s Ability t Cntinue as a Ging Cncern, in September 2014 t remind auditrs that despite the issuance f the ASU, the auditr s requirements under existing PCAOB Standard, AU sec. 341, The Auditr s Cnsideratin f an Entity s Ability t Cntinue as a Ging Cncern (AU 341) have nt changed and cntinue t be in effect. Auditrs shuld cntinue t fllw the requirements f AU 341 when evaluating a cmpany s ability t cntinue as a ging cncern. Amng ther things, AU 341 requires the auditr t mdify the auditr s reprt by including an explanatry paragraph when substantial dubt exists abut the cmpany s ability t cntinue as a ging cncern. Hwever, under AU 341, the auditr s evaluatin f whether substantial dubt exists is qualitative based n the relevant events and cnditins and ther cnsideratins. Therefre, a cmpany s determinatin that n disclsure wuld be required under the ASU is nt cnclusive as t whether an explanatry paragraph is required under AU 341. Auditrs shuld cntinue t lk t the existing requirements in AU 341 when evaluating whether substantial dubt regarding the cmpany s ability t cntinue as a ging cncern exists fr purpses f determining whether the auditr s reprt shuld be mdified t include an explanatry paragraph. Internal Cntrl Over Financial Reprting Deficiencies related t internal cntrl ver financial reprting cntinue t be cited in PCAOB inspectin reprts. Many f the findings identified in the 2014 inspectin cycle are similar t thse highlighted by the PCAOB in its Staff Audit Practice Alert N. 11, Cnsideratins fr Audits f Internal Cntrl Over 6

7 Financial Reprting, (Practice Alert N. 11). Issued in Octber 2013, Practice Alert N. 11 fcused n seven areas related t the audit f internal cntrl ver financial reprting, which are summarized belw. Risk assessment and the audit f internal cntrl ver financial reprting: Risk assessment is a key element f the tp-dwn apprach, and it underlies the entire audit prcess in the audit f internal cntrl ver financial reprting. Understanding the flw f transactins and identifying the risks f material misstatement including the types f ptential misstatements that can ccur and the likely surces f thse ptential misstatements is necessary fr the auditr t select apprpriate cntrls t test and t evaluate whether thse cntrls adequately address the risks. Selecting cntrls t test: The auditr shuld select cntrls that, individually r in cmbinatin, are intended t address the identified risks f material misstatement. This includes selecting cntrls that address the relevant assertins and the cmpnents f the accunt r disclsure with differing risks. Sme risks, including thse related t cmplex prcesses r subjective estimates, may require a cmbinatin f cntrls t prevent r detect misstatements. Als, selecting cntrls t test applies t bth rutine and infrequent prcesses, such as analysis f whether lng-lived assets are impaired, as well as t nnrecurring transactins, such as a material business cmbinatin. Additinally, Auditing Standard N. 5, An Audit f Internal Cntrl Over Financial Reprting That is Integrated with An Audit f Financial Statements (AS 5), requires that a cntrl must be tested directly t btain evidence abut its effectiveness; an auditr cannt merely infer that a cntrl is effective because n misstatements were detected by substantive prcedures. In additin, when perfrming tests f cntrls ver transactins cncurrently with substantive tests f thse transactins (i.e., perfrming dual-purpse testing), the auditr s substantive testing and tests f cntrls shuld be sufficient t meet the bjectives f bth tests. Testing management review cntrls: Auditrs ften test management review cntrls in audits f internal cntrl ver financial reprting. As with ther types f cntrls, the auditr shuld perfrm prcedures t btain evidence abut hw a management review cntrl is designed and perates t prevent r detect misstatements. Sme management review cntrls perate at a level f precisin that wuld adequately prevent r detect material misstatements n a timely basis. Others might nt perate with the necessary level f precisin, but might be effective in cmbinatin with ther cntrls in addressing the assessed risk f material misstatement fr the relevant assertins f significant accunts. Factrs that can affect the level f precisin include the fllwing: Objective f the review cntrl Level f aggregatin r disaggregatin Cnsistency f perfrmance Crrelatin t relevant assertins Predictability f expectatins Criteria fr investigatin 7

8 In additin t assessing precisin, an auditr is required t evaluate whether the design f management review cntrls is capable f preventing r detecting ptential material misstatements, which generally invlves btaining an understanding f and evaluating the fllwing: Whether the cntrl satisfies the crrespnding cntrl bjective Steps invlved in identifying, investigating and reslving significant differences frm expectatins Cmpetence and authrity f thse perfrming the cntrl Frequency f perfrmance f the cntrl The accuracy and cmpleteness f the infrmatin used in perfrming the review cntrl Testing perating effectiveness typically invlves btaining and evaluating evidence abut the steps perfrmed t identify and investigate significant differences and cnclusins reached in the reviewer s investigatin, including whether ptential misstatements were apprpriately investigated and whether crrective actins were taken as needed. The auditr als shuld take int accunt ther relevant evidence btained in the audit when evaluating the effectiveness f a cntrl, such as identified misstatements that were nt prevented r detected by the cntrl. Infrmatin technlgy (IT) cnsideratins, including system-generated data and reprts: PCAOB auditing standards require the auditr t btain an understanding f the cmpany s IT systems relevant t financial reprting and take IT cnsideratins int accunt in assessing the risks f material misstatement. 5 This includes btaining an understanding f the extent f manual cntrls and autmated cntrls used by the cmpany, including the IT general cntrls (ITGCs) that are imprtant t the effective peratin f the autmated cntrls. The auditr als shuld btain an understanding f specific risks t a cmpany s internal cntrl ver financial reprting resulting frm IT. If a cntrl selected uses system-generated data r reprts, the effectiveness f the cntrl depends in part n the cntrls ver the accuracy and cmpleteness f the system-generated data r reprts. In that situatin, assessing the effectiveness f the selected cntrl wuld invlve testing bth the selected cntrl and the ITGCs and IT-dependent cntrls ver the system-generated data and reprts. The existence f cntrl deficiencies in ITGCs may impact the auditr s ability t cnclude n the effectiveness f an IT-dependent cntrl, as well as affect the nature and extent f testing ver ther cntrls that rely n such data and reprts. Rll-frward f cntrls tested at an interim date: Althugh the auditr expresses an pinin n internal cntrl ver financial reprting as f a specific date, auditrs may decide t test sme imprtant cntrls during the year. When cntrls are tested at an interim date, PCAOB auditing standards require auditrs t perfrm rll-frward prcedures t update the results f interim testing thrugh the as f date f the reprt. The amunt f evidence needed frm rll-frward prcedures depends n the risks f the cntrl, the results f and sufficiency f evidence btained frm interim testing, the length f the rll-frward perid, and the pssibility that there were significant changes in internal cntrl ver financial reprting since interim. Inquiry might be a sufficient rll-frward 5 See AS 12. 8

9 prcedure when evaluatin f the preceding items indicates a lw risk that the cntrls are n lnger effective during the rll-frward perid. In ther situatins (e.g., when the cntrl is cmplex, subjective r therwise higher risk; the cntrl was nt tested extensively at the interim date r there were exceptins nted in the interim testing; the rll-frward perid was significant r there were significant changes during it), inquiry alne may nt be sufficient and mre persuasive evidence shuld be btained based n the specific cntrls tested and their assciated risks. Using the wrk f thers: PCAOB auditing standards allw the auditr t use the wrk f thers (e.g., internal audit) as evidence f the effectiveness f selected cntrls, 6 and AS 5 requires auditrs t evaluate the extent t which the wrk f thers will be used. AS 5 prvides that the extent t which the wrk f thers can be used depends n the risk assciated with the cntrl being tested and the cmpetence and bjectivity f the persns whse wrk the auditr plans t use. The risk assciated with the cntrl is the risk that a cntrl might nt be effective and, if nt effective, that a material weakness culd result. As the risk assciated with the cntrl increases, the need fr the auditr t perfrm his r her wn testing f the cntrl increases. In higher risk areas (e.g., testing cmplex cntrls, cntrls that address fraud risks r that require significant judgment), use f the wrk f thers shuld be limited, if used at all, while the wrk f cmpetent and bjective persns culd be used mre extensively in lwer risk areas. When the auditr uses the wrk f thers, the auditr als shuld test and evaluate that wrk, including evaluating the quality and effectiveness f the thers wrk. The necessary extent f testing f that wrk depends n the risk assciated with the cntrl and the cmpetence and bjectivity f the thers. In additin, the auditr shuld re-evaluate during its testing and review f the wrk f thers t determine whether the quality f the wrk is cnsistent with the auditr s initial assessment f cmpetence and bjectivity. Evaluating identified cntrl deficiencies: In additin t cntrl deficiencies identified during the audit f internal cntrl ver financial reprting, cntrl deficiencies might be identified during the audit f the financial statements. AS 5 requires auditrs t evaluate the effect f misstatements detected by substantive prcedures n the effectiveness f internal cntrl and t evaluate the severity f each cntrl deficiency that cmes t his r her attentin t determine whether the deficiencies, individually r in cmbinatin with ther deficiencies, are material weaknesses. Fr example, an IT cntrl might nt be intended t prevent r detect misstatements by itself but an IT cntrl deficiency might impair the effectiveness f imprtant IT-dependent cntrls acrss multiple accunts. Evaluating whether a cntrl deficiency r a cmbinatin f cntrl deficiencies results in a material weakness requires prfessinal judgment and a careful analysis f the evidence btained, including cnsideratin f the likelihd and ptential magnitude f misstatement arising frm the cntrl deficiencies. The severity f a deficiency des nt depend n whether a misstatement actually has ccurred but rather n whether there is a reasnable pssibility that the cmpany s cntrls will fail t prevent r detect a misstatement. Auditrs are encuraged t read Practice Alert N. 11, as well as AS 5, fr a mre thrugh examinatin f each f the abve tpics. 6 See AU 322, The Auditr s Cnsideratin f the Internal Audit Functin in an Audit f Financial Statements. 9

10 Auditing Accunting Estimates, Including Fair Value Measurements 7 When auditing accunting estimates, including fair value measurements, the auditr is respnsible fr evaluating hw accunting estimates have been develped; assessing the reasnableness f accunting estimates made by management in the circumstances; and assessing whether they are presented in cnfrmity with applicable accunting principles and are apprpriately disclsed. Examples f management estimates may include thse related t purchase price allcatins, impairment assessments, the fair value f investments, allwances fr dubtful accunts and lan lsses, and uncertain tax psitins. When issuing an pinin n internal cntrl ver financial reprting r relying n internal cntrls in a financial statement audit, the auditr is respnsible fr testing the relevant internal cntrls related t significant estimates. When evaluating and testing management s cntrl(s) ver an accunting estimate, the auditr shuld: Evaluate the reliability f underlying data used by management in develping the estimate by testing the data r the cntrls ver the data; Evaluate whether the accunting estimate was prepared by qualified persnnel, and whether management has engaged an external specialist 8 t assist in the develpment f the accunting estimate, if necessary; Cnsider whether there has been adequate review and apprval f the estimates including, fr example, surces f relevant factrs, the develpment f assumptins and the level f precisin f the review; Cmpare prir accunting estimates with subsequent results t assess the reliability f the prcess used by management t develp estimates; and Assess management s cnsideratin f whether the resulting accunting estimate is cnsistent with the peratinal plans f the cmpany. Fr the financial statement audit, in evaluating the reasnableness f management s estimates, the auditr shuld btain an understanding f hw management develped the estimate and, based upn that understanding, use ne r a cmbinatin f the fllwing appraches: 9 Review and test the prcess used by management t develp the estimate. Develp an independent expectatin f the estimate t crrbrate the reasnableness f management s estimate. Review subsequent events r transactins ccurring prir t the date f the auditr s reprt. 7 See AU 342 and AU 328 fr additinal guidance related t auditing accunting estimates and fair value measurements, respectively. 8 See AU 336, Using the Wrk f Specialist, fr additinal guidance related t the auditr s use f the wrk f a specialist in perfrming an audit. 9 See paragraph 10, AU

11 In evaluating the reasnableness f an estimate, the auditr nrmally fcuses n key inputs and assumptins that are: Significant t the accunting estimate Sensitive t variatins Deviatins frm histrical patterns Subjective and susceptible t misstatement and bias Additinally, the auditr generally shuld cnsider histrical experience f the cmpany in making past estimates as well as the auditr s experience in the industry. Hwever, changes in facts, circumstances, r cmpany s prcedures may cause factrs different frm thse cnsidered in the past t becme significant t the accunting estimate. After auditing each accunting estimate individually, the auditr shuld cnsider the accunting estimates in the aggregate in rder t evaluate whether the aggregate difference between the estimates best supprted by the audit evidence and the individually reasnable estimates included in the financial statements indicate a pssible bias n the part f the cmpany s management. A retrspective review is required f significant accunting estimates reflected in the financial statements f the prir year t determine whether management s judgments and assumptins related t the estimates indicate a pssible bias n the part f management. This review als will infrm the auditr n estimatin uncertainty r ther histrical difficulties encuntered. Auditing a cmpany s fair value measurements includes verifying that the cmpany has made adequate disclsures in cnfrmity with GAAP. 10 If disclsures are mitted due t the impracticality t determine fair values, the auditr shuld evaluate the adequacy f the required disclsures in these circumstances. If required GAAP disclsures are nt made, the auditr shuld evaluate whether the financial statements are materially misstated and assess the impact n internal cntrl ver financial reprting. Engagement Quality Review Recent inspectin cycles identified findings arund auditrs executin f prcedures in accrdance with Auditing Standard N. 7, Engagement Quality Review (AS 7), that are similar t thse highlighted in a 2013 PCAOB public reprt. 11 AS 7 requires the engagement quality reviewer t perfrm specific prcedures t evaluate the significant judgments made by the engagement team and the related cnclusins reached in frming the verall cnclusin n the engagement and in preparing the audit reprt. The specific prcedures the engagement quality reviewer shuld perfrm include: Evaluating the significant judgments that relate t engagement planning, including cnsideratin f the firm s client acceptance and retentin prcess, the cmpany s business, and the judgments made abut materiality including the effect f thse judgments n the engagement strategy. Evaluating the engagement team s identificatin f significant risks, including fraud risks, and audit respnses t thse risks. 10 See paragraph 3, AU PCAOB Release N , Observatins Related t the Implementatin f the Auditing Standard n Engagement Quality Review. 11

12 Evaluating the significant judgments made abut (1) the materiality and dispsitin f crrected and uncrrected misstatements and (2) the severity and dispsitin f identified cntrl deficiencies. Reviewing the engagement team s evaluatin f the audit firm s independence. Reviewing the engagement cmpletin dcument, cnfirming with the engagement partner that there are n significant unreslved matters. Reviewing the financial statements and related reprts (e.g., management s reprt n internal cntrl). Reading the ther infrmatin in dcuments cntaining the financial statements t be filed with the Securities and Exchange Cmmissin (SEC), and evaluating whether the engagement team has taken apprpriate actin with respect t any material incnsistencies with the financial statements r material misstatements f fact f which the engagement quality reviewer is aware. Based n these prcedures, the engagement quality reviewer als shuld evaluate if apprpriate cnsultatins have ccurred n difficult r cntentius matters and, if s, whether the cnclusins relating t such matters have been apprpriately dcumented. Further, the engagement quality reviewer shuld evaluate whether apprpriate matters have been cmmunicated r identified fr cmmunicatin t the audit cmmittee, management, and ther parties. The respnsibilities f the engagement quality reviewer shuld be carried ut with bjectivity and the applicatin f due care, with the firm apprpriately addressing the reviewer s findings befre issuing the audit reprt. Mrever, dcumentatin f an engagement quality review shuld cntain sufficient infrmatin t enable an experienced auditr, having n previus cnnectin with an engagement, t understand the prcedures perfrmed by the engagement quality reviewer t cmply with AS 7. Prfessinal Skepticism The auditr is required t plan and perfrm his r her wrk with due prfessinal care, which requires the auditr t exercise prfessinal skepticism. 12 PCAOB auditing standards define prfessinal skepticism as an attitude that includes a questining mind and a critical assessment f audit evidence. 13 As a result, prfessinal skepticism shuld be exercised thrughut the audit prcess, including in thse areas f the audit that invlve significant management judgments, transactins that are utside the nrmal curse f business, and as it relates t the auditr s cnsideratin f fraud in an audit. In exercising prfessinal skepticism, the auditr shuld nt be satisfied with less than persuasive evidence because f a belief that management is hnest. Fr example, when applying prfessinal skepticism in respnse t identified fraud risks, an auditr shuld (a) mdify the planned audit prcedures t btain mre reliable evidence regarding relevant assertins and (b) btain sufficient apprpriate evidence (e.g., third-party cnfirmatin, examinatin f dcumentatin frm independent surces). The engagement partner is respnsible fr setting an apprpriate tne that emphasizes the need t maintain a questining mind thrughut the audit and t exercise prfessinal skepticism in gathering and evaluating evidence, s that, fr example, engagement team members have the cnfidence t challenge 12 T remind auditrs f this requirement, the PCAOB issued in December 2012 Staff Practice Alert N. 10, Maintaining and Applying Prfessinal Skepticism in Audits, certain aspects f which are discussed within the Alert. 13 See paragraph 7, AU 230, Due Prfessinal Care in the Perfrmance f Wrk. 12

13 management representatins. The engagement partner and ther senir engagement team members als shuld be invlved in planning, directing, and reviewing the wrk f ther engagement team members s that matters requiring audit attentin, such as unusual matters r incnsistencies in audit evidence, are identified and addressed apprpriately. Prfessinal skepticism invlves, amng ther things, cnsidering what can g wrng with the financial statements, perfrming audit prcedures t btain sufficient apprpriate audit evidence (rather than merely btaining the mst readily available evidence t crrbrate management s assertins), and critically evaluating all evidence regardless f whether it crrbrates r cntradicts management s assertins. Refer t the CAQ s Prfessinal Judgment Resurce, which is designed t prvide auditrs with an example decisin-making prcess intended t facilitate imprtant auditing and accunting judgments in a prfessinally skeptical manner. Related Parties and Amendments t Certain PCAOB Auditing Standards Regarding Significant Unusual Transactins The PCAOB adpted (and the SEC subsequently apprved) Auditing Standard N.18, Related Parties (AS 18) and Amendments t Other Auditing Standards, in June 2014 t strengthen auditr perfrmance requirements in three critical areas f the audit: (1) related party transactins, (2) significant unusual transactins, and (3) a cmpany s financial relatinships and transactins with its executive fficers. AS 18 and the amendments t ther auditing standards are effective fr audits f financial statements fr fiscal years beginning n r after December 15, 2014, including reviews f interim financial infrmatin within these fiscal years. AS 18 supersedes the PCAOB s interim auditing standard, AU sec. 334, Related Parties. Related Party Transactins Amng ther things, AS 18 requires the auditr t: Perfrm specific prcedures t btain an understanding f the cmpany s relatinships and transactins with its related parties, including btaining an understanding f the nature f the relatinships and f the terms and business purpses (r the lack theref) f transactins invlving related parties. These new prcedures are perfrmed in cnjunctin with the auditr s risk assessment prcedures in AS 12. Evaluate whether the cmpany has prperly identified its related parties and relatinships and transactins with its related parties. In making that evaluatin, the auditr perfrms prcedures t test the accuracy and cmpleteness f management s identificatin, taking int accunt infrmatin gathered during the audit. If the auditr identifies infrmatin that indicates that undisclsed relatinships and transactins with a related party might exist, the auditr perfrms prcedures necessary t determine whether undisclsed relatinships r transactins with related parties in fact exist. Perfrm specific prcedures if the auditr determines that a related party r relatinship r transactin with a related party previusly undisclsed t the auditr exists. Perfrm specific prcedures regarding each related party transactin that is either required t be disclsed in the financial statements r determined t be a significant risk. 13

14 Cmmunicate t the audit cmmittee the auditr s evaluatin f the cmpany s (a) identificatin f, (b) accunting fr, and (c) disclsure f its relatinships and transactins with related parties, and ther related significant matters arising frm the audit. Significant Unusual Transactins The amendments related t significant unusual transactins principally revise AU sec. 316, Cnsideratin f Fraud in a Financial Statement Audit, and require the auditr, amng ther things, t: Perfrm specific prcedures t identify significant unusual transactins. Perfrm specific prcedures t btain an understanding f and evaluate the business purpse (r the lack theref) f identified significant unusual transactins. Cnsider additinal factrs in evaluating whether significant unusual transactins may have been entered int t engage in fraudulent financial reprting r cnceal misapprpriatin f assets. Financial Relatinships and Transactins with Executive Officers The amendments related t a cmpany s financial relatinships and transactins with its executive fficers, such as executive fficer cmpensatin, require the auditr, as part f the audit risk assessment prcess, t perfrm prcedures t btain an understanding f the cmpany s financial relatinships and transactins with its executive fficers. These prcedures are intended t heighten the auditr s attentin t incentives r pressures fr the cmpany t achieve a particular financial psitin r perating results, recgnizing the key rle that a cmpany s executive fficers may play in the cmpany s accunting decisins r in a cmpany s financial reprting. Hwever, the amendments d nt require the auditr t make any determinatin regarding the reasnableness f cmpensatin arrangements r make recmmendatins regarding cmpensatin arrangements. 14