Speaker 1: Hello and welcome to my YouTube series on the audit exam. I wanted to create a YouTube series to explain the entire audit process, from the very beginning of an audit, accepting a client, into the main phase of an audit to test cash, to test accounts receivable, and then all of the post audit work, like creating the audit reports and having the different audit opinions. So each video we're going to talk through a different element of how an audit works. Now this series is going to be mostly for people studying for the CPA exams, but also if you're working in auditing, interning in auditing, this is going to really help you understand the why behind why you're performing what you're performing. So let's jump in. So let's first talk about why a company even needs to be audited. So a company creates its financial statements and it gives those financial statements to the users of the financial statements, like to the investors in the company and to the creditors, like the banks that are lending money to the company. So those users of the financial statements need to make sure that the numbers in the financial statements are legitimate. They need to make sure that the company is not just making up their revenue. So this is why the company pays the external auditors to come in to test all of their accounts and to say, yes, their financial statements are fairly presented. So then the users of the financial statements can actually trust in the financial statements. So that's the overall purpose of an audit. So we're first starting out in the very, very beginning phase of the audit. This is the client acceptance phase. So a company comes to us, the auditors, and they want us to perform their audit, but we shouldn't just accept the client because they're willing to pay us. Instead, we need to be careful of who to accept as a client. After all, we're going to be working with them and providing an opinion on their financial statements. So our main goal with accepting a client is avoiding working with clients that lack integrity. If the client doesn't have integrity, we can't really trust anything that they tell to us because we're going to depend a lot on the information that management gives to us about the financial statements. Apart from looking at their integrity, we also need to look at our abilities as the firm. So do we have experience working in this industry? Are we going to need to hire component auditors to audit different sections of the company? We need to look at the deadlines that the company is looking at publishing for their financial statements. So we need to consider all these different elements before accepting the client. Also before accepting the client, we need to make sure that the client's management is going to take on certain responsibilities. There are three main areas that we need them to take on for responsibilities. First is the preparation and fair presentation of their financial statements. So it is the company's responsibility, not the auditor's responsibility for the financial statements. They need to make sure that they prepare them and that the financial statements are fairly presented. Next is for the internal controls. So the client is responsible for designing the internal controls, implementing the internal controls, and maintaining the internal controls. Designing them is simply putting the controls together. What are their processes to make sure that they don't have errors or fraud in their accounting records? Implementing them is apart from just designing the controls, it's actually following the controls. And maintenance is, once you implement the controls, you review the controls from time to time to see if you need to make any changes to the controls. So that's the second responsibility. And then the third responsibility is that the management is going to provide the auditors with access to their documentation and to their employees. That way we have enough access to the client to actually perform the audit. So we need to make sure the management is going to take on these three areas of responsibility before accepting the client. So then if we've decided that we should accept the client, then we need to actually start the audit. So to start the audit, we need what's called the engagement letter. The engagement letter is like the contract for the audit. It's the agreement between the auditor and management of what the auditors are going to perform, what management's responsible for, and the expected reports that the auditors are going to provide to management. So the engagement letter is something that the auditors send to management, management signs it, and then returns it to the auditors. So the type of information that's included in the engagement letter, management's responsibilities, the auditor's responsibilities, it's going to mention the expected reports, it's going to mention the company's method of accounting, it's going to also mention that the auditors provide reasonable assurance and not absolute assurance, because there's a chance that the auditors may not detect a misstatement. And then it might include information such as the fees for the audit. But what it's not going to include is any kind of information that could allow management to manipulate the audit. So for example, it's not going to include the materiality levels that the auditors have set for the engagement. Because if the auditors say the materiality is $100,000, then management knows that it could make a mistake up to $100,000 and be okay. So the auditors are not going to say the specific test work they're going to perform, or their materiality levels. So that's the purpose of the engagement letter. If you're interested in learning more about the audit exam, I have a full comprehensive audit review course, where I go much more in depth on the audit topics. I provide real examples of what audit documentation looks like. I provide fully animated videos and practice questions. So you can check out a free preview right below. So that's it for client acceptance engagement letter. In the next video, we're going to talk about audit documentation. So when we talk about audit documentation, we're talking about what's called the working papers or work papers, which is just simply any document that auditors use to describe the kind of test work that they performed. So it could simply be an Excel spreadsheet, where an auditor records the test work that they performed. That's what a working paper is. So the important element is that the working papers belong to the auditors, they don't belong to the client. So there's no responsibility of the auditor to send the working papers to the client. And then the main purpose of the working papers is one to provide enough documentation to support the auditor's opinion. We want to make sure we have enough evidence to actually support what our opinion is. And the second purpose is to show that we're actually following the auditing standards. So when we're talking about audit documentation, we need to make sure that it is sufficient and appropriate. These are two key terms you're going to see in the audit report. Sufficient refers to the quantity of information. So do we have enough audit evidence? Appropriateness refers to the quality of the evidence. So is the quality good enough of the audit evidence? So then your question might be, how do we affect the quality of the audit evidence? We affect the quality through what is called the nature, the extent and timing of audit procedures. So nature refers to the type of test work that we perform. So for example, if we're testing accounts payable and we perform a search for unrecorded liabilities, that is the nature of the testing. The extent is how much testing we're going to do. So are we going to test 20 invoices or 40 invoices? So the more testing we do, the better the evidence that we get. And third is the timing of the audit procedures. So we can perform what are called year-end audit procedures or interim procedures. Year-end means that we're not going to test the account until after year-end. So we can see the activity for the entire year. Interim means that we're going to test before the end of the year. That way we can go ahead and go to the company before year-end and test the balances. So year-end testing is going to provide higher quality audit evidence than interim testing is. So those are the basics of what we need to know about audit documentation. So now that we have accepted the client and we've learned about audit documentation, we're ready to start planning the audit. So we're going to have two different planning documents for the audit. The first is going to be the audit strategy, which is going to be a high level planning document. Then we're going to have the audit plan, which is a detailed level planning document. So for the audit strategy, we're trying to figure out the overall objectives of the audit. We're trying to figure out how much staff we need for the audit. What are the budgeted hours for the audit? All of the big picture elements. For the audit plan, we're going to actually outline the specific procedures we're going to perform for the audit. So we're going to say for testing accounts payable, for example, we're going to perform a search for unrecorded liabilities. So the plan is going to give a detailed list of what we're going to perform. In addition to these planning documents, we're also going to perform analytical procedures. So analytical to analyze. These are high level analytics, meaning we're going to look at different trend analysis, ratio analysis to identify what the more risky parts of the company are. So we're going to see that there are two parts of an audit that we are required to perform analytics. The planning phase, which is where we're at right now and the overall review phase. So we're first going to perform planning analytics to get a better understanding of the company. In the planning phase, we need to understand the client's business and their industry. So we want to understand how the client actually operates. What are their methods of accounting? What's normal for their industry? So we get to understand this by taking a tour of the client's business, looking at different industry guidelines, and this is going to help us get a good idea of what is normal for the industry and what is not normal for the industry. The next part of this planning phase is understanding the client's internal controls. So internal controls are processes to try to catch errors within the accounting system. So we want to understand how the company's controls work. There are two key terms here. The first is the design of the internal controls and then the implementation of the internal controls. So the design is simply how is the control designed? What are the steps involved in the control? The implementation is, are they actually following this control? Are they actually implementing this control? So for any audit, we are required to understand the design and implementation of the controls. Now the operating effectiveness of the controls is a different area. That means that we would actually be testing the internal controls to see if we can rely on the internal controls. So we're not always required to test the controls for operating effectiveness, but we're always required to understand their design and implementation. In the next part of the planning phase, we need to consider the predecessor auditor. So the current auditor is called the successor auditor and the predecessor auditor is the auditor before the successor auditor. So the successor auditor, the current auditor is supposed to attempt to communicate with the predecessor auditor. The reason is because they want to find out why the company wanted to change auditors. Does the company lack any integrity? So we want to get a better understanding of why the change was made. So we need to at least attempt communication with the predecessor auditor. If you're interested in going further in depth with your audit preparation, I've got a comprehensive audit review course. In my course, I actually show you all of the audit documentation. So for example, when we were talking about understanding the internal controls, I show you an actual example of what the forms look like to document the understanding of the internal controls. So if you're interested, you can check it out, free preview of my course. So now we need to consider who are the different groups of people that we as the external auditors can rely upon. So what groups can actually help us perform the audit? The first group are called the internal auditors. These are the auditors that actually work at the company that we are auditing. So they go throughout the company and they audit the different areas in preparation for the external audit. So we can actually use the internal auditors in our audit. The important thing to keep in mind, though, is that the internal auditors are not independent because they actually work for the company. So we can use them for really any section of the test work. But the key is that it needs to be low complexity, low subjectivity areas. So we don't want them to be involved in making complex estimations because they're not independent of the company. The key is that they need to be competent and objective. So the next group that we can rely upon are called specialists, which is simply someone that has special skills. So imagine that we're auditing a company and they have an investment that is very complex to value. So we could hire a specialist that is specialized in valuing the specific kind of investment. So they're going to come in and perform the valuation for us. The key thing with relying on anybody's work is that the external auditors are still the main ones responsible. So even though the specialist is going to perform the work, the main responsibility falls on the external auditor. So we need to understand their approach for how they're going to perform the valuation. We need to understand their overall skill set to make the proper valuation if we can rely on their work or not. And then the last group we're going to talk about are called component auditors. So when a company has multiple subsidiaries, we might need different auditing firms to audit the different subsidiaries based on where the different subsidiaries are located. So for example, imagine that you have the Walt Disney Company, which is the parent company, and then has two subsidiaries, Parks and Resorts that's located in Florida, and then the Media Network that's located in California. So here what's going to happen is you're going to have the group auditor who's the main one responsible for the parent company's financial statements. They're going to work with the component auditors who are going to audit the different subsidiaries of the company. So the component auditors are going to set their own materiality levels. They're going to perform all of their own test work. And then once they finish their audit, the group auditors are going to review their audits and incorporate the subsidiaries test work into the parent company's test work. So that's how it works when you have a group audit with the group auditor and the component auditors with the different components of a company. So in this YouTube series, I'm providing the basics of auditing. In my comprehensive audit review course, I'm going farther in depth. So for example, I talk about IT specialists. I talk about the different reporting requirements based on whose work we are relying upon. So if you're interested in checking out a free preview, feel free to check it out below.