CHAPTER 2

Questions

3. Name the three sources of business and industry information

Sources of business and industry information are the following:

- PICPA audit and accounting guides
- Industry trade publications
- Government publications

4. What information should a CPA firm seek in its investigation of a prospective client?

In investigation of a prospective client, CPA should seek the background and its reputation
along with major shareholders, directors and officers. As well as to obtain information from third
parties such as underwriters, bankers and attorneys. CPA’s are also required to make inquiries at
previous auditors to acquire information about integrity of management. Financial reports, SEC
filings, credit reports and tax returns are used by CPA firm to acquire financial background
information to prospective client.

Exercise 2

Mary Dizon has been asked to accept an engagement to audit a small financial institution. Dizon
has not previously audited a financial institution.

A. Describe the types of knowledge about the prospective client and its environment that Dizon
should obtain to plan the engagement

CHAPTER 3

Questions

11. Brainstorming is a group discussion designed to encouraged auditors to creatively assess

client risks, particularly those relevant to fraud.

c. Besides encouraging auditors to creatively assess client risks, what other purpose does
brainstorming serve?

The purpose of the brainstorming session is to identify fraud risk factors, guided by the fraud
triangle, and to instill the importance of remaining professionally skeptical, notwithstanding an
auditor’s past experience of management honesty and integrity. To transfer knowledge from top-
level auditors down to senior members of the audit team via interactive and constructive group
dialogue and idea exchange.

D. What are the guidelines that should be followed during a brainstorming session to maximize
effectiveness?

Guidelines during a brainstorming session that should be followed include agreeing on key
conclusions about fraud risks will increase the likelihood of successful application of the team’s
ideas. Also suspension of criticism, freedom of expression, a quantity of idea generation, and
respectful communication all maximize the effectiveness of a brain storming session.

E. What are the typical steps in the brainstorming process?

1. review prior year client information
2. consider client information, particularly with respect to the fraud triangle (incentive, opportunity,
and rationalization)
3. integrate information from steps 1 and 2 into an assessment of the likelihood of fraud in the
engagement
4. identify audit responses to fraud risks

1. Review prior year client information

2. Consider client information with respect to fraud triangle.
3. Integrate information from prior steps into an assessment of the likelihood of fraud in the
engagement.
4. Identify audit responses to fraud risks.

The typical steps in a Brainstorming process: Step 1: To put off with criticism –the best policy is to
forestall any judgment approach; Step 2: Liberty of Expression – Participants should let any
reticence go away in expression individual perceptions; Step 3: Idea generation quantum – “the
higher, the better”. This gives rise to the soaring probability of tumbling on the best of the ideas;
Step 4: Communicating with respect – the opinions of one and all is held in high esteem.

A fraud brainstorming session can be broken down into the following five steps:

1. Select the Team

Auditing standards require the engagement team’s key members to participate in the fraud
brainstorming session. At a minimum, participants should include the lead engagement partner
and review partner, and team members from the senior manager through incharge auditor rank.
For larger audit clients or for clients with preidentified risks of material misstatement due to fraud,
audit teams may consider engaging with a fraud specialist and IT audit specialist. Ideally, the
entire engagement team, including less-experienced audit staff and tax professionals should also
participate. Participation from junior staff allows the audit team leader to promote a tone of
professional skepticism and also allows for known risk assessments predetermined by the audit
partner to be communicated to the entire engagement team.

2. Choose an Approach
There are many different approaches available for conducting the brainstorming session, and
several of these techniques are outlined later in this article. The most common structure currently
used in practice is an open-ended approach with face-to-face communication. Regardless of the
specific technique chosen for the brainstorming session, the effectiveness and efficiency of the
session can be improved with the use of an agenda.
Beasley and Jenkins (2003)3 advocate circulating an agenda in advance of the meeting to
inform the discussion participants of the timing of the brainstorming session and the specific topics
to be discussed. Doing so can also provide a broader context for participants to think about
potential fraud risks prior to the brainstorming session, which can improve brainstorming
effectiveness. The agenda is also useful for documenting the risks identified and the related
responses along with when the brainstorming session took place and who attended – all of which
must be documented and retained in the audit files.

3. Prepare for the Meeting

To prepare for the meeting, the team leader should inform those participating in the
brainstorming session the date and location of the session, and that they will be discussing the
relevant fraud risks of the client. All participants should be expected to prepare a written list of
potential fraud risk factors prior to attending the brainstorming session. As part of preparing for the
discussion, participants who are new to the engagement should seek to gain an understanding of
the entity’s business processes, business risks, corporate governance structure and internal
control system. A review of the prior year’s audit findings and risk assessments can help to identify
risks that may still be present on continuing audit engagements. Finally, the team leader should
assign a recorder for the brainstorming session and also distribute the agenda to those
participating.

4. Conduct the Meeting

Throughout the meeting, an explicit emphasis on applying professional skepticism when
conducting the audit should be made by the discussion leader. Ideally, the audit partner or forensic
specialist should lead the meeting. Brainstorming members tend to rise to the performance level of
the discussion leader. So, if a strong member does not take the lead during the session, the other
participants may begin to disengage, thus limiting the effectiveness of the discussion. The partner
or specialist should also set the tone for the meeting by encouraging participation from all
members and emphasizing that every idea is valued.
A strong leader can also help prevent two common pitfalls that can hinder the effectiveness of
a brainstorming session: social loafing and group dominance. Social loafing occurs when certain
members, typically the less experienced staff, disengage from the process and rely on other
members to carry the discussion. Social dominance occurs when one or two members exert
excessive influence over the brainstorming process, which prevents other members from actively
participating and sharing their views.
It’s not uncommon for brainstorming sessions to use checklists to help guide the meeting. As a
word of caution, these checklists should be limited to use by the brainstorming leader and should
only serve as a discussion guide. Studies show that auditors who use a standard fraud risk
checklist make less effective fraud risk assessments than auditors who do not use a checklist . A
standard fraud risk checklist may inhibit participating auditors from recognizing new and unique
risks which may be present at the client. Auditors also weight the importance of self-identified risks
more than pre-identified risks presented on a checklist, which may lead to instances when
preidentified fraud risks are not given sufficient attention.
The fraud risk factors identified during the brainstorming session must be documented in a
formal fraud risk assessment memo. As previously discussed, the agenda listing the timing of the
brainstorming session and the audit team members who participated in the discussion should also
be incorporated into the risk assessment memo. Once adequate time has been given to
generating fraud risk factors and no new ideas are being generated, the session should transition
to synthesizing and evaluating the identified fraud risk factors. This discussion should also
specifically address how the audit plan will be adjusted to respond to the significant risks identified.
Finally, the leader should conclude the meeting by giving credit to the entire group and discussing
the timing for post-brainstorming followup.

5. Follow-Up and Documentation

Auditors’ consideration of fraud also includes a formal assessment of the risk of material
misstatement due to fraud and how the audit team has responded to the identified risks. The fraud
risk assessments and the audit team’s responses to the risks identified must also be documented
in the audit files. Fraud risk responses include changing the staffing of the audit (e.g., including
specialists and auditors with more client or industry experience), changing the nature of audit
procedures (e.g., changing the type of procedures performed and incorporating elements of
unpredictability into standard procedures), changing the extent of audit testing (e.g., increasing
sample sizes) and changing the timing of audit procedures (e.g., performing substantive testing at
or near the end of the client’s reporting period). The engagement leader should follow-up after the
brainstorming session to ensure that proper documentation of the audit team’s fraud
considerations has occurred and that the audit plan includes appropriate responses to the
identified risks.

Multiple choice
9. D. Facts that might bear on the integrity of management.

Before accepting an engagement the possible successor should ask questions about the
integrity of management, disagreements with management, and the reasons for the
change in auditors. All of the other replies are incorrect because they represent
information that the successor may wish to obtain after accepting the engagement.

10. D. All of the above would typically included in an audit program

11. D All of the above statements

Exercise 2

4-50
 (Materiality and Professional Skepticism, LO 3)
 Auditors makemateriality judgments during the planning phase of the audit in order to be sure
they ultimately gather sufficient evidence during the audit to assure that the financial statements
are free of materialmisstatements. The lower the materiality threshold that an auditor has for an
account balance, the more the evidence that the auditor must collect to be sure the account
balance is correctly stated.Auditors often use quantitative benchmarks such as 1% of total
assetsor 5% of net income to determine whether misstatements materiallyaffect the financial
statements, but ultimately it is an auditorsindividual professional judgment as to whether a given
misstatementis or is not considered material

Required 
a. What is the relationship between the level of riskiness of the clientand the level of misstatement
in an account balance that an auditor would consider material? For example, assume that Client A
hasweaker controls over accounts receivable compared to Client B(i.e., Client A is riskier than
Client B). Assume that Client B issimilar in size to Client A, and that the auditor has concluded
thata misstatement exceeding $5,000 would be material for Client B
’
saccounts receivable account. Should the materiality threshold for Client A be the same as, more
than, or less than that for Client B?Further, which client will require more audit evidence to be col-
lected, Client A or Client B?
b. How might an auditor 
’
s individual characteristics affect his or her professional judgments about materiality?
c. Assume that one auditor is more professionally skeptical than an-other auditor, and that they
are making the materiality judgmentin part (a) of this problem. Compare the possible alternative
mon-etary thresholds that a more versus less-skeptical auditor mightmake for Client A

c. Assume that one auditor is more professionally skeptical than another auditor and that they are
making materiality judgment in part (a) of this problem. Compare the possible alternative monetary
thresholds that a more versus less skeptical auditor might make for Client A

A. The relationship between a financial misstatement and risk is the nature of financial
transactions the company does, the amount of ambiguity involved, any changes which arenot
anticipated. Since in this case the Client A’s control over accounts receivables is less when
compared to the of client B and as the auditor has fixed up a materiality threshold of 5% for client
B, then the materiality threshold for client A must be lower as the risk involved is higher when
compared to that of client B, thus the index needs to be set lowerfor A.
B. An auditor’s individual characteristic can have a telling impact on an audit report as his
negligence in recognizing the lack of congruency of data in the misstatement or misjudging the risk
involved the financial statement and this may impair his judgement on setting materiality threshold
and basis for setting the materiality threshold.
C. A skeptical auditor will keep a lower threshold such as 4% or lower or $3000 than the less
skeptical auditor because he recognizes the risk involved with the client A’s transactions and thus
keeps a higher materiality threshold.

A less skeptical auditor could use a lower monetary threshold. The auditor could conclude that the
misstatement in an account balance (accounts receivable) for the materiality was 4,000.
Therefore, the auditor would have to back up his assertion, and perform more tests, due to his
opinion on what constitutes a higher risk of material misstatement.