Question

1. The communication between successor and predecessor CPA and how is responsible for initiating it (SAS No. 84)
2. The purpose of an engagement letter
3. Materiality
4. The audit risk model, its applications, and its components
5. The relationship between AAR, IR, CR, PDR
6. The relationship between PDR and audit evidence

Answer 1

a. This section provides guidance on communications between predecessor and successor auditors when a change of auditors is in process or has taken place. It also provides communications guidance when possible misstatements discovered in financial statements reported on by a predecessor auditor. This section applies whenever an independent auditor is considering accepting an engagement to audit or reaudit financial statements by generally accepted auditing standards, and after such an auditor has been appointed to perform such engagement.

b. Purpose of an engagement letter

An engagement letter provides a written agreement of the terms of the audit engagement between the auditor and management or those charged with governance. It confirms that there is a common understanding between the auditor and management, or those charged with governance, of the terms of the audit engagement helps to avoid misunderstandings with respect to the audit.

c. Materiality

The objective of an audit of financial statements is to enable the auditor to express an opinion on whether the financial statements are prepared in all material respects, with an identified financial reporting framework. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. The auditor must be concerned with identifying 'material' errors, omissions and misstatements. Both the amount (quantity) and nature (quality) of misstatements need to be considered. To put this into practice the auditor therefore has to set his own materiality levels – this will always be a matter of judgement.

d. The formula for the audit risk model is:

Audit Risk = Risk of material misstatement in the financial statements x Detection Risk

Audit Risk Explained Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of two main components being the risks of material misstatement and detection risk. Risk of material misstatement is made up of two components, inherent risk and control risk.