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Auditing Chapter 6

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CHAPTER 6

Audit Planning, Understanding the Client,
Assessing Risks, and Responding

Review Questions

6–1 In their investigation of a prospective client, the CPAs should assess the backgrounds and reputations of the prospect and its major shareholders, directors, and officers. Thus, inquiries are made of underwriters, bankers, and attorneys that conduct business with the prospective client. Also, the CPAs are required to make inquiries of the prospect’s predecessor auditors to obtain information that might enter into the acceptance decision, such as information regarding the integrity of management. The prospect’s financial reports, SEC filings, credit reports, and tax returns are used as sources of financial background information.

6–2 The audit committee of a board of directors must be composed of at least three independent directors. Independent directors are those who are outside directors (not officers or employees) who have no relationships that might impair their independence. This would include relationships such as performing consulting services for company management. In addition, the members must be financially literate; at least one member must be a financial expert.

6–3 An engagement letter is sent to the client by the auditors to make clear the nature of the engagement, any limitations on the scope of the audit, work to be performed by the client’s staff, and the basis for computing the auditors’ fee. The engagement letter represents the written contract for the engagement, and its primary objective is to prevent possible misunderstandings between the client and the auditors. It constitutes an executory contract between the auditors and the client.

6–4 “Shopping for accounting principles” is a practice whereby management changes auditors to a CPA firm that is more likely to allow an accounting principle…...

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