Quiz 7: Professional Issues

Business

Engagement risk is often defined as the overall economic risk that a specific engagement poses to a firm. More specifically, it might be described as the audit risk associated with a particular client. The risk of auditing a particular client is comprised of: • Inherent risk - risk factors present in a client's particular business model, its industry and overall economic conditions. • Control risk -- risk based on whether a client's particular internal control systems will fail to detect/correct misstatements • Detection risk - risk that the auditor will fail to uncover/identify misstatements • Other factors - These might include whether a company is public or private (a public company may have a larger pool of potential litigants), is the client likely to be able to pay for the audit etc. The auditor's professional responsibilities are generally the same for a high-risk engagement compared with a more typical engagement. The difference is more a reflection of the likelihood that the auditor will run into issues during the course of the audit process or as a result of the audit process.

The key quality control mechanisms to ensure that audit partners have the requisite training and expertise consist of (or are defined by) the Generally Accepted Auditing Standards (GAAS). These standards call for the exercise of "due care" in the planning and performance of the audit including the requirement that the individuals performing the audit have the correct level of expertise and experience to complete the task. Audit firms have a number of control mechanisms to ensure auditor expertise including: • Hiring standards • Licensing standards • Performance appraisals • Mandated training and continuing education • In-house reviews of sample audit engagements

The key accounting principles covering revenue recognition require that: • Revenue is earned: the seller has completed substantially all of its responsibilities in the transaction. • Revenue is realized : the buyer has agreed to the transaction and the seller has exchanged assets (goods or services) with the buyer in exchange for payment or claims of payment. Under each of these requirements are additional factors regarding the timing and amount of recognition as well as a general emphasis on conservatism. For example, to what extent does the buyer reserve the right to return the asset for repayment In this case, the client violated the revenue recognition principle because the earnings process was not complete. • The buyers (wholesalers) had not sold all of the product that they had purchased from the company • The seller (client) did not maintain a sufficient allowance for returns. • Conservatism was not applied because the audit client did not adjust its returns allowance (not recognize revenue) when evidence supported a higher allowance.