CHAPTER 8

EXERCISE
1. What factors should an auditor consider prior to accepting an engagement? Explain
Prior to accepting a client, the auditor should investigate the client. The auditor should
evaluate the clients standing in the business community, financial stability, and relations
with its previous CPA firm. The primary purpose of new client investigation is to
ascertain the integrity of the client and the possibility of fraud. The auditor should be
especially concerned with the possibility of fraudulent financial reporting since it is
difficult to uncover. The auditor does not want to needlessly expose himself or herself to
the possibility of a lawsuit for failure to detect such fraud.
2. What is the purpose of an engagement letter?
An engagement letter is agreement between the CPA firm and the client concerning the
conduct of the audit and related services. It should state what services will be provided,
whether any restrictions will be imposed on the auditors work, deadlines for completing
the audit, and assistance to be provided by client personnel. The engagement letter may
also include the auditors fees. In addition, the engagement letter informs the client that
the auditor cannot guarantee that all acts of fraud will be discovered.
3. Define what is meant by a related party. What are the auditors responsibilities for
related parties and related party transactions?
Related party is defined in auditing standards as an affiliated company, a principal owner
of the client company, or any other party with which the client deals, where one of the
parties can influence the management or operating policies of the other.
Material related party transactions must be disclosed in the financial statements by
management. Therefore, the auditor must identify related parties and make a reasonable
effort to determine that all material related party transactions have been properly
disclosed in the financial statements.

4. For the audit of Raiha Manufacturing Company, the auditor partner asks you to
carefully read the new mortgage contract with the Chartered Malaysia Bank and
abstract all pertinent information. List the information in a mortgage that is likely
to be relevant to the auditor
1. The parties to the agreement
2. The effective date of the agreement
3. The amounts included in the agreement
4. The repayment schedule required by the agreement
5. The definition and terms of default
6. Prepayment options and penalties specified in the agreement
7. Assets pledged or encumbered by the agreement
8. Liquidity restrictions imposed by the agreement
9. Purchase restrictions imposed by the agreement
10. Operating restrictions imposed by the agreement
11. Requirements for audit reports or other types of reports on compliance with the
agreement
12. The interest rate specified in the agreement
13. Any other requirements, limitations, or agreements specified in the document
5. What are the purposes of preliminary analytical procedures? What types of
comparisons are useful when performing preliminary analytical procedure?
Analytical procedures are performed during the planning phase of an engagement to
assist the auditor in determining the nature, extent, and timing of work to be performed.
Preliminary analytical procedures also help the auditor identify accounts and classes of
transactions where misstatements are likely. Comparisons that are useful when
performing preliminary analytical procedures include:
Compare client and industry data
Compare client data with similar prior period data
Compare client data with client-determined expected results
Compare client data with auditor-determined expected results
Compare client data with expected results, using nonfinancial data