Sandy Pitts is auditing Hofmeister Hardware Company, a fast-growing retail hardware chain. While Pitts has previously worked on this engagement, this is her first year as the audit manager. As she planned the engagement, Pitts identified a number of risk factors (such as strong interest in maintaining the company’s earnings and stock price, unrealistic forecasts, and high dependence on debt financing for expansion) that indicated that fraud might exist.
a) How should Pitts respond to the possibility of fraud at the planning stage? What is the required documentation for identified risk factors?
At the planning stage, Pitts identified a number of risk factors that indicated that fraud might exist. As an auditor, she might respond to the possibility of fraud as follows:
• Increase professional scepticism by questioning and critically assessing audit evidence. • Assign more experienced auditors who have the knowledge, skill and ability commensurate with the increased risk of the engagement. • Consider management’s selection and application of significant accounting policies, particularly those related to recognizing revenue, valuing assets, or capitalizing versus expensing. • Modify the nature, timing and extent of audit procedures to obtain more reliable evidence and use increased sample sizes or more extensive analytical procedures.
The auditor has extensive documentation requirements for understanding the entity and its environment, the consideration of fraud, and responding to assessed risks. The auditor should document the risk of material misstatement for all material accounts and classes of transactions in terms of the related assertions. The required documentation for identified risk factors includes the following:
• The nature and results of the communication among engagement personnel that occurred in planning the audit regarding the risks of material misstatement due to...