Audit 411 Chapter 5 review
Sufficiency of audit evidence: Making decisions about the sufficiency of audit evidence requires significant professional judgement. Explain how the following factors might impact the auditor's professional judgement regarding the sufficiency of audit evidence involved in the audit of inventory for a manufacturer: A) Materiality B) Risk of material misstatement C) Size and characteristics of the population
A) assertions that are more material to financial statements users require more sufficient evidence B) Assertions that have a higher risk of material misstatements (RMM) require more sufficient evidence C) Larger more diverse population require more sufficient evidence
How detailed should documentation be? It depends on several factors, such as A. the ____________________________ being performed B. the ______________________________ involved in the area being tested C. the ______________________________ to the overall audit D. the ________________________ in performing the work E. the _________________________________
A. nature of auditing procedure B. risk of misstatement C. Sufficiency of the evidence D. Extent of judgement involved E. nature of the findings/results
The transactions are recorded in the correct accounting period
Cutoff
Bank statement sent directly to the auditor by the bank
Directly from outsiders
Sampling Risk
The risk that the auditors' conclusion based on a sample might be different from the conclusion they would reach if the test were applied to the entire population. For tests of controls, sampling risk include risks of assessing control risk too high and too low; for substantive testing, sampling risk include the risks of incorrect acceptance and rejection.
Examples of routine transactions are ___________________________. They are routine in nature restricts ______________ risks.
sales, purchases, cash distruments, cash receipt, payroll inherent
2) Discuss the validity and limitations of inquiry and oral evidence
same as above: but in critical/important matters we should ask the client to confirm answers in writing
What is the relationship between detection risk and audit risk?
Audit risk uses a formula Detection is within audit risk Audit risk=IR x CR x DR
All assets have been recorded
Completeness
________________ are effectiveness at providing evidence about the existence of accounts, but are less effective at addressing _________________ and valuation
Confirmation completeness
Reconciliation
Establishing the agreement between two sets of related accounting records
Confirmation
Establishing the validity of a balance sheet by direct communication with an outside party
Vouching
Establishing the validity of a transaction by examining supporting documents
There is such an asset
Existence and occurrence
Tracing
Following a transaction from a source document to recorded entries (completeness)
Assets are recorded at proper amounts
Valuation, allocation, and accuracy
Detection risk is restricted by performing __________ _________
substantive procedures
In the course of an audit, the auditor asks many questions of client officers and employees. 1) Describe the factors that the auditor should consider in evaluating inquiry and oral evidence provided by the client officers and employees
1) Competence of person we're asking 2) Disinterestedness (objectiveness) 3) Logic and reasonableness of response
Compare current financial information with comparable prior periods
Analytical procedures
Give examples of specialists whose findings might provide appropriate evidence for independent auditors
Appraisers, attorneys, geologists, environmental consultant
__________ ___ ____________ are designed to test the operating effectiveness of controls in preventing or detecting material misstatements.
Tests of controls
Confirm accounts receivable
Tests of details of account balances, transactions and disclosures
Business Risk
The risk assumed by investors or creditors that is associated with the company's survival and profitability
Information Risk
The risk that the information used by investors, creditors, and others to assess business risk is not accurate
Audit evidence (or evidential matter) may be defined as any information that ...
corroborates or refutes a premise
Estimated transactions
create an account estimate: allowance for doubtful accounts, bad debt expense, goodwill, estimated warranty reserved
Inspection
critical review of a document
Tests of ________ _________ directly address whether there are misstatements in the ending balances of an account
details balances
Substantive procedures include analytical procedures and tests of ______________________________________________.
details of account balances, transaction, and disclosures
Tests of __________ ____ __________ address whether financial statement discloses are properly presented
details of disclosures
Tests of ________ _____ _________ address whether particular types of transactions have been properly accounted for during the period.
details of transactions
Rather than "assessing" ____________ _____________, auditors seek to restrict it through the performance of ____________ _______________. Detection risks exists because the auditors' substantive procedures are _________ ______ __________, due to both sampling and other factors.
detection risk substantive procedures Not 100% effective
A letter signed by offices of the client company at that auditors request which sets forth certain assertions about the company's financial position and operations known as a ________________ ___________. The term ____________ relates to the quantity of evidence to be obtained.
representation letter sufficient
Properly prepared audit documentation will help the auditors should litigation arise, just as improperly prepared documentation __________________________
will work against them
Calculate the ratio of bad debt expense to credit sales
Analytical procedures
What is the 8 types of audit procedures?
1) Analytical procedures 2) External confirmation 3) Inspection of tangible assets 4) Inspection of records and documents 5) Inquiries of knowledge about persons within or outside the entity 6) Observation of process or procedures being performed by others 7) Recalculation of mathematical accuracy 8) Reperformance of procedures
An audit may include computations of various balance sheet and operating ratios for comparisons to prior years and industry averages. Discuss the validity and limitations of ratio analysis in an audit
1) Board overview 2) Ranks lower in reliability and validity than direct evidence 3) Usually considered circumstantial
A canceled check is not considered particularly reliable evidence since the check was prepared within the client's organization
Incorrect-the check was processed externally by two organizations 1) who it was written too 2) banking system
What are the two components of risk of material misstatements?
Inherent risk x control risk
Paid checks returned with bank statement
Internal but validated externally
Who makes assertions? List the assertions
Management 1) Existence and occurrence 2) Rights and Obligations 3) Completeness 4) Cutoff 5) Valuation, allocation, and accuracy 6) Presentation and disclosure
The best means of verification of cash, inventory, office equipment, and nearly all other assets is a physical count of the units, only a physical count gives the auditors complete assurance as to the accuracy of the amounts listed on the balance sheet
Misleading-Accounting office equipment does not establish the cost or ownership *Just as important as physical existence
Can the auditors reduce inherent risk by performing audit procedures?
No- inherent risk will be there anyways
In connection with the audit of the financial statements of a manufacturing company, an auditor is observing the physical inventory of finished goods, which consists of expensive, highly complex electronic equipment. Discuss the validity and limitations of the audit evidence provided by the procedure
Physical evidence is one of the reliable sources of evidence in this case when the inventory consists of individual valued items you should >>>>>>>
Assets are properly classified
Presentation and disclosure
Reperformance
Providing that accuracy of a client-performed activity
Audit Evidence is gathered to use:
RAR 1) Reduce Audit Risk 2) Assess RMM (Risk Material Misstatement) 3) Restrict Detection Risk
The company legally owns the asset
Rights and Obligations
________ ___________ ______________ are designed to obtain an understanding of the client and its environment to assess the risks of material misstatements.
Risk Assessment Procedures
Prepare a flowchart of internal control over sales
Risk Assessment procedures (other than analytical procedures)
__________ ____________ are designed to detect material misstatements of relevant assertions.
Substantive procedures
Distinguish between the sufficiency (results) of audit evidence and the appropriateness (obtained) of audit evidence
Sufficiency is related to quantity and is a matter of judgement in every audit Appropriateness is related to the quality (reliability and relevance)
Determine whether disbursements are properly approved
Tests of controls
Distinguish between the component of audit risk that the auditors gather evidence to ASSESS vs. the component of audit risk that they collect evidence to RESTRICT
The auditor ASSESS IR and CR The auditor RESTRICTS DR
Inherent Risk
The risk of material misstatement of a financial statement assertion, assuming there were no related control
Engagement Risk
The risk of the loss of the auditors' reputation that happens when client goes bankrupt or management lacks integrity
Control Risk
The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control
Audit Risk
The risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.
Detection Risk
The risk that the auditors' procedures will lead them to conclude that a financial statement assertion is not materially misstated when in fact such misstatement does exist
The study of trends, percentage changes, ratios, and other relationships among financial and non financial data is term _________________ _________________.
analytical procedures
When performing analytical analysis, auditors should carefully consider the ____________ and ____________ if the data before drawing conclusions based upon comparisons with industry averages.
comparatively timeliness
Assertions with high inherent risk involve _________ ___ _______ transactions, complex calculations, difficult ___________________, significant ________________________________, or valuations that vary significantly based on _____________________.
difficult to audit accounting issues judgement by management economic factors
Vouchers in client's unpaid voucher file, credit memo in customer's file. management working papers in making accounting estimates, memo in customer file from treasurer authorizing the write-off of the account
entirely internal
Because they involve management judgements or assumptions, ____________ _________ are generally the transactions with the highest level of inherent risk
estimation transactions
Audit risk refers to possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially or immaterially misstated
false
Less control risk means an increase in the risk of material misstatements
false
Rather than restrict detection risk though the performance of more substantive procedures, auditors assess it.
false
The risk of material misstatement is composed of the three components of audit risk (T/F)
fasle- IR and CR
High inherent risk may be indicated by __________________________, operating results that are highly ______________________________, going concern problems, large known and likely ___________________________, substantial turnover, questionable reputation, or ________________________________.
inconsistent profitability sensitive to economic factors misstatements detected in prior audits inadequate accounting skills in management
Creditor monthly statement obtained from client's files, duplicate sales invoices in filled order files, times tickets filed in payroll department, bank statement in client's files, letter in customers files form collection agency on collectability of balance
indirectly from outsiders
When the auditors express an opinion that the financial statements are free from material misstatements, they are relying upon the effectivenesses of the client's ______________ _________ to prevent such misstatement and their _________ _________ to detect any material misstatement that may have occurred
internal control audit procedures
The amount of evidence that is considered sufficient varies _____________ with the competence of the evidence
inversely
Inherent risks many be high for non-rountine transactions because they are ___________________________ of transactions and occur only periodically. Specialized skills may be needed to perform activities such as __________________, ______________, and __________________________.
not part of normal flow physical inventories calculating depreciation adjusting FS for foreign currencies gains/losses.
The client _______________ ________________ should never be used as a substitute for performing audit procedures. It is required on every engagement and is dated as of the _____________________________.
presentation letter date of auditors' report
In relying upon the work of a specialist, the auditors must ascertain the professional _________________ and reputation of the specialist and review the reasonableness of underlying ______________ made by the specialists.
qualifications methods
Appropriateness is measure of _____________________ and _______________ relates to the assertion being addressed
quality being obtained relevance
The ____________ of audit evidence needed is affected by the risk of misstatements and the reliability of the evidence. The ___________ the risk, the more audit evidence required.
quantity greater
A primary challenge for auditors is identifying any related party transactions that management has not disclosed, because they may be ___________________________________ with all other transactions
recorded in the account records
Nonrountine transactions
recur only periodically: depreciation, inventory
Routine transactions
recurring financial activities: sales, payroll, and purchases
Auditors should be cautious when accepting photo copies or tax copies because _____________________________________
they can be altered in anyway, making detection difficult.
Absent any other changes, an increase in the risk of material misstatements results in an increase in audit risk
true
Both inherent risk and control risk exist independently of the audit of financial statements
true
Detection risk does not exist when no audit is performed
true
Inherent risk is the possibility of material misstatement before considering the client's internal control
true