Audit Chapter 13 - Overall Audit Strategy and Audit Program

Test of Controls (TOC) relation to risk model

assessment of control risk

Substantive tests of transactions (STOT) relation to risk model

assessment of control risk and detection risk (PDR)

In the audit of which of the following G/L accounts will tests of controls be appropriate? a. equipment b. bonds payable c. bank charges d. sales

d. sales

Substantive analytical procedures (SAP) relation to risk model

detection risk (PDR)

TOC results poor, STOT results good, Reduction in TODB ________________

fairly substantial

Dual purpose tests

most involve reperformance, and they simultaneously provide evidence on the effectiveness of controls and the existence of monetary errors - TOC - was client verification procedure effective? - STOT - was transaction accurate?

TOC results good, STOT results poor, Reduction in TODB ________________

no reduction

TOC results poor, STOT results poor, Reduction in TODB ________________

no reduction

TOC results good, STOT results good, Reduction in TODB ________________

substantial

When must TOC be performed

test of key controls must be performed to assess control risk below maximum (CR < maximum 100%)

Substantive tests of transactions

tests for monetary errors applied to transactions to test whether transaction-related audit objectives have been met. monetary correctness includes determining whether the amount of the transaction is correct, and whether it is correctly posted and summarized

risk assessment procedures

the auditor is required to perform risk assessment procedures, including procedures to gain an understanding of the internal control system. this includes sufficient documentation and inquiries, as well as a walk-through to support the understanding

Analytical procedures

Direct test - substantive analytical procedure that eliminates the need for detailed testing of account ex. test reasonableness of accrued commissions/expense by multiplying sales x rate Indirect test - good results reduce, but don't eliminate substantive tests ex. compute gross margin percentage (provides evidence as to likelihood of errors in Inv and A/R)

Confirm A/P balances directly with vendors Type of test:

Objective: completeness Test: TODB

Check sequence of checks in cash disb. journal to see whether they were omitted Objective: Type of test:

Objective: completeness Test: TOC

Examine vendor invoice to verify ending AP balance Type of test:

Objective: completeness, accuracy Test: TODB

Foot (add) the AP trial balance and compare total to general ledger Objective: Type of test:

Objective: detail tie-in Test: TODB

Ex: Separation of duties exist among billing, recording of sales, & handling of cash receipts. TOC: observe whether person responsible for handling cash have no responsibilities What TOC is this?

Observation

Tests of Details of Balances (TODB) relation to risk model

PDR

Ex: credit is approved automatically by the computer by comparison to authorized credit limits TOC: examine a sample of sales invoices & compare order with credit limits What TOC is this?

Reperformance

Cost of tests

TOC - $$ STOT - $$$ A/P - $ TODB -$$$$

Which carries more weight, STOT or TOC

- STOT because it directly indicates errors - when STOT are poor, the results of TOC should regard as poor, and CR set at maximum

Distinction between STOT and TODB

- STOT focus on transaction related objectives. They are usually applied to a sample of transactions in a journal for the entire period - TODB test balance objectives. They are usually applied to an ending balance in an account (note that an ending balance consists of transactions)

Relationship between STOT, TOC, and errors

- TOC = indirect evidence of errors - STOT = direct evidence of errors - both indicate likelihood of error in financial statements - both projected as occurrence rates

Tests of transactions include:

- Tests of controls (TOC) - Substantive tests of transactions (STOT)

audit program

- describes all the audit procedures that the auditor considers necessary - based on auditor judgment - reflects risk assessment procedures - should be modified if circumstances change

Relationship between TOC and STOT

- inverse relationship - as more tests of controls are performed, less substantive tests of transactions are necessary (due to the inverse relationship between CR and PDR) - CR decreases, PDR increases, substantive evidence decreases - generally performed on the same sample

Tests of Controls Overview

- most manual controls involve examining evidence of performance (ex. initials) - where a control exists but leaves no evidence of performance, the auditor can often test using reperformance (dual-purpose test) - some controls can only be tested by observation (ex. separation of duties) - a few controls relate to year-end balances, rather than transactions (ex. firms generally have many controls in their procedures to count inventory)

Substantive tests include:

- substantive analytical procedures (SAP) - substantive tests of transactions (STOT) - tests of details of balances (TODB)

TODB

- tests for monetary errors in ending account balances, and are a main form of audit evidence - primarily applied to balance sheet accounts - costly, but usually the best form of evidence - if unfavorable results for other tests are obtained, increase TODB

The four tests auditors perform after performing risk assessment procedures

- tests of controls (TOC) - substantive tests of transactions (STOT) - substantive analytical procedures (SAP) - tests of details of balances (TODB)

Tests of controls are performed in order to determine whether or not: 1. controls are functioning as designed 2. necessary controls are absent 3. incompatible functions exist 4. material dollar errors exist

1. controls are functioning as designed

Timing of tests

1. risk assessment procedures, including procedures to gain an understanding of controls 2. TOT & STOT performed simultaneously 3. AP when used as direct evidence 4. TODB- performed last and after year-end Two other factors accelerate the timing of procedures and cause more work to be performed at an interim date: 1. need for timely financials 2. seasonality of CPA business

The auditor faces a risk the audit will not detect material misstatements that occur in the accounting process. To minimize this risk, the auditor relies primarily on: 1. substantive tests 2. tests of controls 3. internal control 4. statistical testing

1. substantive tests

The auditor looks for an indication on duplicate sales invoices to see if they have been verified. This is an example of: 1) a test of detail balances 2) a test of control 3) a substantive test of transactions 4) both TOC and STOT

2) a test of control

Which types of evidence will an auditor most likely examine to determine whether controls are operating as designed? 1. confirmations of receivables verifying account balances 2. letters or representations corroborating inventory pricing 3. attorney's responses to the auditor inquiries 4. client records documenting the use of computer programs

4. client records documenting the use of computer programs