Auditing SB 2 Chapter 3 Notes

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Client acceptance and continuance policies and procedures generally include

- Communication with the predecessor auditor - Obtaining and reviewing financial information about the prospective client (annual reports, interim statements, registration statements, Form 10-Ks, and reports to regulatory agencies) - Acquiring detailed criminal background checks of all senior managers - Requesting the prospective client's bankers, legal counsel, underwriters, analysts, etc. who do business with the entity to provide info about it and its management - Considering whether the engagement would require special attention or involved unusual risk - Evaluating the public accounting firm's independence with regard to the client - Considering the needs for individuals possessing special skills or knowledge to complete the audit (industry specialist)

Internal auditor objectivity is questioned when:

- They report to divisional management, line managers, or persons with a stake in the outcome of their findings - Managers have some power over the pay or job tenure - Individual internal auditors have relatives in audit-sensitive areas or are schedule to be promoted to positions in the activities under internal audit review

Audit team uses materiality in three ways:

1. As a guide to planning substantive testing procedures 2. As a guide for determining performance materiality 3. As a guide for decisions about the audit report

3 Purposes of Audit Procedures

1. Gain an understanding of client and the risks associated with the client 2. Test the operating effectiveness of client internal control activities 3. Produce evidence about management's assertions related to the amounts and disclosures in a client's financial statements

Stages of an Audit

1. Obtain (or Retain) Engagement 2. Engagement Planning 3. Risk Assessment 4. Substantive Procedures 5. Reporting

8 general audit procedures to gather evidence

1. inspection of records and documents 2. inspection of tangible assets 3. observation 4. inquiry 5. confirmation 6. recalculation 7. reperformance 8. analytical procedures

Auditors should perform the following activities:

1. perform procedures regarding the acceptance or continuance of the audit client relationship 2. determine compliance with independence and ethics requirements 3. reach a contractual understanding with the client for the terms and conditions of the audit engagement

rule of thumb percentages often applied to the benchmarks often range from

3-5 percent of PBT or 1/2-1 percent of revenue/total assets

audit plan

A comprehensive list of the specific audit procedures that the audit team needs to perform to gather sufficient appropriate evidence on which to base their opinion on the financial statements. Required to be led by the assigned engagement partner

Which of the following statements are correct?

Any type of management fraud is considered material regardless of amount The nature or an item or issue impacts materiality considerations

Reperformance ________

Can be completed for any client control procedure Is commonly used when completing internal control system walkthroughs

Reported net income under GAAP is not one "true" figure but a possible range of measure influenced by the choice of ______.

Classification of marketable securities Fixed asset lives Depreciation methods

The physical presence of assets is an example of evidence available to test the ASB assertion of _____

Existence

True or false: One objective of a financial statement audit is to determine if, in all material respects, the entity being audited is reporting the one true net income.

False A range of potential figures is allowable under both GAAP and IFRS

True or false: Auditors should resist using analytical procedures during the substantive testing of balances.

False A well planned procedure can be very effective

External Documents

Formal: bank statements, title papers, and insurance policies Ordinary: vendor invoices, simple contracts, written correspondence

Time budgets:

Identify problem areas early in the engagement Are often based on prior years audits May be based on a predecessor auditor's experience

Inquiry ______.

Is never enough on its own to reach an audit conclusion Generally involves the collection of verbal evidence

Audit documentation ______.

May be in either electronic or hard copy form Should contain support for the audit decision Provides the auditors' record of compliance with standards

Select all that apply External auditors ______. May delegate supervision of internal auditors to the manager of internal audit May rely on some work completed by the internal audit department Must review, evaluate and perform independent testing of the internal audit work Cannot delegate tasks that require professional judgement

May rely on some work completed by the internal audit department Must review, evaluate and perform independent testing of the internal audit work Cannot delegate tasks that require professional judgement

public accounting firm that has been terminated or has voluntarily withdrawn from the engagement (whether the audit has been completed or not) is known as the

Predecessor auditor

Recalculation

Produces compelling evidence Can use computer-assisted audit techniques Provides evidence of valuation when used with other procedures

Confirmation can provide evidence regarding ______.

Rights and obligations Existence Valuation Cutoff

A planning memorandum ______.

Summarizes all important overall planning information Documents that the audit team is following generally accepted auditing standards Includes specific directions related to the audit

Favorable conclusions about the competence and objectivity of internal auditors allow external auditors to rely on the work of internal auditors related to ______.

Testing the internal control system Substantive testing of balances on the audit

termination letter

The documentation provided to former clients dealing with the subject of future services, in particular (1) access to audit documentation by new auditors, (2) reissuance of the auditors' report when required for SEC reporting or comparative financial reporting, and (3) fee arrangements for such future services. The termination letter also can contain a report of the auditor's understanding of the circumstances of termination (e.g., disagreements about accounting principles and audit procedures, fees, or other conflicts).

quality assurance partner

The second audit partner on the audit team as required for audits of financial statements filed with the SEC who reviews the audit team's work in critical audit areas (those areas with the highest potential audit risk).

The objectivity of internal auditors is questionable when ______.

They are scheduled for promotion to areas under internal audit review Divisional managers set their pay They report to a line manager

True or false: Public accounting firms devote substantial time to make sure their audit clients are not likely to become the focus of an accounting scandal

True This is an important element of a firm's quality control policies and procedures

True or false: The engagement letter is designed to act as a contract for the audit

True It sets forth objectives, responsibilities, and any limitations and serves as a means of avoiding legal liability

substantive audit plan

a list of audit procedures for gathering evidence related to the relevant assertions identified for an audit client's significant financial statement accounts and disclosures

internal control audit plan

a plan that would contain the specific procedures needed to obtain an understanding of the client's internal control system and test that understanding for those controls that relate to the relevant financial statement assertions

Persons skilled in areas outside of accounting are sometimes used to acquire information. Such individuals are called audit specialists and may include

actuaries, attorneys and environmental engineers

materiality

an amount or event that has a substantial likelihood to influence the financial statement users' decisions

Nature of the item or issue is

an important qualitative factor

The written record of the basis for the auditor's conclusions that provide the support for the auditor's representations is the PCAOB definition of

audit documentation

A comprehensive list of the specific procedures that need to be performed to gather sufficient appropriate evidence to base an opinion on the financial statements is called a(n) _____ _____ .

audit plan

The audit strategy memorandum becomes the basis for preparing the ______.

audit plan

When the external auditor is gaining an understanding of the business, information may be needed from individuals skilled in areas other than accounting and auditing who are not members of the audit team. Such individuals are referred to as ______.

audit specialists

vouching

auditor selects an item of financial information and follows its path back through the processing steps to its origin

Internal auditors can never

be considered independent in the same sense that external auditors are. Internal auditors can and should be objective

Risk management activities are undertaken ______.

before beginning any audit engagement

The planning process begins with a calculation of a preliminary materiality amount that is based on a relevant _____ and a rule of thumb percentage applied to it

benchmark

During the substantive testing of balances analytical procedures ______.

can be very effective

Internal auditors ______

can never be considered independent in the same sense that external auditors are considered independent

A widely used auditing procedure is ______ by direct correspondence with independent parties.

confirmation

The permanent files are also called ____ ____ files.

continuing audit

The engagement letter acts as a

contract and serves as a means for reducing the risk of misunderstandings with the client and as a means of avoiding legal liability for claims the auditors did not perform the work promised

Observation is commonly used as a test of ______.

control

Professional standards require auditors to reach a mutual understanding with clients concerning requirements and expectations which is usually done by preparing a written _________ ____________ .

engagement letter

Physical inspection of tangible assets provides strong evidence regarding the assertion of ____ and may provide some evidence related to the assertion of ____.

existence; valuation

Giving each document a title including the name of the company, balance sheet date, and a descriptive title is called ______.

heading

Perceptions of others in regards to an auditor being unbiased is referred to as ________ in ________.

independence in appearance

An auditor's unbiased "state of mind" towards the financial statements and other information audited is referred to as the auditor possessing ________ in ________.

independence in fact

Document received directly from an ____ ____ ____ is considered reliable

independent outside party

To reduce risk of accepting a problem client, auditing standards require a prospective auditor to

initiate contact with and attempt to obtain basic information directly from the predecessor regarding issues that reflect direct on the integrity of management. audit client must grant approval before communication can occur

The collection of verbal evidence from independent parties and management is the audit procedure known as ____.

inquiry

A prospective auditor should attempt to obtain basic information directly from the predecessor auditor regarding issues that reflect directly on the ______.

integrity of management

External auditors should consider the objectivity and competence of _______ __________ before relying on their work.

internal auditors

An audit plan ____

is a comprehensive list of specific procedures needed to gather sufficient appropriate evidence

The descriptive nature of an item or issue ______ when setting performance materiality.

is an important qualitative factor

potential errors in the more _____ _____ are more important than potential errors in other accounts

liquid assets (cash, receivables, inventory)

Any type of fraud committed by a member of management is always considered _____ regardless of amount

material

IT auditors

members of the audit team who are specially trained to evaluate computerized controls and processes

independence in fact

mental attitude in which auditors are expected to be unbiased and impartial with respect to the financial statements and other information they audit

With respect to a predecessor auditor, a perspective auditor ______.

must initiate contact and attempt to obtain certain basic information

The auditor must carefully plan the

nature, timing, and extent of control tests and substantive tests that are designed to mitigate risks to an acceptable level

When planning the engagement, the auditor

needs to develop and document a plan that describes the nature, timing, and extent of further audit procedures to be performed to assess the risk of material misstatement at the financial statement and assertion level

Public accounting firms are _____ .

not obligated to provide services for any new or existing client

Prior to relying on the work of internal auditors, external auditors should consider their ____ and ____.

objectivity and competence

Viewing a client's physical facilities and participating in a surprise payroll distributions are examples of the audit procedure known as

observation

Internal auditors' competence is investigated by

obtaining evidence about their educational and experience qualifications, their certifications, and continuing education status

Net income is not necessarily the one "true" figure but

one possibility in a range of potential net income figures allowable under the relevant reporting framework (GAAP or IFRS)

Information to familiarize new audit team members with a client, company history, continuing schedules and prior years financial statements and audit reports may all be found in the _____ files.

permanent

Audit specialists

persons skilled in fields other than accounting and auditing—actuaries, appraisers, attorneys, environmental engineers, and geologists—who are not members of the audit team

All important overall planning information and documentation that the audit team is following generally accepted auditing standards is often summarized in a(n) _____ _____.

planning memorandum

interim audit work

procedures performed several weeks or months before the date of the financial statements

Year-end audit work

procedures performed shortly before and after the balance-sheet date

Materiality is based on ______

professional judgment

auditors most commonly use _____ for their initial determination of materiality, depending on client industry

profit before tax, total net assets, or total revenues

Risk management activities

public accounting firms undertake several activities before beginning any audit engagement to try and reduce their own business risks by carefully managing their audit engagements

In addition to the audit engagement partner, audit teams typically include a(n) ____ ____ partner who reviews the audit team's work in critical audit areas.

quality assurance

Scanning

reading material in an investigative way to search for specific information

When the audit team recomputes computations previously performed by client personnel, the audit procedure is called

recalculation

When the audit team recomputes computations previously performed by client personnel, the audit procedure is called ____.

recalculation

An audit procedure that is similar to recalculation but much broader in approach is called ____.

reperformance

Inspection of tangible assets does not necessarily provide any evidence of ______.

rights

The probability that the firm could issue a clean, unmodified opinion when in fact a modified opinion should have been issued is referred to as

risk

audit firms spend a considerable amount of time on

risk assessment at both the financial statement level and management assertion level for the client being audited

Interim work typically consists of

risk assessment work, internal control testing, and substantive testing of balances as they exist at the interim date

The assignment of staff to an audit engagement depends on the ______.

riskiness of the engagement

An "eyes-open" approach of looking for anything unusual that can raise questions related to evidence that needs to be obtained is called

scanning

cycle

set of accounts that are logically grouped in the internal control system which has been designed to produce the financial statements and notes

engagement letter

sets forth the understanding with the client, including in particular (1) the objectives of the engagement, (2) management's responsibilities, (3) the auditors' responsibilities, (4) any limitations of the engagement, and (5) other matters of understanding

Client continuance decisions

similar to acceptance decisions, typically done annually and/or with the occurrence of major events such as changes in management, directors, ownership, legal counsel, financial condition, etc.

The audit plan needs to specify a list of procedures that must be completed to gather _____ and _____ evidence directed toward achieving particular audit objectives

sufficient; appropriate

Form 8-K

the "current events" report filed periodically at the occurrence of major events, such as earnings releases, major asset sales, acquisitions, changes in control and legal proceedings required when a public company changes auditors, filed with SEC

tolerable misstatement

the amount of planning materiality that is allocated to a financial statement account

Public accounting firms devote substantial time to make sure that

the audit clients they serve do not become the focus of the next big accounting scandal.

tracing

the auditor selects a basic source document and follows its processing path forward to find its final recording in a summary journal or ledger and ultimately the financial statements

independence in appearance

the extent to which others (particularly financial statement users) perceive auditors to be independent

If the auditor is not considered independent

the financial statements are considered unaudited for all practical purposes. Auditors can receive disciplinary actions by regulators and/or professional organizations and litigation by those who relied on the financial statements

audit engagement partner

the person with the final responsibility for the audit, and usually an industry specialist

management integrity (or lack thereof) is

the primary reasons for accepting or not accepting an audit engagement

Risk in audit engagement

the probability that the firm could issue a clean, unmodified audit opinion when in fact a material misstatement does exist in the financial statements and the opinion should have been modified

Auditor's shorthand for abbreviating comments about work performed are called audit or _____ _____

tick marks

To ensure the audit is completed on schedule, a(n) ____ ____ is prepared to assist in identifying problem areas early in the engagement.

time budget

Testing the completeness assertion by following a sample of shipping documents forward to sales invoices, the sales journal and revenue earned is called ____.

tracing

time budget

used to maintain control of the audit by identifying problem areas early in the engagement, thereby ensuring that the engagement is completed on a timely basis usually based on prior year performance or general experience with similar companies

performance materiality

used to make sure aggregate of uncorrected/undetected immaterial misstatements does not exceed materiality for the financial statements as a whole

Reperformance is a representative audit procedure used to test the PCAOB and ASB assertion of ______

valuation and allocation

The auditor begins the search for evidence by focusing on transactions that have already been recorded in the financial statements and following them back to the source when engaged in ______.

vouching


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