Ch 8 Audit Planning and Materiality

Complete certainty= 100 or 0?

0

• Management and Governance- The auditor needs to assess _______ philosophy and operating style and its ability to identify and respond to _____

1, management's 2. risk

Planning extent of tests is done in steps?

1-2

• Auditors have three major difficulties when allocating materiality to *balance sheet accounts:* 1. Auditors expect certain accounts to have _____ misstatements than others. 2. Both _______ and _______must be considered. 3. ________ audit costs affect the allocation.

1. Auditors expect certain accounts to have more misstatements than others. 2. Both overstatement and understatements must be considered. 3. Relative audit costs affect the allocation.

o ____ risk can arise that threaten management's objectives. Knowledge of management's objectives and strategies help the auditor to assess client ________ risk and the risk of ______.

1. Business 2. Business 3. misstatements

____1____ are the official record of the meetings of the board of directors. They include ___2__ and summaries of important topics discussed. The auditor should read the minutes to identify matters ___3___to the audit.

1. Corporate minutes 2. key authorizations 3. relevant

There are two types of likely misstatements: 1. Differences between management's and the auditor's judgment about ______ of account balances 2. Projections of misstatements based on the auditor's tests of ______

1. Differences between management's and the auditor's judgment about estimates of account balances 2. Projections of misstatements based on the auditor's tests of a sample

- The auditor should understand the client objectives related to: 1. Reliability of ____ 2. ____ and ____ of operations 3. Compliance with ___ and ____

1. Reliability of financial reporting 2. Effectiveness and efficiency of operations 3. Compliance with law and regulations

• Industry and External Environment- There are three primary reasons for obtaining a good understanding of the client's industry and external environment: 1. Risks associated with specific industries may affect the auditor's assessment of ________ and ________ 2. Many risks are ________ to all clients in certain industries. 3. Many industries have ________ accounting requirements that the auditor must understand to evaluate whether the financial statements are in accordance with accounting standards.

1. Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk. 2. Many risks are common to all clients in certain industries. 3. Many industries have unique accounting requirements that the auditor must understand to evaluate whether the financial statements are in accordance with accounting standards.

There are five steps to applying materiality 1. ________ for f/s as whole 2. _________ materiality 3. ________ in segment 4. ________ misstatement 5. Compare ____with _____ about materiality

1. Set materiality for f/s as whole 2. Performance materiality 3. Est. total misstatement in segment 4. Est. the combined misstatement 5. Compare combined est. with preliminary or revised judgment about materiality

*Initial audit planning involves four things:* (should be done early) 1. The auditor decides whether to accept a _____ or continue serving an ______. 2. The auditor identifies why the client ___ or _____an audit. 3. To avoid _________, the auditor obtains an understanding with the client about the ______. 4. The auditor develops the ______ for the audit, including _______ and any required _______.

1. The auditor decides whether to accept a new client or continue serving an existing client. 2. The auditor identifies why the client wants or needs and audit. 3. To avoid misunderstandings, the auditor obtains an understanding with the client about the terms of the engagement. 4. The auditor develops the overall strategy for the audit, including engagement staffing and any required audit specialists.

• Identify Related Parties- Because related party transactions may not be at ___1______, auditing standards require that related parties and related party transactions be ____2____in the financial statements.

1. arm's length 2. disclosed

• Continuing Clients: o CPA firms evaluate existing clients to determine whether a continuing client presents risks due to lack of ___1 ___. o Could discontinue Bc of ___2__

1. integrity 2. accessories

• The CPA firm must select staff for the engagement who are _____ about the client's business. If the CPA firm lacks expertise, they may need to hire ____.

1. knowledgeable 2. outside specialists

Client Acceptance and Continuance • New Client Investigation: CPA firms must take care in accepting new clients. The ____1____ auditor is required by auditing standards to communicate with the ___2__ auditor.

1. new (successor) 2. predecessor

Risk of material misstatement Important bc helps determine audit _____and amount of _____ that is needed to be accumulated as well as experience level of ___ needed for audit engagement

1. procedures 2. evidence 3. staff

Auditing standards require the auditor to perform _______1______to obtain an understanding of the client's business and its environment to assess risk of ____2___

1. risk assessment procedures 2. material misstatements.

The auditor identifies and assess risks of material misstatement, whether due to fraud or error, based on an __1____ of the entity and its environment, including the entity's ____2____.

1. understanding 2. internal control

• Identifying Client's Reasons for Audit: o Risk factors associated with the client's reasons for an audit include the likely statement ___1____ and the intended __2__ of the statements.

1. users 2. Uses

Complete uncertainty= 100 or 0?

100

Evaluating results is done in steps 3-5

3-5

• Performance materiality for an account is often set at ___-___ percent of overall materiality.

50-75

A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unmodified opinion has been issued.

Acceptable audit risk

Client business risk arises from changes in ____ conditions, ______ objectives

Arise from changes in industry conditions, inappropriate objectives

Auditors document ___ misstatements found for each audit _____. These may be ______ misstatements or ______misstatements.

Auditors document all misstatements found for each audit segment. These may be known misstatements or likely misstatements.

The risk that the entity fails to achieve its objectives or execute its strategies. Arise from changes in industry conditions, inappropriate objectives

Client business risk

______-_____ financial statements are also often used for comparison between companies or for the same company over different time periods, revealing trends, and providing insight into how different companies compare.

Common-size

_______ misstatements are those that the auditor can determine the amount of in the account.

Known

________companies must disclose whether they have adopted a code of ethics that applies to *senior management.* _______should have an understanding of the code of ethics and investigate any changes.

Public Auditors

The risk that the financial statements contain a material misstatement due to fraud or error prior to the audit.

Risk of material misstatement

• Develop Overall Audit Strategy ______, ____, and ____of audit. Guides development of audit

Scope timing and direction of audit. Guides development of audit

AICPA auditing standards state: The auditor must plan ____ and properly _____ any assistants

The auditor must plan the work and properly supervise any assistants

• Business Operations and Processes- The auditor should understand factors such as major sources of ______, key ______and ______, sources of ______, and information about ______ that may increase client business risk.

The auditor should understand factors such as major sources of revenue, key customers and suppliers, sources of financing, and information about related parties that may increase client business risk.

If the client has set unreasonable objectives, especially when employees are incentivized to meet performance goals, there may be an incentive for _________, which increases the risk of financial statement misstatement.

aggressive accounting

.• Management and Governance- *Governance* includes the organizational structure as well as the activities of the ______1____ and the_____1_____ o Understand how board and audit committee exercise oversight, ____2____, and evaluation of ____3____

board of directors and the audit committee. code of ethics corporate minutes.

Auditors are responsible for having appropriate _____ and _____ to perform the audit

competence and capabilities

A client's *performance measurement system* includes _____ that management uses to evaluate progress towards its objectives.

key performance indicators (KPIs)

Auditing standards defined ____ as the magnitude of misstatements that individually, or when aggregated with other misstatements, could reasonably be expected to influence the economic decision of users.

materiality

Lower acceptable audit risk = be (more/less) certain f/s not materially misstated

more

Client Acceptance and Continuance o Due to confidentiality requirements, the client must _____to this communication. o The purpose is to determine if the client lacks ______ or if there were disputes about __________. o ________ company. o Need to communicate with ______ auditor. Decide whether to accept or not to accept.

o Due to confidentiality requirements, the client must consent to this communication. o The purpose is to determine if the client lacks integrity or if there were disputes about accounting principles. o Investigate company. o Need to communicate with predecessor auditor. Decide whether or not to accept.

o After understanding the client's reason for an audit, the auditor should develop and document a _________.

preliminary audit strategy

The fourth step in audit planning is to make a ____for the audit.

preliminary judgment about materiality

Determining performance materiality can also be referred to as

the allocation of the preliminary judgment about materiality to segments.

• PCAOB standards refer to performance materiality as ________ misstatement.

tolerable

Touring facilities is helpful in obtaining an ________ of the client's operations.

understanding

Three main reasons that the auditor should properly plan the audit engagement: • Enable the auditor to obtain _________ for circumstances. • Help keep audit costs _____. • Avoid _________ with the client.

• Enable the auditor to obtain sufficient appropriate evidence for circumstances. • Help keep audit costs reasonable. • Avoid misunderstandings with the client.

Factors Affecting Preliminary Materiality Judgment: • Materiality is a ____rather than an _____concept. • _______ are needed for evaluating materiality. • ______ factors also affect materiality.

• Materiality is a relative rather than an absolute concept. • Benchmarks are needed for evaluating materiality. • Qualitative factors also affect materiality.

• Obtain an Understanding with the Client o A clear understanding of the terms of the engagement should exist between the _____ and the ____ . Auditing standards require that there be an ________. o Eng affects ___of test and the _____ to audit and other services will take

• Obtain an Understanding with the Client o A clear understanding of the terms of the engagement should exist between the auditor and the client. Auditing standards require that there be an engagement letter. o Eng affects timing of test and the total amt of time to audit and other services will take