AUD Chap 5

True or false: The SEC interpretation of Sarbanes-Oxley requires working papers be retained regardless of whether they support or are inconsistent with the auditor's final conclusion relating to significant matters.

TRUE

The examination of big data to uncover hidden patterns, unknown correlations, market trends, and other useful business applications is called

data analytics

Substantive procedures include analytical procedures and tests of details that are part of the auditors'

further audit

External confirmations are normally used to gather evidence for all of the following accounts except ______.

buildings

Overvaluing information that comes to one's mind quickly is ______ bias.

availability

Audit evidence in paper or electronic form that is obtained through inspection of records is referred to as

documentary

Test of controls are designed to test the operating___ of controls in preventing or detecting material misstatements.

effectiveness

Auditors are required to ______.

evaluate the reasonableness of accounting estimates ensure accounting estimates are properly accounted for and disclosed

Factors that can influence the level of audit documentation detail include ______.

nature of auditing procedures extent of judgment involved risk of misstatement

The client ______.

never has the right to demand access to the auditors' working papers

Auditors are given 60 days after the audit ______ date to complete the audit file.

report release

Auditing standards require auditors to perform analytical procedures at the __stage and near the end of the audit.

risk assesement

Auditors gather evidence to restrict this risk to the appropriate level.

Detection

Which of the following is most likely to be considered a risk factor relating to fraudulent financial reporting?

Extreme degree of competition within the industry.

Which of the following business characteristics is not indicative of high inherent risk?

a large amoun tof assets

Calculating days sales in ending accounts receivable and comparing it to the prior year would be an example of ______.

analytical procedure

For a given level of audit risk, risk varies inversely with the risk of material misstatement.

detection

Inherent risk may be high for __transactions because they are not part of the normal flow of transactions and specialized skills may be needed to perform the activity.

nonroutine

Comparing the price on an invoice to that on an approved price list is an example of the audit procedure of

reperformance

The most technical audit working paper review is performed by the ______.

senior

According the professional standards, audit documentation should be retained for Blank______ years.

not less than five

A spreadsheet that combines Petty Cash with all the company's bank accounts is an example of a ______.

lead schedule summary schedule

A reasonableness test differs from regression analysis in that a reasonableness test:

less formal based on a statistical model

Analytical procedures

Evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data EX:Calculating days' credit sales in ending accounts receivable and comparing to the prior year.

True or false: Auditors are not required to use analytical procedures as substantive procedures to provide evidence about financial statement assertions.

TRUE

True or false: The AICPA Code of Professional Conduct generally allows auditors to share working papers without restriction within the client's organization.

F

test of class of transaction

Tests of inventory purchases to determine if properly accounted for

General on Analytical Procedures 1

Timing of analytical procedures: • Risk assessment (sometimes referred to as planning analytical procedures). • Substantive procedures. • Final review. Steps involved: • Develop expectation of account (or ratio) balance. • Determine amount of difference that can be accepted without investigation. • Compare the company's account (ratio) with the expectation. • Investigate and evaluate significant differences.

Audit documentation is intended to allow _________ to understand the audit work performed, the evidence obtained, and the significant conclusions.

an experienced auditor

Audit documentation should be sufficient to allow ______ to understand the audit work performed, the evidence obtained, and the significant conclusions reached.

an experineced auditor

The working papers for a particular engagement are included in the

audit file

Completed confirmations should be sent directly to the ______.

auditor

The return envelope sent with confirmations should be addressed to the ______.

auditor's office

Factors that affect inherent risk include the nature of the ______.

client's environment account client

Which of the following is not a primary approach to auditing an accounting estimate?

confirm the amounts

The Public Company Accounting Oversight Board requires that auditors emphasize ______.

financial relationships and transactions with executive officers significant unusual transactions relationships and transactions with related parties

Watching a process or procedure being performed by others is the definition of ______.

observation

Auditing standards require that audit documentation provide evidence ______.

of the auditor's basis for concluding on the achievement of the audit's overall objectives that the audit was planned and performed in accordance with GAAS

Control risk is a function of ______.

operating effectiveness of internal control design effectiveness of internal control

The most reliable piece of documentary evidence created within the client's organization is ordinarily a ______.

paid check

Individuals or entities that may have dealings with the client in which one party is significantly influenced by the other such that it may not pursue its separate interests are known as

related parties

Data analytics ______.

results in a more detailed understanding of the client may assist in the assessment of risk of material misstatement may involve testing entire populations instead of samples

Sufficient audit evidence is affected by ______.

risk of misstatement and reliability of evidence

Auditors should investigate ______ differences between their prior expectations and the actual amounts on the client's financial statement.

significant

Detection risk is restricted through the performance of ______.

substantive procedures

Basic Approaches to Auditing Accounting Estimates

• Review and test management's process for developing the estimate. • Independently develop an estimate to compare to management's estimate. • Review subsequent events or transactions bearing on the estimate.

Effects of changes in numerators and denominators of ratios greater than zero

1. Increasing the numerator of a ratio always increases the ratio. 2. Increasing the denominator of a ratio always decreases the ratio. 3. Increasing the numerator and denominator of a ratio by the same amount: a. Decreases the ratio if the ratio is greater than 1. b. Increases the ratio if the ratio is less than 1.

True or false: When performing analytical procedures, the best data for developing an expectation is industry averages.

False;While this is a source, there are potential problems. Every client generates internal information that may also be used.

An audit should include sufficient appropriate evidence to obtain reasonable assurance that related parties, relationships, and transactions have been properly identified, accounted for, and disclosed in the financial statements. This requirement is explicit in the

PCAOB

Management makes financial statement assertions related to ______.

account balances classes of transactions and events presentation and disclosure

Inventory turnover and accounts receivable turnover are

activity

Throughout the audit, auditors accumulate non-trivial misstatements identified and propose appropriate ______ journal entires.

adjusting

Performing analytical procedures may help an auditor to:

Achieve audit objectives related to a particular assertion.

One purpose of a letter of representation is to provide evidence about management's future intentions.

Tracing from source documents to entries in the accounting records.

Complicating factors in evaluating accounting estimates include ______.

: Relatively small changes may lead to large changes in the amount of the estimate. potential management bias when evaluating the reasonableness of assumptions used in estimates some methods may corroborate management's estimates while others contradict them

True or false: Data analytics is not used in most audits because it is often an inefficient procedure that fails the cost-benefit test.

FALSE

In auditing an asset which must be valued at fair value, which of the following, if available, is considered most reliable?

Inputs of observable quoted prices in active markets for identical assets or liabilities.

Data Analytics

Data analytics is the process of using related and unrelated data sets to provide insights into decisions. C P A firms are increasing using data analytic approaches to improve risk assessment, tests of controls and substantive procedures. • In risk assessment, sophisticated data analytics can improve auditors' assessments of risk by significantly increasing the sources of data used. • In tests of controls, data analytics may allow the auditors to use technology to test 100 percent of the items in a population by relating data from multiple sources. • Substantive procedures may be improved by using data from a number of data sources to improve the efficiency and effectiveness of the procedures.

Auditors should investigate any significant differences between their prior expectations and the actual amounts on the client's financial statements. Which of the following are proper methods of investigation?

Expanding the tests of financial statements to determine materiality Inquiry of management Reconsidering the factors and methods originally used in making the expectations

For items that are correctly recorded but not fairly presented in the client's financial statements, auditors develop

reclassifiction JEs

The purpose of the permanent file is to ______.

refresh auditor's memories on items applicable to a period of years for the client provide new staff members with a quick summary of policies and organization of the client

In performing audit procedures, without regard to the effect of controls, ______ assertions are those that have a reasonable possibility of containing a misstatement that could cause the financial statements to be materially misstated.

relevant

Inherent Risk

Risk of material misstatement of a financial statement assertion before considering controls.

Ratio Analysis

AApproaches to ratio analysis. • Horizontal analysis. • Review ratios over time. • Cross sectional analysis. • Analyze ratios of similar firms at a point in time. • Vertical analysis. • Analyze relationships within a period. • "Common size" statements prepared. Other methods. • Regression analysis, reasonableness test.

Management makes an estimate by selecting a method, developing a combination of implicit and explicit____ and using___ to apply that method.

assumptions; data

Account Balances and Related Disclosures (ASB Financial statement Assertions)

- Existence - Rights and obligations -Completeness -Accuracy, valuation, and allocation -Classification

When developing expectations for analytical procedures ______.

-prior year financial statements may be used -dollar amounts, quantities, ratios, or percentages may be used -separate relationships may be computed for each division or product line -Industry averages

Substantive Procedures

Analytical procedures. Tests of details. • Tests of account balances. • Tests of classes of transactions. • Tests of disclosures. • One may change the scope of audit procedures by changing the (N T E, or re-ordered as N E T): • Nature (type and form). • Timing (when performed). • Extent (quantity of evidence obtained).

Second partner review

Choice, Quality review to provide assurance that the CPA firm's in-house quality control policies have been complied with. Quality review to provide assurance that the CPA firm's in-house quality control policies have been complied with.

In-charge partner

Choice, Review of entire set of working papers to determine audit was performed in accordance with GAAS and provide support for audit report. Review of entire set of working papers to determine audit was performed in accordance with GAAS and provide support for audit report.

Assertions with High Inherent Risk

Involve: • Difficult-to-audit transactions or balances. • Complex calculations. • Difficult accounting issues. • Significant judgment by management. • Valuations that vary significantly based on economic factors.

The auditors have assessed the risk of material misstatement for the existence of cash as high. Which is the most effective audit procedure for the auditor to perform?

confirm cash in bank

Documents that substantiate representations contained in the client's financial statements such as audit confirmations, minutes of directors' meetings, and client representation letter are known as ______.

corroborating documents

Comparisons with similar firms at a given point in time is the basis of ______ analysis.

cross-sectional

Workpapers may include ______.

organizational charts ledger account analyses internal control questionnaires board meeting minutes

What type of analytical procedure would an auditor most likely use in developing relationships among balance sheet accounts?

ratio analysis

The comparison of relationships between two or more financial statement accounts is called

ratio anlysis

To prove the arithmetical accuracy of the client's analyses and records, auditors make independent

recalculations

The review of changes in an account balance over time is called ______ analysis.

trend

The backbone of the working papers (which is ordinarily an electronic spreadsheet) is the

working trial balance, which is the key schedule that controls and summarizes all supporting papers.

Making judgments by starting from an initial belief and then making insufficient adjustments to the belief when contrary information is encountered is ______ bias.

anchoring

An audit firm's audit documentation DOES NOT ______.

assist predecessor auditors in performing their role

The term a__ risk refers to the possibility that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

audit

During an audit, client oral inquiries ______.

may be made of both officers and employees

Memoranda of the planning process and significant discussions with management are considered

administrative working papers

In that an explicit expectation is computed for the financial statement amount using financial or nonfinancial data, a reasonableness test is similar to

regression analysis

These components of audit risk exist for a client even if an audit is not performed.

Inherent risk and control risk

Reperformance

An independent execution of procedures or controls that were originally performed by the client (often as a part of the client's internal control)∙ EX:Reperforming the aging of accounts receivable manually or by using computer-assisted audit techniques.

Sufficiency of Audit Documentation

Audit documentation should be sufficient to: • Enable an experienced auditor to understand the work performed and the significant conclusions reached. • Identify who performed and reviewed the work. • Show that the accounting agree or reconcile to the financial statements. Audit documentation should include all significant audit findings and the actions taken to address them.

Appropriateness of Audit Evidence

Auditor must obtain sufficient appropriate audit evidence. To be appropriate audit evidence must be: • Relevant. • Reliable. Principles—Audit evidence is ordinarily more reliable when it is. • Obtained from knowledgeable independent sources outside the client company is less susceptible to management bias, although the reliability of the source must be considered. • Generated internally through a system of effective controls rather than ineffective controls. • Obtained directly by the auditor rather than indirectly or by inference. • Documentary in form rather than oral. • Provided by original documents rather than documents digitized or otherwise copied/converted.

Financial Statement Assertions

Relevant assertions are those that, without regard for controls, have a reasonable possibility of containing a material misstatement; types • Assertions about account balances and related disclosures (Accounts). • Assertions about classes of transactions and events and related disclosures (Transactions).

Which of the following relates to the circumstances in which evidence is obtained?

Reliability

Which of the following is true of analytical procedures?

They involve evaluations of financial statement information by a study of relationships among financial and nonfinancial data.

Workpapers may include ______.

bank reconciliations audit plans representation letter working trial balance

Data analytics is the examination of large datasets or__ to uncover hidden patterns, unknown correlations, market trends, and other useful business applications.

big data

These transactions generally have the highest level of inherent risk.

estimation

Making accounting estimates is the responsibility of ______.

managemennt

Transactions and Related Disclosures ( (ASB Financial statement Assertions)

- Occurrence -Completeness -Accuracy -Cutoff -Classification -Presentation

Types of Audit Procedures

1. Inspection of records and documents. 2. Inquiry of knowledgeable persons within or outside the entity. 3. External confirmation. 4. Inspection of tangible assets. 5. Observation of processes or procedures being performed by others. 6. Recalculation of mathematical accuracy. 7. Reperformance of procedures. 8. Analytical procedures.

Audit Risk Formula

A R = I R * C R * D R A R = Audit risk I R = Inherent risk C R = Control risk D R = Detection risk

Analytical procedures performed near the end of the audit to assist the auditor in forming an overall conclusion on the financial statements are aimed primarily at:

Considering unusual or unexpected account balances that were not previously identified.

Types of Working Files

Current files. • Current year working papers. • Index and cross-referencing. Permanent files. • Items of continuing audit interest.

General on Analytical Procedures 2

Developing an expectation: • Prior period information. • Anticipated results. • Relationships among elements of financial information within a period. • Industry information. • Relationships between financial information and relevant nonfinancial data.

Related Party Transactions

Disclosure requirements must be met. Primary challenge is identifying undisclosed related party transactions. • Determine related parties. • Inquiries of management. • Review S E C filings, stockholder's listings and conflict-of- interest statements. • Be alert for transactions with related parties and any transactions with unusual terms.

Inherent Risk CONT'D

Factors that affect inherent risk: • Nature of the client and its environment. • Nature of the particular financial statement element. Business characteristics indicative of high inherent risk: • Inconsistent profitability of client. • Operating results highly sensitive to economic factors. • Going concern problems. • Large misstatements detected in prior audits. • Substantial turnover, questionable reputation, or inadequate accounting skills of the accounting department.

Extent of Procedures

Holding other factors such as the nature and timing of procedures constant: • The greater the risk of material misstatement, the greater the needed extent of substantive procedures. • The main way to increase the extent of audit procedures is to examine more items. • Sample sizes should reduce detection risk so as to restrict audit risk to a low level.

Nature and Timing of Procedures

Holding the extent of procedures constant, one may increase the scope of procedures (make them more effective) by either changing the • Nature—obtain more reliable evidence. • often externally generated evidence. • Timing—wait until year-end to obtain evidence from entire set of transactions as contrasted to performing interim testing, say two months prior to year-end and simply updating those procedures.

Which of the following is not an example of a likely adjustment in the auditors' overall audit approach when significant risk is found to exist?

Increase the acceptable level of detection risk.

Auditing Fair Values

Inputs to use in applying valuation techniques (F A S 157) • Level 1 - inputs of observable quoted prices in active markets for identical assets or liabilities. • Ex. A closing stock price in W S J. • Level 2 - inputs of observable quoted prices, generally for similar assets or liabilities in active markets. • Ex. Company discounts future cash flows on its not publicly traded debt securities at rate used by market for publicly traded debt securities. • Level 3 - inputs that are unobservable for the assets or liability. • Ex. A private company uses judgment to determine a proper rate to discount the estimated future cash flows of its not publicly traded securities.

Transactions, Journal Entries and Top- Side Entries

Most transactions (routine, nonroutine, and estimation) are ordinarily recorded through journal entries into the accounting system (journals, ledgers, etc.). Top-side entries deviate from the above. Often they are simply recorded directly on a spreadsheet which begins with the year-end recorded account totals. • Examples: consolidation entries, aggregation or disaggregation of certain accounts, and currency translations. These may be entirely appropriate. • Inappropriate—Fraudulent top-side entries, for example, increasing profit by recording a fictitious sale (and receivable) on the worksheet. • Auditors should carefully consider the propriety of top-side entries.

Functions of Audit Documentation

Primary functions: • Support the auditors' compliance with auditing standards. • Support the auditors' opinion. Secondary functions: • Assists continuing and new audit team members in planning and performing the audit. • Serves as a record of matters of continuing audit interest. • Assists in supervision and review of the audit. • Demonstrates the accountability of team members. • Assists internal reviewers, external peer reviewers, P C A O B inspectors, and successor auditors in performing their roles.

Which of the following relates to the assertion being addressed?

Relevance

Which of the following is a basic approach often used by auditors to evaluate the reasonableness of accounting estimates?

Review transactions occurring subsequent to year-end, but before issuance of the financial statements.

Overall Categories of Audit Procedures

Risk assessment procedures. • To obtain an understanding of the client and its environment, including its internal control, to assess the risks of material misstatement. Further Audit Procedures. • Tests of controls. • When appropriate, to test the operating effectiveness of controls in preventing material misstatements. • Substantive procedures. • To detect material misstatements at relevant assertion level. Substantive procedures include (a) analytical procedures, (b) tests of details of account balances, transactions, and disclosures.

Detection Risk

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.

Types of Transactions

Routine. • Recurring financial statement activities recorded in the accounting records in the normal course of business. • Lower inherent risk. Nonroutine. • Involve activities that occur only periodically such as the taking of physical inventories. • High inherent risk. Estimation transactions. • Activities that create accounting estimates. • Higher inherent risk.

Tests for unrecorded assets typically involve tracing from:

Source documents to recorded journal entries.

During an audit, the working papers are primarily considered to be:

Support for the auditors' representations as to compliance with generally accepted auditing standards.

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 auditor expresses an inappropriate audit opinion on financial statements that are materially misstated. • That is: the risk that the auditors will issue an unqualified opinion on financial statements that contain a material departure from G A A P. Auditors must obtain sufficient appropriate audit evidence to reduce audit risk to a low level in every audit.

General on Analytical Procedures 3

Types of Expectations: • Trend analysis—analyze changes in accounts of a company over time. • Ratio analysis — compare relationships between two or more financial statement accounts or comparisons of account balances to nonfinancial data. • Liquidity (for example, current ratio). • Leverage (for example, debt to equity). • Profitability (for example, gross profit percentage). • Activity (for example, inventory turnover).

Scanning

Use of professional judgment to review accounting data to identify significant unusual items that will be tested (often as a part of analytical procedures) EX: • Scanning the general journal for unusual entries. • Scanning the payroll register for unusual payments.

Evaluating Evidence Sufficiency

When evaluating sufficiency of audit evidence auditors. • Apply professional skepticism. • Assess (and reassess) the risks of material misstatement at the relevant assertion level. • Evaluate the nature, timing, and extent of the audit procedures performed. Professional skepticism. • A questioning mind, being alert to conditions that may indicate possible misstatements due to fraud or error, and a critical assessment of audit evidence. • Consider possibility of cognitive biases.

When an unresolved difference of opinion arises ______.

all members of the audit team have the right to document the disagreement in the working papers the opinion of the partner-in-charge will prevail in the audit report

In a financial statement audit, auditors gather evidence that is sufficient and:

appropriate

sufficiency relates to the quantity and __ relates to the quality of audit evidence needed.

appropriateness

Recalculations ______.

are used to prove the accuracy of client calculations such as earnings per share include making certain that accounting records agree with the financial statements

All of the following are acceptable methods to evaluate the reasonableness of accounting estimates except ______.

confirm the estimate with a third party

The risk that a material misstatement could occur in a relevant assertion and not be detected on a timely basis by the client's internal control is called

control

Whether it was created within the company (sales invoice) or outside the company (vendor invoice) impacts the reliability of

documentary evience

No information may be discarded from the working papers after the

documentation date

The reliability of customer sales invoices created by the client and held internally depends on the

effectiveness of internal control

Confirmations are generally effective at providing evidence for the ______ assertion.

existence

Inspections of tangible assets provide high-quality evidence as to the

existence assertion

In performing an audit, auditors perform two general types of audit procedures which are risk assessment procedures and:

further audit procedures

Audit evidence is ordinarily more reliable when it is ______.

generated through a system of effective internal controls provided by original documents obtained directly by the auditors

Data analytic techniques ______.

include the use of artificial intelligence reveal trends related to human behavior can enhance operating efficiency

Working papers are assigned this, which allows the information to be tied together through a system of cross-referencing.

index number

Common methods for auditors to determine related parties include ______.

inquiries of management conflict-of-interest statements reviewing SEC filings

Separate summary or__(also called grouping sheets) are set up to combine similar general ledger accounts.

lead schedules

Test of Disclosure

matches Choice, Test of property, plant, and equipment footnoteTest of property, plant, and equipment footnote

Inherent risk and control risk are the two components of the risk of

material misstatement

The type of audit procedures performed by auditors to obtain audit evidence include ______.

substantive procedures tests of controls risk assessment procedures

The development of common-size financial statements is also known as ______ analysis.

vertical

Audit documentation, which is the record of the audit procedures performed, relevant audit evidence obtained, and the conclusions the auditors reach, is also known as ______.

working papers

Cognitive Biases

• Anchoring bias—too much reliance upon initial belief. • Confirmation bias—Seeking and treating as more persuasive information that is consistent with initial belief. • Availability bias—Overvaluing initial information. • Overconfidence bias—Overestimate one's abilities. • Automation bias—Tendency to consider overly reliable.

Types of Working Papers

• Audit administrative working papers. • Working trial balance. • Lead schedules. • Adjusting journal entries and reclassification entries. • Supporting schedules. • Analysis of a ledger account. • Reconciliations. • Computational working papers. • Corroborating documents.

Combined Assertions

• Existence or Occurrence—Assets, liabilities, and equity interests exist and recorded transactions have occurred. • Rights and Obligations—The company holds rights to the assets, while liabilities are the obligations of the company. • Completeness—All assets, liabilities, equity interests, and transactions that should have been recorded have been recorded. • Cutoff—Transactions and events have been recorded in the correct accounting period. • Valuation, Allocation, and Accuracy—All transactions, assets, liabilities, and equity interests are included in the financial statements at proper amounts. • Presentation and Disclosure—Accounts are described and classified in accordance with generally accepted accounting principles, and financial statement disclosures are complete, appropriate, and clearly expressed.