Audit Chapter 5

Audit procedures

-inspection of records and documents -Inquiry -external confirmation -inspection of tangible assets -observation -recalculation -reperformance -Analytical procedures

Reliability of evidence

1.Obtained from knowledgeable independent sources outside the client company versus nonindependent sources 2.Generated internally through a system of effective controls rather than ineffective controls 3.Obtained directly by the auditors rather than indirectly 4.Documentary in form rather than in the form of an oral representation 5.Provided by original documents rather than photocopies or facsimiles

Evidence requirements for managements estimates

1.Review and tests management's process of developing the estimates 2.Independently develop an estimate of the amounts to compare to management's estimate 3.Review subsequent events or transactions earing on the estimate

Changing Audit Documentation after the Date of the Audit Report

60 Days AICPA 45 days PCAOB

Completness

All BS interests have been recorded All transactions and events have been recorded All disclosures that should have been included have been included

Analytical procedures

Analytical procedures, discussed in detail later in this chapter, involve the comparison of relationships among financial and, sometimes, nonfinancial data.

Recalculation (Audit Procedure)

Another type of audit evidence consists of recalculations made independently by the auditors to prove the arithmetical accuracy of the client's analyses and records. At a high level, this should include making certain that accounting records (e.g., accounts in the general ledger) agree with or can be reconciled to the financial statements.`

Existence assertion

Assets, liabilities and equity interests exist

External confirmation

Audit evidence obtained by the auditors as a direct written response to the auditors from a third party (the confirming party) in paper form or by electronic or other medium (e.g., the auditors' direct access to information held by a third party).

Inquiry (Audit Procedure)

Auditors obtain a variety of representations from a number of company personnel and outside parties (e.g., the client's customers, vendors, financial institutions, and attorneys). In addition, evidence may be obtained from specialists in some audits. Inquiries, which may be oral or written, may result in either oral or written replies.

Work papers

Auditors should retain them for 7 years

Inspection of records and documents

Examination of internal or external records or documents that are in paper form, electronic form, or other media.

Financial statement assertions

Existence & Occurrence Rights & Obligations Completeness Cutoff Valuation, Allocation and Accuracy Presentation/Classification & Disclosure

Data analytics

Have the ability to test all of the transactions in a population

Assertions about Observation (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Low Low Low Low Low

Assertions about reperformance (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Low Low Low Low Low

Assertions about inspection of tangible assets (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Low Low Moderate Low Low

Assertions about Vouching (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Low Moderate High High Low

Assertions about External confirmation (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Low/Mod Mod Mod Mod Low/Mod

Assertions about inspection of records and documents (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

High Moderate High High High High

AR=

IR*CR*DR (Inherent risk X control risk X detection risk)

Accuracy and valuation assertion

Information is disclosed fairly at appropriate amounts

Level 1 evidence regarding fair values

Inputs of observable quoted prices in active markets i.e. a closing stock price listed in The Wall Street Journal for an investment

Level 2 evidance regarding fair values

Inputs of other observable quoted prices for similar assets/liabilities in active markets i.e. a company may discount the future cash flows of its not publicly traded debt securities at the rate used by the market for its publicly traded debt securities

Level 3 evidance regarding fair values

Inputs that are unobservable i.e a private company uses judgment to determine a proper rate to discount the future cash flows of its not publicly traded securities

Assertions about reprocessing (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

Low High Moderate Mod/High High Low

Assertions about inquiry (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

Low Low Low Mod/High Low Low

Inherent risk at the Financial statement level

May affect the business operations and potential outcomes of organizational activities. The organization might have difficulty operating effectively or profitably. May be affected by the overall economic climate, technological changes, competitors actions, geographic locations of suppliers, regulatory requirements, mature and declining industry, products that have multiple substitutes and lack of sufficient capital.

Drawbacks of data analytics

May not be appropriate and cost justified Possible legal implication

Assertions about scanning (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

Mod Low Low Mod Low Low

Assertions about analytical procedures (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

Mod Mod Low High Mod Low

Assertions about recalculation (Existence/occurance, completeness, Rights/obligations, valuation/ allocation/ accuracy, cuttoff, presentation/disclosure)

N/a Moderate N/a Mod/High N/A N/A

Observation (Audit Procedure)

Observation involves watching a process or procedure being performed by others. Examples include observing custodial controls or observing performance of a control activity, such as the auditors' observation of inventory counting by the client's personnel, or observation of a clerk performing a reconciliation

Steps for evidence regarding fair values

Obtain an understanding of the company's process for determining fair value measurements and disclosures Evaluate whether management's assumptions related to inputs are reasonable and reflect market information Consider if historical financial information, if any, used in the development of an input is justified Evaluate whether the company's method for determining fair value measurements is applied consistently and is appropriate`

Inspection of tangible assets

Physical examination of the tangible assets.

Reperformance of procedures

Reperformance involves the auditors independently performing procedures or activities that were originally performed by the client, ordinarily as a part of the company's internal control.

The stronger the internal controls

The less likely errors or fraud will occur and go undetected

Inherent risk at account level

The susceptibility of an assertion about a class of transactions, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements before consideration of internal controls.`

Relevant assertions

Those assertions, that without regard to the effect of controls, have a reasonable possibility of containing a misstatement that could cause the financial statements to be materially misstated.

Cutoff

Transactions and events have been recorded in the correct accounting period

Accuracy assertion

amounts and other data relating to recorded transactions and events have been recorded appropriately

Valuation and allocation

assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded

Disclosure of related party transactions should include

include the nature of the relationship, a description of the transactions, including dollar amounts; and amounts due to and from related parties, together with the terms and manner of settlements.

Related party

individuals or entities who 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.

Inherent risks at the financial statement level don'tlead to

material misstatements in the financial statements, but rather represent issues that threaten the fundamental viability of the organization. These risks may provide incentives to management to misstate accounts in an attempt to make the organization look more financially sound.

Concept of experienced auditor

one who possesses the competencies and skills to perform an audit of the client, but who has had no previous experience with the client.

Rights and obligations assertion

the entity holds or controls the rights to assets, and liabilities are the obligations of the entity Disclosure events pertain to the entity

Inherent risk

the possibility of material misstatement of an assertion before considering the client's internal control.

Audit risk

the possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.

Control risk

the risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.

Detection risk

the risk that the auditors' procedures will not detect a material misstatement that exists in a relevant assertion.

Classification assertion

transactions and events have been recorded in the proper accounts

Examples of inherent risk at financial statement level

•Co. lacks personnel/expertise to deal w/ changes in the industry •Lack of sufficient capital •New products and service offerings have uncertain likelihood of successful introduction and acceptances by the market •Expansion of the business for which the demand for the co.'s products or services has not been accurately estimated. •A new business strategy is incompletely or improperly implemented. •New regulatory requirement increase exposure •Industry is mature and declining •Organization lacks ability to control costs with the possibility of unforeseen costs

Considerations of inherent risks at account level

•The account balances represent an asset that is relatively easily stolen •The account balance is made up of complex transactions •The account balance requires a high level of judgment or estimation •The account balance is subject to adjustments that are not in the ordinary processing routine •Nonroutine transactions