Auditing SB 2 Chapter 3 Notes
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
