Chapter 6

To gain an understanding of the client, its environment, and internal controls, audits will review the:

- Industry, regulatory, and other external factors affecting the client - Nature of the client, including the client's application of accounting policies - The client's objectives and strategies and related business risks

An engagement letter is a written engagement between the CPA firm and the client as to the terms of the audit agreement. The letter should include:

- Inherent limitations - Expected form and content of the reports - Financial reporting framework

Auditors should document several elements of risk assessment including:

- Nature, timing, and extent of further audit procedures - Understanding of the entity and its environment - Audit team discussion

Identify examples of risks at the financial statement level.

A declining industry Ineffective control environment Lack of sufficient capital to continue operations

If auditors identify fraud risks, the auditors may modify their overall approach to the audit in which of the following ways?

Adding specialized audit staff Increase third-party confirmations

rights

All receivables belong to the client.

Auditor's test completeness of receivables in order to determine that:

All receivables have been recorded

completeness

All receivables have been recorded.

existence

All recorded receivables are valid.

Cutoff

Auditor vouches sales transactions near the period end to verify sales are recorded in the proper period.

Valuation

Auditors investigate credit rating for delinquent receivables to verify they are recorded at net realizable value.

Presentation and Disclosure

Auditors obtain a list of related parties and verify all related party transactions are displayed.

Relevant assertions include witch of the following?

Completeness Rights and obligations Valuation and allocation

Auditors obtain a representation letter from management during which stage of the audit?

Completing the audit

A test directed toward the design or operation of a control to assess its effectiveness in preventing material misstatement of financial statement assertion is called test of

Controls

Overall Audit Strategy

Defines audit scope, reporting objectives, timing, etc.

Audit Plan

Describe the nature, timing, and extent of the audit procedures to be performed.

Overall Audit Strategy

Helps define the scope of the audit, determine the reporting objectives that plan the timing, and helps focus the audit team's efforts

materiality

Idea that some matters are important to the fair presentation of financial statements while others are not

Identify which of the following topics should be included in the engagement letter?

Management responsibilities Scope of the audit Auditor responsibilities

Fraudulent Financial Reporting

Material misstatement of financial statements by management with the intent to mislead financial statement users.

Systems Portion of the Audit

Procedures to assess the effectiveness of the internal controls.

Inherent Risk

Risk of material misstatement of an assertion about an account without considering internal controls.

The substantive test portion of the audit addresses:

Substantive tests of account balances

Substantive Test Portion of the Audit

Tests of financial statement account balances.

Inherent Risk

The risk that material misstatement of an assertion about an account without considering internal control.

Control Risk

The risk that material misstatement will not be prevented on a timely basis by internal control.

Audit Risk

The risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements are material misstated.

Misappropriation of Assets

Theft of client assets by an employee or officer of the organization.

T/F At least a portion of the auditors' consideration of internal control usually is performed at an interim date rather than at the balance sheet date.

True

T/F The completeness of recording of assets is generally verified by tracing from the source documents to the recorded entry.

True

T/F The substantive approach to an audit is appropriate for many small businesses.

True

T/F Vouching the acquisition of assets is an audit procedure that is often performed to establish the valuation of the assets.

True

Auditors vouch cash receipt transactions occurring near period end to verify

cutoff of transactions

An audit procedure that serves as a test of controls and a substantive test of the details of the transactions that occurred during the year is known as a(n) ___________ procedure.

dual-purpose

Material misstatement of financial statements by management with the intent to mislead financial statement users is considered ____________ financial reporting.

fraudulent

Even a small misstatement, such as a misstatement that affects a client's loan covenants, may be considered a __________ misstatement to the financial statements.

material

The account balances that exist at the beginning of the period are called ________ balances.

opening

The amount that is set by the auditors at less than materiality for accounts to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for financial statements as a whole is called ________ materiality.

performance

Reviewing related parties to confirm that they are properly recorded is an example of verifying financial statement _______________ of assets.

presentation

Assertions such as existence or occurrence, rights and obligations, completeness, and cutoff are considered _________ assertions.

relevant

Auditors review of confirmation of liabilities to determine if receivables have been sold or factored verifies _________ assets.

rights

At the planning stage of an audit, auditors consider materiality to determine the appropriate ___________ of their audit.

scope

A risk that has been identified and assessed that, in the auditor's opinion, requires special audit consideration is considered a(n) ________________ risk.

significant

Which of the following amounts of planning materiality will require the auditors to gather the most audit evidence?

the smallest amount

An estimate of the time required to perform each step in the audit is called a

time budget

A(n) _________ cycle is the sequence of procedures applied by the company (client) in processing a particular type of recurring transaction.

transaction

Planning materiality is commonly based on which of the following?

% of total assets % of total revenues % of net income

Risk assessment procedures commonly performed by auditors include which of the following:

- Observation and inspection - Inquiry of external parties - Analytical procedures

What are the audit assertions?

- existence -completeness - rights

Further audit procedures include which of the following:

- test of controls - substantive procedures

Audit Program

Details the specific audit procedures to be performed in the course of an audit engagement.

All of the following are common indications of fraud except: Related party transactions Tips to the auditors about fraud Missing inventory Complaints by management about the conduct of the audit

Related Party Transactions

Tests that involve comparisons of financial data of the current year to the prior years, budgets, and industry averages are called ______________ procedures.

analytical

T/F Analytical procedures are seldom used during the risk assessment stage of an audit engagement because they are substantive procedures.

False

T/F An audit plan includes a detailed listing of the audit procedures to be performed in the verification of items in the financial statements.

False; audit PROGRAM

T/F Confirming a bank account establishes existence but not rights to the cash balance.

False

T/F Preliminary arrangements with clients should be set forth in the management letter.

False

T/F The auditors' tests of controls are designed to substantiate the fairness of specific financial statement accounts.

False

The risks that threaten management's ability to achieve the organization's objectives are known as ____________ risks.

business

If the auditors' objective is to test ___________, they follow the stream of evidence back to its source.

existence

T/F Audit committees should be made up of the most qualified directors regardless of whether they are part of management of the company.

False