Audit Exam 2

Substantive Procedures

Substantive procedures are performed to restrict detection risk, the risk that auditors will not detect a material misstatement. These procedures include direct tests of account balances, transactions, and disclosures, as well as substantive analytical procedures.

Assertions

- Existence and occurrence. Assets, liabilities, and equity interests exist and recorded transactions and events have occurred. - Rights and obligations. The company holds rights to the assets, and 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.1 - 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.

Describe the major steps in the audit process.

1. Plan the audit. 2. Obtain an understanding of the client and its environment, including internal control. 3. Assess the risks of misstatement and design further audit procedures. 4. Perform further audit procedures. - Further audit procedures include a combination of additional tests of controls and substantive procedures 5. Complete the audit. 6. Form an opinion and issue the audit report.

CHAPTER 5

CHAPTER 5

CHAPTER 7

CHAPTER 7

CHAPTER 8

CHAPTER 8

Risk Formula

IR x CR = Risk of Material Misstatement IR x CR x DR = Audit Risk compute in decimals

Assessing the Risks of Material Misstatement and Designing Further Audit Procedures

In other words, the auditors try to relate each identified risk to "what can go wrong" at the assertion level.

Audit Committees

Not all entities have audit committees. For example, the concept of an audit committee does not apply to businesses organized as sole proprietorships, partnerships, and small, closely held corporations. Arrangements for an audit of these businesses often are made with the owners, a partner, or an executive, such as the president or the controller

Test of Controls

Notice that a test of a control measures the effectiveness of a particular control in preventing or detecting a misstatement; it does not substantiate the dollar amount of an account balance.

Inherent Risk

Remember that inherent risk is the risk of material misstatement of an assertion without considering internal control. Many inherent risks arise because of business risks faced by management, including the possibility of material misstatement due to fraud.

The Audit Plan

The audit plan includes a detailed list of the audit procedures to be performed in the course of the audit. A tentative audit plan is developed based on the auditors' initial risk assessments. This tentative plan, however, may require frequent modification as the audit progresses. In planning the audit, auditors use materiality in determining the proper scope of audit procedures. The audit should be planned to obtain reasonable assurance of detecting material misstatements of the financial statements. In evaluating audit findings, the auditors use materiality to evaluate whether actual or likely misstatements that have been found are material to the financial statements.

Planning the Audit

The auditors should establish an understanding with the client regarding the terms of the audit engagement. This understanding should include (1) the objective and scope of the audit, (2) auditor and management responsibilities, (3) inherent limitations of an audit, (4) the applicable financial reporting framework (e.g., GAAP), and (5) the expected form and content of reports to be issued by the auditors. This understanding should be in the form of a written engagement letter (or other suitable written agreement).

Obtaining an Understanding of the Client Environment

The required understanding of the client is used by the auditors to help plan the audit and to assess the risks of material misstatement at the financial statement and relevant assertion levels. Concerning the overall attractiveness of the industry, auditors consider such factors as: Barriers to entry. Strength of competitors. Bargaining power of suppliers of raw materials and labor. Bargaining power of customers. The other characteristics of the client's industry that auditors consider include factors such as economic conditions and financial trends, governmental regulations, changes in technology, and widely used accounting methods. Many firms have developed a balanced scorecard that uses a combination of financial and nonfinancial performance measures to assess the financial, customer, internal business process, and learning and growth perspectives of the organization. These measurement systems assist management in gauging progress toward meeting its objectives

Foreign Corrupt Policies Act

Transactions are executed with the knowledge and authorization of management. Transactions are recorded as necessary to permit the preparation of reliable financial statements and maintain accountability for assets. Access to assets is limited to authorized individuals. Accounting records of assets are compared to existing assets at reasonable intervals and appropriate action is taken with respect to any differences.