Auditing Midterm 2
How tests of controls are performed?
- Inquiry of appropriate entity personnel - Inspection of documents indicating the performance of the control - Observation of the application of the control - Reperformance of the application of the control by the auditor
Accounts affected by a purchase transaction
-Accounts payable -Inventory -Purchases or COGS -Various asset and expense accounts
Control activities
-Actions established by policies and procedures to ensure that management directives to mitigate risks are carried out -Performed at all levels of entity and various stages of the business process
If the aggregate misstatement exceeds tolerable misstatement, what are the auditor's options?
-Adjust the accounts to reduce the misstatement -Qualify the audit report
What can result if purchase transactions that do not occur are recorded?
-An incorrect payment will be made -Expenses may be overstated -A liability will be recorded -Assets may be overstated
Testing Only One or a Few Items
-Automated information systems process transactions consistently unless the system or programs are changed -The auditor may test the general controls over the system and any program changes, but test only a few transactions processed by the IT system
Evaluation - statistical sampling
-Calculate the sample deviation rate (deviations/sample size) -Determine the upper deviation rate (sample deviation rate + allowance for sampling risk) -Compare the upper deviation rate to the tolerable deviation rate determined at the beginning
Disadvantages of nonstatistical sampling
-Can become too conservative about sample size -Hard to quantify sample risk
Accounts affected by a cash disbursement transaction
-Cash -Accounts payable -Cash discounts -Various asset and expense accounts
Payment to vendor controls
-Cash disbursement are reviewed and approved by someone other than preparer -Checks are mailed by separate person than preparer
Causes of difference between client's and customer's balance in confirmation
-Client's or customer's balance is wrong (error or fraud) -Customer sent a check right at the end of the year that our client did not receive until after year-end (coincidence, no error or fraud) -Client shipped goods right at the end of the year, and the customer did not receive them until after year end (error on customer)
Determine the sample size - statistical sampling
-Determine the test objectives -Define the population characteristics (sampling population, sampling unit, and deviation conditions/misstatement) -Determine the sample size (use confidence level, tolerable deviation rate, expected deviation rate, population size)
What two technological advances have reduced the number of times auditors need to apply sampling techniques to gather audit evidence?
-Development of well-controlled, automated accounting systems -Powerful audit software to download and examine entire populations of data
Types of alternative procedures - revenue
-Examination of specific subsequent cash receipts (somewhat reliable) -Examination of shipping documentation (not very reliable) Examination of other client documentation (not very reliable)
Receiving controls
-Goods received are agreed to the purchase order -Receiving report sent to accounting to match to purchase order
Control risk assessment - purchasing process
-How purchase, cash disbursements, and purchase return transactions are initiated -The accounting records, supporting documents, and accounts involved in processing purchases, cash disbursements, and purchase returns -The flow of each type of transaction from initiation to inclusion in the financial statements, including computer processing of data -The process used to estimate accrued liabilities
Control risk assessment in the revenue process (IIFE)
-How sales, cash receipts, and sales returns and allowances transactions are initiated -The accounting records, supporting documents, and accounts that are involved in sales, cash receipts, and sales returns -The flow of each transaction from initiation to conclusion in the financial statements -The process used to prepare estimates for accounts such as bad debts and sales returns
Information and communication
-Info is necessary for an entity to carry out internal control responsibilities in support of achievement of its objectives -Communication is both internal and external
The 5 components of internal controls as defined by the COSO Framework are...
-Information and communication -monitoring activities -control environment -entity's risk assessment -control activities
Authorization - purchasing
-Look for purchases that were not authorized -examine purchase requisitions or purchase orders for proper approval -review client's competitive bidding process
Why will technology never completely eliminate the need for auditors to rely on sampling?
-Many control processes require human involvement -Many testing procedures require the auditor to physically inspect an asset -In many cases, auditors are required to obtain and evaluate evidence from third parties -Not all data can be processed depending on the format -Audit data analytics often identify a large number of potential exceptions that the auditor may test using sampling
Inherent risk factors that may affect the revenue process
-Misstatements detected in prior audits -Industry-related factors -Complexity and contentiousness of revenue recognition issues -the difficulty of auditing transactions and account balances
Substantive procedures for high-detection risk entity
-Nature: Corroborative audit tests using physical examination, analytical procedures, and substantive tests of transactions and balances -Timing: Interim and year-end -Extent: Limited testing of accounts or transactions
Substantive procedures for low-detection risk entity
-Nature: physical examination, review of external documents, confirmation, reperformance -Timing: all significant work completed at year-end -Extent: extensive testing of significant accounts or transactions
Advantages of nonstatistical sampling
-Not too much training -Just apply audit firm's policy -Consistent
monitoring controls
-Ongoing evaluations are used to determine whether internal controls are present and functioning -Findings are evaluated and deficiencies communicated in a timely manner -may identify the need for control redesign -is intended to assess quality of performance over time
Physical controls include...
-Physical security of assets -Authorization programs for access to computer programs and data files -Periodic counting and comparison with amounts shown on control records
Three types of transactions processed through the purchasing process
-Purchase of goods and services for cash or credit -Payment of the liabilities arising from such purchases -Return of goods to suppliers for cash or credit
Accounts affected by purchase return transaction
-Purchase returns -Purchase allowances -Accounts payable -Various asset and expense accounts
Key segregation of duties for purchasing
-Purchasing function separate from requisitioning and receiving functions -Invoice-processing function separate from accounts payable function -Disbursement function separate from accounts payable function -Accounts payable function separate from general ledger function
For the revenue process, the auditor is concerned about material misstatements related to...
-Recording of revenue when services have not been performed -Recording of revenue when goods have not been shipped -Sales to fictitious customers
Completeness - purchasing
-Review procedures for accounting for the numerical sequence of purchase orders, receiving reports, and vouchers -trace a sample of receiving reports to their vendor invoices and vouchers -trace a sample of vouchers to the purchases journal
Two important factors for when the auditor considers the control environment and the purchasing process
-The entity's organizational structure -The entity's methods of assigning authority and responsibility
Audit procedures used to search for unrecorded liabilities
-Understand controls over capturing payables in the correct period -Look at cash disbursements after year end and review supporting documentation to determine if an item was recorded in the correct period -Examine unpaid invoices and look for any unrecorded liabilities that should be included in the general ledger at year end
Things to consider when performing the audit procedures on the sample
-Voided or unused documents (error) -Client is unable to provide necessary documents (if nothing is provided, error) -Significant deviations are found
Industry-related factors to consider when auditing the purchasing process
-Whether the supply of raw materials is adequate -How volatile raw material prices are
Risk Assessment Process
-a dynamic process for identifying and analyzing risks to achieving the entity's objectives -should consider internal and external circumstances that may arise and adversely affect the entity's ability to fairly present financial data consistent with management's financial statement assertions
The main accounts affected by the auditor's achieved control risk for the purchasing process include...
-accounts payable -accrued expenses -most expense accounts in the income statement
The uncertainty related to non sampling risk can be controlled by...
-adequate training -proper planning -effective supervision
When payments are sent directly to an entity,...
-all checks should be restrictively endorsed -a control listing should be prepared -checks should be deposited daily
Search for unrecorded liabilities process
-ask management about control activities used to identify unrecorded liabilities and accruals at the end of an accounting period -Vouch large-dollar items from the cash disbursements journal for a limited time after year-end; examine the date on each receiving report of vendor invoice to determine if the liability relates to the current audit period -Examine the files of unmatched/unpaid purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities
Nonstatistical sample sizes are determined by...
-audit firm policy -applying professional judgment
Purchase requisition controls
-authorization policies: certain levels of management have higher $ limits for purchasing -Competitive bidding: used for larger purchases (e.g.: construction companies bid for a job) -Copy of purchase order goes to accounting for matching
The accounts commonly affected by cash receipts transactions are...
-cash -trade accounts receivable -cash discounts
Examples of substantive analytical procedures - purchases
-compare payables turnover and days outstanding in accounts capable to previous years' and industry data -compare current year balances in accounts payable with prior-years' balances -compare amounts owed to individual vendors in the current year's accounts payable listing to amounts owed in prior years -compare purchase returns and allowances as a percentage of revenue or cost of sales to prior years' and industry data
Risk factors to an entity's internal controls over the revenue process include...
-competition -rapid growth -new technology
major audit procedures for testing the existence assertion for accounts receivables
-confirmation of customers' accounts balances -examination of subsequent cash receipts
Considerations for doing substantive testing at an interim date
-control environment -nature of the account/balance -the assessed risk of material misstatement -the purpose of the substantive procedure -availability of information at a later date -The ability of the auditor to perform appropriate procedures to cover the remaining period
Two important controls for processing credit memoranda:
-each credit memorandum should be approved by someone other than the individual who initiated it -a credit for returned goods should be supported by a receiving document indicating that the goods have been returned
Accuracy - purchases
-ensure that company recorded purchases of assets at the appropriate amount -ensure that foreign currency was translated accurately -recompute the mathematical accuracy of vendor invoices -examine reconciliation of vouchers to daily accounts payable report
The auditor must maintain control over the accounts receivable confirmations to minimize the possibility of...
-entity interception of the confirmation -alteration of the confirmation by the entity
Objectives of attribute sampling when used for tests of controls
-evaluate the operating effectiveness of the internal control for purposes of the internal control audit for public companies -determine the degree of reliance that can be placed on controls for a financial statement audit
When the auditor does not receive a response to the positive confirmations, possible alternative procedures include...
-examining specific subsequent cash receipts -sending second and third requests -examining shipping documentation
Comparison of gross profit percentage to previous years' or industry data may provide valuable evidence on...
-fictitious revenue -unrecorded revenue -changes in pricing policies
two broad categories of information systems controls
-general: apply to all computerized applications and consist of a combination of hardware, software, and manual procedures that create an overall control environment ----application: specific controls unique to each computerized application, such as payroll or order processing.
Classification - revenue
-identify and reclassify any material credits contained in accounts receivable (i.e.: classify as accounts payable) -Segregate short-term and long-term receivables -Ensure that different types of receivables are properly classified
Major classification issues - purchases
-identifying and reclassifying any material debits contained in accounts payable (reclassify as receivables) -segregating short-term and long-term payables -Ensuring that different types of payables are properly classified
what is an understanding of internal control used for?
-identifying types of potential misstatement -pinpointing the factors that affect the risk of material misstatement -designing tests of controls and substantive procedures
When do auditing standards allow the auditor to omit confirming accounts receivable?
-if external confirmations would be ineffective -if the assessed level of risk for the assertion is low, and the planned substantive procedures address that risk -the accounts receivable balance is immaterial
Why might an auditor decide to follow a substantive strategy for some or all assertions?
-implemented controls are assessed as ineffective -testing the operating effectiveness of the controls would be inefficient -implemented controls do not pertain to the assertion under consideration
Understanding management's attitudes toward risk relevant to the revenue process
-important for assessing the control risk for the revenue process -auditor must understand how management considers risks, estimates significance, assesses the likelihood of occurrence, and plans appropriate actions
What can the auditor do if the actual misstatement/upper limit misstatement is greater than tolerable misstatement
-increase the sample size -perform other substantive procedures -request the entity to adjust the balance -issue a qualified or adverse opinion if management refuses to adjust the account balance
non statistical sampling
-judgement is used to determine the sample size -the auditor does not use statistical techniques to determine sample size, select sample items, or measure sampling risk
When an entity has a low risk of material misstatement, detection risk may be high. What is high detection risk characterized by?
-less reliable types of substantive evidence (analytical procedures) -audit work conducted at an interim date -tests may have a smaller sample size
Occurrence - purchasing
-look for fraudulent transactions and irrelevant expenses included (e.g.: personal expenses) -test a sample of vouchers for the presence of an authorized purchase order and receiving report
Cutoff - purchases
-look for items that were omitted from the current period -compare the dates on receiving reports with the dates on the relevant vouchers -compare the dates of vouchers with the dates they were recorded in the purchases journal
how does the auditor provide evidence on the valuation of the allowance
-looking at the aged trial balance for old items -considers historical collection to provide evidence of uncollectability for current items
How does the auditor keep control of the confirmation process?
-mail the confirmations outside the client's facilities -send return envelope addressed to the public accounting firm -mail the confirmations in envelopes with the public accounting firm as the return address
Limitations of an Entity's Internal Control
-management override of internal control -human errors or mistakes -collusion
Credit memoranda that are used to process sales returns and allowance transactions...
-may conceal a misappropriation of cash -can cover up unauthorized shipments of goods
two tests for completeness of accounts payable
-obtain a listing of accounts payable, footing the listing, and agreeing it to the general ledger control account -conduct extensive tests to ensure that all liabilities are recorded
With regards to internal controls, what are the auditor's responsibilities?
-obtain an understanding of internal controls -evaluate the design of internal controls -determine if the controls have been implemented -assess control risk
When risk of material misstatement is high, how does an auditor reduce detection risk
-obtain more reliable types of substantive evidence (confirmation, reperformance) -conduct most of the substantive audit work at year-end -make the tests more extensive (larger sample)
If the auditor determines that internal controls are properly designed and implemented and the auditor intends to rely on those controls, the auditor will...
-perform tests of controls to obtain audit evidence that controls are operating effectively -make an assessment of control risk based on the result of tests of controls
Tools used for documenting the auditor's understanding of internal controls
-procedure manuals -organization charts -internal control questionnaires -flowcharts -narrative descriptions
A system of internal controls is designed and carried out to provide reasonable assurance about the achievement of the entity's objectives in the following categories:
-reliability, timeliness, and transparency of external and internal reporting of financial and non-financial info -effectiveness and efficiency of operations -compliance with applicable laws and regulations
How does the auditor develop an understanding of the purchasing process?
-reviewing prior year documentation -conducting a walkthrough
The accounts commonly affected by sales return and allowance transactions are...
-sales returns -sales allowances -trade accounts receivable
Control environment
-set of standards, processes, and structures that provide a basis for carrying out internal control across the organization -sets the tone for an organization and influences the control consciousness of its people
Monitoring of internal controls...
-should be done to determine operating effectiveness -may identify the need for control redesign -is intended to assess quality of performance over time
The accounts commonly affected by sales transactions are...
-trade accounts receivable -bad-debt expense -sales -allowance for uncollectible accounts
The auditor uses risk assessment procedures to:
-understand entity's internal controls -identify key controls -identify the types of potential misstatements -design tests of controls and substantive procedures
Accrued liabilities substantive testing
-usually tested differently than accounts payable -must understand company's process for calculated estimates and express our judgment regarding our comfortability -look at accruals from previous years and evaluate consistency
Steps in sampling for tests of controls/substantive testing
1) Is sampling appropriate? 2) Determine sample size using statistical or non-statistical methods 3) Select the items for the sample using random, systematic, or haphazard approach 4) Test the sample 5) Assess results of sample testing based on statistical or non-statistical approach
Advantages of statistical sampling
1. Design an efficient sample 2. Measure the sufficiency of evidence obtained 3. Quantify sampling risk 4. No human judgement required
Functions of the revenue process (OCSBCAG)
1. Order entry 2. Credit authorization 3. Shipping 4. Billing 5. Cash receipts 6. Accounts receivable 7. General ledger
Disclosure items for the purchasing process
1. Payable by Type 2. Short Term & Long Term Payables 3. Long-Term Purchase Contracts 4. Purchases From and Payable to Related Parties 5. Dependence on a Single Vendor or small number or vendors 6. Costs by Reportable Segment of the business
Segregated duties for the revenue process
1. The credit authorization function should be segregated from the billing function 2. The shipping function should be segregated from the billing function 3. The accounts receivable function should be segregated from the general ledger function 4. The cash receipts function should be segregated from the accounts receivable function.
Disadvantages of statistical sampling
1. Training auditors in proper use. 2. Cost to design and conduct sampling application. 3. Lack of consistent application across audit teams.
significant deficiency
A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.
Material weakness
A deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis.
Monetary-unit sampling
A sampling technique that estimates the dollar amount of misstatement for a class of transactions or an account balance
tolerable error
Acceptable defect rate
Credit authorization function - revenue process
Appropriate approval of customer orders for creditworthiness
Purchasing function
Approval of purchase orders and proper execution as to price, quantity, quality, and vendor
Confirmation
Audit evidence that is a direct written response from a third party to the auditor, in paper form or by electronic or other medium
Auditing standards for conducting a sample
Auditor must properly plan, perform, and evaluate the sampling application and adequately document each phase of the sampling application
How can organizations control requisitioning authorization?
Authorization dollar limits for different levels of employees
Cutoff - revenue
Comparison of the dates on a sample of sales invoices with the dates of shipment and with the dates they were recorded in the sales journal
Walkthrough
Conducted by the auditor in order to gain an understanding of the purchasing process; for continuing audits, prior years' documentation can help, unless significant changes in the system occur
Type 1 SOC Report
Describes the service organization's controls and their effectiveness in achieving specified internal control objectives; no testing done
Examination of specific subsequent cash receipts
Did customer pay for sales occurring soon after year-end
Purchase order
Document prepared by the purchasing department for the purchase of goods or services from a vendor
True or false: population plays a bigger role in some of the sampling techniques used for tests of controls
False, for substantive testing
True or false: an auditor may reduce control risk below high only on the basis of a service auditor's Type 1 report
False, only for Type 2
True or false: substantive analytical procedures are rarely used to evaluate the reasonableness of accounts payable and accrued expenses
False, they can be useful in identifying misstatements and provide evidence regarding the fairness of the recorded accounts
Why use the confirmation process?
Highest and best evidence we can get concerning the AR balance's existence; direct written response from third parties
Requisitioning function
Initiation and approval of requests for goods and services by authorized individuals consistent with management criteria
Billing function - revenue process
Issuance of sales invoices to customers for goods shipped or services provided; also, processing of billing adjustments for allowances, discounts, and returns
Why is the auditor's understanding of internal control so important?
It is a major factor in determining the overall audit strategy
Items to be tested individually
Items that may contain potential misstatements that individually exceed the tolerable misstatement; tested 100% because the auditor is not willing to accept any sampling risk
What do performing substantive procedures test?
Nature, timing, and extent
Four types of control activities
Performance reviews, physical controls, segregation of duties, information processing controls
Disbursements function
Processing of payment to vendors
Cash receipts function - revenue process
Processing of the receipt of cash from customers
Invoice processing function
Processing of vendor invoices for goods and services received; also, processing of adjustments for allowances, discounts, and returns
General ledger function - purchasing
Proper accumulation, classification, and summarization of purchases, cash disbursements, and payables in the general ledger
General ledger function - revenue process
Proper accumulation, classification, and summarization of revenues, collections, and receivables in the financial statement accounts
What is the major control for preventing fictitious purchases?
Proper segregation of duties
Type 2 SOC 1 Report
Provides assurance on the operating effectiveness of the service organization's controls based on the auditor's tests of controls; more ideal option
Purchasing process overview
Purchase requisition > Purchase order > Receiving report and liability recorded > vendor
Revenue process - cash sale
Purchases > Inventory > Cash sales
Revenue process - credit sale
Purchases > Inventory > Credit sales > Account receivable > cash collection
Receiving function - purchasing
Receipt of properly authorized goods and services, compared to purchase order
Period costs
Recognized when cash is spent or liabilities incurred for goods and services that are used up at that time or shortly thereafter; not directly related to specific transactions
Accounts receivable function - revenue process
Recording of all sales invoices, collections, and credit memoranda in individual customer accounts
Accounts payable function - purchasing
Recording of all vendor invoices, cash disbursements, and adjustments in individual vendor accounts
Receiving function - purchasing
Responsible for receiving, counting and inspecting goods delivered from vendors; complete a receiving report that is forwarded to the accounts payable function
Policy
Rule or guideline that calls for certain activities to take place in certain circumstances
Determine the sample size - nonstatistical sampling - substantive testing
Sample size = (sampling population book value/(tolerable - expected misstatement))*confidence factor
When should the confirmation request be sent?
Soon after the end of the accounting period in order to maximize the response rate
substantive audit strategy
Strategy used when the auditor does not plan to rely on the client's controls and instead uses substantive procedures as the main source of evidence about the assertions in the financial statement
what does an auditor do when an entity has some or all of its accounting transactions processed by an outside service organization?
The auditor will have to audit the internal controls of the outside service organization every year
Assessing control risk
The process of evaluating the effectiveness of an entity's internal control in preventing, or detecting and correcting, material misstatements in the financial statements
Nonsampling risk
The risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk.
Risk of incorrect rejection
The risk that the sample supports the conclusion that the control is not operating effectively when it actually is or that the recorded account balance is materially misstated when it is not materially misstated.
Risk of incorrect acceptance
The risk that the sample supports the conclusion that the control is operating effectively when it is not or that the recorded account balance is not materially misstated when it is materially misstated.
Audit sampling
The selection and evaluation of less than 100 percent of the population of audit relevance such that the auditor expects the items selected to be representative of the population and, thus, likely to provide a reasonable basis for conclusions about the population.
Systematic selection
The technique of selecting a sample by drawing every nth item in the population, following one or more random starting points; the auditor determines the sampling interval by dividing the population by the sample size
Significant deviations found in the controls early on
There is no reason to continue testing
Attribute sampling
Used to estimate the proportion of a population that possesses a specified characteristic; most commonly used for test of controls
Representative sample
a sample where the evaluation of the sample results leads to the same conclusions that would be drawn if the same audit procedures were applied to the entire population
stratified sampling
a technique that is more effective in achieving sample representation by dividing the population into separate groups; may possibly reduce the sample size required to achieve a given precision or possibly increase the precision with the same sample size.
Order entry function - revenue process
acceptance of customer orders for goods and services into the system in accordance with management criteria
The auditor assesses the adequacy of the allowance account by first examining the ___ ____ ____for amounts that have been outstanding for a long time
aged trial balance
If a small number of large transactions make up a large percentage of an account, auditors will typically test...?
all the transactions greater than a particular dollar amount
Haphazard sampling
allows the auditor to "randomly" select items judgmentally with no conscious biases or reasons for including or omitting items from the sample; only used for nonstatistical sampling
For what types of evidence is sampling not commonly used?
analytical procedures, scanning, inquiry, observation
The extent of an auditor's understanding of control activities is a function of the ____ _____
audit strategy
Control activities used to identify unrecorded liabilities and accruals should be part of the _____ process for the entity
closing
Accuracy - revenue
comparison of prices and terms on a sample of sales invoices with an authorized price list and terms of trade
substantive tests of account balances - revenue
concentrate on the detailed amounts or estimates that make up the ending balance for revenue-related accounts
substantive tests of disclosures - revenue
concerned with the presentation and disclosures related to accounts receivable and related accounts
The amount of reliance to be placed on audit tests and the consequences of a decision error must be considered in determining ___ ___
confidence level
Three factors to consider in determining sample size
confidence level, tolerable error, expected error
Notes receivable
confirmed and examined for repayment terms and whether interest income has been properly recognized
The auditor should gain sufficient knowledge about the ____ ____ to understand management's and the BOD's attitudes, awareness, and actions concerning it
control environment
Components of internal control
control environment, risk assessment, control activities, information and communication, monitoring
The auditor should again analyze the misstatements discovered through the application of substantive procedures because these misstatements may provide addition evidence as to the ____ _____
control risk
Lockbox system
customers' payments are sent directly to the entity's bank, and the bank then transmits a file of cash receipts transactions and remittance advices to the entity
confidence level
desired level of assurance in the results of the sample
The results of the auditor's testing of internal controls for the revenue process directly impacts _____ risk and therefore the level of _____ procedures that will be required for the accounts affected by this process
detection, substantive
Precision
difference between the expected and tolerable deviation rate of misstatement
Relationship between desired confidence level and sample size
direct
Relationship between expected population deviation rate and sample size
direct
Relationship between population size and sample size
direct (not very strong)
Purchase requisition
document that requests goods or services that is sent to an authorized individual or department within the entity
random selection
every item in the population has the same probability of being selected as every other sampling unit in the population
Receivables from related parties
examined to determine if they were at arm's length
Product costs
expenses that can be matched directly with specific transactions or events and are recognized upon recognition of revenue
True or false: interim date tests are considered stronger than year-end tests
false
True or false: the tax provision and related balance sheet accounts are usually immaterial elements in the financial statements
false
True or false: cutoff is more critical for the revenue process than for the purchasing process
false, because the seller knows exactly when the product ships, but the buyer doesn't know very easily
True or false: if the upper deviation rate exceeds the tolerable rate, the controls may be relied upon, or the balance is fairly stated
false, exceeding the tolerable rate means that the controls should not be relied on, or the balance is not fairly stated
True or false: audit sampling is always appropriate, regardless of the level of risk
false, if certain transactions present a greater than normal risk, the auditor should test all of those items
True or false: auditors normally test the cutoff assertion by conducting tests of controls only
false, in most cases, cutoff tests are conducted as substantive tests of transactions or as a dual-purpose test
True or false: determining the sample size is typically one of the easiest steps of an audit sampling application
false, it is one of the most difficult
True or false: random or systematic sample selection is required for nonstatistical sampling and may be used for statistical sampling
false, it is required for statistical and may be used for non statistical
True or false: a non statistical approach may not involve both random selection and a judgmental evaluation
false, it may involve both
True or false: if a sample size is not statistically derived, it cannot be statistically evaluated
false, nonstatistical sampling allows for nonstatistical methods
True or false: with a nonstatistical sample, the auditor can calculate the sample deviation rate and can mathematically quantify the computed upper deviation rate and sampling risk associated with the test
false, the auditor can calculate the sample deviation rate, but not the the upper deviation rate and sampling risk
True or false: individuals who can requisition goods should receive the goods
false, the duties should be segregated
True or false: substantive analytical procedures are inadequate audit tests for examining the fairness of revenue related accounts because such tests fail to provide sufficient evidence, even though they are low cost
false, they are adequate and efficient audit tests
True or false: Haphazardly selected samples should be formally evaluated statistically
false, they should not be formally evaluated statistically
True or false: the sample sizes for non statistical sampling are very different from the sample sizes of statistical sampling
false, they use approximately the same sizes
True or false: like payables, there is concrete documentation for valuation of accruals
false, unlike payables, accruals do not often as obvious of a valuation process
Substantive tests of transactions - purchasing
focus mainly on the purchases and cash disbursement transactions
Substantive tests of transactions - revenue
focus mainly on the sales and cash receipts transactions
Substantive tests of details of account balances - purchasing
focus on the detailed amounts or estimates that make up the ending balance for accounts payable and accrued expenses
COSO Framework
helps management better control the organization and provides the BOD with an added ability to oversee internal control
If control risk is mistakenly set at a low level, detection risk will be set too ___
high
The larger the sample size, the ____ the confidence level and the ____ the sampling risk
higher, lower
expected error
historical defect rate
Concern of accounts payable confirmations
how much do we owe the company (as opposed to if we owe the company)
If the controls in the purchasing process are reliable, the auditor may be able to ____ the detection risk for the affected financial statement accounts and therefore ____ the number of substantive procedures needed
increase, decrease
Examination of shipping documents and other client documentation
indicators of sale happening; used when cash is not collected; not very reliable
Segregation of duties - purchasing
individuals responsible for requisitioning, purchasing, and receiving should be segregated from the invoice-processing, accounts payable, and general ledger functions
Whether the supply of raw materials is adequate and how volatile raw material prices are two important industry-related factors in assessing _____ risk when auditing the purchasing process
inherent
For what types of evidence is sampling commonly used?
inspection of tangible assets, inspection of records or documents, reperformance, recalculation, confirmation
Relationship between tolerable deviation rate and sample size
inverse
If there is a small margin for error (tolerable error and expected error are nearly equal), a ______ sample size is required
larger
Blank confirmations
leave the dollar amount blank for the respondent; common confirmation used for accounts payable
When the results of testing controls do not support the planned level of control risk, detection risk will have to be set ____.
lower
Determine the sample size - nonstatistical sampling - tests of controls
make a table that relates level of controls reliance to sample size (e.g.: low - 10-15, moderate - 20-30, high - 40-60), so that the policy can promote consistency in sampling applications
Rights and obligations - revenue
make sure of any unidentified factored receivables
the auditor should gain sufficient knowledge about the control environment to understand the attitudes, awareness, and actions concerning the control environment of the...
management, board of directors
When an account or class of transactions is made up of a few large items, the auditor...
may examine all the items in the account or class of transaction
Comparison of gross profit percentage to previous years' or industry data
may provide valuable evidence on unrecorded revenue (understatement) or fictitious revenue (overstatement) and related accounts receivable when this ratio is significantly higher or lower than previous years' or industry data
When audit risk is low and the risk of material misstatement is high, substantive tests should be performed...
mostly at year-end
How should misstatements discovered in the sample for substantive testing be treated?
must be projected to the population, and there must be an allowance for sampling risk
significant deviations found in the substantive testing early on
must continue testing until you feel that you have captured everything to make a judgment about materiality
Existence - revenue
obtain confirmation regarding balance
Authorization - revenue
obtain evidence of a creditworthiness check of customer
The auditor is concerned with a misstatement caused by a cash disbursement being recorded in the entity's records when no payment has actually been made when considering the _____ assertion
occurrence
The possible misstatement that concerns the auditor when considering the ____ assertion is that cash receipts are recorded but not deposited in the entity's bank account
occurrence
unrestricted random sampling
once an item is selected it cannot be selected a second time
In applying attribute sampling to tests of controls, the auditor normally attempts to determine the ____ _____ of a control in terms of _____ from a prescribed internal control
operating effectiveness, deviations
Controls that may be relevant to the audit when they have an impact on data that the auditor uses to apply audit procedures include what types of controls?
operations, compliance
an effective system of internal control allows management to focus on _____ and _____ _____ ____ while maintaining compliance with laws and minimizing surprises
operations, financial performance goals
If purchase transactions that do not occur are recorded, assets or expenses will be _____
overstated
For the occurrence assertion, the auditor is concerned with a misstatement caused by a cash disbursement being recorded in the entity's records when no _____ has actually occurred
payment
Valuation and allocation - revenue
prepare an aged trial balance and discuss results with the credit manager; compare results with the prior year; form your own estimate for allowances and returns and compare it to the company's estimation
Confirmation for accounts receivable
presumed to be mandatory; should always do it unless the AR balance is highly immaterial or the confirmation process is ineffective; controlled by the auditor with no involvement of client
Difference projection
projects the average misstatement of each item in a non statistical sample to all items in the population; used when the misstatement is expected to be relatively constant for all items in the population regardless of their dollar size (e.g.: all of the differences are by $1,000)
The major control for preventing fictitious sales is...
proper segregation of duties
A purchase transaction usually begins with a(n) _____ _____ being generated by a department or support function
purchase requisition
Segregation of duties
reduces the opportunity for an employee to perpetrate and conceal errors or fraud in the normal course of his/her duties
Auditor must understand the control activities that relate to assertions for which a lower level of control risk is expected in a _____ strategy
reliance
The critical segregation of duties for preventing fictitious purchases is the separation of the ______ and _____ functions from the accounts payable and disbursement functions
requisition, purchasing
The important issue in the _____ function of the purchasing process is that the request meets the authorization procedures implemented by the entity
requisitioning
Accounts receivable function
responsible for ensuring that all billings, adjustments, and cash collections are properly recorded in customers' accounts receivable records
The sale of goods and services to customers is the focus of the ____ process
revenue
For virtually all entities, the ____ and ____ processes represent the two major business processes that affect the financial statements
revenue, purchasing
The auditor should obtain sufficient info about the entity's ____ _____ process to understand how management considers risks relevant to financial reporting and decides on appropriate actions to address those risks
risk assessment
Confidence level is the complement of ____ ____
sampling risk
The key control activity to prevent misstatements with respect to the occurrence of cash receipts is...
segregation of duties
Shipping function - revenue process
shipping of goods that have been authorized
Proper segregation of the disbursement function
should be segregated from the accounts payable function
Proper segregation of the invoice-processing function
should be segregated from the accounts payable function
Proper segregation of the accounts payable function
should be segregated from the general ledger function
Proper segregation of the purchasing function
should be segregated from the requisitioning and receiving functions
revenue recognition poses a(n) _____ audit risk to auditors
significant
probability proportionate to size sampling (MUS)
similar to systematic selection, but instead of transactions, the auditor tests every nth dollar
Any entries into customers' accounts should be made from authorized ____ ____ such as sales invoices, remittance advices, and credit memoranda.
source documents
when an auditor decides to follow a(n) _____ strategy, little work is done on understanding specific control activities
substantive
Effectively identifying accounts payable and accrual accounts that are misstated and providing evidence regarding the fairness of recorded accounts can be done using _____ ______ procedures
substantive analytical
To examine the fairness of revenue related accounts, ______ _____ procedures are useful audit tests because they provide sufficient evidence at low cost
substantive analytical
Monetary-unit sampling is used for what kind of testing?
substantive testing
Nonstatistical sampling is more common for what kind of testing?
substantive testing
Stastical sampling is more common for what kind of testing?
tests of controls
If results of the tests of controls support the planned level of control risk...
the auditor conducts substantive procedures at the planned level
reliance strategy
the auditor intends to depend on the entity's controls and may need a more detailed understanding of internal controls to develop a preliminary or "planned" assessment of control risk
In the purchasing process, if the results do not support the planned level of control risk...
the auditor reduces the detection risk, increasing substantive procedures over the planned level
control deficiency
the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis
When testing controls using sampling, what is the auditor judging?
the judgment is whether the controls are working or not
Procedure
the review itself, performed in a timely manner and with special attention given to factors set forth in the policy
Sampling risk
the risk that the sample is not representative of the population
Once the desired confidence level is set, the appropriate sample size is determined by how much ____ ____ exceeds ____ ____
tolerable error, expected error
completeness - revenue
trace a sample of shipping documents to the sales journal
True or false: a substantive strategy requires the auditor to have a sufficient understanding of the entity's internal controls to know whether they are properly designed and implemented
true
True or false: auditing standards require that the auditor document his or her understanding of the entity's internal control components
true
True or false: generally, the purchasing process is not difficult to audit and does not present contentious accounting issues
true
True or false: many times we are searching for liabilities, we are trying to ind completeness and cutoff errors at the same time
true
True or false: on most audits, the purchase cutoff is coordinated with the entity's physical inventory count
true
True or false: steps and techniques for both statistical and non statistical sampling are more similar than different
true
True or false: the auditor should presume that there is a risk of material misstatement due to fraud relating to revenue recognition
true
When a small number of large transactions make up a relatively large percent of an account or class of transactions, the auditor...
typically test all the transactions greater than a particular dollar amount
Risk assessment process - Revenue
understand how management considers risks that are relevant to the revenue process; the auditor should estimate the significance of the risk and assess the likelihood of occurrence
Evaluation for nonstatistical sampling
use ratio projection or difference projection
Substantive analytical procedures - purchasing
used to examine plausible relationships among accounts payable and accrued expenses
Substantive analytical procedures - revenue
used to examine plausible relationships among revenue related accounts
Ratio projection
used to project the amount of misstatement found in a non statistical sample; used when the dollar amount of misstatement is expected to relate to the dollar amount of items tested (e.g.: all of the differences are by 10%)
Statistical sampling
uses the laws of probability to compute sample size and evaluate results
Occurrence - revenue
vouch a sample of sales invoices back to customer orders and shipping documents
Hard accrued liabilities to verify
warranty, litigation, liabilities calculated by specialists (pension liabilities and insurance claims), self-insured liability
When are alternative procedures used for the revenue process?
when the auditor does not receive responses to positive confirmations
