Auditing Topics: chapter 6

relevant assertion risk levels

relevant assertion is one that has a reasonable possibility of containing a material misstatement through -existence and ocurrence - rights and obligations - completeness - cutoff - valuation, allocation, and accuracy - presentation and disclosure

significant risk

risks that require special consideration. auditors consider: -the nature of the risk -the likely magnitude of the potential misstatement that may occur - the likelihood of the misstatement occurring (relate to non-routine and estimation transactions) In response to significant risks, auditors should -carefully consider the design and implementation of the related controls -not rely on evidence about the operating effectiveness of the related controls that has been gathered in prior periods -not rely solely on analytical procedures to obtain audit evidence about the related financial statement assertions

Auditors may use what to analyze cash flows while obtaining an understanding of the client?

statement of cash flows

transaction cycle

the sequence of procedures applied by the client in processing a particular type of recurring transaction typical cycles include: -the revenue cycle - the acquisition cycle - the conversion cycle - the payroll cycle - the investing cycle - the financing cycle

Tracing: test of completeness

trace transactions from the the origin forward to their inclusion in the financial statements. provides the auditor with assurance that all transactions have been properly recorded and reflected in the financial statements . it it a test of the completeness assertion.

Risk assessment procedures:

-inquiries of management and others within the entity -analytical procedures -observation and inspection relating to client activities, operations, documents, reports, and premises -other procedures, such as inquiries of others outside the company and reviewing information from external sources.

What is inherent risk?

-the risk of material misstatement of an assertion without considering internal controls

What are some rules of thumb regarding materiality estimates?

5-10 percent of net income before taxes, 1 percent of total entity

How do auditors respond to fraud risks?

A modification in approach having an overall effect on how the audit is conducted, an alteration in the nature timing and extent of the procedures performed, and performance of procedures to further address the risk of management override of internal control

What are two risk assessment procedures?

Analytical procedures, inquires of management and others within the entity

The AICPA, PCAOB, and international auditing standards all refer to _____ _____ as including the detailed, specific procedures.

Audit Plan

A ___________ _________ must include at least three independent directors.

Audit committee

Why should potential auditors should attempt to communicate with the predecessors before accepting the engagement?

Because the predecessor auditors are an excellent source of information about prospective client, in many circumstances this communication will occur before a formal proposal is presented to a prospective client.

Terms of an audit agreement

Clients should understand: -the objective and scope of the audit -auditor and management responsibilities -inherent limitations of the audit -the applicable financial reporting framework -the expected form and content of reports to be issued to the auditors. All in the form of an engagement letter.

What does effective planning involves?

Effective planning involves arranging the appropriate use of specialist both inside and outside of the client organization.

T or F Interim period is the time interval from the middle of the audit work to the balance sheet date Answer:

False

T or F. An account balance is allowed to contain an inappropriate value/amount known as the tolerable misstatement

False

T or F. As the materiality level increases auditors will need more evidence

False

T or F. Audit procedures should not allow for directional testing

False

T or F. Audit regulations allow auditors to skip risk assessment from a statement caused by Fried

False

T or F. Auditors may address fraud risk by maintaining the planned audit program

False

T or F. Further audit procedures will be based on the immateriality of account balances and the assessed risks of immaterial misstatement

False

T or F. Most substantive procedures are organized to evaluate the income statement

False

T or F. One of three levels of assessing materiality is appropriate level

False

T or F. Predecessor auditors (if used) Must be consulted before excepting a new client engagement

False

T or F. Risk assessment should consider only the items at the financial statement level

False

T or F. Some identified risks are considered to need a special audit consideration and the risk is referred to as a variable risk

False

T or F. The audit plan organization for transaction cycles is based on carrying out substantive procedures

False

T or F. The audit trail test of starting with financial statements and going back to source documents is a test of completeness

False

T or F. When internal control is a week that implies that control risk is low

False

T or F. The risk of association with a prospective client is called client risk

False, engagement risk

What is a tolerable misstatement?

It may be viewed as the application of performance materiality to a particular audit procedure

What is the amount that could influence decisions that users make on the basis of financial information of a specific reporting entity?

Materiality

Analytical procedures assist auditors in planning the _____________, _____________, and _____________ of audit procedures that will be used for a specific account.

Nature, timing, and extent

Audit arrangements are made through...?

The client's audit committee

What are some inquiries an auditor may include when asking a predecessor auditor about a client?

The integrity of management and disagreements with management over related matters

What should the terms of an audit engagement include?

The objective and scope of the audit, auditor and management responsibility, inherent limitations of an audit, the applicable reporting framework, and the expected form and contents of reports to be issued by the auditor.

Why do auditors seek the predecessor auditor?

The predecessor auditor can provide them with information about their financials and their management.

engagement risk

The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on. auditors must assess the risk that they will have in order to take on the client -they talk to third parties about prospective clients

T or F. Substantiation of account balances involves verifying existence of assets, right to asset, valuation of assets, and cut off for the proper period

True

T or F. Substantive procedures are performed to restrict detection risk

True

T or F. The CPAs should investigate the history of the prospective client, including the identities and reputations of the directors, officers, and major stockholders.

True

T or F. test of controls are performed to determine if controls are properly designed and operating effectively

True

T or F Determining the proper valuation of assets requires a thorough knowledge of generally accepted accounting principles.

True, Determining the proper valuation of assets requires a thorough knowledge of generally accepted accounting principles.

substantive portion of the audit plan

aimed at substantiating financial statement amounts organized in terms of major financial statement accounts and classes of transactions, such as cash, accounts receivable, sales, inventories, and plant and equipment. used to restrict detection risk

systems portion of an audit plan

include obtaining an understanding of controls for each transaction cycle, preparing a flowchart for each cycle, testing the significant controls, and assessing control risk for the related financial statement assertions 1. testing controls over transactions that occurred during the year 2) testing the ending account balance directly (helps provide evidence to assess control risk)

test of controls

performed to determine whether key controls are properly designed and operating effectively. purpose is to ensure that all shipments of merchandise are recorded in the accounting records. only measures the effectiveness of a particular control for detecting/preventing misstatement. DOES NOT show dollar amount. -provide auditors with evidence as to whether prescribed controls are in use and operating effectively. shows the likelihood that material misstatements have occurred.

substantive procedures

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

idk

procide auditors with evidence as to wether prescribed controls are in use and operating effectiviely

dual-purpose procedures (tests)

serves as both a test of controls and a substantive test of the details of the transactions that occurred during the year

performance materiality

the materiality amount(s) for segments of the audit, set by the auditor at less than materiality for the financial statements as a whole

What are the six relevant assertion level risks

- Existence and occurrence - Rights and obligations - Completeness - Cutoff - Valuation, allocation and accuracy - Presentation and disclosure

What is a transaction cycle?

- Sequence of procedures applied by the client in processing a particular type of recurring transaction.

audit plan

-comes after the strategy -include a description of the nature, timing and extent of 1) planned risk assessment procedures sufficient to assess the risks of material misstatement 2) planned further audit procedures for each material class of transactions, account balance, and disclosure. this includes test of controls and substantive procedures 3) Other audit procedures in order to comply with generally accepted auditing standards

how auditors modify their approaches:

-professional skepticism and audit evidence -assigning personnel and supervision -accounting principle -predictability of auditing procedures

T or F: Management is required to give the successor auditor permission to contact the predecessor auditor?

False

What are the two distinct types of risks of material misstatement from fraud?

Fraudulent financial reporting (management fraud) and misappropriation of assets (defalcations)

procedures in response to the possibility of management override

- examining journal entries and other adjustments for evidence of material misstatement due to fraud -reviewing accounting estimates for biases -evaluating the business rationale for significant unusual transactions

3. Assess the risks of misstatement and design further audit procedures

-Auditors consider, "what could go wrong?"; "How likely is it that it will go wrong?"; What are the likely amounts involved?" -provides evidence for inherent risk, control risk, and business risk.

What are the two distinct types of material misstatement from fraud?

-Fraudulent financial reporting (management fraud) -misappropriation of assets (defalcations)

6. Form an opinion and issue the audit report

-Issue the audit report based on conclusions. -Form an opinion

4. Perform further audit procedures

-combination of test of controls and substantive procedures related to account balances, transactions and disclosures.

1. Plan the audit

-determine requirements for engagement -understand nature of services and responsibilities to each party -develop audit strategy and audit plan (determining the analytical procedures, risk assessment, level of materiality, and likely need for specialists)

Understanding the client and its environment involves:

-the nature of the client, including the client's application of accounting policies -the industry, regulatory, and other external factors affecting the client -the client's objectives and strategies and related business risks -methods used by the client to measure and review performance -the client's internal control.

2. Obtain an Understanding of the Client and its Environment

-use risk assessment to gather background information to assess the risks of mm of the financial statements and to design the nature, timing, and extent of further audit procedures -understand client and its environment, industry, objectives, and strategies related to business risks -helps auditor identify account balances, transactions, and disclosures with a high risk of mm

How auditors respond to fraud risks:

1) a modification in approach having an overall effect on how the audit is conducted 2) an alteration in the nature, timing, and extent of the procedures performed 3) performance of procedures to further address the risk of management override of internal control

materiality

Information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information. -the more materiality is, the less evidence auditors will have to gather.

Information gathering procedures provide the auditor with evidence on ____________________ and ___________________ risks for significant assertions.

Inherent and Control

T or F Analytical procedures involve comparisons of financial statement balances and ratios

True

T or F Further audit procedures are based on the materiality of account balances, transactions, and disclosures

True

T or F The audit process includes 6 stages

True

T or F The value of audited financial statements is enhanced if the statements are available on a timely basis after year-end

True

T or F. A stage in completing an audit engagement is assessing risk of misstatement

True

T or F. Auditors should gain a sufficient understanding of a client to be able to assess the risks of material misstatement and to design the nature, timing, and extent of further audit procedures.

True

T or F. Based on the assessment process of misstatement, auditors design and perform further audit procedures.

True

overall audit strategy

When the auditors have obtained a sufficient understanding of the client. It considers the characteristics of the audit that determines the scope, such as industry reporting requirements, client locations, and the basis of reporting followed by the client. They look at risks of material misstatement and internal controls

Arrangements for the audit should be made through contact with the company's __________________________.

audit committee

How would an auditor indirectly verify revenue, COGS, and expenses?

by substantiating the changes in the asset and liabilities accounts

5. complete the audit

complete the search of: -unrecorded liabilities, completing the review of minutes -performing final analytical procedures -completing the search to identify loss contingencies and subsequent events -obtaining a representation letter from management -conclude if FS have followed GAAP

What document is used to establish an understanding with the client regarding the terms of the audit engagement?

engagement letter

T or F. Inherent risk involve analyzing the deign an implementations of internal control to decide if the system appears adequate to prevent or detect correct material misstatement.

false

Auditors' consideration of the materiality at the ______ stage of the audit helps them to determine the appropriate scope of the audit procedures.

first

Audit committee

public companies establish a subcommittee of the board of directors that is generally composed of three to six "outside" members of the organization's board of directors. required by NYSE, ASE, and NASDAQ. -at least 3 independent directors who cannot receive any consulting, advisory, or other way affiliated with the company -at least one must be a financial expert -committee is responsible for appointment, compensation, and oversight of auditors

What is the first step in sustaining an asset?

verifying the existence of an item

vouching: test of occurrence and existence

vouching is following the stream of evidence back to its source

While examining journal entries, auditors should carefully consider factors such as who is able to do what?

· Create, approve, record, review journal entries

What is a time budget?

- It is an estimation of the amount of time it takes to do each step up the audit and totaling the times for an overall time budget.

In response to fraud risks, auditors may modify their overall approach to the audit in on or more ways, what are those ways?

- Professional skepticism and audit evidence - Assigning personnel and supervision - Predictability of audit procedures - Accounting principles

How do auditors respond to fraud risk?

1. A modification in approach having an overall effect on how the audit is conducted 2. An alternation in the nature, timing, and extent of the procedures performed 3. Performance of procedures to further address the risk of management override of internal controls

What should be included in the understanding with the client in the terms of the audit engagement?

The objective and scope of the audit, auditor and management responsibilities, inherent limitations of an audit, the applicable financial reporting framework, and the expected form and content of reports issued by the auditors

What are two sources of information?

Tour of Plant and Office and Electronic Research and Analytical Procedures and the statement of cash flows

What is the sequence of procedures applied by the client in processing a particular type of recurring transaction?

Transaction Cycle

T or F. During an audit, when the risk associated with accounts receivable has been deemed to increase the auditor can make an adjustment to the original audit plan

True

T or F. Materiality at the planning stage leads to determining appropriate scope of audit procedures

True

T or F. Risk assessment procedures include: inquiries of management, analytical procedures, observation, and inspection

True

general objectives for an audit plan

a) establish the existence of assets (vouching) b) establish that the company has rights to the assets c) establish completeness of recorded assets (tracing) d) verify the cutoff of transactions e) determine the appropriate valuation of the assets f) determine the appropriate financial statement presentation and disclosure of the assets

What is the overall risk of association with the particular business?

engagement risk

The auditor's selection of __________ is based on the materiality of the account balances, transactions, and disclosures being audited and the assessed risk of material misstatement.

further audit procedures

What is considered in understanding the client and their environment?

- The name of the client, including the client's application of accounting policies - The industry, regulatory, and other external factors affecting the environment - The client's objectives and strategies and related business risk - Methods used by the client to measure and review performance - The client's internal control

two types of risks for material misstatement due to fraud

1) misstatements arising from fraudulent financial reporting (management fraud) 2) misstatements arising from misappropriation of assets (defalcations) The auditors - discuss with engagement personnel, make inquiries of management and others within the organization, perform analytical procedures, and consider fraud risk factors.

What are some of the task that may assigned to a client's employee to prepared?

Among some of the task that may be assigned to the client's employees are the preparation of a trial balance of a trial balance of a general ledger, preparation of an age trial balance of accounts receivable, analyses of accounts receivable written off, list of property additions and retirement during the year analyses of various revenue and expense accounts.

_________ ________ may be the same amount or lower than performance materiality depending upon the audit sampling techniques being used and the number of audit procedures affecting relevant assertions.

Tolerable Misstatements

For risk assessment, auditors should document:

1) the discussion of the audit team concerning the risk of material misstatement due to error of fraud 2) the key elements of the understanding of the entity and its environment 3) the assessment of the risk of material misstatement at both the financial statement level and the relevant assertion level 4) the risks identified

In examining journal entries, auditors should carefully consider factors such as who is able to:

1. Create 2. Approve 3. Record 4. Review journal entries

What are the six stages involve in every engagement?

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 farther audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report

stages with an audit engagement

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 5. Complete the audit 6. Form an opinion and issue the audit report

What tests are performed to determine if controls are properly designed and operating effectively?

test of controls

risk assessment procedures

used to gather this information and include researching the characteristics of the client's industry, inquiries of management, analytical procedures, observation and inspection, and other procedures.