Chapter 3 - Before You Go Solutions

Explain four opportunities that increase the risk of fraud.

(1) accounts that rely on estimates and judgments, (2) a high volume of transactions at year-end, (3) significant adjusting entries and reversals at year-end, and (4) significant related party transactions

Explain four incentives and pressures that increase the risk of fraud.

(1) the client operating in a highly competitive industry, (2) a significant decline in demand for the client's products and services, (3) failing profits, and (4) a threat of takeover

What will an auditor consider in assessing the integrity of a client's management, board, and other personnel?

When assessing the integrity of the client's management, board, and other personnel, the auditor will consider the reputation of the client, its management, directors, and key stakeholders. Auditors will consider a client's reasons for switching audit firms, if the company was previously audited, and management's attitude to risk exposure. Auditors will consider management's attitude to the implementation and maintenance of adequate internal controls, the appropriateness of management's interpretation of accounting rules, and management's willingness to allow the auditors full access to client personnel, records, and information required to form their opinion.

What is qualitative materiality?

information or misstatements that impact a user's decision-making process for a reason other than its magnitude.

The relationship between risk of material misstatement and detection risk

inverse relationship, RMM is high, detection risk is low

Explain how the risk assessment phase helps to improve the efficiency and effectiveness of the audit.

requires auditors to plan with the goal of minimizing audit risk, thereby ensuring that appropriate attention is paid to the accounts and transactions most at risk of being materially misstated.

What are the three main phases of the audit?

risk assessment, risk response, and reporting

Briefly discuss why auditors must treat every audit as unique

risks associated with two companies may be different even if they are in the same industry. For clients in different industries, laws and regulations will differ amongst industries.

Describe the audit strategy when the auditor adopts a predominantly substantive approach

the audit strategy is to increase detailed substantive procedures performed at year-end

What is the purpose of developing an overall audit strategy?

the audit strategy provides the basis for developing the audit plan that details the nature, extent, and timing of audit procedures to be performed.

How does an auditor gather information about management integrity?

the auditor can communicate with the previous auditor (with client permission), client personnel, third parties such as lenders, industry peers, and read industry journals.

What are the components of the audit risk model?

the risk of material misstatement and detection risk. Risk of material misstatement consists of inherent risk and control risk.

Why would the auditors adopt a reliance on controls approach?

when internal controls are effective, and the auditors can perform less extensive detailed substantive procedures at year-end

What is quantitative materiality?

information or misstatements that exceed the magnitude of an auditor's preliminary materiality assessment, which is a percentage of an appropriate benchmark.

What is performance materiality?

amount or amounts set by the auditors at less than the materiality level for particular classes of transactions, account balances, or disclosures.

What is significant risk?

an identified and assessed risk of material misstatement that, in the auditor's judgment, requires special audit consideration.

What are the key components of an engagement letter?

are an explanation and scope of the audit, the timing of the completion of various aspects of the audit, an overview of the client's responsibility for the preparation of the financial statements, the requirement that the auditor have access to all information required to perform the audit, and independence considerations and fees.

Why is an attitude of professional skepticism important for auditors?

auditors remain independent of the entity, its management, and its staff when completing the audit work. When auditors exercise professional skepticism during the risk assessment phase, it helps to ensure they are using appropriate assumptions when developing their audit strategy that will be used in the risk response phase. In the reporting phase, auditors use professional skepticism when evaluating the evidence gathered and forming an opinion that the financial statements are presented fairly.

What are the responsibilities of the client and the auditor when it comes to fraud?

for preventing and detecting fraud, to assess the risk of fraud and the effectiveness of a client's attempt to prevent and detect fraud via its internal control system