Chapter 3-Audit, Auditing

Confirmation

-direct correspondence with independent parties -can produce evidence of existenve and ownership, sometimes valuation and cutoff -should be mailed directly to auditor -must have client's consent

Rights and obligations (rights and obligations)

-does the entity really own the assets? -are related legal responsibilities identified? -statements by independent parties -use confirmation ----letters form outside the firm letting you know something really did happen or they really do own these items

Inspections or records and documents

-examining authoritative documents prepared by individual parties and client -documents prepared by independent outside parties --external to internal documents (prepared by outsiders received by client) -documents prepared and processed by the client

Engagement letters include

-objective of the engagement -management's responsibilities -the auditor's responsibilities -any limitation of the engagement -if public: internal control considerations

Purpose for audit procedures to get evidence

-to gain understanding of the client's risk and risk associated with the client -to test operating effectiveness of clients of clients internal control activities (test of controls) -to produce measures of mgt asserions

before conductiong the audit the auditor should determine that managment

1 uses acceptable financial reporting framework in the preparation and fair presentation of the financial statements 2. understands its responsibility for the preparation and fair presentation of the financial statements 3. understands its responsibility for the design, implementation, and maintenance 4. understands its responsibility to provide access to all info and persons deemed necessary for the audit

Reasons for engagement planning

1. Primary: identify the material misstatements at the financial statement and assertion level 2. execute auditing procedures (both substantive and control tests) that are designed to mitigate these risks to ana cceptable level, which allows the auditor to issue an opinon

what the auditor should consider when developing an audit strategy

1. characteristics of engagement and reporting objectives 2. determine materrilaity 3. areas of high risk of material misstatement 4. involvment of specialists and use of component auditrs 5. reliance on controls 6. relevant entity specific, industry, or financial developments 7. audit resources required 8. the results of preliminary engagement activities related

The analytical procedures

1. comparison of current year balances to balnces of one or more comparable periods 2. comparison to current year account balances to anticipated results found in company's budgets and forecasts 3. evaluation of relationships of the current-year account balance to other current year balances for conformity with predictable patterns based on the company's experience 4. study of relationships of the current year account balances with relevant nonfinancial informaton

Three additional goals of audit planning

1. firm has to conduct audit in accordance with professional standards in a timely and profitable manner 2. determine materiality 3. outline specific audit procedures including control tests and substantive tests

8 general audit procedures to gather evidence

1. inspection of records and documents 2. inspection of tangible assets 3. observation 4. inquiry 5. confirmation 6. recalculation 7. re performance 8. analytical procedure

parts of an engagement letter

1. objective and scope of the audit 2. responsibilities of the auditor and management 3. inherent limitations of the audit of internal controls 4. the financial reporting framework 5. the expected form and content of auditor reports

When significant events, such as a change in auditor occurs, public companies must file a Form ______with the SEC.

8-K

Pre-engagement activities

Also known as risk managment activities. because risk in a audit engagement generally refees to probability of blowing the audit 1. acceptance or continuance -obtaining and reviewing financial statements of clients -background checks of senior managers -ask questions of bankers, legal counsel -evaluating the public accounting firms indepndence with regard to the prospective client -considering the need for individual processing special skill or knowledge 2. compliance with independence and ethical requirements -Independence and due care --independence in mental attitude and appearance

Presentation and disclosure (classification and Understanability)

Classification: -were all transaction recorded in their proper account? are repairs expensed instead of capatalized -comparisons of current year amounts with those from the prior year -analytical procedures Understanability -are the presentations and disclosures understandable to users? -managment prepared financial statements and footnotes -inguiry

Completeness (Completeness, cutoff)

Completeness: -are the financial statements (including footnotes) complete -documents prepared by the client -inspection of records (tracing) start with a source document and go to the journal Is every source document found in the journal Cutoff -were all transactions recorded in the proper period? -client receiving reports and shipping reports -inspections of records or documents (tracing or vouching) -did you record things in the correct period, fob shipping fob whatever

Materiality

In order to plan the nature, timing, and extent of audit procedures to be performed an auditor should establish the materiality level for the financial statements as a whole that is appropriate despite the cirumstance -emphasis of financial statemnt use point of view -auditors must remain conservative

Internal auditora

Objective -not independent -objectivity is questioned when managers have the power over the pay/tenure of individual internal auditors Competence -education, experience, certifications if external auditor reaches favorable conclusion about competence and objectivity enable auditors to accept internal audits documentation and work on review assessment, and the monitoring of iternal controls ***Never trust for judgement decisons if low judgment and low risk can reperform 30% of work if internal auditors are objective and competent

True or false: Given today's complex computing requirements, audits of large companies will require IT auditors as part of the engagement team.

True

True or false: If the auditor is not independent, the financial statements are considered unaudited for all practical purposes.

True

True or false: Public accounting firms devote substantial time to make sure their audit clients are not likely to become the focus of an accounting scandal.

True

True or false: The engagement letter is designed to act as a contract for the audit.

True

True or false: The first step in the engagement planning process includes obtaining an understanding of the client's accounting information system.

True. This is done as well as part of obtaining a detailed understanding of the client's business, industry and strategy.

Valuation and allocation (valuation or allocation and accuracy)

Valuation or allocation: -are accounts valued correctly? -client-prepared accounts receivable aging schedule -reperformance -see if you get the same value Accuracy -were the transactions recorded accurately ? -vendor invoices -inspection of records or documents (tracing or vouching) -did we record it right

Audit plan

a comprehensive list of specific audit procedures that the audit team needs to perform to gather sufficient appropriate evidence in which to base their opinion on the the financial statements -needs to describe the nature, timing, and extent of the procedures to be performed to assess the risk of material of misstatement at the financial statement and assertion level

The first step in the engagement planning process is ______. Multiple choice question. evaluating the client and agreeing to accept the engagement a detailed understanding of the client's business, industry and strategy assigning the engagement partner in charge assessing audit risk

a detailed understanding of the client's business, industry and strategy

substative plan

a list of audit procedures for gathering evidence related to the relevant assertions identified for significant financial statement accounts and disclosures of an audit client it is the nature, the timing, and extent of procedures depends on the assessment of risk at audit client

PCAOB requirws

all documentation must be finalaized within 45 days of the audit report date can ass extra info with sufficent data, but cant repove -audit info be retained for 7 years and retain rsolution of differences

Vouching

an auditor selects an an item of financial info like a journal and follows the path backwards to its origin -help with existence and occurence -Can't help with completeness

When a public company changes auditors ______. Multiple select question. the former auditor must file Form 8-K explaining whether or not they agree with the change Reason: The auditor must submit a letter but the company must file Form 8-K. any pertinent disagreements with the former auditor must be disclosed documents filed regarding the change are available to the public the board of directors must approve the change

any pertinent disagreements with the former auditor must be disclosed documents filed regarding the change are available to the public the board of directors must approve the change

Select all that apply Firms often engage private investigators to conduct searches for additional information when prospective clients ______. Multiple select question. terminated the predecessor auditor have never been audited before are under some type of investigation have shown recent losses are financial institutions

are under some type of investigation have shown recent losses are financial institutions

The audit planning process is required to be led by the ______. Multiple choice question. senior auditor in charge board of directors assigned engagement partner audit team assigned to the entity

assigned engagement partner

A comprehensive list of the specific procedures that need to be performed to gather sufficient appropriate evidence to base an opinion on the financial statements is called a(n) _______ ________.

audit plan

Termination letter

auditors future services -assess to audit documentation by successor auditors -reissuance or auditors report for SEC -fee arrangements for future services

auditiros mark and explanation

auditors short-hand abbreviating comments about work performed. Must be accompanied with full explanation of audit work

Risk management activities are undertaken ______. Multiple choice question. at the conclusion of the audit engagement before issuing the audit report only during the audit fieldwork before beginning any audit engagement

before beginning any audit engagement

Auditors spend a considerable amount of time on risk assessment at ______. Multiple choice question. the financial statement level only both the financial statement and management assertion level neither the financial statement nor management assertion level the management assertion level only

both the financial statement and management assertion level

re-profirmance

broader than recalculation verify that account receivables aging schedule was prepared properly by sorting AR by due date

A lack of auditor independence ______. can lead to investor and client lawsuits requires an adverse opinion can result in disciplinary actions

can lead to investor and client lawsuits can result in disciplinary actions

audit trail

chain of evidence provided through coding, cross-referencing, and documentation connecting account balances and other summary results with the original transaction source documents

Obtaining evidence about their education, experience, and certifications, along with a review of department policies and procedures enables external auditors to investigate internal auditors'

competence

Select all that apply Client acceptance and continuation policies and procedures generally include ______. Multiple select question. considering the need for individuals with special skills or knowledge considering if any unusual risk is involved in the engagement criminal background checks for all senior and mid-level managers inquiries of persons who do business with the entity searching for lawsuits and court cases involving the entity

considering the need for individuals with special skills or knowledge considering if any unusual risk is involved in the engagement inquiries of persons who do business with the entity searching for lawsuits and court cases involving the entity

Client retention reviews are typically ______. Multiple choice question. only done at the request of the client only done if the auditor is considering withdrawing from the engagement only done when a major event occurs done annually

done annually

heading

each doc is titles w/ the name of company, balance sheet date, and descriptive title of the contents document

planning documentation

each relevant financial assertion to be investigated during the audit records of procedures performed evidence obtained decisons made

The goals of audit planning are to ______. Multiple select question. ensure proper staffing determine materiality outline specific audit procedures determine the feasibility of the audit

ensure proper staffing determine materiality outline specific audit procedures

Analytical procedures

evaluate financial statement accounts by studying and comparing relationships among financial and nonfinancial data required to them when planning an audit and when performing the final review before the audit report issued Use analytical procedures to provide evidence about managements financial assertions during the testing phase

Inspections of tangible assests

examining property, plant, and euaipment inventory and securites certificates -physcial inspction of tangible assets provide a compelling evidence and may provide tenative evidence for valuation -does NOT necessarily provide evidence that the entity owns the assets (rights) -leased -under consignment

Existence or occurence (existence occurrence)

existence: - do these assets really exist -the physical presence of assets -inspection of tangible assets occurrence: -did the recorded sales transactions really occur? -client shipping documents -Inspection of records or documents (vouching) (start at journal and go to the source document) prevent fictitious journal entries

indexing

give each document an index number so it can be found, removed, and replaced without loss

3 ways audit team uses materiality

guide for planing substantive testing procedures -to make sure that the aggregate of unncorrected and undetected immaterial misstatements do not exceed materiality for the financial statements as a whole -guide for making the audit report

The term predecessor auditor refers to the public accounting firm that ______. Multiple choice question. has been terminated or voluntarily withdrawn from an audit engagement was considered but did not accept the audit engagement is being considered for an audit engagement

has been terminated or voluntarily withdrawn from an audit engagement

The audit engagement partner ______. Multiple select question. generally also serves as the audit manager has final responsibility for the audit reviews the audit team's work in critical audit areas is usually an industry specialist

has final responsibility for the audit is usually an industry specialist

Select all that apply Firms often engage private investigators to conduct searches for additional information when prospective clients ______. have never been audited before have shown recent losses are under some type of investigation terminated the predecessor auditor are financial institutions

have shown recent losses are under some type of investigation are financial institutions

The audit planning process ______. is prepared after procedures to assess the risk of material misstatement at the financial statement and assertion level have been completed includes the establishment of overall strategy details the nature, timing and extent of control and substantive tests designed to mitigate risk

includes the establishment of overall strategy details the nature, timing and extent of control and substantive tests designed to mitigate risk

Perceptions of others in regards to an auditor being unbiased is referred to as ______ in_______.

independence in appearance

An auditor's unbiased "state of mind" towards the financial statements and other information audited is referred to as the auditor possessing ______ in_______ .

independence in fact

risk assessment procedures performed to obtain understanding

inquiries analytical procedures observation an inspection

Client acceptance and continuation policies and procedures generally include ______. Multiple select question. criminal background checks for all senior and mid-level managers inquiries of persons who do business with the entity searching for lawsuits and court cases involving the entity considering if any unusual risk is involved in the engagement considering the need for individuals with special skills or knowledge

inquiries of persons who do business with the entity searching for lawsuits and court cases involving the entity considering if any unusual risk is involved in the engagement considering the need for individuals with special skills or knowledge

A prospective auditor should attempt to obtain basic information directly from the predecessor auditor regarding issues that reflect directly on the ______. Multiple choice question. team the predecessor auditor used for the engagement reasons why the predecessor auditor is no longer on the engagement basis for the predecessor's last audit opinion integrity of management

integrity of management

Inquiry

involves the collection of oral (but sometimes written) evidence from independent parties and managment -important inquires and responses should be documented in writng -typically used during the early planning stages of the engagement -cannot sant alone, auditor must corroborate evidence with independent findings ----exception is fraud

An audit plan ______. Multiple choice question. is a comprehensive list of specific procedures needed to gather sufficient appropriate evidence details the terms of the engagement, including auditor and management responsibilities is a contract between the client and the auditor that details the time line and fees for the audit

is a comprehensive list of specific procedures needed to gather sufficient appropriate evidence

The three goals of audit planning are to make sure the firm has the requisite staff needed, to outline specific audit procedures needed and to determine _______

materiality

primary reason for engagement planning

mitigating risk

testing is consideres

more effective

substative analytical procedeures

more efficient that testing controls

With respect to a predecessor auditor, a perspective auditor ______. Multiple choice question. is prohibited by auditing standards from initiating any contact should not inform the perspective client if the auditor decides to initiate contact must initiate contact and attempt to obtain certain basic information may not accept the engagement if information from the predecessor cannot be obtained

must initiate contact and attempt to obtain certain basic information

An auditor with no connection to the audit should be able to tell the

nature, timing, and extent, and results of the procedures conclusions reached with respect to the are covered by audit documentation the audit team member performing the work, the date of work, and the date of revies

Public accounting firms are ______. Multiple choice question. only obligated to provide services for clients the firm has audited in the past obligated to provide services for any public company that files reports with the SEC not obligated to provide services for any new or existing client

not obligated to provide services for any new or existing client

cross-referencing

numbers of memoranda related to other documents carry the index of the other documents

Prior to relying on the work of internal auditors, external auditors should consider their ______and______.

objectivity and competence

when do auditors accept engagements

only if the preconditions for an audit are present and a coomon understanding of the terms have been reached preconditions: -use of an acceptable accounting framework -agreement on the premise of the audit

Tracing

opposite direction of vouching auditor selects a basic source document and follows the path processing it forward to find its final recroding in the summary journal or ledger -can see if all events were recorded (completeness) -can also provide evidence with respect to valuation and allocation

two categories of audit documentation

permanent files (continuing audit files) -info relevant for ongong client relationships current files -just one year of the audit relationship

Observation

physical inspection of inventory or view of plant activites -commonly used to test contrils

A public accounting firm that has been terminated or has voluntarily withdrawn from an audit engagement is known as the _______ ________

predecessor auditor

Engagement letters

professional standards require auditors to reach a mutual understanding with clients concerning requirements and expectations to document these understanding in an engagement letter -it must be prepared EVERY year _it acts as a contract

IT auditors ______. Multiple select question. provide specialized skills related to programming languages are not part of the audit engagement team may be needed to evaluate computerized processes assist with understanding software packages

provide specialized skills related to programming languages may be needed to evaluate computerized processes assist with understanding software packages

In addition to the audit engagement partner, audit teams typically include a(n) _______________ __________________ partner who reviews the audit team's work in critical audit areas.

quality assurance

recalculation

recalculation of calculations previously performed by the clients personnel procesures compelling mathmatical evidence -used to provide evidence of valuation and other financial data

Engagement letters ______. are only required for new clients reduce the risk of misunderstandings set forth audit objectives define management and auditor responsibilities should not mention fees

reduce the risk of misunderstandings set forth audit objectives define management and auditor responsibilities

The basis to determine the nature, timing, and extent of internal control tests and substantive tests of account balances and disclosures is the ______ _______process.

risk assessment

The basis to determine the nature, timing, and extent of internal control tests and substantive tests of account balances and disclosures is the ______. Multiple choice question. risk assessment process nature of the client's business prior year's audit number of management assertions

risk assessment process

The probability that the firm could issue a clean, unmodified opinion when in fact a modified opinion should have been issued is referred to as___

risk.

Select all that apply When an auditor/client relationship ends a termination letter ______. Multiple select question. should address access to audit documentation by successor auditors may address the auditors' understanding of the termination circumstances is required by audit standards should not discuss fee arrangements for future services

should address access to audit documentation by successor auditors may address the auditors' understanding of the termination circumstances

Client continuance decisions are generally ______ client acceptance decisions. Multiple choice question. different than similar to

similar to

The nature and extent of work completed during engagement planning depends on the ______. Multiple select question. size of the company being audited prior experience with the company being audited company's industry and complexity number of auditors assigned to the audit

size of the company being audited prior experience with the company being audited company's industry and complexity

Favorable conclusions about the competence and objectivity of internal auditors allow external auditors to rely on the work of internal auditors related to ______. Multiple select question. substantive testing of balances on the audit testing the internal control system assessing the reasonableness of the allowance for doubtful accounts forming the audit decision

substantive testing of balances on the audit testing the internal control system

planning memo

summarizes all the important overall planning info and documentation that the audit team is following GAAS

lead scheduling

summary of accounts or compnents in an account group

When an auditor/client relationship ends a(n) _____letter should be prepared that details the subject of future services and circumstances that caused the conflict.

termination

What the audit plan should servive

the audit plan needs to specify a list of procedures that must be completed to gather sufficient and appropriate evidence directed toward achieving particular audit objective

professional auditing standars require that audit evidence shows

the clients account records agree or reconcile the financial statement the work was adequately planned and supervides sufficient understanding of the clients internal control was obtained sufficient underatnding of the clientsinternal control was obtained suffient appropriate audit evidence was obtained as reasonable assurance for the audit

Planning the audit =

the strategy and developing the audit plan with planned risk assessment and procedures and planned response to material misstatement

signatures and inittials

the suditor who worked and superivsor who reviews it must sign the audit documentation so personnel can be identified

scanning

the way auditors examine their general alertness to unusual items and events in the clients documentation looking for anything anusual -existence of assests and completeness of accountng records, including proper cutoff material transactions

audit documentation

the written record of the basis of the auditors conclusion that provides support for the auditors representations, whether those representations are contained in the auditor's report or otherwise

The objectivity of internal auditors is questionable when ______. Multiple select question. they report to a line manager they report directly to the audit committee they report directly to the board of directors divisional managers set their pay they are scheduled for promotion to areas under internal audit review

they report to a line manager divisional managers set their pay they are scheduled for promotion to areas under internal audit review

Performance materiality

to make sure aggrgate of uncorrected and undetected immaterial misstatements do not exceed materiality for financial statements as a whole

tolerable risk

when auditors use sampling perfromance materiality