Chapter 6

What are the rules of thumb to develop these estimates of overall materiality?

- 5%-10% of net income before taxes - .5%-1% of total assets - .5%-1% of total revenues - 1% of total equity

What procedures do auditors perform to complete an audit?

-Completing the search for unrecorded liabilities -Completing the review of minutes in meetings -Performing final analytical procedures -Completing the search to identify loss contingencies and subsequent events -Obtaining a representation letter from management

What are some sources of information for auditors when trying to learn the nature of the client?

-Electronic research -Tour of plant and offices -Analytical procedures -The statement of cash flows

To obtain the audit, auditors may be asked to submit a competitive proposal that will include?

-Information on the nature of services that the firm offers -The qualifications of the firm's personnel -Anticipated fees

Risk assessment procedures include:

-Inquiries of management and others within the entity -Analytical procedures -Observation, inspection and other procedures, including inquiries of others outside the entity

Where does information on internal control come from ?

-Interviewing client personnel -Observing the application of specific controls -Inspecting documents and reports -Tracing transactions through the information system

An understanding of the client and its environment encompasses:

-Nature of the client -Industry and other external factors affecting the client (competitors, bargaining power, barriers to entry, etc..) -Client's objectives and strategies and related business risks -Methods used by the client to measure and review performance -The client's internal control

What is the relationship of financial statement assertions to the audit?

1. Financial statement 2. Management Assertions 3. Audit objectives 4. Audit procedures 5. Audit evidence 6. Audit report on financial statements

What are the two types of fraud risks?

1. Fraudulent financial reporting (management fraud) 2. Misappropriation of assets (defalcations)

What are the SIX major steps in the auditing process?

1. Plan the audit 2. Obtain an understanding of the client and its environment, including internal control 3. Assess the risks of misstatement and design further audit procedures 4. Perform further audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report

An audit plan should include a description of the nature, timing, and extent of :

1. Planned risk assessment procedures 2. Planned further audit procedures 3. Other audit procedures in order to comply with GAAS

The terms of the engagement should include?

1. The objectives and scope of the audit 2. Auditor and management responsibilities 3. Inherent limitations of the audit 4. The applicable financial reporting framework (GAAP) 5. The expected form and content of reports to be issued by the auditors

What are the steps to substantiating an asset?

1. Verifying the existence of the item (All recorded receivables exist) 2. Rights to the asset (The client has rights to the receivables) 3. Completeness of assets (all receivables are recorded) 4. Cutoff of transaction (Sales and cash receipt transactions are recorded in the proper period 5. Valuation of assets (Receivables are presented at net realized value) 6. Financial statement presentation of assets (Properly presented in the balance sheet)

Audit committee

A committee composed of outside & independent directors (members of the board of directors who are neither officers nor employees) charged with responsibility for appointing, compensating, and overseeing the auditors.

What does material mean to PCAOB?

A fact is material if there is a substantial likelihood that the... fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.

Relevant assertion

A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated.

Audit Trail

A trail of evidence that links source documents, journal entries and ledge entries.

Engagement letter

An agreement between the CPA firm and the client as to the terms of the engagement for the conduct of the audit and related services

What risks are involved with a prospective new client?

An auditor being associated with clients who are engaging in management fraud or other misleading practices, comprising their integrity, objectivity, and reputation.

Time budget

An estimate of the time required to perform each step in the audit

What are auditors attempting to obtain at the 2nd stage?

An overall understanding of the client and its environment, including its objectives and strategies and related business risks, the manner in which management measures and reviews financial performance, and the client's internal control

Because auditors are prohibited from disclosing confidential information w/o permission, the successor auditors must _______?

Ask management of the client to authorize the predecessor auditors to respond fully to the successor's inquiries

Risk assessment procedures

Audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement

When dealing with a prospective client, PCAOB 315 requires the successor auditors to attempt to _________?

Communicate with the predecessor BEFORE accepting the engagement, since they are a excellent source of information about a prospective client

Tests of controls are performed to _________?

Determine whether key controls are properly designed and operating effectively

Audit planning involves:

Developing an overall audit strategy for the conduct, organization, and staffing of the audit

How does a CPA firm evaluate the risk associated with a prospective new client?

Evaluating engagement risk by: -Thoroughly investigate prospective clients Before Accepting An Engagement. -Investigate the history, identities and reputations of the directors, officers, and major stockholders. -Considering the reputation of management and the financial strength and credit rating to help assess the overall risk of association with the particular business AND Consider whether they can complete the audit in accordance with GAAS: -Independence -Appropriate training and experience (might need to hire experienced personnel in that field -Look at Form 8-K

Overall audit findings are evaluated to arrive at a conclusion as to whether the financial statements __?

Follow GAAP

What items are included in engagement letters?

Name of the entity Management responsibilities Auditors responsbilities Arrangements regarding Other services to be provided

Audit documentation

Record of the audit procedures performed, relevant audit evidence, and conclusions the auditor reached -Risk assessment -Procedure results -Consideration of fraud

Substantive procedures are performed to _____?

Restrict detection risk, the risks that auditors will not detect a material misstatement.

Analytical procedures

Tests that involve comparisons of financial data for the current year to that of prior years, budgets, non financial data, or industry averages. From a planning standpoint, analytical procedures help the auditors obtain an understanding of the client's business, identify financial statement amounts that appear to be affected by errors or fraud, or identify other potential problems.

Engagement risk is increased when __?

The client company is in a weak financial position or is greatly in need of additional capital

Engagement risk

The risk of loss or injury to the auditors' reputation by association with a client that goes bankrupt or one whose management lacks integrity.

Inherent risk

The risk of material misstatement of an assertion about an account without considering internal control.

Control risk

The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control.

Overall audit strategy

This strategy involves determining overall characteristics of the engagement that define its scope, determining the engagement's reporting objectives to plan the timing of procedures, and considering important factors that will determine the focus of the audit team's efforts.

Opening balances

Those account balances that exist at the beginning of the period.

When the overall audit strategy has been established, the auditors start the development of a more detailed _________ to address the various matters identified in the audit strategy.

audit plan

Auditors should gather sufficient ___________ to assess the risks of material misstatement of the financial statements and to design the nature, timing, and extent of further audit procedures.

background information

The auditors' consideration of _________ involves analyzing the design and implementation of internal control to decide whether the internal control system appears adequate to prevent or detect and correct material misstatements

control risk

Increases in the level of planning materiality result in ______ in the scope of audit procedures.

deceases

When the engagement letter is accepted by the authorized client official, it presents an ________________ between the auditor and the client.

executor contract

When the auditors have obtained a sufficient understanding of the client, they establish an ___________.

overall audit strategy

A test of control measures the effectiveness of a particular control in _______________________; it does NOT substantiate the dollar amount of an account balance.

preventing or detecting a misstatement

Internal control is designed to provide:

reasonable assurance of achieving objectives related to reliable financial reporting, efficiency and effectiveness of operations and compliance with applicable laws and regulations

In audit planning, auditors use a _______ approach in which they are continually considering the possibility of material financial statement misstatements.

risk-based

Further audit procedures include a combination of additional _____________ and _____________ relating to account balances, transactions, and disclosures.

tests of controls, substantive procedures

The significant portions of the planning process cannot be completed until ____?

the auditors have sufficient understanding of the client and its environment.

What does "planning the audit" include?

-Determining the requirements for the engagement -Determining the financial statements to be audited -Timing of the engagement

What are typically transaction cycles?

1. Revenue 2. Acquisition 3. Conversion 4. Payroll 5. Investing 6. Financing

Business risk

Risks that threaten management's ability to achieve the organization's objectives.

_________ is the basic unit time of measurement for audit fees.

Staff time

Shopping for accounting principles

Term relating to management changing auditors to a CPA firm that is more likely to sanction a disputed accounting principle

What does material mean to FASB?

The magnitude of an omission or misstatement of financial information that, in the light of surrounding circumstances, makes it probable that he judgment of a reasonable person relying on the information could have been changed or influenced by the omission or misstatement.

Audit risk

The possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.

At the assertion level, the auditors consider: ?

What could go wrong? How likely is it that it will go wrong? What are the likely amounts involved?