Audit 411 Chapter 5 review

Sufficiency of audit evidence: Making decisions about the sufficiency of audit evidence requires significant professional judgement. Explain how the following factors might impact the auditor's professional judgement regarding the sufficiency of audit evidence involved in the audit of inventory for a manufacturer: A) Materiality B) Risk of material misstatement C) Size and characteristics of the population

A) assertions that are more material to financial statements users require more sufficient evidence B) Assertions that have a higher risk of material misstatements (RMM) require more sufficient evidence C) Larger more diverse population require more sufficient evidence

How detailed should documentation be? It depends on several factors, such as A. the ____________________________ being performed B. the ______________________________ involved in the area being tested C. the ______________________________ to the overall audit D. the ________________________ in performing the work E. the _________________________________

A. nature of auditing procedure B. risk of misstatement C. Sufficiency of the evidence D. Extent of judgement involved E. nature of the findings/results

The transactions are recorded in the correct accounting period

Cutoff

Bank statement sent directly to the auditor by the bank

Directly from outsiders

Sampling Risk

The risk that the auditors' conclusion based on a sample might be different from the conclusion they would reach if the test were applied to the entire population. For tests of controls, sampling risk include risks of assessing control risk too high and too low; for substantive testing, sampling risk include the risks of incorrect acceptance and rejection.

Examples of routine transactions are ___________________________. They are routine in nature restricts ______________ risks.

sales, purchases, cash distruments, cash receipt, payroll inherent

2) Discuss the validity and limitations of inquiry and oral evidence

same as above: but in critical/important matters we should ask the client to confirm answers in writing

What is the relationship between detection risk and audit risk?

Audit risk uses a formula Detection is within audit risk Audit risk=IR x CR x DR

All assets have been recorded

Completeness

________________ are effectiveness at providing evidence about the existence of accounts, but are less effective at addressing _________________ and valuation

Confirmation completeness

Reconciliation

Establishing the agreement between two sets of related accounting records

Confirmation

Establishing the validity of a balance sheet by direct communication with an outside party

Vouching

Establishing the validity of a transaction by examining supporting documents

There is such an asset

Existence and occurrence

Tracing

Following a transaction from a source document to recorded entries (completeness)

Assets are recorded at proper amounts

Valuation, allocation, and accuracy

Detection risk is restricted by performing __________ _________

substantive procedures

In the course of an audit, the auditor asks many questions of client officers and employees. 1) Describe the factors that the auditor should consider in evaluating inquiry and oral evidence provided by the client officers and employees

1) Competence of person we're asking 2) Disinterestedness (objectiveness) 3) Logic and reasonableness of response

Compare current financial information with comparable prior periods

Analytical procedures

Give examples of specialists whose findings might provide appropriate evidence for independent auditors

Appraisers, attorneys, geologists, environmental consultant

__________ ___ ____________ are designed to test the operating effectiveness of controls in preventing or detecting material misstatements.

Tests of controls

Confirm accounts receivable

Tests of details of account balances, transactions and disclosures

Business Risk

The risk assumed by investors or creditors that is associated with the company's survival and profitability

Information Risk

The risk that the information used by investors, creditors, and others to assess business risk is not accurate

Audit evidence (or evidential matter) may be defined as any information that ...

corroborates or refutes a premise

Estimated transactions

create an account estimate: allowance for doubtful accounts, bad debt expense, goodwill, estimated warranty reserved

Inspection

critical review of a document

Tests of ________ _________ directly address whether there are misstatements in the ending balances of an account

details balances

Substantive procedures include analytical procedures and tests of ______________________________________________.

details of account balances, transaction, and disclosures

Tests of __________ ____ __________ address whether financial statement discloses are properly presented

details of disclosures

Tests of ________ _____ _________ address whether particular types of transactions have been properly accounted for during the period.

details of transactions

Rather than "assessing" ____________ _____________, auditors seek to restrict it through the performance of ____________ _______________. Detection risks exists because the auditors' substantive procedures are _________ ______ __________, due to both sampling and other factors.

detection risk substantive procedures Not 100% effective

A letter signed by offices of the client company at that auditors request which sets forth certain assertions about the company's financial position and operations known as a ________________ ___________. The term ____________ relates to the quantity of evidence to be obtained.

representation letter sufficient

Properly prepared audit documentation will help the auditors should litigation arise, just as improperly prepared documentation __________________________

will work against them

Calculate the ratio of bad debt expense to credit sales

Analytical procedures

What is the 8 types of audit procedures?

1) Analytical procedures 2) External confirmation 3) Inspection of tangible assets 4) Inspection of records and documents 5) Inquiries of knowledge about persons within or outside the entity 6) Observation of process or procedures being performed by others 7) Recalculation of mathematical accuracy 8) Reperformance of procedures

An audit may include computations of various balance sheet and operating ratios for comparisons to prior years and industry averages. Discuss the validity and limitations of ratio analysis in an audit

1) Board overview 2) Ranks lower in reliability and validity than direct evidence 3) Usually considered circumstantial

A canceled check is not considered particularly reliable evidence since the check was prepared within the client's organization

Incorrect-the check was processed externally by two organizations 1) who it was written too 2) banking system

What are the two components of risk of material misstatements?

Inherent risk x control risk

Paid checks returned with bank statement

Internal but validated externally

Who makes assertions? List the assertions

Management 1) Existence and occurrence 2) Rights and Obligations 3) Completeness 4) Cutoff 5) Valuation, allocation, and accuracy 6) Presentation and disclosure

The best means of verification of cash, inventory, office equipment, and nearly all other assets is a physical count of the units, only a physical count gives the auditors complete assurance as to the accuracy of the amounts listed on the balance sheet

Misleading-Accounting office equipment does not establish the cost or ownership *Just as important as physical existence

Can the auditors reduce inherent risk by performing audit procedures?

No- inherent risk will be there anyways

In connection with the audit of the financial statements of a manufacturing company, an auditor is observing the physical inventory of finished goods, which consists of expensive, highly complex electronic equipment. Discuss the validity and limitations of the audit evidence provided by the procedure

Physical evidence is one of the reliable sources of evidence in this case when the inventory consists of individual valued items you should >>>>>>>

Assets are properly classified

Presentation and disclosure

Reperformance

Providing that accuracy of a client-performed activity

Audit Evidence is gathered to use:

RAR 1) Reduce Audit Risk 2) Assess RMM (Risk Material Misstatement) 3) Restrict Detection Risk

The company legally owns the asset

Rights and Obligations

________ ___________ ______________ are designed to obtain an understanding of the client and its environment to assess the risks of material misstatements.

Risk Assessment Procedures

Prepare a flowchart of internal control over sales

Risk Assessment procedures (other than analytical procedures)

__________ ____________ are designed to detect material misstatements of relevant assertions.

Substantive procedures

Distinguish between the sufficiency (results) of audit evidence and the appropriateness (obtained) of audit evidence

Sufficiency is related to quantity and is a matter of judgement in every audit Appropriateness is related to the quality (reliability and relevance)

Determine whether disbursements are properly approved

Tests of controls

Distinguish between the component of audit risk that the auditors gather evidence to ASSESS vs. the component of audit risk that they collect evidence to RESTRICT

The auditor ASSESS IR and CR The auditor RESTRICTS DR

Inherent Risk

The risk of material misstatement of a financial statement assertion, assuming there were no related control

Engagement Risk

The risk of the loss of the auditors' reputation that happens when client goes bankrupt or management lacks integrity

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

Audit Risk

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

Detection Risk

The risk that the auditors' procedures will lead them to conclude that a financial statement assertion is not materially misstated when in fact such misstatement does exist

The study of trends, percentage changes, ratios, and other relationships among financial and non financial data is term _________________ _________________.

analytical procedures

When performing analytical analysis, auditors should carefully consider the ____________ and ____________ if the data before drawing conclusions based upon comparisons with industry averages.

comparatively timeliness

Assertions with high inherent risk involve _________ ___ _______ transactions, complex calculations, difficult ___________________, significant ________________________________, or valuations that vary significantly based on _____________________.

difficult to audit accounting issues judgement by management economic factors

Vouchers in client's unpaid voucher file, credit memo in customer's file. management working papers in making accounting estimates, memo in customer file from treasurer authorizing the write-off of the account

entirely internal

Because they involve management judgements or assumptions, ____________ _________ are generally the transactions with the highest level of inherent risk

estimation transactions

Audit risk refers to possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially or immaterially misstated

false

Less control risk means an increase in the risk of material misstatements

false

Rather than restrict detection risk though the performance of more substantive procedures, auditors assess it.

false

The risk of material misstatement is composed of the three components of audit risk (T/F)

fasle- IR and CR

High inherent risk may be indicated by __________________________, operating results that are highly ______________________________, going concern problems, large known and likely ___________________________, substantial turnover, questionable reputation, or ________________________________.

inconsistent profitability sensitive to economic factors misstatements detected in prior audits inadequate accounting skills in management

Creditor monthly statement obtained from client's files, duplicate sales invoices in filled order files, times tickets filed in payroll department, bank statement in client's files, letter in customers files form collection agency on collectability of balance

indirectly from outsiders

When the auditors express an opinion that the financial statements are free from material misstatements, they are relying upon the effectivenesses of the client's ______________ _________ to prevent such misstatement and their _________ _________ to detect any material misstatement that may have occurred

internal control audit procedures

The amount of evidence that is considered sufficient varies _____________ with the competence of the evidence

inversely

Inherent risks many be high for non-rountine transactions because they are ___________________________ of transactions and occur only periodically. Specialized skills may be needed to perform activities such as __________________, ______________, and __________________________.

not part of normal flow physical inventories calculating depreciation adjusting FS for foreign currencies gains/losses.

The client _______________ ________________ should never be used as a substitute for performing audit procedures. It is required on every engagement and is dated as of the _____________________________.

presentation letter date of auditors' report

In relying upon the work of a specialist, the auditors must ascertain the professional _________________ and reputation of the specialist and review the reasonableness of underlying ______________ made by the specialists.

qualifications methods

Appropriateness is measure of _____________________ and _______________ relates to the assertion being addressed

quality being obtained relevance

The ____________ of audit evidence needed is affected by the risk of misstatements and the reliability of the evidence. The ___________ the risk, the more audit evidence required.

quantity greater

A primary challenge for auditors is identifying any related party transactions that management has not disclosed, because they may be ___________________________________ with all other transactions

recorded in the account records

Nonrountine transactions

recur only periodically: depreciation, inventory

Routine transactions

recurring financial activities: sales, payroll, and purchases

Auditors should be cautious when accepting photo copies or tax copies because _____________________________________

they can be altered in anyway, making detection difficult.

Absent any other changes, an increase in the risk of material misstatements results in an increase in audit risk

true

Both inherent risk and control risk exist independently of the audit of financial statements

true

Detection risk does not exist when no audit is performed

true

Inherent risk is the possibility of material misstatement before considering the client's internal control

true