Auditing Midterm 2

How tests of controls are performed?

- Inquiry of appropriate entity personnel - Inspection of documents indicating the performance of the control - Observation of the application of the control - Reperformance of the application of the control by the auditor

Accounts affected by a purchase transaction

-Accounts payable -Inventory -Purchases or COGS -Various asset and expense accounts

Control activities

-Actions established by policies and procedures to ensure that management directives to mitigate risks are carried out -Performed at all levels of entity and various stages of the business process

If the aggregate misstatement exceeds tolerable misstatement, what are the auditor's options?

-Adjust the accounts to reduce the misstatement -Qualify the audit report

What can result if purchase transactions that do not occur are recorded?

-An incorrect payment will be made -Expenses may be overstated -A liability will be recorded -Assets may be overstated

Testing Only One or a Few Items

-Automated information systems process transactions consistently unless the system or programs are changed -The auditor may test the general controls over the system and any program changes, but test only a few transactions processed by the IT system

Evaluation - statistical sampling

-Calculate the sample deviation rate (deviations/sample size) -Determine the upper deviation rate (sample deviation rate + allowance for sampling risk) -Compare the upper deviation rate to the tolerable deviation rate determined at the beginning

Disadvantages of nonstatistical sampling

-Can become too conservative about sample size -Hard to quantify sample risk

Accounts affected by a cash disbursement transaction

-Cash -Accounts payable -Cash discounts -Various asset and expense accounts

Payment to vendor controls

-Cash disbursement are reviewed and approved by someone other than preparer -Checks are mailed by separate person than preparer

Causes of difference between client's and customer's balance in confirmation

-Client's or customer's balance is wrong (error or fraud) -Customer sent a check right at the end of the year that our client did not receive until after year-end (coincidence, no error or fraud) -Client shipped goods right at the end of the year, and the customer did not receive them until after year end (error on customer)

Determine the sample size - statistical sampling

-Determine the test objectives -Define the population characteristics (sampling population, sampling unit, and deviation conditions/misstatement) -Determine the sample size (use confidence level, tolerable deviation rate, expected deviation rate, population size)

What two technological advances have reduced the number of times auditors need to apply sampling techniques to gather audit evidence?

-Development of well-controlled, automated accounting systems -Powerful audit software to download and examine entire populations of data

Types of alternative procedures - revenue

-Examination of specific subsequent cash receipts (somewhat reliable) -Examination of shipping documentation (not very reliable) Examination of other client documentation (not very reliable)

Receiving controls

-Goods received are agreed to the purchase order -Receiving report sent to accounting to match to purchase order

Control risk assessment - purchasing process

-How purchase, cash disbursements, and purchase return transactions are initiated -The accounting records, supporting documents, and accounts involved in processing purchases, cash disbursements, and purchase returns -The flow of each type of transaction from initiation to inclusion in the financial statements, including computer processing of data -The process used to estimate accrued liabilities

Control risk assessment in the revenue process (IIFE)

-How sales, cash receipts, and sales returns and allowances transactions are initiated -The accounting records, supporting documents, and accounts that are involved in sales, cash receipts, and sales returns -The flow of each transaction from initiation to conclusion in the financial statements -The process used to prepare estimates for accounts such as bad debts and sales returns

Information and communication

-Info is necessary for an entity to carry out internal control responsibilities in support of achievement of its objectives -Communication is both internal and external

The 5 components of internal controls as defined by the COSO Framework are...

-Information and communication -monitoring activities -control environment -entity's risk assessment -control activities

Authorization - purchasing

-Look for purchases that were not authorized -examine purchase requisitions or purchase orders for proper approval -review client's competitive bidding process

Why will technology never completely eliminate the need for auditors to rely on sampling?

-Many control processes require human involvement -Many testing procedures require the auditor to physically inspect an asset -In many cases, auditors are required to obtain and evaluate evidence from third parties -Not all data can be processed depending on the format -Audit data analytics often identify a large number of potential exceptions that the auditor may test using sampling

Inherent risk factors that may affect the revenue process

-Misstatements detected in prior audits -Industry-related factors -Complexity and contentiousness of revenue recognition issues -the difficulty of auditing transactions and account balances

Substantive procedures for high-detection risk entity

-Nature: Corroborative audit tests using physical examination, analytical procedures, and substantive tests of transactions and balances -Timing: Interim and year-end -Extent: Limited testing of accounts or transactions

Substantive procedures for low-detection risk entity

-Nature: physical examination, review of external documents, confirmation, reperformance -Timing: all significant work completed at year-end -Extent: extensive testing of significant accounts or transactions

Advantages of nonstatistical sampling

-Not too much training -Just apply audit firm's policy -Consistent

monitoring controls

-Ongoing evaluations are used to determine whether internal controls are present and functioning -Findings are evaluated and deficiencies communicated in a timely manner -may identify the need for control redesign -is intended to assess quality of performance over time

Physical controls include...

-Physical security of assets -Authorization programs for access to computer programs and data files -Periodic counting and comparison with amounts shown on control records

Three types of transactions processed through the purchasing process

-Purchase of goods and services for cash or credit -Payment of the liabilities arising from such purchases -Return of goods to suppliers for cash or credit

Accounts affected by purchase return transaction

-Purchase returns -Purchase allowances -Accounts payable -Various asset and expense accounts

Key segregation of duties for purchasing

-Purchasing function separate from requisitioning and receiving functions -Invoice-processing function separate from accounts payable function -Disbursement function separate from accounts payable function -Accounts payable function separate from general ledger function

For the revenue process, the auditor is concerned about material misstatements related to...

-Recording of revenue when services have not been performed -Recording of revenue when goods have not been shipped -Sales to fictitious customers

Completeness - purchasing

-Review procedures for accounting for the numerical sequence of purchase orders, receiving reports, and vouchers -trace a sample of receiving reports to their vendor invoices and vouchers -trace a sample of vouchers to the purchases journal

Two important factors for when the auditor considers the control environment and the purchasing process

-The entity's organizational structure -The entity's methods of assigning authority and responsibility

Audit procedures used to search for unrecorded liabilities

-Understand controls over capturing payables in the correct period -Look at cash disbursements after year end and review supporting documentation to determine if an item was recorded in the correct period -Examine unpaid invoices and look for any unrecorded liabilities that should be included in the general ledger at year end

Things to consider when performing the audit procedures on the sample

-Voided or unused documents (error) -Client is unable to provide necessary documents (if nothing is provided, error) -Significant deviations are found

Industry-related factors to consider when auditing the purchasing process

-Whether the supply of raw materials is adequate -How volatile raw material prices are

Risk Assessment Process

-a dynamic process for identifying and analyzing risks to achieving the entity's objectives -should consider internal and external circumstances that may arise and adversely affect the entity's ability to fairly present financial data consistent with management's financial statement assertions

The main accounts affected by the auditor's achieved control risk for the purchasing process include...

-accounts payable -accrued expenses -most expense accounts in the income statement

The uncertainty related to non sampling risk can be controlled by...

-adequate training -proper planning -effective supervision

When payments are sent directly to an entity,...

-all checks should be restrictively endorsed -a control listing should be prepared -checks should be deposited daily

Search for unrecorded liabilities process

-ask management about control activities used to identify unrecorded liabilities and accruals at the end of an accounting period -Vouch large-dollar items from the cash disbursements journal for a limited time after year-end; examine the date on each receiving report of vendor invoice to determine if the liability relates to the current audit period -Examine the files of unmatched/unpaid purchase orders, receiving reports, and vendor invoices for any unrecorded liabilities

Nonstatistical sample sizes are determined by...

-audit firm policy -applying professional judgment

Purchase requisition controls

-authorization policies: certain levels of management have higher $ limits for purchasing -Competitive bidding: used for larger purchases (e.g.: construction companies bid for a job) -Copy of purchase order goes to accounting for matching

The accounts commonly affected by cash receipts transactions are...

-cash -trade accounts receivable -cash discounts

Examples of substantive analytical procedures - purchases

-compare payables turnover and days outstanding in accounts capable to previous years' and industry data -compare current year balances in accounts payable with prior-years' balances -compare amounts owed to individual vendors in the current year's accounts payable listing to amounts owed in prior years -compare purchase returns and allowances as a percentage of revenue or cost of sales to prior years' and industry data

Risk factors to an entity's internal controls over the revenue process include...

-competition -rapid growth -new technology

major audit procedures for testing the existence assertion for accounts receivables

-confirmation of customers' accounts balances -examination of subsequent cash receipts

Considerations for doing substantive testing at an interim date

-control environment -nature of the account/balance -the assessed risk of material misstatement -the purpose of the substantive procedure -availability of information at a later date -The ability of the auditor to perform appropriate procedures to cover the remaining period

Two important controls for processing credit memoranda:

-each credit memorandum should be approved by someone other than the individual who initiated it -a credit for returned goods should be supported by a receiving document indicating that the goods have been returned

Accuracy - purchases

-ensure that company recorded purchases of assets at the appropriate amount -ensure that foreign currency was translated accurately -recompute the mathematical accuracy of vendor invoices -examine reconciliation of vouchers to daily accounts payable report

The auditor must maintain control over the accounts receivable confirmations to minimize the possibility of...

-entity interception of the confirmation -alteration of the confirmation by the entity

Objectives of attribute sampling when used for tests of controls

-evaluate the operating effectiveness of the internal control for purposes of the internal control audit for public companies -determine the degree of reliance that can be placed on controls for a financial statement audit

When the auditor does not receive a response to the positive confirmations, possible alternative procedures include...

-examining specific subsequent cash receipts -sending second and third requests -examining shipping documentation

Comparison of gross profit percentage to previous years' or industry data may provide valuable evidence on...

-fictitious revenue -unrecorded revenue -changes in pricing policies

two broad categories of information systems controls

-general: apply to all computerized applications and consist of a combination of hardware, software, and manual procedures that create an overall control environment ----application: specific controls unique to each computerized application, such as payroll or order processing.

Classification - revenue

-identify and reclassify any material credits contained in accounts receivable (i.e.: classify as accounts payable) -Segregate short-term and long-term receivables -Ensure that different types of receivables are properly classified

Major classification issues - purchases

-identifying and reclassifying any material debits contained in accounts payable (reclassify as receivables) -segregating short-term and long-term payables -Ensuring that different types of payables are properly classified

what is an understanding of internal control used for?

-identifying types of potential misstatement -pinpointing the factors that affect the risk of material misstatement -designing tests of controls and substantive procedures

When do auditing standards allow the auditor to omit confirming accounts receivable?

-if external confirmations would be ineffective -if the assessed level of risk for the assertion is low, and the planned substantive procedures address that risk -the accounts receivable balance is immaterial

Why might an auditor decide to follow a substantive strategy for some or all assertions?

-implemented controls are assessed as ineffective -testing the operating effectiveness of the controls would be inefficient -implemented controls do not pertain to the assertion under consideration

Understanding management's attitudes toward risk relevant to the revenue process

-important for assessing the control risk for the revenue process -auditor must understand how management considers risks, estimates significance, assesses the likelihood of occurrence, and plans appropriate actions

What can the auditor do if the actual misstatement/upper limit misstatement is greater than tolerable misstatement

-increase the sample size -perform other substantive procedures -request the entity to adjust the balance -issue a qualified or adverse opinion if management refuses to adjust the account balance

non statistical sampling

-judgement is used to determine the sample size -the auditor does not use statistical techniques to determine sample size, select sample items, or measure sampling risk

When an entity has a low risk of material misstatement, detection risk may be high. What is high detection risk characterized by?

-less reliable types of substantive evidence (analytical procedures) -audit work conducted at an interim date -tests may have a smaller sample size

Occurrence - purchasing

-look for fraudulent transactions and irrelevant expenses included (e.g.: personal expenses) -test a sample of vouchers for the presence of an authorized purchase order and receiving report

Cutoff - purchases

-look for items that were omitted from the current period -compare the dates on receiving reports with the dates on the relevant vouchers -compare the dates of vouchers with the dates they were recorded in the purchases journal

how does the auditor provide evidence on the valuation of the allowance

-looking at the aged trial balance for old items -considers historical collection to provide evidence of uncollectability for current items

How does the auditor keep control of the confirmation process?

-mail the confirmations outside the client's facilities -send return envelope addressed to the public accounting firm -mail the confirmations in envelopes with the public accounting firm as the return address

Limitations of an Entity's Internal Control

-management override of internal control -human errors or mistakes -collusion

Credit memoranda that are used to process sales returns and allowance transactions...

-may conceal a misappropriation of cash -can cover up unauthorized shipments of goods

two tests for completeness of accounts payable

-obtain a listing of accounts payable, footing the listing, and agreeing it to the general ledger control account -conduct extensive tests to ensure that all liabilities are recorded

With regards to internal controls, what are the auditor's responsibilities?

-obtain an understanding of internal controls -evaluate the design of internal controls -determine if the controls have been implemented -assess control risk

When risk of material misstatement is high, how does an auditor reduce detection risk

-obtain more reliable types of substantive evidence (confirmation, reperformance) -conduct most of the substantive audit work at year-end -make the tests more extensive (larger sample)

If the auditor determines that internal controls are properly designed and implemented and the auditor intends to rely on those controls, the auditor will...

-perform tests of controls to obtain audit evidence that controls are operating effectively -make an assessment of control risk based on the result of tests of controls

Tools used for documenting the auditor's understanding of internal controls

-procedure manuals -organization charts -internal control questionnaires -flowcharts -narrative descriptions

A system of internal controls is designed and carried out to provide reasonable assurance about the achievement of the entity's objectives in the following categories:

-reliability, timeliness, and transparency of external and internal reporting of financial and non-financial info -effectiveness and efficiency of operations -compliance with applicable laws and regulations

How does the auditor develop an understanding of the purchasing process?

-reviewing prior year documentation -conducting a walkthrough

The accounts commonly affected by sales return and allowance transactions are...

-sales returns -sales allowances -trade accounts receivable

Control environment

-set of standards, processes, and structures that provide a basis for carrying out internal control across the organization -sets the tone for an organization and influences the control consciousness of its people

Monitoring of internal controls...

-should be done to determine operating effectiveness -may identify the need for control redesign -is intended to assess quality of performance over time

The accounts commonly affected by sales transactions are...

-trade accounts receivable -bad-debt expense -sales -allowance for uncollectible accounts

The auditor uses risk assessment procedures to:

-understand entity's internal controls -identify key controls -identify the types of potential misstatements -design tests of controls and substantive procedures

Accrued liabilities substantive testing

-usually tested differently than accounts payable -must understand company's process for calculated estimates and express our judgment regarding our comfortability -look at accruals from previous years and evaluate consistency

Steps in sampling for tests of controls/substantive testing

1) Is sampling appropriate? 2) Determine sample size using statistical or non-statistical methods 3) Select the items for the sample using random, systematic, or haphazard approach 4) Test the sample 5) Assess results of sample testing based on statistical or non-statistical approach

Advantages of statistical sampling

1. Design an efficient sample 2. Measure the sufficiency of evidence obtained 3. Quantify sampling risk 4. No human judgement required

Functions of the revenue process (OCSBCAG)

1. Order entry 2. Credit authorization 3. Shipping 4. Billing 5. Cash receipts 6. Accounts receivable 7. General ledger

Disclosure items for the purchasing process

1. Payable by Type 2. Short Term & Long Term Payables 3. Long-Term Purchase Contracts 4. Purchases From and Payable to Related Parties 5. Dependence on a Single Vendor or small number or vendors 6. Costs by Reportable Segment of the business

Segregated duties for the revenue process

1. The credit authorization function should be segregated from the billing function 2. The shipping function should be segregated from the billing function 3. The accounts receivable function should be segregated from the general ledger function 4. The cash receipts function should be segregated from the accounts receivable function.

Disadvantages of statistical sampling

1. Training auditors in proper use. 2. Cost to design and conduct sampling application. 3. Lack of consistent application across audit teams.

significant deficiency

A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.

Material weakness

A deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis.

Monetary-unit sampling

A sampling technique that estimates the dollar amount of misstatement for a class of transactions or an account balance

tolerable error

Acceptable defect rate

Credit authorization function - revenue process

Appropriate approval of customer orders for creditworthiness

Purchasing function

Approval of purchase orders and proper execution as to price, quantity, quality, and vendor

Confirmation

Audit evidence that is a direct written response from a third party to the auditor, in paper form or by electronic or other medium

Auditing standards for conducting a sample

Auditor must properly plan, perform, and evaluate the sampling application and adequately document each phase of the sampling application

How can organizations control requisitioning authorization?

Authorization dollar limits for different levels of employees

Cutoff - revenue

Comparison of the dates on a sample of sales invoices with the dates of shipment and with the dates they were recorded in the sales journal

Walkthrough

Conducted by the auditor in order to gain an understanding of the purchasing process; for continuing audits, prior years' documentation can help, unless significant changes in the system occur

Type 1 SOC Report

Describes the service organization's controls and their effectiveness in achieving specified internal control objectives; no testing done

Examination of specific subsequent cash receipts

Did customer pay for sales occurring soon after year-end

Purchase order

Document prepared by the purchasing department for the purchase of goods or services from a vendor

True or false: population plays a bigger role in some of the sampling techniques used for tests of controls

False, for substantive testing

True or false: an auditor may reduce control risk below high only on the basis of a service auditor's Type 1 report

False, only for Type 2

True or false: substantive analytical procedures are rarely used to evaluate the reasonableness of accounts payable and accrued expenses

False, they can be useful in identifying misstatements and provide evidence regarding the fairness of the recorded accounts

Why use the confirmation process?

Highest and best evidence we can get concerning the AR balance's existence; direct written response from third parties

Requisitioning function

Initiation and approval of requests for goods and services by authorized individuals consistent with management criteria

Billing function - revenue process

Issuance of sales invoices to customers for goods shipped or services provided; also, processing of billing adjustments for allowances, discounts, and returns

Why is the auditor's understanding of internal control so important?

It is a major factor in determining the overall audit strategy

Items to be tested individually

Items that may contain potential misstatements that individually exceed the tolerable misstatement; tested 100% because the auditor is not willing to accept any sampling risk

What do performing substantive procedures test?

Nature, timing, and extent

Four types of control activities

Performance reviews, physical controls, segregation of duties, information processing controls

Disbursements function

Processing of payment to vendors

Cash receipts function - revenue process

Processing of the receipt of cash from customers

Invoice processing function

Processing of vendor invoices for goods and services received; also, processing of adjustments for allowances, discounts, and returns

General ledger function - purchasing

Proper accumulation, classification, and summarization of purchases, cash disbursements, and payables in the general ledger

General ledger function - revenue process

Proper accumulation, classification, and summarization of revenues, collections, and receivables in the financial statement accounts

What is the major control for preventing fictitious purchases?

Proper segregation of duties

Type 2 SOC 1 Report

Provides assurance on the operating effectiveness of the service organization's controls based on the auditor's tests of controls; more ideal option

Purchasing process overview

Purchase requisition > Purchase order > Receiving report and liability recorded > vendor

Revenue process - cash sale

Purchases > Inventory > Cash sales

Revenue process - credit sale

Purchases > Inventory > Credit sales > Account receivable > cash collection

Receiving function - purchasing

Receipt of properly authorized goods and services, compared to purchase order

Period costs

Recognized when cash is spent or liabilities incurred for goods and services that are used up at that time or shortly thereafter; not directly related to specific transactions

Accounts receivable function - revenue process

Recording of all sales invoices, collections, and credit memoranda in individual customer accounts

Accounts payable function - purchasing

Recording of all vendor invoices, cash disbursements, and adjustments in individual vendor accounts

Receiving function - purchasing

Responsible for receiving, counting and inspecting goods delivered from vendors; complete a receiving report that is forwarded to the accounts payable function

Policy

Rule or guideline that calls for certain activities to take place in certain circumstances

Determine the sample size - nonstatistical sampling - substantive testing

Sample size = (sampling population book value/(tolerable - expected misstatement))*confidence factor

When should the confirmation request be sent?

Soon after the end of the accounting period in order to maximize the response rate

substantive audit strategy

Strategy used when the auditor does not plan to rely on the client's controls and instead uses substantive procedures as the main source of evidence about the assertions in the financial statement

what does an auditor do when an entity has some or all of its accounting transactions processed by an outside service organization?

The auditor will have to audit the internal controls of the outside service organization every year

Assessing control risk

The process of evaluating the effectiveness of an entity's internal control in preventing, or detecting and correcting, material misstatements in the financial statements

Nonsampling risk

The risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk.

Risk of incorrect rejection

The risk that the sample supports the conclusion that the control is not operating effectively when it actually is or that the recorded account balance is materially misstated when it is not materially misstated.

Risk of incorrect acceptance

The risk that the sample supports the conclusion that the control is operating effectively when it is not or that the recorded account balance is not materially misstated when it is materially misstated.

Audit sampling

The selection and evaluation of less than 100 percent of the population of audit relevance such that the auditor expects the items selected to be representative of the population and, thus, likely to provide a reasonable basis for conclusions about the population.

Systematic selection

The technique of selecting a sample by drawing every nth item in the population, following one or more random starting points; the auditor determines the sampling interval by dividing the population by the sample size

Significant deviations found in the controls early on

There is no reason to continue testing

Attribute sampling

Used to estimate the proportion of a population that possesses a specified characteristic; most commonly used for test of controls

Representative sample

a sample where the evaluation of the sample results leads to the same conclusions that would be drawn if the same audit procedures were applied to the entire population

stratified sampling

a technique that is more effective in achieving sample representation by dividing the population into separate groups; may possibly reduce the sample size required to achieve a given precision or possibly increase the precision with the same sample size.

Order entry function - revenue process

acceptance of customer orders for goods and services into the system in accordance with management criteria

The auditor assesses the adequacy of the allowance account by first examining the ___ ____ ____for amounts that have been outstanding for a long time

aged trial balance

If a small number of large transactions make up a large percentage of an account, auditors will typically test...?

all the transactions greater than a particular dollar amount

Haphazard sampling

allows the auditor to "randomly" select items judgmentally with no conscious biases or reasons for including or omitting items from the sample; only used for nonstatistical sampling

For what types of evidence is sampling not commonly used?

analytical procedures, scanning, inquiry, observation

The extent of an auditor's understanding of control activities is a function of the ____ _____

audit strategy

Control activities used to identify unrecorded liabilities and accruals should be part of the _____ process for the entity

closing

Accuracy - revenue

comparison of prices and terms on a sample of sales invoices with an authorized price list and terms of trade

substantive tests of account balances - revenue

concentrate on the detailed amounts or estimates that make up the ending balance for revenue-related accounts

substantive tests of disclosures - revenue

concerned with the presentation and disclosures related to accounts receivable and related accounts

The amount of reliance to be placed on audit tests and the consequences of a decision error must be considered in determining ___ ___

confidence level

Three factors to consider in determining sample size

confidence level, tolerable error, expected error

Notes receivable

confirmed and examined for repayment terms and whether interest income has been properly recognized

The auditor should gain sufficient knowledge about the ____ ____ to understand management's and the BOD's attitudes, awareness, and actions concerning it

control environment

Components of internal control

control environment, risk assessment, control activities, information and communication, monitoring

The auditor should again analyze the misstatements discovered through the application of substantive procedures because these misstatements may provide addition evidence as to the ____ _____

control risk

Lockbox system

customers' payments are sent directly to the entity's bank, and the bank then transmits a file of cash receipts transactions and remittance advices to the entity

confidence level

desired level of assurance in the results of the sample

The results of the auditor's testing of internal controls for the revenue process directly impacts _____ risk and therefore the level of _____ procedures that will be required for the accounts affected by this process

detection, substantive

Precision

difference between the expected and tolerable deviation rate of misstatement

Relationship between desired confidence level and sample size

direct

Relationship between expected population deviation rate and sample size

direct

Relationship between population size and sample size

direct (not very strong)

Purchase requisition

document that requests goods or services that is sent to an authorized individual or department within the entity

random selection

every item in the population has the same probability of being selected as every other sampling unit in the population

Receivables from related parties

examined to determine if they were at arm's length

Product costs

expenses that can be matched directly with specific transactions or events and are recognized upon recognition of revenue

True or false: interim date tests are considered stronger than year-end tests

false

True or false: the tax provision and related balance sheet accounts are usually immaterial elements in the financial statements

false

True or false: cutoff is more critical for the revenue process than for the purchasing process

false, because the seller knows exactly when the product ships, but the buyer doesn't know very easily

True or false: if the upper deviation rate exceeds the tolerable rate, the controls may be relied upon, or the balance is fairly stated

false, exceeding the tolerable rate means that the controls should not be relied on, or the balance is not fairly stated

True or false: audit sampling is always appropriate, regardless of the level of risk

false, if certain transactions present a greater than normal risk, the auditor should test all of those items

True or false: auditors normally test the cutoff assertion by conducting tests of controls only

false, in most cases, cutoff tests are conducted as substantive tests of transactions or as a dual-purpose test

True or false: determining the sample size is typically one of the easiest steps of an audit sampling application

false, it is one of the most difficult

True or false: random or systematic sample selection is required for nonstatistical sampling and may be used for statistical sampling

false, it is required for statistical and may be used for non statistical

True or false: a non statistical approach may not involve both random selection and a judgmental evaluation

false, it may involve both

True or false: if a sample size is not statistically derived, it cannot be statistically evaluated

false, nonstatistical sampling allows for nonstatistical methods

True or false: with a nonstatistical sample, the auditor can calculate the sample deviation rate and can mathematically quantify the computed upper deviation rate and sampling risk associated with the test

false, the auditor can calculate the sample deviation rate, but not the the upper deviation rate and sampling risk

True or false: individuals who can requisition goods should receive the goods

false, the duties should be segregated

True or false: substantive analytical procedures are inadequate audit tests for examining the fairness of revenue related accounts because such tests fail to provide sufficient evidence, even though they are low cost

false, they are adequate and efficient audit tests

True or false: Haphazardly selected samples should be formally evaluated statistically

false, they should not be formally evaluated statistically

True or false: the sample sizes for non statistical sampling are very different from the sample sizes of statistical sampling

false, they use approximately the same sizes

True or false: like payables, there is concrete documentation for valuation of accruals

false, unlike payables, accruals do not often as obvious of a valuation process

Substantive tests of transactions - purchasing

focus mainly on the purchases and cash disbursement transactions

Substantive tests of transactions - revenue

focus mainly on the sales and cash receipts transactions

Substantive tests of details of account balances - purchasing

focus on the detailed amounts or estimates that make up the ending balance for accounts payable and accrued expenses

COSO Framework

helps management better control the organization and provides the BOD with an added ability to oversee internal control

If control risk is mistakenly set at a low level, detection risk will be set too ___

high

The larger the sample size, the ____ the confidence level and the ____ the sampling risk

higher, lower

expected error

historical defect rate

Concern of accounts payable confirmations

how much do we owe the company (as opposed to if we owe the company)

If the controls in the purchasing process are reliable, the auditor may be able to ____ the detection risk for the affected financial statement accounts and therefore ____ the number of substantive procedures needed

increase, decrease

Examination of shipping documents and other client documentation

indicators of sale happening; used when cash is not collected; not very reliable

Segregation of duties - purchasing

individuals responsible for requisitioning, purchasing, and receiving should be segregated from the invoice-processing, accounts payable, and general ledger functions

Whether the supply of raw materials is adequate and how volatile raw material prices are two important industry-related factors in assessing _____ risk when auditing the purchasing process

inherent

For what types of evidence is sampling commonly used?

inspection of tangible assets, inspection of records or documents, reperformance, recalculation, confirmation

Relationship between tolerable deviation rate and sample size

inverse

If there is a small margin for error (tolerable error and expected error are nearly equal), a ______ sample size is required

larger

Blank confirmations

leave the dollar amount blank for the respondent; common confirmation used for accounts payable

When the results of testing controls do not support the planned level of control risk, detection risk will have to be set ____.

lower

Determine the sample size - nonstatistical sampling - tests of controls

make a table that relates level of controls reliance to sample size (e.g.: low - 10-15, moderate - 20-30, high - 40-60), so that the policy can promote consistency in sampling applications

Rights and obligations - revenue

make sure of any unidentified factored receivables

the auditor should gain sufficient knowledge about the control environment to understand the attitudes, awareness, and actions concerning the control environment of the...

management, board of directors

When an account or class of transactions is made up of a few large items, the auditor...

may examine all the items in the account or class of transaction

Comparison of gross profit percentage to previous years' or industry data

may provide valuable evidence on unrecorded revenue (understatement) or fictitious revenue (overstatement) and related accounts receivable when this ratio is significantly higher or lower than previous years' or industry data

When audit risk is low and the risk of material misstatement is high, substantive tests should be performed...

mostly at year-end

How should misstatements discovered in the sample for substantive testing be treated?

must be projected to the population, and there must be an allowance for sampling risk

significant deviations found in the substantive testing early on

must continue testing until you feel that you have captured everything to make a judgment about materiality

Existence - revenue

obtain confirmation regarding balance

Authorization - revenue

obtain evidence of a creditworthiness check of customer

The auditor is concerned with a misstatement caused by a cash disbursement being recorded in the entity's records when no payment has actually been made when considering the _____ assertion

occurrence

The possible misstatement that concerns the auditor when considering the ____ assertion is that cash receipts are recorded but not deposited in the entity's bank account

occurrence

unrestricted random sampling

once an item is selected it cannot be selected a second time

In applying attribute sampling to tests of controls, the auditor normally attempts to determine the ____ _____ of a control in terms of _____ from a prescribed internal control

operating effectiveness, deviations

Controls that may be relevant to the audit when they have an impact on data that the auditor uses to apply audit procedures include what types of controls?

operations, compliance

an effective system of internal control allows management to focus on _____ and _____ _____ ____ while maintaining compliance with laws and minimizing surprises

operations, financial performance goals

If purchase transactions that do not occur are recorded, assets or expenses will be _____

overstated

For the occurrence assertion, the auditor is concerned with a misstatement caused by a cash disbursement being recorded in the entity's records when no _____ has actually occurred

payment

Valuation and allocation - revenue

prepare an aged trial balance and discuss results with the credit manager; compare results with the prior year; form your own estimate for allowances and returns and compare it to the company's estimation

Confirmation for accounts receivable

presumed to be mandatory; should always do it unless the AR balance is highly immaterial or the confirmation process is ineffective; controlled by the auditor with no involvement of client

Difference projection

projects the average misstatement of each item in a non statistical sample to all items in the population; used when the misstatement is expected to be relatively constant for all items in the population regardless of their dollar size (e.g.: all of the differences are by $1,000)

The major control for preventing fictitious sales is...

proper segregation of duties

A purchase transaction usually begins with a(n) _____ _____ being generated by a department or support function

purchase requisition

Segregation of duties

reduces the opportunity for an employee to perpetrate and conceal errors or fraud in the normal course of his/her duties

Auditor must understand the control activities that relate to assertions for which a lower level of control risk is expected in a _____ strategy

reliance

The critical segregation of duties for preventing fictitious purchases is the separation of the ______ and _____ functions from the accounts payable and disbursement functions

requisition, purchasing

The important issue in the _____ function of the purchasing process is that the request meets the authorization procedures implemented by the entity

requisitioning

Accounts receivable function

responsible for ensuring that all billings, adjustments, and cash collections are properly recorded in customers' accounts receivable records

The sale of goods and services to customers is the focus of the ____ process

revenue

For virtually all entities, the ____ and ____ processes represent the two major business processes that affect the financial statements

revenue, purchasing

The auditor should obtain sufficient info about the entity's ____ _____ process to understand how management considers risks relevant to financial reporting and decides on appropriate actions to address those risks

risk assessment

Confidence level is the complement of ____ ____

sampling risk

The key control activity to prevent misstatements with respect to the occurrence of cash receipts is...

segregation of duties

Shipping function - revenue process

shipping of goods that have been authorized

Proper segregation of the disbursement function

should be segregated from the accounts payable function

Proper segregation of the invoice-processing function

should be segregated from the accounts payable function

Proper segregation of the accounts payable function

should be segregated from the general ledger function

Proper segregation of the purchasing function

should be segregated from the requisitioning and receiving functions

revenue recognition poses a(n) _____ audit risk to auditors

significant

probability proportionate to size sampling (MUS)

similar to systematic selection, but instead of transactions, the auditor tests every nth dollar

Any entries into customers' accounts should be made from authorized ____ ____ such as sales invoices, remittance advices, and credit memoranda.

source documents

when an auditor decides to follow a(n) _____ strategy, little work is done on understanding specific control activities

substantive

Effectively identifying accounts payable and accrual accounts that are misstated and providing evidence regarding the fairness of recorded accounts can be done using _____ ______ procedures

substantive analytical

To examine the fairness of revenue related accounts, ______ _____ procedures are useful audit tests because they provide sufficient evidence at low cost

substantive analytical

Monetary-unit sampling is used for what kind of testing?

substantive testing

Nonstatistical sampling is more common for what kind of testing?

substantive testing

Stastical sampling is more common for what kind of testing?

tests of controls

If results of the tests of controls support the planned level of control risk...

the auditor conducts substantive procedures at the planned level

reliance strategy

the auditor intends to depend on the entity's controls and may need a more detailed understanding of internal controls to develop a preliminary or "planned" assessment of control risk

In the purchasing process, if the results do not support the planned level of control risk...

the auditor reduces the detection risk, increasing substantive procedures over the planned level

control deficiency

the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis

When testing controls using sampling, what is the auditor judging?

the judgment is whether the controls are working or not

Procedure

the review itself, performed in a timely manner and with special attention given to factors set forth in the policy

Sampling risk

the risk that the sample is not representative of the population

Once the desired confidence level is set, the appropriate sample size is determined by how much ____ ____ exceeds ____ ____

tolerable error, expected error

completeness - revenue

trace a sample of shipping documents to the sales journal

True or false: a substantive strategy requires the auditor to have a sufficient understanding of the entity's internal controls to know whether they are properly designed and implemented

true

True or false: auditing standards require that the auditor document his or her understanding of the entity's internal control components

true

True or false: generally, the purchasing process is not difficult to audit and does not present contentious accounting issues

true

True or false: many times we are searching for liabilities, we are trying to ind completeness and cutoff errors at the same time

true

True or false: on most audits, the purchase cutoff is coordinated with the entity's physical inventory count

true

True or false: steps and techniques for both statistical and non statistical sampling are more similar than different

true

True or false: the auditor should presume that there is a risk of material misstatement due to fraud relating to revenue recognition

true

When a small number of large transactions make up a relatively large percent of an account or class of transactions, the auditor...

typically test all the transactions greater than a particular dollar amount

Risk assessment process - Revenue

understand how management considers risks that are relevant to the revenue process; the auditor should estimate the significance of the risk and assess the likelihood of occurrence

Evaluation for nonstatistical sampling

use ratio projection or difference projection

Substantive analytical procedures - purchasing

used to examine plausible relationships among accounts payable and accrued expenses

Substantive analytical procedures - revenue

used to examine plausible relationships among revenue related accounts

Ratio projection

used to project the amount of misstatement found in a non statistical sample; used when the dollar amount of misstatement is expected to relate to the dollar amount of items tested (e.g.: all of the differences are by 10%)

Statistical sampling

uses the laws of probability to compute sample size and evaluate results

Occurrence - revenue

vouch a sample of sales invoices back to customer orders and shipping documents

Hard accrued liabilities to verify

warranty, litigation, liabilities calculated by specialists (pension liabilities and insurance claims), self-insured liability

When are alternative procedures used for the revenue process?

when the auditor does not receive responses to positive confirmations