chapter four risk assesment part 2: understanding the client

Question 1

Entity Level Risks

Answer 1

client risk that affects multiple financial statements accounts, assertions, and transaction classes.

Question 2

Transaction-level risk

Answer 2

client risk that affects only one transaction’s class, account, or assertion.

Question 3

Entity factors that influence inherent risk

Answer 3

look at table 4.3 add to cheat sheet

Question 4

Industry and Business Environment factors that influence inherent risk

Answer 4

look at table 4.4 add to cheat sheet

Question 5

During Economic upturn

Answer 5

companies are under pressure to perform well. Auditors focus more on the overstatement of revenues and understatement of expenses.

Question 6

During economic downturn

Answer 6

management may decide to “take a bath” meaning the companies on purpose understate profits and maximize write-offs because a fall in profits can easily be explained. Auditors will also carefully consider the understatement of revenues and overstatement of expenses.

Question 7

Procedures performed to gain an understanding of the client

Answer 7

1. Inquire
2. Analytical procedures
3. Observation
4. Inspection

Question 8

Auditors responsibility for detecting incompliances that are Direct and material effect

Answer 8

a situation in which noncompliance with laws and regulations impacts amounts and disclosures already included in the financial statements. The auditors have the same responsibility for detecting those acts as they do for detecting material misstatements caused by error or fraud.

Question 9

Auditors responsibility for detecting incompliances that have an Indirect effect

Answer 9

The auditor’s responsibility is limited to performing specified audit procedures that may identify noncompliance. An audit conducted according to standards does not assure that all illegal acts that have an indirect effect on financial statements will be detected or any contingent liabilities that may result will be disclosed.

Question 10

client approaches to measuring performance

Answer 10

key performance indications (KPI)

Question 11

Key performance indicators

Answer 11

measurements agreed to beforehand, that can be quantified and reflect the success factors of an organization.

Question 12

KPIs examples

Answer 12

profitability, liquidity, solvency, cash flow from operating activities

Question 13

Profitability

Answer 13

the ability of a company to earn profit. EX: earnings per share, price-earnings ratio, cash earnings per share ratio.

Question 14

liquidity

Answer 14

The ability to pay current debts when they fall due. In the short term, companies require cash to pay their employees’ wages, utility bills, supplier bills, interest payments on borrowed funds, dividends to stockholders, and so on.

Question 15

solvency

Answer 15

The ability to meet long-term financial obligations. In the longer term, companies need cash to repay long-term debt and undertake capital investment.

Question 16

The cash flow from operating activities

Answer 16

cash flow from operations adjusted for one-time influences.

Question 17

Analytical procedures

Answer 17

Are evaluations of financial statements through analysis of plausible relationships among financial and nonfinancial data. Analytical procedures involve the identification of fluctuations in accounts that are inconsistent with the auditors’ expectations based upon their understanding of the client.

Question 18

comparisons

Answer 18

Comparisons are often made between account balances for the current year and the previous year(s). Do this to adjust client expectations

Question 19

trend analysis

Answer 19

(or horizontal analysis) is a comparison of account balances over time. To determine whether the underlying trends match their understanding of their client.

Question 20

common size analysis

Answer 20

(or vertical analysis) a comparison of account balances to a singles line item

Question 21

ratio analysis

Answer 21

Auditors perform ratio analysis to assess the relationship between various financial statement account balances. Auditors will calculate profitability, liquidity, activity, and solvency ratios. * In ratio analysis its typical to compare the company to the industry standard.
* You don’t take just a average industry standard you must pick companies specific and related to the client based on their industry and their accounting methods they use.

Question 22

Factors to consider when conducting analytical procedures

Answer 22

1. reliability of client data
2. ability to make comparisons over time- change in methods
3. past results are unaudited

Question 23

audit data analytics (ADA)

Answer 23

using computer software to discover and analyze patterns, identify anomalies, and extract other useful information in data underlying the subject matter of an audit through analysis

Question 24

Related party

Answer 24

an affiliate, principal owner, manager, or other party that is not independent of the entity. Any parties that can significantly influence the management or operating policies of the entity.

Question 25

corporate governance

Answer 25

refers to the people, systems, and processes within companies used to ensure that companies are well-managed and that risks are identified and controlled by management and entity personnel

Question 26

Board of directors

Answer 26

a group that represents the shareholders and is responsible for ensuring the company is being run to benefit the shareholders. Consists of executive directors and non executive directors

Question 27

Executive directors

Answer 27

these directors are full-time employees of the company and are part of the company’s management team, such as the chief executive officer (CEO) and the chief financial officer (CFO).

Question 28

Non-executive directors

Answer 28

board members who are not employees of the company; their involvement on the board is limited to preparing for and attending board meetings and relevant board committee meeting. Including audit commitee

Question 29

Audit committee

Answer 29

a committee of the board of directors responsible for oversight of internal controls, financial reporting and disclosures in the financial statements, regulatory compliance, and the company’s independent auditors.

Question 30

Those charged with governance

Answer 30

persons with responsibility for overseeing the strategic direction of the entity and the obligations related to the accountability of the entity.

Question 31

information technology (IT)

Answer 31

the use of the computers to process, record, and store financial reporting data and other information

Question 32

clients digital mindset

Answer 32

1. social media
2. new technologies
3. cyber security
4. virtual workforces

Question 33

closing procedures

Answer 33

processes used by a client when finalizing the accounts for an accounting period.

Question 34

When gaining an understanding of the client’s closing procedures, auditors consider the following items

Answer 34

• Internal controls over closing procedures. What controls does the client have in place? Oversight of the closing process is the responsibility of those charged with governance.
• How often the client performs closing procedures. Clients that prepare financial statements monthly are more likely to have well-established closing procedures than clients that prepare financial statements only annually.
• Results of past closing procedures. Auditors can assess the accuracy of closing procedures from prior periods and from the most recent monthly or quarterly financial statements.