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AUD > Audit Evidence - Concepts and Standards > Flashcards

Audit Evidence - Concepts and Standards Flashcards

1
Q

Identify the 4 considerations that determine the effectiveness and efficiency of analytical procedures used for substantive purposes.

A
  1. Nature of the assertion;
  2. Plausibility and predictability of the relationship;
  3. Availability and reliability of data; and
  4. Precision of the expectation.
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2
Q

Define analytical procedures.

A

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data.

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3
Q

List the 2 broad categories of substantive procedures.

A
  1. Tests of details
  2. Substantive analytical procedures
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4
Q

What is the only component of the audit risk model that the auditor controls?

A

Detection risk.

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5
Q

How might the auditor’s decisions about the nature of audit procedures lower detection risk?

A

Choosing audit procedures that provide a stronger basis for conclusions will lower detection risk.

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6
Q

How might the auditor’s decisions about the timing of audit procedures lower detection risk?

A

Moving the auditor’s important substantive procedures away from an interim date (before year-end) to year-end will lower detection risk.

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7
Q

How might the auditor’s decisions about the extent of audit procedures lower detection risk?

A

Increasing the sample sizes for audit testing will lower detection risk.

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8
Q

Identify the 2 categories of substantive tests of details.

A
  1. Tests of Ending Balances
  2. Tests of Transactions
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9
Q

Identify the 3 purposes that might be served by performing analytical procedures.

A
  1. Audit planning (required).
  2. As a form of substantive evidence (not required).
  3. A final review (required).
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10
Q

What is meant by “sufficient” and “appropriate” when “Sufficient Appropriate Audit Evidence” is mentioned?

A
  1. “Sufficient” refers to the quantity of evidence that is required; and
  2. “Appropriate” refers to the quality of the evidence involved, in terms of “relevance” and “reliability.”
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11
Q

List the four assertions about presentation and disclosure (footnotes).

A
  1. Occurrence and Rights and Obligations
  2. Completeness
  3. Classification and Understandability
  4. Accuracy and valuation
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12
Q

List the five assertions about classes of transactions and events during the period (income statement).

A
  1. Accuracy
  2. Occurrence
  3. Completeness
  4. Cutoff
  5. Classification
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13
Q

List the four assertions about account balances at the end of the period (balance sheet).

A
  1. Existence
  2. Completeness
  3. Rights and obligations
  4. Valuation and allocation
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14
Q

List the three broad categories of assertions under AICPA professional standards.

A
  1. Account balances at the end of the period (there are 4 assertions related to the balance sheet)
  2. Classes of transactions and events during the period (there are 5 assertions related to the income statement)
  3. Presentation and disclosure (there are 4 assertions related to the footnotes applicable to any of the financial statements)
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15
Q

Define assertion.

A

Implicit or explicit statements of fact by management that are associated with the entity’s financial statements.

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16
Q

Define audit evidence.

A

All the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence includes the information contained in the accounting records underlying the financial statements and other information.

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17
Q

Describe what the valuation or allocation assertion means.

A

It means that the dollar amounts attributed to the elements of the company’s financial statements are appropriate and in accordance with GAAP (or other applicable financial reporting framework).

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18
Q

Describe what the rights and obligations assertion means.

A

It means that the company has all the rights associated with its reported assets and all the obligations associated with its reported liabilities; any limitations on such rights or obligations must be appropriately disclosed.

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19
Q

Describe what the completeness assertion means.

A

It means that there are no omissions of transactions that should have been reported.

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20
Q

Describe what the existence (occurrence) assertion means.

A

It means that the recorded transactions are valid economic events of the period in which they are reported, i.e., the recorded transactions/items are properly recorded.

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21
Q

What are the AICPA’s guidelines to rank the reliability of audit evidence?

A
  1. Direct personal knowledge by the auditor is the most reliable audit evidence.
  2. Evidence obtained from an independent outside source is the next most reliable.
  3. Evidence obtained from the entity under effective internal control is next.
  4. Documentary evidence is more reliable than verbal responses to inquiries (and original documents are more reliable than faxes and photocopies).
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22
Q

What are substantive procedures?

A

Procedures performed to detect material misstatements at the relevant assertion level; these consist of tests of details and substantive analytical procedures.

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23
Q

What are tests of control?

A

Procedures performed to obtain information about the operating effectiveness of controls in preventing or detecting and correcting material misstatements at the relevant assertion level.

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24
Q

What are risk assessment procedures?

A

Procedures performed to obtain an understanding of the entity and its environment, including internal control, to assess the risk of material misstatement, whether due to fraud or error.

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25
Q

List the three categories of audit procedures.

A
  1. Risk assessment procedures
  2. Tests of control
  3. Substantive procedures
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26
Q

What matters must be documented by the auditor in connection with the evaluation of misstatements?

A
  1. The threshold for determining what is viewed as clearly trivial.
  2. All misstatements accumulated during the audit (and whether they have been corrected).
  3. The auditor’s conclusion as to whether any uncorrected misstatements are material (individually or in the aggregate), and the basis for that conclusion.
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27
Q

Describe the auditor’s responsibility to accumulate misstatements identified during the audit.

A

The auditor should accumulate identified misstatements, except for those that are clearly trivial. (Clearly trivial means clearly inconsequential.)

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28
Q

What is meant by the term projected misstatements?

A

The auditor’s best estimate of misstatements in populations suggested by audit sampling. (The AICPA formerly used the term likely error for this concept.)

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29
Q

What is meant by the term judgmental misstatements?

A

Differences arising from the judgments of management that the auditor considers unreasonable; or the selection of accounting policies deemed inappropriate.

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30
Q

What is meant by the term factual misstatements?

A

Misstatements for which there is no doubt.

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31
Q

Define misstatement.

A

A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and that which is required for the item to be in accordance with the applicable reporting framework.

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32
Q

List 3 purposes of audit documentation.

A
  1. Provides the principal support for the auditor’s report
  2. Documents the auditor’s compliance with GAAS
  3. Assists in controlling the audit engagement
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33
Q

What is contained in the permanent file of the audit documentation?

A

The permanent file contains documentation of matters having ongoing audit significance.

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34
Q

Define report release date.

A

The date the auditor grants the entity permission to use the auditor’s report; (that date must be documented).

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35
Q

What is meant by the term documentation completion date under the AICPA and PCAOB standards, respectively.

A
  • Under AICPA standards (applicable to audits of “non-issuers”) - The auditor should complete the assembly of the final audit file no later than 60 days after the “report release date.”
  • Under PCAOB standards (applicable to audits of “issuers”) - The auditor should complete the assembly of the final audit file no later than 45 days after the “report release date.”
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36
Q

What changes can the auditor make to the audit documentation after the documentation completion date?

A
  • The auditor must not delete audit documentation before the end of the retention period;
  • The auditor may add to the documentation but must document any materials added, by whom, when, the reasons for the change, and the effect on the auditor’s conclusions.
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37
Q

What are the audit documentation retention requirements under the AICPA and PCAOB standards, respectively.

A
  • Under AICPA standards (applicable to audits of “non-issuers”) - The audit documentation should be retained for at least 5 years from the report release date.
  • Under PCAOB standards (applicable to audits of “issuers”) - The audit documentation should be retained for at least 7 years from the report release date.
38
Q

List 2 alternative procedures for a nonresponse to a positive confirmation (usually performed after a second request was sent, but no response was received).

A
  1. Verify subsequent cash receipts
  2. Examine underlying documents for apparent validity
39
Q

When might negative confirmations be justified?

A
  • The financial statement item involves a large number of small (immaterial) accounts;
  • Control risk is low (that is, internal control is viewed as effective);
  • Recipients are expected to pay attention to the request.
40
Q

What is meant by the term negative confirmation?

A

A response is only requested in the event the confirming party disagrees with the identified balance. A non-response is viewed as indicating that party’s agreement.

41
Q

What is meant by the term positive confirmation?

A

A response is requested whether or not the confirming party agrees with the entity’s recorded amount. A non-response indicates a “loose end” that must be resolved.

42
Q

List the 2 general types of confirmations

A
  1. Positive
  2. Negative
43
Q

List some audit procedures that might be used to assess accounting estimates.

A
  • Inquire of management to understand how the estimate was developed;
  • Review and test management processes;
  • Develop an independent expectation for comparison to the entity’s estimate;
  • Review subsequent events for additional evidence.
44
Q

What is the auditor’s basic responsibility when auditing accounting estimates?

A

Evaluate the reasonableness (and the adequacy of related disclosures) of any significant accounting estimates relative to GAAP or other applicable financial reporting framework.

45
Q

What is meant by the term estimation uncertainty?

A

The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement. (The risks of material misstatement increase when there is high estimation uncertainty.)

46
Q

What further substantive procedures should the auditor perform in responding to significant risks?

A

The auditor should evaluate: (1) how management addressed estimation uncertainty in making the estimate; (2) whether management’s significant assumptions are reasonable; and (3) whether management has the intent and ability to carry out specific actions, as relevant.

47
Q

What matters should the auditor document in connection with accounting estimates?

A
  1. The basis for the auditor’s conclusions about the reasonableness of accounting estimates resulting in significant risks and their disclosure; and
  2. Any indications of possible management bias.
48
Q

Identify 3 factors affecting the nature of estimation uncertainty.

A

The nature of estimation uncertainty varies with:

  1. The nature of the accounting estimate;
  2. The extent to which there is an accepted method (or model) to be used; and
  3. The subjectivity of any assumptions or the degree of judgment involved.
49
Q

What is meant by the term unobservable inputs?

A

An entity’s own judgments about what assumptions market participants would use. (Estimation uncertainty increases when the fair value estimates are based on unobservable inputs instead of observable inputs.)

50
Q

What is meant by the term observable inputs?

A

Assumptions that market participants would use in pricing an asset or liability based on market data from sources independent of the reporting entity.

51
Q

Define “fair value.”

A

The amount at which the asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale.

52
Q

What is the auditor’s basic responsibility regarding Fair Value Measurement and Disclosures?

A

The auditor must obtain sufficient appropriate audit evidence to provide reasonable assurance that fair value measurements and disclosures comply with GAAP. The auditor should also determine that the methods used to determine fair value are consistently and appropriately applied.

53
Q

What is the best evidence of fair value?

A

Published price quotations in an active market.

54
Q

Under what circumstances might an auditor NOT be required to obtain a letter from the entity’s legal counsel?

A

If the entity had no litigation, claims, or assessments having financial reporting relevance and, accordingly, did not engage legal counsel. (In such a case, the management representations letter would include a statement to that effect.)

55
Q

What is the effect of a limitation in the lawyer’s response to the letter of inquiry on the audit report?

A

This would be considered a scope limitation sufficient to prevent an unqualified opinion and likely resulting in a disclaimer of opinion.

56
Q

What is meant by the term unasserted claims?

A

Audited entity has exposure to litigation but no one has yet filed a lawsuit or announced an intention to sue.

57
Q

What is the auditor’s purpose in obtaining a lawyer’s letter?

A

To corroborate management’s responses to the auditor’s inquiries about litigation-related issues.

58
Q

What is meant by the term asserted claim?

A

Also referred to as “pending or threatened litigation” - a claim that has already been filed (pending) or when the other party has announced an intention to sue (threatened).

59
Q

What is the lawyer’s responsibility for communicating omissions of asserted and unasserted claims that should have been included in the letter of inquiry?

A
  • Regarding asserted claims - the lawyer’s letter should inform the auditor directly of such an omission from the letter of inquiry;
  • Regarding unasserted claims - the lawyer should inform management of such an omission and encourage management to discuss the matter with the auditor (but the lawyer will not inform the auditor directly).
60
Q

List the two types of letters involved in the communication with the entity’s lawyers.

A
  1. Letter of inquiry - management’s letter to the entity’s lawyer(s) (as requested by the auditor) asking the lawyer to provide litigation-related information directly to the auditor;
  2. Lawyer’s letter - the lawyer’s response directly to the auditor.
61
Q

List the 4 matters the lawyer’s letter should address regarding “Asserted” claims.

A
  1. The nature of the litigation;
  2. The progress of the case to date;
  3. How management is responding or intends to respond to the litigation; and
  4. An evaluation of the likelihood of an unfavorable outcome and an estimate, if one can be made, of the amount or range of potential loss.
62
Q

List the three matters the lawyer’s letter should address regarding “Unasserted” claims.

A
  1. The nature of the litigation;
  2. How management intends to respond if the claim is asserted; and
  3. An evaluation of the likelihood of an unfavorable outcome and an estimate, if one can be made, of the amount or range of potential loss.
63
Q

List the members of management who are responsible for signing the management representations letter.

A

The Chief Executive Officer (CEO) and Chief Financial Officer (CFO).

64
Q

What is the purpose of obtaining the required management representations letter?

A

To document in writing the essence of management’s verbal responses to the auditor’s important verbal inquiries.

65
Q

What are the 2 basic categories of issues usually addressed by the management representations letter under the AICPA’s clarified auditing standards?

A
  1. Financial statements
  2. Information provided
66
Q

What would be the effect on an audit opinion of management’s unwillingness to sign the management representations letter?

A

This would be considered a scope limitation; probably resulting in disclaimer or withdrawal.

67
Q

What periods should be covered in the management representations letters?

A

All periods included in audit report.

68
Q

When should the management representations letter be dated?

A

It should have the same date as the auditor’s report.

69
Q

What is meant by the term arm’s length transaction?

A

A transaction conducted on such terms and conditions between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.

70
Q

What is meant by the term related party?

A

One party that controls or can significantly influence the management or operating policies of another party.

71
Q

Identify 3 responsibilities of the auditor when related party transactions have been identified.

A
  1. Obtain an understanding of the business purpose of the related party transaction;
  2. Determine if the related party transaction was authorized by board of directors (those charged with governance);
  3. Evaluate the adequacy of the disclosures of the related party transactions.
72
Q

What is the primary focus of the auditor regarding an entity’s transactions with related parties?

A

Evaluating the adequacy of disclosure about the related party transactions.

73
Q

List audit procedures used to identify the existence of related parties.

A
  • Inquire of management as to the existence of related entities;
  • Review prior year’s audit documentation;
  • Review any applicable SEC filings (for a public company);
  • Inquire of predecessor auditors if applicable;
  • Review stockholder listings of closely held companies to identify major stockholders.
74
Q

List 3 audit procedures that an auditor might use to identify an entity’s transactions with a related party.

A
  1. Review minutes of board of directors’ meetings (those charged with governance) for activities with related parties;
  2. Inquire of management as to such transactions; and
  3. Examine underlying documents for unusual or large transactions or transactions with terms or conditions that are inconsistent with prevailing market conditions.
75
Q

What is meant by the term subsequent events?

A

Events or transactions that occur after the balance sheet date up to the date of the auditor’s report which have a material effect on the financial statements and, therefore, require either financial statement adjustment or disclosure.

76
Q

What period of time defines a subsequent event?

A

The period after the balance sheet date up to the date of the auditor’s report.

77
Q

When would a subsequent event require adjustment of the financial statements?

A

When material events or circumstances clarify (that is, provide better information about) circumstances already in effect as of the balance sheet date.

78
Q

When would a subsequent event require disclosure in (but not adjustment of) the financial statements?

A

When material events or circumstances arise after the balance sheet date.

79
Q

List 4 audit procedures the auditor might perform to identify subsequent events.

A
  1. Inquiry of management;
  2. Review minutes of board meetings (or those charged with governance);
  3. Review the lawyers’ letters in response to the letter(s) of inquiry; and;
  4. Scan the accounting records subsequent to year end for unusual activities.
80
Q

What should the auditor do when subsequently discovered facts become known to the auditor (either before or after the report release date)?

A

Discuss the matter with management (and possibly those charged with governance) and determine whether the financial statements require revision. If so, inquire how management will deal with the matter.

81
Q

When is the auditor’s report normally dated?

A

When the auditor has obtained sufficient appropriate audit evidence as a reasonable basis for the opinion. (The date of the auditor’s report cannot precede the completion of fieldwork and may be later than that.)

82
Q

What is meant by the term dual dating the auditor’s report?

A

The auditor uses one date for the overall audit report, but specifies a later date to address a particular subsequent event. The later date is limited to the specific subsequent event, and does not imply responsibility for other matters beyond the basic date of the report.

83
Q

What is meant by the term reasonable period of time when the auditor is assessing an entity’s going concern issues?

A

A period of time not to exceed one year beyond the date of the financial statements being audited.

84
Q

What is meant by the term mitigating factors when the auditor is evaluating an entity’s going concern issues?

A

Those aspects of management’s strategy that might be expected to improve the entity’s cash flows (that is, generate cash inflows or reduce cash outflows).

85
Q

If management revised the financial statements because of subsequently discovered facts that became known to the auditor after the report release date, what should the auditor do?

A
  • The auditor should perform appropriate audit procedures on the revision.
  • The auditor should assess whether management’s actions are appropriate and timely to inform users about previously issued (erroneous) financial statements.
  • If the resulting opinion differs from that previously expressed, add an other-matter paragraph to the auditor’s report to comment on that change of opinion.
86
Q

What procedures should the predecessor auditor perform when reissuing an audit report?

A
  • Read the subsequent financial statements and compare to those previously audited.
  • Make inquiries of management and obtain written representations from management about issues affecting the previous representations obtained from management.
  • Obtain a representations letter from the successor auditor about known relevant matters.
87
Q

Describe the auditor’s reporting responsibilities when the auditor has substantial doubt about an entity’s ability to continue as a going concern.

A
  • Consider the adequacy of disclosure about these issues relative to GAAP or other applicable financial reporting framework (is there a misstatement?); and
  • If the financial statements (including disclosure) are consistent with the requirements of the applicable framework, the auditor should add an emphasis-of-matter paragraph after the unmodified opinion.
88
Q

When the auditor has substantial doubt about an entity’s ability to continue as a going concern, what further evidence-gathering responsibilities does the auditor have?

A
  1. Inquire about management’s strategy to overcome the entity’s financial difficulties; and
  2. Evaluate the feasibility of the “key” elements of management’s plans with emphasis on “mitigating factors.”
89
Q

List some indicators that might suggest to an auditor substantial doubt about the entity’s ability to continue as a going concern.

A
  • Negative trends (recurring losses, negative cash flows from operating activities, etc.);
  • Internal matters (labor problems, dependence on a single project or customer);
  • External matters (litigation, general decline in the economy or industry, etc.); and
  • Other indicators (defaults on debt, violations of debt covenants, etc.).
90
Q

List routine audit procedures that should identify whether there is “substantial doubt about an entity’s ability to continue as a going concern.”

A
  1. Analytical procedures;
  2. Review for subsequent events;
  3. Review loan agreements for compliance with restrictive debt covenants;
  4. Read minutes of meetings of the board or those charged with governance;
  5. Inquire of management about legal liability issues and obtain lawyers’ letters.
91
Q

What communication is required with those charged with governance when there is “substantial doubt regarding an entity’s ability to continue as a going concern”?

A
  1. Nature of conditions identified;
  2. The possible effect on financial statements and disclosures; and
  3. The effect on the auditor’s report.

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