The financial report audit process - Week 3 Flashcards
Try and memorize these Questions and Answers!
Directors assert that the financials…?
…provide a “true and fair” representation of the company’s financial performance. They assert that truth and fairness are embodied in the balance sheet, income statement and financial report as a WHOLE.
Auditors use assertions to…?
…assess risks by considering the TYPES of potential misstatements that may occur by designing audit procedures in response to those risks.
What are the 6 balance sheet assertions? All must be embodied to be true and fair. (Q4.4 of textbook)
- Existence - there is something “real” represented in the assets, liabilities and equity figures.
- Rights & obligations - entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
- Completeness - all assets, liabilities and equity interests that should have been recorded have been recorded.
- Valuation and allocation - all assets, liabilities and equity interests are included in the financial report at appropriate amounts and any resulting valuation adjustments (e.g. accumulated depreciation, accumulated impairment losses, accumulated amortization) are appropriately recorded.
- Classification - all transactions have been recorded in the proper accounts.
- Presentation - all assets, liabilities and equity interests are appropriately aggregated or dis-aggregated and clearly described, and related note disclosures are relevant and understandable.
What are the 6 income statement assertions? All must be embodied to provide a true and fair view. Describe them (Q4.4 of textbook).
- Occurrence - all transactions and events that have been recorded are validly authorized and pertain to the entity. For example, there are no fake sales in the income statement.
- Completeness - all transactions and events that should have been recorded are recorded. Nothing is missing.
- Accuracy - Data relating to recorded transactions have been recorded at appropriate amounts.
- Cut-off - transactions and events have been recorded in the correct financial year. This assertion focuses on transactions processed in late June, early July.
- Classification - transactions and events are recorded in the proper accounts.
- Presentation - transaction and events are appropriately aggregated or dis-aggregated and are clearly described, and related note disclosures are relevant and understandable.
What is an audit risk? Explain (Q4.9 of textbook)
An audit risk is basically the risk of when an auditor forms a wrong opinion.
What is an inherent risk? Explain (Q4.9 of textbook)
An inherent risk is the risk than an account balance, transaction or event will be materially misstated simply because of its nature. Some accounts are tricky to balance which results in a high level of inherent risk.
What is a control risk? Explain (Q4.9 of textbook)
A control risk is a risk that an entity’s internal controls are not good enough to prevent, detect or correct a misstatement before it gets onto the financial report.
What is a detection risk? Explain (Q4.9 of textbook)
A detection risk is the risk that an auditor’s substantive procedures has failed to detect a material misstatement that exists.
Explain the detection risk matrix.
When there is a low risk of internal controls failing and there is a low risk of inherent risks at play - > detection risk is high, because less substantive procedures are used, as we expect we won’t find any material misstatements.
When there is a high risk of internal controls failing and there is a high risk of inherent risks at play -> detection risks are low => more substantive procedures are used because we will expect to find errors.
What are business risk?
Business risks are risks that the entity’s objectives will not be obtained as a result of external or internal factors, pressures or forces brought upon the entity. Auditors use business risks to assess pressure points which could result in a risk of financial misstatement.
What is materiality?
Materiality is information which, if omitted or misstated, has a potential adverse effect on decisions made by users regarding the financial report.
Explain the inverse relationship between materiality and audit risk.
If audit risk is high, then the materiality THRESHOLD must be low. If the audit risk is low, then the materiality THRESHOLD can be high. E.g. so if the auditor’s chances (statistically) of making a wrong opinion is high, the materiality threshold or limit should be set to the minimum.
Types of audit tests: What are test of controls?
Test of controls is the testing of the controls in place which safeguard the financial integrity.
Name a few common audit procedures used to gather sufficient appropriate evidence:
Inspection Observation External Confirmation Recalculation Re-performance Analytical procedures Inquiry Tracing & Vouching
Discuss the reliability of audit evidence.
- Audit evidence obtained from EXTERNAL sources are often more reliable than the evidence obtained from the entity’s own accounting records.
- Audit evidence that is generated internally are more reliable WHEN the controls are effective.
- Audit evidence obtained directly from the auditor is more reliable than the audit evidence obtained by/from the entity.
- Paper or electronic documentation is more reliable than oral presentations.
- Original documents are always more reliable than photocopies or facsimiles.
