Ch 8 - Audit Planning and Analytical Procedures

Question 1

A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued.

Answer 1

Acceptable audit risk

Question 2

Overall approach to the audit that considers the nature of the client, risk of significant misstatements, and other factors such as the number of client locations and past effectiveness of client controls.

Answer 2

Audit strategy

Question 3

written records of the client’s expectations for the period; a comparison of budgets with actual results may indicate whether or not misstatements are likely.

Answer 3

Budgets

Question 4

The risk that the client will fail to achieve its objectives related to (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with laws and regulations.

Answer 4

Client business risk

Question 5

the official record of the meetings of a corporations board of directors and stockholders, in which corporate issues such as declaration of dividends and the approval of contracts are documented.

Answer 5

Corporate minutes

Question 6

an agreement between the CPA firm and the client as to the terms of the engagement for the conduct of the audit and related services.

Answer 6

Engagement letter

Question 7

a measure of the auditor’s assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal control

Answer 7

Inherent risk

Question 8

involves deciding whether to accept or continue doing the audit for the client, identifying the client’s reasons for the audit, obtaining an engagement letter, and developing an audit strategy.

Answer 8

Initial audit planning

Question 9

affiliated company, principal owner of the client company, or an other party with which the client deals, where one of the parties can influence the management or operating policies of the other.

Answer 9

Related party

Question 10

any transaction between the client and a related party.

Answer 10

Related party transactions

Question 11

What are three main reasons for audit planning?

Answer 11

1) Enable auditor to obtain sufficient appropriate evidence
2) Help keep audit costs reasonable
3) Avoid misunderstandings with the client

Question 12

What are the eight major parts of audit planning?

Answer 12

AUAPSUGD

1) Accept client and perform initial audit planning
2) Understand the client’s business and industry
3) Assess client business risk
4) Perform preliminary analytical procedures
5) Set materiality and assess acceptable audit risk and inherent risk
6) Understand internal control and assess control risk
7) Gather information to assess fraud risks
8) Develop overall audit strategy and audit program

Question 13

Audit risk and inherent risk influence the _____ of evidence that will need to be collected and the _____ level of staff assigned to the engagement.

Answer 13

amount; experience

Question 14

What two risks significantly affect the conduct and cost of audits?

Answer 14

1) Audit risk

2) Inherent risk

Question 15

When the auditor decides on a lower acceptable audit risk, it means that the auditor wants to be (more, less) certain that the financial statements are not materially misstated.

Answer 15

more

Question 16

What are four aspects of initial audit planning?

Answer 16

DIED

1) Decide to accept or continue client
2) Identify reasons for audit
3) Engagement letter
4) Develop overall strategy

Question 17

For prospective clients that have previously been audited by another CPA firm, the new (successor) auditor is required by auditing standards to ___________.

Answer 17

communicate with the predecessor auditor.

Question 18

For what three reasons might an auditor obtain more evidence?

Answer 18

if the company is

1) a public company
2) has extensive indebtedness
3) is being sold in the near future

Question 19

What are the four major components of PCAOP’s Audit Engagement Letter?

Answer 19

• The objective of the audit
• The auditor’s responsibilities
• What is included in the audit
• Management’s responsibilities

Question 20

For public companies, who is responsible for hiring the auditor?

Answer 20

The audit committee

Question 21

What are three reasons to understand a client’s industry and external environment?

Answer 21

1. Risk associated with specific industries affect the auditor’s decisions
2. to gain understanding of inherent risk in a client’s business and industry
3. unique accounting requirements per the client’s business and industry

Question 22

Tells the ability of a company to pay off current liabilities with cash.

Answer 22

Cash ratio

Question 23

Tells the ability of a company to pay off current liabilities very quickly.

Answer 23

Quick ratio

Question 24

Tells the ability of a company to pay off current liabilities within a year.

Answer 24

Current ratio

Question 25

the auditor uses trends in this ratio to assess the reasonableness of the allowance for uncollectible accounts.

Answer 25

Accounts Receivable Turnover

Question 26

Accounts Receivable Turnover expressed in number of days. Tells how long it takes for a company to convert A/R to cash.

Answer 26

Days to Collect Receivables

Question 27

Auditors use trends in this ratio to identify potential inventory obsolescence.

Answer 27

Inventory turnover

Question 28

Inventory Turnover expressed in number of days.

Answer 28

Days to Sell Inventory

Question 29

The extent of the use of debt in financing a company.

Answer 29

Debt to Equity

Question 30

Shows whether a company can comfortably make its interest payments.

Answer 30

Times Interest Earned

Question 31

Shows profitability per share of common stock.

Answer 31

Earnings Per Share

Question 32

Shows the percentage of sales available to pay other expenses after deducting COGS.

Answer 32

Gross Profit Percentage

Question 33

Shows the percentage of sales available after deducting the cost of the product and operating expenses.

Answer 33

Profit Margin

Question 34

Measure of overall profitability.

Answer 34

Return on Assets

Question 35

Amount of net income returned as a percentage of shareholders equity. Measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.

Answer 35

Return on Equity