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Flashcards in audit Deck (106):
1

What is Audit Sampling?

Taking part of a population- subjecting it to audit procedures- projecting results to a population

2

What are the characteristics of Statistical Sampling?

Based on formulas

Helps find an appropriate audit sample

Helps evaluate evidence obtained

Helps evaluate results and quantify Sampling Risk

3

What are the characteristics of Non-Statistical Sampling?

Based on human decision

Equally acceptable as Statistical Sampling

4

What are the characteristics of Substantive Tests?

Variables sampling

Probability proportionate to size sampling

5

What type of sampling are Control Tests?

Attribute Sampling

6

What is Sampling Risk?

Risk that your sample isn't representative of population

Can happen even if audit is done properly

7

What is the risk of assessing Control Risk too high?

A risk of Control Testing - Auditor works to make Control Risk lower

More substantive tests - Sample overstates Control Risk- Leads to an under-reliance on internal control- over-testing- and overall audit inefficiency

Audit ends up being effective (correct result)- but you do more work

8

What is the risk of assessing Control Risk too low?

A risk of Control Testing - Complement to Confidence Level
Inverse relationship to Sample Size

Higher accepted risk of assessing Control Risk too low = Smaller Sample

Lower accepted risk of assessing Control Risk too low = Larger Sample

9

What are the risks if the auditor concludes controls are operating effectively based on the sample and Control Risk is set too low?

Leads to higher Detection Risk - Fewer substantive tests

Sample understates Control Risk

This error leads to over-reliance on internal control- under-testing- and overall audit ineffectiveness.

Does NOT necessarily mean that the Financial Statements are materially misstated - it does mean that if there is one- you are less likely to find it

10

What is the risk of Incorrect Acceptance?

A risk of Substantive Testing - Auditor accepts a balance as fairly stated- when in fact it is not fairly stated

Hurts audit effectiveness

Wrong conclusion reached

Efficient- but not effective

11

What is the risk of Incorrect Rejection?

A risk of Substantive Testing - Auditor rejects balance as fairly stated when in fact it is fairly stated

Hurts audit efficiency

Wrong recommendations given

Effective- but not efficient

12

What is Non-Sampling Risk?

Risk of human (auditor) missing an error

Also called exception- error or deviation.

13

How does Sampling Risk compare to Non-Sampling Risk?

Sampling Risk deals with the chance that your audit sample is flawed

Non-Sampling risk deals with the chance that your human decisions/conclusions are flawed

14

What is Attribute Sampling?

Looking at Control Procedures - Were invoices approved when paid?

Errors are stated in terms of %- not dollar amounts

For example- 5 invoices out of 100 were not properly paid. Error rate is 5%

Hint: If you see Error Rate on the Exam- they are referring to Attribute Sampling.

15

How do you determine if Control Procedures are operating properly or not operating properly?

Control Procedures are either operating properly or they are not operating properly - based on Error Rate and the tolerance you have for errors

16

What is the Tolerable Rate?

Error rate in population that you are willing to accept/tolerate

Inverse relationship to Sample Size

Higher Tolerable Rate = Smaller Sample
Lower Tolerable Rate = Larger Sample

If you're willing to accept a higher probability that errors exist- there is less pressure on the sample

17

What is the Expected Population Error Rate?

What Error Rate are you expecting? - Judgment call- based on experience

Direct relationship to Sample Size

More errors = Larger Sample

Less errors = Smaller Sample

18

What is the basic premise of Attribute Sampling?

Attribute in the sample gives information about the entire audit population

Used to estimate Internal Control error rate

19

For what is the Expected Population Deviation (error) Rate used?

Used to determine initial level of Control Risk

20

What is the Allowable Risk of Over-reliance?

Risk of Assessing Control Risk too low

Gives you the Sampling Risk

21

When is Attribute sampling used?

Attribute sampling is only useful when there is documented evidence (an audit trail) to test

Use when the existence of an error needs to be verified or debunked

22

What is Classic Variable Sampling?

Testing for a dollar amount

Value in sample gives information about value in entire population.

23

What functions are used in conjunction with Classic Variable Sampling?

Mean Per Unit = Sample Average x Number in Population

Stratification - Decreases effect of variance in population and reduces sample size

24

What are the characteristics of Probability Proportionate to Size (PPS) sampling?

A form of Variable Sampling

Does NOT use Standard Deviation

Auditor focuses on a dollar amount

Larger or more valuable items get picked more often as part of the sample

25

What is Projected Misstatement?

Misstatement found in sample - have to project it to remainder of population

26

How does Probability Proportionate to Size (PPS) sampling compare to Classic Variables sampling?

PPS:

Easier to use- Results in a stratified (homogenous) sample- Results in a smaller sample size to audit- Easy to design

Classic Variables Sampling:

Easy to expand sample size- Selecting zero and negative balances easy

27

What factors affect sample size?

Tolerable rate for error - Inverse relationship with sample size

Risk of assessing Control Risk too low - Inverse relationship with sample size

Expected population error rate - Direct relationship with sample size

Population size does NOT affect the sample size - as population is larger- sample size doesn't grow.

28

What is the formula for Audit Sampling?

SER + ASR

29

What is Allowance for Sampling Risk?

The amount that you add to the Sampling Error Rate to get some cushion for your sample.

As high as you think the population error rate could go based on experience.

30

What is the Tolerable Error Rate?

The amount of error rate that you can accept - If population error rate is less than TER- then accept the Control as effective

If population error rate is more than TER- do more testing to get SER lower or conclude control isn't effective. Do more substantive testing

31

What are the steps to develop a sampling plan?

Determine Test Objective - for example- have sales shipments been billed?

Define Population and Deviation - take a sample of shipping document- trace forward to see if billed

Determine Sample Size based on tolerable rate for error- risk of assessing Control Risk too low- and expected population error rate.

Select Sampling Technique

32

After a Sampling Plan is developed- what are the steps in sampling?

Perform the Sampling Plan

Evaluate Results

Document Results

33

What is Systematic Sampling?

Every certain # of a population is selected

Population needs to be randomly ordered

Primary advantage is that population doesn't require pre-numbering

34

What is Sequential Sampling?

Also called Stop or Go sampling

Each audit step determines the next step

35

What is Discovery Sampling?

Audit is testing an area that is so crucial that zero population errors can be tolerated

Any phony employees on payroll?

36

How does Block Sampling compare to other sampling methods?

Easy to implement- but is the worst method of sampling.

37

If Internal Control is poor and a company's accounting practices are sloppy - which risk is higher?

Control risk increases with poor Internal Controls and sloppy accounting practices.

38

If Internal Control is poor - what is the effect on the audit?

Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.

39

What does Internal Control provide reasonable assurance for?

Internal control provides reasonable assurance that

Material misstatements will be prevented

Reliability/integrity of financial statements will be preserved

Assets are protected against misuse

40

What is required in an examination of Internal Control under Sarbanes-Oxley?

CEO/CFO must disclose Internal Control deficiencies

Management must provide assessment of Internal Control

Management must certify Financial Statements

41

What is the relationship between Internal Control and Substantive Testing?

Inverse Relationship

Stronger Internal Controls - Less Testing Needed

Weaker Internal Controls - More Testing Needed

42

What are the 3 objectives of Internal Control?

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

43

What are the 5 components of Internal Control?

Control Environment

Risk Assessment

Information and Communication

Monitoring

Control Activities

44

What is the purpose for a Control Environment assessment?

Sets tone for the entire company

45

What are the components of the Control Environment?

Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resource Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement

46

What does an auditor's assessment of Detection Risk determine?

Detection Risk determines nature- timing- and extent of audit procedures.

47

What determines the acceptable level of Detection Risk?

Risk of material misstatement determines acceptable level of Detection Risk

48

What items could increase the risk of material misstatement?

Rapid growth in the company.

The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence

Major changes to operations- personnel- systems- IT- products- corporate organization- and foreign operations.

49

What happens when Control Risk is assessed to be at the maximum level?

No Internal Control testing is performed.

All audit procedures are increased in intensity to compensate for increased risk.

50

What happens when Control Risk is below the maximum level?

Auditor tests Internal Controls.

Auditor evaluates Control Risk based on tests

Auditor adjusts substantive tests accordingly

Weaker Internal Control - More substantive tests

Stronger Internal Control - Less substantive tests

51

Describe some common examples of Control Activities.

Performance Reviews

Information Processing

Physical Controls

Segregation of Duties

52

What should an auditor understand with respect to Information and Communication on an audit?

Understand Client's

Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external reporting process

53

How must an auditor document understanding of Internal Control?

Through written documentation such as Internal Control memos- flowcharts- and questionnaires

54

What questions should be asked to determine the risk of material misstatement?

Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?

55

What is the purpose of testing Internal Controls?

Auditor needs reasonable assurance that controls are functioning as designed and effective

Internal Control Testing should be strong as (IRON) so that nothing gets past them

Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents

If results are as expected- substantive procedures do not need to be adjusted

56

When can controls tested by an auditor in a prior year be used in the current year's audit assessment?

Controls tested by auditor in a prior year can be used in the current year's audit assuming they are re-tested every third year

Exception If the control has changed since the last audit

57

What happens if Internal Controls are deficient?

Control Risk increases

Scope of substantive procedures increases

Detection Risk decreases

Material Weakness - Reasonable possibility that a material misstatement in Financial Statements would not be found- more than a remote chance of occurrence

58

What is a Material Weakness?

Reasonable possibility exists that a material misstatement in Financial Statements would not be found- and has more than a remote chance of occurrence.

59

What does Tracing test?

Tests Completeness

Starts with source document and traces forward to the journal entry.

60

What does Vouching test?

Tests Existence.

Starts with a journal entry and searches for a voucher or source document to support the entry.

61

What activities represent Segregation of Duties?

Non-compatible duties performed by separate individuals- such as

Authorization of asset disbursement vs. Recording of Assets vs. Custody of assets

If supporting audit evidence doesn't exit - use Observation and Inquiry

Accounting should be segregated from Production

62

With respect to signing checks - how are duties segregated?

Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS

Tip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves

63

With respect to custody of assets - how should duties be segregated?

Employees who have custody of assets should not also RECORD those assets

Someone in charge of petty cash should not also control the petty cash records

Treasury Department (custodians) should NOT have record keeping duties

They control assets and should not be able to adjust any recording of those assets

64

What are the limitations on Control Activities?

Controls can't stop collusion or bad judgment

Management can override controls

Cost vs. Benefit relationship of Internal Control

65

What is required if a Material Weakness is identified?

A written report to management is required.

Report declaring that no material weaknesses were found is allowed

Previous weaknesses reported that still exist should be reported again

Should be reported no later than 60 days after audit report release date

If one or more material weaknesses is uncorrected at year-end- an Adverse Opinion on Internal Control must be given

66

What is the effect of a Significant Deficiency? What is it?

A significant deficiency adversely affects a company's ability to report in the financial statements according to GAAP.

A significant deficiency is a more than a remote likelihood of material misstatement by more than an inconsequential amount

67

What must occur if a Significant Deficiency is identified?

If a Significant Deficiency is identified- a written report to management required

Report declaring that no significant deficiencies exist is not allowed

Previous deficiencies reported that still exist should be reported again

Should be reported no later than 60 days after the audit report release date

68

What is a Control Deficiency?

A control is not operating as intended.

69

What must an auditor ask if using the work of third parties?

Are they competent?

Are they objective?

70

What must an auditor understand with respect to internal auditors?

Auditor needs to understand the role of Internal Auditors within the organization because their work affects the audit plan

Responsibility for judgments about materiality or appropriateness of entries or estimates cannot be shared with third parties like Internal Auditors

Internal Auditors should be asked to do some of the legwork like preparing schedules or running reports

They should not be asked to make any decisions or judgments

71

What is required in an examination of Internal Control under Sarbanes-Oxley?

CEO/CFO must disclose deficiencies

Management must provide assessment of Internal Controls

Management must certify Financial Statements

72

What is the relationship between Internal Control and Substantive Testing?

Has inverse relationship

Stronger Internal Control results in LESS substantive testing

Weaker Internal Control leads to MORE substantive testing

73

What are the three objectives of Internal Control?

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

74

What are the five components of Internal Control?

Control Activities

Risk Assessment

Information and Communications

Monitoring

Control Environment

75

What are the components of the Control Environment?

Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resources Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement


76

What happens when Control Risk is below the maximum level?

Auditor tests Internal Controls.

Auditor evaluates Control Risk based on tests

Auditor adjusts substantive tests accordingly

Weaker Internal Control - More substantive tests

Stronger Internal Control - Less substantive tests

77

What should an auditor understand with respect to Information and Communication on an audit?

Understand Client's

Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external communication process

78

How must an auditor document understanding of Internal Control?

Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires

79

What is the purpose of testing Internal Controls?

Auditor needs reasonable assurance that controls are functioning as designed and effective

Internal Control Testing should be strong as (IRON) so that nothing gets past them

Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents

If results are as expected - substantive procedures do not need to be adjusted

80

What should be included for the Auditor's address?

The City and State where located

81

What is Management Responsible for in regards to the Financial Statements?

Preparation and Fair Presentation of Financial Statements in accordance with the Applicable Financial Reporting Framework

82

What is Management Responsible for in regards to Internal Control?

Internal Control Design, Implementation, Maintenance

83

What are the headings in the Audit Report for an Unmodified Opinion?

(TIM-AA) Title; Introduction; Management Responsibility; Auditor Responsibility; Audit Opinion

84

What are the headings in the Audit Report for an Modified Opinion?

(TIMA-BA) Title; Introduction; Management Responsibility; Auditor Responsibility; Basis for (Modified) Opinion; Audit Opinion

85

In an Unmodified Opinion with Emphasis-of-Matter / Other-Matter sections, what is the order of the headings?

(TIM-AA EMO) Title; Introduction; Management Responsibility; Auditor Responsibility; Audit Opinion; Emphasis-of-Matter; Other-Matter

86

What are the requirements for referencing a Component Auditor in the Audit Report?

Component Financial Statements must be prepared using same Financial Reporting Framework as the Group Financial Statements; Component Auditor must have performed audit in accordance with GAAS or PCAOB Standards.

87

What must the Group Engagement Partner do if they assume responsibility for the Component Auditor's work?

Perform additional audit procedures; Be involved in Component Auditors work; Perform Risk Assessment procedures; Assess Risk of Material Misstatement

88

What standards govern SSARS engagements?

Compilations are governed by SSARS (Statements on Standards for Accounting and Review Services)

89

Which clients can have compilation engagements?

Non-SEC (non-public) registrants only.

90

What is a Compilation?

Accountant puts together financial statements with information PROVIDED BY MANAGEMENT. No opinion is expressed and no assurances are given. Independence is not required.

91

What disclosures are required for Compilation engagements?

Disclosures not necessary must state that they are not included

92

What standards govern Review engagements?

SSARS (Statements on Standards for Accounting and Review Services)

93

What type of assurance is given in a Review engagement?

Reviews give limited assurance.

94

What procedures are required for Review engagements?

Analytical procedures are required for reviews. Compare results to documented predictions.

95

What is a Review engagement?

Financial statements are presented with no opinion expressed- and limited assurances are given. Independence is required for a review engagement.

96

What is a Forecast?

A prospective financial statement that uses normal circumstances. General and limited use allowed.

97

What is a Projection?

A prospective financial statement using hypothetical situations. Only limited use by the client is allowed.

98

What are the requirements for Agreed Upon Procedures?

Independence is required; Only limited use by the client is allowed.

99

What disclosures are required for remote likelihood of losses?

No disclosure required.

100

What disclosure is required for a probable loss contingency?

Accrue if estimable. Emphasis-of-Matter paragraph if not estimable.

101

What disclosure is made if a loss contingency is reasonably possible?

Auditor assesses need for Emphasis-of-Matter paragraph based on loss likelihood.

102

How is a gain contingency reported?

Gain contingencies are not reported.

103

How does an immaterial GAAP issue affect the audit opinion?

It doesn't. Opinion is Unmodified.

104

How does a very material GAAP issue affect the Audit Report?

Modified-Adverse Opinion is issued. Emphasis-of-Matter paragraph is added after Opinion paragraph.

105

How do GAS standards compare to GAAS?

GAS is more strict than GAAS.

106

What is required under the Single Audit Act?

Funding Threshold is $750,000. An audit performed under governmental auditing standards (GAS). A report on internal control is required. GAAS and GAS don't require the I/C report.