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Audit Exam 3 Flashcards

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1
Q

What are 3 reasons audit planning matters in real life?

A
  1. Helps auditors work smarter, not harder in gathering evidence.
  2. Keeps clients happy. (How much $$, What will you need?)
  3. Ensure compliance with GAAS. (Required by AICPA and PCAOB).
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2
Q

Client Business Risk

A

Risk that the client loses customers
Risk that the client gets sued by XYZ
Risk that the client becomes obsolete
Risk that the client loses money

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3
Q

Engagement Risk

A

Risk that the CPA firm suffers as a result of the audit

Enron, PCAOB fines, SEC fines, Lawsuits

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4
Q

Sampling Risk

A

Risk that our sample is not representative of the population.

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5
Q

Audit Risk

A

Risk of an incorrect audit opinion

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6
Q

Acceptable Audit Risk

A

How much audit risk the partner is willing to assume/accept. Low AAR = risk averse; High AAR = less evidence needed

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7
Q

Inherent Risk

A

Risk of an account being materially misstated absent of internal controls. Highly complex accounts; prone to fraud.

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8
Q

Control Risk

A

Risk that the client’s internal controls either fail to prevent or detect material misstatement.

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9
Q

Fraud Risk/Triangle

A
  1. Incentives/pressures
  2. Opportunities (bad IC)
  3. Attitudes/rationalizations
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10
Q

What are the 5 steps in accepting a client and performing initial audit planning?

A
  1. Client acceptance – Bad client < No Client
  2. Intended users/reason for audit - determine audience
  3. Obtain an understanding w/client (scope/engagement letter)
  4. Need outside specialists?
  5. Select staff for engagement.
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11
Q

What are the 6 things to study about a client’s business/industry?

A
  1. Industry/external environment
  2. Business operations - get an in-person tour
  3. Any related-party transactions?
  4. Management and governance
  5. Get corporate minutes
  6. Learn more about the industry!
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12
Q

What is the definition of materiality?

A

Anything that affects the decision of a reasonable user.

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13
Q

Factors affecting materiality

A

A) Dollar amount

B) Everything else

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14
Q

Who decides materiality

A

Auditor

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15
Q

How is materiality applied on audits?

A

On 2 levels -

1) Each account
2) All individual accounts combined

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16
Q

How do you convert performance materiality to actual results?

A
  1. Start with threshold
  2. Look at known misstatement (based on evidence)
  3. Look at allowance for sampling risk.
  4. Sum 2+3 and compare to #1.
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17
Q

What are known misstatements?

What are likely misstatements?

A
  1. Actual, provable misstatements.

2. Sample risk/management estimates

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18
Q

What is the audit risk equation

A 
PDR = AAR / IR X CR
AAR = acceptable audit risk
IR = inherent risk
CR = control risk
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19
Q

What is Planned Detection Risk (PDR)?

A

Risk that an auditor’s tests do not catch a material misstatement.

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20
Q

What is Acceptable Audit Risk (AAR)?

A

How willing an auditor is to issue an incorrect opinion.
Church = high AAR
Boeing = low AAR (public company)

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21
Q

What is Control Risk (CR)?

Study These Flashcards
A

Risk that internal controls fail to detect an MM.
High CR = IC’s bad, more evidence is needed
If auditor plans to rely on good IC, he must have evidence (TOC) that IC’s are operationally effective.

22
Q

What is Inherent Risk (IR)?

Study These Flashcards
A

Risk of material misstatement w/o considering internal controls.
Bad debt is subjective. High IR.
Sales is prone to fraud. High IR.

23
Q

Are auditors responsible for catching fraud?

Study These Flashcards
A

Auditors are responsible for providing reasonable assurance against material misstatements whether due to error or fraud.

24
Q

Fraudulent Financial Reporting

Study These Flashcards
A

Driven by upper-level management
Cookie Jarring
Income Smoothing
Kiting

25
Misappropriation of Assets
Lower level employees | No $$ incentive to commit FFR
26
Why are frauds hard to catch? / Why do auditors only offer reasonable assurance?
1. Sampling (not 100%) 2. Employee collusion 3. Management estimates
27
What are the three parts of the fraud triangle?
1. Incentives/pressures (greed, revenge, fear, addiction) 2. Opportunities (failure of internal controls) 3. Attitudes/rationalization (nobody thinks of themselves as a crook)
28
Assessing the risk of fraud - what elements go into the funnel?
1. Communicate among the team 2. Ask of management - play 20 questions w/controller 3. Risk factors - fraud triangle 4. Analytical procedures - fraud triangle 5. Other information
29
When significant fraud risks are identified, how does the auditor respond?
On three levels 1) Overall level 2) Possible management override -- investigate 3) Assertion level -- check grids/trace forward/vouch back
30
What are the three objectives of effective internal control?
1. Reliable financial reporting (prevent fraudulent financial reporting) 2. Effective operations (support good cash flow, avoid bounced checks, nonpaying customers) 3. Compliance with rules and regulations
31
What is management's job with respect to internal controls?
Design the internal controls Implement the internal controls Monitor the internal controls Operating effectiveness
32
What is the auditor's job with respect to internal controls?
OPINE on internal controls
33
When does an auditor do Tests of Controls?
Interim - prior to fiscal year end Controlling date - last day of FYE Resolve all problems WRT IC's prior to B/S date, all is well
34
Who does the heavy lifting of SOX 404(a) testing?
Internal Audit
35
Who actually signs SOX 404(a)?
CEO and CFO
36
COSO components of Internal Controls
1. Control environment 2. Risk assessment 3. Control activities 4. Information and Communication 5. Monitoring
37
Separation of duties in IT - what are the three silos that should report to the CIO / IT Manager?
1. Systems development 2. Operations 3. Data Control
38
What general controls should IT have?
1. Administration - is it well-funded? 2. Systems development - end users? 3. Separation of duties? 4. Backup and Contingency Planning? 5. Physical and Online Security?
39
What are the four steps to obtain and document understanding of internal controls?
1. Obtain and document understanding of internal control design and operation (flowcharts, look at) 2. Assess control risk. If MAX at this stage, then you'll stop and proceed directly to TOT. 3. If you continue from step 2, design, perform, and evaluate tests of controls. 4. Then, decide planned detection risk and substantive tests (TOTs)
40
How do you assess control risk?
``` By linking key controls and control deficiencies to transaction-related audit objectives. Then test the controls to see that they are working. Transaction-related audit objectives are: 1. Occurrence 2. Completeness 3. Accuracy 4. Posting 5. Classification 6. Timing ```
41
How do you design and perform a test of controls?
See if the control is working as expected. Gather audit evidence, as in Ch 7 (physical exam, confirmation, inspection, inquiry, recalculation, re-performance, observation, analytical procedures) Want to confirm that IC's are being consistently applied 24/7/365. Effectivity date is last day of fiscal year.
42
How does an auditor report on internal controls?
- Contact those charged with corporate governance. - SOX 404(a) is for all public companies; (b) accelerated filers - Management letters are suggestions for improvement/sales job at the end of the audit. - None of this is applicable in private firms
43
Options for testing when AIS is highly computerized?
1. Run test data (but take it back out) 2. Parallel simulation (audit software -- confidence check) 3. Embedded audit module (not popular -- big brother)
44
What accounts are involved in the sales and collection cycle?
``` Sales Cash Receipts Journal Sales Returns Write offs Bad Debt Expense ``` I/S: Sales Rev/Sales Disc/Sales Returns/Bad Debt Exp B/S: A/R/Cash/AFDA
45
What source documents and records are involved in the sales and cash collection cycle?
Sales: Cust Order PO, Sales Order, Bill of Lading, Invoice, AR Subledger, AR Aged Trial Balance, General Ledger, Financial Statements Cash Receipts: Check+Remittance Advice, CR Prelist, Deposit Slip, Validated Deposit Slip, CR Journal, AR Subledger AR Aged TB, GL
46
What are the test of controls for sales transactions?
- Separation of duties - CAR (custody, authorization, recording) - Independent checks - Link to 6 audit objectives (occurrence, completeness, etc.) - GAAS requires we look at IC's - CR in audit risk equation
47
What are the tests of transactions for sales transactions?
Occurrence: Vouch back from SJE to BOL Completeness: Trace forward from BOL to SJE Accuracy: Agree amount of invoice to amount of SJE Cutoff: Agree date of BOL to date SJE Posting / Summarization
48
What are the tests of transactions for cash receipts transactions?
Occurence: Vouch back from CR JE to validated deposit slip Completeness: Trace forward from vaidated deposit slip to CR JE Accuracy: Agree dollar amount on deposit slip to CRJE Posting: Agree details of CR prelist to AR subposting Cutoff: Agree date of deposit slip to CRJE
49
What are the biggest concerns with controls over sales returns and allowances?
1. Occurrence (Misappropriation of assets) | 2. Completeness (FFR)
50
What are the biggest concerns with controls over write-offs?
1. Occurrence Fear = steal cash and hide with bogus writeoff. Ensure proper authorization of writeoffs occurs.

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