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Audit II midterm Flashcards

1
Q

3 approaches to selecting sample items

A

Select all items
Select specific items- by a characteristic (key item) or all items over a certain dollar amount
Audit sampling

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2
Q

3 factors that determine sample size

A

Confidence level- desired level of assurance
Tolerable error- acceptable defect rate
Expected error- historical defect rate

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3
Q

Audit sampling

A

The application of audit procedures to less than 100 percent of the items in a population of audit relevance selected in such a way that the auditor expects the sample to be representative of the population and thus likely to provide a reasonable basis for conclusions about the population

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4
Q

Sampling risk

A

risk that sample selected is not representative of the population and lead auditor to a different conclusion than if the population were tested

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5
Q

Precision (Allowance for sampling risk) equation

A

Tolerable error - Expected error

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6
Q

Statistical sampling

A

Must comply with all laws of probability to compute sample size. Each number must have same probability of being chosen. Any judgement that comes into play makes it non statistical
Pros: Quantify sampling risk, efficient sample
Cons: Training auditors, timely, inconsistency

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7
Q

Non-statistical sampling

A

Judgement in sample size
Haphazard sample size (auditor selects sample, may be unknown bias)
Must test individually significant items 100%
Cannot quantify upper deviation rate or sampling risk

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8
Q

Monetary Unit Sampling (MUS)

A

Substantive test, most common method for balances of transactions
Can be quantified
Population: monetary value of an account balance
Each unit is an individual dollar
Misstatement- difference between monetary amounts
Dollars are organized into “logical units”

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9
Q

Confidence level

A

100% - Sampling risk
The desired level of assurance that the sample results will support a conclusion that the control is functioning effectively.
Generally, when the auditor has decided to rely on controls, the confidence level is set at 90% or 95%.

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10
Q

Tolerable deviation rate

A

The maximum deviation rate from a prescribed control that the auditor is willing to accept and still consider the control as operating effectively.
Typically 3-5% for high importance, 6-10% for moderate

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11
Q

What determines if accounts are materially misstated, and what to do afterward

A

If Upper misstatement > Tolerable misstatement, accounts are materially misstated
• Increase the sample size
○ If more misstatements are found then, request client adjust balance
• Perform other substantive procedures
Request client adjust accounts receivable balance

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12
Q

Substantive tests steps

A

Select a representative sample of items
Calculate the difference between audited values and recorded values for each sampled item
Estimate the population error by multiplying the average error rate in the sample to the population
Adjust for sampling risk (Upper confidence limit)
If the upper confidence limit is less then materiality then the auditor can conclude there is no material misstatement

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13
Q

Disadvantages of MUS

A

Special consideration for zero or negative balances
Assumes error is not more than 100% of audited amount
Sample results may overstate allowance for sampling risk

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14
Q

Fundamental concepts in Auditing

A 
Integrity
Critical thinking
Skepticism
Verification
Independence
Validating evidence
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15
Q

agency theory

A

Assumes principal has different objectives than the agent, and principal does not know agent’s type of actions

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16
Q

Information risk

A

risk that principal makes decisions improperly based on information provided

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17
Q

Audits became mandatory in _____

A

1929, after stock market crashed

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18
Q

Major SOX reforms

A

• Prohibits auditors from Bookkeeping
• Audit committee must hire and fire external auditor
• Audit must pre-approve all non audit services
• Cooling off period: one year period before a member of the audit engagement team can accept an employment at an audit client
• CEO and CFO must certify financial statements
• Established PCAOB- all firms must register and must be inspected either every year or 3 years depending on size of the firm
○ PCAOB has 18 standards: AS1 to AS18
AS 2201 is one of the most important standards

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19
Q

3 required committees on board

A

Audit committee
Compensation committee
Nomination and governance committee

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20
Q

PCAOB inspections

A

Inspect quality of individual audit engagements
Inspect the audit firm’s quality control system
Every year for >100 firms, every 3 years for small firms
50 to 70 engagements- Big 4 audit firm
20 to 40 engagements- mid-tier audit firm
1 to 6 engagements- small audit firm

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21
Q

Inspections- areas with frequent deficiencies

A 
Audit sampling procedures (i.e. sampling done improperly)
Revenues
Inventory and Accounts Receivable
Related party transactions
Internal control testing
Going concern assessments
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22
Q

Audit committee responsibilities

A

Oversee the financial reporting and disclosure process
Be responsible for the appointment, compensation and removal of the external auditor
Discuss with external auditor the nature and scope of the audit
Discuss problems arising from external and internal audits
Act as a buffer between auditors and management
Review interim and annual financial statements

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23
Q

Sequence of an audit (acceptance to completion)

A 
Client acceptance including engagement letter
Risk assessment
Audit plan
Test and evaluate internal controls
Substantive testing
Audit completion and reporting
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24
Q

Engagement letter

A

Contract that lines out auditor’s and management responsibility
Should NOT include audit procedures

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25
Tests of Internal Controls
``` Inquiry Observation Inspection Designed properly? Applied consistently? Who performs controls? ```
26
Substantive tests
Details of transactions and account balances
27
Transaction assertions
``` Occurrence Completeness Authorization Accuracy Cutoff Classification ```
28
Authorization assertion
All transactions are authorized by appropriate personnel
29
Accuracy assertion
Transactions are recorded in full amount without errors
30
Cutoff assertion
Transactions are recorded in the period in which they occurred
31
Classification assertion
Transactions are recorded in proper account
32
Balances assertions
Existence Completeness Valuation and allocation Rights and obligations
33
Rights and obligations
Recorded assets and liabilities are owned/owed by the company
34
AICPA code of conduct
General guidance: auditor should be honest, objective, competent, exercising due care Specific rules: Minimum standards of professional behavior
35
AICPA requires CPA (member) to__
Identify threats Evaluate significance of threats Apply safeguards
36
7 types of threats
Adverse Interest- c Advocacy- member endorses a client's service or product Familiarity Management Participation- a member will take management role during engagement Self-interest Self-review Undue influence
37
Sources of safeguards
Profession, legislation or regulation of auditors Clients (tone at the top) The audit firm policies
38
Auditor independence overarching question
Would a circumstance lead a reasonable person who is aware of all the relevant facts to conclude that there is an unacceptable threat to the member’s and the firm’s independence.
39
3 elements to professional skepticism
Attributes- knowledge, skill, ability Attitude- mindset, faith, integrity Actions- evaluate evidence All three must be met
40
Barriers to professional skepticism
Incentives and pressure to maintain clients Desire to avoid conflict, due to personal or professional characteristics Need to maintain a low audit fee, or desire to provide other services to a client Too much trust in the client Scheduling or workload demands
41
Ratio projection
Assume the auditor finds $1,500 in misstatements in a sample of $15,000. The misstatement ratio is 10%. If the population total is $200,000, the projected misstatement would be $20,000 ($200,000 × 10%)
42
Difference projection
Projects the average misstatement per item. Assume misstatements in a sample of 100 items total $300 (for an average misstatement of $3), and the population contains 10,000 items. The projected misstatement would be $30,000 ($3 × 10,000).
43
Audit risk definition and formula
The risk that the audit opinion is unqualified when the financial statements are materially misstated. Auditor sets the acceptable level. Inherent risk x Control risk x Detection risk
44
Detection risk
Risk that auditor will not detect misstatements. | Auditor can control
45
Business risk
an auditor's risk of financial loss and damage to professional reputation
46
Risk of material misstatement formula
Inherent risk x control risk
47
What determines Risk of material misstatement
``` Revenue has a higher RMM Industry, regulatory factors Nature of entity Internal controls Objectivity ```
48
Client business risk
Any factors, pressures, and forces that bear on entity's ability to survive and profit
49
Management preoccupation with earnings targets affects ________
Inherent risk
50
Securities offerings and acquisitions financed with equity including insider sales affects____
Inherent risk
51
Management compensation contracts incentives affects _____
Inherent risk
52
Going concern risks and financial distress affects _______
Inherent risk
53
Debt covenants and regulatory capital requirements affects _______
Inherent risk
54
Change in senior management, operating activities or economic environment affects ________
Inherent risk
55
Related party transactions affects ______
Inherent risk
56
Operating cycle assets and liabilities affects _____
Inherent risk
57
Attitudes of management and the AC towards internal control and corporate governance affects _____
Control risk
58
Honesty and competence of employees affects ______
Control risk
59
Formal structure and authorization procedures affects _______
Control risk
60
Adequate staffing of accounting and recordkeeping functions and employee turnover affects ______
Control risk
61
Volume of transactions affects ______
Control risk
62
Adequate segregation of duties affects _____
Control risk
63
3 important segregation of duties
Operational (sales) and Accounting Custody of Assets and Accounting Custody of Assets and Authorization
64
Gathering evidence for risk assessment
Inquiries of management- see how well management knows it works, and get an understanding of how well it works Analytical procedures- Assess risk of material misstatement due to error or fraud Observation and inspection
65
Response to risk assessment
Emphasize professional skepticism Properly assign responsibility to engagement team Sufficient supervision Insert an element of unpredictability in conduct of the audit
66
Deviation
Departure from adequate performance of internal control
67
Materiality
The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement. Requires professional judgement
68
Applying materiality steps
Determine materiality for overall financial statements (planning materiality) Determine tolerable misstatement (allocate materiality at individual account/class of transaction level) Evaluate audit findings against materiality for planning (end of the audit)
69
Quantitative materiality thresholds
3-5% of Income before tax, Income from continuing operations | 0.5% of total revenues, total assets
70
Qualitative factors that affect quantitative materiality
``` Company is close to violating loan covenants At or near break-even in earnings High management turnover Market pressures Risk of Bankruptcy ```
71
Audit evidence
All the information, whether obtained from audit procedures or other sources, that is used by the auditor in arriving at the conclusions on which the auditor's opinion is based
72
3 concepts to audit evidence
Nature (what is collected, accounting records, confirmations, etc.) Sufficiency and appropriateness of audit evidence Evaluation of audit evidence- unbiased, considers all evidence equally
73
Sufficiency of audit evidence
The quantity of evidence compared to what is needed, depends on risk of material misstatement
74
Steps of performing an audit
``` Observation Inquiry Inspection Confirmation Recalculation Reperformance Analytical Procedures ```
75
Audit Confirmation
Obtaining a representation of information of an existing condition directly from a third party Usually very reliable Required for A/R
76
Analytical procedures
Evaluation of financial information through plausible relationships Required in planning and completion
77
Evaluative procedures
Auditor compares results with prior periods, expected results, similar companies
78
Predictive procedures
Audit compares results to an expected amount he developed

Audit (5 decks)

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