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Flashcards in Audit Reports Deck (275):
1

What is Audit Sampling?

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

2

What are the requirements for an audit report?

Must conform to GAAP

Consistency with prior period reporting is implied (must state if inconsistent)

Adequacy of disclosure is implied (must state if disclosures are lacking)

Opinion is provided - provides assurance

Must be signed by the auditor- and dated.

2

What is the primary duty of an auditor?

To provide users of financial information with REASONABLE ASSURANCE that the financial statements are not materially misstated.

2

What is the majority of an auditor's work in determining an audit opinion?

Collection of evidence to support the opinion.

2

What does auditing internal control in a company's IT environment accomplish?

Plan the rest of audit - Shorter audit trails that may expire, Less documentation

Assess the level of Control Risk - Unauthorized access to systems or data is more difficult to catch

Systems access controls adds another layer to separation of duties analysis

Focus should be on the general controls, new systems development, current systems changes, and program/data access control or computer ops control changes

3

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

If internal control is poor and a company's accounting practices are sloppy, which risk is higher?

Control risk increases with poor internal control and sloppy accounting practice.

3

Who created the International Auditing Standards?

The International Auditing and Assurance Standards Board (IAASB)

Member of the International Federation of Accountants (IFAC)

3

What engagements are covered by the AICPA Code of Professional Conduct?

Covers all professional engagements and is the minimum standard of conduct

Member should additionally follow specific standards for a specific engagement

4

How should an audit report be adjusted if reporting is not consistent with the prior period?

If inconsistent- an Unqualified Opinion is OK

Explanatory paragraph after Opinion is added

Otherwise - Qualified Opinion issued

4

What is the auditor's responsibility for detecting theft or fraud?

Auditors are *not* responsible for detecting theft or fraud.

Instead, they are responsible for providing REASONABLE ASSURANCE that the financial statements are not materially misstated.

4

Of what does audit Evidence consist?

Evidence consists of client accounting data and supporting documentation from client or from third parties.

4

When is an audit of IT NOT required?

Controls are redundant to another department

The system doesn’t appear to be reliable and testing controls wouldn’t be an efficient use of time

Costs exceed benefit

4

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.

5

What are the characteristics of Non-Statistical Sampling?

Based on human decision

Equally acceptable as Statistical Sampling

5

When is consistency not violated with respect to changes in reporting between years?

Accounting Errors

Reclassifications

Prospective treatment of a new principle

Accounting Estimate Change

5

For whom were IAASB International Auditing Standards created?

IAASB standards are for countries that don’t have their own standards and help set the tone for the rest of the members who do have their own standards (AICPA)

IAASB doesn’t override member standards

5

What must an accountant have under the AICPA Code of Professional Conduct?

Integrity
Objectivity
No Conflicts of Interest
No known misrepresentations of facts
No outsourcing of judgment

6

When should an auditor be hired in relation to the balance sheet date for optimum audit planning and efficiency?

The earlier the auditor is hired, the better for audit planning and efficiency.

6

What is the relationship between Evidence and Detection Risk?

Evidence has an inverse relationship with Detection Risk

The one aspect of Audit Risk an auditor can control through (N)ature, (T)iming, (E)xtent of audit procedures.

Inherent Risk and Control risk are outside of auditor’s control.

6

When can an audit of IT be performed without directly interacting with the system?

System isn’t complex/complicated

System output is detailed

6

For what does internal control provide reasonable assurance?

Internal control provides reasonable assurance that:

Material misstatements will be prevented

Reliability/integrity of financial statements will be preserved

Assets are protected against misuse

6

What financial approach is used under IAASB audit standards?

IAASB standards are based on a risk assessment approach

7

What are the characteristics of Substantive Tests?

Variables sampling

Probability proportionate to size sampling

7

What assurance is provided in an audit opinion?

The opinion states that the financial statements are fairly presented in all material respects

The opinion states if the financials are in conformity with GAAP.

7

When can audit procedures be performed at interim dates?

If Control Risk for the accounts and/or transactions is low, audit procedures can be performed at interim dates.

The auditor then reviews changes in the balances at year-end.

7

What are threats and safeguards to independence?

Safeguards > Threats = Independence

Threats > Safeguards = No Independence

8

Which aspects of Audit Risk can an auditor control?

Detection Risk, which is decreased by gathering evidence.

8

What is the role of a Database Administrator?

Maintains database

Restricts access

Responsible for IT internal control

8

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 Conrol

Management must certify Financial Statements

10

How do IAASB audit standards compare to US audit standards?

IAASB = No Internal Control audits

IAASB = No Referencing another Audit Firm

IAASB = Less detailed documentation

IAASB = Required: obtain written fraud assessment

IAASB = Required: location of auditor’s home office

12

What are the threats to independence?

Self-Review (Auditing own work)

Advocate of the Client

Adverse Interest (Lawsuit against Client)

Too familiar with Client – could impair the appearance of Independence to public

Undue influence on Client - On Board of Directors, exception being an Honorary board position

14

What type of sampling are Control Tests?

Attribute Sampling

16

What are the sections of the audit report?

Title - States that the auditor is independent

Address - whomever hired the auditor

Introduction Paragraph

Scope Paragraph

Opinion Paragraph

Signed and Dated by Author

18

When can an auditor accept an engagement offered after the year is already closed?

The auditor can take the engagement if they are able to overcome the limitations of the engagement.

20

Which aspects of Audit Risk can an auditor NOT control?

Inherent Risk and Control Risk are outside of an auditor's control.

22

What is the role of a Systems Analyst?

Recommends changes or upgrades

Liaison between IT and users

24

What is the relationship between internal control and Substantive Testing?

Inverse Relationship:

Stronger Internal Controls = Less Testing Needed

Weaker Internal Controls = More Testing Needed

26

What are International Ethical Standards?

Standards set by International Ethics Standards Board for Accountants (IESBA)

Code of Ethics for Professional Accountants - Similar to AICPA Code of Professional Conduct

28

What are the Safeguards to independence?

Offset the threats

Safeguards are created by Legislation (SOX), Client (Audit Committee), Accounting Firm (Policies)

30

What is Sampling Risk?

Risk that your sample isn’t representative of population

Can happen even if audit is done properly

32

Which statements are included in the Scope Paragraph of the audit report?

GAAS was followed (IF SEC company, use the standard of the PCAOB)
Reasonable assurance about material misstatements was obtained.
Financial statements and disclosures are supported by evidence.
Management estimates evaluated
Accounting principles evaluated
Financial Statement presentation evaluated
Reasonable basis exists for an opinion

If any scope limitations exist, the auditor tries to work around them and still issue an unqualified opinion if possible.

34

For what does an auditor use professional skepticism?

To plan the scope of the audit

To plan the objectives of the audit

36

How does a high level of acceptable Detection Risk affect an audit?

Less Evidence collected. Opens door for incremental audit risk - Internal Control should be strong.

Business and transactions should be relatively stable and predictable.

(N) Less-competent Evidence collected
(T) Interim testing acceptable
(E) Fewer transactions are verified.


38

What is the role of the data Librarian?

Responsible for disc storage

Holds system documentation

40

What are the three objectives of internal control?

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

42

Which groups are covered under the three sections of the International Ethical Standards?

A) Covers all accountants

B) Covers Public accountants

C) Covers accountants in a business environment

44

What are the characteristics of a Covered Member?

On the engagement team, have Significant influence on Audit, such as:

Reviewing Partner
Managing Partner in CPA Firm
Firm Personnel who does more than 10 hours of non-attest work (Income Taxes)
Partner sharing office with another Partner who oversees an engagement
Financial Interest in Client by Covered Member (Auditor on Engagement)

46

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

48

For an unqualified opinion to be issued- what must be the case with all periods presented?

A prior year’s Financial Statement used for comparative purposes must also meet criteria for an Unqualified Opinion

If an exception arises- the Explanatory and Opinion paragraphs will address the issue

If a prior year’s issue has been corrected- issue an Unqualified opinion and ignore the past issue

50

How can analytical procedures be performed in audit planning?

The auditor can compare actual versus forecasted numbers.

52

What should occur when a low level of Detection Risk is acceptable?

More Evidence collected

(N) More-competent Evidence collected
(T) End of year balance testing
(E) More transactions are verified

53

What is the benefit of Generalized Audit Software in an audit?

Uses computer speed to quickly sort data and files, which leads to a more efficient audit

Compatible with different client IT systems

Extracts evidence from client databases

Tests data without auditor needing to spend time learning the IT system in detail

Client-tailored or commercially produced

54

What are the five components of internal control?

Control Environment

Risk Assessment

Information and Communication

Monitoring

Control Activities

55

What are the requirements for all accountants under the International Ethical Standards?

Accountants should have Integrity
Accountants should be Objective
Accountants should have Competence
Accountants should exercise Due Care
Accountants should maintain Confidentiality
Accountants should act Professionally

56

What are the requirements for a Covered Member?

No direct financial interest

No Material indirect financial interest

Firm personnel who are not Covered Members cannot own more than 5% of stock

Covered Member's immediate family cannot own more than 5% of stock or be employed in Key positions. If Covered member is aware of this, it will impair independence.

Cannot make management decisions.

All requirements apply during the period of the professional engagement, and as long as they are a client.

57

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

58

What is included in an unqualified opinion paragraph with an emphasis?

Includes:

Immaterial GAAP issues
Going Concern worries
Auditor shares responsibility
Emphasizing a particular aspect of Financial Statements
Unqualified Opinion/Assurances not affected

Explanatory paragraph added after opinion

59

What must an auditor have in order to discuss issues relating to a predecessor auditor's work?

If issues relating to predecessor auditor’s work on previous Financial Statements come up during the current audit, Auditor must have client’s permission to discuss the issue.

60

What are the primary risks in an audit for a typical for-profit company?

Auditors are there to verify that

Assets & Revenues are not overstated
Expenses & Liabilities are not understated

Exception – if the CPA Exam states that it is a “tax-driven” company, flip them around

61

What is a Relational Database?

Group of related spreadsheets

Retrieves information through Queries

62

What is the purpose for a control environment assessment?

Sets tone for the entire company

63

What questions should public accountants pose to themselves under the International Ethical Standards?

What are the threats/safeguards?
Does this new client threaten our ethics?
What are the conflicts of interest?
What are the threats/safeguards for offering a second opinion?
What are the threats/safeguards for receiving commissions or contingent fees?
Is our marketing truthful?
What are the threats/safeguards for receiving client gifts?
What are the threats/safeguards to objectivity?

64

What happens when a Covered Member disagrees with a Supervisor?

If Supervisor's position is still GAAP/GAAS, defer to Supervisor

If Supervisor's position is not GAAP/GAAS, report to higher levels of management

If management ignores you, consider leaving the firm

65

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, undertesting, 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

66

What is the effect of a qualified opinion?

A qualified opinion creates reduced assurances.

It results from scope limitations or major inconsistencies.

It includes material problems with GAAP- disclosures- or segment reporting.

If there is an issue that causes a Qualified Opinion- the explanatory paragraph goes after the Scope and before the Opinion paragraphs and the Opinion paragraph refers to the issue as well.

67

What questions must an auditor ask with respect to procedures carried out by assistants?

Were they adequately performed? (Review the working papers)

Are the results consistent with the audit report?

68

What is the primary constraint on audit evidence?

Cost vs. Benefit is a primary constraint.

69

What is a Data Definition Language?

A language that defines a database and gives information on database structure.

It maintains tables, which can be joined together.

It establishes database constraints.

70

What are the components of the Control Environment?

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

71

When is independence required?

Audit

Review

Attestation Engagement

72

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

73

How is the audit report changed if there is Scope Limitation?

Qualified opinion is issued.

Scope paragraph modified

Explanatory paragraph between Scope and Opinion paragraphs

Opinion paragraph points out scope limitation

74

How is audit strategy mapped out?

Auditor determines what the reporting objectives are.

Auditor determines the scope of the audit.

75

What characteristics should audit evidence have?

Sufficient (quantity)

Appropriate: Relevant & Reliable (Quality)

76

What functions are performed by a Data Manipulation Language?

Maintains and queries a database

Auditor needs information, so client uses DML to get the information needed

77

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

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

78

What are the requirements for Non-attest engagements?

Agreement must be in writing.
Independence not required - Must state if you are not independent

Applicable engagements: Consulting, Compilation

79

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

80

How is the audit report modified for major inconsistencies found during the audit?

Qualified opinion is issued.

Scope paragraph remains unchanged

Explanatory paragraph between Scope and Opinion paragraphs

Opinion paragraph points out inconsistency

81

What are the foundations of Generally Accepted Audit Standards (GAAS)?

Materiality and Audit Risk

82

How does the quality of audit evidence vary depending on who has provided it?

Best evidence: Observation of activity by auditor.

2nd Best: Originates from External Parties and is sent directly to auditor (or failing that, items are generated by third party and provided to auditor by the client, such as a bank statement)

Weakest: Oral evidence from management.

83

What functions are performed by a Data Control Language?

A Data Control Language controls a database and restricts access to the database.

84

What determines the acceptible level of Detection Risk?

Risk of material misstatement determines acceptable level of Detection Risk

85

Which standards apply to consulting engagements?

Consulting engagements are covered by Statements on Standards for Consulting Services (SSCS)

Requirements: Competence, Due Care, Planning, Supervision, Obtain Sufficient Data, Must Serve Client Interest, Must have written or oral agreement, must communicate with client.

86

What is Non-Sampling Risk?

Risk of human (auditor) missing an error

Also called exception, error or deviation.

87

How does a Disclaimer of Opinion affect the audit report?

States that an opinion cannot be issued.

Creates negative assurances

Includes severe Scope limitation

88

What are the General Standards for auditing?

Training and Proficiency (Education and Audit Experience)

Independence

Due Professional Care

(TIP)

89

Which documents are the most persuasive and credible?

Third party documents are more persuasive and credible than internally-prepared docs

Auditor Knowledge = Most Persuasive

3rd Party info given to auditor

3rd Party info given to client

Internally-prepared doc

90

What are Check Digits?

A numerical character consistently added to a set of numbers.

It makes it more difficult for a fraudulent account to be set up or go undetected.

91

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.

92

List some common consulting engagements.

Advisory Services

Transaction Services

Management Consulting

Implementation Services

93

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

94

What would cause an Adverse Opinion?

Very material GAAP and Disclosure issues would cause an Adverse Opinion.

If there is an issue that causes an Adverse Opinion- the explanatory paragraph goes after
the Scope and Before the Opinion paragraphs and the Opinion paragraph refers to the issue as well

95

Describe the key components of maintaining auditor independence.

Auditor must be independent in fact and appearance

Honesty

No direct financial interest

No indirect material financial interest

96

What are Substantive Procedures?

Test substance/amounts/values. They help to reduce the risk of material misstatements. They only test accuracy of financial statements and dollar amounts - they don't test internal controls.

97

What is the purpose of a Code Review?

A Code Review tests a program’s processing logic.

Advantageous because auditor gains a greater understanding of the program.

98

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.

99

What is the rule concerning contingent fees for a covered member?

Not allowed if Member also performs services where independence is required

Commissions or referral fees for Covered Members are not allowed

Example – Audit firm gets a commission for recommending to Client that they implement a new A/P System...NOT Allowed

If a firm performing non-attest work doesn't also perform Covered Member services (aka – Independence not
required), then Firm can get a commission on referring products/services, but they must disclose to the Client

Tax Preparation - Payment according to refund amount is disallowed

100

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.

101

How is division of auditor responsibility disclosed?

Disclosed in Introductory Paragraph.

Doesn't name the other auditor without permission.

Referenced in Opinion paragraph and division of responsibility indicated

If other auditor is not referenced- then you take responsibility for their conclusions- so consideration of independence- experience- credentials- etc required

102

Describe Due Professional Care

Technical abilities mirror those held by peers in the profession
Follow GAAS Standards
Obtain a Reasonable Level of Assurance
Maintain Reasonable Level of Skepticism
Supervise Audit Staff
Review judgment at every level

103

What are the substantive tests that are most often performed?

Trace (or Vouch)
Reconcile
Analytical Procedures
Confirmations
Examine evidence that supports management assertions.

(T.R.A.C.E.)

104

What is the purpose of a Limit Test?

Examines data and looks for reasonableness using upper and lower limits to determine if data fits the correct range.

Did anyone score higher than 100%?

105

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

106

When are contingent fees allowed?

When fees are structured relative to judicial proceedings.

Example: IRS audit, or filing an amended tax return subject to tax case with a different taxpayer.

107

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

108

What standards govern SSARS engagements?

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

109

List the Standards of Field Work

Planning and Supervision
Internal Control
Evidence

(PIE)

110

When performing audit procedures, what should auditors focus on?

Auditors focus first on Balance Sheet Accounts, then associated Income Statement items

111

What is the Test Data Method?

Auditor processes data with client’s computer - fake transactions are used to test program control procedures.

Each control needs to only be tested once

Problem with this method - fake data could combine with real data.

112

Describe some common examples of Control Activities.

Performance Reviews

Information Processing

Physical Controls

Segregation of Duties

113

How should recommendations and suggestions by a covered member to a client be handled?

Client must carry them out - covered member cannot perform management functions.

Client must assign someone of competence to oversee the non-attest engagement and CPA must be satisfied that this has occurred.

114

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

115

Which clients can have compilation engagements?

Non-SEC (non-public) registrants only.

116

List the Standards of Reporting

Consistency
Disclosures
Opinion
GAAP

(CDOG)

117

How is Cash audited?

Assurance Level is High.

Acceptable Detection Risk is Low.

118

How can Operating Systems Logs be utilized during an audit?

Auditor can review logs to see which applications were run and by whom.

119

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

120

What are the requirements for Personal Financial Planning Engagements?

Must have definite objectives

Must have specific procedures planned

Must have a basis for recommendations

Must have recommendations communicated

Must have action steps to implement

121

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

122

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.

123

What should an auditor do prior to accepting an audit engagement?

Review the previous financial statements

Speak to third parties

Contact predecessor auditor to evaluate whether engagement should be accepted (must have client permission)

124

How is Accounts Receivable audited?

If Acceptable DR is High - Negative Confirmation is used - Customer only responds if balance is materially wrong.

If Acceptable DR is Low - Positive Confirmation is used - Customer asked to confirm by telling auditor the balance.

Corresponding Income Statement Account - Revenue

125

What is the purpose of Access Security Software?

Helpful in online environments

Restricts computer access - may use encryption.

126

How must an auditor document understanding of internal control?

Through written documentation such as internal control memos, flowcharts, and questionnaires

127

When is a GAAP departure appropriate?

Departure from GAAP is appropriate if GAAP would cause Financial Statements to be misleading, then it must be explained/disclosed.

128

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

129

What disclosures are required for Compilation engagements?

Disclosures not necessary – must state that they are not included

130

What questions should be asked by an auditor prior to taking an engagement?

Note: must have permission of client to contact predecessor auditor (no permission = no engagement)

Why the Auditor Change?
Any Serious Discussions with Audit Committee?
How is Management Integrity? Disagreements?
How was Internal Control?
Understand Industry or Be Willing to Learn
Consider Scope Limitation - Limited evidence available = no engagement

131

How is Accounts Payable audited?

Review purchase orders/invoices

Confirm with Vendors

Corresponding Income Statement Account – Various Expenses

132

How can Library Management Software assist with an audit?

Library Management Software logs any changes to system/applications etc.

133

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?

134

When may a covered member disclose confidential information?

Member may disclose confidential info when client isn't following GAAP

OR

If they receive a subpoena – CPAs are not Attorneys, so there is no CPA-Client privilege

135

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

Used to determine initial level of Control Risk

136

What standards govern Review engagements?

SSARS (Statements on Standards for Accounting and Review Services)

137

What should be included in an audit engagement agreement?

Note: must be written

Objectives of Engagement
Limitations of Engagement
Responsibilities of Management - Provide written assertions
Responsibilities of Auditor - Limited error/fraud responsibility
Expectations of Access to Records
Financial Statements (and Disclosures) are Management’s Responsibility
Compliance with Laws
Internal Control

138

How is Inventory audited?

Examine purchase agreements

Look at Board Minutes

Is Inventory held as collateral?

Corresponding Income Statement Account – COGS

139

How can Embedded Audit Modules in software be utilized in an audit?

Assist with audit calculations

Enable continuous monitoring in an audit environment that is changing

Weakness: requires implementation into the system design

Example: SCARF - Collects information based on some criteria and can be analyzed at a later time (necessary because the audit environment is continually changing)

140

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

141

What is the effect of not returning all client-provided documents upon request?

This is an act discreditable.

You MUST return all documents the client gives you even if they don't pay their bill.

If you create a document, however, like a work paper, you are not required to give the client a copy of papers you created if they haven't paid their bill

They are the firm's work papers, but are still confidential!

142

What is the Allowable Risk of Overreliance?

Risk of Assessing Control Risk too low

Gives you the Sampling Risk

143

What type of assurance is given in a Review engagement?

Reviews give limited assurance.

144

What is management's responsiblity with respect to the financial statements?

Management is responsible for financial statements and adequacy of disclosures.

Presentation & Disclosure
Existence (Tests Overstatements)
Rights & Obligations
Completeness (Tests Understatements)
Valuation & Allocation

145

How are beginning balances audited?

Should match last year's ending balance.

146

What is an Audit Hook?

An Audit Hook is an application instruction that gives auditor control over the application.

147

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

148

What are the rules with respect to CPA firm names?

CPA firm names must not be misleading.

If partner dies, remaining partner has two years to change name if partnership dissolved. If partner dies and more than one partner still remains (i.e. 1 dies and you still have 2 or more partners...you don't need to change the name)

All Partners/Shareholders must be members of the AICPA in order to hold themselves out as members of the AICPA. Non-CPAs can be owners, but 2/3 of Ownership must be CPAs. Non-CPA owner must not be involved with the accounting, and is still bound by AICPA code of conduct, must maintain CPE requirements and have Bachelor's degree.

149

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

150

What procedures are required for Review engagements?

Analytical procedures are required for reviews.

Compare results to documented predictions.

151

What is the purpose of the Audit Committee?

Responsible for Hiring Auditor

Oversees Internal Control

Must Agree with Auditor on: Responsibility of the Parties, Audit Fee, Timing of the Audit, Audit Plan

Acts as Liaison Between Auditor and the Board

Auditor Communicates Concerns about: Internal Control Deficiencies, Errors, Fraud, Illegal Activities

152

What is the general presumption for auditing Ending Balances?

If Beginning Balance, Additions, Subtractions are OK, then Ending Balances should also be OK.

153

What is the purpose of Transaction Tagging?

Transaction Tagging allows logging of company transactions and activities.

154

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

155

What is the consequence of disclosing CPA exam material post-1996?

It is an Act Discreditable.

156

What is Classic Variable Sampling?

Testing for a dollar amount

Value in sample gives information about value in entire population.

157

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.

158

How is Audit Risk calculated?

Inherent Risk x Control Risk x Detection Risk

Risk that material mistakes, errors, omissions, or fraud will result in an inaccurate audit report

Based on Auditor Judgment

Measured in both Qualitative and Quantitative

159

How is a Statement of Cash Flows audited?

Foot all balances – Check the Math

Trace Cash Flow items to other Financial Statements

Check classifications - Operating Activities, Investing Activities, Financing Activities

160

How do Extended Records assist in audit trail creation?

Extended Records add audit data to financial records.

161

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.

162

What are the consequences for a CPA who commits an Act Discreditable?

Licenses are granted at the State level
If State revokes certificate, AICPA Ban
Felony Conviction, AICPA Ban
Prepares Fraudulent Tax Return, AICPA Ban
Intentionally failing to file return, AICPA Ban
SEC can get involved with discipline

163

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

164

What is a Forecast?

A prospective financial statement that uses normal circumstances.

General and limited use allowed.

165

Describe Control Risk

Risk that internal control will not detect error or fraud

Auditor cannot control this.

166

Under the Indirect Method, what must be disclosed on a Statement of Cash Flows?

Interest Paid

Income Taxes Paid

Non-cash Transactions

Cash and Cash Equivalents Definitions

167

How does Real Time Processing affect an audit?

Destroys prior data when updated

aka “Destructive Updating”

Requires well-documented Audit Trail

168

What does Tracing test?

Tests Completeness

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

169

What are the functions of the PCAOB?

Monitors CPA Firms who audit SEC clients - All SEC Audit firms must register

Issues standards for firms to follow - usually stricter than AICPA standards

170

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

171

What is a Projection?

A prospective financial statement using hypothetical situations.

Only limited use by the client is allowed.

172

Describe Inherent Risk.

Which transactions have a higher level of risk?

Auditor cannot control

173

Under the Direct Method, what must be disclosed on a Statement of Cash Flows?

Results as if you had used Indirect Method

Non-cash Transactions

Cash and Cash Equivalents Definition

174

What is the risk of auditing System outputs versus Application outputs?

If the auditor only audits the outputs of a computer system and doesn’t also audit the software applications, an error in the applications could be missed.

175

What does Vouching test?

Tests Existence.

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

176

When is independence impaired under PCAOB standards?

If Client pays a contingent fee (i.e. based on outcome)

With Marketing or Planning engagements

Aggressive Tax Strategies

Firm does tax work for Client employee involved with audit oversight or their
family

177

What is Projected Misstatement?

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

178

What are the requirements for Agreed Upon Procedures?

Independence is required

Only limited use by the client is allowed.

179

Describe Detection Risk.

Will the auditor fail to detect a material misstatement?

Auditor CAN control

Do testing at year-end
Increase substantive testing
Run more effective tests

180

What are Subsequent Events, and what do they require?

Subsequent events occur after the Balance Sheet Date, but before the audit report is issued.

Auditor needs to make inquiries and assess if they affect the audit report.

181

What is a Compiler?

Software that translates source program (similar to English) into a language that the computer can understand

182

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 exist, use Observation and Inquiry

Accounting should be segregated from Production

183

Who must approve non-audit work performed by a firm for a client?

Client Audit Committee must approve non-audit work performed by Firm

Firm must disclose any potential independence issues to Audit Committee

184

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

185

What disclosures are required for remote likelihood of losses?

No disclosure required.

186

What responses should an auditor take based on different levels of acceptable detection risk (DR)? What type of tests should be performed?

Less Acceptable DR = Run More Substantive Tests

More Acceptable DR = Run Less Substantive Tests

More Substantive Tests (DR down) = Less Audit Risk; (AR = IR x CR x DR)

Less Substantive Tests (DR up) = More Audit Risk; (AR = IR x CR x DR)

187

What should occur if the audit report has already been issued and the auditor becomes aware of a situation that was present as of the Balance Sheet date (a subsequent event)?

If audit report has already been issued and auditor becomes aware of a situation that was present as of the BS date, client should issue a disclosure to financial statement users and/or revise the financial statement.

Regulatory agencies might need to get involved under some circumstances.

188

How is Parallel Simulation utilized during an audit?

Client data is processed using Generalized Audit Software (GAS)

Sample size can be expanded without significantly increasing the audit cost

GAS output compared to client output

189

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 – 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

190

Which organization is in charge of determining if federal funds are being misappropriated?

GAO - Government Accountability Office

191

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.

192

What disclosure is required for a probable loss contingency?

Accrue if estimable.

Explanatory paragraph if not estimable.

193

What are quantitative measurements versus non-quantitative measurements with respect to risk?

Quantitative Measurements - Inherent, Control, and Detection Risk can all be measured in terms of percentages

Non-Quantitative Measurements - Inherent, Control, and Detection Risk can all be measured in terms of acceptable ranges

194

What should an auditor do if they discover they have forgotten to perform a substantive procedure?

If auditor discovers that they forgot to perform a substantive procedure, auditor should determine if other substantive procedures performed served as a substitute.

Otherwise support for their audit opinion could be jeopardized.

195

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

196

What rules must auditors follow for governmental audits?

Auditors must follow both GAAS and GAS – aka the “Yellow Book”
Materiality threshold is usually lower
More detail is required on working papers
More stringent CPE rules and requirements - 24 hours of continuing education must be related to governmental auditing every 2 years
Compliance with Regulations is a requirement of the Audit Report

197

What is the formula for Audit Sampling?

SER + ASR < TER

SER = Sample Error Rate

ASR = Allowance for Sampling Risk

TER = Tolerable Error Rate

198

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

Auditor assesses need for explanatory paragraph based on loss likelihood.

199

Whose responsibility is it to FIND and PREVENT fraud?

It is Management's responsibility.

200

When are Analytical Procedures required?

REQUIRED When planning the audit (preliminary)

REQUIRED When reviewing the audit (final)

Analytical procedures may be also performed optionally along with the substantive testing.

Use of Analytical Procedures in the audit must be documented.

201

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

202

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.

203

How is a gain contingency reported?

Gain contingencies are not reported.

204

What is the auditor's responsibility with respect to fraud and illegal acts?

Assess the RISK that such things will lead to material misstatements

Design the audit to provide reasonable assurance against fraud, illegal acts that directly and materially affect the financial statements

Report ALL management fraud to the audit committee (minor fraud by low-level employees not reported to committee)

Perform required inquiries and procedures (management inquiries, analytical procedures, discussions with audit personnel about fraud)

205

How do Analytical Procedures assist the auditor?

Helps the Auditor:

Determine if Management Assertions are reasonable

Develop audit plan

Develop some expectations about the financial statement and hopefully bring to light any glaring errors on financial statement

206

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

207

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

208

How does an immaterial GAAP issue affect the audit opinion?

It doesn't. Opinion is unqualifed.

209

What are the three factors that affect/influence fraud?

Fraud is born out of:

Rationalization
Incentive
Opportunity

(RIO)

210

What is the focus of Analytical Procedures?

Analytical Procedure focus is on dollar amounts (not internal controls)

Analyzes Financial Data: Do Financial Statements Make Sense?

Comparison of data between years

211

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”

212

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

213

How does a material GAAP issue affect the audit opinion?

Qualified Opinion is issued.

Similar to Scope Limitation.

Explanatory paragraph after Scope Paragraph.

Opinion refers to GAAP issue.

214

What is the difference between fraud and errors?

Errors are unintentional, fraud is intentional.

215

How is the Current Ratio calculated?

Current Ratio = Current Assets / Current Liabilities

216

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 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

217

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

Perform the Sampling Plan

Evaluate Results

Document Results

218

How does a very material GAAP issue affect the audit report?

Adverse opinion is issued.

Same paragraph structure as a Qualified opinion.

219

What red flags may indicate higher risk in an audit?

Management compensation tied to stock
Aggressive financial forecasting
Former auditor disagreed with Management
Records not available for audit

Current audit procedures may need to be reconsidered if red flags exist.

220

How is the Quick Ratio calculated?

Quick Ratio = Liquid Assets / Current Liabilities

221

What is a Control Deficiency?

A control is not operating as intended

Written report to management not required

222

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

223

How does a Going Concern issue affect the audit report?

Unqualified opinion with an Emphasis is OK

Explanatory paragraph is added after Opinion paragraph.

224

Describe the characteristics of a Fraud Risk Factor.

Has been observed in similar situations

Does NOT necessarily mean that there is a material weakness in internal control

Leads to an auditor taking action

225

How is the Asset Turnover calculated?

Asset Turnover = Net Sales / Average Assets

226

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

Are the competent?

Are the objective?

227

What is Sequential Sampling?

Also called Stop or Go sampling

Each audit step determines the next step

228

What is a Yellow Book audit?

An audit performed under governmental auditing standards (GAS).

229

What does an examination of internal control accomplish with respect to illegal acts?

Internal control analysis can result in the conclusion that IC is weak, but probably won’t identify illegal acts

230

How is the Inventory Turnover calculated?

Inventory Turnover = COGS / Average Inventory

231

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

232

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?

233

How do GAS standards compare to GAAS?

GAS is more strict that GAAS.

234

What is the purpose of adjusting audit procedures in light of fraud risk factors identified during an audit?

Strives to make audit engagement procedures less patterned and predictable

Re-evaluates management’s application of accounting procedures

Finds and assigns audit personnel with relevant skills in this area

235

How is Gross Margin % calculated?

Gross Margin % = Gross Margin / Sales

236

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

237

How does Block Sampling compare to other sampling methods?

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

238

What is required under the Single Audit Act?

A report on internal control is required.

GAAS and GAS don't require the I/C report.

239

What should be documented with respect to fraud risk factors in an audit?

Any fraud risks identified that could lead to material misstatement

Audit procedures performed to assess risks

Nature of communication made to audit committee and company management

Disclosure to third parties regarding fraud not normally the auditor’s responsibility

Fraud by management should normally be reported to the audit committee, NOT the SEC.

240

What type of testing are ratios?

Ratios are Analytical Procedures

241

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

242

What was the effect of the SOX Act of 2002?

Created PCAOB

Designates Officer responsibility for internal control

Must disclose significant internal control weaknesses to auditor and audit committee

Must disclose any level of fraud discovered by employees with internal control responsibilities

243

What type of procedure is a Budget vs. Actual comparison?

Budget vs. Actual comparisons are Analytical Procedures.

244

What are the three objectives of internal control?

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

245

What is the Hierarchy of Authoritative Literature?

1. Statements on Auditing Standards (SAS)

2. Auditing Interpretations, AICPA Guides & SOPs

3. Industry Articles (no authority)

246

List Common Types of Analytical Procedures

Ratio analysis

Budget vs. Actual comparison

Comparison of data between years

Use of non-financial data to predict expected values for financial data

247

What are the five components of internal control?

Control Activities

Risk Assessment

Information and Communications

Monitoring

Control Environment

248

What quality control activities are undertaken by CPA firms with audit practices?

Firm Leadership exhibits quality and leads by example and sets the tone for the organization

Firm should Monitor and document that its policies and procedures are being followed

Firm should have Relevant Ethical Requirements

Acceptance and continuance of client engagements should continue to be evaluated for client integrity, auditor competency, and legality

Firm should have competent and ethical personnel

Firm engagements are performed, supervised, and reviewed in accordance with professional standards and regulations.

249

How do management asssertions affect the audit?

Management assertions help the auditor to plan the audit and select substantive tests.

250

What are the components of the Control Environment?

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


251

Which literature governs Compilation services?

SSARS - Statements on Standards for Accounting and Review Services

These govern reporting for non-public entities only

252

What assertions do auditors test?

Presentation - Cutoff, Classification - Is it in the right period and category?
Existence/ Occurrence - Did it happen? Does it exist?
Rights & Obligations - Does the company own them?
Completeness - Was everything recorded?
Valuation - Are they worth the amount at which they are recorded?

(PERCV)

253

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

254

What is the independence requirement for Compilations?

Independence NOT required for Compilations

No Internal Control work allowed

No assurance given

255

What assertions are tests for transaction classes?

Occurrence

Cutoff

Classification

Completeness

Accuracy

256

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

257

What type of assurance is provided by a Compilation?

Compilations are not an assurance service. No assurance is provided.

258

For which assertions are disclosures tested?

Occurrence

Completeness

Classification

Accuracy

259

How must an auditor document understanding of internal control?

Auditor must document understanding of Internal Control via Memos, Flowcharts, and Questionnaires

260

What type of assurance is provided by Review services?

Reviews provide NEGATIVE assurance.

261

Is testing the validity of direct evidence a basic audit procedure?

No, it is an extended procedure.

For example, you don’t have to take a loan covenant document and go search out that it’s a valid loan covenant. Instead, you consider the source – if it’s externally prepared, it’s more persuasive.

262

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

263

What is the independence requirement for a Review?

Reviews require independence.

No Internal Control work allowed
Performs analytical procedures
No material indirect financial interest allowed
No immaterial direct financial interest allowed

264

How are Management Estimates audited?

First and foremost, you need to understand management’s rationale and methods for developing estimates before you can judge reasonableness.

Next, Auditor should formulate their own opinion on what a good estimate should be and compare it.

Finally, determine if subsequent events affect the estimate.

265

For compilations and reviews, what knowledge must a service provider have?

Must have an understanding of the client industry.

266

Whose property are audit documentation (audit workpapers)? In what form must they be?

Audit workpapers are the property of the auditor.

They can be paper or electronic.

They must include a WRITTEN audit program (either paper or electronic).

267

What are attestation services?

CPA expresses a conclusion about an assertion - Compliance with laws

NOT considered a Consulting engagement

Independence Required

268

What is the Current File?

Information pertaining to the current year's audit.

269

What is the independence requirement for consulting services?

Independence is not required for consulting services.

270

What is the Permanent File?

Information used for this audit and future audits, which is updated as needed.

271

Describe the limitations on Prospective Financial Statements?

Report is restricted to specified users.

Agreed-upon procedures are implemented.

272

How long must audit workpapers be maintained?

Must be kept for 5 years after the audit release date or according to regulations, whichever is longer.

Must be kept for 7 years under PCAOB Audit

PCAOB audits also require an Engagement Completion Document

273

What is the primary requirement for audit workpapers, besides being written?

Any experienced auditor should be able to look at your work and understand what you did.

274

How should documents added to work papers be treated?

If further documents are added to the work papers after the audit report is issued, it must be documented as to who added them, why they were added, and any effects on the audit report.

275

How should documents removed from workpapers be treated?

After the audit report is released, the firm has 60 days to subtract from the file.

You can still add to the file if you document it, but you cannot delete any information after 60 days.

Note – for SEC auditors, the PCAOB only allows deletions up to 45 days after issuance of the audit report.