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Flashcards in Audit Risk and Materiality Deck (37):

What is an auditor's responsibility in connection with indirect-effect illegal acts?

No responsibility however is it is discovered should be investigated and may need to be disclosed.


What are some questionable events that should alert the auditor to a possible indirect-effect illegal act?

violation of EPA laws

insider trading

civil rights laws

federal employee safety requirments


What is audit risk and why is there a certain level of risk inevitably in every audit?

Audit risk is the possibility that a material misstatement will occur and be reported in an entities F/S.

Due to the reasonable assurance provided there is always some risk a material misstatement will be present in an entities F/S.


What are the three components of audit risk and an explanation of each?

Inherent Risk - the possibility that a material misstatement will occur within the reporting entities accounting info system

Control Risk - the possibility that the company's internal control will not prevent or detect a material misstatement

Detection risk - the possibility that a material statement that has occurred will not be discovered by the auditor's testing


Which audit risk component are company characteristics assessed by the auditor and which will vary based on the work performed by the auditor?

IR and CR - company characteristics assessed by the auditor

DR - vary based on the work performed by the auditor


What types of factors would cause the auditor to assess IR at a relatively high level?

First audit

continuing audit where misstatements were encountered in previous audits

the presence of numerous estimations, large balances, and/or many transactions, some of which are complex

outdated and unsupported accounting information systems

understaffed accounting department or accountants with little training or experience

unexplained significant variations discovered during analytic procedures


How does a high IR impact the assessment of CR?

the assessment of CR is independent of the assessment of IR and should have no impact


If IR and CR are assessed high how does this impact DR?

DR has an inverse relationship to [CR x IR or RMM]

increase substantive testing

perform testing that will obtain more persuasive evidence such as, testing closer to the end of the reporting period, more experienced auditors, more effective techniques such as positive confirms or statistical sampling


What are some of the specific fraud risk factors that indicate either the incentive or pressure for fraudulent financial reporting to occur?

company is vulnerable to rapid changes

company is in a highly competitive industry

declining customer demand for products

significant number of business failures in client's industry

bankruptcy of the company appears imminent

ongoing negative cash flows from operations

significant employee and/or management financial interests in the entity

company faces expensive compliance with new regulations

investors have unreasonable expectations for profitability

company has great need for additional debt or equity financing

BOD, management or employee personal financial difficulties


In order to reduce detection risk to the planned acceptable level the auditor performs what kind of tests?

Substantive testing


What are the major types of substantive testing?

Tests of transactions

Tests of balances

analytical procedures


Fraud risk factors relation to opportunities for management to attempt fraud are what?

Significant related-party transactions

ability of entity to dominate a certain industry

significant estimates exist in financial reporting

significant, unusual or complex transactions exist, especially at the end of the reporting period

significant international or foreign operations

business dominated by one person or a small group of individuals

ineffective BOD or audit committee

high turnover in accounting, internal auditing, and IT staff

inadequate internal controls

overly complex organization structure


What are some specific fraud risk factors that might indicate either the incentive or pressure on the part of management and/or other key employees to misappropriate assets?

personal debts or other personal financial obligations

knowledge that there will be future employee layoffs

recent or anticipated changes in compensation plans or benefits

promotions, compensation, or other rewards that are inconsistent with employee expectations


What are some specific fraud factors that may indicate opportunities for asset misappropriation?

large amounts of cash on hand

inventory items are small in size and/or of high value

assets that are easily convertible to cash

fixed assets that are small and easily marketable

inadequate record keeping with respect to assets

inadequate safeguards over cash and assets

non-mandatory employee vacations, especially for key employees or positions

asset reconciliations and transaction documentation are not timely or provided


What are two areas in a F/S audit where the CPA should presume RMM due to fraud?

Revenue recognition

possible management possible override of internal controls


Describe some of the auditor tests and inquiries in regard to management override of internal controls?

inquire about sales transactions near the end of the reporting period

examine the contents of boxed inventory

review the accuracy of previous management estimations

obtain an understanding of the financial reporting process and the physical controls over JE's

select and test actual JE's especially suspicious entries at year end

ask about any inappropriate or unusual activity with JE's


Define Fraud, errors and direct-effect illegal acts?

Error - unintentional misstatement of the F/S

Fraud - intentional act that results in a misstatement in the F/S 2 types fraudulent financial reporting and misappropriation of assets

direct-effect illegal act - have an immediate impact on the entities F/S


Why is an auditor able to render only reasonable assurance in an audit engagement?

not every transaction can be looked at due to time and cost constraints so no absolute assurance can be given


What are the 3 elements of the fraud triangle?

Incentive and pressure


Rationalization and Attitudes


When is brainstorming performed and what does it mean?

at the beginning of an audit

brainstorming is the audit engagement team getting together and coming up with ideas about how management could perpetrate a fraud


What are some fraud risk factors that indicate attitude to commit fraudulent financial reporting?

Managements failure to correct known significant deficiencies in a timely manner

management's commitment to achieve aggressive or unreasonable financial forecasts

management's interest in maintaining or increasing the price of the company's stock

history of entity violations of securities laws

frequent disputes with the auditor

formal and informal restrictions on the auditors scope of audit activities


What actions should the auditor take in response to the discovery of one or more fraud risk factors?

closely monitor the adoption of an reasons for new accounting principles

make substantive testing procedures more unpredictable and in greater quantities

get more evidence from outside sources

rely more on physical inspections

use more computer-assisted audit techniques

do more testing in close proximity to the end of the reporting period

assign individuals to the audit team who have specialized skills and experience dealing with fraud, if appropriate


In assessing IR what are some procedures an auditor should consider in regards to fraud?

make inquiries of management, the audit committee, and the internal auditors, if any, about the risks of fraud in the company and how they are addressed.

look carefully at any unusual or unexpected relationships identified when performing analytical procedures

looking closely at accounts where a high degree of management judgment and subjectivity exists


What are some comparisons of financial information that are recommended in assessing inherent risk?

net income to cash flows from operations

year to year changes in inventory, A/P, sales and COGS

company profitability as compared to industry averages

company bad debts as compared to industry averages

sales volume as compared to production costs


Does the PCAOB require an auditor to report on whether a previously reported material weakness in internal control over financial reporting as of a date specified by management continues to exist?



What is meant by the term risk in auditing?

risk that the F/S could be materially misstated and these misstatements might go undetected even after the auditor has completed the audit and rendered an audit opinion


How does risk assessment for financial reporting relate to an entities management?

it is managements process for identifying, analyzing and responding to the risks relevant to the preperation of financial statements in conformity with GAAP


What are the risks relevant to financial reporting?

external and internal events and circumstances that may occur and adversely affect an entity's ability to initiate, authorize, record, process, and report financial data consistent with managements assertions in the F/S


List some of the circumstances under which risks impacting F/S can rise or possibly change.

changes in the entity's operating environment

new personnel

new or revamped AIS

rapid business growth

new technology

new business models, products or activities

corporate restructurings

expanded foreign operations

new accounting pronouncements

more complex and/or complicated business transactions


Why do auditors perform risk assessment procedures?

Auditors perform risk assessment procedures to properly asses the RMM and to obtain a preliminary understanding of the entity's internal control


What should the auditor use as audit evidence to support the risk assessment that has been made?

audit evidence obtained in evaluation the design of controls and whether or not not they have been implemented


How should the auditor employ the risk assessment process?

to determine the nature, timing and extent of further audit procedures to be performed


What types of risk assessment procedures should the auditor perform to obtain an understanding of the entity and its environment, including internal control?

inquiries of management and others within the entity

analytical procedures

observation and inspection


The auditor's understanding of the entity and its environment relies on an understanding by the auditor of which aspects of the entity?

the entity's industry, including regulatory and other external factors

the nature of the entity

the objectives, strategies and the related business risks that may result in a material misstatement of the entity's F/S

measurement and review of the entity's financial performance

the entity's internal control which includes its accounting policies and practices


What is the authoritative source for the risk assessment standards for audit engagements of privately held entity F/S?

SAS 104 - SAS 111


What were the three objectives of the ASB in developing risk assessment standards as they relate to auditors and audits?

1. auditors must develop a more in-depth understanding of the entity being audited and its environment, including internal control

2 auditors must conduct a more rigorous assessment of the risks of where and how the client's F?S could be materially misstated

3 there should be improved linkage between the auditor's assessed risks and the nature, timing, and extent of audit procedures performed in response to those risks


What are the areas in which the 's risk assessment standards and provide guidance?

the auditor's assessment of the risks of material misstatement, whether caused by error or fraud

the design and performance of tailored audit procedures to address assessed risks

audit risk and materiality

planning and supervision

audit evidence, including audit sampling

understanding the entity and its environment

evaluation the audit evidence obtained