Ch 5 Flashcards
Describe the relationship between detection risk and audit risk.
The risk that the auditor’s audit procedures will fail to detect a misstatement and the risk that the misstatements will get through the audit procedures.
Identify and describe the two components of the risk of material misstatements.
- Inherent risk - Is affected by two factors either the nature of the client and its environment or nature of the particular f/s element
- Control risk - A function of the effectiveness of both the design and operation of internal control in achieving the client’s objectives related to the preparation of its f/s.
Define inherent risk. Can the auditors reduce inherent risk by performing audit procedures?
Inherent risk - The risk of material misstatement of a f/s assertion, assuming there were no related controls.
Define control risk.
The risk that a material misstatement could occur in a relevant assertion and not be prevented or detected on a timely basis by the client’s internal control.
Distinguish amount routine, non routine and estimation transactions.
Routine - a recurring financial activity recorded in the accounting records in the course of business.
Non routine - Occurs only periodically, such as counting and pricing inventory, calculating depreciation expense, or determining prepaid expenses.
Estimation - Involves management’s judgements or assumptions, such as determining allowance for doubtful accounts, est. warranty reserves and assessing assets for impairment.
Between a sales invoice and purchase invoice which type of these invoices do you think represents the stronger type of evidence?
A sales invoice because they were created by the company internally and sent to outsiders for endorsement.
A canceled check isn’t considered particularly reliable evidence since the check was prepared within the client’s organization.
A canceled check is the most reliable because it was processed by the bank.
When in the course of an audit might the auditor find it useful to apply analytical procedures?
When they need to obtain audit evidence to compare financial and non financial data.
Give at least four examples of specialists whose findings might provide appropriate evidence for the independent auditors.
Judging the value of highly specialized inventory
Making actuarial computations to verify liabilities for post retirement benefits.
Valuation of works of art of restricted securities.
Legal interpretations of regulations or contracts.
What are the major purposes of obtaining representation letters from auditors?
Summarizes the most important oral representations made by management during the engagement.
AICPA required
Reminds client officers of their primary and personal responsibility for the F.S.
Document in the audit working papers the client’s responses to the significant questions asked by the auditors.
Only evidence available with respect to management’s future intentions.
Would the use of a representation letter from the client instead of observing the physical counting of inventory be an acceptable means of reducing the cost of an audit?
No, because a representation letter is just a written letter by management summarizing the most important oral representations made by management during the engagement.
List and briefly describe the three approaches to auditing estimates that are included in a client’s financial statements.
Review and test management’s process for developing an estimate.
Independently develop an estimate of the amount to compare to management’s estimate.
Review subsequent events or transactions bearing on the estimate, such as actual payments of an estimate amount made subsequent to year-end.
“In deciding upon the type of evidence to be gathered in support of a given item on the financial statements, auditors shouldn’t be influenced by the differences in cost of obtaining alternative forms of evidence.”
No, because its not cost efficient
What are related party transactions?
A transaction in which one party has the ability to influence significantly the management or operating policies of the other party, to the extent that one of the transacting parties might be prevented from pursuing fully its own separate interests.
What disclosures should be made in the financial statements regarding material related party transactions?
Nature of the relationship; a description of the transaction, including dollar amounts; and amounts due to and from third parties, together with the terms and manner of settlement.
