Chapter 5

Question 1

What is the difference between nonstatistical and statistical sampling?

Answer 1

Statistical sampling: 1. uses laws of probability for selection and evaluation of a sample 2. allows for quantification of audit risk and sufficiency of audit evidence. Nonstatistical: 1. Does not utilize statistical models in calculations. 2. Auditors use their judgement to determine sample size to evaluate the selected samples.

Question 2

When is professional judgement necessary in the use of statistical or nonstatistical sampling by an auditor?

Answer 2

1. define the population and sampling unit 2. select the appropriate sampling method. 3. evaluate whether the audit evidence is appropriate. 4. evaluate the nature of devitions or errors. 5. consider sampling risk 6. evaluate sample results and project to the population.

Question 3

Define sampling risk.

Answer 3

The risk that the auditor’s conclusion that would have been reached if the tests had been applied to all items in the population.

Question 4

Define the two aspects of sampling risk for tests of controls.

Answer 4

1. Risk of assessing control risk too low: Deciding the controlis more effective/reliable than it really is; affects the audits effectiveness. 2. Risk of assessing control risk too high: Deciding the control is less effective/reliable than it really is; affects audit efficiency.

Question 5

Identify two aspects of sampling risk that the auditor would be concerned with when performing substantive testing.

Answer 5

1. Risk of incorrect acceptance: Deciding from the sample that the balance is correct when it is actually materially misstated; affects audit effectiveness. 2. Risk of incorrect rejection: Deciding from the sample that the balance is materially missated when it is really correct; affects audit efficiency.

Question 6

What is the relationship between sampling risk and reliability (confidence level)?

Answer 6

Sampling Risk + Confidence Level = 100%

Question 7

What is attribute sampling?

Answer 7

A statistical sampling method used to estimate a rate of occurrence in a sample. It is used in tests of controls.

Question 8

Define tolerable deviation rate (for attribute sampling)

Answer 8

The maximum rate (%) of deviation from a control procedure that the auditor is willing to accept while still relying on the control.

Question 9

Define tolerable missstatement (for variables sampling).

Answer 9

The largest amount of misstatement the auditor believes can exist in a balance or class of transactions without causing the financial statements to be materially misstated.

Question 10

What factors affect sample size for an attribute sampling application?

Answer 10

1. Risk of assessing control risk too low (inverse relationship). 2. Tolerable Deviation rate (inverse relationship). 3. Expected deviation rate (direct relationship).

Question 11

What rates are compared in drawing a conclusion about an attribute sampling application?

Answer 11

The auditor comapres the UDR to the tolerable deviation rate in drawing conclusions about an attribute sampling appliation. If the UDR exceeds the auditor’s tolerable deviation rate, the auditor will not rely on the control. (The UDR is the sample deviation rate plus an allowance for sampling risk.)

Question 12

What factors affect sample size for a variables sampling application?

Answer 12

1. Standard Deviation or population variability (direct relationship) 2. Tolerable misstatement (inverse) 3. Acceptable level of risk (inverse). 4. Expected size and frequency of misstatements (direct). 5. Assessed Level of risk (direct)

Question 13

Describe variables sampling.

Answer 13

A statistical sampling method used to estimate the numerical amount of a population. It may be used to substantiate mgt’s assertions in the FS by determining whether amounts are reasonable. Often, this is accomplished by developing independent estimates of FS amounts. Variable sampling is used primarily in substantive testing.

Question 14

What amounts are compared in drawing a conclusion about a variables sampling application?

Answer 14

The auditor compares the client’s book value to the calculated range in a variables sampling application. If the recorded book valueis within the acceptable range, the book value is considered fairly stated. (The calculated range is the point estimate, as determined from the sample, plus/minus an allowance for sampling risk).

Question 15

What is discovery sampling?

Answer 15

A type of attribute sampling used when the expected deviation rate is zero or near zero.

Question 16

What are the sampling plans commonly used for variables estimation?

Answer 16

1. Mean per unit estimation 2. Ratio Estimation 3. Difference Estimation

Question 17

Define Mean per Unit Estimation (a sampling plan commonly used for variables estimation).

Answer 17

The sample mean is multiplied by the numbers of items in the population to estimate population value.

Question 18

Define Ratio Estimation (a sampling plan commonly used for variables estimation).

Answer 18

The ratio between book value and audited value (from a sample) is used to estimate population value.

Question 19

Define Difference estimation (a sampling plan commonly used for variables estimation).

Answer 19

The difference between book value and audited value (from a sample) is used to estimate population value.

Question 20

Define Probability-Proportional to Size (PPS) sampling.

Answer 20

A hybrid sampling technique that uses attribute sampling theory to express a conclusion in dollar amounts rather than as a rate of occurrence. The sampling unit is defined as an individual dollar in a population, which creates the effect of stratified sampling (the unit’s chance of being selected increases as its amount increases).

Question 21

What are the advantages of PPS sampling?

Answer 21

Automatic stratification and efficient (smaller sample)

Question 22

What are the disadvantages of PPS sampling?

Answer 22

May require special considerations for negative, zero, and understated balances

Question 23

How is the sampling interval determined in a PPS sampling application?

Answer 23

Sampling Interval = Tolerable Misstatement / Reliability Factor Note: The reliability factor comes from a table and is based on the risk of incorrect acceptance.

Question 24

What are the 3 primary purposes for obtaining written representations from mgt?

Answer 24

1. to confirm representations explicity or implicitly given to the auditor. 2. To indicate and document the continuing appropriateness of such representations 3. To reduce the possibility of misunderstanding concerning matters that are the subject of representations.

Question 25

What are the general types of info included in a Rep Letter?

Answer 25

1. the FS 2. Completeness of Info 3. Fraud 4. Related Party transactions 5. Recognition, measurement, and disclosure 6. Subsequent events 7. issues specific to a particular entity

Question 26

Who should sign the Rep Letter?

Answer 26

the CEO, CFO, and any other members of mgt who are responsible for and knowledgeable about the items contained in the letter

Question 27

What is a control deficiency?

Answer 27

Exists when the design or operation of a control does not allow mgt or employees, in the normal course of performing their assigned functions, to prevent or detect/correct misstatements on a timely basis.

Question 28

What is a significant deficiency?

Answer 28

A deficiency, or a combination of deficiences, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those charged with governance (responsible for oversight of the company's financial reporting)

Question 29

What is material weakness?

Answer 29

A deficiency, or a combination of deficiences, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the company's annual or interim FS will not be prevented or detected/corrected on a timely basis.

Question 30

What is the auditor's responsibility with respect to contorl deficiencies identified during audit of a nonissuer?

Answer 30

1. The auditor has responsibility to evaluate control deficiences identified during the audit to determine whether they represent significant deficiencies or material weaknesses. 2. Significant deficiencies and material weaknesses should be communciated in writing to mgt and those charged with governance within 60 days of the report release date. 3. The communication with mgt and those charged with governance should be restricted use.

Question 31

What is an integrated audit?

Answer 31

The auditor audits both the FS and IC. The two audits must be performed together, and two opinions will be rendered.

Question 32

When is an integrated audit required?

Answer 32

1. For all issuers 2. When an auditor is engaged to examine the IC of a nonissuer.

Question 33

What is the accountant's responsibility with respect to control deficiencies identified during an engagement to examine the IC of a nonissuer?

Answer 33

1. Significant deficiencies and material weaknesses should be communicated in writing to mgt and those charged with governance by the report release date. 2. Control deficiencies that are not significant deficiencies or material weaknesses should be communicated in writing to mgt within 60 days of the report release date. 3. A material weakness results in an adverse opinion.

Question 34

How are control deficiencies communicated by the auditor to the issuer in an integrated audit?

Answer 34

All internal control deficiencies over financial reporting that were identified during the audit should be communicated to mgt in writing. The audit committee should be informed when the communication was made.

Question 35

How are significant deficiencies communicated by the auditor to the issuer in an integrated audit?

Answer 35

Any significant deficiencies identified during the audit should be communicated in wriitng to the audit committee.

Question 36

How are material weaknesses communicated by the auditor to the issuer in an integrated audit?

Answer 36

Any material weaknesses identified durign the audit should be communicated in writing to both mgt and the audit committee prior to the issuance of the auditor's report on internal control over financial reporting.

Question 37

How does the extent of testing of internal controls differ between a financial statement audit and an examination of internal control for nonissuers?

Answer 37

The extent of testing of IC for a FS audit is more limited than in an IC examination. When rendering an opinion on IC for an examination on IC, the auditor should obtain evidence regarding the effectiveness of selected controls over all relevant assertions. This level of testing is not required for a FS audit.

Question 38

Describe the top down approach used to select controls to test for issuer/nonissuer clients.

Answer 38

1) FS level - auditor evaluates overall risks. 2) Entity level - auditor identifies and tests controls pertaing to: a) control env b) management override c) monitoring results of ops and other controls d) period end financial reporting e) centralized ops 3) Accounts, Disclosure, and Assertions level - auditor evaluates qualitative and quantitative risk factors to identify significant accounts, disclosures, and assertions for which there is a reasonable possibility of material misstatement. Once identified, controls are tested.

Question 39

List the items that an auditor is required to communicate to those charged with governance.

Answer 39

1) auditors responsibility under GAAS 2) planned scope and timing of the audit. 3) significant audit findings including a) significant accounting policies b) managements judgements and accounting estimates c) auditors judgement about the quality of the entitys accounting priniciples d) difficulties encountered in performing the audit; disagreements with management. e) uncorrected misstatements f) management issues discussed prior to retention. g) audit adjustments h) consultation (by management) with other accountants. i) other items required by AICPA standards or SOX. NOTE: communication can be oral or written, but must be documented in the audit documentation (working papers).

Question 40

What are the functions of the audit committee? Part 1

Answer 40

1) Selects and appoints the independent auditor and sets the audit fee. 2) Reviews the nature and details of the audit engagement. 3) Reviews the quality of the auditor's work. 4) Reviews the scope of the audit. 5) Determines that any recommendations made by the auditor are given proper attention.

Question 41

What are the functions of the audit committee? Part 2

Answer 41

6) Maintains lines of communication between the auditor and the BOD. 7) Helps solve any disagreements related to the accounting treatment of material items in FS. 8) Evaluates the internal control of the company with the help of the independent auditor. 9) Makes reports to the BOD and the stakeholders when necessary. 10) Assures that the auditor is independent of the company. NOTE: The audit committee has additional responsibilities under SOX.