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Flashcards in Chapter 6 Deck (84):
1

Before accepting an engagement, a firm should use their quality control policies to consider the following to minimize engagement risk

- History of Client
- Indentities and reputations of client's directors, managers, and major stockholders
- Client's financial stength
- CPA firm's ability/technical expertise to audit client

2

What is the purpose of an engagement letter?

To establish an understanding with client and states that:
 The firm meets professional independence requirements
 There are no issues relating to management integrity
 The client understands the terms of the engagement
- Also mentions inherent limitations of audit, other services to be provided, if specialists or internal auditors will be used, and fee arrangements

3

Define substantive tests/procedures

Tests of account balances and transactions designed to detect any material misstatements in the financial statements. The nature, timing, and extent of substantive procedures are determined by the auditors' assessment of risks and their consideration of the client's internal control.

4

What are the two types of fraud?

- Fraudulent financial reporting (overstating income, understating earnings, and income smoothing)
- Misappropriation of assets (stealing)

5

What could be done if found out that client has large financial statement risks (weak internal control, questionable integrity of management)>

- Bring more experienced/specialized engagement team members
- More supervision of engagement team and audit procedures
- Greater emphasis on professional skepticism
- Greater incorporation of unpredictability of Audit Procedures
- Increase of Overall scope of audit procedures

6

Is contact with prior auditor required?

Yes, and they talk about
- Integrity of management
- Disagreements if any
- client fraud or noncompliance with laws
- significant deficiencies or material weaknesses with internal control
- Reason of change of auditors

7

FASB describes this as the "magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.”

Materiality.

• The auditor’s responsibility is to determine if financial statements are materially misstated.

8

Some requirements of the audit committee are:

- to have at least three independent, financially literate directors (one of which must be a financial expert)

- Appointment, compensation, and oversight of auditors per SOX

9

Once again, list out the six steps of the audit process

1. Plan the Audit
2. Obtain Understanding of Client Environment (including Internal Control)
3. Assess risks of material misstatement and design further audit procedures
4. Perform further audit procedures
5. Complete the audit
6. Form an opinion and issue the audit report

10

Is shopping for accounting principles ok by audit client when choosing auditor?

No, SEC discourages it

11

When completing a first year audit with a new client, which two characteristics are required

- Must be extremely diligent due to lack of familiarity with client
- Must check validity of opening balances (use predecessor's working papers or your own procedures)

12

Form 8-K is filed when _____

Any big change in company takes place, such as a change of auditor. Auditors must provide a response stating if they agree or disagree

13

Would the client cover costs for staff travel, report processing, etc in their fee estimate for the auditor?

Yes

14

What are the objectives of Substantive Programs for asset accounts?

- Establish existence
- Establish rights to assets
- Establish completeness of recorded assets
- Verify Cutoff transactions
- Determine appropriate valuation of assets and accuracy of related transactions
- Determine appropriate statement presentation and disclosure of assets

15

What are some incentives to commit fraud?

- Financial stability or profitability of company is threatened
- personal net worth materially threatened
- adverse relationships between employee and company

16

Define the Audit PLAN

A description of the nature, timing, and extent of the audit procedures to be performed. NOT the program, but is often documented with it.

17

When following an audit trail for existence or occurrence, is that vouching or tacing?

Vouching

18

Define the Audit PROGRAM

A detailed listing of the specific audit procedures to be performed in the course of an audit engagement. Audit programs provide a basis for assigning and scheduling audit work and for determining what work remains to be done. Audit programs are specially tailored to the risks and internal controls of each engagement. Has a Systems and a Substantive Test section.

19

How would an auditor respond to fraud?

- increase professional skepticism
- collect more audit evidence, especially third party evidence
- assign more experience personnel and increase supervision
- greater accounting principle consideration especially where complex
- incorporate unpredictability in audit procedures
- expand audit "NET"
- Nature - collect more reliable evidence
- Extent - increase sample sizes
- Timing - shift timing of testing from interim to year-end

20

When following an audit trail for completeness, is that considered tracing or vouching?

Tracing

21

If receivables that may have been recorded don't exist, which assertion is this situation concerned with and what audit procedures would be taken?

Existence of Assets - Confirm a sample of receivables by direct communication with debtors

22

If accounting personnel may have failed to identify related party transactions, which assertion is this situation concerned with and what audit procedures would be taken?

Financial Statement Presentation of Assets - Provide a list of related parties to all members of the audit team to assist in identification of the transactions

23

Define the assertion of Cutoff of Transactions

Sales and cash receipt transactions are recorded in the proper period

24

If allowance for uncollectible accounts are misestimated by management, which assertion is this situation concerned with and what audit procedures would be taken?

Valuation of Assets - investigate credit ratings for delinquent and large receivables

25

Define the assertion of Valuation of Assets

Receivables are presented at the net realizable value

26

If management may have fraudulently overstated revenue and receivables by making inappropriate adjusting entries, which assertion is this situation concerned with and what audit procedures would be takn?

Existence of Assets - Review monthly adjust entries for suspicious items

27

Define the assertion of Completeness of Assets

All receivables are recorded

28

If management may have shipped items before the end of the period but not recorded sales and related receivables until the next subsequent period, which assertion is this situation concerned with and what audit procedures would be taken?

Completeness of Assets - select a sample of sales invoices in subsequent period and examine related shipping document for date of shipment

29

Define the assertion of Existence of Assets

All recorded receivables exist

30

If allowance for sales returns and allowances may be misestimated by management, which assertion is this situation concerned with and what audit procedures would be taken?

Valuation of Assets - Compare amount of credits given to customers in subsequent period to the amount estimated by management.

31

If accounting personnel may have erroneously treated a sale of receivables as a liability, which assertion is this situation concerned with and what audit procedures would be taken?

Rights to Assets - review confirmations of liabilities to determine if receivables have been sold or factored.

32

If sales and receivables for the next period may be recorded in the current period, which assertion is this situation concerned with and what audit procedures would be taken?

Cutoff of Transactions - Vouch sales and cash receipt transactions occurring near period end

33

Define the assertion of Rights to Assets

The client has the right of receivables.

34

Software routine to develop aged trial balance of receivables may have been erroneously programmed, which assertion is this situation concerned with and what audit procedures would be taken?

Valuation of Assets - Obtain an aged trial balance of receivables, test its clerical accuracy, and reconcile to the ledgers

35

Define the assertion of Financial Statement Presentation of Assets

Receivables are properly presented in the balance sheet, with appropriate disclosures

36

Cutoff issues typically affect which statement?

Balance sheet

37

Assertion/Transaction or Balance? -
Performing test counts of the warehouse personnel’s count of the raw material.

Completeness/Existence - Balance

38

Assertion/Transaction or Balance? - Watching the entity’s warehouse personnel count the raw materials inventory.

Completeness/Existence - Balance

39

Assertion/Transaction or Balance? - Examining large sales invoices for a period of two days before and after year-end to determine if sales are recorded in the proper period

Cutoff - Transaction

40

Assertion/Transaction or Balance? - Agreeing the total of the accounts receivable subsidiary ledger to the accounts receivable general ledger account.

Completeness - Balance

41

Assertion/Transaction or Balance? - Comparing the current-year gross profit percentage with the gross profit percentage for the last four years.

Valuation and allocation - Balance

42

Assertion/Transaction or Balance? - Examining a new plastic extrusion machine to ensure that this major acquisition was received.

Existence - Balance

43

Assertion/Trial or Balance? - Sending a written request to the entity’s customers requesting that they report the amount owed to the entity.

Existence - Balance

44

Assertion/Transaction or Balance? - Discussing the adequacy of the allowance for doubtful accounts with the credit manager.

Valuation and allocation - Balance

45

Can a CPA ethically refuse to provide auditing services to any prospective client which the CPA is competent to audit?

Sure

46

Omissions of amounts unintentionally is a fraud or error?

Error

47

Auditors are required to specifically assess the risk of material misstatement of the financial statements due to fraud on every audit. True or False?

True

48

Intentionally misleading statements is fraud or error?

Fraud

49

Mistakes in data processing is fraud or error?

Error

50

Auditors should never spend more time on an audit than is called for in a conscientiously developed time budget. True or False?

False, audit procedures can be very unpredictable in timing.

51

A declining industry with increasing business failures is an industry condition that is indicative of increased risk of fraudulent financial reporting. True or False?

True

52

Define Audit Risk

Risk of issuing an inappropriate opinion because the auditors' procedures fail to detect a material misstatement in the financial statements.

53

The audit program generally must be modified if the auditors revise their estimate of risk for the engagement. True or False?

True

54

Is an engagement letter considered a written contract between the auditors and the client?

Yes

55

Analytical procedures are optional procedures that may be useful to the auditors during the risk assessment stage of the audit. True or False?

False, these procedures occur during the fourth stage - "Performing further audit procedures"

56

What would be on Substantive Test portion of the audit program?

 Deals with client’s internal control
 Organized around major transaction cycles of client’s accounting system
 Some tests are dual-purpose procedures to also provide substantive transaction evidence
 Evidence of test of controls and assessing control risk
 Based on this, auditor determines amount of substantive testing needed (inverse relationship with effectiveness of internal control)

57

The substantive procedures portion of the audit program generally is organized around income statement accounts.True or False?

False, about all statement accounts

58

Major transaction cycles would be on which part of audit program?

Systems (internal control portion)

59

Substantive procedures are generally completed ____ (before/after) auditor's assess control risk

After - Occurs in 4th stage (Performing the Audit)

60

Plan vs Portion - mnemonic?

Portion has more letters, so more content than the plan

61

The audit program generally must be modified if the auditors revise their estimate of risk for the engagement. True or False?

True. Program can be updated any time

62

What is on systems (internal control) portion of program?

 Deals with client’s internal control
 Organized around major transaction cycles of client’s accounting system
 Some tests are dual-purpose procedures to also provide substantive transaction evidence
 Evidence of test of controls and assessing control risk
 Based on this, auditor determines amount of substantive testing needed (inverse relationship with effectiveness of internal control)

63

An audit program includes procedures for verifying the client’s cutoff of transactions to be included in the financial statements of the current period. True or False?

True

64

An audit _____ (plan/program) should indicate which auditing procedures have been completed and which remain to be done.

Program. Plan reallt only talks about audit "NET"

65

Which of the following is the best example of a substantive procedure?

Flowcharting a client’s cash receipts system.
Comparing signatures on checks to a list of authorized check signers.

Confirming balances of accounts receivable.
Examining a sample of cash disbursements to test whether expenses have been properly approved.

Confirming balances of accounts receivable.

66

A systems approach to an audit emphasizes tests of controls. True or False?

True, systems usually means intenral controls

67

Completeness of an asset account can best be established by vouching recorded entries in the asset account.

False. Tracing is often associated with Completeness

68

Which of the following is a basic tool used by the auditors to control the audit work and review the progress of the audit?

- Time and expense summary
- Progress Flowchart
- Audit Program
- Engagement Letter

audit program

69

Which of the following risk factors indicates an increased risk of misappropriation of assets?

Lack of mandatory vacations for employees performing key functions.
Strained relationships between management and auditors.
Overly complex organizational structure.
High turnover of senior management.

Lack of mandatory vacations for employees performing key functions

70

Hawkins, CPA, requested permission to communicate with the predecessor auditors of a prospective client. The prospective client's refusal to permit this will bear directly on Hawkins' decision concerning the:

Integrity of management.
adequacy of the preplanned audit program.
ability to establish consistency in application of accounting principles between years.
apparent scope limitation.

integrity of management

71

Which of the following is the most likely first step the auditors would perform at the beginning of an initial audit engagement?

Prepare a rough draft of the financial statements and of the auditors' report.
Consider internal control.
Tour the client's facilities and review the general records.

Consult with and review the work of the predecessor auditors prior to discussing the engagement with the client management.

Tour the client's facilities and review the general records.

72

Audit programs in an engagement typically are developed ______ (before/after) the auditors complete their risk assessment procedures

after

73

Which of the following is most likely to be an overall response to fraud risks identified in an audit?

Use predictable, well established audit procedures.
Consider further management’s selection and application of significant accounting principles.
Supervise members of the audit team less closely and rely more upon judgment.
Decrease the use of professional skepticism and increase the use of internally generated evidence.

Consider further management’s selection and application of significant accounting principles.

74

An audit committee's responsibilities normally would not include:

discussing the meaning and significance of audited financial statements.
nominating the independent auditors.
discussing problems and experience with independent auditors in completing the audit of annual financial statements.
discussing all details of the audit programs of the independent auditors.

discussing all details of the audit programs of the independent auditors.

75

Tracing of a transaction from source documents to the accounting records is generally an audit procedure that is designed to establish ______ (completeness/existence)

completeness

76

Another important feature of an engagement letter is the ______ of management and auditor responsibilities.

Separation.

o Managemnet
 Financial statements
 Establishing effective internal control over financial reporting
 Compliance with laws and regulations
 Making records available to the auditors
 Providing written representations at end of the audit, including that adjustments discovered by the auditors and not recorded
to the financials are not material
o Auditor Responsibilities
 Conducting an audit in accordance with GAAS
 Obtaining an understanding of internal control to plan audit
and to determine the nature, timing and extent of procedures
 Making communications required by GAAS


77

Define substantive tests/procedures

Tests of account balances and transactions designed to detect any material misstatements in the financial statements. The nature, timing, and extent of substantive procedures are determined by the auditors' assessment of risks and their consideration of the client's internal control.

78

one inherent limitation is that We cannot look at EVERYTHING. True or false?

True

79

Is the engagement letter basically a contract as well?

Yes

80

Should we ever let the client know what we consider material?

No

81

To make sure resources are being used efficiently, do more work in the most risky areas and less work in the less risky places. True or false?

True

82

Clients accountants are used ____ (rarely/extensively) to explain how things work.

extensively

They should have all the documents anyways

83

Is revenue the most frequently frauded and manipulated account?

Yes. Net income and EPS is most highly examined

84

While obtaining understanding, only test controls that work. No point in testing ineffective ones, because can’t increase detection and substantive testing. True or false?

True