Evidence and Risk Flashcards
(66 cards)
1
Q
What is the majority of an auditor’s work in determining an audit opinion?
A
Collection of evidence to support the opinion.
2
Q
Of what does audit Evidence consist?
A
Evidence consists of client accounting data and supporting documentation from client or from third parties.
3
Q
What is the relationship between Evidence and Detection Risk?
A
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.
4
Q
Which aspects of Audit Risk can an auditor control?
A
Detection Risk which is decreased by gathering evidence.
5
Q
Which aspects of Audit Risk can an auditor NOT control?
A
Inherent Risk and Control Risk are outside of an auditor’s control.
6
Q
How does a high level of acceptable Detection Risk affect an audit?
A
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.
7
Q
What should occur when a low level of Detection Risk is acceptable?
A
More Evidence collected
(N) More-competent Evidence collected
(T) End of year balance testing
(E) More transactions are verified
8
Q
What are the primary risks in an audit for a typical for-profit company?
A
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
9
Q
What is the primary constraint on audit evidence?
A
Cost vs. Benefit is a primary constraint.
10
Q
What characteristics should audit evidence have?
A
Sufficient (quantity)
Appropriate: Relevant & Reliable (Quality)
11
Q
How does the quality of audit evidence vary depending on who has provided it?
A
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.
12
Q
Which documents are the most persuasive and credible?
A
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
13
Q
What are Substantive Procedures?
A
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.
14
Q
What are the substantive tests that are most often performed?
A
Trace (or Vouch) Reconcile Analytical Procedures Confirmations Examine evidence that supports management assertions.
(T.R.A.C.E.)
15
Q
When performing audit procedures what should auditors focus on?
A
Auditors focus first on Balance Sheet Accounts then associated Income Statement items
16
Q
How is Cash audited?
A
Assurance Level is High.
Acceptable Detection Risk is Low.
17
Q
How is Accounts Receivable audited?
A
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
18
Q
How is Accounts Payable audited?
A
Review purchase orders/invoices
Confirm with Vendors
Corresponding Income Statement Account - Various Expenses
19
Q
How is Inventory audited?
A
Examine purchase agreements
Look at Board Minutes
Is Inventory held as collateral?
Corresponding Income Statement Account - COGS
20
Q
How are beginning balances audited?
A
Should match last year’s ending balance.
21
Q
What is the general presumption for auditing Ending Balances?
A
If Beginning Balance Additions Subtractions are OK then Ending Balances should also be OK.
22
Q
How is a Statement of Cash Flows audited?
A
Foot all balances - Check the Math
Trace Cash Flow items to other Financial Statements
Check classifications - Operating Activities Investing Activities Financing Activities
23
Q
Under the Indirect Method what must be disclosed on a Statement of Cash Flows?
A
Interest Paid
Income Taxes Paid
Non-cash Transactions
Cash and Cash Equivalents Definitions
24
Q
Under the Direct Method what must be disclosed on a Statement of Cash Flows?
A
Results as if you had used Indirect Method
Non-cash Transactions
Cash and Cash Equivalents Definition
25
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.
26
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.
27
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.
28
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.
29
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
30
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
31
How is the Current Ratio calculated?
Current Ratio = Current Assets / Current Liabilities
32
How is the Quick Ratio calculated?
Quick Ratio = Liquid Assets / Current Liabilities
33
How is the Asset Turnover calculated?
Asset Turnover = Net Sales / Average Assets
34
How is the Inventory Turnover calculated?
Inventory Turnover = COGS / Average Inventory
35
How is Gross Margin % calculated?
Gross Margin % = Gross Margin / Sales
36
What type of testing are ratios?
Ratios are Analytical Procedures
37
What type of procedure is a Budget vs. Actual comparison?
Budget vs. Actual comparisons are Analytical Procedures.
38
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
39
How do management assertions affect the audit?
Management assertions help the auditor to plan the audit and select substantive tests.
40
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)
41
What assertions are tests for transaction classes?
Occurrence
Cutoff
Classification
Completeness
Accuracy
42
For which assertions are disclosures tested?
Occurrence
Completeness
Classification
Accuracy
43
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.
44
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.
45
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).
46
What is the Current File?
Information pertaining to the current year's audit.
47
What is the Permanent File?
Information used for this audit and future audits which is updated as needed.
48
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
49
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.
50
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.
51
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.
52
An auditor traces the serial numbers on equipment to a non-issuer's sub-ledger. Which of the following management assertions is supported by this test?
a. Rights and obligations.
b. Presentation and disclosure.
c. Valuation and allocation.
d. Completeness
Choice "d" is correct. Completeness is the assertion supported by the auditor tracing the serial numbers on equipment (source) to a nonissuer's sub-ledger (book).
Choice "c" is incorrect. Valuation and allocation relate to whether the amounts have been recorded correctly. Reviewing serial numbers on equipment would not provide information about the proper value of the equipment.
Choice "a" is incorrect. Rights and obligations relate to whether the entity holds or controls the rights to the equipment. Inspecting supporting transactions or inspection of contracts would provide evidence of rights and obligations for equipment.
Choice "b" is incorrect. Assertions about presentation and disclosure relate to making sure components of the financial statements are properly presented, described, and disclosed. The auditor would need to review the financial statements, not the serial numbers on equipment, to support the presentation and disclosure assertion.
53
Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?
a. Review the responses of accounts receivable confirmations for indications of disputes with customers.
b. Compare cash payments made after the balance sheet date with the accounts payable trial balance.
c. Examine a sample of creditor balances to supporting invoices, receiving reports, and purchase orders.
d. Reconcile receiving reports with related cash payments made just prior to the year-end.
Explanation
Choice "b" is correct. An auditor most likely would compare cash payments made after the balance sheet date with the accounts payable trial balance in searching for unrecorded payables. The auditor is looking for items that should have been recorded as of the balance sheet date, but were not.
Choice "d" is incorrect. Reconciling receiving reports with related cash payments made just prior to year-end would not help the auditor search for unrecorded payables. Cash payments for items received should result in the payable being eliminated.
Choice "a" is incorrect. Reviewing the responses of accounts receivable confirmations for indications of disputes with customers is a substantive procedure related to the revenue cycle, not the expenditure cycle.
Choice "c" is incorrect. An auditor most likely would compare a sample of creditor balances to supporting invoices, receiving reports, and purchase orders to verify that the accounts payable exist. The search for unrecorded payables is primarily used to support the completeness assertion.
54
An auditor tests an entity's control of obtaining credit approval before shipping goods to customers in support of management's financial statement assertion of:
a. Completeness.
b. Valuation and allocation.
c. Rights and obligations.
d. Existence.
Choice "b" is correct. By ensuring that credit approval is obtained before goods are shipped to customers, the auditor is testing management's assertion that accounts receivable are collectible (valuation or allocation).
Choice "a" is incorrect. Ensuring that credit approval is obtained before goods are shipped does not support the completeness assertion.
Choice "d" is incorrect. Ensuring that credit approval is obtained before goods are shipped does not support the existence assertion.
Choice "c" is incorrect. Ensuring that credit approval is obtained before goods are shipped does not support the rights and obligations assertion.
55
Which of the following procedures would be appropriate to test the existence assertion during an audit of accounts receivable?
a. Trace transactions from the subsidiary ledger to the general ledger.
b. Send confirmations to customers.
c. Trace a sample of invoices to recording in the general ledger.
d. Determine that all shipments before year-end are recorded as sales.
Explanation
Choice “b” is correct. Sending confirmations to customers is the most appropriate audit procedure to test the existence of accounts receivable.
Choice “a” is incorrect. Tracing transactions from the subsidiary ledger to the general ledger tests the completeness of accounts receivable.
Choice “c” is incorrect. Tracing a sample of invoices to recording in the general ledger tests the completeness of accounts receivable.
Choice “d” is incorrect. Determining that all shipments before year-end are recorded as sales tests the assertions of cutoff and completeness of accounts receivable.
56
Which of the following best describes the auditor's responsibility with respect to fair values?
a. The auditor should make fair value measurements and disclosures in accordance with GAAP and should identify and support any significant assumptions used.
b. The auditor should determine whether management has the intent and ability to carry out courses of action that may affect fair values.
c. The auditor should assess the risk of material misstatement of fair value measurements.
d. The auditor should obtain sufficient appropriate audit evidence to provide reasonable assurance that fair value measurements and disclosures are in conformity with GAAP.
Explanation
Choice "d" is correct. The auditor's overall responsibility is to obtain sufficient appropriate audit evidence to provide reasonable assurance that fair value measurements and disclosures are in conformity with GAAP.
Choice "b" is incorrect. While it is true that the auditor should determine whether management has the intent and ability to carry out courses of action that may affect fair values, this is just one part of evaluating fair value measurements and not the best description of the auditor's overall responsibility.
Choice "c" is incorrect. While it is true that the auditor should assess the risk of material misstatement of fair value measurements, this is done to determine the nature, timing, and extent of audit procedures. It is not the best representation of the auditor's overall responsibility.
Choice "a" is incorrect. Management (and not the auditor) should make fair value measurements and disclosures in accordance with GAAP and should identify and support any significant assumptions used.
57
Which of the following would an auditor least likely consider with respect to fair values?
a. Whether the valuation methods used are appropriate in relation to the industry in which the entity operates.
b. The effect on fair value measurement and disclosures of information available subsequent to the audit.
c. Segregation of duties between those committing the entity to certain transactions and those responsible for undertaking the valuations related to those transactions.
d. The role of information technology in determining fair value measurements and disclosures.
Explanation
Choice "b" is correct. The auditor would consider subsequent events and transactions occurring before the completion of the audit, not after. The auditor is not responsible for predicting the future, and would not be expected to evaluate the effect of conditions arising subsequent to the audit, that, if known at the time of the audit, might have affected fair value measurements and disclosures.
Choice "c" is incorrect. The auditor is responsible for understanding relevant controls. Segregation of duties between those committing the entity to certain transactions and those responsible for undertaking the valuations related to those transactions is a relevant control.
Choice "d" is incorrect. The auditor is responsible for understanding the entity's process for determining fair value measurements and disclosures. Considering the role of information technology in determining fair value measurements and disclosures is part of understanding this process.
Choice "a" is incorrect. The auditor should evaluate whether the valuation model is appropriate given the entity's circumstances. As part of this evaluation, the auditor should consider whether the valuation method is appropriate in relation to the business, industry, and environment in which the entity operates.
58
In evaluating the reasonableness of an entity's accounting estimates, an auditor normally would be concerned about assumptions that are:
a. Susceptible to bias.
b. Consistent with prior periods.
c. Insensitive to variations.
d. Similar to industry guidelines.
Explanation
Choice "a" is correct. An auditor would be concerned about assumptions that are susceptible to bias because it is more likely that estimates based on such assumptions will be misstated.
Choice "b" is incorrect. The auditor would not normally be concerned about assumptions that are consistent with prior periods, as estimates based on such assumptions are less likely to be misstated.
Choice "c" is incorrect. The auditor would not normally be concerned about assumptions that are insensitive to variation, as estimates based on such assumptions are less likely to be misstated.
Choice "d" is incorrect. The auditor would not normally be concerned about assumptions that are similar to industry guidelines, as estimates based on such assumptions are less likely to be misstated.
59
Which of the following procedures would an auditor ordinarily perform first in evaluating management's accounting estimates for reasonableness?
a. Develop independent expectations of management's estimates.
b. Consider the appropriateness of the key factors or assumptions used in preparing the estimates.
c. Test the calculations used by management in developing the estimates.
d. Obtain an understanding of how management developed its estimates.
Explanation
Choice "d" is correct. In evaluating the reasonableness of an accounting estimate, the auditor should first obtain an understanding of how management developed its estimate.
Choice "a" is incorrect. After first obtaining an understanding of how management developed its estimate, the auditor should use one or a combination of the following approaches: a) review and test the process used by management to develop the estimate, b) develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate, or c) review subsequent events.
Choice "b" is incorrect. After having first obtained an understanding of how management developed its estimate, the auditor should consider testing management's process by assessing the appropriateness of the key factors or assumptions used in preparing the estimate.
Choice "c" is incorrect. After first obtaining an understanding of how management developed its estimate, the auditor should use one or a combination of the following approaches: a) review and test the process used by management to develop the estimate, b) develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate, or c) review subsequent events.
60
The primary reason an auditor requests letters of inquiry be sent to a client's attorneys is to provide the auditor with:
a. Corroboration of the information furnished by management about litigation, claims, and assessments.
b. The attorneys' opinions of the client's historical experiences in recent similar litigation.
c. A description and evaluation of litigation, claims, and assessments that existed at the balance sheet date.
d. The probable outcome of asserted claims and pending or threatened litigation.
Explanation
Choice "a" is correct. A letter of audit inquiry to the client's lawyer is the auditor's primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessments.
Choice "d" is incorrect. While the attorney is requested to provide the auditor with the likelihood of an unfavorable outcome, the primary source of this information is management.
Choice "b" is incorrect. The attorney's opinion of historical experiences may provide some information to the auditor, but it is not the primary goal of audit inquiry letters.
Choice "c" is incorrect. While the attorney is asked to comment on management's description and evaluation of litigation, claims, and assessments that existed at the balance sheet date, the primary source of this information is management.
61
After determining that a related party transaction has, in fact, occurred, an auditor should:
a. Obtain an understanding of the business purpose of the transaction.
b. Add a separate paragraph to the auditor's standard report to explain the transaction.
c. Perform analytical procedures to verify whether similar transactions occurred, but were not recorded.
d. Substantiate that the transaction was consummated on terms equivalent to an arm's-length transaction.
Explanation
Choice "a" is correct. After identifying the occurrence of a related party transaction, the auditor should apply the procedures considered necessary to obtain satisfaction concerning the purpose and nature of the transaction and its effect on the financial statements.
Choice "b" is incorrect. While an extra paragraph may be added to emphasize a matter, there is no requirement that related party transactions be disclosed via explanatory language added to the auditor's report.
Choice "c" is incorrect. Analytical procedures are generally not effective in the identification of related party transactions.
Choice "d" is incorrect. It will generally not be possible to substantiate representations that the transaction was consummated on terms equivalent to those that would have prevailed in an arm's-length transaction.
62
Which of the following auditing procedures most likely would assist an auditor in identifying related party transactions?
a. Sending second requests for unanswered positive confirmations of accounts receivable.
b. Retesting ineffective internal controls previously reported to those charged with governance.
c. Reviewing accounting records for nonrecurring transactions recognized near the balance sheet date.
d. Inspecting communications with law firms for evidence of unreported contingent liabilities.
Explanation
Choice "c" is correct. Unusual nonrecurring transactions near year-end are characteristic of related party transactions. Since related party transactions are not at arm's-length, management may use such transactions to bolster sales or assets.
Choice "b" is incorrect. Retesting ineffective controls would not assist the auditor in identifying related party transactions.
Choice "a" is incorrect. Confirmation of accounts receivable would not assist the auditor in identifying related party transactions.
Choice "d" is incorrect. Finding unrecorded contingent liabilities would not assist the auditor in identifying related party transactions.
63
"In connection with an audit of our financial statements, management has prepared, and furnished to our auditors a description and evaluation of certain contingencies."
The foregoing passage most likely is from a(an):
a. Financial statement footnote disclosure.
b. Management representation letter.
c. Audit committee's communication to the auditor.
d. Audit inquiry letter to legal counsel.
Explanation
Choice "d" is correct. Legal counsel is best able to corroborate the description and evaluation of contingencies provided by management.
Choice "b" is incorrect. The management representation letter serves to confirm, in writing, representations provided to the auditor. It does not include a statement indicating that management has prepared and furnished a list of contingencies.
Choice "c" is incorrect. The audit committee would not communicate to the auditor regarding the list of contingencies prepared by management.
Choice "a" is incorrect. It would be inappropriate to indicate in the footnotes whether specific information was provided by management to the auditor.
64
Analytical procedures used in the overall review stage of an audit generally include:
a. Gathering evidence concerning account balances that have not changed from the prior year.
b. Performing tests of transactions to corroborate management's financial statement assertions.
c. Retesting control activities that appeared to be ineffective during the assessment of control risk.
d. Considering unusual or unexpected account balances that were not previously identified.
Explanation
Choice "d" is correct. The objective of analytical procedures used in the overall review stage of the audit is to assist the auditor in assessing conclusions reached and in the evaluation of the overall financial statement presentation. Analytical procedures applied in the overall review stage are used to consider the adequacy of evidence gathered in response to unusual or unexpected balances identified in planning the audit, and to identify unusual or unexpected balances or relationships that were not previously identified.
Choice "a" is incorrect. If analytical procedures are used to gather evidence about account balances that have not changed from last year, they are functioning as a substantive test rather than as a final review procedure.
Choice "c" is incorrect. Analytical procedures are not used to test controls.
Choice "b" is incorrect. If analytical procedures are used as a test of transactions, they are functioning as a substantive test rather than as a final review procedure.
65
An auditor most likely would apply analytical procedures in the overall review stage of an audit to:
a. Determine whether additional audit evidence may be needed.
b. Evaluate the effectiveness of the internal control activities.
c. Enhance the auditor's understanding of subsequent events.
d. Identify auditing procedures omitted by the staff accountants.
Explanation
Choice "a" is correct. In performing analytical procedures as an overall review, the auditor determines whether adequate evidence has been gathered in response to unusual or unexpected balances identified during the audit, and may decide that additional audit procedures are warranted. In addition, the auditor may identify unusual or unexpected balances not already noted during the audit, which would also require the application of further auditing procedures.
Choice "c" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be likely to enhance the auditor's understanding of subsequent events.
Choice "d" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be likely to identify omitted auditing procedures.
Choice "b" is incorrect. Analytical procedures applied during the overall review stage of the audit are meant to evaluate the overall financial statement presentation, and to assess the conclusions reached by the auditor. This is a high-level review, and one that focuses on the financial statements. As such, it would not be useful in evaluating the effectiveness of the client's internal control activities.
66
An auditor finds several errors in the financial statements that the client prefers not to correct. The auditor determines that the errors are not material in the aggregate. Which of the following actions by the auditor is most appropriate?
a. Do not summarize the uncorrected errors in the working papers, and do not document a conclusion about whether the uncorrected errors cause the financial statements to be misstated.
b. Summarize the uncorrected errors in the working papers, but do not document whether the errors cause the financial statements to be misstated.
c. Document the conclusion that the errors do not cause the financial statements to be misstated, but do not summarize uncorrected errors in the working papers.
d. Document the errors in the summary of uncorrected errors, and document the conclusion that the errors do not cause the financial statements to be misstated.
Explanation
Choice "d" is correct. The auditor should document the errors in the summary of uncorrected errors, and document the conclusion that the errors do not cause the financial statements to be misstated.
Choice "c" is incorrect. The auditor is required to document both his/her conclusion and summarize uncorrected errors in the working papers.
Choice "b" is incorrect. The auditor is required to summarize the uncorrected errors in the working papers and document whether the errors cause the financial statements to be misstated.
Choice "a" is incorrect. The auditor is required to perform both of these procedures.
