Unit 4 Flashcards
How do you gain understanding of the client?
- Make inquiries of management and of others within the entity who many have information to help identify the risk of material misstatements (both financial and non-financial staff)
- Perform analytical procedures to identify any unusual or unexpected relationships that may highlight where risks exist
- Perform observation and inspection procedures to corroborate the responses made by management and others within the organization
What levels do you gain understanding of the client? Explain.
- At the entity level, the auditor will determine what the client does, how it functions, how its ownership is structured and what it’s sources of financing are.
- At the industry level, the auditor is interested in their client’s position within its industry, the level of competition in that industry and the client’s size relative to competitors.
- At the economy level, the auditor assesses how economy-level factors affect the client (changes in interest rates, currency fluctuations, etc.) The auditor is also concerned with a client’s susceptibility to these changes and its ability to withstand economic pressures.
What procedures does an auditor follow relating to fraud?
- Ask client management, the internal audit department (if applicable) and those charged with governance if they are aware of a known fraud or suspect that there has been a fraud.
- Attend a team planning meeting with audit staff and the audit partner. Fraud risk factors should be discussed so that less experienced team members can be educated on these high risk areas.
- Perform a preliminary financial statement analysis to identify unusual relationships between accounts that may indicate fraud and thus require further investigation during the audit.
- Consider the risk of management override of the accounting records and controls designed to prevent such fraud.
What does an auditor do when they find fraud during an engagement?
- Seeks legal advice to determine if there is a requirement to report the fraud to an outside third party (client confidentiality must be considered)
- Considers withdrawing from the engagement
- Reports the fraud to the next level of management
- Reports the fraud to the audit committee
What is an audit strategy? What is it based on?
- An audit strategy sets the scope, timing and direction of the audit and provides the basis for developing a detailed audit plan.
- Audit strategy is based on the auditor’s preliminary assessment of control risk (will we take a combined or a substantive approach) AND detection risk (how much detailed testing are we going to perform)
What is materiality?
• Information is considered to be material if it impacts the decision-making process of the users of the financial statements.
What are the eight steps of materiality?
- Step 1: Identify the users of the financial statements
- Step 2: Identify the user’s objectives (earnings, cash flow/collateral)
- Step 3: Determine the base for materiality
- Step 4- Identify the threshold for materiality
- Step 5- Determine materiality
- Step 6- Determine overall performance materiality
- Step 7- Determine specific materiality
- Step 8- Determine specific performance materiality
What are related parties?
- Entities that operate with the client. Auditor must gain understanding of the client, and that they are identified and in accordance with accounting standards.
What is an auditor required to do with related parties?
- Discuss with engagement team risk of material mistatement due to fraund or error on the FS from related parties
- Ask management to identify all related parties and explain the nature, type and purpose of transactions with these entities.
- Obtain an understanding of the processes and procedures management has in place to identify, authorize, account for and disclose related party transactions in accordance with GAAP.
- Remain alert when inspecting documents for indicators that related party transactions may not have been identified or disclosed to the auditor.
- Identify and assess the risk that transactions may not be in the normal course of operations.
What is going concern?
It is whether a company is going to continue operating or not.
What are the standards for auditors related to going concern?
- It is the responsibility of management and those charged with governance to assess if the company is likely to remain as a going concern.
- It is the responsibility of the auditor to obtain sufficient appropriate evidence to assess the validity of the going concern assumption made by the client’s management and those charged with governance.
What are indicators of going concern? List 6.
- a significant debt-to-equity ratio
- long-term loans reaching maturity without alternative – financing in place
- prolonged losses
- an inability to pay debts when they fall due
- supplier reluctance to provide goods on credit
- the loss of a major market, key customer, franchise, or licence
- overreliance on a few customers or suppliers
- staff regularly out on strike
- shortage of a key input or raw material
- rapid growth with insufficient planning
- being under investigation for non-compliance with legislation
- falling behind competitors
What procedures does an auditor take when going concern is in doubt?
o Assessment of cash flows
o Assessment of revenue and expense items
o Assessment of interim financial statements
o Discussions with client management and lawyers
o Review of board meeting minutes
Under step 3 for determining materiality what are some common bases for materiality?
o Common bases include: Income before tax Total assets Total revenues Total expenses Total equity
o Must also identify unusual revenues or expesnes (bonuses, gains/losses)
Under step 4 for determining materiality what are some general thresholds?
o Profit before tax from continuing operations: 3% to 7%
o Assets: 1% to 3%
o Equity: 3% to 5%
o Revenues and expenditures: 1% to 3%
