3.11 Flashcards
An auditor is required to obtain an understanding of the entity’s business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding?
To assist the auditor to accurately interpret information obtained during an audit.
The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement. The understanding addresses, for example, (1) the nature of the entity; (2) transactions, balances, and disclosures; (3) objectives, strategies, and business risks; (4) accounting practices; and (5) financial performance. This understanding is necessary for the auditor to interpret the audit evidence obtained and to determine its sufficiency and appropriateness.
Which of the following procedures is the auditor most likely to perform after accepting an initial audit engagement?
Tour the client facilities.
The auditor performs risk assessment procedures to obtain an understanding of the entity and its environment, including internal control. They include (1) inquiries within the entity, (2) analytical procedures, and (3) observation and inspection. An example of observation and inspection is touring the client’s facilities.
Which of the following is required documentation in an audit in accordance with auditing standards?
An audit plan documenting the procedures to be used to reduce audit risk.
An audit plan should be developed and documented based on the overall audit strategy. This strategy, the audit plan, significant changes in them, and the reasons for changes are documented. The audit plan records the nature, timing, and extent of risk assessment procedures and further procedures performed at the assertion level to respond to assessed risks. It also records other planned procedures required by GAAS. Thus, the audit plan is a record of the planning of the audit procedures that can be reviewed prior to their performance (AU-C 300 and AS 2101).
Which of the following statements is correct regarding the auditor’s consideration of the possibility of noncompliance with laws and regulations by clients?
If specific information concerning noncompliance with laws and regulations comes to the auditor’s attention, the auditor should apply audit procedures specifically directed to ascertaining whether an act of noncompliance has occurred.
Instances of noncompliance are violations of laws or governmental regulations that do not include personal misconduct by the client’s personnel unrelated to their business activities. The auditor’s responsibility for detection of misstatements arising from noncompliance having direct and material effects is the same as that for material errors and fraud. If information comes to the auditor’s attention concerning noncompliance, the auditor should apply specific audit procedures to determine whether an act of noncompliance has occurred.
Analytical procedures reveal significant unexpected differences between recorded amounts and the expectations developed by the auditor. If management is unable to provide an acceptable explanation, the auditor should
Perform additional audit procedures to investigate the matter further.
Inconsistent fluctuations or relationships or significant differences should result in (1) inquiries of management, (2) corroboration of responses with other audit evidence, and (3) performance of any necessary other procedures. Moreover, the RMMs due to fraud should be considered.
In a financial statement audit, inherent risk is evaluated to help an auditor assess which of the following?
The susceptibility of a financial statement assertion to a material misstatement before consideration of related controls.
Control risk and inherent risk are the components of the risk of material misstatement (RMM). The auditor determines the appropriate level of detection risk based on the assessment of RMMs and the acceptable level of audit risk. Inherent risk is the susceptibility of an assertion about a transaction class, account balance, or disclosure that could be material, individually or combined with other misstatements, before consideration of any related controls.
An auditor compares this year’s revenues and expenses with those of the prior year and investigates all changes exceeding 10%. By this procedure the auditor would be most likely to learn that
The client changed its capitalization policy for small tools this year.
Investigating changes in revenues and expenses should detect unusual events, transactions, etc., that have an impact on the income statement accounts. A change in the capitalization policy for tools in the current year would probably have a significant effect on small tools expense.
Early appointment of the auditor enables preliminary work to be performed by the auditor. This benefits the client because it permits the audit to be performed in
A more efficient manner.
Early appointment of the auditor is advantageous to both the auditor and the client. Early appointment aids the auditor in planning the work, especially that to be done before the end of the year. The client benefits from more efficient scheduling of the audit and an early completion of the work after the end of the fiscal year.
Analytical procedures are required for which of the following?
Audit planning.
An audit plan based on the audit strategy must be developed and documented for all audit engagements. It includes the nature, timing, and extent of procedures expected to reduce audit risk to an acceptably low level. Thus, the audit plan includes a description of risk assessment procedures. Risk assessment procedures are performed to obtain an understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) at the levels of (1) the financial statements as a whole and (2) relevant assertions. Risk assessment procedures include (1) inquiries of management and others within the entity, (2) analytical procedures, and (3) observation and inspection. The auditor also may perform other appropriate procedures, such as inquiring of external parties (e.g., legal counsel) or reviewing externally generated information (e.g., financial publications). Analytical procedures may be applied not only as risk assessment procedures (analytical procedures used to plan the audit) but also as substantive procedures. These are procedures (tests of details and analytical procedures) designed to detect material misstatements at the assertion level.
Which of the following procedures would least likely result in the discovery of possible noncompliance with laws and regulations?
Reviewing an internal control questionnaire.
Auditors should design the audit to provide reasonable assurance of detecting noncompliance having a material effect on the financial statements. Internal control questionnaires document the auditor’s understanding of internal control. Reviewing the responses to the questionnaire may reveal control deficiencies but not noncompliance.
When an auditor of a parent nonissuer is also the auditor of a component, then each of the following factors would ordinarily influence the decision to obtain a separate engagement letter from the component, except
Whether there has been any turnover of the component’s board members.
When the auditor of a parent entity is also the auditor of a component, the factors that may influence the decision whether to obtain a separate audit engagement letter from the component include (1) who engages the component auditor, (2) whether a separate auditor’s report is to be issued on the component, (3) legal requirements regarding the appointment of the auditor, (4) degree of ownership by the parent, and (5) degree of independence of the component’s management from the parent entity.
Which of the following information discovered during an audit most likely would raise a question concerning possible noncompliance with laws and regulations?
The entity prepared several large checks payable to cash during the year.
Some examples of information raising questions about possible noncompliance with laws and regulations are unauthorized or improperly recorded transactions, a governmental investigation, violations reported by regulators, large payments for unspecified services to consultants, excessive commissions or fees, unusual cash payments or checks payable to cash, unexplained payments to government officials or employees, and failure to file tax returns or pay governmental duties or similar fees.
One reason the independent auditor applies analytical procedures with regard to the client’s operations is to identify
Unusual transactions.
Analytical procedures are evaluations of financial information made by a study and comparison of the relationships among data. The premise is that certain relationships prevail in the absence of known conditions to the contrary. Analytical procedures identify such things as the existence of unusual transactions and events and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications (AU-C 520). These matters may then be examined and investigated by the auditor.
Analytical procedures performed to assist in forming an overall conclusion suggest that several accounts have unexpected relationships. The results of these procedures most likely indicate that
Additional audit procedures are required.
Analytical procedures used to form an overall conclusion ordinarily include reading the financial statements and considering (1) the adequacy of evidence regarding unusual or unexpected balances detected during the audit and (2) such balances or relationships not detected previously. If analytical procedures detect a previously unrecognized risk of material misstatement, the auditor must revise the assessments of the RMMs and modify the further planned procedures. Inconsistent fluctuations or relationships or significant differences should result in (1) inquiries of management, (2) corroboration of responses with other audit evidence, and (3) performance of any necessary other procedures. Moreover, the RMM due to fraud should be considered.
Inherent risk and control risk differ from detection risk in that inherent risk and control risk are
Functions of the client and its environment, but detection risk is not.
Detection risk is the auditor’s risk. It is a function of the effectiveness of an audit procedure and of its application by an auditor and can be changed at his or her discretion. Inherent risk and control risk differ from detection risk in that they exist independently of the audit. They are the components of the risk that material misstatements exist and therefore are the entity’s risks.
