3.12 Flashcards
Which of the following would a successor auditor ask the predecessor auditor to provide after accepting an audit engagement?
Matters that may facilitate the evaluation of financial reporting consistency between the current and prior years.
An objective of an initial audit is to obtain sufficient appropriate evidence regarding opening balances. The auditor should determine whether they (1) contain misstatements materially affecting the current statements and (2) reflect appropriate accounting policies consistently applied in the current statements. Relevant audit evidence about these matters may include (1) the most recent audited statements, (2) the predecessor’s report on them, (3) the results of inquiry of the predecessor, and (4) a review of the predecessor’s audit documentation (AU-C 510).
Analytical procedures used to form an overall conclusion of an audit generally would include
Considering the adequacy of the evidence gathered in response to unexpected balances identified in planning.
Analytical procedures used to form an overall conclusion ordinarily should include reading the financial statements and considering (1) the adequacy of evidence gathered in response to unusual or unexpected balances identified in planning or conducting the audit and (2) unusual or unexpected balances or relationships not previously detected.
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.
An auditor most likely obtains an understanding of a new client to
Identify areas of audit emphasis.
The understanding provides a basis for assessing risks of material misstatement and responding to them in the exercise of professional judgment. For example, the auditor needs to identify areas that need special audit consideration, such as complex or unusual transactions or related-party transactions.
Which of the following is an analytical procedure that an auditor most likely uses to form an overall conclusion?
Reading the financial statements and considering whether there are any unusual or unexpected balances that were not previously identified.
Analytical procedures used to form an overall conclusion should ordinarily include reading the financial statements and considering (1) the adequacy of evidence gathered in response to unusual or unexpected balances identified in planning or conducting the audit, and (2) unusual or unexpected balances or relationships not previously detected.
The audit risk against which the auditor and those who rely on his or her opinion require reasonable protection is a combination of two separate risks at the assertion level. The first risk (consisting of inherent risk and control risk) is that balances, classes of transactions, or disclosures contain material misstatements. The second is that
Material misstatements that occur will not be detected by the audit.
Audit risk is a function of the risks of material misstatement and detection risk. Detection risk is the risk that the procedures performed to reduce audit risk to an acceptably low level will not detect a misstatement that exists and could be material individually or combined with other misstatements. The auditor assesses the risk of material misstatement after obtaining an understanding of the entity and its environment, including its internal control. It exists at the overall financial statement level and assertion level. The RMM at the assertion level consists of inherent risk and control risk. Some auditors use a mathematical model based on the relationships of the components of audit risk to arrive at an acceptable level of detection risk. For example, it reflects that the acceptable detection risk has an inverse relationship with the RMMs at the assertion level (AU-C 200 and AS 1101).
Risk assessment procedures
Assess the risks of material misstatement of financial statements.
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 at the levels of (1) the financial statements as a whole and (2) relevant assertions.
On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed risks of material misstatement from those originally planned. To achieve an overall audit risk that is substantially the same as the planned audit risk, the auditor would
Decrease detention risk.
Control risk and inherent risk are the components of the risk of material misstatement (RMM). Thus, audit risk is a function of inherent risk, control risk, and detection risk. The only risk the auditor directly controls is detection risk. The auditor can assess what control risk and inherent risk are believed to be, but (s)he can change detection risk directly. Thus, the auditor can achieve the desired audit risk based on the assessed RMMs and the acceptable level of detection risk. Because detection risk has an inverse relationship with the RMMs, increasing the assessed RMMs requires a decrease in the acceptable detection risk if overall audit risk is held constant.
The acceptable level of detection risk is inversely related to the
Assurance provided by substantive procedures.
For a given audit risk, the acceptable detection risk is inversely related to the assessed risks of material misstatement. As the RMMs increase, the acceptable detection risk decreases, and the auditor requires more persuasive audit evidence. The auditor may (1) change the types of audit procedures and their combination, e.g., confirming the terms of a contract as well as inspecting it; (2) change the timing of substantive procedures, such as from an interim date to year end; or (3) change the extent of testing, such as by using a larger sample (AU-C 330 and AS 2301).
Which of the following statements concerning noncompliance with laws and regulations by clients is correct?
An auditor has responsibility to detect noncompliance with laws and regulations that has a direct effect on the financial statements.
According to AU-C 250, the auditor should obtain sufficient appropriate audit evidence regarding material amounts and disclosures in the financial statements that are determined by the provisions of those laws and regulations generally recognized to have a direct effect on their determination.
For which one of the following purposes does an internal auditor not evaluate the risks and the adequacy and effectiveness of controls?
The opinion expressed on financial information.
The independent external auditor’s basic purpose is to express an opinion on (attest to) the fairness of the entity’s general use financial statements. Consequently, the external auditor, not the internal auditor, evaluates the entity’s external financial reporting. Individual internal auditors cannot perform this function because they are employees who cannot be independent in fact and appearance. Independence is only an organizational (not individual) attribute of the internal audit activity.
Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?
Management is interested in maintaining the entity’s earnings trend by using aggressive accounting practices.
Fraud risk factors relate to misstatements arising from (1) fraudulent financial reporting and (2) misappropriation of assets. Each of these categories may be further classified according to the three conditions that ordinarily exist when fraud occurs: (1) incentives or pressures, (2) opportunities, and (3) attitudes or rationalizations. For example, excessive pressure may exist to meet the expectations of third parties (e.g., analysts, investors, and creditors) regarding profitability or trends (AU-C 240).
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.
An auditor’s inquiries of the predecessor auditor should include questions regarding
The predecessor’s understanding as to the reasons for the change in auditors.
Inquiries should include (1) facts that are relevant to the integrity of management; (2) disagreements with management about accounting principles, audit procedures, or other similar matters; (3) communications to those charged with governance (e.g., the audit committee) about fraud and noncompliance with laws and regulations; (4) communications to management and those charged with governance about significant deficiencies and material weaknesses in internal control; and (5) the predecessor’s understanding as to the reason for the change in auditors.
An auditor discovers that a client’s accounts receivable turnover is substantially lower for the current year than for the prior year. This trend may indicate that
Fictitious credit sales have been recorded during the year.
The accounts receivable turnover ratio equals net credit sales divided by average accounts receivable. Accounts receivable turnover will decrease if net credit sales decrease or average accounts receivable increases. Fictitious sales increase both the numerator and denominator. Adding an equal amount to both the numerator and denominator decreases a fraction greater than 1.0. For example, adding 1 to both parts of the fraction 3 ÷ 2 decreases it to 4 ÷ 3. The turnover ratio will decrease still more in the next period because fictitious items will continue to increase receivables (a real account) but not sales (a nominal account).
