A-5 2013

Question 1

What is the difference between nonstatistical and statistical sampling?

Answer 1

Statistical sampling: Uses laws of probablility for selection and evaluation of a sample. Allows for quantification of audit risk and sufficiency of audit evidence. Nonstatistical sampling: Does not utiliize statistical models in calculations. Auditors use their judgment to determine sample sizes to evaluate the selection samples.

Question 2

When is professional judgment necessary in the use of statistical or nonstatistical sampling by an auditor?

Answer 2

The auditor msut use professional judgment to: Define the population and sampling unit; Select the appropriate sampling method; Evaluate whether the audit evidence is appropriate; Evaluate the nature of deviations or errors; Consider sampling risk; Evaluate sample results and project to the population.

Question 3

Define sampling risk.

Answer 3

Sampling risk is the risk that the auditor’s conclusion based on sample is different from the conclusion that would have been reached if the tests had been applied to all items in the population.

Question 4

Define the two aspects of sampling risk for tests of controls.

Answer 4

Risk of assessing control risk too low: Deciding the control is more effective/reliable than it really; affects audit effectiveness. Risk of assessing control risk too high: Deciding the control is less effective/reliable than it really is; affects audit efficiency.

Question 5

Identify two aspects of sampling risk that the auditor would be concerned with when performing substantive testing.

Answer 5

Risk of incorrect acceptance: Deciding from the sample that the balance is correct when it is really materially misstated; affects audit effectiveness. Risk of incorrect rejection: Deciding from the sample that the balanceis materially misstated when it is really correct; affects audit efficiency.

Question 6

What is the relationship between sampling risk and reliability (confidence level)?

Answer 6

Sampling Risk + Confidence Level = 100%

Question 7

What is attribute sampling?

Answer 7

Attibute sampling is a statistical sampling method used to estimate a rate of occurrence in a sample. It is used in tests of controls.

Question 8

Define tolerable deviation rate (for attibute sampling) and tolerable misstatement (for variables sampling).

Answer 8

Tolerable deviation rate: The maximum rate (%) of deviation from a control procedure that the auditor is willing to accept while still relying on the control. Tolerable misstatement: The largest amount of misstatement the auditor believes can exist in a balance or class of transactions without causing the financial statements to be materially misstated.

Question 9

What factors affect sample size for an attibute sampling application?

Answer 9

The following factors affect sample size in an attribute sampling application: Risk of assessing control risk too low (inverse relationship); Tolerable deviation rate (inverse relationship); Expected deviation rate (direct relationship).

Question 10

What rates are compared in drawing a conclusion about an attribute sampling application?

Answer 10

The auditor compares the upper deviation rate to the tolerable deviation rate in drawing conclusions about an attribute sampling application. If the upper deviation rate exceeds the auditor’s tolerable deviation rate, the auditor will not rely on the control. (The upper deviation rate is the sample deviation rate plus an allowance for sampling risk.)

Question 11

What factors affect sample size for a variables sampling application?

Answer 11

The following factors affect sample size in a variables sampling application: Standard deviation or population variability (direct relationship); Tolerable misstatement (inverse relationship); Acceptance level of risk (inverse relationship); Expected size and frequency of misstatements (direct relationship); Assessed level of risk (direct relationship).

Question 12

Describe variables sampling.

Answer 12

Variables sampling is a statistical sampling method used to estimate the numerical amount of a population. It may be used to substantiate management’s assertions in the financial statements by determining whether amounts are reasonable. Often, this is accomplished by developing independent estimates of financial statement amounts. Variable sampling is used primarily in substantive testing.

Question 13

What amounts are compared in drawing a conclusion about a variables sampling application?

Answer 13

The auditor compares the client’s book value to the calculated range in a variables sampling application. If the recorded book value is within the acceptable range, the book value is considered fairly stated. (The calculated range is the point estimate, as determined from the sample, plus/minus an allowance for sampling risk.)

Question 14

What is discovery sampling?

Answer 14

Discovery sampling is a type of attribute sampling used when the expected deviation rate is zero or new zero.

Question 15

What are the sampling plans commonly used for variables estimation?

Answer 15

Mean-per-unit estimation: The sample mean is multipled by the number of items in the population to estimate population value. Ratio estimation: The ratio between book value and audited value (from a sample) is used to estimate population value. Difference estimation: The differnce between book value and audited value (from a sample) is used to estimate population value.

Question 16

Define Probability-Proportional-to-Size (PPS) sampling.

Answer 16

Probability-Proportional-to-Size (PPS) sampling is a hybrid sampling technique that uses attribute sampling theory to express a conclusion in dollar amounts rather than as a rate of occurrence. The sampling unit is defined as an individual dollar in a population, which creates the effect of stratified sampling (the unit’s change of being selected increases as its amount increases).

Question 17

What are the advantages and disadvantages of using PPS sampling?

Answer 17

Advantages: Automatic stratification; Efficient (smaller sample). Disadvantages: May require special considerations for negative, zero, and understand balances.

Question 18

How is the sampling inteval determined in a PPS sampling application?

Answer 18

Sampling interval = Tolerable misstatement / Reliability factor. (The relizability factor comes from a table and is based on the risk of incorrect acceptance.)

Question 19

What are the three primary purposes for obtaining written representations from management?

Answer 19

To confirm representations explicity or implicity given to the auditor. To indicate and document the continuing appropriateness of such representations. To reduce the possibility of misunderstanding concern matters that are the subject of the representations.

Question 20

What general types of items are included in a management representation letter, and who should sign it?

Answer 20

A management representation letter generally includes information related to: The financial statements; The completeness of information; Fraud; Related party transactions; Recognition, measurement, and disclosure; Subsequent events; Issues specific to a particular entity. The management representation letter should be signed by the CEO, CFO, and any other members of management who are responsible for and knowledgeable about the items contained in the letter.

Question 21

List the items that an auditor is required to communicate to those charged with governance.

Answer 21

The auditor is required to communicate with those charged with governance regarding: The auditor’s responsibility under GAAS; The planned scope and timing of the audit; Significant audit findings, including: significant accounting policies; management jusgments and accounting estimates; the auditor’s judgment about the quality of the entity’s accounting princples; difficulties encountered in performing the audit disagreements with management; uncorrected misstatements; management issues discussed prior to retention; audit adjustments; consultation (by management) with other accountants; other items required by AICPA standards or the Sarbanes-Oxley Act. Note: The communication can be oral or written, but msut be documented in the audit documentation (working papers).

Question 22

What are the functions of the audit committee?

Answer 22

The audit committee typically: 1. Selects and appoints the independent auditor and sets the audit fee. 2. Reviews the nature and details of the audit engagement. Reivews the quality of the auditor’s work. 4. Reviews the scope of the audit. 5. Determines that any recommendations made by the auditor are given proper attention. 6. Maintains lines of communication between the auditor and the board of directors. 7. Helps solve any disagreements related to the accounting treatment of material items in the financail statements. 8. Evaluates the internal control of the company with the help of the independent auditor. 9. Makes reports to the board of directors and the stockholders when necessary. 10. Assures that the auditor is indpendent of the company. Note: The audit committed has additional responsibility under Sarbanes-Oxley.

Question 23

What is a control deficiency?

Answer 23

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect/correct misstatements on a timely basis.

Question 24

What is a significant deficiency?

Answer 24

A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those charged with governance (responsible for oversight of the company’s financial reporting).

Question 25

What is a material weakness?

Answer 25

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected/corrected on a timely basis.

Question 26

What is the auditor’s responsibility with respect to control deficiencies identified during an audit of a nonissuer?

Answer 26

The auditor has a responsibility to evaluate control deficiencies identified during the audit to determine whether they represent significant deficiencies or material weaknesses. Significant deficiencies and material weaknesses should be communicated in writing to management and those charged with governance within 60 days of the report release date. The communication with management and those charged with governance should be restricted use.

Question 27

What is an integrated audit. When is an integrated audit required?

Answer 27

An integrated audit requires the auditor to audit both the financial statements and internal control over financial reporting. The two auditrs must be preformed together, and two opinions (one on the financial statements and one on the effectiveness of internal control) will be rendered. An integrated audit is required: 1. For all audits issuers. 2. When an auditor is engaged to examie the internal control of a nonissuer.

Question 28

Describe the top-down approach used to select controls to test for issuer/nonissuer clients.

Answer 28

The top-down approach includes the following chronological levels. Financial statement level–the auditor evaluates overall risks. Entry level–the auditor identifies and tests controls pertaining to: The control environment; Management override; Monitoring the results of operations and other controls; Period-end financial reporting; Centralized opeations. Accounts, Disclosures, and Assertions level–the auditor evaluates qualitative and quantitative risk factors to identify significant accounts, disclosures, and assertions for which there is a reasonable possibility of material misstatement. Once identified, the controls are tested.

Question 29

What is the accountant’s responsibility with respect to control deficiencies identified during an engagement to examine the internal control of a nonissuer?

Answer 29

Significant deficiencies and material weaknesses should be communicated in writing to management and those charged with governance by the report release date. Control deficiencies that are not significant deficiencies or material weaknessse should be communicated in writing to management within 60 days of the report release date. A material weakness results in an adverse opinion.

Question 30

How are control deficiencies, significant deficiencies, and material weaknesses communicated by the auditor to the issuer in an integrated audit?

Answer 30

All internal control deficiencies over financial reporting that were identified during the audit should be communicated to management in writing. The audit committee should be informed when the communication was made. Any significant deficiencies identified during the audit should be communicated in writing to the audit committee. Any material weaknesses identified during the audit should be communicated in writing to both management and the audit committee prior to the issuance of the auditor’s report on internal control over financial reporting.

Question 31

How does the extent of testing of internal controls differ between a financial statement audit and an examination of internal control for nonissuers?

Answer 31

The extent of testing of internal controls for a financial statement audit is more limited than in an internal control examination. When rendering an opinion on internal control for an examination of internal controls, the auditro should obtain evidence regarding the effective of selected control over all relevant assertions. THis level of testing is not required for a financial statement audit.