A3

Question 1

Inquiries auditors should make of management with respect to fraud

Answer 1

How management communicates to its employees its view on acceptable business practices
Whether management is aware of any fraud or allegations of fraud
Whether there are any particular business segments with a higher risk of fraud
Process for identifying/responding to fraud risk
Whether company has entered into any significant unusual transactions

Question 2

Conditions identified during fieldwork that increase risk of fraud

Answer 2

Discrepancies in accounting records
Conflicting or missing evidence
Disagreements between auditor and management
Accounting policies inconsistent with widely recognized industry practices
Frequent changes in accounting estimates that don’t result from changing circumstances
Tolerating code of conduct violations

Question 3

Auditor responses to fraud risk

Answer 3

Assign appropriate personnel to engagement and determine appropriate level of supervision
Evaluate management selection of accounting principles
Incorporate unpredictability in selecting audit procedures
Alter nature/extent/timing of audit procedures
Examine JE adjustments, especially unusual JEs
Review accounting estimates for biases
Evaluate business purpose for significant unusual transactions

Question 4

Rationalization risk factors

Answer 4

Management’s disregard for internal controls
Management knows of significant deficiencies but fails to correct them
Management is overly agressive in meeting financial goals

Question 5

Audit risk definition

Answer 5

The risk that the auditor issue an unmodified opinion on financial statements that are materially misstated

Question 6

Types of misstatements

Answer 6

Factual- no doubt they are incorrect
Judgemental- Incorrect accounting estimates by management
Projected- Auditor’s best estimate of a misstatement in a population based on misstatement percentage identified in a sample

Question 7

Assertion level risk

Answer 7

Risks that relate to specific transactions, account balances, or disclosures at the assertion level, rather than the financial statements as whole

Question 8

If interim substantive tests are performed, what addtional procedures should be performed at year-end?

Answer 8

Substantive analytical procedures for period interim date
Tests of details for activity in period after interim date
Reconciliation of prior year-end balances to interim balances

Question 9

Information that indicates possible noncompliance with laws and regulations

Answer 9

Large payments made to cash, bearers, cashier’s checks, transfer funds
Being forced to discontinue operations in a foreign country

Question 10

Items that indicate possible related party transactions

Answer 10

Compensating balance arrangement
Loan guarantees
Unusual, nonrecurring transactions near year end
Transactions based on terms significantly different than market terms
Nonmonetary exchanges

Question 11

Audit procedures to identify contingencies/litigation

Answer 11

Obtain letter of inquiry from client’s attorney
Inquire of management
Review minutes of BOD and stockholder meetings
Review invoices and correspondences from lawyers
Review contracts, loan agreements, leases from taxing authorities

Question 12

Audit procedures to identify related parties

Answer 12

Evaluate company procedures for accounting for related party transactions
Asking management for a list of related parties
Review company filing’s with SEC
Review material transactions
Review prior year’s audit documentation

Question 13

The relevance of audit evidence depends on (PCAOB)

Answer 13

Whether the audit procedure is designed to test assertion directly
Whether the audit procedure is designed to test for understatement or overstatement
Timing of audit procedure

Question 14

Corroborating evidence

Answer 14

Gives validity to recorded accounting data
Minutes of meetings
Confirmations
Analyst’s reports
Data about competitors
Information obtained through observation, inquiry, inspection

Question 15

Steps of designing and performing analytical procedures

Answer 15

1. Determine procedures suitable for testing the assertion.
2. Evaluate reliability of the data.
3. Develop an expectation of recorded amounts based on prior periods and forecasts.
4. Perform analytical procedures and compare results with expectations.
5. Investigate any significant differences.

Question 16

Purpose of analytical procedures in each audit phase

Answer 16

Planning- To assist auditor in understanding the business environment and alert auditor to problem areas
Substantive procedures- To obtain audit evience about management assertions
Final review- To evaluate overall financial statement presentation, assess conclusions reached, and determine whether adequate evidence has been gathered

Question 17

Examples of analytical procedures

Answer 17

Comparing inventory balances to recent sales activities.

Comparing loan balances, interest rates with interest expense recorded

Question 18

Factors in an auditor’s decision to apply analytical procedures as substantive tests on data

Answer 18

Nature of assertion- I/S accounts, no apparent misstatement
Predictability/plausibility of data relationship- not subject to management discretion
Availability/reliability of data- External vs internal source
Precision of expectation
Methods used to develop auditor’s expectation- trend, ratio, or regression analysis

Question 19

Reconciliation audit procedure

Answer 19

Comparing financial amounts from two independent sources for agreement.
Ex. Cash per books with cash per bank, physical inventory count with perpetual inventory records

Question 20

Walkthough audit procedure

Answer 20

Questioning entity personnel about their understanding of entity’s policies and procedures.
Can include a combination of inquiry, observation, inspection of relevant documentation, recalculation, reporformance

Question 21

Reperformance

Answer 21

Auditor independently performs procedures or controls that were originally performed as part of an entity’s internal control.
Ex. Creating an aging of certain A/R accounts based on company’s aging policies

Question 22

Liquidity ratios

Answer 22

Current ratio

Quick ratio

Question 23

Activity ratios

Answer 23

A/R, A/P, Asset and Inventory turnover
Days sales in A/R, A/P, Inventory
Cash conversion cycle

Question 24

Profitability Ratios

Answer 24

Profit margin
Gross Profit margin
Return on Assets, Sales, Equity
Operating cash flow

Question 25

Investor ratios

Answer 25

Basic EPS
Price earnings ratio
Dividend payout

Question 26

Long-term Debt Paying Ability Ratios

Answer 26

Debt to Equity
Total debt ratio
Equity multiplier
Times interest earned

Question 27

Advantages of Statistical Sampling over nonstatistical

Answer 27

Measure sufficiency of audit evidence obtained
Provide an objective basis of quantitatively evaluating sample rsults
Design an efficient sample
Quantify sampling risk to limit risk to an acceptable level

Question 28

Factors in determining sample size for tests of controls

Answer 28

(Acceptable) Risk of Assessing Control risk too Low
Tolerable Deviation Rate
Expected Deviation Rate
(Population size has little effect)

Question 29

Classical Variables sampling plans (estimating point estimate)

Answer 29

Mean-per-unit estimation: Average sample audited value x Population size
Ratio estimation: (Audited sample value/Book sample value) x Total Book value
Difference estimation: Total Book Value - Average sample difference (Audited - Book) x Population size

Question 30

Planning considerations for a sample of substantive test of details

Answer 30

Relationship of sample to relevant audit objective
Preliminary estimates of materiality levels
Auditor’s allowable risk of incorrect acceptance
Characteristics of the population

Question 31

Factors in determing sample size for variables sampling

Answer 31

Variability in population (standard deviation)
(Acceptable) Risk of incorrect acceptance
Tolerable and Expected misstatement