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audit > A3: Engagement Acceptance and Understanding the Assignment > Flashcards

A3: Engagement Acceptance and Understanding the Assignment Flashcards

1
Q

Before the auditor accepts an engagement, what communication b/t the predecessor and the auditor should be made?

A
  • Obtain client’s permission to make inquiries of the predecessor auditor.
  • Specific inquiries include:
    1. Info. that might bear on MGT integrity
    2. Disagreements with MGT over accounting principles, auditing procedures, or other similarly significant matters
    3. The predecessor’s understanding as to the reasons for the change of auditors
    4. Communication to MGT, the audit committee, and those charged with governance regarding fraud, illegal acts by clients, and matters relating to I/C
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2
Q

After accepting the engagement, what communication between the auditor and the predecessor can be made?

A
  • Make specific inquiries regarding matters that may affect the conduct of the audit (e.g., audit problems)
  • Review the predecessor’s audit documentation related to matters of continuing accounting and auditing significance

Note that the auditor should not make reference to the work of the predecessor as the basis for the opinion.

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3
Q

What should the auditor assess when considering the firm’s client acceptance and continuance policies?

A
  • The firm’s ability to meet reporting deadlines.
  • The firm’s ability to staff the engagement
  • Independence.
  • Integrity of client MGT
  • The group engagement’s team ability to obtain sufficient appropriate audit evidence
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4
Q

What topics should be included in the agreement to audit engagement terms?

A
  • Objectives and the scope of the audit
  • MGT’s responsibilities
  • The auditor’s responsibilities
  • The limitations of the engagement
  • Other matters, such as timing, client assistance, fees and billing, etc.
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5
Q

What is the purpose of establishing an agreement to audit engagement terms?

A

The purpose is to reduce the risk of misunderstanding. Note that an engagement letter documenting the understanding is a requirement under PCAOB standards.

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6
Q

Name the six main F/S assertions for nonissuer and issuers.

A

Nonissuer:
(C) Completeness; (O) CutOff; (V) Valuation, allocation, and accuracy; (E) Existence and occurrence; (R) Rights and obligations; (U) Understandability and classification (COVERU)

Issuer:
(C) Completeness; (E) Existence; (O) Occurence (CEO). (A) Allocation; (P) Presentation; (R) Rights; (O) Obligations; (V) Valuation; (E); (D) Disclosure (APROVED)

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7
Q

Name the relevant assertions for “transactions and events.”

A
  • Completeness
  • (Proper Period) Cutoff
  • Accuracy
  • Classification
  • Occurrence
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8
Q

Name the relevant assertions for “account balances.”

A
  • Completeness
  • Allocation and Valuation
  • Rights and Obligations
  • Existence
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9
Q

Name the relevant assertions for “presentation and disclosure.”

A
  • Completeness
  • Understandability and Classification
  • Rights and Obligations, and Occurrence
  • Valuation and Accuracy
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10
Q

What is the audit strategy?

A

The audit strategy outlines the scope of the audit engagement, the reporting objectives, timing of the audit, and required communications, and the factors that determine the focus of the audit. The audit strategy also includes a preliminary assessment of materiality and tolerable misstatement.

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11
Q

Define materiality.

A

Materiality is the amount of error or omission that would affect the judgment of a reasonable person. The auditor uses judgment to set the initial levels of materiality (including materiality for the F/S as a whole, performance materiality, and materiality for particular classes of transactions, account balances, and disclosures), and to revise them appropriately throughout the audit.

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12
Q

Define tolerable misstatement.

A

Tolerable misstatement is the maximum error in a population that the auditor is willing to accept. Tolerable misstatement is the application of performance materiality to a particular sampling procedure.

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13
Q

What is an audit plan?

A

A written audit plan (required for every audit) is a listing of audit procedures that the auditor believes are necessary to accomplish the objectives of the audit. The audit plan typically follows development of the audit strategy.

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14
Q

What should be included in each step of the audit plan?

A

Each step of the audit plan should set out the procedure in detail, specifying the nature, extent, and timing of the work to be performed and including a reference to the assertion under consideration.

(N) Net
(E) Extent
(T) Timing

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15
Q

List the 3 types of audit procedures and tell why each is used.

A

Risk assessment procedures–to obtain an understanding of the entity and its environment, including its I/C

Tests of controls–to evaluate the operating effectiveness of I/C in preventing or detecting material misstatements.

Substantive procedures–to detect material misstatements in the F/S

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16
Q

What are the responsibilities of assistants when there are disagreements?

A

Assistants have a responsibility to exercise due professional care to observe the standards of fieldwork. They should bring any disagreements with the conduct of the audit to the attention of the auditor-in-charge.

The assistant also has the right to document the disagreement, and, if necessary, to disassociate from the opinion.

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17
Q

What factors determine the amount of reliance an independent auditor may place on the work of internal auditors?

A
  • The objectivity of internal auditors (level of reporting within the organizational structure)
  • The competence of internal auditors
  • An evaluation of the work performed by internal auditors

Note that the external auditor remains solely responsible for the audit report, and may not share judgment responsibility with the internal auditor.

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18
Q

Under PCAOB standards, what factors affect the nature and extent of necessary planning activities?

A
  • The size and complexity of the company
  • The auditor’s previous experience with the company
  • Changes in circumstances that occur during the audit
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19
Q

According to PCAOB standards, what factors indicate less complex operations?

A
  • Fewer business lines
  • Less complex business processes and financial reporting systems
  • More centralized accounting functions
  • Extensive involvement of senior MGT in day-to-day operations
  • Fewer levels of MGT
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20
Q

The engagement partner is responsible for:

A
  • Planning the audit
  • Supervising the work of engagement team members
  • Complying with relevant audit standards
21
Q

What factors determine the nature, extent, and timing of supervision?

A
  • The size and complexity of the entity
  • The nature of the work assigned to each engagement team member
  • The assessed risk of material misstatement
  • The qualifications of the assistants
22
Q

Distinguish between the 3 types of material misstatements.

A

Factual misstatements: There is no doubt.

Judgmental misstatements: MGT and the auditor have material judgment differences on accounting estimates or the application of accounting policies.

Projected misstatements: This represents the auditor’s best estimate of misstatements in populations, by projecting misstatements in an audit sample to the population that the samples were drawn.

23
Q

What is audit risk? List and define the two elements of audit risk.

A

Audit risk is the risk that the auditor may unknowingly fail to modify appropriately the opinion on F/S that are materially misstated. It comprises:

  • Risk of Material Misstatement–The risk that the F/S are materially misstated.
  • Detection Risk–The risk that the auditor will not detect a material misstatement that exists in a relevant assertion.
24
Q

State the audit risk model including the relationship of detection risk to substantive tests.

A

AR = RMM x DR

Where:
RMM = Risk of material misstatement
DR = Detection risk

Note that as the acceptable level of detection risk increases, the assurance required from substantive tests decreases. As the acceptable level of detection risk decreases, the assurance required from substantive testing must increase.

25
Q

What are the two components of the risk of material misstatement?

A

Inherent Risk: the susceptibility of a relevant assertion to a material misstatement assuming there are no related controls

Control Risk: the risk that a material misstatement that could occur in a relevant assertion will not be prevented or detected (and corrected) on a timely basis by the entity’s I/C.

26
Q

What is the difference between error and fraud?

A

An error is an unintentional misstatement or omission of amounts or disclosures in the F/S.

Fraud is an intentional action that results in misstatements or omissions of financial information with the intent to deceive F/S users.

27
Q

State the auditor’s responsibility to detect errors and fraud.

A

The auditor must plan and perform the audit (using due care and professional skepticism) to provide reasonable (not absolute) assurance about whether the F/S are free of material misstatement, whether due to errors or fraud.

28
Q

Name the two types of fraud.

A
  • Fraudulent financial reporting

- Misappropriation of assets, or defalcation

29
Q

What fraud risk factors are generally present when fraud occurs?

A

The three conditions that generally are present when fraud occurs are:
- Incentives/pressures
- Opportunity; and
- Rationalization/attitude.
The auditor identifies and evaluates these fraud risk factors as part of assessing the risk of material misstatement due to fraud.

30
Q

When analyzing fraud risk, which four attributes should the auditor consider?

A
  • Type of risk
  • Significance of the risk
  • Likelihood of the risk
  • Pervasiveness of the risk
31
Q

Why is the auditor required to obtain an understanding of the entity and its environment?

A

To assess the risk of material misstatement and to make informed judgments about other audit matters such as:

  • Materiality and tolerable misstatement
  • The entity’s selection and application of accounting procedures
  • Areas that require special audit consideration
  • Design and performance of further audit procedures
32
Q

What steps should the auditor perform in assessing and responding to risk?

A
  1. Obtaining an understanding of the entity and its environment including its I/C
  2. Assess the risk of material misstatement
  3. Respond to the assessed level of risk by designing further audit procedures based on this assessment
  4. Test I/C to evaluate their operating effectiveness.
  5. Perform substantive tests.
  6. Evaluate the sufficiency and appropriateness of audit evidence obtained.
33
Q

What risk assessment procedures should the auditor use to obtain an understanding of the entity and its environment?

A
  • Inquiry
  • Analytical procedures
  • Observation and inspection
  • Risk assessment discussion
34
Q

What factors should be examined when obtaining an understanding of the entity and environment?

A
  • Industry, regulatory, and other external factors
  • The nature of the entity
  • Objectives, strategies, and business risks
  • The entity’s financial performance
  • I/C
  • The company’s selection and application of accounting principles (issuer audits–PCAOB standards)
35
Q

What are analytical procedures?

A

Evaluation of financial info. made by a study of plausible relationships among both financial and nonfinancial data (e.g., ratio analysis)

Note: Analytical procedures are required in the planning and final review phases of the audit. They also may be used (but are not required) in substantive testing.

36
Q

For what purposes are analytical procedures used in the audit planning phase?

A

Analytical procedures are used in planning the audit to understand the client’s business and to identify unusual transactions and events, amounts, ratios, or trends that might represent specific risks relevant to the audit.

37
Q

What are the objectives of I/C?

A
  • To promote efficiency and effectiveness of operations
  • To ensure reliable financial reporting
  • To encourage compliance with applicable laws and regulations
38
Q

What are some inherent limitations of I/C?

A

Errors may be made in the performance of control procedures.

Collusion provides a way to bypass controls related to segregation of duties.

Top MGT can override I/C.

Segregation of duties may be difficult to achieve in a smaller entity.

39
Q

What are the five components of I/C?

A 
(C) Control environment
(R) Risk assessment
(I) Information and communication systems
(M) Monitoring
(E) Existing control activities
40
Q

Why is the control environment particularly important to I/C?

A

The control environment sets the tone of an organization, influencing the control consciousness of its employees, and providing the foundation for the other components of I/C.

41
Q

What factors are included in the control environment?

A
  • Communication and enforcement of integrity and ethical values
  • MGT’s commitment to competence
  • Participation of those charged with governance
  • MGT’s philosophy and operating style
  • Organizational structure
  • Assignment of authority, responsibility, and accountability
  • Human resource policies and practices
42
Q

Describe the “risk assessment” component of I/C.

A

Risk assessment is an entity’s identification and analysis of risks to achievement of its objectives with respect to financial reporting. Risk assessment involves identification, analysis, and mgt of business risks relevant to the preparation of F/S.

43
Q

What activities may be considered part of the monitoring component of I/C?

A
  • MGT and supervisory activities
  • Separate I/C evaluations
  • The internal audit function
  • Evaluation of communications from external parties
44
Q

Name some control activities that are relevant to an audit.

A

(P) Prenumbering of documents
(A) Authorization of transactions
(I) Independent checks to maintain asset accountability
(D) Documentation
(T) Timely and appropriate performance reviews
(I) Information processing general and application controls
(P) Physical controls for safeguarding assets
(S) Segregation of duties

45
Q

What functions should be segregated?

A

(A) Authorizing transactions
(R) Recording transactions
(C) Maintaining Custody of the related assets

46
Q

What steps should the auditor take in designing the nature, extent, and timing of further audit procedures?

A

The auditor uses his or her understanding of the entity and environment, including I/C, to:

  • ID types of potential material misstatements
  • Consider the factors that affect the risk of material misstatement
  • Design tests of controls, when applicable
  • Design substantive procedures
47
Q

What are the 3 ways in which an auditor should respond to assessed risk?

A
  • An overall response, to address risk at the F/S level
  • A response at the relevant assertion level
  • A response to significant risks
48
Q

What is a significant risk?

A

A significant risk is one that requires special audit consideration. The following factors may be indicative of a significant risk:

  • Nonroutine, unusual, or complex transactions
  • Business risks that may result in material misstatement
  • Fraud risk
  • Significant related party transactions
  • Accounting estimates or other subjective measurements of financial information
  • Accounting principles that are subject to different interpretations
49
Q

When are tests of controls performed?

A

When the auditor’s risk assessment is based on the assumption that controls are operating effectively;

OR

When substantive procedures alone are insufficient, such as when there is a significant amount of electronic processing.

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