A3, M1 Flashcards
Risk assessment procedures allow the auditor to understand what two things about the client?
(1) understand entity and its environment
(2) Understand internal control
What is the other goal of risk assessment procedures?
to identify and assess risks of material misstatements
The auditor should design and perform risk assessment procedures in a manner that obtains not only ___ but also ___ audit evidence.
corroborative, but also contradictory
What types of information can the auditor get from the internal audit function for risk assessment?
Understand processes, controls, and their own assessment of risk.
T/F: Inquiry alone is sufficient evidence.
False. Inquiry should be accompanied with observation and/or inspection.
In what two parts of the audit can analytical procedures be performed?
- Planning Phase
- Final Review Phase
Analytical procedures related to what account are required in the planning phase?
revenue
What are analytical procedures?
(1) evaluations of financial information
(2) by studying meaningful relationships
(3) among financial and nonfinancial data
What is an example of using financial and nonfinancial data?
sales (financial) per square foot (nonfinancial)
In the planning phase, analytical procedures are (high level/low level).
high-level
What are three common comparisons made in analytical procedures (planning phase)?
(1) Compare year over year.
(2) Compare current to budget.
(3) Compare ratio to industry.
Analytical procedures in the planning phase focus on what two objectives?
(1) enhance understanding of entity
(2) identify unusual transactions/events to identify risk of material misstatement
The discussion of fraud risk and overall risk assessment can be held ____.
together
What does the discussion of fraud risk focus on?
potential misstatements as a result of fraud
What does the discussion of risk assessment focus on?
susceptibility of the financials to material misstatement
Can the auditor perform substantive procedures or tests of controls with risk assessment procedures?
Yes, if it is efficient to do so.
T/F: Risk assessment only occurs in the planning phase of the audit.
False. It is an ongoing assessment that can be revised.
Size and what other factor determine the way an internal control system is designed, implemented, and maintained?
complexity
Understanding the nature of an entity involves understanding what four things?
- organizational structure
- ownership and governance
- business model
- use of IT
What are the six PCAOB requirements (procedures) to understand the nature of an entity?
- Read public information.
- Observe or read transcripts of earning calls.
- Obtain information from SEC filings about significant holdings.
- Understand incentive compensation.
- Talk to chair of compensation committee and/or compensation consultants.
- Understand policies for expense reimbursement.
What is the definition of an entity’s objective?
overall plans for an entity
What is the definition of an entity’s strategy?
means used to achieve objectives
What is a business risk?
events/circumstances that could adversely affect entity’s ability to achieve its objectives and execute its strategies
What should an auditor understand about an entity’s accounting policies?
- understand selection and application
- evaluate whether appropriate
- look at significant accounting policies
To evaluate incentives/pressure for fraud, what should the auditor look at?
- measures in contracts
- measures for executive compensation
- measures used by analysts
- measures of key performance
What does the auditor need to understand about a group and its components in relation to the financials?
the consolidation process
What are inherent risk factors (definition)?
factors that affect the likelihood of misstatement, before consideration of controls
What are inherent risk factors (list)?
- Complexity
- Subjectivity
- Change
- Uncertainty
- Management Bias/Fraud Risk
- Significance
- Volume or Lack of Uniformity
How do audit objectives differ in a computerized environment?
They are the same in computerized and manual environments!
An entity’s use of information technology affects what two things?
- design and implementation of system of internal control
- audit procedures used to gather evidence
What is hardware?
physical equipment, including servers, computers, data centers, and other equipment
What is software (examples)?
financial reporting software and ERP systems used
What is a network?
how it all connects (including internet, firewalls, security)
What is the operating system?
manages system resources and hardware
What are the two types of data storage?
traditional infrastructure or cloud infrastructure
What two procedures can the auditor do to understand the IT environment?
- tour facility
- inquiry
Does the auditor need to document their understanding of the IT environment?
Yes.
What are some things the auditor should consider when evaluating industry factors?
- seasonal activity
- market and competition
What are some things the auditor should consider when evaluating regulatory factors?
- environmental requirements
- laws and regulations
What are some things the auditor should consider when evaluating government policy factors?
- taxation
- subsidies
- interest rates
What are some things the auditor should consider when evaluating financial reporting framework factors?
- accounting principles
- industry-specific processes
- regulated industry frameworks
What are some things the auditor should consider when evaluating technology factors?
- automation
- security
What are some things the auditor should consider when evaluating supply chain factors?
- bottlenecks
- product quality issues
What are some things the auditor should consider when evaluating economic factors?
- macroeconomic factors
- microeconomic factors
What is macroeconomics?
elements of the overall economy
What is microeconomics?
elements related to the economy’s impact on individual goods and services provided
The supply curve is (upward/downward) sloping.
Up towards the sky
What does the fundamental law of supply state?
Price and quantity supplied are positively related. That is, if prices received for goods go up, suppliers will create more of that good.
What two parameters show up on the supply and demand graphs (on the x and y, label each)?
X-Axis: Quantity
Y-Axis: Price
What is the difference between a “change in quantity supplied” and a “change in supply”?
Change in Quantity Supplied: Move along the curve, resulting ONLY from a change in price.
Change in Supply: Movement of the curve, resulting from a change in something OTHER THAN price.
Is is typically good or bad if supply shifts to the right?
good
What is the acronym for the 5 things that change supply?
ECOST
What does the E in ECOST stand for?
Change in Price Expectations of the Supplying Firm
If price is expected to go down in the future, what will happen to supply today?
It will increase for suppliers to take advantage of higher prices today.
What does C in ECOST stand for?
Changes in Production Costs
If production costs decrease, what happens to supply today?
Supply will increase because it costs less to produce.
What does O stand for in ECOST?
Change in Price or Demand for Other Goods
If demand decreases for obsolete other goods offered by the same company, what happens to supply today for new goods?
Supply will increase for the new goods.
What does the S stand for in ECOST?
Changes in Subsidies or Taxes
If subsidies increase, what happens to supply?
Supply will increase.
If taxes increase, what happens to supply?
Supply will decrease.
What does the T stand for in ECOST?
Changes in Production Technology
If there are technology improvements, what happens to supply?
Supply increases.
What does the fundamental law of demand say?
Price and quantity demanded are inversely related. That is, the higher the price charged, the less people want the goods.
The demand curve is (upward/downward) sloping.
downward
What is the difference between a “change in quantity demanded” versus a “change in demand”?
Change in Quantity Demanded: Move along the demand curve due to price changes ONLY.
Change in Demand: Shift of demand curve due to changes OTHER THAN price.
What acronym is used for the 5 things that can create a change in demand?
SPINE
What does the S in SPINE stand for?
Change in Price of a Substitute or Complementary Good
If price of a substitute good goes up, what happens to demand?
Demand increases.
If price of a complentary good goes up, what happens to demand?
Demand decreases.
What does the P in SPINE stand for?
Change in Popularity of Good/Service
If popularity of a good goes up, what happens to demand?
Demand increases.
What does the I in SPINE stand for?
Change in Income
If income goes up, what happens to demand for normal goods?
Demand increases.
If income goes up, what happens to demand for inferior goods?
Demand decreases.
What does the N in SPINE stand for?
Changes in Number of Buyers
If the buyers goes up, what happens to demand?
Demand increases.
What does the E in SPINE stand for?
Changes in Consumer Expectations
What happens to demand today if customers expect prices to increase in the future?
Demand will increase today, because customers want to buy at the lower price.
What is the market equilibrium?
where the supply and demand curves intersect
What is elasticity?
measure of how sensitive demand or supply is to a change in price
When is demand price elastic (definiton)?
Percentage change in demand is high when there is a change in price.
When is demand more price elastic (factors)?
There are lots of substitutes available.
When is demand price inelastic (definition)?
Percentage change in demand is low when there is a change in price.
When is demand less price elastic (cause)?
Less substitutes are available.
When is supply price elastic (definition)?
Percentage change in supply is high when there is a change in price.
When is supply price elastic (cause)?
products are stored easily (not perishable)
When is supply price inelastic (definition)?
Percentage change in supply is low when there is a change in price.
When is supply price inelastic (cause)?
products are perishable
What is cross elasticity?
The percentage change in the quantity demanded (or supplied) or one good CAUSED BY price change of another good
What is income elasticity?
percentage change in quantity demanded given a percentage change in income
When is profit maximized?
marginal revenue equals marginal cost
What are business cycles?
the rise and fall of economic activity relative to long-term growth trends
What is the order of the business cycle, starting with the expansionary phase?
- Expansionary Phase
- Peak
- Contractionary Phase
- Trough
- Recovery/Expansionary Phase
What happens at the peak?
___ profits, ___ capacity contstraints, ___ prices & costs
high, high, high
What happens at a trough?
___ profits, ___ capacity constraints, ___ prices & costs
lower, excess capacity, reduced costs through layoffs
What is a recession defined?
two consecutive quarters of falling national output (GDP)
What is a depression defined?
very severe recession
What are the three types of economic indicators?
(1) Leading
(2) Coincident
(3) Laggingg
What are leading indicators (defined)?
predict economic activity
What are five common leading indicators?
- average weekly unemployment claims
- bond yield curve
- interest rate spreads
- producer price index
- orders for goods
How are interest rates used to heat up an economy?
decrease rates
How are interest rates used to cool down an economy?
increase rates
If the bond yield curve is increasing, is this a positive or negative indicator?
positive
What change in the PPI is a good signal?
slight increases in the PPI
What are coincident indicators (defined)?
reflect the current state of the economy
What are examples of coincident indicators?
- industrial production
- manufacturing and trade sales
- GDP
What are lagging indicators (defined)?
tend to follow economic activity
What are some lagging indicators?
- average duration of unemployment
- CPI (consumer price index) for services
Indicators like PPI and CPI should be looked at with …
with other indicators.
When the government intervenes in a market by mandating a fixed price so that the product’s price will not rise and become unaffordable, what will happen to demand and supply?
Demand will increase, supply will decrease.
Analytical procedures involve comparison of ___ __ to ___ ___ developed by the auditor.
recorded amounts, independent expectations
A trough is characterized by (maxed out/unused) productive capacity and an (willingness/unwillingness) to risk new investments.
unused, unwillingness
T/F: Business cycles refer to economic activity of one firm.
False, they relate to overall economic activity.
A peak is characterized by (unused/maxed out) capacity and labor (layoffs/shortages).
maxed out, shortages
In trying to predict how long the economy will be in its current recovery phase before entering an expansionary phase, you want to be looking at which types of indicators?
leading
Which type of economic indicator tends to occur as a result of economic activity?
lagging
Are decreases in commercial loans positive or negative economic indicators?
Negative, because fewer people are borrowing money.
If the economy is entering a slowdown, what will happen to demand and price?
Demand will fall, prices will rise.
Manufacturing and trade sales tend to be _____ indicators. Price changes are _____ indicators.
coincident, leading
