A3 - Risk, Evidence, and Sampling

Question 1

How is the overall audit risk lowered?

Answer 1

If the risk of material misstatement is too high (e.g, with regard of overstatement of revenue), the audit has no choice but to lower the detection risk, and with it, the overall audit risk is lowered by performing more substantive testing.

Question 2

How is detection risk lowered?

Answer 2

If the risk of material misstatement is too high, you lower detection risk as follows:
1. N - Nature: substantive test rather than test of controls
2. E - Extent: More testing rather than less
3. T - Timing: Closer to year end

Increased emphasis on professional skepticism when gathering and evaluating audit evidence.

Question 3

What risks does the auditor assesses?

Answer 3

1. Inherent risk
2. Control risk

Question 4

What risk does the auditor make a decision to increase or decrease?

Answer 4

Detection risk

Question 5

How is detection risk increased?

Answer 5

If the risk of material misstatement is below the maximum, you increase detection risk as follows:
1. Perform less substantive tests or perform them earlier in the year.
2. Test controls instead of substantiative tests
3. Perform testing earlier in the audit

Question 6

How does inherent risk and control risk differ from detection risk?

Answer 6

1. They exist independently of the audit of financial statements. The auditor cannot change them.
2. Assessed by the auditor.

Question 7

Why does the auditor assesses control risk?

Answer 7

Because it affects the level of detection risk that the auditor may accept.

Question 8

How is Audit Risk (AR) computed?

Answer 8

Audit Risk (AR) (should be low) = Risk of material misstatement (RMM) (assessed by auditor) * Detection Risk (DR) (controlled by auditor)

Question 9

How is Risk of material misstatement (RMM) computed?

Answer 9

Risk of material misstatement (RMM) = Inherent risk (IR) * Control risk (CR)

Question 10

How are the components of audit risk assessed?

Answer 10

The components (e.g., inherent risk, control risk, detection risk) can be assessed as either quantitative (e.g., as a percentage) or nonquantitative (e.g., high, medium, low, etc.)

Question 11

What is considered a judgmental misstatement?

Answer 11

Are differences arising from the judgement of management, including those concerning recognition, measurement, presentation, and disclosure of F/S (including selection of accounting policies considered unreasonable/inappropriate and estimates)

Question 12

What is considered projected misstatement?

Answer 12

Auditor’s best estimate of misstatements in populations, involving the projections of misstatements identified in audit samples to the entire population from which the samples were drawn. Auditor’s improper judgement or estimate.

Question 13

What factors represent a high inherent risk (CECH)?

Answer 13

C - Complex calculations
E - Estimates (Amounts derived from estimates)
C - Cash
H - High-volume transactions

Question 14

What other factors specific to the entity and its environment may also increase inherent risk?

Answer 14

1. Technology that renders a product obsolete
2. A lack of working capital
3. A decline in the overall industry or economy

Question 15

What is control risk?

Answer 15

The risk that material misstatements that could occur in a relevant assertion will not be prevented or detected (and corrected) on a timely basis by the entity’s internal control.

Question 16

When does the auditor assess control risk as high?

Answer 16

1. There are no effective controls relative to the specific assertions
2. The implemented controls are not operating effectively
3. it would not be efficient to test the operating effectiveness of the controls.

Question 17

What is audit risk?

Answer 17

It is the risk that the auditor may unknowingly fail to modify the opinion on financial statements that are materially misstated.

Question 18

What is fraud risk?

Answer 18

The risk that misstatements will arise from fraudulent financial reporting or misappropriation of assets.

Question 19

What would the auditor consider in an overall response to financial statement level risk?

Answer 19

1. Communicate the audit team an increased need for professional skepticism
2. Assign staff with more experience or specialized risk
3. Increase the level of supervision
4. Incorporate a greater level of unpredictability into the audit
5. Make pervasive changes to the nature, extent, or timing of tests, such as shifting substantive procedures closer to period end.

Question 20

What is a dual-purpose test?

Answer 20

It is a test of controls that is performed concurrently with a test of details on the same transaction. The test should be designed to achieve both objectives.

Question 21

What is the purpose of the test of controls?

Answer 21

To evaluate the operating effectiveness of a control

Question 22

What is the purpose of a test of details?

Answer 22

To support relevant assertions or to detect material misstatements.

Question 23

How does the auditor performs the risk assessment to determine the effective operation of controls?

Answer 23

1. Identifying specific controls relevant to specific assertions that are likely to prevent or detect material misstatements.
2. Performing tests of such controls to evaluate their effectiveness.

Question 24

How would the auditor validate segregation of duties?

Answer 24

The auditor will perform a test of segregation of duties by relying on inquiry and observation.

Question 25

if an entity is being forced to discontinue operations in a foreign country, what would the auditor assume?

Answer 25

The auditor could assume that the client committed an act of noncompliance with laws and regulations in the foreign country.

Question 26

What would the auditor do if the client refuses to accept an auditor’s report with a modified opinion due to noncompliance with law and regulation?

Answer 26

The auditor should withdraw from the engagement and notify those charged with governance in writing,

Question 27

What would the auditor consider to identify related party transactions?

Answer 27

1. Compensating balance arrangements (which may be maintained by or for related parties)
2. Loan guarantees
3. Unusual, nonrecurring transactions near year-end
4. Transactions based on terms that differ significantly from market terms
5. Nonmonetary exchanges.

Question 28

PECO = appropriate reliability of audit evidence

Answer 28

P = Personal knowledge (most reliable) - performs examination, inspection, or recalculation
E = External Source (e.g., bank confirmations, receivable confirmations)
C = Client Evidence (auditor’s consideration of data developed under an adequate system of internal controls)
O = Oral client evidence (less reliable)

Question 29

RORI = Procedures used to test operating effectiveness of internal controls

Answer 29

R = Recalculation
O = Observation
R = Reperformance
I = Inquiry

Question 30

What is considered auditor’s personal knowledge?
P = Personal knowledge (most reliable)
E
C
O

Answer 30

1. Observation
2. Examination
3. Inspection
4. recalculation

Question 31

What is considered evidence from external sources?
P
E = External Source
C
O

Answer 31

1. bank confirmation
2. receivables confirmation
3. Vendor invoice

Question 32

What is considered evidence obtained from client?
P
E
C = Client Evidence
O

Answer 32

1. Internal evidence in writing
2. client prepared invoices and documents
3. Purchase orders
4. sales orders
5. General ledger
6. Management reports
7. Shipping documents
8. Receiving reports

If the auditor considers that the data is developed under a strong system of internal controls, the auditor would consider the data more reliable but less reliable than personal knowledge.

Question 33

What is considered oral client evidence?
P
E
C
O = Oral client evidence (less reliable)

Answer 33

Client answering auditor’s inquiry. This inquiry would likely need to be corroborated by additional evidence.

Question 34

What does the PCAOB states regarding relevance of audit evidence?

Answer 34

the PCAOB consider the following:
1. The design of the audit procedures to test assertions and understatements/overstatements
2. The timing of the audit procedures.

Question 35

What is the purpose of substantive procedures?

Answer 35

They’re designed to detect material (dollar) misstatements of the F/S at the assertion level. Consist of:
1. Test of details applied to transactions, balances, and disclosures
2. Substantive analytical procedures.

Question 36

How are analytical procedures performed by the auditor?

Answer 36

Analytical procedures are performed by first developing an expected amount and then compare it to the actual amount.

Question 37

What is the best way to use analytical procedures as a substantiative test?

Answer 37

Analytical procedures need to be based on predictable relationships. Income statement accounts are more predictable than balance sheet accounts because represent transactions over a period of time (e.g., interest expense).

Question 38

Are all income statement accounts predictable?

Answer 38

No, those income statement accounts with management discretion are less predictable (e.g., travel and entertainments expense).

Question 39

What is inquiry?

Answer 39

Requesting information from knowledgeable parties both internally (e.g., managers and supervisors) and externally (e.g., attorneys and bankers)

Question 40

What should the auditor consider when performing inquiry?

Answer 40

1. Specific characteristics to whom the inquiry is directed (e.g., knowledge, objectivity, qualification, etc.)
2. Ask appropriate questions
3. Evaluate the response and take appropriate action (e.g., follow up with additional inquiry, modify planned audit procedures, etc.)

Question 41

What is examination/inspection?

Answer 41

Auditor may inspect or examine records, documents, or tangible assets (either physically present or use of remote observation). documents may be internal or external.

Question 42

What are the balance sheet assertions or assertions about account balances at year end (CARE)?

Answer 42

C - Completeness
A - Allocation and valuation
R - Rights and obligations
E - Existence

Question 43

What are the income statement assertions (COCCA)?

Answer 43

C - Completeness
O - Occurrence
C - Cutoff
C - Classification - proper account
A - Accuracy and valuation - proper amount

Question 44

When does the auditor apply reperformance?

Answer 44

Reperformance occurs when an auditor independently performs procedures or controls to ensure that the client performed them correctly.

Question 45

When does the auditor apply recalculation?

Answer 45

An auditor recalculates to verify the mathematical accuracy of statements and schedules by adding down (footing), adding across (cross-footing), or recalculating amounts. It could be done manually or through the use of automated tools.

Question 46

When are analytical procedures required to be completed in the audit?

Answer 46

Analytical procedures are required during planning to obtain an understanding of the entity’s business and final review to assist the auditor in the final review for reasonableness.

Question 47

What steps the auditor uses to develop analytical procedures that are efficient and effective?

Answer 47

1. Develop procedures to test assertions that address the risk of material misstatement in the F/S.
2. Evaluate reliability of client’s data to develop expectations. Strong effective internal controls improve reliability.
3. Develop an expectation of recorded amounts.
4. Perform analytical procedures and compare results to the expectations.
5. Investigate any significant differences by inquiring of management or performing other audit procedures.

Question 48

What would the analytical procedures indicate if there is a mismatch or significant difference?

Answer 48

The mismatch or significant difference indicates either a material misstatement or the fact that the auditor’s expectations are flaw. If analytical procedures disclose unexpected differences, the auditor should consider the F/S to be misstated.

Question 49

How is regression analysis applied for analytical procedures?

Answer 49

it is an advanced analytical technique that often uses data from prior period(s) to develop a model or predict future periods.

Question 50

When is regression analysis best used?

Answer 50

It is best used for creating expectations based on several independent variables

Question 51

What is the level of assurance that regression analysis can provide?

Answer 51

May provide a very high level of precision and may be used as the principal substantive procedure

Question 52

What are advantages of using regression analysis?

Answer 52

1. Provides an explicit, mathematical objective, and precise method for forming an expectation
2. allows inclusion of a large number of independent variables
3. Provides direct and quantitative measures of the precision of the expectation

Question 53

What analytical procedures does the auditor perform as final review?

Answer 53

The auditor is required to evaluate the overall financial statement presentation and assesses the conclusion reached. Auditor will read the financial statements and consider whether there are unusual or unexpected balances.

Question 54

What is the completeness assertion refers to?

Answer 54

The assertion is that all transactions and events have been recorded, if some have not been recorded, the books are not complete.

Question 55

what are the documentation requirements for analytical procedures?

Answer 55

The auditor is required to document:
1. Auditor’s expectations
2. Factors considered in the development of expectations
3. Results of the comparison of the expectations to recorded amounts
4. Additional audit procedures performed in response to significant unexplained differences
5. Results of such additional procedures.

Question 56

What is factual misstatement?

Answer 56

Factual misstatement are those in which there is no doubt

Question 57

How are analytical procedures performed during the planning phase?

Answer 57

Analytical procedures are performed at a high-level using aggregated financial and nonfinancial data

Question 58

What is inherent risk?

Answer 58

The susceptibility of a relevant assertion to a material misstatement, assuming no internal control exist.

Question 59

What is statistical sampling?

Answer 59

auditor specify the sampling risk they are willing to accept and then calculate the sample size that provides the degree of reliability.

Question 60

What is nonstatistical sampling?

Answer 60

Sample size is not determined mathematically, but is selected based on auditor’s judgement.

Question 61

What is incorrect acceptance?

Answer 61

The risk that the sample selected in a test of detail (variable) supports the conclusion that the recorded account balance is not materially misstated when in fact it is materially misstated (i.e., sample result fail to identify an existing material misstatement) - Effectiveness

Question 62

What is incorrect rejection?

Answer 62

the risk that the sample selected in a test of detail (variable) appears to have many errors and the auditor reject the account balance as fairly stated, when the sample is misleading, and the account balance and population are correct. This could lead to inefficiencies as the auditor incorrectly performed more substantive testing than needed.

Question 63

What are the advantages of statistical sampling?

Answer 63

1. Measure the sufficiency of the audit evidence obtained
2. Objective basis for quantitatively evaluating sample results
3. Design an efficient sample
4. Quantify sampling risk to limit risk to an acceptable level.

Question 64

What is nonsampling risk?

Answer 64

All aspects of audit risk that are not due to sampling

Question 65

What are examples of nonsampling risk?

Answer 65

1. Selecting inappropriate audit procedures
2. Using inappropriate audit evidence
3. Failure by the auditor to recognize misstatements in documents examined.

Question 66

When can an auditor incorrectly assess control risk lower than appropriate?

Answer 66

The deviation rate in the auditor’s sample is less than the tolerable rate, but the deviation rate in the population exceeds the tolerable rate.

Question 67

Does the population size has any effect in the sample size?

Answer 67

No, population size is not an issue provided the population is large (i.e., greater than 5,000 items).

Question 68

How to determine if there is a test of control?

Answer 68

Controls often relate to the following:
1. Authorization
2. Validity
3. Completeness
4. Accuracy
5. Appropriate classification
6. Accounting in conformity with GAAP
7. Proper period

Question 69

How to determine if there is a test of detail (substantive test)?

Answer 69

Look for the following words:
1. Account balance
2. Amount
3. Valuation
4. Presentation
5. Disclosure
6. Estimate (reasonableness check, e.g., check for inventory quantities on hand)

Question 70

What should the auditor consider to determine the sample size?

Answer 70

1. Risk of assessing control risk too low
2. Tolerable deviation rate
3. Expected deviation rate
4. Population size (no issue if larger)

Question 71

How is changes to planned assessed level of control risk affect sample size?

Answer 71

The planned assessed level of control risk is related to the expected deviation rate (a low expected deviation rate corresponds to a low planned assessed level of control risk).

Question 72

What are planning considerations for a test of detail?

Answer 72

1. The relationship of the sample to the relevant audit objective
2. Preliminary estimates of materiality (tolerable misstatement)
3. The auditor’s allowable risk of incorrect acceptance
4. Characteristics of a population

Question 73

What is tolerable misstatement?

Answer 73

maximum monetary misstatement in the related account balance or class of transaction that the auditor is willing to accept.

Question 74

What is stratification technique?

Answer 74

Items subject to sampling may be separated into homogeneous groups. Each group is treated as a separate population, and results in a reduced sample size. Used when a population has highly variable recorded amounts.

Question 75

When does the sample size increases in a test of detail?

Answer 75

Sample size increases as the following increase (direct relationship):
1. Expected misstatement
2. Standard deviation (population variability)
3. Assessed level of risk

Question 76

When does the sample size decreases in a test of detail?

Answer 76

Sample size decreases as the following increase (inverse relationship):
1. Tolerable misstatement
2. Acceptable level of risk

Question 77

What is the formula to calculate projected misstatement?

Answer 77

projected misstatement = net over/understatement/sample selection %

Question 78

How to determine if the account is misstated based on the net over/understatement?

Answer 78

if the projected misstatement > tolerable misstatement, the account has a high risk of misstatement.

Question 79

What is the probability proportional to sample size (PPS) technique?

Answer 79

PPS is a method designed to estimate overstatement errors. Zero balances, negative balances, and understated balances require special design consideration.

Question 80

What is Descriptive Analytics?

Answer 80

Descriptive analytics explains what happened or what is happening with the data.

Question 81

How is descriptive analytics used in an audit?

Answer 81

It is important to gain a high-level understanding of the following:
1. Size
2. Range
3. Location
4. Dispersion
5. Other descriptive values of the data being analyzed.

Question 82

What are descriptive analytical techniques?

Answer 82

1. Summary statistics
2. Data sorting
3. Aging data
4. Data reduction

Question 83

What is diagnostic analytics?

Answer 83

Used when an organization wants to understand the underlying cause of results, or why something happened with the data.

Question 84

How is diagnostic analytics used in an audit?

Answer 84

works to do the following:
1. uncover correlations
2. patterns
3. relationships among data to explain outcomes

Question 85

What are diagnostic analytical techniques?

Answer 85

1. Clustering
2. Drill-down and drill-through analysis
3. Data mining and discovery
4. Variance analysis
5. Period-over-period analysis
6. Data profiling
7. Sequence checks

Question 86

What is predictive analytics?

Answer 86

Uses historical data and facts to make predictions, estimates, and assertions about future events. Looks at what will happen in the future.

Question 87

What are predictive analytical techniques?

Answer 87

1. Regression analysis
2. Forecasting
3. Time-series modeling
4. Classification
5. Sentiment analysis

Question 88

What is prescriptive analytics?

Answer 88

It builds on predictive analytics and shifts the focus from addressing what will happen to how to make something happen.

Question 89

What are prescriptive analytical techniques?

Answer 89

1. What-if analysis
2. Decision support and automation
3. Machine learning
4. Natural language processing

Question 90

When is trend analysis used?

Answer 90

Trend analysis is used to develop expectations of future results. It helps the auditor compare internal values that have relationships or even bring in industry/external data for comparative purposes

Question 91

What chart would be appropriate to describe a trend analysis?

Answer 91

A Line chart because they appropriately address the forward-moving concept of time.

Question 92

When is regression analysis used?

Answer 92

Regression analysis allows for an auditor to evaluate relationships between variables (e.g., dependent and independent variables)

Question 93

What chart would be appropriate to describe a regression analysis?

Answer 93

Scatter plots where the data points are plotted with an (X, Y) relationship with a corresponding regression line.

Question 94

What is required in all financial statement audits?

Answer 94

1. Determine risk assessment procedures
2. Analytical procedures (this determines if test of operating effectiveness of internal controls and/or substantive procedures are performed)

Question 95

What is a requirement to obtain audit evidence?

Answer 95

1. Sufficient - quantity (volume)
2. Appropriate - quality (relevance and reliability)

Question 96

What is the auditor’s responsibility when performing an audit of a nonissuer’s compliance with laws and regulations?

Answer 96

The auditor is responsible for obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework.

Question 97

What is considered reliability of audit evidence?

Answer 97

The more effective the internal control structure, the more accuracy it provides about the reliability of accounting data and financial statements

Question 98

When is the auditor sampling for attributes?

Answer 98

Auditor is testing controls hoping that the control passes the auditor’s test and control risk can be lowered, and as a result less substantive testing.

Question 99

When is the auditor sampling for variable?

Answer 99

Auditor is testing account balances looking for overstatements and understatement

Question 100

What is the goal of a sample?

Answer 100

it is to select enough items so that the sample is representative of the population as a whole.

Question 101

What is the estimated actual error (deviation) rate (1st steps) used to determine the sample size and how is it determined in attribute sampling (test of controls)?

Answer 101

1. Auditor estimates the actual error (deviation) rate (or deviation) (or expected error rate or expected misstatement).
2. As the expected error rate rises, the sample size must be increased.

Question 102

What is the tolerable deviation rate (2nd step) used to determine the sample size and how is it determined in attribute sampling?

Answer 102

1. Auditor determines the tolerable deviation rate (or maximum rate of deviation) (highest error rate that could be present before feeling the control activity is not reliable).
2. As the tolerable deviation rate rises, the required sample size will decrease.
3. Determined based on auditor’s judgement

Question 103

How is the allowable level of sampling (3rd step) used to determine the sample size and how is it determined in attribute sampling?

Answer 103

1. Auditors determine allowable level of sampling risk (chance that sample will be misleading)
2. sets a limit for how reliable the sample needs to be (confidence level 100%).
3. As the need for reliability increases (e.g., from 90% to 95%), the sample size increases.

Question 104

How is the sample size actually determined?

Answer 104

1. using the expected error rate, tolerable rate, and allowable level of risk, the auditor uses a chart based on the sampling risk (usually 10%) and using the sample size calculates the sample error rate.
2. Using the sample error rate, calculates the upper (maximum) deviation rate (or population error rate)

Question 105

How is the sample error (or sample deviation) rate calculated?

Answer 105

sample error (deviation) rate = # of errors/sample size based on sample risk chart (using expected error rate and tolerable rate)

Question 106

What is the purpose of the upper (maximum) deviation rate?

Answer 106

Helps the auditor know how high the population error rate could be based on knowledge of the sample error rate. A chart is used to determine the highest expected error rate for the population. This is considered the population error rate. Formula to compute it:

Upper deviation rate = Sample deviation (error) rate + Allowance for sampling risk

Question 107

How is determine if the control is effective?

Answer 107

The upper deviation rate is compared to the tolerable rate. If upper deviation rate > tolerable rate, the control is ineffective. This means substantive testing has to be increased.
Upper deviation rate < tolerable rate, the control is effective

Question 108

How is the allowance for sample risk or precision computed?

Answer 108

Allowance for sample risk/precision = upper deviation rate - sample error rate

Question 109

What is the purpose of the allowance for sample risk or precision?

Answer 109

It represents the closeness of the auditor’s sample result to the true (but unknown) population error rate. it is used to describe the auditor’s evaluation of sampling results by calculating the possible error in either direction

Question 110

When is a nonstatistical predictive model used?

Answer 110

When the auditor uses a simple technique like having multiple independent variables and multiplying them to arrive at the expectation.

Question 111

How does the auditor perform the sample selection using probability proportional to size sampling (PPS)?

Answer 111

The auditor picks individual dollars from the population rather than individual units. This method increases the chance that bigger items (with potentially bigger errors) will be used in the sample.

Question 112

What are advantages of using probability proportional to size sampling (PPS)?

Answer 112

PPS is useful to test for overstatement of receivables, existence assertion. Not good to test understatement/completeness.

Question 113

How is the sampling interval determined in PPS?

Answer 113

sampling interval = Tolerable misstatement/reliability factor

Question 114

How is the sample size determined in PPS?

Answer 114

1. Obtain the reliability factor from table using the # of misstatements and risk of incorrect acceptance.
2. calculate the sampling interval
   sampling interval = tolerable misstatement/reliability factor
3. calculate the sample size by dividing the account BV by the sampling interval
   sample size = Book Value/sampling interval

Question 115

How to determine which samples to include for testing from a sample selection if cumulative totals are used in a PPS selection?

Answer 115

if a random starting point and the sampling interval are determine, perform the following:
1. start with the random starting point and confirm this amount is included in the book value
2. add to the random starting point the sampling interval to obtain a total
3. Compare the total to the cumulative total (sum of BV of sample #1 and #2), if cumulative total > total computed in #2, then select that sample for review. If cumulative total < total computed in #2, then do not select that sample.

Question 116

How is the projected error computed in PPS?

Answer 116

1. Difference of book value and audited value = Book Value - Audited value
2. Calculate the Tainting % (difference BV-Audited value/BV)
3. Determine the sampling interval, if not given
   sampling interval = tolerable misstatement/reliability factor
4. Calculate the Projected error = Tainting % * Sampling interval

If audited value > book value, then you will have negative values.

Question 117

What is the formula to compute the Tainting % in a PPS?

Answer 117

Tainting % = Difference BV - Audited Value/Book Value

Question 118

What are incentives and pressures to misappropriate assets?

Answer 118

1. Management or other employees have significant amount of personal debt.
2. Employee layoffs have occurred or are anticipated.
3. Compensation levels have recently changed and people have may gotten a salary reduction or not the raise they were expecting
4. Job promotions were inconsistent with a person’s expectation.

Question 119

What are opportunities to commit misappropriation of assets that could result in fraud risk?

Answer 119

1. large amount of cash on hand
2. Inventory items are small and are of high value
3. Company holds assets (such as bearer bonds) that can be easily converted to cash
4. Company does a poor job of screening employees with access to assets.

Question 120

What are opportunities to commit fraudulent financial reporting that could result in fraud risk?

Answer 120

1. Significant, unusual, or highly complex transactions, especially those happening towards the end of the year.
2. A number of reported balances are based on significant estimations. Each estimates presents an opportunity to cook the books
3. Management is dominated by one-person - can override all controls or a group of controls without appropriate oversight.
4. High turnover of senior management so the organization is unstable
5. lack of segregation of duties
6. high turnover of accounting or IT personnel
7. Related party transactions as terms of these transactions are different to those used in the ordinary course of business.
8. significant bank accounts in tax-haven jurisdictions with no clear business justification

Question 121

What are incentives and pressures to commit financial reporting fraud?

Answer 121

1. Management/employees are pressured to meet net income to receive bonuses based on stock price
2. Employees may have their personal financial pressures
3. Company announced an overly optimistic earnings forecast, pressure to report higher profits
4. Pressure to meet debt covenants
5. Company’s products are vulnerable to rapid changes in technology, increasing business failure while reporting unusual profitability.
6. Company plans to obtain debt or equity financing.
7. Entity’s industry is experiencing declining customer demand creates pressure to meet financial metrics.

Question 122

What objective does classical sampling help achieve?

Answer 122

To determine the inventory quantity on hand as it helps the auditor determine the reasonableness of the account.

Question 123

How is the point estimate calculated using mean per unit estimation sampling under classical variable sampling?

Answer 123

1. Determine the book value of the account based on a selected sample
2. Determine the audited value of the account for the selected sample
3. Calculate the average value:
   Average value = Audited value/sample selected
4. Calculate the point estimate
   point estimate = average value * total population
5. Identify the true error
   True error = total book value of account - point estimate

Question 124

How is the point estimate calculated using ratio estimation sampling under classical variable sampling?

Answer 124

1. Determine the book value of the account based on a selected sample
2. Determine the audited value of the account for the selected sample
3. Calculate the ratio:
   Ratio = Audited value/Book value
4. Calculate the point estimate
   Point estimate = ratio * total account book value
5. Identify the true error
   True error = total book value of account - point estimate

Question 125

How is the point estimate calculated using difference estimation sampling under classical variable sampling?

Answer 125

1. Determine the book value of the account based on a selected sample
2. Determine the audited value of the account for the selected sample
3. Calculate the difference of BV and audited value
   Difference = BV - Audited Value
4. Determine the value of the selected sample
   Value of selected sample = Difference/selected sample
5. Calculate the projected error
   projected error = value of selected sample * total items in the population
6. Determine the audited value of the entire population
   Audited value of entire population = book value of account - projected error

Question 126

Is documentation related to fraud brainstorming sessions required?

Answer 126

Yes, audit documentation is required to include a description of the discussion among engagement personnel regarding the risk of material misstatement due to fraud.

Question 127

What characteristics impact the sample size in variable sampling?

Answer 127

1. Population (e.g., variability)
2. Tolerable misstatement
3. Expected misstatement
4. Acceptable level of risk
5. Assessed risk

Question 128

How is a large sample size determined in variable sampling?

Answer 128

1. Large expected amount of misstatement
2. Smaller tolerable amount of misstatement
3. Reduction (lower) in the allowable amount of sampling risk
4. Higher amount of variability in the population

Question 129

How is a small sample size determined in variable sampling?

Answer 129

1. Smaller expected amount of misstatement
2. Higher tolerable amount of misstatement
3. Increase in the allowable amount of sampling risk
4. Smaller amount of variability in the population

Question 130

If auditor is in doubt about a material assertion (e.g., valuation), what should the auditor do?

Answer 130

The auditor should gather sufficient evidence to eliminate the doubt and before communicating any issues to management and audit committee.

Question 131

What is attribute sampling?

Answer 131

It is a statistical sampling method used to estimate the rate (percentage) of occurrence (exception) or a specific characteristic (attribute). Samples taken to test the operating effectiveness of controls.

Question 132

How is attribute sampling managed?

Answer 132

Attribute sampling generally deals with yes-or-no questions Example:
1. Are time cards appropriately authorized (e.g., to assure recorded hours were worked)?
2. Are invoices properly voided (e.g., stamped “paid”) to prevent duplicate payments?