AUD deck Flashcards
1
Q
What is Management Responsible for in regards to the Financial Statements?
A
Preparation and Fair Presentation of Financial Statements in accordance with the Applicable Financial Reporting Framework
2
Q
What is Management Responsible for in regards to Internal Control?
A
Internal Control Design, Implementation, Maintenance
3
Q
What are the 4 paragraphs in the Audit Report for an Unmodified Opinion?
A
Introduction
Management’s Responsibility for the F/S
Auditor’s Responsibility
Opinion
4
Q
What are the 5 paragraphs in the Audit Report for an Modified Opinion?
A
Introduction
Management’s Responsibility for F/S
Auditor’s Responsibility
Basis for (Modified) Opinion
(Modified) Opinion
5
Q
In an Unmodified Opinion with Emphasis-of-Matter / Other-Matter sections, what is the order of the paragraphs?
A
Introduction
Management’s Responsibility for the F/S
Auditor’s Responsibility
Opinion
Emphasis-of-Matter
Other-Matter
6
Q
What is Audit Sampling?
A
Taking part of a population- subjecting it to audit procedures- projecting results to a population
7
Q
What are the characteristics of Statistical Sampling?
A
Based on formulas
Helps find an appropriate audit sample
Helps evaluate evidence obtained
Helps evaluate results and quantify Sampling Risk
8
Q
What are the characteristics of Non-Statistical Sampling?
A
Based on human decision
Equally acceptable as Statistical Sampling
9
Q
What are the characteristics of Substantive Tests?
A
Variables sampling
Probability proportionate to size sampling
10
Q
What type of sampling are Control Tests?
A
Attribute Sampling
11
Q
What is Sampling Risk?
A
Risk that your sample isn’t representative of population
Can happen even if audit is done properly
12
Q
What is the risk of assessing Control Risk too high?
A
A risk of Control Testing - Auditor works to make Control Risk lower
More substantive tests - Sample overstates Control Risk- Leads to an under-reliance on internal control- over-testing- and overall audit inefficiency
Audit ends up being effective (correct result)- but you do more work
13
Q
What is the risk of assessing Control Risk too low?
A
A risk of Control Testing - Complement to Confidence Level
Inverse relationship to Sample Size
Higher accepted risk of assessing Control Risk too low = Smaller Sample
Lower accepted risk of assessing Control Risk too low = Larger Sample
14
Q
What are the risks if the auditor concludes controls are operating effectively based on the sample and Control Risk is set too low?
A
Leads to higher Detection Risk - Fewer substantive tests
Sample understates Control Risk
This error leads to over-reliance on internal control- under-testing- and overall audit ineffectiveness.
Does NOT necessarily mean that the Financial Statements are materially misstated - it does mean that if there is one- you are less likely to find it
15
Q
What is the risk of Incorrect Acceptance?
A
A risk of Substantive Testing - Auditor accepts a balance as fairly stated- when in fact it is not fairly stated
Hurts audit effectiveness
Wrong conclusion reached
Efficient- but not effective
16
Q
What is the risk of Incorrect Rejection?
A
A risk of Substantive Testing - Auditor rejects balance as fairly stated when in fact it is fairly stated
Hurts audit efficiency
Wrong recommendations given
Effective- but not efficient
17
Q
What is Non-Sampling Risk?
A
Risk of human (auditor) missing an error
Also called exception- error or deviation.
18
Q
How does Sampling Risk compare to Non-Sampling Risk?
A
Sampling Risk deals with the chance that your audit sample is flawed
Non-Sampling risk deals with the chance that your human decisions/conclusions are flawed
19
Q
What is Attribute Sampling?
A
Looking at Control Procedures - Were invoices approved when paid?
Errors are stated in terms of %- not dollar amounts
For example- 5 invoices out of 100 were not properly paid. Error rate is 5%
Hint: If you see Error Rate on the Exam- they are referring to Attribute Sampling.
20
Q
How do you determine if Control Procedures are operating properly or not operating properly?
A
Control Procedures are either operating properly or they are not operating properly - based on Error Rate and the tolerance you have for errors
21
Q
What is the Tolerable Rate?
A
Error rate in population that you are willing to accept/tolerate
Inverse relationship to Sample Size
Higher Tolerable Rate = Smaller Sample
Lower Tolerable Rate = Larger Sample
If you’re willing to accept a higher probability that errors exist- there is less pressure on the sample
22
Q
What is the Expected Population Error Rate?
A
What Error Rate are you expecting? - Judgment call- based on experience
Direct relationship to Sample Size
More errors = Larger Sample
Less errors = Smaller Sample
23
Q
What is the basic premise of Attribute Sampling?
A
Attribute in the sample gives information about the entire audit population
Used to estimate Internal Control error rate
24
Q
For what is the Expected Population Deviation (error) Rate used?
A
Used to determine initial level of Control Risk
25
What is the Allowable Risk of Over-reliance?
Risk of Assessing Control Risk too low
Gives you the Sampling Risk
26
When is Attribute sampling used?
Attribute sampling is only useful when there is documented evidence (an audit trail) to test
Use when the existence of an error needs to be verified or debunked
27
What is Classic Variable Sampling?
Testing for a dollar amount
Value in sample gives information about value in entire population.
28
What functions are used in conjunction with Classic Variable Sampling?
Mean Per Unit = Sample Average x Number in Population
Stratification - Decreases effect of variance in population and reduces sample size
29
What are the characteristics of Probability Proportionate to Size (PPS) sampling?
A form of Variable Sampling
Does NOT use Standard Deviation
Auditor focuses on a dollar amount
Larger or more valuable items get picked more often as part of the sample
30
What is Projected Misstatement?
Misstatement found in sample - have to project it to remainder of population
31
How does Probability Proportionate to Size (PPS) sampling compare to Classic Variables sampling?
PPS:
Easier to use- Results in a stratified (homogenous) sample- Results in a smaller sample size to audit- Easy to design
Classic Variables Sampling:
Easy to expand sample size- Selecting zero and negative balances easy
32
What factors affect sample size?
Tolerable rate for error - Inverse relationship with sample size
Risk of assessing Control Risk too low - Inverse relationship with sample size
Expected population error rate - Direct relationship with sample size
Population size does NOT affect the sample size - as population is larger- sample size doesn't grow.
33
What is the formula for Audit Sampling?
SER + ASR < TER
SER = Sample Error Rate
ASR = Allowance for Sampling Risk
TER = Tolerable Error Rate
34
What is Allowance for Sampling Risk?
The amount that you add to the Sampling Error Rate to get some cushion for your sample.
As high as you think the population error rate could go based on experience.
35
What is the Tolerable Error Rate?
The amount of error rate that you can accept - If population error rate is less than TER- then accept the Control as effective
If population error rate is more than TER- do more testing to get SER lower or conclude control isn't effective. Do more substantive testing
36
What are the steps to develop a sampling plan?
Determine Test Objective - for example- have sales shipments been billed?
Define Population and Deviation - take a sample of shipping document- trace forward to see if billed
Determine Sample Size based on tolerable rate for error- risk of assessing Control Risk too low- and expected population error rate.
Select Sampling Technique
37
After a Sampling Plan is developed- what are the steps in sampling?
Perform the Sampling Plan
Evaluate Results
Document Results
38
What is Systematic Sampling?
Every certain # of a population is selected
Population needs to be randomly ordered
Primary advantage is that population doesn't require pre-numbering
39
What is Sequential Sampling?
Also called Stop or Go sampling
Each audit step determines the next step
40
What is Discovery Sampling?
Audit is testing an area that is so crucial that zero population errors can be tolerated
Any phony employees on payroll?
41
How does Block Sampling compare to other sampling methods?
Easy to implement- but is the worst method of sampling.
42
What is the primary duty of an auditor?
To provide users of financial information with REASONABLE ASSURANCE that the financial statements are not materially misstated.
43
What is the auditor's responsibility for detecting theft or fraud?
Auditors are *not* responsible for detecting theft or fraud.
Instead- they are responsible for providing REASONABLE ASSURANCE that the financial statements are not materially misstated.
44
When should an auditor be hired in relation to the balance sheet date for optimum audit planning and efficiency?
The earlier the auditor is hired- the better for audit planning and efficiency.
45
When can audit procedures be performed at interim dates?
If Control Risk for the accounts and/or transactions is low- audit procedures can be performed at interim dates.
The auditor then reviews changes in the balances at year-end.
46
When can an auditor accept an engagement offered after the year is already closed?
The auditor can take the engagement if they are able to overcome the limitations of the engagement.
47
For what does an auditor use professional skepticism?
To plan the scope of the audit
To plan the objectives of the audit
48
How can analytical procedures be performed in audit planning?
The auditor can compare actual versus forecasted numbers.
49
What must an auditor have in order to discuss issues relating to a predecessor auditor's work?
If issues relating to predecessor auditor's work on previous Financial Statements come up during the current audit- Auditor must have client's permission to discuss the issue.
50
What questions must an auditor ask with respect to procedures carried out by assistants?
Were they adequately performed? (Review the working papers)
Are the results consistent with the audit report?
51
How is audit strategy mapped out?
Auditor determines what the reporting objectives are.
Auditor determines the scope of the audit.
52
What are the foundations of Generally Accepted Audit Standards (GAAS)?
Materiality and Audit Risk
53
What are the General Standards for auditing?
Training and Proficiency (Education and Audit Experience)
Independence
Due Professional Care
(TIP)
54
Describe the key components of maintaining auditor independence.
Auditor must be independent in fact and appearance
Honesty
No direct financial interest
No indirect material financial interest
55
Describe Due Professional Care
```
Technical abilities mirror those held by peers in the profession
Follow GAAS Standards
Obtain a Reasonable Level of Assurance
Maintain Reasonable Level of Skepticism
Supervise Audit Staff
Review judgment at every level
```
56
List the Standards of Field Work
Planning and Supervision
Internal Control
Evidence
(PIE)
57
List the Standards of Reporting
Consistency
Disclosures
Opinion
GAAP
(CDOG)
58
What should an auditor do prior to accepting an audit engagement?
Review the previous financial statements
Speak to third parties
Contact predecessor auditor to evaluate whether engagement should be accepted (must have client permission)
59
What questions should be asked by an auditor prior to taking an engagement?
Note: must have permission of client to contact predecessor auditor (no permission = no engagement)
Why the Auditor Change?
Any Serious Discussions with Audit Committee?
How is Management Integrity? Disagreements?
How was Internal Control?
Understand Industry or Be Willing to Learn
Consider Scope Limitation - Limited evidence available = no engagement
60
What should be included in an audit engagement agreement?
Note: must be written
Objectives of Engagement
Limitations of Engagement
Responsibilities of Management - Provide written assertions
Responsibilities of Auditor - Limited error/fraud responsibility
Expectations of Access to Records
Financial Statements (and Disclosures) are Management's Responsibility
Compliance with Laws
Internal Control
61
What is management's responsibility with respect to the financial statements?
Management is responsible for financial statements and adequacy of disclosures.
```
Presentation & Disclosure
Existence (Tests Overstatements)
Rights & Obligations
Completeness (Tests Understatements)
Valuation & Allocation
```
62
What is the purpose of the Audit Committee?
Responsible for Hiring Auditor
Oversees Internal Control
Must Agree with Auditor on: Responsibility of the Parties- Audit Fee- Timing of the Audit- Audit Plan
Acts as Liaison Between Auditor and the Board
Auditor Communicates Concerns about: Internal Control Deficiencies- Errors- Fraud- Illegal Activities
63
How is Audit Risk calculated?
Inherent Risk x Control Risk x Detection Risk
Risk that material mistakes- errors- omissions- or fraud will result in an inaccurate audit report
Based on Auditor Judgment
Measured in both Qualitative and Quantitative
64
Describe Control Risk
Risk that internal control will not detect error or fraud
Auditor cannot control this.
65
Describe Inherent Risk.
Which transactions have a higher level of risk?
Auditor cannot control
66
Describe Detection Risk.
Will the auditor fail to detect a material misstatement?
Auditor CAN control
Do testing at year-end
Increase substantive testing
Run more effective tests
67
What responses should an auditor take based on different levels of acceptable detection risk (DR)? What type of tests should be performed?
Less Acceptable DR = Run More Substantive Tests
More Acceptable DR = Run Less Substantive Tests
More Substantive Tests (DR down) = Less Audit Risk; (AR = IR x CR x DR)
Less Substantive Tests (DR up) = More Audit Risk; (AR = IR x CR x DR)
68
What are quantitative measurements versus non-quantitative measurements with respect to risk?
Quantitative Measurements - Inherent- Control- and Detection Risk can all be measured in terms of percentages
Non-Quantitative Measurements - Inherent- Control- and Detection Risk can all be measured in terms of acceptable ranges
69
Whose responsibility is it to FIND and PREVENT fraud?
It is Management's responsibility.
70
What is the auditor's responsibility with respect to fraud and illegal acts?
Assess the RISK that such things will lead to material misstatements
Design the audit to provide reasonable assurance against fraud- illegal acts that directly and materially affect the financial statements
Report ALL management fraud to the audit committee (minor fraud by low-level employees not reported to committee)
Perform required inquiries and procedures (management inquiries- analytical procedures- discussions with audit personnel about fraud)
71
What are the three factors that affect/influence fraud?
Fraud is born out of:
Rationalization
Incentive
Opportunity
(RIO)
72
What is the difference between fraud and errors?
Errors are unintentional- fraud is intentional.
73
What red flags may indicate higher risk in an audit?
Management compensation tied to stock
Aggressive financial forecasting
Former auditor disagreed with Management
Records not available for audit
Current audit procedures may need to be reconsidered if red flags exist.
74
Describe the characteristics of a Fraud Risk Factor.
Has been observed in similar situations
Does NOT necessarily mean that there is a material weakness in internal control
Leads to an auditor taking action
75
What does an examination of internal control accomplish with respect to illegal acts?
Internal control analysis can result in the conclusion that IC is weak- but probably won't identify illegal acts
76
What is the purpose of adjusting audit procedures in light of fraud risk factors identified during an audit?
Strives to make audit engagement procedures less patterned and predictable
Re-evaluates management's application of accounting procedures
Finds and assigns audit personnel with relevant skills in this area
77
What should be documented with respect to fraud risk factors in an audit?
Any fraud risks identified that could lead to material misstatement
Audit procedures performed to assess risks
Nature of communication made to audit committee and company management
Disclosure to third parties regarding fraud not normally the auditor's responsibility
Fraud by management should normally be reported to the audit committee- NOT the SEC.
78
What was the effect of the SOX Act of 2002?
Created PCAOB
Designates Officer responsibility for internal control
Must disclose significant internal control weaknesses to auditor and audit committee
Must disclose any level of fraud discovered by employees with internal control responsibilities
79
What is the Hierarchy of Authoritative Literature?
1. Statements on Auditing Standards (SAS)
2. Auditing Interpretations- AICPA Guides & SOPs
3. Industry Articles (no authority)
80
What quality control activities are undertaken by CPA firms with audit practices?
Firm Leadership exhibits quality and leads by example and sets the tone for the organization
Firm should Monitor and document that its policies and procedures are being followed
Firm should have Relevant Ethical Requirements
Acceptance and continuance of client engagements should continue to be evaluated for client integrity- auditor competency- and legality
Firm should have competent and ethical personnel
Firm engagements are performed- supervised- and reviewed in accordance with professional standards and regulations.
81
Which literature governs Compilation services?
SSARS - Statements on Standards for Accounting and Review Services
These govern reporting for non-public entities only
82
What is the independence requirement for Compilations?
Independence NOT required for Compilations
No Internal Control work allowed
No assurance given
83
What type of assurance is provided by a Compilation?
Compilations are not an assurance service. No assurance is provided.
84
What type of assurance is provided by Review services?
Reviews provide NEGATIVE assurance.
85
What is the independence requirement for a Review?
Reviews require independence.
No Internal Control work allowed
Performs analytical procedures
No material indirect financial interest allowed
No immaterial direct financial interest allowed
86
For compilations and reviews- what knowledge must a service provider have?
Must have an understanding of the client industry.
87
What are attestation services?
CPA expresses a conclusion about an assertion - Compliance with laws
NOT considered a Consulting engagement
Independence Required
88
What is the independence requirement for consulting services?
Independence is not required for consulting services.
89
Describe the limitations on Prospective Financial Statements?
Report is restricted to specified users.
Agreed-upon procedures are implemented.
90
What is the majority of an auditor's work in determining an audit opinion?
Collection of evidence to support the opinion.
91
Of what does audit Evidence consist?
Evidence consists of client accounting data and supporting documentation from client or from third parties.
92
What is the relationship between Evidence and Detection Risk?
Evidence has an inverse relationship with Detection Risk
The one aspect of Audit Risk an auditor can control through (N)ature (T)iming (E)xtent of audit procedures.
Inherent Risk and Control risk are outside of auditor's control.
93
Which aspects of Audit Risk can an auditor control?
Detection Risk which is decreased by gathering evidence.
94
Which aspects of Audit Risk can an auditor NOT control?
Inherent Risk and Control Risk are outside of an auditor's control.
95
How does a high level of acceptable Detection Risk affect an audit?
Less Evidence collected. Opens door for incremental audit risk - Internal Control should be strong.
Business and transactions should be relatively stable and predictable.
(N) Less-competent Evidence collected
(T) Interim testing acceptable
(E) Fewer transactions are verified.
96
What should occur when a low level of Detection Risk is acceptable?
More Evidence collected
(N) More-competent Evidence collected
(T) End of year balance testing
(E) More transactions are verified
97
What are the primary risks in an audit for a typical for-profit company?
Auditors are there to verify that
Assets & Revenues are not overstated
Expenses & Liabilities are not understated
Exception - if the CPA Exam states that it is a tax-driven company flip them around
98
What is the primary constraint on audit evidence?
Cost vs. Benefit is a primary constraint.
99
What characteristics should audit evidence have?
Sufficient (quantity)
Appropriate: Relevant & Reliable (Quality)
100
How does the quality of audit evidence vary depending on who has provided it?
Best evidence: Observation of activity by auditor.
2nd Best: Originates from External Parties and is sent directly to auditor (or failing that items are generated by third party and provided to auditor by the client such as a bank statement)
Weakest: Oral evidence from management.
101
Which documents are the most persuasive and credible?
Third party documents are more persuasive and credible than internally-prepared docs
Auditor Knowledge = Most Persuasive
3rd Party info given to auditor
3rd Party info given to client
Internally-prepared doc
102
What are Substantive Procedures?
Test substance/amounts/values. They help to reduce the risk of material misstatements. They only test accuracy of financial statements and dollar amounts - they don't test internal controls.
103
What are the substantive tests that are most often performed?
```
Trace (or Vouch)
Reconcile
Analytical Procedures
Confirmations
Examine evidence that supports management assertions.
```
(T.R.A.C.E.)
104
When performing audit procedures what should auditors focus on?
Auditors focus first on Balance Sheet Accounts then associated Income Statement items
105
How is Cash audited?
Assurance Level is High.
Acceptable Detection Risk is Low.
106
How is Accounts Receivable audited?
If Acceptable DR is High - Negative Confirmation is used - Customer only responds if balance is materially wrong.
If Acceptable DR is Low - Positive Confirmation is used - Customer asked to confirm by telling auditor the balance.
Corresponding Income Statement Account - Revenue
107
How is Accounts Payable audited?
Review purchase orders/invoices
Confirm with Vendors
Corresponding Income Statement Account - Various Expenses
108
How is Inventory audited?
Examine purchase agreements
Look at Board Minutes
Is Inventory held as collateral?
Corresponding Income Statement Account - COGS
109
How are beginning balances audited?
Should match last year's ending balance.
110
What is the general presumption for auditing Ending Balances?
If Beginning Balance Additions Subtractions are OK then Ending Balances should also be OK.
111
How is a Statement of Cash Flows audited?
Foot all balances - Check the Math
Trace Cash Flow items to other Financial Statements
Check classifications - Operating Activities Investing Activities Financing Activities
112
Under the Indirect Method what must be disclosed on a Statement of Cash Flows?
Interest Paid
Income Taxes Paid
Non-cash Transactions
Cash and Cash Equivalents Definitions
113
Under the Direct Method what must be disclosed on a Statement of Cash Flows?
Results as if you had used Indirect Method
Non-cash Transactions
Cash and Cash Equivalents Definition
114
What are Subsequent Events and what do they require?
Subsequent events occur after the Balance Sheet Date but before the audit report is issued.
Auditor needs to make inquiries and assess if they affect the audit report.
115
What should occur if the audit report has already been issued and the auditor becomes aware of a situation that was present as of the Balance Sheet date (a subsequent event)?
If audit report has already been issued and auditor becomes aware of a situation that was present as of the BS date client should issue a disclosure to financial statement users and/or revise the financial statement.
Regulatory agencies might need to get involved under some circumstances.
116
What should an auditor do if they discover they have forgotten to perform a substantive procedure?
If auditor discovers that they forgot to perform a substantive procedure auditor should determine if other substantive procedures performed served as a substitute.
Otherwise support for their audit opinion could be jeopardized.
117
When are Analytical Procedures required?
REQUIRED When planning the audit (preliminary)
REQUIRED When reviewing the audit (final)
Analytical procedures may be also performed optionally along with the substantive testing.
Use of Analytical Procedures in the audit must be documented.
118
How do Analytical Procedures assist the auditor?
Helps the Auditor:
Determine if Management Assertions are reasonable
Develop audit plan
Develop some expectations about the financial statement and hopefully bring to light any glaring errors on financial statement
119
What is the focus of Analytical Procedures?
Analytical Procedure focus is on dollar amounts (not internal controls)
Analyzes Financial Data: Do Financial Statements Make Sense?
Comparison of data between years
120
How is the Current Ratio calculated?
Current Ratio = Current Assets / Current Liabilities
121
How is the Quick Ratio calculated?
Quick Ratio = Liquid Assets / Current Liabilities
122
How is the Asset Turnover calculated?
Asset Turnover = Net Sales / Average Assets
123
How is the Inventory Turnover calculated?
Inventory Turnover = COGS / Average Inventory
124
How is Gross Margin % calculated?
Gross Margin % = Gross Margin / Sales
125
What type of testing are ratios?
Ratios are Analytical Procedures
126
What type of procedure is a Budget vs. Actual comparison?
Budget vs. Actual comparisons are Analytical Procedures.
127
List Common Types of Analytical Procedures
Ratio analysis
Budget vs. Actual comparison
Comparison of data between years
Use of non-financial data to predict expected values for financial data
128
How do management assertions affect the audit?
Management assertions help the auditor to plan the audit and select substantive tests.
129
What assertions do auditors test?
Presentation - Cutoff Classification - Is it in the right period and category?
Existence/ Occurrence - Did it happen? Does it exist?
Rights & Obligations - Does the company own them?
Completeness - Was everything recorded?
Valuation - Are they worth the amount at which they are recorded?
(PERCV)
130
What assertions are tests for transaction classes?
Occurrence
Cutoff
Classification
Completeness
Accuracy
131
For which assertions are disclosures tested?
Occurrence
Completeness
Classification
Accuracy
132
Is testing the validity of direct evidence a basic audit procedure?
No it is an extended procedure.
For example you don't have to take a loan covenant document and go search out that it's a valid loan covenant. Instead you consider the source - if it's externally prepared it's more persuasive.
133
How are Management Estimates audited?
First and foremost you need to understand management's rationale and methods for developing estimates before you can judge reasonableness.
Next Auditor should formulate their own opinion on what a good estimate should be and compare it.
Finally determine if subsequent events affect the estimate.
134
Whose property are audit documentation (audit workpapers)? In what form must they be?
Audit workpapers are the property of the auditor.
They can be paper or electronic.
They must include a WRITTEN audit program (either paper or electronic).
135
What is the Current File?
Information pertaining to the current year's audit.
136
What is the Permanent File?
Information used for this audit and future audits which is updated as needed.
137
How long must audit workpapers be maintained?
Must be kept for 5 years after the audit release date or according to regulations whichever is longer.
Must be kept for 7 years under PCAOB Audit
PCAOB audits also require an Engagement Completion Document
138
What is the primary requirement for audit workpapers besides being written?
Any experienced auditor should be able to look at your work and understand what you did.
139
How should documents added to work papers be treated?
If further documents are added to the work papers after the audit report is issued it must be documented as to who added them why they were added and any effects on the audit report.
140
How should documents removed from workpapers be treated?
After the audit report is released the firm has 60 days to subtract from the file.
You can still add to the file if you document it but you cannot delete any information after 60 days.
Note - for SEC auditors the PCAOB only allows deletions up to 45 days after issuance of the audit report.
141
If Internal Control is poor and a company's accounting practices are sloppy - which risk is higher?
Control risk increases with poor Internal Controls and sloppy accounting practices.
142
If Internal Control is poor - what is the effect on the audit?
Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.
143
What does Internal Control provide reasonable assurance for?
Internal control provides reasonable assurance that
Material misstatements will be prevented
Reliability/integrity of financial statements will be preserved
Assets are protected against misuse
144
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose Internal Control deficiencies
Management must provide assessment of Internal Control
Management must certify Financial Statements
145
What is the relationship between Internal Control and Substantive Testing?
Inverse Relationship
Stronger Internal Controls - Less Testing Needed
Weaker Internal Controls - More Testing Needed
146
What are the 3 objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
147
What are the 5 components of Internal Control?
Control Environment
Risk Assessment
Information and Communication
Monitoring
Control Activities
148
What is the purpose for a Control Environment assessment?
Sets tone for the entire company
149
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resource Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
150
What does an auditor's assessment of Detection Risk determine?
Detection Risk determines nature- timing- and extent of audit procedures.
151
What determines the acceptable level of Detection Risk?
Risk of material misstatement determines acceptable level of Detection Risk
152
What items could increase the risk of material misstatement?
Rapid growth in the company.
The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence
Major changes to operations- personnel- systems- IT- products- corporate organization- and foreign operations.
153
What happens when Control Risk is assessed to be at the maximum level?
No Internal Control testing is performed.
All audit procedures are increased in intensity to compensate for increased risk.
154
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
155
Describe some common examples of Control Activities.
Performance Reviews
Information Processing
Physical Controls
Segregation of Duties
156
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external reporting process
157
How must an auditor document understanding of Internal Control?
Through written documentation such as Internal Control memos- flowcharts- and questionnaires
158
What questions should be asked to determine the risk of material misstatement?
Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?
159
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected- substantive procedures do not need to be adjusted
160
When can controls tested by an auditor in a prior year be used in the current year's audit assessment?
Controls tested by auditor in a prior year can be used in the current year's audit assuming they are re-tested every third year
Exception If the control has changed since the last audit
161
What happens if Internal Controls are deficient?
Control Risk increases
Scope of substantive procedures increases
Detection Risk decreases
Material Weakness - Reasonable possibility that a material misstatement in Financial Statements would not be found- more than a remote chance of occurrence
162
What is a Material Weakness?
Reasonable possibility exists that a material misstatement in Financial Statements would not be found- and has more than a remote chance of occurrence.
163
What does Tracing test?
Tests Completeness
Starts with source document and traces forward to the journal entry.
164
What does Vouching test?
Tests Existence.
Starts with a journal entry and searches for a voucher or source document to support the entry.
165
What activities represent Segregation of Duties?
Non-compatible duties performed by separate individuals- such as
Authorization of asset disbursement vs. Recording of Assets vs. Custody of assets
If supporting audit evidence doesn't exit - use Observation and Inquiry
Accounting should be segregated from Production
166
With respect to signing checks - how are duties segregated?
Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS
Tip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves
167
With respect to custody of assets - how should duties be segregated?
Employees who have custody of assets should not also RECORD those assets
Someone in charge of petty cash should not also control the petty cash records
Treasury Department (custodians) should NOT have record keeping duties
They control assets and should not be able to adjust any recording of those assets
168
What are the limitations on Control Activities?
Controls can't stop collusion or bad judgment
Management can override controls
Cost vs. Benefit relationship of Internal Control
169
What is required if a Material Weakness is identified?
A written report to management is required.
Report declaring that no material weaknesses were found is allowed
Previous weaknesses reported that still exist should be reported again
Should be reported no later than 60 days after audit report release date
If one or more material weaknesses is uncorrected at year-end- an Adverse Opinion on Internal Control must be given
170
What is the effect of a Significant Deficiency? What is it?
A significant deficiency adversely affects a company's ability to report in the financial statements according to GAAP.
A significant deficiency is a more than a remote likelihood of material misstatement by more than an inconsequential amount
171
What must occur if a Significant Deficiency is identified?
If a Significant Deficiency is identified- a written report to management required
Report declaring that no significant deficiencies exist is not allowed
Previous deficiencies reported that still exist should be reported again
Should be reported no later than 60 days after the audit report release date
172
What is a Control Deficiency?
A control is not operating as intended.
173
What must an auditor ask if using the work of third parties?
Are they competent?
Are they objective?
174
What must an auditor understand with respect to internal auditors?
Auditor needs to understand the role of Internal Auditors within the organization because their work affects the audit plan
Responsibility for judgments about materiality or appropriateness of entries or estimates cannot be shared with third parties like Internal Auditors
Internal Auditors should be asked to do some of the legwork like preparing schedules or running reports
They should not be asked to make any decisions or judgments
175
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose deficiencies
Management must provide assessment of Internal Controls
Management must certify Financial Statements
176
What is the relationship between Internal Control and Substantive Testing?
Has inverse relationship
Stronger Internal Control results in LESS substantive testing
Weaker Internal Control leads to MORE substantive testing
177
What are the three objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
178
What are the five components of Internal Control?
Control Activities
Risk Assessment
Information and Communications
Monitoring
Control Environment
179
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resources Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
180
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
181
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external communication process
182
How must an auditor document understanding of Internal Control?
Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires
183
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected - substantive procedures do not need to be adjusted
184
What is Management Responsible for in regards to the Financial Statements?
Preparation and Fair Presentation of Financial Statements in accordance with the Applicable Financial Reporting Framework
185
What is Management Responsible for in regards to Internal Control?
Internal Control Design, Implementation, Maintenance
186
What are the 4 paragraphs in the Audit Report for an Unmodified Opinion?
Introduction
Management's Responsibility for the F/S
Auditor's Responsibility
Opinion
187
What are the 5 paragraphs in the Audit Report for an Modified Opinion?
Introduction
Management's Responsibility for F/S
Auditor's Responsibility
Basis for (Modified) Opinion
(Modified) Opinion
188
In an Unmodified Opinion with Emphasis-of-Matter / Other-Matter sections, what is the order of the paragraphs?
Introduction
Management's Responsibility for the F/S
Auditor's Responsibility
Opinion
Emphasis-of-Matter
Other-Matter
