Audit 3 Flashcards by Kristen Grewe

What should an auditor consider before accepting a new client or continuance with an old client?

firm’s ability to meet reporting deadlines
firm’s ability to staff the engagement
independence
integrity of client management
group audits

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Required contents of an audit engagement letter

objective and scope of the audit
responsibilities of the auditor
responsibilities of management
statement on inherent limitations of the audit
identification of applicable reporting framework
reference to expected form and content of reports

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Inquiries that an auditor should make of a predecessor auditor BEFORE accepting an engagement

info on management’s integrity
disagreements with management
reasons for change in auditor
communication regarding fraud, noncompliance, or IC matters

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Performance materiality

It’s less than the financial statement materiality and it reduces the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the FS as a whole.

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Tolerable Misstatement

The application of performance materiality to a particular sampling procedures
Maximum amount that an account balance or class of transactions can be misstated without causing the FS to be misstated.

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A written audit plan is…

REQUIRED

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Tests of controls

-they are used to evaluate the OPERATING EFFECTIVENESS of internal controls in PREVENTING or DETECTING material misstatements

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Substantive procedures

Used to detect material misstatements, they include:

Tests of Details
Substantive procedures
Analytical procedures

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What are the main financial statement assertions?

"These assertions COVER U"
Completeness
cutOff
Valuation, allocation and accuracy
Existence and occurrence
Rights and obligations
Understandability and classification

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Completeness

“Land of reality to the land of accounting records”

All account balances, transactions, and disclosures that SHOULD HAVE been recorded HAVE BEEN

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Cutoff

Transactions have been recorded in the CORRECT PERIOD

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Valuation, allocation, and accuracy

Account balances, transactions, and disclosures are recorded FAIRLY at the APPROPRIATE AMOUNTS (and any adjustments are recorded

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Existence and Occurrence

“Land of accounting records to land of reality”

Account balances EXIST and transactions that have been recorded and disclosed OCCURRED

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Rights and Obligations

The entity holds or controls the rights to assets and liabilities are the obligations of the entity

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Understandability and Classification

Transactions have been recorded in the PROPER ACCOUNTS

- Financial info is APPROPRIATELY PRESENTED and DESCRIBED and disclosures are CLEARLY EXPRESSED

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Assertions that relate to transactions/events

CCC-AO

completeness, cutoff, accuracy, classification, and occurrence

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Assertions that relate to Account balances

CAVE-RO

completeness, allocation and valuation, rights and obligations, and existence

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Assertions that relate to Presentation and Disclosure

CUC-ROVA

completeness, understandability and classification, rights and obligations, and valuation and accurancy

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PCAOB standards say that financial statement assertions are…

"CEO APPROVED"
Completeness
Existence
Occurrence
Allocation
Presentation
Rights
Obligations
Valuation
E (buy a vowel!)
Disclosure

The internal auditor cannot share responsibility for…

decisions
judgments
assessments
issuing the report

What is audit risk?

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

Factual misstatements

misstatements about which there is no doubt

Judgmental misstatements

differences arising from judgments of management that the auditor considers unreasonable or inappropriate

Projected misstatements

the auditor’s best estimate of misstatements in populations

Audit risk equation

AR = RMM x DR | audit risk = risk of material misstatement * detection risk

Risk of material misstatement

= Inherent risk * Control risk

Inherent risk

the susceptibility of a relevant assertion to a material misstatement assuming that there are no related controls

Control risk

the risk that a material misstatement will occur without being prevented or detected in a timely basis by the internal controls

Detection risk

the risk that the auditor will not detect a material misstatement that exists in a relevant assertion

Types of fraud

1. Fraudulent financial reporting (lying) 2. Misappropriation of assets (stealing) 3. Corruption (cheating)

The characteristics of fraud (the fraud triangle)

1. Incentive/pressure 2. Opportunity 3. Rationalization/attitude

What two risks are presumed to exist in every audit?

1. improper revenue recognition (Analytical procedures are REQUIRED by PCAOB standards) 2. management override of controls

When are analytical procedures required?

1. Planning stage | 2. Final review stage

When must a CPA communicate fraud with external parties?

1. to comply with legal and regulatory requirements 2. to the successor auditor (with permission) 3. subpoena 4. funding or other specified agency when entity receives governmental financial assistance 5. to authorities in some cases

Assessing the risks of material misstatement

"IM A CPA" Internal control, entity and environment (obtain understanding) Material misstatement (assess risk) Assessed level of risk response Control testing Perform substantive testing Audit evidence (evaluate appropriateness and sufficiency)

The components of internal controls

``` "CRIME" Control environment Risk assessment Information and communication Monitoring Existing control activites ```

Control activities

"PAID TIPS" Pre-numbering of documents Authorization of transactions Independent checks to maintain asset accountability Documentation Timely and appropriate performance reviews Information processing controls Physical controls for safeguarding assets Segregation of duties

Segregation of duties

"segregation of duties is your ARC to protect against a flood of troubles" Authorization Record keeping Custody of assets

Procedures to obtain evidence about design and implementation of internal controls

1. Inquiry 2. Observation of application of the controls 3. Inspection of documents/records 4. Observation of premises and plant facilities 5. Walkthroughs

Documentation of the understanding of internal control

-The auditor must document this -Documentation can include "FIND" Flowchart Internal control questionnaire or checklists Narrative Documentation from client

Common flowchart symbol is a diamond...

"A diamond is a big decision" = Decision symbol

Segregation of duties for IT

``` "COPAL" Control group Operators Programmers Analyst (system) Librarian ``` Note: if someone is a supervisor and they have control over more than one area of COPAL, it may look like an advantage, but really it's a segregation problem

What are the main limitations of internal control?

1. Management override 2. Human error 3. Collusion

Difference between Type 1 and Type 2 reports (Service auditor reports when the entity uses a service organization)

1. Type 1 CANNOT be used to reduce the assessment of control risk while Type 2 can (sometimes) 2. Type 2 actually reports on the operating EFFECTIVENESS of internal controls

Elements of audit procedures

"we cast our NET over the audit" Nature Extent Timing