AUDIT - A3

Question 1

The work of an INTERNAL AUDITOR may aid the external auditor in…

Answer 1

obtaining an understanding of internal control, assessing risk, and performing substantive procedures.

Question 2

Materiality

Answer 2

Based on professional judgment, both qualitative and quantitative facts must be considered, use the smallest level of misstatement that could be material to any one of the FS.

Question 3

FIVE Components of Internal Control (COSO framework)

Answer 3

CRIME

• (C)ontrol environment
• (R)isk Assessment by management
• (I)nformation and communication systems
• (M)onitoring
• (E)xisting Control Activities

Question 4

Audit Risk = RMM X DR
(“AR”) should be low (IR X CR) (controller by auditor)
(assessed by auditor)

Answer 4

Inherent risk is the susceptibility of a relevant assertion to a material misstatement, assuming there are no related controls.

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

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

Question 5

Material misstatement

Answer 5

Defined as an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on this information would have changed or influenced by omission or misstatement.

Question 6

Three types of misstatements

Answer 6

• Factual misstatements - there is no doubt
• Judgmental misstatements-mostly relate to estimates, or application of accounting principles, difference in judgment of management that auditor considers unreasonable.
• Projected misstatements-auditor’s best estimate of misstatements in a population. Projections of misstatements in audit samples to the entire population where sample was drawn upon.

Question 7

The understanding of the design AND implementation of an entity’s relevant controls is required to complete the assessment of RMM (risk of material misstatements).

Answer 7

• Evaluating the design of a control involves determining whether individually, or in combination, preventing or detecting and correcting material misstatements.
• Implementation - A control has been implemented if it exists and is being used.

Question 8

During the planning phase of the audit…

Answer 8

During the planning phase of the audit, the auditor obtains an understanding of the internal control system by considering:
•The types of misstatements that may occur.

• The risk that misstatements may occur.
• Factors that influence the design of tests of controls and substantive tests.
• The assessment of inherent risk.
• Judgments about materiality.
• The complexity and sophistication of the entity’s operations and systems.
• The use of manual vs. computerized control procedures.

Such knowledge may be obtained by appropriate inquiry, inspection, or observation. Knowledge may also be obtained based on previous experience with the client and/or an understanding of the industry in which the entity operates.

Question 9

Assessing risk based on the effective operation of controls

Answer 9

Assessing risk based on the effective operation of controls involves (1) identifying specific internal controls relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions, and (2) performing tests of such controls to evaluate their effectiveness

Question 10

Levels of Responses

Answer 10

• Overall response to Financial Statement Level Risk

- Responses to Relevant Assertion Level Risks (include classes of transactions, account balances, and disclosures).

Question 11

Standard costing system

Answer 11

A standard costing system is a tool for planning budgets, managing and controlling costs, and evaluating cost management performance. A standard costing system involves estimating the required costs of a production process.

Question 12

Account Balances (Balance sheet accounts)

Answer 12

• Completeness (C)
• Valuation, Allocation and Accuracy
• Existence
• Rights and Obligations

Question 13

Six Assertions

COVERU

Answer 13

• Completeness
• Cutoff
• Valuation, Allocation, and Accuracy
• Existence and Occurrence
• Rights and Obligations
• Understandability and Classification

Question 14

Transactions and Events

Answer 14

• Completeness
• Cutoff
• Valuation, Allocation, and Accuracy
• Occurrence
• Classification

Question 15

Presentation and Disclosure

Answer 15

• Completeness
• Valuation, Allocation, and Accuracy
• Occurrence
• Understandability and Classification

Question 16

PCAOB -relevance of audit evidence

Answer 16

PCAOB standards state that the relevance of audit evidence depends on:

• design of the audit procedure, test the assertion directly and whether it is designed to test for understatement or overstatement; and
• timing of the audit procedure

Question 17

Check kiting

Answer 17

Kitting occurs when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank account.

Question 18

Lapping

Answer 18

Theft of cash often concealed by failing to account for cash receipts. The unrecorded receipt is covered by applying a subsequent receipt to the previously unrecorded amount.

Question 19

Evaluating management’s estimate

Answer 19

After first obtaining an understanding of how management developed its estimate, the auditor should use one or a combination of the following approaches:

a) review and test the process used by management to develop the estimate,
b) develop an independent expectation of the estimate to corroborate the reasonableness of management’s estimate, or
c) review subsequent events.

Question 20

Inventory turnover

Answer 20

= COGS / Average Inventory

Question 21

Average number of days to sell Inventory

Answer 21

=Average inventory/ (COSGS/365)
OR
=365 days/ Inventory turnover

Question 22

Accounts receivable turnover

Answer 22

=Net credit sales/ Average net receivable

Question 23

Accounts receivable turnover in days

Answer 23

=Average net receivables/ (net credit sales/365)

OR

=365 days/ Accounts receivable turnover

Question 24

Acid-test ratio (aka Quick ratio)=

Answer 24

=Cash + Marketable securities (trading)+Accounts receivable/ Current liabilities

Question 25

Internal control tested

Answer 25

Rely on Control if:
Upper deviation rate Tolerable deviation rate

Upper deviation rate (per chart) = Sample deviation rate (error in sample %) + allowance for sampling risk

Question 26

Test of controls - Determining the Sample Size factors

Answer 26

• Risk of Assessing Control Risk too low
• Tolerable deviation rate
• Expected deviation rate

Population size is not an issue provided the population is large.

Question 27

Substantive testing - Determining the Sample size factors

Answer 27

• Tolerable misstatement
• expected misstatement (size, frequency, etc)
• acceptable level of risk: audit risk, risk of incorrect acceptance, and risk of incorrect rejection
• characteristics of the population (e.g. estimate of the standard deviation, or variability, of the population)
• Assessed risk: Assessed RMM, and assessed risk of other substantive procedures

Question 28

PPS (Probability-Proportional-to-Size)

Answer 28

Sampling interval = TM/ Reliability factor (per a table, and based on the risk of incorrect acceptance)

Sample size= Recorded amount of population/ Sampling interval

Question 29

Precision interval

Answer 29

In sampling, an allowance for sampling that is added to a point estimate to provide a range within which the true population value is expected to fall.

Question 30

Classical Variable sampling

Answer 30

-Estimate of the standard deviation of the population’s recorded amounts is required for classical variables sampling, but not for PPS sampling

Question 31

Section 404 of the Sarbanes-Oxley Act of 2012

Answer 31

Section 404 of the Sarbanes-Oxley Act of 2002 requires each issuer’s annual report to contain an internal control report that (1) states the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contains an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting

Question 32

Department of Labor (DOL) impairment rules

Answer 32

1. Any direct or material indirect financial interest in the Plan or Plan Sponsor.
2. Connection to the plan or plan sponsor as promoter, underwriter, investment advisor, voting trustee, director, officer or employee
3. An accountant or member of the accounting firm members maintains the Plan’s financial records for the employee benefit plan.

Question 33

Quality Control Standards

Answer 33

The six interrelated elements of quality control are: -human resources

• engagement/client acceptance and continuance, -leadership responsibilities,
• performance of the engagement,
• monitoring, and
• ethical requirements.

Question 34

GAGAS ethics

Answer 34

Ethics, as defined by GAGAS, address the topics of serving the

• public interest,
• integrity,
• objectivity,
• proper use of government information, resources and positions,
• professional behavior.

Question 35

AICPA’s Code of Professional Conduct governs any service that a member of the AICPA performs.

Answer 35

These services include: audits, special reports, compilations, reviews, and services such as financial forecasts, and financial projections, and attestation engagements.

Question 36

Evaluating Accounting Estimates

Answer 36

In evaluating the reasonableness of estimates, the auditor focuses on

• assumptions that are significant to the estimate, -sensitive to variations,
• deviations from historical patterns, or
• subjective and susceptible to misstatement or bias.

Question 37

Parallel simulation technique

Answer 37

Parallel simulation is a technique in which the auditor reprocesses the client’s data using the auditor’s own software. The auditor then compares his or her results to those obtained by the client.