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Core 1 > Audit & Assurance > Flashcards

Audit & Assurance Flashcards

1
Q

Client acceptance & continuance -

4 considerations when determining acceptance or continuance of a prospective client

A

CAS 220 Quality Control for an Audit of Financial Statements and CSQC 1

  1. The integrity of the principal owners, key management and those charged with governance of the entity;
  2. Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and resources;
  3. Whether the firm and the engagement team can comply with relevant ethical requirements; and
  4. Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship.
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2
Q

Client acceptance & continuance -

5 potential factors to consider when assessing a client’s integrity

A
  1. What is the reputation of the client in the business community? What is the reputation of the client’s management, directors, and key stakeholders?
  2. What is the client’s attitude toward risk? How does the client manage risk?
  3. Will the client be co-operative in providing the practitioner with access to information?
  4. What is the client’s attitude toward the audit fee?
  5. In the case of a client acceptance decision, why does the potential client want to switch audit firms?
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3
Q

Client acceptance & continuance -

4 possible procedures to gauge the integrity of a prospective or existing client

A
  1. In the case of a client acceptance decision, communicate with the previous auditor, where applicable.
  2. Communicate with independent third parties, such as lawyers and creditors.
  3. Perform a background check of the client.
  4. Obtain and scan financial statements from prior periods
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4
Q

Client acceptance & continuance -

5 criteria for accepting a new engagement following the client risk assessment

A

CAS 210 & CSQC 1

  1. Is the financial reporting framework to be applied in the preparation of the financial statements appropriate? The practitioner must understand the client’s financial reporting framework and believe that the framework applied is acceptable.
  2. Threats to independence
  3. Is the practitioner able to mitigate or accept engagement risk factors
  4. Is there industry legislation or regulations impacting the financial reporting requirements of the client? The practitioner must understand this in order to demonstrate professional competence and due care.
  5. Has the client’s management agreed to its responsibilities in writing?
  6. Are there any known scope limitations that may restrict the practitioner’s ability to provide an opinion?
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5
Q

Client acceptance & continuance -

2 situations where a new client or an existing client should not be accepted, unless required by law to do so

A

CAS 210

  1. where management does not acknowledge its responsibilities in writing
  2. where the chosen financial reporting framework is not acceptable
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6
Q

Client acceptance & continuance -

6 terms of engagement laid out in the engagement letter

A
  1. the objective and scope of the audit of the financial statements
  2. the responsibilities of the practitioner
  3. the responsibilities of management
  4. identification of the applicable financial reporting framework for the preparation of the financial statements
  5. reference to the expected form and content of any reports to be issued by the practitioner and a statement that there may be circumstances in which a report may differ from its expected form and content
  6. the basis on which fees are computed and any billing arrangements
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7
Q

Materiality -

5 steps to determine overall materiality

A
  1. Identify the users of the financial statements
  2. Identify the users’ objectives
  3. Determine the base for materiality
  4. Identify the percentage threshold for materiality
  5. Perform normalizing adjustments and calculate overall materiality
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8
Q

Materiality -

Common bases for materiality

A
  1. Normalized income before tax - Entity that has shown positive net income over the long term
  2. Gross profit - Entity where there are fluctuations in profit after tax
  3. Sales - Not-for-profit or other entity that has minimal or variable profits
  4. Total assets - Property management company with value derived from asset valuations
  5. Total expenses - Not-for-profit or other entity that has minimal or variable profits
  6. Owner’s equity - Entity whose operating results are so poor that liquidity or solvency is a real concern
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9
Q

Materiality -

How to identify percentage threshold for materiality?

A 
For-profit entities:
• 3% to 7% of normalized income before tax
• 1% to 3% of revenues or expenses
• 1% to 3% of total assets
• 3% to 5% of equity

Not-for-profit entities:
• 1% to 3% of revenues or expenses
• 1% to 3% of total assets

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10
Q

Materiality -

How to set performance materiality

A

60% - 75% of overall materiality, depending on RMM

PM is the figure that is used to design audit tests and determine sample sizes. It will ensure that more work is performed and will increase the probability of the auditor detecting material misstatements.

When the risk of a material misstatement is higher, a PM threshold at the lower end of the range is generally selected, increasing the auditor’s sensitivity to potential misstatements thus creating a larger safety cushion. Unlike overall materiality and specific materiality, PM is based on risk rather than user objectives

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11
Q

Materiality -

When to use specific materiality and how to calculate

A

SM is used for designing audit procedures that address specific risks and balances in sensitive audit areas. Specific materiality (SM) is set if there are balances or classes of transactions where an amount less than overall materiality would influence or change the decision of a known user. Similar to overall materiality, SM is based on user objectives and not on risk.

Establishing SM is based on professional judgment. The auditor can use a percentage of the accounts that the user is concerned about, as long as the amount is less than overall materiality. Alternatively, the auditor may simply use a reasonable
percentage of overall materiality in the calculation of SM.

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12
Q

Materiality -

When to use Specific Performance Materiality and how to calculate

A

60% - 75% of SM, based on RMM

SPM is required only when SM has been set for
an account or group of accounts. Specific performance materiality (SPM) is established by the auditor based on what is required to reduce the RMM to an appropriately low level. To be used when the RMM for a specific group of accounts (e.g. PPE) is set at high

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13
Q

Audit Risk -

Audit Risk calculation

A

AR = RMM x DR

AR = CR x IR x DR

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14
Q

Audit Risk -

RMM calculation

A

RMM = IR x CR

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15
Q

Audit Risk -

What is inherent risk?

A

Inherent risk (IR) is the likelihood that the financial statements are misstated before considering internal control. IR exists independent of the audit, is made up of business risks that prevent an entity from achieving its objectives or executing its strategies.

The auditor CANNOT control IR

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16
Q

Audit Risk -

What is Control Risk?

A

Control risk (CR) is the likelihood that misstatements due to inherent risk will not be prevented or detected and corrected by the client’s internal controls. Control risk is especially important for auditors because it drives the audit approach.

The auditor CANNOT control CR

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17
Q

Audit Risk -

What is Detection Risk?

A

Detection risk (DR) is the likelihood that the auditor will not detect existing misstatements in the financial statements. The auditor’s objective is to design procedures that will bring the detection risk to an acceptably low level to compensate for any RMM and thus bring the overall AR to an acceptably low level.

The auditor CAN control detection risk, unlike IR and CR

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18
Q

Audit Risk -

How to Inherent risk and Control risk influence Detection Risk?

A

Audit risk must always be assessed as low. Auditors will design their audit procedures to bring detection risk an acceptably low level that compensates for the level of RMM

If IR = high and CR = high, DR must be low to make AR low

If IR = low and CR = low, DR may be high and AR will still be low

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19
Q

Audit Risk -

7 inherent risk factors at OFSL

A

The below factors stated in reverse DECREASE risk

  1. Entity in poor financial health - if the entity may not be a going concern it will impact presentation of fin. stmts
  2. Significant market competition that is driving down prices and pressuring cost structures - increases bias to overstate earnings (revenue rec) in order to strengthen fin. stmts and maintain ability to raise financing
  3. Entity has never been audited before - increases risk opening balances are not reliable/accurate
  4. Upcoming purchase or sale of the entity - increases bias to make fin stmts appear more favourable, sale transaction will likely rely on audit report
  5. Imposition of new industry regulations - new users to fin stmts (regulatory agencies), pressure on mgmt to adhere to regulations
  6. IPO, new debt or bank covenants - increases bias to make fin stmts appear more favorable for new users
  7. Bonus structure based on key metrics - e.g. employee bonus based on net income. Increases bias to overstate earnings
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20
Q

Audit Risk -

8 control risk factors at OFSL

A

If the opposite of any points below is found (the company is strong in controls) it reduces the control risk

  1. Use of outdated GL system for financial reporting - risk that software does not reliably compile information
  2. Lack of segregation of duties - Staff have access to complete accounting cycle, increases risk of fraud & error going undetected
  3. Lack of internal audit - Mgmt & board may not be aware of control deficiencies
  4. Lack of computer controls (passwords, access restrictions, etc.) - system is susceptible to loss or data intrusion by unwanted parties
  5. Mgmt does not place adequate importance on controls - risk that controls are not in place or employees don’t follow control procedures
  6. Mgmt override of controls - increases fraud risk, sets the tone for disregard of controls
  7. Lack of policies - risk that employees will act inconsistently, lack of accountability
  8. Lack of system documentation - It may be difficul to ascertain system processes and controls. Employees may not be following complete system processes
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21
Q

Audit risk -

6 possible responses to address RMM at OFSL

A
  1. emphasizing professional skepticism to the audit team
  2. assigning more experienced staff to the audit team
  3. increasing supervision of the audit
  4. adding elements of unpredictability in audit procedures
  5. making changes to the nature, timing, and extent of the audit procedures
  6. if the entity has multiple locations/branches, increasing the number of locations/branches to be tested
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22
Q

Audit Risk -

3 factors that impact inherent risk at the assertion level

A

The below factors states in reverse decrease risk

  1. Industry - if technology rapidly changes (e.g. cellphone producer) inventory is easily made obsolete
  2. Nature of business
    - if customers are concentrated in one industry with an economic downturn, receivables may not be collectable
    - Type of inventory held (electronics become obsolete faster than lumber or steel)
  3. Characteristics of an account balance or class of transaction
    - inventory or fixed assets susceptible to theft
    - significant estimate uncertainty
    - complex transactions or calculations (e.g. derivatives, uncommon financial instruments that are difficult to account for)
    - Unusual / non-routine transactions
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23
Q

Audit risk -

3 factors that impact control risk at the assertion level

A

The below factors in reverse decrease risk

  1. Lack of authorization controls over the credit approval process (e.g. credit checks) - increases risk that credit could be extended to unreliable customers, impacts valuation of A/R balances
  2. Lack of physical security controls over inventory - increases risk of loss/theft, may result in overstatement/understatement of inventory (existence / completion)
  3. Lack of segregation of duties over cash receipts - increases risk of misappropriation
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24
Q

Going concern -

How often must management assess going concern for public companies? (IFRS vs. ASPE)

A

Every 12 months for both standards (IAS 1, ASPE 1400)

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25
Q

Going concern -

How often must management assess going concern for public companies? (IFRS vs. ASPE)

A

Every 12 months for both standards (IAS 1, ASPE 1400)

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26
Q

Going concern -

Financial indicators

A
  • A net liability or net current liability position
  • Adverse key financial ratios
  • Long-term debt that is maturing and cannot be repaid or refinanced
  • Reliance on excessive short-term financing
  • Inability to secure supplier credit or pay bills on time
  • Negative operating cash flows
  • Poor profitability and return ratios
  • Substantial operating losses
  • Negative retained earning
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27
Q

Going concern -

Operating indicators

A
  • Plans to liquidate the entity or cease operations
  • Departures of key management who cannot be replaced
  • Loss of market share
  • Loss of a key customer
  • Inability to obtain key supplies
  • Loss of operating license
  • Labour issues
28
Q

Going concern -

Other indicators

A
  • Non-compliance with the law
  • Material lawsuits against the entity that the entity will not be able to pay if it loses
  • Changes in laws or regulations that will negatively impact the entity
29
Q

Going concern -

Auditor responsibility regarding going-concern assessments

A

a) Obtain sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going-concern assumption.
b) Conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
c) Determine the implications for the auditor’s report.

30
Q

Going concern -

Audit procedures when events or conditions are identified

A

CAS 570 lays out specific procedures to be completed when an entity’s ability to continue as a going concern is in question:

  • request that management perform an assessment, if one has not been performed already
  • evaluate management’s plan of action in relation to the assessment
  • where a cash flow forecast has been prepared, evaluate the reliability of the underlying data
  • consider whether any additional facts or information have come to light since the date of management’s assessment that may influence the conclusion
  • request written representation from management regarding its plans for action
31
Q

Going concern -

Audit opinion if the going-concern assumption is appropriate and material uncertainty does not exist

A

Unmodified opinion

32
Q

Going concern -

Audit opinion if the going-concern assumption is appropriate, but a material uncertainty exists

A

1) If the material uncertainty is adequately disclosed –> Unqualified opinion and include a section under the heading “Material Uncertainty Related to Going Concern” (to highlight existence of uncertainty & draw attention to related note in fin stmts)
2) If the disclosure is inadequate –> qualified or adverse opinion

33
Q

Going concern -

Audit opinion if the going-concern assumption is not appropriate

A

1) If the fin. stmts are presented appropriately –> Unqualified opinion and include a section under the heading “Material Uncertainty Related to Going Concern” (to highlight lack of going concern assumption & highlight that fin stmts are prepared on liquidation basis)
2) If disclosure is inadequate / fin stmts are not prepared appropriately –> Adverse opinion

34
Q

Fraud -

2 types of fraud

A
  1. Fraudulent financial reporting:
    Usually occurs at mgmt level through intentional omissions or manipulation with the intention of deceiving users/stakeholders. Typically pervasive (OFSL).
  2. Misappropriation of assets:
    Usually occurs at the employee level in relatively small amounts (e.g. theft, embezzlement, personal use of company assets, etc). Typically assertion level.
35
Q

Fraud -

Conditions that create an environment for fraud

A
  • inadequate corporate governance
  • lack of “tone at the top”
  • inadequate internal control
  • large financial incentives
  • complex business operations
  • high expectations by investors
36
Q

Fraud -

3 factors that support fraud

A
  1. Incentives and pressures
  2. Opportunity
  3. Rationalization and attitude
37
Q

Fraud -

Auditor objectives with regard to fraud

A

CAS 240
• to identify and assess the RMM of the financial statements due to fraud
• to obtain sufficient appropriate audit evidence regarding the assessment of RMM due to fraud through designing and implementing appropriate responses
• to respond appropriately to fraud or suspected fraud identified during the audit

38
Q

Fraud -

Auditor responsibilities related to fraud

A

CAS 240 -
1. Professional skepticism - maintain a questioning mind, be open to possibility that fraud exists, be alert to conditions that indicate possible misstatement, critically assess audit evidence

  1. Discussions with engagement team - during initial planning to discuss susceptibility of entity’s fin stmts to potential fraud
  2. Fraud detection
39
Q

Fraud -

5 procedures the auditor should perform related to fraud detection

A
  • Make inquiries of management regarding their identification, communication, and response to fraud risks.
  • Make inquiries of both management and those charged with governance regarding actual, suspected, or alleged fraud in the entity.
  • Make inquiries of those charged with governance as to how they exercise oversight of management to identify and assess fraud risk.
  • Look for unusual or unexpected relationships obtained from analytical procedures.
  • Consider the risk of management bias and override.
40
Q

Fraud -

6 procedures required to fulfill auditor’s responsibilities related to fraud

A
  • Perform procedures to identify the RMM due to fraud.
  • Assess the RMM due to fraud at the financial statement and assertion level.
  • Determine audit responses to address RMM.
  • Evaluate audit evidence to consider whether an identified misstatement may indicate fraud has occurred.
  • Obtain written representations from management in relation to fraud.
  • Communicate with management, those charged with governance, and regulatory authorities.
41
Q

Fraud -

Incentives/Pressure risk factors for fraud at OFSL

A
  1. Bonuses/performance incentives based on net income or share price
  2. Sale of the business with price based on financial performance
  3. Increased market competition
  4. Additional users to financial statements
  5. Tax minimization
  6. Debt covenants based on net income or equity
42
Q

Fraud -

Opportunity risk factors for fraud at OFSL

A
  1. Minimal shareholder or owner involvement
  2. Inadequate mgmt oversight of processes and activities within control environment
  3. Weak control environment
  4. No internal audit function
  5. Informal policies/processes
  6. Management too trusting of employees
  7. Ownership too trusting of management
43
Q

Fraud -

Rationalization/ attitude risk factors for fraud at OFSL

A
  1. Aggressive culture (taking on risk)
  2. Mgmt has relaxed attitude towards fraud
  3. Ownership has relaxed attitude towards fraud
  4. Mgmt reduced employee bonuses
  5. Avoiding job losses with poor performance or insolvency
  6. Ownership/mgmt attitude is that controls are not important
44
Q

Fraud -

Incentives/Pressure risk factors for fraud at assertion level

A

Inventory that is valuable and can be easily converted to cash

45
Q

Fraud -

Opportunity risk factors for fraud at Assertion level

A
  1. Inadequate controls safeguarding inventory
  2. Weak controls over purchasing of inventory (e.g. no PO’s, no approval process, etc)
  3. Outdated inventory mgmt tracking system
  4. Inventory is portable (easy to steal) and liquid (easily converted to cash)
46
Q

Fraud -

Rationalization/ attitude risk factors for fraud at Assertion level

A
  1. Poor employee morale (could lead to theft, etc)
  2. Management too trusting of employees, especially in relation to specific accounts (e.g. inventory counts, cash handling)
  3. Ownership too trusting of management, especially in relation to specific accounts (having a relaxed attitude towards discrepancies)
47
Q

Fraud -

Potential planned audit responses to RISK of fraud at OFSL

A
  • assigning additional audit personnel with specialized knowledge and skills based on the fraud risk factors identified
  • evaluating selected accounting policies and their application more carefully
  • including an element of unpredictability in the audit procedures
  • heightening the auditor’s level of professional skepticism
48
Q

Fraud -

Audit response to identified or suspected fraud

A
  1. Re-evaluate the RMM and how it affects the audit. Consider whether there is indication of collusion among employees, mgmt, third parties. Reconsider reliability of evidence already obtained.
  2. Communicate identified or suspected fraud risk on a timely basis to management (CAS 260)
  3. If the auditor has identified or suspects fraud involving management, or significant employees, the auditor shall communicate these matters to the board of directors or others charged with governance on a timely basis.
  4. The auditor shall determine whether they are responsible for reporting the occurrence or suspicion to a third party. Legal responsibilities can override confidentiality of client information.
49
Q

Fraud -

Impact of related party transactions (RPTs) on fraud risk and objectives of the auditor

A

RPTs can result in higher RMM.

The objectives of the auditor are as follows (CAS 550):

  1. Obtain a sufficient understanding of the related party relationships and transactions to be able to achieve the following:
    a) Recognize potential fraud risk factors, given that related party relationships create an opportunity for collusion, concealment, or manipulation.
    b) Conclude whether the financial statements, insofar as they are affected by RPTs, are presented fairly.
  2. Obtain sufficient appropriate audit evidence that RPTs have been identified, recorded, and disclosed in accordance with the applicable financial reporting framework.
50
Q

Fraud -

Auditor responsibilities relating to accounting estimates and related disclosures (CAS 540)

A
  1. Obtain an understanding of the clients use of estimates to identify and assess the RMM
  2. Identify and assess RMM by (a) evaluating degree of estimation uncertainty and (b) determining if any of the identified estimates have a high risk of uncertainty
  3. Respond to the assessed RMM by determining
    (a) Whether mgmt has applied the requirements of the applicable reporting framework
    (b) The methods for making the estimate are appropriate and applied consistently
  4. In response to the assessed risk, undertake one or more of the following:
    (a) Review subsequent events for evidence regarding the estimate
    (b) Test how mgmt developed estimate
    (c) Test operation of controls
    (d) Develop an independent estimate and compare
  5. Perform additional substantive procedures for significant risks (e.g. sensitivity analysis, has mgmt addressed the effects of estimation uncertainty?)
  6. Evaluate the reasonableness of estimates and disclosures and obtain written representations. Evaluate for indications of bias.
  7. Document the basis for conclusions (reasonableness of the estimate and related
    disclosures the give rise to significant risks and any indicators of management bias)
51
Q

Fraud -

Contingent liabilities - responsibilities of mgmt vs. Auditor

A

Management responsibilities:
1. Identify & disclose contingent liabilities

Auditor responsibilities:

  1. Design and perform audit procedures on the contingent liabilities (e.g. inquiry, review meeting minutes)
  2. Identify whether there a CL’s that have not been disclosed, such as lawsuits
  3. Communicate directly with legal counsel by letter to determine whether the claims or litigation exist and are disclosed properly
  4. Review insurance coverage to ensure adequate protection against foreseeable business risks
52
Q

Audit Approach -

Best approach if CR is high vs. when CR is low

A

CR high = Substantive

CR low = combined

53
Q

Audit Approach -

Types of procedures used for substantive approach

A

Substantive analytical procedures & substantive tests of details

54
Q

Audit approach -

Types of procedures used to combined approach

A

Test of controls & substantive procedures (analytical / test of details)

55
Q

Audit approach -

When can audit procedures take place throughout the year?

A
  • The detailed work on systems (controls testing) and testing of revenues and expenses (tests of details) can start at any time of the year. Can result in better understanding of the entity which lends to RMM assessment and substantive procedures required at year-end.
  • The final steps of substantive procedures involve undertaking the detailed testing of the figures themselves, particularly on balance sheet items. Some of these tests cannot commence until after the year end and after the entity has produced a trial balance.
56
Q

Audit approach -

Auditor responsibilities when audit evidence has been prepared using work of a management’s expert

A
  • Evaluate the competence, capabilities, and objectivity of that expert (e.g. professional certification, reputation, impediments to objectivity)
  • Understand the work of the expert (governing standards, relevance to the audit)
  • Evaluate whether that expert’s work is appropriate as audit evidence (source of data, reasonableness of assumptions & findings)
57
Q

Analytical procedures -

5 types of substantive analytical procedures

A
  1. Horizontal analysis (different years)
  2. Vertical analysis (different line items)
  3. Ratio analysis
  4. Reasonableness test (auditor prediction vs. actuals)
  5. Large & unusual item review
58
Q

Analytical procedures -

Reliability consideration

A

When performing analytical procedures over the client’s financial information, the practitioner must question the reliability of the financial information being used.

The practitioner must also consider the reliability of prior years’ financial information when the client has not been audited in the past

Comparison against benchmarks: The practitioner must consider whether the benchmark is reasonable — for example, if an industry average is being used as a benchmark, the practitioner must consider whether the client is comparable to the companies in its industry.

59
Q

Analytical procedures -

Annualizing

A

When performing analytical procedures on the financial information partway through the year, the practitioner must annualize the income statement accounts before comparing the results of the analytical procedures to prior-year results or benchmarks, such as industry averages

60
Q

Analytical Procedures:

4 step approach to financial stmt analysis in case writing

A
  1. Set your expectations: carefully read the case for clues about the expected results for the year (e.g. economic slowdown, brand expansion, new competition, discontinued operations)
  2. Compute ratios: compute most applicable key ratio(s) and compare to prior year performance or industry average
  3. Perform horizontal & vertical analysis - what are the major differences? (focus on income statement accounts and then reflect on effect to balance sheet).
  4. Interpret the results: Determine if the results are in accordance with your expectations. If they are not, you should discuss the issue and then create a course of action that is consistent with your role. A course of action should always be provided with the analysis (RISK, ASSERTION, PROCEDURE)
61
Q

Code of professional conduct -

5 key principles

A
  1. Objectivity (independent, objective mindset)
  2. Integrity & due care
  3. Professional competence (skill level required to undertake work)
  4. Confidentiality
  5. Professional behaviour (behave in way the maintains good reputation of profession)
62
Q

Rules of professional conduct -

5 threats to independence

A
  1. Self-interest threat (financial interest in client)
  2. Self-review threat (position to form an opinion on your own work)
  3. Advocacy threat (practitioner promotes or appears to promote position of the client through sale of securities, legal dispute, etc)
  4. Familiarity threat (close relationship between practitioner and client which makes it difficult for practitioner to apply professional skepticism)
  5. Intimidation threat (Client intimidates practitioner)
63
Q

Rules of professional conduct - Independence

What is the rule for an audit staff that has returned from a secondment with the audit client?

A

No staff member should return to audit any area they worked on while on secondment for a minimum of one financial year after the end of the secondment.

64
Q

Rules of professional conduct - Independence

What is the rule for when an audit staff has left the firm to join an audit client?

A

Engagement partner, key quality control reviewer, or another key role on the audit within the previous two years –> resign from engagement to ensure no significant connections remain. After 2 years threat may be acceptable but must be carefully considered

More junior member of engagement team –> review team composition to ensure independence is maintained

65
Q

Rules of professional conduct - Independence

What is the rule for partner rotation on longstanding engagements?

A

For listed companies, the audit engagement partner and quality control reviewer must rotate off the audit after seven years.

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