Audit - Audit Evidence AUD3

Question 1

What is SAS 106 (AU 326) require for audit evidence?

Answer 1

Sufficient Appropriate Evidence is needed:

• Sufficiency relates to QUANTITY of corroborative evidence, while “Appropriate” relates to quality (relevance & reliability)
• want evidence that is persuasive (not conclusive)
• Concerned with Cost/Benefit

Question 2

How is Acceptable level of detection risk determined? DR

Answer 2

Acceptable DR = Audit Risk/RMM
RMM = IR x CR

As RMM decreases due to effective control, “acceptable” level of RM decreases as well, meaning auditor can reduce substantive testing.

Question 3

How is audit risk calculated?

Answer 3

AR = RMM (IR x CR) x DR

Question 4

What is the effect of high RMM to acceptable DR?

Answer 4

Acceptable DR will decrease (DR is probability substantive test will detect misstatement), thus more substantive testing need.

Question 5

How to reduce audit risk to an acceptable level? Per SAS 110 AU318

Answer 5

1. At Financial Statement Level
   - increase prof. skep, level of supervision, more unpredictable, adjust timing of audit procedures
2. Relevant Assertion Level
   - Review nature of controls, nature and timing of test, extent of procedures

Question 6

What requires substantive procedures? and when is it no sufficient and require control test?

Answer 6

• All material account, transaction class, and disclosure item require substantive test.
• When significant amt of info is initiated, recorded, processed, then substantive is not sufficient.

Question 7

What are the 13 management assertions? Summarized in 6 categories “U-PERCV”

Answer 7

1. Understandably & Classification
2. Presentation & Disclosure
3. Existence & Ocurrence
4. Rights & Obligations
5. Completeness & Cutoff
6. Valuation & Allocation & Accuracy

Question 8

What are the three audit procedures?

Answer 8

1. Risk assessment procedures
2. Test of Controls
3. Substantive procedures

Question 9

What are the two categories of Substantive procedures?

Answer 9

1. Test of Details

2. Analytics

Question 10

What is incremental audit risk?

Answer 10

Auditor should be careful of doing substantive procedures at interim dates (as oppose to YE). Only when acceptable level of DR risk is high or YE balance is predictable, then interim substantive testing is reasonable.

Question 11

What are the five analytical procedures? (CRAFT)

Answer 11

1. Client vs Industry
2. Related Accounts (int. expense and notes payable)
3. Act vs Budget
4. Financial vs. Non Financial (# of flights versus total $ of revenues)
5. This year vs. PY

Question 12

When is analytic procedures mandatory and non mandatory?

Answer 12

Planning and Overall review is mandatory.
Substantive testing - non mandatory.
In general, AP is used to decrease detection risk.

Question 13

What are the common ratios used in analytical procedures?

Answer 13

1. Current ratio - current assets/current liabilities
2. Quick ratio - Quick assets (cash & marketable securities + AR)/ current liabilties
3. Inventory Turnover - COGS/avg inventory
4. Debt-Equity Ratio - Total liabilities/SE

Question 14

What are the two different audit approaches?

Answer 14

1. Test of Balances
   
   • many transactions, small dollar amts (cash, AR, inventory, AP)
2. Test of Transactions
   - Few transactions, large dollar amts (investments, PP&E, bons, NP, SE)

Question 15

What is kiting in cash?

Answer 15

attempt to overstate by showing deposits in CY and disbursements per books in subsequent year

Question 16

What are characteristics of a dervivative? SUN

Answer 16

1. Settlement in cash or equivalent
2. Underlying and notional amount
3. No net invesments - payment is less than cost of acquiring the underlying

Question 17

Loss Contingencies? 4 types

Answer 17

1, Remote - slight chance. No disclosure, No accrual.

2. Reasonably Possible - more than remote, less than possible. Yes disclosure, No accrual.
3. Probable, not estimable. - Yes dislcosure, No accrual.
4. Probable and estimable - Yes, Yes.

Question 18

Subsequent Events - two types

Answer 18

1. Type 1 - Events that happen after YE but affects conditions at YE. Ex. files bankruptcy and AR at YE is invalid.
2. Type 2 - Events that do no affect balances at YE but should be disclosed.