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Audit > Audit II midterm > Flashcards

Audit II midterm Flashcards

1
Q

3 approaches to selecting sample items

A

Select all items
Select specific items- by a characteristic (key item) or all items over a certain dollar amount
Audit sampling

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2
Q

3 factors that determine sample size

A

Confidence level- desired level of assurance
Tolerable error- acceptable defect rate
Expected error- historical defect rate

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3
Q

Audit sampling

A

The application of audit procedures to less than 100 percent of the items in a population of audit relevance selected in such a way that the auditor expects the sample to be representative of the population and thus likely to provide a reasonable basis for conclusions about the population

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4
Q

Sampling risk

A

risk that sample selected is not representative of the population and lead auditor to a different conclusion than if the population were tested

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5
Q

Precision (Allowance for sampling risk) equation

A

Tolerable error - Expected error

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6
Q

Statistical sampling

A

Must comply with all laws of probability to compute sample size. Each number must have same probability of being chosen. Any judgement that comes into play makes it non statistical
Pros: Quantify sampling risk, efficient sample
Cons: Training auditors, timely, inconsistency

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7
Q

Non-statistical sampling

A

Judgement in sample size
Haphazard sample size (auditor selects sample, may be unknown bias)
Must test individually significant items 100%
Cannot quantify upper deviation rate or sampling risk

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8
Q

Monetary Unit Sampling (MUS)

A

Substantive test, most common method for balances of transactions
Can be quantified
Population: monetary value of an account balance
Each unit is an individual dollar
Misstatement- difference between monetary amounts
Dollars are organized into “logical units”

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9
Q

Confidence level

A

100% - Sampling risk
The desired level of assurance that the sample results will support a conclusion that the control is functioning effectively.
Generally, when the auditor has decided to rely on controls, the confidence level is set at 90% or 95%.

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10
Q

Tolerable deviation rate

A

The maximum deviation rate from a prescribed control that the auditor is willing to accept and still consider the control as operating effectively.
Typically 3-5% for high importance, 6-10% for moderate

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11
Q

What determines if accounts are materially misstated, and what to do afterward

A

If Upper misstatement > Tolerable misstatement, accounts are materially misstated
• Increase the sample size
○ If more misstatements are found then, request client adjust balance
• Perform other substantive procedures
Request client adjust accounts receivable balance

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12
Q

Substantive tests steps

A

Select a representative sample of items
Calculate the difference between audited values and recorded values for each sampled item
Estimate the population error by multiplying the average error rate in the sample to the population
Adjust for sampling risk (Upper confidence limit)
If the upper confidence limit is less then materiality then the auditor can conclude there is no material misstatement

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13
Q

Disadvantages of MUS

A

Special consideration for zero or negative balances
Assumes error is not more than 100% of audited amount
Sample results may overstate allowance for sampling risk

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14
Q

Fundamental concepts in Auditing

A 
Integrity
Critical thinking
Skepticism
Verification
Independence
Validating evidence
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15
Q

agency theory

A

Assumes principal has different objectives than the agent, and principal does not know agent’s type of actions

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16
Q

Information risk

A

risk that principal makes decisions improperly based on information provided

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17
Q

Audits became mandatory in _____

A

1929, after stock market crashed

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18
Q

Major SOX reforms

A

• Prohibits auditors from Bookkeeping
• Audit committee must hire and fire external auditor
• Audit must pre-approve all non audit services
• Cooling off period: one year period before a member of the audit engagement team can accept an employment at an audit client
• CEO and CFO must certify financial statements
• Established PCAOB- all firms must register and must be inspected either every year or 3 years depending on size of the firm
○ PCAOB has 18 standards: AS1 to AS18
AS 2201 is one of the most important standards

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19
Q

3 required committees on board

A

Audit committee
Compensation committee
Nomination and governance committee

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20
Q

PCAOB inspections

A

Inspect quality of individual audit engagements
Inspect the audit firm’s quality control system
Every year for >100 firms, every 3 years for small firms
50 to 70 engagements- Big 4 audit firm
20 to 40 engagements- mid-tier audit firm
1 to 6 engagements- small audit firm

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21
Q

Inspections- areas with frequent deficiencies

A 
Audit sampling procedures (i.e. sampling done improperly)
Revenues
Inventory and Accounts Receivable
Related party transactions
Internal control testing
Going concern assessments
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22
Q

Audit committee responsibilities

A

Oversee the financial reporting and disclosure process
Be responsible for the appointment, compensation and removal of the external auditor
Discuss with external auditor the nature and scope of the audit
Discuss problems arising from external and internal audits
Act as a buffer between auditors and management
Review interim and annual financial statements

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23
Q

Sequence of an audit (acceptance to completion)

A 
Client acceptance including engagement letter
Risk assessment
Audit plan
Test and evaluate internal controls
Substantive testing
Audit completion and reporting
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24
Q

Engagement letter

A

Contract that lines out auditor’s and management responsibility
Should NOT include audit procedures

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25
Q

Tests of Internal Controls

A 
Inquiry
Observation
Inspection
Designed properly?
Applied consistently?
Who performs controls?
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26
Q

Substantive tests

A

Details of transactions and account balances

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27
Q

Transaction assertions

A 
Occurrence
Completeness
Authorization
Accuracy
Cutoff
Classification
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28
Q

Authorization assertion

A

All transactions are authorized by appropriate personnel

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29
Q

Accuracy assertion

A

Transactions are recorded in full amount without errors

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30
Q

Cutoff assertion

A

Transactions are recorded in the period in which they occurred

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31
Q

Classification assertion

A

Transactions are recorded in proper account

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32
Q

Balances assertions

A

Existence
Completeness
Valuation and allocation
Rights and obligations

33
Q

Rights and obligations

A

Recorded assets and liabilities are owned/owed by the company

34
Q

AICPA code of conduct

A

General guidance: auditor should be honest, objective, competent, exercising due care
Specific rules: Minimum standards of professional behavior

35
Q

AICPA requires CPA (member) to__

A

Identify threats
Evaluate significance of threats
Apply safeguards

36
Q

7 types of threats

A

Adverse Interest- c
Advocacy- member endorses a client’s service or product
Familiarity
Management Participation- a member will take management role during engagement
Self-interest
Self-review
Undue influence

37
Q

Sources of safeguards

A

Profession, legislation or regulation of auditors
Clients (tone at the top)
The audit firm policies

38
Q

Auditor independence overarching question

A

Would a circumstance lead a reasonable person who is aware of all the relevant facts to conclude that there is an unacceptable threat to the member’s and the firm’s independence.

39
Q

3 elements to professional skepticism

A

Attributes- knowledge, skill, ability
Attitude- mindset, faith, integrity
Actions- evaluate evidence
All three must be met

40
Q

Barriers to professional skepticism

A

Incentives and pressure to maintain clients
Desire to avoid conflict, due to personal or professional characteristics
Need to maintain a low audit fee, or desire to provide other services to a client
Too much trust in the client
Scheduling or workload demands

41
Q

Ratio projection

A

Assume the auditor finds $1,500 in misstatements in a sample of $15,000. The misstatement ratio is 10%. If the population total is $200,000, the projected misstatement would be $20,000 ($200,000 × 10%)

42
Q

Difference projection

A

Projects the average misstatement per item.
Assume misstatements in a sample of 100 items total $300 (for an average misstatement of $3), and the population contains 10,000 items. The projected misstatement would be $30,000 ($3 × 10,000).

43
Q

Audit risk definition and formula

A

The risk that the audit opinion is unqualified when the financial statements are materially misstated.
Auditor sets the acceptable level.
Inherent risk x Control risk x Detection risk

44
Q

Detection risk

A

Risk that auditor will not detect misstatements.

Auditor can control

45
Q

Business risk

A

an auditor’s risk of financial loss and damage to professional reputation

46
Q

Risk of material misstatement formula

A

Inherent risk x control risk

47
Q

What determines Risk of material misstatement

A 
Revenue has a higher RMM
Industry, regulatory factors
Nature of entity
Internal controls
Objectivity
48
Q

Client business risk

A

Any factors, pressures, and forces that bear on entity’s ability to survive and profit

49
Q

Management preoccupation with earnings targets affects ________

A

Inherent risk

50
Q

Securities offerings and acquisitions financed with equity including insider sales affects____

A

Inherent risk

51
Q

Management compensation contracts incentives affects _____

A

Inherent risk

52
Q

Going concern risks and financial distress affects _______

A

Inherent risk

53
Q

Debt covenants and regulatory capital requirements affects _______

A

Inherent risk

54
Q

Change in senior management, operating activities or economic environment affects ________

A

Inherent risk

55
Q

Related party transactions affects ______

A

Inherent risk

56
Q

Operating cycle assets and liabilities affects _____

A

Inherent risk

57
Q

Attitudes of management and the AC towards internal control and corporate governance affects _____

A

Control risk

58
Q

Honesty and competence of employees affects ______

A

Control risk

59
Q

Formal structure and authorization procedures affects _______

A

Control risk

60
Q

Adequate staffing of accounting and recordkeeping functions and employee turnover affects ______

A

Control risk

61
Q

Volume of transactions affects ______

A

Control risk

62
Q

Adequate segregation of duties affects _____

A

Control risk

63
Q

3 important segregation of duties

A

Operational (sales) and Accounting
Custody of Assets and Accounting
Custody of Assets and Authorization

64
Q

Gathering evidence for risk assessment

A

Inquiries of management- see how well management knows it works, and get an understanding of how well it works
Analytical procedures- Assess risk of material misstatement due to error or fraud
Observation and inspection

65
Q

Response to risk assessment

A

Emphasize professional skepticism
Properly assign responsibility to engagement team
Sufficient supervision
Insert an element of unpredictability in conduct of the audit

66
Q

Deviation

A

Departure from adequate performance of internal control

67
Q

Materiality

A

The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement.
Requires professional judgement

68
Q

Applying materiality steps

A

Determine materiality for overall financial statements (planning materiality)
Determine tolerable misstatement (allocate materiality at individual account/class of transaction level)
Evaluate audit findings against materiality for planning (end of the audit)

69
Q

Quantitative materiality thresholds

A

3-5% of Income before tax, Income from continuing operations

0.5% of total revenues, total assets

70
Q

Qualitative factors that affect quantitative materiality

A 
Company is close to violating loan covenants
At or near break-even in earnings
High management turnover
Market pressures
Risk of Bankruptcy
71
Q

Audit evidence

A

All the information, whether obtained from audit procedures or other sources, that is used by the auditor in arriving at the conclusions on which the auditor’s opinion is based

72
Q

3 concepts to audit evidence

A

Nature (what is collected, accounting records, confirmations, etc.)
Sufficiency and appropriateness of audit evidence
Evaluation of audit evidence- unbiased, considers all evidence equally

73
Q

Sufficiency of audit evidence

A

The quantity of evidence compared to what is needed, depends on risk of material misstatement

74
Q

Steps of performing an audit

A 
Observation
Inquiry
Inspection
Confirmation
Recalculation
Reperformance
Analytical Procedures
75
Q

Audit Confirmation

A

Obtaining a representation of information of an existing condition directly from a third party
Usually very reliable
Required for A/R

76
Q

Analytical procedures

A

Evaluation of financial information through plausible relationships
Required in planning and completion

77
Q

Evaluative procedures

A

Auditor compares results with prior periods, expected results, similar companies

78
Q

Predictive procedures

A

Audit compares results to an expected amount he developed

Audit (5 decks)

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