Audit - OFSL - Materiality Flashcards
Audit Planning Process - 4 steps
RAMP
1) Risk
2) Approach
3) Materiality
4) Procedures
Audit Planning Process
1) Risk - Audit Risk Model (formula)
Audit Risk = RMM x Detection Risk
Audit Risk = (IR x CR) x Detection Risk
High IR and CR = Low DR (more work)
Low IR and CR = High DR (less work)
Audit Planning Process
1) Risk - Inherent Risk
- Anything outside of the control of the company
- something the company chose to do because of the business they’re in
- is the susceptibility of an account balance or class of transactions to material misstatement, assuming there are no related controls.
Eg. expand rapidly, foreign exchange, competitors, little experience, close to breaching covenants
Audit Planning Process
1) Risk - Control Risk
- how well a company knows or doesn’t know how their money moves in the business
- is the risk that the system of internal controls will fail to prevent or detect material misstatements.
Eg. Bonus, owner involvement in business, increase flexibility with contracts, high turnover, segregation of duties
Audit Planning Process
1) Risk - Detection Risk
is the risk that the audit procedures will fail to detect material misstatements that were not caught by the internal controls.
Audit Planning Process
1) Risk - RMM
Risk of Material Misstatement
1) Overall Financial Statement Level (OFSL)
2) Account level - accounts that users are sensitive to
Audit Planning Process
2) Audit Approach - Combined Approach
Using both substantive procedures and testing of internal controls
Effectiveness: cannot use if controls are not effective
Efficiency: low number of high dollar value balances or transactions
Audit Planning Process
2) Audit Approach - Substantive Approach
Using only substantive procedures as internal controls are not effective.
Audit Planning Process
2) Audit Approach - Pervasive RMM
Pervasive means found everywhere or spread everywhere. A pervasive misstatement would be so serious that, to all intents and purposes the FS are useless. Similarly with a pervasive lack of sufficient appropriate audit evidence. Pervasive problems (leading to a disclaimer or and adverse opinion) are rare.
- more extensive substantive procedures
- change audit procedures
- more locations audited
Audit Planning Process
3) Materiality - User
Materiality - for the F/S as a whole (OFSL)
Specific materiality - for specific balances, classes of transactions, disclosures
Audit Planning Process
3) Materiality - Auditor
Acts as a buffer to protect the auditor from undetected misstatements.
Performance materiality - for the F/S as a whole (OFSL)
Specific performance materiality - for specific balances, classes of transactions, disclosures
Audit Planning Process
3) Materiality - materiality threshold for profit oriented entities
3 - 7% of income before tax from continuing operations normalized for unusual or non-recurring items (e.g., owner-manager bonuses)
If unprofitable:
1 - 3% of assets
1 - 3% of revenues or expenditures
3 - 5% of equity
Audit Planning Process
3) Materiality - materiality threshold for non-profit organizations
1 - 3% of expenses or revenues
1 - 3% of assets
Audit Planning Process
3) Materiality - performance/specific performance materiality threshold
50 - 75% of materiality/specific materiality based on moderate risk
80 - 90% can be used for extremely low risk
Audit Planning Process
4) Procedures - Balance Sheet Assertions
- Existence
- Rights and obligations
- Completeness
- Accuracy, valuation and allocation
- Classification
- Presentation
Audit Planning Process
4) Procedures - B/S Assertion:
Existence
Do the assets, liabilities, and equity of the entity exist?
Substantive procedure example:
Sending account receivable confirmations to customers asking them to confirm the amount owed to the client - tests the existence of the accounts receivable balance
Audit Planning Process
4) Procedures - B/S Assertion:
Rights and obligations
Does the entity have legal claim or control the rights to the assets? Are the liabilities the obligations of the entity?
Substantive procedure example:
Recalculating the bank covenants to ensure the client is in compliance with its debt requirements and thus ensuring that the bank does not have a right to the assets held as security on the debt - tests the rights and ownership of the property, plant, and equipment balance
Audit Planning Process
4) Procedures - B/S Assertion:
Completeness
Have all the entity’s assets, liabilities, and equity been recorded?
Substantive procedure example:
Performing a floor-to-sheet test count of inventory — tests the completeness of the inventory balance. A floor-to-sheet count involves selecting items in the entity’s warehouse, counting them, and agreeing that count to the entity’s count documentation.
Audit Planning Process
4) Procedures - B/S Assertion:
Accuracy, valuation and allocation
Have the assets, liabilities, and equity of the entity been included in the financial statements at the correct amount?
Substantive procedure example:
Examining subsequent receipts for the accounts receivable balances older than 90 days, as these balances have a greater chance of non-collectability - tests the valuation and allocation of the accounts receivable balance
Audit Planning Process
4) Procedures - B/S Assertion:
Classification
Have the assets, liabilities, and equity of the entity been recorded in the proper accounts?
Substantive procedure example:
Reviewing the accounts receivable subledger for customers with significant credit balances that would be more appropriately classified as liabilities - tests the classification of the accounts receivable balance
Audit Planning Process
4) Procedures - B/S Assertion:
Presentation
Have the assets, liabilities, and equity been appropriately aggregated or disaggregated, and have disclosures been made that are relevant, understandable, and in accordance with the applicable financial reporting framework?
Substantive procedure example:
Examining legal letters and identifying provisions or contingent liabilities where disclosure is required; ensuring that these liabilities have been disclosed - tests the presentation of the accrued liabilities balance
Audit Planning Process
4) Procedures - Income Statement Assertions
- Occurrence
- Completeness
- Accuracy
- Cutoff
- Classification
- Presentation
Audit Planning Process
4) Procedures - I/S Assertion:
Occurence
Have the revenues and expenses occurred?
Substantive procedure example:
Tracing payroll expenses per the general ledger to supporting payroll documentation including timesheets and supporting calculations — tests the occurrence of payroll expense
Audit Planning Process
4) Procedures - I/S Assertion:
Completeness
Have all the entity’s revenues and expenses been recorded?
Substantive procedure example:
Inspecting sales invoices and tracing the sales invoices to the general ledger to ensure that the sales were recorded — tests the completeness of sales
Audit Planning Process
4) Procedures - I/S Assertion:
Accuracy
Have the entity’s revenues and expenses been recorded accurately?
Substantive procedure example:
Recalculating interest expense using confirmed interest rates — tests the accuracy of interest expense
Audit Planning Process
4) Procedures - I/S Assertion:
Cutoff
Have the entity’s revenues and expenses been recorded in the correct reporting period?
Substantive procedure example:
Inspecting shipping documents to verify the date of inventory shipments around period end — tests the cut-off of sales and cost of sales
Audit Planning Process
4) Procedures - I/S Assertion:
Classification
Have the entity’s revenues and expenses been classified to the appropriate accounts?
Substantive procedure example:
Reviewing the general ledger and supporting documentation (such as invoices) for appropriate classification of expense accounts — tests the classification of expenses
Audit Planning Process
4) Procedures - I/S Assertion:
Presentation
Have the entity’s revenues and expenses been appropriately aggregated or disaggregated, and have disclosures been made that are relevant, understandable, and in accordance with the applicable financial reporting framework?
Substantive procedure example:
Obtaining and reviewing contracts with customers to determine if revenue related to those contracts has been appropriately disaggregated into an entity’s various revenue streams - tests the presentation of revenues
Audit Engagement
- Independent Auditor’s Report
- most expensive
- most time consuming
- reasonable assurance
- positive opinion
- Determine if the financial statements present fairly, in all material respects
- Independence
- Substantive testing of account balances through analysis, inquiry, inspection, observation, confirmation and recalculation. Focuses on independent evidence
Review Engagement
- Review Engagement Report
- moderately expensive
- moderately time consuming
- limited assurance
- negative conclusion
- Determine if the financial statements are plausible
- Independence
- Inquiry, analytical procedures and discussion plus additional procedures may be required to determine if information is “plausible”. Focuses on internal evidence
Compilation Engagement
- Standard Compilation Engagement Report (Notice to Reader)
- least expensive
- least time consuming
- no assurance
- no opinion
- Ensure assembly of information into financial statements is arithmetically correct
- accountant doesn’t have to be independent, must disclose
- None required other than ensuring arithmetic accuracy. If statements appear to be false or misleading, then procedures are required to satisfy practitioner’s doubts
