Audit - OFSL - Materiality

Question 1

Audit Planning Process - 4 steps

Answer 1

RAMP

1) Risk
2) Approach
3) Materiality
4) Procedures

Question 2

Audit Planning Process

1) Risk - Audit Risk Model (formula)

Answer 2

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)

Question 3

Audit Planning Process

1) Risk - Inherent Risk

Answer 3

• 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

Question 4

Audit Planning Process

1) Risk - Control Risk

Answer 4

• 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

Question 5

Audit Planning Process

1) Risk - Detection Risk

Answer 5

is the risk that the audit procedures will fail to detect material misstatements that were not caught by the internal controls.

Question 6

Audit Planning Process

1) Risk - RMM

Answer 6

Risk of Material Misstatement

1) Overall Financial Statement Level (OFSL)
2) Account level - accounts that users are sensitive to

Question 7

Audit Planning Process

2) Audit Approach - Combined Approach

Answer 7

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

Question 8

Audit Planning Process

2) Audit Approach - Substantive Approach

Answer 8

Using only substantive procedures as internal controls are not effective.

Question 9

Audit Planning Process

2) Audit Approach - Pervasive RMM

Answer 9

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

Question 10

Audit Planning Process

3) Materiality - User

Answer 10

Materiality - for the F/S as a whole (OFSL)

Specific materiality - for specific balances, classes of transactions, disclosures

Question 11

Audit Planning Process

3) Materiality - Auditor

Answer 11

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

Question 12

Audit Planning Process

3) Materiality - materiality threshold for profit oriented entities

Answer 12

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

Question 13

Audit Planning Process

3) Materiality - materiality threshold for non-profit organizations

Answer 13

1 - 3% of expenses or revenues

1 - 3% of assets

Question 14

Audit Planning Process

3) Materiality - performance/specific performance materiality threshold

Answer 14

50 - 75% of materiality/specific materiality based on moderate risk

80 - 90% can be used for extremely low risk

Question 15

Audit Planning Process

4) Procedures - Balance Sheet Assertions

Answer 15

• Existence
• Rights and obligations
• Completeness
• Accuracy, valuation and allocation
• Classification
• Presentation

Question 16

Audit Planning Process
4) Procedures - B/S Assertion:
Existence

Answer 16

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

Question 17

Audit Planning Process
4) Procedures - B/S Assertion:
Rights and obligations

Answer 17

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

Question 18

Audit Planning Process
4) Procedures - B/S Assertion:
Completeness

Answer 18

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.

Question 19

Audit Planning Process
4) Procedures - B/S Assertion:
Accuracy, valuation and allocation

Answer 19

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

Question 20

Audit Planning Process
4) Procedures - B/S Assertion:
Classification

Answer 20

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

Question 21

Audit Planning Process
4) Procedures - B/S Assertion:
Presentation

Answer 21

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

Question 22

Audit Planning Process

4) Procedures - Income Statement Assertions

Answer 22

• Occurrence
• Completeness
• Accuracy
• Cutoff
• Classification
• Presentation

Question 23

Audit Planning Process
4) Procedures - I/S Assertion:
Occurence

Answer 23

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

Question 24

Audit Planning Process
4) Procedures - I/S Assertion:
Completeness

Answer 24

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

Question 25

Audit Planning Process
4) Procedures - I/S Assertion:
Accuracy

Answer 25

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

Question 26

Audit Planning Process
4) Procedures - I/S Assertion:
Cutoff

Answer 26

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

Question 27

Audit Planning Process
4) Procedures - I/S Assertion:
Classification

Answer 27

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

Question 28

Audit Planning Process
4) Procedures - I/S Assertion:
Presentation

Answer 28

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

Question 29

Audit Engagement

- Independent Auditor’s Report

Answer 29

• 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

Question 30

Review Engagement

- Review Engagement Report

Answer 30

• 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

Question 31

Compilation Engagement

- Standard Compilation Engagement Report (Notice to Reader)

Answer 31

• 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