– Audit Planning, Types of audit tests, and materiality Flashcards
1
Q
A
2
Q
What are the three phases of audit planning?
A
1) Client acceptance and continuance, 2) Preliminary engagement activities, 3) Plan the audit
3
Q
What must an accounting firm determine before accepting a new client?
A
- Has necessary technical knowledge and industry experience
- Has personnel with required competencies
- Has necessary specialists
- Can complete the audit within the reporting deadline
4
Q
What are key legal and ethical requirements for client acceptance?
A
- Maintain independence from the entity
- Ensure compliance with regulatory agency requirements and professional conduct rules
5
Q
What factors are considered regarding client integrity before acceptance?
A
- Business reputation of owners and management
- Business practices and operations
- Attitude toward internal controls and accounting standards
- Indications of criminal activity (e.g., money laundering)
6
Q
When should an auditor re-evaluate an ongoing client relationship?
A
- Near audit completion or after a significant event
- If disputes over fees, accounting methods, or legal issues arise
7
Q
What are the three key topics in preliminary engagement activities?
A
1) Engagement letter
2) Using the internal audit function
3) Role of the audit committee
8
Q
What are the key components of an engagement letter?
A
- Audit objectives
- Management’s responsibilities
- Auditor’s responsibilities
- Limitations of the engagement
9
Q
What case highlights the importance of a written engagement letter?
A
1136 Tenants Corporation case
10
Q
What factors influence the reliability of the internal audit function?
A
- Objectivity
- Competence
- Systematic and disciplined approach
11
Q
What are the key responsibilities of the audit committee for public companies?
A
- Maintain independence
- Oversee external auditors
- Preapprove audit/non-audit services
- Establish complaint procedures
- Hire external experts if needed
12
Q
What are the key steps in planning the audit?
A
1) Assess business risks
2) Assess the need for specialists
3) Consider violations of laws and regulations
4) Identify related parties
5) Consider additional value-added services
13
Q
What are the three components of audit tests?
A
- Nature
- Timing
- Extent
14
Q
What are the types of audit tests?
A
- Risk assessment procedures
- Tests of controls
- Substantive procedures
15
Q
What is the objective of risk assessment procedures?
A
To obtain an understanding of the entity, its environment, and internal controls to identify potential risks
16
Q
What is the objective of tests of controls?
A
Assess the effectiveness of internal controls in preventing or detecting material misstatements
17
Q
What are common control testing methods?
A
- Inquiry
- Inspection
- Walkthrough
- Reperformance
- Observation
18
Q
What is the objective of substantive procedures?
A
Detect material misstatements in financial statements, transactions, and disclosures
19
Q
What are the two main types of substantive procedures?
A
- Substantive analytical procedures
- Tests of details of balances
20
Q
When are substantive procedures required?
A
- When internal controls are weak
- When the risk of material misstatement is high
- When substantive procedures provide better evidence than control testing alone
21
Q
What are dual-purpose tests?
A
Tests that combine a test of controls and a substantive test of transactions on the same sample for efficiency
22
Q
What is materiality in auditing?
A
A misstatement is material if it influences financial statement users’ decisions
23
Q
What are the three steps in applying materiality?
A
1) Determine overall materiality (planning materiality)
2) Determine tolerable misstatement (performance materiality)
3) Evaluate audit findings
24
Q
What are key considerations for materiality?
A
- Materiality is dynamic and may be revised
- Qualitative factors matter (e.g., fraud, regulatory issues)
- Lower materiality requires more extensive testing
25
What is the role of supervision in an audit engagement?
- Inform team members of responsibilities
- Direct team to identify and communicate audit issues
- Review engagement team’s work
26
What are the types of audit and assurance services?
* Audit services: Internal control audits, Compliance audits, Operational audits, Forensic Audits
* Assurance Services: Auditing as a specialized form of assurance service
* Non-audit Services: Tax Preparation, management advisory services, compilation and review services
27
What significant financial scandal impacted CPAs and led to regulatory changes?
Enron scandal
## Footnote
It marked the Pre-Enron and Post-Enron Era, leading to the Sarbanes-Oxley Act in the USA and similar regulations in Canada.
28
What is the auditor's primary responsibility?
To provide reasonable assurance that financial statements are free of material misstatement.
29
How can the expectations gap in auditing be narrowed?
* Complying with standards
* Undertaking peer reviews
* Reviewing and updating auditing standards
* Educating the public
* Enhanced reporting
* Ensuring compliance with auditing standards
* Conducting thorough audits
* Communicating audit findings effectively
30
Who is responsible for the preparation and issuance of financial statements?
Management
31
Why is understanding an entity's business model important for auditors?
* Risk Assessment & Fraud Detection
* Financial Accuracy
* Stakeholder Impact
* Business Strategy & Competition
* Macro Factors
* Compliance & Regulations
32
What role does corporate governance play in audits?
* Ensures transparency and accountability
* Strengthens internal controls
* Promotes ethical behavior
33
What is an Audit Committee (AC)?
* A subset of independent board members overseeing audits
* Acts as a bridge between auditors and the board
* Reviews financial statements and internal controls
34
What actions should auditors take if management is uncooperative?
* Report issues to the audit committee
* Committee intervenes to resolve conflicts
* Issue qualified/adverse opinions if obstruction persists
35
How does an auditor's approach differ between automobile manufacturing and banking?
* Automobile: Focus on inventory valuation, production costs
* Banking: Emphasizes loan loss provisions, liquidity risks
36
What are the four categories of principles in the AASB’s auditing standards?
* Purpose
* Responsibilities
* Performance
* Reporting
37
What are the three responsibilities of auditors?
* Professional, Ethical & Legal
* Complying with relevant ethical requirements
* Maintaining professional skepticism
38
What are the fundamental rules of professional conduct for auditors?
* Professional behaviour
* Integrity and due care
* Objectivity
* Professional Competence
* Confidentiality
39
What is the independence rule in auditing?
A member in public practice must be independent in the performance of professional services.
40
What are the nine categories of prohibited non-audit services post-Enron?
* Bookkeeping
* Financial information systems design
* Appraisal or valuation services
* Actuarial services
* Internal audit outsourcing
* Management functions
* Broker or dealer services
* Legal services
* Expert services
41
What are the elements of quality control in auditing?
* The firm’s risk assessment process
* Resources
* Relevant ethical requirements
* Governance and leadership
* Engagement performance
* Acceptance and continuance of relationships
* Monitoring
* Information and Communication
42
What must be proven for an auditor to be liable to a client?
* Duty
* Breach
* Causation
* Damage
43
What are the different degrees of care auditors must exercise?
* Due care
* Negligence
* Gross negligence
* Fraud
44
What are the four legal standards for third parties in auditor liability?
* Privity
* Near Privity
* Foreseen Third Parties
* Reasonably Foreseeable Third Parties
45
What must a third party prove for fraud claims against an auditor?
* False representation
* Knowledge of falsehood
* Intent to induce reliance
* Reliance on the false representation
* Damages suffered
46
What is the Sarbanes-Oxley Act of 2002?
Legislation enacted after major scandals creating the PCAOB and stricter independence rules for auditors.
47
What is an unqualified audit report?
Issued when the auditor has gathered sufficient evidence, the audit followed Canadian Auditing Standards, and the financial statements conform to GAAP.
48
What case expanded auditor liability to foreseeable third parties?
Hercules Case (Canada)
## Footnote
This case set a precedent for auditor accountability towards third parties who may rely on the audited financial statements.
49
Which case defined auditor liability more clearly?
Canadian Commercial Bank Case (Canada)
## Footnote
This case provided a clearer framework for understanding the extent of auditor liability.
50
What is an unqualified report in the context of public companies?
A report issued when sufficient evidence is gathered, the audit follows Canadian Auditing Standards, and financial statements conform to GAAP.
51
What are the eleven elements contained in the standard unqualified audit report for public companies?
* Report title
* Addressee
* Opinion section
* Basis for opinion section
* Emphasis of matter section, if required
* Key audit matters section
* Responsibilities of management
* Responsibilities of the auditor
* Name/signature of the audit firm
* Audit report location
* Date
52
What major change occurred in the auditor's report after over seventy years?
New reporting standards were adopted that enhanced key audit report features.
53
What is the order of sections in the new auditor's report?
Opinion section first, followed by Basis for Opinion section.
54
What are Key Audit Matters (KAM)?
Matters from the audit of the financial statements communicated to the audit committee that involve challenging auditor judgment.
55
What is an Emphasis of Matter paragraph used for?
To draw attention to a particular matter that is properly presented or disclosed in the financial statements.
56
What are the two main reasons for adjustments to the Standard Unqualified/Unmodified Financial Statement audit report?
* GAAP Departure
* GAAS Departure
57
How does materiality affect Financial Statement Reporting?
If a GAAP departure is judged immaterial, a standard unqualified audit report can be issued.
58
What are the four types of Financial Statement audit reports?
* Unqualified/Unmodified
* Qualified “Except for”
* Disclaimer
* Adverse
59
What condition leads to a qualified opinion or disclaimer?
Scope limitation.
60
What condition leads to a qualified opinion or adverse opinion?
Not in conformity with GAAP.
61
What condition leads to a disclaimer?
Auditor not independent.
62
What is the auditor's responsibility regarding other information in the report?
The auditor has no responsibility beyond the financial information contained in the report.
63
What are the phases related to audit planning?
* Client acceptance and continuance
* Preliminary engagement activities
* Plan the audit
64
What must an accounting firm determine before accepting a new client?
* Capabilities to perform the engagement
* Necessary technical knowledge and relevant industry experience
* Compliance with legal and ethical requirements
65
What topics should be discussed in preliminary engagement activities?
* Engagement letter
* Key components of an engagement letter
* Limitations of the engagement
66
What is the importance of the 1136 Tenants Corporation case?
It highlighted the importance of having a written engagement letter to prevent legal disputes.
67
What factors should be evaluated to determine the reliability of the internal audit function?
* Objectivity
* Competence
* Systematic and disciplined approach
68
What are the key responsibilities of the audit committee?
* Independence
* Oversight of external auditors
* Preapproval of services
* Complaint procedures
* Authority to hire experts
69
What is the purpose of an audit strategy?
Defines the overall audit strategy, including scope, timing, and resources.
70
What is the objective of risk assessment procedures?
To obtain an understanding of the entity, its environment, and internal controls to identify potential risks.
71
What is the role of substantive procedures in auditing?
To detect material misstatements in financial statement accounts, transactions, and disclosures.
72
What are the key types of control testing methods?
* Inquiry
* Inspection
* Walkthrough
* Reperformance
* Observation
73
What is dual-purpose testing?
Combining a test of controls and a substantive test of transactions on the same sample to increase audit efficiency.
74
What defines materiality in auditing?
A misstatement is material if it influences financial statement users' decisions.
75
What are the three key components of audit risk?
* Inherent Risk (IR)
* Control Risk (CR)
* Detection Risk (DR)
76
What does audit risk refer to?
The possibility that an auditor expresses an inappropriate opinion on financial statements that are materially misstated.
77
What are the three key components of audit risk?
* Inherent Risk (IR)
* Control Risk (CR)
* Detection Risk (DR)
78
Define Inherent Risk (IR).
The susceptibility of an assertion in an account or disclosure to a material misstatement before considering controls.
79
Define Control Risk (CR).
The risk that a material misstatement will not be prevented, detected, or corrected in a timely manner by the entity’s internal controls.
80
Define Detection Risk (DR).
The risk that audit procedures fail to detect material misstatements.
81
What is the formula for the Audit Risk Model?
Audit Risk = IR x CR x DR
82
What is Risk of Material Misstatement (RMM)?
RMM = IR x CR
83
What factors contribute to detection risk?
* Inappropriate audit procedures
* Misinterpretation of audit evidence
* Failure to recognize misstatements (nonsampling risk)
84
How do auditors use the Audit Risk Model?
To design audit procedures that reduce audit risk to an acceptably low level.
85
If IR = 1 and CR = 1, what is DR to meet the 5% audit risk threshold?
DR = 5%
86
What are some limitations of the Audit Risk Model?
* Relies on judgmental assessments
* Does not account for potential auditor errors
* Desired audit risk level may not actually be achieved
87
What are the auditor’s risk assessment procedures?
* Inquiries with management and personnel
* Analytical procedures
* Observation and inspection
88
What factors affect Inherent Risk (IR)?
* Industry conditions
* Regulatory environment
* External factors
89
What are the considerations for Control Risk (CR)?
Understanding internal controls helps identify misstatements and assess risk.
90
What is the difference between errors and fraud?
Errors are unintentional misstatements, while fraud involves intentional deception.
91
What are the components of the Fraud Risk Triangle?
* Incentive/Pressure
* Opportunity
* Attitude/Rationalization
92
What is the Fraud Risk Identification Process?
* Audit team discussions
* Management inquiries
* Analytical procedures
* Investigation of unusual period-end adjustments
* Identification of fraud risk factors
93
In the iPayment Fraud case, what type of fraud occurred?
Asset misappropriation and financial statement fraud.
94
What audit considerations arose from the iPayment Fraud case?
* Likely high control risk assessment
* Need for extensive audit procedures to mitigate detection risk
95
What are the risk response strategies auditors may employ?
* Assign experienced auditors to high-risk areas
* Scrutinize accounting policy selections for bias
* Introduce unpredictability in audit procedures
96
What should an auditor document regarding fraud risk?
* Engagement team discussions on fraud risk
* Procedures to identify and assess risks of material misstatement
* Additional procedures performed in response to identified fraud risks
97
True or False: Fraud involving senior management must be reported directly to the audit committee.
True
98
What are management assertions in financial statements?
Representations by management about the financial statements' accuracy and fairness.
99
What is the assertion of Completeness?
Ensures all transactions that should be recorded have been included.
100
What is the assertion of Occurrence?
Ensures that recorded transactions actually happened.
101
What is the assertion of Authorization?
Ensures transactions are approved.
102
What is the assertion of Accuracy?
Ensures transactions are recorded correctly.
103
What is the assertion of Cutoff?
Ensures transactions are recorded in the correct period.
104
What is the assertion of Classification?
Ensures transactions are recorded in the proper accounts.
105
What is the assertion of Presentation?
Ensures disclosures are properly presented.
106
What is the assertion of Existence?
Ensures recorded balances actually exist.
107
What is the assertion of Rights and Obligations?
Ensures the entity has rights to its assets and obligations for its liabilities.
108
What is the assertion of Completeness for account balances?
Ensures all balances that should be recorded are included.
109
What is the assertion of Accuracy, Valuation, and Allocation?
Ensures balances are recorded at appropriate values.
110
What is audit evidence?
The information used by the auditor in arriving at the conclusions on which the audit opinion is based.
111
What is the difference between sufficiency and appropriateness of audit evidence?
* Sufficiency = Quantity of evidence needed
* Appropriateness = Quality of audit evidence
112
What are the three elements of audit procedures?
* Audit Objectives (Assertion)
* Audit technique (Tools)
* Evidential matter (With 95% confidence)
113
What is vouching in audit procedures?
Tracing transactions from financial statements back to source documents.
114
What is tracing in audit procedures?
Following a transaction from its source to the financial statements.
115
What is confirmation in audit procedures?
Audit evidence obtained as a direct written response from third parties.
116
What is recalculation in audit procedures?
Checking mathematical accuracy of documents.
117
What are analytical procedures?
Evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.
118
What are the four steps to analytical procedures?
* Develop an expectation
* Define a tolerable difference
* Compare expected vs. recorded amounts
* Decide if further audit work is needed
119
What are short-term liquidity ratios used for?
Indicate the ability to meet short-term obligations.
120
What is the Current Ratio formula?
Current Ratio = Current Assets / Current Liabilities
121
What is the Quick Ratio formula?
Quick Ratio = (Cash + Receivables) / Current Liabilities
122
What is the Operating Cash Flow Ratio formula?
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
123
What is the purpose of internal control?
To provide reasonable assurance that adequate control exists over the entity’s assets and records.
124
What are the five components of internal control according to the COSO framework?
* Control Environment
* Risk Assessment
* Control Activities
* Information & Communication
* Monitoring Activities
125
What does the Control Environment component focus on?
The tone at the top set by the Board of Directors and senior management.
126
What does the Risk Assessment component involve?
Identifying risks that could impact financial reporting.
127
What is the purpose of Control Activities?
Policies and procedures to mitigate risks.
128
What does the Information & Communication component ensure?
Effective data flow and understanding of internal control responsibilities.
129
What are Monitoring Activities in internal control?
Ongoing review and evaluation of controls.
130
What is a substantive strategy in auditing?
A strategy where control risk is set at high for some or all assertions due to factors such as ineffective controls or inefficient control testing.
## Footnote
This strategy is chosen when controls do not pertain to an assertion or are assessed as ineffective.
131
What is the reliance strategy also referred to as?
Combined Approach.
## Footnote
This involves obtaining an understanding of internal control and planning to rely on it while assessing control risk at a lower level.
132
What are the five components of internal control that an auditor needs to understand?
* Control Environment
* Entity’s Risk Assessment Process
* Information System and Communication
* Control Activities
* Monitoring of Controls
## Footnote
Understanding these components is crucial for effective auditing.
133
How might the size of an entity affect its internal control?
Small or midsize entities may have less formal controls.
## Footnote
For example, a small business owner may personally approve all expenses instead of following a formal process.
134
What is a material weakness in internal control?
A deficiency or combination of deficiencies that creates a reasonable possibility of material misstatement in financial statements.
## Footnote
It indicates a high risk of material misstatements going unnoticed.
135
Define a significant deficiency in internal control.
A deficiency that is less severe than a material weakness but still important enough to warrant attention from management or governance.
## Footnote
It indicates increased risk of financial misstatements.
136
What is a control deficiency?
A flaw in the design or operation of a control that does not allow management or employees to prevent, detect, or correct misstatements.
## Footnote
It typically indicates inefficiencies in internal control.
137
What are common fraud risks in revenue recognition?
* Side Agreements
* Channel Stuffing
* Related Party Transactions
* Bill-and-Hold Sales
## Footnote
These practices can manipulate revenue figures inappropriately.
138
What is included in the customer sales order document?
It validates the existence of a real transaction.
## Footnote
This document is crucial for auditors to assess revenue accuracy.
139
What is the purpose of the shipping document (Bill of Lading)?
It serves as proof of shipment for revenue transactions.
## Footnote
This document is important for occurrence and cutoff assertions.
140
What factors increase inherent risk in revenue recognition?
* Industry-related factors
* Complex revenue recognition
* High volume of transactions
* Past audit findings
## Footnote
These factors heighten the likelihood of material misstatements.
141
What are the steps for control risk assessment in revenue transactions?
* Understand and document the revenue process
* Plan and perform tests of controls
* Set and document the control risk
## Footnote
These steps are essential for effective auditing.
142
What is the risk associated with the occurrence of cash receipts transactions?
Cash receipts may be recorded but not deposited in the entity’s bank account.
## Footnote
This risk is crucial for auditors to consider.
143
What is the significance of authorization in cash receipts?
It prevents cash or checks from being stolen or lost before being recorded.
## Footnote
Proper segregation of duties and systems like lockboxes are strong controls.
144
What should be confirmed during the assessment of accounts receivable?
Existence and rights of recorded A/R balances.
## Footnote
This is typically done through sending confirmations to customers.
145
What is the purpose of accounts receivable confirmations?
To provide direct external verification of A/R balances.
## Footnote
This confirmation process is controlled by the auditor.
146
What is a key control for the completeness of revenue transactions?
Reconciling sales invoices to daily sales reports.
## Footnote
This helps ensure that all sales transactions are properly recorded.
147
What does the term 'cutoff' refer to in revenue transactions?
Ensuring that transactions are recorded in the correct accounting period.
## Footnote
This prevents overstating or understating revenue.
148
Define the term 'valuation' in the context of accounts receivable.
Ensuring A/R is properly valued at Net Realizable Value (NRV).
## Footnote
This includes assessing the adequacy of bad debt reserves.
149
What are the risks associated with sales returns and allowances?
Credit memoranda may be used to cover unauthorized shipments or conceal cash misappropriation.
## Footnote
Proper authorization of credit memoranda is essential.
150
What is the purpose of Accounts Receivable Confirmations?
To confirm the existence and rights of A/R balances through direct external verification.
151
What is the confirmation process in accounts receivable?
It is audit evidence that is a direct written response from third parties about the account receivable balance.
152
When can confirmations be omitted?
If the A/R balance is immaterial, external confirmations would be ineffective, or the assessed level of risk is low.
153
What factors affect the reliability of A/R confirmations?
Type of confirmation request, prior experience with the client, and the intended respondent's competence.
154
When should accounts receivable be confirmed?
At an interim date or at year-end, with requests sent soon after the accounting period ends.
155
Who should send confirmation requests?
The auditor must send them externally, ensuring they are not handled by the client.
156
What should an auditor do if responses to confirmations are not received?
Send a second request to maximize response rates.
157
What should an auditor investigate if customer-reported balances differ from client records?
They must investigate the discrepancy.
158
What are common causes of differences in account balances?
* Timing Differences
* Errors in Recording
* Disputed Invoices
159
What is a positive confirmation?
The customer must respond whether they agree or disagree with the stated balance.
160
When is a positive confirmation used?
When A/R balances are large, high-risk, or prone to misstatement.
161
What is a negative confirmation?
The customer only responds if they disagree with the balance.
162
When is a negative confirmation used?
When the client has many small balances and control risk is low.
163
What are alternative procedures for non-responses to confirmations?
* Subsequent Cash Collections
* Shipping Documentation Review
* Examining Customer Orders & Invoices
164
What are the types of other receivables?
* Employee & Officer Loans
* Related Party Receivables
* Notes Receivable
165
What risks are associated with Employee & Officer Loans?
Loans may not be properly disclosed or repaid.
166
What must related party receivables transactions be?
Properly disclosed and at arm's length.
167
What should be audited in notes receivable?
Collectability and interest income recognition.
168
What should auditors verify regarding related party transactions?
Ensure they are at arm's length and disclosed in financial statements.
169
What does auditing accounts receivable focus on?
* Completeness
* Cutoff
* Existence & Rights
* Valuation
170
What is meant by completeness in auditing A/R?
Ensuring all A/R balances are recorded in the general ledger.
171
What is the valuation of A/R?
Ensuring A/R is shown at Net Realizable Value (A/R minus Allowance for Doubtful Accounts).
