Ch. 1 - Intro to Assurance & Financial Statement Auditing

Question 1

An audit is a…

Answer 1

An audit is a service that provides assurance to investors, creditors, or other stakeholders that a company is being honest about its financial information and that the information is reliable.

Aka
Objectively obtaining and evaluating evidence regarding assertions about economic actions or events to ascertain the degree of correspondence between those assertions and established criteria.

Question 2

An agent is a…

Answer 2

An agent is a manager who serves in a stewardship role for the company.

Question 3

A principal is a….

Answer 3

owner of a company

Question 4

Information asymmetry

Answer 4

The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does.

Question 5

Reporting

Answer 5

The end product an auditor’s work, indicating the auditing standards followed and expressing an opinion as to whether an entity’s financial statements are fairly presented in accordance with GAAP

Question 6

What is the primary role of accounting information?

Answer 6

To hold the manager accountable to the owner.

Question 7

Information risk

Answer 7

The risk that information circulated by a company’s management could be false or misleading.

Question 8

Auditing is demanded because…

Answer 8

Auditing is demanded because it plays a valuable role in monitoring the contractual relationships between the entity and its shareholders, managers, employees, and debt holders.

Question 9

Assertions

Answer 9

Representation, explicit or otherwise, with respect to the recognition, measurement, presentation, and disclosure of information in the financial statements, which are inherent in management, representing that the financial statements are prepared in accordance with the applicable financial reporting framework. Assertions are used by the auditor to consider the different types of potential misstatements that may occur when identifying, assessing, and responding to the risks of material misstatement.

Question 10

Financial statement assertions are…

Answer 10

Financial statement assertions are management’s expressed or implied claims about information reflected in the financial statements.

Question 11

Assertions are central to auditing because…

Answer 11

Assertions are central to auditing because they are the focus of the auditors evidence collection efforts.

Question 12

What are assertions about classes of transactions that an auditor is verifying?

Answer 12

-Occurrence (it happened)
-Completeness
-Authorization (the transaction was supposed to have happened)
-Accuracy
-Cutoff (transactions and events have been recorded in the correct accounting period)
-Classification (the transactions and events have been recorded in the correct accounts)
-Presentation (transactions and events are appropriately aggregated and disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

Question 13

What are assertions about account balances and related disclosures that an auditor is verifying?

Answer 13

-Existence
-Rights & obligations (the entity holds or controls the rights to the assets and liabilities of the entity)
-Completeness (everything that should have been recorded has been recorded)
-Accuracy, valuation, and allocation (assets, liabilities and equity interest have been included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments have been appropriately recorded).
-Classification
-Presentation

Question 14

Assurance services are…

Answer 14

independent professional services intended to help decision makers by improving the quality or context of the information they use.

Question 15

Attest services are…

Answer 15

A subset of assurance services. They are assurance services that involve reporting on an assertion or other subject matter that is the responsibility of another party.

Question 16

How do you define auditing?

Answer 16

Auditing involves objectively obtaining and evaluating evidence to assess another party’s assertions that a particular set of information has been recorded and presented in accordance with a predetermined set of criteria, together with the issuance of a report that indicates the degrees of correspondence between the assertions and the criteria.

Question 17

The conceptual and procedural details of a financial statement audit build on ____ fundamental concepts. What are they?

Answer 17

Materiality, audit risk, and evidence relating to management’s financial statement assertions.

Question 18

Materiality refers to…

Answer 18

Materiality refers to the amount by which a set of financial statements could be misstated without affecting the judgement of a reasonable person.

Question 19

What is a misstatement?

Answer 19

A misstatement refers to a difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be presented fairly in accordance with the applicable financial reporting framework.

Question 20

What is the common rule of thumb to determine materiality?

Answer 20

Total (aggregated) misstatements of more than 5% of income before tax would cause the financial statements to be materially misstated.

Question 21

What is audit risk?

Answer 21

Audit risk is the risk that the auditor may mistakenly give a “clean” opinion on financial statements that are actually materially misstated.

Question 22

What is reasonable assurance?

Answer 22

Reasonable assurance is the concept that an audit done in accordance with auditing standards may fail to detect a material misstatement in a client’s financial statements. In an auditing context this term has been defined to mean a high but not absolute level of assurance.

Question 23

What is audit evidence?

Answer 23

Audit evidence is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence is information to which audit procedures have been applied and consists of information that corroborates or contradicts assertions in the financial statements.

Question 24

The sufficiency of audit evidence simply refers to…

Answer 24

The amount of evidence

Aka the sufficiency of audit evidence simply refers to the quantity of evidence the auditor obtains–does the auditor have enough evidence to justify a conclusion as to whether managements assertions are presented fairly?

Question 25

The appropriateness of audit evidence refers to…

Answer 25

The appropriateness of audit evidence refers to the quality of the evidence. Evidence is considered appropriate when it provides information that is both relevant and reliable.

Question 26

Why do we have audits?

Answer 26

1. Agency conflicts (the idea that agents (aka managers) may not act in the best interest of the principals (shareholders)
2. Information asymmetry (managers typically have superior information on company vs principals)

Question 27

Audits can reduce information asymmetry and agency conflict by…

Answer 27

-Improving the accuracy of financial reporting (eg verifying assertions)
-Reducing the likelihood that agents will not act in the best interest of shareholders

Academic studies show that voluntary audits are more likely in firms with greater agency conflicts and more information asymmetry.

Question 28

Audits can benefit a company because….

Answer 28

reducing agency conflict and information asymmetry can ultimately lead to a lower cost of capital!

Question 29

What does relevance mean as it relates to audit evidence?

Answer 29

Relevance relates to where the evidence relates the specific assertion being tested

Question 30

What are the three important concepts for audit evidence?

Answer 30

1. Sufficiency
2. Relevance
3. Reliability

(More details on specific topic cards)

Question 31

What does reliability means as it relates to audit evidence?

Answer 31

Reliability means can the evidence be relied upon to provide an accurate signal?

Question 32

What are the major phases of the audit (in order of steps)?

Answer 32

1. Client acceptance/continuance
2. Preliminary engagement activities
3. Plan the audit
4. Consider and audit internal controls
5. Audit business processes and related accounts (e.g. revenue generation)
6. Complete the audit
7. Evaluate results and issue audit report

Question 33

Risk of material misstatement (RMM)

Answer 33

The risk that the financial statements are materially misstated prior to the audit.

Question 34

What is the technical definition of auditing?

Answer 34

A systematic process of (1) objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and (2) communicating the results to interested users.

Question 35

The size of the subset of items the auditor examines is primarily a function of…

Answer 35

materiality and the desired level of assurance for the account or assertion being examined.

Question 36

There is an ________ relation between sample size and materiality, and a ______ relation between the same size and the desired level of assurance.

Answer 36

There is an inverse relation between sample size and materiality, and a direct relation between the same size and the desired level of assurance.

Question 37

An auditor collection evidence in each of the ____ stages of the client’s accounting process. What are they?

Answer 37

1. The system of internal control put in place by the client to ensure proper handling of transactions (e.g. evaluate and test controls)
2. The transactions that affect each account balance (e.g. examine a sample of the transactions that happened during the period)
3. Examine the ending account balances themselves (e.g. examine a sample of the items that make up an ending account balance at year-end).

Question 38

Unqualified/unmodified audit report

Answer 38

A “clean” audit report, indicating the auditor’s opinion that a client’s financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP).

Question 39

Audit data analytics (ADA)

Answer 39

Using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit.