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Ch 4 Flashcards

0
Q

Enterprise risk management (ERM)

A

Facilitate assessment and mitigation of business risks that
Entity faces

Management, boards and personnel have to assess what can go
Wrong with business and how to prevent it

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1
Q

Business risks

A

Risk that could adversely affect companies’ ability to achieve
Objectives and execute strategies

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2
Q

Inherent risk

A

In absence of internal controls

Risk frauds and errors can occur through information processing
And financial statements are misstated

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3
Q

Information risk

A

Probability that information distributed by entity will be materially
False and misleading

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4
Q

Control risk

A

Management builds in controls so errors and fraud are less likely
To occur,

but there is risk internal controls will fail to detect fraud or error

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5
Q

Audit risk

A

Risk of incorrect audit opinion when financial statements are
Materially misstated

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6
Q

8 elements of ERM (enterprise risk management framework)

A 
1 internal environment
2 objective setting
3 event identification
4 risk assessment
5 risk response
6 control activities
7 information and communication
8 monitoring
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7
Q

ERM: internal environment define, what 4 items does it include?

A

Risk consciousness of organization

Includes organization’s risk management philosophy and risk
Appetite, ethical values, operating environment

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8
Q

ERM: Objective setting

A

Managements responsibility to determine goals and objectives of
Organization

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9
Q

ERM: event identification, define, examples

A

Identification of conditions and events that could adversely
Affect management’s objectives

Ex. Supplier problems, poor weather

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10
Q

ERM: risk assessment, define, example

A

Systematic process for estimating likelihood of adverse conditions
Occurring

Ex. Chance of Bad weather and financial damage it might cause

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11
Q

ERM: risk response

A

How organization will prevent of respond to adverse conditions
If they actually occur

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12
Q

ERM: control activities

A

Policies/procedures to ensure risk responses are appropriate

Given circumstances

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13
Q

ERM: information and communication

A

Link all components of ERM

Ex. Provide management with all info to minimize/eliminate risk

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14
Q

ERM: monitoring

A

Regular management and supervisory activities over risk
Management activities

to make sure they remain in place and operate smoothly

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15
Q

3 ways management can mitigate risk

A

1 avoid it

2 control it

3 share it

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16
Q

Fraud

A

Act of knowingly making material misrepresentation of fact

With intent of inducing someone to believe in falsehood and
Act on it, suffering a loss or damage

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17
Q

3 ways fraud and aggressive financial reporting occur

A

1 overstating revenues and assets

2 understating expenses and liabilities

3 giving disclosures that are misstated or omit important info

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18
Q

Fraud that affect financial info and causes financial statements to be materially misstated often arise from need to…

A

Get through difficult period

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19
Q

3 Examples of difficult periods where fraud occurs

A

1 cash shortage
2 increase in competition
3 cost overruns

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20
Q

Management fraud AKA fraudulent financial reporting

A

Deliberate fraud committed by management that injures investors
And creditors through materially misstated info

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21
Q

White collar crime

A

Fraud perpetrated by people who work in offices and steal
With pencil or computer

Not through violence

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22
Q

Employee fraud

A

Use of fraudulent means to misappropriate funds or other

Property from an employer

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23
Q

3 phases of employee fraud

A

1 fraudulent act
2 conversion of funds/property to fraudster’s use
3 coverup

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24
Embezzlement
Type of fraud involving employees or non employees wrongfully Misappropriating funds or property entrusted to their care Often accompanied by false accounting entries and other Forms of deception and coverup
25
Larceny
Simple theft Stealing what hasn't been entrusted to you
26
Defalcation
Another name for employee fraud, embezzlement or larceny Misappropriation of assets
27
Errors
Unintentional misstatements or omissions of amounts or | Disclosures in financial statements
28
Significant account or disclosure
Account or disclosure that has reasonable possibility of | containing material misstatement regardless of effect of controls
29
Relevant assertions
Management assertions that have reasonable possibility of Containing material misstatements without regard to effect of Controls
30
Audit risk can be broken down into 3 parts
Risk of: 1 material misstatement occurs (inherent risk) 2 not prevented or detected by client internal controls (control risk) 3 not detected by auditors procedures (detection risk)
31
Inherent risk and control risk are combined into what kind of risk?
Risk of material misstatement
32
Risk of material misstatement (RMM)
Risk a material misstatement exists in financial statements before Auditors apply their procedures
33
Inherent risk, text book definition
Probability that in absence of internal controls, material errors or Frauds could enter accounting system used to develop financial Statements Susceptibility of account to misstatement
34
Detection risk
Probability that auditors procedures will fail to detect material Misstatements that haven't been prevented by client's internal Controls
35
Audit risk model (equation)
``` Audit risk (AR) = Inherent risk (IR) X Control Risk (CR) X Detection Risk (DR) ```
36
Inherent risk is high if...
Material misstatement is likely to enter the accounting info system
37
Control risk is high if...
Material misstatement is not likely to be detected by client's Internal controls
38
High detection risk means...
We can afford less effective testing
39
Low detection risk means we...
Need more effective testing
40
Impact of detection Risk Allowed: Lower detection risk allowed vs. Higher detection risk allowed: nature
Nature: Lower detection risk allowed = more effective tests Higher detection risks allowed = less effective tests
41
Impact of detection Risk Allowed: Lower detection risk allowed vs. Higher detection risk allowed: timing
Timing: Lower detection risk = testing performed at year end Higher detection risk = testing can be performed at interim
42
Impact of detection Risk Allowed: Lower detection risk allowed vs. Higher detection risk allowed: extent
Extent: Lower detection risk allowed = more tests Higher detection risk allowed = fewer tests
43
Susceptibility of accounts to misstatement or fraud: dollar size of account
The higher the account balance, the greater the chance of | Having errors or fraud in the account
44
Susceptibility of accounts to misstatement or fraud: liquidity Example
The greater the accounts liquidity, the more susceptible the account is to fraud Ex. Cash is more susceptible to theft than a building
45
Liquidity define
Ability it be easily converted into cash
46
Susceptibility of accounts to misstatement or fraud: volume of transactions
The higher the volume if transactions, the higher the chance | Of error or fraud occurring in the transactions
47
Susceptibility of accounts to misstatement or fraud: complexity of transactions Ex.
Very complex transactions have higher percentage of errors Ex. Derivatives and hedging transactions
48
Susceptibility of accounts to misstatement or fraud: subjective measurements Ex.
Subjective measurements have more fraud and error as subjective (Estimating allowance for doubtful accounts Than objective measurements (counting petty cash) Measurement is easier to manipulate
49
5 aspects auditors must understand about nature of company
1 company's organizational structure and management personnel 2 sources of funding for operation and investment activities 3 company's significant investments 4 company's operating characteristics 5 sources of company's earnings
50
Company's organizational structure and management personnel
Whether company is centralized or decentralized
51
Company's operating characteristics
Its size and complexity Whether it operates internationally or has subsidiaries in Diverse industries
52
Related parties
individuals and organizations that can influence or be influenced By decisions of company Possibly though family ties or investment relationships
53
Accounting estimates
Approximations of financial statement numbers, often included In financial statements Numerous fraud cases have involved manipulation of estimates
54
3 early information gathering activities of auditors
1 reviewing the corporate charter and bylaws or partnership Agreement 2 reviewing contracts, agreements, legal proceedings 3 reading minutes if meetings of directors and committees Of board of directors
55
Analytical procedures
Reasonableness tests where auditors compare their expectation For each account balance with those recorded by management
56
5 steps auditors should perform when completing analytical procedures
``` 1 develop an expectation 2 define a significant difference 3 compare expectation with recorded amount 4 investigate significant differences 5 document each of preceding steps ```
57
Define a significant difference
What percentage or dollar difference from you expectation is | Still considered reasonable
58
Horizontal analysis
Comparative financial statements and calculate year to year | Changes in balance sheet and income statement accounts
59
Vertical analysis
Calculate common size statements where amounts are expressed As percentage of base (sales of income statement, or total assets Of balance sheet)
60
Significant risks, ex
Risks that require special audit consideration Because nature of risk or likelihood and potential magnitude of Misstatement related to risk Ex. Fraud risks
61
Extended procedures
Audit procedures used in response to heightened fraud awareness As result of identification of significant risks
62
Fraud at the management level should be reported to who?
The audit committee
63
Audit committees
Composed of independent, outside members of board of directors Not involved in company's daily operations Provide buffer between audit firm and managment
64
2 types of noncompliance dealt with by auditing standards
1 direct effect noncompliance 2 indirect effect noncompliance
65
Direct effect noncompliance
Violations of laws or government regulations by entity or its Management or employees That produce direct and material effects on dollar amounts In financial statements
66
Indirect effect noncompliance
Violation of laws and regulations that doesn't directly effect Specific financial statement accounts or disclosures Ex. Insider trading, OSHA violations, FDA regulations, environmental protection, equal employment
67
Private Securities Litigation Reform Act 1995: reporting obligations
If auditors believe a serious illegal act has occurred, they must Inform company's board, and board must inform SEC in 1 business Day If board doesn't inform SEC, auditors should resign and give SEC report in 1 business day
68
Audit strategy memorandum
Scope, timing and direction for auditing each relevant assertion Based on results of audit risk model

Audit (36 decks)

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