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Audit > Ch 5 > Flashcards

Ch 5 Flashcards

0
Q

Internal control is a process that is designed to provide reasonable assurance regarding Achievement of what 3 objectives?

A

1 reliability of financial reporting

2 effectiveness and efficiency of operations

3 compliance with applicable laws and regulations

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1
Q

COSO

A

Committee of Sponsoring Organizations

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2
Q

Management objectives of financial reporting 2

A

Reliable financial reports

Safe guard assets

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3
Q

Management objectives of operations, 5 examples

A 
1 good business reputation
2 ensuring positive return on investment
3 increasing market share
4 promoting new product innovation
5 using assets efficiently
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4
Q

Management objectives of compliance

A

Comply with laws and regulations that affect entity

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5
Q

4 common limitations to internal control systems

A

1 human error due to mistakes in judgement, fatigue, carelessness
2 deliberate circumvention by people in system
3 management can override controls
4 collusion among people who are supposed to act independently
When separation of duties is supposed to occur

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6
Q

Reasonable assurance recognizes that costs of controls…

A

Should not exceed benefits that are expected from the controls

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7
Q

Integrated audit process

A

Describes an audit process that is designed to provide an
Opinion on both the financial statements and internal control
System of entity

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8
Q

3 reasons auditors must evaluate entity’s internal control

A

1 assess effectiveness of internal control
2 identify fraud risk in planning stage of audit
3 assess risk of material misstatement for each relevant assertion

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9
Q

Risk of materials misstatement (RMM), why is it assessed?

A

Give audit team basis for planning audit

And determining nature, timing and extent of further audit
procedures

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10
Q

RMM is composed of…

A

Inherent risk and control risk

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11
Q

Inherent risk

A

Susceptibility of an account to misstatement

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12
Q

Control risk

A

Probability that an entity’s controls will fail to prevent

or detect Material misstatements due to errors or frauds that
Would otherwise have entered the system

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13
Q

What should an audit team do when entity’s control risks are high?
Nature, timing, extent?

A

Audit team would use substantive tests of details to obtain
External evidence (nature) near the entity’s fiscal year end
(Timing)

With large sample sizes (extent)

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14
Q

When there is higher control risk, detection risk is…

2) when there is lower control risk, detection risk is…

A

Lower

2) higher

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15
Q

More reliance is placed on internal control when control risk is…

A

Lower

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16
Q

Lower control risk: nature, timing, extent

A

Nature: less effective tests conducted

Timing: testing can be performed at interim of year

Extent: lower sample size

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17
Q

5 interrelated components of internal control

A 
1 control environment
2 risk assessment
3 control activities
4 monitoring
5 information and communication
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18
Q

Control environment factors include 3 things

A

1 integrity

2 ethical values

3 competence of entity’s personnel

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19
Q

7 general principles of effective internal control environment

A 
1 integrity and ethical values
2 board of directors 
3 management's philosophy and operating style
4 organizational structure
5 financial reporting competences
6 authority and responsibility
7 human resources
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20
Q

Audit committee

A

Subcommittee of board of directors that is generally composed
Of 3 to 6 independent member (not involved in daily operations)

All members are financially literate and one is financial expert

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21
Q

Purpose of including independent members in audit committee

A

Provide buffer between audit team and operating management

Team

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22
Q

Business risks

A

Factors, events and conditions that prevent organization
From achieving business objectives,

including effective financial reporting

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23
Q

Purpose of risk assessment for an entity?

A

Identify risks, estimate their significance and likelihood

And how to manage risks

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24
Q

Control activities

A

Specific actions a client’s management and employees take to

Ensure that management’s directives are carried out

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25
Q

Important reason why professional standards require audit team to document their understanding of internal control system?

A

Their understanding of whether management has implemented
Control activities

that are sufficient to address risks of material misstatement
For each relevant assertion

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26
Q

How audit team should account for Control activity: information technology

A

Assess whether client has taken advantage of significant
advances in information technology

By using entirely automated control systems

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27
Q

How audit team should account for Control activity: level of integration with their risk assessment process

A

Has audit client’s management addressed identified risks

To achieve financial reporting objectives?

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28
Q

How audit team should account for Control activity: selection and development of control activities

A

Control activities are selected/developed considering their cost

And potential effectiveness in mitigating identified risks

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29
Q

How audit team should account for Control activity: policies and procedures

A

Have policies related to reliable financial reporting been

Documented and communicated throughout company?

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30
Q

Preventive controls, define,

Examples

A

Procedures that prevent misstatements before they occur

Ex. Limiting access, hiring competent people, requiring approval,
Separating duties

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31
Q

Detective controls

A

Procedures that detect misstatements after they occur

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32
Q

Performance reviews require what of management?

A

Require management’s active participation in supervision of

Operations

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33
Q

What 4 duties should be separated for entities accounting staff under separation of duties?

A

1 authorization to execute transactions
2 recording transactions
3 custody of assets involved in transactions
4 periodic reconciliation of existing assets to recorded amounts

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34
Q

Incompatible responsibilities

A

Combinations of responsibilities that place a person alone in
A position to create

and conceal misstatements due to errors Or frauds in his
Normal job

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35
Q

Information system

A

Entity’s system, usually built on technological Platform

that has been designed to produce information necessary for entity
to Operate and control its business operations

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36
Q

2 fundamental principles of monitoring

A

1 ongoing and separate evaluations

2 reporting deficiencies

37
Q

Monitoring: ongoing and separate evaluations

A

Evaluations enable management to determine whether other

Components of internal control continue to function over time

38
Q

Monitoring: reporting deficiencies

A

Internal control deficiencies identified and communicated in
Timely manner to parties taking corrective action

Also reported to management and board as appropriate

39
Q

3 phases of internal control evaluation

A

1 understanding

2 assessment

3 testing

40
Q

What 5 areas must be understood to understand internal control?

A 
1 control environment
2 accounting system
3 risk assessment
4 control activities
5 monitoring
41
Q

3 ways auditors document understanding of internal control?

A

1 narrative memo
2 questionnaire
3 flow chart

42
Q

An accounts significance is based on its…

A

Inherent risk

43
Q

Relevant assertions

A

Those that represent possibility of material misstatement

44
Q

Entity level controls

A

Controls pervasive to internal control system and reliability of
Financial statements taken as a whole

45
Q

How are the following types of entity level controls assessed? 2 things:
Controls related to control environment
Controls related to management override
Centralized processing and shared service environments
Controls to monitor results of operations
Controls to monitor other controls

A

1 primary evidence to test controls gather through observation,
inquiry and examination of documents

2 auditor must assess whether managements integrity, values
And operating style promote effective control consciousness throughout entity

46
Q

Entity level control: managements risk assessment

What is audit teams assessment? 2 things

A

1 audit team needs to gain understanding of how client assesses
And responds to risk

2 if client already uses enterprise risk management, inquiry
And obtaining documentation of ERM is usually enough

47
Q

Entity level control: period end financial reporting process

How does audit team assess? 3 things

A

1 assess processes used to produce financial statements and
How IT is involved in period end process
2 document who is participating from management team and
Where process takes place
3 needs to understand and document the types of adjusting
Entries that have occurred and understand oversight by
management, board, and audit committee

48
Q

Entity level control: policies that address significant business control and risk management policies

4 aspects of assessment by audit team

A

1 review and evaluate documentation
2 review previous years audit work with entity
3 responses to inquiries by client personnel
4 examination of documents and records

49
Q

Transaction level controls

A

Controls that pertain to specific classes of transactions, account
Balances and disclosures

50
Q

The purpose of gaining an understanding of internal control is to evaluate…

A

Design effectiveness

51
Q

Design effectiveness

A

Determines whether the controls over financial reporting (if
operating effectively)

would be expected to prevent/detect Errors or fraud that result in material misstatement on financial Statements

52
Q

Walk through

A

Combination of inquiry of personnel, observation of entity’s
Operations

And document and examination while tracing transactions through
Audit trail from initiation of transaction to recording on financial st.

53
Q

Operating effectiveness

A

Whether control is operating as designed

Whether person performing the control possesses the necessary
Authority and qualifications to perform control effectively

54
Q

Internal control questionnaire

A

Organized under headings that identify questions related to
Relevant management assertions

and overall control environment

55
Q

Narrative description (of each important control subsystem)

A

Describes all environmental elements, accounting system and
All control activities

Effective for audit of small businesses

56
Q

Accounting and control system flow chart

A

Pictures that help audit team assess key control points in the
process

Can be helpful in identifying missing controls

57
Q

2 reasons why audit team might not test internal controls

A

1 internal control system is too ineffective at preventing and
detecting misstatements

2 takes more time for the audit team to test the internal Controls
than it would to perform substantive tests for relevant Assertion

58
Q

Phase 2: Assess control risk

A

Auditors seek to identify internal control activities that are
Explicitly designed to support reliable financial statement reporting

59
Q

If audit assessment is less than maximum level, what does this mean?

A

Audit team wishes to rely on internal controls to modify the
Nature, timing and extent of further audit procedures

60
Q

If audit assessment is less than maximum level, what must they do?

A

They must perform tests of controls

61
Q

Perform tests on internal controls: required level of effectiveness is a matter of what?

A

Professional judgement

62
Q

Generally the most effective test of controls is…

A

Reperformance

63
Q

4 types of control tests from least persuasive to most persuasive

A

1 inquiry of client personnel (least persuasive)
2 observation of control activity being performed
3 inspection of relevant documentation
4 reperformance of the control activity (most persuasive)

64
Q

Substantive procedures

A

Detect material misstatements in account balances and financial
Statement disclosures for each relevant assertion

65
Q

Control risk is almost always raised, what is the one exception where it can be lowered?

A

If you were in error understanding the controls phase

There are additional controls you were unaware of

66
Q

Dual-purpose tests

A

Single audit test that produces both control testing and

substantive testing

67
Q

Focus in Auditing Standard 5 (AS 5)

A

Whether material weakness exists at end of year being reported

68
Q

Scope of Internal control audit

A

Test each relevant control activity each year

69
Q

Reporting of internal control audit

A

Opinion on effectiveness of internal control

70
Q

Timing if internal control audit

A

Evaluate effectiveness of internal control as of fiscal year end

71
Q

Scope of financial statement audit

A

Test relevant control activities if relying in them

72
Q

Reporting of financial statement audit

A

No opinion in internal control

73
Q

Timing of financial statement audit

A

Evaluate effectiveness if internal control throughout fiscal year

74
Q

AS 5 emphasizes 6 step audit process designed to evaluate effectiveness of internal control system over financial reporting

A 
1 planning the engagement
2 using top down approach
3 testing controls
4 evaluating identified deficiencies
5 wrapping up
6 reporting internal control
75
Q

Control risk is used to determine…

A

The nature, timing and extent of further audit procedures

76
Q

Inherent risk is used to determine…

A

The nature, timing and extent of tests of controls

77
Q

Top down approach

A

Focuses on threats of integrity to external financial reporting

78
Q

Internal control deficiency

A

Exists when either the design or operation of control under
Consideration

doesn’t allow company management or employees To detect
Or prevent material misstatement quick enough

79
Q

Design deficiency

A

Problem relating to necessary control that is missing

Or existing control that is poorly designed, failing to satisfy
Control’s objective

80
Q

Operating deficiency

A

Occurs when properly designed control is either ignored
Or inappropriately applied

Ex. Could result from poorly trained employees

81
Q

2 groups of serious internal control deficiencies

A

1 material weakness

2 significant deficiency

82
Q

Material weakness

A

Deficiencies that give reasonable possibility that material
misstatement would not be prevented or detected on timely
Basis

Ex. Restatement of previously issued financial statements, fraud by senior management

83
Q

Significant deficiency

A

Combination of deficiencies in internal control that is less
Severe than material weakness

Important enough to merit attention by those charged with
Governance

84
Q

Managements annual report on internal control over financial reporting

A

Report required by SOX that states management responsible
For establishing and maintaining internal control over financial
Reporting
Identifies framework management uses to evaluate effectiveness
Of internal control, provides management’s assessment of
Internal control

85
Q

3 written representations audit team must obtain from managment

A

1 its responsibility for effective internal control over financial
Reporting
2 it’s evaluated effectiveness of internal control over financial
Reporting
3 it has disclosed all internal control deficiencies and frauds to
The audit team

86
Q

AS 5 imposes 2 requirements for SEC registrants related to entity’s internal control over financial reporting at date of financial statements

A

1 management’s report on its assessment of internal control
Over financial reporting

2 auditor’s report on internal control over financial reporting

87
Q

Auditors’ report on internal control over financial reporting

A

Provides opinion on effectiveness if entity’s internal control
Over financial reporting

88
Q

Adverse opinion on internal control over financial reporting

A

Opinion issued when company has material weakness

And not maintained an effective internal control over financial
Reporting

89
Q

Scope limitations

A

Audit teams could encounter scope limitations on their ability to
Evaluate effectiveness of entity’s internal control over financial
Reporting

Ex, failure to obtain written representations from managment,
Management has implemented new controls in response to
Identified martial weakness

90
Q

Scope limitation may result in…

A

The issuance of disclaimer of opinion on internal control over
Financial reporting or withdrawal from engagement

91
Q

Management letter

A

Letter contains commentary and suggestions on variety of
Matters in addition to internal control matters

Report audit teams issue to managment

Audit (36 decks)

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