Ch 6 - planning the audit Flashcards
planning stages
The risk that the auditors unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated
Audit Risk
The overall risk to the CPA firm of association with a particular audit client; risk that a particular client will damage the firm’s reputation and/or result in litigation
Engagement risk
T/F: If Audit Risk is higher, Engagement Risk will almost certainly be lower.
False; the engagement risk will be higher too
Can different things affect engagement risk but while not affecting audit risk?
Yes!
1. socially unacceptable industries (i.e. porn)
2. lots of litigation
3. breaking laws (i.e. illegal marketing)
T/F: When accepting a new (or recurring) client the auditor will evaluate and manage both Audit Risk and Engagement Risk.
True
T/F: The smaller the audit firm, the higher their tolerance for Audit Risk and Engagement Risk.
True; small firms don’t care as much because they don’t have a treasured reputation and want all of the business they can get
As a new auditor it’s crucial to speak with the prior auditor, but before doing so, we must…
- get permission from the client
- initiate communication
It’s important to speak with the prior auditor ______ (before/after) officially accepting the client.
Before
The overall attitude of the management team towards the auditor and financial reporting.
Tone at the top
Drafted by the auditor every year. Signed by the auditor and client and becomes a legally enforceable contract. Covers auditor/client responsibilities, fees, dates, outside parties, prior auditor, and approval from audit committee.
Engagement letter
T/F: Relevant information about the client can come from almost anywhere.
True
T/F: The auditor is not required to have an extremely intimate understanding of the client’s business/strategy.
False; they are required to understand the client’s business (knowing the business is critical to forming an opinion on the financial statements)
A high-level strategy document that outlines the PLANNED audit procedures. Prepared by audit firm and can change
Audit plan (never a fixed plan)
The audit plan should include…
- The planned nature, timing, and extent of the risk assessment procedures
- The planned nature, timing, and extent of tests of controls and substantive procedures
- Other planned audit procedures required to be performed so that the engagement complies with PCAOB standards
A detailed set of tests/tasks/steps that describe how to test a particular account/line of the financial statements.
(Preparer initials every step completed)
**think what Scott kept fucking up
Audit program
‘a substantial likelihood that the …fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.’
Materiality (PCAOB definition)
Magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances makes it probable that the judgment of a reasonable person relying on the information could have been changed or influenced by the omission or misstatement
Materiality (AICPA definition)
T/F: Auditors are equally concerned about individual and aggregate material misstatements.
True; one large misstatement (individual) is equally as bad as many small misstatements (aggregate)
A quantitative number used to determine the nature, timing and extent of audit procedures.
Overall Materiality
Misstatements anywhere in the financials are material if they…
equal or exceed Overall Materiality
Calculating overall materiality steps:
- pick a line item that’s stable (doesn’t change much year to year) - typically income, assets, revenues and equity
- apply average % for chosen line item
- multiply to get your overall materiality
T/F: Tolerable misstatement should be less than the materiality level for the financial statements as a whole
True; don’t want tolerable misstatements for specific accounts to be greater than the overall materiality
T/F: When misstatements are found in a specific account, they are compared to the Overall Materiality.
False; they are compared to the Tolerable Misstatement for that account, not the overall materiality
Tolerable Misstatement calculation:
TOLERABLE MISSTATEMENT = OVERALL MATERIALITY * given %
**higher % for lower amounts, lower % for higher amounts
T/F: Riskier clients/accounts will tend to get higher Tolerable Misstatements.
False; riskier clients will get LOWER TM
T/F: Materiality is inversely related to audit effort.
True;
lower TM –> higher effort
higher TM –> lower effort
T/F: We can adjust the Tolerable Misstatement to be lower for accounts that are difficult/expensive for us audit.
False; TM lower for accounts that are easier/cheaper to audit
(i.e. cash)
** receivables harder/expensive to audit
The materiality set in the early/planning stages of the audit that helps determine sample sizes and audit scope; quantitative in nature
Planning materiality
Used for determining the audit opinion at the end of the audit. The auditor aggregates misstatements to determine whether there is a material misstatement of the financial statements; quantitative and qualitative in nature
Evaluation materiality
T/F: We do not audit all the areas of the financial statements equally.
True; We focus on the riskiest areas, most likely to product material misstatements.
2 types of fraud:
- Misappropriation (stealing/theft)
- Financial reporting fraud (lying/producing false statements to mislead their users/readers)
T/F: Misappropriation and Financial Reporting Fraud have to go together.
False; they don’t have to, but commonly do go together
If material fraud or fraud involving senior management is discovered, the auditor should…
Auditor should go to the Board of Directors, or Audit Committee, or SEC (in some cases)
