Chapter 1 Flashcards
What is a compliance audit?
Audit that determines if an entity is complying with applicable laws and regulations
What is an operational audit?
Audit that evaluates a company’s effectiveness, efficiency, and economy (internal audit)
What is a financial statement audit?
Examination for the purpose of giving an objective opinion to the fairness of the financial statements in conformity with an applicable financial reporting framework (AFRF)
Who establishes the standards for non-public financial statement audits?
Accounting standards board (ASB)
Who establishes the standards for public financial statement audits?
Public company accounting oversight board (PCAOB)
What are the overall objectives and responsibilities for an audit?
T raining and Professional Judgement
I ndependence and other ethical requirements (due car)
P rofessional skepticism
I nteral controls
C orroborative audit evidence
A ccounting principles in conformity with AFRF (explicit)
N o new accounting principles applied (comparability/consistency) (implied)
O mmitted informative disclosures (implied)
E xpression of an opinion (explicitly stated)
What are two key considerations when thinking about accepting an audit?
- Determining the acceptibility of the AFRF applied
- Obtaining management’s agreement that it understands and accepts certain responsibilities ( fair presentation f/s, DIM of I/C, no scope limit)
What should an auditor pay special attention to for a first year audit?
The opening/beginning balances
What should the current auditor do if there was a predecessor auditor on the last financial statements?
Auditor should request mgmt authorization for the predecessor to
- Allow the successor to review the predecessor’s documentation
- Respond fully to inquires by the successor
What are the things the current auditor should talk about with the predecessor auditor?
R easons for change
I ntegrity of management
D isagreements during the audit
C ommunication with mgmt or those charged with governance
What is the requirement for the audit committee?
All members must be independent
What does the audit committee do?
Serve as board of directors not interested in day-to-day operations (independent)
Hire and fire outside auditors
Receive reports and communications
Oversee internal audit for company
What is the audit committee required to sign for the auditor to start an engagement?
An engagement letter or comparable document
What are the matters that should be communicated to the audit committee and governance?
D isagreements with mgmt I llegal acts and other non compliance S ignificant accounting policies A djustments P rior discussions with mgmt before acceptance P roblems or significant difficulties R esponsibilities O ther information V iews of the acccountant E stimates
For a PCAOB audit, when should the auditor submit communcation with those charged with governance?
Prior to the issuance of the auditor’s report
Is an engagement letter required?
An engagement letter isn’t specifically required but recommended. Any written agreement is required.
What are the elements of an engagement letter?
F ees
A uditor’s responsibility (GAAS, reasonable assurance)
C onfirmation of engagement
S cope & Objective of engagement (Auditing F/S and objective is opinion on F/S)
I nternal Control (communicate sig definciencies and material weaknesses)
M gmt responsibility (Prep and fair presentation, DIM of I/C, access to info, mgmt rep letter)
I rregularities - Fraud
i L legal acts - Non-compliance with laws and regs
E rrors
What is audit risk?
Risk that the auditor will fail to appropriately modify the opinion on F/S that are materially mistated.
What are the two components of audit risk?
Risk of material misstatement (inherent risk and control risk)
Detection risk
What is risk of material misstatement?
Risk that the relevant assertations related to balances, class of transactions, or disclosures are material misstatements.
What is inherent risk?
Risk that a material misstatement will occur in the absence of internal controls
Risk associated with how inherently complex or difficult financial statement category is
What is detection risk?
Risk auditor won’t detect a material misstatement
Determines how much substantial testing you are going to do
What is an audit plan/program?
Step by step list of audit procedures that is REQUIRED for each GAAS audit.
What are the key considerations when developing an audit program?
Materiality, risk of material misstatement (RMM), business and industry considerations
What materiality amount do you use is it is different for various financial statements?
Use the smallest aggregate dollar amount (aka the smallest total)
Ex: If balance sheet has materiality of 10 but income statement has materiality of 3, use materiality of 3 for EVERYTHING
What is the relationship between audit risk, materiality, and scope of materiality?
If audit risk is high, materiality level is low, which makes scope of materiality high.’
If audit risk is low, materiality level is high, which makes scope of materiality low.
What is performance materiality?
The idea that a misstatement itself is not material but when considered in relation to the financial statements as a whole may reach materiality when combined with other misstatements.
What are the steps in planning an audit?
B asic dicussions with the client R eview of audit documentation A sk about recent developments I nterim F/S (Analytical procedures mandatory) N onaudit personnel S taffing T iming O utside assistance P ronouncements S cheduling with the client
What are the various equations for audit risk?
AR = IR x CR x DR
AR = RMM x DR
DR = AR/RMM
What is the relationship between reliance, risk of material misstatement, detection risk, and substantive testing?
If reliance is low, then your RMM is high, which means your DR is low and you need to do more substantive testing
If reliance is high, then you RMM is low, which means DR is high and you need to do less substantive testing
What is the relationship between audit risk and materiality?
There is an inverse relationship between them
As audit risk increases, materiality level decreases and vice versa
What is an error?
Unintentional mistake or omission that results in a misstatement
What is fraud?
Intentional mistake or omission using deception that results in misstatement
What are the two types of fraud?
Fraudulent financial reporting (cooking the books)
Misappropriation of assets
What are the two types of misstatements that result from errors or fraud?
Known misstatements - Specifically identified
Likely misstatements - Likely to exist based on evidence
What misstatements must the auditor communicate to management?
All known and likely misstatements (even if immaterial)
Ignore trivial misstatements
Is the auditor required to alert management of fraud?
Yes. Must commicate all knowledge or suspicion of fraud and must document.
What are the three conditions of a fraud? (Fraud triangle)
Reason or motivation (incentive/pressure)
Opportunity
Rationalization
What is noncompliance?
Acts of omission or commission (intentional or unintentional) against laws or regulations
What is the auditor’s responsibility when it comes to noncompliance?
Auditor must considered laws that have a direct effect (affects F/S) or indirect effect on the financial statements
Must communicate noncompliance to those charged with governance
What is one of the most commons ways financial statements are fraudulently misstated?
Overstatement of revenue
How should fraud involving management or senior management be reported?
Report to management at least ONE LEVEL above
What are the 6 elements of quality control?
H uman resources (personnel management)
E thical requirements (independence)
A cceptance and continuance of client relationships and specific engagements
L eadership responsibilities (“tone at the top”)
M onitoring
E ngagement performance
What are peer review programs?
When the PCAOB or another firm reviews and critiques a firm’s policies and procedures
