Chapter 1 Flashcards
Principals
Shareholders or owners. They want the managers information.
Agents
Managers. They have the information.
Information Asymetry
Agents have the information, and the principals want it!
Conflict of Interest
Arises due to information asymmetry.
Assertions
Management makes assertions about transactions, account balances, and financial statement disclosure and presentation.
We as auditors, want to test if management’s assertions are reasonable!
Audit
Most rigorous service. Has audit standards. Looking at historical documents.
Attest
More forward looking. Projections or forecasts.
Assurance
Least rigorous service. Sometimes not even talking about accounting necessarily or financial information/statements. Independent professional services that improve the quality of information, or its context, for decision makers.
Levels of Rigor
Audit is the most rigorous. Assurance is the least rigorous.
Three Fundamental Concepts of F/S Audit
Materiality, Audit Risk, and Evidence.
Materiality
That amount that if someone knew about it, they would do something differently!
Always a question of professional judgment!
Qualitative vs Quantitative
Sometimes can be quantitative immaterial, but qualitative materially.
Ex: A $2 adjusting entry to not violate the debt covenant!
Audit Risk
The risk that you might issue a ‘clean opinion’ but there is a material misstatement in the financial statements (or you’ll give the wrong opinion).
Evidence (more than ‘per discussion with client’)
Have to prove what the client is saying is truthful.
All the underlying work conducted in the audit.
Make sure evidence is sufficient and appropriate!
Sampling
Testing certain items (can not test everything), then extrapolate certain results.
Extrapolation
Apply to the rest of the population, that you didn’t test initially, after you have the information for the sample!
Make sure the sample is reflective of the whole population!
Inverse relationship: sample size and materiality
The smaller level of materiality, the bigger the sample size we need! (need more testing)
Direct relationship: sample size and level of assurance
The more assurance desired, the larger the sample size needed.
Major Phases of the Audit (Figure 1-4)
Acceptance/Continuance, Prelim Engagement Activities, Plan Audit, Consider Internal Control (I/C), Audit Business Processes and Related Accounts, Complete/Finish the Audit, and Evaluate results and Issue Audit Opinion.
Client Acceptance/Continuance (Chapter 3)
Needs to be done every year, for every client.
We want to see if our client has integrity.
Do we want to be associated with this client?
Preliminary Engagement Activities (Chapter 3)
Determine the engagement team.
Look at “independence”.
Issue our letter of arrangement, our contract with the client.
Plan the Audit (Chapters 3,4, and 5)
How we actually do the audit.
Consider Internal Control (I/C)- test or no test (Chapter 6 and 7)
Must test key controls if its a public company audit (PCAOB).
Non-public company audit, should consider testing controls.
Not necessarily have to test them.
Why not test I/C?
May not be efficient.
May know already that they do not work.
May not relate to the assertions.
Audit Business processes and related accounts (Chapter 10-16)
Doing the audit.
Control (testing procedures).
Substantive Tests (testing $ dollars).
Complete/Finish the Audit (Chapter 17)
Get letter of representation from management (assertions).
Look at litigations probable in the future.
Evaluate Results and Issue Audit Opinion (Chapter 1 and 18)
A matter of professional auditor judgment!
Qualified, Unqualified, or Adverse.
Auditor’s Role
We add credibility to what management has said.
Reduce information risk.
Make sure information is reliable, credible, and relevant.
