Chapter 10 - Develop Risk Response: Audit Strategy and Audit Program Flashcards
When developing the overall audit strategy, the auditor should… (5)
- Identify the characteristics of the engagement that define its scope. (i.e., multi-national organization? does the client have internal auditors?)
- Determine the reporting requirements (i.e., private or public? specific industry reporting requirements?)
- Consider the factors that are significant in directing the audit team’s efforts (i.e., staffing of the engagement, who will review?)
- Consider the results of preliminary engagement activities. (i.e., previous materiality assessments, etc.)
- Determine the nature, timing, and extent of resources necessary to perform the engagement. (i.e., do we need to bring in specialists? what experience does the team need?)
What are the 5 types of tests auditors use to determine whether financial statements are fairly stated?
- Risk assessment procedures
- Tests of controls
- Substantive tests of transactions
- Substantive tests of balances
- Substantive analytical procedures
What are risk assessment procedures? Give some examples.
Risk assessment procedures are used to assess the likelihood of material misstatement (inherent risk times control risk) in the financial statements, and gain an understanding of the controls in place.
Examples: management inquiry, observation of processes, walk-throughs, preliminary analytical procedures
What are tests of controls? Give some examples.
Tests of Controls—are audit procedures designed to verify whether the client’s controls match the auditor’s understanding of those controls.
These tests are designed to obtain evidence regarding the effectiveness of controls—if controls can be relied upon, then substantive evidence may be reduced.
Examples: Inquiry, inspection of documents and records, observation of control-related activities, reperformance of client procedures.
What are substantive analytical procedures?
Substantive analytical procedures involve comparisons of recorded amounts $$ to expectations developed by the auditor.
What are substantive tests of balances and substantive tests of transactions (a.k.a. substantive tests of details). Give examples of both.
Substantive procedures that are performed in order to detect material misstatements at the assertion level for balances and transactions.
Test of balances examples: Accounts receivable confirmation, bank confirmation, supplier confirmation, inventory count
Test of transactions examples: select a sample of purchase transactions and do a 3-way match (purchase order, receiving document, invoice) – make sure all of these documents match.
NOTE: We are looking for actual dollar values $$$ of misstatements
What are dual-purpose tests?
Auditors can perform tests of controls separately from all other tests, but it’s more efficient to do them at the same time as substantive tests of transactions.
These are called dual-purpose tests—they provide evidence of whether or not the controls being tested were operating effectively during the period and whether there are misstatements in the data produced by the accounting system.
**TEST OF CONTROLS AND SUBSTANTIVE TEST OF TRANSACTIONS AT THE SAME TIME
What is the difference between the conclusions that can be made from a test of controls and a substantive test?
An exception in a test of control only indicates the LIKELIHOOD of misstatements affecting the dollar value of the financial statements, whereas an exception in a substantive test of transactions or a test of details of balances is a financial statement misstatement.
Test of control – testing a PROCESS and not actual dollar amounts. Therefore, a misstatement COULD exist, but does not tell us whether a misstatement exists for sure or what the $$ amount of the misstatement is
What is the relationship between analytical procedures and substantive tests?
Analytical procedures only indicate the LIKELIHOOD of misstatements affecting the dollar value of the financial statements.
When analytical procedures identify unusual fluctuations, auditors should perform substantive tests of transactions or tests of details of balances to determine whether dollar misstatements have actually occurred.
What are the 2 different audit approaches?
- Combined audit approach
2. Substantive audit approach
What is a substantive audit approach and when would we use it?
If control risk is assessed as high (controls are not effective), the auditor would follow a substantive approach. We would not test controls at all, and rely on substantive analytical procedures, substantive tests of balances and substantive tests of transactions only.
What is a combined audit approach and when would we use it?
If control risk is assessed lower (controls are effective), the auditor could follow a combined approach. This involves testing controls AND doing other substantive testing.
If the control testing reveals that the controls are not functioning, or it is very costly to test internal controls, the auditor may still end up with a substantive approach.
Explain the concept of roll forward (or roll back)
Roll forward—substantive work on journal entries and transactions from a date prior to the balance sheet date to the year-end. This is often done when clients want to issue statements soon after the balance sheet date so that work can be done during the interim period.
Example: December 31 year end, rather than counting inventory at year-end, they count it on December 16. Auditors will attend inventory count, do their own counts (as usual). This gives the auditor comfort over the inventory balance at December 16. However the audit opinion is for the balance at December 31. Client prepares a schedule showing all items shipped out an shipped in between those dates. Test the transactions between these dates to make sure we are happy with it.
