Chapter 3 Flashcards
In an audit, what stage are analytical procedures performed ?
In the planning stage
What do analytical procedures focus on?
Unusual transactions and events that might be significant to financial statements and/or represent risks.
An auditor’s primary objective for performing procedures is to obtain….
Knowledge neccessary for risk assessment and audit planning
A planning stage of an audit includes what type of procedures?
Ex: Comparison of the financial statements with budgeted or anticipated results, unaudited information from internal quarterly reports
The application of analytical procedures
As part of an issuer’s audit, for their risk assessment procedures, PCAOB recommends the auditor to develop an understanding of the client’s…..over financial reporting
Internal control
A stage in the business cycle when economic activity is at its lowest point with no positive indicators for the future is a
Firms often try to reduce the size of their workforce and reduce other costs.
Trough
In what stage of the business cyle would this most likely be?
Scenario: Capacity constraints and labor shortages are likely to put upward pressure on the overall price level
Peak
What occurs in a contractionary phase?
This phase follows a peak and firm profits will generally be decreasing
A decrease in economic activity
What occurs in a expansionary phase?
Firm profits will generally be increasing, because the demand for goods and services is increasing. Examples include: GDP increases, firms’ profits rise, and the demand for goods and services increases
Rising economic activity and growth
Name the normal sequence of a business cycle.
- Expansion
- Peak
- Contraction
- Trough
Difference between a lagging economic indicator and a leading economic indicator
Lagging economic indicators tend to follow economic activity, or occur as result of economic activity (i.e. “after the fact”)
Leading economic indicators tend to occur before the fact or predict economic activity
What is the economic indicator?
- The average length of the workweek
- money supply
- prices of selected stocks
- orders for goods
- price changes of materials
- index of consumer expectations
- building permits
Leading
What is the indicator?
- Inventories-to-sales ratios
- prime rate charged by banks
- bank loans outstanding
- consumer debt-to-income ratio
- The length of time, on average, that job seekers are unemployed
“after the fact”
Lagging
What is the indicator?
- number of employees on nonagricultural
- payrolls
- production
- sales
Coincident
The indicator that changes approximately the same time as the whole economy is what?
Coincident economic indicator
Difference between a preventative control and a detective control
Preventitve controls are performed before to provide reasonable assurance that only valid transactions are recognized, approved, and submitted for processing.
Detective controls are performed after to provide reasonable assurance that errors or irregularities are discovered and corrected on a timely basis.
Define an inherent limitation
Think management override
A limitation that prevents seemingly good controls from working
True or false?
Preforming preliminary test of controls over selected transaction cycles is not a recommended risk assessment procedure by PCAOB Standards
True; preforming test of controls is done after the auditors completes his/hers risk assessment
When would you use manual controls?
For large, unusual, or nonrecurring transactions
What is the phrase?
…of audit evidence refers to its quality such as accuracy, completeness, authenticity, and susceptibility to management bias
Reliability
…of audit evidence refers to the amount of corroborative evidence obtained
Sufficiency
True or false?
In obtaining an understanding of a manufacturing entity’s controls concerning inventory balances, an auditor most likely would review the entity’s descriptions of inventory controls
True
An overall response to address a high-assessed risk of material misstatement at the financial statement level of a nonissuer may include:
Providing more supervision of the audit team
These factors relate to which risk? Control or Inherent Risk?
Complexity, subjectivity, change, uncertainty, management bias or fraud risk, significance, and volume or lack of uniformity
Inherent Risk
What type of account would yield the highest level of evidence?
* Accounts receivable
* Travel and entertainment expense
* Interest expense
* Accounts payable
E.g. Relationships involving transactions
Interest Expense; because they represent transactions over a period of time rather than at one point in time.
What does an auditor’s inspection involve?
Examining records or documents (inspection and examination are often used interchangeably)
Analytical procedures tend to focus on…
Relationships between financial data that are more predictable
An auditor typically develops an expectation and compares it to what is actually recorded
True or False
Balance sheet transactions are typically less predictable and require analytical procedures to test transactions.
False; balance sheet accounts are more predictable since they represent an amount at a point in time
The auditor should trace the…to the….to detect overstatements of sales
Accounting records to the source documents
True or False
In the final review stage of an audit, considering the adequacy of the evidence gathered in response to unexpected balances identified in planning.
True
What is the assertion?
The auditor starts with source documents and then traces transaction information to client’s journal entries.
Completeness
Describe the completeness assertion
Reconciliation processes to identify missing transactions
The completeness assertion relates to the recording of all transactions
Describe the accuracy assertion
Automated checks can detect and correct data entry errors
The accuracy assertion relates to controls recorded correctly
Materially misstatements refer to…testing
Substantive Testing
Materially deviation refer
Test of Controls
What is the next action taken by an auditor that discovers lawsuits filed against a client?
Have the client assess the degree of profitability of an unfavorable outcome for the company
Audit Procedures regarding authorization, valididty, completenesss, accuracy, appropriate classification, accounting in conformity with GAAP, and proper period, are substantive testing or test of controls?
Test of Controls
Audit procedures regarding dollar amounts such as account balances or amounts, valuation, presentation, and disclosures are test of controls or substantive testing?
Substantive Testing
Confirmations involve….
Obtaining representation from external third parties regarding account balances or transations
Inquiry involves…
Questioning
Observation involves…
Observing or watching procedures
Recalculation consist of….
Checking the mathematical accuracy of documents or records either manually or electronically
Reperformance involves…
The independent execution of procedures that were originally performed as part of the entity’s internal control
Analytical procedures involve…
The comparison of an account balance from period to period looking for unusual variances
Define tolerable deviation rate
Tolerable deviation has an inverse relationship with sample size
The maximum rate of deviation from a prescribed procedure the auditor will tolerate without modifying planned reliance on control
Define deviation rate
Expected deviation rate has a direct relationship with sample size
The auditor’s best estimate in the population from which the sample was selected
Sampling
Deviation Rate < Tolerable Rate
means:
Assess control risk low/medium and controls are operating effectively
Population
Deviation Rate > Tolerable Rate
means:
Assess control risk high and controls are not operating effectively
If the upper deviation rate is less than or equal to the tolerable deviation rate, the auditor may rely or not rely on the control?
Rely
If the upper deviation rate exceeds the auditor’s tolerable deviation rate, the auditor may rely or not rely on the control?
Not rely
Difference between incorrect acceptance versus incorrect rejection
Incorrect acceptance (wrongly accepted) supports the conclusion that the account balance is not materially misstated (due to sample size not being representative of population)
Incorrect rejection (wrongly rejected) supports the conclusion that the account balance mistakenly indicates a material misstatement
Sampling risks and deviations refer to…
Either risk of assessing control risk too low or risk of assessing control risk too high
Sampling risks and misstatements refer to…
Risk of incorrect acceptance or risk of incorrect rejection
What does it mean to reduce planned reliance on controls?
To reassess control risk as high
Both the risk of incorrect acceptance and the risk of assessing control risk too low relates to:
The effectiveness of an audit
The risk of incorrect rejection and the risk of assessing control risk too high relates to:
The efficiency of an audit
True or false?
The stratified mean per unit (MPU) sampling is a statistical technique that may be more efficient than unstratified MPU because it usually produces an estimate having a desired level of percision with a smaller sample size
True
True or False?
A low level of tolerable misstatement necessitates a larger sample size.
Tolerable deviation has an inverse relationship with sample size
True
True or false
The risk of assessing control risk too low has an inverse relationship with sample size
True
Formula
Upper Deviation Rate
Sample deviation rate + Allowance for sampling risk = Upper deviation rate
Formula
Mean-per-unit Estimation
Average audited value x number of items in population
Average Audited Value is the Audit Value / # of items in sample
Formula
Ratio Estimation
(Audited book value / book value of sample) x total book value
Formula
Difference Estimation
2 steps
- Calculate projected error
* [(Book value of sample -audited value of sample) / # of items in sample] x population items - Calculate point estimate
* Total book value of population - projected error
Formula
Sampling Interval
Tolerable misstatement / Reliability factor
Formula
Sampling Size
Recorded amount of population / Sampling Interval
Documentation may include:
FIND
- Flowchart (for complex control structures)
- Internal Control Questionnaire or Checklists (yes or no questions)
- Narrative (for less complex control structures)
- Documentation from the client, including copies of the entity’s procedures manuals and organizational charts
What do dual-purpose tests test?
Dual-purpose tests test of controls and test of details
True or false
Under substantive procedures, test of details provides less assurance.
False, test of details provides more assurance
True or false
Under substantive procedures, substantive analytical procedures provides less assurance.
True
True or false
It is the auditor’s responsibility for preventing noncompliance
False, the auditor is not responsible for noncompliance, the auditor is responsible for obtaining reasonable assurance that the financial statements are free of material misstatement due to noncompliance with laws and regulations.
Define cleary inconsequential
Less than material
Fill in the blank
The higher the risk of material misstatement the more…
Persuasive evidence is needed
Define an auditor’s point estimate
An amount, or range of amounts, developed by the auditor in evaluating management’s point estimate
Fill in the blank
The client’s recorded estimate - best estimate supported by the audit evidence is equal to the…
Misstatement
Fill in the blank
The client’s recorded estimate - the closest estimate in range to recorded amount is equal to the…
Range of reasonable estimate
What do you if a loss is probable?
- If you can estimate the loss, accrue and disclose
- If you cannot estimate the loss, disclose
What do you if a loss is reasonably possible?
- If you can estimate the loss, disclose
- If you cannot estimate the loss, disclose
What do you do if a loss is remote?
Generally ignore unless it is a DOG Guarantee
D - Debt of others guaranteed
O - Obligations of commercial banks
G - Guarantees of repurchase A/R sp;d
If an auditor has substantial doubt about the entity’s ability to continue as a going concern, when should an auditor report this for FASB and GASB?
FASB - 1 year after the date of the financial statements are issued (or available to be issued as applicable); this is true for special purpose frameworks
GASB - 1 year beyond the date of the financial statements
What are factors that may indicate substantial doubt?
FINE
- Financial difficulties
- Internal Matters
- Negative trends
- External matters
Difference between corroborating evidence versus contradictory evidence
Corrobating evidence is proof that evidence is correct (e.g. meeting minutes, confirmations, etc.)
Contradictory evidence is proof that evidence is incorrect
What are the 5 biases that impact auditors?
- Availability bias
- Confirmation bias
- Overconfidence bias
- Anchoring bias
- Automation bias
What are the standard audit procedures used in audits as risk assessment procedures, test of controls, or substantive test?
C the FIVE CARROT WARS
- Confirmation
- Footing, Cross-footing, and recalculation
- Inquiry
- Vouching
- Examination/Inspection
- Cutoff review
- Analytical procedures
- Reperfomance
- Reconcilation
- Observation
- Tracing
- Walk-through
- Auditing related accounts simultaneously
- Representation letter
- Subsequent events review
True or false
Analytical procedures are required in the planning and final review stage of an audit.
True
True or false
Substantive procedures are required as an analytical procedure of an audit.
False
What are the methods that provide a level assurance (from least to greatest) that an auditor uses to develop their expectation?
- Trend analysis
- Ratio analysis
- Nonstatistical predictive modeling*
- Regression analysis*
*Auditors typically use these method because it provides the highest level of assurance
Fill in the blank
Directional testing for existence is when you go from…
Vouching is often used for existence
The record to the source
(i.e. you start from big to small)
Directional testing for completeness is when you go from…
Tracing is often used for completeness
The source to the record
(i.e. you start from small to big)
Vouching is used to test overstatements or understatments?
Overstatements
Tracing is used to test overstatements or understatements?
Understatements
The most relevant assertions for account balances (asset, liability, and equity balances) and disclosures are:
CVERUP
- Completeness
- Valuation, Allocation, and Accuracy
- Existence
- Rights and Obligations
- Understandability of Presentation and Classification
*The auditor focuses on testing the existence assertion rather than the completeness assertion because assets for example are more likely to be overstated (existence) than understated (completeness). The auditor focuses on testing the completeness assertion for liability balances, because liabilitities are more likely to be understated than overstated
The most relevant assertions for transactions, events, and disclosures are:
COVEUP
- Completeness
- Occurence*
- Valuation, Allocation, and Accuracy
- Existence*
- Understandability of Presentation and Classification
*The auditor typically focuses on testing the existence and occurrence rather than the completeness assertion because revenues for example are more likely to be overstated (existence) than understated (completeness). The auditor focuses on testing the completeness assertion for expense transactions, because expenses for example are more likely to be understated than overstated
List the auditing procedures for the completeness assertion:
- Tracing
- Analytical review
- Observation
List the auditing procedur for the cutoff assertion:
- Cutoff procedures
List the auditing procedures for the valuation, allocation, and accuracy assertion:
- Inspection
- Footing
- Independent recalculation
- Reconciliation
List the auditing procedures for the existence and occurence assertion:
- Confirmation
- Observation, inspection, and examination
- Vouching
List the auditing procedures for the rights and obligation assertion:
- Inspection
- Confirmation
List the auditing procedures for the understandability of presentation and classification assertion:
- Inspection
- Review
- Inquiry of management
Audit sampling methods can be either statistical or nonstatistical. Both approaches are allowed by GAAS, but requires the use of professional judgement. What is the difference between both sampling methods?
Statistical include quantative samples
Nonstatistical include samples based on the auditor’s professional judgement (i.e. not determined mathematically)
What is management’s assertion?
An auditor’s purpose in reviewing credit rating of customers with delinquent accounts receivable
Valuation and allocation
If the assessed level of control risk is high, an auditor would probably…
Scenario: A client maintains perpetual inventory records in both quantities and dollars
Request the client to schedule the physical inventory count at the end of the year.
True or false
Interim testing is permitted when the risk of material misstatement is low.
Scenario: Well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts
True
True or false
Review of vendor list for fictious vendors in the system would not be effective for detecting misstatements of inventory item pricing schedules.
True
What is the assertion?
Performing cutoff procedures for shipping and receiving
Completeness
What are the four categories of information included in the management’s representation letter?
- Financial statements
- Completeness
- Recognition
- Measurement, and disclosure; and subsequent events.
True or false
All material weaknesses are signifcant deficiencies
True
True or false
All significant deficiencies are material weaknesses
False
