Chapter 3

Question 1

What are the 5 methods for collecting audit evidence?

FYI: AEIOR

Answer 1

1. Analytical procedures
2. Enquiry and external confirmation
3. Inspection
4. Observation
5. Recalculation/Reperformance

Question 2

What 3 activities do analytical procedures comprise?

Answer 2

1. Comparison
2. Calculations and supporting explanations
3. Credibility checks and supporting proof

Question 3

What are tests of control in auditing?

Answer 3

Tests to obtain evidence about the effectiveness of a company’s operations and control systems.

Question 4

What is substantive testing?

Answer 4

Test of detail - checking actual numbers, balances, and transactions to ensure there is no misstatement

Question 5

How does the extent of substantive testing depend on the assurance of tests of control?

Answer 5

No assurance on controls leads to high substantive testing

Question 6

What is the focus of internal control tests?

Answer 6

Prevention – ensuring controls reduce the risk of errors

Question 7

What does substantive testing focus on?

Answer 7

Detection – finding actual errors or fraud in the accounts

Question 8

When are substantive analytical procedures most useful?

Answer 8

For large-scale audits where checking every single transaction is impractical

Question 9

What is meant by ‘sufficient appropriate audit evidence’?

Answer 9

Sufficient
- ‘Enough of’ based on the auditor’s professional judgement Appropriate
- Relevance and reliability

Question 10

What is 3 things are considered reliable evidence in auditing?

Answer 10

1. Obtained from independent sources outside the entity
2. Obtained directly by the auditor
3. Related controls are strong

Question 11

What are assertions in auditing and what 3 components must be proven for them to be assertive?

Answer 11

Assertions:
- Characteristics that all items within financial statements belong there

Components that must be proven:
1. Existence
2. Ownership
3. Correct valuation

Question 12

What are the 7 categories of assertions?

FYI:
ONLY ESSEX
COOL
AUDIT
CHEEKY
CHICKS
PARTY
REGULARLY

Answer 12

1. Occurred/Exists
   - Relate to the entity
2. Completeness
   - Recorded and included in the financial statements
3. Accuracy, valuation, and allocation
   - Recorded appropriately and related disclosures have been measured and described
4. Cut-off
   - Correct accounting period
5. Classification
   - Recorded in proper accounts
6. Presentation
   - Aggregated or disaggregated and clearly described, overall understandable
7. Rights and obligations
   - Entity holds or controls the rights

Question 13

What determines the direction of testing in an audit?

Answer 13

Whether the auditor is checking for overstatement or understatement of financial figures.

Question 14

What are the two sections of automated tools and techniques in auditing?

• Who owns each one?

Answer 14

1. Audit software
   - Auditors System
2. Client Owned systems
   - Clients System

Question 15

What 4 things are Client Own systems useful for?

FYI: TESI

Answer 15

1. Test data
   - Dummy data to check it works
2. Embedded test facilities
   - Small program or test data is built inside a company’s system
3. Systems control and review file
   - Report of how the system is working
4. Integrated test facilities
   - Virtual copy of the system used for testing

Question 16

What is audit sampling?

Answer 16

Checking only a small part of a company’s records to draw an overall conclusion.

Question 17

What is statistical sampling?

Answer 17

Random selection of sample items using probability theory.

Question 18

What are sampling units?

Answer 18

The individual items that constitute a ‘population’ with equal chances of being selected.

Question 19

What is non-statistical sampling?

Answer 19

Using judgement to select a sample instead of a statistical technique.

Question 20

What is stratification in sampling?

Answer 20

Dividing a population into smaller subpopulations to create groups of sampling units, usually by value

Question 21

How can a sample be selected?

• FYI:
  HIGH
  SCHOOL
  MUSICAL’s
  REALLY
  BAD

Answer 21

1. Haphazard selection
   - Auditors pick samples randomly but without using a formal method
2. Systematic selection
   - E.g. every 5th item
3. Money unit sampling (MUS)
   - Value-weighted selection
   - Every nth $ is selected
4. Random selection
5. Block selection
   - Block of continuous items e.g. a particular month, week, person etc.

Question 22

What is the confidence level in sampling determined by?

Answer 22

Determined by an auditor’s assessment of tolerable misstatement

Question 23

What is tolerable misstatement?

Answer 23

The largest error an auditor can accept in a financial statement without it being a big problem

Question 24

What should detection risk be to increase the size of the sample?

Answer 24

Detection risk needs to be low

Question 25

Advantages and disadvantages of different sampling methods FYI: HIGH SCHOOL'S x2 JUST REALLY BAD

Answer 25

Haphazard + Good for targeting your sample - Generate potential bias as its auditors choice Stratified + Allows a broad range of items to be tested within the sample - Larger more complex which can take longer Systematic + Treats every items the same way, eliminating bias - Still requires some judgement to determine start position and starting interval may not be fully representative Judgemental + Good for targeting your sample - Generate potential bias as its auditors choice (can create non-representative samples) Random + Eliminates bias - Requires IT expertise Block + Useful if interrogating a defined group of data - Ignores characteristics of data outside the block

Question 26

Factors and their impact on sample size for test controls: 1️⃣Auditor’s reliance on controls 2️⃣ Increase in the tolerable rate of deviation 3️⃣ Increase in the expected rate of deviation 4️⃣ Increase in the auditor’s belief that the actual deviation rate is lower than the tolerable rate 5️⃣ Increase in the number of sampling unit Options: Increase, Decrease or Negligible

Answer 26

1️⃣Increases – More reliance requires a larger sample to confirm controls are effective. 2️⃣ Decreases – A higher tolerance for deviations means less testing is needed. 3️⃣ Increases – Expecting more issues means a larger sample is required. 4️⃣ Increases – More assurance is needed to confirm deviations remain within limits. 5️⃣ Negligible Effect – The total population size alone does not significantly impact sample size.

Question 27

Factors and their impact on sample size for substantive testing: 1️⃣ Increase in auditor’s assessment of material misstatement 2️⃣ Increase in the use of other procedures at the same assertion 3️⃣ Increase in the auditor’s belief that actual deviation will be lower than the tolerable rate 4️⃣ Increase in tolerable misstatement 5️⃣ Increase in expected misstatement 6️⃣ Stratification of the population 7️⃣ Number of sampling units in the population Options: Increase, Decrease or Negligible

Answer 27

1️⃣ Increases – Higher inherent and control risks require a lower detection risk, leading to more testing. 2️⃣ Decreases – The auditor obtains assurance from other procedures, reducing the need for a large sample. 3️⃣ Increases – More assurance is needed, so a larger sample is selected. 4️⃣ Decreases – A higher tolerable misstatement means errors are more acceptable, reducing the sample size. 5️⃣ Increases – More expected misstatements require more testing to detect them. 6️⃣ Decreases – Stratification allows the auditor to focus on key subpopulations, reducing the sample size needed. 7️⃣ Negligible Effect – The total number of sampling units alone does not significantly impact sample size.