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Audit > Chapter 3 > Flashcards

Chapter 3 Flashcards

1
Q

Analyze and document review of new client

A
  1. Review financial information (annual reports, interim financial statements, income tax returns, etc.
  2. Inquire of third parties about integrity of the prospective clients and its management.
  3. Consider special circumstances that will require special attention or that may represent unusual business or audit risks, such as litigation or going concern issues.
  4. Determine if firm is independent of the entity and able to provide the desired service.
  5. Determine if firm has the necessary technical skills and knowledge of the industry to complete the engagement.
  6. Determine if acceptance of the entity would violate any applicable regulatory agency requirements or the code of professional conduct.
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2
Q

The successor auditor is required to communicate with predecessor auditor

A
  • Successor initiates
  • Predecessor required to respond
  • Predecessor must obtain permission of client before responding (Rule 301)
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3
Q

Reasons for discontinuance

A
  • Conflict over accounting issue.
  • Conflict over auditing issue.
  • Conflict over fees.
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4
Q

Preliminary engagement activities

A
  1. Determine the audit engagement TEAM requirements.
  2. Ensure the TEAM is in compliance with ethical and INDEPENDENCE requirements.
  3. Establish understanding with entity (engagement letter).
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5
Q

Annual independence questionnaire

A

Requests information about auditor’s financial or business relationship with the firm’s clients.

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6
Q

Auditing standards state that the auditor should document the understanding through…

A

A written communication with the entity (AU-C Section 210)

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7
Q

What is an engagement letter used for?

A

To formalize the arrangements reached between the auditor and the entity. It serves as a contract, outlining the responsibilities of both parties and preventing misunderstandings between the 2 parties.

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8
Q

The engagement letter should include:

A 
A. the objectives of the engagement.
B. management's responsibilities.
C. the auditor's responsibilities.
D. the limitations of the engagement.
E. the applicable financial reporting framework (usually GAAP)
F. the format for the audit report.
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9
Q

When the entity has an internal audit function (IAF)…

A

The auditor may use the work of the IAF as evidence and request the IAF provide direct assistance in conducting the audit.

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10
Q

If the auditor determines that the work of the IAF can be used for purposes of the audit, the auditor must evaluate:

A

A. The extent to which the IAF’s organizational status and relevant policies and procedures support the objectivity of the internal auditors.
B. The level of competence of the IAF.
C. The application by the IAF of a systematic and disciplined approach, including quality control.

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11
Q

Audit committee

A

A subcommittee of the board of directors that is responsible for the financial reporting and disclosure process.

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12
Q

Audit committee requirements/duties:

A

A. Each member of the audit committee must be a member of the board of directors.
B. Each member must be independent.
C. Directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by the company.
D. Must pre-approve all audit and non-audit services provided by its auditor.
E. Must establish procedures for the receipt, retention, and treatment of complaints received by the company regarding accounting, internal control, and auditing.
F. Each audit committee member must have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties.

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13
Q

Planning includes:

A

Creating an audit strategy and audit plan.

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14
Q

Audit strategy

A

The auditor’s plan for the expected conduct, organization, and staffing of the audit.

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15
Q

Audit plan

A

A description of the nature, timing, and extent of the planned audit procedures to be used in order to comply with auditing standards.

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16
Q

Auditing standards state that the auditor’s responsibility for detecting illegal acts having a direct and material effect on the financial statements is

A

The same as that for errors and fraud.

17
Q

If an illegal act has occurred or is likely to have occurred…

A

The auditor should consider its implications for other aspects of the audit, particularly the reliability of management representations. The auditor should ensure that the audit committee or those charged with governance are adequately informed about significant illegal acts. The auditor should also recognize that, under the circumstances noted previously, he or she may have a duty to notify parties outside the entity.

18
Q

Steps in audit planning include…

A
  • Assess business risks.
  • Establish materiality.
  • Consider multiple locations.
  • Assess the need for specialists.
  • Consider violations of laws and regulations.
  • Identify related parties.
  • Consider additional value-added services.
  • Document the overall audit strategy, audit plan, and prepare audit programs.
19
Q

Types of audit tests:

A
  • Risk assessment procedures
  • Tests of controls
  • Substantive tests
20
Q

Test of controls

A

Audit procedures performed to test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the relevant assertion level.

21
Q

Substantive procedures

A
  • Tests to detect material misstatements (that is, monetary errors) in a class of transactions, account balance, and disclosure component of the financial statements.
  • Two categories: test of details and substantive analytical procedures.
22
Q

Test of details

A

Test for fraud or errors in individual transactions, ending financial statement account balances, and disclosures.

23
Q

Substantive analytical procedures

A

-The investigation, if necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

24
Q

Materiality

A
  • A low level for materiality = more costly substantive procedures.
  • LOW Materiality % = Need for greater evidence.
25
Q

Overall Materiality (Planning Materiality)

A
  • The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decision of users.
  • Requires professional judgment
  • Often utilizes benchmarks
  • A common rule of thumb is 5% EBITA
26
Q

Materiality is influenced by:

A
  • Material misstatements in prior years
  • High risk of fraud
  • The entity is close to violating a covenant in a loan agreement
  • Small amounts may cause the entity to miss forecasted revenues or earnings, or affect the trend in earnings
  • The entity operates in a volatile business environment, has complex operations (multiple locations), or operates in a highly regulated industry.
27
Q

Three steps in applying Materiality to an audit:

A
  1. Determine overall materiality (planning materiality)
  2. Determine Tolerable Misstatement for individual account balances or disclosures (performance materiality)
  3. Evaluate audit findings
28
Q

Tolerable Misstatements

A
  • The amount of the overall materiality that is used to establish a scope for the audit procedures for the individual account balance or disclosures.
  • A common benchmark is 50-70% of overall materiality.
29
Q

Factors that would cause auditors to use a LOWER percentage for Tolerable Misstatement

A 
A. High risk of misstatement within the account balance, class of transaction, or disclosure
B. Increased number of accounting issues that require significant judgment and/or more estimates with high estimation uncertainty
C. A history of material weaknesses, significant deficiencies, and/or a high number of deficiencies in internal control
D. High turnover of senior management or key financial reporting personnel.

Audit (11 decks)

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