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ACC470 > Chapter 3: Audit Planning, Types of Audit Tests, and Materiality > Flashcards

Chapter 3: Audit Planning, Types of Audit Tests, and Materiality Flashcards

1
Q

Phases of an audit that relate to audit planning

A
  1. Client acceptance and continuance
  2. Preliminary engagement activities
  3. Plan the audit
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2
Q

Prospective Client Acceptance Steps

A
  1. Obtain and review financial information
  2. Inquire of third parties regarding client integrity
  3. Communicate with the predecessor auditor
  4. Consider unusual business or audit risks
  5. Determine if the firm is independent
  6. Determine if the firm has the necessary skills and knowledge
  7. Determine if acceptance violates any applicable regulatory agency requirements or the Code of Professional Conduct
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3
Q

3 Things a public accounting firm should consider before accepting a new client

A
  1. Firm has the capabilities to perform the engagement
  2. Firm complies with legal and relevant ethical requirements (independence)
  3. Firm has considered the integrity of the client
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4
Q

Should a firm check whether or not to continue their relationship with current client?

A

Yes.

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5
Q

What are some reasons that a firm could end its relationship with a client?

A
  • Conflicts over accounting and auditing issues
  • Disputes over fees
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6
Q

When should an audit firm evaluate client retention?

A

Near audit completion or after a significant event

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7
Q

What are the 3 preliminary engagement activities?

A
  1. Determining the audit engagement team requirements
  2. Ensuring that the audit team and audit firm are in compliance with ethical and independence requirements
  3. Establishing an understanding with the entity
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8
Q

What three topics must be discussed when establishing the terms of the engagement?

A
  1. The engagement letter
  2. Using the work of the internal auditors
  3. The role of the audit committee
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9
Q

What SHOULD the terms of the engagement include?

A
  1. Objectives of the engagement
  2. Management’s responsibilities
  3. Auditor’s responsibilities
  4. Limitations of the engagement
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10
Q

Who signs the engagement letter?

A

Partner signs and/or client audit committee signs

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11
Q

Who signs the engagement letter for private companies?

A

Whoever is in charge

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12
Q

What does an engagement letter do?

A

Formalizes the arrangement reached between the auditor and the client

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13
Q

What COULD the engagement letter include

A
  • Arrangements for use of specialists or internal auditors
  • Any limitations of liability of the auditor or client
  • Additional services to be provided
  • Arrangements regarding other services
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14
Q

Are audit firms required to communicate with predecessor auditors?

A

Not required to communicate, but required to inquire at least

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15
Q

What could an audit firm ask a potential client’s predecessor auditors about?

A
  • Information that might bear on the integrity of management
  • Information regarding identified or suspected fraud and matters involving noncompliance with laws and regulations
  • Disagreements with management about accounting policies, auditing procedures, or other similarly significant matters
  • Communications to audit committees or others with equivalent authority and responsibility regarding fraud, illegal acts by clients, and internal-control-related matters
  • The predecessor auditor’s understanding as to the reasons for the change of auditors
  • The predecessor auditor’s understanding of the nature of the company’s relationships and transactions with related parties and significant unusual transactions
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16
Q

When can an auditor use the work of the internal audit function (IAF)

A
  1. Obtain evidence
  2. Use internal auditors to provide direct assistance in conducting audit under the direction, supervision, and review of the external auditor
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17
Q

What does using the work of the IAF to obtain evidence depend on?

A
  1. Whether the internal audit function’s organizational status and relevant policies and procedures adequately support the objectivity of the internal auditors
  2. The level of competency of the internal audit function
  3. Whether the internal audit function applies a systematic and disciplined approach, including quality control
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18
Q

Section 301 of Sarbanes-Oxley Act requires the following for audit committee members of publicly held companies:

A
  1. Member of board of directors and independent
  2. Directly responsible for overseeing work of any registered public accounting firm employed by the company
  3. Must preapprove all audit and nonaudit services provided by its auditors
  4. Must establish procedures to follow for complaints
  5. Must have authority to engage independent counsel.
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19
Q

Audit Committee

A

Subcommittee of the board of directors that is responsible for the financial reporting and disclosure process

20
Q

Audit Strategy vs. Audit Plan

A

Audit Strategy: Helps the auditor determine what resources are needed to perform the engagement
Audit Plan: Should consider how to conduct the engagement in an effective and efficient manner

21
Q

What’s more detailed an audit strategy or audit plan?

A

Audit plan

22
Q

What does an audit committee do?

A
  • Directly responsible for overseeing the work of the audit firm
  • Preapproves all audit and non-audit services provided
  • Communicates with the audit firm before engagement starts to discuss auditor’s responsibilities and client’s significant accounting policies
23
Q

Additional Steps to Planning the Audit

A
  1. Assess business risks
  2. Establish materiality
  3. Consider multilocations
  4. Assess the need for specialists
  5. Consider violations of laws and regulations
  6. Identify related parties
  7. Consider additional value-added services
  8. Document the overall audit strategy, audit plan, and prepare audit programs
24
Q

Why do we assess business risks?

A
  1. To understand the client’s business and transactions
  2. To identify financial statement accounts likely to contain errors

Helps auditor allocate more resources to investigate necessary accounts

25
Q

Materiality

A

The magnitude of an omission or misstatement of accounting information that makes it probably that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement

26
Q

Is materiality relative or absolute?

A

Materiality is relative, not absolute, the determination of it requires professional judgment

27
Q

Two types of materiality

A

Quantitative & Qualitative

28
Q

Two types of Quantitative Materiality

A
  1. Overall Materiality (Planning Materiality)
  2. Tolerable Misstatements (Performance Materiality)
29
Q

Overall Materiality

A

Maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decision of users

30
Q

Common Quantitative benchmarks used

A
  • Income before taxes
  • Income from continuing operations
  • Three year average income
  • Total revenues
  • Gross profit
  • Total assets
  • Total equity
31
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

32
Q

Qualitative Materiality

A

Information about that entity that might make you have lower materiality

Quantitative amounts may be adjusted lower for qualitative factors

Mostly professional judgment

33
Q

Examples of Qualitative Materiality

A
  • Material misstatements in prior years
  • High risk of fraud
  • Potential loan covenant violations
  • 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, or operates in a highly regulated industry
34
Q

Illegal Acts

A

Violations of laws or government regulation

35
Q

Two types of Illegal Acts

A
  1. Direct & Material
  2. Indirect & Material
36
Q

What happens if there is a potential direct and material illegal act

A

Consider laws and regulations as part of audit (Impacts a normal part of their financial statements (tax regulations))

EX: tax laws and regulations that may affect the amount of revenue recognized under a government contract

37
Q

What happens if there is a potential indirect and material illegal act

A

Be aware of what may have occurred; investigate if brought to attention

EX: breach on cybersecurity; bring in team to investigate

38
Q

Types of Audit Tests

A
  1. Risk Assessment Procedures
  2. Test of Controls
  3. Substantive Tests
39
Q

Risk Assessment Procedures

A

Used to gain an understanding of the entity, and determine nature, timing, and extent of audit procedures (used to assess RMM)

40
Q

Test of Controls

A

Used to determine if controls are operating effectively to prevent, detect, or correct RMM

41
Q

Substantive Tests

A

Designed to detect material misstatements (required or public companies for all significant risks)

42
Q

Two types of Substantive Tests

A
  1. Test of details
  2. Substantive Analytical Procedures
43
Q

Test of details

A

Substantive tests of transactions for errors or fraud in individual transactions, account balances and disclosures

44
Q

Substantive Analytical Procedures

A

Evaluations of financial information through analysis of plausible relationships (examinations of trends and ratios) among financial and non-financial data

45
Q

Which two audit tests are dual-purpose

A

Tests of Details & Substantive Analytical Procedures

46
Q

Dual-Purpose Tests

A

Tests of transactions that both evaluate the effectiveness of controls and detect monetary errors (testing revenue, match shipping order, invoice, and purchase order)

47
Q

Audit Program

A

List of all the specific procedures that the auditor will conduct

ACC470 (8 decks)

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