Chapter 4 Part 1 Flashcards
Related parties include those individuals or organizations that can influence or be influenced by decisions of the company, possibly through family ties or investment relationships. Because one of the basic assumptions of historical cost accounting is that transactions are valued at prices agreed on by two independent parties, valuation of related-party transactions is particularly troublesome.
What is the major concern for auditors related to evidence obtained from related parties?
The purpose of obtaining an understanding of the company’s performance measures is to be able to determine what information management and others deem to be key indicators of company performance. It also reveals items to which management might be sensitive
Why should auditors understand their clients’ performance measures when assessing inherent risk?
The purpose of performing preliminary analytical procedures in the audit planning stage is to direct attention to potential problem areas so the audit work can be planned to reduce the risk of missing something important.
What is the purpose of performing preliminary analytical procedures in audit planning?
The five steps auditors use to apply comparison and ratio analysis to unaudited financial statements when completing preliminary analytical procedures are to:
(1) develop an expectation
(2) define a significant difference
(3) calculate predictions and compare them with the recorded amount
(4) investigate significant differences
(5) document each of the first four steps.
What are the five steps involved with the use of preliminary analytical procedures?
The purpose of obtaining an understanding of the company’s objectives, strategies, and related business risks is to identify business risks that could reasonably be expected to result in material misstatement of the financial statements. Of course, the best starting point is with management whose job it is to be knowledgeable about the company’s risks. In order to get understanding of a client’s business and industry, an auditor can consider:
-Studying numerous sources such as AICPA industry accounting and auditing guides, specialized trade magazines and journals, registration statements and 10-K reports filed with the SEC, general business magazines and newspapers
-Using inquiry of client personnel, including review of prior-year audit documentation, inquiry, and interviews with the company’s management, directors, and audit committee.
-Using information from client acceptance and retention evaluation, audit planning, past audits, and other engagements.
-Considering the results of the audit team discussions (brainstorming), this involves sharing information among members of the engagement team.
What are some types of knowledge and understanding about a client’s business and industry that an auditor is expected to obtain? What are some of the methods and sources of information for understanding a client’s business and industry?
There are a number of ratios that can be used in completing preliminary analytical procedures. Some of the ratios that can be used include current ratio, days’ sales in receivables, doubtful accounts ratio, days’ sales in inventory, receivables turnover, inventory turnover, cost of goods sold ratio, return on equity, and Altman’s financial distress ratios and discriminant score.
What are some of the ratios that can be used in preliminary analytical procedures?
Analytical procedures are required (1) at the beginning of an audit—the planning stage by applying analytical procedures discussed in this chapter and (2) at the end of an audit when the partners in charge review the overall quality of the work and look for apparent problems.
They are optional as substantive audit procedures since test of details can be used instead when gathering evidence about each relevant financial statement assertion about each significant account and disclosure.
When are analytical procedures required, and when are they optional?
For laws and regulations having an indirect effect on financial statements, auditors are limited to performing specified audit procedures that may identify noncompliance with those laws and regulations that may have a material effect on the financial statements, inquiry of management and those charged with governance, and inspection of correspondence with relevant licensing or regulatory authorities. However, if auditors become aware of the possibility of indirect-effect noncompliance, they are required to follow up to ensure there is no material effect on the financial statements.
How do the professional audit standards differ for (a) errors, (b) frauds, (c) direct-effect noncompliance, and (d) indirect-effect noncompliance?
The audit strategy memorandum is the basis for preparing the detailed audit plans (often called “audit programs”) for each significant account and disclosure on the audit. The audit plans list the audit procedures to be performed by auditors to gather sufficient appropriate evidence on which to base their opinion on the financial statements. The audit strategy memorandum sets the scope, timing, and direction for auditing each relevant assertion
What is the purpose of an audit strategy memorandum? What information should it contain?
