Chapter 6 Flashcards
1
Q
what is the purpose of audit planning
A
effective conduct of an audit
2
Q
audit planning helps (3)
A
- keep costs reasonable
- avoid misunderstandings with client
- enable auditor to obtain sufficient appropriate audit evidence
3
Q
why is it good to keep costs low?
A
firm remain competitive and retain its clients
4
Q
why is it good to avoid misunderstandings with client?
A
good client relations + facilitate quality work at reasonable costs
5
Q
Def: Acceptable audit risk (AAR)
A
measure of how willing the auditor is to accept that financial statements may be materially misstated after the audit is completed and an unqualified opinion was issued
6
Q
what does low AAR mean?
A
wants to be more certain that there is no misstatement
7
Q
what does high AAR mean?
A
can allow more flexibility
8
Q
Def: risk of material misstatement
A
risk that the financial statements are materially misstated prior to audit
9
Q
two components of material misstatement
A
inherent risk + control risk
10
Q
def: inherent risk
A
measure of the auditor’s assessment of the likelihood of material misstatement in an account balance before considering effectiveness of controls
11
Q
def: control risk
A
risk that material misstatement will not be prevented, detected or corrected on a timely basis
12
Q
def: client business risk
A
risk that the entity will fail to achieve its objectives or execute its strategy
13
Q
what factors can increase client business risk?
A
1) changes in industry conditions
2) regulatory changes
3) setting inappropriate objectives or strategies
14
Q
Quality control policies assure that firm will only take clients where it is (3)
A
- competent to perform the engagement (capabilities, time and resources)
- comply with relevant ethical requirements
- integrity of the client
15
Q
before accepting an engagement what should happen?
A
client investigation
16
Q
what is looked at during client investigation?
A
- standing in business community
- financial stability
- relation with previous public accountant
17
Q
the successor audit must
A
communicate with predecessor auditor to find out if reason be to refuse engagement
18
Q
for the successor to contact the predecessor
A
permission must be obtained from the client
19
Q
if the client does not grant permission the successor should
A
consider declining the engagement
20
Q
indicators that raise doubt about management integrity (7)
A
- history of non-compliance
- poor reputation
- suspicions on management criminal activities
- highly complex transactions or activities that dont seem necessary
- poor tone at the top
- management reluctant to give info
- history of keeping things secret
21
Q
existing clients should be evaluated _____ for reasons to not continue the engagement
A
annually
22
Q
reasons to discontinue association with client (4)
A
previous conflicts over audit scope, type of opinion to issue or fees, excessive risk
23
Q
two things to consider when evaluating ethical requirements
A
- competence
2. independence
24
Q
elements to evaluate competence (2)
A
- capable staff
2. time and resources
25
how to evaluate independence criteria?
independence threat analysis
26
what are the five threats to independence?
1. self-interest
2. self-review
3. advocacy
4. familiarity
5. intimidation
27
steps to conduct independence threat analysis
1. 5 threats assessed and potential ones described
2. possible to implement safeguards to mitigate threat
3. in threats can be diminished --> yes
if threats cannot be diminished --> no
28
two pre-conditions for an audit
1. use by management of acceptable financial reporting framework
2. agreement with mgmt and governance terms of engagement
29
how to get understanding of terms of engagement?
engagement letter
30
what should be included in an engagement letter
restrictions on auditor's work, deadlines, assistance to be provided by personnel or internal audit, schedules, fees
31
auditor must obtain knowledge of entity's ___+___ to reduce audit risk to acceptably low level
business and environment
32
what items to evaluate for business and environment analysis (5)
1. industry, regulatory and external environment
2. nature of business (ops and processes)
3. management and governance
4. client objectives and strategies
5. measurement and performance
33
reasons for obtaining a good understanding of industry (3)
1. certain specific industries have greater risk
2. certain inherent risk are common to all clients of one industry
3. many industries have unique accounting treatments that auditor must understand
34
key areas to consider in business ops and processes (5)
1. tour client facilities and operations
2. organizational and ownership structure
3. operational and reporting structure
4. technology infrastructure
5. identifying related parties
35
examples of items for auditor to know regarding operations and processes
major sources of revenue, key customers and suppliers, sources of financing, related parties
36
why tour client facilities? (3)
1. observe operations firsthand and meet key personnel
2. risks from unused equipment or unsalable inventory
3. discussion with non-accounting people to assess risk
37
with related parties the auditor must disclose
description of transaction (with $), amounts due from and to
38
related party transactions lead to
high inherent risk
39
why does related party lead to higher risk
disclosure requirements and lack of independence
40
what makes a party related?
it has ability to influence decisions directly or indirectly
41
how to identify related parties?
inquiry management, review shareholder and board minutes, review of OSC or SEC filings and examine shareholder listing
42
what elements to look for when assessing management
philosophy, operating style, ability to identify and respond to risk
43
to understand a client's governance system the auditor should get
1. articles of incorporation and bylaws
2. code of ethics
3. minutes of meetings
44
what are business strategies?
approaches followed by the entity to achieve organizational objectives
45
auditors should understand client objectives related to (3)
1. reliability of financial reporting
2. effectiveness and efficiency of operations
3. compliance with laws and regulations
46
risk of material misstatement may be increased if
client has set unreasonable objectives or performance system encourages aggressive accounting
47
preliminary procedures for risk assessment?
analytical procedures (ratios)
48
purpose of preliminary analytical procedures
help auditor better understand the client's business and business risk + areas with high risk of misstatement + fraud risk
49
preliminary tests can reveal unusual changes in ratios compared to
prior years or industry averages
50
the overall audit strategy sets out (3)
1. types and allocation of resources to be deployed for specific audit areas
2. timing of audit procedure
3. materiality
51
auditors develop and document a strategy that sets which three items
scope, timing and direction
52
resources requirement for engagement (4)
1. select staff
2. evaluate need for outside specialist
3. evaluate whether help from internal audit
4. evaluate reliance on other auditors
53
major consideration when selecting staff for engagement
continuity of staff to help maintain familiarity and close interpersonal relations with client
54
does the use of specialist affect auditor's responsibility?
no, the report should not refer to use of a specialist unless his report's results change the audit opinion
55
to use a outside specialist, the auditor must
have sufficient understanding of business, evaluate specialist's qualifications and understand objectives and scope
56
why would auditor use internal auditor's work?
because they have different purpose, they look at if operations are running fluently
57
general guideline for the use of internal auditor
the higher the assessed risk of material misstatement, the more restricted the nature and extent of work should be assigned to internal auditors
58
if external auditor decides to use an internal auditor he must
directly supervise and review the internal auditor's work + obtain written agreement that they are allowed to follow external auditor
59
the audit firm may need to engage other auditors if
a client has multiple locations or subsidiaries
60
critical element of multi-location audit is
determine the amount of work to be performed at each component
61
def: materiality
misstatements and omissions are considered material if they individually or in aggregate could be expected to influence the economic decision of users taken on the basis of financial statements
62
how are judgements about materiality made?
in light of surrounding circumstances
63
what affects judgement of materiality?
size or nature of a misstatement or a combination of both
64
judgement about matters that are material to users of financial statements are based on
consideration of common financial info needs of users as a group
65
is it possible to establish dollar value guidelines for materiality applicable to all audit clients?
NO
66
materiality is a driver of entire audit process in
planning audit, evaluate results and completing the audit
67
decisions during the planning phase provides benchmark for decisions through the audit about
overall or planning materiality
68
def: overall or planning materiality
determining materiality for financial statements as a whole
69
example of numbers for overall materiality
total sales or total income
70
3 steps in determining overall materiality
1. selecting appropriate benchmark
2. determine the percentage to be applied to benchmark
3. justify your decision
71
the choice of appropriate benchmark depends on
your client (and USERS!!!!)
72
examples of benchmarks
revenue, profit before taxes, total assets and expenses
73
factors that affect selection of benchmark (6)
1. elements of financial statement
2. items users focus on
3. past history with audits (a lot of adjustments?)
4. nature of entity and industry
5. ownership structure and financed
6. relative volatility of benchmark (if NI changes always not good)
74
if the current year end results are unavailable
use prior year, period to date, budgets and forecasts or average of past years
75
the % chosen depends on
user's sensitivity or tolerance for misstatements
76
i.e % example
if user low tolerance (high sensitivity) to small errors, auditor use lower end of % threshold
77
def: trivial amounts
clearly inconsequential whether taken individually or in aggregate and whether judged by criteria of size, nature or circumstances
78
def: performance materiality
this is set at an amount less than overall and serves two functions
79
two functions of performance materiality
1. reduce aggregation risk
| 2. provide safety buffer against risk of undetected misstatements
80
def: aggregation risk
the risk that aggregate uncorrected and undetected misstatements individually below materiality will exceed overall for financial statements
81
performance materiality is recommended to be between
50% (high risk) and 75% (low risk)
82
performance materiality guides
the level of work performed (high-less work and low-more work)
83
in the planning stage, which materiality is used to identify what areas need to be audited, how much and what type of work and sample size
performance materiality
84
factors that suggest lower materiality (10)
1. fraud risk
2. non compliance with laws
3. misstatements in prior audits
4. related party transactions
5. change in accounting methods or lots of judgement or estimates
6. change in ops (more locations, high turnover of senior management)
7. deficient internal controls
8. nature of business
9. new client?
10. public client?
85
auditors also need to consider _____ factors
qualitative
86
can you revise overall materiality throughout audit
yes if the results of your audit are different from what you had set at beginning
87
def: specific materiality
amount less than materiality used to plan and conduct financial statement audit engagement to reduce likelihood of uncorrected errors > overall materiality
88
specific materiality involves considerable
professional judgement
89
which type of materiality gears sample sizes and conclusions on material misstatements of accounts?
performance materiality
90
specific performance materiality is
materiality level determined for a particular class of transactions, account balance or disclosure
91
specific performance materiality must be equal to or less than
performance materiality
92
qualitative factors used to set specific performance materiality
analytical procedure results, prior period adjustments, consequences of misstatements and account data for other purposes
93
def: tolerable misstatement
application of performance materiality to a specific sampling procedure
94
tolerable misstatement is either less than or equal to
performance materiality
95
how to categorize misstatements during the audit
1. factual misstatements
2. judgemental misstatements
3. projected misstatements
96
def: factual misstatements
those about which there is no doubt
97
def: judgemental misstatements
differences in management's judgement concerning recognition, measurement, presentation and disclosure AND auditor's judgement
98
def: projected misstatement
the auditor's best estimate based on a sample
99
which category of misstatements would auditors share with management?
request to correct factual misstatements, discuss adjustments for judgemental differences
100
how to conclude overall reasonableness of financial statements
misstatements > overall materiality benchmark
101
if uncorrected material misstatement, the auditor must decide if
materially pervasive or isolated to specific accounts or disclosures
102
auditor must communicate with
those in charge of governance
