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ACCO 360 > Chapter 6 > Flashcards

Chapter 6 Flashcards

1
Q

what is the purpose of audit planning

A

effective conduct of an audit

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2
Q

audit planning helps (3)

A
  1. keep costs reasonable
  2. avoid misunderstandings with client
  3. enable auditor to obtain sufficient appropriate audit evidence
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3
Q

why is it good to keep costs low?

A

firm remain competitive and retain its clients

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4
Q

why is it good to avoid misunderstandings with client?

A

good client relations + facilitate quality work at reasonable costs

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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

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6
Q

what does low AAR mean?

A

wants to be more certain that there is no misstatement

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7
Q

what does high AAR mean?

A

can allow more flexibility

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8
Q

Def: risk of material misstatement

A

risk that the financial statements are materially misstated prior to audit

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9
Q

two components of material misstatement

A

inherent risk + control risk

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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

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11
Q

def: control risk

A

risk that material misstatement will not be prevented, detected or corrected on a timely basis

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12
Q

def: client business risk

A

risk that the entity will fail to achieve its objectives or execute its strategy

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13
Q

what factors can increase client business risk?

A

1) changes in industry conditions
2) regulatory changes
3) setting inappropriate objectives or strategies

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14
Q

Quality control policies assure that firm will only take clients where it is (3)

A
  1. competent to perform the engagement (capabilities, time and resources)
  2. comply with relevant ethical requirements
  3. integrity of the client
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15
Q

before accepting an engagement what should happen?

A

client investigation

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16
Q

what is looked at during client investigation?

A
  1. standing in business community
  2. financial stability
  3. relation with previous public accountant
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17
Q

the successor audit must

A

communicate with predecessor auditor to find out if reason be to refuse engagement

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18
Q

for the successor to contact the predecessor

A

permission must be obtained from the client

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19
Q

if the client does not grant permission the successor should

A

consider declining the engagement

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20
Q

indicators that raise doubt about management integrity (7)

A
  1. history of non-compliance
  2. poor reputation
  3. suspicions on management criminal activities
  4. highly complex transactions or activities that dont seem necessary
  5. poor tone at the top
  6. management reluctant to give info
  7. history of keeping things secret
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21
Q

existing clients should be evaluated _____ for reasons to not continue the engagement

A

annually

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22
Q

reasons to discontinue association with client (4)

A

previous conflicts over audit scope, type of opinion to issue or fees, excessive risk

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23
Q

two things to consider when evaluating ethical requirements

A
  1. competence

2. independence

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24
Q

elements to evaluate competence (2)

A
  1. capable staff

2. time and resources

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25
Q

how to evaluate independence criteria?

A

independence threat analysis

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26
Q

what are the five threats to independence?

A
  1. self-interest
  2. self-review
  3. advocacy
  4. familiarity
  5. intimidation
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27
Q

steps to conduct independence threat analysis

A
  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
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28
Q

two pre-conditions for an audit

A
  1. use by management of acceptable financial reporting framework
  2. agreement with mgmt and governance terms of engagement
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29
Q

how to get understanding of terms of engagement?

A

engagement letter

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30
Q

what should be included in an engagement letter

A

restrictions on auditor’s work, deadlines, assistance to be provided by personnel or internal audit, schedules, fees

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31
Q

auditor must obtain knowledge of entity’s ___+___ to reduce audit risk to acceptably low level

A

business and environment

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32
Q

what items to evaluate for business and environment analysis (5)

A
  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
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33
Q

reasons for obtaining a good understanding of industry (3)

A
  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
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34
Q

key areas to consider in business ops and processes (5)

A
  1. tour client facilities and operations
  2. organizational and ownership structure
  3. operational and reporting structure
  4. technology infrastructure
  5. identifying related parties
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35
Q

examples of items for auditor to know regarding operations and processes

A

major sources of revenue, key customers and suppliers, sources of financing, related parties

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36
Q

why tour client facilities? (3)

A
  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
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37
Q

with related parties the auditor must disclose

A

description of transaction (with $), amounts due from and to

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38
Q

related party transactions lead to

A

high inherent risk

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39
Q

why does related party lead to higher risk

A

disclosure requirements and lack of independence

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40
Q

what makes a party related?

A

it has ability to influence decisions directly or indirectly

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41
Q

how to identify related parties?

A

inquiry management, review shareholder and board minutes, review of OSC or SEC filings and examine shareholder listing

42
Q

what elements to look for when assessing management

A

philosophy, operating style, ability to identify and respond to risk

43
Q

to understand a client’s governance system the auditor should get

A
  1. articles of incorporation and bylaws
  2. code of ethics
  3. minutes of meetings
44
Q

what are business strategies?

A

approaches followed by the entity to achieve organizational objectives

45
Q

auditors should understand client objectives related to (3)

A
  1. reliability of financial reporting
  2. effectiveness and efficiency of operations
  3. compliance with laws and regulations
46
Q

risk of material misstatement may be increased if

A

client has set unreasonable objectives or performance system encourages aggressive accounting

47
Q

preliminary procedures for risk assessment?

A

analytical procedures (ratios)

48
Q

purpose of preliminary analytical procedures

A

help auditor better understand the client’s business and business risk + areas with high risk of misstatement + fraud risk

49
Q

preliminary tests can reveal unusual changes in ratios compared to

A

prior years or industry averages

50
Q

the overall audit strategy sets out (3)

A
  1. types and allocation of resources to be deployed for specific audit areas
  2. timing of audit procedure
  3. materiality
51
Q

auditors develop and document a strategy that sets which three items

A

scope, timing and direction

52
Q

resources requirement for engagement (4)

A
  1. select staff
  2. evaluate need for outside specialist
  3. evaluate whether help from internal audit
  4. evaluate reliance on other auditors
53
Q

major consideration when selecting staff for engagement

A

continuity of staff to help maintain familiarity and close interpersonal relations with client

54
Q

does the use of specialist affect auditor’s responsibility?

A

no, the report should not refer to use of a specialist unless his report’s results change the audit opinion

55
Q

to use a outside specialist, the auditor must

A

have sufficient understanding of business, evaluate specialist’s qualifications and understand objectives and scope

56
Q

why would auditor use internal auditor’s work?

A

because they have different purpose, they look at if operations are running fluently

57
Q

general guideline for the use of internal auditor

A

the higher the assessed risk of material misstatement, the more restricted the nature and extent of work should be assigned to internal auditors

58
Q

if external auditor decides to use an internal auditor he must

A

directly supervise and review the internal auditor’s work + obtain written agreement that they are allowed to follow external auditor

59
Q

the audit firm may need to engage other auditors if

A

a client has multiple locations or subsidiaries

60
Q

critical element of multi-location audit is

A

determine the amount of work to be performed at each component

61
Q

def: materiality

A

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
Q

how are judgements about materiality made?

A

in light of surrounding circumstances

63
Q

what affects judgement of materiality?

A

size or nature of a misstatement or a combination of both

64
Q

judgement about matters that are material to users of financial statements are based on

A

consideration of common financial info needs of users as a group

65
Q

is it possible to establish dollar value guidelines for materiality applicable to all audit clients?

A

NO

66
Q

materiality is a driver of entire audit process in

A

planning audit, evaluate results and completing the audit

67
Q

decisions during the planning phase provides benchmark for decisions through the audit about

A

overall or planning materiality

68
Q

def: overall or planning materiality

A

determining materiality for financial statements as a whole

69
Q

example of numbers for overall materiality

A

total sales or total income

70
Q

3 steps in determining overall materiality

A
  1. selecting appropriate benchmark
  2. determine the percentage to be applied to benchmark
  3. justify your decision
71
Q

the choice of appropriate benchmark depends on

A

your client (and USERS!!!!)

72
Q

examples of benchmarks

A

revenue, profit before taxes, total assets and expenses

73
Q

factors that affect selection of benchmark (6)

A
  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
Q

if the current year end results are unavailable

A

use prior year, period to date, budgets and forecasts or average of past years

75
Q

the % chosen depends on

A

user’s sensitivity or tolerance for misstatements

76
Q

i.e % example

A

if user low tolerance (high sensitivity) to small errors, auditor use lower end of % threshold

77
Q

def: trivial amounts

A

clearly inconsequential whether taken individually or in aggregate and whether judged by criteria of size, nature or circumstances

78
Q

def: performance materiality

A

this is set at an amount less than overall and serves two functions

79
Q

two functions of performance materiality

A
  1. reduce aggregation risk

2. provide safety buffer against risk of undetected misstatements

80
Q

def: aggregation risk

A

the risk that aggregate uncorrected and undetected misstatements individually below materiality will exceed overall for financial statements

81
Q

performance materiality is recommended to be between

A

50% (high risk) and 75% (low risk)

82
Q

performance materiality guides

A

the level of work performed (high-less work and low-more work)

83
Q

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

A

performance materiality

84
Q

factors that suggest lower materiality (10)

A
  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
Q

auditors also need to consider _____ factors

A

qualitative

86
Q

can you revise overall materiality throughout audit

A

yes if the results of your audit are different from what you had set at beginning

87
Q

def: specific materiality

A

amount less than materiality used to plan and conduct financial statement audit engagement to reduce likelihood of uncorrected errors > overall materiality

88
Q

specific materiality involves considerable

A

professional judgement

89
Q

which type of materiality gears sample sizes and conclusions on material misstatements of accounts?

A

performance materiality

90
Q

specific performance materiality is

A

materiality level determined for a particular class of transactions, account balance or disclosure

91
Q

specific performance materiality must be equal to or less than

A

performance materiality

92
Q

qualitative factors used to set specific performance materiality

A

analytical procedure results, prior period adjustments, consequences of misstatements and account data for other purposes

93
Q

def: tolerable misstatement

A

application of performance materiality to a specific sampling procedure

94
Q

tolerable misstatement is either less than or equal to

A

performance materiality

95
Q

how to categorize misstatements during the audit

A
  1. factual misstatements
  2. judgemental misstatements
  3. projected misstatements
96
Q

def: factual misstatements

A

those about which there is no doubt

97
Q

def: judgemental misstatements

A

differences in management’s judgement concerning recognition, measurement, presentation and disclosure AND auditor’s judgement

98
Q

def: projected misstatement

A

the auditor’s best estimate based on a sample

99
Q

which category of misstatements would auditors share with management?

A

request to correct factual misstatements, discuss adjustments for judgemental differences

100
Q

how to conclude overall reasonableness of financial statements

A

misstatements > overall materiality benchmark

101
Q

if uncorrected material misstatement, the auditor must decide if

A

materially pervasive or isolated to specific accounts or disclosures

102
Q

auditor must communicate with

A

those in charge of governance

ACCO 360 (11 decks)

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