Chapter 8 Flashcards
A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued
Acceptable Audit Risk
Overall approach to the audit that considers the nature of the client, risk of significant misstatements. And other factors such as the number of client locations and past effectiveness of client controls
Audit Strategy
Written records of the clients expectations for the period; a comparison of budgets with actual results may indicate whether or not misstatements are likely
Budgets
The risk that the client will fail to achieve its objectives related to (1) reliability of financial reporting (2) effectiveness and efficiency of operation and (3) compliance with laws and regulations
Client Business Risk
The official record of the meetings of a corporation’s board of directors and stockholders, in which corporate issues such as the declaration of dividends and the approval of contracts are documented
Corporate Minutes
An agreement between the CPA firm and the client as to the terms of the engagement for the conduct of the audit and related services
Engagement Letter
A measure of the auditor’s likelihood that there are material misstatements in a segment before considering the effectiveness of internal control
Inherent Risk
Involves deciding whether to accept or continue doing the audit for the client, identifying the client’s reasons for the audit, obtaining an engagement letter, and developing an audit strategy
Initial Audit Planning
Affiliated company, principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other
Related Party
Any transaction between the client and a related party
Related Party Transaction
BLANK is required by auditing standards to communicate with BLANK
New and old auditor
The predecessor auditor must receive what from the client before communicating with the new auditor
permission
Financial reporting frameworks are
GAAP and IFRS
Investigating new clients and reevaluating existing ones is an essential part of deciding BLANK
Acceptable audit risk
BLANK signs the engagement letter for public companies and BLANK for private
Audit Committee and management
The risk that a client will fail to meet its objectives
Client Business Risk
Three primary reasons for obtaining a good understanding of the client’s industry
Risks associated with specific industries, aids auditor in knowing inherent risks of the industry, and helps auditor learn unique accounting requirements of that business
Transactions with BLANK are important to auditors because accounting standards require that they be disclosed in financial statements if they are material
Related Parties
Related parties must be included in the BLANK files
Permanent
Auditors should understand a client’s objectives related to
Reliability of financial reporting, effectiveness and efficiency of operations, and compliance with laws and regulations
Remaining risk after considering the effectiveness of top management controls is called
Residual Risk
The primary source for identifying client business risk
Management
Auditors compare client data with
Industry data, similar prior- period data, client-determined expected results, auditor determined expected results, and expected results using nonfinancial data
Two shortcomings of comparing with previous years
Does not include growth or decline in business activity and relationships of data to other data are ignored
What overcomes both shortcomings of comparing with previous years
Ratio and percentage relationships
Two concerns with budgets
Evaluating if the budget plans were realistic and that current financial information was changed by client personnel to conform to the budget
Short-Term Debt-Paying Ability Ratios
Cash Ratio, Quick Ratio, and Current Ratio
Cash Ratio
Cash+Marketable Securities / Current Liabilities
Quick Ratio
Cash+Marketable Securities+Net Acc Rec / Current Liabilities
Current Ratio
Current Assets / Current Liabilities
Liquidity Activity Ratios
Acc Rec Turnover, Days to Collect Rec, Inventory Turnover, and Days to Sell Inventory
Accounts Receivable Turnover
Net Sales / Average Gross Receivables
Days to Collect Receivables
365 Days / Accounts Receivable Turnover
Inventory Turnover
Cost of Goods Sold / Average Inventory
Days to Sell Inventory
365 Days / Inventory Turnover
Ability to Meet Long-Term Debt Obligations Ratios
Debt to Equity and Times Interest Earned
Debt to Equity
Total Liabilities / Total Equity
Times Interest Earned
Operating Income / Interest Expense
Profitability Ratios
Earnings Per Share, Gross Profit Percent, Profit Margin, Return on Assets, and Return on Common Equity
Earnings Per Share
Net Income / average common shares outstanding
Gross Profit Percentage
Net Sales-Cost of Goods Sold / Net Sales
Profit Margin
Operating Income / Net Sales
Return on Assets
Income before taxes / Average total assets
Return on Common Equity
Income before taxes-preferred dividends / average stockholders’ equity
