Definitions Flashcards
Contingent liabilities
Potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Auditors are especially concerned about:
• Pending litigation for patent infringement
• Income tax disputes
• Product warranties
• Guarantees of obligations of others
• Unused balances of outstanding letters of credit
Comprehensive report
Board is given a comprehensive report with conclusions on the financial reporting, the internal system of control as well as conduct and result of audit
Summary report
General meeting is given a summary report from the audit
True and fair view
The auditor must conclude that the statements follow recognized accounting principles (thereby true and fare view)
o E.g. Swiss GAAP, IFRS or US GAAP
Unqualified with emphasis-of-matter explanatory paragraph or modified wording
A complete audit that is satisfactory, but auditor believes additional information should be provided
• The most important causes are:
• Lack of consistent application of generally accepted accounting principles
• Substantial doubt about going concern
• Auditor agrees with a departure from promulgated accounting principles
• Emphasis of other matters
• Reports involving other auditors
Qualified opinion
- Can result from limitation on the scope of the audit or failure to follow generally accepted accounting principles
- A qualified opinion can be used only when the auditor concludes that the financial statements are fairly stated.
- Qualification of both the scope and the opinion or of the opinion alone
- A scope and opinion qualification can be issued only when the auditor has been unable to accumulate all of the evidence required by auditing standards
Internal auditing
An independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.
Elements of the IIA-Definition
- Add value
- Improvement of operations
- Helps an organization accomplish its objectives
- Governance process
- Risk management process
- Control process
Implementation guides (IA)
Assist internal auditors in applying the standards. They collectively address internal auditing’s approach, methodologies, and consideration, but do not detail process or procedures
Supplementary guides (IA)
Provide detailed guidance for conducting internal audit activities. These include topical areas, sector-specific issues as well as processes and procedures, tools and techniques etc.
Mandatory guidance IA
- Definition of IA
- Principles
- Ethics
- IIA standards
Discrete variable
Only specific values can be taken
Continuous variable
Any value can be taken
Stratification
Divide data into segments, called Stratification (but then variance is altered, not very common to use this in practice).
Sampling risk
o Probability that the sample is not representative and the auditor reach an incorrect conclusion.
o E.g. for substantive tests the sampling risk is: Risk of incorrectly accepting the financial statements when there are material errors within.
Non-Sampling risk
o The risk that the auditor reaches an incorrect conclusion for any reason not related to sampling risk
Four factors influence the initial sample size
o Population size
o TER
o ARO
o EPER
Tolerable exception rate
Represent the highest exception rate the auditor will permit in the control being tested and still be willing to conclude the control is operating effectively. TER can have significant impact on sample size.
Acceptable risk of overreliance
The risk that the auditor concludes that controls are more effective that they actually are is the risk of overreliance. ARO measures the risk the auditor is willing to take of accepting a control as effective when the true population exception rate is greater than TER. ARO represents the auditor’s measure of sampling risk (i.e. an ARO of 5% leads to 95% confidence level). ARO is based on the assessed control risk, the lower the assessed CR, the lower the ARO. Like for TER there is an inverse relationship to planned sample size.
Main steps in Sampling of audit procedures
o 1-9 Plan the sample
o 10 Select sample
o 11 Perform the audit procedures
o 12-14 Evaluate results
Revenue recognition
Different techniques in order to artificially increase revenues and manipulate their market price:
• Sham sales (falsify different records)
• Conditional sales (recorded even though not finalized)
• Round-tripping or recording loans as sales
• Bill and hold transactions (i.e. premature revenue)
• Etc.
Sales should be recognized as revenue only if the following is met:
- Price is fixed or determinable at date of sale
- Buyer has, or is obliged to pay
- Buyer’s obligation will not be changed in event of theft, damage or destruction of product
- Buyer has economic substance
- Seller do not have significant obligations for future performance
- The amount of future returns can be reasonably estimated
Transaction related audit objectives:
Occurrence, completeness, accuracy, posting and summarization, classification, timing
Key internal controls and deficiencies for sale
- Adequate separation of duties
- Proper authorization
- Adequate documents and records
- Pre-numbered documents
- Monthly statement
- Internal verification process
For accounts receivables, these nine general management assertions as for all other accounts are of interest:
- Detail tie-in
- Existence
- Completeness
- Accuracy
- Classification
- Cut-off
- Realizable value
- Rights
- Presentation and disclosure
What are the key elements in designing test of controls and substantive tests of transactions for sales:
- Transaction related audit objective (occurrence, completeness, timing, accuracy, classification, posting and summarization)
- Key existing controls
- Test of controls
- Deficiencies
- Substantive test of transactions
Audit strategy
The external auditor must develop and document an audit strategy, which focuses on the expected scope and expected procedures of the audit.
Aspects to consider:
• Knowledge of business
• Understanding of accounting and internal control
• Risk and probability
• Type, time and scope of procedures
• Coordination, supervision and control
• Further related aspects (e.g. going concern)
Audit program
The auditor has to develop and document an audit program which compromises the type, time and scope of audit procedures required by the audit strategy.
o Guidance for involved auditors
What are the five types of audit tests/procedures?
- Understanding of internal control
- Tests of controls
- Substantive test of transactions
- Analytical procedures
- Tests of balances
What are the all elements of the planning process?
- Materiality
- Audit risk and inherent risk
- Understand internal control and assess control risk
- Detection risk
- Gather information to assess fraud risk
Internal control, key objectives
Internal control is a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance
- Operations
- Reporting
- Compliance
Internal control may help organization:
o Achieve objectives
o Ensure reliable financial reporting
o Ensure compliance with laws and regulations or avoid violation thereof
o Prevent reputational damage
Materiality
The magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have changed or influenced by the omission of the statement
Audit risk (Important concept)
The risk that the auditor expresses an inappropriate (wrong) opinion when the financial statements are materially misstated.
Steps in applying materiality:
- Set materiality for the financial statement
- Determine performance materiality
- Estimate total misstatement in segment
- Estimate the combined misstatement
- Compare combined estimate with preliminary or revised judgment about materiality
- > If combined estimate about misstatement is larger than preliminary judgment, the financial statements cannot be accepted
Acceptable audit risk
Measure of how willing an auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. I.e. lower acceptable audit risk means that the auditor wants to be more certain.
Type 1 error (statistics)
Reject something that is correct
Type 2 error (statistics)
Accept something that is wrong
Analytical procedures, what is the most important risk
- Are conducted in several phases of the audit
- Enhances the auditor’s understanding of the client’s business and assess client risk
- Reveal unusual changes compared to previous years or industry average
- Are used to assist in determining the nature, timing and extent of auditing procedures
- Help the auditor identify which areas represent specific risks of material misstatements
- Often based on aggregated company data, i.e. financial ratios
- > The most important risk of analytical procedures lies in the conclusion that an account is represented correctly although there are actual material misstatements (Type 2 error)
Substantive tests
Procedures designed to test for “dollar” misstatements that directly affect the correctness of the financial statements
Cycle approach
- Idea: keep closely related types or classes of transactions and account balances in the same segment.
- Audit becomes more manageable
- Considers risk and materiality in each field
- Easier to assign tasks
- Transaction cycles, see notebook
Audit evidence
o Information used by the auditor to determine whether the information being audited is stated in accordance with the established criteria
o Includes information contained in accounting records underlying the financial statements
o Major decision: Determine the appropriate types and amounts of evidence needed to satisfy that the client’s financial statements are fairly stated.
o Goal: Obtain sufficient evidence at lowest possible total cost
Persuasive evidence
o Appropriateness • Relevance of evidence • Reliability of evidence • Independent provider • Clients internal controls • Auditor’s knowledge • Quality of provided information • Degree of objectivity • Timeliness o Sufficiency • Adequate sample size • Higher risk leads to higher required sample • Higher quality of evidence leads to smaller required sample • Selection of proper population items
Management assertions
Implied or expressed representations by management about classes of transactions and related accounts in the financial statements
Occurrence
Transactions that have been recorded have occured
Completeness
All transactions that should have been recorded, have been recorded
Accuracy
Amounts and other data relating to recorded transactions and events have been recorded appropriately
Classification
Transactions have been recorded in the proper accounts
Cutoff
Transactions have been recorded in the correct accounting period
