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AUD > Evidence and Risk > Flashcards

Evidence and Risk Flashcards

1
Q

What is the majority of an auditor’s work in determining an audit opinion?

A

Collection of evidence to support the opinion.

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2
Q

Of what does audit Evidence consist?

A
  • Evidence consists of client accounting data and corroborating evidence from client or from third parties
  • Supports auditor’s opinion
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3
Q

What is the relationship between Evidence and Detection Risk?

A

Evidence has an inverse relationship with Detection Risk

The one aspect of Audit Risk an auditor can control through (N)ature (T)iming (E)xtent of audit procedures.

Inherent Risk and Control risk are outside of auditor’s control.

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4
Q

Which aspects of Audit Risk can an auditor control?

A

Detection Risk which is decreased by gathering evidence.

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5
Q

Which aspects of Audit Risk can an auditor NOT control?

A

Inherent Risk and Control Risk are outside of an auditor’s control.

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6
Q

How does a high level of acceptable Detection Risk affect an audit?

A

Less Evidence collected. Opens door for incremental audit risk - Internal Control should be strong.

Business and transactions should be relatively stable and predictable.

(N) Less-competent Evidence collected
(E) Fewer transactions are verified.
(T) Interim testing acceptable

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7
Q

What should occur when a low level of Detection Risk is acceptable?

A

More Evidence collected

(N) More-competent Evidence collected
(E) More transactions are verified
(T) End of year balance testing

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8
Q

What are the primary risks in an audit for a typical for-profit company?

A

Auditors are there to verify that

Assets & Revenues are not overstated
Expenses & Liabilities are not understated

Exception - if the CPA Exam states that it is a tax-driven company flip them around

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9
Q

What is the primary constraint on audit evidence?

A

Cost vs. Benefit is a primary constraint.

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10
Q

What characteristics should audit evidence have?

A

Sufficient (quantity)

Appropriate: Relevant & Reliable (Quality)

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11
Q

How does the quality of audit evidence vary depending on who has provided it?

A

Best evidence: Observation of activity by auditor.

2nd Best: Originates from External Parties and is sent directly to auditor (or failing that items are generated by third party and provided to auditor by the client such as a bank statement)

Weakest: Oral evidence from management.

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12
Q

Which documents are the most persuasive and credible?

A

Third party documents are more persuasive and credible than internally-prepared docs

Auditor Knowledge = Most Persuasive

3rd Party info given to auditor

3rd Party info given to client

Internally-prepared doc

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13
Q

What are Substantive Procedures?

A

Test substance/amounts/values. They help to reduce the risk of material misstatements. They only test accuracy of financial statements and dollar amounts - they don’t test internal controls.

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14
Q

What are the substantive tests that are most often performed?

A 
Trace (or Vouch)
Reconcile
Analytical Procedures
Confirmations
Examine evidence that supports management assertions.

(T.R.A.C.E.)

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15
Q

When performing audit procedures what should auditors focus on?

A

Auditors focus first on Balance Sheet Accounts then associated Income Statement items

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16
Q

How is Cash audited?

A

Assurance Level is High.

Acceptable Detection Risk is Low.

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17
Q

How is Accounts Receivable audited?

A

If Acceptable DR is High - Negative Confirmation is used - Customer only responds if balance is materially wrong.

If Acceptable DR is Low - Positive Confirmation is used - Customer asked to confirm by telling auditor the balance.

Corresponding Income Statement Account - Revenue

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18
Q

How is Accounts Payable audited?

A

Review purchase orders/invoices

Confirm with Vendors

Corresponding Income Statement Account - Various Expenses

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19
Q

How is Inventory audited?

A

Examine purchase agreements

Look at Board Minutes

Is Inventory held as collateral?

Corresponding Income Statement Account - COGS

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20
Q

How are beginning balances audited?

A

Should match last year’s ending balance.

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21
Q

What is the general presumption for auditing Ending Balances?

A

If Beginning Balance Additions Subtractions are OK then Ending Balances should also be OK.

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22
Q

How is a Statement of Cash Flows audited?

A

Foot all balances - Check the Math

Trace Cash Flow items to other Financial Statements

Check classifications - Operating Activities Investing Activities Financing Activities

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23
Q

Under the Indirect Method what must be disclosed on a Statement of Cash Flows?

A

Interest Paid

Income Taxes Paid

Non-cash Transactions

Cash and Cash Equivalents Definitions

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24
Q

Under the Direct Method what must be disclosed on a Statement of Cash Flows?

A

Results as if you had used Indirect Method

Non-cash Transactions

Cash and Cash Equivalents Definition

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25
Q

What are Subsequent Events and what do they require?

A

Subsequent events occur after the Balance Sheet Date but before the audit report is issued.

Auditor needs to make inquiries and assess if they affect the audit report.

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26
Q

What should occur if the audit report has already been issued and the auditor becomes aware of a situation that was present as of the Balance Sheet date (a subsequent event)?

A

If audit report has already been issued and auditor becomes aware of a situation that was present as of the BS date client should issue a disclosure to financial statement users and/or revise the financial statement.

Regulatory agencies might need to get involved under some circumstances.

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27
Q

What should an auditor do if they discover they have forgotten to perform a substantive procedure?

A

If auditor discovers that they forgot to perform a substantive procedure auditor should determine if other substantive procedures performed served as a substitute.

Otherwise support for their audit opinion could be jeopardized.

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28
Q

When are Analytical Procedures required?

A

REQUIRED When planning the audit (preliminary)

REQUIRED When reviewing the audit (final)

Analytical procedures may be also performed optionally along with the substantive testing.

Use of Analytical Procedures in the audit must be documented.

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29
Q

How do Analytical Procedures assist the auditor?

A

Helps the Auditor:

Determine if Management Assertions are reasonable

Develop audit plan

Develop some expectations about the financial statement and hopefully bring to light any glaring errors on financial statement

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30
Q

What is the focus of Analytical Procedures?

A

Analytical Procedure focus is on dollar amounts (not internal controls)

Analyzes Financial Data: Do Financial Statements Make Sense?

Comparison of data between years

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31
Q

How is the Current Ratio calculated?

A

Current Ratio = Current Assets / Current Liabilities

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32
Q

How is the Quick Ratio calculated?

A

Quick Ratio = Liquid Assets / Current Liabilities

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33
Q

How is the Asset Turnover calculated?

A

Asset Turnover = Net Sales / Average Assets

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34
Q

How is the Inventory Turnover calculated?

A

Inventory Turnover = COGS / Average Inventory

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35
Q

How is Gross Margin % calculated?

A

Gross Margin % = Gross Margin / Sales

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36
Q

What type of testing are ratios?

A

Ratios are Analytical Procedures

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37
Q

What type of procedure is a Budget vs. Actual comparison?

A

Budget vs. Actual comparisons are Analytical Procedures.

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38
Q

List Common Types of Analytical Procedures

A

Ratio analysis

Budget vs. Actual comparison

Comparison of data between years

Use of non-financial data to predict expected values for financial data

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39
Q

How do management assertions affect the audit?

A

Management assertions help the auditor to plan the audit and select substantive tests.

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40
Q

What assertions do auditors test?

A

“COVER-U”
Completeness - account balances, transactions, disclosures
Cutoff - transactions
Valuation, Allocation and Accuracy - account balances, transactions, disclosures
Existence and Occurence - balances, transactions
Rights & Obligations - balances, disclosures
Understandability & Classification - transactions

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41
Q

What assertions are tests for transaction classes?

A

“COVE-U”

Completeness
CutOff
Valuation, Allocation, and Accuracy
Existence & Occurrence
Understandability & Classification
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42
Q

For which assertions are presentation & disclosures tested?

A

CVRU

Completeness
Valuation, Allocation, and Accuracy
Rights & Obligations
Understandability & Classification

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43
Q

Is testing the validity of direct evidence a basic audit procedure?

A

No it is an extended procedure.

For example you don’t have to take a loan covenant document and go search out that it’s a valid loan covenant. Instead you consider the source - if it’s externally prepared it’s more persuasive.

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44
Q

How are Management Estimates audited?

A

First and foremost you need to understand management’s rationale and methods for developing estimates before you can judge reasonableness.

Next Auditor should formulate their own opinion on what a good estimate should be and compare it.

Finally determine if subsequent events affect the estimate.

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45
Q

Whose property are audit documentation (audit workpapers)? In what form must they be?

A

Audit workpapers are the property of the auditor.

They can be paper or electronic.

They must include a WRITTEN audit program (either paper or electronic).

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46
Q

What is the Current File?

A

Information pertaining to the current year’s audit.

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47
Q

What is the Permanent File?

A

Information used for this audit and future audits which is updated as needed.

48
Q

How long must audit workpapers be maintained?

A

Must be kept for 5 years after the audit release date or according to regulations whichever is longer.

Must be kept for 7 years under PCAOB Audit

PCAOB audits also require an Engagement Completion Document

49
Q

What is the primary requirement for audit workpapers besides being written?

A

Any experienced auditor should be able to look at your work and understand what you did.

50
Q

How should documents added to work papers be treated?

A

If further documents are added to the work papers after the audit report is issued it must be documented as to who added them why they were added and any effects on the audit report.

51
Q

How should documents removed from workpapers be treated?

A

After the audit report is released the firm has 60 days to subtract from the file.

You can still add to the file if you document it but you cannot delete any information after 60 days.

Note - for SEC auditors the PCAOB only allows deletions up to 45 days after issuance of the audit report.

52
Q

What is audit risk?

A

Risk that auditor will unknowingly fail to appropriately modify the opinion on F/S that are materially misstated

53
Q

How is Audit Risk calculated?

A

Inherent Risk x Control Risk x Detection Risk

54
Q

Describe Control Risk

A

Risk that internal control will not detect error or fraud; Auditor cannot control this.

55
Q

Describe Inherent Risk.

A

Which transactions have a higher level of risk? Client’s accounting system has errors; Auditor cannot control

Susceptibility of a F/S assertion to a material misstatement assuming there are no related controls

56
Q

Describe Detection Risk.

A

Risk that the auditor will not detect a material misstatement; Auditor CAN control

Do testing at year-end; Increase substantive testing; Run more effective tests

57
Q

What responses should an auditor take based on different levels of acceptable detection risk (DR)? What type of tests should be performed?

A

Less Acceptable DR = Run More Substantive Tests
More Acceptable DR = Run Less Substantive Tests
More Substantive Tests (DR down) = Less Audit Risk; (AR = IR x CR x DR)
Less Substantive Tests (DR up) = More Audit Risk; (AR = IR x CR x DR)

58
Q

Whose responsibility is it to FIND and PREVENT fraud?

A

It is Management’s responsibility.

59
Q

What is the auditor’s responsibility with respect to fraud and illegal acts?

A

Assess the RISK that such things will lead to material misstatements
Design the audit to provide reasonable assurance against fraud- illegal acts that directly and materially affect the financial statements
Report ALL management fraud to the audit committee (minor fraud by low-level employees not reported to committee)
Perform required inquiries and procedures (management inquiries- analytical procedures- discussions with audit personnel about fraud)

60
Q

What are the three factors that affect/influence fraud?

A

Fraud is born out of:
Pressure/Incentive
Opportunity
Rationalization

61
Q

What is the difference between fraud and errors?

A

Errors are unintentional

Fraud is intentional.

62
Q

What red flags may indicate higher risk in an audit?

A
  • Management compensation tied to stock
  • Aggressive financial forecasting
  • Former auditor disagreed with Management
  • Records not available for audit

Current audit procedures may need to be reconsidered if red flags exist.

63
Q

Describe the characteristics of a Fraud Risk Factor.

A

Has been observed in similar situations
Does NOT necessarily mean that there is a material weakness in internal control
Leads to an auditor taking action

64
Q

What does an examination of internal control accomplish with respect to illegal acts?

A

Internal control analysis can result in the conclusion that IC is weak- but probably won’t identify illegal acts

65
Q

What is the purpose of adjusting audit procedures in light of fraud risk factors identified during an audit?

A

Strives to make audit engagement procedures less patterned and predictable

Re-evaluates management’s application of accounting procedures

Finds and assigns audit personnel with relevant skills in this area

66
Q

What should be documented with respect to fraud risk factors in an audit?

A

Any fraud risks identified that could lead to material misstatement
Audit procedures performed to assess risks
Nature of communication made to audit committee and company management
Disclosure to third parties regarding fraud not normally the auditor’s responsibility
Fraud by management should normally be reported to the audit committee- NOT the SEC.

67
Q

What are some examples of misstatements?

A
  • Inaccuracies
  • Departures from GAAP
  • Omissions
  • Incorrect estimates or judgments
  • Inappropriate selection or application of accounting policies
68
Q

What are the three types of misstatements?

A

1) Factual/Known
2) Judgmental
3) Projected

69
Q

What are the three types of fraud?

A

1) Fraudulent financial reporting (lying)
2) Misappropriation of Assets (stealing)
3) Corruption (cheating)

70
Q

What procedures can an auditor perform to identify fraud risks?

A

1) Inquire of entity personnel
2) Analytical procedures
3) Fraud risk factors - presence & absence

71
Q

How can an auditor respond to assessed fraud risk?

A

1) Overall general response (assign personnel, supervision, evaluate selection of accounting principles, and unpredictability of audit)
2) Specific audit procedures
3) Management override (adjustments, accounting estimates, and unusual transactions).

72
Q

How should fraud be communicated with client?

A

Report to one level above those involved - discuss with senior management and report to governance

73
Q

What are some third parties that the CPA must communicate with?

A

1) Legal & regulatory
2) Successor auditor
3) Subpoena response
4) Governmental agencies
5) Authorities

74
Q

What is fraud risk?

A

Risk that misstatements will arise from fraudulent financial reporting and misappropriation of assets

75
Q

What are the auditor’s and management’s responsibility towards laws & regulations?

A

Management - making sure everything is in accordance with laws & regulations
Auditor - obtains reasonable assurance; not responsible for preventing noncompliance and cannot be expected to detect noncompliance with ALL laws and regulations.

76
Q

What should an auditor do in a case of noncompliance by management or governance?

A

1) If management involved, go to governance or one level above
2) If that fails, obtain legal advice or withdraw

77
Q

When should an auditor report noncompliance to regulatory authorities?

A

Normally not a part of auditor’s responsibility:

1) response to predecessor auditor
2) response to court order
3) government agencies for financial assistance requirements

78
Q

How should noncompliance be presented in an auditor’s report?

A

1) Material effect on F/S = GAAP issue - Qualified/Adverse
2) Insufficient evidence = GAAS issue - Qualified/Disclaimer
3) Client response/refuse = GAAS issue - withdraw

79
Q

What can an auditor do to assess risk of material misstatement?

A

“IMACPA”

1) Obtain understanding of entity & it’s environment, including Internal Control
2) Assess risks of Material Misstatement
3) Further audit procedures
4) Test internal controls to evaluate their operating effectiveness
5) Perform substantive procedures
6) Audit evidence - evaluate sufficiency & appropriateness

80
Q

What are the risk assessment procedures?

A

1) Inquiry
2) Analytical Procedures
3) Observation & Inspection
4) Risk Assessment discussion with audit team

81
Q

What does Tracing test?

A

Tests Completeness

Starts with source document and traces forward to the journal entry.

82
Q

What does Vouching test?

A

Tests Existence

Starts with a journal entry and searches for a voucher or source document to support the entry.

83
Q

With respect to signing checks - how are duties segregated?

A

Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKSTip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves

84
Q

With respect to custody of assets - how should duties be segregated?

A

Employees who have custody of assets should not also RECORD those assets
Someone in charge of petty cash should not also control the petty cash records
Treasury Department (custodians) should NOT have record keeping duties
They control assets and should not be able to adjust any recording of those assets

85
Q

What is the audit evidence hierarchy?

A

“AEIOU”

1) Auditor’s direct personal knowledge “COIRE”(Observation, Examination, Inspection, Recalculation, Confirmation)
2) External evidence
3) Internal evidence
4) Oral evidence
4) U know it.

86
Q

What are the standard audit procedures?

A

“FIVE CARROT CARS”

1) Footing, Cross-footing, and Recalculation
2) Inquiry
3) Vouching
4) Examination/Inspection
5) Confirmation
6) Analytical Procedures
7) Re-performance
8) Reconciliation
9) Observation
10) Tracing
11) Cutoff Review
12) Auditing related accounts simultaneously
13) Representation letter
14) Subsequent events review

87
Q

What assertions are tests for account balances?

A

“CVER”

Completeness
Valuation, Allocation, and Accuracy
Existence & Occurrence
Understandability & Classification

88
Q

What audit procedures are performed for the completeness assertion?

A

Tracing
Analytical review
Observation

89
Q

What audit procedures are performed for the cutOff assertion?

A

Cutoff procedures

90
Q

What audit procedures are performed for the valuation, allocation, and accuracy assertion?

A

Inspection
Footing
Independent recalculation
Reconciliation

91
Q

What audit procedures are performed for the existence & occurrence assertion?

A 
Vouching
Observation
Inspection
Confirmation
Examination
92
Q

What audit procedures are performed for the rights & obligations assertion?

A

Inspection

93
Q

What audit procedures are performed for the understandability & classification assertion?

A

Inspection
Review
Inquiry

94
Q

What are the procedures to be take with related party transactions?

A

1) Controls related to authorization/approval of related party transactions. Obtain conflict of interest statement from client
2) Names of all related parties
3) Review reports filed with SEC and other agencies
4) Review material transactions (minutes, etc)
5) Review PY audit documentation or inquire of predecessor auditor

95
Q

What are some things that maybe indicative of related party transactions?

A

1) Compensating balance arrangements
2) Loan guarantee
3) Unusual, nonrecurring transactions near year end
4) Transactions based on terms that differ from market terms (not arms length)
5) Nonmonetary exchanges

96
Q

What happens when the auditor discovers related party transactions that he/she was not aware of?

A

1) Communicate information to the team
2) Request management to identify all transactions
3) Inquire why controls failed to identify related party
4) Perform substantive procedures
5) Reconsider risk
6) Evaluate audit implications

97
Q

What are the auditor’s responsibilities while evaluating estimates?

A

1) Evaluate estimation uncertainty
2) Assess written policies/practices
3) All material estimates have been developed
4) Reasonableness
5) Presented and disclosed in conformity with GAAP

98
Q

What do PCAOB standards say on estimate amounts?

A

Auditor must propose AJE if the amount seems unreasonable.

99
Q

What are the 4 things in regards to estimate reporting?

A

1) Consistent method with prior year
2) Past track record of estimates is accurate
3) Justify changes in approach
4) Appropriate in relation to industry

100
Q

What are different levels of fair value reporting?

A 
Level 1 (identical) & Level 2 (similar) - Market Value
Level 3 (DCF) - Estimates & valuation methods
101
Q

What are some examples of contingent liabilities?

A

1) Pending & threatened litigation
2) Actual or possible claims & assessments
3) Guarantees of the indebtedness of others
4) Product warranties
5) Income tax disputes

102
Q

What should an auditor do to identify contingent liabilities?

A

Ask management about them and controls related to them.

Review:

  • Minutes
  • Correspondence & invoices from lawyers
  • Contracts, loan agreements, leases, correspondence from tax authorities
  • Bank confirmations for hidden accounts, guarantees, etc
  • Long term purchase commitments
  • Long term leases
  • Discuss sales contracts
  • Interim financial statements
  • Client representation letter
  • Inquiry to attorneys
103
Q

What audit evidence does an auditor need for inquiry of litigation, claims, assessments, etc?

A

1) Period
2) Degree of probability of an unfavorable outcome
3) Amount or range

104
Q

What do inquiries of client’s attorneys consist of?

A

Means of corroborating information

-Response might be limited due to “substantial attention” limitation or confidentiality limitation

105
Q

What should an auditor do if a client’s attorney refuses to respond?

A

Scope limitation - Qualified opinion or Disclaimer of opinion

106
Q

What should an auditor do if a client refuses the auditor to contact the attorney?

A

Disclaimer of opinion or Withdrawal

107
Q

What type of audit evidence must an auditor gather for evaluation of audit results according to PCAOB?

A
  • Results of analytical procedures performed in the overall review stage
  • Misstatements found in the audit (must evaluate materiality & communicate to management)
  • Qualitative aspects of the company’s accounting practices
  • Conditions that related to fraud risk
  • Presentation of F/S, including disclosures
  • Sufficiency & appropriateness of the audit evidence
108
Q

What is an engagement quality review?

A

Review performed by a partner who is not otherwise associated with the engagement

109
Q

What is a concurring approval of issuance?

A

Firm cannot give the client permission to use the engagement report until the quality reviewer provides concurring approval of issuance. This will be provided if there are no significant deficiencies:

  • Cannot obtain sufficient appropriate evidence
  • Inappropriate overall conclusion
  • Report is not appropriate
  • Firm is not independent
110
Q

What is management’s responsibility regarding fair values?

A

Responsible for making fair value measurements & disclosures in accordance with GAAP

  • Use appropriate valuation methods to estimate FV
  • Valuation methods should incorporate assumptions
  • Management should identify & support any significant assumptions
111
Q

What is auditor’s responsibility regarding fair values?

A

Obtain sufficient appropriate audit evidence to provide reasonable assurance that fair value measurements & disclosures are in conformity with GAAP

  • Understand processes & controls
  • Assess risk of material misstatement
  • Evaluate conformity with GAAP
  • Consider need for specialist
  • Test fair value measurements & disclosures
  • Evaluate sufficiency, competency, and consistency
  • Obtain management representations
  • Communicate relevant matters to governance
112
Q

What procedures should an auditor perform in evaluating management’s accounting estimates?

A

1) Obtain an understanding of how estimates are developed
2) Consider appropriateness of key factors/assumptions
3) Develop independent expectations, test calculations, and subsequent events.

113
Q

What are some qualitative factors in evaluating materiality of an uncorrected misstatement?

A
  • Effect of misstatement on segment information
  • Existence of statutory or regulatory requirements
  • Effects of misclassifications between operating *non operating income
  • Significance of the misstatement relative to user needs
  • Existence of offsetting effects of individually significant but different misstatements
  • Likelihood that a misstatement that is current immaterial will have a material effect in the future
  • Cost of the correction
  • Risk of possible additional undetected misstatements
114
Q

What are some examples of management’s bias?

A
  • Selective correction of misstatements brought to management’s attention during the audit
  • Identification of AJE’s by management that offset misstatements accumulated by auditor
  • Bias in the selection and application of accounting principles
  • Bias in accounting estimates
  • Bias in management’s judgments
115
Q

What are some examples that would heighten an auditor’s concern about the risk of fraudulent financial reporting (lying)?

A

1) An overly complex organizational structure with unusual lines of authority
2) An entity’s industry is experiencing declining customer demand
3) Inability to generate cash flows from operations while reporting substantial earnings growth
4) Management is interested in maintaining the entity’s earnings trend by using aggressive accounting practices
5) Management has frequent disputes with the auditor on accounting matters
6) Management places substantial emphasis on meeting earnings projections

AUD (9 decks)

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