Evidence and Risk

Question 1

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

Answer 1

Collection of evidence to support the opinion.

Question 2

Of what does audit Evidence consist?

Answer 2

Evidence consists of client accounting data and supporting documentation from client or from third parties.

Question 3

What is the relationship between Evidence and Detection Risk?

Answer 3

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.

Question 4

Which aspects of Audit Risk can an auditor control?

Answer 4

Detection Risk which is decreased by gathering evidence.

Question 5

Which aspects of Audit Risk can an auditor NOT control?

Answer 5

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

Question 6

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

Answer 6

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 (T) Interim testing acceptable (E) Fewer transactions are verified.

Question 7

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

Answer 7

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

Question 8

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

Answer 8

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

Question 9

What is the primary constraint on audit evidence?

Answer 9

Cost vs. Benefit is a primary constraint.

Question 10

What characteristics should audit evidence have?

Answer 10

Sufficient (quantity) Appropriate: Relevant & Reliable (Quality)

Question 11

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

Answer 11

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.

Question 12

Which documents are the most persuasive and credible?

Answer 12

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

Question 13

What are Substantive Procedures?

Answer 13

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.

Question 14

What are the substantive tests that are most often performed?

Answer 14

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

Question 15

When performing audit procedures what should auditors focus on?

Answer 15

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

Question 16

How is Cash audited?

Answer 16

Assurance Level is High. Acceptable Detection Risk is Low.

Question 17

How is Accounts Receivable audited?

Answer 17

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

Question 18

How is Accounts Payable audited?

Answer 18

Review purchase orders/invoices Confirm with Vendors Corresponding Income Statement Account - Various Expenses

Question 19

How is Inventory audited?

Answer 19

Examine purchase agreements Look at Board Minutes Is Inventory held as collateral? Corresponding Income Statement Account - COGS

Question 20

How are beginning balances audited?

Answer 20

Should match last year’s ending balance.

Question 21

What is the general presumption for auditing Ending Balances?

Answer 21

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

Question 22

How is a Statement of Cash Flows audited?

Answer 22

Foot all balances - Check the Math Trace Cash Flow items to other Financial Statements Check classifications - Operating Activities Investing Activities Financing Activities

Question 23

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

Answer 23

Interest Paid Income Taxes Paid Non-cash Transactions Cash and Cash Equivalents Definitions

Question 24

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

Answer 24

Results as if you had used Indirect Method Non-cash Transactions Cash and Cash Equivalents Definition

Question 25

What are Subsequent Events and what do they require?

Answer 25

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.

Question 26

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)?

Answer 26

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.

Question 27

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

Answer 27

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.

Question 28

When are Analytical Procedures required?

Answer 28

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.

Question 29

How do Analytical Procedures assist the auditor?

Answer 29

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

Question 30

What is the focus of Analytical Procedures?

Answer 30

Analytical Procedure focus is on dollar amounts (not internal controls) Analyzes Financial Data: Do Financial Statements Make Sense? Comparison of data between years

Question 31

How is the Current Ratio calculated?

Answer 31

Current Ratio = Current Assets / Current Liabilities

Question 32

How is the Quick Ratio calculated?

Answer 32

Quick Ratio = Liquid Assets / Current Liabilities

Question 33

How is the Asset Turnover calculated?

Answer 33

Asset Turnover = Net Sales / Average Assets

Question 34

How is the Inventory Turnover calculated?

Answer 34

Inventory Turnover = COGS / Average Inventory

Question 35

How is Gross Margin % calculated?

Answer 35

Gross Margin % = Gross Margin / Sales

Question 36

What type of testing are ratios?

Answer 36

Ratios are Analytical Procedures

Question 37

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

Answer 37

Budget vs. Actual comparisons are Analytical Procedures.

Question 38

List Common Types of Analytical Procedures

Answer 38

Ratio analysis Budget vs. Actual comparison Comparison of data between years Use of non-financial data to predict expected values for financial data

Question 39

How do management assertions affect the audit?

Answer 39

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

Question 40

What assertions do auditors test?

Answer 40

Presentation - Cutoff Classification - Is it in the right period and category? Existence/ Occurrence - Did it happen? Does it exist? Rights & Obligations - Does the company own them? Completeness - Was everything recorded? Valuation - Are they worth the amount at which they are recorded? (PERCV)

Question 41

What assertions are tests for transaction classes?

Answer 41

Occurrence Cutoff Classification Completeness Accuracy

Question 42

For which assertions are disclosures tested?

Answer 42

Occurrence Completeness Classification Accuracy

Question 43

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

Answer 43

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.

Question 44

How are Management Estimates audited?

Answer 44

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.

Question 45

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

Answer 45

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).

Question 46

What is the Current File?

Answer 46

Information pertaining to the current year’s audit.

Question 47

What is the Permanent File?

Answer 47

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

Question 48

How long must audit workpapers be maintained?

Answer 48

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

Question 49

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

Answer 49

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

Question 50

How should documents added to work papers be treated?

Answer 50

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.

Question 51

How should documents removed from workpapers be treated?

Answer 51

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.