Evidence and Risk

Question 1

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

1

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

1

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

1

Which aspects of Audit Risk can an auditor control?

Answer 4

Detection Risk which is decreased by gathering evidence.

Question 5

1

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

1

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

1

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

1

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

1

What is the primary constraint on audit evidence?

Answer 9

Cost vs. Benefit is a primary constraint.

Question 10

1

What characteristics should audit evidence have?

Answer 10

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

Question 11

1

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

1

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

1

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

1

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

1

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

1

How is Cash audited?

Answer 16

Assurance Level is High. Acceptable Detection Risk is Low.

Question 17

1

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

1

How is Accounts Payable audited?

Answer 18

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

Question 19

1

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

1

How are beginning balances audited?

Answer 20

Should match last year’s ending balance.

Question 21

1

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

1

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

1

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

1

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

1

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

1

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

1

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

1

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

1

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

1

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

1

How is the Current Ratio calculated?

Answer 31

Current Ratio = Current Assets / Current Liabilities

Question 32

1

How is the Quick Ratio calculated?

Answer 32

Quick Ratio = Liquid Assets / Current Liabilities

Question 33

1

How is the Asset Turnover calculated?

Answer 33

Asset Turnover = Net Sales / Average Assets

Question 34

1

How is the Inventory Turnover calculated?

Answer 34

Inventory Turnover = COGS / Average Inventory

Question 35

1

How is Gross Margin % calculated?

Answer 35

Gross Margin % = Gross Margin / Sales

Question 36

1

What type of testing are ratios?

Answer 36

Ratios are Analytical Procedures

Question 37

1

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

Answer 37

Budget vs. Actual comparisons are Analytical Procedures.

Question 38

1

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

1

How do management assertions affect the audit?

Answer 39

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

Question 40

1

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

1

What assertions are tests for transaction classes?

Answer 41

Occurrence Cutoff Classification Completeness Accuracy

Question 42

1

For which assertions are disclosures tested?

Answer 42

Occurrence Completeness Classification Accuracy

Question 43

1

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

1

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

1

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

1

What is the Current File?

Answer 46

Information pertaining to the current year’s audit.

Question 47

1

What is the Permanent File?

Answer 47

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

Question 48

1

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

1

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

1

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

1

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.

Question 52

1

What does an audit procedures should be applied to Required Supplementary Information?

Answer 52

The auditor should make management inquiries about RSI and obtain written assertions regarding its preparation. The auditor should compare the RSI to the rest of the financial statements to ensure consistency.