Exam 1 Flashcards
Why is auditing necessary?
Shareholders- who the auditors give the opion to
Governance:hire auditors
Management- obtain evdience for auditors
conflicts of interest
management and shareholders
Information asymmetry
Internal information not present in financial statements
when is an audit required
public company or required by SEC or Bank
Audit
A systematic process of objectively obtaining and evaluating evidence to corroborate another party’s assertions, and communicating the results to interested users.
Attest
When a professional is engaged to issue a report on specific subject matter, or an assertion about subject matter.
Example: A report regarding the effectiveness of internal controls
Assurance
Independent professional services that improve the quality of information, or its context, for decision makers.
Example: A report reviewing a potential vendor contract
Assurance
involves everything is less involed
Three fundamental concepts
Materiality-Audit Risk-Evidence
Materiality
the amount by which a set of financial statements could be misstated by, without affecting the judgment of a reasonable user.
Auditors make materiality assessments during the planning stage of an audit, but are required to continually assess the appropriateness of such assessments throughout an audit
Planning materiality • Tolerable misstatement • PAJE threshold
Audit risk
the risk that the auditor expresses an inappropriate audit opinion (i.e., clean) when the financial statements are materially misstated (also known as a type II error
Audit risk is decided
by an executive on the audit (i.e., audit partner) before an audit begins and must not change.
•
Audit procedures are designed in order to maintain this pre-determined level of audit risk
Audit evidence
Otherwise stated as evidence regarding management’s assertions (chapter 5).
•
It involves the underlying accounting data and any additional information available to the auditor, whether from the client or an external source.
Audit sampling
Making inferences based on limited observations.
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Statistical and Non-Statistical sampling is acceptable.
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There is an inverse relationship between materiality and sample size.
•
Sampling is used out of concern for efficiency.
The independent auditor’s report
After performing all of their procedures, the auditor provides their conclusion to the users of the financial statements.
•
It’s the deliverable and accompanies every audit
•
The title line of the audit report includes the word independent, and usually, the report is addressed to the stockholders of the company.
Unqualified
Clean
Qualified
except for
Adverse
negative
Disclaimer
omits
Types of auditors
External auditors • Internal auditors • Government auditors • Forensic auditors
audit services
Financial Statement Audit • Internal Control Audits • Compliance Audits • Operational Audits • Forensic Audits
Audit firm organization
Partner • Manager • Senior/In-charge • Staff • Intern
Five business processes
Financing Process (we will largely ignore)
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Purchasing Process
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Human Resource Process (we will largely ignore)
•
Inventory Management Process (we will largely ignore)
•
Revenue Process
•
I add a sixth: Cash Management Process
external audit
independant company
internal audit
works for the company
Types of audit tests
Risk Assessment Procedures
Tests of controls
Substantive Procedures
Risk Assessment Procedures
Assess Financial Statement and Assertion Level Risks • Inherent and Control Risks • High/Moderate/Low
Preliminary engagement activites
Independence requirements • Annual Independence Questionnaire • Audit Team Independence Checklist • Unpaid audit fees • Must be documented
Engagement letter
Auditing standards require written communication
Risk Assessment
Overall and account level
Materiality Assessments
TM, PM, PAJE
Specialists
Industry, IT, other
Documentation
Audit plan
•
Prepare audit programs
3 Steps to Applying Materiality
Determine Planning Materiality Determine PAJE Threshold Determine Tolerable Misstatement
risk assement
inherent risk
control risk
level of assurance
PAJE
determine an inconquntional amount
Audit risk
RMMxDR
inherent and control
RMM (IR x CR)
is risk attributable to the client
•
Inherent – risk that a material misstatement could occur, without any consideration of the controls in place
•
Control – risk that a material misstatement could occur, and not be prevented, or detected and corrected by internal controls
Detection Risk
risk that the auditor controls through
Audit Risk Model in Practice
Three steps involved in using the ARM • (1) Setting a planned level of audit risk • (2) Assessing RMM • (3) Selecting
The auditor’s understanding of the entity and its environment includes
Nature of the entity • Industry, regulation and other external factors (Table 4-2) • Objectives, strategies and related business risks (Table 4-3) • Entity performance measures • Internal controls
How to calculate PM:
Step #1 – choose the appropriate accounting base
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The accounting base should be (1) representative, (2) predictable, and (3) stable
•
Examples include: net income before taxes (profit-oriented); total assets (asset-based company); total revenues (not-for-profit)
•
Step #2 – choose the appropriate percentage to multiply against the accounting base
•
Table 3-5 provides relevant percentages
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Qualitative factors
Determine Tolerable Misstatement
Generally determined in 1 of 2 ways
•
Consistent Method – TM calculation is the same for every F/S account
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Disaggregated Method – TM is calculated separately for each F/S account
Determine PAJE Threshold
This is for determining a clearly inconsequential difference
•
Aids audit testing
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General rule of thumb: 5% of PM or 10% of TM (if Consistent Method is used)
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Fraud is NEVER immaterial
Audit evidence
All the information, from whatever source, used by the auditor in arriving at the conclusions on which the audit opinion is based
Management Assertions
Representations made by management regarding the recognition, measurement, presentation, and disclosure of financial information.
7 Assertions
Existence/Occurrence Rights and Obligations Completeness Authorization Accuracy/Valuation Cutoff Classification
Existence/Occurrence
Transactions have occurred, account balances exist, and disclosed events have occurred
Rights and Obligations
The entity holds appropriate rights to assets, and liabilities are obligations of the entity.
Completeness
All transactions and accounts that should have been recorded have been recorded. All disclosures that should have been included in the financial statements are included.
Authorization
All recorded transactions have been appropriately authorized.
Accuracy/Valuation
All transactions, accounts and disclosures have been included in the financial statements at the appropriate amount
Cutoff
Transactions have been recorded in the appropriate accounting period.
Classification
Transactions are recorded in the appropriate account
The concepts of audit evidence
Nature of audit evidence
Sufficiency and appropriateness of audit evidence
Evaluation of audit evidence
Sufficiency
is the measure
of the quantity of audit evidence
Appropriateness
is the measure
of the quality of audit evidence
existence/occurance
assets
completeness
liabilaties
risk assessment procedures
are alwasy done
- Which of the following best describes relationships among auditing, attest, and assurance services
c. Auditing is a type of assurance service
- Which of the following is commonly referred to as an “Except-for” opinion
b. Qualified
- Who is responsible for hiring the auditor for a public company
c. The audit committee
- Happy Auditor selected a sample of accounts receivable for testing, based on a materiality assessment of $10,000,000. Happy’s manager reviewed Happys work and exclaimed, “Happy, materiality is $1,000,000, not $10,000,000. Which of the following is most appropriate?
c. Happy sampled to few items, as a result, Happy should add some items to the sample selection
- Name 2 out of the three fundamental concepts covered during the prior lecture
a. Audit risk
b. Materiality
c. Evidence collection
