Exam 2 Flashcards
audit sampling
The application of an audit procedure to less than 100 percent of the items for the purpose of evaluating some characteristic of the balance or class.
sampling risk
The possibility that a properly drawn sample may not be representative of the underlying population. The auditor may thus form a different conclusion
procedures that use sampling
Inspection of tangible assets (e.g., inventory)- not easy to look at all inventory
Inspection of records or documents- thousands of contracts
Confirmations- have people confirm that the amount of money they owe is correct
Reperformance- auditor redoes a calculation
procedures that do not use sampling
(Easy to look at entire populations) Analytical procedures- using regression Scanning Inquiry- ask questions about everything Observation- easy to observe all people
advantages of statistical sampling
Plans an efficient sample- gives exact sample size needed
Objective way to determine whether there is enough evidence and whether it is right or wrong
Disadvantages of statistical sampling
Costly to train auditors
Requires semi-random method to draw sample
Selecting items to be tested
systematic sampling formula
in population/ # in desired sample size = sampling interval
haphazard selection
Made without any special reason for including or excluding an item.
Cannot be used in statistical sampling, because it is not based on defined probability concepts.
attribute sampling
Testing controls for effectiveness
Primarily used to assess control risk, by conducting tests of controls
attributes sampling examples
Credit only given to only to authorized customers.
Billing department verification of agreement of sales invoice prices with authorized prices.
Purchase department approval of purchase requisitions.
Variables sampling
Estimating dollar amounts or quantities—primarily to limit detection risk by conducting substantive testing
Ex. Tests of inventory quantities and amounts.
Tolerable deviation rate
The maximum rate of deviations from the control policy that an auditor could accept without altering the planned assessed level of control risk.
Tests of Controls Sampling Steps
Determine the objective Define deviation conditions Define population Specify risk of assessing control risk too low and tolerable deviation rate. Estimate population deviation rate Determine sample size Select the sample Perform the sampling plan Evaluate sample results Document sampling procedure
probability proportional to size
Population is the individual dollars of the population book value
Uses stratification- 3rd dollar- customer 2, 8th dollar- customer 3
Advantages of PPS sampling
Smaller sample sizes than classical sampling
Automatically results in a stratified sample
Sample can be designed and sample selection can begin prior to availability of entire population..
Easier to apply- everyone has a semi-random sample
Disadvantages of PPS sampling
Accounts with zero balances.
Accounts with negative balances.
Accounts are understated.
projected misstatement
The most likely amount of any misstatement in a population
Upper limit on misstatements
Calculating upper limit on misstatements
projected misstatement +
basic precision +
incremental allowance (for projected misstatements)
Calculate basic precision
Reliability Factor x Sampling Interval
Calculate incremental allowance
(Reliability factor Increment - 1) x projected misstatement
Calculate projected misstatement
((Book Value - Audited Value)/ Book value) * projected sampling interval
imprest account
balance maintained at a fixed amount; i.e. petty cash
internal control guidelines for cash
Do not permit any one employee to handle a transaction from beginning to end.
Separate cash handling from recordkeeping.
Centralize receiving of cash to the extent possible.
Record cash receipts on a timely basis.
Encourage customers to obtain cash receipts and observe cash register totals.
Deposit cash receipts daily.
Make all disbursements by check (except for petty cash items).
Have monthly bank reconciliations prepared by employees not responsible for the issuance of checks or custody of cash.
Forecast expected cash receipts and disbursements and investigate variances.
Common substantive tests for cash
Trial balance
Confirmations- paper or email sent out to financial institutions
trial balance
Obtain analysis of cash balances and reconcile to the general ledger.
Client should be checking their cash balances, tying up documents.
bank reconciliations will only record _______
differences between bank statements and financial statements
Bank statement balance 8/31-9/30 reconciliation
Balance 8/31
+Deposits
-Checks and Charges
=Balance 9/30
Bank balance 8/31- Book balance 8/31 reconciliation
Balance 8/31 \+ Deposits in transit 8/31 - Outstanding checks 8/31 \+ Bank service charge August -Interest earned August =Book balance 8/31
purpose of a bank reconciliation
Existence of cash
bank cut off statement
A bank statement for the first 7-10 business days following the end of the client’s fiscal year.
Includes cancelled checks, credit memos etc.
Tie all amounts from bank rec to cut off statements
Make sure that outstanding checks and deposits did show up
3 rules for counting cash on hand
- All cash from client needs to be in the same place
- More than one auditor needs to count the cash
- Someone who works for the client must be there
kiting
Using the “float period” to count the cash in two or more accounts
Moving money around from bank accounts to inflate the bank balance
Clues to kiting
- Frequent Deposits and Checks in same round amounts to same banks.
- Money goes into an account and leaves a day or two later
- Large deposits on Fridays, weekends, bank holidays- largest float period
- High deposits – low average balances
When should revenue be recorded?
When title passes from seller to buyer
Eight common methods for committing financial statement fraud
Early revenue recognition- most common
Holding the books open past the accounting period
Fictitious sales-overstatement in A/R as well
Failure to record returns
Fraud in the percentage of completion method.
Related party transactions
Overstating receivables and inventory
Liability and expenses omissions.
Audit objective of: Obtain aged listing of receivables and reconcile to ledgers
Valuation
Audit objective of:
Inspect notes on hand and confirm those not on hand.
Existence, Rights
Audit objective of: Confirm receivables with debtors
Existence, Rights, Valuation
Audit objective of:
Review year-end cutoff of sales transactions.
Existence, Rights, Completeness
Audit objective of: Perform analytical procedures
Existence, Rights, Completeness
Audit objective of: Verify interest earned on notes receivable, recalculation
Existence, Rights, Completeness
Audit objective of: Investigate the existence of pledges receivables and receivables from related parties
Presentation and Disclosure
Audit objective of: Evaluate the business purpose of significant and unusual sales transactions
Existence, Rights, Valuation,
Presentation and Disclosure
lapping
A person who collects payments for a company pockets it, then applying the payment from another customers account, and so on. Eventually the last payment from a customer just gets written off
Ways to detect lapping
Compare details of bank deposit slips with the details of credits to customer accounts.
Compare names on checks to deposits in A/R
Accounts receivable confirmations—emphasize accounts written off and exceptions
Call customers to confirm when they paid
Analytical Procedures — e.g., Receivable turnover
Average time and balances go up.
Bookkeeping system
Anderson embezzled from her company’s account and at year-end she hid the shortage by making a deposit on December 31 in Bank X, drawn on Bank Y. She has not recorded the transaction on the books. What would be effective in detecting the fraud?
Comparison of bank cut off statements from cash receipts and disbursements journals
What criteria have to be true to use a negative conformation letter?
Risk of material misstatements is low
Low number of accounts with low balances
No reason to believe the auditor just won’t respond
Alternate procedures if no response from positive confirmation
Send a second letter out
Find cash payment from customer sometime after year end
Build portfolio of documents such as sales invoices, shipping documents.
Treat it as an overstatement of receivables.
What assertion are confirmations concerned with?
Existence
Importance of auditing inventory
Inventory is material to the financial statements.
It is related to COGS and indirectly related to revenue. Fraud risk is pretty high.
Valuing inventory involves a lot of subjectivity and estimates.
Audit approach to inventory
Overstate inventory
Audit challenges and procedures
Problem identifying quality- audit specialist
Use of geometric computations- audit specialist
Accuracy of scales- Examine certification
Measurement of volume- climb tanks
Quantity measurement estimation- aerial photos
Movement uncontrollable- animals- use chutes
Auditing inventory steps
Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to inventories and cost of goods sold.
Obtain an understanding of internal control
Assess the risks of material misstatement and design further audit procedures
Perform tests of controls
Perform substantive procedures
Audit objective: Obtain listings of inventory and reconcile to ledgers
Existence, occurrence, rights
Audit objective: Evaluate the client’s planning of inventory
Existence, Occurrence, Rights, Completeness, Valuation, Cutoff
Audit objective: Observe the taking of inventory
Existence, Occurrence, Rights, Completeness, Valuation, Cutoff
Audit objective: Inventory cutoff
Existence, Occurrence, Rights, Completeness, Valuation, Cutoff
Audit objective: Obtain a copy of the completed physical inventory and test its accuracy
Existence, Occurrence, Rights, Completeness, Valuation, Cutoff
Audit objective: Evaluate the bases and methods of inventory pricing. Test the pricing of inventories.
Valuation
Audit objective: Perform analytical procedures
Existence, Rights, Completeness, Valuation, Accuracy
Audit objective: Determine whether any inventories have been pledged
Valuation, Presentation, Disclosure
Audit objective: Evaluate financial statement presentation and disclosure
Presentation and Disclosure
Planning of client’s physical inventory
Who is going to do the counts? – Client or a Professional Inventory Services Co.?
Dates of counts
Adequate written instructions
Inventory tags to keep track of counting
Business shuts down while inventory counting is going on
Set near balance sheet date
Auditor inventory observation process
Review physical layout
Observe client’s team as they take inventory
Watch for any movement of inventory
Observe tag control procedures
Take test counts
Note how the “tagging” process affects the Existence and Completeness Assertions
Write memo
2 types of audit sampling
Attributes- tests of controls
Variables- substantive tests
Two types of variables sampling
Classical
Probability proportion to size
Sample deviation rate
of deviations found/ sample size
Internal control over inventory documents
Purchase requisitions Purchase orders Receiving Reports Material Requisitions Production Orders Move Tickets Time Tickets Shipping Documents Bill of Lading
Grant Thornton tips for detecting inventory fraud
Test count high value items and sample low value items
Do not follow a pattern or advise client ahead of time of what locations will be audited
Be alert for inventory not used in a while
Be skeptical in large differences in test counts
Inventory turnover
COGS/average inventory
Tests for inventory obsolescence
Substantive procedures: Inventory includes in inventory records does not exist
Observe client’s physical inventory count
Confirm inventory held by others on consignment
Vouch items on inventory listing to inventory count tags.
Analytical procedures. Compare inventory turnover and gross margin to budget and previous periods and discuss differences with client personnel.
Substantive procedures: The entity records inventory that is owned by other parties
Inquire whether any inventory is on consignment.
Inquire whether inventory has been pledges as collateral or security.
Inspect loans and other agreements for the use of inventory as collateral.
Substantive procedures: Inventory that should have been recorded has been omitted from the inventory account.
- Trace inventory subsidiary accounts to inventory control account.
- Observe physical inventory to ensure all items were counted.
- Trace test inventory counts to inventory subsidiary accounts and control account.
Substantive procedures: Inventory is included in the financial statements at incorrect amounts
Perform lower-of-cost-or-NRV.
Review cost of goods sold calculations.
Trace inventory cost to standard costs or purchase invoices.
Inquire whether any inventory is obsolete or unsalable.
Analytical procedures. Compare inventory turnover and gross margin budget and previous periods and discuss differences with client personnel.
Accounts payable audit
Best check is to look for who the cash is going out to and any liabilities associated with that are recorded as of the balance sheet date.
Voucher system
Cover sheet for a packet of documents that clients should compile for something they purchased. Voucher includes purchase order, receiving report, and vendor invoice.
Method for internal control over cash disbursements
When do we confirm accounts payable?
Bad internal control
- Bad financial position
- When some vendors don’t send monthly statements
