Exam 2 - Chapter 8 - Audit planning and Analytical Procedures Flashcards
What are the three main reason the auditor should properly plan audits?
- Help auditor obtain sufficient appropriate evidence
- Help keep audit costs reasonable
- Avoid misunderstandings with client (set good dates = not gonna piss someone off)
- Required by auditing standards
What are the 8 steps for planning and designing an audit approach?
- Accept client; perform initial planning
- Understand client’s business and industry
- Assess client business risk
- Perform preliminary analytical procedures
- Set materiality and assess acceptable risk
- Understand internal controls and control risk
- Gather information to assess fraud risk
- Develop overall audit strategy and audit program
What is acceptable audit risk?
Measure of the risk that there are actually material misstatements when the auditor has given an unqualified opinion.
(or vice versa)
(Note: there is always risk of an inappropriate opinion because auditor <u>can't test everything</u>)
What is inherent risk?
Risk that a particular account will be misstated (varies from industry to industry)
What is Control Risk?
Risk that client’s internal controls will fail to detect or prevent material misstatement.
What are the 4 procedures that go into initual audit planning?
- Decide whether to accept or continue serving the client
- Identify why the client wants/needs an audit
- Obtain an understanding with the client about the terms of engagement
- Develop an overall strategy for the audit, including staffing and specialists
For prospective audits that have previously been audited by a CPA firm, auditing standards require that _______
- Code of Professional Conduct requires ________
Communicate with predecessor audit to assess: conflicts, disputes, cooperation of client
Code of professional conduct requires:
- Auditor asks permission from client before investigating predecessor auditor
What tool do auditors use to obtain an understanding with the client?
Engagement Letter
Details engagement objective, responsibilites of auditor and mangement, estimated fees, other services
After understanding the client’s reasons for the audit, the auditor should develop and document an _____.
Audit Strategy
Auditor evaluates client locations and controls and sets:
- scope = what exactly will the auditor audit
- Appropriate staff
- Evalulate need for outside specialits
What do auditing principles state about understanding the business and industry of the client?
Auditor is to assess risk of material misstatement, whether due to fraud or error, based on an understanding of the entity and its environment, including the entity’s internal controls.
What should the auditor attempt to understand about client’s business and industry?
- Industry and external environment
- Business operations and processes
- Management and governance
- Objectives and strategies
- Measurement and performance
What are the 3 primary reasons for understanding the client’s industry and external environment?
- Risks associated with specific industries may affect business risk and acceptable audit risk.
- Many inherent risks are common to all clients in certain industries
- Many industries have unique accounting requirements that the auditor must understand (government, construction, etc…)
What are some things the auditor should understand about business operations and processes?
Major sources of revenue
Assess inherent risks of product/services
Key customers and suppliers
Dependence on few customers may result in material losses from bad debts/obsolete inventory
Information about related parties
All related parties need to be identified and included in the auditor’s permanent files.
What is the governance of a company and what should the auditor learn about management and governance?
The firm’s organizational structure; activities of the board of directors
Obtain corporate minutes
- Official record of the meetings of BoD
- Read minutes for relevant acct info for audit files
Why are analytical procedures required during the planning phase of an audit?
- To better understand the client’s business and assess client business risk;
- assess going concern
- can reveal unusual changes that increase risk of misstatement
- Reduce detailed tests
What is an important preliminary analytical procedure?
Perform the following ratios and compare to industry average:
- Short-term debt paying ability
- Liquidity activity ratios
- Ability to meet long-term obligations
- Profitability ratios
Analytical procedures may be performed at any of three times during an engagement:
- Required in the planning phases to determine nature, extenet and timing of audit procedures
- Often done during the testing phase to support account balances.
- Required ruing the completion phase of the audit; serve as a final review for misstatements
Auditors must develop expectations of what recorded account balances or ratios should be, when performing analytical procedures,
what five expectations may be used to compare client data?
- Industry data
- Similar prior-period data
- client-determined expected results
- Auditor-determined expected results
- Expected results using nonfinancial data
The most important benefits of industry comparisons are:
What is it not so useful at determining?
To aid in understanding the client’s business as an indication of likelihood of financial failure.
Not so useful for finding potential misstatement risk
The major weakness of using industry ratios for analytical procedures is:
- Nature of client’s financial info may differ from those making up the industry.
- Companies follow different accounting methods, which drastically change ratios
The main benefit of using client data with prior-period data is:
Find sudden changes (increases/declines) in values that differs from expected trend.
Can be caused by economic conditions, misstatements, or errors
When comparing client data with prior-period data, what are some comparisons that should be made?
- Compare the CY balance with that of preceding year
- Compare the detail of total balance with detail of preceding year
- Compute ratios and percent changes from year to year
When comparing client data with client-determined expected results, what two concerns should the auditor be aware of?
- The auditor must evaluate whether the budgets were realistic plans
- Auditor should consider that current financial information was changed by client personnel to conform to the budget
How do you find the short-term debt-paying ratios:
- Cash Ratio
- Quick ratio
- Current ratio
How do you find liquidity activity ratios:
- Accounts receivable turnover
- Days to collect receivables
- Inventory turnover
- Days to sell inventory
How do you find the ability to meet long-term debt ratios:
- Debt to equity
- Times interest earned
How do you find the profitability ratios:
- Earnings per share
- Gross profit percent
- Return on assets
- Return on common equity
