Exam Flashcards
o Professional judgement
Judgment is the process of reaching a decision or drawing a conclusion from among a number of alternatives, often in the face of significant uncertainties
o Skepticism
at attitude that includes a questioning mind and a critical assessment of audit evidence
o 5 Professional Judgement Key Steps
Clarify issues and objectives Consider Alternatives Gather and evaluate information Reach Conclusion Articulate and document rationale
• Why is it hard to be skeptical on an audit
o Incentives & Pressures
o Trust in management - Inappropriate
o Unconscious Bias
Where do auditors typically do a bad job exercising skepticism
o Evaluating management estimates or assumptions used to develop estimates in fair value calculations
o Over-reliance on management inquiry regarding adequacy of management’s reserves
o Lack of skepticism in the evaluation of 3rd party confirmations
o Influenced by prior year work papers, other team members, other clients
• Professional Skepticism Characteristics:
o Curiosity o Self-confidence o Interpersonal understanding o Questioning Mind o Self-Determination o Deliberation
o First Movers
risk that management makes auditors (second mover) biased in the direction of management’s judgements.
• Type of cognitive biases
Anchoring Confirmation Familiarity/Availibility Framing Bias False Consensus
• De-biasing techniques:
Decision Aids Tutorials Breaking large tasks to smaller task Develop alternate Explanations Consider decision impact on 3rd parties
o How are auditor judgements biased in ICFR audits
That management tends to lead them to bias
Curse of knowledge is not effort related, but hard wired
Knowledge bias – Explain and document hypotheticals and what you would expect to see – helps mitigate knowledge bias.
o What do authors recommend in order to mitigate bias?
Cognitive restructuring of the task
Document findings like likelihood or magnitude with identified ICFR problems
Perform “self review”
3 Key Decisions in sampling
- Calculate SS
- Select Sample items
- Evaluate Sample Results
Types of Analytical Procedures
Regression analysis
Reasonableness test
Trend analysis/ratio analysis
Regression Analysis
calculate the expected value using a statistical technique where one or more variables are used to predict the account balance
Reasonableness Test
calculate an expected value using data that may or may not be independent of the client’s information system
Trend analysis/ratio analysis
Calculate Changes in account balances - or in relationships between balances - to identify unusual variances
Low Inherent Risk; Low Control Risk
• High Detection Risk: Prime example of where you can use analytical procedures. Maybe exclusively
High Inherent Risk; High Control Risk
• Low Detection Risk: do NOT use analytical procedures exclusively
Advantages of Analytical procedures
Prime example of where you can use analytical procedures. Maybe exclusively
Disadvantages of Analytical Procedures
- Ability to establish auditor expectation
- Lack of precision
- Failure to detect unusual relationship
- Failure to follow up on exceptions
Steps in Sampling
Planning
Performing
Evaluating
Non Statistical Sampling (Judgement involved)
Judgmentally determine sample size implicitly recognizing relevant factors
Judgmentally select a representative sample
Apply Audit Procedures
Evaluate test results judgmentally
o Statistical Sampling (Judgement)
Determine sample size explicitly recognizing relevant factors
Randomly select a representative sample
Apply audit procedures
Evaluate test results statistically using judgement
• Factors that influence the auditor’s decision to use AP as substantive evidence
o Nature of and account
o Predictability
o Availability and reliability of data
o Precision of expectation
Steps/Requirement in performing AP
o Establish tolerable misstatement
o Develop an expectation (precision of expectation tied to req/d level of assurance)
Carefully consider data used in developing expectation (Source, controls over, level of disaggregation)
o Compare auditor expectation to client actual; investigate variance
o Document
Majestic Hotels Case Auditor 2 Challenges
Generating the expectation and evaluation of variance
• Management estimates Definition
an approximation of a monetary amount in the absence of a precise means of measurement
Approaches (Estimates)
Review Client’s Process: used most of the time
Develop Independent Estimate: Hard
Consider Subsequent events: rare
Challenges
Estimate calculations require use of complex modelling
Depend on future events or management’s intentions, which are difficult to verify
• Impairment decisions
• Outcome of litigation
Require balancing detailed calculations with “big picture”
May be misled by unreliable numbers
Steps in Testing Management’s process (Estimates)
Identify areas that contain significant estimates
• Understand company, industry, accounting standards
Evaluate Reasonableness of estimates:
• Management’s process drives auditor’s approach
Conclude whether estimates contain material Misstatements
Exit Price
Exit Price: what someone can SELL the item for (not cost)
Financial vs. non financial
financial are measured on a standalone basis (not part of group) whereas non-financial assets can be measured either way. Non financial assets require consideration of “highest and best use”
Market Approach
Goal is to calculate market value. Inputs are available from an observable market for identical assets (level 1) or similar assets (level 2)
• Stocks
Income Approach
Goal is to calculate the PV of future income; valuation techniques based directly or indirectly on discounted cash flow analysis or a multiple of earnings (Level 2 or 3 depending on source of inputs)
• Goodwill and intangibles
Cost Approach:
goal is to calculate replacement cost of the asset (Most applicable to tangible assets (PPE) – Subtle shift from exit price (to sell) to an entry price (to buy) – (Level 2 or 3)
•Fixed Asset
Level 1 inputs:
observable, quoted prices in active markets for identical assets (or liabilities). Open WSJ, pull out closing stock price
Level 2 inputs:
use of observable inputs other than quotes prices in active markets for identical/similar assets. Can also use less-active markets for identical assets/liabilities (Matrix pricing)
Level 3 inputs:
use of unobservable inputs developed by the reporting entity, using management assumptions
• FASB: Disclose level of input
• How to audit management’s FV measurements and disclosures
o Obtain inventory of FV measurements, assess RMM for each
o Understand management’s process & evaluate conformity with GAAP
o Test FV measurements & disclosures (assumptions, techniques, inputs, underlying data)
o Understand management’s process & evaluate conformity with GAAP
may use specialists
consider need for SOC report
o Need for judgment and skepticism on Hamilton and Wasatch:
management classification of investments
measurement (ie equity method) valuation technique used
inputs and assumptions
determination re impairment losses
What Drives FV?
Identify inputs
Consider assumptions
Consider quality of data
o Attestation:
An accounting service resulting in a report on subject matter or an assertion about subject matter that is the responsibility of another party
o Attest
Subject Matter: Specified subject matter by responsible party
Procedures and Measurement Criteria: Agreed-upon procedures, negotiable
Examination, Agreed-upon procedures, review
Assurance: Positive, negative, or no?
SOC 1
Specific to internal controls over financial reporting
• Restricted distribution to management, user entities, and user auditors
SOC 2
report on internal controls relevant to security, availability, processing integrity, confidentiality, or privacy.
• Restricted use
• Not sufficient for Auditor of F/S
SOC 3
• Similar to SOC 2 but less detail
o Intended for general use (unrestricted)
Type 1
Describes Internal Controls at specific point in time. Tests Design, NOT Effectiveness
Type 2:
Includes description of controls AND evaluation of effectiveness
• Minimum six months
• Only Type 2 meets SOX requirements
Attestation Engagement
Existence of an assertion
Existence of objective measurement criteria
Assertion amendable to verification
Independent assurance provider
Enhances reliability of information
Issuance of written report to a third part
Assurance Engagement
Independent assurance provider
Adequate knowledge of subject matter
Availability of objective evidence
Addresses relevance and reliability of information
Audit Engagement
Examination of historical F/S
