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AUDIT > J&DM > Flashcards

J&DM Flashcards

1
Q

Risk that relates to peculiarities of individual firm’s data

A

Firm specific (unsystematic risk)

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2
Q

What is the risk that the observed F/S ≠ True F/S?

A

Information Risk

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3
Q

Category of EM: opportunistic accounting estimates

A

Accounting Manipulation

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4
Q

2 agency problems that raise agency costs with the Agency theory:

A

Information asymmetry & divergent acts

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5
Q

COMMON LAW—THIRD PARTIES: Third Party Must Prove for Negligence

A
  1. The auditor had a duty to the plaintiff to exercise due care. 2. The auditor breached that duty and was negligent in not following the professional standards. 3. The auditor’s breach of due care was the direct cause of the 3rd party’s injury. 4. The 3rd party suffered an actual loss as a result.
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6
Q

Third Party Must Prove - Fraud

A
  1. A false representation by the CPA. 2. Knowledge or belief by the CPA that the representation was false. 3. The CPA intended to induce the 3rd party to rely on the false representation. 4. The 3rd party relied on the false representation. 5. The 3rd party suffered damages.
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7
Q

risks due to factors not related to sampling. Failure to recognize error in a document or transaction or failure to apply appropriate audit procedures.

A

Nonsampling Risk

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8
Q

Sampling Theory: Uses attribute-sampling theory

A

Monetary-Unit Sampling (MUS)

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9
Q

What is the following factor’s relationship to sample size, Direct or indirect? Expected Misstatement

A

Direct, as it decreases, sample size decreases and vice versa

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10
Q

Forms of Overconfidence: Falsely thinking that you are better than others.

A

Overplacement

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11
Q

Plausibility vs. Sufficiency

A

Auditor have tendency to accept 1st plausible answer and don’t consider enough the sufficiency of the answer (overreliance on mngmnt explanation)

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12
Q

Once the desired confidence level is established, the sample size is determine largely by what?

A

Precision - How much the tolerable error exceeds expected error

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13
Q

The risk that a misstatement that could occur in an account balance or class of transactions and that could be material, individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected and corrected on a timely basis by the accounting and internal control systems. (measurable)

A

Control Risk

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14
Q

2 step process in sampling a population

A

Project population, adjust for Sampling Risk

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15
Q

Important Concepts: Concerned with “How Many” – Used to “Test (Internal) Controls” – Are controls working?

A

Attribute Sampling

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16
Q

Definition: Actions taken with the knowledge and intent to deceive

A

Fraud

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17
Q

Forms of Overconfidence: Thinking you are better than you really are.

A

Overestimation

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18
Q

Category of EM: The use of actual business transactions to manipulate earnings.

A

Real Activities

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19
Q

Definition: People tend to direct their information search towards evidence that confirms their beliefs, thereby following a positive test strategy. Motivation plays a key role

A

Confirmatory Strategies

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20
Q

Generally regulates the disclosure of information in a registration statement for a new public offering of securities.

A

Securities Act of 1933

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21
Q

Definition: A wrongful act, other than breach of contract, for which civil action may be taken.

A

Tort

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22
Q

Definition: the purposeful intervention in the external financial reporting process, with the intent of obtaining some private gain

A

Earnings Management

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23
Q

(Potential) Problems with Rational Decision Making:

A
  1. Human Cognitive Limits (Bounded Rationality) 2. Criteria/goals are malleable, hard to compare, 3. Uncertainty and risk 4. Emotions or Affect 5. Framing 6. Subjective Utility is difficult to quantify
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24
Q

Important Concepts: Used to audit for OVERSTATEMENT. Used to estimate max amount of Error in population

A

Dollar Unit Sampling

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25
Q

Class of law: Written law enacted by the legislative branch of government

A

Statutory Law

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26
Q

Class of law: Case law developed by judges

A

Common Law

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27
Q

Detection Risk is _______ related to the amount of evidence required

A

Inversely - lower the DR, more evidence required

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28
Q

Strategy used when standards are subjective = Bias evidence collection, Depth of information processing, Information combination supporting conclusion, The goal is only accepted if it can be justified while maintaining the “illusion of objectivity”

A

Motivated Reasoning - Directional Goals

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29
Q

Heuristic: We judge the likelihood (probability) of an event by deciding how representative that event is of a larger population of events from which it was drawn

A

The Representativeness Heuristic

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30
Q

Audit Quality is consistent with:

A

Earnings Quality (normally the deviation of net income and operating cash flow)

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31
Q

Liability Under Sarbanes-Oxley: Penalty for Document destruction

A

Felony w/ penalty of up to 20 years

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32
Q

Federal Statutory Law - Civil Liability

A

Negligence, Gross negligence, fraud

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33
Q

Forms of Overconfidence: Being too certain that you know the truth.

A

Over-precision

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34
Q

Common Law Liability for Ordinary Negligence to Third Parties Approach: Auditor aware of identity, they are specifically identified, and auditor acted as though aware

A

Credit Alliance v. Arthur Andersen & Co.

- Near Privity

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35
Q

Sampling Theory: Used for $’s rather than attributes

A

Monetary-Unit Sampling (MUS)

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36
Q

2 risks of material misstatment

A

Control risk and inherent risk

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37
Q

What theory says people take information into account, use it wisely, do not systematically make mistakes

A

Rational expectations theory

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38
Q

What is the following factor’s relationship to sample size, Direct or indirect? Tolerable Deviation Rate

A

Inverse, as it decreases, sample size increases

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39
Q

The basic argument is that management can share liability exposure with an auditor and share the cost.

A

The Insurance Hypothesis; We now have proportionate liability unless you knowingly violate the securities act!

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40
Q

Common Law - Liability to clients

A

Breach of contract, Negligence, Gross negligence, fraud

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41
Q

Conditions that create the demand for audits: conflict between an information preparer and a user can result in biased information production

A

Conflict of Interest

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42
Q

Self-Serving Bias - Example aspects of human nature that amplify the problem:

A

Familiarity with client, Discounting of delayed consequences, Escalation – we explain away minor issues

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43
Q

the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated (AU 312.02).

A

Audit Risk

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44
Q

influence more by most thing you see (pain study) - IC, Accounting Issues, GC, Performance Evals

A

Recency Bias (Order Effects) - significant experience and motivational factors seem to decrease this.

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45
Q

Prevents plaintiffs from seeking to evade the protections that Federal law provides against abusive litigation by filing suit in State, rather than Federal Court

A

Securities Litigation Uniform Standards Act of 1998

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46
Q

Important Concepts: Selection of every nth item in the population. Used where population items are not numbered

A

Systematic Selection

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47
Q

Problem with Rational Decision Making:

A

Weight the criteria - Problems if try to apply broadly among different people – they can change depending on the others (weighting is VERY subjective)

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48
Q

SEC (2000) and SOX (2002) ban 9 types of non-audit services:

A
  1. bookkeeping 2. financial IS design and implementation 3. appraisal or valuation services 4. actuarial services 5. internal audit outsourcing services 6. management functions or human resources 7. investment adviser banking services 8. legal services and expert services9. any other service deemed unacceptable by the PCAOB
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49
Q

CAMS

A

Any matter that was or required to be communicated to the AC

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50
Q

Auditor’s Available Defenses for negligence:

A
  1. No duty was owed to the client. 2. Contributory negligence. 3. The auditor’s work was performed in accordance with professional standards. 4. The client suffered no loss. 5. Any loss was caused by other events (i.e. auditor did not cause loss) 6. The claim is invalid because the statute of limitations has expired.
51
Q

The risk that an auditor’s substantive procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material, individually or when aggregated with misstatements in other balances or classes. Sampling vs. Nonsampling Risk – Risk due to testing

A

Detection Risk

52
Q

Material weakness - Magnitude? Likelihood?

A

Magnitude: Material Likelihood: Reasonably Possible or Probable

53
Q

What 3 things will principals do with the Agency Theory?

A

Expect divergent acts from agent, Estimate the impact of divergent acts, Adjust the agent’s compensation to reflect the cost of divergent acts

54
Q

Federal Statutory Law - Criminal Liability

A

Willful violation of federal statutes

55
Q

Definition: A technique or methodology for (1) Determining Sample Size (2) selecting items to be tested and of (3) evaluating the results of the test on the basis of mathematical laws of probability.

A

Statistical Sampling

56
Q

Factors that drive sample size:

A

a. Desired confidence or reliability level
b. Tolerable deviation rate (misstatement)
c. Expectations

57
Q

Conditions that create the demand for audits: expertise is often required for information preparation and verification

A

Complexity

58
Q

Some consequences of overconfidence:

A

Stock market bubbles, Strikes, Unnecessary lawsuits, High rates of entrepreneurial failure, Failure of mergers and acquisitions

59
Q

Client must establish for negligence:

A
  1. A duty was owed to the client. 2. Failure to act in accordance with that duty. 3. A causal connection between the auditor’s negligence and the client’s damage.4. Actual loss or damage to the client.
60
Q

COMMON LAW—THIRD PARTIES: Auditor’s Defense for Negligence

A
  1. No duty was owed to the 3rd party. 2. The 3rd party was negligent. 3. The auditor’s work was performed in accordance with professional standards (i.e. the auditor exercised due care). 4. The 3rd party suffered no loss. 5. Any loss was caused by other events. 6. The claim is invalid because the statute of limitations has expired.
61
Q

What is the following factor’s relationship to sample size, Direct or indirect? Tolerable Misstatement

A

Inverse, as it decreases, sample size increases

62
Q

What is the following factor’s relationship to sample size, Direct or indirect? Desired Confidence Level

A

Direct, as it decreases, sample size decreases and vice versa

63
Q

Audit-Related Pressures: Having too much to do.

A

Quantitative Overload

64
Q

Important Concepts: Used to measure and control sampling risk. Based on Mathematical Laws of Probability

A

Statistical Sampling

65
Q

Conditions that create the demand for audits: users are frequently prevented from directly assessing the quality of information.

A

Remoteness

66
Q

Appearance vs. Fact

A

Competence in fact and independence in appearance

67
Q

Heuristic: When people make estimates of likelihood, their estimates are influenced by the ease with which relevant examples come to mind.

A

The Availability Heuristic

68
Q

Liability Under Sarbanes-Oxley: Penalty for Securities fraud

A

Criminal penalties increased to 25 years

69
Q

Risk that relates to variability of market as a whole

A

Market related (systematic risk)

70
Q

The SEC’s rules are predicated on three basic principles of auditor objectivity and independence:

A
  1. An auditor should not audit his or her own work. 2. An auditor should not function in the role of management. 3. An auditor should not serve in an advocacy role for his or her client.
71
Q

Important Concepts: Used to control variability of population and reduce sample size. Divide population into sub-groups reducing variability which is measured by Standard Deviation

A

Stratification

72
Q

Risk of incorrect Rejection: in a test of internal controls, it is the risk that the sample supports a conclusion that the control is not operating effectively when, in fact, it is operating effectively (same as alpha from your stat class).

A

Type I

73
Q

What are some things about an individual firm (or an office of the firm) that might affect “actual” audit quality?

A
  1. Human resources – hiring & training. 2. Control Processes (Strong audit methodologies, Peer review, Client acceptance & continuance) 3. Industry Expertise 4. Tone at the Top
74
Q

Determinants of Audit Quality

A

Profession, Audit Firm, Local Office, Audit Team and Individual

75
Q

Important Concepts: Concerned with “How Much” or Dollar Amounts – Primarily used in substantive testing

A

Record (or Dollar) Sampling

76
Q

Overconfidence:

A
  • People (novices & experts) are in general, much more confident about their decisions than is reasonable given the environment in which they are making their decisions. - Potential to close off the search for answers before all available evidence can be collected because of it. - Plausibility vs. Sufficiency
77
Q

The inverse of acceptable audit risk (i.e., the likelihood that an auditor fails to modify the opinion on f/s that are materially misstated).

A

Audit Quality

78
Q

_____ ______ are related and affect quality of ex-ante judgments that turned out to be wrong

A

Outcome Effects

79
Q

Preliminary Materiality:

A

Allocated to audit segments – Usually to balance sheet items & Tolerable misstatement

80
Q

Concerned primarily with ongoing reporting by companies whose securities are listed and traded on a stock exchange.

A

Securities Exchange Act of 1934

81
Q

An item is considered _____ if knowledge of the misstatement would affect the decision of a reasonable user.

A

Material

82
Q

All sample results must be adjusted for:

A

Sampling Risk

83
Q

All sample results must be adjusted for sampling risk and compared to?

A

Top tier of confidence interval

84
Q

Bias that occurs with multiple clients:

A

Contrast Effects

85
Q

How does the profession promote audit quality?

A

Standard Setting, Code of Conduct, Inspections and Peer Review, Research, Legal Liability

86
Q

Common Law Liability for Ordinary Negligence to Third Parties Approach: Reasonably limited and identifiable group of users, even if persons were not specifically known to auditors at time audit was done

A

Restatement of Torts (Restatement Rule)

- Foreseen users

87
Q

Securities Exchange Act of 1934 - 3rd party must prove:

A
  1. A material, factual misrepresentation or omission. 2. Reliance on the financial statements. 3. Damages suffered as a result of reliance on the financial statements. 4. Scienter (the act was committed knowingly).
88
Q

Definition: The frequency of an event in the general population.

A

Base Rate

89
Q

Short Tenure Pros and Cons

A

Pro: Fresh Eyes. Con: Low client familiarity (billing hours)

90
Q

Definition: An extreme, flagrant, or reckless departure from professional standards of due care. Also referred to as constructive fraud

A

Gross Negligence

91
Q

Common Law Liability for Ordinary Negligence to Third Parties Approach: Users the auditor should have reasonably been able to foresee as users of F/S have same rights as those privy to contract

A

Reasonably Forseeable User

92
Q

Common Law Liability for Ordinary Negligence to Third Parties Approach: Authoritative set of legal principles

A

Restatement of Torts (Restatement Rule)

- Foreseen users

93
Q

Judgement Bias: Very important that we have objectivity even at the lower level

A

Source Reliability

94
Q

Long Tenure Pros and Cons

A

Pros: Increase client specific expertise. Cons: Complacent & lose objectivity (aligning with management)

95
Q

Definition: the phenomenon of outcome knowledge altering the evaluations of an ex-ante judgment of the occurrence of an event

A

Hindsight bias

96
Q

Statutory Liability - Three major statutes that provide sources of liability for auditors:

A
  1. The Securities Act of 1933 2. The Securities Exchange Act of 1934 3. FCPA (records & IC) & Sarbanes-Oxley Act of 2002
97
Q

Example: A manager’s mood may influence his or her decision-making. He or she may be more likely to give positive performance evaluations when in a good mood.

A

Affect Heuristic

98
Q

What is the following factor’s relationship to sample size, Direct or indirect? Tolerable Deviation Rate

A

Inverse, as it decreases, sample size increases

99
Q

If control risk decreases, Detection Risk will ____

A

Increase

100
Q

Conditions that create the demand for audits:

A

Conflict of Interest, Consequence, Complexity and Remoteness

101
Q

Definition: An absence of reasonable or due care in the conduct of an engagement. Due care is evaluated in terms of what other professional accountants would have done under similar circumstances.

A

Ordinary Negligence

102
Q

Bias: Changing hypotheses requires greater cognitive effort than maintaining the same hypothesis. Harder to deal with negative (disconfirming) information than positive information. Self-fulfilling prophecy

A

Confirmation Bias

103
Q

Sampling Theory: Commonly used to test accounts such as accounts receivable, loans receivable, investment securities, and inventory (all of which are assets)

A

Monetary-Unit Sampling (MUS)

104
Q

Audit risk assessment dangers…

A

Auditors rely on controls and assess inherent risk below the maximum on most audits

105
Q

Rate comes from our planned assessed lvl of control risk

A

Tolerable Deviation Rate

106
Q

Expands federal jurisdiction to include multistate class actions where there is more than $5 million in dispute. Expected to help in more consistent dismissal of dubious claims.

A

Class Action Fairness Act of 2005

107
Q

Category of EM: The opportunistic classification of items within the income statement, statement of cash flows, and balance sheet.

A

Classification Shifting

108
Q

“…the likelihood that an auditor (1) detects and (2) reports a material misstatement.” Practitioners often define this based on adherence to GAAS.

A

Audit Quality

109
Q

Audit-Related Pressures: Too complex a task to perform.

A

Qualitative Overload

110
Q

New audit reporting model:

A

Pass/Fail, CAMs, challenging, subjective, or complex auditor judgments (must be material, disclose how issue was addressed), and must address tenure with audit firm

111
Q

Sampling Technique: Selection of a sample from a population of items in such a manner that each item in the population has an equal chance of being chosen for examination. 1. Random number table or random number generators are generally used for applying this selection approach.
2. Population items must be numbered.

A

Random sampling

112
Q

Definition: A contract or specific agreement exists between two parties. Absent a contractual or fiduciary relationship, the accountant does not owe a duty of care to an injured party.

A

Privity

113
Q

Sarbanes-Oxley Act of 2002 - 4 key impacts

A
  1. Creation of PCAOB 2. Stricter independence rules 3. Audits of internal controls 4. Increased reporting responsibilities. Most sweeping securities law since 1934
114
Q

Risk of incorrect Acceptance: in a test of internal controls, it is the risk that the sample supports a conclusion that the control is operating effectively when, in fact, it is not operating effectively. Same as beta.

A

Type II – This is the one to AVOID.

115
Q

Conditions that create the demand for audits: information can have substantial economic consequences to a decision maker

A

Consequence

116
Q

Important Concepts: Risk that sample is not representative of the population. – Controlled by Sample Size

A

Sampling Risk

117
Q

What 3 things does the Information Hypothesis imply?

A

Reduces risk, Improves management decision making and trading profits

118
Q

the risk that an auditor incurs loss or injury to his or her professional practice from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on (AU 312.02, fn 2).

A

Auditor Business Risk (Engagement Risk)

119
Q

Common Law - 3rd parties

A

Negligence, Gross negligence, fraud

120
Q

Liability Under Sarbanes-Oxley: Penalty for Failure to maintain workpapers for at least five years

A

Felony w/penalty up to 10 years

121
Q

Definition: Technique for selecting sample size that is not calculated. Ex: “Go pick a few”

A

Non-Statistical Sampling

122
Q

the risk that an audit client’s economic condition will deteriorate in the future.

A

Client Business Risk

123
Q

What are some things about the team that might influence actual audit quality?

A

Partner & Manager attention, Skepticism, Client Experience, Industry experience

AUDIT (5 decks)

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