Module 2: Engagement Planning - Key Terms

Question 1

What is an accounting estimate?

Answer 1

An approximation of a monetary amount in the absence of a precise means of measurement.

This term is used for an amount measured at fair value where there is estimation uncertainty, as well as, for other amounts that require estimation.

Question 2

What are analytical procedures?

Answer 2

Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.

Encompass investigation, as is neccessar, of identified fluctuations or relationships that are inconsistent with other relevant info or that differ from expected values by a significant amount.

Question 3

What are assertions?

Answer 3

Representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur.

Question 4

What is audit evidence?

Answer 4

Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based.

Audit evidence includes both information contained in the accounting records underlying the financial statements and other information:

• Sufficiency of audit evidence is the measure of the quantity of audit evidence. The quantity of the audit evidence needed is affected by the auditor’s assessment of the risks of material misstatement and also by the quality of such audit evidence.
• Appropriateness of audit evidence is the measure of quality of audit evidence; its relevance and its reliability in providing support for the conclusions on which the auditor’s opinion is based

Question 5

What is the audit plan?

Answer 5

A description of the nature, timing, and extent of the audit procedures to be performed. It is often documented with an audit program.

Question 6

What is the audit program?

Answer 6

A detailed listing of the specific audit procedures to be performed in the course of an audit engagement. Audit programs are tailored to the risks and internal control of each engagement.

Question 7

What is the audit risk?

Answer 7

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

Question 8

What is audit strategy?

Answer 8

The approach which involves determining overall characteristics of an audit that defines its scope, its reporting objectives, timing of procedures and various important factors relating to the audit. When the overall audit strategy has been established, the auditors start the development of a more detailed audit plan to address the various matters identified in the audit strategy.

Question 9

What is control risk?

Answer 9

The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Question 10

What is detection risk?

Answer 10

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Question 11

What is an engagement letter?

Answer 11

A formal letter sent by the auditors to the client at the beginning of an engagement summarizing such matters as the nature of the engagement, any limitations on the scope of the audit work, work to be performed by the client’s staff, and the basis for the audit fee.

The main purpose is to avoid misunderstandings.

Question 12

What is fraud?

Answer 12

An intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception that results in a misstatement in financial statements that are subject of an audit.

For financial statement audits, fraud includes two types of intentional misstatements - misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets.

Question 13

What are fraud risk factors?

Answer 13

Events or conditions that indicate an incentive or pressure to perpetrate fraud, provide an opportunity to commit fraud, or indicate attitudes or rationalizations to justify a fraudulent action.

Question 14

What is fraudulent financial reporting (management fraud, cooking the books)?

Answer 14

Material misstatement of financial statements by management with intent t mislead financial statement users.

Question 15

What is further audit procedures?

Answer 15

The additional procedures that are performed based on the results of the auditors’ risk assessment procedures.

Such procedures include (1) test of controls (if needed) (2) detailed tests of transactions, balances and disclosures (3) substantive analytical procedures

Question 16

What is historical financial information?

Answer 16

Information expressed in financial terms in relation to a particular entity, derived primarily from that entity’s accounting system, about economic events occurring in past time periods or about economic conditions or circumstances at points in time in the past.

Question 17

What is inherent risk?

Answer 17

The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Question 18

What is materiality?

Answer 18

The magnitude of an omission or misstatement of accounting info that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the the info would have been changed or influenced by the omission or misstatements.

Question 19

What is misappropriation of assets (defalcations)?

Answer 19

Theft of client assets by an employee or officer of the organization.

Question 20

What is a misstatement?

Answer 20

A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework.

Misstatements can arise from error or fraud. Misstatements also include those adjustments of amounts, classifications, presentations, or disclosures that, in the auditor’s judgment, are necessary for the financial statements to be presented fairly, in all material respects.

Question 21

What are factual misstatements?

Answer 21

Misstatements about which there is no doubt.

Question 22

What are judgmental misstatements?

Answer 22

Differences arising from the judgments of management concerning accounting estimates that the auditor considers inappropriate.

Question 23

What are projected misstatements?

Answer 23

The auditor’s best estimate of misstatements in populations, involving the projection of misstatements identified in audit samples to the entire population from which the samples were drawn.

For examples, if statistical sampling was used with receivables, the difference between auditor estimated total audited value and the book value of receivables is the projected misstatement.

Question 24

What is noncompliance?

Answer 24

Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations.

Such acts involve transactions entered into by, or in the name of the entity, or on its behalf, by those charged with governance, management, or employees.

Noncompliance does not include personal misconduct (unrelated to the business activities of entity) by those charge with governance, management, or employees.

Question 25

What is performance materiality?

Answer 25

The amount set by auditor at less than materiality for financial statements as a whole to reduce to an appropriately low level the probability that aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.

It may also refer to the amount set by auditor at less than the materiality level or levels for particular classes of transactions, account balances, or disclosures

Question 26

What is the predecessor auditor?

Answer 26

A CPA firm that formerly served as auditor but has resigned from engagement or has been notified that its services have been terminated.

Question 27

What is professional judgment?

Answer 27

The application of relevant training, knowledge, and experience, within the context provided by auditing, accounting, and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.

Question 28

What is professional skepticism?

Answer 28

Attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence.

Question 29

What is quality control standards?

Answer 29

AICPA standards designed to provide reasonable assurance that all of a CPA firm’s engagements are conducted in accordance with applicable professional responsibilities.

Question 30

What is reasonable assurance?

Answer 30

In the context of an audit of financial statements, a high, but not absolute, level of assurance.

Question 31

What is relevant assertion?

Answer 31

A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause financial statements to be materially misstated.
The determination of whether an assertion is a relevant assertion is made without regard to the effect of controls.

Question 32

What are risk assessment procedures?

Answer 32

The audit procedures performed to obtain an understanding of the entity and its environment, including the entity’s internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

Question 33

What is risk of material misstatement?

Answer 33

The risk that the financial statements are materially misstated prior to the audit.

Consists of two components: inherent risk and control risk

Question 34

What is significant risk?

Answer 34

An identified and assessed risk of material misstatement that, in the auditor’s judgment, requires special audit consideration.

Question 35

What is a substantive procedure?

Answer 35

An audit procedure designed to detect material misstatements at the assertion level.

Comprise tests of details (classes of transactions, account balances, and disclosures and substantive analytical procedures.

Question 36

What is the successor auditor?

Answer 36

The auditors who have accepted an engagement to replace the CPA firm that formally served as the auditor.

Question 37

What are tests of controls?

Answer 37

An audit procedure designed to evaluate the operating effectiveness of controls in preventing or detecting/correcting material misstatements at the assertion level.

Question 38

What is a tolerable misstatement?

Answer 38

The application of performance materiality to a particular sampling procedure.
May be the same amount of an amount lower than performance materiality.