Module 2 - Engagement Planning, Obtaining an Understanding of the Client & Assessing Risks Flashcards
Audit Risk is what?
The risk an auditor takes by reporting Fairly Presented FS when they really might not be
What is the AR formula?
AR = IR x CR x DR
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Inherent Risk = Nature of situation
Control Risk = Risk that IC will not catch misstatements
Detection Risk = Substantive Risks (Tests of Dollar Amounts) will not catch misstatements
What are the steps to taking on a new audit clinet?
- Decision to Accept
- Evaluate independence & ability to handle
- Evaluate communications with predecessor auditor (with permission of client)
- Accept - Must understand client & industry
- Engagement Letter (Summarizes main points of engagement)
- Determine materiality levels (quantitative & qualitative)
- Evaluate Risk: AR = RMM x DR
- Must do risk assessment procedures
- Further audit procedures (Test of Controls [optional] & Substantive Tests)
Risk of Material Misstatement is?
Inherent Risk x Control Risk
Is assessed because it exists outside of the auditor’s control
If RMM is high, then the auditor must work more to lower DR
Detection Risk is?
Broken down into three categories
- Nature - Type
- Timing - When
- Ex: Auditing at YE will lower DR
- Extent - Sample size
Manipulated by the auditor
Ex: If RMM is high, then DR must be lowered by more substantive testing
If RMM is low because IC are good, then DR can be higher and fewer substantive testing is needed
An Auditor’s Responsibility includes?
Errors & Fraud
- Reasonable Assurance (high level, but not 100%)
Direct Effect Laws & Regulations
- Reasonable Assurance (high level, but not 100%)
- Direct Effect on FS
Other Laws & Regulations (Indirect)
- Operations that do not directly impact the FS
- Less strict than Reasonable Assurance
What are two main kinds of Fraud?
- Fraudulent Financial Reporting
- Usually accomplished by management
- Fraudulent Missapropriation of Assets
- Usually accomplished by workers
What are the characteristics of Fraud?
Fraud Triangle
- Incentive (Pressure)
- Opportunity
- Rationalize (Attitude)
All may be present or only one or two
The auditor brainstorms with the engagement team regarding risks that may lead to material misstatement due to fraud that include:
- Interviews
- Brainstorming
- Fraud Risk Factors
- Analytical Procedures (Look Test)
- Client Acceptance/Continuance
- Entity’s Programs & Controls
- Revenue Recognition/Mgt Estimates/Inventory Quantities (So significant that they are automatically assumed to be a risk)
How does an auditor respond to risks?
- Overall (Personnel, Predictability - be spontaneous so the client does not know what you are going to do)
- Specific (Nature, Timing, Extent)
- Test Journal Entries (Look for anything out of the ordinary, especially at YE)
- Management Override of Controls
Directional Testing is what?
- Completeness (Understatements)
- Source Doc to GL
- Existence (Overstatements)
- GL to Source Doc
Financial Statement Assertions are made up of what?
Transaction Classes
Account Balances
Disclosures
Transaction Classes have what categories?
Occurrence - Transactions & events that have been recorded have occurred and pertain to the entity
Completeness - All transactions & events have been recorded
Accuracy - Amounts & other data relating to recorded transactions have been recorded appropriately
Cutoff - Transactions & events have been recorded in the correct accounting period
Classification - Transactions & events have been recorded at the proper amounts
Account Balances have what categories?
Existence - Assets, liabilities & equity interest exist
Rights & Obligations - The entity holds or controls the rights to assets, and liabilities are the obligations of the entity
Completeness - All assets, liabilities, and equity interests have been recorded
Valuation & Allocation - Assets, liabilities, & equity interests are included at appropriate amounts
Disclosures have what categories?
Occurrence - Disclosed events and transactions have occurred
Rights & Obligations - Disclosed events pertained to the entity
Completeness - All disclosures that should have been included have been included
Accuracy & Valuation - Information is disclosed fairly & at appropriate amounts
Classification & Understandability - Information is presented & described clearly
When is an account considered to be in conformity with GAAP?
When all assertions are met for that account
Fraud communication responsibility of the auditor:
- All fraud involving management should be communicated to the audit committee
- All material fraud should be communicated to the audit committee
An Audit Engagement Letter should include:
- Objectives of the engagement
- Management’s Responsiblities
- Auditor’s Responsibilities
- Limitations of the Audit
Types of Misstatements:
- Factual Misstatements - misstatements for which there is no doubt
- Judgmental Misstatements - differences arising from the judgment of management for which the auditor deems unreasonable
- Projected Misstatements - the auditor’s best estimate of misstatements in populations
Noncompliance defined:
Acts of omission or commission by the entity either intentional or unintentional which are contrary to the prevailing laws or regulations
Significant Risk defined:
Risk of material misstatement that requires special audit consideration
The most difficult type of misstatement to detect is?
The nonrecording of transactions
The Ultimate Focus of an Audit is what?
The Financial Statements
Audit Planning Steps:
- Communicate with Predecessor Auditor
- Engagement Letter
- Preliminary Engagement Activities
- Auditor rechecks independence
- Develop Overall Stategy
- Characteristics of engagement that define scope
- Determine reporting objectives (key dates etc)
- Considering important risk factors that will determine the focus of the audit team’s resources (materiality levels; high risk areas)
- The Audit Plan
- Risk Assessment Procedures
- Further Audit Procedures (Tests of Controls; Substantive Testing)
- Other Audit Procedures (direct communication with entity’s lawyer)
- Audit Program
- Written program should be used to implement the Audit Plan
- Timing of Audit Procedures
- Tests for Controls & Substantive Testing may be tested at any time
An Auditor will ordinarily not discuss details of procedures necessary to complete the audit with management in what?
The Engagement Letter
Basic Auditing Points:
- Assertions
- Objectives
- Procedures
