Planning Activities Flashcards
Preconditions for an audit
Management must use an acceptable financial reporting framework, and agree on the premise of the audit.
Engagement Letter
1) objective & scope
2) respective responsibilities
3) statement of audit inherent limitations
4) statement identifying financial reporting framework
5) expected content of reports
6) fees and other matters (use of specialist)
Five matters that must be address
1) integrity of mgmt
2) disagreements with mgmt about accounting or auditing issues
3) communication to those in charge of governance about fraud or non-compliance with laws
4) communication to those charged with governance of significant deficiencies in internal control
5) predecessor’s understand for reason in change in auditor
AU 300
Planning an Audit
also PCAOB Standard No. 9
Materiality
understanding what is important
Quantitative guidelines for materiality
- 5-10% of Net Income or Earnings before taxes
- 0.5-2% of larger of net sales or total assets
- 5% of owners equity for private companies
Qualitative examples of materiality
- public vs private - lower threshold for public
- unstable vs stable industry - unstable industry would have lower threshold due to higher probability of business failure
Type 1 Error
False negative - Auditor issues modified opinion, but F/S are fairly stated. This is an efficiency error.
Type 2 Error
False positive - Auditor issues an unmodified opinion, but F/S are misstated. This is AUDIT RISK and an effectiveness error.
Inherent Risk
probability that a material misstatement would occur in the particular audit area in the absence of any internal control policies and procedures
Control risk
probability that a material misstatement that occurred in the first place would not be detected and corrected by internal controls that are applicable.
Detection Risk
probability that a material misstatement that was not prevented or detected and corrected by internal control was not detected by the auditor’s substantive audit procedures (that is, an undetected material misstatement exists in a relevant assertion)
Audit Risk Model
AR = RMM * DR (RMM = IR * CR)
ONLY APPLICABLE AT INDIVIDUAL AUDIT AREA, NOT F/S AS A WHOLE!!
Increase Control Risk
Risk of material misstatement occurring and not being detected has increased. To offset this increase, decrease the detection risk. This can be done by adjusting the nature, timing or extent. Test of details and substantive analytical procedures is where these changes are made.
Decrease Detection Risk
Increase or improve test of details (substantive tests). Timing the tests closer to balance sheet date decreasing detection risk by increasing chances of finding misstatements.
