Planning Activities

Question 1

What is meant by the term initial audit?

Answer 1

The prior year’s financial statements have been audited by a predecessor auditor.

Question 2

What matters are typically addressed in an engagement letter?

Answer 2

1. The objective and scope of the audit
2. The auditor’s responsibilities
3. Management’s responsibilities
4. A statement about the inherent limitations of an audit
5. A statement identifying the applicable financial reporting framework
6. Reference to the expected content of any reports to be issued; and
7. Other matters, as warranted (e.g., fees, etc.).

Question 3

What is meant by the term preconditions for an audit?

Answer 3

The use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management to the premise on which an audit is conducted.

Question 4

Who initiates the communications between the predecessor auditor and successor auditor?

Answer 4

The successor auditor initiates the communication with the predecessor by requesting that the client authorize the predecessor auditor to allow the successor auditor to review the predecessor auditor’s working papers.

Question 5

What matters should be covered in the (successor) auditor’s inquiry of the predecessor auditor?

Answer 5

1. Facts related to management’s integrity;
2. Significant accounting or auditing disagreements;
3. Any communications with the audit committee (or others charged with governance) about fraud, illegal acts, and significant deficiencies in internal control matters; and
4. Predecessor’s understanding of the reason(s) for the client’s change in auditors.

Question 6

Identify 3 planning-related issues that should be included in the auditor’s documentation.

Answer 6

1. The overall audit strategy;
2. The audit plan; and
3. Any significant changes made to the audit strategy or the audit plan during the engagement, along with the reasons for any such changes.

Question 7

Identify some activities associated with pre-engagement activities.

Answer 7

1. Perform appropriate procedures to address the quality control issues associated with the acceptance/continuance of the audit engagement;
2. Evaluate the audit team’s compliance with relevant ethical requirements (especially independence issues); and
3. Establish an understanding in writing of the terms of the engagement.

Question 8

What is the difference between an overall audit strategy and an audit plan?

Answer 8

An audit strategy deals with higher level issues, such as allocating audit resources, whereas an audit plan is more detailed and deals more specifically with the nature, timing, and extent of audit procedures to be performed.

Question 9

Identify factors relevant to establishing an overall audit strategy.

Answer 9

1. Identify characteristics of the engagement affecting its scope;
2. Identify the reporting objective of the engagement and required communications;
3. Consider the factors relevant to utilizing the audit team;
4. Consider the results of preliminary engagement planning activities; and
5. Determine the nature, timing, and extent of necessary resources for the engagement.

Question 10

List the audit procedures that should occur during the planning phase of an audit.

Answer 10

1. Review client records
2. Inquire of client personnel
3. Coordinate client assistance
4. Determine if specialists are needed
5. Coordinate staffing requirements

Question 11

List several circumstances that impact the extent of planning activities.

Answer 11

1. Size and complexity of the entity
2. Auditor’s experience with that entity
3. Auditor’s understanding of the entity and its environment, including its internal control.

Question 12

What is the auditor’s basic audit planning responsibility?

Answer 12

The auditor should plan the audit (and design the required written audit program or plan) to be responsive to the auditor’s assessment of the risk of material misstatement.

Question 13

The terms planning stage materiality and evaluation stage materiality in prior auditing standards has been replaced by what single concept in the clarified auditing standards?

Answer 13

Performance materiality.

Question 14

What is meant by the term tolerable misstatement?

Answer 14

The application of performance materiality to a particular sampling procedure or application.

Question 15

What 4 matters should be documented with respect to materiality considerations?

Answer 15

1. Materiality for the financial statements as a whole;
2. Materiality level(s) for applicable transactions, account balances, or disclosures;
3. Performance materiality; and
4. Any revision of those considerations during the audit engagement.

Question 16

The clarified auditing standards introduced the term performance materiality. What does that term mean?

Answer 16

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

Question 17

What is the basic meaning of the concept of materiality?

Answer 17

An understanding of what is important.

Question 18

Prior auditing standards referred to evaluation stage materiality. What did the term evaluation stage materiality mean?

Answer 18

The determination of whether the financial statements were fairly stated in all material respects at the completion of field work.

Question 19

Prior auditing standards referred to planning stage materiality. What did the term planning stage materiality mean?

Answer 19

The size of the misstatements that the audit program was designed to detect.

Question 20

List the variables of planned audit procedures that can be adjusted to change detection risk.

Answer 20

Nature Timing Extent of substantive testing

Question 21

What risk is within the auditor’s control?

Answer 21

Detection risk.

Question 22

Define “detection risk.”

Answer 22

The probability that a material misstatement, that was not prevented or detected by internal control, was not detected by the auditor’s substantive audit procedures.

Question 23

Define “control risk.”

Answer 23

The probability that a material misstatement, that occurred in the first place, would not be detected by applicable internal controls.

Question 24

Define “audit risk.”

Answer 24

The probability that the auditor fails to modify the opinion on financial statements that contain a material misstatement.

Question 25

What is the audit risk model that is applicable to classes of transactions or to account balances?

Answer 25

Audit Risk = inherent risk x control risk x detection risk

Question 26

Define “inherent risk.”

Answer 26

The probability that a material misstatement would occur in the particular audit area in the absence of any internal control policies and procedures.

Question 27

Define “risk of material misstatement.”

Answer 27

The risk that the financial statements contain one or more material misstatements prior to the audit. (Note: RMM = IR x CR)

Question 28

What matters must be documented in connection with analytical procedures?

Answer 28

1. The auditor’s expectation and the factors considered in developing it;
2. The results of the comparison of the recorded amounts (or ratios) with the expectations; and
3. Any additional auditing procedures performed to investigate significant differences identified by that comparison.

Question 29

What is the purpose of analytical procedures in the overall review?

Answer 29

To verify the conclusions reached in the audit.

Question 30

List the four factors that affect the efficiency and effectiveness of analytical procedures for substantive purposes.

Answer 30

1. Nature of assertion;
2. Plausibility and predictability of relationship;
3. Availability and reliability of data;
4. Precision of expectation.

Question 31

What is the purpose of analytical procedures in audit planning?

Answer 31

To aid in understanding client activities and in targeting risky areas where material misstatements are more likely to occur.

Question 32

Define “analytical procedures.”

Answer 32

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

Question 33

What 3 purposes might analytical procedures serve?

Answer 33

Required during planning May be used as substantive evidence (not required) Required during final review.

Question 34

What is the definition of fraud that is relevant to the auditor?

Answer 34

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 the financial statements.

Question 35

List the two types of financial-statement-related frauds.

Answer 35

1. Fraudulent financial reporting (sometimes called cooking the books)
2. Misappropriation of assets (covering up theft by false journal entries).

Question 36

Identify the auditor’s responsibility for detecting fraud in a financial statement audit.

Answer 36

1. Auditors must design audit to provide reasonable assurance of detecting material misstatements whether due to fraud or error;
2. Auditors are required to specifically assess the risk of material misstatement due to fraud;
3. Auditors must document the assessment of the risk of material misstatement due to fraud and the resulting response(s) associated with any risk factors identified.

Question 37

What are the three categories of fraud-related risk factors that should be considered by the auditor?

Answer 37

1. Incentives/Pressures (the motivation for committing fraud)
2. Opportunities (the ability to commit fraud)
3. Attitudes/Rationalizations (the justification or excuse for committing fraud).

Question 38

What is the required form of the auditor’s communications about fraud-related issues?

Answer 38

May be either written or oral, but should be timely.

Question 39

What are the auditor’s responsibilities to communicate fraud identified by the auditor?

Answer 39

If the fraud is not material, the auditor should inform the appropriate level of management. If the fraud is material (or if senior management is involved, even if not material), the auditor should inform those charged with governance.

Question 40

When might an auditor have a duty to inform others outside of the audited entity of fraud-related matters?

Answer 40

1. In response to a valid subpoena;
2. To comply with applicable legal and regulatory requirements;
3. To respond appropriately to successor auditor’s inquiries when the former client has given permission to the predecessor;
4. To report fraud to the applicable funding agency under the requirements of government auditing standards.

Question 41

Who should be informed when the auditor has identified fraud, but that fraud is not material and does not involve senior management?

Answer 41

The appropriate level of management should be notified (defined to be at least one level above the level where the fraud occurred).

Question 42

Who should be informed when fraud has occurred that is material (whether or not senior management is involved in the fraud).

Answer 42

The auditor should inform those charged with governance.

Question 43

What matters should the auditor document with respect to the entity’s compliance with applicable laws and regulations?

Answer 43

1. The results of the discussion with management, those charged with governance, and others, as applicable;
2. Any identified or suspected noncompliance with applicable laws and regulations.

Question 44

Identify 3 audit procedures might bring to the auditor’s attention noncompliance with laws and regulations that do not have a direct effect on the entity’s financial statements.

Answer 44

1. Inquiry of management and those charged with governance about noncompliance with applicable laws and regulations;
2. Inspection of correspondence with regulatory authorities;
3. Reading the minutes of meetings of those charged with governance.

Question 45

What is meant by the term legal and regulatory framework?

Answer 45

Those laws and regulations to which an entity is subject; noncompliance may result in fines, litigation, or other consequences that may have a material effect on the financial statements.

Question 46

When might an auditor have a duty to inform others outside of the audited entity of illegal acts known to the auditor?

Answer 46

1. In response to a valid subpoena;
2. To comply with applicable legal and regulatory requirements;
3. To respond appropriately to successor auditor’s inquiries when the former client has given permission to the predecessor;
4. To report illegal acts to the applicable funding agency under the requirements of government auditing standards.

Question 47

What actions should an auditor consider when an illegal act has been detected?

Answer 47

1. Gather additional evidence to determine relevant facts;
2. Discuss the matter with the appropriate level of management;
3. Consider consulting with the entity’s attorney and/or relevant specialists;
4. Consider the implications to other audit areas.

Question 48

What is the auditor’s responsibility to detect illegal acts?

Answer 48

The auditor should design the audit to provide reasonable assurance of detecting illegal acts having a direct and material effect on the financial statements.

Question 49

What procedure can an auditor undertake to help detect illegal acts?

Answer 49

Make inquiries of management about the entity’s compliance with applicable laws.

Question 50

Define the term specialist.

Answer 50

An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence.

Question 51

List some examples of specialists.

Answer 51

Actuaries, appraisers, engineers, geologists, etc.

Question 52

What considerations should be made when an auditor is selecting a specialist?

Answer 52

The auditor should consider the specialist’s competence, capabilities, and objectivity (including professional credentials, reputation, and any relationship to the client).

Question 53

What reference to a specialist may an auditor make when expressing an unmodified opinion?

Answer 53

The auditor should NOT reference the specialist in an unmodified opinion.

Question 54

What reference to a specialist may an auditor make when expressing a modified opinion?

Answer 54

The auditor may reference the specialist, if that will facilitate the readers’ understanding of the reason(s) for the modified opinion.

Question 55

What matters are the auditor required to communicate to those charged with governance?

Answer 55

1. The auditor’s responsibilities under GAAS
2. The planned scope and timing of the audit
3. Significant findings from the audit

Question 56

What is the auditor’s basic responsibility regarding communication with those charged with governance?

Answer 56

The auditor must communicate those matters that are “significant” and relevant to the responsibilities of those charged with governance in overseeing the financial reporting process.

Question 57

Define what is meant by the term management.

Answer 57

The person(s) with executive responsibility for the conduct of the entity’s operations.

Question 58

Define what is meant by the term those charged with governance.

Answer 58

The person(s) or organization(s) with responsibility for overseeing the strategic direction of the entity and the obligations related to the accountability of the entity.