Quiz 2 Flashcards
Audit Committee
Subcommittee of the Board of Directors that is responsible for the
financial reporting and disclosure process
Required by SOX
Internal audit should
functionally report to
the audit committee and administratively to CEO, CFO…
Audit Strategy vs Audit Plan
Strategy is broad and about resources
Plan is more detailed and actual actions
Related Parties
Affiliates of the enterprise
Nature, Timing, and Extent
Nature: specific audit procedures to perform
Timing: when the audit procedures are performed (interim or year end)
Extent: amount of testing (sample sizes, how much substantive testing)
Risk Assessment
Procedures
Audit procedures used to obtain an
understanding of the entity and its
environment, including its internal control.
Tests of Controls
Audit procedures performed to test the effectiveness of controls in preventing or detecting and correcting material
misstatements
Substantive
Procedures
Audit procedures performed to detect material misstatements in a transaction class, account balance, and disclosure component of the
financial statements.
Tolerable Misstatement
Auditor sets a separate materiality for individual accounts.
It is set at an amount less than overall materiality.
A common benchmark is to
set tolerable materiality at 50-75% of overall materiality.
Audit Risk
Risk the auditor mistakenly expresses a clean audit opinion when the
financial statements are materially misstated
Auditors must consider audit risk at
The assertion level
Inherent Risk
The probability that a material misstatement would occur in client’s financial statements before considering any controls (assumes no controls in place)
Control Risk
The risk that a material misstatement will bypass controls or not be detected and corrected by controls on a timely basis (based on client’s internal control structure)
Risk of Material Misstatement (RMM) =
IR x CR
Detection Risk
The risk that audit procedures performed by an auditor
will not detect a material misstatement (either individual or in aggregate)
Relationship between DR and IR/CR
Inverse
Audit Risk =
IR x CR x DR or RMM x DR
Risks order:
- Audit Risk
- Inherent Risk
- Control Risk
- Detection Risk
Audit Risk Model Steps
- Auditor Sets Audit Risk
- Auditor assesses IR and CR
- Auditor solves for DR
Relationship between DR and testing
Inverse
Relationship between RMM and testing
proportional
Engagement Risk
The risk the auditor is exposed to financial loss or damage to his/her professional reputation from litigation, adverse publicity or
other events arising in connections with the audited financial statements
Fraud Risk Triangle =
Incentive + Opportunity + Attitude
Fraudulent financial reporting
intended to deceive
financial statement users
Misappropriation of assets
theft of assets that
cause financial statement
misstatements
Whenever auditor has found evidence of fraud, that matter should be brought to the
attention of
Typically - at least one management level higher than the fraud
Fraud involving senior management or material misstatement to the financial statements should be reported directly to the Audit Committee
The higher the quality of evidence,
requires less audit evidence
Nature, Timing, Extent
Nature- The type of test to perform, such as observation, confirmation, or reconciliation
Timing- When to perform the test, such as interim or at year-end
Extent- The amount of testing to perform, such as the number of samples or observations
Occurence/Existence order
Vouch down. Start at ledger and go down to source document
Completeness order
Trace up – start at source document and go up to ledger
Highest Reliability Testing:
-Inspection of Tangible Assets
-Reperformance
-Recalculation
Least Reliable Testing:
-Observation
-Inquery
Vertical Analysis
Involves the assessment of line items of a financial statement as a
percentage of a specific base line item
Horizontal Analysis
Compares historical data, which includes ratios and line items,
over a series of accounting periods (month, quarter, year….)
