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CPA Exam Audit > Section 2 - Planning Activities > Flashcards

Section 2 - Planning Activities Flashcards

1
Q

What components are included in an engagement letter?

A
  1. the objective of the audit;
  2. management’s responsibilities for the financial statements, for internal control over financial reporting, and for compliance with laws and regulations;
  3. availability of financial records;
  4. representation letter;
  5. auditor’s responsibilities;
  6. components of an audit; and
  7. correction of misstatements.
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2
Q

Before accepting an engagement to audit a new client, the CPA must obtain what?

A

The prospective client’s consent to make inquiries of the predecessor auditor

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3
Q

Must the the auditor’s required communication with the predecessor auditor be made in writing?

A

No. It is not required that it’s in writing. It can be oral, but should be documented.

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4
Q

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

A
  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;
  4. Predecessor’s understanding of the reason(s) for the client’s change in auditors.
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5
Q

What is meant by the term preconditions for an audit?

A

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.

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6
Q

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

A

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.

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7
Q

What matters are typically addressed in an engagement letter?

A
  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.).
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8
Q

What is meant by the term initial audit?

A

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

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9
Q

Providing more supervision during an audit of a non-issuer in response to assessed risks of material misstatement at the financial statement level is an example of what type of response?

A

An Overall Response

(AICPA Professional Standards discuss responses to the auditor’s assessment of the risks of material misstatement at two levels: (1) overall response; and (2) response at the relevant assertion level. Increasing the extent of supervision would be an example of an overall response.)

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10
Q

What are the 6 items an auditor would consider when planning an audit?

A
  1. the nature of the engagement;
  2. the type of report to be issued;
  3. the nature of the financial statements, schedules, or other information on which the auditor is reporting;
  4. the nature and condition of the client’s records;
  5. the assessed level of control risk (INCLUDING THE ESTIMATED OCCURRENCE RATE OF ATTRIBUTES)
  6. the needs in the particular circumstances for supervision and review of the work.
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11
Q

True or False: “Due care” requires that the auditor put forth the same emphasis on audit planning activities in every audit engagement.

A

False. Not sure why…

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12
Q

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

A
  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.
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13
Q

What is one of the main sources used by the auditor to determine materiality during planning?

A

The entity’s annualized interim financial statements.

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14
Q

True or False: Materiality can be appropriately described as an understanding of what is important to the fairness of the financial statements.

A

True

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15
Q

What is the basic meaning of the concept of materiality?

A

An understanding of what is important.

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16
Q

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

A

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

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17
Q

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

A

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.

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18
Q

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

A
  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.
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19
Q

What is meant by the term tolerable misstatement?

A

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

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20
Q

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

A

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

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21
Q

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?

A

Performance materiality.

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22
Q

What causes a likely misstatement?

A

(1) Differences in judgment between management and the auditor relating to accounting estimates that the auditor considers unreasonable or inappropriate, or
(2) Estimated misstatements based on the extrapolation from a sample to the population.

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23
Q

What happens to RMM when an entity changes from cash to accrual basis accounting?

A

A change to generally accepted accounting principles will increase the risk of material misstatement because the change in basis requires management to prepare a number of entries that have not been made in the past; these entries may be made improperly. Also, difficulties in determining beginning accrual basis balances increases the risk of misstatement.

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24
Q

Yes or No. Do both inherent risk and control risk exist independently of the audit of financial statements?

A

YES

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25
Q

Define “control risk.”

A

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

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26
Q

What risk is within the auditor’s control?

A

Detection risk.

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27
Q

Define “detection risk.”

A

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.

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28
Q

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

A

Audit Risk = inherent risk x control risk x detection risk.

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29
Q

Define “risk of material misstatement.”

A

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

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30
Q

Define “audit risk.”

A

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

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31
Q

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

A
  1. Nature
  2. Timing
  3. Extent of substantive testing.
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32
Q

Define “inherent risk.”

A

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

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33
Q

Comparing the current year’s financial statements with those of the prior year is an analytical procedure most likely performed at what stage of the audit?

A

Final Overall Review Stage

34
Q

What is the goal of analytical procedures in the final review stage of the audit?

A

Assist the auditor in evaluating the overall financial statement presentation

35
Q

Who should perform the final review stage analytical procedures?

A

A manager or partner who has a comprehensive knowledge of the client’s business and industry.

36
Q

What stage of the audit would the analytical procedure “Comparing current-year balances to budgeted balances” most likely be performed?

A

Planning

37
Q

What type of account has very high reliability regarding an analytical procedure?

A

Non-discretionary income statement accounts, such as revenue or payroll expense.

38
Q

Analytical procedures usually involve comparisons of recorded amounts or ratios to expectations developed by whom?

A

The auditor

39
Q

Do analytical procedures involve comparisons of recorded amounts or ratios to assertions made by management?

A

NO. They are comparison of actual amounts to EXPECTATIONS of the AUDITOR, not management.

40
Q

Analytical procedures used in planning should enhance what?

A

The auditor’s understanding of the client’s business.

41
Q

Which account has more predictable relationships with analytical procedures: Accounts Receivable or Interest Expense?

A

Interest Expense

Estimation of interest expense, based on interest rates and principal balances, would most likely yield the highest level of evidence because the relationship is highly predictable. Relationships involving income statement accounts are more predicable than relationships involving balance sheet accounts because income statement accounts involve transactions occurring over a period of time, rather than at a point in time.

42
Q

What is the purpose of analytical procedures in audit planning?

A

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

43
Q

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

A

To verify the conclusions reached in the audit.

44
Q

What matters must be documented in connection with analytical procedures?

A
  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.
45
Q

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

A
  1. Nature of assertion;
  2. Plausibility and predictability of relationship;
  3. Availability and reliability of data;
  4. Precision of expectation.
46
Q

What 3 purposes might analytical procedures serve?

A
  1. Required during planning
  2. May be used as substantive evidence (not required)
  3. Required during final review.
47
Q

Define “analytical procedures.”

A

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

48
Q

Does a large number of bearer bonds on hand increase or decrease the risk of misstatement arising from misappropriation of assets?

A

Increase. Bearer bonds are easily convertible assets.

49
Q

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

A

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.

50
Q

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

A
  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
51
Q

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

A
  1. Fraudulent financial reporting (sometimes called cooking the books)
  2. Misappropriation of assets (covering up theft by false journal entries).
52
Q

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

A
  • Incentives/Pressures (the motivation for committing fraud)
  • Opportunities (the ability to commit fraud)
  • Attitudes/Rationalizations (the justification or excuse for committing fraud).
53
Q

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

A

May be either written or oral, but should be timely

54
Q

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

A

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

55
Q

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

A
  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.
56
Q

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

A
  1. If the fraud is not material, the auditor should inform the appropriate level of management.
  2. If the fraud is material (or if senior management is involved, even if not material), the auditor should inform those charged with governance.
57
Q

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

A

The auditor should inform those charged with governance.

58
Q

If those charged with governance decide not to take action on an illegal act brought to their attention, whether material or immaterial, what should the auditor do?

A

Consider withdrawing from the audit engagement and disassociating from future relationships with the client.

The auditor may decide that withdrawal is necessary when the client fails to take the remedial action considered necessary. This failure may indicate a greater problem with the control environment and overall governance. As a result, it may affect the auditor’s ability to rely on management representations as well as the relationship with the client going forward.

59
Q

If an entity prepares several large checks payable to cash throughout the year, what should the auditor suspect?

A

Large checks payable to cash would be most likely to raise questions regarding possible illegal acts. Valid company disbursements are typically made by check and controlled through accounts payable. Cash payments are unusual and difficult to control. As a result, large checks payable to cash would present a red flag during the audit.

60
Q

Does the auditor have more responsibility to detect illegal acts related to financial reporting than related to operating procedures?

A

Yes. The auditor has a higher responsibility to detect Illegal acts directly relating to financial reporting activities are

61
Q

What is meant by the term legal and regulatory framework?

A

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.

62
Q

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

A
  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.
63
Q

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

A

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

64
Q

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

A
  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.
65
Q

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

A
  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
66
Q

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

A

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

67
Q

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.

A
  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.
68
Q

Can a specialist be used even if it is a related party to the entity being audited?

A

Yes, however the auditor must assess the independence and whether additional procedures must be performed to evaluate results of the specialist. Essentially the auditor should assess the risk that the specialist’s objectivity might be impaired.

69
Q

What are the responsibilities of the auditor in a specialist / Auditor relationship?

A

Responsibility for the reasonableness of the methods and assumptions used and their application belongs to the specialist.

The auditor is responsible for obtaining an understanding of the methods and assumptions used by the specialist, ensuring that the data provided to the specialist are tested, and evaluating whether the specialist’s findings support the related assertions in the financial statements

Finally, the auditor is still completely responsible for the opinion in the audit report if the expertise of a specialist is used.

70
Q

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

A

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

71
Q

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

A

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

72
Q

Define the term specialist.

A

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.

73
Q

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

A

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

74
Q

List some examples of specialists.

A

Actuaries, appraisers, engineers, geologists, etc.

75
Q

Define Those charged With governance

A

The person(s) organization(s) with responsibility for overseeing the strategic direction of the entity and the obligations related to the accountability of the entity (encompasses the term “board of directors” or “audit committee” used elsewhere in the auditing standards).

76
Q

Define Management

A

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

77
Q

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

A
  1. The auditor’s responsibilities under GAAS
  2. The planned scope and timing of the audit
  3. Significant findings from the audit.
78
Q

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

A

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.

79
Q

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

A

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.

80
Q

Define what is meant by the term management.

A

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

CPA Exam Audit (3 decks)

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