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Audit > SU 05 Audit risk and materiality > Flashcards

SU 05 Audit risk and materiality Flashcards

1
Q

Audit risk

A

the risk the auditor may not catch materially misstated financials (due to either error or fraud)

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2
Q

Materiality threshold

A

the acceptable level of misstatment/ the amount of error that can be allowed in an audit

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3
Q

Audit risk assessment types

A

Technical risk assessment
non-technical risk assessment

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4
Q

Technical risk assessment

A

Quantitative risk assessment

auditor “must assess risk associated with a client, to design nature, timing, and extent of audit procedures to be employed”

now generally build into the software

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5
Q

Non-technical risk assessment

A

Qualitative risk assessment, generally from an understanding of internal controls

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6
Q

Risk assessment procedures used to gain an understanding of the entity

A
  • inquiries
  • analytical procedures
  • inspection and observation
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7
Q

what does the non-technical initial assessment of a potential audit client include

A

1) observation and inspection of
- control environment and activities
- documents and reports
- walk through for observation
- inspect prior period information if verified as current/ relevant
- nature of the entity (business plans/ objectives

2) analytical procedures

3) inquiries
- management, internal auditors, lawyers etc

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8
Q

what does the initial assessment of a potential audit client result in

A

preliminary risk determination

general idea of risk level leads to determination of materiality threshold

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9
Q

Equation for audit risk

A

Audit risk = RMM x DR

RMM = risk of material misstatement
DR = detection risk

AKA audit risk model

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10
Q

Detection risk

A

the risk that substantive audit procedures will miss a material misstatement

expressed by a percentage indicating the amount of detection risk that can be tolerated

the only part of the audit equation that can be directly affected by the audit firm

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11
Q

Factors of detection risk

A
  • effectiveness of audit procedures
  • how well audit procedures are carried out by the auditor
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12
Q

Relationship between risk of material misstatement and detection risk

A

Inverse - as RMM rises, DR must be kept lower

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13
Q

Direct connections

A

aka positive - related elements rise or fall together

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14
Q

Inverse connections

A

aka negative - move in opposite directions

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15
Q

Components of RMM

A

RMM = IR x CR

IR = inherent risk
CR = control risk

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16
Q

Inherent risk

A

the susceptibility of an assertion to material misstatement if no controls are in place

largely a factor of the business environment?

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17
Q

Control risk

A

the risk that internal controls in place will not prevent or detect a material misstatement in a timely manner

management responsibility

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18
Q

Expanded Audit risk equation

A

AR = IR x CR x DR

Audit risk = inherent risk x control risk x detection risk

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19
Q

detection risk equations

A

DR = AR / RMM or DR = AR / (IR x CR)

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20
Q

Components of detection risk

A

DR = TD x AP

TD = test of details
AP = risk of substantive analytical procedures

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21
Q

When is materiality considered in an audit

A
  • balances
  • transaction classes
  • disclosures
  • financial statements overal
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22
Q

Materiality threshold

A

amount of misstatement that is tolerable at a given level, must in aggregate be less than the materiality threshold for the financial statements as a whole

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23
Q

Tolerable misstatement

A

the amount of inaccuracy that can be tolerated

aggregated small misstatements may together exceed overall tolerable materiality, ergo tolerable misstatement must be less than materiality by some safety margin

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24
Q

why might misstatements below the materiality threshold still be material misstatements?

A

there may be qualitative considerations, including:
- management integrity or bias
- cumulative affect
- effect of specific regulations

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25
Q

types of misstatements

A
  • identified misstatements
  • likely misstatements
  • errors
  • fraud
26
Q

evidence of likely misstatements may come from

A
  • differences in auditor vs management estimates
  • other evidence collected during audit
27
Q

scienter

A

having intent

related to fraud

28
Q

what parts of the audit use analytical procedures

A
  • planning stage (initial risk assessment)
  • substantive procedures state
  • final stage (overall view of the audit)
29
Q

Sources of data for analytical procedures

A
  • financial information from past comparable periods
  • anticipated results (forecasts/ estimates)
  • relationships among data
  • comparable industry data
  • relationship between financial and non-financial data
30
Q

Current ratio

A

current assets/ current liabilities

31
Q

Quick ratio (acid test ratio)

A

(Current assets - inventory)/ current liabilities

32
Q

Receivables turnover

A

net sales/ average net receivables

33
Q

Days sales in receivables

A

365, 360 or 300 / receivables turnover

34
Q

Inventory turnover

A

COGS/ average inventory

35
Q

Days sales in inventory

A

365, 360, or 300 / inventory turnover

36
Q

Debt-to-equity ratio

A

total debt/ total equity

37
Q

Total asset turnover

A

net sales / total assets

38
Q

Return on equity

A

net income / total equity

39
Q

Gross margin percentage

A

(net sales - COGS) / net sales

40
Q

Net operating margin percentage

A

operating income ./ net sales

41
Q

Cost of good sold ratio

A

COGS / net sales

42
Q

Times interest earned

A

(Net income + interest expense + income tax expense) / interest expense

43
Q

Control environment

A
  • organizational structure
  • assigned authority and responsibility (checking for existence of incompatible job responsibilities)
44
Q

internal control activities that must be assessed

A
  • information processing controls
  • access controls
45
Q

Methods of auditing through the computer

A
  • test data
  • parallel simulation
  • integrated test facility (ITF)
  • Embedded audit module (EAM)
46
Q

Test data computer auditing

A

auditor compares how the system calculates data to manual calculations

47
Q

Parallel simulation

A

same data run through auditor’s computer and clients system to ensure it comes out the same

48
Q

Integrated test facility

A

run dummy transactions through the client’s systems to check results and controls

49
Q

Embedded Audit modules

A

continuous monitoring with an audit module embedded in the client computer system

50
Q

Auditor’s responsibility regarding fraud

A

Provide REASONABLE assurance that financials are free from material misstatement due to error or fraud

51
Q

Who has primary responsibility to prevent/ deter/ detect fraud

A

Management and those charged with governance (board)

52
Q

Fraud Triangle

A
  • Incentives/ pressures
  • opportunity
  • rationalization
53
Q

Fraud pentagon

A
  • revised fraud triangle more focused on middle to upper management
  • Pressure
  • Opportunity
  • Rationalization
  • Arrogance
  • Competence
54
Q

Types of financial statement related fraud

A
  • Fraudulent financial reporting (intended to deceive users of FS)
  • Misappropriation of assets
55
Q

Defalcation

A

per investopedia: “the theft, misuse, or misappropriation of money or funds held by an official trustee, or other senior-level fiduciary. “

form of embezzlement

56
Q

Fraud risk assessment actions required to combat fraud

A
  • Planning: discussion of risks with key personnel on audit
  • brainstorming possible fraud that might be a risk for the client
  • Assess the client’s risk factor
  • continuously monitor for fraud throughout engagement
  • adjust procedures to respond to fraud/ high fraud risk
  • DOCUMENT IN WORKPAPERS
57
Q

Fraud-related items that must be discussed

A
  • management overrides
  • improper revenue recognition
  • significant accounting estimates
  • significant unusual transactions
58
Q

What must be documented in audit workpapers in re fraud

A
  • planning discussions
  • procedures to assess fraud risk
  • identified risks
  • Management override assessment and responses
  • responses to any fraud concerns
  • any fraud related communications

must answer any questions raised in the documentation

59
Q

Common skimming schemes

A

(theft of incoming sales)
- on- site employees
- remote salespeople
- mailroom theft
- check-for-cash substitutions

60
Q

What is the auditor’s responsibility regarding detecting client fraud

A
  • supposed to watch for non-compliance by client
  • only REQUIRED to watch for issues that have a direct and material effect on financials (not all aspects, not indirect aspects)
  • must assess RMM for non-compliance
  • must inquire of management about compliance with laws and regulations - requires a management representation that there are no legal or regulatory violations
61
Q

Management representation letter

A
  • bullet points of all the facts that management has represented to the auditor
  • auditor supplies to management and management signs

Audit (13 decks)

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