Unit 3- Planning and Risk Assessment Flashcards
What are risk assessment procedures?
are procedures performed to obtain and understanding of the entity and its environment, including its internal control, to identify and assess the risks of material misstatement (RMMs) at the levels of 1) the financial statements as a whole and 2) relevant assertions
What is a representation letter?
a written representation about whether the effects of any uncorrected misstatements are immaterial, individually or in aggregate
What are Risks of Material Misstatements (RMMs)?
they are the combined assessment of inherent risk and control risk
What is professional skepticism?
it is an attitude that includes a questioning mind and critical assessment of audit evidence
What is inherent Risk?
Is the susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, individually or in the aggregate, before consideration of related controls.
What is control risk?
is the risk that internal control will not prevent, or detect and correct, on a timely basis a misterial misstatement that could occur in an assertion
What is detection risk?
is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a material misstatement. It is a function of the effectiveness of an audit procedure and its application by the auditor.
What is Audit Risk?
Audit risk consists of the risk of material misstatement ( inherent risk combined with control risk) and detection risk.
What are the five sources of information used to develop analytical procedures?
1) Financial information from comparable prior periods(s)
2) anticipated results such as budgets or forecasts prepared by management ( or others) prior to the end of the period
3) Relationships among elements of financial information, such as those among the balances on the financial statements
4) comparable information from the clients industry
5) Relationships between financial and relevant nonfinancial information
What is Current Ratio?
Current Assets/ Current liabilities
changes in the ratio may be cause by changes in the components of current assets( typically cash, receivables, and inventory) and current liabilities (typically accounts payable and notes payables)
What is Quick (acid test) Ratio?
Current Assets - Inventory/ Current liabilities
quick assets are convertible to cash quickly
What is Receivables Turnover Ratio?
Net Sales/ Average net receivables
changes in sales or receivables affect this ratio
What is Days’s sales in receivables Ratio?
365, 360, or 300/ Receivables
this ratior has the same components as receivables turnover and is affected by changes in sales or receivables.
what is inventory turnover ratio?
Cost of goods sold divided by average inventory
Auditors often calculate this ratio using ending inventory as the denominator because it is the balance being audited. Changes in cost of goods sold or inventory affect this ratio.
What does a high inventory ratio imply?
a hight turnover implies that the entity does not hold excessive inventories that are unproductive and lessen its profitability
it also implies that the inventory is truly marketable and does not contain obsolete goods
What happens if the current ratio is less than 1.0?
equal increases in the numerator and denominator increase the ratio, and equal decreases decrease the ratio
What happens if the current ratio is more that 1.0?
equal increases in the numerator and denominator decrease the ratio, and equal decreases increase the ratio
What is Days’ sales in inventory ratio?
365, 360, or 300/ inventory turnover
this ratio has the same components as inventory turnover and is affected by changes in inventory or cost of sales
What is total asset turnover ratio?
Net sales/ total assets
this ratio calculates how many times the total assets turn over in sales. it is affected by changes in sales and total assets. the denominator also may be average total assets
What is debt to equity ratio?
total debt/total equity
This ratio measures how much external parties contribute to assets relative to owners. shifts in debt or equity affect this ratio.
The atios of total assets to total equity and total assets to total debt provide similar analysis and conclusions.
What is times interest earned ratio?
Net income+ Interest expense+ Income tax expense / Interest expense
Times interest earned measures the ability of an entity to pay its interest charges. Taxes are added back to net income because interest is paid before taxes. interest is added back to net income because it is included in the calculation of net income.
an alternative is to exclude interest from the numerator and to add 1.0 to the quitient once the calculation is made
changes in interest and net income may afffect this ratio.
If earning decline sufficiently, no income tax expense will be recognized
What is the cost of goods sold ratio?
cost of goods sold / net sales
this ratior measurs the percentage amount of sales consumed by cost of goods sold. nonproportional changes in either affect the ratio
What is the Gross margin percentage ratio?
net sales - cost of goods sold / net sales
The gross margin percentage measures earning from the sale of products. Nonproportional changes in net sales and cost of goods sold affect the ratio.
What is net operating margin percentage?
operating income / net sales
Operating income is calulated before subtracting interest and taxes
what is return on equity ratior?
net income / total equity
this is an overall measure of a rate of return on investment. changes in net income or changes in equity may affect this ratio
What is fraud?
is an intentional act by one or more individuals among management, those charged with govenance, employees, or third parties, involving the use of deception that results in a misstatement in financial statements that are the subject of an audit
What are the three conditions ordinarily present when fraud exists?
- pressures or incentives
- opportunity
- and the capacity to rationalize misconduct
What is fradulent financial reporting?
this are intentional misstatements or omissions to deceive users, such as altering accounting records or documents, misrepresenting or omitting significant information and misapplying accounting principles
what is Misappropriation of assets?
These result from 1) theft of physical assets
2) embezzlement (eg stealing collections of receivables) 3) an action that causes payment for items not received or 4) using entity assets for personal reasons
What are fraud risk factors?
are events or conditions indicating prossible fraud
What are the terms that shoudl be documented in an engagement letter?
1) objective and scope of the audit
2) responsibilities of the auditor and management
3) inherent limitations of the audit and internal control
4) the financial reporting framework
5) the expected form and content of audit reports
an engagement letter should be sent by the CPA to the prospective client on each engagement, audit or otherwise. If the client agrees to the terms by signing a copy of the letter and returning it to the CPA, a contract is formed.
Documentation of the consideration of fraud should include?
1) decisions made during the discussions among the engagement team
2) identified and assessed risks at the statement and assertion levels
3) overall responses, procedures performed, and the connection to assessed risks at the assertion level
4) reasons for not identifying improper revenue recognition as a fraud risk
5) results of procedures, including those addressing management override
6) fraud communications
What is Noncompliance?
is an intentional or unintentional act or omission by the entity that is contrary to laws or regulations. it includes an act
1) in the name of the entity
2) on its behalf by
a) those charged with governance
b) management
c) employees
What are the 3 related levels that materiality is defined for planning purposes?
1) Materiality at the financial statement level as a whole is a monetary amount that results in the misstatement of the financial statements
2) Materiality levels also are set for particular account balances, classes of transactions, or disclosures
3) Performance materiality is one amount or more set by the auditor at less than the materiality for the statements as a whole. Performance materiaility also refers to amounts set at less than materiality
