Unit 3- Planning and Risk Assessment

Question 0

What are risk assessment procedures?

Answer 0

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

Question 1

What is a representation letter?

Answer 1

a written representation about whether the effects of any uncorrected misstatements are immaterial, individually or in aggregate

Question 2

What are Risks of Material Misstatements (RMMs)?

Answer 2

they are the combined assessment of inherent risk and control risk

Question 3

What is professional skepticism?

Answer 3

it is an attitude that includes a questioning mind and critical assessment of audit evidence

Question 4

What is inherent Risk?

Answer 4

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.

Question 5

What is control risk?

Answer 5

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

Question 6

What is detection risk?

Answer 6

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.

Question 7

What is Audit Risk?

Answer 7

Audit risk consists of the risk of material misstatement ( inherent risk combined with control risk) and detection risk.

Question 8

What are the five sources of information used to develop analytical procedures?

Answer 8

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

Question 10

What is Current Ratio?

Answer 10

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)

Question 11

What is Quick (acid test) Ratio?

Answer 11

Current Assets - Inventory/ Current liabilities

quick assets are convertible to cash quickly

Question 12

What is Receivables Turnover Ratio?

Answer 12

Net Sales/ Average net receivables

changes in sales or receivables affect this ratio

Question 13

What is Days’s sales in receivables Ratio?

Answer 13

365, 360, or 300/ Receivables

this ratior has the same components as receivables turnover and is affected by changes in sales or receivables.

Question 14

what is inventory turnover ratio?

Answer 14

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.

Question 15

What does a high inventory ratio imply?

Answer 15

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

Question 16

What happens if the current ratio is less than 1.0?

Answer 16

equal increases in the numerator and denominator increase the ratio, and equal decreases decrease the ratio

Question 17

What happens if the current ratio is more that 1.0?

Answer 17

equal increases in the numerator and denominator decrease the ratio, and equal decreases increase the ratio

Question 18

What is Days’ sales in inventory ratio?

Answer 18

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

Question 19

What is total asset turnover ratio?

Answer 19

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

Question 20

What is debt to equity ratio?

Answer 20

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.

Question 21

What is times interest earned ratio?

Answer 21

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

Question 22

What is the cost of goods sold ratio?

Answer 22

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

Question 23

What is the Gross margin percentage ratio?

Answer 23

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.

Question 24

What is net operating margin percentage?

Answer 24

operating income / net sales

Operating income is calulated before subtracting interest and taxes

Question 25

what is return on equity ratior?

Answer 25

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

Question 26

What is fraud?

Answer 26

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

Question 27

What are the three conditions ordinarily present when fraud exists?

Answer 27

• pressures or incentives
• opportunity
• and the capacity to rationalize misconduct

Question 28

What is fradulent financial reporting?

Answer 28

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

Question 29

what is Misappropriation of assets?

Answer 29

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

Question 30

What are fraud risk factors?

Answer 30

are events or conditions indicating prossible fraud

Question 31

What are the terms that shoudl be documented in an engagement letter?

Answer 31

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.

Question 32

Documentation of the consideration of fraud should include?

Answer 32

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

Question 33

What is Noncompliance?

Answer 33

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

Question 34

What are the 3 related levels that materiality is defined for planning purposes?

Answer 34

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