Audit Chapter 6 – Flashcards

1. Plan the audit. - Use a risk-based approach which continually considers the possibility of material financial statement misstatements 2. Obtain an understanding of the client and its environment, including internal control. - Risk assessment procedures are used to gather information and include inquiries of management, analytical procedures, observation and inspections, and more. 3. Assess the risks of misstatement and design further audit procedures. 4. Perform further audit procedures. - include tests of controls and substantive procedures 5. Complete the audit. 6. Form an opinion and issue the audit report.

the audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control. They are designed to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels. Risk assessment procedures include inquiries of management and others within the entity, analytical procedures, and observation and other procedures, including inquiries of others outside the entity

risk of material misstatement of an assertion about an account without considering internal control

representations of management that are communicated by the financial statements

risks that threaten management's ability to achieve the organization's objectives

the risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control

tests directed toward the design or operation of a control to assess its effectiveness in preventing or detecting material misstatements of financial statement assertions

tests of account balances and transactions designed to detect any material misstatements in the financial statements. The nature, timing and extent of substantive procedures are determined by the auditors'' assessment of risks and their consideration of the client's internal control

auditors must consider the reputation of management and the financial strength and credit rating of a prospective client to help assess the overall risk of association with the particular business

composed of at least three financially literate independent directors; responsible for appointment, compensation, and oversight of the auditors

a CPA firm that formerly served as auditor but has resigned from the engagement or has been notified that its services have been terminated

the auditors who have accepted an engagement or who have been invited to make a proposal for an engagement to replace the CPA firm that formerly served as auditor

management changes auditors to a CPA firm that is more likely to sanction a disputed accounting principle

-When the engagement letter is accepted by the authorized client official, it presents an executor contract between the auditor and the client -Printed on letterhead, addressed to chairman of the BOD, dated, signed by CPA -The objective and scope of the audit, the responsibilities of the auditor (GAAS), the responsibilities of management and identification of the applicable financial reporting framework, other information, reporting

When a portion of the client is audited by another CPA firm, efforts should be coordinated

Effective planning involves arranging the appropriate use of specialists both inside and outside of the client organization

-First audit - the auditors should obtain sufficient appropriate evidence about whether the opening balances for the various accounts contain misstatements that materially affect the current period's financial statements -Successor auditors will ordinarily have communicated with the predecessor auditors about management integrity, disagreements, communications with the audit committee, and reason for change

- Identify risks; relate the identified risks to what can go wrong at the relevant assertion level; consider whether the risks are of a magnitude that could result in a material misstatement; consider the likelihood that the risks could result in a material misstatement - Financial statement level risks: risks related to an ineffective control environment; lack of sufficient capital to continue operations; declining industry; risks related to the selection and application of significant accounting policies - Relevant assertion level risks - Significant risks that require special audit consideration: often relate to nonroutine transactions and estimation transactions •Carefully consider the design and implementation of controls •Don't rely on evidence about the operating effectiveness of the related controls that has been gathered in prior periods •Don't rely solely on analytical procedures to obtain audit evidence about the related financial statement assertions

the possibility that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated

Existence or occurrence; rights and obligations; completeness; cutoff; valuation or allocation; presentation and disclosure

1. Misstatements arising from fraudulent financial reporting 2. Misstatements arising from misappropriation of assets 3. PCAOB 314 requires that auditors have a discussion with the audit team members about the susceptibility of the client's financial statements to material misstatements 4. PCAOB 316 requires a discussion on susceptibility to fraud 5. Discussions with engagement personnel, making inquiries related to fraud, performing risk assessment analytical procedures to identify fraud risks, considering fraud risk factors (pressure, opportunity, attitude to rationalize), identifying fraud risks, responding to fraud risks (modification in approach having an overall effect on how the audit is conducted, an alteration in the nature, timing and extent of the procedures performed, and performance of procedures to further address the risk of management override of internal control), overall response (see below), alterations in audit procedures, response to the possibility of management override (see below), evaluating the results of audit tests, discovery of fraud (communicate suspicions to an appropriate level of management)

last-minute adjustments that significantly affect financial results; evidence of employees' access to systems and records inconsistent with that necessary to perform their authorized duties; unsupported or unauthorized balances or transactions

missing documents; missing inventory or physical assets of significant magnitude; significant unexplained items on reconciliations

denial of access to records, facilities, certain employees, customers, vendors, or others from whom audit evidence might be sought; unusual delays by the entity in providing the requested information; tips or complaints to the auditors about fraud

1. Professional skepticism and audit evidence. The auditors may respond by designing procedures to obtain more reliable evidence in support of specific financial statement items or by obtaining additional corroboration of management's explanations or representations concerning material matters, such as through third-party confirmation, the use of a specialist, or examination of documentation from independent sources. 2. Assigning personnel and supervision. The auditors may respond by assigning additional staff with specialized skill and knowledge or by assigning more experienced staff to the engagement. In addition, the extent of the supervision of the audit staff should be adjusted to reflect the fraud risks identified. 3. Accounting principles. The auditors may decide to further consider management's selection and application of significant accounting principles, particularly those related to subjective measurements and complex transactions. 4. Predictability of auditing procedures. The auditors may incorporate an added element of unpredictability in the selection of auditing procedures. As examples, they may use differing sampling techniques, adjust the timing of testing from what otherwise would be expected, or perform procedures at locations on an unannounced basis.

1. Examining journal entries and other adjustments for evidence of material misstatement due to fraud. Material misstatements of financial statements due to fraud often involve the manipulation of the financial reporting process by recording inappropriate journal entries or adjustments. Therefore, the auditors should review such entries and adjustments for suspicious characteristics, such as entries made to unrelated, unusual, or seldom-used accounts; entries recorded at the end of the period or as post-closing entries that have little or no explanation or description; or entries made either before or during the preparation of the financial statements that do not have account numbers. 2. Reviewing accounting estimates for biases. Fraudulent financial reporting often is accomplished through intentional misstatement of accounting estimates, such as the allowance for uncollectible accounts. Thus, auditors should perform a retrospective review of significant accounting estimates reflected in the financial statements of the prior year to determine whether management judgments and assumptions relating to the estimates indicate a possible bias on the part of management. For example, in performing a retrospective review of the allowance for uncollectible accounts, the auditors might compare management's estimate used in the prior financial statements with the amounts eventually determined to be uncollectible. Evidence of bias in the prior year should be considered in auditing the current year accounting estimates. 3. Evaluating the business rationale for significant unusual transactions. During the course of the audit, if the auditors encounter significant transactions that are outside the normal course of business for the client or otherwise appear unusual, they should gain an understanding of their business rationale. The auditors should be especially alert for significant unusual transactions with related parties.

In staffing a high-risk audit, the firm should consider assigning more experienced staff to the engagement, assigning individuals with specialized skills, increasing the extent of supervision

selection is based on the materiality of account balances, transactions, and disclosures being audited and the assessed risks of material misstatement

flow of accounting data or trail of evidence that links the thousands of individual transactions composing a year's business activity with the summary figures in the financial statements; consists of source documents, journal entries and ledger entries; also exists within a computer-based accounting system

starting at the financial statements and finishing at the source documents to test for existence or occurrence (overstatements)

starting at the source documents and finishing at the financial statements to test for completeness (understatements)

some tests of controls that provide substantive evidence about an account or class of transactions that serve as both a test of controls and a substantive test of the details of the transactions that occurred during the year

substantiate an asset - verify existence

physical examination establishes existence but not ownership; established by reviewing the underlying contracts

effective internal control provides assurance that acquisitions are recorded and helps the auditors to establish the completeness of recorded assets; observation and examination

transactions only in the current period and not subsequent - review transactions before and after balance sheet date

establish that accounting method used to value a particular asset is generally accepted and appropriate/properly applied

presentation conforms to the requirements of authoritative accounting pronouncements and the general principle of adequate disclosure

1. Existence of assets - all recorded receivables exist - RMM: receivables may have been recorded that do not exist (confirm a sample of receivables by direct communication with debtors); management may have fraudulently overstated revenue and receivables by making inappropriate adjusting journal entries (review monthly adjusting entries for suspicious items) 2. Rights to assets - the client has rights to the receivables - RMM: accounting personnel may erroneously be treating a sale of receivables as a liability (review confirmations of liabilities to determine if receivables have been sold or factored) 3. Completeness of assets - all receivables are recorded - RMM: management may have shipped items before the end of the period but not recorded the sales and related receivables until the subsequent period (select a sample of sales invoices in the subsequent period and examine the related shipping document for date of shipment) 4. Cutoff of transactions - sales and cash receipt transactions are recorded in the proper period - RMM: allowance for uncollectible accounts may be misestimated by management (investigate the credit ratings for delinquent and large receivables); allowance for sales returns and allowances may be misestimated by management (compare the amount of credits given to customers in the subsequent period to the amount estimated by management); software routine to develop aged trial balance of receivables may have been erroneously programmed (obtain an aged trial balance of receivables, test its clerical accuracy, and reconcile to the ledgers) 5. Financial statement presentation of assets - receivables are properly presented in the balance sheet, with appropriate disclosures - RMM: accounting personnel may have failed to identify related party transactions (provide a list of related parties to all members of the audit team to assist in identification of the transactions)