Audit Exam 1

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Operational Audit
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Evaluates the efficiency and effectiveness of any part of an organization’s operating procedures and methods – not just accounting example- computerized payroll process is operating efficiently and effectively criteria- company stands who? internal auditor CIA controller
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Compliance Audit
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conducted to determine whether the auditiee is following specific procedure, rules or regulations set by some higher authority who? GAO auditors, DCAA (Defense contact audit agency), IRS agents example- determine whether bank reuirements for loan continuation have been met – usually for management
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Opinion
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fair presentation of results of operation financial position & related to cash flows in accordance to GAAp – financial statements is not enough must have knowledge of industry and strategy ex- annual audit of boeings financial statements lots of info -must be a cpa required for public companies, reported with the SEC
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assurance service
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independent professional service that improves the quality for decision makers- could be CPA or other
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attestation service
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type of assurance service in which the CPA firm issues a report about a subject matter of assertion that is made by another party audit of historical financial statements, audit of internal control over financial reporting, review of historical financial statements, attestation service on IT, other attestation services
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audit of historical financial statements
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– auditor issues a written report expressing an opinion about whether the financial statements are fairly stated in accordance to standards – all publicly traded companies are required to have an audit. private companies still do to obtain financing
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audit of internal control over financial reporting
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– mgmt asserts that internal control have been developed and implemented following well established criteria – section 404 required public companies to do so, also require large public companies to attest to the effectiveness of internal control of financing reporting increased used confidence about future financial reporting
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review of historical financial statements
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– cpa provides a lower level of assurance for reviews of financial statements compared to the high level for audits there for less evidence is needed – lots of nonpunlic companies use this
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attestation services on IT
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management makes various assertions about the reliability and security of info technology webtrust- CPA firms that are licensed by the AICPA to preform the service prove assurance to users of websites though the webtrust seals. related to business practice , transaction integrity and information systrust- AISPA and CICA created this to evaluate and test system reliability in areas such a security and data integrity for- mgmt, board of directors, third partied on reliability of real time info
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other attestation services
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– many of these services are natural extension of the audit of historical financial statements as users seek independent assurance about other types of info – provice written assurance about the reliability of an assertion made by mgmt ex- compliance bank loan
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non assurance
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acct and bookkeeping services, tax management, consulting (could be assurance as well ) means non independent
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audit
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ASB is responsible for issuing procurements on auditing matters for all entities besides publicly traded companies, ASB procurements are called SASs statements of audting standards
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compilation and review standards
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accounting and review services committee is responsible issuing procurements of the CPA’s responsibilities wen a CPA is associated with financial statements of privately owned companies that are not audits SSARS statement on standards of accounting and review services
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compilation
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accountant helps the client prepare financial and review service without providing any assurance
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review
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account provides inquiry and analytical proceduresthat provide a reasonable basis for expressing limited assurance on the financial statements
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GAAS two principles-
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1) obtain reasonable assurance about whether financial statements as a whole are free from material misstatement whether due to fraud or error 2) report on financial statements and communicate as required by GAAS. GAAS no longer are used by still relevant structure now is purpose, responsibilities, performance, reporting
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GAAS- general standards
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Training- adequate technical training and proficiency ‘ I- INDEPENDENCE P- PROFESSIONAL CARE
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GAAS-fieldwork standards
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Planning- adequate planning and supervision I- internal control – sufficient understanding of the internal control structure E- sufficient , competent evidence
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GAAS- Reporting Standards
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G- GAAP O- opinion D- disclosures C- consistency- identify those circumstances in which such principles have not been consistently observed have not been consistently observed in current period in relation to the proceeding period
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Errors
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are unintentional misstatements caused by mistakes, carelessness
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Fraud
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intentional misstatements in violation of management policies and ethical standards
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illegal acts
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violations of specific laws or regulations which may or may not affect fair presentation direct effect- accounting period, line item impact indirect effect- operation related ex- hiring process – disclosure impact potnetial line item impact
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Responsibilities- errors, fraud, illegal acts
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errors, fraud, direct illegal acts reasonable indirect illegal acts-none unless normal audit procedures reveal such acts
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Audit procedures regarding suspicion illegal acts
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– read min of board meetings – inquire client management (one level up)and client procedures – inquire client lawyers – consult own legal counsel
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if auditors know of an illegal act
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– consider impact of financial statements – inform audit committee – consider client mgmt integrity ( withdraw if appropriate) – if publicly held, inform the SEC – consult legal counsel
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Types of Fraud- Misappropriation of assets
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relates to the theft of assets perpetrated by an employe for personal benefit, is is the company that is affected but there is a relative small impact on the financial statements
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Misappropriation of assets- RIsk Factors- incentive/pressure
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– personal finance obligations create pressure for those with access – adverse relationship w/ mgmt and employees
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Misappropriation of assets- RIsk Factors – opportunities
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– presence of large amount of cash; small high value or high demand inventory items – inadequate internal control (lack of screening, segregation of duties)
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Misappropriation of assets- RIsk Factors- attitudes& rationalization
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– disregard for need to reduce risk – disregard for internal controls by overriding existing control or falling to correct known deficiencies
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Fraudulent Financial Reporting
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related to misleading info in the financial statements normally perpetrated by mgmt. an may benefit MGMT. Users are adversely affected
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Fraudulent Financial Reporting- Risk Factors- incentives/pressures
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– financial stability is threatened -pressure for MGMT to make debt repayment
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Fraudulent Financial Reporting- Risk Factors- opportunities
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– significant acct estimates involve subject judgement that are difficult to verify – weak internal control
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Fraudulent Financial Reporting- Risk Factors-attitudes and rationalizations
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– inappropriate or ineffective communication and support of entity values -known history of violations
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SAS 99
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– increased importance on maintaining professional skepticism (includes a questioning mindset and a critical assessment of audit evidence) – required brainstorming session – increased emphasis on inquiry of MGMT – Expanded use of analytical procedures to identify risk – a recatagorization of fraud risk
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Brainstorm session
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– discuss the potential for material misstatement – determine what members of the audit committee should be included -both internal and external factors should be considered – disregard any previous beliefs – must include a discussion of MGMT override of controls and improper rev recognition
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overall responses to indentified risks
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– assignment of personnel and supervision – auditor should be sensitive to subjective matter -auditing procedures should not be predictable
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Documenting the consideration
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results of brainstorming procedure performed to identify risks, specific fraud risk, if no improper rev recognition state why, procedures performed to further address the risk of MGMT override of controls
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impact of sarbanes oxley
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– auditors will now report to a company audit committee – auditors cannot participate in other activities(bookkeeping, information services design and implementation, appraisals of valuation services, actuarial services, internal audit, mgmt and hr services, broker/dealer and investment banking services legal or expert services) to create independence – all audits work paper must be kept for 5 yrs other paper work must be kept for 7 yrs or a felony – felony to destroy any documents in a federal or bankruptcy investigation – criminal penalties for securities fraud has increases to 25 years – whisleblowers protected – prohibit inside trading during any \”blackout period\”- 3 days in which at least 50% of the participants in the company’s retirement plan are restricted from trading in the company ‘s securities – ban personal loans to execs
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404
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mgmt must now assess and make representations about the effectiveness of the internal control structure and procedures. each audit report must attest to this including a specific notation about any significant defects or material non compliance found based on such testing
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PCAOB (SOX)
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– only cpa firms that prepare or participate in the preparation of any audit of an issuer not- non audit services, compilation/review standards for non public under SSARS, OCBOA ( cash basis, tax basis, regulatory basis)
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management assertions
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implied or expressed representations which are embodied in the transaction class, account balances and disclosures components of the financial statements. Audit objectives are developed by considering those assertions most relevant to the transactions account or disclosure CPREV
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existence or occurrence
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MGMT asserts that the reported assets and liabilities actually exist at the balance sheet date and transaction reported in the income statement actually occurred in the period. concern- proper inclusion
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completeness
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MGMT asserts that all transactions should be included in the financial statement are included. concern- improper omission
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rights and obligations
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MGMT asserts that the company owns and has clear title to assets and that all liabilities are true obligations of the company concern- ownership and responsibility
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valuation or allocation
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MGMT asserts that assets and liabilities are valued properly and that revenues are expenses are measure properly concern- proper measurement, attribute
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presentation and disclosure
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MGMT asserts that the assets, liabilities, revenues and expenses are properly classified, throughly described, and adequately disclosed in the financial statements concern- fair presentation
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CLE-EAR
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assest/rev os completeness liabilities/expenses us existence
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audit objectives
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relate back to MGMTS assertions . they reflect the goal of designed audit test related to both transactions and balance
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audit procedures
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the specific steps taken to achieve the objective ie- the actions taken
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audit programs
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the combination of those procedures related to a given segment
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audit process
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1) identify MGMT assertions 2) consider the risk of material mistatement 3) establish objective related to the assertions 4) determine what audit procedures are to be performed (nature) (to dos) actions audit programs-> evidence 5) determine when to perform the procedures (timing) 6) determine which items the procedures should be applied to be (extent)
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Phases of an Audit- 1
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1) plan and design an audit program – concern for sufficient evidence and $ – obtain an understanding of the entity and its environment – understand internal control and asses control risk – assess risk of material misstatement
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Phases of Audit- 2
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Perform test of control and substantive test of transactions test of controls- testing the effectiveness of controls – substantive test – evaluate the client’s recording of transactions by verifying the monetary amounts of transactions
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Phases of Audit-3
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Perform analytical procedures and tests of details of balances analytical procedure-> consist of evaluating financial info through analysis of financial and non financial data test of details of balances-specific procedures intended to test for monetary misstatements in the balances in the financial statements
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Phases of Audit-4
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Complete the audit and issue an audit report
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types of evidence- physical examination
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inspection or count by the auditors of a tangible asset. reliable but does not verify ownership, valuation or adequacy of disclosure (limitations) level one of hierarchy
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types of evidence- confirmation
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the process of obtaining and evaluating a direct communication from a 3rd party in response to a request for info about a particular item affecting financial statement assertions -direct receipt by the auditor – written response – received from an independent party -prepared and controlled by the auditor types used 1) positive with info requested 2) positive with info provided 3) negative respond only if you disagree – large amt of small balances (not material) – no risk of misstat – no reason to anticipate no response level one of assurance AR must be confirmed Info that needs to be confirmed- cash in bank, Marketable securites (investment custodian) – AP (creditor) – NP (lender) – shares outstanding (register and transfer agent), – insurance coverage (insurance company)
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types of evidence- documentation
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the inspection of the client documents eg; invoices , canceled checks 1) direct internal 2) indirect internal- originates from client to independent party send back to client then to CPA 3) direct external- confrimation the best 4) indirect- external starts with 3rd party come to client then to cpa internal – level 2 if good internal control level 3 if not external- level 1 internal/ external -> where did it originate from
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types of evidence- observation
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the use of sense to assess certain activities. auditors are always observing insufficient alone level 2
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types of evidence- Inquires of client
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involved obtaining both written and verbal \”hearsay responses from the client – biases source, lack reliability, competent – level 3
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types of evidence 6/7 Re performance/recalculation
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involves re computation and other procedures, tracing, vouching that are performed directly by the auditor examples- extensions of invoices, footing of journals, recalculating accrued interest, tracing post from a journal to ledger, vouching fixed asset acquisition, scanning the vouched register for unusual items, reperfoming aging of a/r level one
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AP- Analytical procedures
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\”reasonableness\” test by way of ratios percentages, trends and other summary indicators – presumption of important relationships among financial and non financial data – attention driving – required during audit planning and the final stage review – for efficiency should be used during the year-end fieldwork in order to reduce detail testing – facilitate in understanding client’s business and industry – may indicate financial difficulty – may indicate possible misstatements (attention driving) – may reduce detail testing and improve audit efficiency level 2 when adequte data level 3 broad analytical procedures
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Factors effecting competency/appropriateness of evidence
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1) relevance- evidence must pertain to audit objective in question 2) independence inside source vs outside source 3) effectiveness of client internal control 4) auditors direct knowledge know (qualified) vs hearsay 5) qualifications of provider 6) objectivity object evidence (verifiable, better) vs. subjective 7) Timeliness- get in when you need it. more persuasive when- balance sheet- obtained as close to year end income statment- reporsents entire period
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Factors effecting persuiveness
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– relevance – timeliness – sufficiency – appropriateness (quality of evidence) reliability
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Sufficiency
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balance between efficiency and effectively factors related to this- 1 representativeness 2) materiality 3) high risk of misstatement 3rd stand of fieldword sufficient and approrpiatness
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client representation letter
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written by auditor, discuss openly with client. CEO and CFO must sign off. emphasis on client responsibility
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Workpaper
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the records kept by the auditor of the procedures, the test performed, the info obtained and the pertinent conclusions made – provide tools for the auditor to plan the audit – accumulate written evidence to support the opinion – facilitate supervisor review
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Current files vs. permanent files
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current – work paper applicable to year under audit, audit program, general info, adjusting and reclassification entires, supporting schedules (analysis( shows activity in general ledger) s, trial balance or list, reconciliation of amounts, test of reasonableness, summary of procedures, examination of supporting documents, informational, outside documentation ) permanent- include data of a continuing nature ex- bylaws, organization charts, internal control, AP controls one file
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ownership and confidentiality
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client personnel can prepare any paperwork as long as it is not confidential and not subject to unauthorized changes ex; working trial balance depreciation schedule all work papers must be reviewed by the auditors auditor must keep info confidential ownership- auditors but could be subpoenaed cannot be released to another firm
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relevant documentation
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all work paper or other documents that form a basis of conclusion for both annual and quarterly statements memos and correspondence, including electronic records that meet the following criteria 1) created, sent or received in connection with the audit or review 2) contain conclusions , opinions, or analysis in connection with the audit or review
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preparation of audit documentation
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should be indexed and cross-referenced to aid in organization and filing. A1- LEAD SCHEDULE A2- A4 INDIVIDUAL GENERAL LEDGER AMOUNTS THAT MAKE UP TOTAL CASH ON THE FINANCIAL STATEMENTS SHOULD BE FOOTED complete audit documentation must clearly indicate the audit work performed. this is accomplished by there ways 1) a memo ,2) initialing the audit procedures in the audit program and 3) notations directly on the schedule (tickmarks must be clearly explained) – audit documentation should include sufficient info to fulfill audit objectives (must know the goal)
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1. accept client and perform initial audit planning Predeessor/successor auditor requirement
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if client has been previously audited requires that the successor, with clients permission, initiate communication with the predecessor auditor. required communication includes – information that might bear on management integrity – disagreements with management as to accounting principles and procedures – communications with the audit committee related to fraud, illegal acts and reportable conditions – reasons for the change of auditors predecessor should respond fully to successor’s inquiries but may limit info in certain circumstance the client may give permission to the predecessor to allow the successor to review predecessor’s workpaper. not required to review work paper but many do continuing client should be evaluated annually to determine for non continuation . if there is pending litigation or unpaid fees for more than 1 year, audit cannot be continues
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If client has never been audited
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acceptance could be based on discussions with banks, attorneys, or other business hat had an association . important to identify why the perspective client is requesting an audit
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Engagement letter
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Purpose a) clarify the conduct of the engagement b) avoid any misunderstanding with the client c) avoid any misunderstanding with the audit staff includes; engagement objectives, the responsibilities of the auditor and MGMT, engagement limitations SAS 108 requires the CPA to establish a through understanding for each engagement and provide details of understanding in the work papers – both competence and independence should be considered for a specialist
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2. understand the client’s business and industry
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sas 108 requires the auditor to understand the clients industry sources of industry information – discussion with MGMT – industry audit guides – previous auditors – industry specialists sas 45 requires to indtify any related party transactions (any third party with which the client deals where one of the parties can easily influence one another-effects proper valuation and presentation and disclosure – should examine corporate charter, leases, contracts and debt agreements, min of BOD meetings, effects all assertions esp presentation and disclosure and rights & obligations
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3. assess client business risk
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client business risk – the risk of economic survival and must be considered in conjunction with the audit risk planning model. SOX requires that MGMT certify it has designed disclosures controls and procedures to ensure that material info about business risks is made known auditor business risk- reputation al impact or association with unsuccessful clients
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4. perform preliminary analytical procedures
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required during the planning phase and completion phase often done in testing phase purposes of AP – understand clients industry – assessing going concern – indicate possible misstatements – reduced detailed test
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5 types of AP
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1. compare client and industry ( intercompany) 2. compare client data with prior periods 3. compare client data with client determined expected results (budgets) 4. compare client data with audit determined expected results 5. compare with projections with non financial data (think hotels)
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trend analysis
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presented on a comparative basis income statement has 3 years balance shet has 2 years
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vertical analysis
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technique for analyzing the relationships between elements in the financial components percentages \”common size statements\” the size differential can be eliminated top to bottom
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horizontal analysis
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technique for analyzing year to year percentage change in elements that compromise a particular financial statements . the earliest period is the base period
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ratio analysis
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means of determining interrelationships between two different elements of financials – critical to financial statement analysis and fraud detection not one is absolute
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cash flow
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more relevant than accrual basis income in assessing liquidity and solvency companies should generate $ from ops – measures companies operating performance on a cash basis (net income does this on an accrual basis) compare the two for quality of ops strong companies have high net come and signifianct net cash inflows from ops suspicious high net income and cash flows from ops cash flow index should be 0 or – net income- cffo/ net income
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AAR
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the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated. in other words, the risk that the audit will give an unqualified opinion on financial statements that are materially incorrect aar is subjectively determined in planning an audit. it is impossible to elimiate but should try to minimize
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inherent risk
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the susceptibility of an account balance or class of transaction to error assuming that there were no related internal account controls. in assessing IR factors such as the nature of the clients business the complexity of the account or class , the use of accounting estimates, initial vs repeat engagements, among other to be considered. IRis function what the client does and the auditor can do little to influence it
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control risk
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the risk that errors are not prevented on a timely basis by the operation of the internal control structure . ie by systems and emplyees in carrying out their normal daily functions . CR tempers IR and considers the risk of material misstatement after considering the internal control structure. I.E IR X CR= risk of material misstatement RMM CR is a function of the effectiveness of the internal control structure. CR will always exist but auditor can help by givign tops to improve IR
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PDR
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the risk that audit procedures will fail to detect material errors that are not prevented by the clients internal control structure . inversely related to to CR. ODR is a function of audit effectiveness and can be minimized by proper planning and completion of the audit process. cant eliminate by can be improved

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