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23 Cards in this Set
- Front
- Back
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Steps of Audit Planning |
1. Understand the client and related parties 2. Identify the Risks 3. Assess Materiality 4. Determine the audit strategy 5. Determine the nature and timing of the audit procedures |
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Audit Risk |
Risk that an auditor issues an unqualified opinion on materially misstated F/S |
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Step 1:Understanding the Client |
-understand controls, IT, corporate gov and closing procedures -assess preliminary risks, determine appropriateness of entity;s policies -identify areas where additional work is required-develop expectations -understand client on entity, industry and economy level Required to: -inquire to management and others in company to help identify risks -identify unusual relationships and risks -confirm information received from inspection and observation |
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Entity, Industry and Economy level |
Entity: What they do, structures, major customers, suppliers, reputation, locations, employees, finances --more time consuming for new clients Industry: size, competition, market share, demand, reputation Economy: upturn (overstate income), downturn (overstate expenses), interest, currency |
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Related parties |
must be identified and discussed (parent companies, subs, joint ventures, family) -Discuss fraud or misstatements that could result from related party -ask if there are any related parties -identify processes in place to control related parties |
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Step 2: Fraud Risk |
Fraud is an intentional act to obtain an unjust or illegal adv through use of deception -use professional skepticism (independence, questioning attitude search for validation) Types of Fraud -Financial reporting fraud: intentional misstatement of omission of items (improper valuation, unrecorded liabilities) -Misappropriation of assets (theft) Governance is responsible for using controls to prevent and detect fraud, auditors only responsible for assessing the risk of fraud and effectiveness of controls |
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Assessing Fraud Risks |
1. Incentives/Pressures (falling profits, losses, market expectations, loans, competition) 2. Opportunities (accounts that rely on estimates, poor internal controls, high turnover of staff, poor corp gov, related party transactions, high volume of trans at year end) 3. Attitudes/Rationalization (poor tone at the top, excessive focus on profits, integrity, rationalizations that other companies do the same) |
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Procedures related to fraud |
1. Ask if management is aware of fraud 2. meeting with partner to discuss fraud 3. identify unusual relationships (in accounts) 4. consider management override (manipulate) If fraud is discovered: 1. seek legal advice 2. consider withdrawal 3. Fraud is reported to level of management above where it is discovered 4. report to audit committee |
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Step 2: Going Concern RIsks |
-management is responsible to asses if company is a going concern -auditor needs to get evidence to validate this IF auditor thinks going concern is in doubt: -assess cash flows, revenues, expenses, interim F/S, discuss wit management and review meetings Indicators: significant debt to equity, prolonged losses, regular strikes, Mitigate: letter of guarantee from parent, non-core assets can be sold, ability to raise funds |
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Audit Risk Model |
-Audit risk is set to low -Audit risk = IR CR X DR -inherent risk: risk of material misstatement without internal controls, risk that can simply happen -control risk - risk of internal controls not preventing or detecting material misstatement -detection risk - risk auditor's procedures will not detect material misstatement ---ONLY RISK AUDITOR CAN INFLUENCE by doing more or less substantive audit work STEPS: 1. Set audit risk low --decreases as users increase and reliance increases 2. assess inherent and control risk 3. determine planned risk |
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Inherent RIsk |
-Two types: account related (estimates, valuables, non-routine, related parties, previous errors) and environmental (integrity, client motivation) -Due to business, environment, econ conditions, technological obsolescence, regulation -Higher when products are easily stolen and valuable -higher when geographically dispersed -Higher when complex -higher when there was previous errors or fraud -higher when in a competitive industry -higher when first audit -higher when new employees |
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Control Risk |
-gain understanding of controls in place and client's attitude towards controls -if control risk is high, auditor will not assess controls and will perform more detailed substantive procedres |
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Detection RIsk |
-If control risk and inherent risk is high, this is set to low -this means increase reliance on substantive procedures (testing) -if detection risk is set as high, will rely more on controls and less on substantive procedures (but will still do some cannot rely solely on client) DR = A/(IRXCR) |
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F/S vs Assertion level |
-F/S level, risk of material misstatement affects the F/S as a hole -Assertion level, risk of material misstatement affects classes of transactions, accounts and disclosures |
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Step 3: Materiality steps |
1. Identify the users of the F/S 2. Identify the user's objectives (NIBT, cash flow, assets) 3. Determine base for materiality (what most users are interest in) -DO NOT user net income if it is --close to 0 or negative --if average is sporadic --if it is a new company? MUST be normalized for unusual rev and exp, special bonsses 4. Identify the threshold for materiality (%) 5. Calculate materiality -rounded to hundred or thousand -pick lower is smaller company and higher if big 6. Determine overall performance materiality -60-75% -creates cushion to cover unidentified misstatements 7. Determine specific materiality -set for accounts where a smaller amount would affect the users decision -bank loan covenant 8. Specific performance materiality (9. IDENTIFY ANY QUALITATIVE FACTORS) -disclosures and notes are done correctly -legal matters are disclosed -changes in accounting -physiological factors -significance of account -effect of account on loan covenants -compensation based on income -missing notes -if there is fraud, materiality does NOT matter NOTE -audit risk is based on factors related to the company -materiality is related to the USERS --When audit risk is high auditor should NOT lower materiality ---more users is increase audit risk as more assurance for appropriate opinion |
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Step 4: Audit Strategy |
Sets scope, timing and direction of the audit and basis for developing audit plan Based on preliminary assessment of control risk (rely more on controls or substantive procedures) Substantive Audit Strategy - little reliance on client controls and more on detailed substantive procedures that include testing accounts Combined audit strategy - obtain detailed understanding on internal controls and rely on it to prevent and detect material misstatements, also use some substantive procedures |
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Audit Strategy Steps |
1. identify risk factors 2. identify controls that could mitigate risks 3. report weakness to BOD 4. Test controls if exists 5. perform substantive procedures as necessary |
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Assertions |
statements regarding the recognition, measurement, presentation and disclosure of items included in the F/S can be explicit or implicit |
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Assertions over transactions (I/S) |
1. Occurrence - transactions have occurred or pertain to entity --important when risk of overstatement 2. Completeness - all transactions that should have been recorded have been recorded --important when risk of understatement 3. Accuracy - amounts and other data relating to recorded transactions and events have been recorded appropriately --important when complex 4. Cut-off - Transactions and events have been recorded in the correct accounting period --important at year end 5. Classification - transactions and events have been recorded in the proper accounts |
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Assertions over Balance Sheet at year end |
1. Existence - A/S/E exists --important for overstatements 2. Rights and Obligations - entity controls the rights to assets and liabilities are the obligations of the entity --important when items are held but not owned (may exist but not owned by company) 3. Completeness - all A/L/E that should have been recorded are recorded --important where risk of understatement 4. Valuation and Allocation - account amounts are appropriate and adjusted properly --important when over or under stated |
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Assertions over Presentation and Disclosures |
1. Occurrence, rights and obligations - disclosed events pertain to the entity and have occurred 2. completeness - all disclosures necessary are included 3. Classification and understandability - financial info is appropriately presented and clearly expressed 4. Accuracy and valuation - financial info is fairly disclosed in appropriate amounts |
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Audit Evidence |
Sufficient appropriate evidence is required --sufficiency - quantity of audit evidence gathered --appropriateness - quality of audit evidence gathered ---relevant - provides confirmation about assertion most at risk ---reliable - reflect true state of information (source, expertise, consistency between evidence, internal controls of info giver) quality of evidence will affect the quantity needed |
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Types of audit evidence |
1. External Confirmation -sent from a 3rd party -can be positive (as for reply) or negative (repl if disagree - limited benefits because may not want to reply) a. Bank confirmation - confirm cash balance --addresses existence, valuation and allocation, and rights and obligations b. A/R confirmation (based on balance, age and location) --addresses existence, rights and obligations --does NOT address valuation and allocation as client may not be a reliable source (conflict of interest and discounts) c. Accounts payable confirmation (sent if balance is small when large in previous years) --addresses completeness, valuation and allocation and rights and obligations 2. Documentary Evidence -invoices, statements, minutes, correspondence, agreements -addresses accuracy and valuation 3. Representations -legal letter, management representation letter (acknowledgement that management is responsible for prep of F/S) --two parts verbal evidence and items such as related parties, no fraud statement, controls 4. Verbal Evidence 5/ Computational Evidence -checks mathematical accuracy of the numbers that appear in F/S -check valuation -trace amount in calculation to documents to ensure correct 6. Physical Evidence -inspect tangible assets -check valuation and allocation (condition of asset) -check existence 7. Electronic Evidence (emails, scans, electronic transaction) |
