Podcast
Questions and Answers
The major purpose of auditing planning is to gain an understanding of the client’s business and industry.
The major purpose of auditing planning is to gain an understanding of the client’s business and industry.
True
Acceptable risk refers to the measure of the certainty that the financial statements are not materially misstated after the audit.
Acceptable risk refers to the measure of the certainty that the financial statements are not materially misstated after the audit.
False
Inherent risk is related to the effectiveness of internal controls when assessing the likelihood of material misstatements.
Inherent risk is related to the effectiveness of internal controls when assessing the likelihood of material misstatements.
False
Performing preliminary analytical procedures is a key step in initial audit planning.
Performing preliminary analytical procedures is a key step in initial audit planning.
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Materiality in auditing refers to the importance of ensuring that all audit costs are minimized.
Materiality in auditing refers to the importance of ensuring that all audit costs are minimized.
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Negotiate risk assessment is an important aspect of audit planning.
Negotiate risk assessment is an important aspect of audit planning.
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A zero risk level indicates complete uncertainty regarding the accuracy of financial statements.
A zero risk level indicates complete uncertainty regarding the accuracy of financial statements.
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The auditor's decision on acceptable audit risk can influence the overall cost and conduct of the audit.
The auditor's decision on acceptable audit risk can influence the overall cost and conduct of the audit.
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Auditors consider the number of client locations when developing a preliminary audit strategy.
Auditors consider the number of client locations when developing a preliminary audit strategy.
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Preliminary analytical procedures are performed solely at the end of the audit.
Preliminary analytical procedures are performed solely at the end of the audit.
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Key customers and suppliers are factors that auditors should understand during the audit planning process.
Key customers and suppliers are factors that auditors should understand during the audit planning process.
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Comparing client ratios to industry benchmarks is part of the overall audit strategy.
Comparing client ratios to industry benchmarks is part of the overall audit strategy.
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Inherent risks are unique to all clients across different industries.
Inherent risks are unique to all clients across different industries.
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Preliminary tests can help reveal unusual changes in ratios compared to prior years.
Preliminary tests can help reveal unusual changes in ratios compared to prior years.
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Staff continuity is not a consideration when developing the overall audit strategy.
Staff continuity is not a consideration when developing the overall audit strategy.
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Assessing going-concern issues is one of the uses of analytical procedures throughout the audit.
Assessing going-concern issues is one of the uses of analytical procedures throughout the audit.
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A CPA firm should be cautious in accepting clients who show a lack of integrity.
A CPA firm should be cautious in accepting clients who show a lack of integrity.
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An engagement letter is not necessary to outline the objectives and responsibilities between the auditor and the client.
An engagement letter is not necessary to outline the objectives and responsibilities between the auditor and the client.
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Communication with the predecessor auditor is optional when a CPA firm investigates a new client.
Communication with the predecessor auditor is optional when a CPA firm investigates a new client.
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Annual evaluations of existing clients by CPA firms help determine whether to continue the audit relationship.
Annual evaluations of existing clients by CPA firms help determine whether to continue the audit relationship.
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CPAs are required to guarantee that all acts of fraud will be discovered during the audit.
CPAs are required to guarantee that all acts of fraud will be discovered during the audit.
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Understanding the client’s business and the industry is important for identifying areas of risk in an audit.
Understanding the client’s business and the industry is important for identifying areas of risk in an audit.
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A CPA firm can continue working with a client that has a history of unpaid fees without concern.
A CPA firm can continue working with a client that has a history of unpaid fees without concern.
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The CPA firm's investigation into a prospective client's standing is not essential for client acceptance.
The CPA firm's investigation into a prospective client's standing is not essential for client acceptance.
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An auditor can develop expectations for an account balance by only looking at prior periods.
An auditor can develop expectations for an account balance by only looking at prior periods.
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Industry data can be used to assess whether a client's performance is in line with expectations.
Industry data can be used to assess whether a client's performance is in line with expectations.
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The inventory turnover ratio for the industry in 2021 was lower than that of the client.
The inventory turnover ratio for the industry in 2021 was lower than that of the client.
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A significant decline in gross margin percentage could indicate potential misstatements in the client's financial statements.
A significant decline in gross margin percentage could indicate potential misstatements in the client's financial statements.
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The gross margin percentage for the client increased from 2020 to 2021.
The gross margin percentage for the client increased from 2020 to 2021.
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Analytical procedures can include comparisons of client data with auditor-determined expected results.
Analytical procedures can include comparisons of client data with auditor-determined expected results.
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Client data comparison only involves financial metrics.
Client data comparison only involves financial metrics.
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An auditor should disregard industry trends when evaluating client performance.
An auditor should disregard industry trends when evaluating client performance.
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Net sales account for 72.3% of the total revenue at the second reporting period.
Net sales account for 72.3% of the total revenue at the second reporting period.
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The gross profit in the first reporting period is $36,350.
The gross profit in the first reporting period is $36,350.
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The administrative expense in the first reporting period is higher than in the second reporting period.
The administrative expense in the first reporting period is higher than in the second reporting period.
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Materiality is defined as the degree to which an audit can be performed with acceptable risks.
Materiality is defined as the degree to which an audit can be performed with acceptable risks.
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Earnings before taxes in the second reporting period increased compared to the first reporting period.
Earnings before taxes in the second reporting period increased compared to the first reporting period.
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Income taxes are represented as 1.1% of net sales in the first reporting period.
Income taxes are represented as 1.1% of net sales in the first reporting period.
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The auditor's responsibility is only to identify financial statements that are entirely accurate.
The auditor's responsibility is only to identify financial statements that are entirely accurate.
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The business risk is not a major concern for auditors when planning the audit.
The business risk is not a major concern for auditors when planning the audit.
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Planned Detection Risk measures the risk that audit evidence will successfully detect misstatements exceeding performance materiality.
Planned Detection Risk measures the risk that audit evidence will successfully detect misstatements exceeding performance materiality.
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Engagement risk influences the auditor's approach to acceptable audit risk.
Engagement risk influences the auditor's approach to acceptable audit risk.
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Control Risk is an assessment of the client's internal controls' effectiveness in preventing misstatements.
Control Risk is an assessment of the client's internal controls' effectiveness in preventing misstatements.
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Acceptable Audit Risk signifies the extent to which an auditor is willing to accept the risk that the financial statements are misstated even after an unqualified audit opinion.
Acceptable Audit Risk signifies the extent to which an auditor is willing to accept the risk that the financial statements are misstated even after an unqualified audit opinion.
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Inherent Risk is unrelated to the existence of material misstatements before considering internal control effectiveness.
Inherent Risk is unrelated to the existence of material misstatements before considering internal control effectiveness.
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Risk assessment procedures are conducted solely based on documentation without any discussions with management.
Risk assessment procedures are conducted solely based on documentation without any discussions with management.
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The likelihood of a client experiencing financial difficulties post-audit affects the auditor's acceptable audit risk.
The likelihood of a client experiencing financial difficulties post-audit affects the auditor's acceptable audit risk.
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The degree of reliance by external users on financial statements does not impact acceptable audit risk.
The degree of reliance by external users on financial statements does not impact acceptable audit risk.
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Study Notes
Audit Planning and Analytical Procedures with Materiality and Risk
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Why Audit Planning is Essential
- Obtaining sufficient appropriate evidence for the circumstances
- Maintaining competitive audit costs
- Avoiding client misunderstandings and facilitating quality work at a reasonable cost
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Major Purpose of the Parts of Auditing Planning
- Gaining understanding of the client's business and industry
- Assessing inherent and acceptable risks to influence audit conduct and cost
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Inherent Risk
- Auditor's assessment of the likelihood of material misstatements in account balances before considering internal control effectiveness (e.g., high likelihood of misstatement in accounts receivable due to changing economic conditions).
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Acceptable Risk
- Measure of auditor's willingness to accept that financial statements might be materially misstated after the audit is completed. (Lower acceptable risk means more certainty that statements are not misstated).
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Initial Audit Planning
- Client Acceptance and Continuance
- CPA firms carefully evaluate potential clients for acceptability based on legal/professional responsibilities, integrity, and consistent conduct during audit.
- Thorough investigations of new clients, including communication with previous auditors if applicable, are required, along with client permission.
- Ongoing evaluation of existing clients is done annually regarding continued engagements with regards to issues, fees and client integrity.
- Client Acceptance and Continuance
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Obtain an Understanding with the Client
- Engagement terms should be clearly understood and documented between the CPA firm and the client in an engagement letter
- The letter includes the engagement's objectives, responsibilities of the auditor and management, and limitations.
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Understanding of the Client's Business and Industry
- Understanding client's business, industry, and environmental factors, including areas with higher risk of misstatements.
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Develop Overall Audit Strategy
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Preliminary Analytical Procedures
- The auditor uses analytical procedures to compare client ratios to industry or competitor benchmarks to help understand the client's business and evaluate business risk
- Preliminary audit strategy should consider:
- Material misstatement risk areas identification
- Number of client locations
- Past effectiveness of controls
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Preliminary Analytical Procedures
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Preliminary Analytical Procedures
- Auditors compare recorded ratios to auditor expectations
- Key purpose is planning, understanding client's business and industry
- Used throughout the audit to:
- Identify possible misstatements
- Reduce detailed tests of account balances
- Assess going-concern issues
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Types of Analytical Procedures
- Auditors evaluate client data against industry data, prior-period data, client-determined expected results, auditor-determined expected results and non-financial data
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Compare Client and Industry Data
- Analyze client data against industry benchmarks to identify potential issues
- Compare inventory turnover and gross margin percentages to determine stability
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Compare Client Data with Similar Prior Period Data
- Assess changes in performance metrics (like gross margin) to detect anomalies that suggest potential misstatements.
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Planning an Audit and Designing an Audit Approach
- Set materiality and assess acceptable audit risk and inherent risk
- Understand internal control and assess control risk
- Gather information to assess fraud risks
- Develop overall audit plan and audit program.
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Materiality
- Determining the appropriate audit report, based on the magnitude of omission/misstatement that would affect the user's decision, considering circumstances.
- FASB Concept Statement 2 defines materiality
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Audit Risk
- Auditors accept some level of risk in performing the audit task
- Risks exist, are difficult to measure, and require careful considerations and response
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Risk and Evidence
- Auditors need to understand the client's business and assess business risk.
- The audit risk model helps auditors identify the potential and likelihood of misstatements.
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Risk Assessment
- Procedures used to identify and evaluate the risk of material misstatement.
- Includes inquiries of management, analytical procedures, observation and inspection, discussions among engagement team members and discussions with predecessor auditors.
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Audit Risk Model for Planning
- Helps auditors determine the appropriate amount and types of evidence for each area of the audit.
- Model components are planned detection risk, acceptable audit risk, inherent risk, and control risk
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Audit Risk Model Components - Planned Detection Risk - Acceptable Audit Risk - Inherent Risk - Control Risk
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Impact of Engagement Risk on Acceptable Audit Risk
- Auditors consider engagement risk (risk client will have financial difficulties, or concerns about management integrity) when determining acceptable audit risk.
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Measurement Limitations in the Audit Risk Model
- Difficulty in accurately measuring components of the audit risk model.
- Preliminary risk assessment knowledge is known, but the actual achieved level of risk is unknown.
References
- Auditing and Assurance Services (Arens, Elder, Beasley, 14th edition)
- Auditing Cases, International Edition (Knapp, 9th edition)
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Description
This quiz covers the essentials of audit planning, including its importance, major purposes, and the concepts of inherent and acceptable risk. Test your understanding of how these factors influence audit conduct and cost while ensuring quality work. Dive into the complexities of materiality and risk assessment in audits.
