Audit Planning and Analytical Procedures
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Questions and Answers

The major purpose of auditing planning is to gain an understanding of the client’s business and industry.

True (A)

Acceptable risk refers to the measure of the certainty that the financial statements are not materially misstated after the audit.

False (B)

Inherent risk is related to the effectiveness of internal controls when assessing the likelihood of material misstatements.

False (B)

Performing preliminary analytical procedures is a key step in initial audit planning.

<p>True (A)</p> Signup and view all the answers

Materiality in auditing refers to the importance of ensuring that all audit costs are minimized.

<p>False (B)</p> Signup and view all the answers

Negotiate risk assessment is an important aspect of audit planning.

<p>True (A)</p> Signup and view all the answers

A zero risk level indicates complete uncertainty regarding the accuracy of financial statements.

<p>False (B)</p> Signup and view all the answers

The auditor's decision on acceptable audit risk can influence the overall cost and conduct of the audit.

<p>True (A)</p> Signup and view all the answers

Auditors consider the number of client locations when developing a preliminary audit strategy.

<p>True (A)</p> Signup and view all the answers

Preliminary analytical procedures are performed solely at the end of the audit.

<p>False (B)</p> Signup and view all the answers

Key customers and suppliers are factors that auditors should understand during the audit planning process.

<p>True (A)</p> Signup and view all the answers

Comparing client ratios to industry benchmarks is part of the overall audit strategy.

<p>False (B)</p> Signup and view all the answers

Inherent risks are unique to all clients across different industries.

<p>False (B)</p> Signup and view all the answers

Preliminary tests can help reveal unusual changes in ratios compared to prior years.

<p>True (A)</p> Signup and view all the answers

Staff continuity is not a consideration when developing the overall audit strategy.

<p>False (B)</p> Signup and view all the answers

Assessing going-concern issues is one of the uses of analytical procedures throughout the audit.

<p>True (A)</p> Signup and view all the answers

A CPA firm should be cautious in accepting clients who show a lack of integrity.

<p>True (A)</p> Signup and view all the answers

An engagement letter is not necessary to outline the objectives and responsibilities between the auditor and the client.

<p>False (B)</p> Signup and view all the answers

Communication with the predecessor auditor is optional when a CPA firm investigates a new client.

<p>False (B)</p> Signup and view all the answers

Annual evaluations of existing clients by CPA firms help determine whether to continue the audit relationship.

<p>True (A)</p> Signup and view all the answers

CPAs are required to guarantee that all acts of fraud will be discovered during the audit.

<p>False (B)</p> Signup and view all the answers

Understanding the client’s business and the industry is important for identifying areas of risk in an audit.

<p>True (A)</p> Signup and view all the answers

A CPA firm can continue working with a client that has a history of unpaid fees without concern.

<p>False (B)</p> Signup and view all the answers

The CPA firm's investigation into a prospective client's standing is not essential for client acceptance.

<p>False (B)</p> Signup and view all the answers

An auditor can develop expectations for an account balance by only looking at prior periods.

<p>False (B)</p> Signup and view all the answers

Industry data can be used to assess whether a client's performance is in line with expectations.

<p>True (A)</p> Signup and view all the answers

The inventory turnover ratio for the industry in 2021 was lower than that of the client.

<p>False (B)</p> Signup and view all the answers

A significant decline in gross margin percentage could indicate potential misstatements in the client's financial statements.

<p>True (A)</p> Signup and view all the answers

The gross margin percentage for the client increased from 2020 to 2021.

<p>False (B)</p> Signup and view all the answers

Analytical procedures can include comparisons of client data with auditor-determined expected results.

<p>True (A)</p> Signup and view all the answers

Client data comparison only involves financial metrics.

<p>False (B)</p> Signup and view all the answers

An auditor should disregard industry trends when evaluating client performance.

<p>False (B)</p> Signup and view all the answers

Net sales account for 72.3% of the total revenue at the second reporting period.

<p>False (B)</p> Signup and view all the answers

The gross profit in the first reporting period is $36,350.

<p>True (A)</p> Signup and view all the answers

The administrative expense in the first reporting period is higher than in the second reporting period.

<p>False (B)</p> Signup and view all the answers

Materiality is defined as the degree to which an audit can be performed with acceptable risks.

<p>False (B)</p> Signup and view all the answers

Earnings before taxes in the second reporting period increased compared to the first reporting period.

<p>True (A)</p> Signup and view all the answers

Income taxes are represented as 1.1% of net sales in the first reporting period.

<p>True (A)</p> Signup and view all the answers

The auditor's responsibility is only to identify financial statements that are entirely accurate.

<p>False (B)</p> Signup and view all the answers

The business risk is not a major concern for auditors when planning the audit.

<p>False (B)</p> Signup and view all the answers

Planned Detection Risk measures the risk that audit evidence will successfully detect misstatements exceeding performance materiality.

<p>False (B)</p> Signup and view all the answers

Engagement risk influences the auditor's approach to acceptable audit risk.

<p>True (A)</p> Signup and view all the answers

Control Risk is an assessment of the client's internal controls' effectiveness in preventing misstatements.

<p>True (A)</p> Signup and view all the answers

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.

<p>True (A)</p> Signup and view all the answers

Inherent Risk is unrelated to the existence of material misstatements before considering internal control effectiveness.

<p>False (B)</p> Signup and view all the answers

Risk assessment procedures are conducted solely based on documentation without any discussions with management.

<p>False (B)</p> Signup and view all the answers

The likelihood of a client experiencing financial difficulties post-audit affects the auditor's acceptable audit risk.

<p>True (A)</p> Signup and view all the answers

The degree of reliance by external users on financial statements does not impact acceptable audit risk.

<p>False (B)</p> Signup and view all the answers

Flashcards

Audit Planning Importance

Properly planning an audit is crucial for obtaining sufficient and appropriate evidence, keeping costs reasonable, and avoiding misunderstandings with the client.

Acceptable Audit Risk

The auditor's willingness to accept that financial statements might be misstated after a clean audit opinion is issued.

Inherent Risk

The auditor's assessment of the likelihood of material misstatements in an account before considering internal controls.

Audit Risk Model

A model relating inherent risk, control risk, and detection risk to acceptable audit risk.

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Engagement Risk

The risk that the auditor will have to make concessions (or face negative consequences) due to audit circumstances or stakeholder demands.

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Analytical Procedures

A technique used to investigate unusual or unexpected balances detected during the audit, and identify potential risk areas.

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Materiality in Auditing

The amount of financial misstatement of a financial statement that would influence a decision made by an investor or lender.

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Initial audit planning

The first stage of the audit, involving understanding the client's businesses and assessing risks.

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Client Acceptance

CPA firms assess if a prospective client is suitable. This includes evaluating their integrity, financial standing, and past relations.

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Client Continuance

Existing clients are evaluated annually to see if there are reasons to discontinue the audit relationship.

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Predecessor Auditor Communication

When auditing a client previously audited by another firm, the new auditor must contact that predecessor auditor.

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Engagement Letter

A formal document outlining the terms of the audit engagement, including objectives, responsibilities, and limitations.

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Client Business Understanding

The audit team must understand the client’s industry and business operations, including areas of high misstatement risk.

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Audit Objectives

Clear goals that must be attained for the audit, which are covered in an engagement letter.

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Auditor Responsibilities

The tasks and duties undertaken by the auditor in the audit. This is laid out in an engagement letter.

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Management Responsibilities

The tasks and duties of the management of the client company.

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Types of Analytical Procedures

Auditors use five types of analytical procedures to compare client data with industry, prior period, client/auditor expectations, and non-financial data.

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Industry Data Comparison

Comparing a client's ratios with industry averages to spot unusual trends or deviations.

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Prior-Period Data Comparison

Comparing a client's ratios to its historical trends to identify significant changes.

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Client-Determined Expectations

Using client-provided forecasts to anticipate account balances.

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Auditor-Determined Expectations

Developing estimates of account balances based on auditor's investigation and analysis.

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Non-Financial Data Comparison

Using external information like economic conditions or market trends to predict account balances or ratios.

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Gross Margin Percentage

A financial ratio showing profitability, calculated as (Revenue - Cost of Goods Sold) / Revenue, expressed as a percentage.

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Preliminary audit strategy

An initial plan by the auditor to determine the resources needed, including staff and possibly specialists, for the audit.

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Preliminary analytical procedures

Procedures performed at the start of the audit to understand the client's business and assess risks of misstatements.

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Client ratios vs. benchmarks

Comparing a client's financial ratios to industry or competitor averages to assess performance and potential risks.

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Material misstatement risk areas

Areas in a client's financial statements that have a high chance of containing inaccuracies that are large enough to affect financial reports.

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Understanding client industry

Gaining knowledge of the client's industry to identify risks related to specific industries, inherent risks in general and unique accounting requirements.

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Analytical procedures (summary)

Procedures to compare recorded amounts with expectations, used throughout the audit to find possible misstatements, reduce detailed tests, or assess issues of the client's ability to continue operating.

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Key customers and suppliers

Important business partners whose performance and relations significantly affect a client's operations.

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Past effectiveness of controls

The history of how well a client's internal control systems worked in the past in helping to avoid financial statements errors.

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Materiality

The amount of misstatement in financial statements that would make a difference to a reasonable person's judgment. It's like a 'tipping point' for how reliable the information is.

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Auditor's Responsibility

Auditors must determine if the financial statements are materially misstated and bring any significant issues to the client's attention for correction.

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Business Risk

The risks that threaten the client's ability to achieve their business goals, affecting the financial statements.

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Internal Control

The policies and procedures implemented by a company to prevent and detect material misstatements.

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Control Risk

The risk that internal controls will fail to prevent or detect material misstatements.

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Fraud Risk

The risk that the financial statements are intentionally misstated.

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Audit Program

A detailed plan outlining the specific procedures the auditor will perform to gather evidence and assess risks.

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Planned Detection Risk

The risk that audit procedures won't detect material misstatements that exist.

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Factors affecting acceptable audit risk

These are the factors that influence how much risk the auditor is willing to accept, such as the reliance of external users on the financial statements, the likelihood of client financial difficulties, and the auditor's assessment of management integrity.

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Impact of engagement risk on acceptable audit risk

Engagement risk affects the auditor's acceptable audit risk. Higher engagement risk leads to lower acceptable audit risk, which means the auditor needs to gather more evidence.

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Study Notes

Audit Planning and Analytical Procedures with Materiality and Risk

  • 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

  • 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

  • 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).

  • 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).

  • 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.

  • 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.

  • Understanding of the Client's Business and Industry

    • Understanding client's business, industry, and environmental factors, including areas with higher risk of misstatements.

  • Develop Overall Audit Strategy

    • 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

  • 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

  • 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

  • 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

  • Compare Client Data with Similar Prior Period Data

    • Assess changes in performance metrics (like gross margin) to detect anomalies that suggest potential misstatements.

  • 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.

  • 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

  • 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

  • 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.

  • 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.

  • 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

  • Audit Risk Model Components - Planned Detection Risk - Acceptable Audit Risk - Inherent Risk - Control Risk

  • 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.

  • 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.

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