Questions and Answers
What are the components of Assertions?
What does Assurance refer to?
Independent professional services that improve the quality of information for decision makers.
Define Auditing.
Systematic, objective evaluation of evidence to make assertions about economic actions and their correspondence to established criteria.
What is Materiality?
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What does Audit Risk involve?
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What encompasses Evidence about Assertions?
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Match the following components of the Audit Process:
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What does the Audit Report include?
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Define the Expectation Gap.
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What are the GAAS General Standards?
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What are GAAS Fieldwork Standards?
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Identify the GAAS Reporting Standards.
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What are the components of Management Assertions?
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Define the Fraud Triangle.
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What are Control Deficiencies?
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What are the objectives of the COSO framework?
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You can still issue an unmodified opinion if there are significant but not material weaknesses.
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What is a material weakness?
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What does remediation refer to?
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Which of the following is not a type of opinion in auditing?
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What is audit sampling?
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What is sampling risk?
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What does a Type I error signify?
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What does a Type II error indicate?
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The three important factors in determining sample size are the desired level of assurance, acceptable defect rate, and ______.
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What is the confidence level in sampling?
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What is precision in audit sampling?
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Where is sampling commonly used?
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What is target testing?
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Non-statistical sampling involves using statistical techniques to determine sample size.
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What is statistical sampling?
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What is an advantage of statistical sampling?
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What is a disadvantage of statistical sampling?
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Study Notes
Audit Assertions
- Assertions include existence, rights & obligations, completeness, valuation, classification, and understandability.
Assurance
- Assurance involves independent professional services aimed at enhancing the quality of information for decision makers.
Auditing Defined
- Auditing is a systematic process to objectively obtain and evaluate evidence concerning economic actions and assert the degree of correspondence to established criteria, followed by result communication.
Materiality
- Materiality represents the significance of an amount to the user of financial statements.
Audit Risk
- Audit risk is approached with a top-down strategy, risk-driven focus, and aims to provide reasonable assurance.
Evidence About Assertions
- Quality of evidence is determined by its relevance and reliability.
Audit Process Steps
- Major stages involve client acceptance, preliminary activities, audit planning, internal control assessment, auditing business processes, completing the audit, and evaluating results leading to report issuance.
Audit Report Components
- Standard report layout includes an independent title, address, introductory paragraph, scope paragraph, opinion paragraph, explanatory paragraph, partner signature, and date.
Expectation Gap
- The expectation gap highlights the difference between public perception of auditors’ roles (finding fraud) and actual duties (identifying fraud risks).
GAAS Standards
- General standards: technical proficiency, independence, due professional care.
- Fieldwork standards: adequate planning and supervision, understanding of internal controls, sufficient evidence gathering.
- Reporting standards: adherence to GAAP, implied consistency, full disclosure, and opinion expression.
Client Acceptance Procedures
- Include reviewing financial information, inquiring about client integrity, communication with predecessor auditors, assessing business risks, confirming independence, and evaluating necessary skills.
Continuing Client Retention
- Address conflicts regarding accounting/auditing and fee disputes.
Preliminary Engagement Activities
- Identify audit team needs, ensure ethical compliance, and establish a mutual understanding with the client.
Engagement Letter Importance
- Outlines responsibilities, mitigating misunderstandings between parties.
Engagement Letter Components
- Relevant sections include the objectives, responsibilities of management and auditors, engagement limitations, and special issues.
Internal Auditor Role
- Emphasizes competence and objectivity.
Audit Committee Function
- A subcommittee of the board of directors focusing on independence, oversight, and approval of audit/non-audit services.
Audit Planning
- Strategy involves assessing business risks, establishing materiality, considering multi-locations, utilizing specialists, evaluating illegal acts, identifying related parties, and addressing additional service options.
Documenting Audit Strategy
- Captures client risk management and its impact on the audit plan along with control risk assessments.
Types of Audit Tests
- Categories include risk assessment procedures, tests of controls, substantive procedures, and dual purpose tests.
Risk Assessment Procedures
- Aim to understand the entity and its environment, including internal controls.
Tests of Controls
- Evaluate internal control effectiveness through various methods such as inquiry, inspection, observation, walkthroughs, and reperformance.
Substantive Procedures
- Focus on tests of details and analytical procedures.
Audit Risk Definition
- The risk that an auditor may issue an inappropriate opinion when financial statements are materially misstated.
Risk Model Formula
- Defined as Audit Risk = Inherent Risk x Control Risk x Detection Risk.
Risk of Material Misstatement
- Calculated as Inherent Risk x Control Risk.
Detection Risk
- The likelihood that auditors will fail to identify material misstatements.
Non-Sampling Risk
- Associated with inappropriate procedures, failure to detect with appropriate methods, and misinterpretation of results.
Sampling Risk
- The risk that conclusions from a sample will differ from what would result from reviewing the entire population.
Errors vs. Fraud
- Errors are unintentional misstatements while fraud involves intentional misstatements.
Fraud Triangle
- Fraud is driven by opportunity, pressure, and rationalization.
Types of Intentional Misstatements
- Include fraudulent financial reporting and misappropriation of assets.
Fraudulent Financial Reporting Defined
- Involves manipulation, falsification, or intentional omission of significant information in financial statements.
Misappropriation of Assets
- Theft impacting financial statements.
Auditor's Response to Fraud Risk
- Involves maintaining professional skepticism, utilizing experienced staff, and enhancing supervision.
Fraud Communications
- Obligations to report fraud only under specific conditions such as regulatory requirements or legal actions.
Management Assertions Repeat
- Assertions again listed as existence, completeness, valuation & accuracy, rights & obligations, and classification.
Audit Evidence Significance
- Defined as all information considered by auditors in forming their audit opinion.
Quality of Audit Evidence
- Evidence must be both relevant and reliable to be effective.
Audit Procedures Definition
- Specific actions taken to gather evidence about particular assertions.
Evidence Obtaining Procedures
- Involves various methods like inspection (vouching and tracing), physical examination, observation, inquiry, confirmation from third parties, recalculation, reperformance, and analytical procedures.
Observation
- Involves watching processes in action.
Inquiry
- Effective inquiry involves asking appropriate open-ended questions of the right individuals.
External Confirmation
- Obtaining information directly from a third party to verify accuracy.
Recalculation
- Involves verifying the mathematical accuracy of documents or records.
Re-performance
- Auditor independently executes original procedures that were part of the internal control system.
Analytical Procedures Defined
- Evaluations of financial data through analysis of correlations between financial and non-financial data.
Scanning
- Involves reviewing accounting data to identify anomalous items.
Audit Documentation
- Essential record of audit procedures, evidence, and conclusions, retained for seven years per SOX.
Audit Documentation Functions
- Serve to support the audit report and aid planning, performance, and supervision.
Audit Documentation Requirements
- Must demonstrate compliance with standards, support conclusions, and reconcile with financial statements.
Content of Audit Documentation
- Must include an audit program, results, performers, reviewers, and must be organized into permanent and current files.
Audit Documentation Format
- Should feature client details, proper indexing, and tick marks indicating auditing processes.
Risk Assessment Usage
- Helps auditors understand business circumstances and effectively plan audit procedures.
Substantive Tests Definition
- Gather evidential matter concerning specific assertions related to accounts and transactions.
Final Analytics Purpose
- Conducted during the final review stage for overall financial assessment.
Analytics Types
- Encompass trend, ratio, and reasonableness analyses.
Steps in Performing Analytics
- Involve developing expectations, defining tolerable differences, and making comparisons.
Internal Control System Objectives
- Protect assets and records while providing reliable decision-making information.
COSO Framework Objectives
- Focus on reliability of financial reporting, operational efficiency, and legal compliance.
COSO Components
- Include control environment, risk assessment, information system and communication, control activities, and controls monitoring.
Control Environment Emphasis
- Involves ethical codes, organizational structure, management tone, and authority clarity.
Risk Assessment Process
- Should encompass both internal and external risk evaluations affecting financial data handling.
Information Systems and Communication
- Involves proper transaction recording and classification ensuring fair financial presentation.
Control Activities Role
- Policies ensuring management directives are executed effectively, maintaining accuracy and restricted access.
Monitoring of Controls
- Evaluates the performance quality of internal controls over time.
Reliance Strategy
- Used when control risk is low, allowing for controls testing and reduced substantive measures.
Substantive Strategy
- Applied when control risk is high, treating controls as ineffective; only substantive testing takes place.
Limitations of Internal Controls
- Include managerial override, human error, and the possibility of collusion.
Type I Report Definition
- Describes the adequacy of a service organization's control design for internal objectives.
Type II Report Definition
- Validates the effectiveness of the controls over a specified period.
Material Weakness Defined
- A significant deficiency that could result in a material misstatement of financial statements.
Significant Deficiency Clarification
- Less severe than a material weakness but significant enough to warrant oversight attention and reported to management.
SOX Section 404 Management Responsibilities
- Requires public companies to report on internal control effectiveness over financial reporting.
ICFR Management Requirements
- Management must accept overall effectiveness responsibility, evaluate controls, document evaluations, and present written assessments.
SOX Section 404 Auditor Responsibilities
- Involves conducting integrated audits on the effectiveness of internal controls over financial reporting.
Internal Control over Financial Reporting (ICFR)
- Aimed to provide assurance on reliable financial reporting according to GAAP.
Control Deficiencies Management
- Exist when controls fail to detect or prevent material misstatements and are only reported to management.
Significant Deficiencies Reporting
- Must be reported to both audit committee and management due to their potential future impact, though they are not material weaknesses.
Material Weakness Conclusion
- Represents a serious deficiency where material misstatements are unlikely to be timely prevented or detected.### Audit Committees and Opinions
- Material weaknesses require reporting to audit committees and management.
- One unresolved issue can lead to a modified audit opinion.
Remediation
- Refers to the corrective measures taken to address material weaknesses in Internal Control over Financial Reporting (ICFR).
Types of Audit Opinions
- Unqualified Opinion: Indicates effective internal controls with no material weaknesses.
- Adverse Opinion: Material weaknesses are identified and remain unremediated.
- Disclaimer Opinion: Issued due to limitations in the audit scope.
Audit Sampling
- Involves selecting and evaluating a less-than-complete subset of an audit-relevant population to draw conclusions about the entire population.
Sampling Risks
- Sampling Risk: Uncertainty in auditor conclusions as a result of sampling; impacts detection risk.
- Risk of Incorrect Rejection (Type I Error): Incorrectly concludes that a control isn't effective when it actually is, or misstates a balance when it is correct.
- Risk of Incorrect Acceptance (Type II Error): Incorrectly concludes that a control is effective when it isn't, or states a balance is correct when it is materially misstated.
Factors Determining Sample Size
- Desired assurance level (confidence level).
- Acceptable defect rate or tolerable error; a lower rate requires a larger sample.
- Historical defect rate; a lower expected error can justify a smaller sample size.
Confidence Level
- Represents the complement of sampling risk; a 5% risk translates to a 95% confidence level in the sample's representativeness.
Precision
- The expected deviation rate versus the tolerable deviation rate, also known as the allowance for sampling risk in the planning phase.
Common Areas for Sampling
- Utilized extensively in tangible asset inspections, document and record reviews, and confirmations.
Target Testing
- Involves testing all items exhibiting a specific characteristic within the sample set.
Non-Statistical Sampling
- Also known as judgmental sampling; does not apply statistical methods to sample size or selection.
Statistical Sampling
- Employs probability laws to determine sample size and assess results, allowing for efficient sampling and quantified sampling risk.
Advantages/Disadvantages of Statistical Sampling
- Advantages: Creates efficient samples, provides quantifiable sufficiency estimates rather than judgment-based conclusions, and measures sampling risk.
- Disadvantages: Requires adequate auditor training, time-consuming to design and implement sampling strategies, and may lack consistency across audit teams.
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