Financial Auditing Concepts

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Questions and Answers

What is the primary purpose of financial statement auditing?

To provide assurance on the accuracy of financial statements (correct)

To replace management in financial reporting

To assist in fraud prevention and detection

To prepare financial statements for companies

Which of the following is NOT responsible for the preparation of financial statements?

Financial reporting team

Board of directors

External auditors (correct)

Management of the company

Which category of companies is exempted from statutory audits based on revenue and membership?

Small companies with annual revenue < S$5 million (correct)

Publicly listed companies

Large private companies with diverse membership

Companies with total assets exceeding S$10 million

What constitutes fraudulent financial reporting?

Inaccurate representation of financial data Signup and view all the answers

What is an auditor's responsibility towards fraud risks?

To assess and respond to the risk of fraud Signup and view all the answers

What is the primary purpose of a financial statements audit?

To provide reasonable assurance that the financial statements are free of material misstatements Signup and view all the answers

Which type of engagement involves a limited scope of work?

Review Engagement Signup and view all the answers

What level of assurance is typically provided by an Agreed Upon Procedures engagement?

No assurance Signup and view all the answers

During a financial audit, what does the auditor focus on ensuring?

That the financial statements are accurate and complete according to the applicable framework Signup and view all the answers

What does a review of financial statements provide?

Negative assurance. Signup and view all the answers

What type of audit is conducted on a quarterly basis as per needs?

Review Engagement Signup and view all the answers

In the context of audit quality, what is meant by 'reasonable assurance'?

The auditor provides assurance that financial statements are free of significant inaccuracies. Signup and view all the answers

What do Agreed Upon Procedures NOT provide to stakeholders?

Assurance over the reliability of the financial statements Signup and view all the answers

What is one type of fraud that the auditor is particularly concerned with?

Fraudulent financial reporting Signup and view all the answers

Which one of the following practices could indicate fraudulent financial reporting?

Early recognition of revenue Signup and view all the answers

Which of these conditions suggests a need for additional audit procedures?

Unusual discrepancies in financial statements Signup and view all the answers

What does misappropriation of assets usually involve?

Theft of an entity's assets Signup and view all the answers

What is a common misconception regarding fraud investigations in audits?

All fraud is always detected Signup and view all the answers

Which action could lead to over generalizing conclusions during an audit?

Making assumptions based on limited evidence Signup and view all the answers

What is a key risk when inappropriate assumptions are used in audits?

Misestimation of audit procedures Signup and view all the answers

The early recognition of revenue is primarily associated with which fraudulent activity?

Fraudulent financial reporting Signup and view all the answers

What is a primary example of misappropriation of assets?

Misappropriating collections of accounts receivable Signup and view all the answers

In the context of fraud, what does the term 'incentive or pressure' refer to?

External or internal pressures to meet unrealistic financial targets Signup and view all the answers

Which of the following is considered an inappropriate payment practice in the context of fraud?

Payments made to fictitious vendors Signup and view all the answers

What key element must exist for an individual to commit fraud?

A perceived opportunity to commit fraud Signup and view all the answers

What is the primary purpose of an audit?

To enhance confidence in the financial statements of users Signup and view all the answers

Which scenario best exemplifies collusion in the context of asset theft?

An employee collaborating with a vendor to inflate prices Signup and view all the answers

Stealing scrap for resale falls under which category of fraud?

Misappropriation of physical assets Signup and view all the answers

Which of the following best describes the opinion expressed by an auditor in an audit?

The auditor states if the financial statements are presented fairly Signup and view all the answers

What does the term 'misalignment of interests' refer to in Agency Theory?

The disparity between owners and management motives Signup and view all the answers

What is a common characteristic of transactions involving non-consolidated related parties?

They often involve complex or unusual financial dealings. Signup and view all the answers

Which factor is associated with the complexity of transactions in the context of audit risk?

The biases and motives of financial service providers Signup and view all the answers

Kickbacks paid by vendors to purchasing agents are classified as what type of fraud?

Inappropriate payments for goods and services not received Signup and view all the answers

What aspect of information distance increases audit risk?

Separation between ownership and management Signup and view all the answers

In the context of a financial statement audit, which statement about applicable financial reporting frameworks is true?

Frameworks dictate how to present financial results to users Signup and view all the answers

Which of the following is NOT typically a responsibility of an auditor?

Detect all instances of fraud in financial reporting Signup and view all the answers

How does trust influence the independence of an auditor?

Trust enhances the auditor's ability to perform independently Signup and view all the answers

What is the primary risk associated with management override of controls?

Management fraud going undetected Signup and view all the answers

Which response is part of the recommended audit approach to manage risks of management override?

Reviewing accounting estimates for bias Signup and view all the answers

What does professional skepticism require from auditors?

Ongoing questioning of audit evidence Signup and view all the answers

How can auditors increase the effectiveness of their testing regarding management override?

Alter timing and nature of audits Signup and view all the answers

What is an example of an unusual transaction that auditors might consider during their testing?

Complex transactions at the end of reporting periods Signup and view all the answers

What should not be accepted by auditors without further scrutiny?

Management documents and records Signup and view all the answers

When auditing, what indicates the need for professional skepticism according to SSA 200.A20?

Audit evidence that contradicts other evidence Signup and view all the answers

Which strategy is NOT recommended to manage the risk of management override?

Using uniform sampling techniques throughout Signup and view all the answers

Study Notes

Learning Objectives

Explain the purpose of financial statement auditing
Identify the people responsible for preparing financial statements and preventing fraud
Explain the external auditor's responsibility for fraud risks
Distinguish between fraud arising from fraudulent financial reporting and misappropriation of assets

Who is Exempted from Statutory Audit?

Small company: Private company meeting at least two of three criteria for the past two financial years:
- Total annual revenue less than S$10 million
- Total assets less than S$10 million
- Number of employees less than 50
Exempt private company: Annual revenue less than S$5 million and fewer than 20 members, none of whom is a corporation
Dormant unlisted company: Total assets within the financial year must not exceed S$500,000 and dormant from formation date or end of previous financial year

Basic Types of Audit & Assurance Engagements

Financial Statement Audit: Complete scope of work done, reasonable assurance, accurate and complete to a certain extent, true and fair view with no material misstatements, positive assurance on assertion(s) - statutory audit
Review: Limited scope of work done, moderate/limited assurance, no evidence that it is not true and fair, no material modifications required, negative assurance on assertion(s) - quarterly reporting or as-needed.
Agreed Upon Procedures (AUP): Specific procedures to be performed, no assurance, as per agreed upon criteria

Purpose of a Financial Statement Audit

Enhance intended users' confidence in financial statements
Achieved by the auditor expressing an opinion on whether the statements are prepared in accordance with an applicable reporting framework
- In the case of most general-purpose frameworks, the opinion is on whether the statements give a true and fair view

Why Do We Need Audits?

Agency Theory: Independence, trust, biases and motives of financial providers, misalignment of interests of owners and management
Information Risk: Technical competence, distance, remoteness of information, complexity of transactions

Origins of Modern Audit

Modern audit originates from failures in the 19th century (e.g., City of Glasgow Bank) revealing the need for independent annual audits, now mandatory for listed and large companies.
Aims to provide assurance to shareholders about the true and fair view of a company's assets, liabilities, financial position, and profit/loss.
Crucial for maintaining investor confidence and market stability, as it impacts employees, customers, suppliers, and pensioners.

Purpose of a Financial Statement Audit (SSA200.36)

Enhance the degree of confidence of intended users about the financial statements, by expressing an opinion on whether statements are prepared in accordance with an applicable financial reporting framework.
An audit conducted in accordance with SSAs and relevant ethical requirements enables the auditor to form the opinion.

Users of Audited Financial Statements

Users and the types of decisions they make
- Management: review of performance, operational decisions, and reporting, buying or selling
- Stockholders/bondholders: determining financial position for buying or selling; Evaluating loan factors
- Financial institutions: evaluating loan decisions; considering interest rates
- Taxing authorities: determining taxable income, and complying tax due
Provides assurance to these users

Level of Assurance & Expectations Gap

Audit reports provide reasonable, high level assurance but there is still an expectations gap.
Expectations gap is the difference between public perception and the responsibilities of auditors regarding the reliability of audited financial statements guaranteeing the entity remains in existence.
Auditors are not responsible for guaranteeing future performance
Auditors cover the type and extent of financial statement items tested, not all errors are uncovered during the audit.
Auditors provide reasonable assurance, but not absolute assurance, regarding accuracy of statements' figures.

Who Is Responsible for the Preparation of Financial Statements?

Management is responsible for the preparation of financial statements in accordance with applicable financial reporting framework
Management is responsible for establishing internal control relevant to the preparation of financial statements

Which Items are Responsibilities of Management?

Everything except the Independent Auditors Report

Management Versus Auditor Responsibilities

Management: Maintaining internal controls, preparing and reporting (financial statements and disclaimers).
Internal audit function: provides independent assurance on internal controls and reports.
Audit committee: provides oversight on the reporting process.
External auditor: conducts independent audit of internal controls and financial statements.

Independent Auditors' Report

Auditors' opinion on the financial statements of a company in accordance with the Companies Act 1967 and Singapore Financial Reporting Standards(International).
Statements provide a true and fair view of the consolidated financial position and financial performance.

Who is Primarily Responsible for Preventing Fraud?

Primarily the management and board of directors.
Internal audit's assessment and recommendation of controls to limit risk of fraud within the company.

SSA Definition of Fraud

Fraud: An intentional act by one or more individuals involving deception to gain an unfair advantage. -Fraud risk factors: Conditions that indicate an incentive or pressure to commit fraud, involving management, those charged with governance, employees, or third parties.
FRAUD TRIANGLE (Pressure, Opportunity, Rationalization) : A framework for spotting high-risk situations. -Prevention & Detection of Fraud: Primary responsibility of management and governance.

How is Occupational Fraud Initially Detected?

Internal audit
Management review
Document examination
Accident / reconciliation
Automated transaction / data monitoring

Who Reports Occupational Fraud?

Employees
Customers
Anonymous sources
Vendors
Shareholders / owners
Competitors

External Auditor's Responsibility Regarding Fraud & Error

Auditors identify and assess risks of material misstatement due to fraud
Auditors obtain sufficient evidence for assessing fraud risks in financial reports
Auditors respond appropriately to identified fraud risk during audits

Limitations of an External Audit on Fraud Detection

Auditors obtain reasonable assurance, but not absolute assurance, about the absence of material misstatement.
Inherent limitations of an audit means that some material misstatements may not be detected regardless of procedural compliance
Risk of not detecting management fraud is greater than that of employee fraud.

Fraud Risk Response Towards Management Override of Controls

Selecting journal entries for testing (SSA 240.32(a))
Reviewing accounting estimates (SSA 240.32(b))
Introduce unpredictability / Modify timing, nature and extent of audit

Professional Scepticism

Ongoing questioning about information and audit evidence
Acknowledging the integrity of management but maintaining a critical stance towards potential inconsistencies
Evaluating records and documents, and investigating discrepancies.

Professional Scepticism - Alertness to..

Contradictions in audit evidence
Questionable reliability of documents and responses
Conditions suggesting fraud
The need for additional audit procedures

What are the Two Common Fraudulent Misstatements?

Fraudulent financial reporting: Perpetrated by those who have vested interest or accountability in the performance of the entity.
Misappropriation of Assets: Theft by employees usually for small amounts.

Fraudulent Financial Reporting (FFR) Examples

Revenue recognition: Early recognition, fictitious sales
Accounting estimates: Intentional misstatement (e.g., sales returns, provisions, accruals)
Complex/unusual transactions: Transactions outside regular business processes involving related parties

Misappropriation of Assets (MA) Examples

Embezzlement: Diverting receipts to personal accounts
Theft of assets: Stealing inventory or scrap
Inappropriate payments: Payments to fictitious vendors or employees
Kickbacks: Payments to purchasing agents in exchange for inflated prices

Drivers of Fraud

Pressure: Incentive from external or internal sources to reach unrealistic financial goals
Opportunity: Percieved chance to commit fraud.
Rationalization: Ability to justify fraudulent actions

Applying the Fraud Triangle to Local Fraud Cases

Summary of the case
Type of fraudulent misstatement
Examination of Fraud Triangle factors (pressure, opportunity, rationalization)
Proposed internal control to prevent fraud

Key Concepts Summary

Overview of key auditing concepts covered in the provided material.

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Description

Test your knowledge on the purpose and responsibilities involved in financial statement auditing. This quiz covers exemptions from statutory audits and different types of audit engagements. Understand the key elements that prevent fraud and ensure accurate financial reporting.