Auditing Revision Sheet PDF

**[Chapter 4]** **[Audit Risk]**: risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. **[What are the three levels of audit risk?]** - Financial Statement Level - Assertion level - Individual account balance or disclosure l...

**[Chapter 4]** **[Audit Risk]**: risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. **[What are the three levels of audit risk?]** - Financial Statement Level - Assertion level - Individual account balance or disclosure level **[What is the Audit risk formula or model?]** Audit Risk = Inherent Risk \* Control Risk \* Detection Risk **[Inherent Risk:]** an error in a financial statement due to a factor other than a failure of internal control. **[Control Risk:]** a risk that a misstatement occur in an assertion that is not detected by the company's internal control. **[Detection Risk:]** Risk that auditors will not detect misstatements. **[What is engagement risk?]** An auditor's exposure to financial loss and damage to professional reputation through litigation and adverse. Note: "Inherent Risk\*Control Risk" together can be expressed as "Risk of material misstatement" (RMM). Note: Qualitative terms may also be used in the audit risk model as very low, low, moderate, and high. **[What are the limitations that must be considered when using audit risk model?]** - The desired level of audit risk may not actually be achieved. - It does not consider potential auditor error. - There is no way of knowing what the preliminary level of risk of material misstatement actually was. **[What is the auditor's risk assessment process?]** Auditors need to identify business risks and understand the potential misstatements that may result. The process is as follows: 1. Inquiries of management and others. 2. Analytical procedures. 3. Observation or inspection. 4. Identify business risks that may result in misstatements. 5. Evaluate the entity's risk assessment process and obtain evidence. 6. Assess the risk of material misstatement at the financial statement and assertion levels. **[How to gather evidence through the risk assessment procedures?]** - Inquiries of management, other entity personnel, and others outside the entity. - Analytical Procedures. - Observation and Inspection. **[How to understand the entity and its environment?]** - Understanding the nature of entity - Understanding the internal control. - Understanding objectives, strategies, and business risks. - Understanding industry, regulatory, and external factors - Understanding entity performance measures. **[Nature of Entity:]** information about entity's structure, management, sources of funding, investment activities, operating characteristics, source of earnings, and key suppliers as well as customer relationships. **[How can we understand industry regulatory and other external factors?]** By understanding the following: - Industry Conditions such as market and competition, supply availability and cost. - Regulatory environment such as accounting principles, legislations, taxation, and government policies. - Other external factors such as economic activity, interest rate and availability of finance. **[Give some examples of misstatements.]** - Inaccuracy in gathering or processing data. - Financial statement disclosure that is not in accordance with GAAP. - An incorrect accounting estimate overlooking a clear misinterpretation of facts. **[Errors:]** Unintentional misstatements of disclosures in the financial statements. (mistake) **[Fraud:]** Intentional misstatements by one or more among management. (deception) **[What is the fraud risk identification process?]** - Communication among the audit team. - Inquiries of management and others. - Analytical procedures. - Investigation of unexpected period-end adjustments - Identification of fraud risk factors **[What are the conditions that indicates fraud and fraud risk factors?]** - Incentive or pressure to perpetrate fraud. - Opportunity to carry out the fraud. - Attitude or rationalization to justify fraud. **[What are the factors relating to incentive/pressure?]** - Excessive pressure for management to meet third party expectation. - Financial stability or profitability is threatened. - Management's personal financial situation is threatened. **[What are the risk factors relating to opportunities?]** - Nature of the industry operations. - Complex or unstable organizational structure. - Ineffective monitoring of management. - Deficient internal control. **[What are risk factors relating to attitudes/rationalizations?]** - Nonfinancial management's excessive participation in selection of accounting principles and estimates. - Excessive interest by management in stock prices and earning trends. - Committing to aggressive or unrealistic forecasts. - Ineffective communication of ethical standards or selection of inappropriate ethical standards. - Recurring attempts to justify marginal or inappropriate accounting based on materiality. - History of violations of securities laws or allegations of fraud. Note: Fraud involves intentional misstatements, either through fraudulent financial reporting or misappropriation of assets. **[What acts does fraudulent financial reporting include?]** - Manipulation, falsification, or alteration of accounting records or supporting documents used to prepare financial statements. - Misrepresentation in, or intentional omission from, the financial statements of events, transactions, or significant information. - Intentional misapplication of accounting principles relating to amount, classification, manner of presentation, or disclosure. **[Misappropriation of assets:]** involves the theft of an entity's assets to the extent that financial statements are misstated. **[How to respond appropriately to financial statement level risk?]** - Assign more experienced personnel. - Evaluate the selection of application of accounting policies. - Make the audit procedures unpredictable by adding elements. **[What should be considered when evaluating an audit test results?]** - If the total misstatements cause the financial statements to be materially misstated. If there is material misstatement, then: - Request management to eliminate the material misstatement or if management did not respond, the auditor should issue a qualified or adverse opinion. **[What should the auditor do if he/she determines that the misstatement may be result of fraud?]** - Obtain evidence. - Consider implications of other aspects of the audit. - Discuss the matter and further investigate. - Suggest that management consult with legal counsel. - Consider withdrawing from the engagement. **[What is the auditor's documentation of the risk assessment?]** - Discussion among engagement personnel. - Procedures to identify the risk of material misstatement. - Fraud risk that results in additional audit procedures. - The nature, timing, and extent of procedures in response to fraud risks identified. - The nature of the communications about error or fraud made to management, audit committee, and others. **[How do auditor's communicate about fraud?]** When the auditor discovers fraud then appropriate level of management should be informed. If the fraud involves senior management then auditee committee should be informed directly. **[Chapter 5]** **[How do audit evidence relate to audit report?]** The cycle goes as follows: 1- Financial Statements 2- Management assertions about components of financial statements 3- Audit Procedures 4- Provide evidence on the fairness of financial statements. 5- Auditors reaches a conclusion based on evidence 6- Audit Report **[What are the categories or classes of assertions?]** 1- Completeness 2- Classification 3- Accuracy 4- Authorization 5- Cut-off 6- Occurrence **[What are account balances assertions?]** 1- Existence 2- Right and Obligations 3- Completeness 4- Valuation and Allocation **[What are the management assertions about presentation and disclosure?]** 1- Accuracy and Valuation 2- Classification and Understandability 3- Completeness 4- Occurrence and rights and obligations **[How to gather evidence about weather specific assertions are being met?]** - Risk assessment Procedures - Test of controls - Substantive Procedures **[What are the procedures for obtaining audit evidence?]** - Inspection of records and documents: inspecting records to obtain evidence whether externally or internally. - Inspection of tangible assets: Physical examination of a tangible asset. - Observation: The process of watching a process being performed by others. - Inquiry: asking questions, queries to better understand. - Confirmation: the process of obtaining representation of information through a third party. - Recalculation: checking the mathematical accuracy or records. - Reperformance: the auditor's independent execution of procedures or controls that were originally performed by company personnel. - Analytical procedures: evaluations of financial information among both financial and non-financial data. - Scanning: judgmentally review accounting data. Note: evidence obtained from external documents is more reliable obtaining it internally. **[How should an inquiry be conducted by auditor?]** Ask appropriate questions whether open ended or closed questions. Ask clearly and listen actively. Finally evaluate the responses. **[What are factors that may affect external evidence?]** - The form of confirmation - Prior experience with entity - Nature of information - The intended respondent **[Audit testing hierarchy:]** an evidence decision process for testing classes of transaction or significant balances. **[What is the audit testing hierarchy process?]** 1. Perform test of controls 2. Perform substantive analytical procedures. 3. Perform substantive test of details on transactions and balances. 4. Document results. Note: the first two steps can be skipped if the auditor has full confidence that it is well done with no misstatements. Last two steps are mandatory and can't be skipped. **[what is the assurance bucket?]** A useful analogy to consider imaginary "Assurance bucket" that needs to be filled with enough evidence to provide reasonable assurance to an auditor. There are many kinds of evidence that can be used such as: 1. Risk assessment procedures. 2. Test of Controls. 3. Substantive Analytical Procedures. 4. Remaining assurance needed from tests of details. **[What is the purpose of analytical procedures?]** - Risk Assessment Procedures: used to assist auditors to understand the business and plan the nature, timing and extent of procedures. - Substantive Analytical Procedures: used to obtain evidence about assertions related to account balances or classes or transaction. - Final analytical Procedures: used as an overall review of the financial information in the final stage of review of the audit. **[What are the types of analytical procedures?]** - Trend Analysis - Ratio Analysis - Reasonableness Analysis **[What is the substantive analytical procedure decision process?]** 1. Develop an expectation. 2. Define a tolerable difference. 3. Compare the expectation to recorded amount. 4. Investigate difference. 5. Accept amount. 6. Document result. **[What expectation can be developed in the substantive analytical procedure?]** - Financial and operating data - Budgets and forecasts - Competitors information. Etc... **[What tolerable differences can be defined in the substantive analytical procedure? ]** - Significance of account. - Desired degree of reliance on the substantive analytical procedures. - The precision of the expectation. Note: in substantive analytical procedures process, investigating difference only takes place if differences were found in the stage of "define tolerable differences" otherwise it is not required. **[What are the short-term liquidity ratios?]** - Current ratio - Quick ratio - Operating cashflow ratio **[What are the activity ratios?]** - Receivable turnover - Inventory turnover **[What are the profitability ratios?]** - Gross profit percentage - Profit margin - Return on assets. - Return on equity. **[What are the coverage ratios?]** - Debt to equity - Times interest earned. **[What are the concepts of audit evidence?]** - Nature of audit evidence - Sufficiency and appropriateness of audit evidence - Evaluation of audit evidence **[Give some examples of the nature of audit evidence.]** 1- invoices 2- Contracts 3- Worksheets 4- adjustments to financial statement **[Sufficiency:]** is the measurement of the quantity of audit evidence. Greater risk of misstatement requires a higher quantity of audit evidence and vice versa. **[Appropriateness:]** is the measure of the quality of audit evidence, measure of relevance and reliability. **[What are important aspects of reliability?]** - Independent source outside the entity - Effectiveness of internal control - Auditor's direct personal knowledge - Documentary evidence - Original documents **[What understanding a proper evaluation of evidence requires?]** - Types of evidence availability - Relative reliability of available evidence The more independent a piece of evidence is, the higher its reliability is. **[What are the functions of audit documentation?]** 1. To provide support for the audit report. 2. To aid in the planning, performance and supervision of the audit. 3. To provide a focal point for reviewing work of subordinates. **[What should be the content of audit documentation?]** - Demonstrate how the audit complied with auditing professional practice standards. - Support the basis for the auditor's conclusions concerning each assertion. - Demonstrate that the underlying accounting records agreed with the financial statements. - Include a written audit program detailing audit procedures necessary to accomplish audit objectives. - Enable a knowledgeable and experienced reviewer to understand the nature, timing extent and results of audit. As well as determine who performed and reviewed the work and dates of the work and reviews. **[What are the two types of audit documentation that public accounting firms maintain?]** - Permanent files such as important contracts, chart of accounts, organization chart. - Current files such as audit report, audit plan, minutes of meeting. **[What is the format of audit documentation?]** - Heading - Indexing and cross-referencing - Tick marks Extra Notes about documentation: - Audit documentation should be organized so that audit team members and others can find evidence supporting financial statement accounts. - All audit documentation is the property of the auditor, including documents prepared by the entity at the auditor's request. - The Sarbanes-Oxley Act of 2002 requires audit documentation to be retained for several years from the completion date of the engagement.