Audit exam 1***

What is an audit?

A service that assures investors creditors or other stakeholders that a company is being honest and reliable.

Why is auditing different from other accounting courses?

It focuses on analytical and logical skills is much more conceptual in nature and uses logical/conceptual tools useful for all business professionals.

What is the principal-agent relationship in auditing?

Principals (absentee owners) provide capital and hire agents (managers) to manage resources. Information asymmetry and conflicts of interest lead to information risk for the principal so an independent auditor is hired to reduce that risk.

What is information asymmetry?

The manager who runs the business day-to-day has more information about the true financial position of the company than the principal/owner.

What is the role of auditing in reducing information risk?

The auditor gathers evidence to evaluate the fairness of management's financial reports and issues an audit opinion to add credibility to the reports thereby reducing the principal's information risk.

What are the three fundamental concepts in conducting a financial statement audit?

Materiality Audit Risk and Evidence.

What is materiality?

The magnitude of an omission or misstatement of accounting information that in light of surrounding circumstances makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced.

What is the rule of thumb for materiality regarding income before tax?

(Aggregated) misstatements of more than 5% of income before tax would cause the financial statements to be materially misstated.

What is audit risk?

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

What is reasonable assurance?

It implies some risk that a material misstatement could be present in the financial statements and the competent auditor will fail to detect it. The audit provides only reasonable not absolute assurance.

What is audit evidence?

All the information used by the auditor in arriving at the conclusions on which the audit opinion is based. It consists of information that corroborates or contradicts assertions in the financial statements.

What are the key descriptors of audit evidence?

Sufficiency (quantity) and Appropriateness (quality). Appropriateness includes Relevance (specific assertion being tested) and Reliability (diagnosticity of the evidence).

What is sampling in auditing?

Examining a subset of transactions because it would be too costly to examine every transaction. The size of the subset is determined by materiality.

What is the overview of the financial statement audit process?

The auditor must understand everything about the client (business industry information system risks) and then express whether company financials are presented fairly.

What are the three stages of the accounting process?

1. Internal controls (ensure proper handling of transactions) 2. Individual transactions (collected into ending account balances) 3. Account balances (summary of all).

What are the three stages of collecting evidence?

1. A system of internal control put in place by the client 2. Transactions that affect each account balance 3. The ending account balances themselves.

Which evidence is usually the highest quality but also the costliest?

Evidence that relates directly to ending balances.

What are the major phases of the audit?

1. Client acceptance/continuance 2. Preliminary engagement activities 3. Plan the audit 4. Consider and audit internal control 5. Audit business processes and related accounts 6. Complete the audit 7. Evaluate results and issue audit report.

What are preliminary engagement activities?

1. Determine the audit engagement team requirements 2. Ensure the independence of the audit firm and audit team 3. Establish an understanding with the client regarding the services to be performed.

What is the purpose of planning the audit?

To determine materiality make a preliminary assessment of the client's business risks assess Risk of Material Misstatement (RMM) and set forth the nature timing and extent of audit procedures.

What is an unqualified/unmodified audit report?

A report indicating that the financial statements are free of material misstatements; the auditor does not find it necessary to qualify or modify the opinion.

What are the requirements for an unqualified opinion?

The auditor must be independent there must be no significant limitations imposed on the auditor's procedures and the client's financial statements must be free of material departures from GAAP.

What is a qualified opinion?

The auditor explains that the financial statements are presented fairly except for the misstatement identified by the auditor.

What is an adverse opinion?

The auditor concludes that the statements are completely off and should not be relied upon.

What is Audit Data Analytics (ADA)?

Using analytics modeling and visualization to discover and analyze patterns anomalies and other data information in the context of the audit.

What are the five steps of the AICPA recommended ADA process?

1. Plan the ADA 2. Access and prepare the data 3. Consider the relevance and reliability of the data 4. Perform the ADA 5. Evaluate and interpret the results.

An independent audit adds value to the communication of financial information because the audit:

Lends credibility to the financial statements.

Which of the following best describes the reason why an independent auditor is often retained to report on financial statements?

Different interests may exist between the entity preparing the statements and the persons using the statements thus outside assurance is needed to enhance the credibility of the statements.

Which of the following best describes relationships among auditing attest and assurance services?

Auditing is a type of assurance service.

Which of the following statements relating to attest and assurance services is not correct?

Financial statement auditing is a form of attest service but it is not an assurance service. (This is false; it IS both.)

For what primary purpose does the auditor obtain an understanding of the entity and its environment?

To plan the audit and determine the nature timing and extent of audit procedures to be performed.

Which of the following statements best describes how materiality is related to audit evidence in a financial statement audit?

The lower the level at which the auditor assesses materiality the greater the amount of evidence the auditor must gather.

Which of the following is the most important reason for an auditor to gain an understanding of an audit client's system of internal control over financial reporting?

Understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.

Preliminary engagement activities include:

All of the above (Understanding the client and industry Determining audit engagement team requirements Ensuring independence).

Which of the following statements best describes what is meant by an unqualified audit opinion?

An unqualified auditor's opinion indicates that in the auditor's opinion the client's financial statements are fairly presented in accordance with agreed-upon criteria with no need for the inclusion of qualifying phrases.

The auditing standards that are used to guide the conduct of the audit are:

Explicitly referred to in the Basis for Opinion section of the auditor's standard report.

A client has used an inappropriate method of accounting for its pension liability. The misstatement is material but not pervasive. The auditor is unable to convince the client to alter its accounting treatment. Which kind of audit report should the auditor issue?

Qualified opinion due to departure from GAAP.

What are the types of auditors?

External Auditors Internal Auditors Government Auditors Fraud Auditors.

What is independence for auditors?

A state of objectivity in fact and appearance including the absence of any significant conflicts of interests. It is the main requirement for auditors.

What are external auditors?

They are not employees of the entities being audited also known as independent auditors. They commonly audit financial statements of publicly traded companies and government entities and must be a CPA.

What are the Three Es of external auditors?

Examination Education Experience.

What are internal auditors?

Hired by companies or government agencies and are employees of those companies. They conduct financial internal control compliance operational and fraud audits within their organizations and may assist external auditors.

What are government auditors?

Employed by federal state and local agencies. Considered a type of internal auditor. Two government agencies that use auditors regularly are the Government Accountability Office (GAO) and the Internal Revenue Service (IRS).

What are fraud auditors?

Employed by corporations government agencies public accounting firms and specialized consulting and investigative service firms.

What is an internal control audit?

An audit of the company's own system of internal control over financial reporting. Not required for private companies but an integrated audit is required for public companies.

What is an integrated audit?

An audit of both financial statements and internal control over financial reporting provided by the external auditor. Required for public companies.

What is a compliance audit?

An audit to determine the extent to which rules policies laws covenants or government regulations are followed by the entity being audited.

What is an operational audit?

A systematic review of part or all of an organization's activities to evaluate whether resources are being used effectively and efficiently. Sometimes referred to as a performance or management audit.

What are attest services?

A subset of assurance services involving reporting on an assertion or other subject matter that is the responsibility of another party. Auditing is an attest service.

What are assurance services?

Independent professional services intended to help decision makers by improving the quality or context of the information they use.