audit exam

Knowingly making material misrepresentations of fact with the intent of inducing someone to believe and act upon the falsehood and, thus, suffer a loss

fraud

Employee fraud usually consists of:

fraud act itself, Conversion of the assets to the fraudster’s use, Cover up

Observation of personal habits and lifestyles and changes to them

Employee red flags

Characteristics of Fraudsters

People who commit fraud do not usually appear any different than a “normal” person, Do not make themselves obvious, “Long-time trusted employees”

3 components of fraud triangle

incentive, oppportunity, rationalization

incentive/pressure

Condition that causes a person to commit a fraud

examples of Conditions that cause a person to commit a fraud

Psychotic, Egocentric, Ideological, Economic

Condition that allows a person to commit a fraud

opportunity

rationalization/attitude

Allows a person to justify illegal behavior

For ___________ control systems must be effective but not too cumbersome or restrictive.

Fraud prevention

examples of control systems for fraud prevention

Managing People and Pressures, Internal Control Activities and Employee Monitoring, & Tone at the Top

Reports and Files Used in an Audit of Cash

Cash receipts journal, Cash disbursements journal, Bank reconciliations, Detecting fraudulent checks, Bank statements

significant account

cash

relevant assertion

Existence is primary, but others may be relevant

these question relates to what: What could go wrong? Does the reported cash balance really exist? Is the cash balance valued properly? Is everything presented properly and are all appropriate disclosures made?

risk of material misstatement

For identified risks, we must determine if controls are in place and operating effectively so the F/S are not misstated

Mitigating the Risk of Material Misstatement

Management must have unusually strong controls because of the chance of theft of the cash.

Preventing or Detecting Employee Fraud

Control Activities for Cash Receipts

Lockbox arrangement, Cash receipt processing procedures, Verification by an independent employee, Reconciliation of the bank accounts, Fidelity bonding

Cash receipt processing procedures

Two people open mail, Immediate restrictive endorsement, List of cash receipts, Separate cash from bookkeeping, Deposit cash daily and intact, Remittance advices go to accountants to record the cash receipts

Verification by an independent employee

Copy of the check listing, Report of receipts recorded in A/R, Copy of the deposit slip from the bank

the decision from the sample differs from the one the whole population would give. Caused by a nonrepresentative sample. Controlled by an appropriate sample size, equal chance of selection for every item, and evaluating results.

sampling risk

wrong conclusion for reasons unrelated to the sample (wrong procedure, misread evidence). Evaluator error, not sample error. It can occur when measuring items.

nonsmapling risk

Sampling makes a statement about a population by examining a…

subset

tests of controls (was the control applied? yes/no)

attribute sampling

substantive procedures on account balances (continuous amounts)

variable sampling

When do we use sampling?

when exact information is not important and the population is large

the maximum deviation rate allowed without changing planned reliance

tolerable rate of deviation

A more important control means a _________ TRD

lower

assessing control risk too low, the auditor thinks the control works but it does not

risk of overreliance or ROO

What is the main concern of ROO

loss of effectiveness

assessing control risk too high, the auditor thinks the control fails but it works.

risk of underreliance

What is the main concern of risk of UNDERreliance

loss of effieciency

this must be less than the TRD; Use prior experience, or a pilot sample for new clients

expected deviation rate

For the gap between ______ & _______ the smaller the gap, the more precise the estimate must be, so the larger the sample

TRD and EDR

The size of the population has little effect unless…

the population is very small

When measuring, you should physically test the control. If there is a missing item what does that mean?

there is a deviation

ULRD < or = TRD then…

the control works as required

ULRD > TRD then…

control does NOT work as required

If ULRD < or = TRD, what action should you take?

rely as planned and keep control risk OR consider reducing acceptable control risk

If ULRD > TRD, what action should you take?

reduce reliance and raise control risk, OR expand the sample

When reviewing deviations, what questions should you ask?

pervasive or isolated? Intentional or accidental? Misunderstanding of instructions or careless? Implications for other controls?

When do you use sequential sampling?

when EDR is relatively low compared to the TRD

How does sequential smapling work?

1. Draw an initial sample.

2. Few deviations: control works, stop.

3. Many deviations: control not working, raise control risk.

4. Cannot decide: enlarge the sample and repeat.

When is discovery sampling used?

for very critical controls or suspected fraud

for discovery sampling, what is the EDR?

0, if there is a deviation of 1 then the control is not working

true or false: a missing document is a deviation

true

Underreliance costs…

efficiency

overreliance costs…

effectiveness

Variables sampling examines _________ distributions of amounts, unlike attributes

continuous

what does variable sampling estimate?

the true balance OR the misstatement

the ____________ is what the account should be if NO misstatements

true balance

_____________ says the misstatement is below tolerable when it is actually above

risk of incorrect acceptance

_______ says it is above tolerable when it is actually below; Reducing exposure to either needs a larger sample

risk of incorrect rejection

for _____, smaller means a larger sample

tolerable misstatement

for _______ larger means a larger sample.

expected misstatement

A small gap between expected and tolerable means more precision, so what size sample?

larger

for _________ larger population means larger sample

population size

what is the formula for tainting %?

(recorded - audited) / recorded

what is the formula for projected misstatement

tainting % x sampling interval

For projected misstatement, if the recorded balance is larger than the interval, the projection is

the actual misstatement

Steps for incremental analysis

1. rank projected misstatements smaller than the interval in descending order.

2. For each, incremental confidence factor (ICF) = CF for n misstatements - CF for n-1.

3. Incremental allowance = PM x (ICF - 1).

basic allowance formula

sampling interval x CF for zero overstatements

ULM formula

projected misstatement + incremental allowance + basic allowance

ULM <= tolerable misstatement

the balance is acceptable

ULM > tolerable misstatement

increase the sample size (reduces the interval and the allowances; if no more errors turn up the ULM may drop below tolerable), or recommend an adjustment to the recorded balance

for understatements…

subtract the projected understatement from the ULM calculated from overstatements