audit exam 1

what are the steps of the audit process?

1. plan the audit

2. perform the audit

3. report the audit findings

Explain step 1 of the audit process

Planning the audit process include 5 basic things:

1. developing a detailed understanding of the clients organization

2. establishing important thresholds/guidelines for the audit (materiality and audit risk)

3. assessing misstatement risk (inherent risk)

4. evaluating the internal controls (control risk)

5. documenting the audi plan

Explain step 2 of the audit process

Performing the audit includes 5 basic things:

1. performing audit tests

2. gathering evidence

3. evaluating evidence

4. documenting your work

5. having your work reviewed by someone else

Explain step 3 of the audit process

Reporting the audit findings includes:

1. reporting to the “public” (the audit report)

2. reporting to the audit committee

What is materiality?

Materiality is misstatements that are big enough or important enough to make a difference for financial statement users. Misstatements that are trivial or insignificant are considered immaterial.

What is audit risk?

The risk of coming to the wrong conclusion about the fairness of the financial statements based on our audit.

Or

The risk of not detecting an existing material misstatement with our audit

What level is audit risk usuallly at?

A reasonable level. It is never zero.

What are management assertions?

They are inferences in the financial statements that must be proven “true” or "false” during an audit

What are the nine types of assertions?

1. existence/occurrence: items shown truly exist or truly occurred

2. completeness: nothing is missing from the financial statements

3. accuracy: items are shown in the correct amounts

4. classification: items are shown in the correct accounts

5. cutoff: items are recorded in the correct periods

6. valuation: items are shown at their correct values (per GAAP)

7. rights/obligations: assets shown are truly owned and liabilities shown are truly owed

8. presentation: the financial statements are presented appropriately and in good form

9. authorization: all transactions were properly authorized

What are the 8 different types of evidence for auditors?

1. inspection of assets

2. inspection of documents/records

3. observation of people’s behavior processes

4. confirmation with third parties

5. inquiry/interviews

6. calculation or recalculations

7. reperformance of client tasks

8. analytical evidence

Why are audit tests used?

They are used to gather evidence and test management assertions

What are the two types of audit tests?

1. test of controls

2. substantive tests

Explain test of controls

indirect tests of management assertions

ex. we test the assertions by testing the client’s internal controls over those assertions

Explain substantive tests

direct tests of management assertions

Fall into 3 categories

1. test of transactions

2. test of details of account balance and disclosures

3. substantive analytical tests

Are risk assessment procedures an audit test?

No. They don’t test assertions.

What is sampling?

We draw conclusions based on tests from a subset of a population. Often, financial statements contains too large of numbers of transactions to test thoroughly.

What is independence?

Audit evidence is persuasive instead of conclusive, so judgement must be used in gathering evidence and conducting tests. Because of this, objectivity is necessary.

What is skepticism?

Having an attitude that includes a questioning mind and a critical assessment of evidence. We must always consider that 1) they might be lying to us and 2) the evidence may have been fabricated/manipulated

What is audit data analytics?

Auditors use analyses, modeling, visualization, and a computer to discover and analyze patterns. Use both to assess risk and identify possible misstatements.

What is GAAS?

Generally Accepted Auditing Standards. They are guidelines/requirements issued by regulatory bodies that direct public accountants in their work. Purpose is to standardize audit quality, which protects the reputation of the auditing profession.

What is an audit?

An investigation into financial statements to determine whether they are free of material misstatements (accidental like errors or intentional like fraud)

What is an organization?

People (management, employees, corporate governance)

processes (revenue, purchasing, payroll, inventory management, financing, and compliance process)

accounting (identifying, recording, updating, summarizing, and reporting information regarding economic states and events that effect and org)

What is the accounting cycle simplified?

events → journals → ledgers → financial statements → decision makers

what are the three truisms?

1. if i want to investigate a number in the financial statements, i must understand how it gets there and what it means

2. if i know how a number gets there, i can surmise where misstatements might come from

3. if i know where misstatements are likely to occur, im more likely to find them and Im more likely to find them quickly

what is the detailed accounting cycle?

1. analyze transaction

2. prepare journal entries

3. post journal entries to GL

4. prepared unadj trial balance

5. make adj JE

6. prepare adj trial balance

7. prepare financial statements

8. prepared closing entries

9. prepare post-closing trial balance

10. create and post reversing entries if needed

What is the internal control over financial reporting cycle?

control environment → control activities → information and communication → monitoring → risk assessment

Why do organizations have audits?

1. regulations

2. contracts

3. managers of organizations want to persuade financial statement users their financial reports are trustworthy

adds value and credibility to financial statements.

Why would managers want to persuade financial statement users that their financial reports are trustworthy?

May result in lower interest rates, higher stock prices, or higher compensation.

how do auditors provide assurance?

they have expertise and independence

how much assurance does an audit provide?

Reasonable assurance. Absolute assurance is not reasonable because it would be too costly to obtain and possible unrealistic.

What are the types of audit regulations?

1. AICPA makes ASB makes SAS

2. SEC makes PCAOB makes AS

3. IFAC makes IAASB makes ISA

what does PCAOB standards regulate?

audits of public companies in the US

what does ASB standards regulate?

audits of non public orgs in the US

what does IAASB standards regulate?

audits of organizations outside of the US

What results in lower audit risk?

better auditing, more audit effort, and more evidence

lower audit risk = higher assurance

what is audit risk in the real world?

less than 2-5%

what is reasonable assurance for public companies?

approx 95-98%

audit tests are used to gather what?

evidence

what reporting “grades” are there?

all OK → unqualified/unmodified

mostly OK → qualified/modified

not at all OK → adverse

unsure → disclaimer

whatre threats to independence?

1. motivated reasoning

2. conflicts of interest

3. confirmation bias

4. recency bias

5. primacy bias

6. over 100 others

how do we strengthen independence?

1. code of professional conduct

2. training

3. review process

4. economic forces

what are threats to skepticism?

1. availability bias

2. truth bias

3. historical relationships

4. other

how do we strengthen skepticism?

1. brainstorming sessions

2. training

3. review process

where are data analytics used?

planning (risk assessment) and performing (searching for missatements)

what are the principles of GAAS?

1. to provide an opinion regarding the financial statements that provides assurance to users

2. management is responsible for the financial statements and they cooperate fully with auditors

3. auditors must be competent, follow ethical standards, and maintain professional skepticism throughout an audit

4. audits must obtain reasonable assurance that all material misstatements from error or fraud are detected

5. audits must have proper planning and supervision, proper materiality levels, proper risk assessments, and sufficient appropriate audit evidence

6. absolute assurance is not possible

7. audit results in written report with opinion (or explanation for why opinion cannot be expressed)

who is responsible for misstatements?

management, accountants, any employee

why do misstatements occur?

mistakes (error) - unintentional

manipulation (fraud) - intentional

what is included in the error triangle?

environmental constraints, complexity/difficulty, incompetence

as each element of the error triangle increases…the risk of error ___

increases. errors are most likely when all three elements are elevated

what is included in the fraud triangle?

rationalization, opportunity, pressure/incentives

misstatements occur where?

journals (incorrect entries), ledgers (incorrect ledger management), financial statement (incorrect preparation)

when do misstatements occur?

errors can occur any time. Fraud can occur any time but typically near or at the end of a period.

what is incompetence?

incompetent/inexperienced accountants or supervisors, inadequate training or education, high turnover, new employees, etc

what is complexitiy/tast difficulty?

complex transactions, complex or difficult accounting, complex or vague accounting standards/regulations, unusual transactions, accounting estimates, etc

what is environmental constraints?

deadlines, high workload, poor working conditions, incomplete information, low morale, poorly developed or obsolete accounting systems,e tc

what is pressure/incentives?

pressure to meet forecasts/budget/expectations, pressure to reduce cost of capital, disappointing firm or department performance, etc

what is opportunity?

poor board oversight, poor internal controls, information asymmetry, complex transactions, etc

what is rationalization?

im helping the org, im protecting the investors, im protecting the employees, etc