AUDIT 1 EXAM 1 NEW

business risk

the risk that an entity will fail to meet its stated business objectives due to economic factors, industry shifts, or poor strategic decisons

information risk

the risk that the information from a company will be materially false or misleading

four environmental drivers of information risk

complexity, remoteness, time sensitivity, significant consequences

complexity

complex accounting standards and business transactions increase calculation and recording errors

remoteness

decision makers are separated from management and daily operations by distance and time, cannot verify records personally

time sensitivity

capital decisions must be made rapidly, making late or unverified information hazardous

significant consequences

misleading financial statements lead to substantial financial losses

financial statement auditing directly reduces _____

information risk

reducing information risk lowers the entities ______

cost of capital

auditing does not reduce business risk, but it does allow users to ______

evaluate business risk accurately

auditing definition

narrowest, most structured attestation service; an objective examination of historical financial statemtns resulting in a formal audit opinion

assurance, scope of subject matter

any information, financial or non-financial

assurance, primary deliverable

evaluation, analysis, or enhanced data quality

attestation, scope of subject matter

primarily financial information / assertions

attestation, primary deliverable

formal written examination, review, or agreed-upon procedures report

auditing, scope of subject matter

historical financial statements and footnotes

auditing, primary deliverable

formal audit report expressing opinon on GAAP/IFRS conformity

SOX Section 302

management holds legal responsibility for the financial reporting process and financial statements

existence or occurrence

do the recorded assets and liabilities exist at the balance sheet date?

did recorded sales/expenses actually happen?

vouching

select items from inventory ledger and physically inspect them in the warehouse

completeness

where all existing transactions and accounts recorded in the proper period?

tracing

select items present in warehouse and verify they appear on inventory listing

valuation / allocation

inspect physical inventory items for damange

rights and obligations

review purchase agreements and vendor contracts to confirm inventory is owned, not held on consignment

presentation and disclosure

verify that inventory is classified under current assets

professional skepticism

auditors questioning mindset toward representations made by management and evidential matter gathered

PCAOB (Public Company Accounting Oversight Board)

sets auditing standards for public company audits

AICPA (Auditing Standards Board)

sets statements on auditing standards for private company audits

audit risk formula

AR = IR x CR x DR

risk of material misstatement

inherent risk x control risk

detection risk

risk that auditors procedures will fail to detect a material misstatement

sufficiency evidence

quantity of evidence, sample size

appropriateness of evidence

relates to quality of evidence, measured of relevance and reliability

relevance

evidence must directly address the specific assertion being tested

reliability

auditor direct personal knowledge and external doc evidence is most reliable

covered persons

• any individual on audit engagement team

• individuals in direct chain of command

immediate family members, covered persons

subject to virtually the same financial interest and employment restrictions as the covered person

close relatives, covered persons

impair independence if they hold a key accounting role with the client or hold material financial interest known to the

unmodified / unqualified audit opinion

financial statements present fairly in all material respects in conformity with GAAP

qualified audit opinion

issued when there is a material departure from GAAP

adverse audit opinion

financial statements are materially and pervasively misstated, not in accordance with GAAP

disclaimer, audit opinon

auditor expresses no opinion

system of quality control

internal policies ensuring compliance with professional standards

predecessor - successor auditor communication

successor auditor must initiate contact with client consent

engagement letter

formal contract establishing mutual responsibilities between auditor and client

materiality

magnitude of an omission or misstatement that makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced

materiality perspective

evaluated form the perspective of the reasonable financial statement user, not management or audit team

pretax income, normalized benchmark

used for-profit entities with stable operational earnings

gross profit benchmark

retail or manuf. with varying overhead

planning materiality

overall threshold calculated using a normalized benchmark applied to the financial statements as a whole

performance materality

applied to individual accounts or classes of transactions to ensure uncorrected misstatements do not exceed overall materiality

performance materiality is set at ______ of overall materiality

50-75%

trivial amounts (posting scope)

misstatements below this threshold are ignored

trivial amounts are set at _____ of planning materiality

1-5%

vouching

tracing backward from recorded balances to original source docs

tracing

tracing forward from source docs into journals and ledgers

scanning

reviewing ledgers and listings for unusual transactions or irregular amounts

inspection of tangible assets

physically examining assets, primary test for existence

observation

watching client personnel conduct a process

inquiry

asking questions of management and external parties, weak and requires corroboration

confirmation

written request sent directly by the auditor to an independent third parrty

recalculation

mathematically verifying schedules, depreciation, etc

reperformance

auditor independently executes internal controls or accounting procedures performed by the client

analytical procedures

evaluating plausible relationships among financial and non-financial data, required during planning and overall review

audit documentation WPs

must enable an experienced auditor with no previous connection with the engagement to understand the process and conclusions reached

WTB

master anchor linking general ledger trial balance accounts to the audit files

lead schedules

summaries grouping related accounts that feed directly into WTB

supporting schedules

worksheets showing testing, calculations, and evidence gathered

indexing and cross referencing

reference codes linking supporting schedules to lead schedules

ownership

WPs are exclusive property of the audit firm

confidentiality

WPs may not be disclosed to client

tick marks

shorthand symbols that document specific audit procedures

golden rule

tick marks must have an accompanying legend or explanation at bottom of the schedule

footing

adding a vertical column of numbers to verify bottom number

cross-footing

adding numbers horizontally across rows to verify