Auditing Processes, Substantive Procedures, and Audit Sampling

Comprehensive vocabulary flashcards covering substantive procedures, audit sampling, revenue and cash cycles, purchasing, and inventory auditing.

Reliance on Controls Approach

An audit strategy where the auditor tests and places greater reliance upon internal controls, thereby reducing the extent of substantive procedures required.

Substantive Approach

An audit strategy where auditors test and rely less upon internal controls and instead perform more extensive substantive procedures to substantiate account balances, transactions, and disclosures.

Dual-Purpose Test

An audit test designed to concurrently execute a test of control and a substantive test on the exact same transaction, such as inspecting an invoice for approval authorization while tracing its cost amounts to inventory records.

Roll-Forward Procedures

Substantive audit procedures performed to update audit findings and evaluate account activity during the period between interim testing and the fiscal year-end.

Factual Misstatement

A misstatement identified by the auditor about which there is no doubt, involving no element of auditor judgment.

Judgmental Misstatement

A misstatement arising from management's judgments in selecting or applying accounting policies, or making accounting estimates that the auditor considers unreasonable or inappropriate.

Projected Misstatement

The auditor's best mathematical estimate of the misstatement in a population, calculated by projecting the misstatement discovered in an audit sample across the entire population.

Sampling Risk

The risk that the auditor's conclusion drawn from a selected sample differs from the conclusion that would be reached if the entire population were subjected to the exact same audit procedure.

Risk of Incorrect Acceptance

The sampling risk that the auditor concludes, based on sample results, that a material misstatement does not exist in an account balance or class of transactions when it actually does exist, compromising audit effectiveness.

Risk of Incorrect Rejection

The sampling risk that the auditor concludes, based on sample results, that a material misstatement exists when it actually does not exist, causing unnecessary audit effort and compromising audit efficiency.

Nonsampling Risk

The risk that an auditor arrives at an inappropriate conclusion for reasons unrelated to sampling mechanics, such as relying on unpersuasive evidence, misinterpreting results, or executing an inappropriate audit procedure.

Statistical Sampling

An audit sampling approach characterized by random item selection and the quantitative evaluation of sample results, which allows the auditor to mathematically measure and control sampling risk.

Nonstatistical Sampling

An audit sampling approach where sample size determination, sample selection, projection of misstatement, and evaluation of sampling risk are based entirely on professional judgment rather than mathematical formulas.

Sampling Unit

The individual element constituting an audit population, which can be a physical item (such as a sales invoice or shipping document) or a monetary unit (such as an individual customer balance).

Systematic Selection

A sample selection technique where the auditor divides population size by sample size to establish a sampling interval ($n$), chooses a random start below the interval, and selects every $n\text{-th}$ item thereafter.

Haphazard Selection

A nonstatistical selection method where the auditor selects sample items without using a structured mathematical technique, while attempting to avoid conscious bias or omission.

Tolerable Misstatement (TM)

The maximum dollar amount of misstatement an auditor is willing to accept in a transaction class or account balance while still concluding that the population is presented fairly; it is equal to or less than performance materiality.

Expected Misstatement (EM)

The anticipated dollar amount of misstatement an auditor expects to encounter within a population based on prior experience and risk assessment; it has a direct relationship with sample size.

Stratification

The technique of dividing an audit population into relatively homogeneous subpopulations (strata) based on characteristics like monetary size to increase audit efficiency and reduce required sample size.

Reciprocal Population

A corresponding population that will be overstated if the primary population of interest is understated (or vice versa), such as examining subsequent cash disbursements in January to identify unrecorded accounts payable at December 31.

Ratio Method (Nonstatistical Projection)

A projection technique estimating the audit value of a population by multiplying population book value by the ratio of sample audit value to sample book value: $\text{Estimated AV of population} = \frac{\text{AV of sample} \times \text{BV of population}}{\text{BV of sample}}$.

Difference Method (Nonstatistical Projection)

A projection technique calculating the average difference per sample item and multiplying it by total population items ($N$) to estimate population overstatement: $D = \frac{(\text{BV of sample} - \text{AV of sample})}{n} \times N$.

Allowance for Sampling Risk (ASR)

A measure of the uncertainty resulting from examining only a sample rather than the complete population; in nonstatistical sampling, it is represented judgmentally by the cushion between projected misstatement and tolerable misstatement.

ASC 606 Revenue from Contracts with Customers

The accounting standard governing revenue recognition, establishing that an entity must recognize revenue only when performance obligations to the customer have been satisfied.

Lapping

A fraud scheme used to conceal cash receipts theft wherein an employee steals a cash payment from one customer and conceals the shortage by applying a subsequent cash receipt from a second customer to the first customer's account.

Customer Master File

An authorized database record containing customer identification, credit approval limits, and shipping details; access must be restricted and segregated from shipping and cash recording functions.

Bill of Lading

A shipping contract issued by a freight carrier confirming receipt of goods for transport, used by auditors to verify shipping dates and ensure corresponding sales invoices are billed and recorded.

Accounts Receivable Growth to Sales Growth Ratio

An analytical ratio computed as: $\frac{\left(\frac{\text{Accounts receivable}_{\text{Current year}}}{\text{Accounts receivable}_{\text{Prior year}}}\right) - 1}{\left(\frac{\text{Sales}_{\text{Current year}}}{\text{Sales}_{\text{Prior year}}}\right) - 1}$; values greater than $1.0$ indicate receivables are growing faster than sales, suggesting potential collectibility issues.

Accounts Receivable Turnover in Days

An analytical ratio calculated as: $365\,\text{days} \div \left(\frac{\text{Net credit sales}}{\text{Average net receivables}}\right)$, used to evaluate collection timeframes against credit terms and industry averages.

Procurement Process

The business process synonymous with purchasing that involves vendor approval, price negotiation, purchase requisitioning, purchase order issuance, receiving goods, voucher generation, and accounts payable disbursement.

Purchase Requisition

An internal, prenumbered document generated by an operating department to initiate a request for goods or services and establish budget authorization.

Purchase Order

A prenumbered document sent to an approved vendor detailing item descriptions, quantities, and agreed prices, establishing legal authorization for a purchase.

Receiving Report

A prenumbered document prepared upon arrival of goods at the receiving dock that records the date, description, condition, and quantity of goods received from a vendor.

Voucher

An internal document package matching the purchase requisition, purchase order, receiving report, and vendor's invoice to authorize recording a payable and issuing a cash disbursement.

Accounts Payable Turnover in Days

An analytical ratio calculated as: $365\,\text{days} \div \left(\frac{\text{Cost of goods sold}}{\text{Average accounts payable}}\right)$, where an unexplained decrease may indicate unrecorded liabilities and a completeness assertion problem.

Phantom Vendors

A procurement fraud scheme where fictitious vendor records are added to the vendor master file to generate unauthorized purchase orders, fake vouchers, and fraudulent payments.

Cost of Goods Sold (COGS) Formula

The inventory equation defined as: $\text{Cost of goods sold} = \text{Beginning inventory} + \text{Purchases (or total manufacturing cost)} - \text{Ending inventory}$.

Compilation of Inventory Values

A detailed schedule that aggregates physically counted quantities and multiplies them by unit prices for each inventory item to establish the total clerical value of ending inventory.

Cycle Counts

A control procedure involving recurring physical counts of a small subset of inventory throughout the year to reconcile actual physical quantities with perpetual inventory records.

Consignment In

Inventory held on company premises that is owned by an outside vendor; controls must segregate this inventory during counts to ensure it is excluded from client inventory balances.

Consignment Out

Inventory owned by the audit client that is located at customer or dealer locations; the client must periodically inspect or obtain external count confirmations to include it in ending inventory.

Imprest Bank Account

A dedicated bank account maintained at a predetermined fixed balance (such as zero or $\$10,000$), where the exact amount needed for disbursements (e.g., net payroll) is transferred in and reverts to the fixed balance once cleared.

Cash Equivalents

Short-term, highly liquid investments possessing original maturities of three months or less, such as commercial paper, Treasury bills, and money market funds.

Standard Form to Confirm Account Balance Information with Financial Institutions (Form ASB-CL-6.1)

A standardized confirmation document approved by the AICPA, American Bankers Association, and Bank Administration Institute sent to banks to confirm client deposit balances, loan balances, interest rates, due dates, and collateral.

Proof of Cash

An extensive substantive audit procedure that reconciles both beginning and ending cash balances as well as total cash receipts and cash disbursements between bank statements and client books, typically used when fraud risk is high.

Bank Transfer Schedule

An audit working paper documenting authorized transfers between client bank accounts for several days before and after year-end to verify that cash disbursements and receipts are recorded in the books and processed by banks in the correct accounting period.