Audit Exam 2 Review

The existence of audit risk is recognized by the statement in the auditors report that the auditor

Obtains reasonable assurance that financial statements are free of material misstatement. 

Which two “client” components make up the risk of material misstatement?

Inherent and Control Risk

The risk that audit procedures fail to detect a material misstatement is known as:

Detection Risk

A client’s new ERP system was implemented during the year. How does this affect audit risk?

It likely increases the risk of material misstatement

Which of the following is least likely considered when assessing inherent risk for sales transactions?

The nature of the credit authorization process

Which factor most likely heightens an auditors concern about intentional manipulation?

Management places heavy emphasis on meeting earnings projections.

Misappropriation of Assets

Theft of cash or inventory, embezzlement or false expense claims.

Error

Unintentional misstatement of financial information

Factual Misstatement

Misstatement due to incorrect pricing on a sales invoice.

Opportunity (Fraud triangle)

Conditions that allow someone to commit fraud without detection

Duty to disclose

circumstances where auditors must communicate beyond management

Which inquiry regarding fraud is required by auditing standards?

Whether management has knowledge of any fraud in or on the entity.

SAS 99

Is the standard guiding auditors responsibilities related to fraud, it requires direct inquiry about known or suspected frauds

Which of the following is an example of fraudulent financial reporting?

Management falsifies inventory count, overstating ending inventory

If the risk of material misstatement is higher than anticipated, how should the auditor respond?

Increase supervision and perform more extensive testing.

If acceptable audit risk is low and RMM is high, detection risk must be

Low

Management Fraud

Deliberate misstatement by management to deceive users

Risk Assessment Documentation

Record of Auditors reasoning and understanding of client risk factors

Which of the following procedures helps the auditor identify potential fraud risk factors?

Conducting brainstorming sessions with the audit team

What should the auditor do if a material misstatement appears due to fraud?

Discuss with management and those charged with governance; consider implications on other aspects of the audit.

What is the auditors primary responsibility related to fraud?

To plan and perform the audit to obtain reasonable assurance that the financial statements are free from material misstatement due to fraud or error.

Reasonable Assurance

A high but not absolute level of confidence that the statements are fairly presented

Audit Risk

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

Risk of Material Misstatement (RMM)

the combined effect of inherent and control risk.

Detection Risk (DR)

the probability that audit evidence will not detect a misstatement that exists.

Inherent Risk (IR)

the susceptibility of an account to misstatement before considering controls.

Fraud Triangle

three conditions for fraud: incentive/pressure, opportunity, and rationalization.

Misappropriation of Assets

theft of cash or inventory, embezzlement, or false expense claims.

Factual Misstatement

a clear, verifiable error identified by the auditor.

Opportunity (Fraud Triangle)

conditions that allow someone to commit fraud without detection.

Duty to Disclose

circumstances where auditors must communicate beyond management (e.g., to regulators or successors).

SAS 99 (AU-C 240)

the standard guiding auditors’ responsibilities related to fraud.

Fraudulent Financial Reporting

intentional misstatement to deceive financial statement users.

Audit Risk Model (AR = IR × CR × DR)

the formula linking risk components.

Management Fraud

deliberate misstatement by management to deceive users.

Risk Assessment Documentation

record of auditor’s reasoning and understanding of client risk factors.

Reasonable Assurance

a high but not absolute level of confidence that the statements are fairly presented.

What factor most likely would cause an independent auditor to decide not to accept a new audit engagement?

Managements disregard of its responsibility to maintain an adequate internal control environment.

Before accepting an audit engagement, what should a successor auditor inquire about from the predecessor

Reasons for the change of auditors

What is correct regarding predecessor-successor communications?

The successor auditor must obtain permission from the entity before contacting the predecessor auditor. 

Preliminary engagement activities include all execpt

Ensuring that there is an independent audit committee

Why do auditors prepare engagement letters?

To communicate and clarify the expectations and responsibilities of both the auditor and client.

A written understanding between auditor and entity regarding responsibility for discovering non compliance is in a(n)

Engagement Letter

Which factor is least Important in determining reliance on internal auditors work?

The nature of the audit software documentation used by internal auditors

Which most likely indicates the existence of related parties?

Borrowing money at an interest rate substantially below market rate.

For which laws and regulations does the auditor have the same responsibility ad for errors and fraud?

Laws and regulations that have a direct and material effect on the financial statements. 

For which laws and regulations does the auditor have the same responsibility as for errors and fraud?

Laws and regulations that have a direct and material effect on the financial statements

When planning an audit, what must the auditor determine?

Overall materiality for audit purposes

Which statement about non-compliance is correct?

The auditors responsibility to detect non-compliance with laws that have a direct and material effect is the same as for errors and fraud.

The engagement partner reviews the work of team members to evaluate:

Performance, whether objectives were achieved, and whether conclusions are supported. 

Which is not typical supervisory activity for an audit?

Performing detailed testing of the accounts payable account.

A dual purpose test is

A procedure that serves as both a test of control and a substantive test of transactions.

The concept of materiality in a financial statement audit

Depends partly on how users of financial statements may be influenced by misstatements

The first step in applying materiality to an audit is

Determine a materiality level for the overall financial statements

Which is not a qualitative factor that may affect materiality?

Firm policy sets materiality at 4% of profit before tax

Performance materiality is

Materiality used to establish scope for procedures for individual balances or disclosures. 

When misstatements exceed overall materiality, what should the auditor do?

Require adjustments of financial statements and modify the opinion if management refuses

Engagement Risk

the risk of association with a client whose management lacks integrity or may harm the auditor’s reputation

Predecessor Auditor

the former CPA firm that previously audited the client’s financials.

Successor Auditor

the new auditor who replaces the predecessor in performing an audit.

Preliminary Engagement Activities

steps to evaluate client integrity, independence, and engagement terms before fieldwork begins

Engagement Letter

a written agreement outlining audit responsibilities, objectives, and limitations.

Internal Auditors

employees who provide independent assurance on the effectiveness of internal controls.

Related Parties

entities or individuals with influence over financial or operating decisions.

Direct and Material Effect Laws

regulations whose violations directly impact financial statement accuracy.

Audit Planning

determining the strategy, timing, and scope of audit procedures.

Materiality

the magnitude of an omission or misstatement that could influence users’ decisions.

Noncompliance

violations of laws or regulations by the entity being audited

Engagement Partner

the lead auditor responsible for signing the audit report

Audit Supervision

directing and reviewing audit work to ensure quality and compliance.

Dual-Purpose Test

an audit procedure that tests both controls and substantive details.

Performance Materiality

an amount lower than overall materiality used for specific accounts or disclosures.

Overall Materiality

the highest level at which misstatements may exist without impacting users’ decisions.

Qualitative Materiality Factors

characteristics of misstatements that make them significant beyond size.

Audit Opinion Modification

a change in the auditor’s report due to material misstatements or scope limitations.

Which SOX statement is false regarding ICFR reporting

Auditors provide recommendations for improving internal control in the audit report

Auditors ICFR role

Express an opinion on the effectiveness of internal control not advise on improvements

Section 404 SOX

Mandates management assessment and auditor attestation of internal control effectiveness for public companies

The auditors role under sox relative to internal controls is to

Express an opinion on the effectiveness of the entity’s internal control

Integrated audit

an audit of both the financial statements and ICFR

Which is not a management requirement under section 404

Guarantee the effectiveness of the entity’s ICFR

Management Responsibility SOX 404

to design, implement and assess the effectiveness of ICFR

Control Deficiency

When a control doesn’t prevent or detect misstatements on a timely basis

A control deviation caused by an unauthorized employee performing a control procedure is a

Deficiency in operation

Which factor does not affect the likelihood that a control deficiency will lead to a misstatement

The financial Statement amounts exposed to the deficiency

Which is the lease likely step in managements assessment of ICFR effectiveness

Communicating its findings to external auditors

Managements assessment process

identification, testing, evaluation of icfr controls

Which of the following is not an entity level control

Controls to monitor the inventory taking process

Entity level controls

Controls that have a pervasive effect on financial reporting

which statement about SOX audit requirements is false

The auditor should provide recommendations to the audit committee for improving internal control as part of their assessment

For high risk locations or business units the auditor must first

determine whether those risks are adequately addressed by entity level controls

Top down, risk based approach

Start with entity level controls, then move to significant accounts and relevant assertion

Generalized audit software would likely be used for all execpt

identifying weakness in documentation of entity controls

Correct order in the top down, risk based approach to auditing ICFR

1⃣ Identify entity-level controls → 2⃣ Identify significant accounts → 3⃣ Understand likely sources of misstatement → 4⃣ Select controls to test.

Controls most likely tested during the interim period are:

Controls that operate on a continuous basis.

If risk for a location is low and entity-level controls are strong, management may rely on:

Self-assessment processes combined with entity-level controls.

Interim Testing

testing performed before the balance sheet date to spread audit work over time.

Self-Assessment Process

internal evaluations conducted by management to assess control performance.

A walkthrough requires an auditor to

Trace a transaction from origination through the system until it’s reflected in the financial statements

Walkthrough

a procedure that follows a transaction end-to-end through the accounting system.