ACTG 435 Auditing Exam 1 Study

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76 Terms

1

How is auditing different?

- Uses analytical and logical skills

- Much more conceptual in nature

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2

What is the purpose of an audit?

To provide reasonable assurance that the financial statements are free of material misstatement

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3

Why are audits demanded?

- Public companies are required to have audited financial statements

- Even if not public, banks require audits when giving loans

- Investors like company transparency from outside party

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4

During the economic boom of the late 1990s and early 2000s, accounting firms aggressively sought opportunities to market various what?

high-margin non audit services

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5

Sarbanes-Oxley Act (2002)

Regulation of audit profession and creation of PCAOB

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6

Dodd-Frank Act (2010)

Expanded the Fed's regulatory authority over financial institutions & shaped the accounting profession and environment

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7

Manager's responsibilities

Establish and maintain internal controls and ensure fair presentation of financial statements

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8

Auditor's responsibility

Provide reasonable assurance that the financial statements are free from material misstatement

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9

Overarching regulator of public companies

Securities and Exchange Commission (SEC)

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10

SEC delegated power to who, who creates GAAP?

Financial Accounting Standards Board (FASB)

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11

This board oversees and issues auditing standards for public companies

Public Company Accounting Oversight Board (PCAOB)

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12

Private companies don't need to use GAAP, rather they follow standards set by the Auditing Standards Board, which is under the

American Institute of Certified Public Accountants (AICPA)

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13

Due Professional Care

The care and skill expected of a reasonably prudent and competent auditor; exercise professional skepticism

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14

Most valuable assets to accounting professionals

Unquestioned integrity and a solid reputation

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15

A member in public accountancy must be_____________, both is fact and in appearancef

Independant

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16

Independence applies to __________ _____________, which is anyone who can influence the audit engagement (partners, managers, senior associates, and associates)

covered members

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17

PCAOB Inspections

A periodic inspection of the work conducted by auditors as well as the audit firm's quality control procedures which is conducted by the PCAOB.

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18

3 Broad Areas of Judgement

- Evaluating evidence

- Estimating probabilities

- Deciding between options

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19

Judgement Trap - "Rush to solve"

- Wanting to immediately solve a problem

- First solution not always the best

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20

Judgement trap - "solving the wrong problem"

Ask the what and why questions

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21

Judgement tendency - Availability tendency

consider information that is easy retrievable from memory (using previous year procedures and do the same thing)

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22

Judgement tendency - Confirmation tendency

Seek and put emphasis on information that is consistent with our beliefs (over rely on management explanation of significant difference)

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23

Judgement tendency - Overconfidence tendency

Overestimate our own abilites

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24

Judgement tendency - Anchoring tendency

Insufficiently adjusting from an initial value when forming final judgement

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25

What does the engagement letter do?

- Formalize contract with client

- Outline responsibilities of manager and auditor

- Explains limitations of the engagement

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26

Who signs an engagement letter?

Audit committee and audit firm

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27

Who hires and fires auditors?

Audit committee

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28

Business risks

- Auditors must understand the entity's business and identify likely errors and risks that can occur and allocate more resources to riskier accounts

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29

Define Materiality

The maximum amount financial statements can be misstated and not affect the decisions of the user

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30

3 steps to applying materiality on an audit

1. Determine overall materiality

2. Determine tolerable misstatement

3. Evaluate auditing findings

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31

How to determine overall materiality

- use quantitative benchmarks to establish materiality i.e. numbers, percentages

(Can be adjusted when considering qualitative facts like previous year misstatements, high risk of fraud, volatile business market, etc)

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32

Determining tolerable misstatements

Taking the materiality threshold and allocating it into different financial statement accounts (accounts with greatest risks want lower thresholds)

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33

Factors that could influence what percentages or amounts to allocate to tolerable misstatements for individual accounts?

- High risk of misstatement

- Accounting issues that are uncertain

- Deficiencies in internal control

- High management turnover

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34

Evaluate audit findings

Give final opinion by aggregating misstatements

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35

Consider Multilocations or Business Units

- If there are multiple locations, auditor must decide where to audit and test

- Facts to determine include by amount of regulation, environmental facts

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36

Assess the Need for Specialists

- What type of specialists? IT? Tax? Actuary?

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37

Related Party Transactions

- Need to be disclosed and investigated

- Should not be given favorable treatment

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38

Supervisions of the audit

Audit partner ensures that all levels of review are comfortable with audit

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39

3 Types of Audit Tests

-risk assessment procedures

-test of controls

-substantive procedures

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40

Risk Assessment Procedures

- Used to obtain an understanding of the entity, environment, and internal controls

- Look at financials, compare to competitors, and establish risks and red flags

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41

Test of controls

- Evaluating the effectiveness of design and operation of internal controls

- Test operating effectiveness of internal controls

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42

Substantive Procedures

- Detect material misstatements in a transaction class, account balance, and disclose components of financial statements

- Details of testing accounts of financial statements, pulling invoices, reports, other analytical procedures

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Dual purpose tests

Combining 2 audit tests so as not to double document

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44

2 components of engagement risk

- litigation

- adverse publicity

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45

Audit risk Model =

IR x CR x DR

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46

Audit risk (AR)

Risk the auditor expresses an inappropriate audit opinion when statements are materially misstated

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47

Inherent Risk (IR)

Susceptibility to a misstatement due to error or fraud

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48

Detection risk (DR)

risk that auditor will not detect misstatements

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49

3 components of audit risk model

1. Setting planned level of risk (generally low)

2. Assess the risk of material misstatement (IR x CR)

3. Determining the appropriate level of detection risk

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50

Causes of misstatements

error and fraud

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51

2 types of fraud

- fraudulent financial reporting (manipulation/misrepresentation)

- misappropriation of assets (theft)

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52

Factual misstatements

exact misstatement known

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53

Judgemental misstatements

disagreement between auditor and manager on judgement

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54

Projected misstatements

Identified misstatement, and project factual misstatement to population

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55

3 components of fraud risk triangle

- Incentive/pressure

- Opportunity

- Attitude or rationalization

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56

Audit evidence

Information gathered by the auditors to arrive at their conclusions

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57

3 components of audit evidence

1. Nature of audit evidence

2. Sufficiency and appropriateness

3. Evaluation of evident

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58

Sufficiency

The measure of the quantity of audit evidence

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59

Approprateness

Measure of the quality of audit evidence (sources independent? Quality of internal controls?)

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60

Why should audit evidence be persuasive?

Reasonable person looking at documentation should be convincing so they make the same conclusion

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61

Inspection of records and documents

Looking at invoices, reports, receiving orders (vouching and tracing)

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62

Vouching

Verifying transactions were recorded in journals and ledgers (ensures they actually took place)

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63

Tracing

verifying the source of documents (ensures they were recorded properly)

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64

Confirmation

Very common, obtained by the auditor from 3rd pary

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65

Inspection of tangible assets

physically inspecting assets

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66

Observation

observe someone else do a procedure

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67

Recalculation

mathematically checking numbers

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68

Reperformance

re execute procedure

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69

Inquiry

probing questions, listening

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70

Scanning

review accounting data to find unusual problems

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71

3 steps to analytical procedures

1. Risk assessment procedures (look for red flags)

2. Substantive analytical procedures (find evidence in particular accounts and assess relationships)

3. Final analytical procedures (explain everything)

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72

Trend analysis

year to year comparison

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73

Ration analysis

comparison to financial statement accounts

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74

Reasonableness analysis

developing an expectation

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75

Why is developing an expectation the most important step in the analytical procedure?

Precision is important and we need to get as close to the true, correct value

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76

4 factos that affect precision

1. Disaggregation

2. Plausibility and predictability

3. Data reliability

4. Type of analytical procedure

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