Chapters 6&7

What is the overall objective of an independent audit?

To obtain reasonable assurance about whether financial statements as a whole are free from material misstatement (due to error or fraud) to express an opinion on fair presentation.

What is the distinction between management and auditor responsibilities?

Management is responsible for adopting sound accounting policies, maintaining internal controls, and preparing F/S; the auditor is responsible for conducting the audit and expressing an opinion on the F/S.

What is Professional Skepticism?

A mental attitude consisting of a questioning mind ('trust but verify') and a critical assessment of audit evidence.

What are the 2 core components of Professional Skepticism?

1. Questioning mindset (approaching with inquiry) ; 2. Critical assessment of audit evidence (probing questions and alertness to inconsistencies).

What are the 4 judgment traps / decision biases in auditing?

1. Anchoring Trap ; 2. Availability Trap ; 3. Confirmation Trap ; 4. Overconfidence Trap.

What is the Anchoring Trap in auditor judgment?

Rushing to a conclusion by anchoring to an initial balance or historical number without adequately evaluating new information (e.g., Chen Li relying on historical allowance formulas despite new regulations).

What is the Availability Trap in auditor judgment?

Over-relying on information that is readily available in memory or easily retrieved from client schedules rather than seeking objective evidence.

What is the Confirmation Trap in auditor judgment?

Seeking or putting more weight on evidence that confirms an initial belief while ignoring or discounting disconfirming evidence.

What is the Overconfidence Trap in auditor judgment?

Overestimating one's personal knowledge, experience, or skills, leading to rushed judgment without performing necessary audit tests (e.g., Allison Garrett relying on quick ratios without substantive testing).

What are the 2 broad categories of Management Assertions?

1. Assertions about classes of transactions and events (for audit period) ; 2. Assertions about account balances (at period-end).

What are the 6 transaction-level management assertions?

1. Occurrence ; 2. Completeness ; 3. Accuracy ; 4. Cutoff ; 5. Classification ; 6. Presentation.

What is the Occurrence transaction assertion?

Recorded transactions and events actually occurred and pertain to the entity (tests for overstatement / fictitious transactions; tested via vouching direction).

What is the Completeness transaction assertion?

All transactions and events that should have been recorded are recorded (tests for understatement / omitted transactions; tested via tracing direction).

What is the Accuracy transaction assertion?

Amounts and data relating to recorded transactions are entered appropriately (correct pricing, math calculation, invoice entry). Quantitative!

What is the Cutoff transaction assertion?

Transactions and events have been recorded in the correct accounting period.

What is the Classification transaction assertion?

Transactions and events have been recorded in the proper accounts (e.g., assets vs. expenses).

What is the Presentation transaction assertion?

Transactions are appropriately described, aggregated/disaggregated, and related disclosures are understandable in the F/S.

What are the 6 balance-level management assertions?

1. Existence ; 2. Completeness ; 3. Accuracy, Valuation, and Allocation ; 4. Rights and Obligations ; 5. Classification ; 6. Presentation.

What is the Existence balance assertion?

Recorded assets, liabilities, and equity interests actually exist at the balance sheet date (vouching balance sheet details back to physical/documentary proof).

What is the Completeness balance assertion?

All assets, liabilities, and equity interests that should have been recorded are recorded (tests for unrecorded assets/liabilities).

What is the Accuracy, Valuation, and Allocation balance assertion?

Balances are included at proper amounts, and valuation adjustments (e.g., AR allowance, inventory write-downs, net realizable value) are appropriately recorded.

What is the Rights and Obligations balance assertion?

The entity holds or controls rights to assets, and liabilities are actually the obligations of the entity (e.g., checking consignment or factored receivables).

What is the Classification balance assertion?

Assets, liabilities, and equity interests are recorded in the proper accounts (e.g., short-term vs. long-term).

What is the Presentation balance assertion?

Balances are clearly described, appropriately aggregated/disaggregated, and related disclosures are relevant and understandable.

What are the 6 General Transaction-Related Audit Objectives?

1. Occurrence ; 2. Completeness ; 3. Accuracy ; 4. Posting and Summarization ; 5. Classification ; 6. Timing.

Kahoot Question: What is the main purpose of an audit program?

An audit program outlines the specific audit procedures to be performed to gather sufficient appropriate evidence for audit objectives.

Kahoot Question: If an auditor applies outdated price lists to sales invoices, which transaction assertion is violated?

Accuracy assertion (invoices were calculated using incorrect pricing data).

Kahoot Question: Who must certify public company financial statements under SOX?

Both the Chief Executive Officer (CEO) and Chief Financial Officer (CFO).

Homework 6-28: What two components of professional skepticism were missing in the Just for Feet audit case?

1. A questioning mindset (failing to probe management assertions) ; 2. Critical assessment of audit evidence (accepting uncorroborated oral representations).

Homework 6-29: What judgment trap did Chen Li fall into regarding the healthcare client's receivables?

The Anchoring Trap (anchoring to historical collection rates despite new healthcare legislation changing collection reality).

Homework 6-29: What judgment trap did Allison Garrett fall into when evaluating liquidity?

The Overconfidence Trap (relying on quick ratio calculations without performing substantive audit tests on underlying inventory and receivables).

Homework 6-32: Vouching recorded sales from the sales journal back to customer shipping documents tests which assertion?

Occurrence (verifying recorded sales represent actual shipments).

Homework 6-32: Tracing shipping documents forward to the sales journal tests which assertion?

Completeness (verifying all shipments were recorded as sales).

Homework 6-33: Inspecting inventory items to ensure proper valuation and allowance for obsolescence tests which assertion?

Accuracy, Valuation, and Allocation.

Homework 6-33: Confirming accounts receivable balances directly with customers tests which balance assertion?

Existence (verifying customer balances actually exist).

Homework 6-34: Reviewing debt agreements to ensure loan covenants are properly described in footnotes tests which assertion?

Presentation (ensuring required footnote disclosures are relevant and understandable).

Homework 6-34: Examining vendor invoices recorded in January to ensure goods were received before December 31 tests which assertion?

Cutoff (ensuring transactions are recorded in the correct accounting period).

Kahoot Question: Does an audit provide absolute guarantee against all misstatements?

No. An audit provides REASONABLE assurance, not absolute assurance, due to inherent limitations of testing and internal controls.

Kahoot Question: What is the auditor's responsibility regarding fraud vs. error?

The auditor must plan and perform the audit to obtain reasonable assurance about detecting material misstatements, whether caused by error OR fraud.

Kahoot Question: What is the difference between direct-effect illegal acts and indirect-effect illegal acts?

Direct-effect illegal acts directly impact financial statement line items (e.g., tax laws); indirect-effect illegal acts impact operations/penalties (e.g., environmental laws).

What are the 3 major audit evidence decisions made by auditors?

1. Which audit procedures to use (nature) ; 2. What sample size to select for a procedure (extent) ; 3. When to perform the procedure (timing).

What determines the persuasiveness / appropriateness of audit evidence?

Relevance (pertaining to the specific audit objective) and Reliability (degree to which evidence can be believable and trustworthy).

What are the 6 factors that determine evidence reliability?

1. Independence of provider ; 2. Effectiveness of client's internal controls ; 3. Auditor's direct knowledge ; 4. Qualifications of individual providing info ; 5. Degree of objectivity ; 6. Timeliness.

What are the 8 types of audit evidence?

1. Physical examination ; 2. Confirmation ; 3. Inspection ; 4. Observation ; 5. Inquiry ; 6. Recalculation ; 7. Reperformance ; 8. Analytical procedures.

What is Physical Examination evidence?

Auditor's direct inspection or count of tangible assets (e.g., cash, inventory, machinery). High reliability for existence.

What is Confirmation evidence?

Direct written or oral response from an independent third party verifying info accuracy. Highly reliable (e.g., bank or AR confirmations).

What is Inspection (Documentation) evidence?

Auditor's examination of client internal or external documents/records (e.g., vendor invoices, shipping docs, canceled checks).

What is Observation evidence?

Watching a process or procedure being performed by client personnel. Rarely sufficient alone because behavior changes when watched.

What is Inquiry of the Client evidence?

Obtaining written or oral information from client personnel in response to auditor questions. Needs corroboration.

What is Recalculation evidence?

Auditor's independent verification of mathematical accuracy (e.g., re-footing journal columns, checking price x quantity).

What is Reperformance evidence?

Auditor's independent test of client accounting procedures or controls (e.g., re-checking transfer of info from sales journal to ledger).

What is Analytical Procedures evidence?

Evaluation of financial info through analysis of plausible relationships among financial and nonfinancial data (ratios, trend analysis).

What is Directional Testing in auditing?

Choosing the testing direction (vouching vs. tracing) based on whether testing for overstatement or understatement.

What is Vouching in directional testing?

Moving BACKWARD from journal/ledger records to underlying source documents (e.g., journal to shipping doc). Tests OCCURRENCE / EXISTENCE (overstatement/fictitious items).

What is Tracing in directional testing?

Moving FORWARD from source documents to journal/ledger records (e.g., shipping doc to journal). Tests COMPLETENESS (understatement/omitted items).

What are the 3 phases of Analytical Procedures and their requirements?

1. Planning phase (REQUIRED to assess risk) ; 2. Testing phase (OPTIONAL substantive test) ; 3. Completion phase (REQUIRED as final review for misstatements).

What are the 4 types of comparison data used in Analytical Procedures?

1. Compare client data with industry data ; 2. Compare client data with prior-period data ; 3. Compare client data with client-determined budgets/forecasts ; 4. Compare client data with auditor-determined expected results.

What are the audit record retention rules for private vs. public companies?

Private companies (AICPA/ASB): Retain audit documentation for 5 years. Public companies (PCAOB/SOX): Retain audit documentation for 7 years.

Group Exercise (Fraud Squad): Why is vouching recorded sales to bills of lading from an outside freight company highly persuasive?

Outside freight bills come from an independent provider, making them highly reliable evidence for the Occurrence assertion.

Group Exercise (Mind the GAAP): Why is a direct bank confirmation more reliable than a bank statement provided by the client?

Direct bank confirmation is sent straight to the auditor (independence of provider), whereas client statements can be altered.

Group Exercise (Audit Assailants): How do internal documents differ from external documents in reliability?

External documents (e.g., bank statements, vendor invoices) are more reliable than internal documents (e.g., duplicate sales invoices) because they originate outside the client.

Kahoot Question: Which type of evidence provides the highest reliability for verifying inventory existence?

Physical examination (auditor directly counts the inventory).

Kahoot Question: When is analytical procedures required during an audit?

Required during 1. Planning phase (risk assessment) and 2. Completion phase (final review). Optional during testing phase.

Kahoot Question: What evidence type is re-adding the column totals on a sales journal?

Recalculation (verifying mathematical accuracy).

Kahoot Question: What evidence type is sending a letter to the client's attorney asking about pending litigation?

Inquiry (or confirmation if formal written legal response).

Kahoot Question: Why is inquiry alone insufficient audit evidence for material assertions?

Inquiry comes from client personnel who may be biased or mistaken; it requires corroborating evidence.