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What is the majority of an auditor's work in determining an audit opinion?
Collection of evidence to support the opinion.
Of what does audit Evidence consist?
Evidence consists of client accounting data and supporting documentation from client or from third parties.
What is the relationship between Evidence and Detection Risk?
Evidence has an inverse relationship with Detection Risk
The one aspect of Audit Risk an auditor can control through (N)ature, (T)iming, (E)xtent of audit procedures.
Inherent Risk and Control risk are outside of auditor’s control.
Which aspects of Audit Risk can an auditor control?
Detection Risk, which is decreased by gathering evidence.
Which aspects of Audit Risk can an auditor NOT control?
Inherent Risk and Control Risk are outside of an auditor's control.
How does a high level of acceptable Detection Risk affect an audit?
Less Evidence collected. Opens door for incremental audit risk - Internal Control should be strong.
Business and transactions should be relatively stable and predictable.
- (N) Less-competent Evidence collected
- (T) Interim testing acceptable
- (E) Fewer transactions are verified.
What should occur when a low level of Detection Risk is acceptable?
More Evidence collected
- (N) More-competent Evidence collected
- (T) End of year balance testing
- (E) More transactions are verified
What are the primary risks in an audit for a typical for-profit company?
Auditors are there to verify that
- Assets & Revenues are not overstated
- Expenses & Liabilities are not understated
Exception – if the CPA Exam states that it is a “tax-driven” company, flip them around
What is the primary constraint on audit evidence?
Cost vs. Benefit is a primary constraint.
What characteristics should audit evidence have?
Appropriate: Relevant & Reliable (Quality)
How does the quality of audit evidence vary depending on who has provided it?
Best evidence: Observation of activity by auditor.
2nd Best: Originates from External Parties and is sent directly to auditor (or failing that, items are generated by third party and provided to auditor by the client, such as a bank statement)
Weakest: Oral evidence from management.
Which documents are the most persuasive and credible?
Third party documents are more persuasive and credible than internally-prepared docs
Auditor Knowledge = Most Persuasive
3rd Party info given to auditor
3rd Party info given to client
What are Substantive Procedures?
Test substance/amounts/values. They help to reduce the risk of material misstatements. They only test accuracy of financial statements and dollar amounts - they don't test internal controls.
What are the substantive tests that are most often performed?
- Trace (or Vouch)
- Analytical Procedures
- Examine evidence that supports management assertions.
When performing audit procedures, what should auditors focus on?
Auditors focus first on Balance Sheet Accounts, then associated Income Statement items
How is Cash audited?
Assurance Level is High.
Acceptable Detection Risk is Low.
How is Accounts Receivable audited?
If Acceptable DR is High - Negative Confirmation is used - Customer only responds if balance is materially wrong.
If Acceptable DR is Low - Positive Confirmation is used - Customer asked to confirm by telling auditor the balance.
Corresponding Income Statement Account - Revenue
How is Accounts Payable audited?
Review purchase orders/invoices
Confirm with Vendors
Corresponding Income Statement Account – Various Expenses
How is Inventory audited?
Examine purchase agreements
Look at Board Minutes
Is Inventory held as collateral?
Corresponding Income Statement Account – COGS
How are beginning balances audited?
Should match last year's ending balance.
What is the general presumption for auditing Ending Balances?
If Beginning Balance, Additions, Subtractions are OK, then Ending Balances should also be OK.
How is a Statement of Cash Flows audited?
Foot all balances – Check the Math
Trace Cash Flow items to other Financial Statements
Check classifications - Operating Activities, Investing Activities, Financing Activities
Under the Indirect Method, what must be disclosed on a Statement of Cash Flows?
Income Taxes Paid
Cash and Cash Equivalents Definitions
Under the Direct Method, what must be disclosed on a Statement of Cash Flows?
Results as if you had used Indirect Method
Cash and Cash Equivalents Definition
What are Subsequent Events, and what do they require?
Subsequent events occur after the Balance Sheet Date, but before the audit report is issued.
Auditor needs to make inquiries and assess if they affect the audit report.
What should occur if the audit report has already been issued and the auditor becomes aware of a situation that was present as of the Balance Sheet date (a subsequent event)?
If audit report has already been issued and auditor becomes aware of a situation that was present as of the BS date, client should issue a disclosure to financial statement users and/or revise the financial statement.
Regulatory agencies might need to get involved under some circumstances.
What should an auditor do if they discover they have forgotten to perform a substantive procedure?
If auditor discovers that they forgot to perform a substantive procedure, auditor should determine if other substantive procedures performed served as a substitute.
Otherwise support for their audit opinion could be jeopardized.
When are Analytical Procedures required?
REQUIRED When planning the audit (preliminary)
REQUIRED When reviewing the audit (final)
Analytical procedures may be also performed optionally along with the substantive testing.
Use of Analytical Procedures in the audit must be documented.
How do Analytical Procedures assist the auditor?
Helps the Auditor:
Determine if Management Assertions are reasonable
Develop audit plan
Develop some expectations about the financial statement and hopefully bring to light any glaring errors on financial statement
What is the focus of Analytical Procedures?
Analytical Procedure focus is on dollar amounts (not internal controls)
Analyzes Financial Data: Do Financial Statements Make Sense?
Comparison of data between years
How is the Current Ratio calculated?
Current Ratio = Current Assets / Current Liabilities
How is the Quick Ratio calculated?
Quick Ratio = Liquid Assets / Current Liabilities
How is the Asset Turnover calculated?
Asset Turnover = Net Sales / Average Assets
How is the Inventory Turnover calculated?
Inventory Turnover = COGS / Average Inventory
How is Gross Margin % calculated?
Gross Margin % = Gross Margin / Sales
What type of testing are ratios?
Ratios are Analytical Procedures
What type of procedure is a Budget vs. Actual comparison?
Budget vs. Actual comparisons are Analytical Procedures.
List Common Types of Analytical Procedures
Budget vs. Actual comparison
Comparison of data between years
Use of non-financial data to predict expected values for financial data
How do management asssertions affect the audit?
Management assertions help the auditor to plan the audit and select substantive tests.
What assertions do auditors test?
- Presentation - Cutoff, Classification - Is it in the right period and category?
- Existence/ Occurrence - Did it happen? Does it exist?
- Rights & Obligations - Does the company own them?
- Completeness - Was everything recorded?
- Valuation - Are they worth the amount at which they are recorded?
What assertions are tests for transaction classes?
For which assertions are disclosures tested?
Is testing the validity of direct evidence a basic audit procedure?
No, it is an extended procedure.
For example, you don’t have to take a loan covenant document and go search out that it’s a valid loan covenant. Instead, you consider the source – if it’s externally prepared, it’s more persuasive.
How are Management Estimates audited?
First and foremost, you need to understand management’s rationale and methods for developing estimates before you can judge reasonableness.
Next, Auditor should formulate their own opinion on what a good estimate should be and compare it.
Finally, determine if subsequent events affect the estimate.
Whose property are audit documentation (audit workpapers)? In what form must they be?
Audit workpapers are the property of the auditor.
They can be paper or electronic.
They must include a WRITTEN audit program (either paper or electronic).
What is the Current File?
Information pertaining to the current year's audit.
What is the Permanent File?
Information used for this audit and future audits, which is updated as needed.
How long must audit workpapers be maintained?
Must be kept for 5 years after the audit release date or according to regulations, whichever is longer.
Must be kept for 7 years under PCAOB Audit
PCAOB audits also require an Engagement Completion Document
What is the primary requirement for audit workpapers, besides being written?
Any experienced auditor should be able to look at your work and understand what you did.
How should documents added to work papers be treated?
If further documents are added to the work papers after the audit report is issued, it must be documented as to who added them, why they were added, and any effects on the audit report.
How should documents removed from workpapers be treated?
After the audit report is released, the firm has 60 days to subtract from the file.
You can still add to the file if you document it, but you cannot delete any information after 60 days.
Note – for SEC auditors, the PCAOB only allows deletions up to 45 days after issuance of the audit report.