Audit Final Exam Review

What is the basic purpose of a financial statement audit?
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What is the basic purpose of a financial statement audit?
To provide assurance regarding whether the auditee's financial statements are fairly stated
Expectation Gap
- Conflict between statement users and auditors
- Most auditors believe that the conduct of the audit in accordance with auditing standards is all that can be expected of auditors
- Many users believe that auditors guarantee the accuracy of financial statements and some even believe that the auditor guarantees the financial viability of the business
- Often results in unwarranted lawsuits, which ultimately result in millions of dollars spent in defense.
What is the risk that the auditor will provide an unqualified opinion on financial statements that are, in fact, materially misstated?
Audit Risk
What is the auditor's risk of loss from events arising in connection with financial statements audited and reported upon?
Engagement Risk
Explain what is meant by an "integrated audit". Who is required to have one?
- An audit of both financial statement and ICFR
- Public Companies
What is meant by "information asymmetry"?
The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner
Explain materiality
- Information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information.
- The amount by which a set of financial statements could be misstated without affecting the judgment of a reasonable person
- Would the information influence the decisions of users of the financial statements?
- Based largely on professional judgment
Name the authoritative bodies affecting financial statement audits in the US. Specifically audits of publicly traded companies, audits of nonpublic companies, and accounting principles.
· PCAOB - Public Companies
· AICPA - Nonpublic Companies
· FASB - Accounting Principles
Explain the concepts of professional skepticism and due professional care.
- Professional Skepticism - An attitude that includes a questioning mind and a critical assessment of audit evidence
- Due Professional Care - Requires that an auditor perform his or her professional services with the same degree of skill, knowledge, and judgment possessed by other members of the profession and also Includes proper training and an attitude of professional skepticism
Identify and describe judgment tendencies
- Confirmation - The tendency to put more weight on information that is consistent with initial beliefs or preferences.
- Overconfidence - The tendency to overestimate one's own abilities to perform tasks or to make accurate assessments of risk or other judgements and decisions.
- Anchoring - The tendency to make assessments by starting from an initial value and then adjusting insufficiently away from that initial value.
- Availability - The tendency to consider information that is easily retrievable or easily accessible as being more likely of more relevant.
According to the Sarbanes Oxley Act of 2002, who must take explicit responsibility for a company's financial statements?ManagementWhat inquiries should the successor auditor make of the predecessor auditor?- Information that might bear on the integrity of management - Disagreements with management · Communications regarding fraud and noncompliance with laws and regulations - Communications regarding significant internal control weaknesses - Understanding about the reasons for the change in auditorsWhat information should be included in the engagement letter?- Services to be provided - Auditor's responsibilities o Express and opinion on the financial statements o Express an opinion regarding ICFR o Provide reasonable, but not absolute assurance of detecting errors and fraud · Management's responsibilities o Responsible for the financial statements and maintaining effective ICFR o Correction of material misstatements o Making accounting records available · Description of timing and fees related to the auditWhat is an analytical procedure?- Evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data - Required during the planning and completion phases of all auditsWhat is a related party transaction?A business deal or arrangement between two parties who are joined by a special relationship prior to the deal. -A business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform renovations to the corporation's offices, would be deemed a related-party transaction. - Create potential conflicts of interest which can result in actions which benefit the people involved as opposed to the shareholders - Should be identified by the auditor during the planning phase of the audit and audit strategy should be modified accordinglyExplain the components of the Audit Risk Model (PDR = AAR/IR x CR)- Inherent Risk (IR) - The risk of misstatement due to error or fraud that exists before the consideration of any related controls - Control Risk (CR) - The risk that a misstatement could occur and not be prevented, or detected and corrected, in a timely manner by the entity's controls. - Detection risk (PDR) - The risk that procedures performed by the auditor will not detect a misstatement - Acceptable Audit Risk (AAR) - A measure of how willing the auditor is to accept that the financial statements may be materially misstatement after the audit is completed and an unmodified opinion has been issuedIdentify the components of the fraud triangle. Give examples of each.- Fraud Triangle - Represents the three conditions of fraud: incentives/pressures, opportunities, and attitudes/rationalization - Incentives/Pressures - Management or other employees have incentives or pressure to commit fraud. - Opportunities - Circumstances provide opportunities for management or employees to commit fraud - Attitudes/Rationalization - An attitude, character, or set of ethical values exists that allows management or employees to commit a dishonest act, or they are in an environment that imposes sufficient pressures that causes them to rationalize committing a dishonest act.What is the difference between vouching and tracing? Identify the related assertion for each- Vouching - From the journal or the G/L to the source document. Occurrence - Have recorded transactions and events occurred - Tracing - From the source documents to the journal or the G/L. Completeness - Have all transactions and events that have occurred been recordedWhat is the difference between relevance and reliability?- Relevance - Refers to the relationship between the evidence and the assertion being tested ·-1 Reliability - Refers to whether or not the evidence can be relied upon to signal the true state of the assertion - Factors affecting reliability: Independence of source, Effectiveness of internal controls, Auditor's direct personal knowledge, Documentary evidence, Original documentsList the 5 components of internal control as defined by COSO.- Control environment - Entity's risk assessment - Control activities - Information and communication - Monitoring activitiesWhat are the differences between a control deficiency, a significant deficiency, and a material weakness?- Control Deficiency - The design and implementation or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis in the normal course of performing their assigned functions - Significant Deficiency - One or more control deficiencies exist that are less severe than a material weakness but are important enough to merit attention by those responsible for oversight of the company's financial reporting - Material Weakness - A significant deficiency, by itself or in combination with other significant deficiencies, results in a reasonable possibility that internal control will not prevent or detect material financial statement misstatements on a timely basisDefine sampling riskThe possibility that the sample drawn is not representative of the population and that, as a result, the auditor reaches an incorrect conclusion about the account balance or class of transactions based on the sampleWhat are the three types of audit reports?- Unqualified: The financial statements are presented fairly, in all material respects, the entity's financial position, results of operations, and cash flows in accordance with GAAP.A "clean" opinion - Qualified: The financial statements are presented fairly, in all material respects, the entity's financial position, results of operations, and cash flows in accordance with GAAP, except for a material misstatement that is not pervasive, Scope limitation, Departure from GAAP - Adverse: The financial statements do not present fairly in accordance with GAAP due to a pervasive material misstatement. Departure from GAAPWhat affect do scope limitations and departures from GAAP have on audit opinions?- Scope Limitations - Qualified or Disclaimer - Departure form GAAP - Qualified or AdverseWhy do most professions develop and enforce a code of conduct?- Users of services know what to expect - Professionals know what is acceptable - Disciplinary action can be taken when appropriate