Study sets, textbooks, questions
Upgrade to remove ads
ACCT 402 Final
Terms in this set (88)
Major consideration in determining the appropriate audit report. Referenced in auditor's responsibility section of the audit report.
What is meant by the term "material"?
The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
Determine whether financial statements are materially misstated. Auditor will bring material misstatement to the client's attention so corrections can be made.
Steps in Applying Materiality
Step 1) Set materiality for the financial statements as a whole. Step 2) Determine performance materiality. Step 3) Estimate total misstatement in segment. Step 4) Estimate the combined misstatement. Step 5) Compare combined estimate with preliminary or revised judgment about materiality.
Set Preliminary Judgment about Materiality
Auditors set materiality thresholds early in the engagement. Thresholds represent the maximum amount that statements could be misstated and still not affect users' decisions.
Factors Affecting Judgment
Materiality is a relative rather than an absolute concept. Benchmarks are needed for evaluating materiality. Qualitative factors also affect materiality.
Qualitative Factors. Considerations that may render material a quantitatively small misstatement include
Loan covenants, changing trend, management compensation, financial statement users, conceals an illegal act.
Accounting and auditing standards do not provide specific materiality guidelines. Professional judgment is used to set and apply materiality guidelines.
Allocate Preliminary Judgment about materiality to segments
Evidence is accumulated by segments rather than for the financial statements as a whole. Most practitioners allocate materiality to balance sheet accounts
Auditor can determine the misstated amount in an account
Two types of Likely misstatements
Judgmental differences. Projections of misstatements from audit samples.
Auditors accept some level of risk in performing the audit. Risks exist, are difficult to measure, and require careful thought in response. Proper risk response is critical to achieving a high-quality audit.
Risk and evidence
Auditors need to understand the client's business and assess business risk. The audit risk model helps identify the potential and likelihood of misstatements
Audit risk model for planning
Planned detection risk = (Acceptable audit risk) / (Inherent risk * Control risk)
Planned detection risk
The risk that audit evidence for an audit objective will fail to detect misstatements exceeding performance materiality. Objective. Inverse relationship w/ evidence.
Measures the auditor's assessment of the susceptibility of an assertion to material misstatement, before considering the effectiveness of related internal controls. Direct relationship w/ evidence. Objective.
Measures the auditor's assessment of the risk that a material misstatement could occur in an assertion and not be prevented or detected on a timely basis by the client's internal controls. Inversely related to PDR, directly related to amount of audit evidence. Objective.
Acceptable audit risk
A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. Subjective. Directly related to PDR. Inversely related to audit evidence.
Describe the three primary objectives of effective internal control.
Compliance with laws and regulations, reliability of financial reporting, efficiency/effectiveness of operations.
Establishing and maintaining the entity's internal controls is who's responsibility?
Management's design and implementation of internal controls is based on two key underlying concepts:
Reasonable assurance and inherent limitations
Management's Section 404 reporting responsibilities. Management of all public companies are required to issue an internal control report that includes the following:
An acknowledgement of responsibility for internal controls, results of annual internal control assessment.
What are the two key aspects of Management's assessment of internal controls over financial reporting?
Management must evaluate the design of internal controls over financial reporting. Management must also test the operating effectiveness of those controls.
Auditor Responsibilities for Understanding Internal Control
Must assess control riskk in every audit
Auditor primarily concerned about controls over:
Reliability of financial reporting, classes of transactions
Auditor Responsibilities for reporting on internal control
Obtains understanding of controls
Auditor performs tests of controls
Significant account balances, classes of transactions, disclosures and related financial statement assertions
Five components of internal control
Control environment, risk assessment, control activities, information and communication, monitoring
The control environment
Integrity and ethical values, commitment to competence, board of directors or audit committee participation
The control environment: Management's philosophy and operating style
Human resource policies and practices, organizational structure
Identify factors that may increase risk, estimate the significance of the risk, assess the likelihood of the risk occurring, determine actions necessary to manage the risk
Adequate separation of duties, proper authorization of transactions and activities, adequate documents and records, physical control over assets and records, independent checks on performance.
Adequate separation of duties
Custody of assets from accounting. Authorization of transactions from the custody of related assets. Operational responsibility from record-keeping responsibility. IT duties from user departments
Transaction Approval policies
General authorization and specific authorization
Management establishes policies and subordinates are instructed to implement these general authorizations by approving all transactions within the limits set by the policy.
Applies to individual transactions. For certain transactions, management prefers to authorize each transaction.
Adequate documents and records
Prenumbered consecutively, prepared at the time of transaction,designed for multiple use, constructed to encourage correct preparation
Physical Control over Assets and Records
The most important type of protective measure for safeguarding assets and records is the use of physical precautions
Independent checks on performance
The need for independent checks arises because internal control tends to change over time, unless there is frequent review.
The purpose of an accounting information and communication system
Initiate, record, process and report transactions and to maintain accountability for related assets.
Monitoring activities deal with management's ongoing and periodic assessment of the quality of internal control performance to determine whether controls are operating as intended and modified when needed.
Process for understanding internal control and assessing control risk
Phase 1) Obtain and document understanding of internal control design and operation. Phase 2) Assess control risk. Phase 3) Design, perform, and evaluate tests of controls. Phase 4 )Decide planned detection risk and substantive tests
Auditing standards require auditors to obtain an understand of...
internal control for every audit.
Procedure to obtain an understanding:
Inspection, inquiry of entity personnel, observation of employees
Methods used to gain an understanding of internal controls
Narrative, flowchart, internal control questionnaire
The origin of every document and record in the system. All processing that takes place. The disposition of every document and record in the system. An indication of the controls relevant to the assessment of control risk.
A diagram of the client's documents and their sequential flow in the organization.
Internal Control Questionnaire
Asks a series of questions about the controls in each audit area as a means of identifying internal control deficiencies.
Evaluating Internal Control Operation
Update and evaluate auditor's previous experience with the entity. Make inquires of client personnel. Examine documents and records. Observe entity activities and operations. Perform walk-throughs of the accounting system
Assess Control Risk
Assess whether the financial statements are auditable. Determine assessed control risk supported by the understanding obtained. Use a control risk matrix to assess control risk.
Control risk matrix
Many auditors use this to assist in the control risk assessment process at the transaction level.
Preparing a control risk matrix
Identify audit objectives. Identify existing controls. Associate controls with related audit objectives. Identify and evaluate control deficiencies, significant deficiencies, and material weaknesses
Identify Deficiencies and material weaknesses
Identify existing controls. Identify the absence of key controls. Consider the possibility of compensating controls. Decide whether there is a significant deficiency or material weakness. Determine potential misstatements that could result.
Communications to those charged with governance
Auditor must communicate in writing significant deficiencies and material weaknesses to the audit committee. Management letters from the auditor. Less significant control weaknesses. Ideas for operational improvements.
Tests of Controls
The procedures to test effectiveness of controls in support of a reduced assessed control risk.
Procedures for tests of controls
Inquire of client personnel. Examine documents, records, reports. Reperform client procedures. Observe control-related activities.
Extent of Procedures
Reliance on evidence from prior year's audit. Testing of controls related to significant risks. Testing less than the entire audit period.
The scope of the auditor's report on internal control is limited to...
obtaining reasonable assurance that material weaknesses in internal control are identified.
What type of opinion is issued if no material weaknesses, no scope restrictions?
Type of opinion if one or more material weaknesses?
Type of opinion if scope limitation?
Qualified or disclaimer
5 types of audit tests to determine whether financial statements are fairly stated
Risk assessment procedures, tests of controls, substantive tests of transactions, tests of details of balances, analytical procedures
Tests of control are performed to support a reduced assessment of...
analytical procedures and tests of details of balances satisfies...
planned detection risk
substantive tests of transactions affect both...
control risk and planned detection risk
Risk assessment procedures
Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls. Assess business risk. Assess risk of material misstatement.
Tests of controls
When control policies and procedures are believed to be effectively designed, the auditor assesses control risk at a level that reflects the relative effectiveness of those controls. To obtain sufficient appropriate evidence to support that assessment, the auditor performs tests of controls. Help auditors evaluate whether controls over transactions in the cycle are sufficiently effective to support the reduced assessment of control risk, and thereby allow reduced substantive testing. Also form the basis for the auditor's report on internal control over financial reporting for larger public companies.
Substantive tests of transactions
Used to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions. Substantive tests are procedures designed to test for dollar misstatements that directly affect the correctness of financial statement balances. Verify transactions recorded in the journals and posted in the general ledger.
Involve comparisons of recorded amounts to expectations developed by the auditor. Emphasize the overall reasonableness of transactions and the general ledger balances.
Tests of details of balances
Focus on the ending general ledger balances for both balance sheet and income statement accounts. Substantive tests. Usually focuses on balance sheet.
Design an audit program
Part 1) Tests of controls and substantive tests of transactions. Part 2) Analytical procedures. Part 3) Tests of details and balances
AO example: Review debt contracts to determine that accounts receivable are pledged as collateral.
Occurrence and rights and obligations
AO example: Use a disclosure checklist to determine if the financial statements include all disclosures required by accounting standards.
AO example: Review financial statements to determine if assets are properly classified between current and non-current categories. Read the footnotes for clarity.
Classification and understandability
AO example: Reconcile amounts included in the long-term debt footnotes to information examined and supported in the auditor's long-term debt audit working papers.
Accuracy and valuation
A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place.
Remote likelihood of contingent liability
No disclosure necessary
Reasonably possible Contingent liability
Footnote disclosure is necessary.
Probable contingent liability
If the amount can be reasonably estimated, financial statement accounts are adjusted. If the amount cannot be reasonably estimated, footnote disclosure is necessary.
Auditors are especially concerned about certain contingent liabilities
Pending litigation for patent infringement, product liability, or other actions. Product warranties. Notes receivable discounted. Guarantees of obligations of others. Unused balances of outstanding letters of credit.
Period covered by subsequent events review
The auditor is responsible for reviewing for subsequent events occurring between 12-31-13 and 3-11-14, but no later than the audit report date. Most subsequent events audit procedures are performed near the audit report date.
Types of subsequent events
Those that have a direct effect on the financial statements and require adjustment. Those that do not have a direct effect on the financial statements but for which disclosure is required.
Subsequent events requiring adjustment
Declaration of bankruptcy by a customer with an accounts receivable balance. Settlement of a litigation at an amount different from the amount recorded on the books. Disposal of equipment not being used in operations at a price below the current book value.
Subsequent events advisability of disclosure
Issuance of bonds or equity securities. Decline in the market value of inventory as a consequence of government action barring further sale of a product. Uninsured loss of inventories as a result of fire. A merger or an acquisition.
Two categories of audit procedures for the subsequent events review:
Procedures normally integrated as a part of the verification of year-end account balances. Procedures performed specifically for the purpose of discovering events or transactions that must be recognized as subsequent events.
Audit tests to obtain information to incorporate into the current year's account balances or footnotes as tests of the completeness presentation and disclosure objective.
Review records prepared subsequent to the balance sheet date. Review internal statements prepared subsequent to the balance sheet date. Examine minutes issued subsequent to the balance sheet date. Correspond with attorneys. Inquire of management. Obtain a letter of representation.
Management Representation Letter Purposes
To impress upon management its responsibility for the assertions in the financial statements. TO remind management of potential misstatements or omissions in the financial statements. To document the responses from management to inquiries about various aspects of the audit.
Four categories in management representation letter
Responsibility for financial statements. completeness of information. recognition, measurement, and disclosure. recording and disclosing subsequent events
Students also viewed
IFRS 10 - Consolidated Financial Statements
FR 3 - Consolidation Less than 100% Ownership
Advanced Financial Exam 2
Sets found in the same folder
ACCT 402 Midterm 2
ACCT 402 - EXAM 1
Other sets by this creator
ACCT 422 Chapter 15
ACCT 401 Chapter 14
ACCT 422 Chapter 14
What factors contributed to revolution in Mexico?
use point-by-point plotting to draw the graph of equation. $$ y^2=4 x^2 $$
Should the rate of return of a call option on a long-term Treasury bond be more or less sensitive to changes in interest rates than the rate of return of the underlying bond?
When consumption is a positive amount, saving: a. must be a negative amount. b. must also be a positive amount. c. can be either a positive or a negative amount. d. is zero.
Recommended textbook solutions
Information Technology Project Management: Providing Measurable Organizational Value
Jack T. Marchewka
Human Resource Management
John David Jackson, Patricia Meglich, Robert Mathis, Sean Valentine
Human Resource Management
John David Jackson, Patricia Meglich, Robert Mathis, Sean Valentine
Service Management: Operations, Strategy, and Information Technology
James Fitzsimmons, Mona Fitzsimmons
Other Quizlet sets
BIO 199 FINAL
EDGC 664 Theories of Counseling Exam questions
One Flew Over the Cuckoo's Nest Test Review
Biology Ch.1 and 3 Practice Quiz