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101 Cards in this Set

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There are 3 main reasons an auditor should properly plan an audit
"1. to obtain sufficient evidence for the circumstances
2. to help keep audit costs reasonable
3. to avoid misunderstandings with the client"
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
inherent risk
a measure of the auditors assessment of the likelihood that there are material misstatements in an account balance before considering the effectiveness of internal control
initial audit planning involves 4 things-these should be done early in the audit
"1. the auditor decides whether to accept a new client or continue serving an existing one.
2. The auditor identifies why the client wants or needs an audit
3. To avoid misunderstandings, the auditor obtains an understanding with the client about the terms of the engagement
4. The auditor develops an overall strategy for the audit, including engagement staffing and any required audit specialists"
8 major parts of audit planning:
"1. accept client and perform initial planningclient's business and industry
2. understand the client's business and industry
3. assess the client business risk
4. perform preliminary analytical measures
5. set materiality and assess acceptable audit risk and inherent risk
6. understand internal control and assess control risk
7. gather information to assess fraud audits
8. develop overall audit plan and audit program"
audit strategy
overall approach to the audit that considers the nature of the client, risk of significant misstatements, and other factors such as the number of client locations and past effectiveness of client controls
budgets
written records of the clients expectations for the period; a comparison of budgets with actual results may indicate whether or not misstatements are likely
client business risk
"the risk that the client will fail to achieve its objectives related to:
1. reliability of financial reporting
2. effectiveness and efficiency of operations
3. compliance with laws and regulations"
corporate minutes
the official record of the meetings of a corporations board of directors and stockholders, in which corporate issues, such as the declaration of dividends and the approval of contracts are documented
engagement letter
an agreement between the CPA firm and the client as to the terms of the engagement for the conduct of the audit and related services
related party
affiliated company, principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other
related party transaction
any transaction between the client and the related party
What is an effective audit planning procedure that helps prevent misunderstandings and inefficient use of audit personnel?
Arrange a preliminary conference with the client to discuss audit objectives, fees, timing and other info.
When auditing related party transactions, and auditor places primary emphasis on:
evaluating the disclosure of the related party transactions of he related parties
Which of the following will most likely indicate the existence of the related parties
borrowing money at a rate significantly below the market rate
When using the work of the specialist the auditor may identify and refer to the specialist in the auditors report if the
auditor expresses a qualified opinion as a result of the specialists findings
In assessing whether to accept a client for an audit engagement, a CPA should consider
client business risk and acceptable audit risk
When apporached to perform an audit for the first time, the CPA should make inquiries of the predecessor auditor. This is a necessary procedure because the predecessor may be able to provide the successor with info that will assist the successor in determining whether
the engagement should be engagement
a successor would most likely make specific inquiries of the predecessors auditor regarding
disagreements with management as to auditing procedures
Analytical procedures used in planning an audit should focus on identifying
areas that may represent specific risks relevant to the audit
For all audits of financial statements made in accordance with generally accepted auditing standards the use of analytical procedures is required to some extent
in the planning stage and the completion stage
What is least likely to be comparable between similar corporations in the same industry line of business
earnings per share
What is an effective audit planning procedure that helps prevent misunderstandings and inefficient use of audit personnel?
Arrange a preliminary conference with the client to discuss audit objectives, fees, timing and other info.
When auditing related party transactions, and auditor places primary emphasis on:
evaluating the disclosure of the related party transactions of he related parties
Which of the following will most likely indicate the existence of the related parties
borrowing money at a rate significantly below the market rate
When using the work of the specialist the auditor may identify and refer to the specialist in the auditors report if the
auditor expresses a qualified opinion as a result of the specialists findings
In assessing whether to accept a client for an audit engagement, a CPA should consider
client business risk and acceptable audit risk
What is the best chance of being detected when a CPA compares 2009 revenues and expenses with the prior year and investigates all changes exceeding a fixed percent
the company changed its capitalization policy for small tools in 2009
What are the benefits derived from planning audits?
"There are three primary benefits from planning audits:
*it helps the auditor obtain sufficient appropriate evidence for the circumstances,
* helps keep audit costs reasonable,
*and helps avoid misunderstandings with the client."
Identify the eight major steps in planning audits
"1. Accept client and perform initial planning
2. Understand the client’s business and industry
3. Assess client business risk
4. Perform preliminary analytical procedures
5. Set materiality, and assess acceptable audit risk and inherent risk
6. Understand internal control and assess control risk
7. Gather information to assess fraud risks
8. Develop overall audit plan and audit program"
What are the responsibilities of the successor and predecessor auditors when a company is changing auditors?
The new auditor (successor) is required by AU 315 to communicate with the predecessor auditor. This enables the successor to obtain information about the client so that he or she may evaluate whether to accept the engagement. Permission must be obtained from the client before communication can be made because of the confidentiality requirement in the Code of Professional Conduct. The predecessor is required to respond to the successor’s request for information; however, the response may be limited to stating that no information will be given. The successor auditor should be wary if the predecessor is reluctant to provide information about the client.
What factors should an auditor accept prior to accepting an engagement?
Prior to accepting a client, the auditor should investigate the client. The auditor should evaluate the client’s standing in the business community, financial stability, and relations with its previous CPA firm. The primary purpose of new client investigation is to ascertain the integrity of the client and the possibility of fraud. The auditor should be especially concerned with the possibility of fraudulent financial reporting since it is difficult to uncover. The auditor does not want to needlessly expose himself or herself to the possibility of a lawsuit for failure to detect such fraud.
what is the purpose of an engagement letter? What subjects should be covered in such a letter.
Auditing standards require auditors to document their understanding of the terms of the engagement with the client in an engagement letter. The engagement letter should include the engagement’s objectives, the responsibilities of the auditor and management, and the engagement’s limitations. An engagement letter is an agreement between the CPA firm and the client concerning the conduct of the audit and related services. It should state what services will be provided, whether any restrictions will be imposed on the auditor’s work, deadlines
Who is considered the client when auditing public companies?
"8-6 Because the Sarbanes-Oxley Act of 2002 explicitly shifts responsibility for hiring and firing of the auditor from management to the audit committee for public companies, the audit committee is viewed as “the client” in those engagements."
Which services must preapproved by the audit committee of a public company?
All audit and non-audit services must be preapproved in advance by the audit committee for public companies.
Explain why auditors need an understanding of the clients industry. What information sources are commonly used by auditors to learn about the clients industry?
"8-8 The second standard of fieldwork requires the auditor to obtain an understanding of the entity and its environment. Auditors need an understanding of the client’s business and industry because the nature of the business and industry affect business risk and the risk of material misstatements in the financial statements. Auditors use the knowledge of these risks to assess the risk of material misstatement and to determine the appropriate extent of further audit procedures.
The five major aspects of understanding the client’s business and industry, along with potential sources of information that auditors commonly use for each of the five areas are as follows:

1. Industry and External Environment – Read industry trade publications, AICPA Industry Audit Guides, and regulatory requirements.
2. Business Operations and Processes – Tour the plant and offices, identify related parties, and inquire of management.
3. Management and Governance – Read the corporate charter and bylaws, read minutes of board of directors and stockholders, and inquire of management.
4. Client Objectives and Strategies – Inquire of management regarding their objectives for the reliability of financial reporting, effectiveness and efficiency of operations, and compliance with laws and regulations; read contracts and other legal documents, such as those for notes and bonds payable, stock options, and pension plans.
5. Measurement and Performance – Read financial statements, perform ratio analysis, and inquire of management about key performance indicators that management uses to measure progress toward its objectives."
For prospective clients that have already been audited by another CPA firm, the new successor auditor is REQUIRED by AU 315
to communicate with the predecessor auditor.
investigating a new client involves
clients standing in the business community, financial stability, and relations with with previous CPA firm
Many firms evaluate existing clients to determine if there are reasons for not continuing with the client, some reasons are:
"*previous conflicts over scope
*the type of opinion to issue
*client lacks integrity
*pending lawsuit
*unpaid fees for services provided more than one year ago"
Audits with a LOW acceptable audit risk will result in:
higher audit costs-higher audit fees
Two major factors affecting major audit risk:
"*likely statement users
*intended uses of the statements"
AU 311 requires auditors to document their understanding with the client in an engagement letter, it should include the following:
"*the objectives of the engagement
*the responsibilities of the auditor and management
*the engagements limitations
*an agreement to provide other services allowable under the Professional Code of Conduct"
Auditor develops overall strategy it includes staffing the engagement and any related specialists:
staffing of the engagement is tied up in the first general standard that states an auditor must have adequate training and proficiency to perform the audit and AU 336 establishes the requirement for slecting specialists and reviewing their work
client business risk is
the risk that the client will fail to meet its objectives
Factors that have increased the importance of understanding the clients business and industry:
"*recent declines in economic conditions worldwide
*information technology connects clients to major suppliers and customers
*clients have expanded operations globally, through joint ventures or strategic alliances
*information technology affects internal client processes, improving timeliness of accounting information
*the increased importance of human capital and other intangible assets has increased accounting complexity and the importance of management judgments and estimates
*many clients have invested in complex financial instruments (CDO's) which have little value and require complex accounting treatment"
3 Primary reasons for obtaining a good understanding of the clients industry and external environment are:
"*risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risk
*certain inherent risks are typically common to all clients in certain industries
*many industries have unique accounting requirements that the auditor must understand to evaluate whether the clients financial statements are in accordance with GAAP."
Many auditor litigation cases result from the auditors failure to fully understand
the nature of transactions in the clients industry
Business operations and processes:
"*Tour client facilities and operations
*identify related parties"
management and governance:
"*understand the corporate charter and bylaws
*consider the code of ethics
*read the corporate minutes"
Auditors should understand client objectives related to:
"1. reliability of financial reporting
2. effectiveness and efficiency of operations
3. compliance with laws and regulations"
Transactions with related parties are important to auditors because GAAP requires that they be
disclosed in the financial statements if they are material
a transaction with a related party is NOT
an arms length transaction
Because materially related party transactions must be disclosed, all related parties need to be
identified and included in the auditors permanent files early in the engagement
A clients performance measurement system includes key performance indicators that management uses to measure progress toward its objective, examples include:
"*market share
*sales per employee
*unit sales growth
*unique visitors to a website
*same-store sales
*sales by a country
*sales per square foot"
If compensation for sales people is based on market share the auditor will test
for occurrence because there is an increased risk of recording sales before they are earned
If performance is measured off of ratio analysis and benchmarking against competitors the auditor should perform
ratio analysis or review the clients calculations of key performance ratios
residual risk
the remaining risk after considering the effectiveness of top management controls
The auditors primary concern is
the risk of material misstatements in the financial statements due to client business risk
Management is a _________ source for identifying client business risk.
Primary
Short term debt paying ability
"*cash ratio
*quick ratio
*current ratio"
Liquidity activity ratios
"*A/R turnover
*Days to collect A/R
*inventory turnover
*days to sell inventory"
Ability to meet long term obligations
"*debt to equity ratio
*times interest earned"
Profitability ratios
"*gross profit margin
*profit margin
*ROA
*ROE"
Analytical procedures are defined in AU 329 as
evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data...involving comparisons of recorded amounts...to expectations developed by the auditor
Four major parts of planning
"1. Accept client and perform initial planning
2. Understand the clients business and industry
3. Assess clients business risk
4. Perform preliminary analytical procedures"
Accept client and perform initial planning:
"1. New client acceptance and continuance
2. Identify clients reason for audit
3. Obtain an understanding with the client
4. Staff the engagement"
Understand the clients business and industry
"1. Understand clients industry and external environment
2. understand clients operations, strategies, and performance system"
Assess client business risk
"1. Assess client business risk
2. Evaluate management controls affecting business risk
3. Assess risk of material misstatements"
Analytical procedures may be performed at any of three times during the engagement
"1. Required during planning stage
2. Often done during testing phase
3. Required during the completion stage"
Planning phase REQUIRED (analytical procedures)
"Primary purposes:
1. understand client's industry and business
2. indicate possible misstatements
Secondary purposes:
1. Assess going concern
2. reduce detailed test"
Testing Phase (analytical procedures)
"Primary purpose
1. Reduce detailed test
Secondary purpose
1. Indicate possible misstatements"
Completion phase REQUIRED (analytical procedures)
"Primary purpose:
1. Indicate possible misstatements
Secondary purpose
1. Assess going concern"
Auditors compare client data with
"1. industry data
2. similar prior-period data
3. client-determined expected results
4. auditor determined expected results
5. expected results using nonfinancial data"
five analytical procedures:
"1. compare client and industry data
2. compare client data with similar prior period data
3. compare client data with client determined expected results
4. compare client data with auditor-determined expected results
5. compare client data with expected results using nonfinancial data"
Compare client data with prior period data, examples:
"1. current year's balance with that of the preceding year
2. detail of a total balance with similar detail from prior year
3. ratios and percent relationships for prior year comparisons"
Auditors often prepare common size financial statements for one or more years
this displays all items as a percent of a common base such as sales
cash ratio
(cash + marketable securities)/current liabilities
quick ratio
(cash + marketable securities + net accounts recievable)/current liabilities
current ratio
current assets/current liabilities
accounts receivable turnover
net sales/average gross receivables
days to collect receivables
365 days/accounts receivable turnover
inventory turnover
COGS/average inventory
days to sell inventory
365 days/inventory turnover
debt to equity
total liabilities/total equity
times interest earned
operating income/interest expense
earnings per share
net income/average common shares outstanding
gross profit percent
(net sales-cost of goods sold)/net sales
profit margin
operating income/net sales
return on assets
income before taxes/average total assets
return on common equity
(income before taxes-preferred dividends)/average stockholders equity
cash ratio determines
the ability to pay debts immediately
current ratio measures
the conversion of assets to cash to pay debt
quick ratio measures
ability to pay debt not including inventory
accounts receivable turnover ratio is used
to assess the reasonableness of the allowance for doubtful accounts
trends in inventory turnover ratio identifies
potential inventory obsolescence
debt-to-equity ratio shows
the extent of the use of debt in financing a company...HIGH means too much debt TOO LOW not leveraged adequately
times interest earned shows
whether the company can comfortably make its interest payments if earnings are stable
gross profit percent shows
portion of sales available to cover all expenses and profit after deducting the cost of the product.
profit margin
show the portion of sales available to cover expenses and profit after deducting the cost of goods sold and operating expenses
return on assets
shows the companys ability to generate a profit based on every dollar of assets it owns
return on equity
shows the company's ability to generate a profit based on every dollar of equity it owns