• Shuffle
    Toggle On
    Toggle Off
  • Alphabetize
    Toggle On
    Toggle Off
  • Front First
    Toggle On
    Toggle Off
  • Both Sides
    Toggle On
    Toggle Off
  • Read
    Toggle On
    Toggle Off
Reading...
Front

How to study your flashcards.

Right/Left arrow keys: Navigate between flashcards.right arrow keyleft arrow key

Up/Down arrow keys: Flip the card between the front and back.down keyup key

H key: Show hint (3rd side).h key

A key: Read text to speech.a key

image

Play button

image

Play button

image

Progress

1/65

Click to flip

65 Cards in this Set

  • Front
  • Back
  • 3rd side (hint)
AUDIT RISK
The risk (likelihood) that the auditor may unknowingly FAIL TO MODIFY THE OPINION (e.g., give an unqualified opinion on misstated financial statements).
3
audit risk
ENGAGEMENT RISK
The risk that the auditor is exposed to FINANCIAL LOSS or REPUTATION DAMAGE from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.
3
engagement risk
AUDIT RISK MODEL
Decomposes overall audit risk into 3 components:
1. INHERENT RISK (IR)
2. CONTROL RISK (CR)
3. DETECTION RISK (DR)

AR = IR x CR x DR
3
ARM
RISK OF MATERIAL MISSTATEMENT (RMM)
IR x CR
3
RMM
WHAT STEPS ARE USED IN THE AUDIT RISK MODEL?
1. Set a planned level of audit risk so that an opinion can be issued on the financial statements.
2. Assess inherent risk and control risk.
3. Use the audit risk equation to solve for the appropriate level of detection risk.

AR = IR x CR x DR

DR = AR / IR x CR
3
ARM model
WHAT ARE THE CONCEPTS OF THE ARM (the Audit Risk Model itself)?
- The ARM formula is judgmental/theoretical/ conceptual
- Focus on the relationships the model implies (not on interpreting the numbers)
- The model is generally applied to individual accounts/balances/assertions/disclosures
3
ARM
WHAT ARE THE CONCEPTS OF THE ARM IN REGARDS TO THE AUDITOR?
- Auditor cannot affect inherent risk or control risk. Auditor can only ASSESS them.
- Auditor can only affect detection risk - generally by examining more evidence or better evidence.
- For a given level of Audit Risk, Detection risk is inversely related to Control Risk and Inherent Risk.
3
ARM
WHAT IS INHERENT RISK?
The likelihood that, IN THE ABSENCE OF INTERNAL CONTROLS, a material misstatement could occur. In other words, it is a measure of the SUSCEPTIBILITY OF AN ACCOUNT TO MISSTATEMENT.
3
inherent risk
WHAT ARE THE FACTORS AFFECTING AN ACCOUNT'S INHERENT RISK?
1. Dollar size of the account
2. Liquidity
3. Volume of transactions
4. Complexity of the transactions (New accounting pronouncements)
5. Subjective estimates
3
Inherent risk
WHAT ARE THE OTHER FACTORS AFFECTING OVERALL INHERENT RISK?
1. Competition
2. Economy
3. Nature of Industry - cyclical vs steady
4. Management Style - aggressiveness (tone at the top)
5. Leverage - debt burden, loan convenants
3
Inherent risk
WHAT IS CONTROL RISK?
The likelihood that a material misstatement would not be caught by the client's internal controls.
3
control risk
WHAT ARE THE FACTORS AFFECTING CONTROL RISK?
- Control environment
- Existence (or lack thereof) and Effectiveness of control procedures
- Monitoring activities (audit committee, internal audit function, etc)
3
control risk
WHAT IS DETECTION RISK?
The risk that a material misstatement would NOT BE CAUGHT BY AUDIT PROCEDURES.
3
detection risk
WHAT ARE THE FACTORS AFFECTING DETECTION RISK?
- Nature, timing, and extent of audit procedures
- Sampling risk (risk of choosing an unrepresentative sample)
- Nonsampling risk (risk that the auditor may reach inappropriate conclusions based upon available evidence, i.e., auditor error)
3
detection risk
WHICH FACTORS CREATE A LOWER DETECTION RISK AND WHAT IS THE EXTENT OF THE AUDIT PROCEDURES?
Nature - More effective tests
Timing - Testing performed at year-end
Extent - More tests
3
detection risk
WHAT CREATES A HIGHER DETECTION RISK AND WHAT IS THE EXTENT OF THE AUDIT PROCEDURES?
Nature - Less effective tests
Timing - Testing can be performed at Interim
Extent - Fewer tests
3
detection risk
WHAT ARE ERRORS (in the Risk of Material Misstatement)?
UNINTENTIONAL MISSTATEMENTS or omissions of amounts or disclosures in financial statements.
3
RMM
WHAT IS MANAGEMENT FRAUD (in the Risk of Material Misstatement)?
Includes INTENTIONAL MISSTATEMENTS or omissions of amounts or disclosures in financial statements.
3
RMM
WHAT IS DIRECT-EFFECT ILLEGAL ACTS (IN THE RISK OF MATERAIL MISSTATEMENT)?
VIOLATIONS of laws or government regulations by the company or its management or employees that produce DIRECT AND MATERIAL EFFECTS on the FINANCIAL STATEMENTS (e.g., violations of tax law)
3
RMM
WHAT ARE SOME FAR-REMOVED (OR INDIRECT-EFFECT) ILLEGAL ACTS THAT ARE VIOLATIONS OF LAWS AND REGULATIONS THAT DO NOT DIRECTLY AFFECT THE FINANCIAL STATEMENTS?
1. Insider securities trading
2. Occupational health and safety (OSHA) violations
3. Food and drug adminstration (FDA) violations
4. Environmental protection (EPA) violations
5. Equal employment opportunity (EEO) violations
3
RMM
What is the FRAUD triangle?
When the 3 factors of Incentive/Motive, Opportunity and Rationalization are involved, there is a higher risk of fraud.
CH 3 - FRAUD
What are the factors leading to an increased probability of fraud?
(Fraud Elements)
1. INCENTIVE / MOTIVE
2. OPPORTUNITY
3. RATIONALIZATION
CH 3 - FRAUD
What are the components of Risk of Material Misstatement?
1. ERRORS
2. Management FRAUD
3. Direct-effect ILLEGAL ACTS
4. Indirect-effect ILLEGAL ACTS
CH 3 - FRAUD
What does Errors mean in RMM?
These are UNINTENTIONAL MISSTATEMENTS OR OMISSIONS of amounts or disclosures in financial statements.
CH 3 - FRAUD
What does Management FRAUD mean in RMM?
This includes INTENTIONAL MISSTATEMENTS OR OMISSIONS of amounts or disclosures in financial statements
CH 3 - FRAUD
What does DIRECT-EFFECT ILLEGAL ACTS mean in RMM?
1. Direct-effect ILLEGAL ACTS are violations of laws or government regulations by the company or its management or employees that produce DIRECT and MATERIAL effects on the financial statements (e.g., violations of tax laws)
CH 3 - FRAUD
What are the Auditors' responsibilities for the detection of FRAUD
1. Discussion among audit team members about the risks of material misstatement due to fraud.
2. Inquire of management and others about their views on the risks of fraud and how it is addressed.
3. Consider any unusual or unexpected relationships that have been found in using analytical procedures in planning the audit.
4. Understand the client's period-end closing process and investigate unexpected period-end adjustments.
CH 3 - FRAUD
What is the difference between Errors and Fraud?
Whether the misstatement was INTENTIONAL (Fraud) OR UNINTENTIONAL. (Error)
CH 3 - FRAUD
What is the responsibility of the engagement team members in communication in RMM?
Whether it is an error or fraud, the engagement should be conducted as if there is a possibility that fraud could be present.
CH 3 - FRAUD
What is the responsibility of the auditor in regards to the entity's management?
1. Auditor should find out what management knows about any fraud within the entity.
2. Auditor must understand programs and controls that management has established to prevent any risk factors and how mngmt monitors those.
3. Auditor should question the audit committee about its oversight activities in risk assessment.
4. Auditor should take inquiries and ask questions of others from within the entity (vendors, customers)
CH 3 - FRAUD
What is the auditor's responsibility in regards to Direct-Effect Illegal acts?
SAS 54 says that direct-effect illegal acts require the same assurance as frauds and errors. Even if you have no knowledge of the Direct illegal act, the auditor is responsible.
CH 3 - ILLEGAL ACTS
What is the auditor's responsibility in regards to Indirect-effect Illegal acts?
SAS 54 says that the auditor should be aware of the possibility that such illegal acts may have occurred, but if there is no knowledge of the illegal act, the auditor is not responsible.
CH 3 - ILLEGAL ACTS
What does INDIRECT-EFFECT ILLEGAL ACTS mean in RMM?
2. Indirect-effect ("FAR REMOVED") ILLEGAL ACTS are violations of laws and regulations that do not directly affect the financial statements.(e.g., OSHA violations)
CH 3 - ILLEGAL ACTS
What are Direct-Effect Illegal Acts?
Violations of laws or government regulations by the company or its management or employees that produce direct and material effects on the financial statements (e.g., violations of tax laws)
<Part of RMM>
CH. 3 - ILLEGAL ACTS
What are Indirect-Effect Illegal Acts?
These "far removed" illegal acts are violations of laws and regulations that do not directly affect the financial statements (e.g., OSHA violations, FDA violations, EPA violations)
CH. 3 - ILLEGAL ACTS
What is Incentive/Motive in committing fraud ?
One of the Fraud Elements - this is a kind of pressure that a person experiences and believes unshareable with friends and confidants encouraging the person to commit fraud.
CH. 3 - FRAUD ELEMENTS
What are the Motive types?
1. ECONOMIC: Actual of perceived need for money
2. EGOCENTRIC: Committing fraud for personal prestige
3. PSYCHOTIC: "Habitual criminal" who steals for the sake of stealing
4. IDEOLOGICAL: Cause is morally superior, justified in making others victims.
(Economic and Egocentric are the most common)
CH. 3 - FRAUD ELEMENTS
What is Opportunity in committing fraud?
One of the Fraud elements - an open door for solving the unshareable problem by violating a trust.
CH. 3 - FRAUD ELEMENTS
What factors increase Opportunity in committing fraud?
1. WEAK INTERNAL CONTROLS: (e.g., inventory not counted on a regular basis, petty cash box left unattended)
2. CIRCUMVENTION OF INTERNAL CONTROLS
3. The greater the position, the greater the trust and exposure to unprotected assets.
CH. 3 - FRAUD ELEMENTS
What is Rationalization in committing fraud (misappropriation of assets)?
When people do things that are contrary to their personal beliefs - outside their normal behavior - they provide AN ARGUMENT to make the action seem like it is IN LINE WITH THEIR MORAL AND ETHICAL BELIEFS.
CH. 3 - FRAUD ELEMENTS
What are some of the red flags in employees' behavior in possible fraud?
1. Not enough sleep
2. Drinking too much
3. Work late or work alone
4. Being irritable, defensive, argumentative
CH. 3 - FRAUD ELEMENTS
What are some of the red flags in accounting records in possible fraud?
1. Missing documents
2. Photocopied documents
3. Altered documents
4. Customer complaints
5. Inventory shortages
6. Cash shortages and overages
CH. 3 - FRAUD ELEMENTS
What are some of the approaches in Fraud Prevention?
1. Managing people pressures in the workplace (counseling, hotlines)
2. Control procedures and employee monitoring (job descriptions, willingness to enforce/prosecute)
3. Integrity by example and enforcement (ethics, code of conduct, background checks)
CH. 3 - FRAUD PREVENTION
What are the required steps in the consideration of fraud in a F/S audit?
1. Audit team discussion (brainstorming)
2. Identify information to assess fraud risk factors
3. Identify and Assess fraud risk factors
4. Respond to risk assessment
5. Evaluate audit evidence
6. Communicate fraud matters
7. Document fraud matters
CH. 3 - SAS 99 = STEPS IN CONSIDERATION OF FRAUD
What is important about the audit team discussion?
- REQUIRED ANNUAL PROCEDURE
- OBJECTIVE is to gain understanding of previous experiences with client, how a fraud might be perpetuated and covered up in the entity, and what procedures that might detect fraud.
- Discussion should be ONGOING throughout the engagement.
CH. 3 - SAS 99 = STEPS IN CONSIDERATION OF FRAUD
What are the sources of information in identifying fraud risks?
1. Inquiries of Management, Audit committees, and Internal Auditors)
2. Review of Company discussion boards
3. Planning analytical procedures (THIS IS REQUIRED) (e.g., Net income to cash flows, days sales in receivables, Gross margin, Sales growth index)
CH. 3 - SAS 99 = STEPS IN IDENTIFYING FRAUD RISK
What are the categories of risk factors in fraudulent financial reporting?
1. Management's characteristics and influence
2. Industry conditions
3. Operating characteristics and financial stability
CH. 3 - SAS 99 = STEPS IN IDENTIFYING FRAUD RISK
What are the risk factors that might be caused from management's characteristics and influence?
1. Management's pressure on employees to overstate or understate company results.
2. Management's decisions dominated by one person or a small group
3. Single focus on earnings and earnings projections.
4. High turnover of senior management.
5. History of violations
6. Evasive responses to auditors.
7. Disputes with auditors.
CH. 3 - SAS 99
What risk factors might be caused by Industry conditions?
1. Profits lag in the industry
2. New requirements potentially impair stability or profitability
3. Saturated market/fierce competition
4. Declining industry
5. Rapidly changing industry
CH. 3 - SAS 99
What risk factors might be caused by Operating characteristics?
1. Weak internal control environment
2. Cash flow problems / Pressure to raise capital
3. Complex accounting measurement and presentation issues
4. Significant related-party transactions
5. Inexperienced accounting personnel
CH. 3 - SAS 99
What is involved in Step 3 of assessing fraud risks?
1. Type of risk
2. Significance of risk
3. Liklihood of risk
4. Pervasiveness of risk
5. Controls and programs in place to prevent and detect fraud
CH. 3 - SAS 99
** What are the required risk assessments?
1. Audit team must presume that IMPROPER REVENUE RECOGNITION is a fraud risk.
2. Identify risks of MANAGMENT OVERRIDE OF CONTROLS. (Examine journal entries, Review accounting estimates, Evaluate business rationale for unusual transactions)
CH. 3 - SAS 99
What are the responses to assessed risks?
1. Change in assignment of personnel to the audit team
2. Change in extent, focus and nature of audit procedure
3. Change in predictability of auditing procedures
4. Examine journal entries
5. Review of prior year acct estimates
6. Surprise inventory counts
7. Count the petty cash twice in 1 day
8. Contract confirmations
CH. 3 - SAS 99
To whom do you communicate evidence of fraud existence?
1. Appropriate level of MANAGEMENT
-- If MATERIAL: Audit committe
-- If IMMATERIAL: to one level above
(any fraud committed by management is MATERIAL!!)
CH. 3 - SAS 99
What is documented in regards to Fraud Matters?
1. Discussion of fraud consideration by engagement team.
2. Procedures to identify and assess risk.
3. Specific risks identified and auditor responses
4. Results on procedures regarding management override.
5. Anything else that leads to more audit work
6. Communication to management and audit committee
CH. 3 - SAS 99
What are the auditors' responsibilities in Direct-effect illegal acts?
Require the same ASSURANCE AS FRAUDS AND ERRORS
CH. 3 - ILLEGAL ACTS
What are the auditors' responsibilities in Indirect-effect illegal acts?
Do not carry the same responsibility for detection and reporting as direct-effect, but the auditor should have a general awareness that these types of acts can have an effect on the F/S (esp related to contingent liabilities)
CH. 3 - ILLEGAL ACTS
What are some red flags of potential Illegal acts?
1. Unauthorized transactions
2. Government investigations
3. Regulatory reports of violations
4. Payments to consultants
5. Excessive sales commissions
CH. 3 - ILLEGAL ACTS
What are the auditor's Risk Assessment procedures?
1. Inquiries of Managements and Others
2. Analytical Procedures
3. Observation and Inspection
CH. 3 - SAS 99
What MIGHT the Auditor's response be to pervasive financial statement risk?
1. Emphasize to the Audit team the need to maintain PROFESSIONAL SKEPTICISM
2. Assign more EXPERIENCED STAFF or those with specialized skills
3. Provide more SUPERVISION
4. Incorporate additional elements of unpredicatability in the selection of audit procedures.
CH. 3 - AUDIT RISK
What is MATERIALITY?
The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement. (Emphasis is on USER, rather than management or audit team)
- MATERIALITY IS A MATTER OF PROFESSIONAL JUDGMENT.
CH. 3 - MATERIALITY
What are the Qualitative criteria in Materiality?
- Nature of the item or issue
- Circumstances
- Uncertainty
CH. 3 - MATERIALITY
What are the Quantitative criteria in Materiality?
- Absolute size
- Relative size
- Cumulative effects
CH. 3 - MATERIALITY
What are the steps in applying Materiality of an Audit?
1. Determine a materiality level for the overall financial statements (planning materiality) -- Quantitative base = 3 to 5 % of Total revenues, Gross profit, Income before taxes, Total assets, etc.
May be adjusted lower for qualitative factors.
2. Determine a tolerable misstatement (allocation of materiality at individual account/class of transactions level)
3. Evaluate auditing findings (near the end of the audit)
CH. 3 - MATERIALITY
What is tolerable misstatement?
- The amount of planning materiality allocated to an account or class of transactions.
- Combined tolerable misstatement is generally greater than planning materiality because:
---- Not all accounts will be misstated by their full tolerable misstatement allocation
---- Audits of individual accounts are conducted at the same time
---- When errors are identified, more testing is performed in that account and related accounts
---- Overall materiality serves as a "safety net"
CH. 3 - MATERIALITY