Auditing, Ch. 3/ Fr. Louwers 4E

Front 1

Errors

Back 1

Unintentional

Front 2

Fraud

Back 2

Knowingly making material misstatements

Front 3

Management Fraud

Back 3

Deliberate fraud committed by mgmt. that injures investors and creditors through materially misleanding information.

Front 4

7 Steps to considering Risk of Fraud

Back 4

1) Audit Team Discussion; 2) ID info. necessary to assess Fraud Risk Factors; 3) ID and assess Fraud Risks; 4) Respond to Risk Assess.; 5) Evaluate Audit Evidence; 6) Communicate Fraud matters; 7) Document Fraud Matters

Front 5

Step 1: Audit Team Discussions (Brainstorming)

Back 5

Previous experience w/ client; how fraud might be perpetrated; and procedures that might detect fraud. Begin w/ planning phase but continue throughout the engagement.

Front 6

Step 2: ID information necessary to asses fraud risk factors

Back 6

Try to ID red flags by gathering necessary information, obtained through mgmt., internal auditors or other key employees.

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Step 3a: ID Risk Factors Related to Fraudulent Financial Reporting

Back 7

Misleading statements through: 1) OS revenues and assets; 2) US expenses and liabilities; 3) giving disclosures that are misleading or that omit important info.

Front 8

Step 3b: Assess Fraud Risks

Back 8

The likelihood that fraud has occurred, the magnitude of the fraud risk; the pervasiveness of the potential for fraud.

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Step 4: Respond to Assessed Risk

Back 9

Implement extended procedures: include more experienced team members if fraud risk is high; examine more trans.; perform more tests at Y/E; gather higher quality evidence.

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Step 5: Evaluate Audit Evidence

Back 10

F/U w/ mgmt. on any conflicting evidence, discrepancies or missing docs. Mgmt's response is key.

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Step 6: Communicate Fraud Matters

Back 11

Misappropriations by employees at low levels should be reported to mgmt. at least one level above the people involved. Frauds involving senior mgmt. should be brought to the audit committee's attn.

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Step 7: Document Fraud Matters

Back 12

Provide a record of the procedures performed: Discussions of engagement personnel, to ID and assess risk; audit team responses to risks ID; communication to mgmt.

Front 13

Auditors responsibility to Illegal Acts (2 types)

Back 13

1) Direct-effect illegal acts produce direct, material effects on financial statements; 2) indirect-effect illegal acts refer to violations of laws and regulations that are far removed from financial statement effects

Front 14

Information Risk

Back 14

Probability that the information distributed by the entity will be materially false or misleading as a result of errors, fraud or direct-effect illegal acts.

Front 15

Audit Risk

Back 15

The probability that an audit team will expreess an inappropriate audit opinion when financial statements are materially mistated.

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Types of Audit Risk

Back 16

1) Inherent Risk: a material misstatement occurs; 2) control risk: not prevented or detected by entity's ICs; 3) Detection Risk: is not detected by auditor's procedures.

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Audit Risk Formula

Back 17

AR = IR * CR * DR; perform an audit well enough to keep AR to about 5%.

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Detection Risk

Back 18

Detection Risk depends on the other risks. DR = AR/(IR * CR)

Front 19

Risk of Material Misstatement (RMM)

Back 19

Control and Inherent risk b/c auditors have little control over them. RMM = IR * CR

Front 20

Matrix Approach to Detection Risk

Back 20

Goes hand in hand with materiality. IR in rows; CR in columns. Match low/mod/high IR w/ low/mod/high CR.

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Materiality Judgment Criteria

Back 21

Absolute Size; relative size; Nature of item or issue; circumstances; Cumulative Effects

Front 22

Materiality Judgment Criteria: Absolute Size

Back 22

Pick a number. It may not mean the same thing to all companies; some say $1M is material NMW

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Materiality Judgment Criteria: Relative Size

Back 23

Percentage used

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Materiality Judgment Criteria: Nature of the item or issue

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Qualitative Factor that is descriptive in nature of the item or issue.

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Materiality Judgment Criteria: Circumstances

Back 25

How the financial statements will be used: eg, widely, politically, foreign countries. Also amounts that can change the company from a loss to a profit.

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Materiality Judgment Criteria: Cumulative Effects

Back 26

Auditors must evaluate the sum of known or potential missatements.

Front 27

Audit Evidence: Inspection of Records and Documents

Back 27

prepared by outsiders, prepared internally.

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Inspection of Records and Documents: Vouching

Back 28

Goes backwards from GJ to its origin/completeness

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Inspection of Records and Documents: Tracing

Back 29

A basic source document that follows its processing path forward to the journal or ledger.

Front 30

Inspection of Records and Documents: Scanning

Back 30

Scan documents looking for any unusual items and events.

Front 31

Audit Evidence: Inspection of Tangible Assets

Back 31

examining PPE, inventory, and securities certificates.

Front 32

Audit Evidence: Observation

Back 32

the physical inspection of inventory, auditors view clients physical facilities and personnel on an inspected tour.

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Audit Evidence: Inquiry

Back 33

collection of oral evidence from indpend. 3rd parties and mgmt.

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Audit Evidence: Confirmation

Back 34

by direct correspondence w/ indpend. 3rd parties. Existence and ownership evidence.

Front 35

Audit Evidence: Recalculation

Back 35

mathematical evidence. Can be done using CAATs.

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Audit Evidence: Reperformance

Back 36

Broader than recalculation. Involves any client control procedure such as matching vendor invoices w/ supporting PO and receiving reports.

Front 37

Audit Evidence: Analytical Procedures

Back 37

Evaluate financial statement accounts by studying and comparing relationships among financial and nonfinancial data.

Front 38

Audit Plan

Back 38

List of audit procedures that the audit team needs to perform to gather sufficient appropriate evidence on which to base their opinion.

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Internal Control Audit Plans

Back 39

contain the specification of procedures for obtaining and understanding of the client's business and internal control and for assessing the IR and the CR related to the financial acct. balances and classes.

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Substantiive Audit Plans

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contain specification of substantive procedures for gathering direct evidence on mgmt's assertions.

Front 41

Accounting Cycles

Back 41

1) Revenue and Collection; 2) Acquisition and expenditures cycle; 3) productiton and conversion cycle; 4) finance and investment cycle.