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78 Cards in this Set

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What is the first generally accepted auditing standard?
The auditor must adequately plan the work and must properly supervise assistants.
What are the 3 main reasons why the auditor should properly plan engagements:
1. To enable the auditor to obtain sufficient appropriate evidence for the circumstances
2. To keep audit costs reasonable
3. To avoid misunderstandings iwth the client.
Why must auditors have sufficient and appropriate evidence?
This is essential if the CPA firm wants to minimize legal liability and maintain a good reputation in the community.
What does keeping audit costs low do?
Helps the firm remain competitive.
How does avoiding misunderstandings with the client help?
It is necessary for good client relations and for facilitating high-quality work at reasonable cost.
What are the 2 types of risks in an audit?
Acceptable audit risk
Inherent audit risk
How do the 2 types of audit risk affect an audit?
These 2 risks significantly influence the conduct and cost of audits. Much of the early planning of audits deals with obtaining information to help auditors assess these risks.
What is 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. When the auditor decides on a lower acceptable audit risk, it means that the auditor wants to be more certain that the financial statements are NOT materially misstated. Zero risk is certainty and 100% risk is uncertainty.
What is inherent audit risk?
Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements in an account balance before considering the effectiveness of material misstatements in accounts receivable due to changing economic conditions, the auditor concludes that the inherent risk is high.
Why is determining acceptable audit risk and inherent risk important?
Because it helps determine the amount of evidence that will need to be accumulated and staff assigned to the engagement.
What 4 things does initial audit planning involve?
1. The auditor decides whether to accept a new client or continue serving an existing one. Decision typically made by an experienced auditor.
2. Auditor identifies why client wants/needs an audit.
3. To avoid misunderstandings, 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.
What causes a CPA firm to turn down a company requesting an audit?
The firm's legal and professional responsibilities are such that clients who lack integrity or argue constantly about proper conduct ofthe audit and fees can cause mor problems than they are worth. Some CPA firms now refuse clients in high-risk industries such as software technology companies, health, and casualty insurance companies.
What is stated in the terms of acceptable audit risk?
An auditor is unlikely to accept a new clcient or continue serving and existing client if acceptable audit risk is below the risk threshold the firm is willing to accept.
New client investigation
Before accepting a new client, most CPA firms investigate the co. to determine its acceptability. They do this by examining the prospective client's standing in the business community, financial stability, and relations with previous CPA firm.
Before taking on a client the CPA firm must ensure they have individuals who
Are competnet and have industry knowledge to accept the engagement and ensure they meet all independence requirements.
If a company has been previously audited by another CPA form what are they required to do by auditing standards?
If they have been audited the auditor is required to communicate with the predecessor auditor. This requirement is to help the successor evaluate whether to accept the engagement.
When a CPA firm is contacting a previous auditor what happens?
The burden of initiation rests with the successor auditor. The predecessor is required to respond to the request for info. However, due to confidentiality requirements they must obtain permission from the client before any communication may take place. In the event of unusual circumstances such as legal problems or disputes between the client and the predecessor, the predecessor's response can be limited to stating that no info can be provided.
In extreme cases before taking on a client what can a CPA firm do to accumulate evidence about a company?
They can gather info from local attorneys, other CPAS, banks, and other businesses. In some cases they may hire a professional investigator to obtain info about reputation and background of key members of management. This is appropriat when no previous auditor or when they refuse to provide info or if there are any type of communication problems.
What do CPAs do every year with regards to continuing clients?
MAny CPA firms evaluate existing clients annually to determine whether there are reasons for not ocntinuing to do the audit. Previous conflicts over the appropriate scope of the audit, the type of opinion to issue, unpaid fees, or other matters may cause the auditor to discontinue the relationship. Also if they determine the client lacks integrity they may discontinue relationship.
Can an auditor dismiss a client due to excessive risk?
YES
What is an essential part of deciding acceptable audit risk for new and old clients?
Investingating.
What does an audit with low acceptable audit risk result in?
This normally causes higher audit costs which should be reflected in higher audit fees.
What are 2 major factors affecting acceptable audit risk?
1. The likely statement users
2. Their intended uses of the statements.
When does the auditor need to accumulate more audit evidence?
When statements are to be used extensively, as is the case for publically held companies, those with extensive indebtedness, and companies that are to be sold in the near future.
How do auditors determine the likely uses of the financial statements?
The likely use can be determined from previous experience with the client and discussions with management. If they get additional information during the engagement they can affect the auditor's acceptable audit risk.
In order to have a successful audit what must you do with the client?
You must have a clear understanding of the terms of the engagement.
Where do auditors document their understnaing with the client?
In an engagement letter
What information should an engagement letter include?
IT should include engagement objectives, the responsibilities of the auditor and of management, and management limoitation. Often includes an agreement on fees.
What are some terms an engagement letter may include?
They may include info such as agreement to provide other services such as tax returns or management consulting allowed under the Code of Professional Conduct and regulatory requirements. It should also state any restrictions to be provided by the client's personnel in obtaining records and documents and schedules to be prepared for the aditor Often includes agrement on fees. Informs the client that the auditor cannot gurantee that all acts of fraud will be discovered.
What does the letter of engagement inform the client of?
nforms the client that the auditor cannot gurantee that all acts of fraud will be discovered.
Why is engagement letter info important for planning the audit?
Because it affects the timing of the tests and the total amount of time the audit and other services will take. Client imposed restrictions on the audit can affect the procedures performed and possibly even the type of audit opinion issued.
What does the audit strategy do?
It considers the nature of client's business and industry, including areas where there is greater risk of significant misstatements.
What does the planning strategy help the auditor do?
Determine the resources required for the engagement including engagement staffing.
What does the first general auditing standard state?
The auditor must have technical training and proficiency to perform the audit.
Who is involved when a large audit is done?
When a large audit is conducted, more partners and staff at several experience levels are required. Individuals in multiple offices of the firm may be included, including offices outside the U.S. if the client has numerious locations worldwide. In smaller audits only 1-2 people needed/
What is a major staffing consideration?
A major consideration in staffing is the need for continuity from year to year. Continuity helps the CPA firm maintain familiarity with the technical requirements and closer interpersonal relations with client personnel. An inexperienced audit staff assistant is likely to become the most experienced nonpartner on the engagement within a few years.
Evaluate the need for outside specialists
If the audit requires specialized knowledge, it may be necessary to consult outside specialists. Auditing standards establish the requirements for selecting specialists and reviewing their work. Example diamond experts, consulting with attorneys on legal interpretation of contracts ect.
What must the auditor have to recognize when a specialist is needed?
An auditor must have a sufficient understanding of the client's business to recognize whether a specialist is needed.
When selecting outside specialists to work on an audit what must the auditor consider?
The auditor needs to evaluate the specialist's professional qualifications and understand the objectives and scope of the specialist's work. Auditor should also consider specialist's relationship to the client, including circumstances that might impair the specialist's objectivity.
What effect does using an outside specialist have on the audit report?
The use of a specialist doesn't affect the auditor's responsibility for the audit and the audit report should not refer to the specialist unless the specialist's report results in a modification of the audit opinion.
What does the second standard of fieldwork state?
The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of financial statements whether due to error or fraud, and to design the nature, timing, and extent of future audit procedures.
What effect does tha nature of client's business and industry have?
IT affects audit risk a
What factors have increased the importance of understanding the client's business and industry?
1. Declines in economic conditions
2. IT connects clients to customers and suppliers.
3. Clients have expanded globally
4. IT affects client processes improving quality and imteliness of acceounting info.
5. Increased importance of human capital and other intangible assets increase the accounting complexity and importance of management judgements and estimates.
6. Many clients investigate in complex financial instruments which may create financial risks
What are the 3 primary reasons for obtaining a good understanding of the client's industry and external environment?
1. Risks associated with specific industries may affect the auditor's assessment of client business risk and acceptable audit risks
2. Many inherent risks are common to all clients in certain industries. FAmiliarity with those risks aids the auditor in assessing their relevance to the client.
3. Many industries have unique aaccounting requirements that the auditor must understand to evaluate whether the client's financial statements are in accordance with accounting standards.
What can risks associated with specific industries affect?
May affect auditor's assessment of client business risk and acceptable audit risk. May also influence auditors against accepting engagements in riskier industries, such as financial services and health insurance industries.
What are some risks that could be inherent to clients in certain industries?
Potential inventory obsolesence in the fashion clothing industry, accounts receivable collection inherent in cosnumer loan industry, and reserve for loss inherent risk in the casualty insurance industry.
What are some industries which have unique accounting requirements?
If the auditor is doing an audit of a city government, they must understand governmental accounting and auditing reequirements.
If an auditor fails to fully understand the nature of transactions in the client's industry what is the result?
Many auditor litigation cases result from this.
What are things that can affect the client's external environment
volatility in economic conditions, extent of competition, and regulatory requirements.
What must the auditor understand about business operations and processes?
Must understand factors such as major sources of revenue, key customers and suppliers, sources of financing, and info about related parties that may indicate areas of increased client business risk. Many IT firms are dependent on one or a few products. If these products becoe obsolete due to new technologies or new competitors may result in major losses from obsoltet inventory.
Why is it important to tour a client's facilities and business operations?
A tour is helpful in obtaining a better understanding of the client's business operations because it provides an opportunity to observe operations firsthand and meet key personnell. By observing physical facilities the auditor can assess physical safeguards, interpret accounting data related to assets such as WIP and equipment. WIth such first hand knowledge, the auditor is better able to identify inherent risks, such as unused equipment or potentially unsalable inventory.
What is a related party?
An affiliated company, a principal owner of the client company, or any other party with which a client deals where one of the parties can influence the management or operating policies of the other.
What is a related party transaction?
A transaction between the client and a related party. CAn be purchase transactions between parent co and subsidiary, exchange of equipent between 2 companies owned by the same person, or ect.
Why are related party transactions risky?
Because a risk is that it may not be valued at the same amount as a transaction with an independent 3rd party.
What are the 2 reasons auditors consider related party transactions high in inherent risk?
BEcause of the accounting disclosure requirements and because of the lack of independence between parties involved in the transactions, and the opportunities they have to provided to engage in fraudulent financial reporting.
Because materially related party transactions must be disclosed an auditor must
identify and include all related parties in the auditor's permanent file early in the engagement. Discloseure requirements include that the nature of the related party relationship must be disclosed as well as a description of transactions, including dollar amounts; and amounts due from and to related parties.
What does Sarbanes Oxley act say of related party transactions?
Becaue of lack of independence SOX prohibits related party transactions that involve personal loans to any director or executive officer of a public company.
What should an auditor do in regards to a company's management and governance?
Because management establishes a company's strategies and business processes, an auditor should asses management's philosophy and operating style and its ability to identify and respond to risk.
What did Fraudulent Financial Reporting 119-2007 find?
They found that in over 340 instances of fraudulent financial reporting investigated by the SEC, the CEO or CFO was named as involved in perpetrating the fraud.
What is a firm's governance?
Includes a firm's organizational structure as well as the activities of the BOD and the audit committee/
What does an effective BOD do?
They ensure that the company takes only appropriate risks, while the audit committee, although oversight of financial reporting can reduce the likelihood of overly aggressive accounting.
WHat must the auditor do to understand a company's governane system?
To gain an understanding of the client's governance system, the auditor should understnad how the BOD and audit committee exercise oversight, including consideration of the company's code of ethics and evaluation of the corporate minutes.
What are corporate minutes?
They are the official record of the meetings of the BOD and stockholders. They include key authorizations and summaries of the most important topics discussed at these meetings and the decisions made by the directors and stockholders. Common authorizations in the minutes include compensation of officers, new contracts and agreements, acquisitions of property loans, and dividend payments.
What should the auditor do with corporate minutes of a company?
They should read the minutes to obtain authorizations and other info relevant to performing the audit. THis info should beincluded in the audit file. Before it is complete the auditor must follow up with this info to ensure management compiled with actions taken by stockholder and BOD. Auditors often supplemet their review of minutes with inquiries of audit comittee or full board memebers about their awareness of events that might affect financial reporting.
Auditors should understand client objectives related to
1. Reliability of financial reporting
2. Effectiveness and efficiency of operations
3. Compliance with laws and regulations
What does knowledge of client objectives and strategies help the auditor do?
DEspite management's best efforts, business risks arise that threaten management's ability to achieve its objectives. As a result knowledge of client objectives and strategies help the auditor assess client business risk andinherent risk in the financial statements.
What should an auditor be familiar with in understnading clien't compliance with laws and regulations
Should become familiar with the terms of client contracts and other legal obligations.
What does a client's performance measurement system include? Examples?
Key performance indicaters that management uses to measure progress toward its objectives. Examples include market data, sales per employee, unit sales growth, unique visitors to a web site, same store sales by country, and sales per square foot for a retailer.
How can inherent risk of financial statement misstatement be increased by performance and measurement?
IF the co has set unreasonable objectives or if performance measurement system encourages aggressive accounting.
What does performance measuremnet include?
Benchmarking and ratio analysis. AS part of understnading the clien'ts business, auditor should perform ration analysis or review client's calculations of key performace ratios.
Client business risk
The risk that client will fail to achieve objectives.
What do client business risk factors arise from?
These factors can arise from any factors affecting the client and its environment, such as significant declines in the economy that threaten the client's cash flows, new technology eroding a client's competitive advantage, or a client failure to execute its strategies as well as its competitors.
What does an auditor's assessment of client business risk consider
It considers the client's industry and other external factors, as well as the client's business strategies and processes and other internal factors. Auditor also considers management control that may mitigage business risk, such as effective risk assessment practices and corporate governance.
What is management's role if identifying client business risk?
They are the primary source for identifying these risks.
What should management do in public compaies in assessing business risk?
They should conduct thorough evaluations of relevant client business risks that affect financial reporting to be able to certify quarterly and annual financial statements and to evaluate the effectiveness of disclosure controls and procedures required by SOX.
What does SOX require managers to certify in regards to business risk?
SOX requires managemnet to certify that it has designed disclosure controls and procedures to ensure that material info about business risks are communicated to management and disclosed to external stakeholders, such as investors.
What should procedures capture?
Sould capture info relevant to assess the need to disclose developments and risks that pertain to the company's business. If a subsidiary engages in significant hedging activities, controls should exist so that top management is informed of and discloses this information. Inquiries of management about client business risks it has identified.
What does SOX require in regards to internal controls?
REquires management to certify that it has informed audit committee of any deficiences in internal control. This info allows auditors to figure out how internal controls may affect likelihood of material misstatements in financials.