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Summary - Auditing: A Risk Based-Approach
1 Quality Auditing: Why it Matters
From which factors does the need for independent assurance arises?- Potential bias
Potential biasManagement might have incentives to bias financial information to convey a better impression of the financial data than circumstances would merit.
RemotenessAn organization and the users of its financial information are often remote from each other, both in terms of geograpich distance and the extent of information available to the both parties. Most users must rely on financial statements to communicate the results of management's performance. These factors can tempt management to keep information from users or bend GAAP so the organization looks better.
ComplexityTransactions, information, and precessing systems are often very complex, so it can be difficult to determine their proper presentation. This factor provides an opportunity for management to mislead users.
ConsequencesWhen financial information is not reliable, investors and other users lose a significant source of information tat they need to make decisions that have important consequences.
Independence, often referred to as the cornerstone of the auditing profession, requires objectivity and freedom from bias.
Audtitors must be independent in fact and independent in appearance.
Financial Statement AuditA financial statement audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria; and communicating the results to interested users.
Unqualitfied audit reportWhen the auditor had no objections about management's financial statements or internal controls, the auditor issues an unqualified audit report.
Adverse opinionIf the auditor had reservations about the effectiveness of the client's internal controls, the auditor would issue an adverse opinion on internal controls.
Which parties are involved in preparing and auditing financial statements and related disclosures?- Management: preparing and presenting FS; designing, implementing and maintaining internal control over financial reporting; providing auditors with information relevant to FS and IC
- Internal audit function: provides internal assurance on internal controls and reports
- Audit committee: oversees both management and the internal auditors; they also hire and oversee the external auditors
- External auditer: provides independent audit of internal controls and financial statements.
Organizational hierarcy of audit firms1. Partners
4. Staff auditors
Which skills do auditors need?Technical knowledge, leadership, teamwork, communication, decision-making, critical thinking and general professionalism.
What is a quality audit?An audit performed in accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are 1) presented in accordance with GAAP and 2) are not materially misstated whether due to errors and fraud.
What are, according to the Financial Reporting Council's Audit Quality Framework, the five primary drivers of audit quality?1. Audit firm culture
2. The skills and personal qualities of audit partners and staff
3. The effectiveness of the audit process
4. The reliability and usefulness of audit reporting
5. Factors outside the control of auditors that affect audit quality.
AICPA Principles of Professional Conduct- Responsibilities
- Public interest
- Objectivity and independence
- Due care
- Scope and nature of services
Steps of the Conceptual FrameworkSee book
ThreatsThreats are circumstances that could result in an auditor lacking independence in fact or in appearance
Threats to independence1. Self-review threat
2. Advocacy threat
3. Adverse interest threat
4. Familiarity threat
5. Undue influence threat
6. Self-interest threat
7. Management participation threat
SafeguardsSafeguards are actions or other measures that may eliminate a threat or reduce a thereat to an acceptable level
What do these safeguards include?1. Safeguards created by the profession, legislation or regulation (e.g. education, standards, external review, independence requirements, audit partner rotation)
2. Safeguards implemented by the audit client (e.g. policies and procedures to encure accurate financial reporting, appropriate relationship with auditor and appropriate tone at the top)
3. Safeguards implemented by the audit firm (e.g. quality-control policies and procedures, leadership, monitoring processes, rotation of senior egagement personnel)
The Independence RuleThe Independence Rule requires that a memeber in public practice be independent in the performance of professional services as required by standards promulgated by bodies designated by the AICPA.
What can influence the Independence Rule?- Financial Interest
- Employment of family members
- Performance of other nonaudit services
- Network firms
An important point concerning the Independence Rule is that it only applies to a covered member
Auditors and their immediate family should not have any direct or material indirect financial interest in that client.
Direct financial interestA direct financial interest is a financial interest owned directly by or under the control of, an individual or entity or beneficially owned tourgh an investment vehicle, estate, or trust when the beneficiary conrols that intermediary or has the authority to supervice or perticipate in the intermediary's investment decisions.
What are the two related, but distinct, public policy goals which the independence requirements serve?1. One goal is to foster high-quality audits by minimizing the possibility that any eternal factors will influence the auditor's judgments
2. The other related goal is to promote investor confidence in the financial statements of public companies.
According to the four basic principles of the SEC statements on independence, the independence of the auditor is impaired when the auditor has a relationship that:1. Creates a mutual or conflicting interest between the accountant and the audit client
2. Places the accountant in the position of auditing his or her own work
3. Results in the accountant acting as management or an employee of the audit client
4. Places the accountant in a position of being an advocate for the audit client
What are the additional requirements for professional conduct for auditors of public companies- Preapproval of services
- Fee disclosures
- Audit partner rotation
- Prohibited services (e.g. bookkeeping, financial information system inplementation and design, management functions, legal services unrelated to the audit, actuarial services etc)
What are the five fundamental principles of the Code of Ethics for Professional Accountants of the IESBA?- Integrity
- Professional Competence and Due Care
- Professional Behavior
Professional SkepticismProfessional Skepticism is an attitude that includes a questioning mind and a critial assessment of audit evidence. By exerciing professional skepticism, auditors are less likely to overlook unusual circumstances, to overgeneralize from limited audit evidence or to use inappropriate assumptions in determining the nature, timing and extent of audit procedures.
What is a difficulty auditors face when exercising professional skepticism?Being human: we trust others and accept information and assertions as truth. Further, if an auditor did not rust management, that auditor would presumably cease to perform audit services for that client.
How can audit firms be sure that they maintain and exercise appropriate professional skepticism?- Training on how to be skeptical
- Create firm policies and procedures to encourage skepticism
When does an ethical dillemma occurs?An ethical dillemma occurs when there are confliciting moral duties or an individual is ethically required to take an action that may conflic with his or her immediate self-interest.
Utilitarian theoryUtilitarian theory hols that what is ethical is the action that achieves the greatest good for the greates number of people. Actions that reult in outcomes that fall short of the greatest good for the greates number and those that represent inefficient means to accomplish such ends are less desirable.
What does utilitarian requires?- An identification of the potential problem and possible course of action
- An identification of the potential or direct impact of actions on each affect party who may have a vested interest in the oucome of actions taken
- An assessment of the desirability (goodness) of each action
- An overall assessment of the grates good for the greatest number
Right theoryRights theory focuses on evaluating actions based on the fundamental rights of the parties involved. However, not all rights are equal. In the hierarchy of rights, higher-order rights take precedence over lower-order rights.
What does the rights theory requires?It requires that the 'rights'of affected parties be examined as a constraint on ehical decision making.
Ethical decision making framework1. Identify the ethical issue(s)
2. Determine the affected parties and identify their rights
3. Determine the most important rights
4. Develop alternative courses of actions
5. Determine the likely consequences of each proposed course of action
6. Assess the possible conseuqences
7. Decide on the approprate course of action
What are the three things that can happen in the beginning-of-period client portfolio?- Client-initiated departures
- Client continuance decisions
- Client acceptance decisions
Which evaluation is important by client continuance decisions and client acceptance decisions?- Risk
- Audit fees
Types of key risks- Clients entity characteristics: e.g. history of earnings management
- Independence risk factors: e.g. Audit engagement partner has a business relationship with the client CEO
- Thirt-party/due diligence risk factors: e.g. reason for changing auditors is negative relationships between the client and the previous auditor
- Quantitative risk factors: e.g. client is in significant distress
- Qualitative risk factors: e.g. client's business model is weak
- Entity organizational or governance risk: e.g. client management lacks integrity
- Financial reporting risk: management records unusual transactions at the end of each quarter
Auditors should provide aut services only when the preconditions for an audit are present. These preconditions are:- Management's use of an acceptable financial reporting framework
- The agreement of management that it acknowledges and understands its responsibilities
What does the engagement letter includes?- The objective and cope of the audit of the FS
- The responsibilities of the auditor
- The responsibilities of management
- A statement that because of the inherent limitations of an audit, together with the inherent limitations of internal control, an unavoidable risk exists that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with reelvant auditing standards
- The identificant op the applicable financial reporting framework for the preparation of the FS
- A reference to the expected form and content of any reports to be issued by the auditor and a statement about circumstances that may arise in which a report may differ from its expected form and content
Indirect financial interestAn indirect financial interest occurs when the beneficiary neither controls the intermediary nor has the authority to supervise or participate in the intermediary's investment decisions. The concept is that a covered member may have some limited financial interest in clients as long as the interest are not direct and not material.
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What's the greatest risk of the cutoff period?
The greatest risk is that transactions are being recorded in the wrong period.
The cutoff period is usually several days before and after the balance sheet date.
The period between the interim date and the balance sheet date.
A negative confirmation asks the customer to review the balance owed to the client, but requests the customer to respond directly to the auditor only if the customer disagees with the indicated balance.
Positive confirmations are correspondence sent to a sample of customers, asking them to review the current balance or unpaid invoice(s) due to the client and return the letters directly to the auditor indicating whether they agree with the balance. If the customer does not return a signed confirmation, the auditor needs to use follow-up audit procedures to verify the existence of the customer's balance.
Revenue: cutoff issues
Additional audit attention should be given to sales transactions recorded just before and after year-end.
Revenue: completeness assertion
In testing the completeness assertion, the auditor expects the client to have used prenumbered shipping and billing documents. He selects a sample and trace them into the sales journal to obtaine vidence on whetehr the client has recorded all shipments as sales transactions in accordance with the revenue recognition accounting standards.
Revenue: existence and valuation assertions
The existence and valuation assertions are usually the most relevant for revenue accounts. Vouching a sample of recordes sales transactiosn back to customer orders and shipping documents provides support for the eistence assertion.
What are the two potential outcomes of the tests of controls?
1. Control deficiencies: the auditor will assess those deficiencies to determine their severity. The auditor would then modify the preliminary control risk assessment and document the implecations of the control deficiencies.
2. No control deficiencies: the auditor will likely determine that the preliminary assisment of control risk as low is still appropriate.
What are the steps in planning analytical procedures?
1. Identify suitable analytical procedures
2. Evaluate reliability of data used to develop expectations
3. Develop expectations
4. and 5. Define and identify significant unexpected differences
6. and 7. Investigate significant and unexpected differences and ensure proper documentation