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Auditing ACC0048 Review Assignment

The following audit review assignment is intended to help you study for the next mid-term test on April 26th, 2011. I will provide you with class time in order to complete much of the assignment. You will need to bring your textbook to class (yes you will actually have to open it once more!) in order to answer the following questions: Chapter 6: 1. What procedures would an audit firm undertake to determine whether or not to accept a client or not? What are some reasons that an auditor may not continue audit engagements? Answer: Before beginning an audit, auditors undertake two types of activity. a. Risk Management: Auditors try to reduce the risk (Probability of something going wrong) by carefully managing the engagement. b. Quality Management: Auditor Manage audit in accordance with quality control standard. Client acceptance or retention procedure should include. i. Make sure you are independent ii. Get knowledge of the client iii. Obtaining and reviewing of financial information about client iv. Evaluation of competency and resources Reasons for not continuing: - When the auditor finds himself not independent from the client - When the client sue the auditor for any reason - When the auditor found mistake in the financial statement and is not able to correct it. 2. The engagement letter forms the basis of a contract between the auditor and its client. What are the basic elements of an engagement letter? Answer: An engagement letter is a contract between the auditor and client; written about the deadline, auditor’s responsibility and the client’s responsibility. The basic element of the engagement letter is: - Standard require the auditor and management to agree on the terms of the audit engagement and the auditor’s fee - An engagement letter can head off claims that the auditors did not perform the work promised. - A new engagement letter should be obtained every year of a continuing audit 3. Why does the auditor attempt to understand the client’s business? Answer: a. To know the risk of the company, and help the audit plan, the type of audit risk we are facing b. In order to design an effective audit, auditors must understand the business and the economic environment of the business including factors such as: i. National economic condition and policies ii. Geographic location

Study the relationships of current year balances to relevant nonfinancial information 5.iii. Ratios: current ratio. Lowest dollar of amount that affects the decision making on the financial statement and that the users can tolerate it. What are five different types of analytical procedures that an auditor will perform on the financial statements? Briefly describe each one. Development in taxation and regulation Specific industry characteristics 4. Answer: a. sales vs assets or Inventory vs. and the company’s anticipated results b. What are some examples of distress ratios? Answer: a. 5-10% of income from continuing operations (should be normalized or averaged before using) b. Debt Ratio. ½ to 2% of revenues or expenses for non-for profit entities d. gross margin ratio. 5-10% of net income before bonus c. Why does the auditor use preliminary analytical procedures at the planning phase of an audit? Answer: a. information to financial information. Page 214 on the book. 6. Materiality is the largest amount of uncorrected misstatement that might exist in financial statements that still fairly present the company’s financial position and results of operation 8. Current to budget or industry. Define the term materiality. Answer: a. Vertical: compare 1 year financial statement balance to another balance. Gross Margin Ratio. Evaluate the relationships of current year balances to other current year balances for conformity to predictable patterns d. or e. User related factors . Non. What other factors should be considered after quantitative calculations when determining materiality? Answer: a. Working capital over total asset. Actual to Budget. Horizontal: Compare the numbers and ratios of 1 year to other years b. 1% of revenue for the real estate industry. Current ratio. 9. To compare the current Year’s account balances to the years before. d. Compare the current year’s account balances and financial relationship with similar information for the auditee’s industry c. retained earnings over 7. b. e. COGS for same year c. ½ to 1% of net asset value for the mutual fund industry. Current to non-financial. What are the quantitative benchmarks used by auditors to determine an auditee’s materiality? Answer: a. Acid Test Ratio.

Inherent Risk: The probability of material misstatement occurring in transactions entering the accounting system or being in the account balances is inherent risk. . Answer: a. Components of audit risk: . liability. 2. Answer: a. Materiality refers to the magnitude of a misstatement. What is audit risk and what are the components of audit risk? Describe each one briefly. . . liabilities. d. Chapter 7: 1. Ownership: Establish with the evidence that the amounts reported as assets of the company represent property rights and the amounts reported as liabilities represent obligations c. What are the five main financial statement assertions made by management? Briefly describe each one in your own words.Control Risk: Control risk assessment provides only an indirect assessment of monetary misstatements in the financial statements. c. b. Presentation/ Disclosure: Determine whether the accounting principles are properly selected and applied and whether disclosures are adequate. Existence/Occurred: it means that assets. b. Audit risk is the probability that an auditor will fail to express a reservation that financial statements are materially misstated. Revenue and expenses transactions actually occurred as of a proper date. Promote operational efficiencies c. e. How are materiality and audit risk related? If the IR and CR are too high how would an auditor control this? Answer: a. Completeness: Establish with evidence that all transactions and accounts that should be presented in the financial reports are actually included d. To asses adherence to management policy b.b. revenues and expenses. and equity actually exist. Nature of the item or issue Other circumstances Effect on share price 10. Auditor cannot control IR and CR. We have to lower the materiality to detect the risk. What is the purpose of management’s controls? Answer: a. Audit risk is related to information risk that financial statements are materially misstated. b.Detection Risk: The risk that any material misstatement that has not been corrected by the client’s internal control will not be detected by the auditor is detection risk. Address strategic risks These are called the Company-level controls and permeate the organization and can have a big impact on whether its financial reporting and disclosures objectives are met. equities. Valuation: Determine whether proper values have been assigned to assets. these are the responsibility of managements 3. audit risk refers to the level of assurance that material misstatement does not exist.

Management’s risk assessment process c. Like environmental controls. included the related business processes. and periodic comparison. Application controls are viewed in terms of whether they relate to input. Answer: a. General controls include organizational features such as capable personal.authorization checks prior to data input . are authorized. Segregation of duty 8. 6. expense reimbursements. and are referred to as management controls. accounts payable approvals. For these reasons.arithmetical checks of the accuracy of records . applications. general controls are primarily preventive and have a pervasive impact on the various accounting processes. when you run a report to verify . Why are a client’s internal controls important to an auditor? Answer: a. Policy and procedure is documented Components (a) (b) (c) and (e) operate at the company level. Control activities e. They help ensure that all recorded transactions really occurred. Do they exist? If they do 5. Monitoring of controls f. e. or output of the accounting system. and are completely and accurately entered and processed through the system. These controls are more closely related to accounting information.4. Examples: . relevant to financial reporting and communication d. b. What is the difference between a compliance test and a substantive test? Answer: a. Control activities are controls over processes. auditors’ preliminary evaluation of internal controls tends to focus on environmental and general controls. In compliance testing you gather evidence with the objective of testing an organization's compliance with control procedures. Information system. Think of a typical financial statement account with high inherent risk and one with a low inherent risk. and some others. Inherent risk is high in counting the revenue (revenue recognition) and is low in Tax calculation and accruals. What is a general control and give an example? Answer: a. What is an application control and give an example? Answer: a. What are the components of an internal control? Answer: a. 7. and transactions. controlled access. Control environment b.maintenance and review of accounts and trial balances 9. processing. segregation of responsibilities. and will be referred to as accounting controls.g.

Confirmation: do a research about the company and find out if any mistake d. e. Enquiry: enquire about frequency of bank reconciliation procedure. Inspection of Assets: Mark the Assets. Recalculation: Auditor didn’t count the inventory properly b. Through analysis an auditor can detect any misstatement on the financial statement. Enquiry: check the record. analysis is an evidence-gathering procedure during the audit. Page 289 Answer: a. take the VIN number on the car if any c. E. review inventory variance analysis report. Answer: a. On page 282 there is a list of potholes in audit gathering techniques – read each one and suggest how you would have avoided these issues. personal knowledge: . Analysis: Analyze monthly gross margin by product line. then the auditor can find this fraud through analysis. Chapter 8: 1. An auditor must determine what is sufficient (amount) and appropriate (Quality) audit evidence when referring to appropriate an auditor must determine what is relevant and reliable information. you gather evidence to evaluate the integrity of data. For example. petty cash control. b. Analysis is the method of study and comparison of evidence about financial statement accounts. Discuss how effective analysis is in discovering fraud and errors.g. cheque received and anything related to the situation. Inspection: read term of lease agreement for lessee. check if some of the receivable are received or not. Recalculation/Reperformance: recomputed amortization expense using declining balance method. d. f. auditee’s inventory counting procedure. Also. e. you run a report to verify if the amount paid to vendors is accurate. check if the amount is correct or not. when the company reports heavy weight inventory on their financial statement and the company has the forklift to carry only light weighted inventory. In substantive testing.that certain controls had been applied over a database table. Also. Recomputed the tax as percentage of total sale amount on invoices. Auditors direct. Confirmation: obtain written confirmation of A/R balance and detail from customer. Auditors use six basic audit evidence gathering techniques – describe each one and give an example. which employee totals cash receipts and deposit them to the bank. There is a hierarchy of the quality or reliability of audit evidence – provide what procedures provide the auditor with the highest level of reliability. (Slide) Answer: a. Inspection by the scanning procedure: Disclose this problem on the financial statement. 4. 2. Answer: a. Inspection by Examination of Documents: re-add up all the deposits. f. 3. Observation: observe data entry procedure. c. a transaction or other information.

CPAB inspectors) Chapter 5: 1. critics. Representations should be corroborated with other types of evidence. Explained on 4 above 6. What procedures provide auditors with the lowest amount of assurance? Answer: a. 5. What must a plaintiff prove in a common law action when seeking damages from an auditor? Answer: a. but used extensively under satisfactory internal control conditions. f. That they were the direct cause of the loss . The decision must be based on enough evidence to be acceptable by other auditors and outsiders (Judges. How does an auditor gage sufficiency of audit evidence? Answer: a. but the auditor must use his/her professional judgment to find efficient and appropriate evidence to make a decision on the financial statement. That he/she relied on the statement’s advice e. Internal evidence: Evidence that is produced within the client’s system. or that the accountant’s advice was faulty d. but that has been received and processed by the client. generally considered the weakest form of evidence. That the financial statements were materially misleading. b. Very reliable evidence c. This is reliable evidence (although circumstances of internal control are important). Used for preliminary risk identification and attention directing early in the audit. d. Answer: a. management. Must prove that he/she was damaged or suffered a loss b. External evidence: Documentary evidence that is obtained directly from independent sources. directors. Listing the six general audit procedures – determine what is (are) the primary management assertion(s) that each one is testing. less costly than other evidence e.Gained though observation and recalculation. Analysis: Broad analytical procedures of general nature are not considered highly reliable. Low reliability. and employees in response to enquiry. That there was a beneficiary relationship with the defendant c. Although. 7. this is the most reliable evidence. Spoken and written representations: Evidence that comes from the client’s officers. External-internal evidence: Documentary evidence that originates outside the client’s system. Analysis using specific data the auditor has verified produces evidence that is fairly reliable. Plentiful and easy to obtain. there no official standard on auditing profession.

not correcting internal control weaknesses. or otherwise responsible for damages.140) is missing. 5. c. a. primary beneficiary and foreseeable beneficiaries. . Primary Beneficiary: Is the third parties the audit or other accounting service is primarily performed for. In this case the plaintiff need only to prove that the accountant was negligent and showed lack of reasonable care in the performance of professional accounting tasks. b. Privity: the relationship of direct involvement between parties to a contract. In terms of negligence. Do EP3 and EP5 case studies on pages 162 and 163. b. The auditor’s defense is to demonstrate that at least one of the Elements of Negligence (P. 4. The primary defense against negligence claim is to offer evidence that the audit had been conducted in accordance with GAAS with due professional care. b. In many cases proof of ordinary negligence is sufficient to make accountants liable for damages to primary beneficiaries. he/she will have to pay percentage of their responsibility to the investors and if the company fail to pay to the investor the portion of auditor will go up to 50% of the liability. deceitful. Class action law suit: Under this law suit if the auditor found liable. What must each prove to be successful against an auditor? Answer: a. for example. Investors who rely on accountant’s work. Foreseeable Beneficiary: these are external users such as Creditors. The auditor may also argue that the plaintiff contributed to his own loss by. That the accountant was grossly negligent.f. What are the main sources of Statutory Law concerning auditors? Answer: a. 3. 2. What are the main defences used by an auditor to defend him/herself in a common law suit? Answer: a. Define and explain the meaning of privity. If they are able to show that a public auditor was grossly negligent and perpetrated a constructive fraud.