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Audit Final
| Term | Definition |
|---|---|
| Assurance vs. Audit | Audit is a specific type of assurance engagement providing reasonable assurance on financial statements. |
| GAAS Principles | Responsibilities (competence, ethics), Performance (planning, evidence), Reporting (opinion) |
| Independence | Required in both fact (mind) and appearance (relationships). Prohibited: owning stock, decision-making roles |
| Audit Risk Model | AR = IR × CR × DR |
| RMM (Client Risk) | IR × CR. The auditor assesses this but cannot control it. |
| Detection Risk | The risk the auditor fails to find a misstatement. The only risk the auditor controls |
| Inverse Relationship | High RMM → Low acceptable DR → More Substantive Testing required |
| Preliminary Materiality | Maximum misstatement for statements as a whole. |
| Tolerable Materiality | Materiality allocated to a specific account |
| Materiality Qualitative Factors | Fraud, debt covenants, changing a loss to profit. |
| Existence/Occurrence Question | Did it really happen? Is it Real |
| Existence/Occurrence Example | Overstatement Risk. Recording a sale that never happened (Fictitious Revenue) or listing inventory that doesn't exist (Phantom Inventory) |
| Completeness Question | Is everything recorded? Did you miss anything? |
| Completeness Example | Understatement Risk. Failing to record an invoice for goods received (Unrecorded Liability) or omitting a loan from the balance sheet |
| Valuation and Allocation - Question | Is the dollar amount correct? |
| Valuation and Allocation Example | Recording inventory at cost when market value is lower (Obsolete Inventory), or calculating the Allowance for Doubtful Accounts incorrectly (Accuracy) |
| Rights and Obligations - Question | Do we own it? Do we owe it? |
| Rights and Obligations - Example | Listing inventory that is actually held on consignment (we don't own it) or failing to disclose that A/R has been factored (sold). |
| Presentation and Disclosure Question | Is it in the right place and described correctly? |
| Presentation and Disclosure Example | Listing a 5-year loan as a Current Liability instead of Long-Term Debt, or failing to disclose a lawsuit in the footnotes. |
| Cutoff (Timing) Question | Is it in the correct time period? |
| Cutoff (Timing) Example | Recording a sale in December (to hit a bonus target) when the goods weren't shipped until January. (Part of Completeness/Existence). |
| Fraud Triangle | Incentive/Pressure (Need), Opportunity (Weak Controls), Rationalization (Justification) |
| Internal Control | COSO |
| Control Environment - COSO | "Tone at the top" |
| Risk Assessment - COSO | Management's identification of risk |
| Control Activities - COSO | Policies/procedures (Segregation of Duties) |
| Info & Communication | Reporting systems |
| Monitoring - COSO | Assessing quality over time |
| Segregation of Duties | Separate Authorization, Recording, Custody, and Reconciliation |
| Auditor Responsibility for Private | Must understand controls. Testing is optional (for efficiency) |
| Auditor Responsibility for Public | Must test controls and issue an opinion on ICFR effectiveness (SOX 404). |
| Three categories of contingent liabilities | Probable, reasonably possible, and remote |
| Vouching (Existence/Occurrence) | Start at the Ledger/Journal → Go back to Source Documents. (Tests for Overstatement). |
| Tracing (Completeness) | Start at Source Documents → Go forward to Ledger/Journal. (Tests for Understatement). |
| Primary Risk for Cash | Existence and Fraud (Lapping, Skimming, Kiting) |
| Key Assertions of Cash | Existence and Fraud |
| Primary Substantive Tests of Cash | Bank Recs, Cutoff Bank Statement, and Bank Confirmation |
| Bank Reconciliation | Test year-end balance |
| Cutoff Bank Statements | Verify reconciling items (DITs, OCs) cleared after year-end. |
| Bank Confirmation | Third-party evidence of balance and loans. |
| Fraud Tests for Cash | Proof of Cash (reconciles all transactions) and Schedule of Interbank Transfers (detects Kiting). |
| Primary Risk of Revenue and Collection | Occurrence/Existence (Overstatement/Fictitious Sales) |
| Primary Substantive Tests of Revenue and Collection | Vouching, A/R Confirmation, Sales Cutoff, and Allowance Review |
| Vouching | Sales Journal -> Shipping Doc (Tests Occurrence) |
| A/R Confirmation | Required test for Existence. (Positive vs. Negative) |
| Sales Cutoff | Compare Sales Invoice date to Shipping Doc date |
| Allowance Review | Test Valuation using A/R Aging |
| Primary Risk of Acquisition and Expenditure | Completeness (Understatement/Unrecorded Liabilities) |
| Key Assertions Acquisition and Expenditure | Completeness (A/P), Cutoff |
| Primary Substantive Tests of Acquisition and Expenditure | Search for unrecorded liabilities and three-way match (control) |
| Search for Unrecorded Liabilities (SUL) | Vouch subsequent cash disbursements (Jan payments) back to the Receiving Report date. (Did liability exist at year-end?). |
| Three-Way Match (Control) | PO ← Receiving Report ← Invoice |
| Primary Risks of Production and Inventory | Existence (Theft/Phantom Inventory) and Valuation (Obsolescence/Costing) |
| Key Assertions of Production and Inventory | Existence, Valuation (LCNRV) |
| Primary Substantive Tests for Production and Inventory | Physical Inventory Observation and Price Testing |
| Accounts Payable Primary Risk | Completeness |
| Price Testing | Test Standard Cost Variance and Lower of Cost or NRV. |
| Primary Risks of Finance and Investment | Completeness (Debt), Valuation (Investments/Estimates) |
| Primary Substantive Tests of Finance and Investment | Debt and Investments |
| Debt | Read Board Minutes (Authorization/Completeness) and Confirmations |
| Investments Level 1 | Vouch to quoted market prices |
| Investments Level 2 | Vouch to broker quotes/matrix pricing |
| Investments Level 3 | Test management's assumptions or use a specialist (High Risk) |
| Alpha Sample Risk (Type 1) | Risk of Underreliance/Incorrect Rejection → Hurts Efficiency (Auditor does too much work) |
| Beta Sample Risk (Type 2) | Risk of Overreliance/Incorrect Acceptance → Hurts Effectiveness (Auditor issues wrong opinion - Most Dangerous) |
| Goal of Attribute Testing | Estimate deviation rate (%) |
| Risk of Attribute Testing | Risk of Overreliance (Assessing CR too low) = Beta Risk |
| Decision of Attribute Testing | If Upper Deviation Rate > Tolerable Rate → Reject Control. |
| Goal of Variables Testing | Estimate dollar misstatement |
| Risk of Variables Testing | Risk of Incorrect Acceptance = Beta Risk |
| Method of Variables Testing | MUS (Monetary Unit Sampling) selects dollars, automatically stratifying for high-value items. |
| Decision of Variable Testing | If the Upper Misstatement Limit is greater then the tolerable misstatement then reject the balance. |
| The contingencies of completing the audit | Review legal letters (Probable/ Reasonably Possible/Remote) |
| Probable | Make the changes to the financials |
| Reasonably Possible | Make a footnote |
| Remote | Do nothing |
| Type 1 (Recognized) - Completing the audit | Existed as Balance Sheet closing date then adjust the financials |
| Type 2 (Non-recognized) - Completing the audit | New event after B/S date → Disclose only. Going Concern: Evaluate ability to survive one year. |
| Unmodified | Clean opinion |
| With Emphasis of Matter | Going concern, change in principle |
| Qualified | "Except for..." (Material but Not Pervasive GAAP departure or Scope Limitation). |
| Adverse | "Do not present fairly" (Material AND Pervasive GAAP departure) |
| Disclaimer | "We do not express an opinion" (Material AND Pervasive Scope Limitation or lack of Independence). |
| CAMs | Critical Audit Matters must be disclosed for public companies (complex/subjective areas) |
| Identification of the CAM | Describe the critical audit matter. |
| Principal Considerations of a CAM | Explain why the matter is critical and required subjective or complex auditor judgment. |
| Audit Response of a CAM | Describe how the CAM was addressed in the audit (procedures performed). |
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