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ACCT 107 Chapter Notes - Chapter 14: Audit Risk, Audit Evidence, Financial Statement

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beigewhale811
21 Oct 2020
School
American River College
Department
Accounting
Course
ACCT 107
Professor
Dr.Charles“ Kale” Braden

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Document Summary

The degree to which external users rely on the statement. The likelihood that a client will have financial difficulties after the audit report is issued. We want to keep is low because we don"t want to accept that there is a high risk of misstatement in the financial statements. Scenario 1 keep aar low (5% chance is what we are willing to live with for misstatements. That means a confidence level of 95% that fs are not misstated). We might have very high ir and very high cr (ir x cr), then there is high risk for rmm and we would need a low dr (ir x cr x dr). We need dr to be low in order to lower everything and to lower the overall aar. To keep the dr low, we need a high level of audit evidence and do more testing! Factors affecting acceptable audit risk: degree external users rely on the financial.

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Related Questions

Which of the following statements is most correct regarding the independent auditor's reliance on the tests of controls performed by the internal auditors to reduce their substantive testing?

1-The independent auditor must obtain assurance of the independence of the internal auditors but need not test their work.
2-It is not acceptable for the independent auditor to rely upon the work of the internal auditors.
3-There are no restrictions in relying upon the work of internal auditors.
4-The independent auditor must evaluate the competency and objectivity of the internal auditors and must test a sample of the work of the internal auditors in order to rely upon their work.

The term "materiality" as used in auditing is best described as the

1-substance of the auditing procedures.
2-amount of misstatement on the financial statements that would influence a decision maker.
3-underlying evidence upon which the audit opinion is based.
4-amount of material the auditor gathers as evidence to support the audit opinion.

Prior to accepting an audit client an auditor has a professional obligation to

1-contact the predecessor auditor.
2-perform preliminary analytical review procedures.
3-do all of the listed actions.
4-obtain approval for the audit engagement from the SEC.

Which of the following best represents financial statement fraud?

1-The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board of directors.
2-The controller of the company decreases a contingent liability by $3 million so the company will meet analysts' expectations this quarter.
3-The in-house attorney receives payments from the French government for negotiating the development of a new plant in Paris.
4-The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without authorization.

Sampling risk is the risk that

1-errors are inherent and may be present in the population without regard to the internal controls.
2-the population will not contain characteristics representative of the sample such that inferences made about that sample will be incorrect.
3-internal controls are not adequate to prevent or detect material errors.
4-the sample will not contain characteristics representative of the population such that inferences made about that population will be incorrect.

Control risk that is assessed excessively high (i.e. the auditor believes control risk is high when in reality it is moderate or low) leads to:

1-audit inefficiency.
2-a less expensive audit.
3-reduced substantive testing.
4-errors that are more likely to occur than anticipated.

The purchasing process consists of each of the following phases except

1-receipts of goods and services.
2-approval of items for payment.
3-authorized request for goods and services.
4-cash receipts.

The following audit report was drafted by a trainee on the audit of Golf (Pty) Ltd (“Golf”), a company which manufactures golf clubs. The trainee was asked to draft the report at the conclusion of the audit for the financial year end 31 March 2017 as part of on-the-job training and you have to evaluate his report. The shareholders of Golf included a clause in the company’s Memorandum of Incorporation which requires that the company’s annual financial statements are extremely audited.

Independent Report To the board of directors. We have evaluated the accompanying financial statements of Golf for fairness based on our annual audit carried out in terms of the Memorandum of Incorporation of the company.

Management is responsible for the preparation of the financial statements and for the prevention of fraud.

The auditor’s responsibility is to perform the audit and in doing do, to detect any fraud which may have material effect on the financial statements not having been prevented by the directors.

We report on the following aspects of the audit: 1. With regard to the detection of fraud, we detected a small wage fraud relating to unauthorized overtime. We reported this to management who subsequently dismissed the guilty persons.

2. An expert was engaged by our firm to assist in the valuation of the work-in-progress. Due to the complexity of the some of the company’s golf clubs, the risk of misstatements in the work-in-progress warranted this.

3. The company is currently being sued by a former employee who suffered personal injury at work whilst testing certain golf clubs during quality control procedures.


Page 12 of 17

In our opinion, except for the matters raised in 1 to 3 above, there are no outstanding issues arising from the audit which was conducted in terms of the International Standards on Auditing and the International Financial Reporting Standards.
Emphasis of matter There are no matters which require emphasis.

ABD Audit Kings 31 March 2017 Windhoek Namibia

YOU ARE REQUIRED TO:

Detail the errors / deficiencies in the audit report presented to you for evaluation (give explanations where necessary). You are NOT required to redraft the report. (30 marks)


QUESTION 4 (16 marks) According to ISA 240R- The auditors responsibility to consider fraud in an audit of financial statements, the auditor is required to recognize situations which may result in misstatements arising out of the misappropriation of assets. Consider the following. 1. A client company which holds large quantities of inventory does not keep the perpetual inventory records. 2. A company makes all its payments (e.g. wages, salaries, creditors) by electronic funds transfer. 10 employees are provided with the facilities on their computers to effect electronic transfers for their various sections. 3. The company reconciles its creditors ledger with creditors statements only at year – end. 4. The company pays salaries well below the industry norm and adopts the attitude that “if staff don’t like it if they can leave”. 5. Employees caught stealing from the company or making unauthorized use of company assets are dismissed immediately and prosecuted. 6. The company makes a significant number of cash sales. 7. Management and other employees constantly complain about the company (many of the complaints being unfounded). Company morale is low.


Page 13 of 17

8. There is inadequate authorization of expenditure incurred by management and employees on behalf of the company e.g. salesmen’s expense claims, management travel claims.

ISA 240R classifies the factors which could lead to the risk of misstatement arising from misappropriation as follows:

Classification a – incentive/pressures to misappropriate assets Classification b – opportunities to misappropriate assets Classification c – attitudes/rationalization which suggest the misappropriation may take place.

YOU ARE REQUIRED TO indicate into which classification each of the above risk factors (1 to 8) falls, and give a brief explanation as to why each of the factors increases the risk of misappropriation

2–31. Simulation
Casa Royale, Inc., a nonpublic company, retained Ying and Company CPA to perform an
audit of the fi nancial statements for the current year. Howard Smythe, the partner in charge of
the audit, drafted the following unmodifi ed report:

To the Management of Casa Royale, Inc.:
We have examined the accompanying consolidated balance sheet of Casa Royale, Inc., and
its subsidiaries, as of December 31, 20X1, and the related consolidated statements of income,
retained earnings, and cash fl ows for the years then ended.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
fi nancial statements in accordance with accounting principles generally accepted in the United
States of America; this includes the design, implementation, and maintenance of internal control
relevant to the preparation and fair presentation of consolidated fi nancial statements that are
free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these fi nancial statements based on our audit. We
conducted our audit in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated fi nancial statements are free of material
misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures
in the consolidated fi nancial statements. The procedures selected depend on the auditor’s
judgment, including the assessment of the risks of material misstatement of the consolidated
fi nancial statements, whether due to fraud or illegal acts. In making those risk assessments, the
auditor considers internal control relevant to the entity’s preparation and fair presentation of
the consolidated fi nancial statements in order to design audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the entity’s internal control. An audit also includes evaluating the appropriateness of accounting
policies used and the reasonableness of signifi cant accounting estimates made by management,
as well as evaluating the overall presentation of the consolidated fi nancial statements.
We believe that the audit evidence we have obtained is adequate to provide a basis for our audit
opinion.
Opinion
In our opinion, the consolidated fi nancial statements referred to above present fairly, in all material
respects, the fi nancial position of Casa Royale, Inc., and its subsidiaries as of December 31,
20X1, and the results of their operations and their cash fl ows for the years then ended in accordance
with auditing standards generally accepted in the United States of America.
Howard Smythe , Partner
Phoenix, Arizona
February 12, 20X2
Reviewer’s Comments
Comment Is
Correct (yes or no)
a. The report should not be addressed to management.
b. The report should indicate that we have “audited,” rather than “examined,”
the fi nancial statements (fi rst paragraph after introduction).
c. The report should not indicate anything concerning management’s
responsibility for internal control.
d. The report should state that the auditors’ responsibility is to express
“reasonable assurance,” not an opinion (fi rst paragraph under “auditor’s”
responsibility).
e. The audit is designed to assess risks of material misstatements due to
errors or fraud; the term “illegal acts” is incorrect (second paragraph
under auditor’s responsibility).
f. The report should not refer to the auditors “evaluating the appropriateness
of accounting policies,” since those are the responsibility of management.
g. The evidence should be suffi cient and appropriate rather than “adequate”
(third paragraph under auditor’s responsibility).

Reviewer’s Comments
Comment Is
Correct (yes or no)
h. The opinion should not include “in all material respects” since the auditors
are providing an opinion on the accuracy of the fi nancial statements
(opinion paragraph).
i. The opinion should be on “accounting principles generally accepted in the
United States of America,” not on auditing standards (opinion paragraph).
j. The signature on the report should be that of the CPA fi rm, not that of
the partner.