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Management and Organizational Studies
Management and Organizational Studies 3363A/B

Chapter  15  Notes   Review   1. Pre-­‐planning   2. Client  Risk  Profile-­‐  preliminary  analytical  review   3. Develop  the  strategic  audit  Approach   4. Develop  Audit  Programs   5. Tests  of  Controls   6. Substantive  Tests       Analytical       Tests  of  Details  of  Balances   7. Ongoing  evaluation,  quality  control  and  final  evidence  gathering   8. Complete  quality  control  and  issue  Auditors  report     control risk The risk that material error in a balance or transaction class will not be prevented or detected on a timely basis by internal controls. inherent risk The susceptibility of a balance or transaction class to error that could be material, when aggregated with other errors, assuming no related internal controls. detection risk The risk audit procedures will lead to a conclusion that material error does not exist when in fact such error does exist.     Sales  and  Collection  Cycle   If  there  were  mistakes  in  billing  of  customers,  then  there  would  be  an  overstatement  of   sales  and  A/R.   • Transactions  flow  through  Accounts  Receivable  are  almost  always  material,   unless  collections  are  highly  automated.  Materiality  is  set  for  the  financial   statements  as  a  whole  rather  than  for  each  account.   • The  inherent  risks  are  mainly  in  two  audit  objectives  for  accounts  recievable       1.  Stated  at  net  realizable  value-­‐  based  on  clients               judgment       2.  Correct  cutoff-­‐  can  be  easily  misstated   • The  control  risk  of  accounts  receivable  varies  among  clients,  but  generally   Managers  want  accurate  records  to  maintain  good  relationships  with   customers.   If  internal  controls  are  weak,  auditor  will  increase  tests  of  details  of  balances.     In  deciding  the  appropriate  evidence  for  test  of  details  of  balances,  the  Auditor  has   to  consider  the  inherent  and  control  risk.  It  is  complicated  because  inherent  and   control  risk  both  vary  by  objective.    An  evidence  planning  spreadsheet  is  used  to   determine  the  tests  of  details  of  balances  (see  p518  for  example).     Materiality   Assess  Control  Risk-­‐  Applied  to  Sales  and  Collections  Cycle  in  Chapter  14     Related  accounts  are:  Sales;  Purchase  Returns  and  Discounts;  Accounts   Receivable;  Cash;  Allowance  for  Doubtful  Accounts;  Foreign  Exchange  and  Bad  Debt   Expense.   Identify  at  Risk  Assertions-­‐  where  substantive  testing  is  insufficient.     If  controls  are  good  then  substantive  testing  can  be  substantially  reduced.  Testing  for   accuracy  and  completeness  can  be  reduced  if  there  is  a  highly  automated  system  with   good  controls.   Design  and  Perform  Tests  of  Controls-­‐  Chapter  14   Substantive  Tests     Analytical  Procedures-­‐  after  the  balance  sheet  date   Review  large  and  unusual  amounts,  receivables  from  affiliated  companies  and   related  parties.       Examples:     -­‐Compare  gross  margin  percentage  with  previous  years  to  see  if  sales  and  A/R  might   be  under  or  overstated.   -­‐Compare  bad  debt  expense  as  a  percentage  of  gross  sales  with  previous  years  to  see  if   there  are  uncollectible  accounts  the  have  not  been  provided  for.   -­‐Examine  relationship  between  sales  and  COGS  using  regression  analysis  to  see  if  sales   or  A/R  is  under  or  over  stated.     Test  of  Details  of  Accounts  Receivables-­‐  depends  on  factors  from  evidence   planning  spreadsheet.  Confirmation  is  the  most  important  balance-­‐related  audit   objective  for  A/R.   Planned  detections  risk  is  hard  to  determine  because  it  is  based  on  judgment  and   weighted  by  the  Auditor.  Detection  risk  is  inversely  related  to  inherent  and  control   risk.  If  control  risk  is  high,  the  Auditor  will  increase  substantive  testing.  Increasing   substantive  testing  decreases  the  detection  risk.    
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