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Auditing Principles 2, audit risk, control risk, detection risk, inherent risk, risk of material misstatement, audit plan, risk assessment, information risk, substantive procedures, audit evidence, client acceptance, engagement letter, audit plan, internal auditors, time budget, audit procedures, Auditing Principles 2, audit risk, control risk, detection risk, inherent risk, risk of material misstatement, audit plan, risk assessment, information risk, substantive procedures, audit evidence, client acceptance, engagement letter, audit plan, internal auditors, time budget, audit procedures, substantive, audit plan, vouching, tracing, scanning, tangible assets, observation, inquire, confirmation, recalculation, JoseCintron, Advance Business Consulting, mba4help.comsubstantive, audit plan, vouching, tracing, scanning, tangible assets, observation, inquire, confirmation, recalculation, JoseCintron.com, Advance Business Consulting, mba4help.com
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Auditing Principles
Jose Cintron, MBA-CPC [email protected]
Http://josecintron.comhttp://mba4help.com
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Audit Risk
Audit risk is the probability that an audit team will express an inappropriate audit opinion when the financial statements are materially misstated (i.e., give an unqualified opinion on financial statements that are misleading because of material misstatements that the auditors failed to discover). Such a risk always exists, even when audits are well planned and carefully performed.
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Audit RiskAudit risk can be broken down into the risks that (1) a material misstatement occurs (inherent risk), (2) is not prevented or detected by client internal controls (control risk), and (3) is not detected by the auditor's procedures (detection risk). Inherent risk and control risk are combined into risk of material misstatement (RMM)
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Inherent Risk
Inherent risk is the probability that, in the absence of internal controls, material errors or frauds could enter the accounting system used to develop financial statements. You can think of inherent risk as the susceptibility of the account to misstatement. In other words “what could go wrong?”—inherent risk is a function of the nature of the client's business, the major types of transactions, and the effectiveness and integrity of its managers and accountants.
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Control Risk
Control risk is the probability that the client's internal control activities will fail to prevent or detect material misstatements provided that they enter or would have entered the accounting system in the first place.
Auditors do not create or manage control risk. They can only evaluate an entity's control system and assess the probability of its failure to prevent or detect material misstatements.
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Detection Risk
Detection risk is the probability that audit procedures will fail to detect material misstatements provided that any have entered the accounting system in the first place and have not been prevented or detected and corrected by the client's internal controls. In contrast to inherent risk and control risk, auditors are responsible for performing the evidence-gathering procedures that manage and establish detection risk. These audit procedures represent the auditors' opportunity to detect material misstatements in financial statements. In other words, unlike inherent risk and control risk, auditors can and do influence the level of detection risk.
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Audit Plan
GAAS require the preparation of a written audit plan. An audit plan(formerly referred to as an audit program) is a list of the audit procedures auditors need to perform to gather sufficient appropriate evidence on which to base their opinion on the financial statements. The procedures in an audit plan should be stated in enough detail to instruct the assistants about the work to be done.
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Audit PlanThe audit plan is a comprehensive list of the specific audit procedures that the audit team needs to perform in order to gather sufficient appropriate evidence on which to base their opinion on the financial statements.
Although risk assessment provides the basis to determine the nature, timing, and extent of procedures to be performed at an audit client.
Other planning issues include properly staffing the audit, considering the work of internal auditors, the use of specialists, the use of IT auditors and the time budget.
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Risk Assessment
An important part of the performance principle is for auditors to identify important concerns (or risks) they face in the audit. This process is referred to as risk assessment and follows engagement planning, as follows:
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Information Risk
Information risk is the probability that the information distributed by an entity will be materially false and misleading. Auditors' evidence-gathering and reporting reduce this risk to financial statement users, but the team itself faces the risk of issuing an incorrect opinion on the financial statements
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Risk Assessment
The risk assessment process requires an understanding of the client, its operating environment, and its industry. This includes internal controls operating within the client's accounting information systems that ultimately produce the client's financial statements. Internal control may be defined as the policies and procedures implemented by an entity to prevent or detect material accounting frauds or errors and provide for their correction on a timely basis. Satisfactory internal control reduces the probability of frauds or errors in the accounts.
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You are who your friends areIt's important to acknowledge the power of a positive attitude. This goes not only for yourself, but also for the people you surround yourself with.
Attitudes are catchy. Whether they're positive or negative, they're rubbing off on you. If you're around people who complain, judge, spread negative gossip, blame others and play victim roles, chances are you do, too.
Successful people surround themselves with successful people, plain and simple. They want to be around others who are achieving goals and making things happen. They want to know their secrets and strategies for winning
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Substantive ProceduresEffective internal control reduces the control risk, and auditors thus have a reasonable basis for reducing the necessary effectiveness of further audit procedures.
Ineffective internal control increases control risk, and auditors must increase the necessary effectiveness of further audit procedures.
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Audit EvidenceThe final element of the performance principle requires that the audit team collect and evaluate sufficient appropriate evidence to afford a reasonable basis for their opinion. Evidence is the information used by auditors in arriving at the conclusions on which the audit opinion. To be considered appropriate, evidence must be relevant and reliable
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Detection Risk
Detection risk represents the risk that the audit team's substantive procedures will fail to detect a material misstatement. As auditors require higher quality evidence (lower detection risk), they must gather more relevant and reliable evidence (appropriateness) and evaluate a larger number of transactions or components (sufficiency).
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Client Acceptance or Continuance
An important element of a public accounting firm's quality control policies and procedures is a system for deciding whether to accept a new client and, on a continuing basis, deciding whether to continue providing services to existing clients. Public accounting firms are not obligated to accept undesirable clients, nor are they obligated to continue to serve clients when relationships deteriorate.
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Engagement LettersProfessional standards require auditors to reach a mutual understanding with clients concerning engagement requirements and expectations and to document this understanding, usually in the form of a written letter. When a new client is accepted or when an audit engagement continues from year to year, an engagement letter should be prepared.
This letter sets forth the understanding with the client, including in particular: (1) the objectives of the engagement, (2) management's responsibilities, (3) the auditors' responsibilities, and (4) any limitations of the engagement.
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Engagement Letter
In effect, the engagement letter acts as a contract. Thus, it serves as a means for reducing the risk of misunderstandings with the client and as a means of avoiding legal liability for claims that the auditors did not perform the work promised.
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Audit PlanAn audit plan is a comprehensive list of the specific audit procedures that the audit team needs to perform to gather sufficient appropriate evidence on which to base their opinion on the financial statements. The professional standards require that the auditor plan each audit engagement, including the establishment of an overall strategy for each audit engagement.
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Internal AuditorsExternal auditors must obtain an understanding of a client's internal audit department and its work as part of the understanding of the client's internal control.
Objectivity. Internal auditors can never be considered independent in the same sense as external auditors because internal auditors are employed and compensated by the client.
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Time Budget
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Audit Procedures
Auditors use audit procedures for three purposes;1. They use audit procedures to gain an understanding of the client and
the risks associated with the client (risk assessment procedures).
2. Auditors use audit procedures to test the operating effectiveness of client internal control activities (tests of controls).
3. Auditors use audit procedures to produce evidence about management's assertions (i.e., relating to existence, occurrence, completeness, cutoff, rights and obligations, valuation and allocation, accuracy, classification, and understandability) related to the amounts and disclosures in a client's financial statements (substantive procedures).
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Substantive Audit PlanA substantive audit plan would contain a list of audit procedures for gathering evidence related to the relevant assertions identified for the significant financial statement accounts and disclosures at an audit client. The substantive audit plan (i.e., the nature, timing, and extent of procedures) depends almost exclusively upon the assessment of risk at an audit client.
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Documents Prepared by Independent Outside Parties
A great deal of documentary evidence is external-internal (i.e., documents initially prepared by an external party but received by the client). The signatures, seals, engraving, or other distinctive artistic attributes of formal authoritative documents make such sources more reliable than ordinary documents prepared by outsiders.
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Internal evidenceDocumentation of this type is internal evidence. Some of these documents may be quite informal and not very authoritative or reliable. As a general proposition, the reliability of these documents depends on the quality of internal control under which they were produced and processed.
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Vouching and Tracing
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Scanning—Examination of Documents
Scanning is the way auditors exercise their general alertness to unusual items and events in clients' documentation. A typical scanning directive in an audit plan is: “Scan the expense accounts for credit entries; vouch any to source documents.”
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Inspection of tangible assets
Examination of DocumentsInspection of tangible assets includes examining property, plant, and equipment, inventory, and securities certificates. Physical inspection of tangible assets provides compelling evidence of existence and may provide tentative evidence of valuation.
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Observation
Examination of DocumentsAlthough inventory observation often refers to the physical inspection of inventory (tangible assets), auditors use observation when they view the client's physical facilities and personnel on an inspection tour, when they watch personnel carry out accounting and control activities (such as observing client inventory counts), and when they participate in a surprise payroll distribution.
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Inquiry
Examination of DocumentsInquiry is a procedure that generally involves the collection of oral (but sometimes written) evidence from independent parties and management (commonly referred to as management representations). Important inquiries and responses should be documented in writing. Auditors typically use inquiry procedures during the early planning stages of the engagement.
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ConfirmationConfirmation by direct correspondence with independent parties is a procedure widely used in auditing. It can produce evidence of existence and ownership and sometimes of valuation and cutoff.
Banks—cash and loan balances.Customers—receivables balances.Borrowers—note terms and balances.Agents—inventory on consignment or in warehouses.Lenders—note terms and balances.Policyholders—life insurance contracts.Vendors—accounts payable balances.Registrar—number of shares of stock outstanding.Attorneys—litigation in progress.Lessors—lease terms.
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Recalculations/Re-performance
Auditor recalculation of calculations previously performed by client personnel produces compelling mathematical evidence. A client calculation is either right or wrong.
Reperformance is broader in approach. Reperformance can involve any client control procedure such as matching vendor invoices with supporting purchase orders and receiving reports.
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