Session Three Auditing Summer 2010

Session Three Auditing Summer 2010 - Session Three-...

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Unformatted text preview: Session Three- Auditing - August 17, 2010 Professor Roger Mayer, DBA, CPA, CIA C - 917-887-0448 Housekeeping Quizzes Mid-Term Toy Central Toy Central Part 3 Chapter 7 discusses the audit of internal controls over financial reporting. While the case study indicates that Toy Central does not need to be in compliance with SarbanesOxley requirements, an assessment of controls creates value. For example, the case identifies specific control weaknesses such as access controls over posting and approving journal entries. You will find other control issues throughout the case study. In this assignment you are to identify specific control weaknesses over financial reporting. Discuss how you would conduct an audit of ICFR The paper should conform to APA standards and is a continuation of the paper you started in Session One. This paper is woryh 40 points and is due five days after chat session three. Questions Sample CPA As a result of analytical review procedures, the independent auditor determines that the gross profit percentage has declined from 30% in the preceding year to 20% in the current year. The auditor should A. Consider the possibility of an error in the financial statements. B. Express an opinion which is qualified due to inability of the client company to continue as a going concern. C. Evaluate management's performance in causing this decline. D. Require footnote disclosure. An auditor's working papers serve mainly to A. Satisfy the auditor's responsibilities concerning the Code of Professional Conduct. B. Monitor the effectiveness of the CPA firm's quality control procedures. C. Document the level of independence maintained by the auditor. D. Provide the principal support for the auditor's report. Questions To help plan the nature, timing, and extent of substantive auditing procedures, preliminary analytical procedures should focus on A. Enhancing the auditor's understanding of the client's business and events that have occurred since the last audit date. B. Developing plausible relationships that corroborate anticipated results with a measurable amount of precision. C. Applying ratio analysis to externally generated data such as published industry statistics or price indices. D. Comparing recorded financial information to the results of other tests of transactions and balances. Which of the following most likely would indicate the existence of related parties? A. Writing down obsolete inventory just before year end. B. Borrowing money at an interest rate significantly below the market rate. C. Failing to correct previously identified internal control structure deficiencies. D. Depending on a single product for the success of the entity. Chapter 7 Auditing Internal controls over financial reporting (ICFR) Sarbanes-Oxley Section 404 Management responsibility Auditor responsibility Internal Controls over Financial Reporting defined IC deficiencies Material Weakness Significant deficiency Management Responsibilities under Section 404 Management must comply with the following in order for its public accounting firm to complete an audit of ICFR. Auditor Responsibilities under Section 404 The entity's independent auditor must audit and report on the effectiveness of ICFR. The auditor is required to conduct an integrated audit of the entity's ICFR and its financial statements. Key issues in financial statement controls Controls typically included in ICFR testing Entity level controls IT access controls Antifraud programs Non-routine transactions involving judgment and estimates Top sided entries Interim financial reporting Risk based approach to ICFR Identify Identify entity level controls significant accounts and disclosures likely sources of misstatement controls to be tested Understand Select Internal Control Deficiencies Defined M Material A G N I T Not material U but significant D E Not material or significant Material weakness Significant deficiency Control deficiency Remote Reasonably possible or probable LIKELIHOOD Reporting on ICFR Management's Auditor's report report Unqualified opinion Adverse opinion Audit Sampling Audit sampling is the application of an audit procedure to less than 100 percent of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class. Sampling Risk Risk of incorrect rejection (Type I) in a test of internal controls, it is the risk that the sample supports a conclusion that the control is not operating effectively when, in fact, it is operating effectively. Risk of incorrect acceptance (Type II) in a test of internal controls, it is the risk that the sample supports a conclusion that the control is operating effectively when, in fact, it is not operating effectively. Sampling Risk Three Important Factors in Determining Sample Size 1. The desired level of assurance in the results (or confidence level), 2. Acceptable defect rate (or tolerable error), and 3. The historical defect rate (or estimated error). Confidence Level Confidence level is the complement of sampling risk. The auditor may set sampling risk for a particular sampling application at 5 percent, which results percent in a confidence level of 95 percent. percent Tolerable and Expected Error Once the desired confidence level is established, the sample size is determine largely by how much the tolerable error exceeds expected error. Precision, at the planning stage of audit sampling, is the difference between the expected and tolerable deviation rates. Auditing Standards refer to Precision as the "Allowance for sampling risk" Audit evidence involving sampling Sampling commonly used Tangible asset inspections Inspection of records Re-performance Confirmation Sampling generally not used Analytical procedures Inquires Observations Non-statistical sampling judgment sample Statistical Sampling Tests of controls and Substantive tests of transactions Attribute and exception sampling Tests of details of account balances Looking for monetary misstatements Monetary-Unit sampling Probability proportion to size Attribute Sampling Used to estimate the proportion of a population that possess a specified characteristic. The most common use of attribute sampling is for tests of controls. Yes, I know. We are planning a test of that control using attribute sampling. Our client's controls require that all checks have two independent signatures. Ch 9 Substantive testing Looking for monetary misstatements sampling "to draw The purpose of audit inferences about the entire populations from the results of the sample" Example inventory Substantive Tests of Details of Account Balances Consider the following information about the inventory account balance of an audit client: Book value of inventory account balance Book value of items sampled Audited value of items sampled Total amount of overstatement observed in audit sample $ 3,000,000 $ 100,000 98,000 $ 2,000 The ratio of misstatement in the sample is 2% ($2,000 $100,000) Applying the ratio to the entire population produces a best estimate of misstatement of inventory of $60,000. ($3,000,000 2%) Substantive Tests of Details of Account Balances The results of our audit test depend upon the tolerable misstatement associated with the inventory account. If the tolerable misstatement is $50,000, we cannot conclude that the account is fairly stated because our best estimate of the projected misstatement is greater than the tolerable misstatement. Monetary-Unit Sampling (MUS) MUS uses attribute-sampling theory (used primarily to test controls) to estimate the percentage of monetary units in a population that might be misstated and then multiplies this percentage by an estimate of how much the dollars are misstated. Monetary-Unit Sampling (MUS) Advantages of MUS 1. When the auditor expects no misstatement, MUS usually results in a smaller sample size than classical variables sampling. 2. The calculation of the sample size and evaluation of the sample results are not based on the variation between items in the population. 3. When applied using the probability-proportional-to-size procedure, MUS automatically results in a stratified sample. Monetary-Unit Sampling (MUS) Disadvantages of MUS 1. The selection of zero or negative balances generally requires special design consideration. 2. The general approach to MUS assumes that the audited amount of the sample item is not in error by more than 100%. 3. When more than one or two misstatements are detected, the sample results calculations may overstate the allowance for sampling risk. Steps in MUS Sampling Steps in MUS Sampling Application Planning 1. Determine the test objectives. 2. Define the population characteristics. Define the population. Define the sample unit. Define a misstatement. 3. Determine the sample size, using the following inputs: The desired confidence level or risk of incorrect acceptance. The tolerable misstatement. The expected population misstatement. Population size. Performance 4. Select sample items. 5. Perform the auditing procedures. Understand an alayzye any missstatements observed. Evaluation 6. Calculate the projected misstatement and the upper limit on misstatement. 7. Draw final conclusions. Conclusion Questions See you in two weeks available tonight after Midterm/Quiz- 9:00 PM ...
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This note was uploaded on 11/24/2010 for the course TXX 5762 taught by Professor Allen during the Fall '10 term at Nova Southeastern University.

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Session Three Auditing Summer 2010 - Session Three-...

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