Chapter 5

• The Possibility that the auditors may unknownly fail to appropriately modify their opinion on FS that are materially mistated
• Auditors must obtain sufficient appropriate audit evidence to reduce audit risk to a low level in every audit.

Assets,Liabilities,Equity interest exist and recorded tranactions have occured

• Accounts Assertion
• Ex: Fixed Assets can be located and identified to match the accounting records
• Transaction Assertion
• Ex: All events needed to recognize revenue have occured
• Presentation & Disclosure
• Ex: All leases are properly executed and in full force

The company holds rights to the assets and the liability are the obligations of the company

• Accounts Assertion
• Ex: The compnay owns all the fixed assets; not leased
• Presentation & Obligation
• Ex: All leases of the company are disclosed and the company has a legal obligation

All assets,liabilities, equity interests, and trasactions that should have been recorded are recorded

• Accounts Assertion
• Ex: All fixed assetsa are included in the accoutning records
• Transaction Assertion
• Ex: All transactions meeting revenue recognition criteria are recorded
• Presentation & Disclosure Assertion
• Ex: All lese related disclosures are included in the footnotes.

Transactions and events have been recorded in the correct accounting period

• Transaction Assertion
• Ex: Revenue events are assigned to the correct accounting period

All transactios, assets, liabilities and equity interest are included in the financal statements at proper amounts

• Accounts Assertion
• Ex: Fixed assets recorded at cost, including shipping, taxes, installation; impairment of idle capacity considered.
• Transaction Assertion
• Ex: Recorded revenue is calculated correctly
• Presentation & Disclosure
• Ex: Capital leases are properly recorded; ommitments and other terms are accurate

Accounts are described and classified in accordance to GAAP

• Transaction Assertion
• Ex: Revenue related returns and discounts are properly recorded; sub-accounts are correct
• Presentation & Disclosure Assertion
• Ex: lease footnote is clear and concise

Risk of material misstatement occuring in an assertion assuming no related internal controls

• Business characteristics indicative of high inherent risk:
• Inconsistent profitability of client
• Operating results highly sensitive to econcomic factors
• Going concern problems
• Large known and likely misstatements detected in prior audits
• Substantial turnover, questionable reputation, or inadequate accounting skills of managment

Risk that material misstatement in an assertion will not be prevented or detected on a timely basis by the company's internal control

Risk that the auditors procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist.

this is were the risk that auditors will fail to detect material mistatement can happen

• Dificult to audit transaction or balances
• Complex calulations
• Difficult accounting issues
• Significant judgement by managment
• Valuations that vary significantly based on economic factors

The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to perform a reasonable basis for an opinion regarding the financial statements under audit

• Sufficent audit Evidence
• The quantity of audit evidence that must be obtained

• To be appropriate audit evidence must be:
• Relevant
• Reliable

• Audit evidence is ordinarily more reliable when its
• obtained form knowledgeble indpendent source outside the company
• Generated internally through a system of effective controls
• Obtained directly by the auditor
• Documentary in form rather than oral
• Provided Original Documents rather than copies

To obtain an understanding of the client and its enviornment, including its internal control, to assess the risks of material misstaatement.

When appropriate, to test the operation effectiveness of controls in preventiing material misstatements

To detect material misatemtns at relevant assertion level.

the greater the risk of material misstamtemnt, the greaterh the needed extenet of substantive procedures.

• Substantive procedures include
• 1. Analytical Procedures
• 2. test of details of accounts balances, transactions and dissclosures.

• You can change the scope of the audit by:
• nature
• timing
• extent

• Obtain mofre reliable evidence
• _{often externally generated evidence}

Wait until year-end to obtain evidence from entire set of transactions as contrasted to performing interm teting, say tow months prior to year-end and simply updating those procedures.

Holding other factors such as the nature and timiing of procedures constant

• Steps Involved
• Develop expectation of account (or ratio) balance
• Determine amount of difference accepted without investigation
• Compare the company's account (ratio) with expectation
• Investigage and evaluate significant differences

• Trend Analysis
• Ratio Analysis

• Prior period information
• Anticpated results
• relationships among elements of financial infomration within a period.

Analyze changes in accounts of a company over time

• Cmpare relationships between two or mre financail statemtns accounts or comparisons of account balances to non-financial data
• Liquity-(Current ratio)
• Leverage-(debt to equity)
• Profitability-( gross profit %)
• Activity ( Inventory turnover)

• Horizontal Analysis
• Corss sectional analysis
• vertical analysis
• other methods

Review ratios over time

Analyze ratios of similar firms at a point in time

• Analyse relationships with in a period
• "common size" statements prepared

Regression Analysis, reasonableness test

• Reveiw and test managements process for developing the estimate
• Independently develop an estimate to compare to management's estimate
• Review subsequent events or transactions bearing on the estimate.

Inputs to use in applying valuation techniques (FAS 157)

• Level 1- Inputs of observable quoted prices in acte markets for identical assetss or liabilities
• _ex: a closing stock price in WSJ

• Level 2: inputs of observable quoted prices, generally for similar assets or liabitlites in acte markets.
• ex: Company discoutns future csh flows _{on its not publicly traded debt securities at rate used by market for publicly traded debt securities.}

• Level 3- Inputs that are unobservable for the assets or lialitity
• _Ex: a private comapny uses judgement to determine a proper rate to discount the future cash flows of its not publicly traded securities.

• Disclosure requirements must be met
• Primary challenge is identifying undisclosed related party transactions
• Be alert for transactions with related parties and any transations with unusual terms

• Support the auditors compliance with auditing standards
• support the auditors opinion

Assist contiinuning and new audit team members in planning and performing the audit.

Should include all significant audit findings and the actions taken to address them.

It should enable an experience auditor to understand the work performed, also id who performed and reviewed the work.

• Audit administrative working papers
• Working trial balance
• lead schedules
• Adjusting journal entries and reclassification entries
• Supporting Schedules
• Analysis of a ledger account
• Reconciliations
• Computational working papers
• Corroborating documents

• Current Files- Cirrent year working papers
• Permanent files- itmes of continuing audit interest.

Figure 5.8 look at it might be on exam.

• because of the nature of the clients busines
• the business enviornment
• financial statment elements

this is were Mistatments likely to occur in the clients Financail Statements

Can reduce inherent risks, but cannot eliminate all risks of material misstatement

this is were misstatements are prevented or detected by controls

figure 5.2

mistatments Undetected by the auditors