MGAD10H3 Chapter Notes - Chapter 4: Audit Risk, Financial Statement, Net Income

When planning a financial statement audit, a CPA must understandaudit risk and its components. The firm of Pack & Peckevaluates the risk of material misstatement (RMM) by disaggregatingRMM into its two components: inherent risk and control risk.

Required:

For each illustration, select the component of audit risk that ismost directly illustrated. The components of audit risk may be usedonce, more than once, or not at all.

Note if each illustration below is Control risk, Detectionrisk or Inherent risk


1. A client fails to discover employee fraud on a timely basisbecause bank accounts are not reconciled monthly.
2. Cash is more susceptible to theft than an inventory ofcoal.
3. Confirmation of receivables by an auditor fails to detect amaterial misstatement.
4. Disbursements have occurred without proper approval.
5. There is inadequate segregation of duties.
6. A necessary substantive audit procedure is omitted.
7. Notes receivable are susceptible to material misstatement,assuming there are no related internal controls.
8. Technological developments make a major product obsolete.
9. The client is very close to violating debt covenants.
10. XYZ Company, a client, lacks sufficient working capital tocontinue operations.

A424

Homework #3

Due Tuesday, February 28

Worth 100 Points

Note: Students are expected to work independently (i.e., on your own) on all homework assignments. Please type and post to Canvas.

Part I. Risk Assessments

a. A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.

b. Cash is more susceptible to theft than an inventory of coal.

c. Confirmation of receivables by an auditor fails to detect a material misstatement.

d. Disbursements have occurred without proper approval.

e. There is inadequate segregation of duties.

f. A necessary substantive audit procedure is omitted.

g. Notes receivable are susceptible to material misstatement, assuming there are no related internal controls.

h. Technological developments make a major product obsolete.

i. The client is very close to violating debt covenants.

j. XYZ Company, a client, lacks sufficient working capital to continue operations.

2. Read Case 1.6, Nextcard, Inc. from our Casebook. Pretend you are the auditor for Nexcard, Inc. in the planning phase of the audit for FY 2000 and perform the following risk assessment procedures. That is, just focus on the information in the case prior to the discovery of the fraud (pages 83-86). (50 points total)

a. Perform a risk assessment as part of your audit plan for fiscal year 2000. Set or assess each component/factor of the audit risk model. Describe in detail how you set or assessed each factor (i.e., include specific risk factors from the case and explain how they influenced your assessment). (25 points)

b. Perform a fraud risk assessment for the risk of material misstatement due to fraudulent financial reporting. That is, identify and briefly describe specific fraud risk factors (i.e., more than 1) for each of the three components of the fraud risk triangle, specific to fraudulent financial reporting. (15 points)

c. Identify and describe one significant pervasive risk present during the Nextcard audit. In doing so, explain how the pervasive risk affects the risk of material misstatement. Then, describe how the auditor could respond to that pervasive risk (how could they change the audit plan to address that risk). (5 points)

d. Identify and describe one significant specific risk present during the Nextcard audit. In doing so, explain how the specific risk affects the risk of material misstatement. Then, describe how the auditor could respond to that specific risk (how could they change the audit plan to address that risk). (5 points)

Part II. Evidence and Management Assertions

1. For each of the following specific audit procedures, indicate the type of audit procedure it represents: (1) inspection of records or documents, (2) inspection of tangible assets, (3) observation, (4) inquiry, (5) confirmation, (6) recalculation, (7) reperformance, (8) analytical procedures, and (9) scanning. (10 points, 1 point each)

a. sending a written request to the entity’s customers requesting that they report the amount owed to the entity

b. examining large sales invoices for a period of two days before and after year-end to determine if sales are recorded in the proper period.

c. agreeing the total of the accounts receivable subsidiary ledger to the accounts receivable general ledger account.

d. discussing the adequacy of the allowance for doubtful accounts with the credit manager.

e. comparing the current-year gross profit percentage with the gross profit percentage for the last four years.

f. examining a new plastic extrusion machine to ensure that this major acquisition was received.

g. watching the entity’s warehouse personnel count the raw materials inventory.

h. performing test counts of the warehouse personnel’s count of the raw material.

i. obtaining a letter from the entity’s attorney indicating that there were no lawsuits in progress against the entity.

j. tracing the prices used by the entity’s billing program for pricing sales invoices to the entity’s approved price list.

2. For each of the audit procedures listed above in Part II. 1. (a-j), identify the category (assertions about classes of transactions and events, or assertions about account balances) and identify the primary management assertion being tested. (30 points, 3 points each)

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?

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

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

Which of the following best represents financial statement fraud?

Sampling risk is the risk that

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:

The purchasing process consists of each of the following phases except