7.1 Purchases Responsibilities/ Organizational Structure

• Sampling risk - means the possibility that the auditor's conclusion, based on a sample, may be different from the conclusion that would have been reached if the entire population were subject to the same audit procedure
• Non- Sampling risk - is the risk of auditor error and arises from:

  • Inappropriate or ineffective audit procedures
  • Failure to recognize errors in the sample tested
  • Misinterpretation of evidence obtained
• The higher the level of prescribed detection risk then the lower level of substantive procedures and audit resources
• AR = Low

  IR = Low

  CR = high

  DR = Moderate
• AR = Moderate

  IR = High

  CR = Low

  DR = Moderate
• Nature of substantive Test

  Lower DR = Should use more persuasive tests

  Higher = Could use less persuasive
• Timing of substantive test

  Lower = perform tests at balance sheet date

  Higher = perform tests at interim dates
• Extent of substantive test

  Lower DR = Test more extensively

  Higher DR = Test less extensively
• Risk assessment procedures - are the audit procedures designed and performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion level
• Analytical procedures - involve analysis and evaluation of significant financial information made by a study of relationships among both financial and non-financial data
• Non routine transactions arising from matters

  • Greater management intervention to specify the accounting treatment
  • Greater manual intervention for data collection and processing
  • Complex calculations or accounting principles
  • The nature of non routine transactions which may make it difficult for the entity to implement effective controls
• Steps in Applying Materiality

  1. Establish a preliminary judgment about Materiality
  2. Determine tolerable misstatement
  3. Estimate likely misstatement and compare totals to the preliminary judgement about Materiality
• Risk is a measure of uncertainty
• Materiality is a measure of magnitude or size
• There is inverse relationship between sufficiency and appropriateness of audit evidence
• Vouching - refers to first selecting an item for testing from the underlying accounting data and then examining the source of document (existence) FS to economic transaction
• Tracing - selecting an accounting transaction and tracing it into the journal of ledger (completeness) economic transaction to FS
• Recalculation - checking mathematical accuracy of documents or records. Can be performed through the use of information technology
• Reperformance - auditor's independent execution of procedures or control that were originally perform as part of the entity's internal control, either manually or through the use of CAATS
• In planning the audit engagement, the auditor should consider each of the following exceptA)The kind of opinion (unmodified, qualified, or adverse) that is likely to be expressed.B)The auditor's independence.C)Anticipated levels of audit risk and materiality.D)Risks of material misstatement due to fraud.


  A)The kind of opinion (unmodified, qualified, or adverse) that is likely to be expressed.
• It would not be appropriate for the auditor to initiate discussion with the audit committee concerningA)Details of potential problems that the auditor believes might cause a qualified opinion.B)The extent to which change in the company's organization will influence the scope of the audit.C)The extent to which the work of internal auditors will influence the scope of the audit.D)Details of the procedures that the auditor intends to apply.

  D)Details of the procedures that the auditor intends to apply.
• In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about theA)Influence of management on the scope of the internal auditor's duties.B)Quality of the internal auditor's documentation.C)Organizational levels to which the internal auditor reports.D)Organization's commitment to integrity and ethical values.

  B)Quality of the internal auditor's documentation.
• The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when, in fact, such misstatement does exist isA)Audit risk.B)Control risk.C)Detection risk.D)Inherent risk.

  C)Detection risk.
• A CPA wishes to determine how various issuers have complied with the disclosure requirements in a new Accounting Standards Update. Which of the following information sources would the CPA most likely consult for this information?A)AICPA Audit and Accounting Manual.B)AICPA Accounting Trends & Techniques.C)FASB Statements of Financial Accounting Concepts.D) FASB Technical Bulletins.

  B)AICPA Accounting Trends & Techniques.
• When a management's specialist has assumed full responsibility for taking the client's physical inventory, reliance on the specialist's work is acceptable ifA)The auditor is satisfied with the competence of the specialist.B)The auditor conducted the same audit tests and procedures as would have been applicable if the client employees took the physical inventory.C)Circumstances made it impracticable or impossible for the auditor to test the work done by the specialist.D)The auditor's report contains a reference to the assumption of full responsibility by the specialist.

  B)The auditor conducted the same audit tests and procedures as would have been applicable if the client employees took the physical inventory.
• Which of the following statements concerning the auditor's use of the work of an auditor's external specialist is true?A)The auditor's specialist should observe the same confidentiality requirements as the auditor.B)If the auditor believes that the determinations made by the auditor's specialist are unreasonable, only a qualified opinion may be expressed.C)The auditor's specialist need not have an understanding of the extent of the auditor's use of the specialist's work.D)The auditor's specialist may be identified in the auditor's report only when the auditor expresses an unmodified opinion.


  A)The auditor's specialist should observe the same confidentiality requirements as the auditor.
• A corporate balance sheet indicates that one of the corporate assets is a patent. An auditor will most likely obtain evidence regarding the continuing validity and existence of this patent by obtaining a written representation fromA)The patent owner.B)A regional state patent office.C)The patent inventor.D)A patent attorney.

  D)A patent attorney.
• In using the work of an auditor's external specialist, an auditor may refer to the specialist in the auditor's report if, as a result of the specialist's findings, the auditorA)Modifies the opinion because of a material misstatement with effects that are not pervasive.B)Corroborates another specialist's findings that were consistent with management's assertions.C)Makes suggestions to management that are likely to improve the entity's internal control.D)Adds a paragraph to the auditor's report to emphasize an unusually important subsequent event involving the specialist's findings.


  A)Modifies the opinion because of a material misstatement with effects that are not pervasive.
• An auditor who uses the work of an auditor's external specialist may refer to the specialist in the auditor's report if theA)Reference is needed for an understanding of a modification of the opinion.B)Auditor's use of the specialist's findings is different from that of prior years.C)Specialist's findings provide the auditor greater assurance of reliability about management's representations.D)The specialist's findings fully corroborate management's financial statement assertions.

  A)Reference is needed for an understanding of a modification of the opinion.
• Which of the following procedures is the auditor most likely to perform after accepting an initial audit engagement?A)Assess control risk for the assertions embodied in the financial statements.B)Tour the client's facilities.C)Prepare a rough draft of the financial statement and of the auditor's report.D)Consult with and review the work of the predecessor auditor prior to discussing the engagement with the client management.

  B)Tour the client's facilities.
• Which of the following types of risk increases when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date?A)Detection.B)Inherent.C)Sampling.D)Control.

  A)Detection.
• In developing an audit plan, an auditor shouldA)Determine whether the allowance for sampling risk exceeds the achieved upper precision limit.B)Perform risk assessment procedures.C) Consider whether the inquiry of the client's attorney identifies any litigation, claims, or assessments not disclosed in the financial statements.D)Evaluate findings from substantive procedures performed at interim dates.

  B)Perform risk assessment procedures.
• Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion?A)The audit plan.B)The audit documentation.C)Auditing standards.D)The auditor's judgment.

  D)The auditor's judgment.
• Which one of the following statements is correct concerning the concept of materiality?A)Materiality depends on the nature of an item rather than the dollar amount.B)Materiality is determined by reference to AICPA guidelines.C)Materiality depends only on the dollar amount of an item relative to other items in the financial statements.D)Materiality is a matter of professional judgment.


  D)Materiality is a matter of professional judgment.
• After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances, the auditor most likely wouldA)Issue a qualified opinion of this finding as part of the auditor's report.B)Withdraw from the audit because the internal controls are ineffective.C)Increase the assessment of control risk and increase the extent of substantive tests.D)Issue a disclaimer of opinion about the internal controls as part of the auditor's report.


  C)Increase the assessment of control risk and increase the extent of substantive tests.
• An auditor is required to attempt communication with the predecessor auditor prior toA)Accepting the engagement.B)Performing tests of controls.C)Making a proposal for the audit engagement.D)Testing beginning balances for the current year.

  A)Accepting the engagement.
• If the auditors plan to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, they should assess the internal auditors'A)Training and supervisory skills.B)Efficiency and experience.C)Competence and objectivity.D)Independence and review skills.

  C)Competence and objectivity.
• Detection risk differs from both control risk and inherent risk in that detection riskA)Arises from risk factors relating to fraud.B)Exists independently of the financial statement audit.C)Should be assessed in nonquantitative terms.D)Can be changed at the auditor's discretion.

  D)Can be changed at the auditor's discretion.
• Audit planning for an initial audit most likely includesA)Performing procedures involving opening balances.B)Selecting a sample of invoices for comparison with shipping reports.C)Obtaining an engagement letter prepared by the auditee.D)Determining the opinion to be expressed.

  A)Performing procedures involving opening balances.
• Analytical procedures are used for the following purposes:

  1. To assist the auditor in planning the nature, timing, and extent of other auditing procedures
  2. As a substantive test to obtain evidential matter about particular assertions related to account balances or classes of transactions
  3. As an overall review of the financial information in the final review stage of the audit