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Chapter 3. Management Fraud and Audit Risk. stages of an audit. Obtain (or retain) engagement CH 2 Engagement planning SoFW #1 CH 3-4 Risk assessment (int cont) SoFW #2 CH 5 Substantive Procedures SoFW #3 reporting R S CH 12. Alyssia.

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Chapter 3
Chapter 3

Management Fraud

and

Audit Risk


Stages of an audit
stages of an audit

Obtain (or retain) engagement CH 2

Engagement planning SoFW #1 CH 3-4

Risk assessment (int cont) SoFW #2 CH 5

Substantive Procedures SoFW #3

reporting R S CH 12


Alyssia
Alyssia

What is the definition of Audit Risk


Nick

What is the definition of Control Risk


Jason g
Jason G

What is the definition of Detection Risk


Chris mc
Chris Mc

What are the elements of the “Audit Risk Model”?

What is the Audit Risk Model ?


Engagement planning
Engagement planning

the Audit Risk Model

AR = IR * CR * DR

page 82

in our class

let IR = 1.00 AR = CR * DR


Engagement planning1
Engagement planning

the Audit Risk Model

let IR = HIGH AR = CR * DR

Matrix on Page 84

We are only going to look at the diagonal


Engagement planning2
Engagement planning

the Audit Risk Model

Risk of Material Misstatement

RMM = combines IR and CR


Tracy
Tracy

Describe the relationship between Control Risk and the required level of Detection Risk?

The mathematical relationship







Darryn
Darryn

What are the two basic audit approaches?


Engagement planning3
Engagement planning

the Audit Risk Model

Diagonal of Matrix on Page 84

let IR = HIGH or 1.00 AR = IR* CR * DR

We will focus on these as approaches


Engagement planning4
Engagement planning

AR = IR* CR * DR

Reduced level of Control Risk

Primarily Substantive


Jason c
Jason C

Which Component(s) of Audit Risk is the auditor unable to reduce?

Which Component(s) of Audit Risk can the auditor reduce?


Craig
Craig

Describe a Significant Class of Transactions ?

Describe a Transaction Cycle?

page 95


Class of Transactions

Accounts receivable xxx.xx

Sales xxx.xx

Revenue & Collection Cycle

Accounts receivable xxx.xx

Sales xxx.xx

Cash xxx.xx

Accounts receivable xxx.xx


David
David

Under which Audit Approach are we required to Understand the Internal Controls?


Rachel
Rachel

Why are we required to obtain an understanding of the internal controls when we are taking

the primarily substantive approach ?


Planning phase
planning phase

we are required to obtain an understanding of the Internal Control Structure under both Audit Approaches

The auditor must obtain a sufficient understanding of the entity, its environment, including its internal control, to assess the risk of materialmisstatement and to design the nature, timing, and extent of the audit procedures


Jesun
Jesun

Under which Audit Approach are we required to evaluate the design of the internal controls and assess the risk of material misstatement?

remember RMM = IR*CR


Stages of an audit1
stages of an audit

Obtain (or retain) engagement CH 2

Engagement planning SoFW #1 CH 3-4

Risk assessment (int cont) SoFW #2 CH 5

Substantive Procdures SoFW #3

reporting R S CH 12


Patrick
Patrick

Under which Audit Approach are we required to TEST the effectiveness of the Internal Controls?


Rob f
Rob F

Under which audit approach are we required to obtain sufficient appropriate evidence?


we are required to obtain sufficient appropriate evidence under both audit approaches

The auditor must obtain sufficient appropriate audit evidence through audit procedures to afford a reasonable basis for an opinion


Kathleen
Kathleen under both audit approaches

If CR = Low, what does that tell us about the allowable level of DR …. ?

If CR = High, what does that tell us about the required level of DR …. ?


Randy
Randy under both audit approaches

If we assess CR = Low, will we need to TEST the effectiveness of the Internal Controls?


Sunny
Sunny under both audit approaches

If we want to assess Control Risk as Low, what will the evidence provided by our audit procedures need to demonstrate?


Lisa under both audit approaches

If we assess CR = Max, will we need to TEST the effectiveness of the Internal Controls?


Tony under both audit approaches

If the allowable level of DR = High, what does that tell us about Control Risk …. ?

If the required level of DR = Low, what does that tell us about Control Risk …. ?


Song under both audit approaches

If the required level of DR = Low, will we need to perform extensive Substantive Tests?


Kyle under both audit approaches

If we plan the audit to result in Low Detection Risk, what will the evidence provided by our audit procedures need to demonstrate?


Sarah
Sarah under both audit approaches

If the required level of DR = MAX, will we need to perform extensive Substantive Tests?


Cesar
Cesar under both audit approaches

In your statistics class, why does a larger sample increase your level of confidence?

How does evidence reduce risk?


Ben under both audit approaches

What is the definition of Materiality


Keith
Keith under both audit approaches

Given the definition of Audit Risk

what is the relationship between

materiality and Audit Risk?


what is the risk the courts will decide that the financial statements are materially misstated if the courts decide that

$5,000,000 is material

500 is material


Lindsey
Lindsey statements are materially misstated if the courts decide that

Name 5 different of audit procedures


Audit procedures
Audit procedures statements are materially misstated if the courts decide that

  • Inspection of records and documents

  • Vouching or Tracing

  • Inspection of Assets

  • Observation

  • Inquiry

  • Confirmation the sample size project

  • Recalculation

  • Re performance

  • Analytical procedures


High risk areas and transactions
High Risk Areas and Transactions statements are materially misstated if the courts decide that


  • 1. Accounting Estimates statements are materially misstated if the courts decide that

  • 2. Non Routine Transactions

  • 3. Complex Transactions

  • 4. Related Party Transactions


1 accounting estimates
1. Accounting estimates statements are materially misstated if the courts decide that


Auditing accounting estimates
Auditing accounting estimates statements are materially misstated if the courts decide that

high risk

Considerations for control over

audit estimates bottom of p. 389

Keep track of differences


Auditing accounting estimates1
Auditing accounting estimates statements are materially misstated if the courts decide that

With estimates, there often is no right answer

  • Keep track of differences between the estimate and what auditor finds reasonable

  • Evaluate differences taken together


2 non routine transactions
2. Non Routine Transactions statements are materially misstated if the courts decide that

high risk


3 complex transactions
3. Complex Transactions statements are materially misstated if the courts decide that

high risk

page 383


4 related party transactions
4. Related Party Transactions statements are materially misstated if the courts decide that

high risk


Related party transactions
Related Party Transactions statements are materially misstated if the courts decide that

high risk - page 382

One of the parties is in a position to exert significant influence over another party

Related parties can structure transactions to conceal problems in the financial statements


Related party transactions1
Related Party Transactions statements are materially misstated if the courts decide that

page 119

blue box on page 121


Kim statements are materially misstated if the courts decide that

Please describe Professional Skepticism ?


Professional Skepticism statements are materially misstated if the courts decide that

.07 Due professional care requires the auditor to exercise professional skepticism. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. .....

.09 The auditor neither assumes that management is dishonest nor assumes unquestioned honesty. In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest.

See page 69 (bottom)


Red flags
“red flags” statements are materially misstated if the courts decide that


Fraud risk factors page 73
“Fraud Risk Factors” statements are materially misstated if the courts decide thatpage 73

  • Domination by one individual or a small group of individuals

  • Aggressive attitude toward financial reporting

  • Excessive emphasis on earnings

  • Turnover of employees

  • Evasive responses to auditors’ questions


Fraud risk factors page 731
“Fraud Risk Factors” statements are materially misstated if the courts decide thatpage 73

  • The audit client’s profits lag the industry

  • The audit client is in a declining industry


Fraud risk factors page 732
“Fraud Risk Factors” statements are materially misstated if the courts decide thatpage 73

  • audit client has a Weak internal control environment

  • client unable to generate sufficient cash flow

  • Highly profitable, complex hard-to-audit transactions

  • Related party transactions

  • Highly profitable transactions near year-end


Illegal acts red flags page 77
Illegal Acts – Red Flags statements are materially misstated if the courts decide thatpage 77

  • Government investigations

  • Regulatory reports of violations

  • Unusually large cash payments

  • Unexplained payments to Gov’t officials

  • Failure to file tax returns


Page 69 the blue box
page 69 – the Blue Box statements are materially misstated if the courts decide that

  • Fraud

  • Embezzlement

  • Larceny

  • Defalcation

  • Direct effect illegal acts


Aaaaaaron
Aaaaaaron statements are materially misstated if the courts decide that

From the auditors’ perspective, what is fraud ?


AU Section 316 statements are materially misstated if the courts decide that

Consideration of Fraud in a Financial Statement Audit

(Supersedes SAS No. 82)

Source: SAS No. 99.

Effective for audits of financial statements for periods beginning on or after December 15, 2002.


Description and Characteristics of Fraud statements are materially misstated if the courts decide that

.05 Fraud is a broad legal concept ....................... For purposes of the section, fraud is an intentional act that results in a material misstatement in financial statements

.06 Two types of misstatements are relevant to the auditor's consideration of fraud—misstatements arising from fraudulent financial reportingand misstatements arising from misappropriation of assets.

• Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements designed to deceive financial statement users ...........

• Misstatements arising from misappropriation of assets (sometimes referred to as theft or defalcation) involve the theft of an entity's assets ..........

.07 Three conditions generally are present when fraud occurs. First, management or other employees have an incentiveor are under pressure, which provides a reason to commit fraud. Second, circumstances exist— …. ineffective controls, -that provide an opportunity for a fraud to be perpetrated. Third, those involved are able to rationalize committing a fraudulent act.


National commission on fraudulent financial reporting
National Commission on statements are materially misstated if the courts decide thatFraudulent Financial Reporting

Fraudulent financial reporting is intentional or reckless conduct, whether by act or omission, that results in materially misstated financial statements


Illegal acts
Illegal Acts statements are materially misstated if the courts decide that

Indirect-effect illegal acts

Direct effect illegal acts


Christine
Christine statements are materially misstated if the courts decide that

  • To whom does the auditor report Illegal Acts of which they become aware


After discovering an illegal act
After discovering an Illegal Act statements are materially misstated if the courts decide that

  • Inconsequential – minor misappropriation by low level employees

    • Report to management one level above

  • Frauds that could cause material misstatement

  • Illegal acts involving senior management

    • Report to the Board of Directors


Max statements are materially misstated if the courts decide that

Private Securities Litigation Reform Act 1995

  • When auditors believe an illegal act has a material effect on the financial statements

  • Describe the reporting process for the Board of Directors and the Auditor


After discovering an illegal act1
After discovering an Illegal Act statements are materially misstated if the courts decide that

  • Private Securities Litigation Reform Act 1995

  • When auditors believe an illegal act has a material effect on the financial statements

    • Notify the Board of Directors

    • The Board must notify the SEC within 1 day

    • If the Board doesn’t notify SEC

    • Auditor must notify the SEC


  • Audit program
    Audit Program statements are materially misstated if the courts decide that

    • Examples page 253 6B-2

    • Examples page 296 7B-1 & 7B-2


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