Transcript Chapter 2 - Audit, Assurance and Quality Control Standards

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Learning Objectives
LO6 Develop a simple audit program for an account
balance, considering the influences of risk and
tolerable misstatement.
a. Specify objectives and a population of data.
b. Determine sample size and select sample units.
c. Evaluate monetary error evidence from a balance
audit sample.
LO7 Apply and integrate the chapter topics to
analyze a practical auditing situation/case/scenario.
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Substantive Procedures for
Auditing Account Balances
Substantive tests of details auditing is the
performance of procedures to obtain direct
evidence about the dollar amounts and
disclosures in the financial statements.

Substantive procedures include:
 analytical
procedures, and
 test of details of transactions and balances.
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Risk Model Expansion
Detection risk (DR) is actually a combination of
two risks:

Analytical procedures risk (APR)
 The
probability that analytical procedures will fail
to detect material errors.

Risk of incorrect acceptance (RIA)
 The
probability that tests of details procedures will
fail to detect material errors.
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Risk Model Expansion
Expanded risk model:
AR = IR * CR * APR * RIA
Only risk of incorrect acceptance can be
controlled by the auditor. Solve the risk
model for RIA:
with AR, IR, and AP held constant RIA
varies inversely with CR or control risk.
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Sampling Risk
In sampling for substantive procedures, the
auditor faces two sampling risks.

The risk of incorrect acceptance (beta risk)
 Accepting
a balance as materially correct when
material misstatements have occurred.

The risk of incorrect rejection (alpha risk)
 Deciding
a balance is materially misstated when it
is not.
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Sampling Risk
Risk of incorrect acceptance is considered the
more important of the two.
Incorrect
acceptance leads to audit failure.
Incorrect rejection leads to additional audit
procedures to determine actual misstatement.
 Auditor
will determine that the amount is not
materially misstated.
Audit
effectiveness (the right conclusion) is
more important than efficiency (least work).
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Sampling Steps for
Account Balance Audit
1.
2.
3.
4.
5.
6.
7.
Specify the audit objectives.
Define the population.
Choose an audit sampling method.
Determine the sample size.
Select the sample.
Perform the substantive-purpose
procedures.
Evaluate the evidence.
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Plan the Procedures
The first three steps represent the problemrecognition phase.


The client’s implicit assertions with respect to
balances include existence, completeness,
valuation, ownership and presentation.
Are the client assertions about the balances
accurate?
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1. Specify the Audit
Objectives
Objective is to decide whether the client’s
assertions about existence, rights, and valuation
are materially accurate.

Hypothesis testing: auditors hypothesize that
the book value is materially accurate and test
that hypothesis.
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2. Define the Population
Definition of population must match objectives.

Examine individually significant items.
 Individual

items that exceed materiality.
Apply stratification to the remaining population.
 Subdivide
the population by account balance size.
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3. Choose an Audit Sampling
Method
Auditor will decide whether to use statistical or
judgmental sampling methods.

For statistical sampling methods, classic
variables sampling methods and attribute
sampling methods (dollar unit sampling) are
available.
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Perform the Procedures
Steps 4 to 6 represent the evidence-collection
phase.

Sample size determination requires
consideration of several factors. It is important
to get the sample size right, to avoid overauditing or under-auditing.
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4. Determine the Sample Size
The sample size is based on the following:
 risk
of incorrect acceptance (RIA),
 risk of incorrect rejection (RIR),
 material misstatement amount,
 expected dollar misstatement in the population,
 variability within the population, and
 size of the population.
DUS can be used to calculate a sample size.
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5. Select the sample
Random or non-random methods, as in sample
selection for test of controls.
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6. Perform the substantive
purpose procedures.
Substantive-purpose audit program produces
evidence to support or refute management
assertions.
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7. Evaluate the Evidence
Evaluate the evidence:

Determine amount of known misstatement.
 Total
amount of errors actually uncovered by
procedures.

Determine the likely misstatement.
 Project
the misstatement found in the sample to
the population.


Average difference method.
Dollar-unit sampling projection method.
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7. Evaluate the Evidence
Consider sampling risks:

Auditor uses professional judgment and
experience to consider these risks.
Quantitative evaluation:

Follow up on all differences uncovered to
determine any misunderstanding of GAAP,
simple mistakes, intentional irregularities, or
management override of controls.
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7. Evaluate the Evidence
Evaluate the misstatement:


Known misstatement and likely misstatement
are combined and compared to materiality.
Sample risk gives rise to “possible
misstatements.”
 Misstatements
that remain undetected in units not
sampled.
 Can be calculated where statistical methods are
used.
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Timing of Substantive
Procedures
Account balances can, in part, be audited at an
interim date.


Auditor will extend the interim date audit
conclusions to balance sheet date.
Audit work is performed at interim dates:
 to
spread auditor’s workload over the year, and
 to allow for timely production of audit report
following year end.

Poor controls, or significant business risk may
preclude performing procedures at interim.
LO6