QUESTIONS ANSWERS

1) Management might be extremely  Human error

committed to internal controls, yet it has  Collusion
been stated that it is impossible to create  Management override
an infalable control system. Please list some  Deterioration over time
reasons why this is the case.  Things change, technology, business that
you are in, etc.

2) Briefly describe and contrast the difference a) A reportable condition is something of

between a reportable condition and a
material weakness. To whom are these
items presented (assume a public company)
3) State what is the definition of "material".  Material is any item which would impact the
Include guidance on the consideration of
____
and _____ factors (hint: both words start  Materiality considers both quantitative as
with the letter "q")
4) List the factors to be considered in  I ntegrity and ethical values
evaluating the control environment.
5) List the four broad categories of "control  Performance reviews
activities"
sufficient significance that the auditor is
compelled to tell the audit committee about
it.
b) A material weakness is a reportable
condition in which the design or operation
of one or more of the internal control
components does not reduce to a relatively
low level the risk that misstatements caused
by error or fraud in amounts that would be
material in relation to the financial
statements being audited may occur and
not be detected within a timely period by
employees in the normal course of
performing their assigned functions.
c) The difference between a reportable
condition and a material weakness is that a
material weakness is a reportable condition
in which the condition could result in a
material misstatement which the company
would not detect.
decision making of a reasonable financial
statement user.
well as qualitative characteristics.
 Consequently, an item which may appear to
be of an immaterial amount or percentage
magnitude would still be material if it would
alter the decision making of a user.
 C ommitment to competence
 H uman resources
 A ssignment of authority and responsibility
 M anagement philosophy and operating
style
 B oard of directors or audit committe
 O rganizational structure
 Information processing
 Physical controls
 Segregation of duties
What is risk and materiality?
 Materiality is assessed by determining how much of a unit's financial information could be
misstated, by error or fraud, without affecting the decisions of reasonable financial
information users.

What is risk and risk of material misstatement?

 Audit risk is a function of the risks of material misstatement and detection risk'. Hence, audit
risk is made up of two components – risks of material misstatement and detection risk. Risk
of material misstatement is defined as 'the risk that the financial statements are materially
misstated prior to audit.

What is audit materiality and how is it related to audit risk?

 There is an inverse relationship between materiality and the level of audit risk, that is the
higher the materiality level, the lower the audit risk and vice versa. Auditors take into
account the inverse relationship between materiality and audit risk when determining the
nature, timing and extent of audit procedures.

Audit risk has an inverse relationship with

materiality. The lower the materiality, the higher
the audit risk as a lower materiality means there
is less room for error.

What is materiality in audit risk?

The concept of materiality is therefore
fundamental to the audit. It is applied by
auditors at the planning stage, and when
performing the audit and evaluating the effect of
identified misstatements on the audit and of
uncorrected misstatements, if any, on the
financial statements.

Tests of control vs. tests of detail

1) A test of controls involves many similar audit procedures to a test of detail, but the outcomes are
different.
2) While a test of controls supports control risk assessment, a test of details is performed to
support the overall audit opinion of a company’s statement of financial position (balance sheet)
and accompanying transactions.
3) Tests of control are only performed when the auditor believes that the control risk is low,
enabling them to verify this assessment.
4) However, a test of details is almost always required to obtain sufficient audit evidence.

Purposes of tests of control

There are several reasons to perform tests of control in auditing. If a company’s internal controls are
working effectively, it reduces the need for additional substantive audit procedures, which can be
time-consuming and costly. Another purpose of these tests is to obtain further audit evidence to
support the auditor’s statements.
Tests of control fall into four main categories:

1) Inquiry: At the first stage, auditors may ask clients to explain their control processes. Simply
inquiring about procedures qualifies as a test of control, but it provides limited evidence, so it
will need to be supplemented with additional audit sampling.
2) Observation: The test may involve observing a business process or transaction while it’s
happening, taking note of all relevant control elements. One example of observational audit
sampling for tests of controls would be to watch the client’s year-end inventory counting
procedures.
3) Reperformance: The auditor might start a new transaction to repeat the internal controls used
by the client during this process. This is considered to be one of the most reliable audit sampling
methods for tests of controls because it actively gathers direct evidence rather than relying on
observation alone.
4) Inspection: Tests of control involve the examination of business documents for any signs of
review. Signatures, checkmarks, and stamps are all signs that internal controls have been used. In
this fourth category, audit sampling for tests of controls requires the inspector to look at a
random selection of documents over time. If only a few of them show signs of review, this
indicates a weak internal control system. However, if they are all uniformly marked with a
verifying signature, this would indicate efficient controls.

Analytical procedures
To accomplish this, the analytical procedures used in planning the audit should focus on (a)
enhancing the auditor's understanding of the client's business and the transactions and events that
have occurred since the last audit date, and (b) identifying areas that may represent specific risks
relevant to the audit.

7 examples of analytical procedure methods

1) Efficiency ratio analysis. ... 5) Investment trend analysis. ...
2) Industry comparison ratio analysis. ... 6) Reasonableness test. ...
3) Other ratio analysis methods. ... 7) Regression analysis.
4) Revenue and cost trend analysis. ...

Understanding Financial Statement Assertions

1) Accuracy and Valuation

The assertion of accuracy and valuation is the statement that all figures presented in a financial
statement are accurate and based on the proper valuation of assets, liabilities, and equity
balances.
2) Existence
The assertion of existence is the assertion that the assets, liabilities, and shareholder equity
balances appearing on a company's financial statements exist as stated at the end of the
accounting period that the financial statement covers. Put simply, this assertion assures that the
information presented actually exists and is free from any fraudulent activity.
3) Completeness
This assertion attests to the fact that the financial statements are thorough and include every
item that should be included in the statement for a given accounting period. The assertion of
 completeness also states that a company's entire inventory (even inventory that may be
temporarily in the possession of a third party) is included in the total inventory figure appearing
on a financial statement.
4) Rights and Obligations
The assertion of rights and obligations is a basic assertion that all assets and liabilities included in
a financial statement belong to the company issuing the statement. Put simply, the company
confirms that it has legal authority and control of all the rights (to assets) and obligations (to
liabilities) highlighted in the financial statements.

The rights and obligations assertion states that the company owns and has the ownership rights
or usage rights to all recognized assets. For liabilities, it is an assertion that all liabilities listed on
a financial statement belong to the company and not to a third party.
5) Presentation and Disclosure
The final financial statement assertion is presentation and disclosure. This is the assertion that all
appropriate information and disclosures are included in a company's statements and all the
information presented in the statements is fair and easy to understand. This assertion may also
be categorized as an understandability assertion.

What Are Financial Statement Assertions?

Financial statement assertions are claims made by companies that attest that the information on
their financial statements is true and accurate. Information related to the assertions is found on
corporate balance sheets, income statements, and cash flow statements. There are five assertions,
including accuracy and valuation, existence, completeness, rights and obligations, and presentation
and disclosure.