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									Audit Planning
   Audit planning tools used to guide and
    direct audit work are classified as
     preliminary   risk assessment,
     preliminary   materiality decisions,
     preliminary   analytical procedures, and
     audit   programs
The Audit Risk Model
   Audit risk is the probability that an
    auditor will give an inappropriate
    opinion on financial statements. The
    auditing profession has no official
    standard for an acceptable level of
    overall audit risk, except that it should
    be ―acceptably low.‖
The Audit Risk Model (Client)
    Inherent risk is the probability that material
     misstatements have occurred in transactions
     entering the accounting system used to prepare
     financial statements.
    Control risk is the probability that the client's
     internal control system will fail to detect material
     misstatements. Control risk should not be
     assessed so low that complete reliance is on
     controls and no other audit work is performed.
The Audit Risk Model
     (Auditor)
    Detection risk is the probability that
     audit procedures will fail to produce
     evidence of material misstatements.
    Detection risk is realized when
     substantive procedures fail to detect
     material misstatements.
    Substantive procedures include
             audit of the details of transactions or
              balances, and
             analytical procedures.
The Audit Risk Model
    Audit risk can be expressed in the
     following model which assumes the
     elements to be independent:
        Audit risk (AR) = Inherent risk (IR) x
         Control risk (CR) x Detection risk
         (DR).
The Audit Risk Model
    DR =            (Detection risk)
    AR              (Audit risk)
    (IR x CR)       (Inherent risk x
     Control risk)
Preliminary Assessment of
  Planning Materiality

        Materiality is considered to be the
         largest amount of uncorrected dollar
         misstatement that could exist in
         published financial statements, yet still
         be fairly presented in conformity with
         GAAP (i.e., not misleading).
Planning Materiality
   Some of the common factors
    auditors use in making judgment
    are
       absolute size,
       relative size,
       nature of the item or issue,
       circumstances,
       uncertainty, and
       cumulative effects.
Assignment of Materiality
      Bottoms-up approach—judging
       materiality amounts in each account
       separately, then combining them to
       determine the overall effect.
      Top-down approach—judging an
       overall material amount for the
       financial statements and then
       allocating it to particular accounts.
Planning Materiality

   The concept of materiality is used
    by auditors as a guide
        to planning the audit program,
        to evaluation of the evidence, and

        for making decisions about the audit
         report.
Preliminary Analytical
      Procedures
    Analytical procedures must be applied
     in the beginning stages of each audit.
    Preliminary analytical procedures are
     primarily attention directing.
      Preliminary Analytical
            Procedures
   Five general types of procedures for analysis of
    current year account balance are as follows:
     Compare   to balances for one or more comparable
      periods.
     Compare to anticipated results (budget and
      forecasts).
     Evaluate relationships to other current-year
      balances for conformity with predictable patterns.
     Compare with similar industry information.
     Study relationships with relevant non–financial
      information.
    Planning Memorandum

   It provides a summary of the preliminary
    analytical procedures and the materiality
    assessment with specific directions about the
    effect on the audit.
   It is used to prepare an audit program.
   An audit program is a specification of
    procedures that auditors use to guide the work
    of inherent and control risk assessment and to
    obtain sufficient competent evidence that
    serves as a basis for the audit report.
           Audit Programs
   An internal control program contains
    procedures to obtain an understanding of the
    client's business and management's control
    structure, and for assessing the inherent and
    control risk.
   A balance-audit program contains substantive
    procedures for gathering direct evidence about
    the five assertions about dollar amounts in the
    account balances
Internal Control Evaluation: Assessing
            Control Risk

     The Second Standard of Field Work
        A sufficient understanding of the internal control structure
         is to be obtained to plan the audit and to determine the
         nature, timing, and extent of tests to be performed.
        How will the auditor's understanding of the internal
         control structure influence the nature, timing, and extent
         of audit tests?
        The Audit Risk Model (Assessment of Control Risk)
         AR = IR x CR x DR
         Competence of Evidential Matter (AU326.19b.):
         The more effective the internal control structure, the more
         assurance it provides about the reliability of the
         accounting data and financial statements.
          The COSO Report
   In 1992, the Committee of Sponsoring Organizations of
    the Treadway Commission (COSO) produced a report
    titled Internal Control—Integrated Framework.
   Definition. The COSO report defines internal control as a
    process designed to provide reasonable assurance that
    objectives are achieved in three areas.
       Effectiveness and efficiency of operations.
       Reliability of financial reporting.
       Compliance with applicable laws and regulations.
     Fundamental Concepts.
   The COSO report identifies four fundamental
    concepts.
     Internal control is a process to achieve objectives.
     People establish objectives, implement controls,
      and operate controls.
     Internal control provides reasonable assurance,
      not absolute assurance, that control objectives will
      be achieved.
     Internal control is designed to achieve objectives,
      as described above.
Internal Control
Components.
   Control environment
   Risk assessment
   Control activities
   Control monitoring
   Control information and
    communication
Management versus Auditor
     Responsibility
    Management is responsible for establishing and
     maintaining components of the entity's internal
     control.
    External and internal auditors are responsible
     for evaluating existing internal controls and
     assessing the related control risk.
General Categories of Internal Control Errors,
     Irregularities, and Misstatements

      Invalid transactions are recorded (validity).
      Valid transactions are omitted from the accounts
       (completeness).
      Unauthorized transactions are executed and recorded
       (authorization).
      Transaction amounts are inaccurate (accuracy).
      Transactions are classified in the wrong accounts
       (classification).
      Transaction accounting and posting is incorrect
       (accounting/posting).
       Transactions are recorded in the wrong period (proper
       period).
     Internal Control Deficiencies
   Reportable Conditions
     Reportable  conditions represent significant deficiencies in
      the design or operation of the internal controls that could
      adversely affect the organization's ability to record, process,
      summarize, and report financial data in the financial
      statements. (AU32)
   Material Weaknesses.
    A   material weakness in internal control, which is a more
      serious reportable condition, is a condition in which internal
      controls do not adequately lower the risk level of material
      errors in the financial statements and may not be found on a
      timely basis by employees of the entity. (AU325)
      The Auditor’s
    Evaluation Process
   Understand a client's financial
    reporting controls.
   Document the understanding.
   Assess the control risk.
   Use the control risk assessment to plan
    remaining audit work.
                 Control Objectives
   Validity. Ensure that recorded transactions are the ones that should
    have been recorded.
   Completeness. Ensure that valid transactions are not omitted entirely
    from the accounting records.
   Authorization. Ensure that transactions are approved before they are
    recorded.
   Accuracy. Ensure that dollar amounts are figured correctly.
   Classification. Ensure that transactions are recorded in the right
    accounts.
   Accounting and Posting. Ensure that the accounting process for a
    transaction is completely performed and in conformity with GAAP.
   Proper period. Ensure that transactions are accounted for in the period
    in which they occur.
General Control Activities
      Capable personnel.
      Segregation of responsibilities.
      Authorization to execute transactions,
      Recording transactions,
      Custody of assets involved in the
       transactions, and
      Periodic reconciliation of existing assets
       to recorded amounts.
      Controlled access.
      Periodic comparison.
Segregation of Technical Responsibilities
       and Application Controls

     Phases of a Control Evaluation
            Phase 1: Understanding the Internal Control.
            Phase 1: Documentation of the Control Structure
             Elements.
            Phase 2: Assess the Control Risk (Preliminary).
            Phase 3: Perform Test of Controls Audit Procedures.
                Tests of control procedures are performed.
                Direction of the test.
            Phase 4: Assess the Control Risk.
Control Evaluation and
     Cost/Benefit

          Revenue and
           Collection Cycle
Revenue and Collection Cycle:
     Typical Activities
         Receiving and processing service
          requests.
         Delivering services to agencies and the
          public.
         Billing entities or agencies and
          accounting for accounts receivable.
         Collecting and depositing cash
          received from all sources.
         Reconciling bank statements.
Cash Receipts and Cash Balances

   Authorization:
    Approving adjustments or cancellation of
    indebtedness.
   Custody:
    Control and custody of the physical cash.
   Recording:
    Accountants who record cash receipts and credit
    individual accounts should not handle the cash.
   Periodic Reconciliation:
    Bank accounts should be reconciled carefully.
Audit Evidence in Management
   Reports and Data Files
   Receipts received but not posted to Master File.
    Contains payment transactions started but not
    completed.
   Fine and Fee structure.
    File of fees mandated by the State, County or
    Judicial Order.
   Receipt Detail File.
    Contains detailed receipt entries.
Audit Evidence in Management
   Reports and Data Files
        Receipts Analysis Reports.
          Various  receipt analyses, for example, by
           fee type or by section, division or
           department.
        Accounts Receivable Aged Trial Balance
         (each office should have one if they are
         due funds).
         List of balances owed by individual or
         agency including aging information.
Control Risk Assessment
   General Control Considerations.
    Proper segregation of responsibilities for
    authorization, custody, recording and
    reconciliation.
   Persons who handle cash should be insured
    under a fidelity bond.
   Provide for detail error-checking activities.
   Information about the control system can be
    gathered by an internal control questionnaire, a
    ―walk-through‖ or a ―sample of one.‖
Detail Test of Controls
  Audit Procedures
     The general control objectives
      (validity, completeness,
      authorization, accuracy,
      classification, accounting and
      posting, and proper period
      recording) must be related to the
      revenue cycle activities.
Detail Test of Controls Audit
         Procedures
      Detail tests of control procedures include
        identification of the data population from which
         a sample will be selected for audit, and
        the action to be taken to produce relevant
         evidence (the action involves vouching, tracing,
         observing, scanning, and recalculation).
      Test of controls audit procedures can be used to
       audit the accounting transactions in two
       directions:
        Completeness
        Validity.
     Control Risk
Assessment (completed)

      Summary: Control Risk Assessment
       and the Audit Risk Model
       AR = IR x CR x DR
Substantive Testing
     Existence/Occurrence
     Completeness
     Valuation
     Rights/Obligations
     Presentation and Disclosure
     Confirmations
Confirmation of Cash and
  Receivable Balances

       Auditors use a standard bank
        confirmation form approved by
        AICPA, ABA, and BAI.
Confirmation of Accounts
  and Notes Receivable

        Positive confirmation
        Negative confirmation
 Confirmation
Evidence Issues
   Assertions
   Negative v. Positive
   Respondent
   Facsimile responses (faxes)
   Alternative Procedures
           Bank Reconciliations
   Accounts Receivable Lapping
     Lapping   is the process whereby an employee takes
      receipts and attempts to cover up by using later
      receipts to credit accounts of customers from which
      receipts were taken.
   Check Kiting
     Check  kiting is the practice of building up apparent
      balances in one bank account based on uncollected
      checks drawn against similar accounts in other
      banks.
Bank Reconciliations

 Proofof Cash
 The ―proof of cash‖ is a reconciliation in
 which the bank balance, the bank report of
 cash deposited, and the bank report of
 cash paid are all reconciled to the client's
 general ledger.

								
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