Exam 2 Review Fall 2015 Chapter 4

1. Discuss and explain the independent auditor's responsibilities to detect and report errors and frauds? The overall responsibility of the auditors is to provide reasonable assurance about the client financial statement is free from material misstatement. The responsibility of an independent auditor relating to detection and report error and frauds are as follows: To assess the risk that errors and frauds may cause a client's financial statements to be

materially misstated. Design the audit to provide reasonable assurance of detecting errors and frauds

material to the financial statements.The auditor should decide on the extent of the audit procedure depending on the evidence indicating the material errors or fraud.

2. Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.Audit risk model

AR = IR * CR * DR

An auditor cannot place complete reliance on internal control to the exclusion of other audit procedures. You cannot have a condition whereAR = IR x CR (= 0) x DR = 0 As we know there is inverse relationship between the risks of material misstatement(IR* CR) and detection risk. So if risk of material misstatement is high the auditor should perform substantive test in depth in order to reduce the detection risk, because it is the detection risk which the auditor can control. In the above audit risk model each variable are independent thus if auditor completely rely on internal control the CR in audit risk model will be equal to zero and this will result in overall audit risk to be zero. Such condition never exists in practical.

The auditor should not rely on internal control as they are not designed to detect all fraud error and material misstatement in the financial statement.

3. Discuss some sources of inherent risk factors relating to the client’s business and environment.

“Inherent risk is a probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements”.Auditing standard required auditor to obtain the thorough understanding of the client business and its environment to plan and perform audit work. Some of the source that auditor should use to assess the inherent risk are:

Relevant industry, regulatory, and other external factors The nature of company and related parties The effect of the client computerized processing

The company’s selection and application of accounting principle, including related discloser.

The company’s objective and strategies and those related business risk that might reasonably expected to result in risk of material misstatement.

The companies measurement and analysis of its financial performance  Chapter 5

1. Explain the different opinions that auditors can issue for an entity's internal control over financial reporting.

The three type of opinion that auditor can issue on the entities internal control over the financial reporting are;

Unqualified. no material weaknesses in internal control have been identified as existing at the as of date (year-end) and when there have been no restrictions on the scope of the auditor's work.

Disclaimer. The audit team cannot perform all of the procedures considered necessary and therefore cannot issue an opinion.

Adverse opinion. When one or more material weaknesses exist in internal control of the client business.

2. Explain the difference between a significant deficiency and a material weakness concerning internal control.

“Significant deficiencies-conditions, or combinations of conditions, that could adversely affect the organization's ability to initiate, record, process, and report financial data in the financial statements”

“Material weakness in internal control is defined as a deficiency or combination of deficiencies, those results in a reasonable possibility that a material misstatement would not be prevented or detected on a timely basis”

From the above two definition the difference between a significant deficiency and a material weakness is the

Likelihood and Materiality that a potential (or actual) misstatement would not be detected on a timely

basis.

3.    Discuss what constitutes a material weakness in internal control.  

A material weakness in internal control is defined as a deficiency, or combination ofDeficiencies, that results in a reasonable possibility that a material misstatement would not be

Prevented or detected on a timely basis. The following circumstances should be regarded asStrong indicators that a material weakness exists:

Restatement of previously issued financial statements to reflect the correction of a misstatement.

Evidence of material misstatements (caught by the audit team) that were not prevented or detected by the client's internal controls.

Ineffective oversight of the financial reporting process by the entity's audit committee. Indication of fraud (either material or immaterial) by senior management.