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EXAM 2 Study Guide MGP Chapter 3 (Lesson 11: pp. 82-91). This chapter is very important.  Know the different types of audit tests (tests of controls and substantive tests and the differences between them). Know and understand what the three different types of substantive tests are. (There are 2 types of tests of details and there are substantive analytical procedures.) - Test of controls-Directed toward the evaluation of the effectiveness of the design and operation of internal controls.o Assess Control Risk (which contributes to Audit Risk) by evaluating both the design and operational effectiveness of the company’s controls.o Examples – inspecting documents, inquiries of management, walkthroughs, performanceo More specifically:  Observe whether shipping personnel have access to order entry or billing Inspect sample of sales orders  Recompute information on a sample of sales invoices - Substantive tests-Detect material misstatements in a transaction class, account balance, and disclosure component of the financial statements.o There are three types of substantive audit tests: Test of details- Tests for errors or fraud in individual transactions, account balances, and disclosures (sampling involved/ examining items “on a test” basis)1. Substantive Tests of Details of Transactions – verify transactions making up an account or balance.- Tests for errors of fraud in individual transactions2. Substantive Tests of Account Balances – directly test the ending balance in an account.- Focus on items that are contained in ending financial statement balances. EX: Example, auditor may want to test the account receivable balance  Substantive Analytical procedures- no sampling, involves ratios and fluctuations3. Substantive Analytical Procedures –high-level tests of reasonableness of an account balance, or association with other financial or nonfinancial information.- Can be used as a type of ST but will have to be looked at, at more of a detailed level. Using ratios and fluctuation, looking at overall reasonableness of the amount. Looking at the final balance compared to the prior months balance. Vs. Compared to taking a transaction receipt and following back all the way = test of details. - The auditor must perform some substantive tests regardless of how low RMM is.o Table 3-4, examples of internal controls and test of controls Know what dual-purpose tests are. (They are just tests that simultaneously accomplish a test of a control and a substantive test.) - Test that involves both: Test of Controls and Substantive test of transactions and test of details of account balances.- Ex: Account reconciliation, test whether control Is working properly = Test of control, then also “test of detail” testing reconciliation by testing balance of reconciliation (getting comfortable with number) = Substantive test Understand qualitative factors that might influence the auditor’s materiality judgment (Table 3-5 on page 86)- The planned qualitative amounts may be adjusted lower for qualitative factors such as:o Material misstatements in prior years.o Potential for fraud or illegal acts.o Potential loan covenant violations. o High market pressures.o High fraud risk.o Higher than normal risk of bankruptcy. Understand the definition of materiality and each of the 3 steps involved in applying materiality. - The magnitude of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would be changed or influenced by the omission or misstatement.- Materiality is not an absolute or a black and white issue! The determination of materiality requires professional judgment of the auditor.- Steps in Materiality (3) 1. Determine a materiality level for the overall financial statements o Quantitative base for materiality is a % of income, 3 year average, total assets, total revenue, gross profit o Qualitative amounts may be adjusted lower for different factors (discussed above) o Planning materiality – maximum amount the auditor believes the financial statements could be misstated and still not effect influence of users (materiality as a whole)2. Determine tolerable level of misstatements o Tolerable misstatement is the amount of planning materiality that is allocated to an account or class of transactions o Combined tolerable misstatements is greater than planning materiality because – not all accounts will be misstated by their full amount, when errors are found more testing is done anyway, simultaneous testing etc. 3. Evaluate findings o When evaluating evidence the auditor should consider: Aggregate misstatements from each account The effects of misstatement not adjusted from prior periods  If aggregate misstatements are less than the planning materiality, the auditor can conclude that the financial statements are fairly presented  If not, adjustments should be made  Understand the difference between planning materiality and tolerable misstatement. - Planning Materiality o Is the maximum amount that the auditor believes the financial statements could be misstated by and still not affect users (as a whole) - Tolerable Materiality o Amount of planning materiality that is allocated to an account or class transaction - Example: planning materiality is like picking a dollar amount, tolerable materiality is like allocatingthe planned materiality ($) to specific accounts  Understand the auditor’s decision rule when evaluating audit findings. The last sentence in the textbook listed under step 3 on page 90 is extremely helpful. Anytime the misstatement in an account is larger than tolerable misstatement or if the aggregate misstatement in the financials is greater than planning materiality, the auditor will have to require the client to book an adjustment.- Anytime the misstatement of an account is larger than the tolerable misstatement or is the aggregate misstatement in the financials is greater than the planning materiality the auditor will have to require the client to make a book adjustment- When evaluating audit evidence, the auditor should consider:o Aggregate misstatements from each account or class of transactions (including known and likely misstatements).o The effect of misstatements not adjusted in the prior period.o The aggregate misstatement in relation to planning materiality.o If the aggregate misstatement is less than planning

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FSU ACG 4632 - EXAM 2 Study Guide

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