Chapter 12 - answer.pdf

CHAPTER 12

FRAUD AND ERROR

Questions

1.

Hold Holdin ing g a beli belief ef that that a pote potent ntia iall conf confli lict ct of inte intere rest stss alway alwayss exis exists ts caus causes es auditors to perform procedures to search for errors or irregularities that would have a material effect effect on financial statements. This tends to make audits audits more extensive for the auditor auditor and more expensive for the client. client. The situation is not a desirable one in the vast majority of audits where no errors or irregularities exist.

2.  Errors and irregularities irregularities : uditors are re!uired re!uired to plan the audit to detect errors and irregularities that would have a material effect on the financial statements. Clients’ illegal acts : uditors are not re!uired re!uired to search for illegal illegal acts" but they are warned to be alert to any that might be detected in the ordinary course of an audit. #.

$even major assertio assertions ns in financia financiall state statements ments:: a.  Existence assertion: The practical objective is to establish with evidence that assets" liabilities and e!uities actually exist and that sales and expense transactions actually occurred. %ut&off can be considered considered an aspect of the existence assertion. assertion. b.

Occurrence assertion: Occurrence assertion: The practi practical cal object objective ive is to establ establish ish with with eviden evidence ce that that record recorded ed transacti transactions ons or events events that occurred occurred during during a given given accountin accounting g period period pertained to the entity.

c.

Completeness assertion: Completeness assertion: The practical objective is to establish with evidence that all transactions of the period are in the financial statements and all transactions that properly belong belong in the preceding preceding or following following accounting accounting periods periods are excluded. excluded. nother term for these aspects of completeness is cut-off .

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Solutions Manual – Public Accountancy Profession %ompleteness also refers to proper inclusion in financial statements of all assets" liabilities" revenue" expense" and related disclosures.

d.  Rigts and Obligations assertion: Obligations assertion: The practical objectives related to rights and obligations are to establish with evidence that assets are o!ned 'or o!ned 'or rights such as capitali(ed leases are shown) and liabilities are o!ed. o!ed. e.  Measurement  assertion:  assertion: The practical objective is to establish with evidence that a transaction or event is recorded at the proper amount and revenue or expense is allocated to the proper period. f.

"aluation assertion: The practical objective is to establish with evidence that proper values have been assigned to things 'assets" liabilities" e!uities and related disclosures) and events events 'reven 'revenues ues"" expen expenses ses and relat related ed disclo disclosur sures) es).. udit uditing ing $tandards $tandards refer to the practical practical objective objective of obtaining obtaining evidence about *valua *valuatio tions ns++ achiev achieved ed by cost cost alloca allocatio tions ns such such as deprec depreciat iation ion and inventory costing methods.

g.  Presentation and #isclosure #isclosure assertion:  assertion: The practi practical cal object objective ive is to establ establish ish with with eviden evidence ce that that accoun accountin ting g principles used by management are appropriate in the circumstances and are applied properly" and that disclosures contain all information re!uired by generally accepted accounting principles. ,.

-enefits -enefits of prelimina preliminary ry assessment assessment of materiali materiality: ty: ine&tune the audit for effectiveness and efficiency. Help auditors avoid surprises related to: inding out too late about not auditing enoug. enoug . inding out later about auditing too muc. muc . /s 0" 0" material3 4aybe.  Absolute si$e. si$e. /f you think so" it5s it5s material material just because because it5s a large large number.  Relati%e si$e. si$e. 6o. /f 0" is less less than 7 of a relevant base. 4aybe. /f 0" is between between 7 and 17 of a relevant base. 8es. /f 0" is 17 or more of a relevant relevant base.  &ature of te item. item . 8es" 0" is material if it it arises from an illegal illegal act.

 'raud and Error

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8es" 8es" audito auditors rs have credited credited discove discovery ry of errors errors and irregul irregulari aritie tiess to analytic analytical al review procedures in 29.17 of the cases in a set of audits" and another 1.7 discovery rate was attributed to *prior expectations+ and *discussions.+

;.

/n assessing assessing inhere inherent nt risk and and control control risk" risk" the auditor auditor must must consider consider the the types types of errors errors or irregu irregular lariti ities es that that might might occur occur and their their impact impact on the financ financial ial statements 'materiality.) 'materiality.) /n evaluating materiality" materiality" the auditor should consider consider the impact of errors and irregularities both individually and in the aggregate. uditi uditing ng $tanda $tandards rds re!uir re!uiree that that the audito auditorr design design the audit audit to provid providee reasonable assurance of detecting errors and irregularities irregularities that are material to the financial statements. statements. uditing $tandards re!uire re!uire that audit risk and and materiality be considered both in planning the audit and in evaluating audit results. %ontro %ontroll risk risk and inherent inherent risk risk are also direct directly ly relate related d to the setting setting of materiali materiality ty thresholds. thresholds. /f" for example" example" application application of analytic analytical al procedures procedures 'inherent risk analysis) leads the auditor to suspect earnings inflation" individual item materiality materiality thresholds thresholds should should be reduced reduced accordingl accordingly y 'i.e." either the materiality percentage or the amount of unaudited income should be decreased.) $imilarly" if control risk analysis leads the auditor to suspect numerous errors" aggregate materiality thresholds need to be lowered accordingly.

9.

n auditor5 auditor5ss reaction reaction to an immate immaterial rial error error may may differ differ from from his or her reacti reaction on to an immaterial immaterial irregular irregularity. ity. uditors uditors generally generally accumulate accumulate the amount of individual immaterial errors to be sure that the aggregate of all errors is not material. /n addition" the auditor is is concerned about whether an error error came from a misunderstanding or other cause that would have resulted in yet more errors during the period. n auditor is expected to report all irregularities irregularities to the audit committee or the board of directors and senior management.

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