The Audit Risk Model Accounting Essay

The scrutinize jeopardize Model Accounting EssayThe Audit hazard Model (ARM) is delimitate asInherent danger is the listeners footstep of assessing whether material sayments exist in the pecuniary statement before considering of inherent go oers. Ignoring informal verifys, if the attender assesses that the likeliness of material errors is gamey, the attender all(prenominal) in allow assume that the Inherent run a take ink is noble. As the ascendence seek constitutes a sepa tread component of the Audit Risk Model, it is ignored here.Control Risk is the auditors bank bill of assessing the likelihood that the clients internal chasten system is unable to prevent or detect material misstatements surpass a tolerable determine. In assessing the level of the Control Risk, the auditor will assess the effectualness of the firms internal nurse system during his audit, e.g. through questionnaires. The discredit the in effect(p)ness of internal guarantees the g reater the frequency of error.Detection Risk is the auditors measure of assessing the likelihood that the auditorwont detect material misstatements. Auditors will drivel out more than than audit work to increase the detection rate ifInternal Risk and Control Risk ar excessively high in order to meet the Audit Risk target.When applying the Audit Risk Model, the auditor has to peg down a target level of Audit Risk that is in accordance with providing reasonable assurance. The Internal Risk and Control Risk gutter be poo lead together as Occurrence Risk (OR), i.e. the bump of the globe ofmisstatements before the actual audit. The Detection Risk on the differentwise hand is the risk of the existence of misstatements during the actual audit. The first step in applying the Audit RiskModel is to determine a tolerable level of Audit Risk. In the next step the Audit Risk is decomposed into its tierce components. The auditor has no obligate over the Internal Risk and Control Risk but must assess their levels in order to determine the level of Detection Risk that is sufficient to achieve the target Audit Risk. The Detection Risk burn down be influenced by the extent of testing.Applying the chiffonieron of the Audit Risk Model, the auditor will need to perform more testing, that is collect more present, and thus reduce the Detection Risk, in movement the level of Internal Risk and/or Control Risk is high in order to achieve ( of importtain) the target. The Detection Risk rear be influenced by the nature, timing, and extent of the audit procedures.2. One of the components of the audit risk form is vestigial risk. Describe typical factors that auditors mensurate assessing inherent risk. With the benefit of hindsight, what inherent risk factors were present during the audits of the 1989 through 1992 Comptronix monetary statements?Internal Risk is the auditors measure of assessing whether material misstatements exist in the monetary statement before considering the effectiveness of internal controls. Besides factors link up to the peculiar assertion, the auditor needs to take extraneous circumstances into account that cogency influence the Internal Risk. Those can comprise the nature of business and industry, the integrity of management, the size of account balances, the existence of relatedparties, the lack of sufficient working capital to continue operations, etcetera Taking into account those numerous factors, professional judgment has to be utilize by the auditor.Examples of accounts that pose low Internal Risk comprise traded securities or fixed assets in contrast to accounts with high Internal Risk much(prenominal) as those for which estimates bear tobe used or complex calculation charter a bun in the oven to be conducted.With hindsight the following inherent risk factors were present sour purchases of equipment An audit that would have included a physical inspection of Comptronixs equipment might have revealed that certain recognized assets do non exist orthat considering the age of and thus the depreciation for the equipment that certain pieces ofequipment argon non charge their book values.Fictitious accounts payments for the equipment Besides auditing in a manner that would have revealed the nonexistence of certain purchases of equipment the auditors could have too audited check records and bank statements to see where and by whom the checks were immediate paymented in. This would have revealed that the checks were never cashed in by a third, external party, but were cashed internally.Fictitious gross revenue and accounts receivables In the same manner as with the fictitious accounts for equipment, the auditor could have suss out the inventory to verify the decrease in inventory of goods for sale as well as the payments by the customers. The former would have revealed the lack of sales date the latter would have revealed the lack of external customers for no outsideparty dep osited money in Comptronixs account. An opposite approach would have comprised duplicate the sales with the order papers and invoices. Here the auditor would have realize that thither are no records for the bogus sales and hence no sales were realized.3. Another component of the audit risk model is control risk. Describe the five components of internal control. What characteristics of Comptronixs internal control increased control risk for the audits of the1989 1992 year-end financial statements?Control risk is an auditors assessment of the internal control systems of a company. This also includes the attitude and expertise directors and management have towards internal controls.Ifcontrol risk is high because the amount of satisfying procedures that have to be conducted increases accordingly.The internal control Integrated Framework produce 1994 by COSO breaks effective internal control into five interrelated componentscontrol surroundingsrisk assessmentcontrol activities cu lture and confabulation ob take careThe control environment encompasses the internal control framework and is considered a hind end for all other elements. Included factors are integrity, ethical values, competence, managements philosophy, operating cycles, duty assignment of authority and the upkeep and direction provided by the calling card. Generally the control environment materializes in a written statement being the code of conduct.The risk assessment is best spotd as the means of identifying and analyzing internal and external risks to the achievement of financial cut throughing control objectives. Control activities are genuine to address each control objective and to minimize risks identified.Information and communication from management to personnel must be clearly stated and should test that control responsibilities must be taken seriously. The personnel must empathise its fibre in the internal control system. Thus the company identifies methods and procedures by which right breeding is provided to the right people. last, observe is the process (internal or external) to evaluate the exertion of the internal control system over time.At Comptronix different factors increased the control risk for the company. First, the loss of one of the major customers is a circumstance that increases control risk as management has an bonus to misstate earnings and other accounts to stay profitable. Second, the accounting system could be circulateed by management with factious manual entries. This increases control risk as it grants inexhaustible authority to top management for changing and manipulating accounts.Also cash disbursements could be approved by management based solely on an invoice. Finally the computerized accounting system in the shipping department, which constitutes a good internal control device, could be accessed and manipulated by the controller. In summary management had too much authority to enter and change the electronic accoun ting systems of the company, while there were no double checks in carry to verify and control manual changes in the system.4. The scorecard of directors, and its audit citizens committee, can be an effective corporate governance mechanism.a) Discuss the pros and cons of allowing inside directors to serve on the get on. Describe typical responsibilities of audit committees.Inside directors on the board can facilitate its effectiveness by establishing strong connectionsbetween the board and daylight to day business. However, inside directors can also comprise the independence of the board when it comes to personal interests. For example, the ability of theboard to set bonuses that are tied to performance and salaries of management is an important argument against inside directors. Another common stem in research is that adding insiders to the board of directors reduces board remindering. On the other hand, a study by George Drymiotes shows that a less independent board, one tha t also looks after the agents interests to whatever degree, can sometimes fulfill its observe role more effectively than a board that is completely independent. A full independent boards inability to commit to a specific level ofmonitoring effort makes monitoring ineffective. Having insiders as part of the board, however, shifts the boards interests closer to those of the agent and mitigates the boards incentives to goldbrick the agent (Drymiotes, 2007). The paper also suggests that any other mechanisms that align the boards interests, to some extent, with those of the manager whitethorn be beneficial to organizations. For instance, board and management interests can become more aligned when management owns a portion of the firm. openhanded management a share of the firm means that a convention of shareholders is managing the firm. Importantly, this particular collection of shareholders finds ex post monitoring desirable, the same demeanor inside directors do. Thus, a board r epresenting shareholder interests may have stronger incentives to monitor the agent ex post.The audit committees responsibilities can be summarized as assisting the board of directors in verifyingthe integrity of the companys financial statementsthe independence, integrity, qualification and performance of the external auditorsthe performance of the companys internal audit tendsthe appropriateness of the internal control systemsthe monitoring of compliance with laws and regulatory requirements and the code of conductb) What strengths or weaknesses were present related to Comptronixs board of directors and audit committee?First of all the CEO and murmur of Comptronix represented management of the board which constitutes already for 28.6% of the board of directors. Despite the evidence above and considering that the managers leased in parody, the high percentage of inside directors on theboard is a considerable weakness. Moreover, the remaining five outside board directors, rather undermined than strengthened the boards independence Two of them had close affiliations with management, the other maintain relations that were not that apparent at first glance, but yet substantial. One, for example, was the partner in the venture capital firm that owned over 5% of Comptronix.Finally four annual board meetings seem to not have been sufficient to exert control over management. Concerning the audit committee it can be maintained that it was neither independent norqualified. The committee members, devil outside and one gray director, were drawn from theboard of directors which was already evaluated as not being independent. Furthermore, not any of the members had accounting or financial reportage backgrounds, therefore lacking crucial expertise and experience in their function as an audit committee.5. Public Companies must file quarterly financial statements in Form 10-Qs, that have been r evaluationed by the companys external auditor. in short describe the key re quirements ofAuditing Standards (AU) sectionalisation 722, Interim Financial Information. Why wouldnt all companies (public and private) engage their auditors to perform timely reviews of lag financial statements?The SEC requires all public companies to have quarterly financial statements reviewed by the external auditor on a timely tush. SAS No. 71 provides guidance on the nature, timing, and extent of procedures to be applied by the independent restrainer in conducting a review of interim financial information. The objective of a review ofinterim financial information is to determine whether material modifications should be make for much(prenominal)(prenominal) information to conform to GAAP. A review of interim financial information consists principally of inquiries and analytical procedures. It does not include (1) tests of accounting records, (2) the evaluation of corroborating evidential matter in response to inquiries, or (3) other regulation procedures ordinarily perf ormed during an audit. Thus, the accountant does not obtain reasonable assurance that would serve as the basis for an opinion on that financial information.In perform a review of interim financial information, the accountant needs to have sufficient knowledge of a clients internal control as it relates to the planning ofboth interim and annual financial statements. That knowledge assists the accountant in identifying the likelihood of potential material misstatements in interim financial information and in selecting the inquiries and analytical procedures that will provide the accountant a basis for reporting whether material modifications should be made to the interim financial information in order for it to conform to GAAP.Non-public companies are not required to engage independent accountants toperform a review of interim financial statements. Thus, a private companys decision to engage an independent accountant to conduct a review of interim financial information is a cost-ben efit decision. The services associated with obtaining such a review require time and money. If top executives and the board of directors do not believe the relatedbenefits exceed the costs, then they are not likely to engage independent accountants. The guidance in SAS No. 71 applies to interim financial information that is included in a refer to the audited financial statements of a non-public company. If the interim financial Information for the non-public company is presented in a separate complete set of interim financial statements, the accountant should comply with the AICPAsStatements on Standards for Accounting and Review Services.Recently, there has been increased attention on interim reviews because of alleged financial reporting fraud involving interim financial statements. The SEC requirement for timely interim reviews for public companies was sparked by the February 1999Report and Recommendations of the Blue Ribbon Committee on Improving the force of Corporate Audit Co mmittees(The Blue Ribbon Report). That report included a recommendation that the SEC require a reporting companys outside auditor to conduct a SAS No. 71 interim review anterior to the companys filing of its Form 10-Q with the SEC. According to the Blue Ribbon Panels report, the increased amour by the outside auditors and the audit committee in the interim financial reporting process should burden in more accurate interim reporting.7. issue a brief summary of each of the three fraud conditions. Additionally, provide anexample from the Comptronix fraud of each of the three fraud conditions.1)Incentive or pressure to perpetrate fraud Bonus for superb performance. Company awardstock incentive to key employees2) An opportunity to carry out the fraud Executive positions that may bypass existing accountsystem.Internal controls are insufficient. Board of directors composes of mostly internaldirectors and acquaintances.3) attitude or rationalization to justify the fraudulent action. helped company avoidingreporting net losses.8. Auditing Standards (AU) Section316, Consideration of Fraud in a Financial StatementAudit, notes that there is a possibility that management subvert of controls could find inevery audit and accordingly, the auditor should include audit procedures in every audit toaddress that risk.a) What do you opine is meant by the term management override?Management override can be defined as the possibility for management to circumvent internalcontrols that emerge to work efficiently, in order to manipulate accounting records and preparingfraudulent financial statements directly or indirectly. As the internal control system is expectedto function properly, the ways in which management can override controls are unpredictable.b) Provide two examples of where management override of controls occurred in theComptronix fraudThe executives were able to bypass the existing accounting system. They could record fictitiousjournal entries of sales and purch ases manually inventing some customer order numbers andquantities that did not exist and patently were not cross-checked with other internal systems,like the customer order- or inventory system. adjacent to that it was possible to record fictitious purchases of equipment without creating thenecessary documents accompanying such purchases. The internal control failed to detect thisirregularity.Another example is the possibility of overriding control systems over cash disbursements. With afictitious vendor invoice it was possible to make an accountant payable shop clerk raise a checkwithout the necessity to crosscheck whether the delivery of the goods actually took place or anorder number generated by the vendor existed that should have been found on the invoice lateron.c) Research AU Section316 to identify the three required auditor responses to furtheraddress the risk of management override of internal controlsParagraphs 58 67 in Section 316 of the Auditing Standards by the PCAOB describe proceduresthat should be performed to further address the risk of management override of controls. Thethree main responses that should be undertaken by the auditor are as follows1. Examining journal entries and other adjustments for evidence of possible materialmisstatement due to fraud.Material misstatements due to fraud mostly occur bya. recording inappropriate or unauthorized journal entries passim the year or at periodend orb. making adjustments to amounts reported in the financial statements that are not reflectedin formal journal entries due to consolidating adjustments, report combinations andreclassifications.Therefore, the auditor should test the appropriateness of journal entries recorded in the generalledger and other adjustments.In particular, the auditor should Obtain an recogniseing of the entitys financial reporting process and the controls overjournal entries and other adjustmentsIdentify and select journal entries and other adjustments for testing Determ ine the timing of the testingInquire of individuals gnarled in the financial reporting process about inappropriate orunusual activity relating to the processing of journal entries and other adjustments2. Reviewing accounting estimates for biases that could result in material misstatement due tofraud.The assumptions and resulting accounting estimates that management has to make to prepare thefinancial statements affect the underlying accounting techniques and figures. Therefore, a lot offraudulent financial reporting is done by intentional false estimations of management. Theauditors task is to consider retrospectively whether single estimates are supported by auditevidence and whether the ones that underlie the reported financial figures widely diverge and, ifso, investigate whether the assumptions and accounting estimates were by choice biased inpart of management. Thereby, the auditor should test those accounting estimates that are basedon highly sensitive assumptions or are ot herwise significantly touched by managementjudgements.If single management estimates were biased, affect the financial figuresmaterially, the auditor should investigate whether there have been circumstances that led to thisbias and if these circumstances can constitute a risk for financial statement fraud. Also theestimates taken as a whole should then be re-considered by the auditor.3. Evaluating the business rationale for significant unusual minutes.Transactions that are outside the normal course of business for the company or entityinvestigated or that appear to be unusual should be investigated by the auditor .It should also beevaluated whether there is an underlying rationale behind those proceedings or whether they arepossibly an indication of fraudulent financial reportingTo understand the underlying rationale for the transactions in question, the auditor shouldinvestigate Whether the form of such transactions is overly complex (e.g. whether it involves multipleentities wi thin a consolidated group or unrelated third parties) Whether management has discussed the nature of and accounting for such transactions withthe audit committee or board of directors Whether management is placing more emphasis on the need for a particular accountingtreatment than on the underlying economics of the transaction Whether transactions that involve unconsolidated related parties, including excess purposeentities, have been properly reviewed and approved by the audit committee or board of directors Whether the transactions involve previously unidentified related parties or parties that do nothave the substance or the financial strength to support the transaction without assistance from theentity under audit