Determining the Extent of Determining the Extent of TODB TODB Risk model factors Risk model factors • Acceptable audit risk Acceptable audit risk • Inherent risk Inherent risk • Control risk Control risk Materiality Materiality (partially (partially depends on AAR) depends on AAR)
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Determining the Extent of TODB Risk model factors Acceptable audit riskAcceptable audit risk Inherent riskInherent risk Control riskControl risk Materiality.
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Determining the Extent of TODBDetermining the Extent of TODB
Risk model factorsRisk model factors• Acceptable audit riskAcceptable audit risk
• Inherent riskInherent risk
• Control riskControl risk
MaterialityMateriality (partially depends on (partially depends on AAR)AAR)
Determining the Extent of TODBDetermining the Extent of TODB
Risk model factorsRisk model factors
MaterialityMateriality
Results of other testsResults of other tests• Tests of controlsTests of controls
• Substantive tests of Substantive tests of transactionstransactions
Softwood increased 3.9%, industry Softwood increased 3.9%, industry stablestable
Changes Changes usually most informativeusually most informative (also want to understand (also want to understand differences from industry)differences from industry)
Easier to spot errors in Easier to spot errors in disaggregated datadisaggregated data
Client will be able to suggest likely Client will be able to suggest likely non-error causes, which you will non-error causes, which you will evaluate.evaluate.
Consider error causesConsider error causes
What errors would cause gross What errors would cause gross profit to increase?profit to increase?
Error Causes of Gross Profit IncreaseError Causes of Gross Profit Increase
• Cutoff error - January sale recorded in Cutoff error - January sale recorded in December (COS not matched)December (COS not matched)
Cost of sales understatedCost of sales understated• Inventory overstatedInventory overstated
• Purchases understated or cutoff error - Purchases understated or cutoff error - December purchase recorded in JanuaryDecember purchase recorded in January
Extent of TestsExtent of Tests
Amount of testing for TODB objectives Amount of testing for TODB objectives will depend upon results of TOT for will depend upon results of TOT for related transaction objectives:related transaction objectives:
– see following slide for related see following slide for related objectives (from Ch. 6)objectives (from Ch. 6)
– see table in notes for specific testssee table in notes for specific tests
–main sampling application in main sampling application in TODB for AR is confirmationsTODB for AR is confirmations
Weak evidence for completeness Weak evidence for completeness - why?- why?
Confirmation are required unless Confirmation are required unless (SAS # 67):(SAS # 67):
• Accounts receivable are Accounts receivable are immaterial.immaterial.
• Confirmations are expected to be Confirmations are expected to be ineffective.ineffective.
• Combined IR and CR are lowCombined IR and CR are low, and , and other evidence reduces audit risk to other evidence reduces audit risk to an acceptably low level.an acceptably low level.
ConfirmationsConfirmations
Why would auditors like to Why would auditors like to minimize confirmations?minimize confirmations?
What is the alternative to What is the alternative to confirmations?confirmations?
Positive ConfirmationsPositive Confirmations
• Emphasis in testing is usually larger, and Emphasis in testing is usually larger, and older accountsolder accounts• Testing may be balance or individual Testing may be balance or individual
invoiceinvoice– Invoice may increase response rateInvoice may increase response rate
–Reduces extent of reconciling itemsReduces extent of reconciling items
–However, provides less assuranceHowever, provides less assurance
Negative ConfirmationsNegative Confirmations
Used whenUsed when
• Internal control effectiveInternal control effective
• Many small balancesMany small balances
• Customers expected to give Customers expected to give adequate considerationadequate consideration
Any untested portion should be Any untested portion should be treated as an error for projection treated as an error for projection purposes.purposes.
95% of returned confirmations indicated 95% of returned confirmations indicated the customer owed a smaller balance. the customer owed a smaller balance. This may be explained by:This may be explained by:
a. a. Cash receipts journal was held open after Cash receipts journal was held open after year-end.year-end.
b. There are a large number of unrecordedb. There are a large number of unrecorded liabilities.liabilities.
c. Sales journal was closed prior to y/e.c. Sales journal was closed prior to y/e.
d. Sales journal was held open after year-d. Sales journal was held open after year- end.end.
Sales Cutoff - Sales Cutoff - Primary focus is on sales Primary focus is on sales recorded just recorded just beforebefore year-endyear-end
Cash receipts cutoff -Cash receipts cutoff - Primary focus is Primary focus is on receipts recorded on receipts recorded beforebefore year-endyear-end
Purchases Cutoff -Purchases Cutoff - Primary focus is on Primary focus is on purchases recorded purchases recorded afterafter year-endyear-end
( does not affect A/R)( does not affect A/R)
Sales Cutoff ErrorsSales Cutoff Errors
Key issue is whether COS is matched. Key issue is whether COS is matched. Determining factor is whether good Determining factor is whether good are included or excluded from are included or excluded from inventory.inventory.