Target AR & DR

Our Target AR is in between 0-5%

Target AR calculations for Sale and Collections processes of SDE

AR = (IR x CR) x DR

IR Inherent Risk Factors

1. Nature of client's business and industry: stable or mature -low risk
2. Integrity of management: dubious(especially if there is a prior record of accounting manipulation) -moderate risk
3. Client ownership and/or management motivations: unknown
4. Results of prior year audits: Frequent errors found in prior year engagements (have cleaned up) -moderate risk
5. Tenure of auditor: Initial audit engagement with new client and little client-specific knowledge - moderate risk
6. Existence of related parties: few related party transactions -low risk
7. Frequency of transactions: frequent transactions whose handling is automated and electronic on a regular basis -low risk
8. Subjectivity of transaction values: easily determined exchange price for transactions -low risk
9. Susceptibility to defalcation: assets cannot be easily moved or misappropriated -low risk
10. Size of balance: moderate sized transactions -moderate risk 

Out of these 10 factors we have 0 high risk, 4 moderate and 5 low. Weighing these scores giving high risk a score of .8, moderate a score of .5 and low a risk of .05 we have the value of .5(4) + .05(5) /(9) = .25

IR =.25

Control Risk (CR) - the likelihood that internal control will not prevent or detect a misstatement in a management assertion.

Control Risk Assessment - We have seen that from interviews of the managers and workers of the subdivisions of Sales and Collections that they are honest and upfront about the weaknesses of their internal controls, ready to point out flaws, and inaccuracies that occurs in their credit approval process and communication lines between warehouse and shipping. We will give the control risk a factor of .5 moderate. The control risks already in place may not prevent or detect a material misstatement in a management assertion.

CR = .5

Detection Risk (DR) - the risk that the auditor will not detect a material misstatement that exists in the financial statements or more specifically in a financial statement assertion. Detection risk factors are as follows.

1. Inadequate planning: An auditor may not plan or perform the audit procedures necessary to detect an existing misstatement. Palm Springs audit team has thoroughly conducted audit procedures to detect material misstatements, ranging from management interviews, checklists, financial statement analysis, business environment analysis, procedural analysis and etc. Risk is low.
2. Sampling missions: Auditors cannot look at every transaction; thus an existing misstatement may not be discovered because it is not among the sample of transactions that are examined. We are able to access every transaction due to SDE's transaction record being digitally recorded. With ACL, we bring this risk to non existent.
3. Procedural errors: An auditor may not apply a procedure correctly or may not recognize an error even when an erroneous transaction is selected for testing. This problem may result from poor supervision and review of work of junior auditors, but can occur at any level in the audit firm. We have an extremely experienced Auditor and professor who will be able to detect any errors made by the audit team. We bring this risk to non existent.
4. Improper corrective actions: Even when an auditor identifies an erroneous transaction, there is a possibility that the auditor's response will be inappropriate (intentionally or unintentionally) and not result in the removal of the misstatement. Our team is trustworthy, and cannot be bribed out. This risk is nonexistent.

Detection Risk score weighted. .05+0+0+0/4 = .0125

Audit Risk Calculations

AR = (.25 x .5) x .0125 = .01

Target AR is met. We are near complete certainty that financial statements do not contain material misstatements. We are in the green.

Likelihood

Description	Scale	Definition
An estimate of the probability of the threat occurring.	1. Rare	This event may occur only in exceptional circumstances. It will occur less than 5% of the time.
	2. Unlikely	This event could occur at some time. It will occur between 5% and 20% of the time
	3. Moderate	This event should occur at some time. It will occur between 21% and 59% of the time.
	4. Likely	This event will probably occur in most circumstance. Will occur from 60% to 94% of the time.
	5. Almost Certain	This event is expected to occur in most circumstances. Will occur 95% of the time.

Table 5 Attribute Criteria - Likelihood

Description	Scale	Definition
A subjective rating of the current residual risk related to a specific threat or risk after considering the current mitigation estimats	Green	Low Risk: no action required
	Amber	Moderate Risk: monitor closely
	Red	High Risk: Action required

References:

• Initial IRM Implementation Guidelines                                                                             http://www.dfo-mpo.gc.ca/ae-ve/irm-gir/guide-eng.htm#n2
• Auditing Assurance & Risk; by Knechel, Salterio and Ballou

Uses of ACL for Audit Evidence

Uses of ACL for Audit Evidence

Using the the guidance on sampling, we will have a large sample to acquire data from.  With ACL and the sample, we are able to use multiple types of tests to test for materiality or any other issues we might find as audit-relevant.


Tests:

• Z-Score
•  Some of the tests we can use to find significance are using a Z-Score analysis.  Using the Z-Score, we can find which numbers are significant and can potentially be inaccurate or fraudulent.
• Statistics
• We are able to see the range of transactions, highs and lows, the median, and the average.  This just gives us an idea of what are the common numbers.
• Stratification
• Using stratification, we can find intervals and see where most of the charges occur.
• Classification
• Using classification, we are able to go through charges and test and see if those charges are potentially fraudulent.
• Either through:
• Dates
• Vendors
• Benford Analysis
• We can also use a Benford Analysis along with the Z-Score to find out which starting digits, either 1 or 2 digit tests, are statistically significant.

Guidance on Sampling

Considering the guidance on sampling, the sampling used by us depends on the assertions being tested, the nature of the population and our assessment of the risk material misstatement. Examples that involve sampling include samples of:

• weekly sales report and review management's response to potential problems in the process
• purchase requisitions and verify proper authorizations
• locations and observe inventory count procedures executed by client personnel
• shift changes within the factory and observe employees clocking in and out
• sales invoices and test the accuracy of individual transactions by verifying quantities and prices against appropriate supporting documentation
• accounts receivable to be confirmed with customers

Although the increased use of  different tests enables us to examine all items in a population and reduces the need for sample based tests, there are many process controls that cannot be tested through tests such as ACL which can consist of the manager actually reviewing the report, a discrepancy, and that the sales system is under control.

As auditors we must address the the size of the population to use when gathering evidence from a larger population because we can't test every single item that we come across. The sample size will depend on two main factors: the assertions being tested and the assessment of risk. Once the sample size is determined, we choose the items or transactions to examine from the population. Common attributes that we would consider when selecting a sample include (similar to what we did in ACL):

• the magnitude of the transaction
• date of a transaction
• parties to the transaction
• nature of underlying assets and liabilities.

References:

• Auditing Assurance & Risk by Knechel, Salterio and Ballou

Substantive Analytical Procedures: Revenue, Cash, and A/R

Substantive Analytical Procedures – the comparison of quantitative relationships among account balances and other indicators to an auditor’s expectations.

If auditor expectations are not met, additional evidence is gathered to identify possible misstatements. (Knechel)

Documentation of Substantive Analytical Procedures (PCAOB):

a.       Form expectation

b.      Results of comparison

c.       Additional procedures to be performed

Expectations:

Revenue - $222,086

Cash - $14,176.25

Accounts Receivable – $4,609

Results:

Account	2011(Unaudited)	Auditor’s Expectations	Expectation Gap
Revenue	$352,523	$222,086	$130,437
Cash	$9,347	$14,176.25	$4,829
Accts. Receivable	$10,846	$4,609	$6,237

 

Expectations were formed based on linear progression.  Information from the Balance Sheet and Income Statement balances to form expectations.

Additional Procedures to be performed:

·         Inquiry

·         Recalculation and re-performance

·         Tests of transactions – verification of details and occurrence of transactions

·         Tests of accounts – test details of year-end balance through test of existence and valuation

·         Tests of presentation and disclosure – examine footnotes and disclosure for better understandability of financial statements

·         Inspection of records and documents – helps support all assertions in financial statements

·         Analytical evidence – examination of relationships among importance account balances, percentages and ratios for unexplained variations

References:

 Linda S. McDaniel and William R. Kinney, Jr. Expectation-Formation Guidance in the Auditor's Review of Interim Financial Information. https://webvpn.ucr.edu/+CSCO+0h756767633A2F2F6A6A6A2E77666762652E626574++/stabe/-CSCO-3p--pdfplus/2491292.pdf?acceptTC=true

AU Section 329 Substantive Analytical Procedure. PCAOB. http://pcaobus.org/Standards/Auditing/Pages/AU329.aspx#ps-pcaob_88942dde-5310-4f3e-88a9-fd8f8a478f54

Presentation 3/22/2012

Dear team, here is our presentation for tomorrow. comments & suggestions are welcome. And our Server Database, hosted in Microsoft Azure.

I hope it will work tomorrow. If not, well, i've wasted five hours working on it... But we still have our Website and this blog to document stuff. Good luck in finals week.
Best regards, Andreas

Tolerable Error and Materiality

As auditors we need to understand that tolerable error can differ from each account because some accounts are more susceptible to error or are more significant to the overall financial results of the organization. Since we do not have formal rules for determining tolerable error for account balances two generally accepted guidelines that we will use are: tolerable error should be less than the overall materiality level, and the sum of tolerable error across all accounts may equal materiality or may exceed materiality.

Materiality is subject to a great deal of judgment so as auditors we have to develop numerous rules of thumbs for setting an initial quantitative materiality level. Since every person looking at financial statements will have a different idea to what constitutes as a material misstatement we will use what is generally suggested for net income or net assets as the base for establishing quantitative materiality with percentages between 5 and 10 for net income and 1 and 3 for percent of net sales.

As auditors, rather than increase the sum of allocated tolerable errors and tolerating a larger error in some accounts we will instead decrease the sum of allocated tolerable errors because we want to decrease the overall risk that a material misstatement will remain undetected. So when all audit procedures are considered, we can conclude with reasonable assurance that the financial statements are not materially misstated. Looking at the audit documentation requirement we see that we have complied with most of them, therefore we should not have as many errors since we have documentation that would support our conclusions with respect to financial statement assertions and documentation that show that accounting records agree with financial statements, etc. Since our audit team also uses ACL to detect potential fraud, material misstatements and weaknesses this should also help keep the tolerable error and materiality low.

The tolerable error level for an account reflects the maximum size of a misstatement that could exist before the auditor would conclude that the account is materially misstated. As auditors we can set tolerable errors in one of two ways: by directly allocating a portion of overall materiality to the account in dollar terms; or calculating TEL as a specified percentage of the account where the smaller values of TEL are associated with lower detection risk.

References:

·         http://www.hkicpa.org.hk/file/media/section6_standards/standards/sas430.pdf

·         Auditing Assurance & Risk by Knechel, Salterio and Ballou

 

Calculator

Here are two simple calculators that allow us to calculate AR and DR. Or you can download the excel file below.

Audit Risk Calculator

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Detection Risk Calculator

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