ACCT 4200 - Chapter 5, ACC 450 Ch. 5

When applying valuation techniques a client can choose from 3 levels of inputs (assumptions). What are these called and who do they belong to?

"Fair Value Measurements and Disclosures" - FASB ASC

Level 3

*inputs that are UNOBSERVABLE for the assets or liabilities

Level 2

*quoted prices for SIMILAR assets of liabilities*

Further audit procedures - why are they called that - what are they

- Because their timing, nature, and extent depend on results of risk assessment - Test of Details - Balances, Disclosures, transaction - Analytical Procedurs

Administrative working papers

- audit plans and programs - internal control questionnaires and flowcharts - engagement letter - time budgets - significant discussion with client management

Assertions with high inherent risk

- difficult to audit transactions - complex calculations - difficult accounting issues - significant judgement by management - valuations

Indications of High Inherent risk

- inconsistent profit of client compared to similar firms in industry - going concern problems - operating results that are highly sensitive to economic factors - detections in prior audits - substantive turnover, questionable reputation, inadequate skills

Evidence is more reliable when

- obtained from outside source - generated internally with effective controls - obtained directly by auditor - Documented and original

Reasonableness Test - how is it similar to regression? - how is it different example. hotel

- similar to regression because an explicit expectation is computed using financial and non-financial data - less formal and not based on statistical model ex. average rate * average occupancy rate to find revenue for period

Relevant assertions

- without regard to effect of controls Have a reasonable possibility of containing a misstatement that could cause financial statements to contain material misstatement

When it comes to auditing estimation transactions the AICPA standards require 3 items to be determined by auditor

1. All necessary estimates have been developed 2. They are reasonable 3. properly accounted for and disclosed

Representation Letter from client

1. End of Audit 2. Summarizes the most important oral representations made by management during engagement. - all accounting, financial data, and minutes of directors meetings been made available - FS are complete and conform with GAAP - suggested adj entries not recorded are not material - acknowledges responsibility to design and implement programs and controls to prevents and detect fraud - all items that need to be disclosed have been, properly.

8 other audit procedures?

1. Inspection of Documentation/records 2. Inquiry 3. External Confirmation 4. Inspection of Tangibles 5. Re-performance 6. Re- calculation 7. Observation 8. Analytical procedures

Purpose of Representation Letter 1. Primary 2. others

1. Remind the client officers of their primary and personal responsibilities for the FS 2. to document in working papers the clients responses to the significant questions asked by auditor during engagement - evidence with respect to managements future intentions

3 types of transactions and their inherent risk levels

1. Routine : restricted 2. non- routine : high 3. Estimation : highest!

current file order of docs

1. admin working papers( include FS draft and audit report ) 2. working trial balance, adj, reclassification 3. papers supporting balances

4 categories of working papers

1. audit administrative working papers 2. lead schedules and working trial balance 3. adjusting journal entries and reclassification entries 4. supporting schedules, analysis, reconciliations, and computational working papers 5. corroborating documents

2 things auditors should consider when determining extent of analytical procedures

1. cost benefit 2. effectiveness

Two forms of ratio analysis

1. horizontal 2. cross sectional

working papers assist 3 people

1. internal QC reviewers 2. inspection or peer reviewers 3. future auditors

4 steps to analytical procedure

1. ration/ balance expectation 2. determine acceptable difference 3. Compare company's to expectation 4. Investigate+evaluate significant differences from the expectation

3 purposes of a permanent file

1. refresh auditor memories 2. new staff with summary of policies and organization of client 3. to keep paper on items that show no changes, eliminating necessity to prepare each year

Three ways to evaluate estimations

1. review managements process: reasonableness of steps 2. develop your own process compare results to managers estimate 3. Review the calculations made based on actual events that happen after year end

Audit risk = ____ + ______

1. risk of material misstatement 2. risk of not detecting a misstatement

How many days after report release date do auditors have to complete the audit file? and what is that day called?

60 days Documentation completion date

Most reliable piece of documentary evidence created within client org.? - evidence that an... - 2 items a check bears that indicates review by outsiders

A Paid Check - asset was acquired @ given cost or liability was paid, or expense was incurred. 1. signature of payee 2. stamp indicating payment made by bank

Common- Size Income Statement

All revenues and expenses are expressed as a % of NEW SALES assets, liabilities, and equity are a percentage of total assets

Most efficient test of certain assertions like evaluating the COMPLETENESS of various rev and expense accounts

Analytical substantive procedures

Example of Inquiry

Asking personnel about their operations

Representation letters are dated as of the date of the ___

Audit report

why is the working trial balance the backbone to the audit working papers?

Because it is a key schedule that controls and summarizes all supporting papers.

Vertical Analysis is a

Common- Size income Statement

Management makes assertions about components of the FS. Name the following assertion for the situation: The accounts and transactions that should be included are included; thus, the FS are complete

Completeness

Inventory can be observed as it is _____ by client personnel

Counted

Current files vs Permanent file

Current: solely that years audit papers Permanent: continuing audit interest like articles of incorporation

Substantive Procedures

Designed to detect material misstatement of relevant assurtions

Industry averages available through

Dun & Bradstreet's Key Business Ratios Robert Morris Associate's Annual Statement Studies

Assertions about ACCOUNT BALANCES

Existence Rights and Obligations Completeness Valuation and allocation not- cutoff and Classification

Confirmations generally are effective at providing evidence about the assertion of __________ but not ___________ or __________ . ex. account receivable confirmation provides reliable evidence about the existence of an obligation but not address...

Existence of accounts Completeness or Valuation ... whether the debtor can actually pay the obligation

Management makes assertions about components of the FS. Name the following assertion for the situation: The assets and liabilities exist, and the recorded transactions have occurred

Existence or occurrence

Fair values can be evaluated by comparing to prices on ______ markets.

Existing

Internal or external: Bank statements

External

Internal or external: Long-term debt agreements

External

Internal or external: Remittance advices

External

Internal or external: Vendors' invoices

External

RJE affect only the ________ ________ presentation so should not be included in the clients __________ _________ only in the accounting __________

Financial statement accounting records worksheets

Level 1

Inputs of observable prices are of *quoted prices in active markets* for identical asset or liability

Internal or external: Duplicate copies of sales invoices

Internal

Internal or external: Materials requisition forms

Internal

Internal or external: Overhead cost allocation sheets

Internal

Internal or external: Payroll checks

Internal

Internal or external: Purchase orders

Internal

Internal or external: Shipping documents

Internal

Analytical procedures are the primary way to test data _____.

Interrelationships

The primary source of evidence about pending litigation is the attorney _____.

Letter

2. Compare R&D costs to budget

Misclassification of R&D expenses

5. Compare production records to units to sales

Misstatement of Sales and Inventory

1. Comparison of inventory levels for this year and last

Misstatement of inventory Inventory Obsolescence

4. compare client GP % to industry average

Misstatement of sales and accounts receivable Misstatement of COGS and inventory

3. compare AR turnover for this year to last

Misstatement of sales or AR Misstatement of Allowance for doubtful accounts

Should a representation letter be used as substitute for performing other audit procedures?

NOOOOO! thats what the financial statements do, this just asserts the original representations were correct.

Because documents like checks, shipping documents, and receiving reports are usually _____, it is easier for auditors to verify cutoffs

Numbered

Assertions about Presentations and Disclosures

Occurrence Rights and Obligations Completeness Accuracy and valuation Classification not- cutoff

Assertions about Classes of Transactions

Occurrence completeness accuracy cutoff classification - not rights and obligations

Analytical procedures will be on this side for the next 6 cards

Potential misstatements will be on this side for the next 6 cards

Re-performance Example

Re performing aging of accounts receivable on your own

analytical procedures related to ________ are performed during Risk Assessment stage to identify any unusual relationships involving revenue account.

Revenue

Management makes assertions about components of the FS. Name the following assertion for the situation: The assets are the rights of the entity, and the liabilities are its obligations

Rights and obligations

The amount appearing as an asset on a FS is usually the accumulation of many ___ items

Smaller

Auditors may use audit ____ to test clerical accuracy.

Sowftware

______ may be involved in some testing of calculations.

Specialists

A company sells a particular product only in the last month of its fiscal year. The company uses commission agents for such sales and pays them 6% of their net sales 30 days after the sales are made. The agents' sales were $10 million. Experience indicates that 10% of the sales are usually not collected and 2% are returned in the first month of the new year. The auditor would expect the year-end balance in the accrued commissions payable account to be a. $528,000 b. $540,000 c. $588,000 d. $600,000

Step 1: 10M x 98% = $9,800,000 Step 2: $9,800,000 x 6% commission % = $588,000 c. $588,000

Example of Inspection

Test of controls to inspect records for proper authorization

A cutoff test that relates to plant assets typically affects _____.

The balance sheet

6. compare interest expense to average outstanding balance of interest-bearing debt

Understatement of liabilities Misstatement of interest expense

Management makes assertions about components of the FS. Name the following assertion for the situation: Assets, liabilities, equity revenues, and expenses are appropriately valued and are allocated to the proper accounting period.

Valuation or allocation

What is the backbone of all the audit papers? It is a schedule listing what??

Working trial balance - schedule listing the balances of accounts for current and previous year with columns for auditors proposed adj entries/ reclassifications

In testing the existence assertion for an asset, an auditor ordinarily works from the a. accounting records to the supporting documents b. Potentially unrecorded items to the financial statements c. Supporting documents to the accounting records d. FS to the potentially unrecorded items

a. Accounting records to the supporting documents

An audit document that reflects the major components of an amount reported in the FS is referred to as a(n) a. Lead schedule b. Working trail balance c. Supporting schedule d. Audit control account

a. Lead schedule

The assurance bucket is filled with all the following types of evidence except a. The audit report b. Substantive analytical procedures c. Test of details d. Test of controls

a. The audit report

working papers demonstrate ____________ of audit team for work performed

accountability

Matters that should be in working papers. findings or matters that are significant and action taken to address them, like... 1. selection of appropriate _____________ principles 2. _______/________ transactions 3. issues related to __________ 4. Test __________ indicating misstatement 5. difficulties applying audit __________ 6. finding resulting in Modification _______ 7. identify those who ______ and ______ the work and dates

accounting complex/unusual estimates results procedures report performed and reviewed

Scanning

an analytical procedure using professional judgement to review accounting data and identify significant or items.

Corroborating Documents

articles of incorporation mortgages, audit confirmations, representation letters

Which of the following are ordinarily designed to detect possible material monetary errors in the FS? a. Test of controls b. Analytical procedures c. Computer controls d. Post-audit review of audit documents

b. Analytical procedures

The auditor generally gives most emphasis to ratio and trend analysis in the examination of the a. SOE and R/E b. I/S c. B/S d. CFs

b. I/S

Which of the following procedures would provide the most reliable audit evidence? a. Observations of procedures performed by the entity's personnel on the entity's TB? b. Inspection of bank statements obtained directly from the entity's financial institution c. Inspection of prenumbered entity purchase orders filed in the couchers payable department

b. Inspection of bank statements obtained directly from the entity's financial institution

An auditor would be least likely to use confirmations in connection with the examination of a. LTD b. Refundable income taxes c. SO/E d. inventory held in a third-party warehouse

b. Refundable income taxes

Which statement concerning audit evidence is NOT valid a. The auditor is seldom convinced beyond all doubt with respect to all aspects of the FS being audited b. The auditor performs tests to collect convincing evidence that the FS are not misstated c. The auditor weighs the cost of obtaining evidence with its usefulness d. The auditor considers the amount of risk present in deciding the nature and extent of evidence to be collected

b. The auditor performs tests to collect convincing evidence that the FS are not misstated

An auditor's analytical procedures performed during the overall review stage indicated that the entity's accounts receivable balance had doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following explanations most likely would satisfy the auditor? a. The entity liberalized its credit standards in the current year and sold much more merchandise to customers with poor credit ratings b. The entity opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet.

b. The entity opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet.

A schedule is a listing of elements comprising the ________ of an asset or liability account at a specific ____

balances date

Examples of working papers

bank reconciliation photocopies of minutes of director meetings flowcharts of internal control letters working trial balance

Why is ratio a richer form of analysis than trend analysis

because it examines relationship between two or more variables and may involve industry data.

The primary objective of final analytical procedures is to a. Identify areas that represent specific risks relevant to the audit b. Satisfy doubts when questions arise about an entity's ability to continue in existence c. Assist the auditor in assessing the validity of the conclusions reached

c. Assist the auditor in assessing the validity of the conclusions reached

Which of the following procedures would an auditor most likely rely on to verify management's assertion of completeness? a. Observing the entity's distribution on payroll checks b. Reviewing standard bank confirmations for indications of cash manipulations c. Comparing a sample of shipping documents to related sales invoices

c. Comparing a sample of shipping documents to related sales invoices

The permanent file section of the working papers that is kept for each audit client most likely contains a. a schedule of time spent on the engagement by each individual auditor b. Review notes pertaining to questions and comments regarding the audit work performed c. Narrative descriptions of the entity's accounting system and control procedures

c. Narrative descriptions of the entity's accounting system and control procedures

The substantive analytical procedure known as trend analysis is best described by a. The comparison, across time or to a benchmark, of relationships between FS accounts or between an account and nonfinancial data b. The comparison of common-size FS over time c. The examination of changes in an account over time

c. The examination of changes in an account over time

Which of the following statements concerning audit evidence is correct? a. The difficulty and expense of obtaining audit evidence concerning an account balance are a valid basis for omitting the test b. To be appropriate, audit evidence should be either persuasive or relevant but need not to be both c. The measure of the reliability of audit evidence lies in the auditor's judgment

c. The measure of the reliability of audit evidence lies in the auditor's judgement

You are auditing a store that sells merchandise. Some of the store merchandise is held on consignment. Which account balance assertion for inventory should you be more concerned about verifying? a. Existence or occurrence b. Completeness c. Rights and obligations d. Valuation or allocation

c. rights and obligations

Analysis of a ledger account shows the _________ in an asset, liability, equity, rev, or expense account during period. Most useful for accounts affected by few _______ like plant assets, long term debt.

change transactions

Cross- sectional analysis

compare ratios of similar firms at the same point in time

The current file of the auditor's working papers should generally include a. A flowchart of the accounting system b. Copies of bond and note indentures c. organization charts d. A copy of the FS

d. A copy of the FS

Audit evidence can come in different forms with different degrees of reliability. Which of the following is the most persuasive type of evidence? a. Prenumbered entity sales invoices b. Bank statements obtained from the entity c. Vendors' invoices included in the entity's files d. Computations made by the auditor

d. Computations made by the auditor

Which of the following types of audit evidence is the least reliable? a. Test counts of inventory performed by the auditor b. Bank statements obtained from the entity c. Correspondence from the entity's attorney about litigation d. Pre-numbered purchase order forms prepared by the entity

d. Pre-numbered purchase order forms prepared by the entity

Representation letters are dated as? are signed by?

date of the auditors report Client CFO AND CEO

risk that exists only if audit happens

detection risk

Reclassification Journal Entries, must be reclassified for _____ presentation. ex. AR with large credit balance should be reclassified as ________.

fair liability

Analytical procedures evaluates financial statement info by looking at relationships among _____ and __________ data. simple example

financial and non-financial compare revenue and expense from this year to last and note any significant differences

These lead schedules are set up to combine similar _______ ________ _______. The totals appear on the ______ ___________ _______.

general ledger accounts. Working trial balance

Lead schedule a.k.a

grouping sheet or summary schedules

Two types of material misstatement risk

inherent control

Risk that exists without audit

inherent and control

Detection risk varies inversely with the risk of....

material misstatement

working papers assist future and current auditors in planning and performing audit. It also serves as a record of

matters of continuing significance for future audits

Disclosure of related party transactions need to have (3 things)

nature of relationship description of transactions terms and manner of settlement

Analytical procedures performed at risk assessment stage of audit are used to determine

nature, timing, and extent of further audit procedures

Risk Assessment Procedures

obtain understand of client environment, internal control, and assess the risks of material misstatement

report release date is the date the client is granted

permission to use the report

Primary measurement of effectiveness of an analytical procedure is ___________. Can be increase by performing a more _______ analytical procedute

precision detailed ex. use monthly data rather than annual

working papers

procedures findings conclusion

Trend/Ratio analysis auditors use __________ __________ to specify an absolute amount of difference that will result in an investigation vs Regression analysis statistical model will identify the items that should be investigated based on degree of ___________ and reliability specified by the ________

profession judgement precision auditor

Appropriate is the measure of the

quality of the audit evidence

Sufficient is a measure of the

quantity of audit evidence that should be obtained

analytical procedures at the end of audit include

reviewing FS and recomputing ratios to find any undetected or unusual

horizontal analysis

reviewing clients ratios and trends over time

Analytical Example

scanning payroll register for unusual payments

working papers assist auditors responsible for _____________ in reviewing the quality of work

supervision

Test of Controls

test the operating effectiveness of controls in preventing or detecting material misstatements

Who's review is the most technical when reviewing audit papers?

the seniors to see if staff assistants have performed procedures correctly and clearly expressed conclusion

Tests of Details of balances directly address whether... Example

there are misstatements in ending balance of account ex. confirmation of ending balances in AR

Test of classes of transactions address whether particular...

types of transactions have been properly accounted for

Regression analysis - what is the advantage of using

using statistical models to quantify expectation. - more variables may be used so expectation my be precisely measured

Observation example

watching client count inventory watching mailroom clerks

cold review or quality review is...

when a 2nd partner reviews the audit working papers before signing off CPA firm name.