Audit Final (Ch 9-11)
Off-Balance Sheet Commitments (finance/investment cycle)
-repurchase or remarketing agreements -commitments to purchases at fixed prices -commitments to sell at fixed prices -guaranteed obligations of unconsolidated subsidiaries -loan commitments -lease commitments
Clients role in audit of litigation, claims, and assessments
-respond to auditors inquiries -*provide auditors a list*, description and evaluation of litigation, claims, and assessments -*prepare attorney letter*
What can go wrong in the capital stock account (finance/investment cycle)
-some *issued stock is not recorded* -*treasury stock repurchases* are *not recorded* -Exercise of *stock options not allocated* correctly between capital stock accounts
Due to the Complexity of Accounting for Derivative Securities and Hedging Activities, auditors may need special skills or knowledge to:
-understand client hedging transactions -ensure that effective controls are in place -to audit the transactions.
Typical audit procedure of Off-Balance Sheet Commitments
-vouch the contract/agreement -inquiry
Risk of Material Misstatement 6 things in production cycle
1. *Inventory* has been included (*completeness*) 2. *Inventory* has been properly accounted for and valued using the *acceptable GAAP method* (*valuation*) 3. Items included in *inventory* on the B/S date (*existence and cutoff*) 4. Items included in *inventory* were property of the client (*rights*) 5. Proper presentation and disclosures have been provided for *inventory* (*presentation & disclosure*) 6. *COGS* includes all applicable materials, labor, and overhead properly valued (*accuracy*)
Production Cycle Errors / need to have substantive procedures for
1. *Inventory* included in inventory records *does not exist* 2. The entity *records inventory* that is *owned by other parties* 3. Inventory that should have been recorded *has been omitted* from the inventory account 4. Inventory is included in the financial statements at *incorrect amounts* and any *valuation adjustments* are *not properly recorded*
Attorney Letter Audit Process
1. Auditors request client to prepare attorney letter 2. Client sends letter made back 3. Auditors send letter to the attorney 3. Attorney replies with letter with responses to auditor
Investments account Internal Control activity (finance/investment cycle)
-broker transaction confirmations reviewed by BOD -investment purchases and sales *should be approved by BOD* -*securities held in lockbox* and *custody separate* from record keeping *SOD* -*qualified staff* responsible for *end of period fair value estimates*
Capital Stock Account Assertions (Finance/Investment Cycle)
-completeness -presentation and disclosure
Inventory Assertions in Production Cycle Explained
-items *included* in inventory *that are not inventory items* -held on *consignment is included* -items included in inventory when *received in different period* -inventory pledged *as collateral* is not disclosed -*items NOT included*
Inventory Transaction assertions explanations
-management *may overstate inventories* -*Raw material and finished good* inventories are most often *overstated* -*WIP* is difficult to *value* and may be *overstated*
What can go wrong in the investments account (finance/investment cycle)
-management sell company-owned securities for own benefit -*investments held* by entity may *be stolen* -management records *fictious interest income* -transactions recorded in *subsequent period* -*fail to mark* marketable equity securities *to fair market value* -*equity method* investments *not accurately adjusted* for investee income -*impairments* to investment securities are not properly recorded -available for sale debt securities *misclassified as Held to Maturity*
Retained Earnings account Internal Control activity (finance/investment cycle)
-management should periodically *review equity accounts* -*hired qualified personnel* and review their work
Wages and Salary Expense Assertions in Production Cycle Explained
-not recorded *in proper amount* -Some employees are paid off the books
Accounting Estimates used in the finance/investment cycle
(1) depreciation, (2) financial instruments, (3) accruals, (4) leases, (5) interest rates, and (6) other such as losses, net realizable value on segment disposal and restructurings, and the impairment of goodwill.
Audit Timeline - Audit Report Release Date
*Audit Report Release Date* Example: Feb 17 -*subsequently discovered facts* -omitted audit procedures -*management letter* -*communications* with those charged with governance
Long Term Debt account substantive analytical procedures (finance/investment cycle)
*Compare expected debt balances* to *actual* debt balances based on understanding of client's financing needs and prior year balances
Capital Stock account substantive analytical procedures (finance/investment cycle)
*Compare* current year capital stock accounts *with expectations* *based on* the review of *the BOD minutes* and *prior year* balances
Audit Timeline - Date of the Auditor's Report / Audit Completion Date
*Date of the Auditor's Report* (audit completion date) Example Feb 15 if 12/31 YE -*subsequently discovered facts*
Production Cycle Test of Controls
-*Inspect evidence of* reconciliation -Inspect evidence that inventory counts are compared to perpetual records -*Trace receiving reports to* *perpetual inventory* -*Reconcile* inventory records -*Vouch inventory records to* *receiving reports*
Audit Timeline
*During the year:* *Interim Testing* -test of controls -substantive procedures *Year-End* (date of the financial statements): -*Completing substantive procedures* -*written representations* -Going concern assessment -adjusting journal entries -audit documentation review -*subsequent events* *Date of the Auditor's Report* (audit completion date) Example Feb 15 if 12/31 YE -*subsequently discovered facts* *Audit Report Release Date* Example: Feb 17 -*subsequently discovered facts* -omitted audit procedures -*management letter* -*communications* with those charged with governance
Inventory Balance assertions explanations
*Fictitious inventory* may exist in *raw materials and finished goods* *finished goods* may include *consignment* items *inventory costs overstated*
Subsequently Discovered Facts If discovered prior to audit report release date Discovered Following audit report release date
*Following audit report release date:* *If facts would result* in *revision of auditors' report* or F/S and *individuals are relying* on F/S -*Notify individuals relying* on F/S -*Issue revised F/S* which provide disclosure of facts
Contents of Written representations
*Information related to financial statements* -*Management's responsibility* for F/S and internal control over financial reporting -*Appropriate disclosure, presentation*, *and reasonableness* of items -Statement that uncorrected *misstatements are immaterial* -Information *provided to auditors by management* -Internal control over financial reporting (for public entities)
Audit Timeline - During the year
*Interim Testing* -test of controls -substantive procedures
Extent of Substantive Inventory Procedures for Balance Assertion of Existence
*Low detection risk* = high control risk -*observe physical inventory* *count at year-end* -Take *substantial number of tests* *medium detection risk* = -*observe inventory at interim* -*test roll-forward* to year end -*moderate vouching* *high detection risk* = -*rely heavily on analytical procedures* -*observe cycle counts* of inventory -*rely on roll forward procedures* -*minimal testing*
Work in Process (WIP) Inventory Assertions
*Transaction* high/medium assertions -completeness -accuracy *Balance* assertions -valuation & allocation *Presentation and disclosure* assertions -rights and obligations -accuracy, valuation, and allocation -classification and understandibility
Raw Materials Inventory Assertions
*Transaction* high/medium assertions -occurence -cutoff -accuracy *Balance* assertions -existence -rights and obligations -valuation & allocation *Presentation and disclosure* assertions -occurence -rights and obligations -accuracy, valuation, and allocation
Finished Goods Inventory Assertions
*Transaction* high/medium assertions -occurrence -cutoff -accuracy *Balance* assertions -existence -rights and obligations -value and allocation *Presentation and disclosure* assertions -occurence -rights and obligations -accuracy, valuation, and allocation
Audit Timeline - Year End
*Year-End* (date of the financial statements): -*Completing substantive procedures* -*written representations* -Going concern assessment -adjusting journal entries -audit documentation review -*subsequent events*
Main risk of material misstatement in finance/investment cycle is
*failures to record and disclose* *transactions* and to *appropriately adjust asset valuations* for either *changes in fair value* on marketable securities or impairments.
Attorney role in audit of litigation, claims, and assessments
*respond* to auditors regarding client's description of litigation, claims, and assessments contained *in the attorney letter*
Long term account Internal Control activity (finance/investment cycle)
-*BOD authorizes issuances* of long-term notes and bonds -*SOD* of *authorization of lease agreements* from accounting for the agreements -*qualified personnel* to review their work -ensure active *oversight by independent financial experts* *from the audit committee*
US GAAP and Inventory
-*Costing methods* = Specific ID, Weighted Average, LIFO, FIFO -standard costing -*lower of cost or net realizable value*
Internal Control Activities to Mitigate the Risk of Material Misstatements in Production Cycle
-*Entity-Level Controls* -*Control Considerations* (authorizations, count items, reviews) -*custody* -*internal control questionnaire*
Long Term Debt account test of Internal Control (finance/investment cycle)
-*Inspect BOD minutes* for evidence of approval of debt -*inquire* -*inspect documents for evidence of management review -*obtain minutes* *of audit committee meetings*
Production Cycle Substantive Procedures
-*Observe client's physical inventory count* -*Confirm inventory* held by others on consignment -*Vouch items* on inventory listing to inventory count -*Inquiry* whether inventory is on consignment -*Trace inventory sub account* to inventory control account -*Perform lower cost or NRV* -*Review COGS calculations* -*Analytical procedures* with inventory turnover and gross margin to previous periods.
Production Cycle Control Considerations
-*Production runs are authorized* -*Raw Materials* should be *counted, and inspected* -As production is undertaken, materials and labor quantities should be summarized -*All inventory items *should be *accounted for* •Used in production •Scrap •Returned to inventory -Use of transfer tickets -Count and inspect the items and compare quantities -Cost accounting department reviews •*Quantity* of raw materials *to materials requisition* •*Quantity of direct labor to time sheets* and labor distribution report •Cost accounting applies overhead costs to production *using overhead tickets* •*Cost summary*
Capital Stock account Internal Control activity (finance/investment cycle)
-*authorization of BOD* *for treasury stock* -management regularly obtains *register of* *issued stock from third party*
Capital Stock account substantive test of details (finance/investment cycle)
-*confirm* capital stock *with third party registrar* -*inspect cash receipts ledger* for presence of equity transactions around year-end -*inspect schedule of treasury stock repurchases* -*inspect BOD minutes* for approval of stock options -*obtain schedule of stock options* and *test for accuracy* -*trace* capital stock ledger *to GL*
Investments account substantive test of details (finance/investment cycle)
-*confirm* investments *with brokerage* -*vouch* purchases and sales of securities to broker's advices -*physically inspect* all investment securities held by entity -*inspect client documentation for calculations* of possible impairments and test
Long Term Debt account substantive test of details (finance/investment cycle)
-*confirm* long term debt *with debtors* -*inspect lease agreements* and evaluate for appropriate accounting treatment -*obtain debt amortization schedules* and *recalculate balances* -*complete disclosure checklist* -*inspect debt agreements* and *recalculate ratios*
COGS Internal Control Activities
-*cost sheets should be reviewed* for all projects and runs to ensure *all items included and properly valued*
What can go wrong in the retained earnings account (finance/investment cycle)
-*declared dividends* are *not recorded* -*prior period error corrections* are not recorded appropriately
What can go wrong in the long term debt account (finance/investment cycle)
-*fully paid notes not properly removed* from schedule of long-term debt -management fails to record capital lease obligations -*amortization* of long term debt *is calculated incorrectly* -management fails to *reclassify current portions of long term debt* -*fails to disclose* future minimum required debt payments
Auditors role in audit of litigation, claims, and assessments
-*inquire of client* regarding the *existence* of litigation, claims and assessments -*perform various procedures* -*initiate request* to client *for attorney letter* -*mail attorney letter prepared by client*
Retained Earnings account test of Internal Control (finance/investment cycle)
-*inquiry of management about process for* ensuring accuracy and completeness of *equity accounts* -*inquire about hiring process*
Retained earnings account substantive test of details (finance/investment cycle)
-*inspect BOD minutes* for evidence of *dividend declarations* and *trace to GL* -*trace* schedule of known *prior period adjustments* to retained earnings
Capital Stock account test of Internal Control (finance/investment cycle)
-*inspect documents for evidence of review* by management of *stock registers* -*inspect BOD minutes* for approval of treasury stock -*Inquire about hiring process*
Investments account test of Internal Control (finance/investment cycle)
-*inspect* *documents* for *evidence of periodic board review* of purchase transactions -*review BOD minutes* for evidence of authorization of investment purchases -*inquire about proper SOD* -*inquire* about other things
Investments account substantive analytical procedures (finance/investment cycle)
-*recalculate interest income* -*compare* *current year* investment account *balances with expected balances* based on PY -*inspect client budgets* and compare with actual budget investment returns
Investments Account Assertions (Finance/Investment Cycle)
-Existence / occurence -completeness -valuation -presentation and disclosure
Long Term Debt Account Assertions (Finance/Investment Cycle)
-Existence / occurence -completeness -valuation -presentation and disclosure
Significant Accounts in the Production Cycle
-Inventory -Wages and salary expense -COGS
Inventory Internal Control Activities
-Inventory *areas secure* to prevent theft -*Physical count* of inventory *to compare* to records -*receiving reports* should be *prenumbered* -receiving reports *dates traced* to inventory records (proper period) -documentation for inventory *state ownership* of items -*separate account* to track *consignment items* -*valuation calculations reviewed by management*
US GAAP Inventory Disclosure Issues
-Inventory pledged *as collateral* -*Classifications* of inventory -*Cost methods* and any *changes in methods* -*Deductions of valuation allowance* for inventory losses -*Existence* and *terms of* inventory *purchase commitments*
Finance/Investment Cycle Significant Accounts
-Investments -Long Term Debt -Capital Stock -Retained Earnings
Presentation and disclosure assertions for the production cycle include:
-Occurrence -Rights and obligations -Completeness -Classification and understandability -Accuracy and valuation
Production Cycle Errors / need to have controls for
1. Production and related events that have been *recorded have not actually occurred* 2. All production *documents* have *not been recorded* 3. Production information, including costs, has been *improperly calculated and recorded* 4. Production events have *not* been *recorded in the correct* accounting *period* 5. Production material has *not* been *recorded in the proper accounts*
Chapter 9 Production Cycle
1.Describe the production cycle, including typical *source documents* 2.Identify *significant accounts* and *relevant assertions* related to the production cycle. 3.Discuss the *risk of material misstatement* in the production cycle. 4.Identify *important internal control* activities present in a properly designed system to *mitigate the risk* of material misstatements for each relevant assertion in the production cycle. 5.Give examples of *tests of controls* to test the operating effectiveness of internal controls in the production cycle. 6.Give examples of *substantive procedures* in the production cycle and relate them to assertions about significant account balances at the end of the period.
Chapter 11 Completing the Audit
1.Identify major activities performed by auditors in *completing the substantive procedures* *following the date* of the financial statements. 2.Understand the *role of attorney letters* in evaluating litigation, claims, and assessments. 3.Explain *why auditors obtain* *written representations* and identify the *key components* of written representations. 4.Identify the final steps in the *completion of an audit* 5.Understand *auditors' responsibility* *for subsequent events* and subsequently *discovered facts* 6.Identify *important activities* and *communications* *following the completion of the audit* and audit report release date.
Which of the following questions would auditors most likely include an internal control questionnaire for notes payable? (Other are more management decisions) 1. Are assets that collateralize notes payable critically needed for the entity continued existence? 2. Are two or more authorized signatures required on checks that repay notes payable? 3. Are the proceeds from notes payable used to purchase noncurrent assets? 4. are direct borrowing on notes payable authorized by the board of directors?
4. are direct borrowing on notes payable authorized by the board of directors? Because: Authorization of notes payable transactions is best done by the board of directors.
Production plan
A *schedule of goods to be produced* for a period based on sales forecasts
Sales forecasts
A report, usually prepared by marketing, predicting future sales of product.
Auditing Stock-Based Compensation Plans
ASC 718 requires that employee stock-based compensation must be *recorded using a fair value-based method* at the date the award is granted and must be credited to paid-in-capital
Wages and Salary Expense Assertions in Production Cycle
Accuracy (high) Completeness (moderate)
Overhead Allocation:
An accounting procedure used to *assign indirect costs to* *various products*
Which of the following management assertions is an auditor MOST likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance?
Completeness
Finance and Investment Cycle: Typical Activities
Concerned with *transactions related to* the use of the *organization's funds (investing)* *and* *sources of those funds* *(financing)* other than operations tangible and intangible *assets*, *long-term liabilities*, deferred credits, *stockholders' equity*, *gains and losses*, *expenses*, and *income taxes*. equity method, *consolidation*, *goodwill*, income taxes and derivatives
Production Cycle Controls
Controls: -reconcile material usage reports to other documents -have *documents prenumbered* -*periodic count of inventory* *compared to perpetual* records -*receiving reports posted* *to perpetual inventory records*
An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. This procedure most likely obtained evidence concerning management's balance assertion of
Existence Tracing the details of test counts to the final inventory schedule assures the auditor that items in the observed physical inventory are included in the inventory records. The auditor should compare the inventory tag sequence numbers in the final inventory schedule to those in the records of his or her test counts made during the client's physical inventory.
Inventory Assertions in Production Cycle
Existence Valuation & Allocation Cutoff Presentation (moderate) Rights (moderate) Completeness (low)
Roll-Forward Procedures
Extend work from interim period to date of the financial statements •Include both *tests of controls* and *substantive procedures* •*Performed following date* of the financial statements •Idea is to *obtain evidence through* *the date* of the financial statements
Production Cycle
In between acquisition and revenue cycle production cycle is mostly concerned with accounting for inventory as it moves through the production stages *from raw materials to* *work-in-process* *to finished goods* and for accumulating *accurate costs* of the inventory items.
Inventory Presentation & Disclosure assertions explanations
Inventory *disclosures* *concern valuation method* and *lower of cost and NRV rule* different type of *disclosures required*
To make a year-to-year comparison of inventory turnover MOST meaningful, the auditor performs the analysis: -for the company as a whole -by division -by product -all of the above
by product
The auditor tests the quantity of materials charged to work-in-process by vouching these quantities to
Material requisitions Material requisitions are the authorization for the inventory custodian to release raw materials and supplies to production personnel.
Stockholders' Equity: Substantive Procedures (finance/investment cycle)
SE = *low risk* •*Stockholders' equity* *transactions* usually are *well documented* *in minutes* of the meetings of the board directors, *proxy statements*, and securities offering *registration statements* •*Review* certificate *book for stock issued* during the year •Review *record of outstanding stock certificates* for stock purchased or retired
Test of Production Cost Controls: Occurrence Direction
Sample of production cost reports → vouch to: -labor reports -materials used reports -issue slips → compare to: -material requisitions -bill of materials -inventory ledger
Test of Production Cost Controls: Completeness Direction
Sample of production orders → match to bill of materials → trace to: -issue slips -materials used reports -production cost reports -labor reports
Communication with Individuals Charged with Governance
Sections 204 and 404 of SOX required communications between auditors and the client's audit committee -*either* oral or in writing but if significant in writing Auditors required to communicate: -all *significant internal control deficiencies* and *material weaknesses* *public entities* the communication must be *prior to audit report release date* private- no later than 60 days after if internal control deficiencies are significant, communicate during the audit
Standard costs
The *estimates of cost to produce a product*; used for transferring products between departments and to finished goods and to record costs of goods sold; compared to actual costs to obtain variances.
Analytic Procedures of Production Cycle
To verify *reasonableness of COGS*: -*gross profit* margin -*compare prior* year, *or* competitors/industry *averages* To verify reasonableness of *Inventory*: -*days sales* in inventory -*inventory turnover*
COGS Assertions in Production Cycle
Valuation (high) direct material, labor, and overhead have not been properly included
Bill of materials
a list of raw materials and supplies used to build a product that is used to develop standard costs
From the auditors point of view, inventory counts are more acceptable prior to the year-end when -internal controls are weak -accurate perpetual inventory records are maintained -inventory is slow moving -significant amounts of inventory are held on consignment basis
accurate perpetual inventory records are maintained Auditors rely on accurate perpetual records to maintain an accurate inventory balance during the intervening period between the physical count and the balance sheet date.
Retained Earnings Account Assertions (Finance/Investment Cycle)
completeness
Audit communications
engagement letter (auditors → client) -before engagement -written acceptance letter (clients → auditors) -before engagement -written *attorney letter response* (attorney → auditors) -*near date of auditor's reports* -written *written representations* (clients → auditors) -*audit completion date* -written *internal control deficiencies* (auditors → individuals charged with governance) -*prior to audit release date* -written *communications with individuals* charged with governance (auditors → them) -*after audit* -*oral or written* *Management Letter* (auditors → client) -*after audit* -*oral or written*
Which of the following is the most important audit consideration when examining the stockholder's equity section of the client's balance sheet?
entries in the capital stock account can be traced to resolutions in the minutes of the meetings of the BOD (Capital stock transactions are important by definition, and the directors should have approved all of them)
Which of the following approaches is most suitable for auditing the finance and investment cycle? -perform extensive tests of controls and limit substantive procedures -ignore internal controls and perform substantive procedures -gain an understanding of internal controls and perform substantive procedures -ignore internal controls and limit substantive procedures to analytical
gain an understanding of internal controls and perform substantive procedures
To determine the client's planned amount and timing of production of a product, the auditor reviews the
production plan shows what is planned to be actually produced
A client has a large and active investment portfoilio that is kept in a bank safe deposit box. If the auditors are unable to count securities at the balance sheet date, they will most likely
request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date
A client maintains perpetual inventory records in quantities and in dollars. If the assessed control risk if high, an auditor would probably
request the client to schedule the physical inventory count at the end of the year if control risk is high then observation of inventory at year-end would provide the best evidence as to existence.
Material requisition (materials transfer ticket)
the authorization for the inventory custodian to release raw materials and supplies to production personnel.
If the auditors discover that the carrying amount of a client's investments is overstated because of a loss in value that is other than a temporary decline in market value, they should insist that
the loss in value be recognized in the financial statements Losses on investment should be recorded in the accounts and shown in the financial statements.
An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management's balance assertions
valuation and allocation An examination of inventory turnover pertains to the audit objective of identifying slow-moving, excess, defective, and obsolete items included in inventories. This audit objective relates to the valuation or allocation assertion.
Manual Physical Inventory Count Reasoning to do
•*Observation* of inventory count -*Existence & Completeness* (physical quantities) •*Tests of pricing* and compilation -*Valuation* •*Analytical procedures* -Excessive inventory -Slow moving inventory (*inventory turnover*)
Adjusting Entries and Financial Statement Disclosure
•*Accumulate* dollar effects of *identified misstatements* •*Evaluate materiality* •*Recommend adjustment* of all misstatements identified •*Communicate all adjustments* and misstatements *to audit committee* or individuals charged with governance
Substantive Tests of Interest-Bearing Liabilities (IBL) (finance/investment cycle)
•*Agree to beginning balance* and *confirm with holders* or makers •Loan Proceeds -*Vouch to cash receipts* to cash journal and bank statement -*Recalculate Discount/Premium* -Confirm IBL and examine note •Loan Payoff -*Recalculate Interest Expense* -Recalculate *Gain/Loss* on Retirement -*Vouch to cash disbursements* journal and bank statement -*Confirm with debt holder* if necessary
Audit Documentation Review
•*Audit supervisor* -Have all steps in audit *plan been performed*? -Is *referencing* among documentation clear? -Are *explanations understandable*? •*Audit manager and partner* -Is the overall *scope* of the audit *adequate*? -Do overall *conclusions support the opinion*? •*Reviewing partner* -Is the *quality of audit work* and reporting consistent with quality standards of the firm? -*Engagement quality review*
Physical Inventory Observation for Auditors
•*Auditors are required* to make, or observe, *some physical counts of the inventory* and apply appropriate tests of intervening transactions
Going concern assessment
•*Auditors required to consider* whether *evidence* obtained during audit *raises questions about* ability to continue as *a going concern* •*Indicators*: -Negative trends -Financial difficulties -Internal matters -External matters -If concerns remain: *Disclose in F/S* and *modify auditors' report*
Why Inventory is a Target for Fraud
•*Complexity* (cost buildups and costing methods) •*Subjectivity of estimates* •*High volume* (*subject to theft*) •*Significant Financial statement values* (often largest current asset) *Double benefit*: *Overstate Inventory* and *Understate Costs* -Increases both Total Assets and Operating Income
Subsequently Discovered Facts If discovered prior to audit report release date
•*If discovered prior to audit report release date*, perform procedures related to items -*Revise date* of auditors' reports to reflect new completion date -*Dual date auditors' reports*
Procedures for Litigation, Claims, and Assessments
•*Inquiry* of clients •*Review minutes* of meetings of stockholders, directors, and committees •*Review contracts*, *loan agreements*, and correspondence from taxing and governmental agencies •Obtain information concerning guarantees from bank confirmations •*Review documentation* related to legal services •*Attorney's letters*
Procedures to Identify Subsequent Events
•*Obtain understanding*of procedures management performs to identify subsequent events •*Inquire of management* *and those charged with governance* •*Read minutes* of meetings of owners, management, and those charged with governance •*Review entity's interim* *financial statements*
Types of Subsequent Events
•*Provide new information about conditions* *existing at date* of the financial statements(Type1) -*Adjust financial statements* to reflect new information •*Involve events that arose following* the date of the financial statements(Type2) -*Disclose in financial statements*
Activities in Production Cycle
•*Sales Forecasts* •*Production Planning* -Production plan •Production and *Inventory Control* -Bill of materials -*Requisitions* •*Cost Accounting* -Standard costs -Overhead allocation
Procedures Following Audit Report Release Date
•*Subsequently discovered facts* •Omitted procedures •*Communication* with those charged with governance •*Management letters*
Testing Operating Effectiveness of Internal Control for Production Cycle
•*Tests of controls* -*Physical* controls -*Separation of duties* -*Performance* reviews •Direction of tests of controls -*Completeness* -*Occurrence* •Control Risk Assessment
Finance/Investment Cycle control considerations
•*Transactions authorized* *by Board of Directors* •*Documentation*: -*Investments in securities* •*Broker advice* for all transactions -*Property, plant, and equipment* •*Vendor's invoice* for purchased PPE •Internal cost records for company-built PPE -Bonds and notes *payable* •*Documentation from debtholders* -Stockholders' Equity: •*Documentation from registrar* •*Show me the money!!* -*Trace transactions* to cash receipts and disbursements journals
Pricing Tests in Production Cycle
•*Valuation (Price Tests)* -Vendor *invoices* -*Cost flow assumption* (FIFO, LIFO, average, specific identification) -*Lower of cost or market valuation* of inventory •Check extensions and footings •Agree to general ledger
Lit of examples of Communication with Individuals Charged with Governance
•Auditors' responsibility under GAAS •Overview of planned scope and timing of audit •Judgment about quality of accounting policies, estimates, and disclosures •Significant difficulties encountered during audit •Uncorrected misstatements •*Disagreements with management* •Material, corrected *misstatements* •*Representations requested* from management •Management consultations with other auditors •*Significant issues* discussed with management •*Auditor's understanding* *of significant unusual transactions* •Other findings or issues significant and relevant to those charged with governance
Other finance/investment cycle Long-Term Liabilities and Related Accounts
•Balance-sheet assertions of *completeness and presentation and disclosure* •*Unrecorded liabilities must be tested* •*Confirmations sent* to lenders to *verify long-term liabilities* •*Interest expense* may be estimated by analytical procedures •*Confirmations and inquiry* procedures for *off-balance-sheet commitments* (loan agreements, leases, endorsements, guarantees, and insurance policies) and contingencies
Procedures Performed During Fieldwork (interim and year end)
•Completing *substantive procedures* •*Attorney's letters* •*Written representations* •*Going-concern* assessment •*Adjusting* entries •Audit *documentation review* •*Subsequent events* •Subsequently discovered *facts*
Higher risk of material misstatement is present in the finance/investment cycle due to the following issues:
•Complex transactions •Fair market value •Related-party transactions •Lease accounting •Loan covenants •Impairments •Presentation and disclosure
Management Letters
•Not required under GAAS •*Are prepared as a by-product* of procedures performed in audit •*Provide recommendations to client* *for improving effectiveness and efficiency* of operations •*Delivered by auditors to client* *following audit* engagement
Omitted Procedures
•Perform procedures if: -Omitted procedures *are important* -Individuals *are currently relying on financial statements* and auditors' reports if previous opinion cannot be supported -*withdraw the original* report -*issue revised* reports -*inform persons* currently relying on the financial statements
Walkthrough of the production transaction will collect the following documents:
•Production order •Bill of materials •Inventory record (raw materials used) -Issue slips -Materials used reports •Journal Entry (moving RM to WIP) •Labor report (time records) •Journal entry (moving labor costs to WIP) •Production cost analysis (Materials & Labor) •Inventory record (finished goods addition) •Journal entry / Inventory record (moving WIP to FG)
Written representations
•Provided *by management to auditors* •Dated *using date of auditors' reports* (audit completion date) •*Qualify or disclaim an opinion* if not provided by the client
Earnings management analytical procedures
•Review accounts for "miscellaneous," "other," and "clearing" accounts (may relate to earnings management)
Production Cycle Substantive Evidence
•Sales Forecasts •Inventory reports -Items on hand -Open purchase orders •Production plans and reports •Physical Inventory Observation
Analytical Procedures (in completing the audit)
•Study of relationships among financial and nonfinancial data -used in *planning* (required), *substantive testing*, and *near the end* of the audit (required) -*Near the end of the audit*, analytical procedures *identify unusual* or unexpected *relationships not previously identified*
Trouble Spots in Audits of Investments and Intangibles
•Valuation of investments at cost or market or impairment that is other than temporary •Determination of significant influence relationship for equity method investments •Impairment of goodwill •Capitalization and continuing valuation of intangibles and deferred charges •Propriety, effectiveness, and risk disclosure of derivative securities used as hedges of exposure to changes in fair value (fair value hedge), variability in cash flows (cash flow hedge), or fluctuations in foreign currency •Determination of the fair value of derivatives and securities, including valuation models and the reasonableness of key assumptions •Realistic distinctions of research, feasibility, and production milestones for capitalization of software development costs •Adequate disclosure of restrictions, pledges, or liens related to investment assets
