MGA 614 Midterm

Five Types of Accounts

(1) Assets (2) Liabilities (3) Equity (4) Revenues (5) Expenses

Types of Audit Procedures

(1) Inspection (2) Observation (3) Inquiry * Inquiry of company personnel alone is never enough! (4) Confirmation (5) Recalculation (6)Reperformance (7) Analytical procedures

Fair value

-A fair value measurement is a form of accounting estimate. -The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Audit documentation -contra evidence

-Audit documentation must include information the auditor has identified relating to significant findings or issues that is inconsistent with or contradicts the auditor's final conclusions ("contra evidence"). -Contra evidence to be retained includes, but is not limited to: -procedures performed in response to the information, and -records documenting consultations on, or resolutions of, differences in professional judgment among members of the engagement team or between the engagement team and others consulted

Procedures for obtaining audit evidence

-Audit procedures can be classified into the following categories: -(1) Risk assessment procedures, and -(2) Further audit procedures, which consist of: -(A) Tests of controls, and -(B) Substantive procedures, including tests of details and substantive analytical procedures.

PCAOB Auditing Standards

-Auditing Standards have an overall framework: •General auditing standards •Audit procedures •Auditor reporting •Matters relating to filings under Federal Securities Law •Other matters associated with audits

Level 2 Fair Value Ex

-Bonds that trade infrequently, options/warrants, futures, swaps, mortgage backed securities • Don't trade with the same frequency • Have variations in individual characteristics - not all the same (vs. a share is a share is a share of XOM) • May trade through a broker • May be modeled using observable inputs -Can generally find prices for similar transactions and use them to model values of the security in question

What substantive approach should be used to audit estimates?

-Can use one or a combination of the following approaches: 1. Test the company's process used to develop the accounting estimate; 2. Develop an independent expectation for comparison to the company's estimate; and/or 3. Evaluate audit evidence from events or transactions occurring after the measurement date related to the accounting estimate for comparison to the company's estimate -The approach to auditing an estimate should consider the auditor's understanding of the process the company used to develop the estimate and, if relevant controls are tested, the results of those control tests

Level 3 Fair Value Ex

-Derivatives, private equity shares • Don't trade on an active exchange • Unobservable inputs generally based on company specific assumptions -Generally use a complex model to value

What about using audit evidence from events or transactions occurring after the measurement date?

-Events and transactions that occur after the measurement date can provide relevant evidence to the extent they reflect conditions at the measurement date -Need to ensure the evidence is sufficient, reliable and relevant -Consider whether it supports or contradicts the Company's estimate -Consider changes in circumstances and conditions

Level 1 Fair Value Ex

-Exchange traded stocks, bonds and funds • Stocks have a ticker symbol • Bonds have a CUSIP number • Funds have a ticker symbol Can look up the prices in the WSJ or online

What does audit documentation accomplish?

-Facilitates the planning, performance, and supervision of the engagement -The basis for the review of the quality of the work because it provides the reviewer with written documentation of the evidence supporting the auditor's significant conclusions.

How is fair value determined?

-Fair Value is determined using inputs applied in the valuation techniques. -Inputs are the assumptions that market participants use to make pricing decisions, including assumptions about risk. -We distinguish between: -Observable inputs, which are based on market data obtained from sources independent of the reporting entity, and -Unobservable inputs, which reflect the reporting entity's own assumptions. Reporting entities should maximize their use of observable inputs.

Reliability of audit evidence

-If a third party provides evidence to an auditor subject to restrictions, limitations, or disclaimers, the auditor should evaluate the effect of the restrictions, limitations, or disclaimers on the reliability of that evidence. -The auditor is not expected to be an expert in document authentication. However, if conditions indicate that a document may not be authentic or that the terms in a document have been modified but that the modifications have not been disclosed to the auditor, the auditor should modify the planned audit procedures or perform additional audit procedures to respond to those conditions and should evaluate the effect, if any, on the other aspects of the audit.

Financial Statement Assertions

-In representing that the financial statements are presented fairly in conformity with the applicable financial reporting framework, management implicitly or explicitly makes assertions regarding the recognition, measurement, presentation, and disclosure of the various elements of financial statements and related disclosures. -Those assertions can be classified into the following categories: (1) Existence or occurrence (2) Completeness (3) Valuation or allocation (4) Rights and obligations (5) Presentation and disclosure

International Auditing Standards

-International Auditing and Assurance Standards Board (IAASB)

Fair value hierarchy

-Level 1: Observable inputs that reflect quoted prices for identical assets or liabilities in active markets -Level 2: Quoted prices for similar assets/liabilities, quoted prices for identical assets/liabilities in an inactive market, and model-derived valuations whose inputs are observable -Level 3: Unobservable inputs (e.g., a company's own data)

How do we identify the Company's significant assumptions in making the estimate?

-Look for assumptions that are: -Sensitive to variation, such as minor changes that can cause significant changes in the result; -Susceptible to bias; -Involve unobservable data or adjustments to observable data made by the Company; or -Depend on the Company's ability and intent to carry out specific courses of action

How do we test the Company's data utilized in making the estimate?

-Need to consider -Is the data complete and accurate? -Is the data sufficiently precise? -Is the data relevant and reliable? -Is the data internally consistent with other information and calculations produced by the company? -Has the data source changed?

How do we evaluate the company's methods?

-Need to consider: -Is the method in conformity with the financial reporting framework? -is the method appropriate, considering the company and its environment? and -if the method has changed, consider the reasons for the change and their appropriateness. -Do different/alternate methods produce significantly results? If so, why has the Company selected the method it is using?

AICPA Code of Professional Conduct

-Principles (overall framework) -Rules (Govern professional services) -Interpretations (Provide guidelines)

When does audit documentation need to be completed?

-Prior to the issuance of the audit report, the auditor must have completed all necessary auditing procedures and obtained sufficient evidence to support the representations in the auditor's report. -A complete and final set of audit documentation should be assembled for retention as of a date not more than 45 days after the report release date.

US Auditing Standards

-Public Company Accounting Oversight Board (PCAOB) -American Institute of Certified Public Accountants (AICPA)

AICPA Six Principles

-Responsibilities -The public interest -Integrity -Objectivity & Independence -Due Care -Scope & Nature of Services

Significant findings and issues which must be documented

-Significant matters involving the selection, application and consistency of accounting principles -Results of audit procedures that indicate the need for modification of planned auditing procedures the existence of material misstatements the existence of significant deficiencies and or material weaknesses in internal control -The accumulation of misstatements and the evaluation of the materiality of uncorrected misstatements -Disagreements among members of the audit team and the basis for resolution -Difficult circumstances in applying audit procedures -Significant changes in risk assessments and how the planned audit procedures were modified, and -Any matters that could result in a modification of the auditors report

How to test the company's process to develop an estimate?

-Testing the process to develop an estimate involves evaluating the methods, data, and significant assumptions used in the estimate, in order to form a conclusion about whether the estimate is properly accounted for

Responding to RMM

-The auditor needs to design and implement appropriate responses that address risks of material misstatement; -Those responses must include applying substantive procedures to accounting estimates in significant accounts and disclosures - tests of controls are not enough; -The auditor must evaluate whether the estimate -conforms to the applicable financial reporting framework; -is reasonable under the circumstances; and -is subject to management bias

How do we develop an independent expectation of the estimate?

-The auditor uses some or all of their own methods, data and assumptions -Must have a reasonable basis for methods and assumptions selected -Must consider relevance and reliability of data from a third party, or test Company data per Company process above -A reasonable range, rather than a point estimate, may be appropriate

What is Audit Documentation?

-The written record of the basis for the auditor's conclusions that provides the support for the auditor's representations -Demonstrates compliance with professional standards -Supports basis for conclusions regarding every relevant financial assertion, and -Demonstrates that the underlying accounting records agree and or reconcile to the financial statements

Auditor Actions in Performing the Audit

-To express and opinion, the auditor obtains reasonable assurance about whether the FS as a whole are free from material misstatement, due to fraud or error

Quantity of Audit Evidence

-affected by the following: (1) Risk of material misstatement (in the audit of financial statements) or the risk associated with the control (in the audit of internal control over financial reporting). As the risk increases, the amount of evidence that the auditor should obtain also increases. For example, ordinarily more evidence is needed to respond to significant risks. (2) Quality of the audit evidence obtained. As the quality of the evidence increases, the need for additional corroborating evidence decreases. Obtaining more of the same type of audit evidence, however, cannot compensate for the poor quality of that evidence.

Elements of COSO Framework

-control environment -risk assessment -control activities -information and communication -monitoring

Valuation techniques

-market approach -cost approach -income approach

Audit documentation examples

-memos -confirmations -correspondence -schedules -audit programs -representation letters

Relevance of audit evidence

-refers to its relationship to the assertion or to the objective of the control being tested. The relevance of audit evidence depends on: -The design of the audit procedure used to test the assertion or control, in particular whether it is designed to (1) test the assertion or control directly and (2) test for understatement or overstatement; and the timing of the audit procedure used to test the assertion or control.

What is control risk?

-the risk that a misstatement due to error or fraud that could occur in an assertion and that could be material, individually or in combination with other misstatements, will not be prevented or detected on a timely basis by the company's internal control. -Control risk is a function of the effectiveness of (1) the design and (2) operation of internal control. -The auditor assesses control risk using evidence obtained from tests of controls (if the auditor plans to rely on those controls to assess control risk at less than maximum) and from other sources.

Risk of Material Misstatement

-the risk that the financial statements are materially misstated. - The auditor should assess the risks of material misstatement at two levels: (1) at the financial statement level and (2) at the assertion level -Risk of material misstatement at the assertion level consists of the following components: (1) Inherent risk, and (2) Control risk

What is detection risk?

-the risk that the procedures performed by the auditor will not detect a misstatement that exists and that could be material, individually or in combination with other misstatements. -Detection risk is affected by (1) the effectiveness of the substantive procedures and (2) their application by the auditor, i.e., whether the procedures were performed with due professional care

What is Inherent Risk?

-the susceptibility of an assertion to a misstatement, due to error or fraud, that could be material, individually or in combination with other misstatements, before consideration of any related controls. -The auditor assesses inherent risk using information obtained from performing risk assessment procedures and considering the characteristics of the accounts and disclosures in the financial statements.

Typical estimates in accounting

-uncollectible receivables -allowance for loan losses -obsolete inventory -valuation of securities -useful lives and residual values -insurance loss reserves -compensation in stock option plans and deferred planes -warranty claims -percent of completion -probability of loss -Fair value -impairment -FV of non-monetary exchanges

Goodwill Impairment Test

1. Goodwill is tested for impairment annually, or more often if there is an indicator of impairment 2. Goodwill is allocated to reporting units (operating segment or one level below) and tested at that level 3. Impairment test compares the carrying value of the reporting unit to its fair value. 4. If book value exceeds fair value, there is an impairment.

Scope & Nature of Services

A member in public practice should observe the Principles of the AICPA Code in determining the scope and nature of services to be provided.

Internal Control

A process, effected by the entity's board of directors, management, and other key personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting and compliance.

Completeness

All transactions and accounts that should be presented in the financial statements are so included

What is an accounting estimate?

An accounting estimate is a measurement or recognition in the financial statements of (or a decision to not recognize) an account, disclosure, transaction, or event that generally involves subjective assumptions and measurement uncertainty

Premise of an audit

An audit in accordance with generally accepted auditing standards is conducted on the premise that management and, when appropriate, those charged with governance, have responsibility: -A. for the preparation and fair presentation of the FS in accordance with the applicable financial reporting framework; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of FS that are free from material misstatement, whether due to fraud or error. -B. To provide the auditor with all information, unrestricted access to those within the entity from whom the auditor determines it necessary to obtain audit evidence.

Valuation or allocation

Asset, liability, equity, revenue, and expense components have been included in the financial statements at appropriate amounts

Existence or Occurrence

Assets or liabilities of the company exist at a given date, and recorded transactions have occurred during a given period

Personal Responsibilities of the Auditor

Auditors are responsible for having appropriate competence and capabilities to perform the audit; complying with relevant ethical requirements; and exercising professional skepticism and professional judgement throughout the planning and performance of the audit

Who reviews audit documentation?

Auditors who are new to an engagement, to understand work performed and to aid in planning this year -Supervisory personnel, who are responsible for review -Engagement quality reviewers, to understand how significant conclusions were reached and whether there is adequate support for those conclusions -Successor auditors, to rely on opening balances -Internal and external inspection teams, to ensure the audit complies with applicable audit standards -Others, such as advisors or representatives of a party to an acquisition

Reporting Results of an Audit

Based on an evaluation of the audit evidence obtained, the auditor expresses, in the form of a written report, an opinion in accordance with the auditor's findings, or states that an opinion cannot be expressed. The opinion states whether the FS are presented fairly, in all material respects, in accordance with the applicable financial reporting framework

Ethical Dilemmas

Often involve a mental conflict between differing moral requirements, in which to obey one requirement will result in disobeying another.

What does audit documentation include?

Records of the planning and performance of the work, the procedures performed, evidence obtained, and conclusions reached by the auditor.

Rights and obligations

The company holds or controls rights to the assets, and liabilities are obligations of the company at a given date

Presentation and disclosure

The components of the financial statements are properly classified, described, and disclosed

Identifying and assessing RMM

The process includes: (1) Identifying accounting estimates in significant accounts and disclosures; (2) Understanding the process by which accounting estimates are developed; and (3) Identifying and assessing the risks of material misstatement related to accounting estimates, which includes determining whether the components of estimates are subject to significantly differing risks, and which accounting estimates are associated with significant risks

Objective of an Audit

To conduct the audit of financial statements in a manner that reduces audit risk to an appropriately low level.

Purpose of an Audit

To provide financial statement users with an opinion by the auditors on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. An auditor's opinion enhances the degree of confidence that intended users can place in the financial statements.

nonroutine transactions

a transaction that is unusual, either due to size or nature, and that is infrequent in occurrence

Audit Evidence

all the information, whether obtained from audit procedures or other sources, that is used by the auditor in arriving at the conclusions on which the auditor's opinion is based. Audit evidence consists of both information that supports and corroborates management's assertions regarding the financial statements or internal control over financial reporting and information that contradicts such assertions.

Materiality

refers to the impact of an omission or misstatement of information in a company's financial statements on the user of those statements. If it is probable that users of the financial statements would have altered their actions if the information had not been omitted or misstated, then the item is considered to be material. If users would not have altered their actions, then the omission or misstatement is said to be immaterial.

Appropriate audit evidence

the measure of the quality of audit evidence, i.e., its relevance and reliability. To be appropriate, audit evidence must be both relevant and reliable in providing support for the conclusions on which the auditor's opinion is based

Sufficient audit evidence

the measure of the quantity of audit evidence

Audit Risk

the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated, i.e., the financial statements are not presented fairly in conformity with the applicable financial reporting framework.

Ethics

the study of moral principles and values that govern the actions and decisions of an individual or group.

significant accounting estimates

• due to their subjective or complex nature, or the need to make assumptions about the affects of future events (i.e., assets and liabilities measured at FV)

Objectivity & Independence

•A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Due Care

•A member should observe the profession's technical ethics standards, strive to continually improve competence and the quality of services, and discharge responsibility to the best of the member's ability.

Test of Controls

•Auditors perform tests of controls to obtain evidence about the operating effectiveness of controls. The approach is to: 1.Identify the controls likely to prevent or detect material misstatements, and 2.Perform tests of controls to determine whether they are operating effectively. •Tests of controls address the following: •How controls were applied. •The consistency with which controls were applied. •By whom or by what means (e.g., electronically) the controls were applied.

Assess RMM

•Auditors should identify and assess the risks of material misstatement at both the financial statement level and the relevant assertion level for account balances, transaction classes, and disclosures. •The general approach followed during risk assessment is to use all the audit evidence obtained on the client and its environment, including internal control, to: •Identify risks. •Relate the identified risks to what can go wrong at the relevant assertion level. •Consider whether the risks are of a magnitude that could result in a material misstatement. •Consider the likelihood that the risks could result in a material misstatement.

Performing Risk Assessment

•Clearly specify objectives to allow the identification and assessment of risks related to those objectives. •Identify and analyze risks to the achievement of its objectives and determine how they may be managed. •Consider potential fraud relating to the achievement of objectives. •Identify and assess changes that could impact internal control.

Control Environment

•Commitment to integrity and ethical values •Board of directors demonstrates independence from management and exercises effective oversight of internal control •Establishment of effective structure, including reporting lines, and appropriate authorities and responsibilities •Commitment to attract, develop, and retain competent employees •Holding employees accountable for internal control responsibilities

Control activities

•Control activities mitigate the risk that the organization's objectives are not met. Examples: •Performance reviews •Transaction control activities •General controls and application controls •Physical controls •Segregation of duties

Results of test of controls

•Determine if it is necessary to revise assessed levels of control risk (or risk of material misstatement) based on results of tests. •If results indicate controls operate as effectively as had been assumed, no revision needed. •If results reveal controls are less effective that originally assumed, auditors revise their planned assessments and carefully consider the possible misstatements that may exist in the financial statements. •If so, design additional substantive audit procedures.

AICPA

•Establishes standards for nonpublic companies (auditing, attestation, accounting & review, quality control, independence, ethical behavior). •AICPA standards have authority based on their general acceptance by state boards of accountancy, other legislative organizations, and the courts. •AICPA requires firms to participate in a peer review program. •No standard-setting or regulating responsibilities regarding public company audits; however, the AICPA Code of Professional Conduct applies to AICPA members while performing public company audits.

PCAOB

•Establishes standards for public companies (auditing, attestation, quality control, independence, and ethical behavior). •SEC has oversight responsibility •Standards have authority based on federal legislation. •Registers CPA firms to audit public companies, and can revoke a firm's registration. •Performs inspections of public company audit practices. •No standard-setting or regulatory responsibilities for nonpublic companies.

Control over accounting estimates

•Financial statements include a number of estimates (i.e., fair values of assets and liabilities). •Controls over these estimates are very important because the development of the estimates requires significant judgments.

AICPA Code of Professional Conduct- Rules

•Independence •Integrity and Objectivity •General Standards •Compliance with Standards •Accounting Principles •Acts Discreditable •Contingent Fees •Commissions and Referral Fees •Advertising and Other Forms of Solicitation •Confidential Client Information •Form of Organization and Name

Information and Communication

•Information is needed at all levels of an organization to assist management in meeting the organization's objectives. •An accounting information system consists of the methods and records established to initiate, authorize, record, process, summarize, and report an entity's transactions and to maintain accountability for the related assets, liabilities, and equity. •Can be manual •Often organizations use software packages to assist (i.e., NetSuite) •An organization's AIS should also include a chart of accounts and a manual of accounting policies and procedures which clearly state in writing the methods of treating transactions.

Audit procedures used to test controls

•Inquiries of appropriate client personnel •Inspection of documents and reports •Observation of the application of controls •Reperformance of the controls

The Public Interest

•Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism.

Monitoring

•Monitoring of controls is a process to assess the quality of internal control performance over time. •Select, develop, and perform ongoing and separate monitoring evaluations to determine that the components of internal control are present and functioning. •Evaluate and communicate internal control deficiencies in a timely manner to those responsible for taking corrective action, including senior management and the board of directors and its audit committee.

Areas Difficult to Control

•Nonroutine transactions - unusual, due to either size or nature, and occur relatively infrequently. •Significant accounting estimates - due to their subjective or complex nature, or the need to make assumptions about the affects of future events (i.e., assets and liabilities measured at FV) •When determining whether an identified risk of misstatement is significant, requiring special audit considerations, auditors should consider the following: •Complexity of calculations involved •Risk of fraud •Selection and application of accounting policies •Internal and external circumstances giving rise to business risks (i.e., technological change in the industry) •Recent developments in the industry and economy

Overall approach of an audit

•Plan the audit •Obtain an understanding of the client and its environment, including internal control. •Assess the risks of misstatement and design further audit procedures. •Perform further audit procedures. •Complete the audit. •Form an opinion and issue the audit report.

Assess RMM p 2

•Strong controls over an area are likely to result in the proper recording of transactions; therefore, expected effectiveness of internal control is often a key factor in assessing the risks of material misstatement. •However, when auditors assess the risks of material misstatement at this stage of the audit, they have little information on the actual effectiveness of controls. •Auditors ordinarily know the system as it has been described to them, this only allows them to assess the effectiveness of the design. •If auditors wish to rely on the controls with respect to particular assertions, they should perform... tests of controls!

Risk Assessment

•The auditors' risk assessment is primarily concerned with evaluating the likelihood of material misstatements in the financial statements. •Management's risk analysis in the areas of operations, compliance, and internal reporting is much broader.

AICPA Standards

•The standards are structured around a set of principles. •They make clear that the purpose of an audit is to provide an opinion on the financial statements, with an underlying premise that management is responsible for both preparing financial statements in accordance with the applicable financial reporting framework and for providing the auditors with access to necessary information. -Principles: •Purpose of an audit •Premise of an audit •Personal responsibilities of the auditor •Auditor actions in performing the audit •Reporting results of an audit

Integrity

•To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity

Responsibilities

•in carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities